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Will oil troubles push the US into a severe recession?

High oil prices and continued oil problems around the world will likely push the US economy into a severe recession by the end of 2013, Tverberg writes.

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There seem to be several reasons behind this decline. One reason, already mentioned, is high oil prices leading to US layoffs, because of decreased discretionary expenditures.

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Gail Tverberg, an actuary with a background in math, analyzes energy and financial matters from a perspective that the world has limited resources. For more of Gail's posts, click here.

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Another reason for the decline is increased automation. Electricity can often be substituted for human labor, reducing costs, but also reducing jobs. Economists seem to term this change higher labor productivity. They also seem to believe that new jobs will appear from somewhere, but in practice, this is not happening. Instead, lack of jobs is part of what is leading to recessionary influences.

Another reason for the decline is increased competition from countries with lower labor costs and lower fuel costs. China joined the World Trade Organization in December 2001, and its manufacturing (and thus use of fuels) increased dramatically shortly thereafter.

Another reason is demographic. Baby boomers are reaching retirement age. This has already begun affecting the number of individuals who retire each year. In the future, the number of retirees can be expected to increase further.

In total, we see a very large drop in the percentage of US citizens with jobs, starting about 2000 (Figure 6). This is very close to the time that China ramped up its growth (Figure 5).

In calendar years 2011 and 2012, workers’ contributions for Social Security funding were temporarily reduced by 2% of wages, as a way of stimulating the economy. As of January 1, 2013, this temporary reduction was removed. For a couple with combined wages of $100,000, take-home pay is thus being decreased by $2,000 per year. With less disposable income, workers can be expected to cut back somewhere–buying a larger home, buying a new car, or going out to eat.

So far, only a small amount of other tax increases have been put in place, and only a few cuts have been made. More tax increases or benefit cuts will be needed later this year to bring revenue and expense into better alignment. Any such change will tend to have a recessionary impact, because citizens’ discretionary incomes will be affected.

Issue 4. The spending gap and the amount of debt look too big to be fixable without excellent economic growth.

As noted above, wages have not been keeping up with GDP. The majority of federal taxes are based on wages, so in my comparisons,  I use wages, rather than GDP, as a base.

If we use the wage base from Figure 2, the amount of government outgo vs income (all levels, not just federal) is as follows:

Based on Figure 7, the issue in recent years has been primarily rising expenditures. These higher expenditures would seem to be partly because of high-priced oil, but also because of other influences noted above that are leading to declining employment. The amount of the gap is close to 15% of wages–something that is very hard to fix. Even the current increase in Social Security taxes (“only” 2% of wages) will exert downward pressure on discretionary spending.

A related issue is that compared to wages (using the same wage base as in Figure 2), debt of all kinds is extremely high.

Government debt is in now more than household debt of all kinds, including mortgage, credit card, auto, and student loans. It is close to two times the wage base used in this analysis.

One issue with paying down debt is that during the pay-down period, the government (or individual) reducing the debt “feels poorer,” because funds available for spending on goods and services needed today is lower. This happens because some current tax revenue, or some current wages, must be used to pay down debt, and thus is not available for today’s spending. This is a turn-around from the increasing debt situation experienced many times in the past. For example, part of the reason times seemed good in the 2002-2006 period was because people were able to refinance their homes and use the funds to buy a new car or add on a family room. If we are forced to pay down debt, we have the reverse effect.

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