Friday, February 25, 2011

Libya Now, Iran Then: How Close Are We to 1979?

Today, the UK’s Telegraph is reporting that British government drones in Whitehall are figuring out the legal means to seize Muammar al-Gaddafi’s assets in Britain, which are said to total some £20 billion. 

“Fire in Libya”: Oil fire in 2010.
Notice that’s pounds sterling—the equivalent of US$32 billion: Enough cash to plug up California’s and New York State’s deficits, and still have enough left over for a very respectable weekend at The Palms in Las Vegas. 

That these assets are going to be seized is, according to the story, a done deal: The only issue seems to be the legal means by which to do so—

—which means that the British government isn’t worried about pissing off Gaddafi—

—which means that Gaddafi’s days in power are numbered: Whitehall would never dare seize his UK assets, unless they were sure that Gaddafi won’t be around to exact revenge or retribution. After all, the Brits let the Lockerbie Bomber go in 2009, in order to shore up relations with Gaddafi. 

Now, for my patented History Flashback™ (All Rights Reserve, All Wrongs Deferred): 

When the Shah of Iran was overthrown by the Islamic Revolution in January 1979, Iran’s oil production dropped from 5.75 million barrels a day to zero. Such was the chaos of the Revolution.

Production eventually picked back up in the days that followed, to a new average of 2.25 million barrels a day in 1980—but as they say, the damage was done: In short order, the price of crude shot the moon from $14.95 per barrel in 1978, to $25.10 per barrel in 1979—the inflation adjusted equivalent of $74.67 in today’s dollars. By 1980, even though Iran’s oil production was improving, the price situation was worse: Oil averaged $37.22 in 1980, the equivalent of $99.11 per barrel. (Data is here.)

This led—directly—to the recession of ‘79–‘83, the worst since the Great Depression. Unemployment got to double digits, as did inflation. Gold famously went up to highs never seen before, as a hedge against that inflation, and it was all Paul Volcker could do to reign it in by inflicting 20% interest rates—that’s right: 20%. 

An Oil Shock is nothing to take lightly. 

Today, Libya represents far less of the world’s total oil production than Iran did in 1979. As of last year, from the worldwide total of 84 million barrels per day, Libya produced just 1.79 million barrels per day, according to the CIA Factbook—that’s less than 2% of world production, compared to Iran’s 5%. 

But what’s happening in Libya is not just limited to Libya: 2011 is shaping up to be the region’s very own 1848, as Anne Applebaum cleverly pointed out. What started in Tunisia and spread to Egypt has now spread to Libya. And now this morning, there are reports that of severe disturbances in Iraq (Iraq! Where the U.S. is sitting like an army of occupation, and there are popular riots!). The Saudis—conspicuously—ominously—are giving free money and promising more benefits to their people. 

Even before the revolutions in the Middle East, oil prices have been steadily rising—along with food, precious metals and industrial metals—as hot money flows to commodities. Regardless of what Krugman says, this rise in commodity prices is a direct product of the U.S. Federal Reserve’s zero interest rate policy (ZIRP, otherwise known as “free money”) and Quantitative Easing 2 (QE2, otherwise known as “money printing”). 

So what does this all mean? 

It means that, when Gaddafi falls, Libyan oil production is going to be hurt or outright interrupted. And just as Mubarak’s fall embolden Libyan dissenters, Gaddafi’s fall will embolden more waves of unrest in other parts of North Africa and the Middle East—perhaps Iraq, perhaps Saudi Arabia, perhaps the U.A.E.—putting more pressure on oil prices. 

Brent Crude is today at $112 per barrel—and poised to rise even further. If Libyan production is tripped up or outright shut down, there’s every reason to believe that oil will reach its historic high of $140. Reach it, and surpass it. And if, say, disturbances in Iraq or Saudi Arabia or any other oil producing nation trigger further falls in oil production, then the price per barrel could rise even further—and much more drastically. 

In other words, we could be about to experience another Oil Shock—just like 1979.

Now, what happened after 1979’s Iranian Oil Shock? Like I said: Severe inflation, unemployment, and a Fed that had to raise rates catastrophically, in order to stop an inflation that was spiralling out of control. 

But back in 1979, there was no kindling for that inflationary fire. Federal Reserve money policies were fairly responsible. The Federal government’s total debt and liabilities was less than 50% of GDP. Back in 1979, the U-3 unemployment rate was about 5%, compared to over 9% today. 

