10
Jul
09

Oil prices are a leading indicator

A lot of people I know think I am a bit daft for my insistence on an economic doom and gloom perspective. They were more convinced of it before the credit crunch and now are starting to think so again since I am still saying that things are going to crash horribly while others are talking about green shoots and the worst being over. Of course, they are ignoring certain fundamentals. One key is my oft repeated phrase “Physics trumps economics every time”. What this means, is that in order to increase the wealth of a society, that wealth has to come from somewhere. You can create the illusion of wealth with credit, but that can only last for a little while. Credit means you can buy more DVD players and flat screen TV’s and even food, but without increasing the amount of raw materials a society has access to you haven’t really increased wealth, just an illusion of wealth.
In fact, what has happened is that the store of raw materials has pretty much hit stagnation but at the same time consumption keeps going up, meaning that there is less of everything to go around. When that happens, your economy is bound to fall apart eventually.
A little thought experiment: There is a group of people and they all smoke cigarettes. Now, that group consists of ten people, and a hundred cigarettes come in a day. For a while, they are all smoking nine cigarettes a day, then a couple of them increase the amount they smoke. Not a big deal at this point – the couple of people have only gone up to 11 cigarettes. Sure, the groups surplus is a little bit lower, but they are doing fine, steadily accumulating a surplus, and since they are rotating the surplus nothing is going bad. Now, a new guy joins the group. Now you have a hundred cigarettes a day, divided 11 ways. In a fair world each would get 9.090909091 per day. They could take the excess and store it. Now, with a couple of people taking more you have a deficit, so you have to start drawing down from the stores. At this point you could either have the couple of guys smoking 11 cigarettes cut down, or you could see your stores shrink to nothing over time, or you could have some of the people who only smoke nine cut down. Now, you add a twelfth person… things are getting bad for the stores, but no-one has cut down. Eventually, the stores are empty. Now, the guys who smoke 11 are pretty well liked, and they swear they will cut down, but they need to keep smoking 11 for now… they will cut down soon. So, they keep getting 11 and the rest of the group starts cutting down. Eventually, if you keep adding people the supply will be so low that everyone who isn’t one of the two guys who smoke 11 gets pissed off and cranky, in a constant state of withdrawl (because if they quit they are out of the group… or if you replace cigarettes with food – dead) and things start to break down, fast.
This is pretty much how things have gone with us. The west has been taking more than our fair share for decades, even as the overall pool of resources has not increased and the number of hands reaching into that pool has gotten much larger. Now, we have been buying our lifestyle on credit, basically promising that we will start dropping more into the pool later, but now people have started to figure out that there just isn’t more that can go into the pool.
The big thing that ran the pool was oil. Oil is the single most important thing in the pool, because you can decrease almost anything else in the pool in a given area, and increase the amount of oil and it balances. Once the oil starts to stagnate, you just can’t substitute the shortages any more. You need to have fertile soil or oil based fertiliser. You need to have local food production or oil to transport remote goods to your location. Interestingly, you can see that the price of oil leads the stock market. It has the same permutations, but they are exaggerated in the market as a whole (each bump in the price of oil is massively larger in the overall market). This is simple and logical given the role oil plays in our society.

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1 Response to “Oil prices are a leading indicator”


  1. December 12, 2009 at 4:45 am

    I highly enjoyed reading your article, keep on creating such interesting articles.


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