Our Investment Sinkhole Problem
Off the keyboard of Gail Tverberg
Published on Our Finite World on February 8, 2013
Discuss this article at the Epicurean Delights Smorgasbord inside the Diner
We are used to expecting that more investment will yield more output, but in the real world, things don’t always work out that way.
Figure 1. Comparison of 2005 to 2011 percent change in real GDP vs percent change in oil consumption, both on a per capita basis. (GDP per capita on a PPP basis from World Bank, oil consumption from BP’s 2012 Statistical Review of World Energy.)In Figure 1, we see that for several groupings, the increase (or decrease) in oil consumption tends to correlate with the increase (or decrease) in GDP. The usual pattern is that GDP growth is a little greater than oil consumption growth. This happens because of changes of various sorts: (a) Increasing substitution of other energy sources for oil, (b) Increased efficiency in using oil, and (c) A changing GDP mix away from producing goods, and toward producing services, leading to a proportionately lower need for oil and other energy products.
The situation is strikingly different for Saudi Arabia, however. A huge increase in oil consumption (Figure 1), and in fact in total energy consumption (Figure 2, below), does not seem to result in a corresponding rise in GDP.
Figure 2. Total primary energy consumed per capita, based on BP’s 2012 Statistical Review of World Energy data and population data from EIA.At least part of problem is that Saudi Arabia is reaching limits of various types. One of them is inadequate water for a rising population. Adding desalination plants adds huge costs and huge energy usage, but does not increase the standards of living of citizens. Instead, adding desalination plants simply allows the country to pump less water from its depleting aquifers.
To some extent, the same situation occurs in oil and gas fields. Expensive investment is required, but it is doubtful that there is an increase in capacity that is proportional to its cost. To a significant extent, new investment simply offsets a decline in production elsewhere, so maintains the status quo. It is expensive, but adds little to what gets measured as GDP.
The world outside of Saudi Arabia is now running into an investment sinkhole issue as well. This takes several forms: water limits that require deeper wells or desalination plants; oil and gas limits that require more expensive forms of extraction; and pollution limits requiring expensive adjustments to automobiles or to power plants.
These higher investment costs lead to higher end product costs of goods using these resources. These higher costs eventually transfer to other products that most of us consider essential: food because it uses much oil in growing and transport; electricity because it is associated with pollution controls; and metals for basic manufacturing, because they also use oil in extraction and transport.
Ultimately, these investment sinkholes seem likely to cause huge problems. In some sense, they mean the economy is becoming less efficient, rather than more efficient. From an investment point of view, they can expect to crowd out other types of investment. From a consumer’s point of view, they lead to a rising cost of essential products that can be expected to squeeze out other purchases.
Why Investment Sinkholes Go Unrecognized
From the point of view of an individual investor, all that matters is whether he will get an adequate return on the investment he makes. If a city government decides to install a desalination plant, the investor’s primary concern is that someone (the government or those buying water) will pay enough money that he can make an adequate return on his investment over time. Citizens clearly need water. The only question is whether citizens can afford the desalinated water from their discretionary income. Obviously, if citizens spend more on desalinated water, the amount of discretionary income available for other goods will be reduced.
The same issue arises with pollution control equipment installed by a utility, or by an auto maker. The need for pollution control equipment arises because of limits we are reaching–too many people in too small a space, and too many waste products for the environment to handle. The utility or auto makers adds what is mandated, since clearly, buyers of electricity or of an automobile will recognize the need for clean air, and will be willing to use some of their discretionary income for pollution control equipment. Mandated renewable energy requirements are another way that governments attempt to compensate for limits we are reaching. These, too, tend to impose higher costs, and indirectly reduce consumers’ discretionary income.
All types of mineral extraction, but particularly oil, eventually reach the situation where it takes an increasing amount of investment (money, energy products, and often water) to extract a given amount of resource. This situation arises because companies extract the cheapest to extract resources first, and move on to the more expensive to extract resources later. As consumers, we recognize the situation through rising commodity prices. There is generally a real issue behind the rising prices–not enough resource available in readily accessible locations, so we need to dig deeper, or apply more “high tech” solutions. These high tech solutions indirectly require more investment and more energy, as well.
While we don’t stop to think about what is happening, the reality is that increasingly less oil (or other product such as natural gas, coal, gold, or copper) is being produced, for the same investment dollar. As long as the price of the product keeps rising sufficiently to cover the higher cost of extraction, the investor is happy, even if the cost of the resource is becoming unbearably high for consumers.
The catch with energy products is that consumers really need the products extracted–the oil to grow the food they eat and for commuting, for example. We also know that in general, energy of some sort is required to manufacture every kind of product that is made, and is needed to enable nearly every kind of service. Oil is the most portable of the world’s energy sources, and because of this, is used in powering most types of vehicles and much portable equipment. It is also used as a raw material in many products. As a result, limits on oil supply are likely to have an adverse impact on the economy as a whole, and on economic growth.
The Oil and Gas Part of the Problem
A major issue today is that oil supply is already constrained–it is not rising very quickly on a world basis, no matter how much investment is made (Figure 3).
Figure 3. World oil supply with exponential trend lines fitted by author. Oil consumption data from BP 2012 Statistical Review of World Energy.As noted above, the easy-to-extract oil and gas was extracted first. New development is increasingly occurring in expensive-to-extract locations, such as deep water, Canadian oil sands, arctic oil, and “tight oil” that requires fracking to extract. This oil requires more energy to produce, and more inputs of other sorts, such as water for fracking. Because of rising costs, the price of oil has tripled in the last 10 years.
Investment costs also continue to soar because of rising costs associated with exploration and production. Worldwide, oil and gas exploration and production spending increased by 19% in 2011 and 11% in 2012, according to Barclays Capital. Such spending produced only a modest increase in output–about 0.1% increase in crude oil production in 2011, and 2.2% increase in the first 10 months of 2012, based on EIA data. Natural gas production increased by 3.1% in 2011, according to BP. Estimates for 2012 are not yet available.
If we want to “grow” oil and gas production at all, businesses will need to keep investing increasing amounts of money (and energy) into oil and gas extraction. For this to happen, prices paid by consumers for oil and gas will need to continue to rise. In the US, there is a particular problem, because the selling price of natural gas is now far below what it costs shale gas producers to produce it–a price estimated to be $8 by Steve Kopits of Douglas Westwood. The Henry Hub spot natural gas price is now only $3.38.
The question now is whether oil and gas investment will keep rising fast enough to keep production rising. Barclays is forecasting only a 7% increase in worldwide oil and gas investment in 2013. According to the forecast, virtually none of the investment growth will come from North America, apparently because oil and gas prices are not currently high enough to justify the high-priced projects needed. The flat investment forecast by Barclays suggests a major disconnect between what the IEA is saying–that North America is on its way to becoming an energy exporter–and the actual actions of oil and gas companies based on current price levels. Of course, if oil and gas prices would go higher, more investment might be made–a point I made when writing about the IEA analysis.
What will the ultimate impact be on the economy?
I would argue that for most of the developed (OECD) countries, the ultimate impact will be a long-term contraction of the economy, similar to that illustrated in Scenario 2 of Figure 4.
Figure 4. Two views of future economic growth.What happens is that as we increasingly reach limits, more and more investment capital (and physical use of oil) is allocated toward the investment sinkholes. This has a double effect:
(1) The prices paid for resources that are subject in investment sinkholes need to continue to rise, in order to continue to attract enough investment capital. This is true both for goods that directly come from investment sinkholes (oil, gas and water) and from products that have a less direct connection, but depend on rising-cost inputs (such as food and electricity).
(2) Products outside of essential goods and services will increasingly be starved of investment capital and physical resources. This happens partly because of the greater investment needs in the sinkhole areas. Also, as consumers pay increasing amounts for essential goods and service because of (1), they cut back on the purchase of discretionary items, reducing demand for non-essentials.
In some real sense, because of the sinkhole investment phenomenon, we are getting less and less back for every dollar invested (and every barrel of oil invested). This phenomenon as applied to energy resources is sometimes referred to as declining Energy Return on Energy Invested.
As discussed above, world oil supply in recent years is quite close to flat (Figure 3). The flat supply of oil is further reduced by the additional oil investment required by sinkhole projects, such as the ones Saudi Arabia is undertaking. Also, there is a tendency for the developing world to attract a disproportionate share of the oil supply that is available, because they can leverage its use to a greater extent. Both of these phenomena lead to a shrinking oil supply for OECD countries.
The combination of shrinking OECD oil supply, together with the need for oil for many functions necessary for economic growth, leads to a tendency for the economies of OECD nations to shrink. It is hard to see an end to this shrinkage, because there really is no end to the limits we are reaching. No one has invented a substitute for water, or for unpolluted air. People talk about inventing a substitute for oil, but biofuels and intermittent electricity are very poor substitutes. Often substitutes have even higher costs, adding to the investment sinkhole problem, rather than solving it.
Where we are now
When resource prices rise, the impact is felt almost immediately. Salaries don’t rise at the same time oil prices rise, so consumers have to cut back on some purchases of discretionary goods and services. The initial impact is layoffs in discretionary sectors of the economy. Within a few years, however, the layoff problems are transformed into central government debt problems. This happens because governments need to pay benefits to laid-off workers at the same time they are collecting less in taxes.
The most recent time we experienced the full impact of rising commodity prices was in 2008-2009, but we are not yet over these problems. The US government now has a severe debt problem. As the government attempts to extricate itself from the high level of debt it has gotten itself into, citizens are again likely to see their budgets squeezed because of higher taxes, lay-offs of government workers, and reduced government benefits. As a result, consumers will have less to spend on discretionary goods and service. Layoffs will occur in discretionary sectors of the economy, eventually leading to more recession.
Over time, we can expect the investment sinkhole problem to get worse. In time, the impact is likely to look like long-term contraction, as illustrated in Scenario 2 of Figure 4.
Is there an End to the Contraction?
It is hard to see a favorable outcome to the continued contraction. Our current financial system depends on long-term growth. The impact on it is likely to be huge stress on the financial system and a large number of debt defaults. It is even possible we will see a collapse of the financial system, or of some governments.
In a way, what we are talking about is the Limits to Growth problem modeled in the 1972 book by that name. It is the fact that we are reaching limits in many ways simultaneously that is causing our problem. There are theoretical ways around individual limits, but putting them together makes the cost impossibly high for the consumer, and places huge financial stress on governments.
How High Oil Prices Lead to Recession
Off the keyboard of Gail Tverberg
Published on Our Finite World on January 24, 2013
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There is ample evidence that spikes in oil prices leads to recession, at least in the US, which is an oil-importing nation. James Hamilton has shown that 10 out of the last 11 US recessions were associated with oil price spikes. How does this happen? An analogy can perhaps help explain the situation. This analogy also sheds light on a number of related economic mysteries:
- How can oil have a far greater impact on the world economy than its share of the world GDP would suggest? After all, BP’s World Energy Outlook to 2030 shows the world cost of oil is only a little over 4% of world GDP.
- How can high oil prices continue to act as a “drag” on the economy, long after the initial spike is past?
- Why isn’t a service economy insulated from the problems of high oil prices? After all, its energy use is relatively low.
The Oil Analogy
An oil product, such as jet fuel, is in some ways analogous to a specialized employee, with skills different from what human employees have. Let’s think of an airline. It has human employees–pilots, copilots, flight attendants, baggage workers, mechanics, and airport check-in personnel. None of these human employees can actually provide the energy to make the jet fly, however. It takes jet fuel to do that.
What happens if the price of jet fuel triples? Jet fuel is now more that than triple the price (near $3.00 gallon) it was in the late 1990s (under $1.00 gallon, at today’s prices).
Figure 1. Jet fuel price in December 2012 $. Jet fuel price per gallon is Spot Gulf Coast price from EIA; price adjustment based on CPI-Urban, from US Bureau of Labor Statistics.The high cost of jet fuel is analogous to the jet fuel employees’ union demanding triple the wages they were paid previously. So what is the airline to do? With very high aviation fuel prices, many tourists who might buy airline tickets will be “priced out” of the market for long distance travel. The airline can sell some airline tickets at higher prices, but not as many.
One thing airlines can do is to cut the number of flights, taking the least fuel-efficient planes out of service and reducing flights on routes with the most unfilled seats. According to a recent Wall Street Journal article, airlines spend 34% of revenue on fuel. With such a high fuel cost, even with these changes, airline ticket prices will remain high. But perhaps with fewer flights, the airline can make a profit.
If an airline cuts its number of flight, this leads to an “across the board” cut in the goods and services the airline buys. The airline will use less jet fuel (and thus use fewer “jet fuel employees”). If it is able to retire quite a few fuel-inefficient jets, “jet fuel employees” will be cut to a greater extent than human employees. It will use fewer human workers, at all levels: pilots, copilots, flight attendants, and ground workers of all types. The airline will reduce its electricity usage because it needs fewer gates in airports for its operations. The airline will also need less gasoline because it will operate fewer baggage-transport vehicles and other ground vehicles.
In many ways, the airline is simply shrinking in size to reflect reduced demand for its high-priced services. When this happens in multiple industries, the result looks very much like recession. I described this situation earlier in a post called How is an oil shortage like a missing cup of flour?. In that post, I said that if oil supplies are short, the situation is not too different from a baker who does not have enough flour to make a full batch of cookies. If he still wants to make cookies, he needs to make a smaller batch, and so needs to cut back on all of the other ingredients as well.
Other Changes an Airline Can Make to Fix Profitability
Apart from cutting back on the number of flights and retiring inefficient jets in the process, there are other things an airline can do to offset the higher “wages” demanded by the jet fuel employees union. One is to reduce the wages of human workers. For example, wages and pension plans of pilots can be cut back, or hours lengthened. Wages of other workers can be frozen or cut back.
Another approach is a merger with another airline, so that “redundant” employees can be eliminated, and flights can perhaps be cut back further. Of course, these layoffs and cutbacks in wages will add to recessionary impacts, because these workers will have less discretionary income.
A third approach to restoring profitability is to automate some of the functions previously handled by human employees. In this case, electricity is used to substitute for human workers. We can think of this automation as substituting new “electrical employees” (analogous to the “jet fuel employees”) for human employees. Relative to the amount of physical work (pushing buttons, moving luggage, etc.) humans can do, humans are far higher paid than either “oil employees” or “electricity employees”. If we assume that the energy of humans is similar to that used by a 100 watt light bulb, at $20,000 a year, humans are paid roughly 1,500 times as much as “oil employees” and 3,500 times as much as “electricity” employees, to do equivalent physical work. So if automation is an option, it almost always saves money.
A fourth way an airline can reduce costs is by purchasing lighter, more fuel-efficient jets. Making a transition of this type takes a long time. Boeing’s Dreamliner 787 is an attempt in this direction, with a 20% fuel savings anticipated. Boeing has over 800 jets of this type on order, but the 50 already in use have been grounded until battery problems are resolved. Quite a few changes have been made in the new jet, so there is a possibility of additional problems also needing to be ironed out, before production ramps up as planned.
Another Example: Asphalt
Asphalt is another product whose consumption has dropped in recent years.
Figure 2. Trends in US Fuel Consumption by Type, with 1994 = 1.0, based on EIA data.The amount of asphalt produced in 2012 was only about 70% as much as was produced in 1994. The reason for the shortfall in asphalt is partly because at current high oil prices, refineries can make more profit by selling high-valued products like gasoline, diesel, and jet fuel than they can make by selling asphalt. A recent EIA article titled, Hydrocracking is an important source of diesel and jet fuel, makes the statement, “A refinery’s ability to upgrade low-value products into high-value products and convert high-sulfur material to low-sulfur material with a secondary unit like a hydrocracker plays a key role in determining its economic fate.”
State budgets are tight for a variety of reasons, including inadequate gasoline taxes to cover the cost of maintaining roads. While part of the need for asphalt can be obtained from recycling, many governments are finding that today’s asphalt costs are so high that concrete roads would be cheaper in the long run. Many states have found it necessary to go back to gravel on some of the smaller roads, because of the high cost of paving today. State and local budgets are likely to be stretched even farther if the US government solves its budget woes by sending programs back to the states, and lets the states work out the funding.
What happens when a state decides move some roads from asphalt back to gravel? For one thing, jobs lost in the road paving business. Also, the new gravel roads have an uneven surface, providing more rolling resistance, so automobile and truck mileage is poorer. In addition, roads tend to degrade more quickly, keeping long-term maintenance costs high. If budgets are tight and roads are not maintained, there is a chance gravel roads will become unusable.
If local governments continue to use asphalt for paving (or switch to concrete, which has even higher initial costs, but lasts longer), they find a need to cut back on other types of services they provide, if they are to avoid a tax increase. This leads to services such as library hours being cut. Cutting back on services reduces both wages and energy costs (lighting and heating/cooling costs). The effect is not all that different from what happens in the airline industry: cuts are made that affect both wages and energy usage of many types. Employee wages seem to be especially affected because changes in employee hours can be made more easily than, say, closing a building or running fewer school buses.
The More General Problem
It is not just airlines and users of asphalt that cut back because of high oil prices. The story plays out in different ways in many industries. Clearly any restaurant is at risk if high oil prices cause consumers to cut back on discretionary purchases, because reducing the frequency of eating out is an easy way of reducing discretionary expenditures. If restaurants have fewer customers, some restaurants will close and are not replaced. This is the restaurant industry’s way of “making a smaller batch”. The result is fewer jobs, less oil use, and less use of resources in general.
Another type of discretionary purchase that gets cut when oil prices are high is the purchase of a new car. A recent article by the New York Times says that the recovery of auto sales since the recent recession has been very slow, with charts for several countries. Reduced car sales is yet another example of making a “smaller batch.” The result is fewer jobs, less use of oil, and less use of many other types of resources.
A similar story can be told about new home sales. These dropped in the recent recession, and have been slow to recover. The drop-off is frequently attributed to the housing bubble bursting, but rising oil prices played an important role as well. When oil prices increased in the 2004-2005 period, the Federal Reserve raised interest rates, trying to cut oil prices. Instead, the higher interest rates together with lower discretionary income from high oil prices led to lower housing prices, starting in 2006. (See my article from the journal Energy, here or here.)
The Economic Implications of High Oil Prices
Our economy is all about “adding value”. But where does this value added come from? To a significant extent, this value comes from adding external energy of some sort. It is really the “energy employees” I mentioned earlier that add this value. Human workers are needed as well, but with automation, the number of human workers required tends to decline.
The ability of external energy to add value is what causes the link between GDP, energy consumption, and oil consumption. Oil plays a special role, because it is easily transported, and can be used in many situation where electricity or some other form of energy (such as human energy, wind energy, or natural gas) would not work.
If we look at a graph of changes GDP compared to changes in world oil and energy usage, (Figure 3, below), we see that all three tend to rise and fall together. In fact, changes in oil and energy usage appear to slightly precede GDP changes. This is the pattern we would expect, if economics are causing a “smaller batch” to be made when oil prices are high.
