Shale's Credit Struggles a Reminder of Fed's Inconsequential Nature
Around this time a year ago those who should know better were up in arms about the Federal Reserve. After an early December rate hike, the Fed-obsessed expressed rage that the central bank was supposedly asphyxiating economic growth. President Trump chimed in with all sorts of complaints about how President Obama enjoyed zero rates of interest, yet the “Trump economy” had to endure all manner of hikes.
All of this was well beneath a Republican party normally respectful of market forces. To the Republicans of the past, the idea that the Fed was or could be controlling the price of and access to credit would have been laughable. Conservatives and Republicans who’d come of age during an era in which central planning of resources was thoroughly rejected around the world would have laughed at the idea that the Fed could somehow make credit easy by decree. Hadn’t lefty New Yorkers tried to decree low apartment-rental prices in New York, with scarcity the result?
Ok, so the interest rate is the cost of borrowing access to everything, including apartments, but the Fed could or can decree “easy” borrowing rates? In the past this was something wise conservatives would have again laughed off. Politicians and governments operate under the pretense that “cheap” housing, healthcare, education and other market goods can be had because politicians say so, but markets always have the last word. They always correct childish policymaking. Paraphrasing P.J. O’Rourke, “if you ever want truly expensive healthcare, make it free!”
Oh well, reality is once again intruding on the yearnings of those who believe entities like the Fed can “bend” the proverbial cost curve downward. Republicans and conservatives demanded as much last year, cheered the Fed’s subsequent conceit whereby it "lowered" rates, but did lenders comply? No. Rates still reflect the quality of the borrower. As they should.
As the Wall Street Journal reported last week, “Some large financial institutions, including Capital One Financial Corp. and JPMorgan Chase & Co., are likely to decrease the size of current and future loans to shale companies linked to reserves as a result of their semiannual reviews of the loans.” Banks are pulling back given their concern that “if some companies go bankrupt, their assets won’t cover the loans.”
None of this should be construed as a celebration of struggles within the oil patch. Far from it.
At the same time, conservatives who should know better have cheered the Trump administration’s pro-energy policies as though it’s the job of presidential Administrations to favor certain sectors. Not really. Conservatives of old logically decried industrial policy, or government support of industry at all. Their view, surely correct in the past, was that freedom was the answer to economic growth. If so, it wouldn’t matter if businesses with U.S. addresses extracted even one barrel of oil stateside. Why? The answer is that when markets are free and open, it’s as though every business in the world is headquartered next door given the abundance of product access.
Oil is no different. The “U.S.” could be 100% bereft of oil, at war with or embargoed by every oil-producing nation on earth, yet Americans would still consume the world’s oil as though it had been extracted next door so long as U.S. markets were open, and the American people productive. Production begets imports, and imports always reach the productive regardless of their origin. Translated, Americans would buy the oil from those the oil producers sold it to.
So while the excitement of conservatives about President Trump’s excitement about the energy industry was odd, and anti-conservative given the implicit drumbeat inside the movement for the economically bankrupt notion of U.S. “energy independence,” it also seemingly couldn’t overcome market realities. Put simply, shale and “fracking” are only economic stateside insofar as oil is nominally very expensive. Translated, the dollar isn’t weak enough for fracking to be economic. Translated a second time, for fracking to make economic sense every other sector of the U.S. economy must endure the low-investment (meaning low growth) agony that is always and everywhere a consequence of a weak dollar. Which leads to a quiz of sorts: which were the two slowest growth, worst stock-market decades of the last 50 years? The easy answer is the ‘70s and ‘00s when the oil patch was thriving, but the rest of the U.S. economy was operating at a fraction of its potential. Weak dollar equals slow growth (investors are buying future income streams in dollars, get it?) because investment slows down.
So what does all this have to do with the Fed? The answer here is pretty easy. While the Fed has shifted to rate-cutting mode with conservatives either excited or fearful of the central bank’s alleged “easy money” policies, reality has yet again intruded. Much as the Fed would like for credit to be “easy,” those with money to lend couldn’t care less about the Fed’s yearnings.
As the Journal’s Christopher Matthews, Bradley Olson and Allison Prang reported, banks are lending quite a bit less against the value of oil reserves offered up by shale companies as collateral. It seems banks don’t trust the value of oil-company reserves as much, and they’re logically pulling back. The Fed can fiddle with rates all it wants, but as one would expect when it comes to the world’s most dynamic economy, markets are markets. The cost of credit is what banks and investors say it is, not what a collection of central bankers cheered on by politicians want it to be.
Applied to the U.S. economy more broadly, does any reader seriously think that what affects struggling oil companies doesn’t similarly apply to other sectors of the economy? As in do readers really believe the Fed, simply by fiddling with interest rates, can overwhelm market realities? Translating the question, if credit costs set by market actors are dear as a consequence of lender fear about company/individual ability to pay monies borrowed back, does anyone seriously think the Fed can essentially overrule market sentiment?
The sapient among us know the answer to the above. The Fed once again can’t alter economic reality. Struggles in the shale sector are merely a reminder of what’s obvious: the Fed is a legend in its own mind, along with the minds of obsequious economists, equally obsequious reporters, along with angry self-proclaimed “free market” types so gullible (or eager to be mad) as to believe the Fed actually controls credit costs.
Reality is thankfully different. Paraphrasing last Thursday’s column, market forces ended the Fed around 113 years ago.