Tim Morgan continues to impress.
Here he explains what caused the 2008 financial crisis, why it will happen again soon, why it will be much worse this time, and what will probably trigger it.
I challenge you to find a single example from mainstream journalism with such intelligent explanatory clarity.
It is so refreshing to find a mutant not in denial.
We may not be clear yet about when the next crash will come, but we understand a very great deal about the mechanism that will make it happen. Put another way, we have a narrative that puts all the pieces in the right places.
This narrative is telling us that a crash is highly likely – and that it may happen a lot sooner than we think.
Let’s start with the fundamentals. Contrary to conventional thinking, the economy isn’t really a monetary system at all, but a surplus energy dynamic. What drives the output of goods and services is the quantity of energy we can access, less the energy consumed in the access process. If the available quantity is constrained – or the energy cost of accessing it increases – the output of the economy will decrease.
Money, having no intrinsic worth, has value only as a “claim” on the output of the real economy, which means, ultimately, that money is a claim on surplus energy. Debt, as a ‘claim on future money’, is really a claim on future energy.
For more than two centuries, there has been sustained growth in available surplus energy. This has enabled total financial claims – the aggregate of money and credit – to increase as well, without toppling the financial system.
What we’ve been witnessing since the turn of the century, though, has been an increase in the energy cost of energy (ECoE), combined with emerging constraints on the quantity of accessible energy. This process makes the continued growth in aggregate money and credit dangerous, because we are creating claims that the real economy will not be able to meet.
Once understood, this process makes sense of what has been happening. Between 2000 and 2008, credit creation soared, but debt-financed growth drove up energy demand in a way that eventually brought the system to the brink of collapse. In 2001, when prices averaged $24/bbl, OECD consumers spent about $430bn on oil, of which around $240bn went on imports. By 2008, when oil averaged $97/bbl, these numbers had increased to $1,700bn and $1,050bn. Oil was now costing OECD customers $1,270bn more than it had just seven years earlier – and $810bn of that increase was being spent on the higher cost of imports.
Moreover, these huge liquidity drains are only those related to oil. Other forms of energy also soared in cost, as did energy-intensive commodities such as minerals and foodstuffs.
This was what brought the debt-financed party to an end.
Looking a little more closely at this, the increase in the cost of oil to the OECD quadrupled between 2001 and 2008. The increase in ECoE over the same period was much smaller than this. According to SEEDS, global ECoE for all energy sources rose from 4% in 2001 to 5.4% in 2008, a rise of one-third.
So the rise in market prices vastly over-cooked the underlying trend in ECoEs. In relation to this fundamental benchmark, oil was underpriced in 2001, and overpriced in 2008.
This tells us that something else was going on.
That ‘something else’ was supply constraint.
Just as westerners were bingeing on credit, emerging market economies (EMEs) were consuming more energy and other commodities, notably as exports ramped up. Rising energy demand was colliding with more pedestrian growth in supply. Investment in supply tracked market prices higher. When demand dropped after 2008, the ensuing fall in prices became inevitable.
In retrospect, we “got away with it” in 2008, for three main reasons.
First, governments’ balance sheets were strong enough for them to bail out the banks without forfeiting their own credibility, and that of their currencies.
Second, the authorities bought time by adding monetary adventurism to the established credit adventurism.
Third, the cooling of the economy took the heat out of energy markets.
To know when and if a second crash may happen, and what its results are likely to be, we need to test these three “get-outs” as they now are.
First, government balance sheets. On the basis of amounts owed (rather than the market value of bonds), the aggregate debt of advanced country governments was 67% of GDP in 2007. Now it is 102%, and still rising. Bailing out the banks now would be a lot harder than it was back in 2008. Not only are government balance sheets weaker, but bank exposure has increased as global debt has grown. To be sure, reserves ratios are higher now than they were back in 2007. But, because banks borrow short and lend long, no amount of reserving can render them immune from the consequences of a loss of faith.
Second, “monetary adventurism”. Back in 2008, typical rates were 5.25% in the United States and 4.3% in the European Union. Now, the equivalent numbers are around 1% and -0.25%. There’s no scope, then, for further monetary adventurism, unless central banks are prepared to go for deeply negative nominal rates, a policy which would be barking mad, even if it didn’t, very probably, necessitate helicopter money and the banning of cash.
So that leaves us with our third component, which is energy. Essentially, a big rise in oil prices would crash the system.
Is this likely? On balance, it is. Oil demand is growing at around 1.4 mmb/d each year. Supply has kept pace, mainly thanks to increased shale and other unconventional output, plus an increase in supply from OPEC. Neither may be sustainable. Shales are extremely capital intensive, because of the “drilling treadmill” caused by ultra-rapid decline rates. Few OPEC countries have much scope to deliver increased supplies. Underlying ECoE, SEEDS says, is 42% higher now than it was in 2007.
