Debunking ‘Lower Oil Supply Will Raise Prices’

We often hear the statement, “When oil supply is lower, oil prices will rise because of scarcity.” Now, we are getting to see firsthand whether oil prices really do rise, as oil supplies become more scarce.

Figure 1. Figure from the OPEC Monthly Oil Market Report for August 2019 showing world and OPEC oil production by month.

Figure 1 shows that world oil supply hit a peak in November 2018 and has declined since then, mostly because of a decline in OPEC’s production. So, total oil production seems to be down for about eight months, relative to the peak in November 2018.

Despite this big cutback by OPEC in its oil production, prices have not responded as OPEC had hoped:

Figure 2. Average monthly spot Brent Oil prices, based on EIA data.

In fact, as I write this, Brent oil price is currently quoted as $60.48, which is back in the range of December 2018 and January 2019 low prices. Also, reducing production doesn’t seem to be reducing inventories. Figure 3 suggests that they are now higher than they were before the reduction in oil supply took place.

Figure 3. Figure from the OPEC Monthly Oil Market Report for August 2019 showing OECD commercial oil stocks.

Why aren’t oil prices rising and oil inventories falling, if oil production has fallen?

The basic issue is that the economy is very much interconnected under the laws of physics, because energy is required for every activity that is considered part of GDP. Energy is required for any kind of heat or any kind of movement. Energy is even required for electricity. Without energy from the sun, food can’t grow; without supplemental energy of some kind (such as using electricity to heat an electric stove or burning animal dung or sticks), it becomes impossible to cook food or smelt metals.

One strange phenomenon that arises from the interconnected nature of the economy is the fact that the prices of all energy products (including those not listed on Figure 4) tend to move together.

Figure 4. Comparison of changes in oil prices with changes in other energy prices, based on time series of historical energy prices shown in BP’s 2019 Statistical Review of World Energy. The prices in this chart are not inflation-adjusted.

This strange phenomenon arises because energy products are well-buried within every part of the world economy. A person’s job requires energy consumption. The tasks that governments do, such as building roads and schools, require energy consumption. Both transporting and cooking food require the use of energy products. Refrigerating food requires energy products. These energy uses, as well as many other everyday hidden uses of energy, aren’t things that we can easily cut back on.

Consumers often think, “I will drive less, and that will cut back on my energy consumption.” Unfortunately, in the whole scheme of things, whether or not individuals cut back on their optional use of gasoline doesn’t get the world economy very far. Gasoline accounts for about 26% of world oil consumption, or about 8.7% of total energy consumption, based on the most recent BP energy data. Cutting back on the optional use of gasoline would not reduce total consumption very much. If it were possible to reduce gasoline consumption by 10% by voluntary cutbacks, it would still reduce world energy consumption by less than 1%.

The strange pattern of the price changes shown on Figure 4 indicates that there is something affecting energy prices of many kinds, simultaneously. I would describe this as “affordability.” It has to do with how affordable finished goods and services are to the population in general, much more than it does scarcity. (Economists call this affordability issue “demand.”) If finished goods and services are affordable to a large number of consumers, as they were in 2008 and in 2012 and 2013, prices will be bid up to very high levels (Figure 4). If finished goods and services aren’t very affordable, a drop-off in prices, such as that experienced in November and December of 2018 (Figure 2), is likely to occur.

When OPEC decided to cut back its production of oil in response to the low prices in late 2018, this cutback in oil production didn’t help the affordability of finished goods and services. In fact, this cutback probably made the worldwide total quantity of affordable finished goods and services a little lower. This happened because, with the cutback in oil production, the governments of OPEC countries were able to collect less tax revenue on the smaller quantity of oil that the countries were selling. In fact, this smaller quantity of oil wasn’t even being sold at a higher price.

With lower revenue, governments of OPEC countries are being forced to cut back on funding of new projects such as roads and schools. These projects will use fewer energy products, and the would-be workers will have less money to spend on goods made with energy products. Thus, these cutbacks help to lower the world’s “demand” for oil and other energy products and thus help lower the price of oil.

The fact that the economy is interconnected in this strange way makes shifting prices upward much more difficult than if scarcity were the primary issue. In effect, the whole stack of energy prices in Figure 4 must somehow be made to rise. This is difficult to do because it is the lack of wages of the many poor people around the world that is holding back “demand” for energy products. If, somehow, higher wages could be sprinkled on the many poor workers of the world, including those in India and Africa, then oil (and other energy) prices would tend to rise. With higher wages, these poor people would be able to afford items such as nice homes, cars, and air conditioning, pulling world food and energy demand upward.

