The deflationary wave intensifies

Little darling, I feel that ice is slowly melting
Little darling, it seems like years since it’s been clear
Here comes the sun, here comes the sun
And I say it’s all right
     –George Harrison, The Beatles, Here Comes the Sun

Most people have probably heard by now that world crude oil prices are in a dramatic plunge. In the futures market, the price is down 47% since June, from $107.68 per barrel to $57.49. The scuttlebut is that prices in the cash market are even lower as desperate countries and companies get what prices they can.

And it isn’t just crude oil prices that are crashing. Think stuff that China used for its “economic miracle,” like the price of iron ore (used in making steel), which has been cut in half since 2013.

But this current wave of deflation has taken on a new intensity. ZeroHedge summarized the most recent week quite well in Crude Carnage Contagion: Biggest Stock Bloodbath In 3 Years, Credit Crashes [my explanatory remarks in brackets]:

WTI’s [oil] 2nd worst week in over 3 years (down 10 of last 11 weeks)
Dow’s [stocks] worst worst week in 3 years
Financials [stocks] worst week in 2 months
Materials [stocks] worst week since Sept 2011
VIX’s Biggest week since Sept 2011 [VIX is a fear index, it rises when people are afraid]
Gold’s best week in 6 months [Gold is real money, solidified sunlight 🙂 ]
Silver’s last 2 weeks are best in 6 months [Silver is also real money!]
HY Credit’s worst 2 weeks since May 2012 [HY = High Yield (aka junk) bonds]
IG Credit’s worst week in 2 months [IG= Investment Grade bonds]
10Y Yield’s best week since June 2012 [10Y = US 10 year note]
US Oil Rig Count worst week in 2 years [Rigs are for drilling/fracking]
The USDollar’s worst week since July 2013
USDJPY’s worst week since June 2013 (USDJPY = US$ priced in Japanese Yen]
Portugal Bonds worst week since July 2011
Greek stocks worst week since 1987

So, why the intensifying deflation? Because, as has been explained here on several occasions, the world is groaning under an increasingly fierce debt load. The central banks have printed up $11 trillion in new money in the last 5 years to try to fend off deflation. Why? Because when debt loads get too large, some people and companies can’t pay back their loans, so they default, and the money they owe disappears. If they are companies, their employees lose their jobs. So their households spend less. Putting pressure on more businesses because of lost sales. Leading to more layoffs and more defaults. It’s a vicious cycle, an economy in reverse, and economy that is deflating. Remember, because all of the money in the system is debt, the economy must always grow to pay the interest on that debt. If the economy stops growing, the interest can’t be paid, defaults arise, and the deflationary cycle ensues. People tend to associate deflation with falling prices, but the falling prices are the result of deflation, not its cause.

So the central banks tried to ease the debt load by lowering interest rates to zero or lower. But one of the results was that all that cheap money financed all kinds of projects that would never have been created without this almost-free money because they weren’t very good ideas to begin with, such as the stories we’ve all heard about China having 3,000 companies all basically in the same business–how can they all make money? They can’t. Such overcapacity makes life tough for all of the companies, which all have to lower their prices, which start laying off employees, which can’t pay back their debts, etc. etc. as explained above. So this lowering of rates might seem to work for a short time, but when it’s carried on for years, it’s deflationary!

The second thing the central banks did was create this new $11 trillion to buy more debt! So they are trying to fight a problem of too much debt by creating more debt! Historians will marvel at the lack of logic by an entire academic profession. The reason for this pervasive illogic is that academic economists have for years purged from their ranks anyone who brought up the topic of gold as real money, ridiculing and marginalizing them. So they banished logic from their own ranks.

But let’s get back to the big deal of the last several weeks, the crash in oil prices. Cool, you might say, I’ll be able to pay less when I fill up my car with gas. True. But it might be wise to consider why oil prices are crashing:

     World Oil Demand Outlook Cut Again; Sub-$60 Price Seen Holding

Any hope that global demand would provide a floor for oil’s freefall was dashed as the leading energy forecaster cut its outlook for the fourth time in five months and crude extended its tumble.

Frankly, I don’t think I’ve ever heard of one of these international organizations like the International Energy Agency cutting their forecast four times in five months. So what’s happening is collapsing demand for oil.

Several recent financial statistics that measure changes in the economy are reporting levels of decline “last seen in 2009.” Recall that in 2009, a lot of people thought the world economy was not just staring into the abyss, but was about to fall in.

     PPI Slides, Misses Estimates, After Finished Goods Prices Tumble Most Since July 2009

     Short-Term Inflation Expectations Have Crashed To 5 Year Lows (In The US)

Now how does this relate to yet another “miracle” discovered by the pom-pom and short-skirt-bedecked economic and political cheerleaders, the “US shale miracle”? This is the miracle by which the US will allegedly frack its way to energy independence.

