Notes on the Global Economy: Drowning in Oil and Credit

Global markets gave fallen 7.1% since January 1, their worst start since 1970. George Soros, the renowned business magnate, says the situation developing in China reminds him of the period prior to the banking crisis of 2008. Former US Treasury Secretary Larry Summers has said, “The global risk to domestic performance in the US, Europe, and many emerging markets is as great as any time I can remember.”

It has been a historically poor start for global markets. The S&P 500 reported a $1.3trn loss, the worst 8-day start in its history. This was in the wake of a World Bank Report raising the possibility that the “BRICS” (Brazil, Russia, India, China and South Africa) could all face simultaneous crises this year, jeopardizing growth. It reported that 2015 had failed to live up to its expectations and that, in a development unmatched since the 1980s, most of the largest “emerging market economies” were slowing at the same time.

Albert Edwards, strategist at the bank Société Générale, warned this week that the West is about to be hit by a wave of deflation. “The financial crisis will reawaken. It will be every bit as bad as in 2008–9 and it will turn very ugly indeed . . . We have seen massive credit expansion in the US. This is not for real economic activity; it is borrowing to finance share buybacks.”

Andrew Lapthorne, another specialist at Société Générale, said, “We are in a US profits recession . . . earnings have never been cut this dramatically outside a recession. The worst earnings momentum on the planet is not in Asia, it’s not emerging markets, it’s not in Europe, it’s in the US.”

The Royal Bank of Scotland has published a note to its clients: “Sell everything except high-quality bonds. This is about the return of capital, not return on capital. In a crowded hall, exit doors are small.” According to The Guardian, it likened the current situation with 2008, when the collapse of the Lehman Brothers investment bank led to the global financial crisis, only this time with China as the trigger.

Oil prices have fallen 18% since January 1, and 72% since the summer of 2014. It is one of the biggest oil market routs in history. US oil prices slipped under $30 a barrel once again on Friday, January 15, reaching their second 12-year low this year. Capital is flowing to perceived safe havens such as gold, government bonds, and the Japanese yen, which has risen in value, damaging the competitiveness of Japanese exports.


The drop in oil has hit producing countries, widening budget deficits and weakening currencies. Energy companies have laid off an estimated 70,000 workers in the recent period. Projects such as Canada’s oil sands and the deepwater fields of the Gulf of Mexico have been shelved. In total, oil groups have now shelved $400bn in new investments. Deferred capital spending in oil has doubled since June 2015. British Petroleum this week announced plans to cut 4,000 jobs across its exploration and production business.

On January 6 it was announced that US oil inventories had risen 10%, the biggest increase since 1993. A week later, stockpiles of crude at Cushing, a key delivery point in the US, were reported to have reached a record high of 64m barrels. Total US crude stocks have risen to 482m barrels, levels which have not been seen in 80 years. US Inventories of gasoline increased 8.4m in the first week of the year, following a 10.6m buildup the week previous, according to the Energy Information Administration on January 13, much larger than the 1.6m analysts had predicted. The Financial Times quotes Ed Morse, global head of commodities research at Citigroup: “The industry appears to be running out of storage capacity.”

Miner BHP Billiton, the world’s most valuable by market capitalization, has written down the value of its US shale assets by $7.2bn. Despite being a miner, it has a $20bn stake in US shale shares. It plans to reduce output from the twenty-six rigs it operated last year to just five this year. Alongside this miner, Glencore’s share price fell 63% in the year to September 2015, followed by Anglo-American, whose share price fell 57%. Anglo-American has announced plans to close 60% of its mines and shed 85,000 of its 135,000 person workforce.

In November last year, a trio of US bank regulators reported a $34bn rise in aggregate loans in danger of default to the oil and gas sector, five times higher than a year earlier. Smaller oil companies are liable to be subject to takeovers in the next period, following the rash of mergers and acquisitions in the last period. In 2015 mergers and acquisition volumes reached $3.34tn globally, a record, and a high not seen since 2007, the year before the crash. It is a sign of a slowing economy, as the little companies struggle to compete and are eaten up by their larger competitors, who look for somewhere to invest their capital.