One difficulty with rising oil (and other energy) prices: They don’t translate into rising wages.

Rising oil prices tend to cause recessions and layoffs. We can see this from historical data. Average wages, considering layoffs, tend to fall rather than rise during times of spiking oil prices. In fact, the chart seems to suggest that the big increases in average wages tend to occur when oil prices are under $40 per barrel. A growing supply of cheap energy thus seems to be the magic ingredient that shifts wages upward.

Figure 5. Average wages in 2017 US$ compared to Brent oil price, also in 2017 US$. Oil prices are from BP’s 2018 Statistical Review of World Energy. Average wages are total wages based on BEA data adjusted by the GDP price deflator, divided by total population. Thus, they reflect changes in the proportion of population employed as well as wage levels.

Because of this difficulty with spiking energy prices, high energy prices tend not to last for very long. One issue is that regulators quickly raise short-term interest rates to solve what they perceive as “the problem of rising food and energy prices.” Once recession sets in (gray bars in Figure 6), regulators find that they need to lower interest rates and raise the level of debt to stimulate the economy again. With lower interest rates and more debt, major purchases (such as homes, cars, and factories) become more affordable, because purchases bought on credit have lower monthly payments. With greater affordability, food and energy prices again rise, to again encourage more production.

Figure 6. Three-month and ten-year interest rates through July 2019, in chart by Federal Reserve of St. Louis.

So we end up with an endless seesaw of energy and food prices. In fact, the peaks have tended to fall lower and lower since 2008, as can be seen in Figure 7, showing monthly average prices.

Figure 7. Monthly average Brent Oil prices since January 2000, based on data of the US Energy Information Administration.

Monthly average peaks started at $132.72 in July 2008. More recently, peaks have fallen as follows:

  • Peak of $125.25 for the month of March 2012
  • Peak of $109.54 for May 2014.
  • Low month average price of $30.70 in January 2016.
  • Most recent average peak was $81.03, for the month of October 2018.

From this pattern of falling peaks, we can see that the stimulus being used recently (which includes Quantitative Easing in some parts of the world) has become less and less effective at stimulating demand for food and energy products.

It looks as though growing debt at ever-lower interest rates is becoming a less effective workaround for the economy’s real need, which is a need for a rapidly growing supply of under $40 per barrel oil and other low-priced energy products.

Oil prices can be a problem in two different directions: (a) Too high for consumers or (b) Too low for producers.

From the Point of View of the Consumer. Many people have had the “Ah Ha” moment, in which they have figured out that high oil prices are a problem from the point of view of consumers. In part, they have deduced that these high oil prices may mean that we are “running out” of cheap-to-extract oil. Processes are becoming more complex, and as a result, consumers need to pay more to cover the higher cost of extracting and refining the oil.

But there is a related issue: Higher oil prices are likely to cause recession. If oil prices rise, the prices of many different types of goods and services (such as food, goods transported by truck or airplane, and vacation travel) rise at the same time. Wages don’t rise as quickly, in part because it is the true energy content (measured in Btus, barrels of oil equivalent, or something similar) that the economy requires. If the economy needs to dedicate a larger share of its resources to producing energy products, this is an issue that is akin to growing inefficiency. There are fewer resources remaining (such as human labor, metals, fresh water, and energy products) for investment that might provide goods such as new homes, cars, clothes and air conditioning.

With fewer resources to use, the economy reacts by shrinking back. I think of the situation as being akin to the way a chemist might “make a smaller batch,” if the quantity of one necessary reagent is low. An adequate supply of energy products is what makes the economy operate as it does; if buying an adequate amount of energy products becomes too expensive for consumers, a cutback in the buying of discretionary goods is forced on the economy (Figure 8). Lowering interest rates tends to make the debt repayment portion on new purchases lower, helping to alleviate the squeeze.

Figure 8. Chart made by author in 2010, to illustrate a talk called Peak Oil: Looking for the Wrong Symptoms.

From the Point of View of the Oil Producer. There are oil producers of many kinds, including:

  • Tight oil producers from shale operations,
  • Heavy oil producers in places such as Canada and Venezuela,
  • Producers of oil from deep water such as Brazil and Angola, and
  • Middle Eastern oil exporting countries that seem to have a very low direct cost of oil production.