Figure 3. World growth in energy use, oil use, and GDP (three-year averages). Oil and energy use based on BP’s 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.Part of this change may simply reflect a transfer of energy use from less efficient industries (ones using more high-priced oil in their fuel mix) to more efficient industries (ones using less high-priced oil in their fuel mix). If could also reflect a shift in oil and energy distribution to more less efficient countries (ones using more high-priced oil in their fuel mix) to more efficient countries (ones using less high-priced oil in their fuel mix). For example, Greece (which specializes in vacation tourism, and which uses much oil in its energy mix) would be expected to be an oil/energy loser (Figure 4, below).
Figure 4. Greece’s growth in energy use, oil use, and GDP (three-year averages). Oil and energy use based on BP’s 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.China (which uses much coal in its energy mix and thus keeps costs low, and specializes in inexpensive manufacturing) would be expected to be an oil/energy gainer (Figure 5, below). See my posts, Energy Leveraging: An Explanation for China’s Success and the World’s Unemployment and Why Coal Consumption Keeps Rising, for discussion of this issue.
Figure 5. China’s growth in energy use, oil use, and GDP (three-year averages). Oil and energy use based on BP’s 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.High prices work together with a number of other factors (including increased automation and increased competition from countries with lower wages) to force wages of humans down, and to reduce the number with jobs. The proportion of US citizens with jobs started declining about the year 2000 and accelerated with the recent recession:
Figure 6. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census. 2012 is partial year estimate.If we look at the ratio of wages (broadly defined, including proprietors’ income and taxes paid on behalf of employees by employers, but not including transfer payments, such as Social Security payments and Unemployment Insurance) to GDP in Figure 7, below, we see that the ratio of wages to GDP has been dropping since 2000–another indication that human wages are not keeping up with the rest of the economy.
Figure 7. Wage Base (defined as the sum of “Wage and Salary Disbursements” plus “Employer Contributions for Social Insurance” plus “Proprietors’ Income” from Table 2.1. Personal Income and its Distribution) as Percentage of GDP, based on US Bureau of Economic Analysis data. *2012 amounts estimated based on part-year data.If “Energy Employees” Are Really Doing Most of the Work
If it is really the “energy employees” doing most of the work, then the models used by many economists today are not really correct, and some of the standard beliefs based on these model aren’t right either. For example:
1. The idea that the value of oil or other energy to the economy is proportional to its price doesn’t hold. This can be seen from the examples provided. In fact, if oil or another needed energy product is removed, very close to no work gets done. Humans can provide a little energy, but compared to the energy of oil or electricity, our efforts are puny, and very high-priced. Without external energy, humans’ efforts are limited to tasks like digging with a stick in the ground, or making baskets with reeds that they have gathered.
2. One type of energy doesn’t necessarily substitute easily for another type of energy. Just as one type of employee (mechanic, airline pilot, or flight attendant) can’t necessarily be substituted for another, one type of energy cannot necessarily be substituted for another. Dreamliner’s battery problems illustrate that even trying to substitute a little more electrical energy for oil energy can provide a technological challenge.
3. Somewhat surprisingly, high oil prices remain a drag on the economy permanently, because the high wages of the “oil employees” remain. Output isn’t any higher with these higher wages, so there is not a proportional benefit to society from these higher oil wages. More human workers may be hired in the oil extraction process (often in another country). But even if more workers are hired in the same country, their output does not replace the entirely different kind of output that is provided by the (now-unaffordable to many) high-priced oil.
Another factor in the slow uptake of high oil prices is the fact that governments can temporarily hide some of the effects of high-priced oil through unemployment benefits and stimulus programs. This temporary cover-up cannot continue for long, though, because governments (such as the US and other oil importers) soon run into problems with high deficits (as is happening now). When governments raise taxes or reduce benefits to solve their financial problems, the deferred high-priced oil problems return, showing that the problem never really left.
4. An economy which is mostly services, is not insulated from the problem of high oil prices. Both the airline and asphalt examples illustrate how high oil costs can circulate through the economy and disrupt discretionary spending, even in the US. (Also see Ten Reasons Why High Oil Prices are a Problem.)
Services tend to be the “fluff” of society because for the most part, because we could live without them, at least temporarily. For now, we have a temporary respite from oil-price impacts because of high deficit spending by governments. If governments are forced to balance their budgets, cutbacks seem likely in many areas of services, including medicine for the elderly, higher education, and government-sponsored research programs. If cutbacks occur in areas such as these, we can expect that GDP will shrink faster than savings in oil and energy use–a reversal of what has happened in the past, and a reversal of what many economists have come to expect in the future.
Also, contrary to popular belief, we cannot increase the economy very much by simply selling services that do not require energy to one another. It really takes “energy employees” to play their role as well. Without external energy, we can dig in each others’ back yards with sticks, but this activity doesn’t add much to the economy. We need “energy employees” playing their role as well, if we are to have computers, and metal scissors, and the many other tools we expect, even in a service economy.
Ten Reasons Why High Oil Prices are a Problem
Off the keyboard of Gail Tverberg
Published on Our Finite World on January 17, 2013
Discuss this article at the Epicurean Delights Smorgasbord inside the Diner
A person might think from looking at news reports that our oil problems are gone, but oil prices are still high.
Figure 1. US crude oil prices (based on average prices paid by US refiners for all grades of oil based on EIA data) converted to 2012$ using CPI-Urban data from the US Bureau of Labor Statistics.In fact, the new “tight oil” sources of oil which are supposed to grow in supply are still expensive to extract. If we expect to have more tight oil and more oil from other unconventional sources, we need to expect to continue to have high oil prices. The new oil may help supply somewhat, but the high cost of extraction is not likely to go away.
Why are high oil prices a problem?
1. It is not just oil prices that rise. The cost of food rises as well, partly because oil is used in many ways in growing and transporting food and partly because of the competition from biofuels for land, sending land prices up. The cost of shipping goods of all types rises, since oil is used in nearly all methods of transports. The cost of materials that are made from oil, such as asphalt and chemical products, also rises.
If the cost of oil rises, it tends to raise the cost of other fossil fuels. The cost of natural gas extraction tends to rises, since oil is used in natural gas drilling and in transporting water for fracking. Because of an over-supply of natural gas in the US, its sales price is temporarily less than the cost of production. This is not a sustainable situation. Higher oil costs also tend to raise the cost of transporting coal to the destination where it is used.
Figure 2. US Energy Prices as % of Wages and as of GDP. Ratio to GDP provided by EIA Short Term Economic Outlook – Figure 27, converted to Wage Base by author, using same wages as described for Figure 3.Figure 2 shows total energy costs as a percentage of two different bases: GDP and Wages.1 These costs are still near their high point in 2008, relative to these bases. Because oil is the largest source of energy, and the highest priced, it represents the majority of energy costs. GDP is the usual base of comparison, but I have chosen to show a comparison to wages as well. I do this because even if an increase in costs takes place in the government or business sector of the economy, most of the higher costs will eventually have to be paid for by individuals, through higher taxes or higher prices on goods or services.
2. High oil prices don’t go away, except in recession.
We extracted the easiest (and cheapest) to extract oil first. Even oil company executives say, “The easy oil is gone.” The oil that is available now tends to be expensive to extract because it is deep under the sea, or near the North Pole, or needs to be “fracked,” or is thick like paste, and needs to be melted. We haven’t discovered cheaper substitutes, either, even though we have been looking for years.
In fact, there is good reason to believe that the cost of oil extraction will continue to rise faster than the rate of inflation, because we are hitting a situation of “diminishing returns”. There is evidence that world oil production costs are increasing at about 9% per year (7% after backing about the effect of inflation). Oil prices paid by consumers will need to keep pace, if we expect increased extraction to take place. There is even evidence that sweet sports are extracted first in Bakken tight oil, causing the cost of this extraction to rise as well.
3. Salaries don’t increase to offset rising oil prices.
Most of us know from personal experience that salaries don’t rise with rising oil prices.
In fact, as oil prices have risen since 2000, wage growth has increasingly lagged GDP growth. Figure 3 shows the ratio of wages (using the same definition as in Figure 2) to GDP.
Figure 3. Wage Base (defined as sum of “Wage and Salary Disbursements” plus “Employer Contributions for Social Insurance” plus “Proprietors’ Income” from Table 2.1. Personal Income and its Distribution) as Percentage of GDP, based on US Bureau of Economic Analysis data. *2012 amounts estimated based on part-year data.If salaries don’t rise, and prices of many types of goods and services do, something has to “give”. This disparity seems to be the reason for the continuing economic discomfort experienced in the past several years. For many consumers, the only solution is a long-term cut back in discretionary spending.
4. Spikes in oil prices tend to be associated with recessions.
Economist James Hamilton has shown that 10 out of the last 11 US recessions were associated with oil price spikes.
When oil prices rise, consumers tend to cut back on discretionary spending, so as to have enough money for basics, such as food and gasoline for commuting. These cut-backs in spending lead to lay-offs in discretionary sectors of the economy, such as vacation travel and visits to restaurants. The lay-offs in these sectors lead to more cutbacks in spending, and to more debt defaults.
5. High oil prices don’t “recycle” well through the economy.
Theoretically, high oil prices might lead to more employment in the oil sector, and more purchases by these employees. In practice, this provides only a very partial offset to higher price. The oil sector is not a big employer, although with rising oil extraction costs and more US drilling, it is getting to be a larger employer. Oil importing countries find that much of their expenditures must go abroad. Even if these expenditures are recycled back as more US debt, this is not the same as more US salaries. Also, the United States government is reaching debt limits.
Even within oil exporting countries, high oil prices don’t necessarily recycle to other citizens well. A recent study shows that 2011 food price spikes helped trigger the Arab Spring. Since higher food prices are closely related to higher oil prices (and occurred at the same time), this is an example of poor recycling. As populations rise, the need to keep big populations properly fed and otherwise cared for gets to be more of an issue. Countries with high populations relative to exports, such as Iran, Nigeria, Russia, Sudan, and Venezuela would seem to have the most difficulty in providing needed goods to citizens.
6. Housing prices are adversely affected by high oil prices.
If a person is required to pay more for oil, food, and delivered goods of all sorts, less will be left over for discretionary spending. Buying a new home is one such type of discretionary expenditure.
US housing prices started to drop in mid 2006, according to data of the S&P Case Shiller home price index. This timing fits in well with when oil prices began to rise, based on Figure 1.
7. Business profitability is adversely affected by high oil prices.
Some businesses in discretionary sectors may close their doors completely. Others may lay off workers to get supply and demand back into balance.
8. The impact of high oil prices doesn’t “go away”.
Citizens’ discretionary income is permanently lower. Businesses that close when oil prices rise generally don’t re-open. In some cases, businesses that close may be replaced by companies in China or India, with lower operating costs. These lower operating costs indirectly reflect the fact that the companies use less oil, and the fact that their workers can be paid less, because the workers use less oil. This is a part of the reason why US employment levels remain low, and why we don’t see a big bounce-back in growth after the Great Recession. Figure 4 below shows the big shifts in oil consumption that have taken place.
Figure 4. Percentage growth in oil consumption between 2006 and 2011, based on BP’s 2012 Statistical Review of World Energy.A major part of the “fix” for high oil prices that does takes place is provided by the government. This takes the place in the form of unemployment benefits, stimulus programs, and artificially low interest rates.
Efficiency changes may provide some mitigation, as older less fuel-efficient cars are replaced with more fuel-efficient cars. Of course, if the more fuel-efficient cars are more expensive, part of the savings to consumers will be lost because of higher monthly payments for the replacement vehicles.
9. Government finances are especially affected by high oil prices.
With higher unemployment rates, governments are faced with paying more unemployment benefits and making more stimulus payments. If there have been many debt defaults (because of more unemployment or because of falling home prices), the government may also need to bail out banks. At the same time, taxes collected from citizens are lower, because of lower employment. A major reason (but not the only reason) for today’s debt problems of the governments of large oil importers, such as US, Japan, and much of Europe, is high oil prices.
Governments are also affected by the high cost of replacing infrastructure that was built when oil prices were much lower. For example, the cost of replacing asphalt roads is much higher. So is the cost of replacing bridges and buried underground pipelines. The only way these costs can be reduced is by doing less–going back to gravel roads, for example.
10. Higher oil prices reflect a need to focus a disproportionate share of investment and resource use inside the oil sector. This makes it increasingly difficult maintain growth within the oil sector, and acts to reduce growth rates outside the oil sector.
There is a close tie between energy consumption and economic activity because nearly all economic activity requires the use of some type of energy besides human labor. Oil is the single largest source of energy, and the most expensive. When we look at GDP growth for the world, it is closely aligned with growth in oil consumption and growth in energy consumption in general. In fact, changes in oil and energy growth seem to precede GDP growth, as might be expected if oil and energy use are a cause of world economic growth.
Figure 5. Growth in World GDP, energy consumption, and oil consumption. GDP growth is based on USDA International Macroeconomic Data. Oil consumption and energy consumption growth are based on BP’s 2012 Statistical Review of World Energy.The current situation of needing increasing amounts of resources to extract oil is sometimes referred to one of declining Energy Return on Energy Invested (EROEI). Multiple problems are associated with declining EROEI, when cost levels are already high:
(a) It becomes increasingly difficult to keep scaling up oil industry investment because of limits on debt availability, when heavy investment is made up front, and returns are many years away. As an example, Petrobas in Brazil is running into this limit. Some US oil and gas producers are reaching debt limits as well.
(b) Greater use of oil within the industry leaves less for other sectors of the economy. Oil production has not been rising very quickly in recent years (Figure 6 below), so even a small increase by the industry can reduce net availability of oil to society. Some of this additional oil use is difficult to avoid. For example, if oil is located in a remote area, employees frequently need to live at great distance from the site and commute using oil-based means of transport.
Figure 6. World crude oil production (including condensate) based primarily on US Energy Information Administration data, with trend lines fitted by the author.(c) Declining EROEI puts pressure on other limited resources as well. For example, there can be water limits, when fracking is used, leading to conflicts with other use, such as agricultural use of water. Pollution can become an increasingly large problem as well.
(d) High oil investment cost can be expected to slow down new investment, and keep oil supply from rising as fast world demand rises. To the extent that oil is necessary for economic growth, this slowdown will tend to constrain growth in other economic sectors.
Airline Industry as an Example of Impacts on Discretionary Industries
High oil prices can be expected to cause discretionary sectors to shrink back in size. In many respects, the airline industry is the “canary in the coal mine,” showing how discretionary sectors can be forced to shrink.
In the case of commercial air lines, when oil prices are high, consumers have less money to spend on vacation travel, so demand for airline tickets falls. At the same time, the price of fuel to operate airplanes rises, making the cost of operating airplanes higher. Business travel is less affected, but still is affected to some extent, because some long-distance business travel is discretionary.
Airlines respond by consolidating and cutting back in whatever ways they can. Salaries of pilots and stewardesses are reduced. Pension plans are scaled back. New more fuel-efficient aircraft are purchased, and less fuel-efficient aircraft are phased out. Less profitable routes are closed. The industry still experiences bankruptcy after bankruptcy, and merger after merger. If oil prices stabilize for a while, this process stabilizes a bit, but doesn’t really stop. Eventually, the commercial airline industry may shrink to such an extent that necessary business flights become difficult.
There are many discretionary sectors besides the airline industry waiting in the wings to shrink. While oil prices have been high for several years, their effects have not yet been fully incorporated into discretionary sectors. This is the case because governments have been able to use deficit spending and artificially low interest rates to shield consumers from the “real” impacts of high-priced oil.
Governments are now finding that debt cannot be ramped up indefinitely. As taxes need to be raised and benefits decreased, and as interest rates are forced higher, consumers will again see discretionary income squeezed. New cutbacks are likely to hit additional discretionary sectors, such as restaurants, the “arts,” higher education, and medicine for the elderly.
It would be very helpful if new unconventional oil developments would fix the problem of high-cost oil, but it is difficult to see how they will. They are high-cost to develop and slow to ramp up. Governments are in such poor financial condition that they need taxes from wherever they can get them–revenue of oil and gas operators is a likely target. To the extent that unconventional oil and gas production does ramp up, my expectation is that it will be too little, too late, and too high-priced.
Note:
[1] Wages include private and government wages, proprietors’ income, and taxes paid by employers on behalf of employees. They do not include transfer payments, such as Social Security.
2013: The End of the Beginning
Off the keyboard of Gail Tverberg
Published on Our Finite World on January 6, 2013
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We have been hearing a lot about escaping the fiscal cliff, but our problem isn’t solved. The fixes to date have been partial and temporary. There are many painful decisions ahead. Based on what I can see, the most likely outcome is that the US economy will enter a severe recession by the end of 2013.
My expectation is that credit markets are likely see increased defaults, as workers find their wages squeezed by higher Social Security taxes, and as government programs are cut back. Credit is likely to decrease in availability and become higher-priced. It is quite possible that credit problems will adversely affect the international trade system. Stock markets will tend to perform poorly. The Federal Reserve will try to intervene in credit markets, but if the US government is one of the defaulters (at least temporarily), it may not be able to completely fix the situation.
Less credit will tend to hold down prices of goods and services. Fewer people will be working, though, so even at reduced prices, many people will find discretionary items such as larger homes, new cars, and restaurant meals to be unaffordable. Thus, once the recession is in force, car sales are likely to drop, and prices of resale homes will again decline.
Oil prices may temporarily drop. This price decrease, together with a drop in credit availability, is likely to lead to a reduction in drilling in high-priced locations, such as US oil shale (tight oil) plays.
Other energy sources are also likely to be affected. Demand for electricity is likely to drop. Renewable energy investment is likely to decline because of less electricity demand and less credit availability. By 2014 and 2015, less government funding may also play a role.
This recession is likely be very long term. In fact, based on my view of the reasons for the recession, it may never be possible to exit from it completely.
I base the foregoing views on several observations:
1. High oil prices are a major cause of the United States Federal Government’s current financial problems. The financial difficulties occur because high oil prices tend to lead to unemployment, and high unemployment tends to lead to higher government expenditures and lower government revenue. This is especially true for oil importers.
Figure 1. US Government Income and Outlay, based on historical tables from the White House Office of Management and Budget (Table 1.1). *2012 is estimated by OMB. http://www.whitehouse.gov/omb/budget/Historicals2. The United States and world’s oil problems have not been solved. While there are new sources of oil, they tend to be sources of expensive oil, so they don’t solve the problem of high-priced oil. Furthermore, if our real economic problem is high-priced oil, and we have no way of permanently reducing oil prices, high oil prices can be expected to cause a long-term drag on economic growth.
3. A cutback in discretionary spending is likely. US workers are already struggling with wages that are not rising as fast as GDP (Figure 2). Starting in January, 2013, US workers have the additional problem of rising Social Security taxes, and later this year, a likely cutback in government expenditures. The combination is likely to lead to a cutback in discretionary spending.
Figure 2. Wage Base (sum of “Wage and Salary Disbursements” plus “Employer Contributions for Social Insurance” plus “Proprietors’ Income” from Table 2.1. Personal Income and its Distribution) as Percentage of GDP, based on US Bureau of Economic Analysis data. *2012 amounts estimated based on part-year data.4. The size of our current financial problems, both in terms of US government income/outgo imbalance and debt level, is extremely large. If high oil prices present a permanent drag on the economy, we cannot expect economic growth to resume in a way that would fix these problems.
