What´s next after the reopening of Hormuz? Prof. Steve Keen

[00:00:00]The straight of Hormuz may finally open up soon. That is if the US Iran deal sticks. Yet, provocative professor Steve Keane believes this will not save the global economy from a massive 10% hit to GDP. Today, I was able to discuss with him what's behind his pessimism and why he believes financial markets are way too optimistic even if this deal goes through.

[00:00:27]Professor Keane, first I want to just talk about your yeah pretty confident uh take on 10% drop in GDP as a consequence of the straight of her moose closure. So far so good, right? Like so far the narrative now is it's it's been less intense than expected partially because we've we have this massive AI boom. Now just now today there's the news that Trump Okay, we've been here before but I think markets are fairly optimistic at least right now that the Trump deal we're seeing right now with Iran will stick. Do you think this changes your your calculation or not?

[00:01:02]>> No, because I mean what you're saying fundamentally is there's still plenty of drinking water because there's still water in the dam. Okay, there's water in the dam but it's running down rapidly.

[00:01:11]Those are the current stocks of oil in that sense. We're relying upon the flow being continuously coming into the dam to replenish it. And that's what happened before this closure of the straight of horns that we had small stocks of oil and other essential inputs in most countries in the western world.

[00:01:30]And so when the flow of the straight of homos stopped then we start running down those buffers the dams in effect. Now the question is you know how what's the capacity of the dam compared to the size of the river you're talking if you look at you know I'm using an analogy here obviously but most dams would take a long time to fill with the flow for the from the river so you're actually going to get to the dam being empty you'd need the river to be turned off for a substantial period of time now apply the same thing to the stocks and the flows of oil how long can most western countries survive running down the stocks if there's no flow of water flow flow of oil into the reservoirs. And the answer is most countries that have followed the International Energy Association guidelines have 90 days of stocks and reserve. Now this war, this stupid war that was going to be over in 3 days and is now entering its third month. Well, it's fourth month. I start losing track. That mean that that length of time is enough to run those dams down to zero for a lot of countries. And we're now seeing falling stocks of oil in turning up in most countries because that's how they're coping with the fact that the straight of Hal is no longer flowing. Okay. Now with that, let's say there's a 3mon hole in that in in the the flow of water. So we we cut the river off for 3 months. How much is left in the dam? Uh the answer is zero for most countries. So when that and thing you don't actually see it because you cut the river off again this is using analogies but I hope it makes sense. You cut the river off a few hundred miles from the from the the dam itself. So you've got water flowing into the dam from rain that had fallen previously.

[00:03:10]Well now that cut off for 3 months. If that 3 months hits you while you you you look like you got the flow but suddenly the flow stops because that 3-month period catches up with you. There's nothing coming in. How do you replenish it? You don't. So that's why I'm talking about like of the order of a 10% fall in oil and liquid natural gas coming through that that system. So that is still going to hit us. That's still in the system. And countries are running down their reserves right now. there's dramatically varying lengths of time that various countries can survive. So like for example, the UK and Australia have almost no stocks. So they're ones who are going to be very vulnerable.

[00:03:51]That's why you've seen Australia sending emissaries to try to get countries that rely upon our liquid natural Australia's liquid natural gas to agree to continue providing it with refined petroleum and refined and particularly diesel. That's what scared because something at the order of 30% of the world's diesel passes through that straight. So we're on the edge of seeing the impact of that cut off of supply and it's you know the the month of the months of June and July and August were the time that most people who are looking at this were saying okay we're going to see a crunch in this period and when you to have that much of a fall in your physical supply so you've cut off 10% of the fly of oil more than that of liquid natural gas substantially more than the case of things like fertilizer and sulfuric acid when the stocks we currently have run out then those processes are no longer possible and there's an incredibly tight link most people aren't aware of between the global version of gross domestic product GDP is actually called gross world product GWP and the link between energy and gross world product is ludicrously tight. The conventional economy theory ignores this relationship, but it's fundamentally true that what gross world product fundamentally is is the raw energy we take out of our mines and and and you know from fossil fuels fundamentally that raw energy converted into useful energy for us. So we take coal as potential energy we turn it into light and heat and so on. That's what gives us our standard of living. So when there's a fall in gross world product there's a fall in energy. When there's a fallen image, it's a fallen gross world product. They're almost Simon is twins.