Strange as it may seem, Middle Eastern oil exporting countries are among the most vulnerable to problems associated with continued low oil prices. The reason why these countries are so vulnerable is because their entire economies are oriented toward oil and gas production. They often have large populations with inadequate income unless the government provides them with handouts or with programs that provide jobs. If these governments need to cut back too much, there is a real danger that the governments will be overthrown. In fact, the population may break down into warring factions. Oil production may stop because of internal disorder.

It is because of issues such as these that the OPEC countries have cut back on oil production, in the hope that prices would rise to more acceptable levels for their countries. Fiscal Breakeven prices, relating to the level of oil prices that are needed so that each government can collect sufficient taxes for its budget, are published from time to time.

Figure 9. Chart published by the Arab Petroleum Investments Corporation (APICORP) giving Fiscal Breakeven Prices estimated to be needed for 2013.

Now that oil prices have been low since late 2014, Middle Eastern countries won’t admit to the true level of oil prices that are needed to operate their countries in the way that they have in the past. Their populations have been rising faster than their oil production, so it is hard to believe that the oil prices that the countries truly need, if they do not cut back on programs, are any lower than the amounts shown in Figure 9. At about $60 per barrel, the current Brent Oil price is clearly far too low for the major oil producers of the Middle East.

Shale and heavy oil producers are often less vulnerable than Middle Eastern producers, because the entities funding their operations (that is, buyers of shares of stock and providers of debt) believe that “of course” oil prices will rise in the future because of scarcity. Because of this, they are willing to provide additional funding, even when a recent owner has gone bankrupt from low prices. Middle Eastern oil producers have less of this benefit. If the money isn’t available for major programs, they are forced to cut back. Growing debt is unlikely to cover more than a portion of the shortfall.

There are other producers in the energy price “stack” in Figure 4 that are vulnerable to collapse or bad outcomes from continued low energy prices. One example is coal producers in China. China seems to be experiencing Peak Coal because of continued low coal prices; while new mines have been opened, they do not act to increase the total quantity produced, because so many mines needed to be closed because they were losing money at current low prices.

Figure 10. China energy production by fuel, based on 2019 BP Statistical Review of World Energy data. “Other Ren” stands for “Renewables other than hydroelectric.” This category includes wind, solar, and other miscellaneous types, such as sawdust burned for electricity.

If the world economy is hoping for China’s increasing demand to pull the world economy forward in the future, it is likely kidding itself. China cannot expect imports to make up for its lack of growth in coal production. China’s lack of adequate energy supplies likely underlies the tariff issue that we hear so much about. There is a need to pull back production of goods from China, if China doesn’t really have the energy resources to continue in the role it has been playing.

The big question is how high oil prices will be in the future

The contention of the IEA and many others is that energy prices can rise arbitrarily high. For example, the IEA showed the figure I have numbered Figure 11 in its World Energy Outlook 2015 .

Figure 11. IEA Figure 1.4 from its World Energy Outlook 2015, showing how much non-OPEC oil can be produced at various price levels.

The big groupings in Figure 11 are

  • Conventional Crude (such as from the Middle East and perhaps deep water like Brazil),
  • Tight Oil from Shale, and
  • Extra Heavy Oil and Bitumen (such as from Canada and Venezuela).

Evidently, in 2015, the IEA believed that $300 per barrel oil prices were not too high to show as a possibility on a chart. With $300 per barrel oil, there would certainly be enough oil. At such a high price, it might be possible to move the city of Paris, France, out of the way and extract the tight oil from shale underneath it!

Unfortunately, in the real world, prices cannot rise this high. Market prices are set by the laws of physics. The economic limit we reach is a price limit that pushes the economy back into recession. We have seen in Figure 7 that this price limit seems to be dropping lower and lower, over time. In fact, I am one of the coauthors of an article published in the journal Energy called, An Oil Production Forecast for China Considering Economic Limits. This 2016 article makes the point that the economic limit we are reaching is a limit on how high oil prices can rise. I am the lead author of Section 2, which discusses this issue at length. If prices cannot rise high enough, the vast majority of the oil that seems to be available based on published reserve amounts and geological surveys cannot really be extracted.

Whether there are ways to raise oil and other energy prices higher than they are now remains to be seen.

Why don’t standard models forecast low oil prices in the future? 

