Oil over gold – in a world of endless debt, it’s the only truly functional reserve currency

To warn readers in advance, this post includes concepts that are usually left to the realm of economists. Nothing puts a damper on the day like economic theory, it’s like stepping in dog crap. On the other hand, for energy people it is worth considering the implications for oil’s growing importance in relation to the utterly unsustainable debt trajectories of most governments.

By way of background for those who’ve never had to sit through an economics class, gold is viewed as the ultimate safe haven when currencies become worthless. Currencies most often go to hell because of hyperinflation, where a government loses control of inflation and more and more money gets printed as a result. (The theory is far more complicated than that with many more steps; you may investigate that elsewhere if you have absolutely, positively, nothing else to do. For purposes of this discussion, it really doesn’t matter.)

Most currencies were once backed by gold reserves (the days of the “gold standard”) but governments abandoned that scheme because it tied their hands too much; it hindered their ability to play with monetary policy and essentially meant life without a credit card (again, this is too simplistic; again, who cares, we’re not trying to fill a book here).

Because governments became addicted to debt, life was much easier when not tethered to gold reserves. Now, when inflation rears its head, gold prices race up because gold bugs think currencies will become worthless and gold will be the only real store of tradeable value. This concept arises out of historical habit, being one medieval superstition that survived despite the similarity to the belief in dragons. Any rare metal could have sufficed as a standard of value, though I suppose gold has a nicer ring to it than ruthenium.

Governments have gotten themselves into such huge debt problems that inflation seems inevitable. At some point people will refuse to lend more money to governments, and then governments will have to crank up the printing presses to fuel spending binges. The argument then is that gold will be the only thing that will hold value.

But that argument is pretty old and probably useless. First off, gold is itself useless. It has only ever had value because of its relative rarity. But gold also suffers from the same problem as currencies – the amount in circulation steadily grows with each new mine, and gold is rarely destroyed. So the supply keeps growing independent of any sort of link to a true asset-backed value.

Oil, on the other hand, has become an absolute staple and necessity for our way of life. Back when gold was seen as a fundamental part of the world economy, oil was more of a novelty. It was once used to caulk ships, or in bitumen form was once used as a setting for jewellery. Now the roles have reversed. Oil is indispensable, and gold is a trinket.

It’s true that one can’t physically lug oil around for trading purposes, but physical currency is rarely carried around in material amounts either. It’s all done electronically, as proven by the Bitcoin phenomenon. To me it’s quite probable that Bitcoin is just a big practical joke; if one purely digital currency can be created out of thin air why not one hundred more. Yet it has gained some sort of bizarre momentum. If the world’s debt bubble pops, the world won’t be able to eat currency (though they may be able to burn it for a while) and they won’t be able to eat Bitcoins.
Of course they also won’t be able to eat oil, but at least they can do something with it – fuel vehicles, heat buildings, cook food. Oil is a store of value that can actually sustain lives independent of whatever a government says its worth. In the event of a total currency meltdown, a barrel of oil will have a functional value that any person would trade for because it can keep them alive, as opposed to gold or wheelbarrows full of hyper-inflated currency.

As with most political discussions, venturing into the world of the purely hypothetical is usually just a waste of time, serving only to stir up the passions of the 1 percent-ers at either end of the spectrum (who have way more in common than they think). And it is hard to fathom a complete currency meltdown of global proportions actually happening. But on the other hand we have never witnessed a global debt buildup as we have now (history buffs, please don’t tell me about 1322 in Mesopotamia or something, things really are different now – for the first time in history the whole world is truly intertwined – except maybe North Korea).

We live in an era where the government debt totals $60 trillion (and feel free to take that number as having large error bars, but regardless it’s freaking huge), and where more than $10 trillion of that is negative interest rate debt. Think about that for a second – investors hate holding cash so bad they’d rather lend it out and have a guaranteed loss. We live in a world where a long-bankrupt country like Greece continues to borrow money in international markets, and they can do it for less than 8 percent. That’s because they’re backed by the EU, but that just makes the whole thing more insane – would you co-sign loans for a bankrupt 20 year old who tells you he plans to keep going to the casino since you so graciously spotted the cash?

While a certain segment of the population may sneer at fossil fuels, in the event of a global debt meltdown they will line up to get a ration just like everyone else, and maybe for a while stop biting the hand that feeds.