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Peak Oil, Cheap Oil and Stagflation

America is addicted to oil. We deem it a constitutional right to drive Hummers and have $4 a gallon gasoline. But there is an Achille’s heel to our lifestyle—oil is a finite resource, and one day we will run out of cheap oil.

The story of peak oil

Let’s say that you live in New York and you make $80,000 a year. Life is good, it isn’t great, but at least you are making $80k. So how is it that you make $80k? Is it because you are skilled and worth it? Sure, you are, but is there something supporting your salary? Indeed if you were worth $80k but there were no currency to pay you, you couldn’t collect your $80k. Are there aspects of the economy supporting your income?
Let’s examine your news stand that you visit every day.  Joe, the news stand owner, makes $40k a year. He makes an unlivable wage in New York, but he and his girl friend get by each having jobs. Joe drives 10 miles to work every day.

On your way to work you reminisce of the good times as you fuel up. “Geeze, I remember when gas was $4 a gallon.” 

You stop by the news stand and see Joe boarding it up. “Joe, what happened? You were doing great business here!”

“Yeah, I am. But fuel is too expensive, and the misses and I can’t make it in New York anymore. We are moving somewhere cheaper.”You, now at a loss of information, must also drive 2 additional miles to get your news. Dang, news has become less available, and more costly.

The economics of peak oil

The stagflation of the 1970’s was caused by a combination of a decrease in the aggregate supply curve and loose monetary policy. As policy makers tried to stimulate the economy, what they didn’t realize was that the oil embargo had shifted the aggregate supply curve to the left. The economic issue wasn’t a lack of demand; it was a lack of supply.

We are addicted to oil, and it is ubiquitous throughout the economy. And as we begin to run out, like in the 1970’s, the aggregate supply curve in the economy will begin to shift left. But unlike the 1970’s, it won’t be an episode of lack-of-oil, it will be a trend.

So how is it that the end of cheap oil will equate to stagflation? Well, cheap oil drives the aggregate supply curve. As supply decreases, price increases, and economic output decreases. Cheap oil equates to stagflation via fundamental arguments of economics.

The challenges of peak oil

We will get to a precipice where we realize “oh crap, we are at peak oil.”Car makers and industries in the economy will adapt and search for more fuel-efficient alternatives. But do you know what the challenge will be? Everyone will be demanding these alternatives, and the decrease in the supply of oil will lead to an increase in the demand in these alternatives. The lack of cheap oil leads to inflation even in these alternatives.

Things also will move “slower”. That hybrid you now drive, can’t go 0-60 in 5.8 seconds. It can’t go 0-60 ever; the speedometer only goes to 55! On the macro scale, “slower” equates to fewer jobs and a stagnate economy. The end of cheap oil has delivered you both higher prices and a stagnate economy. You are at jeopardy of losing your job because the economic activity experienced under cheap oil is now diminished and is not coming back for at least a decade until the economy adapts to the loss of cheap oil.

The fundamental questions of cheap oil

We will run out of cheap oil—we know that and it is a indefensible to take the contrary position. Instead the relevant questions are:

1) how quickly will we run out of cheap oil and
2)how quickly will we adapt to running out of cheap oil.

I am no expert on the matter, but to be frank, I think that no one is. I think that we will run out of oil quickly. We will get to an “oh shit” moment and realize that cheap oil is arrived; ie it won’t be a tenable, gradual occurrence. On the longer end, the how quickly we will adapt, I am a little more optimistic. I think that we will have a decade of stagflation, but only a decade of stagflation.


One day peak cheap oil will come. When that day comes, I think that stagflation will grip the economy because of a decrease in the aggregate supply curve. If that is the case, then we will have persistent, unsolvable, wrenching stagflation.

By. Zeke Phillips

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