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Forecast 2007: First a Look Backward

Let’s get this out of the way up front: the worst call I made last year was for the Dow to crumble down to 4000 when, in fact, it melted up to a new all-time record high of about 12,500. The reason we saw this, in my opinion, was that inertia combined with sheer luck to keep the finance sector decoupled from reality long enough for the Wall Street insiders to guarantee their 2006 Christmas bonuses — perhaps the last they will ever see.

Finance has been trending away from economic reality since the Ronald Reagan era on an accelerating basis. By this I mean the role of finance no longer represents sets of mechanisms and institutions designed to raise legitimate capital for investment in legitimate productive activities. Finance is now an end in itself, essentially a racket. The capital is no longer capital, i.e. genuine wealth accumulated from previous productive activities. Now it is jive-capital: notional “wealth” spun out of activities that are fundamentally not productive — for instance, sub-prime mortgages bundled into tradable securities. In reality, the mortgages backing these securities are contracts for repayment of huge loans made on hazardous terms by shifty means to people with poor prospects for making their payments for assets (suburban houses made of vinyl and glue) that are, in any case, fated to lose much of their nominal value, becoming worth less than the obligations yet due on them, and rapidly so.

The sub-prime loans were made in the first place because the contracting institutions (banks) could pass off the risks associated with these jive contracts by off-loading them to larger institutions such as the government sponsored enterprises Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation) which are largely exempt from regulatory oversight and hence could buy up whatever cockamamie paper contracts they felt like buying and convert them into bonds, certificates said to represent future earnings. (Not.)

These mortgage backed securities were only one species of engineered abstract financial “instruments” among many orders of incomprehensibly abstract mutant financial “products” (derivatives, credit default swaps) and procedures (carry trade, leveraged buyouts,) based on the fundamental unreality that it is possible to get something for nothing.

The inertia part of the story is that this collective hallucination (that jive-capital was real) was sustained through 2006 by the sheer massive weight and flow of jive capital and its ability to elude scrutiny by countless chimerical conversions from one abstruse form to another — from loan, to bond, to bet, to position, to Christmas bonus. . . . The final result, though, was a nation with an increasingly impoverished middle class, a bankrupt public treasury, and all remaining wealth (notional or residual) creamed off by a racketeering upper crust of logrolling insiders who, for the moment, could convert their dollars into multiple mansions, private jet planes, and sky boxes at the gladiatorial combats du jour.

The rest of the US economy was increasingly composed of a suburban development hyper-boom that amounted to little more overall than a colossal misinvestment in a living arrangement with no future (and the irreparable destruction of the remaining US landscape). The building-and-selling of suburban houses and the ancillary accessorizing of them with collector highways, strip malls, and big box stores, fast food huts, and all the jobs associated with constructing, lending, evaluating, selling, servicing, and staffing these things, along with additional rackets like home equity withdrawal refinancing to keep the cash registers ringing in the Wal-Marts and Home Depots — these were the activities supposedly keeping the “regular” (i.e. lumpenprole) economy chugging along. If you subtracted all this “housing bubble” activity from the rest of this economy since 2001 there was very little left besides, hair-styling, fried chicken, and open heart surgery.

Yet, marvelous to relate, the whole toxic, entropy-laden, creaking, reeking cargo of shit-and-deceit that comprised this system just managed to keep rolling along for another year without collapsing under its own stinking, fantastically stupid weight.

The luck part of the story came partly from the weather — there was barely any hurricane activity in US territory last year and global warming was so advanced that the northern states set records for warm winter temperatures — which redounded into the fossil fuel part of the 2006 story.

