Future Shock：Can we survive another stagflation?
Zan-dong Ding
Department of Finance and Banking
Kun shan University, Taiwan
Abstract
The 2009- stagflation is significantly different from the three previous ones
occurring in the periods 1973-1975, 1980-1981 and 1990-1991 characteristically.
Although the causes of these four stagflations are all because of the shortness of oil
supply, the previous three are due to certain political events. Once the political
events ceased, the stagflation ended. The 2009- stagflation, however, is caused
by long term oil depletion. A few petroleum geologists have predicted the global
oil depletion through different approaches. Hubbert predicted the global oil
depletion since year 2000 with his “oil production peak＂theory. Other
petroleum geologists have predicted the oil production has reached its peak from
2004-2008. The data provided by US Energy Information Administration also
showed the world has gone through long term oil depletion since 2006. With
long term lacking energy supply, the future global economy will become very
unstable and face repeated stagflations. The global economy system may
inevitably be forced toward a great change. The modern civilization may even
collapse due to a lack of energy.
I. Introduction
Stagflation, especially in macroeconomics, is the phenomena in which inflation
and economic stagnation occur simultaneously and remain for a period of time.
This is in contrary because in a normal economic situation, inflation and recession
are mutually exclusive. Economists offer two principal explanations for the
occurrence of stagflation. Firstly, stagflation results when an economy is slowed by
an unfavorable supply shock, e.g. short supply of oil in an oil importing country or
short supply of food in the market. This causes the price of certain product rises
while in the meantime slowing down the economy by making production less
profitable. Secondly, stagflation can result from inappropriate macroeconomic
policies. For example, central banks can cause inflation by permitting an excessive
growth of the money supply. In history there have been 4 global stagflations, occurring in 1973-75, 1980-1981,
1990-1991 and currently. They were all caused by a short supply of oil and
resulted in serious global economic recessions. However, in this article we will
emphasize the fact that the 2009- stagflation is intrinsically different to the
previous three stagflations in history. The size and economic impact of the 2009stagflation is in a much greater scale and will continue to threat the global
economy for a long time. Therefore the policies the government applied before and
the experience we learned in the past may not be suitable in dealing with the
current 2009- stagflation. We need to understand the intrinsic characteristic of
2009- stagflation and be extremely cautious in how to handle this economic crisis.
The characteristic of 2009- stagflation will be discussed further in this article.
II. Encountering a long term Stagflation
From the view of resource scarcity, stagflation results when economic growth is
inhibited by a restricted supply of raw materials. After the supply shock occurs,
the economy will first try to maintain momentum — that is, consumers and
businesses will begin paying higher prices in order to maintain their level of
demand. The central bank may exacerbate this by increasing the money supply,
by lowering interest rates for example, in an effort to combat a recession.
Since the 1970s global stagflation, many economists and scholars have
published quite a number of studies on the topic of stagflation. These papers
basically deal with stagflation from the view of government policy, for example,
Martin Bronfenbrenner (1976), A. Blinder (1979), Michael Bruno & Jeffrey
Sachs (1985) , Paul Krugman (2000), Robert B. Barsky & Lutz Kilian (2000)
etc… However these studies based on the previous experiences of stagflation
may not be able to handle the 2009- stagflation properly. The previous three
stagflations were all caused by a single political event. Once the political event
was removed, the market immediately returned to normal. The situation of
2009- stagflation is different. The cause of 2009- stagflation is long term oil
depletion. The stagflation can be mitigated only when the replacement of oil
can be applied immediately or the system can be upgraded with higher energy
efficiency. Matthew R. Simmons in his book “Twilight in the Desert＂
proposed a solution of oil depletion by governments applying a plan using the
oil more effectively (using less oil) to create a new world order. It does not
seem like the world political leaders have done much actions towards making
this a solution. Therefore the damage of 2009- stagflation will probably
continue for a long time.
In this article we provide the views from the petroleum geologists in
interoperating the 2009- stagflation, especially the “oil production peak＂
theory. King Hubbert proposed his oil production peak theory in1956.
Around late 1990s a few other petroleum geologists reaffirmed Hubert＇s
theory. They predicted the global oil production peak from 2004 to 2008.
The data provided by Energy Information Administration (EIA, 2008) shows
that the global economy encountered an oil production peak at 2006. With this
long term oil depletion in view, we predict a pattern of the coming global
economy system. We will see the world is facing a serious “long term
stagflation＂ that challenges the continuation of the human civilization.
III. Stagflations in history
1. 1973-1975 stagflation
The 1973-1975 stagflation started in October 1973, when the Organization of
Petroleum Exporting Countries (OPEC) proclaimed an oil embargo in response
to the U.S. decision to re-supply the Israeli military. Oil prices unexpectedly
rose from $2.60/barrel in 1973 to $11/barrel in 1975 in nominal terms (Fig 1).
This caused a long and deep recession in which both the inflation rate and the
unemployment rate rose significantly. The inflation rate and the
unemployment rate in many countries almost doubled during the recession.
The recession lasted 16 months from November 1973 to March 1975. It
ended when OPEC resumed the regular quota of oil production for each OPEC
country.
