The Oil Drum: Europe

At this time of year, we read many financial forecasts for the year ahead. Nearly all of these are written with the "filter" assumption of infinite growth. "Oil production problems are a temporary issue; after a short dip, the economy is likely to continue growing rapidly again. We may have a short recession, but we will soon be back to business as usual." Etc.

I think this filter is fundamentally in error, and leads to a mistaken impression with respect to where the world is headed. The world is changing in a very major way. Oil is in short supply, and this shortage is likely to get larger in the future. The pressure of short supply and rising prices adds a systematic bias that the financial community is not recognizing. This bias has as its basis the fact that it is becoming more and more difficult for both people and businesses to pay back loans, because of the rising costs of oil and food. This situation cannot be expected to go away. In fact, it is certain to get worse in years ahead, as oil supplies become tighter.

Besides the systematic bias, there is also a systemic risk, arising from the interconnectedness of all of the parts of the economy. This was well described in a post a few days ago called The Failure of Networked Systems. One of the issues in systemic risk relates to the financial system itself. If one party in the financial system fails, it increases the likelihood that other parties in the economic system will fail as well.

Another aspect of systemic risk is the close ties of the financial system to the rest of the economy. One example is the higher oil and food prices mentioned above that lead to a systematic bias toward higher defaults. Another is the fact that the lack of oil can be expected to impede economic growth, making the infinite growth model underlying the current economic system less sustainable, based on the economic model of Robert Ayres and Benjamin Warr. Another linkage is that of oil with ethanol. Higher oil prices leads to increased pressure to produce more ethanol, which further raises food prices, as demonstrated by Stuart Staniford in Fermenting the Food Supply.

(More below the fold)

Ok, so first, Greenspan says it's all about oil: AMERICA’s elder statesman of finance, Alan Greenspan, has shaken the White House by declaring that the prime motive for the war in Iraq was oil.

Without elaborating, he writes, "I am saddened that it is politically inconvenient to acknowledge what everyone knows: the Iraq war is largely about oil."

Then Gates, says "nuh-uh!": U.S. Defense Secretary Robert Gates on Sunday rejected former Federal Reserve Chairman Alan Greenspan's statement that the Iraq war "is largely about oil."

And then today, Greenspan "clarifies" his statement claiming the war was essential for "oil security.": Alan Greenspan, the former Federal Reserve chairman, said in an interview that the removal of Saddam Hussein had been "essential" to secure world oil supplies, a point he emphasized to the White House in private conversations before the 2003 invasion of Iraq.

I'm not sure, once you start thinking about it, that this makes things "better."

http://www.timesonline.co.uk/tol/news/world/article2461214.ece

AMERICA’s elder statesman of finance, Alan Greenspan, has shaken the White House by declaring that the prime motive for the war in Iraq was oil.

http://www.washingtonpost.com/wp-dyn/content/article/2007/09/14/AR200709...

Without elaborating, he writes, "I am saddened that it is politically inconvenient to acknowledge what everyone knows: the Iraq war is largely about oil."

More on Greenspan's book from the New York Times.

UPDATE: WASHINGTON (Reuters) - U.S. Defense Secretary Robert Gates on Sunday rejected former Federal Reserve Chairman Alan Greenspan's statement that the Iraq war "is largely about oil."

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