Lower oil prices are a mixed economic bag and in fact are doing a lot to destabilize the global economy. Russia’s attempt to stem the decline of the ruble with an interest rate hike to 17% had the opposite effect from what was intended. In fact, the country’s currency plummeted another 15% today.
As if that’s not enough, now it would appear that the Obama administration is prepared to back new sanctions against Moscow which could well put Russia’s oil dependent economy into a death spiral.
Economists predict that Russia’s GDP could shrink by at least 4.5% next year should oil remain at $60 per barrel. With Saudi Arabia and other major oil producers not willing to curtail production, the specter of $40-$50 per barrel in the not too distant future would put the global economy into uncharted territory.
Russia’s debts are mostly internal so the probability of another 1998-style debt default are not very high. However, the unpredictable nature of Vladimir Putin and the West’s constant prodding of the Russia bear could have political consequences that the U.S. and its European allies have failed to consider.
Clearly, the most explosive situation is Ukraine where Russia recently annexed Crimea and has assisted “Russian volunteers” in their takeover of the southeastern part of the country. Despite denials to the contrary, the West has been supplying arms and training to Ukrainian military forces, setting the stage for a proxy war that could destabilize other countries in the region including Estonia, Lithuania and Latvia which are all part of the NATO alliance.
While lower oil prices make driving cheaper (gas is selling below $2.00 per gallon in many U.S. states), not all countries are benefiting. Japanese drivers haven’t seen any benefit from the almost 50% drop in oil prices because the value of the yen has plummeted along with it.
Ergo for Brazil, whose currency has virtually collapsed, and perhaps less so for Venezuela where gas prices are heavily subsidized by the government, with drivers paying about $0.05 per gallon. Socialist utopia that Venezuela claims to be, driving there is mostly restricted to the military and government supporters. Fuel costs in Indonesia have actually climbed as the government took the opportunity to cut oil subsidies as did Malaysia which in fact is an oil exporter.
The global impact of lower oil prices has hit markets worldwide including the DOW which has already given up a large portion of this year’s gains. With all the Fed pumping of markets this year, there would be no greater irony in my opinion than the DOW ending 2014 solidly in the red.
For long suffering gold investors, the almost unprecedented instability in the global economy caused by lower oil prices could well be a harbinger of higher gold prices in the months ahead. Gold has been holding steady near the $1,200 per ounce level and the slow motion train wreck that we see unfolding in global markets increases the probability of a “Black Swan” event that no one expected but seemed perfectly rational in hindsight.