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Philip Pilkington: Fear and Loathing in the Financial Markets – What Happens to the Economy When the Oil Bubble Bursts?

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By Philip Pilkington, a journalist and writer living in Dublin, Ireland

In 2008 profits in the US economy crashed out. But they soon bounced back. This bounce was largely due to the profits being reaped in the financial sector – which sickened many given that 2008 was in large measure caused by the financial sector. This always struck me as odd – not to mention unsustainable. If the ‘real’ economy is in the doldrums you can be sure that, in the medium to long run, the business class will go down with it.

In what follows I will draw on Chris Cook’s post on this site the other day to argue that, if he is correct (and I think he may be), judgment day is just around the corner for the profiteers. Soon they will have to learn that you cannot financial engineer your way to profitability forever, especially when the rest of the economy is withering. Who knows, this may even inspire what has come to be called the 1% to focus their attention on the problems that have arisen in the global economy in recent months – for they have been truly burying their heads in the sand for the past three years.

But first, let us look at this incredible post-2008 resurgence of profitability.

From Profit Bust to Profit Boom

When the world financial markets crashed out in 2008 profits hit the wall. Yet, they did not hit it quite as hard as one might expect. As the below graph shows profits did not even reach the levels they did during the 1983 recession as a percentage of GDP.

I think that the reasons for this have largely to do with the manner in which wealth has come to be distributed in the US. As the below chart shows a far greater proportion of national income now goes to profits than was the case in 1983 when labour compensation was at an all time high.

If we take this into account we can then appreciate that the hit that profits took in 2008 was quite substantial.

But then we saw a major kick back in profitability. Have a look at that first chart again. As a percentage of GDP profits soon nearly reached their pre-crash levels. Yes, a lower rate of GDP growth probably had an effect on this, but even if we simply look at the nominal level of corporate profits (below) we will see that they surpassed their previous height in 2008 despite the crisis.

We can safely say that, while unemployment soared and people found themselves completely drowning in debt, profitability essentially made a comeback. Many publications that were not known for their left-wing or redistributive credentials, noted this phenomenon. In 2010 The Economist magazine wrote:

One of the many oddities of the current joyless economic recovery is that this traditional enthusiasm is strikingly lacking. Corporate America has bounced back impressively. The quarterly results season that is now nearly over has revealed that profits are back within a whisker of the all-time highs achieved before the downturn in late 2008. By some calculations, the rate of recovery of profits from their trough is the strongest since the end of the Great Depression.

An oddity indeed. One can palpably sense in such pieces a suspicion that this bounce back in profitability might be too good to be true. Certainly, it does seem so. And when we look at the source of this new profitability our suspicions only mount. All this profitability was coming, as hinted at in the intro, from the financial sector. Just look at the graph below.

It was financial profits that made a roaring comeback, not profitability more generally. That graph only charts up until 2009, but if we look at the more recent data it correlates. Below is a graph charting the percentage of total domestic profits that is accounted for by financial sector profits.

The Wall Street Journal economics blog summarised the situation well:

Top-line, or pretax, operating profits economywide hit a record high at the end of 2010. All of the gain was in the financial sector…

Since [the crash in 2008], the sector has come roaring back. The GDP report shows finance profits jumped to $426.5 billion. While profits haven’t returned to their high levels of 2006, the gain in finance profits last quarter more than offset a drop in profits posted by nonfinancial domestic industries. (My emphasis)

This was simply carrying on a trend we’ve been seeing in the US economy – and probably much of the Anglo-Saxon economies – for some time now. Look at the below chart that shows how the different business sectors contribute to profitability.

That graph, of course, shows the rise of the bubble economy of the 1990s and the 2000s like no other. It also leads one to suspect that the resurgence of profitability after 2008 was, to some extent at least, due to the inflating of yet another bubble.

Instinctively many of us feel this. It seems so obvious. The economy is doing horribly and yet, for all their complaining, Wall Street does not seem to be doing so badly. Frankly, that stinks; not just morally, but logically and economically. The financial community are supposed to channel funds into productive activity, thereby turning a profit while increasing investment and economic growth. If they’re not doing that and they’re still making money – well, chances are that they’re blowing more bubbles.

The article run on this site the other day by Chris Cook may point in what direction this remarkable resurgence in profits came from. Let us briefly run through Cook’s argument before we go any further.

Big Oil, Big Finance, Big Trouble!

Chris Cook argues that financial investors have fled into commodities and inflated a bubble which they are using to keep their margins up. While one is tempted to reach for the gun shouting “speculation!” one should be more careful. According to Cook, this is not the cynical, greed-fuelled speculation that led to the pre-2008 housing bubble. No, this something altogether different. This is a bubble mainly based on fear. But such makes it no less ominous.

First a run through of the structure of the modern oil market as Cook portrays it.

Basically what has occurred in the oil markets in the past few years is that oil has begun to be traded as an inflation hedge. Investors trade dollars for oil to ensure that, in the event that the value of the dollar is eroded by inflation, they possess something that holds its value. It’s a bit like the strategy of the gold bug. Fearing inflation they give away their dollars that they think to be declining in value for something ‘tangible’ that they believe will hold its value or appreciate.

On top of this Cook tells us how Big Oil and Big Finance have locked arms in this regard. Each has something the other wants: Big Finance has access to dollar loans that can be used to ensure that, should oil decline in value, Big Oil has ample amounts of dollar liquidity lying around. Meanwhile, Big Oil has plenty of barrels of crude lying around that can be exchanged for dollars, thus allowing Big Finance to hedge against any inflation that may take place.

Such an institutional arrangement has given rise to a highly opaque and unstable market that few can see into. Indeed, no one really knows just how much oil is being ‘held’ as an inflation hedge by Big Finance. These stockpiles have even gained themselves an ominous name within the industry (recently christened by Izabella Kaminska over at FT Alphaville who has been doing some of the best work on this): Dark Inventory.

Looking at recent market trends Cook raises concerns that we could be seeing the beginnings of the end of a bubble that began to inflate in the oil market after the crash of the previous bubble in 2008. This bubble, Cook argues, was inflated due to inflation fears after the QE programs undertaken by the Federal Reserve and the Bank of England. With the markets awash with dollar and sterling liquidity, banks and investors piled into commodities to escape what they saw to be a looming inflation.

In recent months Cook focuses on the move of the market from a position of ‘contango’ to a position of ‘backwardation’ – which he sees as evidence of a bubble deflating. While some investors read in this that the short-run demand for oil has risen, Cook points out that with the global recession grinding along there is no fundamental reason that this should be occurring. Instead Cook sees in this move a sign that the long-run demand for oil is falling as the current bubble begins to burst.

Cook thinks that the price collapse is going to be very painful – falling possibly as low as $45-$55 a barrel. In response to this OPEC will try to ramp up prices by cutting production and, most importantly for our purposes, a financial crisis of sorts will occur as inflation hedged investors see their net worth cut to pieces.

If this is as Cook says – if this is a bubble of fear and it bursts – the financial sector is going to see a huge wiping out of the profits they have been reaping from it. We have no way of knowing how much profitability is tied up in these dodgy markets – but my thinking is: a lot.

And Then… Depression?

One could speculate for hours on what happens to the economy next. Certainly lower oil prices will mean higher effective demand for other goods and services. On the other hand, the rich will undoubtedly be licking their wounds in the case of such a collapse and will retract spending (think: the ‘capitalist consumption’ part of the Kalecki profit equation). Pension funds and the like will also likely see red ink ooze from their balance sheets.

However, there is something else to consider – something alluded to at the start of this piece. For the first time the rich may see no tangible way to regain their lost income. In short, they may not see any other potential bubbles to inflate.

In the past few decades the real economy has become increasingly financialised. And so, as shown in the first half of this piece, nonfinancial companies have been able to maintain their profitability through their financial arms despite the real economy of production, distribution and consumption stagnating. If financial profits fall off a cliff they’ll have little left to hold onto. They’ll be in the ditch with their financial buddies.

Certainly this could push our elites to take real action and expand fiscal policy and with it the real economy. We all know Big Finance’s lobbying power and if they began to really see their profitability tied up with the real economy we might see our ignorant and shameful governments getting off their asses and actually doing something about our economic problems.

So, perhaps this will be a positive development in the long run. But in the short run this will be anything but. With their profitability squeezed, businesses are likely to turn on their workers and attempt to cut their wages and living standards. At this point we could well see a true depression taking shape in which businesses cut workers and wages to increase profitability, all the while profitability continues to fall as the unemployed and underpaid buy less and less stuff.

What can I say? I hope I’m wrong. I really do.

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125 comments

  1. mmckinl

    The problem is not an oil bubble … The problem is a debt bubble that when it implodes will take out markets and then take down oil.

    We are in fact at peak of conventional oil production. Oil will fall in price when the economy crashes and producers, needing the cash, do not cut back supply.

    1. Jonus

      Nice theory but the evidence to support the Peak Oil theory is weak and inconclusive. If you look at oil discovery historically, you can see that its always been ahead of demand, and in fact recent discoveries support that idea.