We came out of 2005 in very poor shape for oil and gas because so many platforms in the Gulf of Mexico were destroyed or damaged by Hurricanes Katrina and Rita — something like 23 percent of total production capacity at the worst point, some of which never recovered — not to mention the circumstances worldwide regarding oil supply (more on this ahead). The supernaturally warm winter kept home heating prices super low in early 2006. Nonetheless, oil prices began ramping up in the spring as we approached the happy motoring part of the year joined by fear of yet another harsh hurricane season. At midsummer, we got the spasm of the Hezbollah-Israeli war, which threatened to infect the oil-producing areas of the Middle East. Around this time, oil spiked to $78 a barrel.

But that little war terminated with next-to-zero immediate repercussions. Both Hezbollah and Israel went home to regroup. The US was not tempted to step on Hezbollah’s sponsor, Iran, and Saudi Arabia kept its beak out of the beef, too. The world’s focus returned to the ongoing fiasco of America’s misadventure in Iraq, and that just ground on and on like a giant Cuisinart making human guacamole in wholesale batches day after day.

The hurricane season turned out to be a total bust. The panic buying of oil contracts at mid-summer turned to an autumn rout as inventories were already built up and bidders left the futures markets. Oil prices sank from $78 to the high $50s. The Amaranth hedge fund crapped out on an oil futures play. It was rumored that Goldman Sachs (its CEO Hank Paulson just elevated to Secretary of the Treasury last summer) used its vast resources to further queer the oil futures markets going into the November election to keep prices down and voters zonked out. Whether this was true or not, I simply don’t know — but obviously it didn’t help preserve the Republican hold on congress.

But it brings us to a crucial final angle on the story-as-a-whole, which is that the stresses, distortions, and perversities we see in the financial markets and the economy are largely attributable to the peculiar circumstances of Peak Oil .– namely, a grinding background reality that this point of the world’s highest-ever petroleum production represents the final blow off of an economy that really has no future, an economy in which typical industrial growth is no longer possible. And if this growth, this ceaseless expansion of everything is no longer possible, if instead we enter a wholesale global contraction of available energy, of industrial activity, and expectation of future activity, why then the markersused to signify the expectation of growth (at least the retention of wealth) — currencies, stock certificates, bonds, derivative contracts, mortgages — all these things lose their legitimacy and finally their value. That is the fundamental underlying reality in Peak Oil’s relation to our modern economies in general and to the finance sector that is supposed to serve it.


Looking Ahead

I will be so bold to say that I called the housing crash correctly last year, though the worst symptoms are slow to present for technical reasons. There’s no question that the action on the real estate scene changed drastically in mid-year. The implosion of this mighty structure of fraud, folly, and misinvestment so far has taken place in such breathtaking slow-motion that its victims have not really felt the pain from the falling bricks yet. By late summer, buyers started evaporating. Real estate signs planted in lawns last June are still sitting there on New Years. Prices have come down a bit in many markets, including most of the hotties such as Florida, Phoenix, Las Vegas, San Diego, and Boston. But the buyers are still not bidding. Meanwhile, the sellers have dug in, determined to get something at least close to their wished-for inflated prices, egged on by their representatives, the realtors. This mutually reinforcing psychology cannot hold indefinitely. Many of these sellers don’t have the luxury to wait around forever. Some have had to move to other houses in other places because of job changes, and are stuck paying two mortgages. Many are stuck with “creative” mortgages that all the evil ingenuity of the human mind conjured in recent years to enable the feckless to live above their means — adjustable rate, payment optional, no money down contracts that suckered buyers into booby-trapped obligations whose initial low-interest terms lured them in and are now set to blow up in their faces as terms automatically re-set upwards to higher rates and “optional” deferred payments get backloaded onto the principal, putting the mortgage holders so far underwater on their contracts that a tour of the Titanic would feel like a day at the beach.

The trouble is, when both the sellers and their agents decide to get with the reality program and lower their prices, they will only stimulate a massive death spiral of house price deflation as buyers see the numbers go lower and hold out longer in the expectation that prices will go down even further. That would, of course, put more sellers into gross distress and lead them either to dump their properties or enter the cold waters of default and foreclosure. The whole process could run for a couple of decades, and as that occurs it will be made much much worse by oil depletion — as so many suburban houses drastically lose locational value, combined with the consequences of poor construction carried out in cheap materials like vinyl and chipboard.

