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Black Gold and Real Gold

Peak Oil is a defining event and process. As the oil wave we have ridden for the last 150 years begins to ebb and roll back forever, it will suck back into its retreating wake many things that we have enjoyed and taken for granted. One of these things is easy money.

Oil makes the world go round because money makes the world go round. Easy and cheap oil has acted as guarantor for the trillions of easy and cheap dollars that swim around this debt-ridden world in ever increasing amounts. So long as the tens of millions of barrels of oil keep gushing out of the wells, the money can keep gushing out of the banks to finance personal, corporate and government debt by the billions each day and every day, on the hour, every hour.

To say it is money of gargantuan proportions is probably an understatement in itself as the US government debt alone approaches $8 trillion. This does not tell the whole story as we consider how much interest is paid on this federal debt each year - over $300 billion annually and climbing since short term interest rates began to take off again after 2003. On average, that's over $35 million an hour paid out in interest to holders of government promises to pay from 3-month T-bills to 30 years bonds.

But 2005 dollars are not the same as, say, 1945 dollars. Thanks to the increased demand for money backed by increasing amounts of black gold, we have had too much money chasing too few goods with the resultant deterioration of the purchasing power of the dollar and every other currency on this planet.

Back in 1945, the federal debt was $279 billion due to the war effort, but a dollar in 1945 had the purchasing power of eleven dollars today. That means the federal debt today would be only $727 billion if it were transported back to 1945 values. This is how corrosive inflation is on the wealth of a nation.

Actually, 1945 was around the last time federal debt exceeded national GDP at about 120% of GDP. Today federal debt stands at about 67% of GDP, so does that make things okay? One may compare the government to a private individual taking out a mortgage. This person may earn about $50,000 a year and they take out a mortgage of $200,000 to buy their dream home. That gives a debt to personal "GDP" of 400%! This seems to make the government look downright prudent at 67%.

Not really. Firstly, unlike the government, the individual intends to pay off the debt through perhaps a gradual repayment scheme or maybe buying a cheaper house at retirement or mayhap through an inheritance.

The State, however, regards itself as an immortal entity that does not die. A person's debt stays with them throughout their working life. The government intends to "work" forever and hence never pay off the debt. Neither is it buying a cheaper "home" to reduce debt - the government just seems to keep on buying bigger and better "houses".

Finally, having no parents, the government has no inheritance and no one else will at the rate taxes will have to rise to pay off this debt!

The presumption of perpetual federal debt is based on the presumption of perpetual taxation that is itself based on the presumption of perpetual energy to work. Unlike an individual who may get laid off, the government does not expect tax revenues to dry up and make it "redundant". Perhaps income may drop during lean times, but drop precipitously? Never.

That was at least until Peak Oil reared its ugly head. As we said, just as real gold used to back the money of America and nearly all other countries, so black gold does this work today. What do we mean by that? Back in the days before the Second World War, a holder of twenty dollars in bank notes could confidently go to his local bank and redeem them for one gold double eagle. After 1933, you could only redeem those twenty dollars in notes for more notes or silver and copper coins. Gold was demonetised and the government felt it had liberated itself from a discipline that had constrained it from expanding the money supply at reckless rates. The figure of $8 trillion federal debt bears testimony to such an undisciplined monetary system.

Yet a monetary system now backed by black gold. Of course, you cannot take sixty dollars to your local bank and redeem it for a barrel of oil. No, oil cannot explicitly be marketed as commodity money because it lacks the properties of a true medium of monetary exchange. However, where it approaches this monetary paradigm is in its role as the engine of economic growth and hence monetary growth.

The problem is that the expansion of money cannot get too far ahead of the expansion of economy. We noted the fact that federal debt was 120% of the value of the economy in 1945. That number is 67% today but when we add corporate and personal debt, we leap like a gazelle over 1945 to nearly 300% of the economy's GDP!

This means that politicians, executives and mortgage holders have taken a leveraged bet of 3:1 that oil will sustain such a debt ratio by virtue of the fact that it will continue to expand production to accommodate this unprecedented leverage. That game was played with real gold back in 1929 when banks over issued credit despite being on a gold standard to fuel the roaring 20s and its manic stock market speculation. As we know, that ended in tears.

Now as Peak Oil approaches, the guarantor is beginning to lose his creditworthiness. As crude oil production begins to falter globally, GDP will begin to falter globally. Players of the futures markets will know what happens when a leveraged bet goes against you, you lose big time and the margin calls come in. When GDP begins to decrease for years to come on this type of leverage, the equivalent of margin calls will be made to governments across the world.

What will they do? You either pay the extra margin (inflate the money supply) or you close out your position at a loss (default on your debt). One is inflationary, the other is deflationary. We think the government will pay the extra margin but the private sector will close out. Either way, the economy must contract and money must seek a new backer. That backer will be Gold, an old friend long spurned but one who can be trusted and whose time will come next decade at the earliest.

Roland Watson writes the investment newsletter The New Era Investor that can be purchased for an annual subscription of $99. To view a sample copy of the newsletter, please go to www.newerainvestor.com and click on the "View Sample Issue Here" link to the right.

Comments are invited by emailing the author at newerainvestor@yahoo.co.uk.

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