The world economy is slowing down and the authorities are fretting.
Japan, Italy, and Greece are all in recession. China is slowing down
according to official statistics, and even more according to whispered
accounts.
Germany, France and the Netherlands are all at stall speed.
According to the BLS, the United States is doing just great at nearly
4% growth for two straight quarters, but you wouldn't know
that either from the quality of the few jobs being created (which
is low) or from consumer spending (also low).
The worry, as always, has nothing to do with the central banks'
concern for you, your job, your children, the actual prices you pay, wealth
equality, or the future,
and everything to do with
the simple fact that the stability of the banking system absolutely depends
on a steady stream of new loans.
The
problem, as always, is that we have a monetary system that is either
expanding or collapsing. It has no steady state.
Either money
and credit are expanding and the banks are relatively happy or the banks are collapsing and
demanding taxpayer bailouts. It's really that stark. We are being driven by
our system of money, we serve it not
the other way around, which is a tragedy of both epic and comic proportions.
I guess
with the binary choices of growth or collapse before them it only makes sense
for the current crop of central bankers to do whatever it takes to keep that
system limping along, er growing,
for as long as possible.
In 2008
and 2009, net credit creation was only slightly negative, but that was enough
to very nearly cause the entire system of money and banking in the developed
world to collapse.
Now
after the most heroic period of interest rates forced to zero (ZIRP) and
below (NIRP in Europe) and the grandest experiment with money printing in
global history, credit growth is somewhat
back on track but not enough to ease the banker worries or to justify their
actions.
So the
bankers continue to pump, jawbone, and panic at every slight downturn in
financial market prices because that's all they have left in the world upon
which they can hang their reputations.
The
actual economy, the one that lives on Main Street, never really bounced back
fully, at least not compared to past recoveries. Growth, jobs and incomes all
were anemic compared to prior recoveries. Investment in new capital was and
remains dead in the water.
Bad
Ideas Repeated
Left
unsaid by practically everyone, always, is that it was never a very good idea
in the first place to weld our perceptions of adequate economic growth to a
scheme that relied upon continuously compounding debt at a faster pace than
economic growth.
We did
this for so many decades in a row that everyone forgot to question whether it
made sense to do this.
It did
not, but too many decades had passed for anyone to remember another time.
So when
the crisis came, which was rooted in too
much debt, there were no sane voices in the central banks or
halls of government power saying, hey you
know what? That wasn't such a good idea. Perhaps we should pay off our past
debts and then take on new credit at a pace no faster than our growth in
income.
Instead,
there was a blind adherence to the prior policy of fostering rapid credit
creation, not because it made any particular sense at all, least of all math
sense, but simply because that’s how
things had always been done.
Well,
not ‘always’ but at least during the past 4 decades when everybody in power
was learning about how things are done.
Looking
forward, not only does it not make sense to attempt to increase debt faster
than income, it makes no sense to continuously compound debts and other
claims on real wealth because resources are not infinite.
Whether
it's now, or in ten years, or in a hundred, sooner or later the economy of
'stuff' cannot grow any more simply because there won't be enough land, ore
bodies, or energy to do do so.
Just
because a lot of powerful people are ignoring something does not make it go
away. Bad ideas are still bad ideas whether they are being ignored by even
the most important people, or not.
Central
Follies
The
world’s central banks have been given a lot of leeway as they’ve done what
they can to stimulate more economic growth. Leaving aside the impossibility
of sustainable exponential growth in a finite system, how have the central
banks done?
How
would we score their efforts so far?
Well,
if you are in the Eurozone or Japan, the answer has to be ‘poorly.’ Trillions
have been spent, government deficits, enabled by central bank printing, have
exploded and yet growth of the sort that could justify these efforts has not
returned.
Massive
new debts and no improved means of paying them back. Why people will spurn a
company that engages in such obviously poor financial and management practices
but give a free pass to nations and central banks that do the same thing is a
mystery to me.
If the
past efforts have not yielded the expected results then what will even more
of the same efforts brings us except a bit more time before an even larger
financial accident?
Those
in charge always arrive at the same conclusion, which is to even more of the
very things that have already not worked.
Given
the macroeconomic data as we have it, there's nothing that would rationally
or logically support the prices we see for equities and bonds we currently
see.
Both
equities and bonds are priced to perfection, eagerly awaiting a world where
high economic growth can justify their historically elevated prices.
Our
view here at Peak Prosperity is that the days of rapid economic growth are
behind us, and that if we do experience rapid growth again it is from much
lower levels as we rebound from some major slump.
But to
grow even more from here, even if that's just 4% annually across the globe
implies that we'll find a way to fully double the entire world's consumption
of resources in just the next 18 years.
