Sunday, 14 December 2014

Oil Price. Good For The Economy, Terrible For Financial Markets - Part 1

Anyone who has been following my blog for the last few years will not have been surprised by the global fall in oil prices. For example, in July 2013, I pointed out that a conjunctural shift was taking place, from the Spring to Summer phase of the long wave cycle. During such shifts, the drive to develop new sources of primary materials, that occurs in the Spring phase, begins to manifest itself in an increasing supply of those products, bringing to an end the sharp rise in their prices, and frequently manifesting itself in an actual over supply. At the time, I specifically referred to the example of the development of US shale.

One major example, is the development of shale oil and gas in the US. Faced with large rises in the prices of inputs – themselves in large part caused by the global boom since 1999 – capital has to find cheaper alternatives. The US, highly dependent on energy, had more reason to do so than many other economies. Shale oil and gas are providing it with an energy bonanza that has brought its energy prices down considerably.”

But, in addition to the development of these new supplies, I also pointed to another feature of the development arising from the long wave cycle. That is that it also promotes innovation, so that even as output expands, a more efficient use of energy and materials, reduces the extent of demand growth. For example, as I pointed out,

“But, one reason these rapidly rising prices of inputs during the Spring Phase of the boom do not bring it to a halt, is precisely that during the Winter Phase, capital has been developing all of the new means of producing more efficiently that raise productivity. It is not just a rise in productivity of labour, resulting in an increase in relative surplus value that occurs, but much greater efficiency in the use of materials, energy etc. Oil provides a good example. 

Global oil consumption rose from 63 million barrels per day in 1980, to 85 million barrels per day in 2006. That is an increase of 35%. But, between 1980 and 2012, Global GDP increased from $18.8 Trillion to $71.8 Trillion (1990 dollars). That is an increase of 282%! Even allowing for the 6 years difference in periods that means that global GDP rose by around seven times the increase in oil consumption. That is also despite the huge growth in the number of cars in places like China, which is now the biggest car market in the world. The reason that oil consumption has increased by only a fraction of the increase in global economic growth is because huge advances have been made in the efficiency of oil use. That is why in the 1970's a four fold increase in oil prices sparked a global slump, but from the late 90's a ten fold increase in the price of oil has not.”

I made the same point in relation to other such primary products. But, I also pointed out that, for the last ten years or more, I have been arguing that not only did that previous innovation cycle provide new more efficient means of using primary products, but it also led to the development of new materials that replaced some of those old materials. For example, carbon fibre has been developed as a lightweight, but stronger alternative material to steel and other metals. In addition, that same Innovation Cycle led to the development of new base technologies that formed the basis of new consumer industries, in technology, and a range of service industries. It changed the whole structure of consumption, away from consumer goods that required ever increasing quantities of raw materials, to consumer goods that required ever more complex labour for their production.

Anyone who has been following my blog will then have seen nothing unusual in the fall in the oil price, or in the prices of other primary products, that have gone through a similar cycle. And, as previously set out in the analysis conducted over that period, the effects of those price falls have also been detailed, as well as the other features of this conjuncture of the long wave cycle.

The fall in the price of these primary products means that those economies that have remained dependent on their sale as the main source of national income, will be badly affected, as that income drops. Those that have used the high incomes over the period of higher prices and above average profits from their sale, to diversify and to invest in new productive industries, will be less affected, and those that have diversified into new industries that use these primary products as inputs, will gain from a reduction in the cost of their constant capital. Those that have used the higher than average profits only to build up cash hoards – usually in the shape of sovereign wealth funds, often invested in the US and Europe – will begin to need to draw down on those funds to cover the deficits in their domestic budgets, as their income from trade falls.

But, those same falls in the prices of these primary products – I made a similar point about the large scale investments that are being made in agriculture in Africa and elsewhere – act inevitably to reduce the cost of constant capital for all those developed, industrial economies that rely on these products as inputs. In addition, because these products are either directly consumed by workers – for example, oil in various forms for transport or heating; food to eat; and so on – or else are used as inputs by the producers of a wide range of consumer goods consumed by workers, let alone play a significant role in the cost of transporting all those goods around the globe, the reduction in these input costs, significantly reduces the value of wage goods. It thereby reduces the value oflabour-power, raising the rate of surplus value, and thereby the rate of profit.

The rate of profit is, thereby, raised due to two separate factors. Firstly, this reduction in the value of labour-power, increases the rate of surplus value, and thereby the rate of profit. Secondly, the reduction in the value of the constant capital also means that the rate of profit is raised, because a given quantity of surplus value is measured against a smaller mass of advanced capital. The reduction in the value of constant capital and variable capital, also means that capital is released, and this released capital is then available for additional accumulation on top of the increase in the rate of profit. The overall effect, for the global economy, of the fall in the oil price – and of all other primary products, typical of this phase of the long wave – is, therefore, very positive.

But, from what has already been said above, and in the previously linked posts, this is not the case in relation to financial markets. What has already been set out, indicates that some economies that are reliant on income from the sale of these products, will at the least cease to become providers of large quantities of loanable money-capital into the money market. Many will need to draw down their money hoards thereby increasing demand for loanable money-capital, causing global interest rates to rise.

From what has been written previously, in relation to this phase of the long wave cycle, it will also be seen that the rate of profit, itself begins to decline, as more capital has to be invested. That again acts to reduce the supply of loanable money-capital, and to increase the demand for it, again causing interest rates to rise globally.

In addition, the fact that a large number of new, often small capitals were drawn into the production of these primary products, as a result of the high prices and profits that arose during the Spring phase, means that many of these companies will now become unprofitable, and also lack the size of balance sheet to withstand several years of losses.  As described recently, many of these companies are heavily indebted, having financed themselves not with their own capital, but by debt raised in the junk bond markets. About a third of that debt is now distressed. No one knows, how much fictitious capital is itself built up on the back of these junk bonds, as collateral, or indeed of oil itself as collateral. But, the potential for this to develop into a new sub-prime crisis, as in 2008, is apparent, as already the prices of junk bonds have begun to fall sharply, and there are again rumours in the trading pits about credit seizing up, and becoming unavailable. This, however, is in conditions, unlike 2008, where already official interest rates are at zero, and where unprecedented amounts of money printing has already been undertaken.

Its against this backdrop that the falls in stock markets occurred, last week. I will examine the effects on the economy and financial markets further in the next posts.

Forward To Part 2

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