[00:05:23]Pardon the using the expression from being in the country called Siam. But that that means that if there's a 10% fall in in energy supply, there will be a 10% fall in capacity to produce output and I think that's still coming our way.

[00:05:37]>> Okay. Okay. So, this is where you get the the 10% number from and you you use it worldwide. I see. So, one uh if we can stick to the damn analogy. So one thing that's very different in economics in macroeconomics than or in economics in general than with a dam is that if the price is is getting very high then there will be a lot of new water suppliers or oil suppliers in this case potentially coming online right that that's a massive >> I'm sorry I have to jump on bad ideas because they're so prevalent in economics. How long do you think it takes to build an oil refinery? This this this is the thing. We we we've been fooled into having like a a timefree version of economics by drawing supply and demand diagrams and just imagining you can move those two lines around on the piece of paper and that'll describe what's happening in the real world.

[00:06:27]In in other words, it assumes you can if willing to pay a higher price, you can get a higher quantity out of the system.

[00:06:32]Now, if you've destroyed a few facilities like the the biggest ones are the impact upon liquid natural gas but also upon helium. If you destroy those facilities, then you've suddenly cut your capacity by the scale of that destruction. And the length of time it takes to make these devices is is enormous. And I'm again, I'm not an expert in these particular industries.

[00:06:53]I'm going for what I've been told by people who are experts in those industries. So the devices that for example extract helium from predominantly liquid natural gas. So I'm told in the in the Arabic peninsula there were 14 devices which are called trains because they look like train carriages. Two of them have been destroyed. So you had a 1 seventh fall in the capacity of generate helium. Now according to the people I've been informed by on this front there are only five companies on the world that can make those machines and it would take them 5 years. So rather than just think which is over instantly and all you got to do is you know and get the price up a bit and you'll get more helium supplies.

[00:07:30]That's a fiveyear process. Okay. So, you might get there after five years, but you're going to go through five years of probation before you get there.

[00:07:38]>> Yeah. No, that that's for many industries probably partially true. I have read that for oil there there has been more capacity because you always do also have refineries that are maybe just not running at full capacity or can be upgraded or can run a little bit longer uh because they they are postponing maintenance, right? Yeah. But uh the second thing of course is then sure okay even if energy supply cannot be expanded that quickly then the alternatives might kick in very quickly. So for example in Asia they switched to coal for for a very big extent from their natural gas plants right and you could imagine that the over capacity that might be there when it comes to electric vehicles and other EV alternatives in China might find a bigger might quickly catch on in all across the world if oil and energy prices are are high enough. So that's still a big difference with the dam anality, right?

[00:08:38]>> Except that again and it takes time to build dams as well. There is excess capacity. One of the standard things of a of a well-managed corporation, it has excess capacity because excess capacity lets you respond to competitive advantages. When you don't have the excess capacity, you can't respond. So the excess capacity is there. But then of course this is a very complicated supply chain. you if you want to produce oil, okay, you've got to have the right oil coming out. You can't use Venezuelan oil in a refinery designed to handle West Texas crude. They're just totally different products. They don't you don't have the capacity to do the chemical breakdown with one using the other. So, you can't simply swap from one oil input to another. And the thing is where can you can you So, now you've lost the oil coming out of the out of the Persian Gulf. Can and that's that's that's lost.

[00:09:30]Okay, we've got two or three months that that's gone. Okay, can you simply swap that for something coming out of West Texas? The answer again is no, you can't because the refineries are fine-tuned to the particular mixes they take in. They can blend them to some extent. They can change there's some capacity to change ratios. But the America for example exports a large amount of its oil and reimpports it because it doesn't have the production facilities to to process its own oil. It's it's actually again this is area that I'm not an expert in but I'm going from talking people who are and there's a the the they'll use different terms that describe the the the nature of the of the oil they're processing heavy versus light and sweet versus sour etc etc. Their comments about the you know the type of of of polymer chains that the actual oil has whether it's lots of methane which is what we call natural gas or it's you know benzene or other mixtures. So there's different lengths of those carbon based molecules that come up which will give you whether heavy or light and then there's difference amount of sulfur in those and of course the sulfur in the in the Middle East has much the oil in the Middle East has a higher sulfur content apparently than the American one. Therefore refineries are fine tuned for that sulfur. That's where the sulfur sulfuric acid comes out of the Middle East comes from. That's why the Middle East, the region we're talking about is responsible for say roughly 10% of oil exports for roughly 30% of sulfuric acid exports. Okay? So, it's a higher percentage. Well, you can't change that. You can't just substitute that for West Texas to put the West Texas into a refinery rather than Middle Eastern oil. And therefore, you can't get the sulfur dioxide out.

