2013: Beginning of Long-Term Recession?

We have been hearing a lot about escaping the fiscal cliff, but our problem isn’t solved. The fixes to date have been partial and temporary. There are many painful decisions ahead. Based on what I can see, the most likely outcome is that the US economy will enter a severe recession by the end of 2013.

My expectation is that credit markets are likely see increased defaults, as workers find their wages squeezed by higher Social Security taxes, and as government programs are cut back. Credit is likely to decrease in availability and become higher-priced. It is quite possible that credit problems will adversely affect the international trade system. Stock markets will tend to perform poorly. The Federal Reserve will try to intervene in credit markets, but if the US government is one of the defaulters (at least temporarily), it may not be able to completely fix the situation.

Less credit will tend to hold down prices of goods and services. Fewer people will be working, though, so even at reduced prices, many people will find discretionary items such as larger homes, new cars, and restaurant meals to be unaffordable. Thus, once the recession is in force, car sales are likely to drop, and prices of resale homes will again decline.

Oil prices may temporarily drop. This price decrease, together with a drop in credit availability, is likely to lead to a reduction in drilling in high-priced locations, such as US oil shale (tight oil) plays.

Other energy sources are also likely to be affected. Demand for electricity is likely to drop. Renewable energy investment is likely to decline because of less electricity demand and less credit availability. By 2014 and 2015, less government funding may also play a role.

This recession is likely be very long term. In fact, based on my view of the reasons for the recession, it may never be possible to exit from it completely.

I base the foregoing views on several observations:

1. High oil prices are a major cause of the United States Federal Government’s current financial problems. The financial difficulties occur because high oil prices tend to lead to unemployment, and high unemployment tends to lead to higher government expenditures and lower government revenue. This is especially true for oil importers.

Figure 1. US Government Income and Outlay, based on historical tables from the White House Office of Management and Budget (Table 1.1). *2012 is estimated. http://www.whitehouse.gov/omb/budget/Historicals

Figure 1. US Government Income and Outlay, based on historical tables from the White House Office of Management and Budget (Table 1.1). *2012 is estimated by OMB. http://www.whitehouse.gov/omb/budget/Historicals

2. The United States and world’s oil problems have not been solved. While there are new sources of oil, they tend to be sources of expensive oil, so they don’t solve the problem of high-priced oil. Furthermore, if our real economic problem is high-priced oil, and we have no way of permanently reducing oil prices, high oil prices can be expected to cause a long-term drag on economic growth.

3. A cutback in discretionary spending  is likely. US workers are already struggling with wages that are not rising as fast as GDP (Figure 2). Starting in January, 2013, US workers have the additional problem of rising Social Security taxes, and later this year, a likely cutback in government expenditures. The combination is likely to lead to a cutback in discretionary spending.

Figure 2. Wage Base (defined as sum of "Wage and Salary Disbursements" plus "Employer Contributions for Social Insurance" plus "Proprietors' Income" from Table 2.1. Personal Income and its Distribution)  as Percentage of GDP, based on US Bureau of Economic Analysis data. *2012 amounts estimated based on part-year data.

Figure 2. Wage Base (sum of “Wage and Salary Disbursements” plus “Employer Contributions for Social Insurance” plus “Proprietors’ Income” from Table 2.1. Personal Income and its Distribution) as Percentage of GDP, based on US Bureau of Economic Analysis data. *2012 amounts estimated based on part-year data.

4. The size of our current financial problems, both in terms of US government income/outgo imbalance and debt level, is extremely large.  If high oil prices present a permanent drag on the economy, we cannot expect economic growth to resume in a way that would fix these problems.

5. The financial symptoms that the US and many other oil importers are experiencing bear striking similarities to the problems that many civilizations experienced prior to collapse, based on my reading of Peter Turchin and Sergey Nefedov’s book Secular Cycles. According to this analysis of eight collapses over the last 2000 years, the collapses did not take place overnight. Instead, economies moved from an Expansion Phase, to a Stagflation Phase, to a Crisis Phase, to a Depression/Intercycle Phase. Timing varies, but typically totals around 300 years for the four phases combined.