      The whole Peak Oil theory reeks of the same problems with the Malthusian theory of food production. It ignores technological advances and declining demand growth.

      1. They didn't leave me a choice

        Yes, because historical data obviously always directly correlates with future trends. Also, assuming that you can always increase oil production on a limited planet is precisely the same kind of magical thinking that allows people to think that growth in general can go on forever.

        Besides, have you noticed at all how the difficulty of extraction along with the harmful economic impact have skyrocketed lately? Just because you can extract oil does not automatically mean that it is palatable to local populations to have their lands and livelyhoods annihilated in the name of extending and pretending the current parasitical capitalism can go on for another couple of years. Sooner or later you are going to see uprisings and civil wars as a result of this kind of feckless extraction. Oh wait, that is happening right now. Nevermind then.

  2. jake chase

    I cannot help thinking this is all wishful thinking. This business of inflation hedging being somehow different from speculation is just proof by assertion. The idea that the price of oil is determined by “market” forces is a fantasy. Oil producers are monopolists. Bank money is free to those with high connections. Bank profits (and imperial ambitions) depend heavily upon maintaining an artificially high oil price, which is the reason we have had one since 1970. Anybody who thinks this is likely to come out in the death of the rentier class is free to think so, but I would certainly not bet on it. A more likely scenario is a determined grinding down of those drowning in debt, and an episodic whipsaw in financial markets wiping out heavily margined speculators in favor of those with the courage (and the cash) to buy during the selling climaxes.

    If logic were a useful tool in the investment game, all college professors would be rich.

    1. Philip Pilkington

      “This business of inflation hedging being somehow different from speculation is just proof by assertion.”

      No. This isn’t about moralising. This is about recognising reality. The current commodities bubbles are being inflated by peoples’ fear rather than by their greed. This makes them far less visible than the excesses of the housing bubble (which was pure greed).

      Think gold, which I’ve long referred to as an ‘anxiety investment’. Everyone I talk to is piling into gold out of fear. This is a whole different ball game to the housing bubble when everyone I talked to was buying housing to turn a profit.

      This ‘anxiety bubble’ looks like a true ‘aftershock’ to the main financial earthquake. And it may be just enough to take the whole damaged building with it.

      1. jake chase

        What matters is the use of credit. Suppose a great many people are persuaded to stockpile gold (or oil). So what? The commodity changes hands and everyone is satisfied until something happens to change perception, at which time all those buyers become sellers, except there are then no buyers, so the price craters until buyers step up. When you introduce credit the equation changes. Changes in the perception of lenders (as opposed to buyers) leads to withdrawal of credit and forced selling. Trends are accelerated and exacerbated in both directions. Meanwhile, notice what is not terribly important: production of the physical commodity. In the case of gold, this is because annual production is a tiny percentage of the amount available for sale; in the case of oil, it is because the producers are united in a conspiracy dominated by Saudi Arabia under the direction of US banks and oil companies. Finance is the dog and commodities are the tail. Demand is fleas on the dog. It makes the dog scratch but does not propel the dog into orbit.

      2. F. Beard

        The current commodities bubbles are being inflated by peoples’ fear rather than by their greed. Philip P

        No. Bubbles are inflated with credit as Jake Chase said and as is implied by George Soros’s “Theory of Reflexity.” No credit = no speculative bubbles or much smaller ones.

        What is it about counterfeiting that Progressives don’t get? Credit behaves just like real money when it comes to driving up prices. Those who can’t or won’t borrow get stuck with the price inflation of those who do borrow.

        1. jake chase

          FB,

          For some reason, Progressives do not understand that Woodrow Wilson was a Morgan stooge, that the Fed and the Income Tax were regressive innovations. I suspect they do not understand money because they rarely have responsibility for investing money. They traffic in ideas, an infinitely inflatable currency.

          1. F. Beard

            that the Fed and the Income Tax were regressive innovations. jake chase

            The FED is certainly regressive but I see the Progressive Income Tax as a bit of socialism to counter the fascism of the FED. One theft to counter another…

            But yes, the Income Tax was implimented so the FED could be paid its usury. That function is now absolete since the FED refunds the interest it collects (less expenses) back to the Treasury.

          2. Jonus

            Yeh progressives are just jealous poor folk that never own a business or control the finances or make a payroll.

      3. Philip Pilkington

        You didn’t read the piece properly. I said that the bubble was being inflated by credit:

        “On top of this Cook tells us how Big Oil and Big Finance have locked arms in this regard. Each has something the other wants: Big Finance has access to dollar loans that can be used to ensure that, should oil decline in value, Big Oil has ample amounts of dollar liquidity lying around. Meanwhile, Big Oil has plenty of barrels of crude lying around that can be exchanged for dollars, thus allowing Big Finance to hedge against any inflation that may take place.”

        But credit cannot fuel a bubble alone. Investors must have some reason to take out the credit and enter the market. In the housing bubble this was due to greed. In the oil/commodity bubble it is due to fear.

        1. jake chase

          Wall Street is an engine that applies leverage to fear and greed. Investing is intelligent speculation. Anyone who believes otherwise is deceived by propaganda about safe investment techniques, which are determinable only by hindsight. The future is always uncertain.

        2. F. Beard

          Investors must have some reason to take out the credit and enter the market. Philip P

          Does a stampede need a reason? Technically, yes it does. But once started it is self-reinforcing. The thing then is run with the herd or get run over by it.

          It’s called the “rat race” and the bankers have been running it for centuries.

      4. don

        Everyone you talk to is buying gold? Says a lot about who you’re spending your time with.

        How does one know whether its fear or greed that drives the increased price for natural resources (or what most here about prefer to call commodities). On what basis can one determine whether it is fear or greed? Anyway, many talk about buying the physical resource. Lets take oil. How does one buy the physical? Well if you’re GS then yea, you can buy the physical. But the individual buys the paper that represents oil, unless he is storing it in the backyard. So that looks to me to be more speculation than not, but no need to argue semantics.

        Is all a replay of 2008, when resource prices such as oil went through the roof. But I don’t recall the argument being one of inflation fears in 2008. In any case, I’m not sure the inflation (hyper?) fears are grounded in reality, though the fear doesn’t need to be grounded in reality, nor does the greed. The effect is the same: higher prices creates impressions of inflationary pressures, thus encouraging more to get in the game, thus creating a feedback loop. What triggers the reversal? This is what I find most interesting.

        1. Philip Pilkington

          “Everyone you talk to is buying gold? Says a lot about who you’re spending your time with.”

          A good investor today knows that if monetary policy is ratcheted up the short run price of gold will rally. I don’t deal with gold bugs. It’s all a Keynesian beauty contest…

          1. don

            So, a good investor is someone who buys gold.

            As someone who lives in an area with a long history of gold mining (and the scares to prove it), and with pressure to racket up more gold mining well underway, including exploratory drilling only miles from my home, I can attest to the environmental consequences, not only aesthetically but more important the impacts on water quality, native fish populations, etc., impacts that are not only ecological but economic.

            I guess the gold investor either could care less about said impacts or doesn’t give a damn, or maybe just ignorant (including of the ramifications of the 1872 Mining Act), which is never a good excuse.

          2. F. Beard

            I can attest to the environmental consequences, not only aesthetically but more important the impacts on water quality, native fish populations, etc., impacts that are not only ecological but economic. don

            But don, gold is shiny!

            Actually, Progressives and others who support the current money system should be ashamed that it works so badly that people are retreating to an insanely obsolete, primitive money form and that calls for a new gold standard abound.

        2. Philip Pilkington

          “…I’m not sure the inflation (hyper?) fears are grounded in reality…”

          They’re not. The markets are thicker than my sister’s pet hamster.

          1. don

            So if not, then the fear-based “investors” are irrational.

            Seems to me one could be motived — as in (e)motional — by both fear and greed simultaneously. So why does it have to be one or the other? In either case it is emotional and ego-driven self-interest, that is, asocial, if not anti-social.

        3. F. Beard

          What triggers the reversal? don

          Consumers must have the desire and ABILITY to spend otherwise stockpiles will build and prices collapse. Conversely, once Steve Keen’s universal bailout comes about and people can spend again, a muzzle MUST be placed on credit creation to prevent severe price inflation.

          What a twisted mess we make
          when we dare to fractionate.
          “Thou shalt not steal”
          - a simple rule -
          but much too simple
          for complex fools?

  3. Max424

    The speculation about speculation is important; it is a tree in the forest, and unlike the callous dumbkopf Ronald Reagan, we know that each individual tree is special (in its own unique way), and should be valued as such, and discussed.

    On the other hand, as much as we like trees, we never want to miss the forest … for the trees. And this, is the forest:

    http://static.seekingalpha.com/uploads/2010/8/19/saupload_engy_crudeoil_081310_wd.png

    If China’s future crude oil import curve goes exponential (i.e., remains on its current track — or, more simply, if its GDP growth rate continues to mirror, say, 80′s Japan), it will be forced to import somewhere between 40 to 50 million barrels of oil –every 12 months!– in the year 2020.

