Q & A with Jeff Rubin

The former chief economist of CIBC World Markets talks about his new book The End of Growth.

Q: What compelled you to write The End of Growth?

A: I ended up in my last book arguing that triple-digit oil prices were no accident. It wasn’t the result of financial market speculations; it’s basically where the demand and supply for oil now rested, and that we would see a return of these prices very early into an economic recovery. And low and behold, that’s pretty well what happened. As of, say, January 2011, Brent, which is the world oil price, crossed into triple-digit range, got as high as $127 a barrel, and it’s even still today in the triple-digit range. So, what are the consequences of that? I think the basic dilemma is this: we need those kinds of prices to get millions of barrels out of things like tar sands, deep water, oil shale, Brazilian sub-salt, but unfortunately, the very prices that we need to lift oil out of the reserves that it now comes from translates into the same prices that basically kill our economies.

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Q: The basic theme of your book seems to be that economic growth requires affordable fuel. Essentially, the issue isn’t running out of fuel, but of running out of affordable fuel.

A: We’re never going to run out of oil in some absolutely geological sense. There’s 170 billion barrels of the stuff in the tar sands alone, and more in the Orinoco heavy oil belt in Venezuela. But that stuff doesn’t flow at prices that we would like to fill up at the pumps. If we know anything about the performance of the global economy over the last 40 years, we know this: feed it cheap oil and it runs like a charm, but ration expensive fuel and it seizes up literally over night. Every major global recession we’ve had in the last four decades has oil fingerprints all over it.

Q: You had a controversial view that the last recession was actually caused by oil prices. Could you explain why?

A: I mean, sure, there was a bubble, but bubbles need to be pricked. And what pricked it was the rise in interest rates from one per cent – I’m talking about the Fed fund rate in the States – from one per cent in 2004, to five-and-a-half per cent in 2006. And, of course, what caused that rise in interest rates was the rise in inflation, but that rise in inflation was almost primarily driven by oil.

Q: As you explain in this book, only a decade ago the price for a barrel of oil was only $20. But with the current prices of oil, those good times seem to be over.

A: Yeah, and I’m saying the problem – we’re not doing ourselves any favours by having the foot floored to the accelerator, because neither zero interest rates nor a trillion-dollar budget deficit, as they have in the States, is really a substitute for $20 oil. We might get a sudden jolt of economic activity, but in the long-run, it’s going to make it even more difficult because yesterday’s bailouts are tomorrow’s cutbacks. We’re already seeing that in places like recent Spain.

Q: Why hasn’t government policy adapted to rising oil prices in a way that you feel is necessary?

A: Because most economists – not withstanding what I said about if we know anything about the world economy we know it needs cheap oil – don’t consider the price of oil in determining how fast an economy can grow. They look at labour force growth, productivity growth, and in short, they think we have the same speed limit that we had 10 years ago. And that’s leading to the wrong policy choices. I think we have to recognize that we have to gear down; that all of our economies are slowing down. Not just Canada, even in China and India. For them it might mean growing at five per cent instead of 10 per cent. For us, it might mean growing at one-and-a-half per cent instead of three per cent. I think in this part of the world we’re going to find that adjusting to lower energy and slower economic growth does not necessarily mean going back into the Stone Age. And I point out some examples around the world, where countries have adjusted to using less energy quite successfully, like Denmark and Japan. And also point out that the countries that have adjusted are ones that have had no choice. Like if Denmark had the tar sands I’m sure they’d have a very different policy than they have today. But, they didn’t – that was just the way nature dealt the cards. Denmark doesn’t have hydrocarbons, so it’s learned to burn less of them. And I think that’s a lesson that we can all learn.

Q: What are some of the wrong decisions that governments are making in regards to triple-digit oil prices?

A: Well, zero interest rates, I think, are the wrong decision. I mean, I always find it curious how the governor of the Bank of Canada lectures Canadians about carrying too much debt and not to get a mortgage to buy that new condominium, while keeping interest rates at a level where he guarantees that that’s exactly what they’re going to do. It’s like saying, ‘Hey, you need to go on a diet and lose some weight,’ and then serve you a 12-course meal. So I find a major disconnect there. I don’t think running big budget deficits is the answer, because all we’re going to end up doing in the future is raising taxes and slashing spending. I think these huge deficits – countries are expecting to be able to grow their way out of them. They’re not going to be able to grow their way out of them. All that debt might as well be denominated in barrels of oil, because to grow your way out of that debt, the only problem is to grow you have to burn a whole lot of oil. And when you start burning a whole lot of oil, guess what? You’re looking at $147 a barrel prices, and economies don’t grow at those kinds of prices. That’s why I think, more likely, we’re just going to see places like Greece, Portugal, Ireland, Spain, default. And who knows, we may see America default in its own way.

Q: You talk about the PIIGS defaulting and possibly leaving the European Union. One thing I found interesting was that they might actually really want to do that.