Back in 1979, there was no ZIRP, no QE2, no $1.6 trillion deficit. There weren’t so many freshly-minted dollars sloshing around, looking for yields like army ants looking for dead meat. There wasn’t a total government debt that was bigger than the total gross domestic product of the United States. 

In short, back in 1979, the economy, the fiscal situation and the monetary policy were far healthier than they are today. 

Yet the 1979 Oil Shock brought us the worst recession since the Great Depression. 

And that is very, very bad for us today, in 2011. 

When—not if, but when—Gaddafi falls, the bloodiest, longest-lived dictator in the Middle East/North Africa region will be gone. And that’s a good thing. 

But in all likelihood, his fall will also trigger another Oil Shock—which just might kill us. 

28 comments:

  1. I read some other guy the other day telling how this would play out.

    When oil, food and everything else goes to the moon along with gold and silver, the fed will proclaim that it has nothing to do with money and, thus, can continue to print even more to try to "fix" the economy from the troubles of all these inflating assets. They'll place all the blame on weather, revolutions, etc., on the price rises. And of course Krugman et al will be egging them on and giving them the academic support to back it up. (some people think krugman is quality academic support. I know, hard to believe, but they do)

    The goal is to never have an economic downturn on obama's watch. They desire to run the biggest deficits and print the most money ever to prevent a recession. Then, when a republican gets in office, you'll be amazed at how fast krugman's tune changes, and suddenly they'll want all manner of policies to be implemented to fix things, with the benefit of it producing the short term pain that they're now trying to avoid. All on republican watch. Of course they won't talk about the "fix" part at all during the pain. They'll only talk of just how much pain there is being foisted on the country by the evil republican.

    How can anyone ever forget that Krugman said in 2002 that we need a real estate bubble. And how can any column about him ever omit that fact.

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  2. I think as far as the deficit goes, both parties are in mutual agreement to continue to drive it off a cliff. Lets face it, neither has any vested interest in reigning in the national debt. I also think its safe to say that the effort required to reign in said debt would make any politician who supports it lose his/her office.

    We've been talking about the out of control national debt for the last 20 years. Its not going anywhere except off a cliff.

    Funny thing is that nobody gets it. I was on CNN's talk back board yesterday spelling out our true debt picture, to the tune of $112 trillion dollars. Do you know what people were trying to tell me? Most of them played the "blame the other guy" card (ie its was Bush or another republican - or it was all Clinton's fault, etc.). One guy accused me of fear mongering. Another tried to claim that we had 75 years to pay it back (you know, all the debt must have been issued last year on a 75 year bond - even though bonds go 30 years max).

    Citizens of the US seem to be stuck in fantasy land right now and nothing will wake the majority of them up.

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  3. This is basically what we were expecting, if not exactly how we were expecting the suicidal policies of the Fed and the US gov to end up. Cheap money exports inflation to the countries least able to cope with it, who fall to pieces and take the US with it. Every day brings us closer to cascading failure. Rising oil prices will definitely do the job if something else doesn't first

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  4. Well, this should be REALLY positive for gold as tin horn dictators around the world take note, and move their paper assets into metal, parked in their own fleet of C-141's.

    "If you don't hold it, you don't own it"
    Ponce de Cuba

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  5. Well, this should be REALLY positive for gold as tin horn dictators around the world take note, and move their paper assets into metal, parked in their own fleet of C-141's.

    "If you don't hold it, you don't own it"
    Ponce de Cuba

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  6. All of what you predicted regarding inflation is due for its first checkpoint by the end of March.
    I have to admit that events seem to be playing very well with that time table. Remarkable how these perfect storms form. Could be a Black Swan on the horizon.

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  7. Wow, it seems like so much is happening so fast. If only there was some web site that could give us updates on a regular basis - like hourly even. Who could provide such a service? Hmmmmm......

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  8. That big dark cloud on the horizon just may be a whole flock of black swans...

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  9. "a Fed that had to raise rates catastrophically, in order to stop an inflation that was spiralling out of control."

    If they did this today, personal household debt would become totally unserviceable - their traditional tools for dealing with these situations have run out, there is literraly nothing they can do anymore (FED, IMF , ECB),
    If you think gold and silver are expensive now, It's not too late to buy, I still am..

