Distance costs money: Interview with Jeff Rubin

oil barrels

In a world of triple digit oil prices, distance costs money. Photo: ezioman via Flickr.

Among the many compelling speakers at the Association for the Study of Peak Oil (ASPO-USA) conference in Washington, DC this October, only a few gave keynote addresses to the attendees. Jeff Rubin, former chief economist at CIBC World Markets and author of Why Your World Is About to Get a Whole Lot Smaller: Oil and the End of Globalization, was among that elite. His talk, “Oil and the End of Globalization”

hinged on a few key points. One of the most compelling, a refrain he returned to again and again, was that “distance costs money.”

As an economist, Rubin analyzes the role of prices in the overall financial picture. And with world economic crises, from fraud and abuse, to bubbles and bailouts, from credit to credit collapse, a world economy on the verge of a meltdown has become the third leg of imminent disaster among those who like to talk about…well, imminent disaster.

First it was climate change. Then it was climate change and the global peak in oil production. Now it’s about how climate change, peak oil, and economic collapse are headed for a shared crash. Perhaps economic crash will stave off a climate meltdown, but perhaps only by a few decades. Perhaps an economy in crisis also depresses oil prices, which will at some point increase energy demand. But then that increased demand will lead to more energy use, more greenhouse gas emissions, and worse climate change. Effects of climate change then could hurt the economy and, and, and….THEN…

What?

That’s the question.

There are more than enough bleak looking potential outcomes on the horizon in today’s world. And to hear it from some Cassandras, that horizon might only be about ten feet away. Who to trust to sort it all out becomes a major question when evaluating competing notions about the future. In another column I address how this relates to a fourth tier problem—communication—but more on that later.

Energy and the economy

Right now the hot topic in financial blame falls on shyster bankers and their whole rotten crew. Bad apples becomes the explanation for a nation and a world in recession, for the crumbling economies of countries and the reason why millions of Americans risk losing the roof over their heads. And a much worse spread of toxic loss looms just around the corner.

Speculators and bad-faith financial players are a major part of the story, no doubt. But for Rubin, the larger story of spreading ruin wouldn’t even be unfolding if it weren’t for the oil price spikes of 2008.

“Most people view the recent recession as purely a financial crisis, one whose origins lie in the failed sub-prime mortgage market in the US. But what people fail to ask themselves is, What caused the Fed Funds rate to go from one to five percent in 2005 and 2006? Inflation went up to six percent because of the spike in oil prices. Every recession since 1973 has had oil’s fingerprints all over it. Oil shocks are inflationary.”

Not so fast

But it’s just this kind of insider view that lay financial writer Nicole Foss says misses the point. Foss, who is touring the world as Stoneleigh, urges folks to cash out and hunker down for deflation.

People have had enough of experts, Stoneleigh suggests. “If anything, the fact that I am not a formally taught economist carried more weight with many who were there at the ASPO conference. I taught myself informally everything I know about economics,” Stoneleigh says.

She has her beefs with Rubin, too. She accuses him of mischaracterizing her as a monetarist. “Monetarists don’t recognize the role of credit, and as I say, credit is the absolute key to why we are going into a deflation.”

And there’s the crux. While Rubin and Stoneleigh might agree on how some of these terms and effects play off of each other, the plain fact is that when someone hears that one of them says inflation is coming and bound to deliver a wallop, and the other says, no, it’s deflation that will kick our asses, there’s a disconnect.

For Rubin, resolving this is simple. For him, it’s all about prices. And the key price is the cost of a barrel of oil.

The price is not right

“Other economists were basically in denial that oil prices could ever get to $147 a barrel. They said they’d stay at $30,” Rubin explained. “Also, most are in the financial markets. They think they’re the center of the universe and they don’t look farther. If the Fed funds rate had stayed at zero percent all those people in Arizona would still be in their homes. But all of a sudden money wasn’t free, there was a massive de-leveraging of the system. And when oil prices go up again it will be the same as in 1973.”