A: I don’t think they’re going to have a choice. You know, unemployment is 25 per cent in Spain, the Greece economy has contracted say by five per cent for three years in a row. In the past, when these countries have run into these problems, and they have, I mean, technically Greece has been in default over half the time in the last 200 years. What would happen is there would be a huge devaluation of the drachma against, say, the German deutsche mark. And instead of German taxpayers sending welfare cheques to Athens, German tourists would get a holiday in Santorini. That’s basically what’s going to happen. Greece’s No. 1 industry is tourism, the drachma is coming back, it’s going to be massively devalued against the euro, and people are going to go to Santorini. It will create a chain reaction because Portugal’s No. 1 industry is also tourism. So, how’s Algar or the Azores going to compete against Santorini if Algar is priced in euros and Santorini is priced in drachmas. So, pretty soon we’ll see the escudo come back in Portugal, the peseta in Spain, the lira in Italy, the Irish pound in Ireland, and the European Monetary Union will shrink to probably what it should have been in the first place, which is France, Germany, the Benelux countries, Demark, because I would argue putting the so-called PIIGS in a monetary union with northern Europe would be broadly akin to putting Mexico in a monetary union with Canada and the United States.

Q: You also mention how countries like Germany wouldn’t necessarily want the PIIGS to leave. Could you explain?

A: There’s a reason why Germany has bailed out the PIIGS, even though ultimately it’s not going to be enough. It’s because what does Germany get in return? Germany gets a real cheap euro. Why is that important to Germany? Because next to China, it’s the largest exporter in the world. So everybody from Audi to Siemens to Mercedes to BMW benefits from the euro being 1.30 against the U.S. dollar. Without the PIIGS, the euro might trade parity with the U.S. dollar. If all of the sudden you had a 30 per cent appreciation of the euro, I’ll guarantee you Audi is selling less cars in China than it is today.

Q: You note that there’s a possibility that Chinese banks could get “different marching orders” and stop buying from U.S. treasuries to keep the yuan down versus the U.S. dollar. Do you think this possibility will come to fruition?

A: Yes, I do. First of all, I think the relationship is bizarre. I mean, it’s communism’s last stand funding capitalism’s fallen angel. They’ve done it in the past, as you note, to keep the value of the yuan down and to support Chinese exports to the U.S., but the days of China being the supplier to Wal-Mart, the days of exports to the U.S. driving Chinese economic growth, that’s all in the rear-view mirror. First of all, in a world of triple-digit oil prices, where distance costs money, China is not the logical supplier to Walmart, and secondly, Wal-Mart sales aren’t growing like they used to because the U.S. economy is in a very different position, and so is the U.S. consumer. What will be driving China’s economic growth is the domestic market. Already its auto market is bigger than the U.S.’s. Auto production is soaring there, not for exports, yet, I’m sure they will in time, but simply to meet domestic demand. So when China realises that they’re not exporting a whole lot more to the U.S., I think they’re going to let the yuan rise. And in the 1970s, the Japanese yen appreciated about 40 per cent against the U.S. dollar; I wouldn’t be surprised if the Chinese yuan appreciates that or more against the U.S. dollar in the next decade. And when the People’s Bank of China fails to show up at the treasury auction, Americans are going to know that, because while Ben Bernanke, the federal reserve chairman, has promised that interest rates wouldn’t be increased until at least 2014, interest rates will go up almost over night the minute China decides it’s not buying treasury bonds.

Q: How do you see this potential rise in interest rates affecting the U.S.?

A: Not great. I think the U.S. doesn’t realise how PIIGS-like it has become. It doesn’t realize that, because it thinks that its banker, the People’s Bank of China, has no choice but to continue to lend it money. I mean, why would you want to cut your debt if you thought your banker had no choice but to lend you more. But I think that’s very much a mistaken view. I think that the People’s Bank of China will stop lending the U.S. money, and at that time, the U.S. is going to have to do something about its huge deficit. As a percentage of GDP it’s not that much different than Greece’s. And, you know, probably the policies taken, and it won’t really matter whether it’s Obama or a Republican, but the policies needed to address the deficit are as unlikely to be as popular in the U.S. as they are in Spain or Greece right now.

Q: Essentially, Americans are going to have to learn to live with a lot less?

A: That’s right. And, if not for China, they would have already started doing that about a decade ago.

Q: You also mention how this shift could alter the attitude towards manufacturing in North America. Could we see a revival in manufacturing here, as opposed to shipping it over seas, as we’ve seen of the last few decades?

A: In fact, it is. In fact, it already has in the U.S. One of the surprises has been the strength of the manufacturing rebound, given how generally weak the economic recovery is. We haven’t seen it as much in Canada because of the Canada-U.S. exchange rate. But as I argued in my first book, Why Your World is About to Get a Whole Lot Smaller, when oil is over $100 a barrel, it’s cheaper to make steel in North America than it is for North America to import steel from China. Now whether those steel plants come back to Pittsburgh or they come back to Hamilton, that’s an issue of the Canada-U.S. exchange rate.

