Britain, the Canary down the Western Coal Mine

"We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step."

Jim Callaghan - Speech at the Labour Party Conference, 28 September 1976

Gold prices had been on the rise for weeks, then all of a sudden fell back with a thud as we were told that only 11,000 jobs were lost in the US during November. Another Brown bounce in the polls left Cameron backtracking, austerity is so last month, instead 'growth' by government spending is now acceptable as policy is dictated by focus groups. The Middle Easts version of Las Vegas got a helping hand which was good news for many UK banks, however only a mere $80 Billion would have been at stake. Years ago it would have meant something, not today with Trillion dollar bailouts. China's vice governor at the peoples bank declared 'We must watch out for bubbles forming on certain assets, and be careful in those areas' referring to golds recent upward trajectory. Nice try, that deceit may wash with CNBC but those of us in the loop know full well that China would love to transfer much of their paper assets into hard assets such as Gold.

It's sometimes easy to forget what the average person thinks in relation to financial matters. Articles posted here are certainly not consistent with mainstream thinking. People are still on the same broken record, 'Buy a house now while prices are cheap before you get priced out', 'We are past the worst now and good times are ahead', 'The government will make a good profit for the taxpayers with the bank bailouts'. Ask people who read the financial sections of broadsheet newspapers about gold and you get told 'The price can go up as well as down' as though this is a unique quality that does not apply to other assets such as bonds, real estate or stocks. Indeed it is important to remember just what people are thinking, because you don't want to be on the same page as them. 'Repeat after me, Gold is a bubble, Central Banks can 'tame' markets, the sustainable recovery is here and there is no inflation! There is no spoon!' There's no analysis of the thunderstorm that is brewing in the distance.

So what about this Gold bubble then? People are right, however they are 5, 10, 15 years too early in calling it. People are buying the stuff because one day it will be a bubble as the Worlds Central Banks are busy blowing the next bubbles as I write. The currency and Government Bond bubbles will eventually burst causing mass inflation and creating the next bubble, commodities and precious metals. As Bernanke and Company try to assess how best to deal with bubbles, they fool the public as though these events are some mystical force that no one can control. I have a simple solution, how about stop printing so much money. We instead move from bubble to bubble, the Centrals banks policy after one pops is to inject further easy money into the system. Like some drunk who throws up after a bottle of vodka, 'I best have another to sort myself out'.

Could the US unemployment figures signal the turn with people getting back to work? Maybe in the short term, but I don't think this will be a long term trend. You have to remember governments everywhere are printing huge amounts of money and this is bound to give the so called 'prosperity' effect in the short term but it won't last, the free market hasn't healed. During the coming stagflation a lot of conventional indicators will seem to be healing when in fact the underlying fundamentals are deteriorating. For ten years after the credit crunch in 1973/74 the unemployment rate in the UK kept rising.

It didn't move up in a straight line, with periods of consolidation and even movements to the downside. When the correct path was taken it took years to fall. Numbered estimates in the news are useless, three million, four million, all have been given as figures for the short term, however no one can say for certain, all we do know is that history says it will keep rising over the long term.

For a developed country the British people sure do love their inflation. While many other nations inflation indices have plummeting like many a British Banks shares, the UK's inflation rate has remained remarkably 'sticky'. Whether its the appreciation of our assets, our rising incomes, our increased levels of debt or the fallacy that we believe the weak pound is good, we really do want to beat other nations in the race to the bottom. The yanks scream 'bloody murder' watching their beloved dollars debasement from the powers that be, not realising that one hundred years ago a British pound used to be worth $5. Anything you can do across the pond, we can do it much worse. Over the next decade I'm sure we will show the developed world what not to do. The problem I see is that British people want inflation. We want to see rising prices, we believe that this is a healthy state of affairs and will thus allow a greater level of leniency towards our policymakers compared with other nations when it comes to expansive monetary policy.

Will the BoE raise interest rates when the market forces their hand? Contrary to what people believe it is the market that controls long term interest rates. We may like to think of central banks under a paternalistic viewpoint, our saviours there to insulate us from financial destruction and chaos, to solve economic issues should they arise. Central bankers are just like their Communist Central Planning counterparts, eventually market forces get the better of them where eventually they follow the market, not set the tempo as they would have us all believe.