Indeed oil still hovers in the mid $80 range. Though volatility might send it back to $40, Rubin says this is only a signal that, “we’ve gone into another oil-caused recession.”

But before prices go anywhere near as south as all that, Rubin expects them to go back to the triple digit range that hit 2008 in the knee, dragging the economy into the ditch.

Though economists still bemoan the current economy (while curiously remarking on its exact opposite, saying that we’re in recovery) oil prices haven’t yet reflected the real intensity that tightened supply would suggest. In a sense, relatively low American gas prices suggest that the US is not in fact in recovery. At least if Rubin’s take on energy as the driver is correct. The problem is that world demand has grown too, with no signs of slowing down.

“It’s not the American consumer who drove prices up in ’08 and it won’t be the American consumer who drives up demand in ’11. Our demand has peaked. But unfortunately we’ll feel the effects,” says Rubin.

Rubin cites an increasingly energy hungry China along with a Middle East that is just as content to burn its own oil at home in order to ski down indoor slopes in July as they are to continue exporting oil to us. Competition has, in a word, increased.

The form increased competition has taken hasn’t necessarily meant that the US is a player. Quite the opposite in fact. With our manufacturing jobs exported, and service jobs more about pouring coffee than selling software, the US continues to limp along. There’s no clear vision for a way out of the morass even while President Obama tours Asia pushing continued global economic plans.

In fact the administration appears unconcerned about fuel costs and the competition for resources. No strategy has been advanced to address the IEA’s recent announcement that the world hit peak oil in 2006. Perhaps they imagine that getting oil from deep water platforms and tar sands costs the same as light sweet crude?

But not Rubin. He says the global economy and the price of oil go hand in hand, and their future isn’t promising. “Globalization is about to become obsolete. Globalization doesn’t work in that world of triple-digit oil prices, where distance costs money.”

If the people lead, the leaders will follow

For him, our leaders aren’t likely to change course and lead in the ways most needed.  “Institutions like the Fed or Congress or the White House will be the last people to recognize this. They won’t be the ones to re-engineer the economy.”

As a firm believer in the power of prices, Rubin sees business waking up to the crisis first. Citing Proctor and Gamble as a company already rerouting their supply networks closer to home, Rubin says prices are driving decisions on organization even as we speak. That same response will play out all over the country: “I don’t have a lot of faith in Congress, but I do have a lot of faith in ordinary Americans. We’re going to reshape our economy.”

The relocalization talked about in official Transition communities and among others who link energy and economy is the same solution Rubin sees coming, calling it a silver lining in a terrible storm.

“The way we can grow our economies in the face of those transport prices is to go back to a regional economy. Triple-digit oil prices may breathe new life into our Rust Belt and turn suburbs back into farmland. In order to be able to grow with those kinds of oil prices, we’re going to have to go back to a more local economy.”

In tomorrow’s more localized economy, Rubin says, “Transport costs will not play as important a role.”

Similarly, Rubin sees a return to hard resources as the drivers of real value. “Countries with resources are doing better than those without, like Canada doing better than the US. Oil and potash are more important than research in motion,” he explains. “By the same token, the Middle East will become less important to the US. Your future supply won’t be coming from OPEC and it won’t be cheap. Places like Canada and Venezuela will become more important.”

It’s a small world after all

Going local is certainly fashionable, and makes sense on a certain level. But if Rubin firmly believes in the power of prices, what about the higher cost of making things at home again?

To him this isn’t such a problem, again, because distance costs money. “If we’re not importing our steel from China and start making our own steel in places like Pennsylvania and Ohio it won’t cost as much as hauling it across the Pacific Ocean, but it will cost more. The Fed is absolutely wrong in thinking the big boogie man is Japanese style deflation. The real problem is American-style inflation. Things will become more expensive as production is repatriated at home.”

