If you listen to Ben Bernanke and Wall Street economists, it was the damage the subprime mortgage crisis inflicted on highly leveraged banks that deep-sixed the global economy.

No one has to tell me about how severe the banking crisis was. Why the hell do you think I’m an author now? But blowing up bonuses at investment banks and blowing up the world economy are two very different notions.

Everyone will tell you that it was virtually free credit conditions that spawned the subprime mortgage phenomenon. And everyone acknowledges that it was the sharp mid-decade run-up in interest rates that burst the bubble and caused the collapse in US housing prices and in the value of those mortgage-backed securities that are still wreaking havoc on bank balance sheets all around the world.

But the question folks aren’t answering is, what forced that fatal five-fold increase in the federal funds rate in the first place?

The answer to that, my friends, doesn’t lie with foreclosed homes in Cleveland, or with over-leveraged banks in New York, but rather with something that was happening in Cushing, Oklahoma.

From January 2004 to January 2006, a doubling in the price of West Texas Intermediate (the benchmark oil price in North America, which is priced at Cushing), from $35 per barrel to $70 per barrel, drove energy inflation through the roof.

Inflation, as measured in the energy component of the US Consumer Price Index, soared from an annual rate of less than one per cent to as high as 35 per cent. That, in turn, drove the headline consumer price inflation rate from less than two per cent to almost six per cent, the highest reading since Saddam Hussein lit Kuwaiti oil fields ablaze in 1991.

The Federal Reserve Board had no choice but to follow suit. Pretty soon, not only was inflation at almost 6 per cent, but the federal funds rate was as well.

Suddenly borrowing wasn’t free any more, and then, when homeowners couldn’t make the mortgage payments on homes they couldn’t afford in the first place, the whole financial system imploded.

But if oil had stayed around $35 per barrel (incidentally what the “energy experts” were calling for at the time), energy inflation would never have spiked, and neither headline inflation nor the federal funds rate would have gotten anywhere remotely close to the levels that sparked the financial crisis.

The subprime mortgage crisis was not the cause of the recession. It was a symptom of a much bigger problem—an energy shock.

It was oil prices that brought about the last recession, and unless we make some major changes to the way we live, it’ll be oil prices that bring about the next recession as well.

Ben Bernanke doesn’t get it. Make sure you do.

  • hera1

    Well I do agree now what must we do to protect ourselves. Get out of equities totally or Cash is King. There is so much info that it is hard to wrap our heads around it. What to believe or actually, What must we do!!!!!

  • Colin Smith

    I've been saying this all along. In fact you will find energy, and its implications, behind all economic movements, especially now – as Jeff Rubin well knows. And currently, with US demand still down, oil is creeping quickly towards $80. China is ramping up demand, and when oil hits $85/90; you guess it, the economies will crack again. Doubtless they'll blame government, global warming and banking again, but we know the truth.

    By the way; have you realised that global warming is just governmental euphemism for energy shortage, and a brilliant excuse to tax us into energy conservation.

    A very concise and well explained article by the way. Thanks.

  • marcovth

    Hello Jeff …

    Absolute great book. I hope Obama will read it.

    I noticed in Amazon that it has been translated into Spanish.
    Will you have it translate into French as well for Quebec?
    My spouse would love it.

    Is there any chance you will publish an audible.com audio book?

    Thanks for writing this book. It happens not often that I change my
    perspective on certain global issues, but this book certainly has.

  • marcovth

    What does it take the bring the cleanest and most reliable source of alternative energy to ALL of the developed world?

    The ability to dig holes, in most places on average 10+ km deep, in an economical way, to generate electricity from geothermal power plants.

    With current drilling technologies, how deep can one dig holes economically?

    About 5 km, depending on the rock layers.

    Please, Jeff, study this company. Please visit them !

    Potter Drilling is a google supported start-up company which is getting very close to being able to dig 10+ km holes in an economical way. This could be one of the technologies that can change the world.


    DISCLOSE: Unfortunately, I have absolutely NO financial interests in this company.
    They are not on the stock market. I am just excited about their technology and potential.

  • Richard

    Geothermal power plants could provide part of the non fossil fuel renewable energy global energy soultion. Rgardless, North American society needs to focus much more on end use energy efficiency which is often the most cost effective path. For example in Edmonton we helped designed and recently built a net zero energy duplex ( Riverdale Net Zero Energy Helathy Home). This beautiful duplex has no natural gas service and uses solar energy to provide all annual energy needs.

  • Colin Smith

    The Germans have been building passivhausen for nearly thirty years; these can actually feed power into the grid without ever taking power out. It can be done. All we need is legislation to enforce it. And a tax on exurban living to encourage people back into cities. Most American homes are not really permanent structures anyway, being built of softwood and tar paper, so the US has an advantage here.

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  • Chad Comeault

    Okay, let's dig a little deeper still. What caused the doubling of WTI from $35 to $70 a barrel in 2 years and over $100 for 5 months in 2008? Did world oil demand double from 2004 to 2006 (no)? What are the fundamentals behind the sustained price escalation?

  • Chad Comeault

    Okay, let's dig a little deeper still. What caused the doubling of WTI from $35 to $70 a barrel in 2 years and over $100 for 5 months in 2008? Did world oil demand double from 2004 to 2006 (no)? What are the fundamentals behind the sustained price escalation?

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