The Great Recession Of 2007-09
Granted this first paragraph contains a bit of a nit, but this message is heading deeper. “Financial Crisis” is a poor term for the 2007-09 event. I have noticed it gaining traction in recent years, and it makes me groan inwardly every time I see it. It is a label that appears to explain what caused the economic dislocation, when in fact it does not–it is only describing a symptom and indeed one symptom of many. “Great Recession” is better, as it makes no pretense to describing a cause while telling us what it actually was: a recession. What the Great Recession should really be called is the “2007-09 Oil Shock and Recession”. This underscores that concepts of liquidity, solvency and bankruptcy are second-order items in terms of trying to understand what happens during many recessions and therefore are lower-tier items when making economic forecasts. Because they can be manipulated, they are somewhat of a foggy lens for looking ahead.
As you have pointed out many a time, Chris, energy is the master controller of economic activity. Therefore, this is the place to start.
In the summer of 2004, the rate of increase in world oil production (crude + condensate) stalled. This key source of energy feeding the machines of industry no longer increased with the demands of a growing globally interwoven economy. By 2007, with oil production rates were still stalled (at about 73-74 million barrels a day for crude + condensate), the lack of growth in liquid fuels began to bite hard. A key issue in this situation is net export math. Exporting countries tend to do well during oil price spikes, as they are making more revenue. This can feed a growing economy. Growing economies demand more oil. This oil has to come from somewhere: Net exports go down. By 2007, a major net export crisis was underway. Global net exports were on the decline.
A bidding war ensued. This is reflected in the dramatic increase in oil prices during 2007, especially the latter half and more dramatically into the summer of 2008 (oil speculators were the scape-goat at the time—in reality they cannot move oil prices much but simply follow the trends). There are peer-reviewed papers that explore how high-oil-prices affect industrial economies. They have been around a long time–since at least the 1970s. For the United States the data indicate that when the price of oil escalates to a point where around 4-5% of the national GDP is consumed to pay for the “black gold”, the economy tips into recession. Nearly every post-WWII recession is linked to an oil-price spike (key exceptions: 1947-48 triggered by the mass post-WW II production layoffs; possibly the 2001 dot-com bust [a modest oil price escalation may actually have triggered this delicate bubble]; and, of course 2020 during the lockdowns). In 2008, oil prices grew relentlessly and reached a phenomenal point where 7-8% of US GDP was required to pay for the critical liquid fuel (given the rate of oil consumption in the US at the time). Economically speaking, this was nearly fatal. Best estimates are that when the cost of oil reaches about 15% of GDP, you will be standing over the smoking ruins of your industrial economy—game over.
For every extra dollar spent on fuel, that is one less dollar going into some other segment of the economy. During price spikes, the oil companies are making big profits and could spend this windfall, but much of this newfound liquidity goes to keeping the business operating and searching for new plays thereby having limited effect on key economic sectors. The cost of shipping goes up, too, which also sucks “free” dollars from other sectors. All the while, J. Q. Public paying more for fuel ends up eating out less, going to the movies less, stretching out the time they wear clothing purchased long ago, and so on. They drive fewer miles, which means less time exposed to the temptations of visiting downtowns, malls, parks and museums. High oil prices are a major economic headwind. I like to think of the WTI price in terms of wind speed. $100/bbl = 100 km/h. Well, 80 to 120 km/h is difficult to walk through, let along the 140-150 km/h ($/bbl) that occurred in 2008. Economic growth slows, stalls and then reverses under such heavy loads.
The Great Recession was not triggered by a housing crash, or the collapse of Lehman Bros or any other distraction from what actually happened. It was simply (and ominously) due to high oil prices, or more specifically a constrained energy supply. In other words, Joules for oil importing countries were on a downward trend. This manifested economically in varied and sundry ways. One interesting detail is the dramatic impact oil prices had on people who had to commute long distance—housing prices generally fell the most sharply in those neighborhoods that had the highest car dependence. While this is a bit of a digression, I note that today, one growing story is the number of people simply getting rid of their cars—something to keep an eye on. This can become an easy decision in a time of rampant price inflation for just about everything. Given the cost of maintenance, fuel, insurance, payments (if one borrowed to get the vehicle) and so forth, giving up a car is like giving yourself a $10-30K annual raise. Ebikes may be part of this story–these I think represent a much bigger game changer than electric cars that are far more expensive, especially in climate zones amenable to cycling.
Ultimately, during the Great Recession, the loss of accessible Joules resulted in massive dysfunction in complex, poorly designed (with the insult of various band-aids put on in kludge fashion after the 1970s oil-shocks) and badly managed economic systems. The thermodynamic link to the economy is inescapable. Thermodynamics are at the core of understanding the functioning of an economy. Oil supply, a primary energy source, became constrained (i.e. the supply could not grow at the time) and economic growth faltered (contracting GDP). Credit (loans) cannot be easily serviced without economic growth—thus many delinquent mortgages, and even more dramatically (and ominous) a massive credit freeze.
Another thing to keep in mind: High oil prices are a global phenomenon. They hit the economies of nations all over the planet. This best explains a global economic downturn. Such as we saw in 2007-09 and are experiencing again right now. After the down-in-the-dirt dumb-as-a-box-of-rocks sanctions against Russia, we went through a sudden and sharp increase in oil prices due to a loss of oil supply in global markets. Joules are constrained—yet again. The prices are still at historically high levels even at the $75-85/bbl range. The rather predictable recession from the latest oil shock now appears well underway, and indeed as you point out in detail in the video there are symptoms–popping rivets–just about everywhere you look.
-best
Anyway, thanks for the in-depth look at the developing financial symptoms!