5. The financial symptoms that the US and many other oil importers are experiencing bear striking similarities to the problems that many civilizations experienced prior to collapse, based on my reading of Peter Turchin and Sergey Nefedov’s book Secular Cycles. According to this analysis of eight collapses over the last 2000 years, the collapses did not take place overnight. Instead, economies moved from an Expansion Phase, to a Stagflation Phase, to a Crisis Phase, to a Depression/Intercycle Phase. Timing varies, but typically totals around 300 years for the four phases combined.
It appears to me that the corresponding secular cycle for the US began in roughly 1800, with the ramp up of coal use. Later other modern fuels, including oil, were added. Since the 1970s, the US has mostly been experiencing the Stagflation Phase. The Crisis Phase appears to be not far away.
The Turkin analysis started with a model. This model was verified based on the experiences of eight agricultural civilizations (beginning dates between 350 BCE and 1620 CE). While the situation is different today, there may be lessons that can be learned.
Below the fold, I discuss these observations further.
Issue 1. High oil prices tend to lead to government financial problems.
Food prices tend to rise at the same time as oil prices, partly because oil is used in the production of food (for example, plowing, irrigation, herbicides and insecticides, harvesting, transport to market). Also, because oil is in short supply, corn is now being grown for use as ethanol to be used as a gasoline-extender. Growing additional corn puts pressure on food prices, because it drives up the price of land and encourages farmers to put more land into corn production, and less into other crops.
The reason governments are affected by high oil and food prices is as follows. When oil and food prices rise, buyers cut back in discretionary spending, so as to have enough for “basics,” including food and commuting expenses. Workers are laid off in discretionary industries, such as vacation travel and restaurants. These laid off-workers pay less taxes, and sometimes default on loans. Governments are quickly drawn into these problems, for two reasons:
- Their tax revenue is lower, because of layoffs in discretionary sectors.
- Their expenditures are higher, because of the need to pay more unemployment benefits, provide economic stimulus, and bail out banks.
Oil importers are especially affected, because they are also paying out funds to oil exporters. The countries with well-publicized financial problems (including several European countries, the United States, and Japan) tend to be major oil importers.
Oil exporters are not adversely affected to the same extent, because they have additional revenue from higher prices on oil they are exporting. They may still be somewhat affected because of rising food prices, and the fact that higher oil revenues do not necessarily go to those buying food. A recent study shows that food shortages helped trigger the Arab Spring protests.
Part of the reason that the impact of high oil prices is as severe as it is, is because there are many follow-on effects. For example, if oil prices rise, the price of shipping goods of all types rises. If businesses are able to pass through these higher costs, discretionary income of buyers for other goods falls. If not, businesses find that their higher costs lead to lower profits. To bring profit margins back up to an acceptable level, businesses may lay off workers.
As another example, prices of homes are likely to be adversely affected by high oil prices, because a family with inadequate discretionary income will forgo moving to a larger home, and may even default on a mortgage.
It should be noted that the impact of high oil prices doesn’t completely go away unless oil prices go down and stay down. Businesses can partly mitigate the impact of high oil prices by laying off workers in discretionary segments. Some businesses will fail completely, however. Replacement may be by an overseas company, with a lower cost structure that uses less oil. See my post on energy leveraging.
Workers generally must permanently adjust their budgets to higher food and oil prices. This is often difficult to do. The lack of jobs is a particular problem–something that workers cannot fix by themselves. Government programs can mitigate the job shortfall, by paying benefits to unemployed workers and by reducing interest rates, so that businesses can more easily make investments that will lead to more employment. These programs are costly, though, and are a major cause of the current mismatch between government income and expense.
Issue 2. World oil problems have not been solved.
There have been a number of reports this years, such as one by the International Energy Agency, seeming to suggest that the world oil problem has been solved. These analyses are incomplete. They do not recognize that our real problem is a financial problem. Our economy (everything from interstate highways to electric transmission to Social Security programs) was put in place using cheap ($10 or $20 barrel) oil. Shifting to today’s high cost of oil (up near $100 barrel) causes severe economic dislocations. There is no more cheap oil to be found, however, because oil companies extracted the cheapest to extract oil first and now the “easy oil” is gone.
The impression one gets from reading the papers is that US oil production is having a huge impact on world oil production. If a person looks at the numbers, world oil production is close to flat. Rising US production makes up for falling European production, but doesn’t do a whole lot more.
Figure 3. World crude oil production, based on EIA data. *2012 estimated based on partial year data.The rise in United States oil production is indeed somewhat helpful, but we are still many years away from being “energy independent” and even farther from becoming “oil independent.” The real issue is high oil prices, and these are not being fixed.
Figure 4. US crude oil prices (based on average prices paid by US refiners for all grades of oil based on EIA data) converted to 2012$ using CPI-Urban data from the US Bureau of Labor Statistics.Our financial problems are here and now, in 2013. Promises of hoped-for higher oil production in several years at a still very high price don’t fix today’s financial problems. In fact, they will likely continue to contribute to financial problems in the future.
Issue 3. Declining wages and increased taxes can be expected to lead to a decline in discretionary spending.
As indicated at the beginning of the post, wages (including earnings of businesses owners considered as “proprietors,” but not including “transfer payments” such as Social Security and unemployment insurance) have not been growing as fast as GDP since 2000. Below is a repeat of Figure 2 shown at top of post.
Figure 2. Wage Base (sum of “Wage and Salary Disbursements” plus “Employer Contributions for Social Insurance” plus “Proprietors’ Income” from Table 2.1. Personal Income and its Distribution) as Percentage of GDP, based on US Bureau of Economic Analysis data. *2012 amounts estimated based on part-year data.There seem to be several reasons behind this decline. One reason, already mentioned, is high oil prices leading to US layoffs, because of decreased discretionary expenditures.
Another reason for the decline is increased automation. Electricity can often be substituted for human labor, reducing costs, but also reducing jobs. Economists seem to term this change higher labor productivity. They also seem to believe that new jobs will appear from somewhere, but in practice, this is not happening. Instead, lack of jobs is part of what is leading to recessionary influences.
Another reason for the decline is increased competition from countries with lower labor costs and lower fuel costs. China joined the World Trade Organization in December 2001, and its manufacturing (and thus use of fuels) increased dramatically shortly thereafter.
Figure 5. China’s energy consumption by source, based on BP’s Statistical Review of World Energy data.Another reason is demographic. Baby boomers are reaching retirement age. This has already begun affecting the number of individuals who retire each year. In the future, the number of retirees can be expected to increase further.
In total, we see a very large drop in the percentage of US citizens with jobs, starting about 2000 (Figure 6). This is very close to the time that China ramped up its growth (Figure 5).
Figure 6. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census. 2012 is partial year estimate.In calendar years 2011 and 2012, workers’ contributions for Social Security funding were temporarily reduced by 2% of wages, as a way of stimulating the economy. As of January 1, 2013, this temporary reduction was removed. For a couple with combined wages of $100,000, take-home pay is thus being decreased by $2,000 per year. With less disposable income, workers can be expected to cut back somewhere–buying a larger home, buying a new car, or going out to eat.
So far, only a small amount of other tax increases have been put in place, and only a few cuts have been made. More tax increases or benefit cuts will be needed later this year to bring revenue and expense into better alignment. Any such change will tend to have a recessionary impact, because citizens’ discretionary incomes will be affected.
Issue 4. The spending gap and the amount of debt look too big to be fixable without excellent economic growth.
As noted above, wages have not been keeping up with GDP. The majority of federal taxes are based on wages, so in my comparisons, I use wages, rather than GDP, as a base.
If we use the wage base from Figure 2, the amount of government outgo vs income (all levels, not just federal) is as follows:
Figure 7. US Government Spending (all levels) as percentage of Wage Base, as defined in Figure 2, above, based on US Bureau of Economic Analysis data.Based on Figure 7, the issue in recent years has been primarily rising expenditures. These higher expenditures would seem to be partly because of high-priced oil, but also because of other influences noted above that are leading to declining employment. The amount of the gap is close to 15% of wages–something that is very hard to fix. Even the current increase in Social Security taxes (“only” 2% of wages) will exert downward pressure on discretionary spending.
A related issue is that compared to wages (using the same wage base as in Figure 2), debt of all kinds is extremely high.
Figure 8. US Debt as a Percentage of the Wage Base, where the Wage Base is as defined in Figure 2, and Federal Debt is from Treasury Direct, and other types of debt are from the Federal Reserve Z.1 report.Government debt is in now more than household debt of all kinds, including mortgage, credit card, auto, and student loans. It is close to two times the wage base used in this analysis.
One issue with paying down debt is that during the pay-down period, the government (or individual) reducing the debt “feels poorer,” because funds available for spending on goods and services needed today is lower. This happens because some current tax revenue, or some current wages, must be used to pay down debt, and thus is not available for today’s spending. This is a turn-around from the increasing debt situation experienced many times in the past. For example, part of the reason times seemed good in the 2002-2006 period was because people were able to refinance their homes and use the funds to buy a new car or add on a family room. If we are forced to pay down debt, we have the reverse effect.
Issue 5. Similarity to “Secular Cycles” of Peter Turchin and Sergey Nefedov.
Throughout the ages, many economies that have experienced long-term expansion. Eventually, they reached limits of some sort and collapsed. The book Secular Cycles by Peter Turchin and Sergey Nefedov takes an analytical approach to looking such past cycle. They developed a fairly complex model of what they would expect over time, in terms of trends in wages, prices, population, income inequality, and other variables. They then examine historical records (relating to eight civilizations in four countries, with “start dates” between 350 BCE and 1620 CE) to see whether this predicted pattern was born out in practice. In general, the authors found good agreement with the predicted model.
Typically, civilizations analyzed were reaching upper limits in population growth because of limits on food availability, but sometimes limits on water or fuel also were important. The model predicted four phases (expansion, stagflation, crisis, and depression/ intercycle). The typical length of the entire cycle was 300 years. The length of the various segments was fairly variable. The stagflation stage often lasted 50 or 60 years. The crisis stage tended to be shorter, more often in the 20 to 50 year range. There often was overlap between phases, with a civilization seeming to cycle back and forth between, say, expansion and stagflation.
In the model, there are various feedback loops. For example, as the number of workers rises relative to the amount of land, the price of land and food tends to rise. Jobs outside of agriculture do not rise proportionately, so wages of common workers tend to fall in inflation adjusted terms. With lower wages for common workers, nutrition declines. Eventually, the population becomes weakened, and population declines. There are also other players–the elite and the state itself.
Some characteristics of the four phases are as follows:
- Expansion phase (growth) – Increasing population, relatively low taxes, political stability, low grain prices, and high real (inflation-adjusted) wages.
- Stagflation phase (compression) – Slowing population growth, much heavier taxes needed to support a growing elite class, low but increasing political instability, rising grain prices, declining real wages for most workers, increasing indebtedness, and increasing urbanization.
- Crisis phase (state breakdown) – Population declining from the peak (typically by disease or by deaths from warfare), high income inequality, political instability increasing to a peak, high but very variable grain prices, high urbanization, tax system in a state of crisis, peasant uprisings.
- Depression/intercycle – Low population, attempts to restore state, declining economic inequality, grain prices decreasing but variable.
It seems to me that the United States and much of the world are going through a cycle much as described by Turchin. The Growth Phase of our current cycle seems to have begun around 1800, with the rise of coal use. Stagflation in the United States seems to have started with the drop in US oil production in 1970. All of the government budget and debt problems now seem to suggest that we are reaching the Crisis Phase.
Obviously, there are differences from the civilizations modeled, because we now live in a much more integrated world. Furthermore, earlier societies did not depend on oil and other modern fuels the way we do today. We do not know how the current situation will play out, but the comparison is concerning.
The String Economy…
Off the keyboard of Steve from Virginia
Published on Economic Undertow on December 9, 2012
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After five years of ‘The Great Financial Crisis’ there is a sense of relief as Christmas approaches. There is nervous talk by central bankers and economists, but also hope of ‘recovery’and a following new period of prosperity … tomorrow.
It’s always tomorrow: where this recovery is going to come from or what will drive it nobody really knows, It is just taken on faith that a recovery is certain to arrive because recoveries have always arrived in the past. “Why not?” the economists ask, “It’s never different this time!”
The sense of security is misleading and unsettling. We are like a person wearing a sweater with a thread caught on something, we are walking away … Pulling the string does not blow up the sweater or cause it to crash. The sweater diminishes without our being too much aware of it. There is little drama, only a Great Unraveling. Instead of a strong economy, we have a string economy, the pulling of which is invisible to economists.
(Unknown photographer) Fairy-tale palaces for the well-to-do in the Paris of the Midwest, on Alfred Street in Brush Park in Detroit in 1881. It was all a fantastic dream, a stage-set for Victorian manners and unimaginable prosperity without end, a gilded age, the product of the settlement of the far West, of the overreaching railroads and steamships … and of millions of highly skilled immigrants from Europe.
Brush Park was a psychedelic dream-scape of hundreds of extravagant, gilded mansions, with hundreds more throughout the city: not so much an idea but an escape from the necessity of having to think about anything at all. It was as if the prosperity wasn’t real but needed physical manifestations, each more outlandish than the next … to reassure those with the most that most was indeed what they had.
What the most have today is an irksome and uncertain non-crisis, a fake. Relief resides entirely in the form of central bank credit. These banks offer trillions in low-cost loans to both governments and the finance industry so that these establishments might dodge the consequences of the gigantic debts they have already taken on. There is no gilded palace on Alfred Street for this debt for it must squirreled away out of sight. Managers hope that ordinary citizens will ignore the creaking colossus until it is safe to set it loose again, debt giving rise to still more debt against a renewed backdrop of ‘growth’.
The only gain from the central bank lending/hiding strategy is a reduction of the interest cost and an escape from accountability. Both the reduction and the escape are temporary: the banking sector receives the benefits of interest reduction while the costs are shifted to the citizens. Escape keeps finance scoundrels out of jail until the statute of limitation expires. Nothing is done to reduce the overall debt burden, indeed nothing can be done! Modernity and industry both require a constant increase of debt and cannot tolerate any decrease. ‘Growth’ is a measure of the increase in debt and therefor a measure of wealth! Without the general increase of wealth it is impossible for tycoons to gain more beyond what they already have. In a debt-constrained world, one tycoon can only gain when other tycoons lose. It is a pitiless world indeed that sets one tycoon against the others.
Any increase in debt must take place in the private sector because wealth cannot exist unless it can be extracted at great pain from the citizens. This is because money, wealth and debt are all interchangeable claims against the non-tycoons’ vanishingly small allotment of time. A tycoon can always obtain more money but no human can gain more time: for wealth to have meaning it must be worth what is dear to everyone, not just tycoons! To be a tycoon is to have a great surplus of others’ time.
Debt repayments must therefor be extracted from the public, the higher the cost to the public the more useful/satisfying wealth is for the tycoon … being a sadistic libertine is a characteristic which enables an individual to become a tycoon in the first place.
Sadly, the private sector is unable to increase its supply of debt as there is already too much debt for ordinary economic activity to manage properly. Enter the central banks, which lend in the place of the private sector. Inflationists cry that this is horrible, like beating a dog with a curtain rod … Having the central banks or the government write checks to tycoons simply will not do, it’s bad manners, the payments do not represent wealth, in fact do not represent anything. The certainly do not represent anyone’s time.
This concern is misplaced for two reasons. One is because lending to tycoons is what central banks do constantly: lending-plus-sadism is how tycoons get to be that way. Second, because the absence of real money is considered to be temporary. With the loans offered by the central banks, there is certain to be more private sector credit made available … tomorrow.
There is no inflation because the central banks do not really replace the private sector, they only fake it. Whatever amounts of credit the central bank offers is less than what is retired or destroyed by private sector deleveraging. Even as the central banks’ expand their balance sheets, the private sectors’ balance sheets contract … without the efforts of the central banks there is no credit to be had with dire consequences all around!
The governments could issue currency without borrowing and use it to retire some of the debt. This would not add to the supply of money because retiring the debt would extinguish newly-issued currency at the same time. The governments so far have refused to do this. Bankers would object … as would the tycoons who desire to extract wealth from the workers’ bloodstreams, not from the government. The government could issue sufficient currency so that the supply of money expands enough for the tycoons to gain more of it. Having the government write checks to tycoons simply will not do, it’s bad manners, etcetera …
Meanwhile, the Establishment attempts to prop up key men everywhere around the world by any means necessary. Any institution that is deemed to be ‘systemically important’ is supported with the ordinary citizens’ credit … except for those things the same Establishment deems worthy of being blown up by drones or commandos. Non-key institutions such as Detroit and other American cities are abandoned to molder then collapse.
The citizens mutter, they are under a cloud that grows longer and darker with each pull of the string. Unemployment relentlessly increases, there are rumors of ‘austerity’ to be added onto the thermodynamic variety that emerges from diminished energy availability. The establishment has only one tactic: to add more debt, which has typically increased since the beginning of the industrial revolution. Debt has become non-productive, we have the unraveling sweater economy as a consequence … there needs to be another approach.
We are caught between what we want and what we need. We want it all, we feel entitled: we are like children. We cannot help ourselves. The yarn is pulled and the sweater becomes very small, the bottom is now at our armpits. We know there are steps that we must take … we must stop pulling the string … but we refuse to take them.
Alfred street in 1993 (Unknown photographer for City of Detroit). The house behind the car is the third house from the left in the top photo. Modern Detroit, a first-world slum:
Slums are a product of modernity just the same as automobiles and jet airplanes. They are economically segregated areas, places where society’s losers are swept. Modernity washes its hands of the slum-dwellers then moves onto other business … the creation of more slum dwellers. Slums are the end product of social Darwinism, the necessary ‘yin’ to business success ‘yang’.
More success = more slums. Failure of the process also = more slums. Modernity asserts that it eliminates poverty. Slums stand as evidence that modernity creates poverty. More modernity = more poverty.
As with Mumbai and Nairobi, so goes Detroit and other slum-cities, the product of- as well as destination for industrial prosperity.
Detroit was undone by the extraction of time from tens-of-millions of Americans by Detroit’s auto- and other business tycoons. At the end of the day, America had no time for Detroit. The stock market crash of 1929 and the following Depression ruined many of the old Detroit families. The manors were sold or divided into apartments or configured as rooming houses for auto workers. Others were demolished and replaced with cheaply built stores, shabby institutional buildings or parking lots. In 1935, the immense Brewster-Douglass public housing project for the ‘working poor’ was built at the far end of Alfred Street, just out of range of this photograph. War production saw the city filled with hundreds of thousands of job-seekers and factory workers who required housing. Many of these job-seekers were Negroes from the American south. Blacks were undesirables in nearly every Detroit neighborhood. As a consequence, housing was very expensive in neighborhoods where they were allowed to settle, much more so than for whites who could live anywhere in the city. Housing for blacks was also in far more advanced states of decay. Tension between races exploded in 1943 with a city-wide race riot that killed 34, with thousands arrested and soldiers patrolling the streets.