Add to this that the late stages of the hyper-boom caused so much “product” to be brought onto the market by the “production home builders” that there now exists an unprecedented oversupply of exactly the kind of crappy suburban houses (in all price ranges) that are bound to lose value going just a little bit forward. Foreclosures will only add more to the oversupply. In the subprime mortgage niche, defaults are officially reported to be running at 20 percent. Foreclosures are trailing because the process is so awkward, and many have not yet shown up in the housing markets. I predict that foreclosures on subprime mortgages will run above the 50 percent range when all is said and done.

As the music stops in the lending rackets, liquidity in the form of mortgage backed securities and other sources of hallucinated “money” will dry up, and will start to make itself felt in all the other arenas and regions that “money” has been migrating to. Jobs associated with house-building and all those ancillary enterprises — big box shopping, chain restaurant revenues, car sales — will disappear and incomes with them. Many home sales in past decade were made to people benefiting directly from the housing bubble. (The sheer number of real estate agents in America more than doubled since 2001.) This evaporation of both credit and incomes will impact the so-called “consumer economy”, said to make up 70 percent of the total US economy. In other words, the term “depression” might be applicable as this economy lurches into actual contraction of more than a few percentage points.

This scenario suggests that earnings in corporations listed on the public stock exchanges — the companies that elude acquisition by “private equity” — would necessarily see severe drops in earnings, and therefore in stock value. While many commentators view the rise in the Dow as just another symptom of inflation — asset inflation — the activity in these assets — companies making, doing, and selling things — must be reported on a quarterly basis. And if that activity is trending strongly downward, then stock prices will trend down even if the value of the dollar is going down and it takes more dollars to buy an equivalent share of stock year-over-year. So I would conclude by again predicting a substantial drop in the Dow and other equity markets. To some extent, it seems to me that the 2006 blow off in stock prices was just another symptom of the finance sector being decoupled from economic reality since real GDP probably contracted one percent in the second half of the year while misreporting and delusional thinking drove stock prices up.

One would think that the US dollar is poised to take a beating, and indeed the signs have been abundant that this is underway — especially when the value of the dollar started to implode against the Euro around Thanksgiving. It has leveled off since then. But since then there have been other moves around the world to de-link commodity prices from the US dollar and restate them in Euros, especially oil, and the dollar’s plunge will probably continue. A lot of commentators around the web have pointed out the side benefit for the US government to promote dollar inflation: to inflate itself out of crushing debt. But the government can’t accomplish this without destroying the purchasing power of ordinary Americans and whatever remains of their meager savings. I’d have to conclude that the Federal Reserve is out of tricks for goosing economic activity. Their last major trick was hitching a jive economy to a real estate bubble by making loan money available to any jabonie with a pulse and promoting the demise of lending standards. The gambit lasted five years and is now blowing up in America’s face.


The Energy Predicament


Oil ended 2006 roughly where it began, at just over $60 a barrel. This reassured the public that all talk about Peak Oil was hysterical blather from a lunatic fringe. It was reinforced by publication of the mendacious Cambridge Energy Research Associates (CERA) report issued this fall — a tragic document put out by a giant public relations firm representing the oil industry — with the mission of staving off windfall profits taxes and other regulatory moves that a true resource emergency might recommend.

But beyond this debate, in the background, another ominous trend can account for the stalling of oil prices in 2006 — totally unrecognized by the public and ignored by the news media: prices on the oil futures market leveled off because the Third World has effectively dropped out of bidding for it — and using it. They cannot afford it at $60-a-barrel. The Third World has entered an era of energy destitution and it is manifesting in symptoms such as local resource wars, genocides, falling life expectancies, and in many places a near-total unraveling of the sociopolitical order. American mall-walkers and theme park visitors are oblivious to this tragic process, but it is perhaps the major reason why we are not now suffering from $100-per-barrel (or greater) oil prices (with the consequent unraveling of our sociopolitical and economic order).