It appears to me that the corresponding secular cycle for the US began in roughly 1800, with the ramp up of coal use. Later other modern fuels, including oil, were added. Since the 1970s, the US has mostly been experiencing the Stagflation Phase. The Crisis Phase appears to be not far away.

The Turkin analysis started with a model. This model was verified based on the experiences of  eight agricultural civilizations (beginning dates between 350 BCE and 1620 CE). While the situation is different today, there may be lessons that can be learned.

Below the fold, I discuss these observations further.

Issue 1. High oil prices tend to lead to government financial problems.

Food prices tend to rise at the same time as oil prices, partly because oil is used in the production of food (for example, plowing, irrigation, herbicides and insecticides, harvesting, transport to market). Also, because oil is in short supply, corn is now being grown for use as ethanol to be used as a gasoline-extender. Growing additional corn puts pressure on food prices, because it drives up the price of land and encourages farmers to put more land into corn production, and less into other crops.

The reason governments are affected by high oil and food prices is as follows. When oil and food prices rise, buyers cut back in discretionary spending, so as to have enough for “basics,” including food and commuting expenses. Workers are laid off in discretionary industries, such as vacation travel and restaurants. These laid off-workers pay less taxes, and sometimes default on loans. Governments are quickly drawn into these problems, for two reasons:

  1. Their tax revenue is lower, because of layoffs in discretionary sectors.
  2.  Their expenditures are higher, because of the need to pay more unemployment benefits, provide economic stimulus, and bail out banks.

Oil importers are especially affected, because they are also paying out funds to oil exporters. The countries with well-publicized financial problems (including several European countries, the United States, and Japan) tend to be major oil importers.

Oil exporters are not adversely affected to the same extent, because they have  additional revenue from higher prices on oil they are exporting. They may still be somewhat affected because of rising food prices, and the fact that higher oil revenues do not necessarily go to those buying food. A recent study shows that food shortages helped trigger the Arab Spring protests.

Part of the reason that the impact of high oil prices is as severe as it is, is because there are many follow-on effects. For example, if oil prices rise, the price of shipping goods of all types rises. If businesses are able to pass through these higher costs, discretionary income of buyers for other goods falls. If not, businesses find that their higher costs lead to lower profits. To bring profit margins back up to an acceptable level, businesses may lay off workers.

As another example, prices of homes are likely to be adversely affected by high oil prices, because a family with inadequate discretionary income will forgo moving to a larger home, and may even default on a mortgage.

It should be noted that the impact of high oil prices doesn’t completely go away unless oil prices go down and stay down. Businesses can partly mitigate the impact of high oil prices by laying off workers in discretionary segments. Some businesses will fail completely, however. Replacement may be by an overseas company, with a lower cost structure that uses less oil. See my post on energy leveraging.

Workers generally must permanently adjust their budgets to higher food and oil prices. This is often difficult to do. The lack of jobs is a particular problem–something that workers cannot fix by themselves. Government programs can mitigate the job shortfall, by paying benefits to unemployed workers and by reducing interest rates, so that businesses can more easily make investments that will lead to more employment. These programs are costly, though, and are a major  cause of the current mismatch between government income and expense.

Issue 2. World oil problems have not been solved.

There have been a number of reports this years, such as one by the International Energy Agency, seeming to suggest that the world oil problem has been solved. These analyses are incomplete. They do not recognize that our real problem is a financial problem. Our economy (everything from interstate highways to electric transmission to Social Security programs) was put in place using cheap ($10 or $20 barrel) oil. Shifting to today’s high cost of oil (up near $100 barrel) causes severe economic dislocations. There is no more cheap oil to be found, however, because oil companies extracted the cheapest to extract oil first and now the “easy oil” is gone.

The impression one gets from reading the papers is that US oil production is having a huge impact on world oil production. If a person looks at the numbers, world oil production is close to flat. Rising US production makes up for falling European production, but doesn’t do a whole lot more.

Figure 3. World crude oil production, based on EIA data. *2012 estimated based on partial year data.

Figure 3. World crude oil production, based on EIA data. *2012 estimated based on partial year data.