    Wow, 40 to 50 million.

    Note: For those not doing the math at home; that is roughly half the globe’s current — and forever stagnant– supply of oil, and two and half times more oil than the planet’s stumbling leading-man uses, each year (the crude-aholic US, obviously).

    Note: If China’s economy slows down big time, and grows more like say an up-and-coming –minus those deep recessions– South Korea (5.5% ish), it will still be forced to import at least 20 million barrels of oil, just one short decade hence.

    1. ambrit

      Dear Max;
      Would this be a major driving force behind the PRC’s push into “Renewable” Energy? Call them what you will; the Chineese aren’t any stupider than the rest of us.

    2. robert157

      You mean every 24 hours, not every 12 months.

      40 – 50 million barrels per day.

      But that won’t be possible, unless they nuke the rest of us.

  4. Commiemaniac

    Or, US/Israel/UK will attack Iran, oil will shoot through the roof and the hedgers will win their bets. Don’t think the deaths of a few million brown people will give the 1% pause in their quest for profits. It never has before.

    1. Philip Pilkington

      Yes, if they attack Iran the bubble might last a little longer. But not much. If Chris is right the fundamentals are out of whack so much that even a supply shock like that would only be temporary.

      Besides we’re not even sure what ‘attacking Iran’ would mean. Air strikes wouldn’t shut down production. And, as Larry Wilkerson has pointed out, in order to undertake a ground assault the US would have to reinstate conscription. Fat chance of that.

      1. Max424

        “Air strikes wouldn’t shut down production.”

        Iranian missile strikes against against the Saudi’s two sitting duck oil terminals will, however, and those indefensible Persian Gulf targets service more than 40% of the world’s oil supply.

        Also, just behind the twin terminals, on dry land, and within easy missile range, sits a megalopolis of oil superstructure, the refineries and storage tanks that line the east coast of Arabia. Say good-bye to much of that too, should war commence.

        There will be no shutting down of the Straights of Hormuz. The US Navy and Air Force will make sure of that. But outside of destroying Iran outright, there is nothing we can do to stop thousands of low flying Iranian missiles from –let’s say optimistically– greatly depressing for years, our oil dependent way of life.

        1. Philip Pilkington

          Which is why Cook sees an attack as highly unlikely.

          Unless the Big Players have some plan to stop such chaos from happening I cannot see them marching on. More likely there will be more espionage action by the Israelis — like we saw today with the nuclear scientist being assasinated James Bond-style.

          1. Max424

            I have to disagree with Cook; I think an attack is not only probable, but almost assured. What exact form the attack will take is likely the only thing that is holding it up.

            Iran is on the right-wing’s agenda (has been for 30 years), and what the right-wing wants, the right-wing ultimately gets.

          2. Philip Pilkington

            North Korea? Cuba? Syria?

            This lot:

            http://en.wikipedia.org/wiki/Axis_of_evil

            I disagree. I think your opinions are being coloured by the atypical events of 2003. Historically, the right-wing have only rarely got what they want in this regard. Vietnam; Iraq; half-assed attempts in Cuba and Nicaragua.

            This war stuff is 90% rhetoric. It always has been. Iraq was an unusual case in which the loonies got what they wanted. But it needed a 9-11 to spark it off.

          3. Max424

            “I think your opinions are being coloured by the atypical events of 2003.”

            My opinions are only coloured by oil production, or lack thereof, so the events of 2003, in my opinion, we’re not atypical, but easily predictable.

            The targets have always been Iraq AND Iran, from the moment we lost the latter to the Mullahs and the former to insanity (Saddam, we were just kidding, buddy, you can’t attack Kuwait).

            Unlike most of the other players in the Big Game, the United States has no state oil companies. This means, we cannot compete equally against other sovereign nations on the Great Petroleum Playing Field.

            We can only use our military to bust up nations like Libya, Iraq, AND Iran that not producing for us like they did in the past, that have taken to ignoring us, that have decided to look “inward” (i.e., keep the oil for themselves), or, most egregiously, have signed, or threatened to sign, large, separate, multiple, “non-free market” contracts with our rivals, and compounded this mistake by committing the greatest faux pas of all, brazenly traded their product in currencies other than the dollar.

            Note: Our big boy, our private, for-profit “champion,” Exxon/Mobile, right at this moment, may be at its apex, but as far as oil players go, it is dying entity — losing 5% of its oil reserves every year. It needs all the help it can get (subsidies and aggressive military action!), if it wants to survive.

            And it is important to remember just how relatively tiny a competitor Exxon really is. For instance, Exxon/Mobile is to Saudi Aramco (approximately) as the moon is to the earth; whereas Saudi Aramco would be to China Oil and Inc, as the earth is to the sun.

          4. Philip Pilkington

            I don’t buy this “all geopolitics is due to oil line”. Clearly the main determinate in the Iran debacle is Israel and AIPAC.

            “We can only use our military to bust up nations like Libya, Iraq, AND Iran that not producing for us like they did in the past, that have taken to ignoring us…”

            Again, doesn’t add up. Libya were moving politically to the West prior to the air assault. I think the explanation was much simpler: it centered around Cameron and Sarkozy (the US were reluctant) and had more to do with distracting people at home from the economic situation. It was like Falklands redux.

          5. Jack M.Hoff

            Max, You do put forth a good argument, but when u said “Unlike most of the other players in the Big Game, the United States has no state oil companies.” you could have easily stated with accuracy that “Unlike other players in the Big Game, only in the U.S. do the Big Oil companies own a govt. and a huge military at their disposal” In reality there’s no difference in either statement is there?

          6. Yves Smith Post author

            Richard Klein, who monitors quite a lot of news and broader history, says the ISRAELIS aren’t serious about attacking Iran. They know they won’t prevail if they were to try. He’s discussed this pretty long from in some comments.

          7. Max424

            Jack M. Hoff

            Good point. Who can forget that the United States gave BP personal use of the Coast Guard, for six months, during the Gulf spill crisis? Not me.

            There are some major differences, however. For instance; the six Supermajors, the remaining private actors in the Great Oil Game, Exxon/Mobile, BP, Dutch Shell, Chevron, Total S.A., and Conoco/Phillups, are small fries — very small fries.

            To give an example; the biggest of the six, Exxon, sits on roughly 10-15 billion barrels of recoverable crude oil. Saudi Aramco, in contrast, has 250 billion (China’s state run oil companies, taken as a whole, will control at least as much, and probably a lot more than Saudi Aramco, in the coming decade).

            Also, state run oil companies, for the most part, work for the state. The Exxon/Mobiles of the world, as I think we all know, work for nobody but themselves.

            To paraphrase –very closely– what Exxon CEO Rex Tillerson said recently to Congress, “You fuck with me, I take my business elsewhere.” Imagine Saudi Aramco saying that to the King.

            YS: “…the ISRAELIS aren’t serious about attacking Iran.”

            Agree.* In fact, I consider Israel a non-actor in this long and dramatic build up to WAR. We dangle them out there as a player, only because the media and general public gobble them up.

            Everybody loves that tough little nut Israel.

            *Israel’s right wing is sane, ours is not.

          8. Fiver

            This blithe pooh-poohing of a possible move against Iran somehow misses the fact that the Israeli leadership is certifiably insane, and that Obama, who has shown in every single decision that he will do what is short-term politically expedient (ie., he will kiss the ass of Power)will have no choice but to follow should an “incident of opportunity” arise via Israeli action, or an Iranian response in the face of repeated severe violations of its sovereign rights under International Law.

            Israel can by itself set any nuclear program back for a good long time. There are literally hundreds of analyses floating around, the bulk to that effect. Those opinions I find suggesting otherwise come from people who oppose the notion of a war on moral grounds (with which I quite agree) or simply the “it’s unthinkably stupid” stance (with which I also agree) but which proved so disastrously wrong re assessing the real prospects of war with Iraq – just because it’s crazy doesn’t mean it won’t happen. Here’s just 1:

            http://www.thedailybeast.com/articles/2011/11/16/israel-s-secret-iran-attack-plan-electronic-warfare.html

            But of course, Israel would almost immediately NOT be on its own. As noted before here, Obama would simply cave and go all in, but NO boots on the ground anywhere. Just an air war demolishing most of Iran’s critical infrastructure and no plan to fix anything. It will just be left to burn.

            As Iran is already under vicious attack, it is quite obvious it does not want a war, or it would’ve already countered. But that was quite true in Iraq as well. The Iranians are anything but fools, they are determined, and they quite rightly believe they are acting in their own defence. If the US/Israel keep squeezing the windpipe the pain calculus is going to change and they will conclude they MUST respond or collapse. The US and Israel are playing an unbelievably brutal and dangerous game. To just dismiss the possibility of a crisis by deliberate action or miscalculation is just plain silly.