[00:11:08]So, there are many many elements of this. It isn't just the oil. Oil is extremely important. It's the absolutely vital input. Yes, you can replace you can replace using oil for generating generating electric power with using coal for generating electric power, but you can't put coal into your petrol tank. So there are various ways in which we've got a system refined for a particular type of supplies coming through and you simply cannot substitute those. There's there's again the way that conventional economics has got us to think falsely about the nature of a capitalist economy. It basically presumes you can substitute anything with anything else. So they say if you haven't got enough labor, you can replace it with capital. If you haven't got enough capital, you can replace it with energy, etc., etc. They're singing them as as substitutes. Now, in fact, they're compliments. You you can't, you know, you you you can't replace labor with with you can't put workers into your petrol tank, okay? You've got to have petrol to do that. So, they're compliments, and if you don't have one, then you can't produce output from the other. So I think we're still on the edge of a serious decline and uh we can do things to attenuate it. We can have policies that reduce the impact but you can't get away from the fall in the physical supply of both not just energy but critical inputs into production systems primarily in this particular case fertilizer sulfuric acid and helium. You can't replace those uh in any anything like the speed at which economics textbooks fool us into believing these things can be done.

[00:12:34]>> Yeah. But I is the correlation that you speak about with on which you base this 10% drop in GDP prediction isn't that largely about oil oil and gas where you where you have more of this.

[00:12:46]>> No, it's not just about oil and gas. I mean a large part of what I'm saying is the impact of losing things like sulfuric acid. Now I mean unless you're a chemist you last time you saw sulfuric acid was in a school experiment in year 11. Okay. We would most of us aren't conscious of the role of a products like that in the manufacturing process and again roughly speaking 30% of the sulfuric acid the world uses comes out of the Gulf the the Persian Gulf. Now what what sulfuric asset is specifically used for because I I haven't dove into that aspect that much yet most people haven't because it's again we are so divorced from the production processes in which we rely that we might as well going you know when you go shopping you might as well be going to a magic store and buying different forms of magic wands in terms of how much we know about I bought a microwave it heats the food I bought a refrigerator movie it cools the cools the food I don't know how it does it okay I might as well be buying a magic wand in terms of how much knowledge each of us individuals has of the incredibly sophisticated technological devices we take for granted in the modern world. Now for example sulfuric acid yes I had some awareness there but my friends who research material science much more than me have been well and trilling given me a heavy education on the process. One of the simplest things is you can't refine copper without sulfuric acid. Okay. So if you have a 30% fall in sulfuric acid roughly speaking you've got a 30% fall in your capacity to produce copper. Now what are we using copper for right now?

[00:14:12]Data centers, robots. Okay, gold I'm sure turns up there as well. Refining gold. Gold is used for the connectors in and semiconductors and so on. There's an enormous way in which our production system is dependent upon inputs that are that you cannot replace either not only in the short term but even in the medium term. So if you wanted to go from copper that use sulfuric acid to copper that use only hydrochloric acid for example, you've got to redesign entire factories.

[00:14:39]So it's more the dam the damage that we're doing by slashing out something which is used throughout the manufacturing cycle which chemists would be aware of if they work in those businesses and people running those companies are aware of. The vast majority are completely dumb about it.

[00:14:54]So we're going to find out the hard way.

