2016: Oil Limits & the End of the Debt Supercycle

debtOver the years I have often talked about the likelihood that we are nearing a time when additional debt could no longer be sustained. And when we reach that limit, we will face a very painful systemic deflationary collapse. I believe my IDW is telling me that we are on the precipice of the great unwind of debt and for reasons explained in an article below by Gail Tverberg, I believe there is nothing policy makers can do to stop it.

I have had folks like the late Matthew Simmons on my radio show to talk about peak oil as well as a much more civil Chris Martenson who talked of peak prosperity and related issues. And certainly various Austrian economic thinkers who understand the damage caused by printing massive amounts of money are frequently guest on my show.

But the article below by Gail Tverberg really hit home the notion that the entire globe is heading into a gigantic deflationary vortex that is impacted not only by peak debt and peak oil, but also as a result of physical limits related to energy and other resources required by our modern world with its exponential population growth. The issuance of debt made possible by going off the gold standard has allowed us to live in a make believe world for several decades and it has enabled the U.S. to fund a military industrial complex that has made a huge mess around the world. Massive growth of money manufactured with debt at first seems like a very good idea because it created a rush of what seemed to be prosperity. But that excessive credit also has led to wasteful behavior and unrealistic expectations which when unmet will most definitely lead to civil unrest, wars, a reallocation of wealth and poverty for the masses. I wished I could paint a happier picture, but I believe Ms. Tverberg makes a huge amount of sense. Here is the start of her excellent article.

What is ahead for 2016? Most people don’t realize how tightly the following are linked:
1. Growth in debt
2. Growth in the economy
3. Growth in cheap-to-extract energy supplies
4. Inflation in the cost of producing commodities
5. Growth in asset prices, such as the price of shares of stock and of farmland
6. Growth in wages of non-elite workers
7. Population growth

It looks to me as though this linkage is about to cause a very substantial disruption to the economy, as oil limits, as well as other energy limits, cause a rapid shift from the benevolent version of the economic supercycle to the portion of the economic supercycle reflecting contraction. Many people have talked about Peak Oil, the Limits to Growth, and the Debt Supercycle without realizing that the underlying problem is really the same–the fact the we are reaching the limits of a finite world.

There are actually a number of different kinds of limits to a finite world, all leading toward the rising cost of commodity production. I will discuss these in more detail later. In the past, the contraction phase of the supercycle seems to have been caused primarily by too high population relative to resources. This time, depleting fossil fuels–particularly oil–plays a major role. Other limits contributing to the end of the current debt supercycle include rising pollution and depletion of resources other than fossil fuels.

The problem of reaching limits in a finite world manifests itself in an unexpected way: slowing wage growth for non-elite workers. Lower wages mean that these workers become less able to afford the output of the system. These problems first lead to commodity oversupply and very low commodity prices. Eventually these problems lead to falling asset prices and widespread debt defaults. These problems are the opposite of what many expect, namely oil shortages and high prices. This strange situation exists because the economy is a networked system. Feedback loops in a networked system don’t necessarily work in the way people expect.

I expect that the particular problem we are likely to reach in 2016 is limits to oil storage. This may happen at different times for crude oil and the various types of refined products. As storage fills, prices can be expected to drop to a very low level–less than $10 per barrel for crude oil, and correspondingly low prices for the various types of oil products, such as gasoline, diesel, and asphalt. We can then expect to face a problem with debt defaults, failing banks, and failing governments (especially of oil exporters).

The idea of a bounce back to new higher oil prices seems exceedingly unlikely, in part because of the huge overhang of supply in storage, which owners will want to sell, keeping supply high for a long time. Furthermore, the underlying cause of the problem is the failure of wages of non-elite workers to rise rapidly enough to keep up with the rising cost of commodity production, particularly oil production. Because of falling inflation-adjusted wages, non-elite workers are becoming increasingly unable to afford the output of the economic system. As non-elite workers cut back on their purchases of goods, the economy tends to contract rather than expand. Efficiencies of scale are lost, and debt becomes increasingly difficult to repay with interest. The whole system tends to collapse.

About Jay Taylor

Jay Taylor is editor of J Taylor's Gold, Energy & Tech Stocks newsletter. His interest in the role gold has played in U.S. monetary history led him to research gold and into analyzing and investing in junior gold shares. Currently he also hosts his own one-hour weekly radio show Turning Hard Times Into Good Times,” which features high profile guests who discuss leading economic issues of our day. The show also discusses investment opportunities primarily in the precious metals mining sector. He has been a guest on CNBC, Fox, Bloomberg and BNN and many mining conferences.