Prediction Leftovers

SUBHEAD: Predictions on world economy and energy in 2014 leads to conclusion of a self-reinforcing energy deflation.

By Steve Ludlum on 13 January 2014 for Economic Undertow -

[IB Publisher's note: The order of some sections of this article have been re-arranged. Also the original article has several graphs we did not include. See link above.]

Image above: Wall Street Journal illustration from 2008 - "Economic Whirlpoo". Still ticking. From (

China has lived beyond its means for twenty years, it must now begin to pay the price. China’s expansion has been built upon a foundation of cheap coal; there is still the coal and it is still cheap but the price of other fuels has risen to adversely affect the consumption of the coal.

China’s consumers are faced with a dilemma: buy the coal or Saudi Arabian gasoline. China’s gigantic manufacturing ‘investment’ is now competing against the precious automobiles. We know how this contest will turn out, the cars will win; humans will chose cars over life itself, certainly over poison dog food.

With diminished external flows of funds there will be less for China’s economy to leverage, there is a credit squeeze already, this will intensify, there will be a race for cash, a dump of Chinese assets.

China’s thirst for credit and its customers’ prior claims upon it — in the form of their cars — is the incentive for deleveraging in China. What is underway is a war between the Chinese’ and the Americans’ cars. The fallout will be severe not just for China but for all of its trading partners … and for the Chinese cars!

A deleveraging China will be less smog-bound.

A deleveraging China will effect credit markets and depress commodity prices, perhaps below the level needed by crude oil suppliers = fuel shortages. Economists will insist shortages should cause prices to increase but nobody can explain how having less fuel will make China or anyone else ‘richer’.

The massively over-leveraged Japan faces similar difficulties as over-leveraged China … only more so. Japan’s overseas customers must decide whether to buy fuel for their current Japanese cars or skip the fuel and buy new cars, anyway. In the ‘good old days’ all of the above was possible but Japan’s ballooning trade deficit suggests a change in the paradigm: there is an opportunity cost of cars! Sacre bleu! New cars must compete against the old cars for fuel. We already know how this movie turns out before it even begins; fuel for the car in hand crushes the promise of a new car with iffy fuel in the future. This hostile dynamic is in the process of stranding the entire Japanese auto industry … just like it has already stranded the EU version.

Analysts can say what they want, the Japanese trade deficit — and the creeping Chinese version — speaks for itself. If the Japanese were selling more cars they would ‘enjoy’ a trade surplus.

Look for more radiation leaks and emissions from Fukushima Daiichi. By the end of the year the Japanese will still have no idea where the reactor cores have migrated nor will they have built a barrier or cofferdam around the reactor complex to contain the flows of radioactive water from the plant. Japan is saddled with an incompetent, militarist, reactionary government that has lost contact with reality/not ready for prime time. Credit costs will climb as more credit will be needed to retire maturing loans than the Bank of Japan can provide … even as overseas lenders recoil from palpable risk. At the same time, Japanese will ‘take the money and run’ away from the yen.

Look for more posturing and aggression in South China Sea between China, Vietnam, the Philippines and India; between China and Japan over the Sea of Japan; between Iran and the West in the Persian Gulf; between Russia, Norway and Canada over the Arctic Ocean. Look for increased US involvement in Somalia, Yemen, Uganda, Kenya, Mali, Democratic Republic of Congo, Nigeria, southern Africa, Venezuela, Honduras, Bolivia and elsewhere. Venezuela is likely to be the focus of American attention as its current government struggles leaving a political vacuum in that country. Look for all-out war between militant groups within Mexico.

At the same time, there will not be an outright war between China and any other country. China cannot afford a war, neither can any of its likely adversaries. China’s new government is very weak and uncertain; even a small war would result in a China embarrassment which would be fatal for the leadership, perhaps even for the Chinese Communist Party (CCP). China is adept at bullying its own citizens but there is little to gain by bullying others. China depends upon external credit and resources from its trade partners, unlike the bullying Soviet Union. A China war would result in a drop in trade which would be damaging. China knows this so …

The CCP will not risk a war but will rattle the saber and be very provocative, so as to distract its citizens from the crumbling economy. The mere fact of the saber rattling is evidence of Chinese anxiety, yet, posturing is playing with fire. Public pressure within China for a war against anyone is intense now and set to become overwhelming. The Chinese public is both frantically xenophobic and too youthful to recall the losses and miseries that accompanied the country’s wars against the Europeans, Japan, Russia, Vietnam, the US and others.