Oil and mineral producing countries such as Russia, Canada, South Africa, Norway, and Australia have all had their currencies drop in value against the dollar. Venezuela’s cash reserves are at a twelve-year low of $12bn.

In Canada, unemployment in Alberta’s oil sands has doubled. Capital spending in Alberta in 2014 is 40% down on the previous year. Longmay Mining, the largest SOE in the northern province of Heilongjiang in China, said in September it would cut 100,000 jobs—half its workforce.

The Russian government is slashing budget expenditure by 10% and introducing cuts of $9bn for 2016. The budget had been prepared for a 3% deficit based on $50 dollar oil, which now seems optimistic. This will be the second consecutive year that Russia has had to cut its budget due to sliding oil prices. According to Russia’s Federal Statistics Agency, the country’s gross domestic product is expected to have contracted 3.7 percent in 2015.

On December 8, Alexei Moiseev, Russia’s Deputy Finance Minister, told Reuters:

If oil goes to $20, we will need to do additional [spending] cuts. Clearly we have shown that we are very willing to cut fiscal spending in line with an oil price at $60, for example. In order for us to be long-term sustainable [with the] oil price at $40, we need to do additional cuts, but if the oil price goes to $20 we need to do even more cuts.

On December 4, Iran, Saudi Arabia, and other members of the OPEC cartel failed to agree to curb production, allowing for prices to float freely for a second year running. Iran will likely have its sanctions lifted in January, being deemed by the United Nations to have complied sufficiently with its obligations to dismantle its nuclear program. This will flood the oil market with an additional million barrels a day, which means $10 a barrel is not being ruled out in the coming months. This will also give Tehran access to $100bn of frozen Iranian assets.

Oil accounts for 9/10 of Saudi Arabia’s revenues. The fall in the price of oil has pushed Saudi’s budget deficit up to 20% of GDP. Despite planned austerity measures by the Saudi government that will cut public spending by $80bn in the coming year, a continued fall in prices and $10 oil would mean another large deficit and further rounds of austerity cuts. Saudi’s foreign exchange reserves have fallen $100bn in the past 18 months, to $636bn, in order to plug the hole in the countries’ finances.

. . . three of the things they relied on—slow but steady decision making, family cohesion, and limitless cash—now seem in short supply. The oil price has crashed and reserves are being drawn down. Policy is in the hands of Mohammed bin Salman, the dynamic but untried deputy crown prince and favorite son of the ailing king, who even supporters say risks challenge from his royal peers. He is also embarking on an overhaul of the kingdom’s clientelist and paternalist economic management—by slashing energy subsidies, for example.” (David Gardner, Financial Times, Jan. 14.)

Credit Suisse predicts the Saudi economic output will grow at its slowest since 2009. Lower economic activity in the region will continue to depress power output and oil usage

One of the symptoms of the Saudi crisis is that they are now considering the privatization of Aramco, the state-owned oil company. Aramco has hydrocarbon reserves of 261bn barrels, ten times its nearest competitor, Exxon Mobile, worth $323bn. Estimates are that a market valuation of such a company would be $3–4tn, making it the world’s biggest company.

To manage the crisis, the new Saudi economic policy includes sacking public sector workers, privatization of education and health, and abolishing subsidies (in December subsidies on water, electricity, and fuel were cut). Soon, Saudis will have to pay 5% VAT on nonessentials. Sales of shares in the crown jewels are even being considered! The crown prince Mohammed, who has in his hands many of the strings of government, has plans to sell stakes in telecoms, power stations, and the national airline according to The Economist.

On January 8 The Economist commented thus:

. . . [The old] covenants are fraying. America is semi-detached from the Middle East. The plummeting price of oil, which provides almost all of the government’s revenues, means the old economic model can no longer sustain the swelling and unproductive population. And the alliance with obscurantists brings threats, because they provide intellectual sustenance to jihadists, and form an obstacle even to modest social reforms that must be part of any attempt to wean the country off oil and create a more productive economy.