Fig 1: Oil price in history (1946-2009)
2. 1980-1981 stagflation
The 1980-1981 stagflations occurred in the wake of the Iranian Revolution.
Amid massive protests, the Shah of Iran, Mohammad Reza Pahlavi, fled his
country in early 1979, allowing the Ayatollah Khomeini to gain control. The
protests shattered the Iranian oil sector. While the new regime resumed oil
exports, it was inconsistent and at a lower volume, forcing prices to go up.
The price of crude oil went up from US$15.85 per barrel on April 5, 1979 to
$39.50 per barrel over the next 12 months. This caused high inflation rate
and unemployment rate. The recession lasted 16 months from July 1981 to
November 1982. Again, after the political event was over, the recession
ended. The price of crude oil began to decline from 1980 until it reached a 46
percent drop in 1986 (Fig 1). This was due to reduced demand and
over-production.
3. 1990-1991 stagflation
The 1990-1991stagflation was caused by the Iraqi invasion of Kuwait on
August 2, 1990. The price increases occurred after the Iraqi invasion of Kuwait
on August 2. The price of crude oil rose from $21 per barrel at the end of
July to $46 by mid-October. However the 1990 oil price shock was
numerically milder and briefer than previous oil crises, lasting only 3 quarters.
The recession ended immediately after the Persian Gulf War.
4. 2009- stagflation
The 2009- stagflation is not caused by any single political event. Since 2004,
the price of crude oil has risen from $21 per barrel to $60 in 2005, $70 in 2006,
and $100 in 2007, to $147 by July 2008 (Fig. 1). This was due to over demand
and reduced production. The strong growth of the economy in Asian
countries, especially China and Indo, enhanced the need of oil supply. The
data provided by European International Energy Agency (IEA) or US Energy
Information Administration (EIA) all shows the expected demand of oil will be
greater than the supply (Fig. 2) after 2006.
Fig 2: The oil production and the expected demanding curves (EIA data） To minimize the impact on inflation caused by the rising oil price, the U.S.
Federal Reserve Board increased interest rates 17 times from 2004 to 2006 (Fig.
3). This eventually caused the outbreak of the financial crisis of 2007–2009.
The financial crisis was linked to reckless lending practices resulting from the
deregulation of real estate mortgages in the United States. The emergence of
Sub-prime loan losses in 2007 began the crisis and exposed other risky loans
and over-inflated asset prices. With loan losses mounting and the fall of
Lehman Brothers on September 15, 2008, a major panic broke out on the
inter-bank loan market. As share and housing prices declined many large and
well established investment and commercial banks in the United States and
Europe suffered huge losses and even faced bankruptcy, resulting in massive
public financial assistance. Some economists have predicted that this recession may last to 2011. With
the view that the world is facing long term oil depletion, 2009- stagflation may
linger on even longer than we expect and cause more damage to the economy.
Fig 3: United States Official Interest Rates (1999-2009) IV.
A long term Oil Depletion
1. Predicted by “Oil Production Peak Theory＂ To understand the fact that the world is going through long term oil depletion,
we need to check the evidences from the petroleum geologists. The first
petroleum geologist that predicted the global oil reservoirs will be depleted is
M. King Hubbert. In a paper "Energy from Fossil Fuels, Science" given in
1956, he pointed out that the fossil fuel era would be of very short duration.
On the estimation of energy resources and global oil production rate, Hubbert
predicted the patterns of discovery and depletion of American and global
petroleum reservoirs.
According to Hubbert the energy cost of exploration and production will get
higher when the production well gets older. So long as oil is used as a source
of energy, when the energy cost of recovering oil becomes greater than the
energy content of the oil, production will cease no matter what the monetary
price may be. Hubbert used a world oil ultimate of 1250 Gb against a total
discovery of 340 Gb to forecast a peak around the year 2000 (Fig 4).
Hubbert＇s peak was widely used later to denote the peak of oil production
rate.
Figure 4: Ultimate world crude-oil production based upon initial reserves
of 1250 billion barrels
The term of Global Oil Production Peak does not mean that world economy will
face the problem when the oil reservoirs are all depleted. The real meaning of
the Oil Production Peak is that as long as the global oil production rate passes
the peak, the crisis occurs. Since the civilization of technology is so closely
related to the energy supply, it is almost impossible to separate one from the
other. This is like the relationship between the water and human body.
Although human body contains 70% water, it collapses with even just 10 - 15%
loss of water. During the energy crisis occurred in 1973 to1975, as soon as
OPEC cut 5% of the total oil supply, the oil prices in the market almost
quadrupled.
Hubbert passed away in 1989, but other petroleum geologists continued to
examine the theory with updated data. These included Hatfield, C.B. (1997),
Kerr, R.A. (1998), Campbell, C. A. and Laherrere (1998) etc… They used
similar methods as Hubbert did and obtained a global oil production peak at the
year of 2004 to 2008. Their results were published in well known scientific
journals such as “Nature＂, “Science＂ and “Scientific
America＂. With the oil prices rising rapidly from 2004 to 2008
and causing a global recession since 2008, the warnings of long term oil
depletion from these petroleum geologists are probably significant. Currently
in 2009, among the 65 oil producing countries, 58 countries have reported their
peak in their oil fields.
