96 THE BiG DROP
high-cost fields to be shut in. That means layoffs and reduced
capital expenditure for pipes, equipment and transportation.
Jobs in the oil field are high-paying jobs. Jobs waiting in a
restaurant are not. If we gain restaurant jobs and lose oil field
jobs, it’s not clear the economy is better off.
That’s the bad news.
From there, things start to get ugly. The price of oil is low
both because demand has slowed down along with slower
global growth and because supply is up due to fracking. But
all of that fracking output costs money to develop, and a lot of
that money was raised in the form of junk bonds. When those
junk bonds were issued, the projects behind them assumed oil
would be priced in a range from $80–130 per barrel.
With oil in the $45–55 per barrel range, those projects are
no longer profitable and that debt will begin to default in late
2015 or early 2016. Who holds that debt? Some of it might be
in your 401(k) buried inside a “high yield” fund sold to you
by your broker. That’s something you might want to take a
look at. Whether it’s owned by you, your neighbor or the bank
across the street, the point is someone owns it and those hold-
ers are looking at a tidal wave of write-offs coming their way.
Finally, we should consider the impact of rapidly falling
oil prices on the Federal Reserve and U.S. monetary policy.
The Fed has a stated policy of achieving 2% inflation. Right
now, inflation is below that target and falling fast. Recent
price indexes have shown outright deflation, the opposite of
what the Fed wants.
When the Fed looks at price data, they focus on “core” in-
flation, which excludes the impact of food and energy prices.
The basis for this is that food and energy prices are highly
volatile and tend to track core inflation over long periods of
time. You can ignore the spikes and dips of energy prices be-
cause they tend to be monthly noise, which evens out over the
course of a year.