Put this higher ECoE together with the slump in investment caused by the fall in crude prices, and the implication is that crude prices could spike, and do so rather more quickly than is generally expected.
That, then, is what we should be watching for when looking out for another crash. All the other conditions are in place, including excessive debt, weak underlying growth (reflecting rising ECoEs), overstretched government balance sheets, and an inability to repeat the monetary adventurism of 2008-09.
All that we’re waiting for is an oil price spike, and a trigger equivalent to the “Lehman moment”.
Both may come sooner rather than later.
10 thoughts on “By Tim Morgan: Will things go bang soon?”
As you consider the next financial crisis and what might trigger it, how do you reconcile Tim Morgan’s thoughts about a looming oil price spike with the views of Gail Tverberg about oil prices being held down because of affordability?
Your most recent post about Gail’s views is here: https://un-denial.com/2017/10/18/by-gail-tverberg-the-approaching-us-energy-economic-crisis/)
Both of them write with clarity, although I tend to accept Gail’s line of reasoning more than Tim’s. Perhaps an oil price spike will come just before the crisis hits as oil producers make a futile, last-ditch attempt to cover their heightened expenses, including interest on unsustainable amounts of debt. But in the meantime, Gail presents a pretty strong argument for why oil prices might be down for good.
In any case, I’m interested to hear what you think.
Thanks for stopping by. I have high regard for Gail Tverberg and have read most of her work. I think Tverberg and Morgan are saying the same thing but with different language and focus. Morgan started by studying the debt problem and then linked it to energy. Tverberg started by studying the energy problem and then linked it to debt. Both I think would agree that the pace of worldwide debt growth has created an unstable situation that could be collapsed by a variety of events. Both I think would agree that the economy will eventually collapse due to debt growth alone, even if energy prices stay low. Both I think would agree that low prices threaten energy supply due to a reduction in investment. Both I think would agree that any energy supply problems will damage the economy. Both I think would agree that energy prices high enough to make extraction profitable are unaffordable and therefore if energy prices rise they will not do so for long before the economy contracts (or crashes).
Please correct me if you interpret their conclusions differently.
Thanks. I agree with you, and appreciate your reasoning.
Separately, here’s an idea to consider for something I believe we can and should do now. Like you mentioned in a previous post, it’s too slow to avoid the worst problems but it just makes sense to pursue.
I’m currently attempting to catalyze an international campaign that leads to the United Nations establishing a Framework Convention on Population Growth, or something akin to the Paris Agreement for population growth.
Formal recognition of the only possible permanent solution — population stabilization followed by steep reductions over time — should occur regardless of whether or not we choose to act on it. I definitely don’t think we’ll act on reversing population growth if it’s not formally recognized like this, so if nothing else it appears worth the investment to take this first step toward success (i.e. sanity).
I’ve already started building an international coalition but am not far down that path. For those that choose to “participate”, I mean something like various organizations and/or individuals signing a joint international position statement which would urge the UN to pursue this new treaty. UK-based Population Matters prepared one of these in 2013 which is a good example. Participation could also mean using these organizations’ networks of contacts to help engage with additional like-minded folks that might want to join us in signing the position statement. The goal I have in mind is to present this new position statement with signatory organizations and/or individuals representing countries from every inhabited continent to the UN in 2018.
What do you think? If interested, consider emailing me separately to discuss further.
We can mobilize grandmothers, too. I like that idea. If grandmas can’t get the UN to formally recognize human overpopulation as an existential threat, no one can.
For anyone curious I think Rob Harding is referring to this grandmother idea for creating population reduction laws…
Yep, that’s the one.
Denial’s Grim Fruits — Actual Puerto Rico Death Toll Probably Near 500; May Climb to Over a Thousand
“Many of the 3.4 million people still living in Puerto Rico have been forced to go without reliable access to water, food, and power for 54 days now. Trump Administration failure to mobilize a major effort to respond to the largest power outage and infrastructure disruption in U.S. history has been coupled with the allowance of vulture capitalist firms like Whitefish to prey on Puerto Rico by charging excess fees for power restoration.”
Thanks for the link. I think Puerto Rico is extremely revealing. Millions staring down the barrel of a gun for decades, yet woefully unprepared for the inevitable. A lesson for us all.
U.S. SHALE OIL PRODUCTION UPDATE: Financial Carnage Continues To Gut Industry
Rob – good article from Tim Morgan – seems to be a follow-up of his 2013 book “Life After Growth” (which is excellent). Russ