The rise in United States oil production is indeed somewhat helpful, but we are still many years away from being “energy independent” and even farther from becoming “oil independent.” The real issue is high oil prices, and these are not being fixed.

Figure 4. US crude oil prices  (based on average prices paid by US refiners for all grades of oil based on EIA data) converted to 2012$ using CPI-Urban data from the US Bureau of Labor Statistics.

Figure 4. US crude oil prices (based on average prices paid by US refiners for all grades of oil based on EIA data) converted to 2012$ using CPI-Urban data from the US Bureau of Labor Statistics.

Our financial problems are here and now, in 2013. Promises of hoped-for higher oil production in several years at a still very high price don’t fix today’s financial problems. In fact, they will likely continue to contribute to financial problems in the future.

Issue 3. Declining wages and increased taxes can be expected to lead to a decline in discretionary spending.  

As indicated at the beginning of the post, wages (including earnings of  businesses owners considered as “proprietors,” but not including “transfer payments” such as Social Security and unemployment insurance) have not been growing as fast as GDP since 2000. Below is a repeat of Figure 2 shown at top of post.

Figure 2. Wage Base (defined as sum of "Wage and Salary Disbursements" plus "Employer Contributions for Social Insurance" plus "Proprietors' Income" from Table 2.1. Personal Income and its Distribution)  as Percentage of GDP, based on US Bureau of Economic Analysis data. *2012 amounts estimated based on part-year data.

Figure 2. Wage Base (sum of “Wage and Salary Disbursements” plus “Employer Contributions for Social Insurance” plus “Proprietors’ Income” from Table 2.1. Personal Income and its Distribution) as Percentage of GDP, based on US Bureau of Economic Analysis data. *2012 amounts estimated based on part-year data.

There seem to be several reasons behind this decline. One reason, already mentioned, is high oil prices leading to US layoffs, because of decreased discretionary expenditures.

Another reason for the decline is increased automation. Electricity can often be substituted for human labor, reducing costs, but also reducing jobs. Economists seem to term this change higher labor productivity. They also seem to believe that new jobs will appear from somewhere, but in practice, this is not happening. Instead, lack of jobs is part of what is leading to recessionary influences.

Another reason for the decline is increased competition from countries with lower labor costs and lower fuel costs. China joined the World Trade Organization in December 2001, and its manufacturing (and thus use of fuels) increased dramatically shortly thereafter.

Figure 5. China's energy consumption by source, based on BP's Statistical Review of World Energy data.

Figure 5. China’s energy consumption by source, based on BP’s Statistical Review of World Energy data.

Another reason is demographic. Baby boomers are reaching retirement age. This has already begun affecting the number of individuals who retire each year. In the future, the number of retirees can be expected to increase further.

In total, we see a very large drop in the percentage of US citizens with jobs, starting about 2000 (Figure 6). This is very close to the time that China ramped up its growth (Figure 5).

Figure 6. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census.  2012 is partial year estimate.

Figure 6. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census. 2012 is partial year estimate.

In calendar years 2011 and 2012, workers’ contributions for Social Security funding were temporarily reduced by 2% of wages, as a way of stimulating the economy. As of January 1, 2013, this temporary reduction was removed. For a couple with combined wages of $100,000, take-home pay is thus being decreased by $2,000 per year. With less disposable income, workers can be expected to cut back somewhere–buying a larger home, buying a new car, or going out to eat.

So far, only a small amount of other tax increases have been put in place, and only a few cuts have been made. More tax increases or benefit cuts will be needed later this year to bring revenue and expense into better alignment. Any such change will tend to have a recessionary impact, because citizens’ discretionary incomes will be affected.

Issue 4. The spending gap and the amount of debt look too big to be fixable without excellent economic growth.

As noted above, wages have not been keeping up with GDP. The majority of federal taxes are based on wages, so in my comparisons,  I use wages, rather than GDP, as a base.

If we use the wage base from Figure 2, the amount of government outgo vs income (all levels, not just federal) is as follows:

Figure 7. US Government Spending (all levels) as percentage of Wage Base, as defined in Figure 2, above.

