Shale Oil And Gas Adventure Unleashing Positive Supply Shock

A Positive Supply Shock = Low Inflation And Higher Growth‏
While plenty of pessimism has been expressed about the global economy over recent years, the truth is that we have witnessed several positive supply shocks over the past 20- 30 years. These shocks have given a temporary lift to global growth several times and we are about to witness another with the rise of oil production from shale oil and gas.

In the 1990s global growth benefited from a rise in productivity growth thanks to the IT revolution.
It was called ‘new economy’ at the time but it was really just a positive supply shock, which meant growth could be higher for a while before causing inflation, as long as the transition of implementing the new technology took place. As a consequence, Fed Chairman Alan Greenspan kept rates lower than usual and most likely helped fuel the IT bubble.

The 2000s was the decade of emerging markets.
A positive supply shock on a global scale took place as millions of people in emerging markets became markedly more productive. They went from farming, which added little value, to working in factories producing goods for western consumers. The outsourcing boom from developed markets to emerging markets led to a rise in global productivity, which meant the global economy could grow faster without inflation and thus with lower central bank rates – all else being equal. Actually, inflation was not that low in this period but was mostly concentrated in commodity prices. It was therefore deemed ‘temporary’ by western central banks and did not count as real inflation. Consequently, rates were kept low for long, which helped fuel the Great Housing Bubble in the US and most of western Europe.

In the 2010s we are witnessing another positive supply shock, as the shale oil and gas adventure is unleashing new production potential, which, all else being equal, is reducing oil costs. This feeds through to other commodity prices. Since the positive supply shock comes at a time when the western world is already experiencing a large output gap (demand much below supply), the disinflationary forces are quite significant. The fall in inflation stemming from the positive supply shock gives a lift to growth, though. Lower inflation in energy and food frees up purchasing power to buy refrigerators, DVDs, cars etc. Since consumption of these items is suppressed already, the case for recovery becomes stronger.

The global recovery in 2014 will be underpinned by easing headwinds as well as pent-up demand.
Fiscal austerity was the name of the game in Europe and the US in 2013 and this will be over in 2014. At the same time, the euro debt crisis has been tamed and the ‘bond yield shock’ to the US economy in 2013 is likely to fade in 2014. Pent-up demand is biggest in Europe where recent years’ significant stress has pushed investments and durable goods consumption to extremely low levels.

Overall, we look for the global recovery to move up a gear next year, while inflation stays low and probably moves even lower in the euro area over the coming quarters.

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