I got a letter last week from a reader complaining bitterly that the stock market hasn't crashed and blaming me for predicting that it would. He didn't say, but I hope he hadn't been out there on a shorting spree. In case any of you haven't noticed, 2007 is not over yet.
The markets have been on an extraordinary spring run. The Dow finished 23 out of the best 26 days on the upside -- some of them pretty way on the upside. This is the biggest US stock market up-streak since a 19 for 21 streak in July of 1929, prior to the October crash. Bill Fleckenstein points out a similar run on the Tokyo exchange -- 32 upside trading days out of 38 -- just prior to its 1989 tanking.
While this kind of behavior seems ominous, I'm not claiming it necessarily has predictive value. One can say that the financial markets per se are running in an impressive state of structural distortion and imbalance and that systems way out of balance do not stay that way forever. But I risk more opprobrium by stating the obvious.
I think the persistence of this gross imbalance can be accounted for in large part by the current global energy situation. The world is at peak energy, peak oil especially, and the world runs on oil. Peak is peak. The most. There are about 84 million barrels of oil a day flowing around the industrial economies of the world. It is running a lot of activity.
Now, I happen to think that oil production probably peaked about a year ago, but we are still so close to it that the net available energy remains immense. Even if 2007 averages out to 83.5 million barrels a day instead of 84 million, it will still seem like a lot. Markets may be dumber than we think. All they see is a vast amount of cheap energy for manufacturing plastic salad shooters, for powering tourist jet charters to Cancun, for running WalMart, Walt Disney World, and Taco Bell. All that energy is here right now.
Among the many tragic elements in the human condition is this tendency toward short-term thinking, the inability to imagine how our arrangements will work in a time that is not right now.
Interestingly, the main effect of post-peak oil on markets and economies is that it will produce shocking instabilities in complex systems dependent not just on the energy itself, but on the expectation for continuity of the energy. Financial markets are especially sensitive because they operate on sheer expectations. The Dow Jones doesn't manufacture salad shooters, or haul tourists to the Mexican beaches, or build suburban houses. It just relays a dumb signal that says "we expect more" and investors respond. The trouble will start when the signal changes to "we don't expect more." That moment will be when the recognition of peak oil galvanizes the public's attention. It will manifest as a simple societal binary switching mechanism. When that happens, the markets will exhibit the dumb herd behavior that they are famous for.
Of course, I have argued previously that the stupendous run-ups of market indexes themselves represent a kind of instability (those distortions and imbalances), as do also the supernatural flows of "liquidity" -- notional money extended to investors for harvesting future notional profits -- and I would stick to that observation. After all, if the world is "high" on oil -- and I would argue that it is zonked out of its mind -- then it would naturally spring way up off the diving board before swan-diving into the empty pool below.
Me, I'm keeping my eye on things like the production figures coming out of Mexico, the North Sea, and the Kingdom of Saudi Arabia. They're all sliding down. Mexico is especially interesting because it is our Number 3 source of oil imports and its production is crashing so hard that a couple of years from now it may not be able to send us a single drop of oil. What do you think of that? Maybe the Walton family will buy Iowa so they can keep WalMart running on ethanol.
Meanwhile, US oil refineries are running above 90 percent production capacity to keep up with the gasoline demand for Happy Motoring. The stress on these complex operations is unprecedented. It gives them no slack time for routine repairs. The results are liable to interesting, too, between the Fourth of July and Labor Day.