Figure 7. US Government Spending (all levels) as percentage of Wage Base, as defined in Figure 2, above, based on US Bureau of Economic Analysis data.

Based on Figure 7, the issue in recent years has been primarily rising expenditures. These higher expenditures would seem to be partly because of high-priced oil, but also because of other influences noted above that are leading to declining employment. The amount of the gap is close to 15% of wages–something that is very hard to fix. Even the current increase in Social Security taxes (“only” 2% of wages) will exert downward pressure on discretionary spending.

A related issue is that compared to wages (using the same wage base as in Figure 2), debt of all kinds is extremely high.

Figure 8. US Debt as a Percentage of the Wage Base, where the Wage Base is as defined in Figure 2, and Federal Debt is from Treasury Direct, and other types of debt are from the Federal Reserve Z.1 report.

Figure 8. US Debt as a Percentage of the Wage Base, where the Wage Base is as defined in Figure 2, and Federal Debt is from Treasury Direct, and other types of debt are from the Federal Reserve Z.1 report.

Government debt is in now more than household debt of all kinds, including mortgage, credit card, auto, and student loans. It is close to two times the wage base used in this analysis.

One issue with paying down debt is that during the pay-down period, the government (or individual) reducing the debt “feels poorer,” because funds available for spending on goods and services needed today is lower. This happens because some current tax revenue, or some current wages, must be used to pay down debt, and thus is not available for today’s spending. This is a turn-around from the increasing debt situation experienced many times in the past. For example, part of the reason times seemed good in the 2002-2006 period was because people were able to refinance their homes and use the funds to buy a new car or add on a family room. If we are forced to pay down debt, we have the reverse effect.

Issue 5. Similarity to “Secular Cycles” of Peter Turchin and Sergey Nefedov.

Throughout the ages, many economies that have experienced long-term expansion. Eventually, they reached limits of some sort and collapsed. The book Secular Cycles by Peter Turchin and Sergey Nefedov takes an analytical approach to looking such past cycles.  They developed a fairly complex model of what they would expect over time, in terms of trends in wages, prices, population, income inequality, and other variables. They then examine historical records (relating to eight civilizations in four countries, with “start dates” between 350 BCE and 1620 CE) to see whether this predicted pattern was born out in practice. In general, the authors found good agreement with the predicted model.

Typically, civilizations analyzed were reaching upper limits in population growth because of limits on food availability, but sometimes limits on water or fuel also were important.  The model predicted four phases (expansion, stagflation, crisis, and depression/ intercycle). The typical length of the entire cycle was 300 years. The length of the various segments was fairly variable. The stagflation stage often lasted 50 or 60 years. The crisis stage tended to be shorter, more often in the 20 to 50 year range. There often was overlap between phases, with a civilization seeming to cycle back and forth between, say, expansion and stagflation.

In the model, there are various feedback loops. For example, as the number of workers rises relative to the amount of land, the price of land and food tends to rise. Jobs outside of agriculture do not rise proportionately, so wages of common workers tend to fall in inflation adjusted terms. With lower wages for common workers, nutrition declines. Eventually, the population becomes weakened, and population declines. There are also other players–the elite and the state itself.

Some characteristics of the four phases are as follows:

  1. Expansion phase (growth) – Increasing population, relatively low taxes, political stability, low grain prices, and high real (inflation-adjusted) wages.
  2. Stagflation phase (compression) – Slowing population growth, much heavier taxes needed to support a growing elite class, low but increasing political instability, rising grain prices, declining real wages for most workers, increasing indebtedness, and increasing urbanization.
  3. Crisis phase (state breakdown) – Population declining from the peak (typically by disease or by deaths from warfare), high income inequality, political instability increasing to a peak, high but very variable grain prices, high urbanization, tax system in a state of crisis, peasant uprisings.
  4. Depression/intercycle – Low population, attempts to restore state,  declining economic inequality, grain prices decreasing but variable.

It seems to me that the United States and much of the world are going through a cycle much as described by Turchin. The Growth Phase of our current cycle seems to have begun around 1800, with the rise of coal use. Stagflation in the United States seems to have started with the drop in US oil production in 1970. All of the government budget and debt problems now seem to suggest that we are reaching the Crisis Phase.