After the war, whites who could fled the city for the ballooning suburbs, a period of migration that lasted for decades. Cities are made and broken by flows of capital and human beings. Detroit originally grew and took form from the incoming tide of European immigrants who built in the manner and with the materials they were familiar. The craftsmen who built the fairy castles were replaced with unskilled agricultural workers looking to toil in the expanding automobile factories, these workers had no background or interest in city-building. They needed a paycheck, the city would take care of itself.
Instead, big business ‘took care’ of the city. Beginning in 1908 came the machines: the city was steadily made over as an auto habitat. It didn’t take much: Detroit’s street plan was laid out before the automobile — the width of the streets and boulevards and vast spaces anticipated it. The distances were too great for walking, often there was no ‘place’ to walk to. Starting in the 1950s and 60s, the city was divided by superhighways. the Chrysler and Edsel Ford freeways were built north and east of Brush Park, flattening the commercial districts and cutting off neighborhood from the rest of the city … by 1970, after another race riot, the Brush Park neighborhood was abandoned to street criminals and drug addicts. The fairy palaces grew furry and gray with rot, they collapsed or were demolished one at a time, the housing projects were also abandoned then stripped. Today there are a couple of dozen occupied houses in this neighborhood, the rest is weed-covered vacant space dotted with gaping ruins and some low-quality replacement housing and commercial buildings.
Not just Detroit: the machines overran neighborhoods and commercial districts in cities all over the country, this happens to be Buffalo, New York (Atlantic) James Howard Kunstler calls this the suicide of Midwest American cities, instead it is inadvertent suburbanization. The post-auto density and the form of building within the cities is identical to that of the surrounding suburbs. Replacement construction in places like Brush Park is identical to that of the suburb: quickly constructed low-rise apartment complexes or ‘pods’ of identical, cheaply designed and built vinyl-sided shacks.
Brush Park- Alfred Street by way of Google. It is only a matter of time before these ‘new’ buildings go the way of their predecessors. There is no reason for anyone to care about them, any more than they did for the housing projects or the fairy palaces.
Nothing in the Brush Park neighborhood or the rest of the city was made to withstand the test of time, the appeal of the place was narrowly immediate and instant. There was no ‘greater place’ that the original neighborhood could be an indispensable part of. Detroit was a collection of unrelated buildings and occupation districts. The Park was created as a ghetto, a place of confinement for rich people who had no choice but to look at each others’ wealth every day and become bored with it. The vast endeavor could never be re-purposed into anything other than a self-referential institution, the same as an insane asylum or a water tower. There was nothing transcendent, every building was a single-function enterprise, created to mandate/channel behavior.
No doubt there are many who could rebuild the entirety of Brush Park as it was … as a museum piece. The Federal government could certainly do it for the cost of one mile of urban freeway. The fashion impulse that made the place possible 140 years ago no longer exists. Americans have nothing in the way of tools that would give such a project form other than nostalgia and wonder over building and design skills that were common in the late-nineteenth century but no longer exist. We don’t know how to create engaging urban spaces and we don’t know how to inhabit them. We have forgotten how to be Victorian merchants. We know how to get in our cars and drive.
Which is why we cling to the immediate present so desperately, we really don’t know how to do anything else. For us to learn is too dangerous because we don’t have the luxury of time, it has been stolen by the tycoons! By the time … we find out what danger we are in it will be to late to do anything about it.
All I want for Christmas is the TRUTH
Off the keyboard of Jim Quinn
Published on The Burning Platform on December 3,2012
Discuss this article at the Epicurean Delights Smorgasbord inside the Diner
“Eyes blinded by the fog of things
cannot see truth.
Ears deafened by the din of things
cannot hear truth.
Brains bewildered by the whirl of things
cannot think truth.
Hearts deadened by the weight of things
cannot feel truth.
Throats choked by the dust of things
cannot speak truth.”
― Harald Bell Wright – The Uncrowned King
I consider myself a seeker of truth. It isn’t easy finding it in todays’ world. In an alternate version of the famous scene from A Few Good Men, I picture myself telling Turbo Tax Timmy Geithner that I want the truth and his angry truthful response:
“Son, we live in a world that has Wall Street banks, and those banks have to be guarded by puppet politicians in Washington D.C. with lobbyist written laws and Madison Avenue PR maggots with media propaganda. Who’s gonna do it? You? You, Representative Paul? I have a greater responsibility than you could possibly fathom. You weep for the average middle class American family, and you curse the ruling oligarchs. You have that luxury. You have the luxury of not knowing what I know. That the death of the American middle class, while tragic, probably saved the bonuses of thousands of Wall Street bankers. And my existence, while grotesque and incomprehensible to you, increases the wealth of these same bankers who destroyed the worldwide economic system in 2008. You don’t want the truth because deep down in places you don’t talk about in the food bank line, you want me on Wall Street, you need me on Wall Street. We use words like derivative, fiscal stimulus, quantitative easing. We use these words as the backbone of a life spent syphoning off the wealth of the nation. You use them as a punch line. I have neither the time nor the inclination to explain myself to a man who rises and sleeps under the blanket of the very debt that I provide, and then questions the manner in which I provide it. I would rather you just said thank you, and went on your way, Otherwise, I suggest you pick up 1000 shares of Apple, and hope our high frequency trading supercomputers can ramp the market for a while longer. Either way, I don’t give a damn what you think you are entitled to.”
I find myself more amazed than ever at the ability of those in power to lie, misinform and obfuscate the truth, while millions of Americans willfully choose to be ignorant of the truth and yearn to be misled. It’s a match made in heaven. Acknowledging the truth of our society’s descent from a country of hard working, self-reliant, charitable, civic minded citizens into the abyss of entitled, dependent, greedy, materialistic consumers is unacceptable to the slave owners and the slaves. We can’t handle the truth because that would require critical thought, hard choices, sacrifice, and dealing with the reality of an unsustainable economic and societal model. It’s much easier to believe the big lies that allow us to sleep at night. The concept of lying to the masses and using propaganda techniques to manipulate and form public opinion really took hold in the 1920s and have been perfected by the powerful ruling elite that control the reins of finance, government and mass media.
Peddlers of Propaganda
“Great is truth, but still greater, from a practical point of view, is silence about truth.” – Aldous Huxley – Brave New World
Adolf Hitler understood the power of the big lie over the ignorant masses who want to believe:
“All this was inspired by the principle–which is quite true within itself–that in the big lie there is always a certain force of credibility; because the broad masses of a nation are always more easily corrupted in the deeper strata of their emotional nature than consciously or voluntarily; and thus in the primitive simplicity of their minds they more readily fall victims to the big lie than the small lie, since they themselves often tell small lies in little matters but would be ashamed to resort to large-scale falsehoods. It would never come into their heads to fabricate colossal untruths, and they would not believe that others could have the impudence to distort the truth so infamously. Even though the facts which prove this to be so may be brought clearly to their minds, they will still doubt and waver and will continue to think that there may be some other explanation. For the grossly impudent lie always leaves traces behind it, even after it has been nailed down, a fact which is known to all expert liars in this world and to all who conspire together in the art of lying.” – Adolf Hitler – Mein Kampf
We are all liars. We lie to friends, family and co-workers. We convince ourselves they are only small lies and just protect others from being hurt. We would rather be lied to than face the blunt truth about our deficiencies, shortcomings and failures. Willfully believing mistruths allows a person to become dependent upon those promulgating the mistruths. It relieves them of their responsibility to act upon the knowledge that something is wrong and must be fixed. It is a cowardly path to ultimate servitude and destruction. The German people chose this path in the 1930s and the American people have chosen a similar and ultimately destructive path today. The United States Office of Strategic Services prepared a psychological profile report during the war describing Adolf Hitler’s method for controlling the minds of the German masses:
“His primary rules were: never allow the public to cool off; never admit a fault or wrong; never concede that there may be some good in your enemy; never leave room for alternatives; never accept blame; concentrate on one enemy at a time and blame him for everything that goes wrong; people will believe a big lie sooner than a little one; and if you repeat it frequently enough people will sooner or later believe it.”
America’s corruptible politicians, greedy corporate chieftains, criminal banking overlords, and despicable media manipulators all learned the sordid lessons of mass propaganda from the masters. Our willingness to lie and be lied to set us up to be manipulated by those who understood the mass psychology of a nation. Goebbels and Hitler were heavily influenced by the father of propaganda – Edward Bernays. He and his disciples are professional poisoners of the public mind, exploiters of public foolishness and ignorance, and never allow truth to interfere with a good story. What master manipulators realized is that it is easier to change the attitude of millions than the attitude of one man. By analyzing and understanding the process and motives of how the group mind works, the invisible government has been able to manipulate and regulate the masses according to their will without the masses knowing they are being managed. Bernays described this elitist view of the world in 1928:
“Those who manipulate the unseen mechanism of society constitute an invisible government which is the true ruling power of our country. We are governed, our minds are molded, our tastes formed, our ideas suggested, largely by men we have never heard of. This is a logical result of the way in which our democratic society is organized. Vast numbers of human beings must cooperate in this manner if they are to live together as a smoothly functioning society. In almost every act of our lives whether in the sphere of politics or business in our social conduct or our ethical thinking, we are dominated by the relatively small number of persons who understand the mental processes and social patterns of the masses. It is they who pull the wires that control the public mind.” – Edward Bernays – Propaganda
The super-rich elite believe they are more intelligent, more capable of managing the affairs of state, masters of the financial world, and chosen to decide what is best for the masses. In reality, they are egocentric, psychotic, power hungry, myopic, self-serving ravenous vultures, feasting upon the carcass of a once great nation. Truth is inconsequential and irritating to their plans for world domination and control. Therefore, no truth will be forthcoming from any organization or person that is associated with the existing political, economic, financial or social order. Every bit of information that is permitted into the public realm has been vetted, manipulated and spun for public consumption. The public does not like bad news. They do not like hard facts. They do not like to think or do math. They want to be spoon fed mindless sound bites and happy talk. The oligarchs need to keep the masses sedated and subservient while they continue to plunder and pillage, so all data is massaged to provide a happy ending.
This is where I deviate from the ideologue one-trick ponies that refuse to see both sides of the issue. The ruling oligarchs are wealthy, influential, psychotic, amoral, and few. The masses are relatively poor, easily influenced, willfully ignorant, and many. The ruling oligarchs are most certainly evil, but the masses are not the hard working, stoic, downtrodden portrayed by liberal ideologues. One just needs to walk down the street in one of our urban enclaves, saunter through a suburban mall, or click on People of Wal-Mart to witness the tattooed, pierced, butt crack showing, slovenly, obese, and ignorant, attached to their electronic iGadgets, to understand how far our society has deteriorated. Every individual born into this world has the capability to become educated, think critically, not follow the herd, live beneath their means, and not be influenced by propaganda. Aldous Huxley understood in 1931 that those in power could use material goods to invoke passivity and egotism among the populace. He feared that truth would be obscured by an avalanche of irrelevance (500 Reality TV shows), cultural trivialities (Lady Gaga, Lindsey Lohan), distractions (Professional sports), and pharmaceutical enhanced escape (Prozac). He saw the possibility that we would grow to love our servitude as the pleasures of life provided by our controllers overwhelmed any desire to think or question authority.
“There will be in the next generation or so a pharmacological method of making people love their servitude and producing dictatorship without tears, so to speak, producing a kind of painless concentration camp for entire societies so that people will in fact have their liberties taken away from them but will rather enjoy it.” ― Aldous Huxley
By 1962 when Huxley wrote his last book, he was certain that his worst dystopian nightmares had been unleashed. His description of Western society fifty years ago could have been written today and accurately reflected our current economic paradigm. War, debt and consumption still make our world go round, but the end is nigh.
“Armaments, universal debt, and planned obsolescence – those are the three pillars of Western prosperity. If war, waste, and moneylenders were abolished, you’d collapse. And while you people are over-consuming the rest of the world sinks more and more deeply into chronic disaster.” – Aldous Huxley – Island
The pillars are crumbling. The $1.4 trillion wasted on two worthless wars of choice in the Middle East, the trillions wasted and liberties sacrificed for the never ending unwinnable War on Terror, the Keynesian spending frenzy that has driven the National Debt from $9 trillion to $16.3 trillion in the last five years, the looting of the American taxpayer by Wall Street and their co-conspirators at the Federal Reserve and in Congress, and the belief that ramping up the debt driven consumption that drives 71% of our GDP is our path to prosperity is absolutely freaking nuts. The pillars will not be abolished willingly. The ruling class depends upon their continued existence and expansion. There is the rub. The math doesn’t work. We’ve reached the point where continued expansion of debt and money printing no longer works. With a national debt to GDP ratio of 102% and a total credit market debt to GDP ratio of 350%, we have passed the Rogoff & Reinhart point of no return. This time is not different. A country cannot run trillion dollar deficits indefinitely and expect to not suffer the consequences. This is why those in power are increasingly resorting to propaganda, data manipulation, and outright lies to convince the masses of their omnipotence and brilliance in managing the fiscal affairs of the state.
“One believes things because one has been conditioned to believe them.” – Aldous Huxley – Brave New World
Through decades of mass media messaging the masses have been conditioned to believe whatever those in power want them to believe. To our invisible government rulers we are nothing but rats to be manipulated through food pellets and shock therapy. Pleasure and fear of pain are the drivers of our warped society. The ruling oligarchs truly think they know what is best for the masses and believe any means is worthwhile as long as the ends support their agenda. This is blatantly obvious to anyone with their eyes open and their brain functioning. Sadly, the government run educational system produces mostly drones that are barely able to tie their own shoes, spell Cat, or make change from a one dollar bill. Only 20% of all high school seniors score high enough on the SAT test to get a B minus in college and most of these kids come from private and parochial schools. This is exactly what those in power prefer. They want non-critical thinking, mindless consumers, who don’t understand the criminal nature of Federal Reserve created inflation or their enslavement in the chains of debt at the hands of their Wall Street slave owners. They certainly don’t want the masses to understand that real median household net worth is lower today than it was in 1969. Luckily for the oligarchs, 95% of the public couldn’t define the terms: real, median or net worth. Math is hard.
The average person is inundated on a 24/7 basis with pabulum from liberal network media talking heads, CNBC Wall Street shills regurgitating whatever their sponsors desire, Fox News blonde bimbos and neo-con war mongers programmed to spew Rupert Murdoch talking points, MSNBC tingling leg faux journalists, NYT intellectually corrupt Nobel prize winners, NAR nitwits repeating “best time to buy” on a daily basis for the last 12 years, and government agencies whose sole purpose is to manipulate data in a way that supports the agenda of those in power. The intellectually lazy and willfully ignorant masses are no match for those who control the message and the media. How else can you explain their ability to convince millions of drones to line up for hours in front of a store and stampede like crazed hyenas to grab a $5 crockpot, the Chinese produced gadget of the moment or a designer top made by slave labor in safety conscious Bangladesh factories? How else can you explain a population willing to be molested by government TSA dregs in the name of security from phantom terrorists, the passive acceptance of military exercises in US cities, unquestioning submissiveness as Presidential Executive Orders allow the government dictatorial powers based on their judgment, the monitoring of internet and voice correspondence of all citizens, and believing that FBI agents luring clueless teenage Muslim dupes into fake terrorist plots, providing the fake explosives, and then announcing with great fanfare how they saved us from another 9/11?
But, the prize for boldest, most outrageous, blatant use of propaganda and misinformation to cover-up their criminal looting of America goes to Ben Bernanke, his cronies at the Federal Reserve, and the Wall Street banks that own and control our Central Bank. Having the gall to portray themselves as the stabilizer of our economic system over the last 100 years is a putrid joke on the dying and broke middle class. Their mandate has been stable prices, full employment, and avoiding financial crisis. It is a tribute to Bernays and the rest of the public relations swine that the average American actually believes inflation is a good thing and it is under control despite the FACT that 96.2% of their purchasing power has disappeared since 1900, with the most rapid decline occurring since Nixon closed the gold window in 1971.
The average American actually believes Ben Bernanke saved us from a Great Depression when in actuality he saved the owners of the Federal Reserve from accepting the losses they generated through the greatest financial fraud in history. His “solutions” have zombified our economic system, just as the Japanese Central Bank did 20 years ago. He has destroyed the concept of saving, while rewarding the indebted and profligate with his QE to Infinity money printing policies. And the ignorant masses have been convinced by the corporate media and their corrupt government lackeys that Ben did this for them. Kyle Bass knows otherwise. He knows how the Fed and their backers have preyed upon the masses through their understanding of human psychology:
“Humans are optimistic by nature. People’s lives are driven by hopes and dreams which are all second derivatives of their innate optimism. Humans also suffer from optimistic biases driven by the first inalienable right of human nature which is self-preservation. It is this reflex mechanism in our cognitive pathways that makes difficult situations hard to reflect and opine on. These biases are extended to economic choices and events. The primary difficulty with this train of thought is the bias that most investors have for the baseline facts: they tend to believe that the central bankers, politicians, and other governmental agencies are omnipotent due to their success in averting a financial meltdown in 2009.
Central banks have become the great enablers of fiscal profligacy. The overarching belief is that there will always be someone or something there to act as the safety net. The safety nets worked so well recently that investors now trust they will be underneath them ad-infinitum. Markets and economists alike now believe that quantitative easing (“QE”) will always “work” by flooding the market with relatively costless capital. Unlimited QE and the zero lower bound (“ZLB”) are likely to bankrupt pension funds whose expected returns happen to be a good 600 basis points (or more) higher than the 10?year “risk-free” rate. The ZLB has many unintended consequences that are impossible to ignore.
Our belief is that markets will eventually take these matters out of the hands of the central bankers. These events will happen with such rapidity that policy makers won’t be able to react fast enough. The fallacy of the belief that countries that print their own currency are immune to sovereign crisis will be disproven in the coming months and years. Trillions of dollars of debts will be restructured and millions of financially prudent savers will lose large percentages of their real purchasing power at exactly the wrong time in their lives. Again, the world will not end, but the social fabric of the profligate nations will be stretched and in some cases torn. Sadly, looking back through economic history, all too often war is the manifestation of simple economic entropy played to its logical conclusion. We believe that war is an inevitable consequence of the current global economic situation.” – Kyle Bass
What’s Normal in a Profoundly Abnormal Society?
“The real hopeless victims of mental illness are to be found among those who appear to be most normal. Many of them are normal because they are so well adjusted to our mode of existence, because their human voice has been silenced so early in their lives, that they do not even struggle or suffer or develop symptoms as the neurotic does.” They are normal not in what may be called the absolute sense of the word; they are normal only in relation to a profoundly abnormal society. Their perfect adjustment to that abnormal society is a measure of their mental sickness. These millions of abnormally normal people, living without fuss in a society to which, if they were fully human beings, they ought not to be adjusted.” – Aldous Huxley – Brave New World Revisited
No sane person could honestly say that what has happened to our society over the last forty years, and particularly in the last five years, is normal. But somehow those in power have convinced the masses that $1.2 trillion deficits, 0% interest rates, declining real wages, the highest average gas prices in history, pre-emptive wars, policing the world and buying rubber dog shit produced in China with a credit card is normal and beneficial to our economy. It seems that I and a few million other people in this country are the abnormal ones. We choose not to be led to slaughter by our masters. The seekers of truth have turned to the alternative media and are able to connect with like-minded critical thinking individuals on websites like Zero Hedge, Jesse’s Americain Café, Of Two Minds, Mish, Financial Sense, among many other truth seeking blogs. This is dangerous to the powers that be and they are using their political clout and extreme wealth to try and lock down and control free speech on the internet. If this is accomplished all hope at disseminating truth will be lost.
