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We Are So Not Prepared For Another Oil Shock

In one sense, energy doesn’t matter all that much to what’s coming. Once debt reaches a certain level, oil can be $10 a barrel or $200, and either way we’re in trouble.

But the cost of energy can still play a role in the timing and shape of the next financial crisis. The housing/derivatives bubble of 2006 -2008, for instance, might have gone on a while longer if oil hadn’t spiked to $140/bbl in 2007. And the subsequent recovery was probably expedited by oil plunging to $40 in 2008.

With the Middle East now lurching towards yet another major war, it’s easy to envision a supply disruption that sends oil back to its previous high or beyond. So the question becomes, what would that do to today’s hyper-leveraged global economy?

So what would $150/bbl oil mean today? Several things:

Another recession. The US economy contracted at an annual rate of about 2% in the first quarter and isn’t nearly as strong as analysts had predicted going forward. Let gas go to $5 a gallon, and the consumer spending on which the US economic model depends would dry up. Put another way, we might spend the same amount but it will be mostly for gas and not much else. So much for the recovery.

Equity bear market. Stock prices depend on corporate profits, which in turn depend on sales. If Americans buy less, corporations earn less. With blue chip equities currently priced for perfection, major companies faced with a sales slowdown will, if they want to keep their stock prices from tanking, have to borrow even more money and buy back even more shares, which will only work until interest costs start consuming what’s left of their profits. Then US stocks fall hard.

Currency crisis. If Saudi Arabia manages to stay out of this latest conflict, it will see its revenues surge as it sells the same amount of oil at higher prices. But it’s not happy with the US (something about us recently tilting towards Iran) and apparently no longer feels obligated to accept only dollars for its oil. Let it start accepting euros, yen and yuan, and the result will be lessened demand for dollars, a falling dollar exchange rate and all manner of turmoil in global bond markets.

Derivatives implosion. Derivatives — basically private bets on the behavior of interest rates, currency exchange rates and corporate bond defaults — on the books of major banks have actually increased in the five years since those instruments nearly destroyed the global financial system.

There are between half a quadrillion and one quadrillion dollars face value of derivatives out there, and a spike in financial market volatility would cause a lot of them to blow up.

Source Dollar Collapse

 

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