Obviously, there are differences from the civilizations modeled, because we now live in a much more integrated world. Furthermore, earlier societies did not depend on oil and other modern fuels the way we do today. We do not know how the current situation will play out, but the comparison is concerning.

About Gail Tverberg

My name is Gail Tverberg. I am an actuary interested in finite world issues - oil depletion, natural gas depletion, water shortages, and climate change. Oil limits look very different from what most expect, with high prices leading to recession, and low prices leading to inadequate supply.
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158 Responses to 2013: Beginning of Long-Term Recession?

  1. Don Stewart says:

    A little earlier in the discussion I mentioned that Wendell Berry identified the drivers of the modern economy as Greed and Gullibility. Luckily, Albert Bates current article gives us a very good example of how that is working for us:

    http://peaksurfer.blogspot.com/2013/01/bittman-beyonce-and-cool-memes.html

    The Corporations provide the greed and the pop culture audience provides the gullibility. (The second part of Albert’s piece talks about stealing some of the corporate methods to promote the goals of Climate Change activists–I won’t say anything about that.)

    For the sake of argument, take a look at this video on health:

    https://nutritionalresearch.org/content/dr-fuhrman-interviewed-buck-institute-ceo?

    Whether you agree with all of Dr. Fuhrman’s recommendations or not, the overwhelming evidence is that the modern lifestyle promotes chronic disease–which medical science does not cure. One of the reasons is that the modern lifestyle is constantly sending bad signals to our cells and genes. No matter how you drug someone, unless the bad signaling stops, you aren’t likely to cure them.

    So what is the prescription? I think it has to begin with disconnecting from Pop Culture. Pop Culture is financed by Corporations which (or do we have to call them ‘who’ now?) have mastered the arts of persuasion and ‘moving up Maslow’s hierarchy’ so that consuming a certain brand of soft drink brings meaning to an otherwise meaningless life. Humans are not designd, I think, to resist the constant barrage. So the first step in achieving health is to Kill Your Television.

    I began to seriously try to limit my exposure to advertisements about 30 years ago when I read Four Arguments For The Total Elimination of Television. I switched it off, and never turned it back on. Whatever small accomplishments I have achieved owes at least some credit to that book and my decision to eliminate pop culture advertisements from my life. I now view people who watch the Super Bowl with pity–think about the wasted time and the exposure to toxic advertisements!

    The Pop Culture and its deadly ways DO contribute mightily to GDP. But would we be better off if Pop Culture just disappeared? I sure think so. That is one of the reasons I find all the arguments that we must ‘restart economic growth’ so appalling.

    Don Stewart

    • I totally agree with you. My wife and I have also deliberately taken action to limit our exposure to any kind of advertising. We have also done our best to keep our kids from any exposure as well. We hardly watch any television and when we do its the public one here in Norway (NRK) which is not ad-financed. We also don’t get advertisement in our postbox (fortunately you can put a sticker on your postbox here to say you don’t want ads). I only listen to NRK radio (public radio station), and mostly news channels (there is just too much crap on the other channels and basically indirect advertising for pop culture and whats “cool”). We don’t buy any newspapers either as a lot of them consist of 50% advertisement, although I do check news on the web now and then (or listen to it on the news radio station). Neither do we buy magazines of any kind except I have a retro hobby so I like to read Retro Gamer now and then. :) – Most magazines contain 70% ads and 30% heavy edited “information”. You get more information by reading Wikipedia or some scientific paper on a subject than any newspaper and magazine can hope to convey (normally the story in those are published with a “twist” to sell you the story). A trip to the library to rent some books is also a good idea and we use the library as often as we can. Lately I have been buying some e-books though as I don’t really need to decorate my shelves with books to prove anything to anyone coming by (and neither do I have to show off a DVD or CD collection). I doubt my e-book collection would impress many though as its mostly about peak oil, a finite world, collapse and whatnot. Haha, not very happy reading, but still quite worthy of a healthy discussion with anyone who bothers to listen. :)

      It doesn’t take many years of this “isolation from pop culture” to peel away the skin of the world and get a real feeling of what our relation to the physical world is – and indeed its limits. The honest truth is really staring at us but so many are just too busy distracting themselves with pop culture so they don’t have to deal with it. Its the biggest disease in society today and the only pill I can suggest is a “reality check”. These normally come in the form of serious disaster or collapse, either on a personal level or indeed as a society which can be just as fragile on the basis of cheap fossil energy. The information doesn’t really depress me, but at least allows me to value life and how fragile it really is.

