Why is a falling oil price bad for many asset markets?

But there is, I believe, something else going on: there’s an important nonlinearity in the effects of oil fluctuations. A 10 or 20 percent decline in the price might work in the conventional way. But a 70 percent decline has really drastic effects on producers; they become more, not less, likely to be liquidity-constrained than consumers. Saudi Arabia is forced into drastic austerity policies; highly indebted fracking companies find themselves facing balance-sheet crises.

Or to put it differently: small oil price declines may be expansionary through usual channels, but really big declines set in motion a process of forced deleveraging among producers that can be a significant drag on the world economy, especially with the whole advanced world still in or near a liquidity trap.

That is from Paul Krugman, speculative (as I think he would admit) but worth a ponder.

Another possibility is simply that, along with China and ongoing terror attacks, investors are realizing they don’t understand the world nearly as well as they thought they did.  Or perhaps the rapidly falling price means one set of investors is learning from another just how soft the demand curve is, thus spreading bearish sentiment.

Addendum: Izabella Kaminska adds comment.


Comments for this post are closed