The major trend on the oil scene the past 12 months is the apparent inability of the world to lift total production above 85 million barrels a day — with demand now rising above that line. It is unclear how much more demand destruction will come out of the Third World before bidding intensifies between the developed nations. One commentator in particular, Dallas geologist Jeffrey Brown –a frequent contributor on the web’s best oil debate site,THEOILDRUM.COM — is advancing the idea that we are entering an oil export crisis that will presage a more general permanent world-wide oil emergency. Brown holds that the major oil exporting nations are using so much of their own product, because of rising populations, that their net exports are falling at an alarming rate, perhaps as much as 9 percent annually. This trend combines with general depletion rates now said to be around 3 percent a year.

The question of total oil reserves around the world remains somewhat murky, but Brown, Kenneth Deffeyes of Princeton, and others using a straightforward mathematical model, have stated that the world is roughly at the same point in all-time production as the Lower-48 United States was at in 1970, when America passed its all-time production peak. We know for certain that three of the four super giant oil fields (Daqing in China; Cantarell in Mexico; Burgan in Kuwait) are past peak and there is plenty of evidence that the greatest of them all, 50-year-old Ghawar in Saudi Arabia is not only past peak but perhaps “crashing” into a super-steep decline.

Discovery of new oil to replace the production from declining fields remains paltry. Chevron announced it’s “Jack” discovery in the deepwater Gulf of Mexico with great fanfare this year, but neither conclusively demonstrated that all the wished-for oil was down there (between 3 and 15 billion barrels, Chevron said) or that they could get it out of there in a way that made sense economically, since the oil was extraordinarily deep and difficult to lift up.

Meanwhile, companies developing tar sand production in Alberta announced that their costs of production were rising substantially, while a reckoning lay ahead as to how much of Canada’s fast-disappearing natural gas reserves will be squandered in melting tar. The oil shale project is going nowhere. American corporate farmers have entered into a racket with congress to subsidize ethanol production from corn and biodiesel fuel from soybeans. The American public remains ignorant of the tragic futility of this project, which depends on oil-and-gas “inputs” to keep the crop yields up and ultimately is a net energy “loser.” As the world crosses into the uncharted territory of “The Long Emergency,” Americans will find themselves having to chose between eating food and making fuel to keep the car engines running.

The signal failure of public debate in this country is embodied in our obsession with this particular theme — how to keep the cars running by other means at all costs. Everybody from the greenest enviros to the hoariest neoliberal free market pimps believe that this is the only thing we need to worry about or talk about. The truth, of course, is that we have to make other arrangements for virtually all the major activities of everyday life — farming, commerce, transport, settlement patterns — but we are so over-invested in our

suburban infrastructure that we cannot face this reality.

The bottom line for oil in 2007: expect the bidding on the futures markets to regain intensity between the US, China, Europe, and Japan. A contracting US economy could take some demand out of the picture, but the sad truth is that we burn up most of the oil we use in cars, and American life is now so hopelessly based on incessant motoring that citizens cannot even go down to the unemployment office without driving. Geopolitical events can only make the oil supply situation worse and probably will. (See ahead.)

