Are high oil prices pushing us towards debt limits?
The US is reaching debt limits because of a specific resource limit – lack of inexpensive oil, Tverberg writes.
If an economy is growing, it is easy to add debt. The additional growth in future years provides money both to pay back the debt and to cover the additional interest. Promotions are common and layoffs are few, so a debt such as a mortgage can easily be repaid.Skip to next paragraph
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The situation is fairly different if the economy is contracting. It is hard to find sufficient money for repaying the debt itself, not to mention the additional interest. Layoffs and business closings make repaying loans much more difficult.
If an economy is in a steady state, with no growth, debt still causes a problem. While there is theoretically enough money to repay the debt, interest costs are a drag on the economy. Interest payments tend to move money from debtors (who tend to be less wealthy) to creditors (who tend to be more wealthy). If the economy is growing, growth provides at least some additional funds offset to this loss of funds to debtors. Without growth, interest payments (or fees instead of interest) are a drain on debtors. Changing from interest payments to fees does not materially affect the outcome.
Recently, the growth of most types of US debt has stalled (Figure 3). The major exception is governmental debt, which is still growing rapidly. The purpose of sequestration is to slightly slow this growth in US debt.
The growth in government debt occurs because of a mismatch between income and expenditures. There is a cutback in government revenue because high oil prices make some goods using oil unaffordable, causing a cutback in production, and hence employment. The government is affected because unemployed workers don’t pay much in taxes. Government expenditures are still high because many unemployed workers are still collecting benefits.
What can we expect going forward? Will the debt situation get even worse?
I think we can expect that from here, the debt situation will deteriorate. One issue is rising oil prices. While there seems to be a large supply of oil available, it is at ever-higher cost of extraction, because of diminishing returns. (This is even true of tight oil, such as from the Bakken.) Furthermore, I recently showed that not only do high oil prices adversely affect government finances, they also adversely affect wages.1
If wages are low, the temptation is for governments to try to create more “spendable income” by increasing debt. This can’t really fix the situation, however. The real issue is increasingly high oil prices, which adversely affect both government finances and wages. Adding debt adds yet more interest payments, adding a further burden to wage earners, and creating a need for payback in the future, when wages are even lower.