Low gas prices are not good news

Since Standard & Poor’s downgraded U.S. Treasury bonds last week in the aftermath of the debt-ceiling debacle, financial markets have been whipsawing up and down like a demented yo-yo. In the midst of all the turmoil, there is one seeming (I say, seeming) bright spot you may have noticed: the price of gasoline has gone down. Over lunch hour today I filled my tank at 119.3 cents per liter, a price level lower, by a few pennies at least, than we’ve seen for a while. (My touted e-bike has a flat tire just now, darn it.) Sorry to break it to you, but the price drop isn’t really good news, it’s just another species of bad news.

To boil things down, the price of gas was as high as it was because worldwide demand for oil was near the limits of supply. Things weren’t quite as tight as they were back in 2008, but they were tight enough. Oil isn’t just essential (you can’t run an industrial society on muscle power), it is non-substitutable: it would be a decades-long project both to switch to alternate energy sources for most applications, assuming such sources can be found at all; to rebuild transport and other infrastructure to run on a non-petroleum basis; and to find replacements for the myriad other uses to which petroleum is put. This combination of traits means that demand for oil is inelastic: in the face of supply constraints, the demand doesn’t go down even as the price goes up, up, up. Under these circumstances, the price of oil becomes a brake on the economy, as the increased costs of new productive activity gobble up any possible return. Now, with the financial system roiling from the effects of the downgrade, the game is over: people and institutions with money they could be investing are fleeing instead, looking for safe harbours. Productivity will drop, plants will close, people will be thrown out of work, shipping will shrink, there will be less travel and overall less activity, and demand for oil will go down the hard way – by being destroyed. Paying a few pennies less to fill your tank is a small consolation for all that misery, especially if you’re one of the newly unemployed and a full gas tank is more than you can afford.

That’s the bad news. The worse news is, demand destruction due to supply constraints is just going to keep happening. The magic words are, you guessed it, peak oil. The low-hanging fruit has all been plucked, and what’s left is the half that is most difficult, marginal, and unrewarding to extract. As the supply becomes ever more constrained, it becomes ever costlier to keep up even the same level of activity, much less increase it, until the activity becomes completely unsustainable and collapses to what the available resources will permit. This is what we’re beginning to experience, and will be an increasing part of our lives for the foreseeable future and beyond.

Jim Flaherty says that Canada is well-placed to weather the economic storm, but he would say that, wouldn’t he? Not only is it in his job description to make such optimistic pronouncements, but it’s not clear to me that he could be brought to understand the reality of our situation. As the finance minister of a G-8 country, he should be assumed to be as out of touch with reality as the economics profession is.

The financial crisis we’re in now isn’t new, it’s just a continuation of what started with the collapse of the U.S. subprime mortgage market in 2007 and really hit the fan with the failure of Lehman Bros. in September 2008 and the subsequent bailouts. The Great Recession that followed was partly, but sluggishly, reversed by a round of Keynesian stimulus, which has since petered out. Things might have coasted on a bit longer, but the Tea Party put a stop to that by using the threat of preventing a rise in America’s statutory debt limit as a way to pursue their demands. Absent extraordinary measures (there was talk of President Obama using seigniorage – literally ordering the Mint to produce a platinum coin denominated at TWO TRILLION DOLLARS to deposit at the Federal Reserve), this would have rendered the U.S. Treasury – effectively the cornerstone of the world economy – incapable of meeting its obligations. In other words, America’s Tea Partiers effectively put a gun to the head of Money Itself and threatened to pull the trigger. Small wonder if S&P decided this reflected poorly on the viability of U.S. government debt.

The ratings agencies, Standard & Poor’s not least, still have a lot to answer for. They continued to give residential mortgage-backed securities their top ratings long after it should have become obvious that they were so much toxic waste. In a saner age, the ratings agencies were paid by investors, who would have reason to punish them for such a failure. Nowadays their compensation comes from the other side of the equation, and can expect to be rewarded for letting investors take a bath on the banks’ offerings. The fact that this goes on in full view and no one does anything about it is one strong indication of how corrupt the financial system has become.

In some quarters, S&P is vehemently suspected of having enacted the downgrade not on the merits of the case but as part of a coordinated, ideologically-driven campaign to push the banks’ agenda. The invaluable Yves Smith pursues the story to the next step: a suggestion that another agency, Moody’s, might downgrade certain municipalities inhabited by a large number of high net-worth individuals – even though these municipalities are the least likely to default – in order to prompt the HNWIs to start pressuring their representatives to perform in a bank-approved fashion. Like a series of bad torture-porn films, this stuff just keeps escalating.

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