Friday, July 4, 2008

The economics of running on empty

The economics of running on empty

Jul 02, 2008
The New Paper

By Dr Larry Haverkamp

Surprisingly, there are only two ways to invest: You can own or you can lend. That's it.

Owning is called 'buying equity'. Examples are stocks and property.

It earns about 12 per cent a year with lots of ups and downs. You could lose some sleep.

Lending is called 'buying debt'. Examples are fixed deposits and bonds.

It earns about 3 per cent a year and lets you sleep soundly.

An age-old truth of investments is that equity earns more than debt. I guess it's obvious since 12 per cent is more than 3 per cent.

A WHOLE NEW WORLD

But now, everything has changed. The world is entering a new era of shortages that could turn the old rules on their heads.

Stocks would follow the economy down, leaving fixed deposits as the top money-earner.

The story begins with the higher prices for natural resources like food, fuel and minerals.

High prices, however, are only a symptom. Chronic shortages are the problem.

You can imagine, for example, the difficulty of building a house without steel or cement.

We saw something like this in 1973 and again in 1982. The US was hit with an oil shortfall, which resulted in both recession and inflation, called stagflation. It spread to Singapore and around the world.

In hindsight, it seems overblown, since everything turned out okay. Prices shot up, then they came down. Growth slowed, then it picked up.

Prosperity returned, as it always does. If it didn't, you would have a permanent recession. The notion is so absurd that no economist in their right mind would even consider it. So I will.

In a worse-case scenario, permanent recession hits and each generation becomes poorer than the last. Gross domestic product (GDP) declines continuously. It eventually hits zero and we return to subsistence living, like our cavemen ancestors.

We may be seeing the beginning of that now.

Demand is out-pacing the world's limited supplies, pushing prices higher.

NEW OIL RECORD

Last Friday, oil hit another new high of US$142 a barrel. It is exactly double the price of one year ago.

The demand comes from a rising middle class in China, India and the Middle East. This is new. We didn't have it in 1973 and1982.

When Li Yong, Ramesh and Abdullah buy their first motorbikes, they love it. They find it hard to go back to peddling bicycles.

The US Department of Energy expects energy use in 30 developed countries to increase 25 per cent by 2030. In developing countries, it will increase 95 per cent.

As high prices persist for one, two, three and then 10 years, people will grow to understand that this is more than just a speculative bubble. (Sorry, Fat Cat.)

A permanent shortage of input (resources) produces a continuous decline in output (GDP). That, by the way, is the definition of a permanent recession.

To drive the point home, try this experiment:

Fill up your car or motorbike with one tank of gas and drive to Kuala Lumpur. When you run out of petrol, walk the rest of the way. It shouldn't take more than a week.

You'll be tired, but you will gain insight into a life without natural resources.

The shortages will sneak up on us gradually. A tank of petrol will soon cost some drivers a full day's wages. After that, it will take a month's wages and then a year's.

Finally, availability will cease altogether and the lights will go out.

Future generations will sit around the campfire and tell fantastic stories about hollow trees with wheels that took people from Yishun to Orchard Road in less than an hour.

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