And there’s other good news. “We’ll also have a more diversified economy. Not everybody will be working in services, on Wall Street or at Starbucks.”

But we’re not going to get there on a smooth and easy road. There’s plenty of games already set in motion that will have to run their course or fall apart before resolving into something more manageable.

“People are hurting right now because there’s a 9.6% unemployment rate and that’s with a hugely artificially stimulated economy with a huge federal debt and deficits at the state and local level along with zero percent interest rates,” explains Rubin. “These policies that buffered the severity of the recession today just make the future more problematic.”

He argues that debt will need to be paid down through tax increases and budget cuts. “There are many examples around the world that record budget deficits and zero percent interest rates are a marriage that cannot last. America has become a borrower and China is basically funding the Treasury deficit. There are very tough adjustments that America faces.”

For Rubin the solution is a vigorous move away from oil dependence. He says the way to do that is to relocalize, and he says we’ll do that not because of community projects like Transition initiatives as much as because of the power of prices. “That’s what the price signals that triple digit oil prices will do. I have great faith in the power of prices to change people’s behavior.”

Some advance awareness of the problem could help. But Rubin says that the public doesn’t hear a lot of discussion of the issues that he talks about in his blog. “The majority of Americans probably believe that oil prices only got to their previous high because of market speculation,” he says. That’s a view also held by those who invest the market roulette with greater power than resources. But Rubin says when oil prices go back up, “we’ll see a sea change.”

Even if there is volatility, with prices spiking and then plunging, the main input, or lack of it, remains key. “That doesn’t mean there’s a lot of oil in the world. That just means we’ve gone into another oil-caused recession. But what could be a more telling indictment of the global economy than that scenario, that a global economy doesn’t work in a world of triple digit oil?”

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Comments

  1. Jb says

    I agree with those that say the threshold for an oil induced recession is now lower than a triple digit price. Without access to credit or the demand for credit, there is no economic expansion. Without economic expansion (of BAU), the price of oil cannot go above the price people are willing to pay. I believe we are very close to the point where the price we are willing to pay is lower than what the oil companies need to bring lower quality and harder to obtain oil to market. Thank you.

  2. says

    “Distance costs money” You hear this frequently, along with hand-wringing over globalization. Of course its true for Big Things like steel and cars and equipment and raw materials. But via rail or sea, per pound costs are very low. Bunker oil can double or triple in cost and have little effect on the price of iPods, electronics, computers, clothes – basically everything they sell at the mall. Even shipping by air adds little cost to small valuable things like electronics or expensive clothes.

    Further, trucks are much less efficient than trains or ships, so local shipping based on trucks is going to inflate faster than the cost of global shipping. So if you live in LA it may still be cheap to get a car from the Far East, or by train, but if you live far from a dock and a railroad domestic cars may cost just as much to ship as imports. A Honda may be cheap in Ohio where they make them, or off the dock in California, but expensive in South Carolina, where the BMWs are made.

    Shipping energy costs are a devil-in-the-details problem. I’d like to see some numbers for some typical products, and not just a generalization.

    What about those corsets? Merry Widows maybe?

    John

    • says

      Re-reading what I wrote hurriedly, I see a big mish-mash of ideas. So I am now looking for references on shipping costs vs fuel prices. My sense is, it’s a complex situation, with unknowns and variables like ship speed reduction and future pollution controls, plus very different costs per pound-mile among rail, truck, air, and ocean. The fact that consumer goods are often shipped by air is, I think, a proof that things aren’t as simple as they seem.

      There also needs to be a consensus on just what we mean by “Globalization” I mean I myself have a sort of hazy working definition, which on consideration, I find to be meaningless.

  3. says

    I see no evidence that Mr Rubin has an appreciation of net energy. That will be Canada’s problem now that conventional supplies have peaked. The EROEI of unconventional supplies is extremely low, and our ability to scale up production is also very limited. Far from being a major energy source with energy security, Canada will face significant energy problems of its own, especially in the east.