            As Wesley Clark made clear, there were 7 nations on the Pentagon’s list for regime change. All but Syria and Iran are done, Libya just completed (and you actually think that had nothing to do with oil? wow) There has been no change whatever in the grip anti-Islam neocons AND Oil-firsters have on the Pentagon and Defence.

            I think Obama would prefer 2013, and that Syria is enough to chew on (and swallow) for 2012. But Israel will keep pushing with its assassinations, bombings, electronic attacks, other sabotage even as Obama tightens the economic screws. As I said, an incredibly wreckless approach. And note that the collapse in oil prices that has been floated here would in fact make it more likely an attack occurs.

          1. Fiver

            The war games were in 2002. That is ancient history vis a vis technological change. The US has had many years to lay the groundwork for any contingency. Should Israel push too far (blowing up any more missile sites fits the bill)and force an Iranian reaction, the US is immediately in. And what you’d see is massive electronic attack on Iranian command and control and a hailstorm of cruise missiles, etc. already in place.

            Obama would clearly prefer 2013 or later and an Iranian internal collapse, but Israel is the one in the driver’s seat – and the calculation of ITS leadership looks only at the domestic political reaction in the US. I’ve no doubt the US public would NOT object to a 1-sided pounding.

    2. rps

      Iran is under China’s protective wing. An attack on Iran would be attacking China’s relationship with Iran. They are cozy bed partners. Not gonna happen unless the U.S. wants a major global war.

      Reuters: China defends Iran oil trade despite U.S. push
      The picture is hilarious of Timmy Geithner with Wen. It appears Timmy won’t be able to sit comfortably for awhile.

  5. Mark Chembrovich

    @Meanwhile, Big Oil has plenty of barrels of crude lying around that can be exchanged for dollars, thus allowing Big Finance to hedge against any inflation that may take place.

    Big oil does not have plenty of bbls lying around. Opec has that, in addition too our sweet crude sources have dried up, and soon there will be the big switch to sour crude refining. The strategic sweet crude reserves will soon be depleted. This will need to be filled with sour crude and our insistence that Iran accept no money for its oil will facilitate the high price of oil for some time to come. If there were a stock pile of oil, it would contain the price fluctuations at the pump over a longer period of time than it currently has. The release of the petroleum reserves have done that recently, but once gone the straw returns to load the camels back, and there are plenty of straws waiting in the wings. How long before we don’t go back to $80 oil will it take for the speculators to relize they need to leverage their investment in the hopes that the margins can still be clipped, just as occurred in the paper ponzi gold mkt.

    1. Philip Pilkington

      Chris’ argument is that they do. And they’re still sitting in the ground. This is because the ‘demand’ for them is artificial/financial. It’s just futures contracts traded on their being extracted down the road. This seems to be happening in many commodity markets. And it seems due to investors using commodities as an inflation hedge.

        1. reason

          Seems pretty ironic doesn’t – hedging against inflation creating inflation. Even more ironic if the END result is in fact deflation.

          1. Philip Pilkington

            Very ironic. You could make a good conspiracy theory out of it. It would go something like this:

            Bernanke wants to pursue negative interest rates (i.e. have inflation outstrip interest rates) but has realised that he has no control over inflation. So he undertakes QE programs that generate commodity inflation that then feeds in to the CPI.

            Complete rubbish, of course. But its sometimes fun to think these things through…

      1. Mark Chembrovich

        And we have seen what occurs when that oil is attempted to be removed, in the Gulf in 2010, again in Brazil a couple of months ago bringing oil to the shores of Rio. So yes, it is there, but the risk has already damaged the reputations of some big oil co.’s and the the safe extraction of that oil is now years down the road.
        In the mean time traders and speculators act as if the oil extraction is just around the corner when in fact our current recoverable reserves, especially for gasoline, is at a low while the cost to refine it rises. There is no reversing this trend, all that is occurring is a bubble that once bursts places the tangible commodity price above the subsidized paper price just as is currently happening to gold and silver. The price to purchase the tangible product is 20% higher, than to trust your broker. Its quite the juggling act, and only seems to want to expand.

  6. Yearning to Learn

    At this point we could well see a true depression taking shape in which businesses cut workers and wages to increase profitability, all the while profitability continues to fall as the unemployed and underpaid buy less and less stuff.

    Although I agree, I would assert that this isn’t a future possibility, it’s a description of what’s already happened/happening.

    here’s the equation:
    -profitability up = lay off workers, lower their pay, get rid of their benefits.
    or
    -profitability down = lay off workers, lower their pay, get rid of their benefits.

    later, as consumption falls secondary to the above, which puts pressure on GDP:
    - call them lazy and lower taxes on the top 1% so they can cremate more jobs. They are the ultimate job cremators. (the press is forever misspelling the quote).
    - dismantle social security and medicare and all other EARNED BENEFITS (press keeps misspelling earned benefits as entitlements… very irritating).

    Unfortunately, we are already IN the depression… but it is a long drawn out thing that will be more obvious 20 years from now. we’re boiling like frogs or lobsters.

    Thank you for your excellent post elucidating how big oil and big finance fit into this picture, a good sized and important piece of the puzzle. If/when oil drops, it will be another acute shock in the slow moving train wreck that is the global financialized economy.

    but we need to be clear here: NOTHING will be allowed to get into the way of the rentier classes profits, except perhaps another more powerful rentier. If oil takes down big oil and then big finance, we will see TARPzilla and war. Big War will never let it’s favorite son Big Oil suffer for long.

    how else to explain all the saber rattling about Iran? It certainly isn’t about Nukes… because we did nothing of the sort with North Korea who HAS nukes, and is just as, if not more, crazy than Iran. Ditto with India/Pakistan.

    1. JefeMT

      Y–T-L Thank you for providing my morning smile for the day! It’s all about oil, its about brown people, and I am disconcerted by the notion that five generations of convenient, empire-reinforced life in the first world has dulled our ability to conceive a 90 degree turn to a different future.

      Peace

  7. Paul Tioxon

    Phil,
    Putting together precisely what is going on within the black box at the commanding heights of capitalism is never easy. It is Kremlinology as mirror opposite, but I think you are onto to big shift within the energy industry and oil in particular. The industrial geography of oil refining in the US has not changed much since WWII. There are 4 nodes of production for oil: 1. NYC/Phila adjacent to ports. 2. Gulf Coast 3. West Coast of CA. 4. Mid-West

    2 points of interest are the closing of oil refining in the Philadelphia region by all of the major refineries present. Sunoco is completely exiting the oil industry as refiner and retailer. It is focusing on natural gas line development, transmission and export from the Port of Phila, for starters. How does this connect to Dark Reserves? We seem to importing as much oil but are about to shut down almost 5% of our national refining capacity. That would be a lost of 800,000 b/day of gasoline and other fuel refining lost in a national ecnonomy that uses about 18 million b/day of crude just to operate. Is some of the import going into some reserve and not being refined or has refining picked up utilization % to offset the complete loss of the Phila portion of the supply chain? That is a lot of refining capacity to put out of commission. Is demand that off, is it going into speculative reserves, not just in paper but floating somewhere off shore of Asia in idled tankers?

    http://articles.philly.com/2011-10-02/business/30235392_1_refineries-delaware-river-oil-facilities

    http://www.fas.org/sgp/crs/misc/R41478.pdf

    See p. 3 of the above link for map of refinery nodes and discussion of plant closing. This has got the Congressional Research office’s attention.

    The 2nd point of interest is natural gas. PA is politically turning into Texas in regards to the outsize influence of the Big Oil money pouring into gas drilling and politicians pockets, so much so, that gas is being extracted with absolutely no revenue going to the state, unlike Alaska or even Texas which raises some revenue with a drilling tax.

    This is not a drill: Pennsylvania works around Grover Norquist

    http://www.politico.com/news/stories/1111/69333.html

    Since Shell bought out the so called little guys, how much profit is coming not from crude but from natural gas? It is being drilled for all across the country with fracking technology. Is the move to electric vehicles and unstable Middle East supplies enough to finally move us off of crude oil and onto alternatives, unfortunately, natural gas as well as solar?

    1. Philip Pilkington

      Spot on. Cook pointed out that refineries closing down are a system of this Brave New World:

      http://www.nakedcapitalism.com/2012/01/chris-cook-naked-oil.html

      “We also see Petroplus, a major independent Swiss refiner, crippled by inflated crude oil prices, and shutting down three refineries because demand for its products has disappeared, and it can no longer finance crude oil purchases now that banks have pulled its credit lines.

      In my world, refineries closed due to reduced demand for their products imply a reduction in demand for crude oil: but not, apparently, on the Planet Hype of investment banks with funds to sell.”

      1. Jim Elliot

        Isn’t closing down refineries essentially the same idea as OPEC reducing production? Wouldn’t oil companies agreeing to reducing the production of gasoline (so prices could be forced up) be illegal under our “capitalist” system? Closing down refineries as a response to market conditions is just fine. What better way to get public/political support for decreased regulation, increased profits, war against Iran? So it seems to me markets are going to be manipulated, it’s just a question of who does it and why? Who do you want in charge? The oil and finance corporations or the oil and finance corporation stooges? I personally don’t see that the 99% have any real choices.

