Plunging oil prices will starve the world of its economic fuel

The world economy is slowing down and the authorities are worried.

Besides the official gross domestic product statistics, we have further confirmation of this slowdown from the four big commodities associated with growth; oil CLF5, -3.81%   (-40% from June 2014), coal (-52% from peak in 2010), copper (-14.4% in 2014), and iron ore (-41% year-to-date 2014).

Japan, Italy, and Greece are all in recession. China is slowing down according to its official statistics, and even more according to the whispers.

The days of rapid economic growth are behind us because the days of cheap oil are behind us.

Germany, France and the Netherlands are all at stall speed.

The U.S. is, according to the Commerce Department, doing just great at nearly 4% growth, but you wouldn’t know that from either the quality of the new jobs being created (which is low) or consumer spending (also low).

The worry, as always, has nothing to do with the central banks’ concern for you, your job, your children, 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 being created.

The core of the problem is that we have a monetary system that is either expanding or collapsing. It has no steady state.

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.

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.

Now after the most heroic run 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 bankers’ worries.

So they continue to pump, and jawbone, and panic at every slight downturn in wildly inflated financial asset prices because those are their only major successes in this drama.

The actual economy, the one that lives on Main Street, never really recovered, at least not compared to past recoveries. Growth, jobs and incomes all were anemic compared to prior recoveries. Capital expenditures by corporations were all but dead in the water throughout the “recovery.”

If oil prices do not recover and quickly, the U.S. shale miracle will rapidly turn into a shale bust.

And this brings us to the collapse in oil prices.

Our view here at Peak Prosperity is that the days of rapid economic growth are behind us because the days of cheap oil are behind us.

Oil fuels the engine of growth and the world has spent $2.5 trillion over the past nine years chasing more oil and yet is producing roughly the same amount of oil as it was before it spent all that money.

As Jeremy Grantham put it in his latest quarterly newsletter:

“As a sign of the immediacy of this problem, we have never spent more money developing new oil supplies than we did last year (nearly $700 billion) nor, despite U.S. fracking, found less — replacing in the last 12 months only 4½ months’ worth of current production! Clearly, the writing is on the wall.”

Unless investment in oil production really accelerates from here, new production will be swamped by existing declines.

But with oil down some 40% since June, new oil drill programs are being scrapped left and right.

New drill permits in the U.S. shale plays were down 40% in November compared to October and for good reason: most of the plays are uneconomical at current prices:

The bottom line, though, is that without growth in oil supplies robust economic growth is impossible to achieve.

Worse, global oil projects are now on hold and those potential future supplies have been pushed out further waiting for higher oil prices.

No new oil means no new economic growth. It’s as simple as that.

This calls into question the sky-high valuations we currently see for stocks and bonds. The operative question being, what is the value of these stocks and bonds in a world without growth?

To me the answer is simple; a lot less than they currently are.

So the central banks are worried that their efforts to ignite new borrowing are not working, but I am worried that the bloated asset prices that were a product of this quest are going to run straight into the reality of diminished oil output.

In short, my worry is that we are now well past the point where the next financial correction can be avoided. It’s going to hurt.

The central banks have failed, perhaps honestly and with good intentions, but they have failed nonetheless. All because they were peering out just one of several portholes and thought they understood the world.

Chris Martenson is an economist and futurist who co-founded the PeakProsperity.com blog.