4 ms·

Can the Oil Shock Alone Explain the Financial Crisis?

22 points by robg 18y ago

brc 18y ago
The central tenet is that it is the 1970's all over again. And I've been bleating this for years to my friends (who are sick of hearing it). This is how the story goes: 1) long, expensive and difficult foreign war that becomes increasingly unpopular at home 2) increasing government spending on military adventures means increases in debt and inflationary policies 3) oil producing countries realise the dollars they are being paid with are worth less and less, do their best to manipulate the oil price higher through supply shortages 4) oil and gold prices start to rise precipitously 5) interest in alternative energy starts to rise, and detroit car makers get into serious trouble 6) recession and long bear market for stocks 7) high inflation and low growth You can (roughly) overlay this pattern on the late '60's, early '70s, with (6) running up until the late 1970's. And you can lay it on 2002-onwards, we're at point (6) at the monent. There were no CDO's in 1970, but I'm sure there was something else. I would classify the CDO/Subprime mortgage problems as a problem magnifier rather than a problem cause. In theory, as long as a person can keep paying a subprime mortgage, or can refinance to a better rate a few years down the track, there's nothing wrong with them. However, too many were given to too many people, and thus what might have been a small slowdown turned into a banking and credit crisis.
- eru 18y ago
  Isn't this a bit too US centric?
  - brc 18y ago
    Yes precisely, because the similarity is that the US started the process of both times by starting expensive foreign wars and borrowing big to pay for them. Nixon dropped the Gold standard because countries holding USD (notably the French) were starting to get nervous about the massive waste of money in Vietnam and started demanding Gold for their USD. That was the true start to inflation in the 1970's, and very much a US-based event. I didn't compare it to the Asian financial crisis of 1998 or the LTCM crisis of 1999 because the US didn't start those off. My main point is the Vietnam ~= Iraq and Oil Crisis 1973/74 ~= Oil Price Spike 2007/8, so therefore hyperinflation 1975-1982 ~= hyperinflation 20009-??
- ajju 18y ago
  The main difference is how closely linked the world economies are now than they were in the 70s. Additionally, CDOs made it nearly impossible to separate the subprime mortgages from the prime ones or even performing mortgates from non performing ones. Because of the incredibly complex nature of CDOs and the close linkage between financial instruments and world economies, the subprime crisis is (was) not so much a magnifier as the first domino.
bwd 18y ago
I don't really agree with this analysis. I expect that the 2008 oil shock was the Gavrilo Princip of the current financial crisis. The amount of debt was certainly at unsustainable levels, but it seems possible that things could have continued for another year or so before some other trigger, such as higher interest rates, brought the whole thing crashing down.
- aaronblohowiak 18y ago
  Saving you the google search: Gavrilo Princip was the assasin of Franz Ferdinand, which started the chain of events that lead to WWI. http://en.wikipedia.org/wiki/Gavrilo_Princip http://en.wikipedia.org/wiki/Gavrilo_Princip
banned_man 18y ago
The housing bubble would have crashed regardless of oil prices and availability. The severity of the crash might have been less if oil were abundant.
quoderat 18y ago
In a sense, cheap oil (in the US and other countries) allowed the creation of far-flung suburbs that enabled the rocketship of suburban debt to launch. Without those suburbs enabled by cheap oil, the housing crisis never would've been so severe, as no one would've thought of driving 50 miles each way to a McMansion every day in the middle of nowhere.
teilo 18y ago
Oil has contributed. But the real culprit is monetary policy. The Keynesian model, where every dollar in your pocket is someone else's obligation, is a balloon that always grows too big and has to either deflate or pop. You cannot borrow your way out of debt. If all money is created by debt, then ultimately things like oil, speculative investments, and creative financial instruments can only pop the bubble faster. Even without them, the bubble will continue to grow beyond the breaking point. It will just take longer to get there. It's simple math. You can argue against the principles of sound currency and the laws of supply and demand about as successfully as you can argue against the law of gravity. What do you expect to happen, honestly? When you push out cheap money, when you take away risk, when you create a moral hazard which prevents investors from being burned by their own bad choices, they WILL spend and invest recklessly. Wall Street is not the problem. Oil is not the problem. The man behind the curtain who is setting interest rates at artificially low levels such that the expenditures exceed the available capital in the economy, IS the problem. And that man is called the Fed. This is the fundamental force driving our economy, and it is broken. Until this is addressed, all the focus on oil, investment banks, and Wall Street is just a stage show.
- anigbrowl 18y ago
  There is no such thing as 'sound money'. Being on a gold standard is not a panacea: you're just exchanging one kind of debt marker for another. The US was on the gold standard in 1929 and other countries were on it much later. Booms and busts will still occur. As soon as you move away from a barter system and give up trading bullets for beans, then whatever you substitute, whether it's gold, greenbacks, or cowrie shells, is someone's obligation to pay - with a bank or government treasury acting as their proxy. The Dutch Tulip mania in the 17th century is a case in point. No matter how treasury power is configured, it will be open to abuse. This is not to dispute your valid points about moral hazard. However, the 'sound money' meme is nothing more than a fetish which appeals to people who have trouble dealing with the abstractions of economics. In the simplest possible therms: gold is only valuable because a lot of people believe it to be so. Blaming the Fed for everything is a rabbit-hole down which intelligent analysis goes to die. Countries with an independent central back are almost always more stable than those where the government has direct control of the money supply. Today's outstanding example of that is Zimbabwe.
pragmatic 18y ago
No.
10ren 18y ago
Cheap gasoline from the 1990s into this decade encouraged families to set up their homes farther from the cities where they worked. Summary: Gas goes up, families can't pay mortgage. Crude has now dropped to about $50 per gallon - I wonder what Hamilton's model predicts from that? (of course, the drop seems mostly due to reduced demand, so it won't stay there if economic conditions improve)
varjag 18y ago
The article looks like a great example of "correlation implies causation" fallacy. I did not see anywhere in the piece why the current theory (oil prices sank when shown a crack) explains the graph any less.
anigbrowl 18y ago
Absolutely not. The financial crisis was an inevitability from September 2007. If anything the oil crisis slowed down or even softened its impact in 3 ways: a) it vented liquidity from the dreadfully overheated mortgage market b) it deflected attention onto oil companies even though most of the change in oil prices was driven by merchant bankers looking for somewhere to park cash c) it created a high degree of demand destruction, slowing the economy down significantly This didn't drive us (or any other country) into recession, but rather caused us to take a closer look at the drivers of the economy and realize that the real estate bubble had already peaked. My personal opinion is that if it hadn't been for the oil shock the financial crisis would have come 3-6 months earlier and been even more stabilizing. I did a lot of research into this last year for a documentary, but shelved it due to inertia and changing events. I feel strongly that the oil crisis happened because of the deeper financial crisis, but still can't decide if it was a naturally emergent symptom or a wholly engineered plan B which succeeded in staving off total collapse. Or somewhere in between.

