
Can the Oil Shock Alone Explain the Financial Crisis? - robg
http://business.theatlantic.com/2009/04/can_the_oil_shock_alone_explain_the_financial_crisis.php
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teilo
Oil has contributed. But the real culprit is monetary policy. The Keynesian
model, where every dollar in your pocket is someone else's obligation, is a
balloon that always grows too big and has to either deflate or pop.

You cannot borrow your way out of debt. If all money is created by debt, then
ultimately things like oil, speculative investments, and creative financial
instruments can only pop the bubble faster. Even without them, the bubble will
continue to grow beyond the breaking point. It will just take longer to get
there.

It's simple math. You can argue against the principles of sound currency and
the laws of supply and demand about as successfully as you can argue against
the law of gravity.

What do you expect to happen, honestly? When you push out cheap money, when
you take away risk, when you create a moral hazard which prevents investors
from being burned by their own bad choices, they WILL spend and invest
recklessly.

Wall Street is not the problem. Oil is not the problem. The man behind the
curtain who is setting interest rates at artificially low levels such that the
expenditures exceed the available capital in the economy, IS the problem. And
that man is called the Fed. This is the fundamental force driving our economy,
and it is broken. Until this is addressed, all the focus on oil, investment
banks, and Wall Street is just a stage show.

~~~
ewjordan
What caused this bubble is what causes almost every bubble that has ever
happened: people see some item that they can buy and sell going up in price
over a reasonably long period, they leverage the ever loving crap out of it
because it's fairly easy to borrow money to buy something that always goes up,
and eventually the damn thing comes down once there's nobody left to speculate
on it. Boom! End of story, at least until 10 years later when the economy has
picked up again to more or less match where it would have been if the bubble
had never happened.

The particulars of any individual bubble are not even worth analyzing or
assigning blame over, because the fact is, someone is always going to be
willing to lend money out so that someone else can "invest" in a "sure thing."
Thus far, I've never heard anyone offer a solution to that fundamental problem
short of flat-out illegalizing lending, which would cause a host of other
economic woes.

Unless you have some idea to magically smooth out the risks inherent in any
market, there will always be leverage, and there will always be bubbles; there
may be some reasonable arguments for getting rid of the Fed, but the idea that
without them we'd be immune to unpredictable major corrections is just
ludicrous (and it doesn't count as a "prediction" if your economic school has
_always_ claimed that a crash is imminent because our economic model is too
Keynesian).

The Fed is the "fundamental force driving our economy," _really_? Here I was
thinking that what drove our economy was the production and sale of useful
goods and services...guess I have a lot to learn.

~~~
teilo
The magic to "smooth out the risk inherent in any market" is to let the
interest rates be set by market forces, which will inevitably (almost
magically one might say) through the principle of competition, set the
interest rates at the level which the available capital in the market can
bear. The speculative investing which you assume as a given is not a given if
money is only so cheap as the resources in the economy which support it.
However, decouple the market from interest rates, and drive those rates down
to a level which the capital in the economy cannot support, and you create a
demand glut for resources.

The market, if left to itself, is automatically self regulating, both in
regards to the price of consumable goods, and in regards to the ability of
speculative investors to obtain cheap money. Such a market punishes
speculators who fail with interest rates appropriate to the level of risk. It
cannot do this, however, when those rates are set artificially by a central
bank. Though the Fed is an independent institution on paper, they serve at the
behest of Congress and the President. For all practical purposes they are an
arm of the Federal government, exercising power from on high, and dictating to
the market how it will run.

Appealing to Zimbabwe as a counter-example, as did the previous commenter, is
an example of cognitive dissonance. Zimbabwe is a perfect example of what
happens when the government does NOT let the market self-regulate, when,
rather, the government sets prices and interest rates, distributes property,
and prints massive quantities of fiat money to compensate for its inability to
create true wealth. No government, no matter how much control it exercises,
can possibly manage an economy better than the economy can manage itself. It
is too big a beast, too complex, with too many interlocking parts.