In order to understand how markets dictate prices such as interest rates its easier to compare the lowering of interest rates to say lowering the price of bread. If the government declared rather than liquidity not been easily accessible that the issue was now high bread prices, they therefore set forth a policy to fix the price lowering it below the market one. As suppliers begin making losses they shut down production, at the same time people consume more as they can purchase more of the product. Eventually the country runs out of bread with all stocks depleted. Rather than bite the bullet immediately the government would in all probability resort to rationing rather than admit the error of their ways with bread queues becoming a common occurrence. A black market may appear as people under their free will and against the governments law begin selling bread to one another for a price set by people, the marketplace. If however the government wishes to fix the state of affairs they must liberate the price once more, allowing the market to determine the price of production. As suppliers closed down long ago abandoning their supply networks it takes a short while for supply to meet demand once more. During this period the price of bread goes into the stratosphere as people bid up the cost of the present scarce bread. Eventually market forces will drive the cost down over time to a point of equilibrium.

How does bread relate to interest rates? Its the same principle. Governments can set the price low but eventually the market will force its hand to raise the price, with the price going into the stratosphere. This is why we had 18% interest rates when Thatcher tried to put things right, or when Paul Volker put US rates above 20%. The policy makers were just chasing the market, trying to reign in inflation which was driving the free markets interest rates haywire. During the 1973/74 credit crunch Central Banks had the same idea as now, that is they lowered interest rates in response to the recession, but the longer and lower you try to hold down these prices the higher and sharper they have to eventually rise as many an older reader will painfully remember.

The BoE could be forced to raise interest rates under a number of scenarios. They may have to raise rates if there is a currency crisis with the pound falling as investors flee. Like the bread situation above, they will put off the price liberation, instead they will put currency controls or limits on capital (like bread rationing) in order to try and provide a short term fix. Eventually the market beats them and they have to hike rates as over the long run a lack of foreign investment creates a less dynamic economy and higher inflation.

It could be forced to raise rates if inflation got out of hand with the free market demanding increased real rates of return to negate the depreciation of the currency. Even if central banks keep buying government debt at artificially low rates, private banks still lend to all of us, with this mortgage rates could rise for example. Its similar to what we see now, despite base rates at near zero average mortgage rates are far higher as the free market realises there are inflation risks over the medium to long term. They are also hedging against their potential losses as the government props them up.

However they could do none of the above. They could keep rates low, spurring on more inflation as the government can no longer afford increased rates on the ever expanding debt. They by pass the market and lend to individuals themselves at these rates. They print money directly to cover the shortfall in the various government payrolls. Currency collapse is ensured at this point as it becomes clear to all that its time to pack your suitcase. Marc Faber believes this is the conundrum America will face at some point in which its policymakers will not rise to challenge, instead they will shirk away from the correct action to take, opting for runaway inflation. At some point the stock market of such a country would be a screaming buy, just at the depths of the seemingly never ending hyperinflation when the average person has lost all confidence.

Could the UK be the Canary down the Western coal mine? There are many other nations with serious issues that have faced or will face issues sooner, but I wouldn't put them in the same tier as Britain, a nation who still has a recent innovative and industrious past. She could however, be the warning signal for many other Western nations that mass inflation and/or interest rate rises are just around the corner. Either option ain't pretty.

Oil - Our Deadly Addiction

"Now the only thing that saved the U.K. was the North Sea oil fields, even though Prime Minister Margaret Thatcher likes to take credit, but Margaret Thatcher has good PR. Margaret Thatcher came into office in 1979 and North Sea oil started flowing and the U.K. suddenly had a huge balance-of-payment surplus. You know, even if Mother Teresa had come in [as prime minister] in ’79, or Joseph Stalin, or whomever had come in 1979 – you know, Jimmy Carter, George Bush, whomever – it still would have been great. You give me the largest oil field in the world and I’ll show you a good time, too. That’s what happened."
Jim Rogers, Chairman Rogers Holdings


Since the modern world began to industrialise we have seen huge advancements in all aspects of technology and living standards in the West. Since the application of fossil fuels into our industries we have been able to grow our material wealth immeasurably compared to any other point in human history. Most of human history is marked by an agrarian focused system with closely knit communities that did not produce much of an economic surplus, other than to feed itself, a basic civil service, taxation system and law and order. But over the course of the last 200 years that has changed. Society suddenly began producing increasing amounts of labour surplus. Jobs became ever more specialised and productive leading to a feedback process of more productive surplus in society. There seemed to be no limits to the growth of the modern world as it embarked on the experimentation of modern globalisation into the next millennium. But where and how did all this wealth get created along with the extra productivity gains? People had not evolved significantly for thousands of years, yet their economies and populations had grown exponentially. The answer lies in the fossil fuel revolution that began roughly 200 years ago.