We are probably also in the early stages of a natural gas crisis in the US. Over the next decade, the gap between US demand for natural gas and dwindling supply may amount to one-and-a-half times the current equivalent of our oil imports. This is a staggering deficit. Natural gas is used for heating in more than half the houses in the US and accounts for just under 20 percent of our total electricity production. Domestic supply is crashing. We are drilling as fast as we can, with more and more rigs each year, just to to keep up. To make matters worse, the means of gas delivery — through a vast web of pipeline networks around the nation — makes “just-in-time” delivery the norm and, tragically, also makes “just-in-time” pricing normal, too. Thus, gas prices are responding only to the shortest-term signals — for instance, unusually mild winter weather — rather than to the catastrophic long-term reserve picture. Finally, we are unlikely to solve our natural gas problems with imports for technical reasons having to do with the cost and difficulty of moving the stuff by means other than pipelines and for geopolitical reasons, namely that most of the remaining gas in the world is in Asia. Bottom line: we could enter a home heating and electricity production crisis anytime. Massive price increases are likely to be required in order to reduce demand to the level of available supplies. This will be one of the major factors in the disabling of suburbia — which is to say, normal American life.



The Iraq misadventure has turned self-evidently into a fiasco and the American public is understandably losing the will to persevere there. Ditto Afghanistan. The overall trend is for dwindling American influence over events in the Middle East. Whether this is a good thing or a bad thing in the long run is not as important as the sheer fact that it is happening.

Iran has benefited from every American misstep and sign of weakness and is seeking to become the regional hegemon. Is it worth it to them just to be the Big Cheese in the region? Or is this just a sort of booby prize in a contest between religious sects? Iran’s current momentum is favorable toward this goal in the short term, but in the longer term Iran is faced with steeply depleting oil reserves and an exploding population that is growing restless under a now ossified regime of mullahs. Iran’s natural gas reserves are impressive, but they cannot rely on them indefinitely for both export income and running their own electrical grid. While their pursuit of atomic weapons may be for real, it is also a fact that Iran must make plans for producing electricity without using up absolutely all of its fossil fuel — and so their pursuit of atomic energy is not without practical necessity.

Shia influence, led by Iran, appears ascendant in the Middle East for the moment. Iraq is under Shia control (though Iraqi Shia are ethnically not Persian). Hezbollah is taking over Lebanon by degrees. Shia populations in Saudi Arabia are concentrated in the oil-producing area along the Persian Gulf. Iran and its Shia proxies appear avid to challenge Saudi Arabia’s leadership — and Arabia is, after all, the birthplace of Islam and the owner of its holiest shrines. What this boils down to is a collision between Saudi Arabia and Iran. However this plays out, in proxy wars or in direct conflict, it can only play havoc with Middle East oil production and export.

The players involved have the means to make enormous mischief if they want to. Any of them could take out a major oil installation with a jet plane and a suicide pilot, or missiles, or even with common small arms in a well-orchestrated operation. Doing so, of course, would so grievously damage the major importing nations that the global economy would seize up and effectively bring down the curtain on the industrial era. Other players currently lurking off-stage could make dramatic entrances in the year ahead — for instance, Pakistan, perhaps the most dangerous nation in the world, a country held together with scotch tape and baling wire, with the world’s biggest supply of angry Islamic maniacs and an arsenal of about twenty atomic bombs.

In short, the Middle East is rigged like a gargantuan booby trap, the biggest IED the world has ever seen. There are too many things that can go wrong, and countless possible combinations for Murphy’s Law to come into play. As bloody and horrible as events have been in the Islamic world through 2006 — including everything from the genocide in Darfur to the daily violence in Iraq and Afghanistan to the Hezbollah-Israel fight — things can obviously get worse. At the bottom of all this are the exploding populations in a part of the world that has historically possessed only meager resources for human existence. Now that the most special resource of all — abundant oil — is heading into depletion all that remains on the horizon is a long, grinding competition among more people for less of every other resource. My guess is that the Middle East will shut down politically before it shuts down geologically. The process is underway. The populations aren’t shrinking and the pressures are only getting worse. So I would predict greater disorder in the Middle East through 2007. The US may suffer a “double Dien Bien Phu” event of having to vacate both Iraq and Afghanistan at the same time.

