Worst-Case Scenario It's 1981

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Includes: DIA, IWM, OIL, QQQ, SPY, USO
by: Dana Blankenhorn

Summary

Economists are warning of a global rout over the oil bust.

Oil busts have happened before but recessions, not depressions, followed a year later.

Be defensive but don't panic.

Warning A lot of analysts who are heavily tied to oil and other commodities are predicting doom for the U.S. economy. Not just doom, but DOOM! DOOO-OOM! DOOOOOOO-OOOOO-OOOMMMM!

The reason is simple. There is a huge overhang of oil industry debt that can't be repaid at current prices. Writing off that debt, it's assumed, will crash the economic ambulance. Taking out those companies, it's assumed, will destroy the economy in a deflationary spiral.

It's true that the fracking boom has created enormous debt. Companies have raised equity, taken out high-yielding loans against that equity, and sought to pay back the loans with production in order to get rich on the equity. It's a story as old as the oil cycle, which dates to the 1860s.

But we also know how that cycle plays out, because booms have turned bust before, many times. Consolidation has happened. Standard Oil has happened. Production controls have happened. Efficiency has happened.

Along the way there was also the pain of unemployment throughout the oilpatch. I well remember visiting my Texas relatives at Christmas in 1984 and driving through what felt like a post-apocalyptic dystopia. Roads were cracked and filled with potholes, billboards empty or advertising preachers. See-through skyscrapers were everywhere, empty. Friends from school with high-end degrees were reduced to jobs in pest control. A developer took some of the most expensive land in town and built a waterwall on it to say the city would survive.

The city did survive, and Texas was not the whole economy. Trading centers on both coasts thrived on low oil prices. It happened again in the late 1990s. Look at the macro chart on oil prices and you will see it clearly. Oil bottomed in November 1998 and the economy boomed. It crashed in the mid-1980s and it was still morning in America.

We know how to write off bad loans.

There is a danger. The rest of the economy, especially the tech sector, can get overheated after oil crashes. A year later, in both these cases, we did have a stock market crash, as tech stocks got beyond their fundamentals and speculation (meant to make up for oil losses) went wild.

But that's different from DOOOOO-OOOM! The crash of 1987 didn't even result in recession. And the best tech stocks eventually made it back from the dot-bomb.

One hallmark of this recovery, as I've been writing since 2011, has been how renewable energy, most especially efficiency, is allowing for real growth with less consumption. Clouds and devices are fulfilling the promise of the dot-boom. Markets and marketplaces are being fully automated, with both transportation and health systems on the list for future growth.

This generates deflation, just as the oil rout generates deflation. Deflation is a terrible thing. But we know how to deal with deflation. Print money, spend more, spur demand for abundance, write down the bad loans and write good ones on what is working.

So there may be a global recession ahead as policy adjusts to the deflationary impact of cheap oil and technology productivity. But it's only doom if you're a Luddite in the oil patch. Otherwise it's a bump in the road. I'm going to be more defensive here -- you don't get the kind of gains from Wal-Mart (NYSE:WMT) evolving than you do from Amazon.Com (NASDAQ:AMZN) transforming the world. But that's not DOOOO-OOOO-OOOMMM! It is not even doom.

Just choppy markets, rough seas, and a new horizon ahead.

Disclosure: I am/we are long WMT, AMZN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.