Rule Britannia

Beginning around the end of the 18th and the early 19th Century, a technological revolution was underway. The invention of the steam engine allowed the production of powerful machines that could do huge amounts of work and this meant large factories could be built on a massive scale. With the introduction of iron founding, railways and steam powered ships could be built and thus a mass haulage system was built to move the goods that were being produced in significant volumes by the new factories. The Coal age had arrived and with it a revolution in the way modern society would function. People would migrate from rural areas into the urban towns and cities to further produce more goods which in turn generated wealth that had never been seen before.

Land of Plenty

Oil had been known for hundreds of years however it was not until the mid and late 19th Century that it became used for productive purposes. It was originally used for lighting domestic homes due to the shortage of sperm whale oil, that was used before it. America was beginning to rise as a prosperous industrial nation spurred on by home grown technical innovation. As a resource rich nation it did not need a vast empire like Britain to grow. The turn of the 20th Century marked a great transition from coal to oil, something America possessed in abundance. With the advent of flight by the Wright brothers and the Model T Ford in 1908, new applications were found that required Oil, a hydrocarbon substance that was packed with energy. Demand for oil increased as the 1920's came along with increased use in agriculture and the start of Amercian's romance with suburbia as the motor car became more affordable. Further uses of energy became increasingly common with domestic labour saving devices running off electricity powered by various fossil fuels, creating further productivity gains in the economy. The Great Depression ushered in an era where the fossil fuel economy had simply being too over productive as people began to stop buying these new devices that had drove the unsustainable boom. A Second World War erupted in Europe, marking industrial countries reliance on oil. The Germans had ensured oil supplies from the start of the war with Russia in signing the Molotov-Ribbentrop pact. Hitler would later conquer western Europe - well almost. Later he would try to take Russia by surprise in an attempt to capture their oil reserves, that Hitler so desperately needed to sustain an efficient war machine. He simply didn't trust Stalin or Communism. Like Napoleon, over 100 years before him, he was beaten by the harsh Russian winter and the vastness of its terrain.

After the war America emerged as the new superpower of the world and its people over the course of the next two decades would enjoy some of the biggest improvements in living standards in human history. Oil is by far the most energy rich and versatile fuel humans have every come across and learned how to use successfully. The abundance of domestic cheap oil meant the American economy was powering ahead.

Dr M King Hubbert

In 1956 a geoscientist named Marion King Hubbert gave a talk proclaiming that American oil production would peak somewhere around 1965 - 1971. He was laughed at, as America had huge amounts of Oil, enough for many years and generations to come. Then in 1970, the US hit peak oil production. They would never again in history produce more domestic oil then they did in that year. Dr Hubbert had been proved right and suddenly America was now a net importer of Oil as demand continued increasing with domestic supply embarking on a long decline.

The Oil Shocks

1973 and the Yom Kipper War erupted in the middle east, in which an Oil embargo on the west would coincide. Overnight the price of Oil rocketed and the price went from roughly $3 a barrel to $5. With it the western economies suddenly began to break down, as everything was either made or transported with oil. Panic buying began with prices rising. Amercians and Europeans woke up to the fact that their economies could not function without Oil. This set off a decade of stagflation and general discontent. A Second Oil Crisis was to erupt in 1979 as the Shah was overthrown in Iran thus creating another Oil price spike (one of the reasons that the Americans would later bank roll Saddam Hussein against Iran).