    • Jan Steinman says:

      I stopped watching TV years ago.

      And yet, here we all sit, in front of glowing screens.

      Yes, there are myriad ways in which computers are different than television — interactive versus passive, information seeking versus programmed consumption, democratic versus plutocratic — and yet, here I am in front of the screen when I should be out tending the farm…

      If I “go dark” on y’all, you’ll know I’ve pulled the plug on yet another glowing screen. :-)

      • Don Stewart says:

        Jan
        I took the chair away and elevated my notebook computer. So I stand–not sit. Which gives me an incentive to only pay attention to the cream of the crop.

        Don Stewart

    • There are enough other things to do besides watch television that it is hard to understand why so many are willing to listen to it all the time.

  2. Hi Gail:

    Thank you for another well researched and well thought out article.

    I’ve been reading your articles over the years. Enjoy your detailed approach to blog articles. The article comment discussion and your responses are just as interesting as the main article, which is rare in this day and age of blog comment trolling.

    I’m still learning about energy and the impact on the overall world economy. Your articles help me picture different scenarios for the long-term view and help me filter the day to day ups and downs of the financial markets and latest economic data point sound bites.

    I’ve learned one must take care of the near-term to be around for the long-term. But it’s important to understand the various possibilities and the probability of the various long-term scenarios and driving forces.

    High cost energy is just one driving force that long-term will change developed economy society as we know it today and probably already has (the general decline of average living standards in developed economies). It’s just impacted some of us (the invisible poor and working poor in developed countries) more than others so far. I also believe there are other very important driving forces (dumbing down of independent thought, attacking science, attacking those who questioning those in charge of large institutions/corporations, inequality in education depending on social status, institutional and business influence on government, etc.) that will contribute to the decay.

    Contrary to the “Everything in the world is going to be alright, trust us!” theme that Wall Street is pushing right now, every day I see the slow decay in the developed economies that has been visible in the economic numbers since around 2000 (developed country real wages stagnant and even declining, equity market prices flat since 2000, lack of good jobs that pay a livable wage, building up excessive debt just to get by, etc.).

    The underlying issues (whether they are directly energy cost related or not, I have no idea) probably existed well before 2000, but at least for myself I really started to notice a change in society (and individual people) around that time.

    Gail, you’ve probably touched on this in other articles (sorry, I have not read every article yet). I looked at the US Food Price Index for Urban Consumers (data from the St. Louis Fed) and the non-inflation adjusted price for WTI. Trying to determine using simple statistical analysis if there is a correlation between crude oil and food prices.

    I’ve found it depends on how you group the data by time period (given the short amount of history available on the St. Louis Fed site). If one runs the correlation from 1986 to the end of 1999, at best there is a weak correlation between WTI and food price inflation, (correlation of +0.125). Annual food price inflation has peaks and valleys, but on average food price inflation has been about 3.0% (yoy % chg. from 1986 to Dec 2012). Food price inflation rarely, goes below 1% yoy and has been as high as around 6.8% yoy. At least according to the government numbers, I know some disagree strongly with the government inflation numbers.

    But after 2000, something fundamentally changed and WTI price increases started to trend towards catching up with food price inflation, and since 2000 there is a strong correlation between food prices and WTI (correlation of +0.85 from beginning of 2000 to Dec. 2012). I’m not sure if is attributed to the “financialization” of commodities as I’ve read about or simply all the cheap $20/barrel oil ran out in 2000.

    My point is if energy prices (at least centered around crude oil) continue to rise anywhere near the recent average annual pace since 2000. And assuming the high correlation with food prices continues. I know, two “ifs” that may not happen. I just can’t see how the average person is going to be able to afford to feed themselves and their families, given the poor outlook for jobs and real wage growth (even if one has a job, no guarantee it pays a livable wage these days, even for a college grad).