He [Prince Mohammed] seems determined to use the collapse in the price of oil, from $115 a barrel in 2014 to below $35, to enact radical economic reforms. This begins with fiscal retrenchment. Even after initial budget cuts last year, Saudi Arabia recorded a whopping budget deficit of 15% of GDP. Its pile of foreign reserves has fallen by $100 billion, to $650 billion. Even with its minimal debt of 5% of GDP, Saudi Arabia’s public finances are unsustainable for more than a few years.

Illustrating the increased social unrest being provoked by the policies of the House of Saud, more people have been executed in King Salman’s first year in office than in any of the previous twenty. Spending on defense and security has increased from 7% of GDP in 2012 to 10% in 2015. In 2016 it is expected to rise again.

The crisis is also hurting her satellites. Bahrain and Oman need oil at around 80 dollars a barrel to balance their fiscal and external accounts, the highest in the region. Oman expects a 13% budget deficit this year. Bahrain’s public debt is expected to rise to 75% of GDP this year, according to Luis Costa, emerging market currency and credit strategist at Citi. Both Oman and Bahrain are considered to only have two years of foreign exchange reserves to cover their budget deficits if oil prices remain low.

Ultimately, despite the geopolitical interests of the Saudi government, the oil collapse is rooted in the contradictions of the capitalist system. Stephen King, HSBC’s senior economic adviser:

. . . falling oil prices are less about shale production or the Machiavellian machinations of oil ministers and more about persistently weaker-than-expected global growth. Put another way, oil prices have come down not because of an outward move in the supply curve—which would be largely positive for the global economy—but, instead, because of an inward move in the demand curve. The price effect is much the same but the consequences are rather different: unlike the late-1980s, agony for oil-producing nations is not offset by ecstasy for oil-consuming nations . . . oil prices have been falling for a good 18 months, yet the evidence in favor of an economic nirvana is sorely lacking.

The Saudi government is now reported to be considering breaking the riyal’s peg to the dollar, which it has held for 30 years. The riyal-dollar peg has become less relevant than it once was. The USA has moved toward self-sufficiency in oil, and with the dollar rising makes Saudi exports less competitive. This would replicate a similar move made by China recently.

Rise of the dollar

Before the US Federal Reserve raised its rates in December, capital flight out of the so-called “Emerging Markets” were at their highest since the financial crisis. This is a trend that has continued since the Fed ended its quantitative easing program in 2013–14, which saw dollars flow back to the USA. With the rising value of the dollar, the Chinese have attempted to diversify their “peg,” the fixed link that mirrored price movements between the yuan and the dollar, enabling stabilized trade.

Much to the annoyance of US protectionists, China has flooded America with cheap goods with this mechanism for years. They have now shifted it to a peg that is linked to a number of currencies, rather than exclusively the dollar. This has led to some currency devaluation in an attempt to make Chinese exports, on which it remains heavily dependent, more competitive.

Net inflows from overseas investors to “Emerging Markets” have dropped from $285bn in 2014 to $66bn in 2015, according to the Institute for International Finance. Capital flows out from “EMs” are lifting the dollar—$52bn in the third quarter of 2015, the largest quarterly outflow on record

The consequence is that US markets are overvalued. According to Professor Robert Shiller’s cyclically adjusted price/earnings ratio, the US market has been more highly valued than it is at present only during the bubbles that burst in 1929 and 2000.

The World Bank reports that half of the 20 largest “developing country” stock markets experienced falls of 20 percent or more from their 2015 peaks. The currencies of commodity exporters (including Brazil, Indonesia, Malaysia, Russia, and South Africa), and of big developing countries subject to rising political risks (including Brazil and Turkey), fell to multi-year lows both against the US dollar.

The world economy is a sinking ship that has hit an iceberg. At one end the hull is breached and is taking in water. As it sinks, the other end is lifted from the water. At a certain point, however, the raised end will break off and hit the water in a dramatic fashion.


