The oil price crash could signal the start of a deflationary crisis

John Stepek looks at the consequences of the collapse of the oil price in the MoneyWeek cover story this week and brings his usual clarity to the matter.

Falling energy prices should be good. But in this case they might not be. That’s partly be
cause of the size and speed of the fall (don’t underestimate this: it is absolutely huge), and the political instability that causes as it wrecks the finances of countries from Russia and Iran to Venezuela.

It’s partly because of the still-interconnected nature of the global economy: someone’s going to be going bust as a result of the oil price crash, and many someone elses are going to be found to have lent them money.

But it’s also because the fall in the oil price is as much a symptom of crisis as a cause of crisis. Ruffer’s Steve Russell wonders if it wasn’t the “slow poison” of super-low interest rates that encouraged the spending that created the oversupply in the first place (our own Bill Bonner says much the same here).

And Paul Hodges, writing for www.eri-c.com, reckons that the 40% fall represents the “first stage of the Great Unwinding of policy maker stimulus” that has dominated markets since 2009.

The US has stopped printing money, for one thing. And over in China, President Xi wants to work to improve income levels for everyone, rather than just create wealth for the well-off via asset price bubbles. That means everyone betting on money-printing in China might well be disappointed.

The next great shock, Hodges says, will come as investors realize just how much China’s economy has slowed, at a time when the aging Baby Boomers are cutting back energy consumption too.

This will all “create a demand shock equivalent to the supply shock seen in 1973” and a firm deflationary mindset worldwide. That would take a stunning and co-ordinated effort from central banks to see off.

I’ll write more on this next week – but for now professional investors can read more by Paul on the Eric website and subscribers should turn to the cover story in this week’s magazine. (If you’re not already a subscriber, you can get your first four issues free here).