North Sea Oil and the Alaskan Oil fields - The false illusion

Around the end of the seventies North Sea Oil and the Alaskan Oil field slopes had been discovered, giving Western Governments control over their own supplies once more. This extra supply along with improved middle eastern relations would bring prices back under control and bring in the illusion that the seventies was a false alarm, there would always be plenty of oil. During Britain's long decline since the First World War they had become the basket case of the West on the verge of going bankrupt and resorted to begging the IMF for money just before North Sea Oil began to come to the market. As Jim Callagahan would say, whoever won the 1979 election would retain power, the revenues from Oil would see to that. Thatcher won and had the full benefits of north sea oil and gas, the real Thatcherism was in fact surplus energy. Oil began two decades of stagnant prices and was as low as $10 a barrel in the late nineties. I remember my dad at the time having to announce a lot of redundancies in his industry and his remarks at how low the price of Oil was. It was not to last. Alaska peaked around 1988 while North Sea oil peaked around the turn of the millennium. The West was running on empty again.

A New Age of Price Shocks

The Globalised economy was beginning to take shape. Factories and jobs had been relocated to Asia with the emerging far east economies being titled as 'Tigers'. The mass investment of capital from West to East spurred forward further demand for oil and coal. China had once been a net exporter of oil. Now it had become a net importer with an insatiable appetite. Geological Analysts began reviving Dr King Hubberts work suggesting we were near worldwide peak oil. Again they were laughed at or denounced, just like Hubbert was 50 years ago. Meanwhile Countries began peaking in oil production. Mexico, Oman, UK, Indonesia all past their peak. The Saudis told us there was no problem they could cover the demand, however for years they had been pumping their oil wells with seawater to sustain the output. Some say the Saudis are now pumping at peak or will reach peak soon. From the turn of the millennium prices began a slow and long climb upwards, supply seemed to be hitting limits yet the further industrialisation of Asia demanded more. Americans and Europeans had been consumming, buying bigger cars with a 4x4 culture further increasing demand. The end of cheap oil and energy had come. A new era of price rises and economic turmoil had been ushered in. The first significant price spike occurred over the course of late 2007/2008 with Oil reaching just under $150 a barrel. Gordon Browns Solution - go ask the Saudis to pump some more. The price dropped to sub $100 prices as the global economy began to slow. People thought the earlier price spike was driven by speculators and oil companies and cheap energy would soon return with oil prices collapsing. In reality the price had been driven by the most simple economic dynamic - supply and demand. A new period of Oil Shocks was only just beginning with the potential to cause chaos in the industrialised economies of the world.

There's plenty of Oil still left

Of course there is plenty of Oil left. Estimates of proven oil reserves are around 1 trillion barrels of oil. Humans have currently used to date around the same amount, 1 trillion barrels. However the oil we have already used has been the easiest to access. Oil was first discovered on parts of the earths surface, you didn't even need to drill to get the stuff. Then to get further reserves you had to drill, but this was on land and there was little energy expended for the amount of energy returned. In the first part of the Twentieth Century you could expect to get 30 barrels of Oil for every 1 barrel you used in energy for getting the stuff out of the ground and to the market. This ratio has been going through a slow decline as time has gone on. Oil fields were routinely left with half the oil still there as it was not economical to extract the remaining amount. No doubt in time as prices rise these will be re-drilled. As oil in the reservoir declines so does the pressure therefore you have to expend more energy to pump the stuff out. As Oil became more scarce offshore drilling was used, however this is a lot more expensive to do than drilling on land and I don't mean economically but the return on the energy. Those offshore rigs have to be constructed and built through the burning of more fossil fuels. The early oil that was discovered and extracted was also the best quality oil, with little refinement costs, but as there has become less and less there has become more and more refinement costs.

The point is we may have lots of oil left. Everyone accepts this. The point is we have run out of cheap and easily accessible oil. Most of the oil in the world would be so hard to get that you would get negative energy returns. There's no point extracting a barrel of oil if it took 2 barrels to get it. Oil fields extract following a very exact pattern, following a bell shape curve. Production ramps up ever more until it reaches a peak. Once this peak is hit, you can never get more Oil at any given time again. This means even if there is lots of oil in the reservoir it can only flow at a specific rate, thus if demand increases supply can not. The oil field follows a set pattern, one of decline (see age of growth post for graph pattern). It doesn't matter how hard you pump, extra drilling, it will always never yield the same daily return.