Abraham Lincoln once said that he believed in the people and that if you told them the truth and gave them the cold hard facts they would meet any crisis. That may have been true in 1860, but not today. The cold hard facts are available for all to see:
- A $16.3 trillion National Debt
- 47 million people on food stamps
- Over $222 trillion of unfunded Federal entitlement liabilities
- Over $5 trillion of unfunded State entitlement liabilities
- True unemployment above 20%.
- True inflation above 5%.
- A stock market at the same level as 1999, with a 10 year expected annual return of less than 4% – Stocks for the really, really long run. 10 year bond returns of 0% will be a miracle.
- A savings rate of 3.7% and with Bernanke’s ZIRP, no incentive to save. Real hourly earnings continue to fall.
- Baby Boomers within 10 years of retirement have saved an average of only $78,000, and more than a third of them have less than $25,000. More than half of U.S. workers have no retirement plan at all.
- A crumbling, decaying infrastructure, with 150,000 structurally deficient bridges, bursting water mains, and an overstressed electrical grid.
- Horrific government public education producing millions of low functioning morons.
- Rotting social fabric, with 40% of children born out of wedlock (72% of black children) and a 50% divorce rate.
- An energy policy based upon unicorns farting rainbows and press releases about green energy and the miracle of shale fracking, as average gas prices in 2012 and 2011 were the highest in U.S. history.
As the pitiful excuses for statesmen in Washington D.C. pander and posture about the dreaded fiscal cliff which was purposely created by the oligarchs as a show for the masses, none of the true issues above are being addressed. The dramatic compromise that will ultimately be reached between the equally corrupt parties will be hailed by the corporate media and Wall Street shysters and an HFT supercomputer engineered stock market rally will ensue. The cowardice of these politicians is revolting. As Huxley knew in 1958, politicians and propagandists prefer nonsense and storylines to truth, knowledge and honesty.
“Human beings act in a great variety of irrational ways, but all of them seem to be capable, if given a fair chance, of making a reasonable choice in the light of available evidence. Democratic institutions can be made to work only if all concerned do their best to impart knowledge and to encourage rationality. But today, in the world’s most powerful democracy, the politicians and the propagandists prefer to make nonsense of democratic procedures by appealing almost exclusively to the ignorance and irrationality of the electors.” – Aldous Huxley – Brave New World Revisited
We want to be lied to because the truth is too painful. Hope and denial with a dash of delusion is the recipe the mindless masses prefer. The average person doesn’t want to understand the chart below. They want to believe the U.S. will dominate economically and lead the world for decades to come. We are still the bright shining beacon of democracy on the mountaintop. Even though the facts unequivocally reveal a declining empire, the masses desperately grasp at straws in the wind. The United States share of world GDP will be vastly lower in 2021, as the hubris of declining empires never allows them to take the necessary steps to reverse the decline (Rome, Great Britain).
It is fitting that during this magical Christmas season of fantasy, delusion, debt fueled material over-consumption and fairy tales, we look at the biggest fairy tale of all – the great jobs recovery. I know from the two thousand Obama campaign commercials I was forced to watch in the last few months and 500 robo-calls at dinner every night that we’ve added 4 million jobs due to Obama’s wise economic policies. The magical journey from a 10.3% unemployment rate to a 7.9% rate is a humdinger. I stumbled across a myriad of charts on those truth-telling websites that I had previously mentioned.
“You shall know the truth and the truth shall make you mad.” ― Aldous Huxley
The first chart that grabbed my attention shows the historical relationship between the U3 unemployment rate reported to the masses versus the U6 truer picture of unemployment, along with the percentage of people unemployed for longer than 15 weeks. A funny thing happened shortly after the election of Barack Obama. From 1994 through 2008 the gap between the U3 and U6 rates consistently ranged between 3% and 4%. Suddenly, the gap surged to 7% and currently sits at almost 8%. The figure reported to the masses of 7.9% is so much easier to digest than the 15% to 17% that captures the truer level of unemployment. If the gap between these two figures had remained at the levels of the previous 14 years, the unemployment that should be reported to the masses would be 11%. That is unacceptable to those in power, so the data is massaged and the propaganda machine spins the storyline necessary to confuse and mislead the masses.
The next two charts from Mike Shedlock again reveal truths the existing social order doesn’t want you to know. Even though the working age population has grown by 10 million people since 2008, the BLS expects critical thinking people to believe the labor force has only grown by 1.3 million people. You see, the unemployment rate is calculated using the labor force. If your economic policies don’t create jobs, just adjust the labor force dramatically lower based on nothing. In desperate economic times, people do not voluntarily leave the workforce. Only a non-thinking drone would believe that 8.7 million Americans voluntarily left the workforce since 2008, when only 4 million left the workforce from 2003 through 2007. It is not a coincidence that student loan debt, which was taken over by the Obama administration in 2009 rose by $300 billion. Those in power have doled out these billions with no concern for credit risk or academic credentials in order to reduce the number of people in the labor force. Unemployed union Twinkie workers seeking a new career in lesbian studies can get a $20,000 loan from the American taxpayer to sit in their basement along with the 500,000 other University of Phoenix enrollees. The future $300 billion taxpayer bailout was worth it to keep the unemployment rate low enough to insure Obama’s re-election.
The Obama PR machine never fails to expound upon the fact that the economy added 4.9 million jobs since January 2009. In the same timeframe, uncovered employment rose by 6.6 million. Inquiring minds might want to know what an “uncovered” job entails. Selling your accumulated Chinese crap on Ebay is an uncovered job. Calling yourself a consultant while sleeping until noon is an uncovered job. Day trading Facebook and Apple stock is an uncovered job. Trash picking is an uncovered job. The truth is that real jobs are 1.7 million lower than they were at the depths of the recession, while bullshit jobs paying virtually nothing and offering no benefits have surged by 6.6 million. These facts don’t make a great campaign commercial. The number of employed Americans is at the same level as mid-2005, even though the working age population has grown by 18 million. Since 2008 there are 3 million less full-time jobs and 3 more part-time jobs. This trend is accelerating as small businesses react rationally to the oncoming Obamacare train, resulting in aggregate work hours declining and wage growth stagnating.
Zero Hedge reveals more truth about our glorious jobs recovery with the following two charts. They obliterate the false narrative spun by liberal ideologues that the reason for the increase of those not in the labor force is due to Baby Boomers retiring. The truth is that while those in the 55-69 age brackets have gained nearly 4 million jobs under President Obama, everyone else has lost just over 2.5 million jobs. Is this a positive development or a sign of extreme desperation among older Americans who have seen their interest income vaporized by Ben Bernanke and there food, energy, and healthcare expenses skyrocket?
Those in their prime earning years of 25 to 54 still have a net cumulative loss of 2.2 million jobs since 2009. Recent college graduates, with their billions of student loan debt, have nabbed 400,000 TGI Fridays jobs, singing happy birthday to 3 year olds, with their newly minted college degrees. This is the “normal” healthy jobs market sold to the American public by the propagandists and politicians.
The final jobs chart that portrays the truth of what has been a decades’ long spiral downward paints a picture of a country that once created wealth through producing goods from the 1940s through 1970. Since 1970 we’ve degenerated into a debt creating country that consumes foreign produced goods and makes entitlement promises it can never keep. Selling houses to each other, peddling crap on Ebay, and eating out three times a week has shockingly failed to propel our economy. The jobs picture has deteriorated rapidly since 2008 and is not improving, despite the best propaganda money can buy. There is absolutely no chance of any substantive improvement over the next four years based on the policies in place and refusal to acknowledge the economic realities that we face.
The accumulation of material possessions through the use of consumer debt, peddled by bankers and reinforced through relentless corporate marketing propaganda has left the country’s citizens weary, miserable, greedy, indebted and sick. Our obsession with technology has merely provided another means of distracting ourselves from confronting the dire challenges that must be addressed. We can ignore the facts but that doesn’t mean they do not exist. The abnormality that grips this nation is breathtaking to behold, as the status quo cheer on and encourage consumers to buy more things with money they don’t have in order to support an economic recovery that is dependent upon zero interest rates for Wall Street banks, QE to infinity, and the delusional desire for a miraculous return to the good old days when getting something for nothing was possible. We can no longer deny reality. If we want to add 30 million people to Medicaid, it must be paid for. If we want to wage never ending wars and police the world, it must be paid for. If we want a Federal government to spend $3.8 trillion per year, it must be paid for. Nothing is free in this world, but more than 50% of Americans seem to believe that to be true.
“Our economy is based on spending billions to persuade people that happiness is buying things, and then insisting that the only way to have a viable economy is to make things for people to buy so they’ll have jobs and get enough money to buy things.” – Philip Elliot Slater
We are seen by those in control as nothing more than common house flies caught in their web of lies. Your owners don’t care about you. They only care about their own wealth and power. They want to control and manipulate you. They want to keep you enslaved in debt and running on the treadmill of consumption. They want passive, non-critical thinking drones to do the menial service jobs that remain in this country, while they use their control of our financial, political, tax, and legal systems to ransack and pillage the wealth of the dwindling middle class. The truth is the continuation of our current economic system is mathematically impossible. Your owners know this. This is why the use of propaganda, misinformation, fake data, and false storylines has taken on astronomical proportions. The time for passivity and accepting the deceitfulness of our leaders is coming to an end. While you’re waiting in line this Christmas season at Wal-Mart to purchase a fabulously priced shirt that only required the deaths of 112 Bangladesh slave laborers, try to figure out how we got here. Your owners think they have you by the balls.
“They spend billions of dollars every year lobbying to get what they want. Well, we know what they want; they want more for themselves and less for everybody else. But I’ll tell you what they don’t want—they don’t want a population of citizens capable of critical thinking. They don’t want well informed, well educated people capable of critical thinking. They’re not interested in that. That doesn’t help them. That’s against their interest. You know something, they don’t want people that are smart enough to sit around their kitchen table and figure out how badly they’re getting fucked by a system that threw them overboard 30 fucking years ago. Because the owners of this country know the truth, it’s called the American Dream, because you have to be asleep to believe it.” – George Carlin
How many Americans are awake enough to handle the truth?
All I want for Christmas is the truth.
Financial Issues Affecting Energy Security
Off the keyboard of Gail Tverberg
Published on Our Finite World on November 6, 2012
Discuss this article at the Epicurean Delights Smorgasbord inside the Diner
Last week, I gave a talk called Financial Issues Affecting Energy Security at the Advances in Energy Studies conference in Mumbai, India. The general topic of the conference was, “Energy Security and Development-The Changing Global Context.”
As I look at the situation, it seems to me that many of the crises around the world are connected to oil supply and the cost of this oil supply. If oil supply gets tighter, there is potential for these crises to get worse. In this talk, I will also show the connection of oil supply limits to some of the financial crises we see today, and to energy security. I will also show some slides on the Indian oil and coal situation, and explain some connections to world limits.
World GDP, oil consumption, and energy consumption tend to move in tandem (Slide 2). While the figures shown above are for the world, the same situation tends to exist for smaller groupings as well. Countries with rapid economic growth tend to use a growing amount of energy, especially oil. This is logical, because making goods and services tends to use energy. For example, growing food and transporting it using modern methods uses oil.
Another reason energy consumption and growth in GDP tend to go together is because workers who earn a salary by making goods or services can afford to buy goods and services using oil and other energy products. For example, they may be able to afford to buy a car or to go on a vacation. People who have lost their jobs have much less to spend on goods and services. This is another reason energy (and oil) consumption tends to be higher when more people have jobs–that is during periods of economic growth.
Countries with little economic growth tend to be ones with little growth in oil consumption, and in energy consumption in general.
If we look at world oil supply and price (Slide 3), we see that there have been two big price spikes. The first one came in the 1970s and early 1980s, after the oil production of the United States began to fall in 1971. The United States found itself increasingly dependent on imports, leaving the door open for the Arab Oil Embargo. By the mid-1980s, the world got its oil supply problem under control, partly by drilling for oil in new places (North Sea, Alaska, and Mexico) and partly by finding ways to reduce oil consumption (smaller cars; shifting electricity production to coal or nuclear instead of oil).
In recent years, we are facing a second sharp rise in oil prices. This sharp rise really reflects both a “demand” and a “supply” problem:
(1) Demand. World demand for oil started rising sharply after China joined the World Trade Organization in 2001. China, India, and other Asian countries began rapid economic growth, leading to a greater need for oil and other energy products. Slide 3 shows world supply did not show any unusual “spurt” to meet this demand. Instead prices began to rise.
(2) Supply. To a significant extent, “The easy oil is gone“. What is left in the ground is oil that is both expensive and slow to extract. Two examples of such oil are “shale oil” and bitumen from the Canadian oil sands. Because of high extraction costs, these types of oil need a high sales price to justify their extraction. In fact, a recent report indicates that costs in the Canadian oil sands are soaring. If growth in oil sands production is to continue at forecast levels, oil prices will need to be higher than has recently been the case.
If we look at a graph of growth in oil supply with fitted trend lines, we can see that the rate of growth has in fact been declining over time. This is precisely the opposite of what is needed to accommodate the energy needs of rapidly growing countries such as India and China, and is part of the reason for current high prices.
If we look at world oil consumption divided among three different parts of the world (Slide 5), we see three very different patterns:
(1) European Union, United States and Japan combined. Consumption has fallen since 2005. These are precisely the countries with serious recessions in the 2007-2009 period, when oil consumption was dropping rapidly.
(2) Former Soviet Union (FSU) – Consumption fell when the Soviet Union collapsed in 1991, and has never recovered.
(3) Remainder (many countries, including China, India, and oil exporters) – Consumption grows rapidly, year after year, even though world supply is not growing by much.
If world oil supply remains relatively flat (as is recently the case on Slide 4), and the growth pattern shown on Slide 5 continues, it is clear that there will soon be a conflict. Either the EU, US, Japan grouping will need to drop their consumption by more, or the “Remainder” group will need to slow down on their consumption, or both. This pattern could mean slower growth for the “Remainder” grouping, or outright recession for the European Union, US and Japan.
In countries where oil prices are not subsidized, such as the European Union, the United States, and Japan, there are several basic issues:
(1) Because oil prices are not subsidized, higher oil prices are passed through to consumers. These higher prices lead consumers to cut back on discretionary expenses because oil is used for some of the necessities of life, including food production and commuting to jobs. As a result, people in discretionary industries, such as vacation travel, and restaurants, tend to be laid off. There may also be debt defaults, if laid-off workers cannot afford to repay loans. The combination of these factors leads to recession.
(2) Governments are affected, too, because laid-off workers pay less in taxes. Furthermore, laid-off workers often need unemployment benefits and other benefits to mitigate their circumstances. The government may also choose to “stimulate” the economy, or to bail out banks with bad loans. With all of the additional spending and less revenue, recessionary forces get transferred to the governmental sector. This is why so many governments are now troubled with high debt.
(3) In the Euro zone, counties in poor financial condition find it necessary to pay higher interest rates. adding to the country’s financial difficulties. The US has been spared this problem so far, partly because it is viewed as a “safe haven” from Euro problems, and partly because it has the ability to manipulate the level of its currency.
Countries vary in their exposure to high oil prices. Oil importers who get a large share of their total energy from oil (as opposed to other types of fuel) seem to be most at risk. The PIIGS (Portugal, Italy, Ireland, Greece and Spain) tend to be countries using large share of oil in their energy mix. A country which can’t regulate its own currency, such as Greece and other Euro countries is at particularly high risk, because of the problem with higher interest rates mentioned earlier (because these countries cannot drop the value of their currency, to make their exports more competitive).
Eventually, it seems likely that high oil prices will affect all economies, even those of oil exporters. Extra funds from oil exports do not “make their way” to all consumers. So while some parts of an economy may be booming, others will collapse from lack of funds.
Greece provides an example of the dip in oil consumption that occurs when a country enters a recession. Greece’s largest industry is tourism. High oil prices affect consumers’ ability to purchase vacations in Greece. Large multinational companies (such as Coca Cola Hellenic) decide to move out, for more stability, further adding to the country’s problems. With less investment, the country has an even greater tendency to spiral downward.
Other European countries requiring bailouts tend to follow a similar pattern to Greece (Slide 9).
So far, we have been talking about countries which don’t subsidize oil prices. How about other countries?
One such country is Egypt (Slide 10). For quite some time, it was an oil exporter. It historically has subsidized both food and oil prices. It has run into problems recently because oil consumption has been rising at the same time that oil production has been falling. Without oil exports to sell, it is very hard to have enough money to fund subsidies of food and oil. Cutbacks in subsidies lead to civil unrest, and the situation starts going downhill quickly. I wrote a post about the Egypt situation earlier, What Lies Behind Egypt’s Problems?
India is not an oil exporter, but it has been subsidizing diesel prices. The graph shown on Slide 11 shows that oil consumption has been rising rapidly, while India’s own oil production has been almost flat. This combination is problematic, because it becomes very expensive to subsidize increasing imports. The growing gap puts pressure on the rupee. It also leads to deficit spending, which in turn leads to a lower sovereign debt rating.
India is now using more coal for generation than it is exporting. Furthermore, the rate of increase in supply and consumption seem to be diverging, with coal production recently becoming much flatter than consumption.
Coal imports cannot be expected to rise indefinitely. China and Europe are both interested in purchasing coal imports, so there is competition for available supply. Also, coal imports tend to be expensive, because of the cost of transport. Coal import costs put pressure on India’s financial condition, just as oil imports do.
Shortages of oil, coal and gas are already taking a toll on India’s economic growth, according to the Wall Street Journal: Grinding Energy Shortage Takes Toll on India’s Growth.
It seems to me that government officials are making plans for the future without really understanding what a limited supply of cheap oil means. What it means, in practical terms, is that governments and citizens will be poorer, rather than richer, in the future. There will be fewer people employed in jobs that require external energy (practically all jobs in Western countries today). Because of energy constraints, wages of most workers will tend to fall in inflation adjusted terms.
Governments will be particularly be affected, because there will be a drop in their tax revenue at the same time that there is more need for governmental services. It will be difficult to keep up pension programs and fuel subsidy programs. The higher cost of fuel (including cooking fuel, where there are subsidies) will mean that consumers will find fuel less affordable. Governments of countries that are particularly affected are likely to be subject to major changes, as citizens become increasingly unhappy with the status quo.
We can look at countries such as Greece to get an idea of the more direct financial security impacts that we can expect. In Greece, we find that high solar feed in tariffs are increasingly a problem, and have recently been reduced. Two electricity companies that rely heavily on natural gas have gone bankrupt. The possibility of rotating blackouts has been mentioned, if the country cannot afford to import high-priced natural gas and oil for electricity. As the highest cost-electricity becomes less affordable, an increasing proportion of electricity seems likely to come from the lowest cost fuel, locally produced lignite.