    The oil price spike of 2008 was clearly a speculative bubble, as I explained in the talk I gave at ASPO. Prices reflect perception, not reality, and there was a perception of scarcity at that time that was unfounded. Of course oil will be scarce in the future, but the perception of scarcity over-reached itself at that time. Financial markets have their own internal dynamics, and and speculative bubbles bring forward demand, at the expense of the future. This crashes demand afterwards, and with it prices. I see no evidence that Mr Rubin understands this, and I found his analysis very superficial.

    By the way, the quote you attribute to me is not accurate, although it roughly paraphrases my words. Portraying me as a lay writer is not entirely fair either. I have plenty of formal qualifications and have worked as an academic in the energy field (as a research fellow at the Oxford Institute for Energy Studies). I am not an economist, but that is hardly a handicap in field so fatally flawed. We need to discard what passes for economic theory these days, as it is little more than a religion grounded in assumptions with no relation to reality.

    If you would like to interview someone with a PhD in economics who has done more than anyone else to reconstruct his discipline, I suggest you talk to Steve Keen. His work is exceptionally well developed.

    Regards,

    Nicole Foss (Stoneleigh)

    • says

      Thanks for chiming in Nicole, it’s flattering to think of you reading Transition Voice.

      I do want to point out that no slight was meant by calling you a lay financial writer. I would not have used the same descriptor to frame your work on energy. But I am mindful that your writing and speaking now is focused very much on markets and financial insider baseball—credit, securities, speculation, bubbles, market behavior— while touching on how that affects us all. You do mention energy, but you are very focused right now on market machinations.

      As a journalist, my aim is to present a picture of a person that accurately reflects their background. Given your speeches on economy I felt that “lay financial writer” best described your foray into that field. Had your comments been far more tipped in the direction of energy inputs and considerations, I would have noted that. In fact, in last month’s issue I used the profile from the ASPO website, which pointed to your energy work in Canada, and then you commented elsewhere (on FB) that you were no longer doing that work, so I changed the interview to note that (Nov issue: http://transitionvoice.com/2010/11/deflated-economy-in-a-talk-with-nicole-foss/ ). Similarly, in my interview with James Howard Kunstler, I indicate that he is not an economist, but an observer of financial goings-on. This is no slight, but rather an journalist’s accurate reflection of his credentials in that field. And it’s certainly not an indication that we only want to talk to Phd’s. However, we will look into your recommendation in the spirit of good will. That doesn’t necessarily make either Kunstler or your observations any less worthy. They are just not those of a trained economist. As journalists we want to provide enough information for our readers to decide for themselves.

      On that note, you allege that you were misquoted in the item above. That is a matter you would have to take up with Helen Loughrey, the writer of the piece on you, Dec: http://transitionvoice.com/2010/12/nicole-foss-extended-interview/ Loughrey told me that she had an extended telephone interview with you that she taped, and that what is on that unedited version is a direct transcript of the conversation. If you were misquoted, it was not by me, as I took the quote directly from Loughrey’s piece with no changes. I do need to stand by my writers, and she did tell me this was a direct transcript of a phone conversation.

      In using your quotes and views in this piece my intention was only to illustrate that while Mr. Rubin has his views, not everyone agrees. In fact I asked Kunstler his view (Dec. Transition Voice: http://transitionvoice.com/2010/12/interview-james-howard-kunstler/) and he agrees with you that markets are playing a more immediate role and one that is revealing a fundamental crisis in the legitimacy of government.

      I do extend the invitation for you to write an original piece for Transition Voice on your views, or on any topic of your choosing. Our aim is not to assert the unequivocal truth, nor even the truth as we might see it. But rather to explore, question, promote, dissect, profile, investigate, muse, introduce, challenge, etc.

      All my best,

      Lindsay Curren
      Editor
      Transition Voice

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