(I originally wrote this in 2011 for another publication. I recently found a copy and posted it here.)
The world is experiencing the worst economic recovery since the Great Depression. So why is oil hovering around $100/bbl? And as a gold investor, why should you care about oil?
Some might point to developments in the Middle East as the reason for high oil prices. However, I believe the root cause of current Middle East angst is the steady depletion of easily accessible oil and, consequently, government revenues needed to quell the population. Everything that is happening across the Middle East — citizen revolts, government crack downs, production disruptions and oil price inflation — tells me the world may have crossed the point of peak oil.
I don’t think the world will run out of oil anytime soon. However, based on the advice of expert geologists, I do believe that a) the world is running out of inexpensive oil and b) global demand is pressuring oil prices.
Given these pre-conditions, it is my view that the world has entered a new boom-bust cycle driven by oil prices. Oscillating oil prices — as opposed to credit cycles — will repeatedly stimulate and crash the highly levered global economy. Governments have not recognized this new cycle, and as part of a fruitless effort to retain control over deteriorating real growth and rising unemployment central banks will print more and more money, risking a hyperinflationary depression (stagflation at best). The only respite for many investors is gold.
The 2008 Financial Crisis was the First of Many
During the last thirty years debt has spread like a cancer throughout the developed world. Today’s consumption was financed by tomorrow’s higher revenues, creating a vicious cycle between growth and the need for debt. This system worked as long as growth needed to repay expanding credit could be subsidized by inexpensive energy.
Unfortunately, rising oil prices have stealthily and persistently chipped away at the foundation of our heavily indebted financial system. Ultimately, in 2008, oil prices and total debt passed the threshold beyond which the economy could not operate, and the financial system came crashing down. With collapsing demand, oil prices fell.
Many mistakenly point to sub-prime mortgages and CDSs as the cause of the 2008 crisis — I believe they were merely the transmission mechanisms. In reality, rising oil prices eroded the weakest links in the increasingly levered global economic system.
Enter the Central Banks
As we’ve witnessed repeatedly since Richard Nixon suspended dollar convertibility into gold, the Federal Reserve solves all economic problems with the monetary cure-all. Either by using the proverbial helicopter or the Treasury as an intermediary, central banks have repeatedly pumped liquidity into the economy and bought bad debts from the private sector. This effectively transfers the bad debt to the taxpayer by way of liability and currency debasement. In addition, fiscal policy (which is often the hand maiden of monetary policy) adds additional public sector debt in the name of stimulus. In whole, debt burdens and money supply rise. Of course, all this is done under the assumption that the economy will somehow be able to repay these new debts through future growth.
In the new boom-bust cycle driven by oil prices, the central banks are unknowingly impotent. As the economy crashes, they print money to stimulate economic activity, but it is short-lived and inflationary. More stimulative is the lower oil prices caused by the crash. However, any renewed growth and inflation sends oil prices back up towards another threshold, once again breaking the weakest links of the economy…and the default-bailout-growth cycle repeats.
Right now, oil price inflation is most noticeable when we fill up our gas tanks. But as high oil prices become pervasive throughout the economy the destruction of aggregate wealth will intensify. This will increase the number of weak links throughout the economy. It will also increase the sensitivity of those weak links to higher oil prices — another vicious cycle.
Consequently, as the default-bailout-growth cycle repeats and rising oil prices become more omnipresent, periods of economic growth become weaker, and periods of economic bust more frequent and persistent. Eventually, as the cycle repeats, the sharp economic contrasts of boom and bust blend together becoming a permanent shade of economic grey.
In a world of economic grey, defaults become more frequent, bailouts to support financial infrastructure and the growing mass of unemployed cause monetary growth to spiral out of control and economic ‘successes’ are characterized as periodic episodes of stabilization.
Assuming current policies persist, and until we find an alternative economic subsidy to inexpensive oil, over the long-run this cycle would turn into a hyperinflationary depression, as central banks print, the economy shrinks and the masses suffer.
The reversal of the cheap energy dividend would spell the end to middle class society, as the limited number of ‘haves’ hoard their wealth, food and weapons. What little wealth and property the middle class controls would be sequestered by the elite as the middle class citizens lose their jobs and default on their debts. Eventually the middle class become serfs living a life of subsistence, providing the labor to toil on the land they once owned – a less punitive alternative to debtors’ prison.
Those that are able to escape the drudgery of indentured servitude will be the middle class citizens who default while the system still works in their favor or who have nothing to default on. Unfortunately, the defaulting unemployed also cannot pay rent so to avoid the unfortunate trade-off between serfdom and homelessness one must own land that isn’t mortgaged or own enough assets to buy a home or pay rent indefinitely. In other words, to survive or thrive in this grey economic future one must either reduce their dependence on income or have a large enough asset base to generate cash flow.
Saved by Gold
As they did in 2008, central banks will print money to bail out collapsing financial infrastructure and support a growing mass of unemployed. While each cycle may begin as a deflationary shock, causing gold prices to decline, the eventual monetary response will destroy currencies and send gold prices soaring. This has already started to happen.
Unless high ROI replacement energy sources are found, over the long-run this cycle could turn into a hyperinflationary depression, as central banks naïvely fight a losing battle. Savings could be wiped out as the value of paper currency plummets, and in the new boom-bust cycle one of the few ways to protect wealth over the long run may be to own gold.