Thursday, July 26, 2007

PAUL KRUGMAN: The Sum of Some Fears

Yesterday’s scary ride in the markets wasn’t a full-fledged panic. The interest rate on 10-year U.S. government bonds — a much better indicator than stock prices of what investors think will happen to the economy — fell sharply, but even so, it ended the day higher than its level as recently as mid-May, and well above its levels earlier in the year. This tells us that investors still consider a recession, which would cause the Fed to cut interest rates, fairly unlikely.

So it wasn’t the sum of all fears. But it was the sum of some fears — three, in particular.

The first is fear of bad credit. Back in March, after another market plunge, I spun a fantasy about how a global financial meltdown could take place: people would suddenly remember that bad stuff sometimes happens, risk premiums — the extra return people demand for holding bonds that aren’t government guaranteed — would soar, and credit would dry up.

Well, some of that happened yesterday. “The risk premium on corporate bonds soared the most in five years,” reported Bloomberg News. “And debt sales faltered as investors shunned all but the safest debt.” Mark Zandi of Moody’s said that if another major hedge fund stumbles, “That could elicit a crisis of confidence and a global shock.”

I saw that one coming. But what’s really striking is how much of the current angst in the market is over two things that I thought had been obvious for a long time: the magnitude of the housing slump and the persistence of high oil prices.

I’ve written a lot about housing over the past couple of years, so let me just repeat the basics. Back in 2002 and 2003, low interest rates made buying a house look like a very good deal. As people piled into housing, however, prices rose — and people began assuming that they would keep on rising. So the boom fed on itself: borrowers began taking out loans they couldn’t really afford and lenders began relaxing their standards.

Eventually the bubble had to burst, and when it did it left us with prices way out of line with reality and a huge overhang of unsold properties. This in turn has caused a plunge in housing construction and a lot of mortgage defaults. And the experience of past boom-and-bust cycles in housing tells us that it should be several years at least before things return to normal.

I’ve written less about oil prices, so let me emphasize two points about the oil situation. First, we’re now in our third year of very high oil prices by historical standards — prices as high, even when adjusted for inflation, as those that prevailed in the early 1980s, after the Islamic revolution in Iran. Second, unlike the energy crises of the past, this price surge has happened even though there hasn’t been any major disruption in world oil supply.

It’s pretty clear what’s happening: economic development is colliding with geology.

The “peak oil” theorists may or may not be right in asserting that world oil production is already as high as it will ever go — anyone who really knows what’s going in Saudi Arabia’s fields, please drop me a line — but finding new oil is getting a lot harder. Meanwhile, emerging economies, especially in Asia, are burning ever more oil as they get richer. With demand soaring and supply growth sluggish at best, high prices are what you get.

So why did people seem so shocked by a few more bad housing and oil numbers? What I guess I didn’t realize was how deep the denial still runs.

Over the last couple of years a peculiar conviction emerged among some analysts — mainly, for some reason, among those with right-wing political leanings — that the housing bubble was a myth and that the real bubble was in oil prices.

Each new peak in oil prices was met with declarations that it was all speculation — like the 2005 prediction by Steve Forbes that oil was in a “huge bubble” and that its price would be down to $35 or $40 a barrel within a year. And on the other side, as recently as this January, National Review’s Buzzcharts column declared that we were having a “pop-free” housing slowdown.

I didn’t think many people believed this stuff, but the market’s sudden freakout over housing and oil suggests that I was wrong.

Anyway, now reality is settling in. And there’s one more thing worth mentioning: the economic expansion that began in 2001, while it has been great for corporate profits, has yet to produce any significant gains for ordinary working Americans. And now it looks as if it never will.


Anonymous said...

Good assessment. The Saudis are notorious for witholding information on their reserves and production. However, you don't have to go to Saudi to see they are struggling to maintain production now. Just look at what they are buying from the oil services companies -- smart well technology to shut off early water production, sand control screens, and even ESPs, or electric submersible pumps. At the same time they are spending billions redeveloping fields they had produced and abandoned earlier. They are drilling expensive maximum contact horizontal wells and moving OFFSHORE and developing heavy and sour oil and gas resources. IF they had ready reserves, or their fields were not in the last stages of production, they would not be doing any of this.
OPEC production figures are down despite record high prices and massive investment. NON OPEC production has clearly peaked and is now in permanent decline. The only conclusion I can arrive at is that the global peak has been reached. What this means for the world economy has not been discussed sufficiently and certainly has not been planned for. This is, in my mind, is a critical issue for every country on earth to consider -- and soon.