Economists have put together a simple model of how the economy works. In their model, there are always substitutes. The only thing that goes wrong seems to be that prices rise, if there isn’t enough supply. These rising prices encourage greater supply and substitution. The type of chart a person typically sees is a Supply and Demand curve as shown in Figure 12.

Figure 12. Supply and Demand model from Wikipedia.
Attribution: SilverStar at English Wikipedia CC BY 2.5 (, via Wikimedia Commons

They have never considered a situation where energy products are deeply buried within essentially all goods and services that are made. If there isn’t enough supply, a “smaller batch” of the world economy is made. We think of this as recession, but it can take on other forms as well:

  • Depression
  • Wars
  • Epidemics
  • Defaulting debts; falling prices of assets
  • Failing governments and intergovernmental organizations
    • Collapse of the central government of the Soviet Union in 1991
    • UK’s decision to leave the European Union
  • Increasing conflict between political parties and between countries
  • A reduction in globalization
  • Ultimately, the collapse of a civilization

Economists have not understood the connection between physics and the economy. There is a need for a sufficient quantity of affordable energy products every moment of every day. In fact, we seem to need a vastly increased quantity of inexpensive-to-produce energy supplies right now if we are to fix the world economy’s problems from an energy point of view. The “lower interest rates and more debt” way of hiding problems seems to be reaching an end point. If nothing else, interest rates today are close to as low as they can go.

Is the economy approaching a singularity?

In physics and math, a singularity is a point at which a function takes an infinite value. We end up with a situation that seemingly cannot exist. It is like dividing the number 1 by the number 0. No matter how many times that the number 0 is added together, it will never equal 1.

The economy seems to be reaching an equally strange situation. It is not a situation where we are running out of oil; it is a situation of too much wage disparity, and this wage disparity makes the prices of many commodities too low for producers of these commodities. For example, farmers cannot afford to pay their mortgages. And prices for all fossil fuels and many metals are too low for companies extracting these materials to make an adequate profit for reinvestment and taxes. The problem is not simply low oil prices.

This situation of excessive wage disparity is related to globalization, with many workers around the world earning very low wages, so that they cannot afford goods such as homes and cars. It is related to the increased use of robots substituting for manual labor. It is also related to wage disparity within countries as jobs become increasingly specialized.

As this situation plays out, energy prices fall when common sense would seem to suggest that they should rise. In fact, the problem of falling prices extends to more commodities than fossil fuels and food; it extends to minerals of many kinds, including copper and aluminum.

In such a situation of falling commodity prices, we can expect many related problems. For example, governments of countries that depend on the revenue of these exports may fail, leading to Balkanization of these countries in some cases. A wide range of debt defaults can be expected, leading to failing financial institutions that need to be bailed out. Rapidly changing relativities among currencies are likely to put markets for derivatives at the risk of failing. Needless to say, stock markets are likely to be adversely affected. So-called renewables will quickly fail because they are currently dependent on fossil fuels for repairs and the electric grid. In fact, it is hard to see any aspect of the world economy that can continue unaffected.

How does what appears to be an approaching calamity play out?

Perhaps it is fortunate that we don’t really know. Collapses of early economies seemed to take many years, typically over 20 years. Today, the world economy depends on global supply chains and the electric grid. The financial system is also very important. It is hard to believe that the overall system can stay together for many years, but perhaps, in parts of the world, it can. We just don’t know.

Given how connected the economy seems to be, and how widespread the problems seem to be at the singularity we are reaching, it almost appears that there is a plan behind what is happening. From what we can observe, there seems to be some literal higher power behind all of the energy flows that we observe in the universe. This literal higher power seems to have put into place all of the laws of physics. This literal higher power seems to also be behind all of the self-organizing elements within the universe, including humans, ecosystems and economies. I cannot help but wonder whether there is some plan for what is ahead that we don’t understand.


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 financial problems for oil producers and for oil exporting countries. We are really dealing with a physics problem that affects many parts of the economy at once, including wages and the financial system. I try to look at the overall problem.
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1,469 Responses to Debunking ‘Lower Oil Supply Will Raise Prices’

  1. Shawn says:

    Oh boy, an invitation to be philosophical….

    A complex system can arise from a few simple principles. Jeremy England’s work suggests how the laws of physics (particularly the 2nd Law of thermodynamics) and chemistry can give rise to life and how it functions. I believe that evolutionary theory (of life) on earth might eventually be subsumed under the fundamental theories of physics.

