We Are So Not Prepared For Another Oil Shock

Guest Post by John Rubino at Dollar Collapse

In one sense, energy doesn’t matter all that much to what’s coming. Once debt reaches a certain level, oil can be $10 a barrel or $200, and either way we’re in trouble.

But the cost of energy can still play a role in the timing and shape of the next financial crisis. The housing/derivatives bubble of 2006 -2008, for instance, might have gone on a while longer if oil hadn’t spiked to $140/bbl in 2007. And the subsequent recovery was probably expedited by oil plunging to $40 in 2008.

With the Middle East now lurching towards yet another major war, it’s easy to envision a supply disruption that sends oil back to its previous high or beyond. So the question becomes, what would that do to today’s hyper-leveraged global economy? Bad things, obviously. But before looking at them, let’s all get onto the same page with a quick explanation of why everyone seems so mad at everyone else over there:

The story begins in 570 A.D. in what is now Saudi Arabia, with the birth of a boy named Muhammad into a family of successful merchants. After having some adventures and marrying a rich widow, around the age of 40 he begins having visions and hearing voices which lead him to write a holy book called the Qur’an. More adventures follow, eventually producing a religious/political system called Islam that comes to dominate a large part of the local world.

In 632 Muhammad dies without naming a successor, creating a permanent fissure between the Shi’ites, who believe that only descendants of the Prophet Muhammad should run Islam, and the Sunnis, who want future leaders to be chosen by consensus.

Now fast forward to the end of World War I: British leader Winston Churchill sits down with some other old white guys to draw a series of rather arbitrary lines through the Middle Eastern territories recently captured from the Turkish Ottoman Empire. They name their creations Jordan, Syria, and Iraq and appoint kings to rule them. Unfortunately, the new borders enclose both Sunnis and Shi’ites, along with Kurds and Christians who don’t get along with either kind of Arab Muslim. Shortly thereafter, Israel is tossed into the mix and massive but unequally-distributed oil fields are discovered, pretty much guaranteeing instability for as far as the eye can see.

Since then, the Western powers have been trying to keep the oil flowing by periodically deposing/replacing leaders and making/breaking alliances. All without the slightest idea of what they’re doing. So the situation has gone from really bad in the 1960s and 1970s to potentially catastrophic today as various Middle Eastern dictatorships and terrorist groups plot to create a pan-Islamic “New Caliphate” while secretly developing weapons of mass destruction.

Which brings us to the present crisis: The US, having deposed Iraqi dictator Saddam Hussein and spent a trillion or so dollars trying to create a functioning democracy, has pulled out, only to see the new Shi’ite government oppress the Sunni minority into rebellion. With the help (or leadership, it’s not clear) of Syrian Islamists trained in that country’s ongoing civil war, the Sunnis are on the verge of taking over Iraq, and both the US and (Shi’ite) Iran are being pulled back in — apparently on the same side.

It’s a mess, in other words, and the flow of oil, of which Iraq and Iran produce a lot, is now threatened.

So what would $150/bbl oil mean today? Several things:

Another recession. The US economy contracted at an annual rate of about 2% in the first quarter and isn’t nearly as strong as analysts had predicted going forward. Let gas go to $5 a gallon, and the consumer spending on which the US economic model depends would dry up. Put another way, we might spend the same amount but it will be mostly for gas and not much else. So much for the recovery.

Equity bear market. Stock prices depend on corporate profits, which in turn depend on sales. If Americans buy less, corporations earn less. With blue chip equities currently priced for perfection, major companies faced with a sales slowdown will, if they want to keep their stock prices from tanking, have to borrow even more money and buy back even more shares, which will only work until interest costs start consuming what’s left of their profits. Then US stocks fall hard.

Currency crisis. If Saudi Arabia manages to stay out of this latest conflict, it will see its revenues surge as it sells the same amount of oil at higher prices. But it’s not happy with the US (something about us recently tilting towards Iran) and apparently no longer feels obligated to accept only dollars for its oil. Let it start accepting euros, yen and yuan, and the result will be lessened demand for dollars, a falling dollar exchange rate and all manner of turmoil in global bond markets.

Derivatives implosion. Derivatives — basically private bets on the behavior of interest rates, currency exchange rates and corporate bond defaults — on the books of major banks have actually increased in the five years since those instruments nearly destroyed the global financial system. There are between half a quadrillion and one quadrillion dollars face value of derivatives out there, and a spike in financial market volatility would cause a lot of them to blow up.

There are other possible consequences of a major Middle East war, but the preceding is enough to make the point that the more leveraged a system is, the more vulnerable it is to external shocks. And no one has ever been as leveraged as we are right now.

7 thoughts on “We Are So Not Prepared For Another Oil Shock”

  1. We are at the point where a “Minsky Moment” is guaranteed. Only question is when the “trigger” occurs. BC-LR to all.

  2. You know you’ve got a bad signature line or tag line when people have to constantly ask what the hell it means! It’s like the opposite of getting the message out!