2.
Observed from the field data
Long term global oil depletion can also be seen by the world crude oil
production data. The plot in Figure 2 shows that the global oil production rate
was slowly in reduction since 2006. In spite of a continuously rising oil price,
the oil production rate still declined. The oil production rate not increasing is
probably due to the fact that the global oil production has peaked. Although
the crude oil price dropped significantly since September 2008 with the
economic recession, it will rise tremendously when the recession ended.
The world facing oil depletion can also be seen by the scarcity of new oil fields
to be found. Figure 5 shows the plot of oil discovery versus production from
The Association for the Study of Peak Oil and Gas (ASPO). The plot shows
the oil discovery versus production up to 2004 and projected forward after 2004
by the trend. We can see that before the mid- 1980s the world discovered as
much oil as it produced, but after mid- 1980s this trend is clearly unsustainable.
In the last couple of years, the world has consumed almost three times as much
crude oil as has been discovered. Because new oil fields are fewer, most oil
companies even cut 2/3 of their prospecting expenses. The scarcity of new oil
fields is another sign that the world is going through long term oil depletion.
Figure 5:
Oil discovery versus production
V. Future Economy
With long term oil depletion, the world economy will be very unstable.
Unless the alternative energy can be found in time, the world will go
through stagflation nightmares again and again. Each time it will
become more serious. Figure 6 explains the development of economy in
the future, where S represents the supply curve of crude oil. Because the
total oil supply has a limit, S curve approaches to a vertical line in the
upper right. When the demand moves up from D1 to D2, the price P and
the produce Q both move up to P2 and Q2. When the demand moves up
from D2 to D3, the price moves up with a faster rate than the produce.
When the demand moves up above D3, only price increases but produce
remains.
Fig6:
The model in explaining the economy of future We can visualize the development of economy in the future through Figure 6.
Because the only way to curb oil prices is the demand, the economy will
repeatedly move up and down along the S curve. When the economy
resumes its prosperity, the oil price speedily moves up above D3 and causes
the inflation on market. It soon causes an economic recession and the oil
price drops back to D1. Therefore the economy becomes very unstable and
tosses about the supply of oil.
Because of the gradual depletion of oil, there are many problems we will face
in the future. How can we maintain the transportation system when lacking
of energy? How can we maintain the power supply? Can we supply
enough food for populations? Can we maintain the current lifestyles? Can
the trading system maintain as usual, for example, in globalization? Will
wars break out because of the fight for remaining oil? In other words, due
to the shortage of energy supply, the modern civilization can not be
maintained and may even collapse in the future.
VI.
Conclusion
In this article we reviewed the stagflations in the history. We have shown
that the 2009- stagflation is significantly different from the stagflations
occurring in 1973-1975, 1980-1981 and 1990-1991. We provided the
evidence from petroleum geologists that 2009- stagflation was caused by
long term oil depletion. The scarcity of oil discoveries also shows that the
world is facing a serious shortage of energy supply. The future global
economy will therefore become very unstable, fragile and will likely go
through stagflations again and again. The global economy may inevitably
be forced toward a great change. The modern civilization may even
collapse because of a lack of energy.
VII. References
1.
Robert B. Barsky & Lutz Kilian , A Monetary Explanation of the Great
Stagflation of the 1970s, 2000 , National Bureau of Economic Research
2. A. Blinder, (1979), Economic Policy and the Great Stagflation, New York:
Academic Press.
3. Martin Bronfenbrenner (1976), "Elements of Stagflation Theory",
Zeitschrift für Nationalökonomie 36: 1–8
4. Michael Bruno & Jeffrey Sachs, Economics of Worldwide Stagflation, 1985,
Harvard university Press
5. U Colin J. Campbell, PEAK OIL: A TURNING FOR MANKIND, Hubbert
Center Newsletter # 2001/2-1
6. Colin J. Campbell amd Jean Laherrere , The End of Cheap Oil, Scientific
American 278, 1998
7. Kenneth S. Deffeyes, Hubbert＇s Peak, Princeton University Press, 2001
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9.
Kenneth S. Deffeyes, Beyond Oil, Hill and Wang, 2006
M. King Hubbert，Nuclear Energy and the Fossil Fuels, American
Petroleum Institute Drilling and Production Practice, Proceedings of Spring
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Meeting, San Antonio, 1956
R. A. Kerr, The Next Oil Crisis Looms Large-And Perhaps Close, Science 281,
1998
Craig Hatfield, Oil Back on the Global Agenda, Nature 387, 1997
Paul Krugman，Currency Crises (National Bureau of Economic Research
Conference Report) (September 2000)
Matthew R. Simmons, Twilight in the Desert, John Wiley & Sons, Inc. ,
2005
Colin J. Campbell http://www.hubbertpeak.com/Campbell/
Energy Information Administration (EIA)
http://tonto.eia.doe.gov/abouteia/
The Association for the Study of Peak Oil and Gas (ASPO)
http://www.peakoil.net/