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  10. Gonzalo, where have you been? I was afraid that Krugman and Mish had taken you out.

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  11. Please extend this Iran/Libya parallel by telling us what happened to the Iranian money held by British and US banks after the revolution.

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  12. Today , I was tuned into a Boston radio show and 'heard that Gaddafi has a $60 billion art collection .....sweet . Maybe he could donate it to bail out- the World somehow ? With a honest trusted team of non- profit investors from all walks of life, to turn that $60 Billion into several Trillion Dollars , to a central fair distribution center . It could just save the Worlds Ass et's .

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  13. @Anonymous at 5:53 PM, you probably have another 18-24 months where Gold will be a good buy. After that time, Gold will have run it's course. Since 1896 there are have been 3 periods where Gold outperformed the DJIA. The first 1928-1942, the second was 1965-1979 and the third began in 1999. Gold outperforms the DJIA for 14 year periods. That gives you until 2013 and then the gold party is over.

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  14. What happened to your film making career?

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  15. your conclusions are always the same. dollar down, commodities up, stocks up (for a while) hyperinflation etc.

    how about a post on all of the reasons why you are biased and MIGHT be wrong. a devil's advocate post. it might be your most highly read.

    and also, you stand a make a fortune if the above potential trades pan out, right? so what you're really doing is selling a trading strategy you have frontrun, even when most states of the world in 1, 5, 10 years down the road won't look like the one you're selling.

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  16. I can't wait to move into that house you "think" you own - sheep....

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  17. Why do we play their game? Is gold and silver...a material possession that has a nice shine...so precious to you that it gives you a sense of power or security? Is that what it takes to muster some confidence in yourself?

    I'm amazed as to the ignorance and adolescent naivete towards a possession such as gold just because someone tells you its worth something. What is it really? Gold is no different than being in a nanny state with a rogue government. You are controlled one way or another.

    You are your gold. How does that feel? Do you feel better than others? Richer? More secure?

    What a sad sad society we live in such that our most prized possession is a metal taken from mother earth. I think you all are confused and will hopefully realize that there are much more important things to worry about for our future.

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  18. Gold and silver have not changed. They are the same all through time. The amount of paper that it takes to get them is changing because there is so much of it printed.

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  19. Wow .... Anon 9:38 ... of course there is bias here

    Toward reality, and the facts that begin to reveal it. If you want opposing facts, merely sample the daily stream of Mainstream Media. You are intellectually unencumbered.

    12:40 / DogBoy ! ... naivete would be to hold onto any fiat currency. Gold and silver do not feed the hungry. Take steps to secure real tangibles [ think Alpha Strategy ]which include true information and true skills, then if you wish to preserve your capital, buy PMs. That would be the polar opposite of naivete in thinking that they are the "most prized posessions" as you state. I think we'd all prefer a pound of coffee to a gold Kruggerand. If one chooses to own a store of capital, they are taking steps that are literally OUTSIDE the abilty of a government to control their future. Those same governments have DEMONSTRATED their willingness to hoover-up precious metals when it serves their needs, and the needs of their Central Bankers.

    Naivete is trusting in the beneficence of a Government to save you. Personal responsibility extends to my choices in attempting to secure personal, private property for my own uses, which may - or may not - extend to assisting Clueless Fools. Your unfamiliarity with facts and reality will not insulate you from their very real effects. Good luck with your magical beliefs

    OhioDude

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  20. First, I usually hate to nitpick, but you "rein in" inflation (or a horse). A king "reigns" over his kingdom. Spellcheck strikes again, I guess. Anyhow...

    dogismyth, consider reading more about the history (and theory) of money.

    As long as humans have had economies based on trade (many centuries), people have used the tool we call money to take the excess work out of the process of acquiring the things you need by trading for them. A single commodity is chosen by mutual agreement to act as a proxy for "real" value, even though most people accepting it in trade don't actually want that particular commodity.

    Through all those centuries, the item nearly universally used as money has been gold. Occasionally silver has been used, and in societies that didn't have access to gold, other things were used (wampum by American Indian tribes, cigarettes in prisons).

    Gold was considered the ideal money because, (1) people knew nobody could drastically change the supply, so figuring out prices was easy, (2) it was fairly easy to test for genuineness, (3) it was reasonably convenient to carry around in quantities most people needed, and (4) it wasn't perishable.

