Luc Vallée is the Montreal-based chief strategist at Laurentian Bank Securities.
Many people are wondering why lower commodity prices have not done more to spur economic growth in Canada and around the world. After all, on an annual basis, a $65-a-barrel drop in oil prices represents a $2-trillion (U.S.) windfall for oil consumers. Natural gas prices are also at their lowest in years and many experts expect most commodities prices, as well as interest rates, to remain low for years. This should be good, right?
There is no doubt that lower energy prices greatly benefit consumers. However, the current situation in the oil sector is the result of overinvestment by companies that overestimated the growth potential of the global economy, failed to take into account that many of their competitors were similarly aggressively investing or miscalculated the speed at which innovation could render their own investment unprofitable.
Overinvestment is not a blessing. It's simply wasteful. To say that today's low oil prices are a good thing for the world economy is equivalent to asserting that it's wonderful when businesses fail during a recession because consumers get to buy their goods for less. When low oil prices are the result of investments that should not have been made in the first place, they're symptomatic of a problem. We would have been much better off if scarce resources had been invested in sound projects that didn't lead to a fire sale. It's true that failure and success are part of capitalism, but in the end, the successes have to outweigh the failures for economic growth to ensue. Otherwise, investors have wasted resources more than they've contributed to increasing our wealth.
In general, when prices (real estate, wages, oil, capital) are low because of overinvestments, rather than innovation and productivity improvements, they are an indication of waste and failure – not a sign of success and an improving outlook. Fire sales help to clear excesses, but they also cripple those who have failed and ultimately have to pay for their mistakes.
Over all, it would be surprising if the large debacle observed in the oil industry today turns out to be positive. If oil prices had remained high, it would have signalled that past investments in oil were indeed necessary. But with crumbling oil prices and extensive bankruptcies, we have evidence instead that at least some of these investments were a terrible idea. With the discovery of cheaper, better-quality and more accessible oil from massive shale deposits, where production is also much more flexible, Canadian oil sands plays – developed at an average cost of $75 a barrel – were probably ill-fated, in retrospect.
Who could have known? Even the Saudis were surprised by the so-called shale revolution. I don't know what could or should have been done differently. But based on what we now know about the shale oil market, this cannot end well if oil prices remain low for the foreseeable future. Resources injected into developing oil sands projects would simply have found better use elsewhere. Harsh? Yes, even for those of us saddened by the outcome. But this is the new reality our market-based economy is forcing us to accept – and the sooner, the better.
Because Canada's economy is well-located, rich and diversified, we should take some comfort. While Canada's resource regions are going through a difficult period, the rest of the country's economy should benefit. Yet, the story is more complex than the oil sector. On one hand, the huge "oil and commodity dividend" from the recent overinvestment in natural resources constitutes a very powerful tailwind for the global economy, and we should definitively take advantage of that huge windfall. On the other hand, the fact that investors wasted precious financial resources in three successive bubbles over a very brief period (technology in the late 1990s, real estate in the middle of the last decade and commodities and energy over the past few years) is not very conducive to growth and acts as a huge drag on investors' confidence.
This confidence drag helps explain why worldwide credit conditions are getting tighter, regardless of very expansionary global monetary policies. And perspectives on future growth may worsen if investors remain hesitant because of this poor investment track record – a vicious cycle that has to be reversed for things to improve.
Who would be confident in our financial system if, during every cycle, investment leads to a huge crisis and eventually a central bank rescue? Would you trust an adviser who would constantly steer you toward such investment? Probably not – except if you knew that you would be bailed out. But what if the bailouts stop because policy makers run out of ammunition, make a mistake or finally recognize that their interventions are only making things worse? What would you do?
As an investor, you would probably freeze. This is what is happening today.
Faced with growing evidence that monetary stimulus is failing, many observers now favour aggressive fiscal policies, because it's commonly believed that when rates are zero and animal spirits are at their lowest, policy makers have got to resort to good old Keynesian policies. It might work if public infrastructure investment is done right. But what if bureaucrats don't invest our money wisely? Will this be the ultimate last-resort bailout, with more debt piling up as a result?
With such uncertainty, "What if" scenarios are beginning to cloud our vision. What if the yuan goes down the drain? What if credit conditions continue to tighten for small and medium-sized businesses and developing economies? What if? What if?
If private investors no longer want to take risks, we may have no other choice but to pin our hopes on co-ordinated global fiscal policies that will eventually rekindle risk-taking without government assistance or support. Let's hope that public infrastructure spending will succeed in restoring global investors' confidence to borrow at interest rates high enough to invest in sound investments that yield proper returns. It's the only path to sustainable growth. We're about to embark on this voyage – keep your fingers crossed.