For the last three years, the US shale drillers have been borrowing $1.50 for every $1.00 in oil and gas that they pull from the ground. And that was with oil prices above $100 per barrel. The industry as a whole expected to get to breakeven–instead of losing money hand over fist, which is what they have been doing with oil just above $100–with oil above $120 per barrel. But now the price is under $60, which is less than half of the price needed for them to break even. (Chris Martenson’s group has done a great, clear video on this if you want the details.)

All told since early 2010, these energy producers have borrowed at least $550 billion. Remember that the size of the sub-prime mortgage problem was around $1.1 trillion, and the collapse of that sub-prime mortgage market nearly took down the whole system. These oil frackers have borrowed over a half trillion just since 2010 and now it looks like a lot of that borrowing will not get repaid, that is, they will default.

Now that $550 billion was a lot of spending for purchasing equipment and creating jobs to use that gear. It turns out that 1/3 of business capital spending in the US in recent years has been for energy exploration and production. And some estimate that 90% of new jobs created in the US in the last five years are related to energy production.

But now suddenly, no one wants to lend the frackers cheap money to create more overcapacity in the shale patch (because the lenders know there is a good chance they will never get paid back.) So now there will be a huge drop in equipment purchases and lots of job layoffs, leading to, you guessed it, more deflation!

If you don’t think this will happen, check this headline:

     Exclusive: New U.S. oil and gas well November permits tumble nearly 40 percent

Plunging oil prices sparked a drop of almost 40 percent in new well permits issued across the United States in November, in a sudden pause in the growth of the U.S. shale oil and gas boom that started around 2007.

Data provided exclusively to Reuters on Tuesday by industry data firm Drilling Info Inc showed 4,520 new well permits were approved last month, down from 7,227 in October.

So, the “US shale miracle” will be proven to be another fable, along with the US energy independence it was supposed to engender. It was fueled by a supply of ultra-cheap money that has now dried up. One aspect of fracked wells is that they lose 70% of their production capacity in two years, and 80% to 90% in three years. So to keep more oil flowing, these fracking companies have had to borrow more and more money to drill more and more wells. As described above, it wasn’t a very good business model and would not have existed were it not for the cheap money being provided to Wall St by the central banks.

So while you may be able to buy cheaper gas for your car, the US economy is likley to take a serious hit relating to jobs and business spending from the oil collapse.

And the US is supposed to be the bright spot in the world economy. Japan is in recession yet again. The Eurozone perennially flirts with recession, and is being dragged down by the US-led sanctions against Russia, which itself has fallen back into recession. China claims to still be growing, but the hard evidence of the falling prices mentioned above, falling real estate prices, and stalling growth in the use of electricity in China argues otherwise. From Deutsche Bank:

…the global financial system is still extremely fragile and not sustainable…2015 will be the 9th year of highly unconventional central bank policy and…we’re no nearer to finding a sustainable solution…
–Deutsche Bank

But not to worry: Uber, the emerging ride sharing service, is said to be valued at $40 billion. (Those must be some rides!)  And Jessica Alba’s new diaper-cleaning service company is apparently valued at $1 billion!

     No Bubble At All: Jessica Alba’s Diaper-Delivery Startup Is Valued At $1 Billion, Prepares For IPO

So I guess everyone will get rich (again, like in the year 2000) from internet startups?

Historically, deflation is rather unkind to stock prices. World stock markets are currently being floated by the free money from the central banks, but how long can that last? And this deflationary trend has supports beyond the overload of debt, such as the end of several cycles, including the the 26,000 year precession of the equinoxes, which tends to really clear the decks on this planet.

Now, will this deflation crash the price of gold? Not at all likely. Historically, gold increases in purchasing power during both inflationary and deflationary periods; these are periods during which people start to think that governments are losing control, so people opt for real money over government-issued scrip. Gold loses purchasing power when people think everything is, to put it technically, hunky-dory, and that their government is doing a great job. Most people don’t see it that way during bouts of deflation. Intelligent observers are still stacking real coins:

     Sales Of Silver American Eagles Rise To Record High For Second Consecutive Year

and likely hanging onto their hats to get ready for a very wild ride. Because sometimes, in reaction to deflation, governments really ramp up the money printing presses, and people lose all confidence in government money, which is known as hyper-inflation.

Whatever it is that’s coming, it’s good to know that our bank regulators will be well protected:

     Why Is The US Treasury Quietly Ordering “Surival Kits” For US Bankers?

The Department of Treasury is spending $200,000 on survival kits for all of its employees who oversee the federal banking system, according to a new solicitation. As FreeBeacon reports, survival kits will be delivered to every major bank in the United States and includes a solar blanket, food bar, water-purification tablets, and dust mask (among other things). The question, obviously, is just what do they know that the rest of us don’t?