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brc
The central tenet is that it is the 1970's all over again. And I've been
bleating this for years to my friends (who are sick of hearing it). This is
how the story goes: 1) long, expensive and difficult foreign war that becomes
increasingly unpopular at home 2) increasing government spending on military
adventures means increases in debt and inflationary policies 3) oil producing
countries realise the dollars they are being paid with are worth less and
less, do their best to manipulate the oil price higher through supply
shortages 4) oil and gold prices start to rise precipitously 5) interest in
alternative energy starts to rise, and detroit car makers get into serious
trouble 6) recession and long bear market for stocks 7) high inflation and low
growth

You can (roughly) overlay this pattern on the late '60's, early '70s, with (6)
running up until the late 1970's. And you can lay it on 2002-onwards, we're at
point (6) at the monent. There were no CDO's in 1970, but I'm sure there was
something else. I would classify the CDO/Subprime mortgage problems as a
problem magnifier rather than a problem cause. In theory, as long as a person
can keep paying a subprime mortgage, or can refinance to a better rate a few
years down the track, there's nothing wrong with them. However, too many were
given to too many people, and thus what might have been a small slowdown
turned into a banking and credit crisis.

~~~
eru
Isn't this a bit too US centric?

~~~
brc
Yes precisely, because the similarity is that the US started the process of
both times by starting expensive foreign wars and borrowing big to pay for
them. Nixon dropped the Gold standard because countries holding USD (notably
the French) were starting to get nervous about the massive waste of money in
Vietnam and started demanding Gold for their USD. That was the true start to
inflation in the 1970's, and very much a US-based event.

I didn't compare it to the Asian financial crisis of 1998 or the LTCM crisis
of 1999 because the US didn't start those off.

My main point is the Vietnam ~= Iraq and Oil Crisis 1973/74 ~= Oil Price Spike
2007/8, so therefore hyperinflation 1975-1982 ~= hyperinflation 20009-??

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bwd
I don't really agree with this analysis. I expect that the 2008 oil shock was
the Gavrilo Princip of the current financial crisis. The amount of debt was
certainly at unsustainable levels, but it seems possible that things could
have continued for another year or so before some other trigger, such as
higher interest rates, brought the whole thing crashing down.

~~~
aaronblohowiak
Saving you the google search: Gavrilo Princip was the assasin of Franz
Ferdinand, which started the chain of events that lead to WWI.
<http://en.wikipedia.org/wiki/Gavrilo_Princip>

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quoderat
In a sense, cheap oil (in the US and other countries) allowed the creation of
far-flung suburbs that enabled the rocketship of suburban debt to launch.

Without those suburbs enabled by cheap oil, the housing crisis never would've
been so severe, as no one would've thought of driving 50 miles each way to a
McMansion every day in the middle of nowhere.

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anigbrowl
Absolutely not. The financial crisis was an inevitability from September 2007.
If anything the oil crisis slowed down or even softened its impact in 3 ways:

a) it vented liquidity from the dreadfully overheated mortgage market b) it
deflected attention onto oil companies even though most of the change in oil
prices was driven by merchant bankers looking for somewhere to park cash c) it
created a high degree of demand destruction, slowing the economy down
significantly

This didn't drive us (or any other country) into recession, but rather caused
us to take a closer look at the drivers of the economy and realize that the
real estate bubble had already peaked. My personal opinion is that if it
hadn't been for the oil shock the financial crisis would have come 3-6 months
earlier and been even more stabilizing.

I did a lot of research into this last year for a documentary, but shelved it
due to inertia and changing events. I feel strongly that the oil crisis
happened because of the deeper financial crisis, but still can't decide if it
was a naturally emergent symptom or a wholly engineered plan B which succeeded
in staving off total collapse. Or somewhere in between.

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10ren
_Cheap gasoline from the 1990s into this decade encouraged families to set up
their homes farther from the cities where they worked._

Summary: Gas goes up, families can't pay mortgage.

Crude has now dropped to about $50 per gallon - I wonder what Hamilton's model
predicts from that? (of course, the drop seems mostly due to reduced demand,
so it won't stay there if economic conditions improve)

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varjag
The article looks like a great example of "correlation implies causation"
fallacy. I did not see anywhere in the piece why the current theory (oil
prices sank when shown a crack) explains the graph any less.

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pragmatic
No.

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banned_man
The housing bubble would have crashed regardless of oil prices and
availability. The severity of the crash might have been less if oil were
abundant.