    I know humans are generally very industrious and adaptable, but long-term, things do not look good unless a lot more cheap oil is found. Or alternative sources of cheaper energy are developed and the infrastructure build to distribute and consume them. Right now, everything in developed countries is based on crude oil, especially in the US.

    I won’t put a time frame on the continued decay in developed economies. These things can take much longer than we think possible to play out. But again, the future does not look good going forward based on crude oil as the dominant source of energy.

    I included some links to the graphs to put together.

    Food price index and WTI crude oil: http://valdaoresearch.com/?attachment_id=692

    Food price index and WTI crude oil, year over year % chg: http://valdaoresearch.com/?attachment_id=694

    Thanks for your time. Greatly appreciated.

    • One thing to keep in mind is that biofuels (especially corn ethanol) have become much more common in the last decade. They compete with food for land and fertilizer. So they are a factor in the recent trend, but not in the earlier trend. It would make more sense to look at the correlation since about 2003 or 2004, because that is when biofuels are also important. Also, the run up in oil prices is much higher since 2003 or 2004, and would have greater “weight” compared to other factors affecting food prices.

      Weather plays a role as well, so some variability is expected. Some food inputs are not from oil, so food prices theoretically should be less variable than oil prices.

      • Hi Gail:

        Thanks for the input.

        Interesting…the simple correlation is actually less starting from Jan 2003 to today at +0.753 (the measure of the linear relationship between food price inflation and crude oil price, not the “slope” of the linear regression which is something different). The big price drop in the crude oil price in 2008/early 2009 probably lowered the linear relationship (less data points than the longer time-frame data series that had higher correlations). Regardless, it’s a strong linear relationship.

        A simple linear regression on the two data sets starting from the beginning of 2003 to today produces a linear approximation equation for the food price index vs crude oil price/barrel as follows:

        Food price index = 0.5379 * (crude oil price/barrel) + 169.32

        The adjusted R square is 0.565, which indicates about 56.5% of the variability in the food price index using this simple one variable regression can be attributed to crude oil price. I’d need to do more research and introduce many more variables (maybe introduce ethanol prices, etc.) and see which set of equations yield a better linear approximation for the food price index.

        But the general idea is the same, crude oil has a big impact on food price inflation.

        Back to the big picture long-term dilemma, it’s imperative we find a long-term solution to the general trend of increasing crude oil prices(which will require a detail engineering/design plan that will take decades to put in place).

        Assuming higher crude oil prices is where we’re going, the future does not look good for any scenario based on crude as the dominant energy source. Many don’t agree with this projection for higher crude prices. For now at least, they have the upper hand in the argument given the range bound crude price the last year or so and the more or less stable supply and slightly decreasing demand from the peak(we should hope the decreasing global demand for crude won’t last too longer, otherwise we’ve got bigger problems near-term). WTI’s most recent price peak was around $110 back in April of 2011.

        Thanks again for the information and your excellent research.

        Regards,

        • Gail…above, I meant to indicate slightly decreasing crude oil demand at least in the US…

          Sorry, I was not clear in my phrasing.

          Take care…

        • I think there is a limit to what price governments of oil importers can handle. So while the cost of production keeps rising, it is hard for oil importing economies to incorporate those changes. This puts downward pressure on prices, and pushes toward a point where discontinuity of some sort (or perhaps only severe fluctuation in price) takes place.

          Even China is increasingly getting to be an oil importer. It uses less oil in its total fuel mix, but it is increasingly difficult to keep subsidizing oil prices. So it may see some slowdown related to higher oil prices too. If nothing else, it is getting fewer orders from buyers whose economies are shrinking.

          • Thanks, Gail:

            I’m with you on the theory that there is a “limit” to how high crude oil prices can go before the developed country (mostly oil importers) economies (the “system) begin to experience stress. Like any complex system, it operates within bounds, whether we know what those bounds are or not (e.g. these ultra-fast trading algorithms running stock markets these days where people really don’t have 100% certainty in the machines). The “global developed country system” as designed today can fail as we’ve seen.