There will be an expanding civil war in Iraq, a spillover from the war in Syria, a parallel war with much the same impulses being acted upon. There will be much looking back in America and elsewhere upon the Saddam Hussein period as ‘the good old days’. As a consequence of this war, Iraqi oil production will suffer … as it now suffers in Libya.

Western rapprochement with Iran will lead to more Shiite adventures in Iraq versus the resident Sunnis. While Syrian fighting peters out due to exhaustion it will intensify within Iraq.

Sunnis in Anbar Province battled the US to a standstill by using indirect tactics — targeting Iraqi security forces operating with the Americans as well as their political allies, hitting them hard with car bombs and improvised explosive devices. Al Qaeda in Iraq became a force to be reckoned with. Only when the US stopped fighting and started buying did the tide turn in Falluja, Ramadi and elsewhere in Western Iraq.

If the Sunnis want to fight again they can easily defeat the Iran-backed Maliki forces. They not only have the Saudi money but also the best training, gained by years of house-to-house fighting against US Marines. The Malikis are not American soldiers, they are disgruntled youths fighting Iran’s war for Shia dominion. The Shiites have already learned to steer clear of the Kurds, they seem both eager and certain to learn a hard lesson at the hands of the Sunnis.

Outcome: land-grab of eastern Iraq and decent of Shialand to becoming a de-facto colony of Iran.

The ‘Arab Spring’ will deflate as neither Salafists nor idealists can gain the energy needed to support extremists or keep modernity expanding . As the cars run, the owners are doomed; the countries fall into ruin.

What comes next over a period of years is the brutal struggle for economic survival with diminishing external sources of support.

Egypt has little ion the way of foreign currency reserves, its oil exports are nil; it is currently subsidized by Saudi Arabia. That country cannot permanently support Egyptian fuel waste even as Saudia itself confronts its own political and economic uncertainties.

 European and UK credit spreads will widen as lenders will balk at the deteriorating political situation on the continent and in Britain. Political instability signals increased risks.

Darkness spreads across Europe as ancient demons re-emerge from the sewers and dungeons to which six years of war and a total Allied victory had consigned them. Extremist political groups are gaining ascendency in Europe, with their guns, truncheons, hate and street brawls, particularly in Italy, Finland, Netherlands, Greece and Hungary.

This follows the ‘success’ of the banker-led bureaucratic overthrow of democracy in Europe: certainly the EU and ECB did not anticipate this outcome! The resulting vacuum is proven to be fertile ground for groups perceived by the public as effectively able to take on the finance cartel.

Yet, the latest iterations of Nazi Germans or Ustasha fascists are not interested in bankers or conventional policy, choosing instead to finger immigrants, leftists and Jews as scapegoats and potential victims.

The extremists are as incapable of forming the course of events as their technocratic antecedents. The bounds of politics are outlined by resource limits. Europe is utterly dependent upon Russia and North Africa for its fuel supply; managers in these countries look upon European extremists with pause.

Europe also relies on external creditors, particularly Wall Street financiers.

These dependencies were not issues during the rise of fascism and Nazism in the 1920s and 30s.

Europe possessed significant resources including coal, iron, other mineral metal ores, timber and water, petroleum was close at hand in Romania, Americans were willing to sell oil and money to governments that were at the time, novelties. The fascists were quick to default on war reparations and other debts, to abandon the gold standard and gain the positive shock effect from the increase in broad money.

Fast forward to 2014 and fascist extremism is no novelty for those with the willingness to remember. Beating and killing immigrants in alleys cannot end fuel poverty; the extremists will not be able to redistribute what they cannot set their hands upon.

Yet, they are already much more sinister than the parties they replace; they cannot fix Europe but will turn it into Bosnia if given the opportunity. This is not certain, but the chance is there and will ripen even as it is already a poisonous canker. There will be violent disorder as the Nazis will claim to speak for all young people but rather will be violently opposed by them.

The extremists are confronted with their own dilemma as abandonment of the current repressive economic regime would end the euro and make it very difficult, if not impossible for Europeans to import motor fuel. The Nazis have no choice but to bind themselves to the currency they despise and the policies that support it in order to meet their own promises … unless they promise a return to an agrarian Europe little different from North Korea. Like the rest of the establishment, the Nazis bottom-line promise is a return to the ‘good old days’ of friction-free resource waste.

 The upcoming EU parliamentary elections look to produce new members who are violently anti-EU. Like the central banks, the Europeans have painted themselves into the ‘stupid corner’. The euro is under assault on all sides: it is unwieldy, there is no real federal European government or treasury to support it, there is less and less political enthusiasm for the currency, the euro fiscal and monetary structures are unable to manage the flows of credit sensibly between the countries that use it.