Europe and Japan have been lurking quietly on the sidelines since the US was lured into the “War on Terror” in 2001. Japan imports 95 percent of its oil and gas. If those lifelines are severed, Japan is simply toast. The only question is whether they will take it lying down, or revisit other options like military adventure. Given their energy disadvantages, military adventuring seems unlikely this time around. Perhaps they just go medieval again and retreat into the comfortable romance of a Neo-Shogun island culture.

Europe has been coasting along letting America take all the heat in the Middle East. Europe’s own energy supply (the North Sea) is crashing. Only Russia has substantial supplies — though it, too, is past peak — and will probably continue making moves to use its oil leverage for political advantage. Britain has been the most feckless European nation, utterly ignoring its own energy crisis as North Sea oil and gas dwindles down to nothing. France can take a little comfort in getting 70 percent of its electric power from nukes — and the nations that maintain electric service will be the nations that remain civilized. Germany, Italy, and Spain are now at the mercy of their oil importers. They didn’t behave as foolishly as the US did; they didn’t destroy their public transit or their city centers or their local agriculture. But they still face great difficulties in reorganizing daily life to fit the requirements of the post-oil age.

China faces difficulties at least as awesome as the United States. They have zilch left for oil. Their ecological problems are worse, their political stability depends on an export economy that could fall apart in 2007 as WalMart shoppers spend fewer and less valuable dollars on things made in China’s factories. A hundred million unemployed factory workers might make things hairy for a central government that enjoys little true legitimacy. And there is always the chance that Chinese internal politics will return to the psychotic state of the mid-1960s if the stress is too great. What I wonder is when China might begin to go adventuring into former Soviet lands such as Kazakhstan in search of oil. Perhaps 2007 is the year that China turns aggressive.

US Politics

Elation ran through the body politic in November when the Republicans lost control of congress and the senate, and many state governments as well. But the Democrats have not shown any better understanding of the nation’s economic and energy predicaments than the Republicans have. The Democrats are equally lost in fantasies about running WalMart and the interstate highway system on corn instead of petroleum. The Democrats are every bit as invested in our suburban gross liabilities as the Republicans have been. One way or another, we will either have to get some revolution in party ideology or the American political system is going to fail. Unfortunately, instead of ideas and agendas for facing our real problems, the public remains lost in a political personality showcase that is just one facet of our absurd celebrity culture.

My prediction for 2007 is that American politics will become more delusional, more based on false hopes for salvaging our tragic misinvestments, and more disappointing. I have stated many times on this blog that America faces a political readjustment of the kind not seen since the Civil War — though not with the same plot and themes. I also believe that the feckless complacency of our current behavior could lead to a situation here in which Americans will beg an authoritarian leadership to tell them what to do. Winston Churchill famously remarked that Americans could always be relied upon to do the right thing — after they had exhausted all the other possibilities. I hope we are not heading in that direction, but we are already romancing the “other possibilities” (like running WalMart on corn) instead of taking intelligent steps like fixing the railroads, or ending subsidies and incentives for suburban development, or slapping realistic taxes on gasoline.

To sum it all up, I believe 2007 will be the year that the US finally feels the pain. More disorder will appear in the system. More cries of anguish will be heard throughout the land. More paralysis will set in. The bid for leadership may not follow the current story line — Barack…Hillary…Edwards…McCain…blah blah blah. Jokers and wild cards could step into the frame. America will be looking for a man on a white horse and instead they’ll get Newt Gingrich on an electric Humvee.

About James Howard Kunstler

View all posts by James Howard Kunstler
James Howard Kunstler is the author of many books including (non-fiction) The Geography of Nowhere, The City in Mind: Notes on the Urban Condition, Home from Nowhere, The Long Emergency and the four-book series of World Made By Hand novels, set in a post economic crash American future. His most recent book is Living in the Long Emergency; Global Crisis, the Failure of the Futurists, and the Early Adapters Who Are Showing Us the Way Forward. Jim lives on a homestead in Washington County, New. York, where he tends his garden and communes with his chickens.

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