Also in Greece, non-payment of bills, theft of electricity, and theft of copper wire are already being reported as problems.
In Portugal, China recently bought an interest in the company operating Portugal’s electric grid. The sale was necessitated by the poor financial condition of the company.
Civil unrest is increasingly becoming a problem in countries with shortfalls in affordable energy. Greece. Spain, and Egypt all report civil unrest. If nothing else, such unrest could lead to damage to energy structures, such as electric power plants, including nuclear plants.
As there is more competition for limited resources, the world as we have known it is likely to change. Willingness to accept foreigners into one’s country will decline, if there are not enough good-paying jobs to go around. There will be direct conflict over resources, such as China and Japan’s recent oil dispute.
The Euro zone brought together unequal countries, nearly all of which were short on energy supplies. Now, we are hearing increasing reports about the possibility of the Euro zone’s financial disintegration.
Even within countries, there is the possibility of rich areas wanting to be free from areas which are less well off. We see this dynamic playing out as there are growing calls in Catalonia for independence from Spain.
As countries face the need to cutback, rather than grow, world trade can be expected to decline. In fact, the Wall Street Journal recently reported, “World Trade Volumes Decline for Third Month.” While it is not certain the current dip will continue, this is a pattern we can expect to see again. Conflict between countries, such as we are seeing between Japan and China, can be expected to lead to a drop in trade. The need for austerity measures in countries with financial problems is also likely to lead to a drop in trade.
While it would be nice to assume “Business as Usual” will continue, and “a rising tide will lift all boats,” these situations look increasingly less likely. What we are instead seeing is that a lowering tide can adversely affect the energy security of many countries at the same time. This is not an easy thought to consider, especially for a country such as India, whose per-capita energy use lags far behind the world average.
The Close Tie Between Energy Consumption, Employment, and Recession
Off the keyboard of Gail Tverberg
Published on Our Finite World on September 17th, 2011
Discuss this article at the Epicurean Delights Smorgasbord inside the Diner
The number of jobs available to job-seekers has been a problem for quite a long tine now—since 2000 in the United States, and longer than that in Europe. If we look at the percentage of the US population who are employed, it is now back to 1984 or 1985 levels.
Figure 1. Total number of individuals employed in non-farm labor, and reported by the US Bureau of Labor Statistics, divided by US resident population, as reported by the US Census Bureau.I have run into a number of clues about what is happening. In this post, I’d like to discuss what I am seeing. Part of the problem is that high oil costs squeeze the economy, reducing employment. Part of the problem is growing trade with Asia. It is even possible that the Kyoto protocol (which the US did not sign) has something to do with what we are seeing. Let me start by explaining a fairly strange relationship.
A Strange Relationship – A Close Tie Between the Amount of Energy Consumed and the Number of People Employed
Since 1982, the number of people employed in the United States has tended to move in a similar pattern to the amount of energy consumed. When one increases (or decreases), the other tends to increase (or decrease). In numerical terms, R2 = .98.
Figure 2. Employment is the total number employed at non-farm labor as reported by the US Census Bureau. Energy consumption is the total amount of energy of all types consumed (oil, coal, natural gas, nuclear, wind, etc.), in British Thermal Units (Btus), as reported by the US Energy Information Administration.I have written recently about the close long-term relationship between energy consumption and economic growth. We know that economic growth is tied to job creation, so it stands to reason that energy consumption would be tied to job growth1. But I will have to admit that I was surprised by the closeness of the relationship for the period shown.
This close relationship is concerning, because if it holds in the future, it suggests that it will be very difficult to reduce energy consumption without a lot of unemployment. It also would seem to suggest that a shortage of energy supplies (as reflected by high prices) can lead to unemployment.
Why Rising Energy Cost (Particularly Oil) Leads to Lower Employment and Less Energy Consumption
Suppose oil prices rise2. The critical issue is that consumers’ incomes do not rise at the same time. Consumers’ budgets get squeezed, and they cut back on discretionary spending. For example, they may go out to restaurants less, make fewer long-distance vacation trips, put off buying a new car, or contribute less to their favorite charities. Workers in discretionary sectors of the economy tend to get laid off, as a result. We have come to know this as part of recession.
(The impact of an oil price rise will be worse if other fuel prices, such as natural gas, rise as well. It will be mitigated, if natural gas prices are low, as they are in 2012 in the United States. Europe has much higher natural gas prices than the United States. This is big part of the reason why recessionary impacts are now worse in Europe than the United States.)
In the case of high oil prices and lay-offs, less energy of all types–not just oil–is used. Laid-off workers may move in with relatives, and thus reduce their living expenses. Each laid-off worker would have used oil to get to their job, and this will no longer be required. The jobs experiencing layoffs themselves may have required fuel use of various types, such as heat for buildings, fuel for airplanes, or electricity used in making new cars, and this is reduced as well.
There is also likely to be a link to housing prices. Moving up to a more expensive home is a discretionary expenditure. If people’s incomes are squeezed by high oil prices, and some are being laid off, there will be less demand for homes as well. This lower demand can be expected to reduce housing prices, especially in areas where commuting distances are longest (and thus, oil use for commuting greatest). There are also likely to be layoffs in the construction industry, as there is less demand for new homes and new buildings of all sorts.
As I have mentioned previously, James Hamilton (2011) has shown that 10 out of 11 recessions in the United States since World War II were associated with oil price spikes.
High Energy Costs in One Area Tend to Lead to Substitution to Places Where Energy Costs Are Lower
If there is a possibility of international trade, manufacturing and some types of services will tend to move to areas where costs are lowest. Part of these costs are energy costs. A manufacturer with cheap electricity costs will have an advantage over one with higher electricity costs. As energy costs rise (as they have in recent years), they get to be more important in determining where manufacturing will be done.
Besides direct energy costs, wages are another part of the difference in costs from one part of the world to another. Wages tend to be lower in the warmer areas of the world. In part, this is because energy from the sun provides much of the needed energy for heating homes, so there is less need for supplemental energy. This means that wages do not need to be as high for a comparable standard of living.
If we look at recent world energy consumption, we see rapid growth in energy consumption. This pattern is quite different from the US pattern we saw in Figure 2, which was much flatter.
Figure 3. World Energy Consumption based on BP’s 2012 Statistical Review of World EnergyFigure 4 below shows that there has been a striking difference in how energy consumption has grown in various parts of the world.
Figure 4. Energy Consumption divided among three parts of the world: (1) The combination of the European Union-27, USA, and Japan, (2) The Former Soviet Union, and (3) The Rest of the World, based on data from BP’s 2012 Statistical Review of World Energy.Energy consumption has been quite flat in the grouping of industrialized countries I show first (European Union-27, USA, and Japan). The Former Soviet Union (FSU) collapsed in 1991, and the consumption for those countries has never recovered. Energy consumption for the “Rest of the World” has been increasing amazingly rapidly since 2002. The rest of the world includes China, India, Bangladesh, and many small countries, plus oil exporters, such as Saudi Arabia and Mexico. Although I don’t break it out separately on Figure 4, the increase in energy consumption since 2002 has been especially marked in Asia.
The “bend” in the line for “Rest of the World” energy consumption took place immediately after China joined the World Trade Organization in December 2001. If we look at China’s fuel consumption by itself, we see that its huge rise in energy consumption (Figure 5, below) came mostly from increased coal consumption starting at that time. Oil consumption also increased. Nuclear and renewables are too small to be visible on the chart.
Figure 5. China’s energy consumption by source, based on BP’s Statistical Review of World Energy data.Other countries, especially Asian countries like India, also ramped up their energy consumption at a similar time. India also uses coal as its primary fuel, with 53% of its energy consumption in 2011 coming from coal (based on BP 2012 data).
While I don’t have employment data for Figure 4 groupings, I do have economic growth data (Real GDP is Gross Domestic Product, adjusted to remove effects of inflation), shown in Figure 6, below.
Figure 6. Three-year average real GDP growth for (1) EU-27, USA, and Japan, (2) Former Soviet Union, and (3) Rest of the World, based on data by Angus Maddison through 2008, and USDA since then.Figure 6 indicates that the economy of the “Rest of World” has been growing much faster than the EU, USA, and Japan grouping since 2001. In fact the Rest of the World’s growth has been much faster for nearly the entire period shown on the graph. Based on the steeper rise in energy consumption of the “Rest of World,” in Figure 4 compared to the old industrialized countries grouping, this might be the predicted result.
One point that many people miss is that the Great Recession of 2007-2009 was to a significant extent a phenomenon of the older industrialized countries. EU, USA, and Japan all were hit very hard, while the “Rest of the World” almost sailed along. This can be seen in the energy consumption data on Figure 4, and the economic growth data on Figure 6. The Rest of the World slowed down a bit, but even during that period, its growth rate exceeded the best growth rate of the EU, USA, and Japan grouping during the 1984-2011 period (based on Figure 6).
Is it Possible to Change the Relationship between Energy Consumption and Number Employed?
The answer is pretty clearly, yes, but lower wages may be part of the mix.
Let’s look at how the United States changed its energy consumption, per number of people employed, over time. If we go back to the 1949 to 1972 time period, we also see a close relationship ( R2 = 99%) between US energy consumption and employment, but it is a different close relationship than since 1982, (shown in Figure 2, near the top of this post).
Figure 7. Graph of amounts similar to Figure 2, but for the period 1949 to 1972.During the 1949 to 1972 period, energy consumption was consistently rising faster than the number of people employed. Oil was cheap, as were other energy sources, so not too much thought was given to how efficiently it was used. Also, as we will see in Figure 9, wages for workers were rising much more quickly (in inflation-adjusted terms) than they have been in more recent times.
About 1972, we discovered we had a big problem:
Figure 8. US crude oil production based on data of the US Energy Information Administration.Oil had been our largest source of energy, and our own domestic production was dropping quite rapidly. By 1973, the Arabs had discovered our vulnerability, and the 1973 Oil Embargo began, leading to a sharp rise in gasoline prices. The US Federal Government regulated oil prices from 1973 to 1981. At the same time, a major effort was made to switch oil use to another fuel whenever possible. Electricity generation was switched to include more coal and nuclear (based on EIA data), and to remove production using oil. There was great demand for more fuel-efficient cars, leading to the import of cars from Japan (a country that had been making smaller cars for years), and the down-sizing of US cars.
Figure 9. Employment and Energy Consumption using data similar to that used in Figure 2 and 7, but for the 1972-1982 time period.As a result, the period 1972-1982 was a time when energy consumption was relatively flat, but employment rose. A big part of this rise reflected the addition of women who had not previously worked outside of the home to the work force. With the higher price of oil, salaries did not go as far, so having another family member working was helpful. According to Toosi, the percentage of women who were part of the workforce rose from 43.3% in 1970 to 51.1% 1980. Wages of women were lower than those of men (Figure 10, below), helping to hold down the average wage.
Figure 10. US Median Wages, separately for males and females, in 2010$. Based on Census Historical Income Tables: People, Table P5 – Regions by Median Income and Sex.Also, the wages of lower-paid men stopped rising in real (inflation-adjusted) terms. (The wages shown are Figure 5 are median wages–50% of wage-earners earn more than that amount and 50% year earn less.) Wages of high-paid workers, such as business executives and physicians (not shown on the chart), were still rising.
It is hard to tell what the relative impacts were of the many changes that took place in the 1972 to 1982 time period. Clearly, lower average wages (with more women in the work force) and flatter wages were a big part of the change. But there were other changes as well, including more imported manufactured goods, changes to fuels other than oil, and more efficient use of oil, all contributing to the differences we see between Figure 2 and Figure 7. The US became a net importer during this period as well, and thus began running up external debt (based on US Bureau of Economic Analysis data).
Comparing energy-employment patterns in Figure 2 and Figure 7 may be confusing for some. I show the change in the relationship in another way in Figure 11. Here I show (energy consumption/number of people employed). It shows that energy consumption per employed person was rising prior to 1972, came down for a variety of reasons in the 1972-1982 period, and is now pretty close to flat (decreasing slightly).
Figure 11. Total US energy consumption divided by number employed. Energy consumption from US EIA, number of non-farm workers from US Bureau of Labor Statistics.On a positive note, one factor that has helped keep quality of life up is increased efficiency in using energy. Homes are better insulated now. Home heating and cooling units are more efficient. Businesses have worked hard to keep energy use down, because energy is a major factor in their cost structure. For example, we read about airlines retiring their less fuel-efficient jets. Thus, even though energy consumption divided by number of workers is flat or trending slightly downward, our standard of living has risen considerably since 1970 or 1980.
Another thing that has helped improve living standards is the amount of manufactured goods we are now importing from China and other countries around the world, especially Asian countries. The amount of debt we need to keep amassing to buy all of the goods we buy abroad is a problem, however, because we are not earning enough to pay the full amount of these goods. If we could count on economic growth forever, perhaps we could simply “grow” out of this debt, but this seems increasingly unlikely, for reasons I will discuss in later posts.
The United States Hit Peak Percentage Employed in 2000
If we look at the percentage of the US population who have jobs outside the home (or self-employed farm workers), the trend is quite alarming (Figure 12):
Figure 12. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census. (This includes children and others not usually in the labor force.) 2012 is a partial year estimate.While the percentage of people with jobs was rising between 1960 and 2000, in recent years it has dropped. The recent drop seems to be at least in part related to the shift in energy consumption growth (and jobs) to the “Rest of the World,” which includes China, India, and many other developing countries and oil exporting countries. Jobs that the United States would have had, seem to have been shifted elsewhere.
The percentage of US population employed outside the home or farm has grown for a very long time. The increase started in the 1800s, as the use of coal allowed a reduction to the number of workers needed in farming, because it allowed more use of metals, enabled the use of electricity, and helped make farmers more efficient. See my post The Long-Term Tie Between Energy Supply, Population, and the Economy. See also Smil, (1994) and Lebergott (1966). Later, women increasingly joined the work force, especially after World War II.
The combination of rising energy costs (especially oil) and increased international trade gave China and other Far Eastern countries an opportunity to ramp up their manufacturing and service industries (call centers in India, for example). Jobs migrated to China and to other countries with low energy costs (thanks to lots of coal in the mix) and low costs of living, thanks in part to better solar heating.
There had always been some foreign trade, but the amount of trade increased in the late 1970s, when we started importing smaller cars from Japan, as well as more oil. It increased again later, especially after China entered the World Trade Organization in late 2001. US imports of goods and services increased from $54 billion in 1970, to $291 billion in 1980, to $616 billion in 1990, to $1.4 trillion in 2000, and to $2.7 trillion in 2011 (US Bureau of Economic Analysis).
Other Observations
Role of World Trade. Figure 4 suggests that world trade makes a huge difference in the amount of energy consumed. If we truly wanted to reduce our energy consumption (which I doubt world leaders are really interested in), we could reduce world trade through taxes on imports, or some other mechanism. The number of people employed would likely drop as well, although perhaps part of the difference could be made up by greater efficiency and by lower wages for individual workers.
The important role of world trade also brings up another issue. If world trade were, for some reason, interrupted or seriously scaled back, this would likely significantly reduce energy consumption (and employment) around the world.
Energy Consumption vs Number of Jobs Patterns by Country will Vary. I have shown US data. Patterns in other countries are likely to vary, in part because of the different specializations (amount of services compared to manufacturing, for example) of different countries, and different wage levels in different countries.
Good Intentions Aren’t Always Helpful. The Kyoto Protocol with respect to Climate Change was adopted in 1997. Figure 4 and Figure 5 suggest that adding China to the World Trade Organization had far more impact, and in the opposite direction. In fact, additional carbon taxes on goods that require high energy input may have encouraged competition in countries without such controls. Furthermore, reduced oil consumption through, say, higher taxes on gasoline, left more oil on the world market, to be used by developing countries. (This is related to “inelastic supply” of oil. Reducing demand in one area leaves more supply for other areas.)
Figure 13. Actual world carbon dioxide emissions from fossil fuels, as shown in BP’s 2012 Statistical Review of World Energy. Fitted line is expected trend in emissions, based on actual trend in emissions from 1987-1997, equal to about 1.0% per year.Figure 13 shows that while Kyoto Protocol may have helped reduce emissions in some countries, world carbon dioxide emissions have grown more than what would have been expected, based on the 1987-1997 trend in emissions. If the Kyoto Protocol influenced China’s and the rest of Asia’s decision to ramp up exports, this decision would have indirectly affected job availability in the United States, even if the US was not a signer of the Protocol.
The “Smaller Batch” Issue. If there is not enough energy to go around at prices people can afford to pay, recession seems to be nature’s way of fixing the situation. I compare the situation to a chemical formula, or to a cake recipe. If one necessary ingredient is in short supply, the economy behaves as if it is making a “smaller batch”. It contracts in a way that leaves out those who were most marginal to begin with–such as employees of discretionary industries, and borrowers who could only barely make payments on loans (subprime borrowers), and countries with the highest energy costs. Employment is reduced, and unemployed people tend to move in with friends or their family, to cut expenses. This reduces energy consumption.
Increased Wage Dispersion May Reflect Another of Nature’s Coping Mechanisms. In the animal kingdom, any “K-selected species,” such as a dog or cats or primates, (probably including humans), has an inborn instinct toward hierarchical behavior. The manifestation of this instinct tends to be greater as there is greater crowding, and greater competition for resources (Dilworth, 2009). The intent in the animal kingdom is survival of the fittest, with those at the bottom of the hierarchy being starved out, if there is not enough to go around.
It is striking to me that since the mid-1970s, we have seen what could perhaps be interpreted as increased hierarchical behavior in humans and corporations. Wage dispersion has tended to become greater since the mid-1970s, when we started encountering energy supply problems. We have also seen the growth of international businesses. These large businesses have been increasingly favorably taxed, because they can choose tax havens around the world to incorporate. All of these changes tend to concentrate wealth at the top, in large companies and in the wealth of high paid workers. Perhaps all of this is a coincidence, but the timing is striking.
Increased use of part-time and contract jobs might be considered a trend in this direction as well. Job sharing has been proposed as a way of dealing with having an inadequate number of jobs in the older industrialized countries, but this tends to act in the same way (pushes the wages of lower-paid workers down, while leaving the top wages untouched).
Economic Models. Economic models seem not to take into account the very substantial shift in percentage of the population employed. Part of economic growth on the “way up” was growth in the percentage of people employed. If economists miss this change, as well as the fact that the percentage now seems to be headed down, their models will be wrong. Expected economic growth may disappear.
The World War II baby boom generation is now reaching retirement age. This change will tend to push the percentage of population employed down further, all other things being equal.
Impact on Governments. If fewer people are employed, this is a problem for governments around the world. Governments in Europe are particularly affected now, partly because of the generous benefits they offer. The US budget deficit is very much related to this issue as well. I will write more about debt and government funding in another post.
Notes:
[1] The idea of looking at employment in relationship to the economy after reading Mario Giampietro and Kozo Mayumi’s book, The Biofuel Delusion: The Fallacy of Large-Scale Agro-Biofuel Production, Earthscan, 2009.