    Whether there is a higher power behind the universe we may never know. For now the physics and observations suggest that a universe can arise spontaneously from the void and we are just are a flash of life in a vast universe that might be one of many. I kind of like the idea that there is no higher power behind it all, because it suggests that we might be free to make our own choices and determine our own destiny.

    Except that maybe we are not. As Gail (and others) have highlighted, our collective actions appear to be broadly driven and constrained the energy available to us in the environment. That is the hidden hand? Some of the biggest questions of our lives now are how much (fossil) energy is still available to us to burn, and whether we are free and able to make a collective choice to burn far less of it, or burn it over a far longer period of time. Right now we appear to be acting as if we not have any collective choice in this regard. We are burning everything we can dig up, and now it seems, every tree still standing.

    If we slide down the backside of Hubbert’s curve to the stone age, it will be hard to argue from a human race perspective that there is any teleological direction or hidden hand to the universe. If we somehow escape this fossil energy decline through the ‘singularity” or some other technological breakthrough, it might suggest a teleological direction but we will probably come to regret what might be a post human future.

    • We know that the lifetime of dissipative structures is finite. Thus, we cannot expect our economy to last forever, no matter how conscientious we are in trying to preserve it. We will run into a bottleneck, one way or another.

      Today, researchers have computers, and with these computers, it is easy to make models. Jeremey England at least understands the constraints he is working under. Most of the researchers don’t. They tend to create models of how they think some aspect of the world should work. Their work probably should be considered today’s version of Fairy Tales, but because it comes out of a computer, people assume it has validity.

      I think the models of how humans can save the earth are pretty much of the Fairy Tale variety. Even if we can fix one aspect of our problem (say, cheap energy products), we still have many other aspects of our problems, including rising population, not enough fresh water, declining fish population, deforestation, and continually changing climate. We can’t fix all of the other problems, even if we can fix one problem.

      • Robert Firth says:

        Gail, I agree that all these problems are interlinked, but there is one that stands out:

        Not enough fresh water => too many people drinking it
        Declining fish population => too many people fishing
        Deforestation=> too many people demanding firewood, arable land, …

        That is near the heart of our predicament: we are no longer a species, subject to natural predators, checks and balances: we are a cancer. And I have no hope that there is any solution other than collapse. Especially when I hear spokesmen for major international organisations say things like “by 20xx, India will need twice as much water”, or “by 20xx, Africa will need twice as much food”. In other words, let us work hard to make the problem twice as bad as it is now.

        • Tim Groves says:

          To paraphrase what Woody Allen said about getting old; overpopulation, it has nothing going for it.

          I broadly agree with whoever wrote the words on the Georgia Guidestones .
          The first guideline reads:
          Maintain humanity under 500,000,000 in perpetual balance with nature.

          • Robert Firth says:

            Tim, many people have studied this issue, and most of them have reached the same conclusion. I did the research almost 20 years ago (won’t bore you with the methodology), and came up with the same answer. What is the maximum sustainable population with enough surplus to maintain a humane civilisation? My answer: 600 million.

          • Ed says:

            I agree but would pick 100 million.

          • The Georgia Guidestones were erected on March 22, 1980. This was not too long after the 1972 book “The Limits to Growth” was published. It is about the time William Catton’s book “Overshoot” was published (October 1980).

            If we look at UN Total Fertility per Mother data, we find that the average number of births per woman as dropping in developed countries about this time. In the US, the Births per Woman dropped as follows:

            1955 -1960 3.58 births per mother
            1960-1965 3.23
            1965-1970 2.54
            1970-1975 2.03
            1975-1980 1.77

            Better birth control was developed near the beginning of this period. Also, there must have been information being publicized that having too many babies was not good.

  2. Niko B says:

    Gail, there is a strong push towards UBI (universal basic income) and MMT (modern monetary theory) being implemented. This would immediately raise the wage of workers. How do you think this would then impact your theories on energy vs wages?
    Thanks for another great post.

    • First of all, I am doubtful that the strong push toward UBI and MMT will really be implemented. The countries that need more income are especially the very poor countries, like India, Pakistan, Bangladesh, and sub-Sahara Africa. These countries are not in a position to do much of anything, I don’t think. Also, Saudi Arabia and other oil producing countries really need more money for its citizens. For Saudi Arabia, it would (perhaps?) make more sense to devalue its currency relative to the US. dollar than to start with UBI.

      Advanced nations seem to be the ones interested in UBI and MMT. It seems like using these approaches very much will end up changing currency relativities–the greater the debt, the farther the currency falls.