  3. Hollywood_Song_ISIS_Iraq.jpg

    Iraq Crisis: While Obama’s Away, He Needs Options to Weigh

    Being President of the United States and Leader of the Free World is not only hard work, but a lot of work for just one person, even if he is that Healer of the Planet, Stopper of the Rising Oceans and The One We’ve Been Waiting For otherwise known as Barack Obama.

    Take this very weekend, for example. In addition to his daily Father’s Day speech about how he had to grow up without a father, he’s also traveling to North Dakota for a photo-op with Native Americans and another speech about how he really does care about them and wants to use his pen and phone to give them free stuff.

    Then it’s off to California to do the two things he always does in California – Democratic fundraisers, which are important if we hope to stop Republican terrorism and obstructionism in Congress; and golf, because, you know, presidents always play golf no matter what – Republican presidents certainly did, but even though it was wrong and out-of-touch for them to do so, the fact that they did makes it alright for Obama to do so now.

    But now, on top of all that, there’s this kerfluffle in Iraq. And while he’s away from the bubble of Washington, Obama is depending on his staff to come up with an array of options for him to consider in dealing with said kerfluffle.

    Dudes, we are, like, just as qualified as Tommy Vietor or – with a necklace that looks clunky enough – Jen Psaki, or anyone else in the Obama Administration to conjure up options for dealing with the crisis in Iraq. Surely we can do our part to help Obama and lighten his heavy load! Here are a few possibilities:

    More selfies of people holding up signs with hashtags. #ISISbenice or #ISISplaynice or #BlameBush4Ever or something that will make those ISIS guys think about what they’re doing and maybe back down if enough of us hold up signs and tweet and retweet. Maybe Jim Messina could write something on his hand about how he’s in on the newest OFA approved hashtag. Are you in? Or should it be #AreYouIn? #DoYouCare?

    Hollywood celebrities could get together to record a song that will raise awareness of the crisis. If enough people download the song and it gets enough airplay on the radio, it just might reach Iraqi ears. It will give those on one side hope because we care about their plight, and warn the other side that we’re raising awareness of what they’re doing so they might want to consider reconsidering what they’re doing.

    Or, we could throw shoes at an effigy of Bush before chopping it to pieces and setting it ablaze. After all, none of this would’ve happened if not for George Bush! It’s just not fair for anyone to expect Obama to clean up the mess Bush made! Isn’t it enough that it’s the first thing he thinks of when he wakes up, and the last thing he thinks about before falling asleep? Isn’t it enough that he cares?

  4. Obama Considers Special “Boots On The Ground” Forces In Iraq As Explosions Rock Baghdad Airport

    Submitted by Tyler Durden on 06/16/2014 16:40 -0400

    If you like your boots on the ground, you can keep them – as long as they are Special Forces boots. Following promises that there would be no American “combat” ‘boots on the ground’, AP reports that President Obama is considering sending a small number of special forces to help the government in Baghdad. According to the official rules of “boots-on-the-ground”-edness, CIA and Special Forces do not count so ‘officially’ no promises have been broken. It’s not clear how quickly the special forces could arrive in Iraq; or whether they would remain in Baghdad or be sent to the nation’s north. With rumors of explosions rocking Baghdad airport, we suspect the former.

    As AP reports,

    The White House is considering sending a small number of American special forces soldiers to Iraq in an urgent attempt to help the government in Baghdad slow the nation’s rampant Sunni insurgency, U.S. officials said Monday.

    While President Barack Obama has explicitly ruled out putting U.S. troops into direct combat in Iraq, the plan under consideration suggests he would be willing to send Americans into a collapsing security situation for training and other purposes.

    It’s not clear how quickly the special forces could arrive in Iraq. It’s also unknown whether they would remain in Baghdad or be sent to the nation’s north.

    But The White House is being very careful to exaplin that this is not “real” boots on the ground…

    White House spokeswoman Caitlin Hayden said no combat troops would be sent to Iraq, but that the U.S. is looking at other options.

    “The president was very clear that we will not be sending U.S. troops back into combat in Iraq,” Hayden said in a statement. “That remains the case and he has asked his national security team to prepare a range of other options that could help support Iraqi security forces.”

    Just special ones…

    The mission almost certainly would be small: one U.S. official said it could be up to 100 special forces soldiers. It also could be authorized only as an advising and training mission — meaning the soldiers would work closely with Iraqi forces that are fighting the insurgency but not officially be considered as combat troops.

    The troops would fall under the authority of the U.S. ambassador and would not be authorized to engage in combat, another U.S. official said. Their mission is “non-operational training” of both regular and counter terrorism units, which the military has interpreted to mean training on military bases, not in the field, the official said.

    Already, about 100 Marines and Army soldiers have been sent to Baghdad to help with embassy security, according to a U.S. official.

    Obama made the end of the war in Iraq one of his signature campaign issues, and has touted the U.S. military withdrawal in December 2011 as one of his top foreign policy successes.

    Mission Accomplished…

  5. We just need to send Obama, Biden, Kerry and Hillary to handle things in Iraq PERSONALLY.

    One way or another, the problem would be resolved…


Leave a Comment

Your email address will not be published.

You can add images to your comment by clicking here.