[00:14:55]>> Do you do you think or do you know if these the markets for these things that you're most worried about like helium sulfuric acid do they already reflect this this reality? Because >> no. Okay. No, no, >> let's let's I'm going to give you an opening to bash economics a little bit more because I'm just going to >> going to follow the economic logic here a little bit because financial markets are full of various are forward-looking should be forward looking that is there's lots of traders they're very smart people probably you think so as well >> they are trading on the on a lot of knowledge and that should all be reflected in the price so so far when it comes to oil traders. Well, if the deal does go through today, then traders have been fairly smart. They've priced oil quite a lot higher, but not as high as, for example, experts from the Energy Institute in the US predicted because they predicted the deal that we've seen today. Sure, we don't know if it will hold that. Absolutely. I'll concede that. But let's if we go to these rare elements or they're not rare earth elements, but sulfuric acid, helium, etc. Why do you think this is not reflected then in financial markets where they are trading for expectations of the future? So they could make a lot of money.

[00:16:15]>> You gave it away when you said these markets are forwardlooking. Okay. Now this is the myth. Okay. It's a total absolute myth that conventional economics has taught us. This is what's called the capital asset pricing model and it tells us that markets are forwardlooking. They take they price into they take into account future shocks yada yada yada. If you look at where that theory came from, I'm going to give you a quote from the paper that gave us that which is a paper called let's see looking at its title here capital asset prices a theory of market equilibrium under conditions of risk that was written in 1964 and that's the foundation of the efficient markets hypothesis. Now in the person who put that paper together what he did was a model of an individual okay individual person trading and combining risky assets with a risk-free asset to work out the point that maximize their return giving their preferences for risk. So he had a theory of a single person. Then what he wanted a theory of the entire market. So how did he handle that? This is a quote. In order to derive conditions for equilibrium in the capital market, we invoke two assumptions. First, we assume a common pure rate of interest with all investors able to borrow all funds on equal terms.

[00:17:18]Secondly, we assume homogeneity investor expectations. Investors are assumed to agree on the prospects of various investments.

[00:17:25]>> Mhm.

[00:17:26]>> That sound realistic to you?

[00:17:28]>> No, it doesn't. But >> it's garbage. Okay. It's garbage. He finally says, "Needless to say, these are highly restrictive and undoubtedly unrealistic assumptions." Well, empirical research has proven that's the case over time, and the people who developed them push the theory the most have now said you shouldn't use CAPM.

[00:17:43]And the reason is it isn't just that that it assumes that, you know, people share expectations. It also assumes those expectations are correct. Now, you won't find this in textbooks. You won't find it in newspapers and so on. you've got to get into what I do, which is dive in and read the the the economic literature. Now, when this theory was assessed, and again, you still you're channeling it by saying they're forwardlooking, which is how the economists will describe what they claim people in the finance markets are doing.

[00:18:11]>> Now, this this paper 2004 by Fammer in French said the empirical record of the CAPM is poor. Poor enough to invalidate the way it's used in applications. Now, one reason why is it invalid. He said, "Well, the first assumption that was made is complete agreement on market clearing prices." He puts it in a jargonistic way, but they say what they fundamentally say is we assumed that not only did we assume that expects had investors had the same expectations, we assumed they're correct. We assume investors can predict the future. Now, if we lived on a planet where that was true, the finance markets will reflect what's going to happen. They can't predict the future. And I've had a few run-ins with people in the finance sector now talking about this. Not one of them is aware of the physical the role of physical inputs like oil and sulf sulfuric acid and helium in production systems. So what they're actually doing is they're guessing what other speculators are going to guess.

[00:19:02]It's the feedback of uncertain expectations and speculation and lack of knowledge. That's what gives the current value of those assets on those markets.

[00:19:11]So markets underreact initially to bad news and then overreact on the other side. And I think we're still in the middle of the underreaction phase.

[00:19:19]>> Yeah. No, look, I think the under and overreaction way of looking at markets, I can totally see that logic and I I just want to push back a little bit, but I I don't think saying look, I I think markets are forward-looking and and doing that from a practical uh perspective. saying look I think there's lots of smart people trading on the future and together their expectations form the current market price and sometimes though they know something that maybe you know we don't know as non-experts or people just talking to experts that know nothing about trading on on that specifically I I don't think I think that position can can be fine with saying well I I don't believe in the CAPM model specifically and I think the mathematical assumptions there specifically make no sense like look I I've never in my life uh I don't think the cap model is useful and yet I can take the position that I think markets are fairly are sometimes forward-looking but on imperfect information. Well, and again, this is all framing with this.