We will just transition nicely onto the alternatives

Did we prepare for when Western Oil production peaked in the early seventies? Only a crisis brings about change within human society. Then we get onto the question of what alternatives? If there are more economical alternatives then wouldn't we be using them already? The bottom line is that oil is still dirt cheep and convenient compared with all other energy sources we know of and can exploit. It comes back to energy expended during extraction, compared with energy returned.

So what about hydrogen fuel cell technology thats in the news? When someone starts to go through the practicalities it becomes laughable. First you have to make the hydrogen, which is not like drilling oil that naturally occurs. It's an expensive operation using techniques such as electrolysis. Then you have to compress the gas in order to try allow it to be delivered to the refueling stations, yet it will still not contain any where near the same amount of energy as a tanker of oil would contain (in fact it barely becomes economical after the distribution network has expended energy in delivering the tanker). Then you need to unload it at the refueling stations, a highly explosive gas when combined with air (Hindenburg), into a high pressure container. Then the car would need to be fitted with a high pressure tank with high pressure connectors to put the pressurised gas into the car - a feat just to engineer all this. After which the user would be able to drive around in a car of highly flammable gas at which the piping system could burst in a crash or even just leak due to Hydrogen's corrosive properties over time. And the fuel making all this possible is of course fossil fuels which produces the hydrogen in the first place as things currently stand.

That leaves electric which is just not as energy dense as oil. First you have to make the electricity. Then you have to charge your battery powered car for hours, not like oil where it takes a few minutes to refill a tank. Then when fully charged the electric car still gives no where near the same mileage as oil. What are lorry drivers going to do that deliver goods over long distances (plus you are going to need some serious batteries). You could have an electric car running on an electric grid based road, but this is not going to happen overnight. Plus western government finances are already in a mess - do you really think they have money to retrofit our roads.

Hybrid is the other car being discussed, but again it still uses oil and merely dampens demand and the car itself is expensive for the majority of people. Renewables such as solar, wind and hydroelectric etc will never be able to meet our high energy demanding economies and our transportation network. Plus what do you think makes these viable at the moment? Again its Oil, Gas and Coal that are used to build and deploy the equipment. We could burn ethanol just at a time when the there will be huge demands on corn as the globe is becoming more affluent, aggravating global hunger (plus the energy yields again on ethanol are poor). Nuclear fusion is just a pipe dream along with lots of other futuristic technologies leaving just fission as the proven alternative. In the coming years political sensitivity will be ignored for the sake of increasing energy demands and narrowing alternatives.

Our whole transport infrastructure is based on Oil

It's not just cars that rely on oil. Its agriculture machinery, ships and lorries that transport goods, building equipment, mining trucks etc. If oil is becoming more expensive then guess what, your food will be more expensive as the tractors become more expensive to keep running. If the food you import is from overseas then the ship or aeroplane trip becomes more expensive. The supermarket van that delivers the goods near to where you live becomes more expensive. More of your income, your economic productive surplus gets consumed by higher energy costs leaving you less money to spend on other goods in the economy, thus starting the feedback process in reverse from the advent of the industrial revolution. Jobs become less specialised, reversing Adam Smiths theory's of increasing job specialisation (look at the back of a £20 note). The division of labour goes into reverse as you can no longer afford all your shopping so decide to grow your own vegetables leaving you less time to go to that gym you pay £30 a month for, to name one of many plausible permutations. It's the division of labour that has drove economic growth at such a rapid rate in the past two hundred years which has been accelerated abundant supplies of cheap energy and a technological ability to exploit it. Society has in fact been living off an invisible form of slave labour, machines powered by oil have done jobs and tasks that were typically done by many. There may be some wonderful future power source which may be much more convenient, efficient and cheaper than oil however they are just ideas or theories and I like to look at the current situation we face now. Claims of future scientific and engineering brilliance doesn't answer the current problem we have.

Oil Shale, Oil Sands and Synthetic Oil

With the recent discoveries of the oil sands and shale in Canada there has been great belief that this will flood the market with oil. However this is not conventional crude oil of the liquid type. First it has to be processed which is a very energy intensive process. Then there are all the environmental costs as a lot of toxic waste is produced that will be opposed by many environmental groups (which will probably be ignored when demand for oil becomes so desperate). All this extra processing means that for every 3 barrels of oil you produce, you use 2 barrels of energy to extract it. Sure there may be technological improvements and innovations but there are limits, specifically the laws of thermodynamics and it will never be as easy as it has been in the twentieth century.

