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17 December 2014

Chilly Winds at Christmas



There’s a chill wind swirling around this Christmastime. Anybody who was thinking that the chaos wrought by the 2007/08 crisis might have eased and that the world was back on the economic fast train must by now be admitting to a sad disappointment. The desperate attempts by politicians of all hues to roll the problems forward, ideally beyond their next election date, seem to be floundering as unexpected events take their toll. Things that in the past have been desired now turn out to have a bad side as well. 

Falling Oil Price

Look at the falling oil price; for years, it’s been axiomatic that a low oil price was a big benefit to the global economy. Now, though, in the face of a (near) halving in the last few months, the beneficial effects are called into question. On the surface, the issue, of course, is the imbalance of supply and demand. Consumption has dropped, because of weak growth, particularly in Europe, and Chinese growth, which, yet again, looks like failing to reach the analysts’ estimates. 

That’s half the story; the other bit, which in many ways is the more concerning part, is that the low-cost producers of the Kingdom and the Gulf, who, because of their size and influence, in previous periods of imbalance have cut back production to protect the price and thus indirectly shelter the higher-cost producers, have declined to take that route and have continued as they were  - and in some cases even pumped more. 

Shale and the Rouble

Why have they chosen to do that? Well, they see two opportunities; first, shale oil production in the US has the power to change the market fundamentally and substantially weaken the cartel producers. Secondly, they can push themselves back ahead of Russia. The result of that is (relatively) cheap oil. So those are the causes; what are the effects? The most obvious is the plummeting value of the rouble. Russia is effectively a one-product economy and damaging it’s position in that commodity (oil and gas) will inevitably cause chaos in that economy. There’s (at the moment) unquantifiable collateral damage as well, in the shape of the fate of some of the higher-cost producers (Venezuela, Nigeria, for example), which may be prone to political unrest in the face of a plunging economy. 

Lower Costs, but....

The beneficial effects for energy-importing western and asian economies are obvious; lower fuel and transport costs, lower input costs for industry - that should be a shot in the arm for all of us. Well, yes, but it’s rather the speed of the decline which has created the chaos; there’s been no chance for economies to adjust to the changing environment and politicians with their hands on the economic levers are not on the whole hugely impressive even when things are going well, so faced with sudden change, they tend to struggle. 

Where does it go from here? Well, for the extremely limited amount my opinion is worth, I tend to the view that technology advances far more reliably than politicians are able to generate social change. So my medium to longer term thoughts would be that the strongest likelihood is that rather than shale being squeezed out by dropping prices, the cost of extraction will decline as technology advances, meaning that we should be looking at a lower - or at least a less volatile - oil price environment. Can I back that up with technological knowledge? Absolutely not; I base it simply on an appreciation of what has happened in the past. Does that solve the near term instability in the market and in some producer economies? Again, absolutely not. Short term, it still looks a mess; but at least filling the car and heating the house will be cheaper…

Low Inflation Good...up to a Point

And here’s another one. Low inflation is good, right? Well, only up to a point. Dropping inflation in the Eurozone is causing rising concern, with the danger of deflation and stagnation being openly discussed. It’s a bit of a two-edged sword. Consumers don’t like prices going up too much, but if they stay the same or go down, then those same consumers don’t want to buy at all, because they can see that products may be cheaper tomorrow. The downside of all that, though, is that if they don’t buy, then manufacturers will eventually go out of business - so the economy weakens and unemployment rises. It’s actually quite a tough demand for a developed economy - the policy-makers need to keep inflation in a narrow band of something like two to three percent to protect against uncontrolled price rises or falls. That’s a really small target window, if you think of all the possible inputs and outcomes. The Eurozone looks ominously as if it is going to undershoot that target and the results of that are likely to be economic stasis and social and political unrest.

Chilly Winds, but Positives from History

As I said, good things sometimes have bad effects as well. And then there are the truly dreadful terrorist happenings - in just the last couple of days in places as diverse as Sydney and Peshawar. So yes, the winds blowing around us this Christmas are very chilly; but then, as often despite the efforts of politicians, economists et al, the world has emerged healthily from crises before. Onward and upward is the overall lesson of history. 

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