No matter how it tries, China remains an economy dependent on exports. For seven years it seemingly defied gravity, maintaining GDP growth rates above 7% when demand from the US and Europe was drying up.

One of history’s greatest Keynesian stimulus programs was launched following the crisis of 2008. China pumped half a trillion dollars into its economy in 2009, embarking on huge infrastructure projects. Up until recently China was building a city the size of Rome every two weeks. Between 2010 and 2013 China poured more cement than the US did in the whole of the twentieth century, according to Larry Summers (Financial Times, January 10, 2015).

With a relatively larger section of its economy in state-owned hands, the Chinese government was less reliant on courting borrowing to stimulate the economy, and intervened directly. Nevertheless, the “Great Chinese Infusion” created great distortions. A giant shadow banking bubble was one result. A boom in the luxury goods market was another. Not all the money found its way into productive investment.

China’s rate of growth is now at a quarter-century low. Estimates of capital flight from China in 2015 are between $750bn and $1tn. The trade surplus was a record $595bn, but that is explained by a big fall in imports, falling further than exports, which dropped 2.8%.

In the year to June a bubble developed in Chinese shares, inflating 150% in value. China accounts for 15% of world GDP and has contributed to 25% of all growth since 2008. The “Great Fall of China” in August saw world trade suffer its biggest fall in 6 years. The stock market collapse saw the government intervene to inject $48bn.

Following the August collapse the People’s Bank of China intervened and froze the activity of large shareholders for six months. They also stepped up internal repression, including against stock market traders. This has only increased the desire for investors to pull out of China.

The freeze on activity expired this January. The large stockholders sold, not least for fear that if they vacillated they would fall foul of the newly introduced “circuit breakers” put in place to halt trading if a fall exceeding 7% took place. They tripped the circuit breakers within a few hours on January 4, the opening day of trading, and again on January 7 within 15 minutes! After realizing the mechanism was exacerbating panic, the Chinese government scrapped it.

A weaker yuan against the dollar, however, is not good news for Chinese companies—even exporters who might be expected to benefit from a competitive advantage. In the past eight years they have accumulated $10trn worth of debt, 10% of which is denominated in dollars, which will mean increasing total Chinese debt further.

Chinese debt has grown from $7trn in 2007 to $28trn today, or a staggering 282% of GDP. It has been a period of debt-fuelled growth, similar to the UK and USA pre-2008. Eight years ago it was 160% of GDP. In December alone an additional $260bn was borrowed. In an attempt to stimulate China’s flagging economy, the central bank cut interest rates five times in 2015 and indirectly allowed Rmb2.5tn into the banking system by reducing the ratio of cash deposits banks are required to hold in reserve.

According to the Caixin index, Chinese manufacturing contracted for the 26th consecutive month in December. China is attempting to increase borrowing as a means of boosting the economy, but at the cost of increasing debt. However, if they try to reverse this policy by increasing the price of borrowing, they will compound the deflating Chinese economy further, which is at the root of the oil and mineral price collapse.

The ILO figures for China estimate unemployment at 6.3%, far higher than the official 4%. The Financial Times estimated it is possibly higher, at between 60 and 100m unemployed. However, the “Hukou” system of household registration distorts the reports. Migrant workers, numbering 270m, do not have the right to permanent dwelling in the cities, nor to collect unemployment insurance. When they lose their jobs, they are expected to return to the countryside and do not feature in the unemployment figures.

In addition the IMF notes what it terms “increased labor hoarding in overcapacity sectors.” This means maintaining workers in state-owned enterprises (SOEs) in order to suppress the unemployment figure, at the cost of falling productivity. Something similar has occurred in Britain, but through shifting the economy towards more exploitative, casualized employment.

Highlighting the weakening of the economy is the 12% growth of employment in the service sector against employment in manufacturing, which grew by just 1.2% in 2015. Pressure on employment will not be eased when 300,000 PLA soldiers are released into the job market as part of government cutbacks in the military. SOEs will be legally obliged to reserve 5% of vacancies for demobilized soldiers.