22 points by robg 18y ago

brc 18y ago

The central tenet is that it is the 1970's all over again. And I've been bleating this for years to my friends (who are sick of hearing it). This is how the story goes: 1) long, expensive and difficult foreign war that becomes increasingly unpopular at home 2) increasing government spending on military adventures means increases in debt and inflationary policies 3) oil producing countries realise the dollars they are being paid with are worth less and less, do their best to manipulate the oil price higher through supply shortages 4) oil and gold prices start to rise precipitously 5) interest in alternative energy starts to rise, and detroit car makers get into serious trouble 6) recession and long bear market for stocks 7) high inflation and low growth You can (roughly) overlay this pattern on the late '60's, early '70s, with (6) running up until the late 1970's. And you can lay it on 2002-onwards, we're at point (6) at the monent. There were no CDO's in 1970, but I'm sure there was something else. I would classify the CDO/Subprime mortgage problems as a problem magnifier rather than a problem cause. In theory, as long as a person can keep paying a subprime mortgage, or can refinance to a better rate a few years down the track, there's nothing wrong with them. However, too many were given to too many people, and thus what might have been a small slowdown turned into a banking and credit crisis.

eru 18y ago
Isn't this a bit too US centric?
- brc 18y ago
  Yes precisely, because the similarity is that the US started the process of both times by starting expensive foreign wars and borrowing big to pay for them. Nixon dropped the Gold standard because countries holding USD (notably the French) were starting to get nervous about the massive waste of money in Vietnam and started demanding Gold for their USD. That was the true start to inflation in the 1970's, and very much a US-based event. I didn't compare it to the Asian financial crisis of 1998 or the LTCM crisis of 1999 because the US didn't start those off. My main point is the Vietnam ~= Iraq and Oil Crisis 1973/74 ~= Oil Price Spike 2007/8, so therefore hyperinflation 1975-1982 ~= hyperinflation 20009-??
ajju 18y ago
The main difference is how closely linked the world economies are now than they were in the 70s. Additionally, CDOs made it nearly impossible to separate the subprime mortgages from the prime ones or even performing mortgates from non performing ones. Because of the incredibly complex nature of CDOs and the close linkage between financial instruments and world economies, the subprime crisis is (was) not so much a magnifier as the first domino.