[2] While total energy costs are important, individual energy costs, such as gasoline cost, are important as well, because there is little short-term substitutability across sectors. For example, coal is not an option for running today’s gasoline-powered cars, and public transport is not an option in most of the US. If there is a long enough lead-time and citizens can afford the transition, substitutions might be made, but it is not something we can count very much in the short term.
Other References
Hamilton, J. D. Historical oil shocks. NBER working paper No. 16790. Feb 2011. Available from http://www.nber.org/papers/w16790.pdf
Toosi, M. A Century of Change; the US Labor Force 1950 to 2050, in Monthly Labor Review, Bureau of Labor Statistics, May 2002. Available from http://www.bls.gov/opub/mlr/2002/05/art2full.pdf
Smil, Vaclav, Energy in World History, Westview Press, 1994.
Lebergott, S. Labor Force and Employment 1800 to 1960, in Brady, D. S., Editor, Output, Employment and Productivity in the United States after 1800, National Bureau of Economic Research. (1966) Available at http://www.nber.org/chapters/c1567.pdf
Dilworth, C. Too Smart for Our Own Good, Cambridge University Press, 2009.
An Optimistic Energy/GDP Forecast to 2050, Based on Data since 1820
We talk about the possibility of reducing fossil fuel use by 80% by 2050 and ramping up renewables at the same time, to help prevent climate change. If we did this, what would such a change mean for GDP, based on historical Energy and GDP relationships back to 1820?
Back in March, I showed you this graph in my post, World Energy Consumption since 1820 in Charts.
Figure 1. World Energy Consumption by Source, Based on Vaclav Smil estimates from Energy Transitions: History, Requirements and Prospects and together with BP Statistical Data on 1965 and subsequent. The biofuel category also includes wind, solar, and other new renewables.
Graphically, what an 80% reduction in fossil fuels would mean is shown in Figure 2, below. I have also assumed that non-fossil fuels (some combination of wind, solar, geothermal, biofuels, nuclear, and hydro) could be ramped up by 72%, so that total energy consumption “only” decreases by 50%.
Figure 2. Forecast of world energy consumption, assuming fossil fuel consumption decreases by 80% by 2050, and non fossil fuels increase so that total fuel consumption decreases by “only” 50%. Amounts before black line are actual; amounts after black lines are forecast in this scenario.
We can use actual historical population amounts plus the UN’s forecast of population growth to 2050 to convert these amounts to per capita energy equivalents, shown in Figure 3, below.
Figure 3. Forecast of per capita energy consumption, using the energy estimates in Figure 2 divided by world population estimates by the UN. Amounts before the black line are actual; after the black line are estimates.
In Figure 3, we see that per capita energy use has historically risen, or at least not declined. You may have heard about recent declines in energy consumption in Europe and the US, but these declines have been more than offset by increases in energy consumption in China, India, and the rest of the “developing” world.
With the assumptions chosen, the world per capita energy consumption in 2050 is about equal to the world per capita energy consumption in 1905.
I applied regression analysis to create what I would consider a best-case estimate of future GDP if a decrease in energy supply of the magnitude shown were to take place. The reason I consider it a best-case scenario is because it assumes that the patterns we saw on the up-slope will continue on the down-slope. For example, it assumes that financial systems will continue to operate as today, international trade will continue as in the past, and that there will not be major problems with overthrown governments or interruptions to electrical power. It also assumes that we will continue to transition to a service economy, and that there will be continued growth in energy efficiency.
Based on the regression analysis:
- World economic growth would average a negative 0.59% per year between now and 2050, meaning that the world would be more or less in perpetual recession between now and 2050. Given past relationships, this would be especially the case for Europe and the United States.
- Per capita GDP would drop by 42% for the world between 2010 and 2050, on average. The decrease would likely be greater in higher income countries, such as the United States and Europe, because a more equitable sharing of resources between rich and poor nations would be needed, if the poor nations are to have enough of the basics.
I personally think a voluntary worldwide reduction in fossil fuels is very unlikely, partly because voluntary changes of this sort are virtually impossible to achieve, and partly because I think we are headed toward a near-term financial crash, which is largely the result of high oil prices causing recession in oil importers (like the PIIGS).
The reason I am looking at this scenario is two-fold:
(1) Many people are talking about voluntary reduction of fossil fuels and ramping up renewables, so looking at a best case scenario (that is, major systems hold together and energy efficiency growth continues) for this plan is useful, and
(2) If we encounter a financial crash in the near term, I expect that one result will be at least a 50% reduction in energy consumption by 2050 because of financial and trade difficulties, so this scenario in some ways gives an “upper bound” regarding the outcome of such a financial crash.
Close Connection Between Energy Growth, Population Growth, and Economic Growth
Historical estimates of energy consumption, population, and GDP are available for many years. These estimates are not available for every year, but we have estimates for them for several dates going back through history. Here, I am relying primarily on population and GDP estimates of Angus Maddison, and energy estimates of Vaclav Smil, supplemented by more recent data (mostly for 2008 to 2010) by BP, the EIA, and USDA Economic Research Service.
If we compute average annual growth rates for various historical periods, we get the following indications:
Figure 4. Average annual growth rates during selected periods, selected based on data availability, for population growth, energy growth, and real GDP growth.
We can see from Figure 4 that energy growth and GDP growth seem to move in the same direction at the same time. Regression analysis (Figure 5, below) shows that they are highly correlated, with an r squared of 0.74.
Figure 5. Regression analysis of average annual percent change in world energy vs world GDP, with world energy percent change the independent variable.
Energy in some form is needed if movement is to take place, or if substances are to be heated. Since actions of these types are prerequisites for the kinds of activities that give rise to economic growth, it would seem as though the direction of causation would primarily be:
Energy growth gives rise to economic growth.
Rather than the reverse.
I used the regression equation in Figure 5 to compute how much yearly economic growth can be expected between 2010 and 2050, if energy consumption drops by 50%. (Calculation: On average, the decline is expected to be (50% ^(1/40)-1) = -1.72%. Plugging this value into the regression formula shown gives -0.59% per year, which is in the range of recession.) In the period 1820 to 2010, there has never been a data point this low, so it is not clear whether the regression line really makes sense applied to decreases in this manner.
In some sense, the difference between -1.72% and -0.59% per year (equal to 1.13%) is the amount of gain in GDP that can be expected from increased energy efficiency and a continued switch to a service economy. While arguments can be made that we will redouble our efforts toward greater efficiency if we have less fuel, any transition to more fuel-efficient vehicles, or more efficient electricity generation, has a cost involved, and uses fuel, so may be less common, rather than more common in the future.
The issue of whether we can really continue transitioning to a service economy when much less fuel in total is available is also debatable. If people are poorer, they will cut back on discretionary items. Many goods are necessities: food, clothing, basic transportation. Services tend to be more optional–getting one’s hair cut more frequently, attending additional years at a university, or sending grandma to an Assisted Living Center. So the direction for the future may be toward a mix that includes fewer, rather than more, services, so will be more energy intensive. Thus, the 1.13% “gain” in GDP due to greater efficiency and greater use of “services” rather than “goods” may shrink or disappear altogether.
The time periods in the Figure 5 regression analysis are of different lengths, with the early periods much longer than the later ones. The effect of this is to give much greater weight to recent periods than to older periods. Also, the big savings in energy change relative to GDP change seems to come in the 1980 to 1990 and 1990 to 2000 periods, when we were aggressively moving into a service economy and were working hard to reduce oil consumption. If we exclude those time periods (Figure 6, below), the regression analysis shows a better fit (r squared = .82).
Figure 6. Regression analysis of average annual percent change in world energy vs world GDP excluding the periods 1980 to 1990 and 1990 to 2000, with world energy percent change the independent variable.
If we use the regression line in Figure 6 to estimate what the average annual growth rate would be with energy consumption contracting by -1.72% per year (on average) between 2010 and 2050, the corresponding average GDP change (on an inflation adjusted basis) would be contraction of -1.07% per year, rather than contraction of -0.59% per year, figured based on the regression analysis shown in Figure 5. Thus, the world economy would even to a greater extent be in “recession territory” between now and 2050.
Population Growth Estimates
In my calculation in the introduction, I used the UN’s projection of population of 9.3 billion people by 2050 worldwide, or an increase of 36.2% between 2010 and 2050, in reaching the estimated 42% decline in world per capita GDP by 2050. (Calculation: Forty years of GDP “growth” averaging minus 0.59% per year would produce total world GDP in 2050 of 79.0% of that in 2010. Per capita GDP is then (.790/ 1.362=.580) times 2010′s per capita income. I described this above as a 42% decline in per capita GDP, since (.580 – 1.000 = 42%).)
Population growth doesn’t look to be very great in Figure 4, since it shows annual averages, but we can see from Figure 7 (below) what a huge difference it really makes. Population now is almost seven times as large as in 1820.
Figure 7. World Population, based on Angus Maddison estimates, interpolated where necessary.
Since we have historical data, it is possible to calculate an estimate based on regression analysis of the expected population change between 2010 and 2050. If we look at population increases compared to energy growth by period (Figure 8), population growth is moderately correlated with energy growth, with an r squared of 0.55.
Figure 8. Regression analysis of population growth compared to energy growth, based on annual averages, with energy growth the independent variable.
One of the issues in forecasting population using regression analysis is that in the period since 1820, we don’t have any examples of negative energy growth for long enough periods that they actually appear in the averages used in this analysis. Even if this model fit very well (which it doesn’t), it still wouldn’t necessarily be predictive during periods of energy contraction. Using the regression equation shown in Figure 8, population growth would still be positive with an annual contraction of energy of 1.72% per year, but just barely. The indicated population growth rate would slow to 0.09% per year, or total growth of 3.8% over the 40 year period, bringing world population to 7.1 billion in 2050.
Energy per Capita
While I did not use Energy per Capita in this forecast, we can look at historical growth rates in Energy per Capita, compared to growth rates in total energy consumed by society. Here, we get a surprisingly stable relationship:
Figure 9. Comparison of average growth in total world energy consumed with the average amount consumed per person, for periods since 1820.
Figure 10 shows the corresponding regression analysis, with the highest correlation we have seen, an r squared equal to .87.
Figure 10. Regression analysis comparing total average increase in world energy with average increase in energy per capita, with average increase in world energy the independent variable.
It is interesting to note that this regression line seems to indicate that with flat (0.0% growth) in total energy, energy per capita would decrease by -0.59% per year. This seems to occur because population growth more than offsets efficiency growth, as women continue to give birth to more babies than required to survive to adulthood.
Can We Really Hold On to the Industrial Age, with Virtually No Fossil Fuel Use?
This is one of the big questions. “Renewable energy” was given the name it was, partly as a marketing tool. Nearly all of it is very dependent on the fossil fuel system. For example, wind turbines and solar PV panels require fossil fuels for their manufacture, transport, and maintenance. Even nuclear energy requires fossil fuels for its maintenance, and for decommissioning old power plants, as well as for mining, transporting, and processing uranium. Electric cars require fossil fuel inputs as well.
The renewable energy that is not fossil fuel dependent (mostly wood and other biomass that can be burned), is in danger of being used at faster than a sustainable rate, if fossil fuels are not available. There are few energy possibilities that are less fossil fuel dependent, such as solar thermal (hot water bottles left in the sun to warm) and biofuels made in small quantities for local use. Better insulation is also a possibility. But it is doubtful these solutions can make up for the huge loss of fossil fuels.
We can talk about rationing fuel, but in practice, rationing is extremely difficult, once the amount of fuel becomes very low. How does one ration lubricating oil? Inputs for making medicines? To keep business processes working together, each part of every supply chain must have the fuel it needs. Even repairmen must have the fuel needed to get to work, for example. Trying to set up a rationing system that handles all of these issues would be nearly impossible.
GDP and Population History Back to 1 AD
Angus Maddison, in the same data set that I used back to 1820, also gives an estimate of population and GDP back to 1 AD. If we look at a history of average annual growth rates in world GDP (inflation adjusted) and in population growth, this is the pattern we see:
Figure 11. Average annual growth in GDP in energy and in population, for selected periods back to the year 1 AD.
Figure 11 shows that the use of fossil fuels since 1820 has allowed GDP to rise faster than population, for pretty much the first time. Prior to 1820, the vast majority of world GDP growth was absorbed by population growth.
If we compare the later time periods to the earlier ones, Figure 11 shows a pattern of increasing growth rates for both population and GDP. We know that in the 1000 to 1500 and 1500 to 1820 time periods, early energy sources (peat moss, water power, wind power, animal labor) became more widespread. These changes no doubt contributed to the rising growth rates. The biggest change, however, came with the addition of fossil fuels, in the period after 1820.
Looking back, the question seems to become: How many people can the world support, at what standard of living, with a given quantity of fuel? If our per capita energy consumption drops to the level it was in 1905, can we realistically expect to have robust international trade, and will other systems hold together? While it is easy to make estimates that make the transition sound easy, when a person looks at the historical data, making the transition to using less fuel looks quite difficult, even in a best-case scenario. One thing is clear: It is very difficult to keep up with rising world population.
Evidence that Oil Limits are Leading to Declining Economic Growth
The usual assumption that economists, financial planners, and actuaries make is that future real GDP growth can be expected to be fairly similar to the average past growth rate for some historical time period. This assumption can take a number of forms–how much a portfolio can be expected to yield in a future period, or how high real (that is, net of inflation considerations) interest rates can be expected to be in the future, or what percentage of GDP the government of a country can safely borrow.
But what if this assumption is wrong, and expected growth in real GDP is really declining over time? Then pension funding estimates will prove to be too low, amounts financial planners are telling their clients that invested funds can expect to build to will be too high, and estimates of the amounts that governments of countries can safely borrow will be too high. Other statements may be off as well–such as how much it will cost to mitigate climate change, as a percentage of GDP–since these estimates too depend on GDP growth assumptions.
If we graph historical data, there is significant evidence that growth rates in real GDP are gradually decreasing. In Europe and the United States, expected GDP growth rates appear to be trending toward expected contraction, rather than growth. This could be evidence of Limits to Growth, of the type described in the 1972 book by that name, by Meadows et al.
Figure 1. World Real GDP, with fitted exponential trend lines for selected time periods. World Real GDP from USDA Economic Research Service.
Trend lines in Figure 1 were fitted to time periods based on oil supply growth patterns (described later in this post), because limited oil supply seems to be one critical factor in real GDP growth. It is important to note that over time, each fitted trend line shows less growth. For example, the earliest fitted period shows average growth of 4.7% per year, and the most recent fitted period shows 1.3% average growth.
In this post we will examine evidence regarding declining economic growth and discuss additional reasons why such a long-term decline in real GDP might be expected.
Connection of GDP Growth with Oil Supply Growth
It should not be surprising to find that there is a close tie between GDP growth and oil supply growth. Oil is used in many ways, from the manufacture of goods (synthetic cloth, pharmaceuticals, chemicals, asphalt for roads), to transport of goods and people, to food production (plowing, harvesting, weed killers, diesel irrigation), to operating construction equipment, to mining. While it is possible to substitute away from oil in some situations, or to find more efficient ways of using the oil, we have literally trillions of dollars of machinery in the world that uses oil right now. Because of this, the rate of substitution away from oil is necessarily very slow.
James Hamilton has shown that in the United States, 10 out of 11 post-World War II recessions were associated with oil price spikes. He has also published a paper specifically linking the recession of 2007-2008 with stagnating world oil production and the resulting spike in oil prices. I wrote an academic paper, Oil Supply Limits and the Continuing Financial Crisis, explaining some of the connections I see involved.
One connection between oil supply and the economy is the fact that when oil prices rise, indicating short supply, salaries don’t rise at the same time. Fuel for commuting and food (which is grown and transported using oil) are necessities, and their prices tend to rise as oil prices rise. Consumers cut back on buying discretionary goods and services, so as to have enough money for these necessities. This leads to people being laid off from work in “discretionary” industries, and a whole host of other effects we associate with recession.
Figure 2, below, shows world oil supply (broadly defined, including biofuels) with trend lines fitted to periods exhibiting similar growth patterns. It is these same time periods that I fit trend lines to in Figure 1, with one small exception. I had consistent real GDP data going back only to 1969, so stopped at 1969 rather than 1965 with GDP.
Figure 2. World oil supply with exponential trend lines fitted by author. Oil consumption data from BP 2012 Statistical Review of World Energy.
What we see in Figure 2 is a pattern of falling growth rates in oil supply rates, similar to the declining pattern we saw for real GDP in Figure 1. In Figure 2, the growth in oil supply falls from 7.8% per year in the first fitted period, to 0.4% per year in the last fitted period. The “gaps” that I didn’t fit lines to were periods of falling oil consumption. A glance up at Figure 1 shows that these periods where no line was fit (that is, the places where the black “actual” data shows through on Figure 1) correspond to relatively flat GDP periods–as a person would expect, if high prices/short supply are associated with recession.
A person wouldn’t expect the two types of growth rates (oil supply and real GDP growth) to be exactly the same. The GDP growth rate would likely be higher than the oil growth rate because the oil growth rate is theoretically depressed for several reasons: continued switching from oil to cheaper fuel (often electricity); improvements in energy efficiency; and a gradual change to more of a service economy. (Services use less energy per unit of GDP than the manufacturing of goods.)
If we compare the two fitted growth rates (world oil consumption and world real GDP), this is what the comparison looks like:
Figure 3. World Oil Supply Growth vs Growth in World GDP, based on exponential trend lines fitted to values for selected groups of years. World GDP based on USDA Economic Research Service data. Earliest time-period uses 1969 to 1973 for both oil and GDP for consistency.
Downtrend in Real GDP May Be Understated
The last thing governments want to do is to let their constituents know that the economy is currently doing less well than in the past. There are (at least) two ways that governments can increase real GDP:
1. Understate their inflation estimates. The way “real GDP” is calculated involves first figuring GDP based on how much goods and services increased during the period in question, and then “backing out” the amount of the GDP increase that was due to inflation. There is latitude in figuring out how much inflation to reflect. For example, in the early years, my understanding is that if the price of beef went up, it directly affected the calculation of the inflation rate; now, there is an implicit assumption that they buyer will be willing substitute chicken to some extent instead, keeping the inflation assumption lower and the real GDP increase (as calculated) higher. There are many other things that be manipulated as well–for example, how the cost of housing goes into the calculation. The site Shadowstats gives one view of how changes since 1983 distort reported US real GDP amounts.
2. Encourage lots of additional debt. Real GDP looks at the amount of goods and services are produced and sold, not how they are paid for. If the government sponsors a program to provide mortgages to people who have no chance of ever paying them back, and this results in the sale of more houses, this will help real GDP–at least until the borrowers start defaulting on their loans. Increases in other types of loans work to increase real GDP too, including auto loans, student loans, and government debt.
Besides increasing real GDP, increasing debt also acts to increase employment, since it takes workers to build the things that people who get the loans can now afford. In other worlds, the higher loan amounts increase employment of people who build new cars or new houses, or who teach at universities.