Anonymous said...

Excellent piece, as always, from PK.

I would point out that one of the basic ideas of peak oil, namely that we will exhaust the cheap sources of oil and then increasingly have to replace them with more expensive oil (from ultra deep water, Arctic, and heavy/sour reserves) is playing out right now. The supergiant oil fields in production have been producing for several decades, and there simply are no direct replacements for them.

This is why we've been on a worldwide oil production plateau since the most recent high point in May 2005. Many experts are concluding that oil's peak has either passed or is no more than 4 or 5 years away. If you have a relatively new car in the US, the odds are pretty strong that you'll be putting $5 gasoline into it before you sell it or trade it in.

Rory McMullan said...

Since energy is what powers economic development, the probable peak in oil production isn't great news for the markets, but that might not be a bad thing...

Initially there will be a switch from oil to coal, of which the peak is likely to be 30 years or more away, but the devastating effects of this 'dirty' energy source on the environment may derail the economy anyway.

The investment in renewable sources is increasing as oil is becoming more expensive and we should be able to power up to 10% of our electricity needs within 5 – 10 years, transport is another question all together.

Ultimately energy efficiency is the only real solution, which in reality means we just have to learn to make do with less of everything, not something the markets want to hear, but then maybe its time to switch to a completely new paradigm.

The idea that we can have endless growth in consumption when our resources are finite never made much sense to me anyway, and surveys show rampant consumerism has failed to make us any happier. But maybe I’m just ill informed; perhaps an economist can explain how the 6.5 billion people on the planet can all enjoy standards of living that match the average American, since although estimates vary most seem to predict we would need an extra 9 planets to live like this?

Anonymous said...

Thanks to See You… for posting Krugman!

Seems to me that the “peculiar conviction” the article mentions is more prevalent on the right is that the right, especially that part of it currently in ascendance, is heavily based on believing stuff, as opposed, say, to thinking about it, investigating it, following its logic, and looking at the results.

They believed that a war in Iraq would be good for the US and Israel, and were willing to lie to get that war started.

They believed that their own wealth indicated the economy was going well, and couldn’t understand why the lack of any increase in real wages for decades kept the vast majority from seeing the truth.

They believed that God created the earth six thousand years ago despite all the evidence.

They believed that faith in their God was more important than whether they chose to kill people and steal their resources.

In the end, it seems that they’ve managed to convince Americans that pre-emptive war is folly, that economic inequality is a very important problem, that people who don’t accept the idea of evolution are idiots, and that faith in their type of God is destructive.

Anonymous said...

Regarding Peak Oil.
To me it seems we may have "peak oil" now; but if that is true why is the price of oil still below the inflation adjusted level of the 1970s???
Or am I missing something?
Whenever Ive talked with folks who say the oil is running out and I bring that fact up they are unable to give an answer.
Maybe Mr. K can?

sb322 said...


This week we learned that on August 30 the United States Air Force flew a B-52, locked and loaded with nuclear warheads, from North Dakota to Louisiana. This broke a military policy going back to the 1960s against such flights.

There is a still more dreadful prospect though. Our "unitary executive" may be threatening or preparing a strike against us, the unruly and now war weary American People who are the greatest impediment to the Neocon New American Century plan. It used to be that only the 911 Truth community would entertain the idea that the next 911, the "911-2B" attack, could come from our own government. However, a recent spate of Bush administration pronouncements that we are due for such an attack has made it apparent to many other Americans that Bush would welcome a 911-2B event -- or might even arrange one


Why was a nuclear-armed bomber allowed to fly over the US?

Wednesday’s revelation that a US Air Force B-52 bomber flew over the length of the United States armed with six cruise missiles carrying nuclear warheads has attracted amazingly little media attention.

RUMOR: Within intelligence circles there are rumors that the munitions airmen acting on their own without orders, disconnected the powersuppy to each of the missiles prior to mounting them on the B52's pylons. This act prevented the onboard missile computers from being overridden from the ground and launched remotely [out of the control of the B52 pilots].

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