      • milan says:

        what if there were to be a robin hood moment? that is some unknown political who will do the unthinkable by taking control of the worlds money supply and due to socialism will embark on a process of wealth confiscation the likes of which the world has never seen and then embark upon a far reaching redistribution program through the implementation of a social credit system similar to the China model. All it would take really is to implant your tax number in your hand and voila problem solved but only for a short period of time.
        Isn’t this something the Zionists would crave for and indeed would want under a coming false king of Jerusalem?

        • We know through many examples that even distribution of wealth doesn’t really work. As the people in Cuba say, “They pretend to pay us, and we pretend to work.” There is not sufficient “buy in” to wanting to work hard, if everyone gets paid the same amount, regardless. If everyone gets the same amount, perhaps it sort of looks like it fixes the problem, but for a temporary time. But Russia made it work for a time, and Cuba has as well.

          One thing that the even distribution of assets/income did in Cuba (and also Russia) is encourage a very low birth rates. Neither country used much debt (perhaps related to the fact that there is not much hope of growth under this approach). There was no way of building more homes, other than perhaps sweat equity (build one room at a time, as a person manages to save up resources). Without more homes, and with the expectation of a certain level of standard of living, there is no room to add more citizens. So families hold back on their numbers of children. Population grows very slowly compared to other countries.

      • Niko B says:

        Yes good points. It is really the countries that don’t make up the main reserve currencies that need to do it. But if they do, their currencies will go into the toilet.

      • Robert Firth says:

        Gail, I think the last word on UBI and MMT was written exactly one hundred years ago:

        ** In the Carboniferous Epoch we were promised abundance for all,
        By robbing selected Peter to pay for collective Paul;
        But, though we had plenty of money, there was nothing our money could buy,
        And the Gods of the Copybook Headings said: “If you don’t work you die.” **

        From “the Gods of the Copybook Headings”, by Rudyard Kipling: › poems_copybook

  3. info says:

    I wonder why this “higher” power allowed us to industrialize and uglify much of the earth in the 1st place before ensuing we pull back?

    • adonis says:

      according to Buddhism there is no higher power there is only change so the changes we have made to the earth are no big deal in time there will be balance again

      • I agree that the changes we humans have made on earth are no big deal, from the point of the earth and its ecosystems. The earth will again adapt. It is made to change and adapt.

    • Industrialization allows more energy dissipation and more population growth. It is strange, I agree.

  4. adonis says:

    thanks for the new article Gail I think that now that we have reached Peak Oil on November 2018
    the collapse of the worlds financial system will be upon us soon

  5. adonis says:

    I was hoping that the elites had some plan but putting their faith in renewable energy just proves how misinformed they are so it looks like a fast eddie challenge kind of world will be soon upon us . will anyone survive

    • Tim Groves says:

      Reluctantly, I’ve got to agree wholeheartedly with this comment.

      But there is no way I’m going to share it with my friends or relatives.

      If they believed me, it would put a huge damper on their carefree outlook on life.

      And if they didn’t, they would mark me down as a doomsday cult member and warn their kids not to drink any Kool-Aid I might serve them.

  6. It's different this time around....NO says:

    Thank you Gail for the new article.
    Remember a friend of mine in the Pizza restaurants business claimed his fundamentals was ratios and percentages. If they were out of wzck, one could loose ones shirtr!


    iBuyinb nto the near–$17 trillion heap of global bonds with negative yields might sound like a losing proposition. But for some investors — those who predicted correctly that bond prices this year would climb amid worries about sluggish global growth — negative yields actually have been a cash cow.
    “There is a big misunderstanding about negative-yielding debt,” said James Bianco, founder of Bianco Research, in an interview with MarketWatch. “Owners of these bonds have been seeing huge price increases
    With bond prices moving in the opposite direction of yields, the sharp yield decline this summer, as the U.S.-China trade war has raged and American recession fears have bubbled up, has put significant price gains on the table.

    Take Austria’s 100-year bond, which has seen its yield to maturity plunge to below 1% in recent weeks.
    The European country set a record two years ago when it borrowed €3.5 billion for a century in the international bond markets at a yield to maturity of 2.1%, according to the Financial Times. But this chart shows the yield to maturity shrinking to just 0.71% as of Aug. 20, as demand (and the security’s price) has climbed
    As a result, investors in Austria’s century bond at par, or 100 cents on the euro, roughly two years ago at issuance, could have sold in August when the price briefly soared above 200 cents, for a more than 100% return.