            We got a glimpse of how “it starts” in mid 2007 through to the fall of 2008 when the financial part of the system almost collapsed (negatively impacting the entire system) and continued through around mid-2009. They (developed market governments and central banks) were able to stabilize (at least stop the decent) when they basically went to “extra-ordinary measures” many never thought possible. Just to name a few: broad private bank bailouts using public debt, banning short selling, changing accounting rules to hide what’s going on with distressed debts, astonishing amounts of credit and money created out of thin air, and increased influence of large corporations on government policy.

            Whether the “trigger” back then can be directly linked to high crude prices and/or the nutty state of real estate prices in the US and many other developed country nations, we’ll never know.

            My concern is that each time we get near a point in the cycle where crude prices reach the “trigger point” that the “system” can’t handle (or some other stressed part of the system could be the “trigger”, but let’s assume it’s crude prices for simplicity). The subsequent decline in economic activity, if it’s as bad as 2007/2008/2009 wipes out most of the collective and individual (per capita) upside gains of the current cycle. And maybe, like in 2007/2008/2009, it wipes out 10 years of economic gains. On a per capita basis, the average person is worse off as we go through each decline. We’ve been seeing it for years now (since 2000/2001 in my view) in the “lost generations” of young people across the developed world. They will continue to have very tough futures ahead of them.

            A long-term direction (or set of directions) needs to be engineered and built to “stabilize and then fix the system” in developed countries for the long-term, say 50 to 100 years. I don’t think Wall Street and the private capital markets are going to be able to solve this one. Their thinking is too short-term. The average “first past the post” voting system elected representative is probably not skilled enough. Most federal level politicians come from backgrounds where building or fixing things in a sustainable, long-term fashion is not a priority (many politicians today are career politicians and have never had a job in industry building anything of a complex nature). See the amount of lawyers in the US congress(sorry nothing against lawyers). And more of what we’re doing today to “kick the can” is not the solution.

            To your above point on China. The performance of Shanghai stock market (basically gone nowhere since 2006, down over 50% from the all-time high in 2007) should be an indicator that things are not as rosy as Wall Street is trying to make everyone believe (the thesis that as long as China GDP growth holds up above 7% or 8%, we’ll all be OK).

            That said, culturally the people of mainland China are not like people in the developed world (included Japan and Hong Kong). They have shown they can cope with hardship. This concept that we’re going to turn the people of mainland China into the average developed country consumer is far-fetched in my view.

            But the one thing the Chinese system of government has going for it (whether people agree or not with their system doesn’t matter). Their leaders do/will have a very long term plan with multiple branches. Observing Chinese government and business activities in African countries and other resource rich nations around the world, one can see they are going about securing access to the energy resources and land they will need in the future (they go about things quietly, which is generally their nature). They know they can’t depend on exporting low end goods to developed country consumers for real economic growth over the long-term.

            Take care…

            • I agree that we are going to have tougher and tougher futures ahead of us.

              I am not sure it is really possible to “stabilize the system”. I think a big part of the issue is depletion of resources and growing world population. If you haven’t read my post, 2013: Beginning of Long Term Recession? you might want to read it.

              The situation with China seems to involve a lot of things. I have written about China in several posts recently. You can find them by using the “search” button with the word “China”. One issue is China joining the World Trade Organization in December 2001. Another is their big ramp up of coal use, keeping costs low. Another issue is their one child family policy, which allows a larger than normal share of the population to work. They also do not have a pension program, so workers tend to save more (since their kids won’t be of much help). The money they save can be used for investment.

              One thing that I was not aware of until a reader sent some information is that the Chinese keep returns in invested capital artificially low. (Yet another reason we cannot compete with them!)

              I was trying to find the publication by Colonial First State by James White but didn’t find it. These are some links relating to his writing

              http://ftalphaville.ft.com/2012/07/12/1080091/

              http://inpraiseofchina.blogspot.com/2012/07/chinas-economic-miracle-how-it-works.html

              http://noahpinionblog.blogspot.com/2012/07/this-time-its-different-china-edition.html

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