The euro’s utility as a fuel price hedge diminishes as it becomes scarce. Instead of a symbol of liberal European social- and economic progress the euro is becoming both a symbol- and enabler of violent hate groups. Everything gained by way of the common currency falls out of reach. Most importantly, the ‘euro = gasoline’ equation is coming to an end; this equation has held the euro and the EU together … but not for long.

Haircuts of EU bank depositors is possible but the outcome will be even more credibility to the Nazis and more street violence. So far demonstrations against the inept and corrupt governments have been peaceful, this will not be so with the emergence of extremists as political managers.

Argentina looks to default in 2014. How they managed to avoid it in 2013 is a mystery.

The backdrop of the World Cup in Brazil will be riots as the economy unravels, capital flows out of the country and the Brazilian currency becomes nearly worthless. The problem is deflating China whose voracious consumption of raw materials will slacken; there will also be economic difficulties in Peru, Chile and Venezuela, across Central America and Mexico.

The ‘asset price bubble as energy price hedge’ will fail in 2014 as it has every time since 1973. Assets are claims against fuel; as such assets are effected by both price of fuel and the price of credit. Needless to say, fuel prices cannot possibly hedge fuel prices! Keep in mind, credit is also a fuel (price) derivative; there are no substitutes for fuel-energy.

US natural gas prices will continue to increase due to declining output in shale plays. The cause will be less drilling activity and declining prices for gas liquids. This is not really a fair prediction rather a continuation from last year.

US oil output overall will not increase in 2014; light, tight oil will increase along with output from the Gulf of Mexico, output from all other areas including Alaska and conventional plays will decline.

There will be more industry attempts to allow crude exports, these will be accompanied by claims of higher output to come as well as more talk of an ‘energy revolution’. Volumetric output will be inflated by including refinery gains as well as natural gas plant liquids, neither of which are useful as motor fuels. As per usual, any gains in high-priced export market will be more than offset by losses in domestic markets as too-broke customers cannot meet the higher world price.

Shale fuel efforts overseas will bust. Geology rules.

Arctic fuel efforts will also bust. The energy industry will be staring into the abyss as the year progresses as it confronts failure after failure.

Russian petroleum production will level off, evidence is drilling efforts in the Arctic. If Russian plays held excess oil there would be no need to drill there. The increase in ex-Soviet production since the year 2000 has been the chief factor in putting off what would otherwise have been a severe oil supply crisis.

Interest rates are set to rise, part of this is cyclical as rates have been low for an unprecedented period. The dilemma for central banks is to continue to ease or not. Easing in the face of rising rates calls into question the banks’ effectiveness, yet letting rates rise is dangerous for markets that are extremely over-levered.

From ‘cleanest dirty shirt’ department: US stock markets will be subject rising interest rates to ‘capital’ flight from Europe and the Far East, this will cause stock prices to rise further and set up short-squeezes. At the same time, rising interest rates will open a chasm at the feet of ‘investors’.

In 2014 there will be violent push-back in Latin America, Africa, India,  and elsewhere against and neo-colonial ‘land-grabbing’. What will support asset prices is capital flight from economies that are more damaged than that of the US.

For the holders of gold the dilemma will be to bail out of it or not. Holding has been a good trade for a long time … yet, returns can only be gained by swapping gold for hated electronic money. In the meantime, gold would follow other assets into a deleveraging decline but gold will still be worth relatively more than other assets. All of this is subject to capital flight from overseas.

For crypto-currencies such as Bitcoin, the moment for them is not at hand, there is too much self-defeating speculation in the various -coin units. If the price of a Bitcoin was less than $10 there would be no public interest in it, even though its utility of a means of exchange operating outside the corroded and crumbling banking system is clear.

The question is whether the banking system will hold together long enough for a useful crypto-currency to emerge as an alternative.

The cost of fuel will continue to rise relative to the cost of everything else, the cause will be our prior decades’ as well as current consumption success. By the end of this year or very shortly afterward, the price that drillers need to bring new fuels to market will be the same price that shuts down consumption. This will occur even if the managers make no serious errors, such as start a great war or cause a run out of banks or a major currency.

The reason for this has nothing to do with the physical ability to produce nor does it imply an actual shortage of reserves.

Instead, it is the inability of consumption to provide any returns - this leads to returns being be borrowed - the effect is too little can be borrowed - meaning this borrowing incapacity is the result of high fuel prices. This is self-reinforcing energy deflation.

That is the word for the year: Deflation. Coming to your town.


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