The world is experiencing the worst economic recovery since the Great Depression. So why is oil hovering around $100/bbl? And as a gold investor, why should you care about oil?
Some might point to developments in the Middle East as the reason for
high oil prices. However, I believe the root cause of current Middle
East angst is the steady depletion of easily accessible oil and,
consequently, government revenues needed to quell the population.
Everything that is happening across the Middle East — citizen revolts,
government crack downs, production disruptions and oil price inflation —
tells me the world may have crossed the point of peak oil.
I don’t think the world will run out of oil anytime soon. However,
based on the advice of expert geologists, I do believe that a) the world
is running out of inexpensive oil and b) global demand is pressuring
Given these pre-conditions, it is my view that the world has entered a
new boom-bust cycle driven by oil prices. Oscillating oil prices — as
opposed to credit cycles — will repeatedly stimulate and crash the
highly levered global economy. Governments have not recognized this new
cycle, and as part of a fruitless effort to retain control over
deteriorating real growth and rising unemployment central banks will
print more and more money, risking a hyperinflationary depression
(stagflation at best). The only respite for many investors is gold.
The 2008 Financial Crisis was the First of Many
During the last thirty years debt has spread like a cancer throughout
the developed world. Today’s consumption was financed by tomorrow’s
higher revenues, creating a vicious cycle between growth and the need
for debt. This system worked as long as growth needed to repay expanding
credit could be subsidized by inexpensive energy.
Unfortunately, rising oil prices have stealthily and persistently
chipped away at the foundation of our heavily indebted financial system.
Ultimately, in 2008, oil prices and total debt passed the threshold
beyond which the economy could not operate, and the financial system
came crashing down. With collapsing demand, oil prices fell.
Many mistakenly point to sub-prime mortgages and CDSs as the cause of
the 2008 crisis — I believe they were merely the transmission
mechanisms. In reality, rising oil prices eroded the weakest links in
the increasingly levered global economic system.
Enter the Central Banks
As we’ve witnessed repeatedly since Richard Nixon suspended dollar
convertibility into gold, the Federal Reserve solves all economic
problems with the monetary cure-all. Either by using the proverbial
helicopter or the Treasury as an intermediary, central banks have
repeatedly pumped liquidity into the economy and bought bad debts from
the private sector. This effectively transfers the bad debt to the
taxpayer by way of liability and currency debasement. In addition,
fiscal policy (which is often the hand maiden of monetary policy) adds
additional public sector debt in the name of stimulus. In whole, debt
burdens and money supply rise. Of course, all this is done under the
assumption that the economy will somehow be able to repay these new
debts through future growth.
In the new boom-bust cycle driven by oil prices, the central banks
are unknowingly impotent. As the economy crashes, they print money to
stimulate economic activity, but it is short-lived and inflationary.
More stimulative is the lower oil prices caused by the crash. However,
any renewed growth and inflation sends oil prices back up towards
another threshold, once again breaking the weakest links of the
economy…and the default-bailout-growth cycle repeats.
Right now, oil price inflation is most noticeable when we fill up our
gas tanks. But as high oil prices become pervasive throughout the
economy the destruction of aggregate wealth will intensify. This will
increase the number of weak links throughout the economy. It will also
increase the sensitivity of those weak links to higher oil prices —
another vicious cycle.
Consequently, as the default-bailout-growth cycle repeats and rising
oil prices become more omnipresent, periods of economic growth become
weaker, and periods of economic bust more frequent and persistent.
Eventually, as the cycle repeats, the sharp economic contrasts of boom
and bust blend together becoming a permanent shade of economic grey.
Saved by Gold
As they did in 2008, central banks will print money to bail out
collapsing financial infrastructure and support a growing mass of
unemployed. While each cycle may begin as a deflationary shock, causing
gold prices to decline, the eventual monetary response will destroy
currencies and send gold prices soaring. This has already started to
Unless high ROI replacement energy sources are found, over the
long-run this cycle could turn into a hyperinflationary depression, as
central banks naïvely fight a losing battle. Savings could be wiped out
as the value of paper currency plummets, and in the new boom-bust cycle
one of the few ways to protect wealth over the long run may be to own