A report this year from Peking University has found China has one of the world’s highest levels of income inequality, with the richest 1 percent of households owning a third of the country’s wealth. The poorest 25 percent of Chinese households own just 1 percent of the country’s total wealth, the study found.

The number of dollar millionaires in China had risen 8 percent over the past year to 3.14m. According to Hurun’s 2015 China Rich List, the country is home to 596 dollar billionaires, more than the US.

The contradictions in the Chinese economy are stoking social unrest. The China Labor Bulletin recorded 2,774 strikes and worker protests in 2015, double the 2014 figure of 1,379.

World Trade

One such protest was by the workers at the Sainty Marine shipyard on the Yangzi River, who marched out and blocked a nearby highway after the company stopped paying them late last year. Many workers employed by the shipyard have not been paid in months. It is a symptom of the dropoff in world trade.

The Baltic Dry Index, which measures the cost of shipping raw materials globally, has fallen to its lowest point since records began in 1985. It has been reduced to 10% of its 2010 value. The cost to dispatch cargo by sea is the lowest in 30 years. This has been caused by an overproduction of shipping capacity, spurred by cheap lending over the past period.

Investment in shipping was based on expected expansions of world trade, similar to the decade prior to the crash, where global trade grew at 7% a year, faster than global GDP. Now it has slowed to 3% growth. Due to the low cost of shipping it is becoming unprofitable for shipowners to put their vessels to sea. According to the Financial Times, the largest capsize vessels cost $8,000 a day to run, while they only receive on average $5,000 in fees. Thus, they remain in port as the arteries of world trade seize up.

The number of US freight trains carrying grain has spiked as spare capacity has been freed, another impact of the collapse of world trade. The Dow Jones Transportation Index has declined 10.5% so far this year as a result. The demand for US coal and grain has fallen with the rising dollar. In 2015 shipments of US coal fell 5.1%. US mining company Arch Coal sought bankruptcy protection this week.

The crisis in oil has fed through to grain; the cost to ship wheat has fallen by 1/3 in past two years. In 2014 big grain producers with a train to spare could sublet $6,000 per car. Today, in order to avoid cancellation costs, they are paying people to use their sublet cars from them.

Oil and credit have been the historical lubricants for the world economy for more than one hundred years. The contradictions at this acute stage of the capitalist crisis mean today that such precious resources abound as never before. Little good it does for the capitalist system at present, however. Oil must be refined, capital must be invested. In a rational world, one might expect their abundance to be of benefit to mankind. But instead of irrigating society, they preside over a drought. Ships remain in port and freight trains rust, as world trade contracts.

After years of building up unprecedented productive capacity, we now face the phenomenon that there is too much capacity, too much that is for the limited market that capitalism is able to create. And none of the “remedies” used in the past work any longer, neither monetarist reduction in the money supply nor Keynesian state spending. Interest levels are at record lows, in some cases being negative, and cannot really be lowered much more, while state debt has rocketed through the roof. What we are seeing, therefore, are all the inner contradictions of the capitalist mode of production coming to the surface.

What all this highlights is that we are living through a crisis as described by Marx and Engels in the Communist Manifesto:

In these crises, there breaks out an epidemic that, in all earlier epochs, would have seemed an absurdity—the epidemic of overproduction. Society suddenly finds itself put back into a state of momentary barbarism; it appears as if a famine, a universal war of devastation, had cut off the supply of every means of subsistence; industry and commerce seem to be destroyed; and why? Because there is too much civilization, too much means of subsistence, too much industry, too much commerce. The productive forces at the disposal of society no longer tend to further the development of the conditions of bourgeois property; on the contrary, they have become too powerful for these conditions, by which they are fettered, and so soon as they overcome these fetters, they bring disorder into the whole of bourgeois society . . .

That “disorder” is only too evident today. But the biggest “disorder” will come from the class struggle, which will challenge all the established norms of bourgeois society and pose a concrete alternative, a system not based on the anarchy of the market but on production for need and not profit, production rationally planned in a democratic manner by those who produce the wealth, the workers of the world.

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