[00:20:20]The extent to which you're talking like a neocclassical economist, and I know you're not one, is remarkable.

[00:20:25]Forward-looking markets, you know, uh rational expectations, etc., etc. It's all myths, and we you're going to get a fairly heavy education in that front as to why it is. Kanes was a real speculator. He actually was as well as being a noted economist, he also speculated on commodity markets. and he described himself as a speculator who lost two fortunes and made three. Best way I come to come out. He said that markets are not concerned with long-term forecasting but was speculating what average opinion expects average opinion to be a short time ahead of average opinion actually waking up. So rather than speculators looking at what they think is going to be the long-term impact of something like the straight of horos closure, they're looking at what other speculators are putting up as their guesses about it. and they're all completely devoid of the actual physical syndrome they're talking about. It's one bunch of speculators gambling while another bunch of speculators think the the overall market is going to do.

[00:21:22]That's what gives the short-term price dynamics. So there's no way that I see what this market's currently put forward as being based on a rational calculation of the impact of losing the goods and services flowing through the straight of horns. It's more that there's the the the moment the markets the general mood on the markets is to think this is all going to be solved. Uh and they're pricing it that way and none of them have a clue what's going to happen when there's no sulfur dioxide turning up at at ports in America and ports in in Europe.

[00:21:51]>> Okay. Fair fair enough. I think that's a very clear answer. Look uh before we get in get back to depth the depth situation.

[00:21:58]>> Yeah. I just want to ask one more thing about your 10% GDP global contraction uh prediction because it's so interesting.

[00:22:07]You also mentioned look like oil is still a major factor right and you mentioned it's very important to keep into keep in mind that there's different grades of sour and sweet etc etc and I did look into that and look Europe depends on American oil very light oil the the shell oil US depends on very heavy sour uh Latin American oil so that that that jives with what you said about them import still needing to import oil and then it's mostly Asia exposed to Middle Eastern medium uh crude I think right so if you say look there's this 10% link between GDP and and energy overall so hence maybe a big recession 10% could that that could on average be true but could could it then be it's actually going to be a massive depression in Asia but Europe and the US are going to be relatively fine >> yeah that's those sorts of outcomes are feasible and on that same front in terms of the stocks of available oil it Looks like China has set itself up well and surely to survive crisis like this because again going from my colleagues in these areas they tell me that China has stocks of up to one and a half years of supplies of various commodities of this nature including grain as it happens. So if there's a like we know there's something like a 30% fall in fertilizer availability. Well, China apparently has stocks of fertilizer that can last almost of the order of a year rather than a month. So China is not going to be hit by this. But Thailand, where I am right now, relies heavily upon diesel and petrol. Now, if they suddenly, not suddenly, if they if when when the supply shock hits in terms of the the there are still ships turning up with oil, you know, it's getting to the critical point now, but while the war was going on, there were still ships on the other side of the state of Hums that were still sailing to their destinations. So, they've been turning up and they've been replenishing all these stocks for that length of time.

[00:24:01]But now we know there's you know this two or three month hole in that supply chain that is now going to come and bite. And at that point you will find that countries like Thailand, Indonesia perhaps they've got their own oil to some extent but a a range of countries are not going to have the oil input.

[00:24:16]They're not going to have the fertilizer input they need at that point in time.

[00:24:19]So you got to have policy changes to try to cope with that as best you can. I expect to see petrol rationing and diesel rationing becoming part of what happens when this hole hits. And there's the beginnings of movements in that direction by a number of countries as well. So you can modify your behavior to some extent be less wasteful. But I still think it's going to have uh you know the average effect over the entire planet is going to be something of the order of 10%. I hope it's less okay if it it doesn't even need to be that big to have other effects which are catastrophic. So if you find that you don't get the fertilizer when you need it for a growing season and again there are time issues there. So the the current growing seasons whether there's two or four per year in different crops probably will be covered by current stocks. But if you go one or two growing periods further forward then you're not going to have you know for a while 30% of the fertilizer you need and that is going to have a dramatic impact upon food production. So all these things are you know I I don't want to think that the last thing we should be doing is playing these things down. Okay. Because humans do have a tendency to underreact to serious channels challenges. you underreact and then you overreact on the other side of the finance markets do it.

