Charles
Hugh Smith and Gordon T Long discuss the dramatic impacts the recent fall in
energy prices is having and will have on global financial markets.
Situational Analysis
The
impact of lower oil is financial, political and geopolitical.
Lower
oil revenues will impact:
- Oil-exporters' revenues,
- Monetary policy of central banks,
- Trade flows and
- Global financial markets.
Lower
state revenues will pressure:
- Oil-dependent governments such as Russia,
Venezuela and Iran, and
- Destabilize the geopolitical order as weakened
oil exporters sink into recession or political turmoil.
Reduced Global Liquidity Flows
Four Likely Causes
- Shale Oil,
- Weak Global Demand,
- A Geo-Political Clash,
- Financialization of Oil
- Consumer "Tax Cut":
Consumers will be better off. Lower gasoline prices will be like a tax
cut for the middle class, who will be able to spend more on other goods.
- Smaller US Trade Deficit:
The US trade deficit will become smaller as the cost of oil imports
falls (although this will be partially offset since Americans are likely
to use their savings from a lower gasoline bill to buy more consumer
goods made overseas). A lower trade deficit will boost GDP.
- Shift In Central Bank Stances:
Lower oil prices will mean more downward pressure on consumer prices and
a greater risk of deflation. The fear of deflation is likely to cause
the Fed and the Bank of England to delay their plans to increase
interest rates, while it may force the European Central Bank and the
Bank of Japan to accelerate their asset purchases.
- Lower Sovereign Bond Yields:
In most countries, government bond yields have already fallen in
response to the increasing disinflationary/deflationary pressures that
will result from lower oil prices. Government bond yields in a number of
European countries fell to record lows last week.
- Sovereign Fiscal Pressures:
The finances of the oil exporting countries will suffer. The currencies
of Russia, Norway, Venezuela and Nigeria have already fallen
significantly, reflecting the deterioration in those countries' economic
prospects.
- Production Breakeven Costs:
Lower oil prices are likely to put some high cost producers out of
business. Canadian oil sands look particularly vulnerable. Some of the
marginal shale oil producers in the US may also go to the wall. As
bankruptcies occur, defaults on energy junk bonds are likely to rise
significantly. At this stage, I don't believe that the losses in the
junk bond market will be significant enough to cause a new financial
sector crisis. Nor do I believe that so many wells will shut down in the
United States that US oil production will begin to fall. Production
costs have been falling rapidly and are likely to continue falling. Oil
prices will have to fall considerably further before most of the new
shale oil production becomes unprofitable. Of course, the possibility
that oil will fall much further can't be ruled out. It was $20 per
barrel not all that long ago.
- Reduced Capital Flows:
Finally, the reduction in the US trade deficit will mean a reduction in
capital inflows into the US. (Capital inflows are the mirror image of
the Current Account Deficit, since every country's balance of payments
must balance.) The reduction in capital inflows will reduce the upward
pressure on US asset prices that has come from this source in the past.
Video: The Oil-Drenched Black Swan
with Charles Hugh Smith & Gordon T Long
28 Minutes