That's
the nature of compounding...even 4% growth means a 100% increase in just 18
years.
Because
oil is the main engine of growth, and we know that even with 2.5 trillion
dollars of additional spending over the past 9 years the world is producing
roughly the same amount of oil as ever. Why? Because depletion of existing
reserves is being matched by new production.
Unless
investment in oil production really accelerates from here, new production
will be swamped by existing declines.
In the
US we know that even under the best of circumstances shale oil, the one and
only engine of increased oil production growth, will peak in 2020.
But
these are no longer the best of circumstances and oil is now priced well
below the actual cost to get most of the shale oil out of the ground:
(Source)
As we can see in that chart, the only plays that are still viable at
today's prices are the core areas of the Bakken and Eagleford plays, which
should not surprise anybody. Those were the ones drilled first and hardest
because they are the most economic.
Oil
prices most recently peaked in the summer of 2014, and then began a slump
that really picked up steam in October and now everybody is talking about it.
The fun
thing about the shale companies is that they are incredibly nimble and very
sensitive to prices. They can stop drilling at any time. As soon as they do,
the peak of shale production will be measured within a month.
While
they have not stopped drilling, the speed of the pullback is incredible and
drilling permits dropped by a whopping 40% in November alone as compared to
October:
New U.S. oil and gas well November permits tumble nearly 40 percent
(Reuters)
- Plunging oil prices sparked a drop
of almost 40 percent in new well permits issued across the United States in
November, in a sudden pause in the growth of the U.S.
shale oil and gas boom that started around 2007.
Data
provided exclusively to Reuters on Tuesday by industry data firm Drilling
Info Inc showed 4,520 new well
permits were approved last month, down from 7,227 in October.
The pullback was a "very quick response"
to U.S. crude prices, which settled on Tuesday at $66.88 CLc1, said Allen
Gilmer, chief executive officer of Drilling Info.
New permits, which indicate what drilling rigs will be doing 60-90
days in the future, showed steep declines for the
first time this year across the top three U.S. onshore fields: the Permian
Basin and Eagle Ford in Texas and North Dakota's Bakken shale.
The Permian Basin in West Texas and New Mexico showed a 38 percent
decline in new oil and gas well permits last month, while the Eagle Ford and
Bakken permit counts fell 28 percent and 29 percent,
respectively, the data showed.
(Source)
I have
to ask - 40% - is that a lot? Yes, it sure is. And in just one month.
Notice
that the decline in permits was even quite pronounced in the core shale plays revealing that
even within the Bakken and Eagleford there are operators who don't believe it
makes economic sense to drill at these oil prices.
The
shakeout that is coming to that industry is going to be quite pronounced and
we're expecting some serious fireworks as investors wake up to the fact that
sometimes defaults really do happen and losses are a part of this
game....something the central bank liquidity injections have managed to mask
and forestall for quite some time now.
The
bottom line, though, is that without growth in oil economic growth is hard to
achieve. I'll go further and say it's impossible to achieve, at least under
the old paradigm of consumption based growth.
If oil
prices do recover and quickly, the US shale miracle will rapidly turn into a
shale bust. The decline rates on these wells are ferocious. With that loss of
production will go the entire narrative that says our energy predicament is
safely off in the future and that we can safely ignore it for now.
And
with the loss of that fantasy will go the sky-high valuations we currently
see for stocks and bonds. After all, the operative question always should be what is the value of these stocks and bonds in a world
without growth?
To me
the answer is simple; a lot less.
Unfortunately
nobody - and I mean nobody
- in the any central bank is even remotely talking about or in any way
displaying that they are even dimly aware of the role of energy in economic
growth. To them it is all about the banks.
And the
banks need growth like your body need oxygen. Sure, you can hold your breath
for a minute or two, maybe longer with training, but after that things get
dicey and quickly.
There
are signs everywhere across the globe now that the central banks have failed
to induce growth in the real economy, and have instead simply bought some
time at the expense of pushing things even further into a zone of massive
malinvestment, rank speculation, and badly inflated prices.
In
short, we are now past the point where the next correction could be survived
injury free. It's going to hurt.
In Part II: Central banks have lost, deflation is here, we
look at the various global warning signs that slow growth has morphed into
something more deadly to the banking system; deflation and recession.
We'll discuss and review the basic commodities that are telling us far
more than the distorted stock or bond prices ever could about the true state
of global growth and future economic prospects.
Copper,
oil, iron ore, coal, gold and silver are all telegraphing major economic
weakness ahead. The next round of deflation will be absolutely punishing for
financial markets and possibly even spark international conflicts given the
raw state of diplomacy and east-west tensions.
Click here to access Part 2 of this report (free executive summary; enrollment required
for full access)