Q: Do you see a role reversal between China and the U.S. in the near future?

A: We’re seeing that right now. We thought we were going to be selling our oil to the U.S. through the Keystone XL, but right now, it looks like Enbridge wants to build the Northern Gateway, and that oil will go to China. And that’s probably the right call. When you sell oil to China you get the full-world oil price, and we’ve been basically subsidizing the U.S. to about $20 a barrel. Secondly, U.S. oil consumption has peaked and it will decline, whereas China is an economy that has gone from consuming about 2.5 million barrels a day circa 1985 to already 10 million barrels a day. If China is going to increase its oil consumption in a world where oil supply is hardly growing at all, or growing very slowly, it means that somebody else is going to have to decrease consumption. And that somebody else looks like it’s going to continue to be the U.S.

Q: This could have an affect on attitudes, as you say in the book, with regards to conspicuous consumption as well.

A: Right. I think that the days of flashing a Rolex watch probably sends the wrong message. And I think that sustainability is going to become a bigger and bigger theme. I know that most of that theme is just pure green wash today. But I think in the future it’s going to carry real bite. We’re going to see a new sensibility about consumers, and maybe that will require different marketing strategies.

Q: With the shifting economic climates around the globe, do you see Canada adopting policies similar to Germany’s job sharing initiative to help curb unemployment?

A: I do. To me that makes a whole lot more sense than zero interest rates or big budget deficits. So instead of one person losing their job, maybe four people take a 25 per cent cut in their worked time – and don’t forget, leisure is not taxed. So, I mean, half of this is being paid by your government because they lose the taxation on your paycheque. I think that that makes a whole lot of sense. I think that that program that has been credited with saving 1.5 million jobs in Germany during the recession, there’s no reason why programs like that couldn’t be implemented in Canada as well.

Q: Why hasn’t Canada explored options like that?

A: Well, because just the notion of job sharing, I mean, it’s not the North American way. Just like the notion of less is more is not the North American way. But we’re going to adapt. When you look at countries like Denmark, Germany, Japan, you see countries that have adapted. It’s no mystery why certain countries have adapted before other countries, because that has to do with national resource endowment and necessity, but I think job-sharing makes a whole lot of sense. Moreover, I think in the future, instead of working at one particular job, I wouldn’t be surprised if people had multiple sources of income, and certainly more leisure time, which, again, I don’t think is such a catastrophe.

Q: You also mention that even though growth may be slowing, there is a silver lining. You feel recession is actually the best way to tame runaway carbon emissions, correct?

A: That’s right, and we’re going to find that even our inexorable path to environmental self-destruction is going to run out of fuel. That we’re not going to emit half the carbon that the Intergovernmental Panel on Climate Change predicts we will. Not because of any actions that governments take, but simply, our economies stop growing, we stop admitting. Just look at the U.S. – emissions fell in 2009, not because of anything President Barack Obama did, certainly not anything congress did. They fell because the U.S. GDP shrank. When the Soviet Union collapsed and Russia de-industrialized, Russia’s emissions fell by almost 30 per cent, and Moscow wasn’t even targeting carbon emissions at the time. I’ll put my money on the economy and lack of economic growth over 1,000 Kyoto-type agreements.

Q: And we’re pulling out of the Kyoto pact anyways.

A: But we’re pulling out of the Kyoto program because we didn’t want to pay billions of dollars for our emissions being 30 per cent higher. But I’m saying we don’t need to be in a Kyoto program. If the Canadian economy stops growing, I can guarantee you our emissions are going to stop growing, and not in 30 years, almost instantaneously.

Q: What are the long-term implications for Canada as growth slows?

A: I think we’re going to find that the big fault lines that run in Canada aren’t between east and west, and isn’t between English and French-speaking Canadians, rather, it’s between those that have oil and those that don’t. And you’ll find that already oil has totally redefined Canada’s fiscal landscape. Ontario used to be the country’s wealthiest province and the banker to equalization cheques paid to poorer regions of the country. [But] oil has made Ontario a have-not province. At the same time, the same oil prices have made Newfoundland, perennially a fiscal basket case, into a have province. And I think that’s only the beginning of the kinds of reversal of fortunes that triple-digit oil prices can bring to different regions in the Canadian federation.

Q: What do you hope people learn most from your book?

A: I think what people should learn is that when we start talking about triple-digit oil prices or record food prices, what we’re really feeling is the boundaries of a finite world beginning to press in upon us. I think our challenge is – the key of adjusting to that world is – basically to learn to make do with less than to always want more. That, I think, is probably the central message of the book.

Jeff Rubin
Recognized for his bold predictions on oil prices and their effect on the global economy, Jeff Rubin is the author of Why Your World Is About to Get a Whole Lot Smaller and The End of Growth. He is a renowned energy expert and former chief economist at CIBC World Markets.
www.jeffrubinssmallerworld.com