You can create a synthetic oil from coal. Germany used the process during Hitlers time in power, as Germany had no oil reserves of their own. Again though there are costs, specifically the processing of it hence why Hitler still wanted access to the conventional liquid oil. It was out of necessity that they were processing oil from coal. People have made claims that it can be done as long as the price of oil is around $50 a barrel. I'm yet to see these huge coal synthetic processing plants, as oil long ago went beyond $50 a barrel.

Coal and Gas

The other two fossil fuels are Gas and Coal. We are told we have hundreds of years of coal but yet if we dig a bit deeper the practicalities remain to be seen. We have already used the best burning, high energy and easily accessible coal. We are already using lower quality grades of coal that do not yield the same energy performances as coal did 50 years ago. There's also the practicalities of getting it. We are having to dig deeper and further, expending more energy in order to extract it. If we believe the estimates that say we have hundreds of years of coal remaining, do you know that these estimates include certain grades of rocks. Gas is similar to oil in that it will be exhausted within the century. The problem with Gas fields is that unlike Oil where it slowly declines, gas just suddenly drops off when fields become empty giving little warning. With North Sea Gas in decline the UK is having to rely on the pipelines from Russia for the delivery of its energy needs, last in the western European chain except for Ireland. Can we really trust Russia? A nation that is still suffering from decades of internal decline with a corrupt political system.

Where from here?

It will be interesting that is for sure. Our leaders are still in denial and will still not face up to the realities of a transition occurring in human history. If history is any guide US peak discoveries occured in 1930, with peak production occuring in 1970, 40 years later. Worldwide discoveries peaked in 1965, so have we passed peak? We will only know in hindsight. All I do know is that our society is ill prepared for a world with ever increasing demand for a finite resource that is critical to our economy and the modern lives we lead. This could well be the biggest challenge we face in the near term future. We currently have an economic system that demands growth. We are so obsessed with growth that when our economies contract we call it negative growth. There are some people that believe China will never be able to fully industrialise and they arrived just as the party was ending. Our financial system has been stretched to its limits, our ageing population is due to retire, we have record levels of debts that are becoming more expensive to service, savings are at record lows thus we have no store of capital to pay for investments, just future promises to pay other nations. All this would be a big enough challenge as history I have looked at has no parellels, however our main source of energy that has powered all of the above to historic highs is now running out. The credit crunch could evolve to become the energy crunch.

This is why I'm such a beliver in higher commodity prices over the comming decade. Oil is used in all parts of bringing products to the market, agriculture is dependant on it, mining of base metals is dependant on it and so on. If materials and basic staples such as food increases then this leads to more inflation. In another 5-10 years if you want to add value to your house you won't be adding a conservatory or granite worktops in the kitchen, you will be adding solar panels or wind turbines (in fact you will be knocking down the conservatory). That is what will happen. The UK has been too caught up in the hysteria of North Sea Oil and Gas, and failed when it had the chance to invest in its decaying public transport infrastructure which will inhibit mobility in the future. The US experiment with suburbia will come to an end and with it the billions (more likely trillons) of dollars that was put into the unsustainable American dream.

I am a believer in technology and the ingenuity of people. I studied Physics, Computing and Mathematics during my A-levels. But I also studied history, and for all humanties brilliance there are always times of sheer stupidity. We could be ushering in a new dark age, a collapse of order, governments falling and widespread anarchy. If the world leaders allow peak to pass, there is no going back and we will be racing against the clock to find alternatives while our oil infrastructure is expossed for its reliance on a finite resource and how dependant we have all become on it. The world will become smaller once again. There will be no one left to turn up the pumps.


"Through our inattention, we have wasted the years that we might have used to prepare for lessened oil supplies. The next ten years are critical."
Kenneth S. Deffeyes, Author of Beyond Oil: The View from Hubbert's Peak

"Oil depletion and climate change will create an entirely new context in which political struggles will be played out. Within that context, it is not just freedom, democracy, and equality that are at stake, but the survival of billions of humans and of whole ecosystems."
Richard Heinberg, Powerdown