    The flip side to this “upside-down, anything is possible” world of negative-yielding bonds that fetch “astronomical prices,” according to Bianco, is that bonds are only required to be repaid at par by the issuer when they mature. “When you’re paying more above par than the sum of all coupons, that is how you get to negative yields,” he said. “At some point that will blow up, but it hasn’t yet.”

    The culprit? Demand for government debt that’s been climbing along with expectations that weakening eurozone economies would eventually force the European Central Bank to restart its asset-buying program to bolster the bloc’s economies.

    • I posted a link to an article recently that claimed, “Negative yielding bonds are for trading, not for holding to maturity.” Buying them is basically done as a bet that interest rates will fall into more negative territory, so that asset prices will rise. The longer the bond, the more leverage this effect has. Your article is an example of this.

      Of course, if interest rates head toward zero (in other words, rise), we get precisely the opposite effect.

      A contracting economy doesn’t really work, as far as I can see. The bonds are in some sense a bet about how the economy will contract over time. I expect that there will be a fast turning point at some time, after which the contraction will be more of a cliff.

  7. Harry McGibbs says:

    “Growth is sputtering all over the world. Germany and the U.K. have both reported that their economies shrank in the second quarter, and signs of a slowdown are apparent in lots of other places. But as central bankers gather in Jackson Hole, Wyoming, and government leaders in Biarritz, France, to discuss what to do, it seems worth pointing out how slow growth already was in most rich countries even before the recent bad news…

    “We aren’t really back in the Middle Ages. But per-capita GDP growth in wealthy countries does seem to have slowed to a much slower pace than in the 20th century, and possibly at any time since the dawn of the Industrial Revolution. Add to this the fact that population isn’t growing much in these countries, and in some cases is actually shrinking, and you have at least part of the explanation for why interest rates are so low and politics so weird these days. The growth that we’ve gotten used to over the past two centuries or so just hasn’t been there lately.”

    • Harry McGibbs says:

      “…the global economy may be at risk of returning to the rut it tumbled into after the financial crisis of 2007-2009.

      “Worse, solutions seem far from obvious. Central banks can’t just slash interest rates. Rates are already ultra-low. And even if they did, the central banks would risk robbing themselves of the ammunition they would need later to fight a recession. What’s more, high government debts make it politically problematic to cut taxes or pour money into new bridges, roads and other public works projects.”

      • Harry McGibbs says:

        “…the wheels are spinning in reverse for the world’s manufacturing economies. As multinational companies scramble to mitigate the effects of trade tariffs by reorganising supply chains and onshoring production, Emerging Markets need to find a new source of demand. If they fail to adapt, global growth will grind to a halt…

        “Lowering interest rates relieves some of the immediate pressure on EMs by reducing the rates on dollar-denominated debt. This sugar rush buys EMs time to develop new sources of demand for the manufacturing industries. But the strategy is fraught with risk, and if it fails we can expect major headwinds for global growth…

        “Investors should not put faith in the idea that Fed can stop the unravelling of global growth, regardless of the statements coming out of Jackson Hole on Friday.”

    • Those are really nice charts for a few countries in the Medieval article. We use sight of how unusual high per capita economic growth really is.

  8. Harry McGibbs says:

    “Rajiv Kumar says India is facing such an economic downturn for the first time in 70 years, a liquidity crisis wherein lenders have stopped funding businesses, resulting in a situation where they have to survive on cash… “Niti Aayog Vice-Chairman Rajiv Kumar has said the ongoing financial crisis in India is “unprecedented”…

    • Harry McGibbs says:

      “With India’s auto sales declining for the ninth straight month in July, more automotive manufacturers are laying off workers and temporarily halting production to keep costs in check, according to sources and documents seen by Reuters. Japanese carmaker Toyota Motor and South Korea’s Hyundai Motor are the latest in a string of companies to halt production at plants to combat slumping sales…”

      • Grant says:

        As reported by the FT and elsewhere, motor sales in India, recently seen as an important growth market for global manufacturers and their components suppliers, were down circa 30% in July.


        A significant number.

        Recently I read a report that sales of personal use vehicle in the UK (possibly also much of Europe) were now something like a form of Lease finance Credit in 80% of “sales”.