The problem with encouraging additional debt is that it at some point the amount of debt becomes too much for holders of the debt to service, and they start cutting back on other purchases. For example, recent graduates with a lot of debt are likely not to be in the market for new homes unless they have very high-paying jobs. So, at some point, additional debt becomes self-defeating, especially when the economy is not growing very quickly. Too much debt seems to be one of the limits, besides oil limits, we are reaching now.
Other Factors Holding Down Real GDP Growth
We live in a finite world, and this fact imposes limits. The amount of land suitable for cultivation is not expanding over time. There is limited fresh water for irrigation and other uses. In many areas, water tables are dropping. Ores are declining in quality because the highest quality ore tends to be extracted first.
Pollution, including carbon dioxide pollution, leads to attempted substitution by higher cost alternatives. It also leads to the addition of devices such as expensive filters. Both of these add costs, without increasing the amount of usable goods and services (in the usual definition) produced. Peoples’ funds for discretionary goods can be expected to drop as a result, (since funding through taxes or other approaches is mandatory) putting downward pressure on real GDP growth.
There is also the issue of how many new entrants are added to the paid labor force. If, for example, in the early years, many homemakers are being added to the paid labor force, their addition will tend to raise GDP growth, because the goods or services the homemaker creates will be added to real GDP, as well as the cost of daycare for her children, if this is purchased. Once homemakers have been pretty well absorbed into the labor force, that positive influence on real GDP will disappear. If the number of people employed starts declining (because of more retirees, or because people can’t find jobs), or fails to rise as quickly, this will tend to slow economic growth.
Oil Importers are Likely to Have Lower Economic Growth than Others
There are a couple of reasons why oil importers can be expected to have lower economic growth than other countries, especially when oil prices are high. First, oil importers have the problem of needing to pay exporters for crude oil or oil products. The revenue that is spent on higher priced crude oil could have been spent on discretionary expenditures. It is unlikely that the oil exporters will reinvest the money in the economy of the buyer of its oil–they are just as likely to reinvest it in their own country.
The second reason is that oil importers tend to be the countries like the United States and Europe that “developed their economies” early on. Since these countries have hired women in large numbers since World War II, most homemakers who want jobs already have them. If birth rates have slowed, these countries may be seeing disproportionate growth in the retiree population and fewer workers in ages where employment usually takes place.
In the United States, if we do curve fitting (of the type shown in Figures 1 and 2) to the reported number of non-farm workers employed in the United States (from the Bureau of Labor Statistics), and compare these employment trend rates with the corresponding trend rate in US GDP growth, we find a high correlation:
Figure 4. US growth in number of non-farm workers versus growth in real GDP. US real GDP from US Bureau of Economic Activity; Non-Farm Employment from US Bureau of Labor Statistics
Note that decreased growth in the number of employees could be taking place for any number of reasons–less growth in illegal immigrants, fewer homemakers going back to work, more people going to college, or more people retiring or taking disability coverage, or just generally discouraged.
It is my observation that the number of workers in the US today seems to depend on the number of jobs available. If jobs in some fields are being increasingly shipped to lower-cost countries–the ones we will see in Figure 7 are now using a disproportionate share of the world’s oil–these jobs will not be available, no matter how many workers might be willing to take them, if they were available.
If we look at the trend in real GDP growth for three major areas (United States, European Union-27, and Remainder = World minus the US and EU-27) , we discover that indeed, all three of the areas show a downward trend in real GDP over time (Figure 4, above). The GDP growth of the EU-27 and the US start from a lower level, and drop off more in the 2007-2011 period, (when the price of oil imports was more of an issue) than the “Remainder” grouping.
Figure 5. Annual growth in world oil supply compared to annual growth in real GDP, both based on exponential trend fits to values for selected years. Oil supply data from BP oil consumption data in 2012 Statistical Review of World Energy; real GDP from USDA Economic Research Service.
One reason why the Remainder-GDP may be doing better than the others is that heavy manufacturing, and the jobs that go with heavy manufacturing, are finding their way to lower cost countries. High oil prices may also be discouraging oil importers from purchasing oil. If we look at oil consumption for the three groups, this is what we see:
Figure 6. Comparison of oil consumption by area (United States, European Union -27, and rest of the world), based on BP’s 2012 Statistical Review of World Energy
Much of heavy manufacturing has been moved out of the United States and the European Union. Figure 7 below shows that the rest of the world is now using well over half of the world’s oil:
Figure 7. Percentage shares of world oil consumption based on BP’s 2012 Statistical Review of World Energy.
Going Forward
We have seen (Figure 5, above) that all three grouping shown (United States, EU-27, and the rest of the world) are showing declining real GDP patterns, similar to the world pattern. GDP growth rates of the United States and EU-27 are both at lower levels than the World and Remainder, for reasons explained.
It is hard to see why current trends wouldn’t continue, with growth in real GDP continuing to decrease for all three groups. Regardless of the hoopla in the United States press about supposed growth in oil supply, the fact remains that growth in world oil supply has been worrisome for many for roughly 40 years, since US oil production started decreasing in 1970. It is hard to believe that the latest “fix” is going to turn things around. The typical pattern in oil supply is for extraction in an area to hit a maximum (or perhaps a plateau) and then decline.
Figure 8. Crude oil production in the US 48 states (excluding Alaska and Federal Offshore), Canada, and Europe, based on data of the US Energy Information Administration.
Figure 8 shows (among other things) how steep the US drop in oil production in the contiguous 48 states was starting in 1970. This decline set the stage for the 1973 Arab Oil Embargo, since oil-producing countries now had the upper hand. Production in Alaska and in the Gulf of Mexico eventually helped offset part of the drop, but the Alaska production (not shown) is now declining as well. Change in the balance of power regarding oil production following the decline in US production, and recognition that increased imports would cause balance of payments problems, seem to have influenced the US and Europe’s decision to focus on service industries and on industries with little oil usage, holding their oil usage down (Figure 6).
Figure 8 also shows how new onshore techniques–fracking and other enhanced oil recovery–are affecting US crude oil production. While US-48 states crude oil production has shown a 25% increase since 2006, this production is still only 39% of the 1970 amount, and about equal to 1942 production. Oil production in Canada (which includes the oil sands) is rising, but not very rapidly, from a low base. It is hard for small increases such as those of Canada and the US-48 to make up for major declines in production occurring in Europe and elsewhere. World oil supply would be increasing by more than a fraction of 1% per year if changes frequently noted in the US press were really making an important difference in world supply.
If growth in world oil supply is constrained and may possibly begin to fall in total in not too many years, this adds to the downward pressure on world GDP growth for all of the areas of the world. Thus, re-examination of GDP growth assumptions seems to be in order. Perhaps slow recent growth is not an aberration–perhaps future real GDP growth will be even lower.
New IMF Working Paper Models Impact of Oil Limits on the Economy
The International Monetary Fund (IMF) recently issued a new working paper called “The Future of Oil: Geology versus Technology” (free PDF), which should be of interest to people who are following “peak oil” issues. This is a research paper that is being published to elicit comments and debate; it does not necessarily represent IMF views or policy.
The paper considers two different approaches for modeling future oil supply:
- The economic/technological approach, used by the US Energy Information Administration (EIA) and others, and
- The geological view, used in peak oil forecasts, such as forecasts made by Colin Campbell and forecasts made using Hubbert Linearization.
The analysis in the IMF Working Paper shows that neither approach has worked perfectly, but in recent years, forecasts of oil supply using the geological view have tended to be closer than those using the economic/technological approach. Since neither model works perfectly, the new paper takes a middle ground: it sets up a model of oil supply where the amount of oil produced is influenced by a combination of (1) geological depletion and (2) price levels.
This blended model fits recent production amounts and recent price trends far better than traditional models. The forecasts it gives are concerning though. The new model indicates that (1) oil supply in the future will not rise nearly as rapidly as in the pre-2005 period and (2) oil prices are likely to nearly double in “real” (inflation-adjusted) terms by 2020. The world economy will be in uncharted territory if this happens.
It seems to me that this new model is a real step forward in looking at oil supply and the economy. The model, as it is today, points out a definite problem area (namely, the likelihood of oil high prices, if growth in oil production continues to be constrained below pre-2005 rates of increase). The researchers also raise good questions for further analysis.
At the same time, I am doubtful that the world GDP forecast of the new model is really right–it seems too high. The questions the authors raise point in this direction as well. Below the fold, I discuss the model, its indications, and some shortcomings I see.
The Two Models
Economic /Technological Approach. With the economic/ technological approach, the assumption is made that high oil prices will encourage substitution and/or new oil production. Because of this, high oil prices are not expected to persist. Instead, the most important consideration in determining future oil supply is the level of future demand. The level of future demand, in turn, is primarily driven by anticipated GDP growth, since world GDP growth and world oil production growth tend to be highly correlated.
In effect, models of this type assume that whatever oil supply is needed will be available; they don’t consider the possibility that geological considerations may limit oil supply over the long term. As an example of how well these models have worked for prediction, the paper shows a graph of historical EIA forecasts (Figure 1, below).
Figure 1. Graph showing that oil production forecasts by the US Energy Information Administration have been revised downward, year after year, from paper.
Each year, EIA’s forecasts have been adjusted downward, because actual oil supply growth was lower than forecast.
Models Based on the Geological View. The paper considers forecasts of oil supply such as those of Colin Campbell (shown in ASPO-Ireland Newsletters) and forecasts based on Hubbert Linearization to be models based on the Geological View. The paper observes that forecasts of oil supply based on geological view have tended to be too low, but not by as big a margin as those made using the economic/technological approach. As an example, it gives the following graph of changes in forecasts by Colin Campbell.
Figure 2. Colin Campbell Forecasts of Future Oil Supply, from paper.
A review of the two methods by the IMF group indicates that neither works precisely as hoped, but each has some validity. While oil production did not rise as fast as the economic/technological view would predict, higher oil prices have allowed oil production to stay on more or less a plateau after 2005, rather than declining as predicted by geological methods. The new model in the IMF Working Paper combines indications from both points of view, using an approach that allows them to estimate the relative contribution of geological impacts vs higher prices.
How the Two Methods are Combined
The oil supply equation in the new model is set up so that there are two different ways that the forecast oil supply can change. There is a downward tug from oil depletion at the same time that there is an upward tug from oil prices. It is expected that in the short run, high prices will get producers to utilize spare capacity, and over a longer period (estimated at 4 to 6 years), it will get producers to add new capacity. I will not try to explain all the variables and coefficients, but the blended supply equation is
Figure 3. Oil Supply Equation
In the above equation, qt is the quantity of oil produced in year t and Qt is the cumulative quantity produced in year t, so the ratio qt / Qt produces the familiar downward-sloping line one sees in charts used for Hubbert Linearization. The first two terms to the right of the equal sign are the ones based on the geological approach to depletion. The later terms depend on pt, which is price of oil at the time “t”. Adding the pt terms tends to raise the line at later periods so it does not slope downward as quickly as if depletion were the only factor affecting the relationship.
Growth Rate of GDP
In the model, high oil prices have some impact on GDP, but as we will see in Figure 5, below, not very much. There are two places in modeling GDP where high oil prices come into play. The first is in the Potential Growth Rate of GDP. According to the paper,
The growth rate of potential world GDP is specified as fluctuating around an exogenous long-run trend, with oil price changes making the fluctuations more severe. Oil prices are allowed to have persistent but not permanent effects on the growth rate of GDP. . . The estimated steady state world potential growth rate of potential GDP equals four percent. The average annual growth rate of real oil prices, which is the growth in oil prices at which the model assumes zero effect of oil prices on output growth, is seven percent. The results indicate that an oil price growth that is higher than that historical average has a small but significant negative effect on the growth rate of potential. [emphasis added]
Interesting–the model assumes real oil price growth of 7% per year has no impact growth rate of GDP. Perhaps this is supposed to be picked up by the second place where high oil prices come into forecasting GDP, called Output Gap. This is an excerpt from what the paper says about Output Gap:
Apart from allowing for an effect of higher oil prices on the growth rate of potential output, the model also allows for the possibility that higher oil prices can cause fluctuations in the amount of excess demand in the economy. . . . Similar to the equation for potential, the coefficient estimates show that high oil prices have a small but significant negative effect on excess demand, and that this effect is highly persistent.
Model Output
When all is said and done, what does the IMF model forecast?
Figure 4. Oil Output Forecast with Error Bands, (in gigabarrels per year), from report.
The forecast for future world oil supply, shown in Figure 4 above, is similar to EIA’s most recent forecast of world oil supply (but lower than earlier EIA estimates). Oil supply is expected to rise a 0.9% per year. An alternate tighter oil supply forecast is given as well.
The forecast for world GDP growth (shown in Figure 5 below) is not too much different from standard estimates, either. The point forecast is about four percent per year.
Figure 5. World GDP (in logs) forecast with error bands, with 2011 world GDP normalized to 1.00, from report.
The thing that is different in this analysis is oil prices (in inflation adjusted dollars). Forecast oil prices are expected to be much higher that what the EIA is estimating.
Figure 6. Oil price forecast with error bands (in 2011 Real $) from report.
The report points out that these high oil prices are a real concern. The report says:
The predicted average annual growth rates of oil output are well below the historical forecasts of EIA, but above the forecasts of proponents of the geological view. . . . However, this projected positive trend in oil production comes at a steep cost, because the model finds that it requires a large increase in the real price of oil, which would have to nearly double over the coming decade to maintain an output expansion that is modest in historical terms. Such prices would far exceed even the highest prices seen in 2008, which according to Hamilton (2009) may have played an important roll in driving the world economy into a deep recession.
Need for Enhancements /Areas of Concern Pointed Out by Authors of Paper
The authors raise of the IMF Working Paper raise the following issues:
1. Impact of high oil prices on GDP growth. The expected impact of a continued rise in oil prices on forecast GDP is small, according to the model as constructed. Perhaps the relationship should be non-linear (convex) instead of linear. More generally, what is the importance of the availability of oil inputs for continued overall GDP growth? The report mentions studies showing the close connection between energy growth and GDP growth, such as by Ayers and Warr.
2. Substitutability for oil. What is the substitutability between oil and other factors of production? Is it reasonable to assume that elasticities of substitution will become greater over time? Or is there a possibility that there are limits to the extent of substitutability of machines and labor for energy?
3. Is there a pain barrier? At some point, does the effect of high oil prices on the economy change, and become much worse?
4. Independence of Technology from Fossil Fuel Availability. Perhaps a reduction in fossil fuel availability will negatively affect the availability of future technology improvements since, for example, it takes fossil fuels to make new more efficient cars. This has not been reflected in the model.
5. Smaller Amounts of “Spare” Oil Capacity Available in the Future. The model reflects amounts of OPEC spare oil production capacity available in the past. In the future, less spare production capacity seems likely.
My Comments on the Paper
The IMF is to be commended on putting together this analysis. To me, the big step forward is that questions about the impact of geological depletion of oil on the economy are starting to be addressed. The fact that the paper also points out the level to which oil prices will need to rise, if oil production is to rise at 0.9% a year between now and 2020, is important as well.
Some of the issues I see that aren’t addressed in the paper:
1. Factors underlying world long term growth rate, other than energy. It would seem to me that there are a number of factors which have permitted long term world economic growth, over and above the economic growth enabled by fossil fuels. Some of the following seem to be diminishing in importance, so perhaps the forecast of a 4% world GDP growth rate going forward is too high, apart from oil supply issues:
a. Trend Toward Globalization. The trend toward globalization has allowed greater synergies to occur, and thus has contributed to world GDP growth. The trend toward globalization started over 4,000 years ago, with trade from northwest India to the Mediterranean region (Chew). In recent years, we seem to be approaching a maximum level of world globalization. In fact, higher price of oil has been raised as an issue cutting back on trade of bulky, low valued items (Rubin). Higher cost of oil may also have an adverse impact of commercial airline flights for international companies to oversee their distant operations, because the costs of these flights is now supported by a large number of international tourists, and this international tourist trade may dry up. Thus, the trend toward globalization that has been supporting world GDP growth in the past may not persist, and may even reverse.
b. Growth in Education. Part of what has supported world GDP growth is likely growth in education, since literate workers are better able to use technology. There is evidence that the advanced economies are now plateauing in terms of educational level of new workers, relative to the existing work force. Even less advanced economies, such as China, are showing much higher levels of literacy. (See this post). To the extent that educational levels are reaching a plateau, the “boost” to historical GDP rates that came from this factor can be expected to be lessened.
c. Growth in Debt. GDP growth is enabled by debt growth. Consumers are able to purchase more goods and services, with increased levels of debt; businesses are able to increase their investment in new plants and equipment through more debt; and governments are able to undertake the development of new construction, roads, and other development, through the addition of more debt. But we seem to be reaching limits on debt growth. Theory also suggests that higher levels of debt are enabled by higher economic growth rates (Tverberg). Governments have been aware that increased borrowing can be used to pump up economic growth, but limits are being reached on the amount of debt that can be added. To the extent that debt fails to grow as quickly in the future as it has in the past, this can be expected to have an adverse impact on world GDP growth rates.
d. Quantitative Easing and Extraordinarily Low Interest Rates. An argument can be made that GDP growth of advanced economies in recent years has been held up by quantitative easing and extraordinarily low interest rates. These would seem to be a temporary fixes that cannot be continued long-term. If this is the case, world GDP rates can be expected to be lower in the future, regardless of oil supply growth.
2. Limits on Substitutability of Other Fossil Fuels for Oil. The paper does not address the issue of whether there are limits of substitutability of other fossil fuels for oil. Stationary (as opposed to transportation) uses of oil have been substituting away from oil for years. There are millions of vehicles and other machines that use oil currently in operation. There will be a high cost in replacing these before the end of their normal lifetimes. Also, significant fossil fuels will be required for making vehicles and supporting infrastructure that use another fossil fuel source.
3. Limits on Capital Available for New Investment in Substitutes for Oil, and in New Oil Production. In recent years, we have made heavy use of debt financing for new investment. Government subsidies have also been used. To the extent that debt financing and government subsidies are less available, less investment can be expected in the future.
4. Impact of High Oil Prices on Diverse Parts of the Economy, Not Reflected in the Model. For example, prices of homes may be affected by high oil prices. People with less discretionary income are less likely to “trade up” to a more expensive homes, so high oil prices seem to be one of the reasons for the decline in home prices (Tverberg). Lower home prices affect ability of homeowners to borrow against the value of their homes for new purchases, so affect GDP, apart from oil price’s direct impact on the number of new homes built.
5. Which comes first: Oil Growth or Economic Growth? The assumption in the model is that GDP growth drives oil growth. While this is true, it is to some extent a “chicken” and “egg” situation. Perhaps the availability of inexpensive oil and other fossil fuels is one of the main drivers of economic growth (in addition to the other drivers I mention in the subparts of Item 1 above). Perhaps the cycle is started by the availability of cheap fossil fuels for industrial use and continued by the increased demand to which this growth gives rise.
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I appreciate the work that has been done by the IMF in putting together this model and look forward to seeing further enhancements to the model. The work that has been done and the questions that are being raised are important ones.
I expect that commenters to this post will be able to point out other plusses and minuses of the model. The report itself is very interesting. Again, it can be found at The Future of Oil: Geology versus Technology.