        1. rps

          Closing down refineries isn’t even diabolically original, rather a energy shortage move right out of Enron’s 2000-01 playbook of orchestrated rolling brown outs. What happened to originality or ingenuity? Are there no geniuses left on this planet?

          1. Paul Tioxon

            You know, if some people would take the time to read the info I provide for with links and page numbers to read, I mean, I slave over a hot lap top, I type and type without calling people stupid fucking assholes or stuff like that and this is how I’m treated? Like I’ve not said anything at all on topic?

            Just kidding.

            If you(not you Phil!)look at the Congressional research piece, the trend is that the US is losing refineries.

            According to their study, a decade ago, there were 158 refineries. Here is a part of the summary:

            “In response to weak demand for gasoline and other refined products, refinery operators have
            begun cutting back capacity, idling, and, in a few cases, permanently closing their refineries. By
            current count, 124 refineries now produce fuel in addition to 13 refineries that produce lubricating
            oils and asphalt. Even as the number of refineries has decreased, operable refining capacity has
            actually increased over the past decade, from 16.5 million barrels/day to over 18 million
            barrels/day. Cyclical economic factors aside, U.S. refiners now face the potential of long-term
            decreased demand for their products. This is the result of legislative and regulatory efforts that
            were originally intended, in part, to accommodate the growing demand for petroleum products,
            but which may now displace some of that demand. These efforts include such policies as
            increasing the volume of ethanol in the gasoline supply, improving vehicle fuel efficiency, and
            encouraging the purchase of vehicles powered by natural gas or electricity.” p. 2

            These numbers of refineries closed down do NOT include the loss of Philadelphia, which is well over half of all refining on the East Coast. The combined policies of the government to displace oil with ethanol, by at least 10 and now up to 15% plus forced increases MPG by EPA regs plus alternative electric cars, are forcing down demand for those reasons outside of the ecnomy sputtering or prices too high forcing people to public transit or god forbid walking. The government is simply squeezing oil out of the market through deliberte policy that has nothing to do with the market. The market is squeezing oil by other means.

  8. Pat

    Sorry, but I don’t see the logic in PP’s article.
    He claims that collapsing oil prices will hurt nonfinancial businesses, who will in turn cut wages.
    Actually, high oil prices are little more than a (largely regressive) tax on consumers and nonfinancial producers, who must pay higher prices for gas, heating oil and transportation. This tax goes to foreign countries and energy speculators (i.e. oil and financial companies). Sure, they may use these profits to buy US bonds and stocks, but most of it is used nonproductively.
    Wouldn’t an oil-price collapse greatly benefit general consumers worldwide, which would in turn boost demand for consumer goods and services? And wouldn’t it also decrease inflation? The liquidity crisis at the top (from decreased oil profits) would be more than offset by profits from increased consumer demand, which has a much greater multiplier effect.
    The only thing better (i.e. more stimulative and productive) than an oil price collapse would be to cut defense spending by one-half and use that money on stuff the US people really need.

    1. Philip Pilkington

      The collapse in prices would hurt profits because the nonfinancials are, as the WSJ says above, counteracting falling profits by increasing their financial profits (which are coming from commodity price inflation).

      Simple logic.

      I note the effects falling oil prices will have on consumers but I think the effects to corporate profitability will be more substantial.

      1. anon62453

        I actually agree with PP here: for much of the late 1990′s, SW Airlines was only making money from its “oil hedging” operations and not from its flight operations. When the market crashed, SW Air became far less profitable. That said, why isn’t, for example, Asian demand driving prices up as opposed to financial/contango schemes?

        1. Philip Pilkington

          I see this comment below too. The Chinese/India demand thing is a myth. Good investors have known this for years.

          Perhaps it was believable during the boom years, but the global economy has collapsed and prices are enormous. It doesn’t make sense.

          It’s similar to the idea that the backwardation in the markets at the moment is due to increased demand in the short-term. Look at the global economy right now. Look at Europe. You really think short term demand is on the increase?

          1. robert157

            It doesn’t make sense if you ignore the fact of ongoing depletion of some the world’s largest oil fields, which both you and Cook manage to do. What if loss in demand is canceled or outpaced by loss of production?

          2. Nathanael

            Indeed, the problem with this article is failure to consider the underlying phenomenon of peak oil.

            Obviously short term demand is down *and* long term demand is down.

            *But long term supply is also down*. That will immediately drive a speculative rush on whatever’s left, exacerbating the effects of long term supply being down, and swamping the drop in demand — price will rise.

            This will form a positive feedback cycle until the speculators realize that demand is down permanently and bail out. But at that point the long-term supply crunch will *still be happening*.

            A DB report I read recently said we would see high volatility in the oil market, with big price runups followed by busts, and in each case the resulting price after the bust would be higher than before, while the resulting global per capita demand would be lower. This seems about right. The endgame is when the world population stops using oil, at which point the price finally crashes for good along with the volume.

      2. Pat

        It may be true that many nonfinancials have invested in commodities (especially oil) as a hedge, but wage rates and hiring are more directly tied to general employment levels than to corporate profit levels.
        For instance, if the general employment level is effectively 20-25%, as it is now (including labor force discouraged and underemployed), then corporations can easily drop wages and increase hours. If the level is 5-10%, as it was in the early 2000s, then they can’t. In other words, corporations screw workers because they can, because the available labor pool is so large that they can replace anyone.
        Corporate profitability is mostly independent from hiring and wage levels. A corporation can and will increase profits using the excuse of the need to provide a security cushion during a recession, and justify it by the desire for stock buybacks and larger dividends to shareholders. More likely than not, a large proportion of profits will be passed out to corporate insiders as salary, or to shareholders as dividends. Corporations will not usually (or at least not now, when greed and croneyism is unchecked) pass along profits to workers in the form of higher wages or lower hours. Likewise, corporations will not necessarily cut wages simply because profits are down. They will cut wages only after looking at the replacement labor pool.
        Further, most Americans are employed by small businesses that are not hedging in commodities, so they would not be affected by decreased corporate profits.
        I think this WSJ “study” is a propaganda piece on behalf of Big Business to get the US government to keep intact the oil bubble and not to meddle by releasing oil reserves or bothering the big oil companies’ oil cartel. Don’t swallow it, Phil.

        1. Philip Pilkington

          “Likewise, corporations will not necessarily cut wages simply because profits are down.”

          Agreed. The early 90s were a good case study in this. And employment is mainly a feature of effective demand.

          BUT we don’t know what sort of an effect a profit crash could have in the current stagnant environment. I would say that many large corporations have kept themselves ‘ticking over’ by expanding their financial arms (into commodities). When they see this come to an end they will no longer be able to ‘tick over’. They will be in a situation where they must increase profitability or die.

          We see this in Ireland right now — where real depressionary forces are building. The companies simply have nowhere to run. So what do they do? Cut, cut, cut. This unleashes a deflationary wave and pulls down domestic sales even more.

          My hypothesis is that many US corporations are in the same position but they’re using their financial portfolios as life-support.

          1. Nathanael

            Indeed, but we quickly leave the realm of pure economics when we discuss depression spirals. The question of how we exit them is essentially political.

            Is it through a rich businessman single-handedly deciding to revive the economy through policies like Henry Ford’s (pay your workers enough to buy your product)? Unlikely. Is it through politicians providing New Deal? Well, it’s been done. Is it through bloody revolution and the execution of the capitalist running dogs? Well, that’s been done *several* times. Perhaps it’s through a demagogue who promises everyone military jobs and wealth by invading our neighbors. That’s been done too!

  9. JefeMT

    It seems Phil and Chris both gloss over or de-emphasize the demand-side of the equation. India and China wax and increase demand. 1st tier ‘cheap oil’ is exhausted, new sources are dirtier and more expensive. Estimated cost of production of a BBL in the Williston Basin is $70.00/ bbl. If we go to $40 or $45, it will, like the last time, be for a very short period of time, it MIGHT hurt a few, ON PAPER, it will not stay down long enough to spur on any sort of economic ‘recovery’. Here’s another equation: Less oil = more freedom.

    From the oil patch

  10. Stephen Neumeier

    This sentence captures your essay:

    “We have no way of knowing how much profitability is tied up in these dodgy markets – but my thinking is: a lot.”

    Your thinking might be accurate but I would prefer some data.

    1. anon62453

      This was my biggest problem with the piece as well. Aren’t there also Peak Oil theories and Asian demand theories that could also explain the higher prices?

      1. Philip Pilkington

        Dealt with the Asian demand theory above.

        The Peak Oil argument appears to me to be something of a cult. It is a negative and you cannot (dis)prove a negative. They can just keep pushing the date of Doomsday forward.

        I refuse to buy into an argument structured like that (i.e. that is True and can never be proved false).