        So the market buoyancy, such as it is, is entirely predicated on credit for things that will not retain any asset value whether because they will wear out or be damaged in use and considered to be beyond economic repair (favoured by manufacturers needing to shift credit funded boxes) or because they will be mandated out of the economy – likely before their manufacturing cost has been recouped via the service they provide – by political diktat related to proposals to immediately reduce CO2.

        That the cost of the establishing an alternative infrastructure is likely to challenge the markets and the tax system and incur increased CO2 emissions for several decades even under the most optimistic number crunching – entirely negating the claimed purpose of the exercise – seems to be a point of discussion that is perpetually and resolutely avoided.

        One has to wonder why, although I suppose the answer is obvious to anyone with a nominal grasp of logical thinking.

        • A person has to wonder. Taking perfectly good vehicles out of services has a cost involved. A person wonders how those companies leasing the vehicles will fare. Perhaps the government will change the rules and fix the mess.

          It is hard to imagine the infrastructure for charging all of the vehicles will be put in, in time for the proposed changes. Also, people cannot be forced to buy cars that they cannot really afford. What do they use for down payments, after leasing in the past, for example?

          • Grant says:

            Manufacturers seek to shift boxes. To do that they(may) need a reputation for good or even extreme longevity of life for their product but in reality they might wish for the shortest life possible unless they can make a large profit in service/spare parts.

            Thus modern cars, for various reasons, may become difficult to repair even if expensive to manufacture. Planned obsolescence.

            If you can make a “safe” car that is safe mainly because the slightest bump can be used as an excuse to quote a repair cost that is well beyond the value of the vehicle in even of damage.

            In the UK even minor collisions can result in car being written off. An occupant ponly has to claim that their neck hurts (seeking compensation payouts via insurance) and the rescue services will chop the roof off the vehicle to extract them, thus clearly making the vehicle beyond (legal) economic repair in most cases

            The consumers look for deals that require little or no down payment and attempt to extend the life of the deal over multiple years.

            If boxes are shifting slowly such deals will be available. At least they keep the numbers up and defer the lack of profits to a later point in the cycle.

            Plus the retailers hope that the used market picks up the slack a few years down the line.

            The problem seems to be that there is only one period of slack with which to operate.

            Over a 5 year (or less) cycle it may be a viable option. Over 10+ years the results seem to be less certain.

            Any relatively high value personal “desire rather than need” purchase may be questionable. And short lived as an article of utility.

            This GDP is improved – but nothing else.

    • Liquidity crises are a huge problem. Here, the statement is made that lenders have stopped funding businesses. I can’t imagine loans are easy to get for citizens, either.

  9. Harry McGibbs says:

    “The world’s second biggest economy, which is slowing, is past a point where it cannot ignore its enormous debt anymore, according to an analyst…

    ““China is very much past the tipping point where the debt simply no longer can be ignored. The cost of servicing the debt … simply distracts from almost everything else…””

    • Harry McGibbs says:

      “China’s currency the renminbi has fallen to its lowest level against the dollar in 11 years in a move likely to anger US President Donald Trump, who earlier this month accused Beijing of currency manipulation…

      “The trade war has hurt China’s currency, which has in turn affected other emerging market currencies.”

    • The question the CNBC article raises, “Will the demand for new debt be there?” if more credit is available.” I suppose, if there are not workers wanting new high-priced condo homes, the demand for debt from builders will fall. Also, auto companies will need less debt, it they are building fewer autos.

      • Robert Firth says:

        “Also, auto companies will need less debt, it they are building fewer autos.”

        Gail, that is good classical economics, but alas we don’t live in that world any more. The big US automakers have not made their money selling boxes for years. They make the money on the auto loans, which provide a predictable income stream, at least until the borrowers default.

        But fewer boxes means fewer loans, and a rapidly shrinking income stream. If that stream shrinks faster than the companies can cut costs, which I suspect is indeed the case, they will need to take on more debt, not less. Not being a modern monetary theorist, I would call that a death spiral.

        • The big automakers do have a lot of fixed costs.

          I don’t know all of the details regarding how this works in practice. At one point there were articles about Tesla not being in a position to finance all of the autos it was selling. The company making the loans must somehow have a reasonable balance sheet itself.

  10. Harry McGibbs says:

    “A report from the Confederation of British Industry (CBI) has found that retail sales volumes and orders both fell at their sharpest rate since December 2008 in the year to August. Companies in the retail sector are also expecting further trouble in the months ahead, with industry sentiment falling to its lowest levels in more than a decade.”

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