Thursday, April 7, 2011

Extreme Leverage, Extreme Instability, Extreme Risk

Leverage isn't just financial--it's in crude oil and technology, too. We tend to speak of leverage in financial terms, but as frequent contributor Harun I. notes, leverage and thus risk is ever-present in everything from oil to technology.

Some call it complexity or hyper-complexity, to me it's all about leverage. The greater the leverage the greater the instability. And developed societies are too heavily leveraged in technology (knowledge), finance (credit) and energy. Remember, your prediction of a 4% failure in housing causing a complete collapse in that sector was dead on. But that 4%, which globally represented much less, collapsed the entire global banking system. Technologically, there are too few people holding the knowledge to systems that are now considered vital; the same can be said of the monetary systems (the Fed insists on black box operations in conducting monetary matters). Crude oil and all its derivatives from which we get fertilizer to Tupperware to space shuttles: the extend to which we are leveraged via oil is incalculable.
Thank you, Harun. The greater the leverage, the greater the inherent instability and thus the greater the risk.
We tend to think of crude oil as the feedstock for gasoline and jet fuel, but it's also the feedstock for agriculture (fertilizers and transport), plastics (a significant percentage of industrial products) and ultimately everything else via transport.
Conventional economists are constantly cooing that oil accounts for a smaller percentage of the U.S. economy that it did in the 1970s; but does that mean that the economy is any less vulnerable to supply disruptions? The concept of leverage helps us understand how removing $650 billion in crude oil from the U.S. economy (18 million barrels a day X 365 days = 6.5 billion barrels X $100 per barrel = $650 billion) is not just a simple subtraction of 4.5% of total GDP ($14.7 trillion): it would trigger the implosion of the entire U.S. economy.
That's leverage.
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