        The theory laid out above may be false — I admit that and Chris admits it — but at least we will be able to see if it is or not in the next year or two (provided the US and Israel don’t attack Iran and cause chaos).

        1. Philip Pilkington

          Peak Oiler responded above with this:

          “Less oil = more freedom.”

          There’s a partisan bias in this argument. It is 90% ideology. It is, as an economist friend of mine said to me today, wishful thinking.

          I don’t buy arguments with such emotional overtones.

        2. Max424

          “The Peak Oil argument appears to me to be something of a cult.”

          A cult? Here are some basic and indisputable facts: the United States hit Peak Oil in 1970 (that’s four fucking decades ago), and the Carter Doctrine, spelled out thirt-two years ago, is nothing, if not a classic Peak Oil argument.

          And regardless of who has been in charge of the US last three decades, whether it was Reagan, Bush, Clinton, Junior, or Obama, US foreign policy has never dared to stray outside of the basic guidelines of the Peak Oil inspired Carter Doctrine.

          The United States, self-admittedly, is completely beholden to Peak Oil, and has been my entire life.

          Get a grip, man. You are looking at a knot in a tree while the forest consumes you.

          1. Philip Pilkington

            “A cult? Here are some basic and indisputable facts: the United States hit Peak Oil in 1970…”

            Very indisputable. I’m converted… *Cough* Self assertie-bullshit *Cough*.

          2. Paul

            Germany used 44 million barrels per year from before the war until we started breaking those synfuel plants. The US now uses about 19 million barrels per day, or over 150 times as much. German synfuels only partly compensated for reduced import purchases; four million barrels a year were taken from the Soviets rather than paying for them, and that was less pleasant than it sounds.

            It’s one thing to say that commodity prices have been driven up by financial factors, but assuming that static production and rising consumption in many countries is irrelevant goes a bit far.

          3. F. Beard

            but assuming that static production and rising consumption in many countries is irrelevant goes a bit far. Paul

            Thanks for those interesting figures. I’m not saying that static production is irrelevant; I’m just saying the problem is far from hopeless.

          4. Nathanael

            Philip, you have to learn about Peak Oil because you don’t actually understand it.

            First key point: it is better described as “Peak Cheap Oil”. The US hit it in the 1970s (this is easy enough to look up, look up the production figures), but of course oil is a world market. We have already hit it in the world market too.

            If you have looked at any realistic oil production curves which break out the oil production by *type* of oil production (gusher vs. tertiary vs. deep ocean vs. mining tar sands etc.) and attach the *cost* of that type of oil production, you’ll realize the truth of peak oil pretty quickly.

            Of course, the price effects of peak oil are *amplified* by speculators such as you describe — the DB report I mentioned describes the phenomenon in detail.

        3. Fiver

          Cook quite specifically said H1 2012. Saying “over the next year or two” renders this “prediction” worthless.

        4. Fiver

          Peak oil deniers have always deliberately left out the word “cheap” which Hubbert was at pains to make explicit. He never, ever said $300 oil would be unavailable any time soon, just that it would be $300 and climbing.

          It would be of interest to the American (and global) public to learn that the Iraq War(s) had nothing to do with actually securing oil (as in taking on the “burden” of controlling its development and distribution within the Empire), that it was only a completely unnecessary ruse to drive up the price (what’s a few thousand Americans and a million Iraqis when easy money is to be had through a major WAR? – until you find out just hitting “print” does the same thing) and that US oil companies plowing investment money into Iraq (and everywhere else) are about to lose their shirts due to, get this, a decline in inflation fears (the fears that drove this bubble, we are told) at the same time Central Banks are ALL “easing” in one way or other.

          This notion of an oil price collapse as the trigger, not the effect for a new financial crisis at THIS price and demand level is simply ridiculous unless it is US policy to crash prices – period. While it would doubtless please consumers, it would bring ruin to much of the world, and not least finish the job of killing the fight against climate change, global environmental degradation, and the vital requirement to transform to alternate sources of energy.

          Better induce some “fear” to keep that price up, right Ben? Right PP? Right Goldman? Right Russia? Right Exxon? Right Mexico? Right JPM? Right UK? Right Morgan Stanley? Right Canada? Right CFTC?

    2. Philip Pilkington

      There is no data. So, we cannot do anything but speculate.

      This is all a theory. But it is a theory that explains the rise in corporate profitability quite well. And I’ve been trying to do that for a long time.

  11. rps

    “Profits” are a in fact, a fairytale accounting. The financial sector’s “profits” from Goldman Sachs to Bank of America are due to the feeding at the gluttonous trough of taxpayer bailouts generously handed out by Greenspan, Bernanke, Paulson, and Geithner. All of these institutions would’ve sunk and remained in their watery graves next to Atlantis if not for the Christmas everyday for the criminals provided by the taxpayers and the Fed’s generous discount window. “Profits” due to the contraction of the labor workforce, lower wages, and off-shoring jobs to third world states without equitable compensation for their labor force is again not truly “profits,” but a scam to steal labor’s wages and upstream the stolen wages and compensation to the very few.

    Sorry to sound like a bore, but the truth is government makes or breaks all the financial institutions and corporations. Saving Goldman Sachs and burying Bear Stearns was Paulson’s choice to protect his alma mater and divide up BS and hide the toxic trash under the beds of the taxpayers and Bernanke’s complicity on the Fed’s books; not those books, the other books wink/nod.

    Oil companies cannot exist without the government’s assistance from fabricated wars, subsidies, contracts, government grants and research, and development, tax exemptions, and intervention such as BP’s oil spill. BP will never fully pay for the damage done.

    Again, the elected officials of government chooses the winners and the losers.

    Profits are a myth

  12. joecostello

    “This bubble, Cook argues, was inflated due to inflation fears after the QE programs undertaken by the Federal Reserve and the Bank of England.”

    This is a nice theory that has at best inconclusive facts. First, “oil markets” have to be talked about always with a great incredulity, as there haven’t been any since the days Mr. Rockefeller crushed them creating THE Standard Oil Company.

    Secondly, the price of oil(definitely manipulated by the oil industry as much as our pig financiers) crashed from its high in spring of 08 to winter 09, with the collapse of the global economy and thus demand.

    The real oil put was from Feb to June 09 when they brought the price up from $30 a barrel to over $60, an increase of 100%, where it stayed in the mid-60s range like a rock for well over year. Many take, at least, mid-60s as marginal price to produce a barrel these days. In Fall 10, prices continued a new rise, along with the Fed’s QE2 is right, but the price stayed in lock step with commodities and other assets, so how different than from any other commodity in that regard?

    The most interesting thing is how the price of oil in the last couple months has decoupled from most other commodities and now stays above $100 a barrel, which is detrimental for the US economy. Are you and Mr. Cook saying oil has become the only inflation hedge?

    Yes the price of oil is manipulated, and it good to see the poor boys on the Street have finally gotten their fingers in it, but there are a lot bigger problems with oil than that, the oil industry itself being number 1.

    1. Philip Pilkington

      “Are you and Mr. Cook saying oil has become the only inflation hedge?”

      No. All commodities have become inflation hedges. Cook simply thinks that oil will be the first one to blow. (Perhaps taking the rest with it?)

  13. David C Macemight finally sieze up.

    my ? is based on the Bernake&Co way
    Cleraly the lessons he learned from his long study of the mstakes in ~1930 is that what you have to do to revent a full scale depression is save the finance system
    The real economy can still be left to recover slowly over time
    If the finance capital sector loses its last renmaining soucres of bonanza profit(commoditiy speculation/hedging) its extant insolvency is going to be seriously threatened with exposure. That cannot be allowed to happen or the finance sector

    1. David C Macemight finally sieze up.

      may in fact sieze up.
      Ergo – war with Iran (not ground troops of course) may be the only solution.

  14. Susan the other

    I keep suspecting that the real cause of the 2008 crash had little to do with MBS, which might still be holding together as investment instruments if the bubble in commodity investments – and their derivatives – had not occurred. Why did Hank Paulson tell Sarkozy and Legarde in early 2007 that it would just take a few months for the markets to “reprice”? Why did Legarde say it would be a deluge? There is more to this entire episode than will ever meet the eye. The perception that commodities would become scarce has been there since the 80s with everyone looking nervously at India and China. I get the feeling that this whole depression we are in is in fact a controlled, slow motion crash. And going forward, markets and prices will be forever controlled.

    1. Lambert Strether

      “a controlled, slow motion crash”

      That’s my feeling, too, Susan, looking at our situation from the standpoint of the employment numbers. Permanently higher DISemployment looks like a successfully achieved policy goal, to me.

    2. Nathanael

      “And going forward, markets and prices will be forever controlled.”

      Nope. This is the intentionality fallacy. They didn’t plan any of this. The elites *had* a plan, but their plan isn’t going according to plan.

      The elites are much stupider than you think. The current situation is unsustainable and will collapse rapidly and violently. Markets and prices will not be controlled — rather, the markets as we know them will largely cease to exist.