    Government paper money not backed by gold is a very recent phenomenon, except for occasional isolated experiments that always ended badly. In the past, governments that gave themselves the power to dictate what was to be used as money (always it's a paper item which they alone produce) have always ended by abusing that power and eventually losing the ability to force people to use their money. Only time will tell if "it's different this time."

    Anyway, people buying gold now generally do it out of fear that their pockets are being picked by Ben Bernanke. Not because they feel personally inadequate, or any such silliness.

    To make the math simple, if Helicopter Ben creates as many new notional dollars as already exist, he doubles the number of dollars, which according to the law of supply and demand would halve the real purchasing power of each dollar in your pocket.

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  21. The Swan is Black because it's covered in oil.

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  22. The after effect of the 70's oil shock was never learned by the U.S... If Alaska were to secede from the union and begin drilling all of it's assets, it would become the 6th leading oil producer in the world. We should drill to prevent the immense transfer of our wealth to foreigners. However, as much as I despise taxation, the only way to stop the insane purchases of 500 horsepower cars and 5,000 lb. SUV's , is to tax horsepower and torque--HEAVILY. We also have a natural gas bounty, cars and trucks can be fitted to burn this lower polluting fuel. Electricity is not YET ready to replace fossil fuels especially in cold climates. Coal can be converted to a low sulphur diesel fuel using the Tropsch-Fisher process. The Jetta TDI ( for one) gets 50 miles per gallon and is as fast as most high horse power guzzlers. Increasing fuel economy and fuel production must go hand in hand.

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  23. Mohamed Bouazizi is the true definition of a black swan. He is the Tunisian fruit vendor that was abused by a brutal and corrupt government that set himself and subsequently the entire world on fire. Yes, the entire world. Despite what the MSM is telling us, this will not be confined to the Middle East and North Africa. Freedom and Democracy have been unleashed and we are in for an era of tumult and turmoil until governments redefine themselves.

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  24. KAREN PERPETUATES A POPULAR MYTH, I.E. that GOLD has historically been the favourite monetary metal, in actual fact SILVER has been more widely used over long periods than gold. Mexico and China being prime examples, and there is no reason BOTH can not be utilized!

    The KEY is having a fair measurement of value and exchange mechanism for trade that can not be manipulated, debased or otherwise used as a mechanism of control by greedy bankers and corrupt politicians.

    All the evidence needed is found in history; that can NOT be done with any paper currency created out of thin air with no intrinsic value, particularly when controlled by greedy bankers and corrupt politicians.

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  25. Also should be pointed out that today, unlike 1979, the US and other big oil importers have strategic petroleum reserves. The US stockpile is some 700 million barrels or about a year's worth of Libya's production. China doesn't reveal its stocks but, given their enormous trade surplus, its a fair bet they have used some of that cash to squirrel away a large oil reserve too.

    That said, were there to be chaos in the Persian Gulf, and that Sunni/Shia confrontation in Bahrain could be the catalyst for that, then our reserves would be totally inadequate to make up for anything but a brief interuption in supplies from this region. Such an interruption may seem unlikely at present but so did the idea that Mubarak would be overthrown and Gadafi under seige by his own people seem absurd 6 months ago.

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  26. I think oil holds at least at these levels - $100/barrel. There is a new premium built into the price of oil as a result of the "threat" of disruption from the Gulf states. It is a very real threat. I don't see how all of this goes away in the coming weeks or months.

    Interesting how the UN came down on Lybia for killing its own citizens. It froze the assets of Quadaffi. The Gulf states must be looking at this action with dread. So, now the Saudi Monarch can't just kill all of the protesters without fear of having their foreign assets confiscated. Man, these autocarats are in a real box.

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  27. Myron -
    The world wide supply situation with silver makes me think that a bi-metallic standard is not a good choice going forward (if it ever was). While I hope to benefit personally from that fact, I don't think there is enough above ground supply of silver to adequately serve as money going forward. For reasons already mentioned,as well as others, I think gold is the clear choice as a monetary standard.

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  28. well done
    but commodities also cycle.
    . browser "West world cant pay princial"
    needs loans to pay interest.
    Sam 's debts: total u . s. $ 200 T
    two hund tril = t o m

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