[00:25:30]We all tend to do it. But if we say we can do this and we can do that and you don't actually do it, it's all hypotheticals. Then when it hits, you're really in trouble.

[00:25:37]>> Yeah. Yeah. And and I think it's important that you mention the timing because it could be that the the fuel crisis gets significantly worse especially in Asia fairly soon as stocks are depleted.

[00:25:49]>> But as you mentioned the fertilizer crisis like crops growing seasons that that may take half a year, a year or something, right? So it could be that we get a sort of a two sprung crisis where we first have a few crisis in Asia and then we get the food crisis only after a year or something like that right >> after the length of time. Yeah. The growing season and how long fertilizers are currently stocked up for and so on.

[00:26:09]Yeah. And like some of the again the usual fear is that it's country like India which will cop that collapse because u you know such an agricultural society you need the fertilizer for the for the growing cycles so called green revolution. In fact, the green revolution was a brown revolution that it has increased dramatically increased food consumption by using oil based fertilizers. So, we're actually eating oil in that sense. But if you you could see, you know, depending on the time at which it happens, you could have a 20 or 30% fall in capacity to produce food.

[00:26:39]Now, we have roughly speaking, we waste about 1/3 of the field where you create anyway. So there's a potential for efficiency gains and less waste to avoid the severity, but it's still substantial and it still requires major policy changes to make it possible to get through that. So again, I can't say where the famines would be, but for example, one country which could cop a serious shock from the lack of availability food is in fact the United Kingdom because that country imports at least 40% of its food. And when you look at how the packaging is done, they can claim stuff as UK based made if it includes some UK ingredients. I've seen claims as high as 70% of the food has to be imported. Now, if you don't if the food's not being made and you get a fall in the availability, then England is going to be scrambling to find food supplies. And of course, if that all pass through to the prices, workers won't be able to afford, you know, going shopping will bankrupt you. So we have all these potential disturbances on our doorstep and about to hit in the next one to one one to 3 months. And again it's a surprise to most people because we just don't have awareness of how the production system works and in the particular case of fertilizer the extent to which we rely upon petroleum based fertilizers to feed the planet.

[00:27:54]Basically we don't realize the extent to which we're dependent upon these products. Okay, there's you might not know an old old Journey Mitchell song, but it's called Yellow Taxi and it's got a line, you don't know what you got till it's gone.

[00:28:06]>> Okay, now in this case with most people are unaware that we need fertilizer to produce food on the scale that we do.

[00:28:13]So, you're only going to find out that it matters when it's no longer there.

[00:28:16]Now, this is again something that is not my area of expertise, but again, dealing with people in agricultural economics and so on. uh they'll tell me that if we didn't have the the processes that take take f take oil as an input and produce fertilizers as an output whether that's nitrogenous fertilizers or phosphate fertilizers we didn't have them the carrying capacity of the planet is not the currently population of 8 1.5 billion roughly it's 2 billion so if we lost f okay if we lost fertilizer the completely 100% low that's it 6 billion people are going to starve okay that's the absolute extreme now we're losing 30% % Well, that gives you an implication that maybe a 30% and it's not linear. It's more than the 30% fall in food availability would cause more than the 30% fall. Sorry, a 30% fall in fertilizer availability could cause more than 30% fall in most countries. There are some countries which over supply fertilizers though you know again these things are they have nuances to them.

[00:29:13]But the basic point is we've sustained the population we have on this planet by using petroleum not just in terms of transportation but also fertilizer for food. So we're not aware of it and suddenly bang it's not there anymore. Oh god what's going to happen? Well the answer is we lose that capacity to feed that many people. So we're learning about the fragility of our global system through this ridiculous war. And that's what scares me that people who had no awareness of it at all to begin with are the ones making the decisions about whether we have the war in the first place, which is crazy. But also, what are the going to be? How do we react to that war? And we we don't have the the knowledge to guide us in those reactions. So, we're going to find out the hard way again.

[00:29:55]>> Yeah, I think that's actually a perfect way to end end our conversation.

[00:29:59]Professor Steve Keen, thank you so much for joining this discussion of >> Thank you. Time.