    3. Jonus

      We may just end up stuck with a higher “Norm” when it comes to unemployment in the US. Certainly if people have changed their consumerism from the “rabid” to a more sustainable “fanatic” mindset, what’s going to pick up the slack?

  15. Hugh

    Who knows, this may even inspire what has come to be called the 1% to focus their attention on the problems that have arisen in the global economy in recent months – for they have been truly burying their heads in the sand for the past three years.

    I think the whole premise is mistaken. Our elites don’t do reform. They don’t apply the brakes. Face it if these were really options for them, they would have already made use of them.

    Our elites loot. That’s all. They are not a uniform, centrally organized group. They do not split the loot equally among themselves. There are relative winners and losers, and some outright losers, among them. But there overall dynamic, as we saw in and before the 2008 meltdown, is to loot to a crash and then loot the crash.

    In the intial downturn, they lose along with everyone else, but the rate of their losses is less than among the 99% and their bailouts are hugely larger. In the aftermath of the crash, they come out somewhat poorer but relative to everyone else they control more of the financial pie and their politic control is increased.

    The key to understanding and action here is that this is a thoroughly criminal enterprise. Our elites are not going to wake up and change their ways. They are awake and they do know what they are doing. They are building a new feudalism where they are the lords and we are the serfs. The only option we have other than accepting the fate they have ordained for us is to replace them and their system, root and branch.

    This is also the mistake those make who now cheer on Ron Paul. It is the same mistake the cheerleaders of Kucinich and Sanders make. This is not about replacing some bad actors. It is not about more and better this and that of what we already have. The whole lot have to go, every. last. one. of. them.

    1. Lambert Strether

      Our elites always double down on #FAIL.

      Because “fail” for us is not fail for them. At all. So, no “head in the sand” to begin with.

      UPDATE If Ron Paul were not one of them, he’d be calling for the banksters to be prosecuted for accounting control fraud. He’s not doing that. Hopey change 2012, but from the right.

        1. F. Beard

          Fasting is good for one. BF could have spared a few pounds :)

          Also, Ben Frankling is not a very good spiritual guide, imo. I find he contradicts the Bible in spots.

          1. F. Beard

            As for the Bible, it contradicts itself. Nathanael

            Sometimes within two adjacent sentences!

            Answer not a fool according to his folly, lest thou also be like unto him.

            Answer a fool according to his folly, lest he be wise in his own conceit. Proverbs 26:4-6 King James Version (KJV)

            Actually, I find the entire Bible, both OT and NT, consistent.

            A long time ago, in my college days, I had only one working music cassette for the 255 mile drive home. It was a 3-piece jazz tape – piano, drums and bass. Anyway, I hated that tape the first dozen or so times I listened to it. But I had no choice so I kept listening. Eventually, I came to love that cassette.

      1. F. Beard

        If Ron Paul were not one of them, he’d be calling for the banksters to be prosecuted for accounting control fraud. Lambert Strether

        His call for a return to the gold standard would also help bankers. And we know how Austrians love deflation “to purge the malinvestments”.

    2. Jill

      Hugh I also feel the same way. I also agree with Susan the other and Lambert’s analysis. I was just thinking about this when I heard about all the sanctions being put on Iran.

      I think demand for oil is low. People are too poor to buy that much, many cannot afford a tank of gas. Companies that actually produce goods are going under, so they don’t need it. A sane leadership would have seen this was happening and taken care of it. With the kind of money they blew they could have created a large number of jobs that paid well and need doing ie:-alternative energy, a new grid, environmental clean-up for starters. But doing something would actually make things better for the vast majority of people isn’t in the plan. It’s simply about looting.

      So the price of oil was getting a little low. How to fix it? Well Iran of course. That’s why we see all this propaganda about how those evil doers in Iran are getting the bomb. You’ll see that in the NYTimes as well as in both left and right wing newz outlets. Iran needs to be prevented from selling their oil or at least people need to think they can’t sell their oil–the price of oil goes up right on cue. A profit is made.

      They’ll go to war with Iran if they want to because Armageddon is a money maker. I respect Larry Wilkerson but I don’t agree with him on this. We hardly need a draft. That’s why we’ve been moving to mercenaries for years now. We currently have nearly a 2/1 ratio of mercenaries to regular forces. Other of our forces are as hidden in the budget as the barrels of oil. They are our “dark forces”.

      No this stops when we do what you say Hugh or it will stop when the earth and its people have been stripped of everything.

    3. Nathanael

      “I think the whole premise is mistaken. Our elites don’t do reform. They don’t apply the brakes. Face it if these were really options for them, they would have already made use of them.

      Our elites loot. That’s all.”

      Ding ding ding! We have a winner!

      The key point is that they are such short-term thinkers that they will, eventually, destroy the very legal system which allows them to retain their loot, and destroy the very sources of profit (manufacturing, agriculture, services) which they “own”, and eventually destroy the support of the military and police forces which protects their loot. They will inevitably destroy themselves.

      The trouble is, they’re taking the entire system down with them. The question is what will replace it. Feudalism is a likely possibility, but *they* won’t be the feudal lords — any warlord could knock them out in a trice, and once they’ve destroyed the system and alienated the security forces, warlords WILL do that.

      We would rather establish an alternative successor to the existing system: a social democracy, or something. If we don’t get a huge number of people solidly ready to back such a system, warlords will fill the vacuum.

  16. kevinearick

    So, I ask my ignorant nephew why he keeps asking me when I tell him no every single time and his response, because everyone else gives in, sooner or later, is the market assumption – irrational markets outlast rational investors. Knowledge is presumptuous by nature.

    The good old boy and girl networks in Mass and DC remain unconvinced that no means no. Let’s warm up the motor…

    The Traveling Salesman Problem, Part Infinity

    Krugman/NY Times: “First, families have to pay back their debt [ask Trump]. Governments don’t – all they need to do is ensure that debt grows more slowly than the tax base [of, by, and for the people]… Second – and this is the part almost no one seems to get – an over-borrowed family owes money to someone else [future generations]: US debt is, to a large extent money we owe ourselves [exactly who is we].”

    Under the empire demographic ponzi assumption of agency proprietary participation, money is free (speech), the only difference between limousine liberals and social conservatives is the temporary destination of embezzlement, and that the family (new) serves at the pleasure of government (legacy). Really, really bad assumption.

    What happens when the real tax base (income) can no longer be measured and must be replaced by monetary expansion (RE price inflation) into make-work for robots (govt. employment) to produce balance sheet leverage? Are Apple sales organic growth or system cannibalization? Is there such a thing as a private corporation within the Constitution or under common law? Why can’t China buy male progeny to balance its population?

    Authority/talk always comes from behind. Of all the Admirals’ sons, the Senator should know that best. If the empire cannot convince you that you are helpless, it must compete for your cooperation. The empire prison is built with a printing press and its blood pressure may be measured by the price of energy.

    Energy on the margin is free; it existed long before the empire. The transmission start-up cost is empire modification. Don’t worry about Iran /core detonation / empire MAD. Economics is like Judo; the planet has an automatic recycling mechanism. Employ ignorance against itself.

    Free money demands viral population growth, disconnecting the empire from the planet at the tangent. Always schedule completion of the root and communication vehicle by the time population growth decelerates.

    Law evolves to root out non-conformers, creating fat tails. One it sees; the other it does not. You do not have to break a single law to think, which is why empires employ Family Law embedded in common law to create a catch-all.

    The empire pays consumers to liquidate investors, for empire growth. There is no such thing as organic empire growth. As we observe increasingly nonperforming assets hang declining participation, driving the market…

    Municipal bankruptcy recasts debt, leaving the banks to blow up. As a security asset/threat, intelligent non-conformers providing the organic growth, with no interest in cheap empire crap, are taxed at 100%, so the firefighters can grow pot, the police state can protect them, the banks won’t go broke, and their feminist wives can run non-profits, to which the non-conformer is assigned as a dishwasher in the churn pool, leaving the children to empire discretion. Invest accordingly.

    70% of kids are directly dependent upon government. Most of the rest are indirectly dependent. Printing money to tax it through agency delay, paying off the elder majority, as the basis to print more money is not an intelligent process; it’s gravity. Empires are like cheap magicians with ever more expensive diversions, encouraging the coordinated applause of black holes seeking each other’s company.

    Once unelected agency rolls out non-personhood through Family Law, there is nothing left to balance the positive feedback, and it implodes. The planet sees the fat tail, because it is fully engaged.

    The university is a fraud. Why wouldn’t you expect a student loan crisis? The issue is timing of recognition.

  17. frank c

    I would highly recommend anyone really interested in this topic to buy and read Daniel Yergin’s new book “The Quest”. Yergin is a preeminent oil analyst and takes you through oil throughout the world including capacity, history and geopolitics. It is a substantial book and absolutely capitivating.

    He also acknowledges the financialization of oil and commodity funds, pools and etf’s and their impact on prices.
    And how brokerage houses and speculators have changed the market. And of course the OPEC cartel.

