The 2004-2007 petro growth cycle showed that oil prices close to or above $125 a barrel can be absorbed, and these energy prices, with related non energy commodity prices, drive global growth.
By Andrew McKillop
Published December 06, 2010
Far back in financial history - August 2009 - Ben Bernanke opined that "strains persist" in the world banking system and finance markets across the globe, saying this at the 2009 Jackson Hole meeting of banking and finance deciders.
Then as now, Bernanke and other leading bankers claimed that the economic recovery "is relatively slow at first", and that energy and food prices are rising faster than warranted by the fundamentals they decide to take notice of, with the bottom line being the risk of double-dip recession - and/or double digit inflation.
This outlook, they said in 2009 and still today, is driven faster by "speculative trades", the code word for higher oil prices.
In his 2009 Jackson Hole warning, Bernanke identified oil as the looming threat, a kind of Black Hole for the green shoots of growth. He said: "Last year, oil at $145 a barrel was a tipping point for the global economy as it created negative terms of trade and a disposable income shock for oil importing economies".
He went on to add the oil-phobic punch line: "The global economy could not withstand another contractionary shock if similar speculation drives oil rapidly to $90 a barrel."
In early December 2010, with oil near $90 a barrel on the Nymex and ICE, we could ask if Bernanke's warning still holds true, especially since he now publicly wants higher inflation rates, as a kind of surrogate sign of would-be economic growth.
Put another way: any trading day the dollar declines, chances are that oil prices and the Euro will increase, the same way that equities usually rise when the oil price rises.
While the ECB's Trichet has to worry about continuing debt meltdowns in the Eurozone, in small but dangerously unstable economies like Spain, Italy, Belgium and Portugal, as well as Ireland, and rising jobless numbers almost everywhere in Europe outside Germany, his public worry #1 goes straight to the essential of Keynesian go-for-growth tinkering.
Trichet is still concerned on how to design what in 2009 at Jackson Hole he called a "credible exit strategy" from quantitative easing, as the tides of printed and borrowed money inexorably drive up European debt, exactly like US public debt.
Basic Keynesian theory is you can borrow money from the future and hope economic growth is strong enough, and concern about money depreciation and stability is low enough, to repay that debt, or absorb rising debt, later on. The official hope is that debt will not grow, due to growth.
If that fails, however, money depreciation or a change of currency, tricking the CPI figures, austerity cures and other weapons can be wheeled on stage, when public and political opinion gets too roused by rising public debt, higher taxes and austerity to pay for it.
One problem is very simple to state: maybe Keynesian deficit spending works, and maybe it does not. The jury is out to lunch on this one, and arguments on the subject stretch back more than 70 years.
Petro Keynesian growth stimulus to the global economy is different. Sometimes it works too well. Its outright and unambiguous success through 2004-2007 was quickly followed by failure. As we know, and Bernanke reminded us in August 2009, global growth turned south when oil prices went far north in 2008 - but were the two events linked?
The basic reason we don't know is unpalatable to those, like Trichet and Bernanke who hope growth will soon return, to trim the soaring peaks of national debt. Due to another kind of peak, peak oil braking world oil supply growth and also slowing OPEC export supply growth, and exuberant Wall Street oil traders, it is simply not possible to stop oil price growth - totally unlike natural gas price growth.
High oil prices are driven by the same supply-side factors that trim world grains and food output growth. More bad news for inflation and consumer spending potential outside food and energy basics, is delivered by shortage inducing factors affecting supply of most metals and minerals. Through 2004-2007, peaking in 2008, even such basics as cement aggregates, iron ore, alumina and world bulk shipping charges climbed smartly in price.
What Jim Rogers calls the Commodity Super Cycle, now with an Asian resource demand turbo effect, in fact stretches back to well before Keynes invented his theories, including his debt based remedies for fighting recession. Long-term read outs from commodity price peaks and crashes, and global growth trends, is that higher prices for commodity resources have certainly levered up the economy, in most periods through the 20th century, if not in others.
Bernanke may be right to fear higher oil prices, but he can only claim to be right about 33 percent of the time. With present stakes so high, is that enough?
The simple answer is that higher oil prices can and likely will boost and bolster growth, but not for long, if we look at 2004-2007 performance. The Petro Keynesian growth driving paradigm and process is easy to set out. Wealth is transferred from global consumers to energy and resource producers, most of them lower income, who then rapidly spend more.
Classic debt based Keynesian programs in high income economies tend only to shift more spending power to the already rich, who spend a lower percent of their revenue gains, received through government tax cutting largesse and printing press activity.
OPEC ability to spend more when revenues rise is easy to forecast: not many OPEC states are in the Qatar or Saudi camp, where more personal consumption, at least for national citizens and not low paid economic migrants presents challenges for the imagination. Most oil exporter countries are in the Nigeria, Algeria, Iran or Venezuela camp.
The same quick reinjection of revenue gains, or windfalls to the global economy applies for revenue gains for exporters of iron ore or bauxite, rubber, coffee, sugar, or cotton exporting countries. With some exceptions, more spending almost automatically generates on the back of revenue gains, when real resource export prices increase. Keynes and his latter-day followers fondly imagined, with Greenspan and Bernanke that a similar process would work in the the case of tax cuts and government largesse applied to higher income groups inside the USA or other wealthier nations.
Certainly since the 1980s, the growth generating feedback from tax cuts and selective aid to high income groups inside the OECD countries has been low or absent, and since around 2005 has turned into a disaster strategy for governments ideologically tied to cutting tax rates for the rich - and funding ballooning national debts.
The basic problem for Petro Keynesian growth is that it works, but the stimulus it delivers to the global economy has no self-limiting feedback. Like we know, and a thousand rousing editorials say, oil traders always go a mile or three too far talking up oil prices, the same way natural gas traders currently talk gas prices down - at least in the US.
Few editorialists are roused by bargain basement gas prices, but their selective ire grows with every dollar on the barrel price. To be fair, plenty of fundamentals help the quest of oil traders to get that ultimate high barrel price, also aided by oil geopolitics, but the paradigm is basically driven by fundamentals.
Oil depletion and capacity shortage supplies at least 50 percent of the real driver for saving or substituting oil in the global economy. Hunting down the Evil Molecule CO2 to fight global warming occupies the high ground media slot as the politically correct reason we have to transit away from fossil fuels, but the credibility of "climate catastrophe" is now very low.
More pressing and urgent, global oil and fossil energy reserve outlooks show we are in the narrowing comfort zone between voluntary energy transition, or being forced into embracing Clean Energy, or long-term recession and permanent high debt.
Rising oil prices with a faster and much wider economic leverage than Keynesian tax cuts can supply the missing real economic credibility, at least in the short term, which Keynes often said is a whole lot more important than the long. The 2004-2007 petro growth cycle showed that oil prices close to or above $125 a barrel can be absorbed, and these energy prices, with related non energy commodity prices, drive global growth.
The danger is clear: above this pain ceiling, the petro growth process implodes - specially when aided by a massive rout in the ultra-leveraged world of hubris and self-delusion called financial engineering and trading.
When oil prices regain the 100-dollar price level, we could expect ritual shudders from the finance and banking establishment, but with the debt ball and chain making interest rate hikes a kamikaze strategy, we could expect a Petro Keynesian growth interlude.
How long this would last is the 63 trillion dollar question, this being the approximate value of global GDP - and the choice of whether to let it grow, or hike interest rates to beat oil price rises, and bring down the Temple.