bwd 18y ago

I don't really agree with this analysis. I expect that the 2008 oil shock was the Gavrilo Princip of the current financial crisis. The amount of debt was certainly at unsustainable levels, but it seems possible that things could have continued for another year or so before some other trigger, such as higher interest rates, brought the whole thing crashing down.

aaronblohowiak 18y ago
Saving you the google search: Gavrilo Princip was the assasin of Franz Ferdinand, which started the chain of events that lead to WWI. http://en.wikipedia.org/wiki/Gavrilo_Princip http://en.wikipedia.org/wiki/Gavrilo_Princip

banned_man 18y ago

The housing bubble would have crashed regardless of oil prices and availability. The severity of the crash might have been less if oil were abundant.

quoderat 18y ago

In a sense, cheap oil (in the US and other countries) allowed the creation of far-flung suburbs that enabled the rocketship of suburban debt to launch. Without those suburbs enabled by cheap oil, the housing crisis never would've been so severe, as no one would've thought of driving 50 miles each way to a McMansion every day in the middle of nowhere.

teilo 18y ago

Oil has contributed. But the real culprit is monetary policy. The Keynesian model, where every dollar in your pocket is someone else's obligation, is a balloon that always grows too big and has to either deflate or pop. You cannot borrow your way out of debt. If all money is created by debt, then ultimately things like oil, speculative investments, and creative financial instruments can only pop the bubble faster. Even without them, the bubble will continue to grow beyond the breaking point. It will just take longer to get there. It's simple math. You can argue against the principles of sound currency and the laws of supply and demand about as successfully as you can argue against the law of gravity. What do you expect to happen, honestly? When you push out cheap money, when you take away risk, when you create a moral hazard which prevents investors from being burned by their own bad choices, they WILL spend and invest recklessly. Wall Street is not the problem. Oil is not the problem. The man behind the curtain who is setting interest rates at artificially low levels such that the expenditures exceed the available capital in the economy, IS the problem. And that man is called the Fed. This is the fundamental force driving our economy, and it is broken. Until this is addressed, all the focus on oil, investment banks, and Wall Street is just a stage show.

anigbrowl 18y ago
There is no such thing as 'sound money'. Being on a gold standard is not a panacea: you're just exchanging one kind of debt marker for another. The US was on the gold standard in 1929 and other countries were on it much later. Booms and busts will still occur. As soon as you move away from a barter system and give up trading bullets for beans, then whatever you substitute, whether it's gold, greenbacks, or cowrie shells, is someone's obligation to pay - with a bank or government treasury acting as their proxy. The Dutch Tulip mania in the 17th century is a case in point. No matter how treasury power is configured, it will be open to abuse. This is not to dispute your valid points about moral hazard. However, the 'sound money' meme is nothing more than a fetish which appeals to people who have trouble dealing with the abstractions of economics. In the simplest possible therms: gold is only valuable because a lot of people believe it to be so. Blaming the Fed for everything is a rabbit-hole down which intelligent analysis goes to die. Countries with an independent central back are almost always more stable than those where the government has direct control of the money supply. Today's outstanding example of that is Zimbabwe.

pragmatic 18y ago

No.

10ren 18y ago

Cheap gasoline from the 1990s into this decade encouraged families to set up their homes farther from the cities where they worked. Summary: Gas goes up, families can't pay mortgage. Crude has now dropped to about $50 per gallon - I wonder what Hamilton's model predicts from that? (of course, the drop seems mostly due to reduced demand, so it won't stay there if economic conditions improve)

varjag 18y ago

The article looks like a great example of "correlation implies causation" fallacy. I did not see anywhere in the piece why the current theory (oil prices sank when shown a crack) explains the graph any less.

anigbrowl 18y ago

Absolutely not. The financial crisis was an inevitability from September 2007. If anything the oil crisis slowed down or even softened its impact in 3 ways: a) it vented liquidity from the dreadfully overheated mortgage market b) it deflected attention onto oil companies even though most of the change in oil prices was driven by merchant bankers looking for somewhere to park cash c) it created a high degree of demand destruction, slowing the economy down significantly This didn't drive us (or any other country) into recession, but rather caused us to take a closer look at the drivers of the economy and realize that the real estate bubble had already peaked. My personal opinion is that if it hadn't been for the oil shock the financial crisis would have come 3-6 months earlier and been even more stabilizing. I did a lot of research into this last year for a documentary, but shelved it due to inertia and changing events. I feel strongly that the oil crisis happened because of the deeper financial crisis, but still can't decide if it was a naturally emergent symptom or a wholly engineered plan B which succeeded in staving off total collapse. Or somewhere in between.