FRACTIONAL FLOW

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GLOBAL CREDIT GROWTH, INTEREST RATE AND OIL PRICE – ARE THESE RELATED?

For some years my general understanding has been that the price formation for most commercial traded materials/products/items (including oil, which is paramount for all economic activities) is very much related to credit/debt growth, total debt levels and the interest rate (the price of money which also is a measure of credit risk).

In an effort to continue economic growth (to save the system and avoid the mother of all deflations) the worlds leading central banks (US Federal Reserve [FED], the most important one as the US dollar also serves as the world’s reserve currency, Bank of England [BoE] and will the European Central Bank [ECB] soon follow?) in recent years resorted to quantitive easing (QE) and lowered interest rates to almost zero to ease the burden from growing total debt loads. QE was intended to be a temporary measure.

The central banks (CB) actions appear to be a lot about preserving wealth ({inflating} assets) while there is little they can do about nature’s CAPITAL, like energy stocks (most importantly fossil fuels).

The CBs likely pursued these measures as they had few other good alternatives. It appears that the CBs policies may also have influenced the oil markets and helped shape the oil companies’ strategies to deal with a tighter supply/demand balance since 2005 by encouraging them to take on more debt and go after the more “expensive” oil.

The world has also become more complex, interconnected and continued good growth in its Gross Domestic Product (GDP) post the global financial crisis.

CBs do not have the capabilities to create cheap, abundant and lasting energy supplies. For some limited time the world’s CBs and their policies may have alleviated (and for some time continue to) some of the effects of the growth in oil/energy prices, though this was likely not their primary objective when they deployed their policies.

WHAT SUPPORTED GROWTH IN OIL DEMAND AND PRICE FORMATION?

Econ 101 refers to the law of supply and demand as the price arbitrator for raw materials, goods and services. The credit/debt will be assumed and mortgaged against promises to honor it in the future and pay interest.

One understanding of our economies is to view them as thermodynamic flows where money is the facilitator that brings energy/thermodynamic flows to and allocate these within the economies.

During the recent decades, growth in credit/debt (borrowing from the future) grew aggregate demand and to some extent negated the price growth induced from demand growth.

The recent years continued growth in credit/debt was stimulated by lowering the interest rate. By keeping interest rates low, less revenues/funds were needed to service the consequences of the growth in total debts, and thus allowed for continued deficit spending and thus support economic activities at elevated levels.

In March 2014 the Bank for International Settlements (BIS in Basel, Switzerland) published a paper titled Global liquidity: where it stands, and why it matters (pdf file, 200 kB) which presented some interesting data and observations about developments in global bank credit/debt levels.

Figure 01: The 6 panel graphic above shows global bank credit aggregates and the most important borrower regions. The chart at upper left shows that global bank credit more than doubled from 2000 to 2013. In the US [upper middle chart] the growth in bank credit slowed from around 2007 (the subprime/housing crisis) and overall credit growth was continued by increased public borrowing for deficit spending. In the Euro area [upper right chart] the total debt levels led to a slowdown in growth of bank credit post 2008 (or the Global Financial Crisis; GFC) and more recently it appears as deleveraging has started [default is one mechanism of deleveraging]. In the Euro area petroleum consumption is now  down around 13% since 2008. Asia Pacific [lower left chart] which includes China, continued a strong credit growth and thus carried on the global credit growth. Latin America [lower middle chart] which includes Brazil, continued together with Asia Pacific the strong total global credit growth. Global GDP in 2013 was estimated at above $70 trillion.

Figure 01: The 6 panel graphic above shows global bank credit aggregates and the most important borrower regions. The chart at upper left shows that global bank credit more than doubled from 2000 to 2013.
In the US [upper middle chart] the growth in bank credit slowed from around 2007 (the subprime/housing crisis) and overall credit growth was continued by increased public borrowing for deficit spending.
In the Euro area [upper right chart] the total debt levels led to a slowdown in growth of bank credit post 2008 (or the Global Financial Crisis; GFC) and more recently it appears as deleveraging has started [default is one mechanism of deleveraging]. In the Euro area petroleum consumption is now down around 13% since 2008.
Asia Pacific [lower left chart] which includes China, continued a strong credit growth and thus carried on the global credit growth.
Latin America [lower middle chart] which includes Brazil, continued together with Asia Pacific the strong total global credit growth.
Global GDP in 2013 was estimated at above $70 trillion.

Private and public debt growth through the recent decades added support for the increased oil consumption and negated the effects of higher prices caused by a tight supply/demand balance. In recent years the consumers (private sector) in many Western countries are at what appears as debt saturation, and several sovereigns are trying to carry on the overall debt growth through increased  public borrowing and deficit spending, albeit at lower levels.

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