    As for oil prices, keep in mind oil was at $10 a barrell in 2004. And when the market crashed in 2008 it went from $140 down to $38.00.

    I would also encourage one to look at the Natural Gas pricing. Today it is below $2.70 and looks like it is going to $2.00. It was over $9.00 not long ago. The fracking and shale finds have created a glut. Hard to believe.

    The WTI & Brent oil price have a very good war premium built into them. The demand does not substantiate the current price and looks very overbought. Interestingly that the dollar has rallied and oil increased. When historically this is the opposite.

    As for the financial sector profits, I would like to see them back out the bank stock profits as well as see what the net figures really look like. Those profits are still based on mortgages marked to make believe instead of taking the proper allowances for loan losses.

    Very interesting times we live in. Or as Bill Gross recently wrote – the paranomal.

    1. Fiver

      Oil was last at $10 briefly in the late ’90′s. This set of graphs and analysis make clear the connection between oil and Gulf “crises” – but also note the enormous ramp after 2000. Note that oil took off at the same time Greenspan blew the last phase of the Internet Bubble (Y2K), then hit the panic button after the Internet bust and 9/11. Note there is no sign whatever that loss of Iraqi production even registered.

      http://www.wtrg.com/prices.htm

      Bernanke deliberately set out to reflate this and other bubbles. That was about the stupidest move one can imagine. The author’s (and Cook’s) analysis suddenly sees Bernanke and other Central Banks changing their spots – or are they looking for yet another excuse to print?

      1. F. Beard

        Bernanke deliberately set out to reflate this and other bubbles. Fiver

        A problem with our money system is that the incentives are wrong. Those who create money (the government and banks) are NOT the ones that suffer if the money supply is mismanaged – at least not in the short one.

    2. Nathanael

      There are two phenomena in oil prices: the long-term trend and the short-term volatility (bubble/bust) overlay.

      The short-term volatility is larger than the long-term trend.

      This will be familiar to anyone who has studied the stock market.

  18. Because

    A commodity crash would help the old sectors of the US economy and probably outpace the loss in the energy sectors, though it would create some problems globally. The economy is far from “horrible” right now.

    The bubble orginated from Chindia. If they go, the liquidity of the bubble goes.

  19. Chris

    Great piece, but the associated bubble is your stock market. Price to earning ratios remain well over their long term average and has been propped up only by the huge bailouts which your Government decided were necessary. US stocks are expensive and must fall in value.

    The Accounting profession has been moving for many years to mark to market or fair value for all assets and liabilities on the balance sheet. Corporate America has stuck a great big stick in the wheels of this movement. The result, the numbers in the income statements and balance sheets of corporations in the US cannot be relied upon.

    A lot of this ‘profitability’ is pure bullshit and the reckoning day is coming. If your investments hold red ink, you cannot hide this indefinately.

    Watching America decline is facinating – I would never have believed this could ever happen – but when governments get into bed with criminals, it is the people who can least help themselves that get screwed and you are all being screwed royally.

    Who wants a Green Card – anyone??

    1. Nathanael

      Well, there are now more people moving from the US to Mexico than the other way around. So, indeed, who wants to move here? Not many.

  20. Fiver

    I cannot believe that PP is making this argument. He, along with the bulk of presenters at NC have been calling for all-out Central Bank (ECB and Fed in particular) “easing” in this DEFLATIONARY (so we’re told) environment and now we’re supposed to believe the huge ramps in commodity prices were about “fear” of an inflation which for some strange reason showed up IN COMMODITIES, STOCKS, and emerging markets only? We’re supposed to ignore all those millions of sets of “investor” eyes popped out with $$ signs by the sight of Fed free-money Greedballs? That is a hoot. There’s a great big difference between fear of inflation eating your savings, and the prospect of huge returns in commodities – or a pension fund that MUST make its 8% make-believe return.

    Cook explicitly argued for a burst in H1 2012. Unless specifically engineered by the US Government (not impossible), the only way a bust is in the cards is some REAL fear, and that of a meltdown in Europe or China forcing very large asset liquidation. And THAT only happens if engineered by Wall Street as part of the general stripping of European assets already underway. I’ve previously posted a piece from Morgan Stanley that calculates Europeans will have to liquidate $3 trillion at depressed prices. All of this, though, supposes the Fed and ECB just stand by and watch, rather than immediately intervene to prop them up yet again – which is why so many people think it was idiocy to begin with, given the new money goes through the most crooked hands on the planet before it comes anywhere near the real economy.

    It’s not that I disagree that oil and commodities are not TODAY too expensive by roughly 20%, or that Bernanke did not deliberately re-flate these bubbles. It’s the incredible inversion of the explanation of WHY those assets (and financial assets) soared that freaks me out. Fear of inflation? Less than 3% annual losses over 3 years vs first doublings, then high double digit returns? Fear that is that lucrative ought to be bottled.

    As for corporate profitability, let’s not forget that they fired millions, competitors were destroyed, closed all their own less-productive facilities, unloaded pensions and other benefits on top of slashing wages, availed themselves of ultra-freebie Federal tax and accounting treatments that were even more obscene than pre-crisis, and finally that they re-financed mountains of debt at ZIRP levels.

    What might be worth keeping an eye on is what is now showing up in Europe, which is huge corporate cash reserves being loaned to banks – there is an awful lot of money available should this get underway in earnest and start to really crank-up the shadow banking system.

    Anyway, it’s true there is a potential short-term (2-3 years) supply glut in the offing, though, as previously stated, that does not mean ultra-cheap oil – there are too many important countries that MUST have that revenue for it be too low too long. And of course, if Bernanke hits the floor with QE3, you can chalk in $120 at least, and maybe $130.

      1. Fiver

        Just re-read all this and have to ask myself what sort of person as a matter of routine pops all those who disagree with him into the category of “cultist” (how many ARE there by the way: you’ve named Marxists, Libertarians, orthodox economists, any religion, and Peak (Cheap) Oil advocates in the past 2 months alone and I don’t read every piece), a “conspiracy” type (let me guess, you actually believe the official 9/11 story), or otherwise simply piss on readers who dare question various bald assertions, eg., that there is no problem with the Japanese or Chinese financial systems/economies, there is no problem with shrinking resources and galloping environmental destruction in the decades directly ahead (which means act now or reap the whirlwind) in part driven by the not-problem with massive over-population, that there is no problem with paying people to piss into the wind indefinitely pretending that it’s “work” because humans can create wealth out of nothing as easily as creating electronic money? Who, on top of it all, touts a money theory which is as useless as a 5-cornered stool unless willingly adopted by the US-based global financial/power elite (only some sort of “cultist” could actually believe they will NOT yield power except via some sort of revolutionary upheaval) in which case it will not long be a theory worth advocating.

        You toss out a highly speculative piece you admit is an evidentiary puffball, including the notion that world markets which you argue are highly manipulated for financial gain (as they of course are – but by people who in your idiosyncratic universe completely misunderstand that the huge profits accrued were fear-driven, not greed-driven, are doubted here and there, then assign everyone who does so a dismissive label along with a sneer. What exactly IS your problem?

        You have your language for conveying what you believe is happening and is going to happen, and I, as a life-long socialist and student of a range of human events, have mine. I will stack my assessment of what goes on in this world against yours any day of the week. Now you’ve got my attention.

    1. Philip Pilkington

      “As for corporate profitability, let’s not forget that they fired millions, competitors were destroyed, closed all their own less-productive facilities, unloaded pensions and other benefits on top of slashing wages, availed themselves of ultra-freebie Federal tax and accounting treatments that were even more obscene than pre-crisis, and finally that they re-financed mountains of debt at ZIRP levels. ”

      This is complete crap. ALL the publications noted above recognise the simple fact that THE UPSHOT IN PROFITS CAME FROM THE FINANCE SECTOR.

      Simple.

  21. kingbadger

    This needs to be a log scale:

    http://www.nakedcapitalism.com/wp-content/uploads/2012/01/Screen-shot-2012-01-12-at-1.49.13-AM.png

    The linear scale makes the last decade look like it had a massive boom in finance profits compared with previous decades, but the actual increase seems similar to what happened in the 70s/80s/90s, a doubling in each decade. I can’t compare it with the 50s and 60s properly, since the linear scale becomes too bunched up. Death to linear charts.

  22. Jonus

    First of all, I don’t buy into the “Peak Oil” myth. Why do you think the Arabs never state how much oil they have? Becuase theres too much of it. Secondly, if the oil market collapses, it will create an economic boom. Anyone who understands that oil is the essential ingredient in man’s recent spectactular industrial rise (the past 150 years), understands that cheap oil will grease the wheels of economic growth.

  23. greg gerritt

    Interesting article to be sure. But it leaves out ecology. I agree with the idea that al Wall St can do is create bubbles and skim them, but I also think that real growth is dead due to the collapse of ecosystems, so we have to use less and share more.

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