Random thoughts on energy, debt and economic growth

There has always been a direct correlation between economic growth and the cost of energy: The cheaper the cost of energy, the greater the economic growth. While it is true that low oil prices will negatively affect companies that deal directly in them, the opposite is true for the rest of the economy. If the price of oil remains low for the next few years, there will inevitably be an increase in economic growth throughout the world. This is because there is a "ripple" effect whereby lower oil prices translate into cheaper goods and services - cheaper transport costs a) allow producers to sell their goods at a higher profit margin, and b) allow consumers to have more disposable income left after purchasing them. In short, cheap energy (which means plentiful energy in reality), is a win-win for the entire economy.

As for the "debt supercycle", I am getting more and more convinced that the economy is actually about goods and services that people and businesses produce and consume. Debt and money are simply numbers which affect how much a person/business/government can purchase or produce something. If there is cheap and plentiful energy available to an economy, the numbers involving debt and money will tend to balance each other out more quickly. Prior to the 1980s and the birth of neoliberalism, sharemarkets and debt markets grew at the same pace as, if not lower than, economic performance. This changed from 1981 onwards, as nations began cutting taxes on high income earners and businesses in the hope that this would spur investment. It did spur some investment, but over the long term all it did was create a huge bubble of debt existing alongside skyrocketing sharemarket indices (like the Dow Jones). Flush with massive amounts of cash, the rich and the corporations made money and profit simply through a debt/sharemarket/property balloon. Unlike previous generations, in which what went up went back down, monetary policy (interest rates) was able to simultaneously stop any crash and keep the bubble expanding. Instead of popping, the investment balloon remained and still remains very big. What has changed is that the economy has slowed down. A pre-1981 economic system, in which taxes on the rich and corporations remain high and significant economic resources are transferred to ordinary people, will result in higher economic growth (alongside lower debt levels, lower property prices and lower share market indices).

The Energy part of the equation here is important because obviously a market economy that is dependent upon fossil fuels is more likely to experience peaks and troughs as oil levels move from plentiful to scarce. If the world economy was a game, and if global warming did not exist, it would be far better to pump out oil continually at a pace beyond demand, ensuring that a large reservoir of ready-to-refine oil exists above ground rather than below it, and by doing so keep energy flowing into the economy at a stable pace. But because energy is in the hands of market forces, this doesn't happen.

Recession Looming?

With a lot of focus on the potential for another recession, I thought I'd post some thoughts, as well as some graphs from various spreadsheets that I have kept going during my current absence.

Yield Curves on Inflation adjusted Bonds.

Since interest rates have been so low for so long, one standard method of recession prediction - an inversion of the yield curve - has become problematic. As a result I decided a while back to keep tabs on inflation-indexed securities (since these incorporate negative interest rates). When you compare the curve between 5-year, 7-year, 10-year and 20-year inflation indexed securities, the current situation is:

(I would've put this in chart form, but only the 2015-12 data would be shown).

The "TIIPS Yield Curve" column in yellow is just the average difference between the 5 & 7, 7 & 10 and 10 &20. Since Inflation adjusted bonds have only recently been added to Fred at St Louis Fed, there isn't much history to go on. The history does, fortunately, encompass pre-2008 data:

This data shows an inverted yield curve occurring in late 2006, which indicated the recession on the way.

In short, the current yield curve data does not show any oncoming recession... yet.

Net Monetary Base vs. NSA Inflation (yearly spread)

A few years ago I created the idea of a "Net Monetary Base", by which the Excess Reserves are taken away from the Monetary Base. The idea being that excess reserves have the same function as money taken out of circulation (and are thus deflationary). This was recognised back during the Depression as part of the 1933 Banking Act, one of the policies being an enforced reduction in commercial bank excess reserves. After the passing of this act, prices began rising after being in decline since 1929. Post-2008, no comparable law was passed, allowing banks to hold excess reserves and probably prolonging the "long recession" (which I think is what it is being called now).

Anyway, one way to determine recessions is to compare the net monetary base to inflation. One of the discoveries I found a few years ago was that every recession was accompanied (both before and during) by a negative result. (A "negative result" is when the rate of increase of the net monetary base is lower than the rate of increase in inflation). ALL recessions for which data is available show a clear association with a negative result.

(Of course I have not done any major statistical analysis of this data. I'll leave that for the statistical experts who can prove me right or wrong later on).

So what of this data? What is it showing? Here is a screenshot of my spreadsheet:

It is the far left column that is important. If it is negative, it indicates an oncoming recession. At the moment it isn't. Compare this to 2005, which showed a recession was coming:

Or maybe the 2001 recession:

Put all my data into a graph, and it looks like this:

In short, the data does not suggest a recession yet.