The New Abnormal
Off the keyboard of James Howard Kuntsler
Published on Clusterfuck Nation on May 20, 2013
Discuss this article at the Favorite Dishes Smorgasbord inside the Diner
The collective state of mind in the USA these days may be even more peculiar than what went on in Germany in the early 1930s, when the Nazis were freely elected to lead the country and reconstructed the battered national psyche into a superman cult that soon beat a path to mass death and ruin. America has its own way of going crazy. We don’t goose-step to tragedy; we coalesce into an insane clown posse and stumble into it by pratfall — juggaloes dancing backwards off the cliff edge.
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Reaching Limits in a Finite World
Off the keyboard of Gail Tverberg
Published on Our Finite World on May 6, 2013
Discuss this article at the Epicurean Delights Smorgasbord inside the Diner
We don’t usually think about it, but we live in a finite world. In other words, in theory we can count precisely how many atoms make up the earth. We can also theoretically count how many humans live on earth and how many of any other species live on earth at a particular point in time.
At some point, in a finite world, we start reaching limits. There are now about seven billion people in the world. We could probably add some more, but how many? What is it that limits our ability to add more people to the world we live in today?
Too Much Population “Morphs” to an Energy and Financial Limit
One obvious guess as to what might limit world population is the amount fresh water that is available. If we don’t have enough fresh water available, we can’t continue to expand population.
The amount of fresh water that is available can be changed, though, by adding desalination plants. There are many other ways of getting fresh water. To give an extreme example, the amount of fresh water available could be increased by melting ice in Antarctica and importing it by ship. Either of these solutions would require energy in an appropriate form—either to run the desalination plant, or to melt the ice and transport it by ship. Thus the fresh water shortage, at least for the foreseeable future, can be worked around if there is sufficient energy available of the right type.
The other not-so-minor detail is that the cost of desalination or of importing melted ice from Antarctica needs to be inexpensive enough that users of fresh water can afford it. In order for this to be the case, the cost of the appropriate type of energy must be extremely inexpensive.
We can think of other kinds of limits to population growth as well. For example, carbon dioxide limits. In theory, there are ways around carbon dioxide limits. For example, assuming current research projects are successful, we can build carbon capture and storage facilities and change our electricity generating plants so that the carbon dioxide that is emitted can be captured and stored underground.
Here, too, there are energy limits and cost limits. Carbon has a molecular weight of 12, while carbon dioxide has a molecular weight of 44. Because of this, if we create carbon dioxide from coal, the carbon dioxide we produce is much heavier and bulkier than the coal that we burned to make the electricity. It will take a lot of energy to store this gas underground in a suitable place. Thus, we have another problem that can be handled, if there is enough cheap energy of the right type available.
Almost any kind of obstacle to increased human population that we can think of has an energy-based work-around. Will people be so crowded that disease transmission will be a problem? There are workarounds: better water treatment plants and sewer treatment plants, especially in the poorer parts of the world; more immunizations; more and better hospitals; antibiotics for all those who need them. These solutions also require energy, as well as other inputs (which indirectly require energy as well). The difficulty is making them affordable for the people who need them.
If the problem is not enough food, perhaps because of degraded soil, there are energy-based workarounds as well. Food can be imported from a distance. More fertilizers and soil amendments (either made using fossil fuels, or transported using fossil fuels) may be used. Irrigation, which uses either diesel fuel or electricity to pump water may be used to pump water to too dry areas, to increase food production per acre. In some cases, artificial soil can be created, and plants grown in a green house—again requiring much energy. The issue again gets to be whether consumers can afford the food produced using this more energy-intensive procedure.
The Problem With Degraded Resource Supplies
Degraded resource supplies occasionally run out—for example, an aquifer may run dry. A more common situation, though, is that resources become progressively more expensive to extract as we approach limits. We tend to extract the easiest to extract (and thus cheapest-to extract) resources first. These resources are the highest quality ones, in the easiest to access locations. We then move on to more expensive to extract resources. A similar pattern applies to many types of resources, including ore used in making metals, oil, gas, coal, and uranium.
When we analyze resources of a given type, say uranium, we find that there are always more resources available. The problem is that they are increasingly expensive to extract because the ore is of lower concentration, or is located in a harder to reach area, or there is some other problem involved.
We have illustrated this situation in Figure 1, as a triangle with a dotted line at the bottom, because of the uncertain cut-off regarding how much is available. The cut-off is really a price cut-off. At some point, the resource becomes too expensive for customers to afford products made with it.
FIGURE 1 – Triangle of Available Resources
Figure 1. Triangle of available resources, with dotted line indicating uncertain financial cut-off.A company starts from the top of this triangle, extracting whatever resource is involved. A company can “see” a little way ahead, as it looks down toward the bottom of the triangle. The company will report reserves which are continually increasing because the width of the triangle keeps getting wider, even though these reserves are of lower quality and can only be extracted in a more energy-intensive way. The question then becomes whether customers can really afford products made with these expensive-to-extract resources.
The Broader Energy Picture
Energy is pretty amazing. Energy is what allows work of any kind to be done, from making a clay pot by hand, to baking a cake, to creating a carbon capture and storage facility. Humans by themselves are able to produce some energy, because of the food we eat. But we are also able to leverage the energy that our own bodies produce with energy from other sources, such as from burning biomass. We learned to burn biomass a very long time ago, over 1,000,000 year ago.
If humans were like other large primates, there would be only 100,000 or 200,000 of us, rather than 7 billion of us. We would live in an area to which we are biologically adapted, most likely a very warm part of Africa. Humans’ population is much higher, because once we learned to control fire, we were able to settle areas of the world that would otherwise be too cold or dry to live in, and we were able to increase population densities through energy-related techniques we developed.
One thing we learned to do was cook part of our food supply. This had many advantages. Unlike apes, we no longer needed to spend literally half of our day chewing. This freed up time for other activities, like tool-making, hunting, and clothing making. It also allowed the human body to evolve in a way that allowed a bigger brain and smaller digestive organs. Gradually we used our improved brain to develop other techniques such as making heat-tempered stone tools, which were sharper than other stone tools, and teaching dogs to help us with hunting for food. All of these approaches to using external energy allowed humans to leverage our own puny energy supply from food with energy supply from other sources and gain an advantage over other animals.
Human prosperity was able to increase and population was able to grow as we learned to use increasing amounts of energy from outside sources. Energy sources we gained control over included domesticated plants and animals, facilitating agriculture. World population by the year 1 C. E. reached 200 million, or over 1,000 times the population level before the leveraging impact of external energy supplies began enabling greater human world population.
Fossil fuel (coal, oil and natural gas) use became common after about 1800 C. E., and population grew very quickly. In fact, when population is graphed, it looks like it went straight up starting when fossil fuels were added.
FIGURE 2 – World Population
Figure 2. World population based on data from “Atlas of World History,” McEvedy and Jones, Penguin Reference Books, 1978 and Wikipedia-World Population.Use of fossil fuels did not grow by themselves. Their use was facilitated by the development of improved technology, which provided the vehicle for their use. Increased debt also facilitated fossil fuel use, because it allowed potential buyers to afford the new products being developed, and provided companies doing energy extraction funds for their work.
Our ability to do physical work using human labor is quite limited. For example, if we want to dig a well for water, the depth that humans can dig without the assistance of a machine intended for this purpose is only about 20 feet. With mechanical drilling equipment, typically powered by oil, we can quickly and cheaply dig a well many hundreds of feet deep.
As another example, if we want to transport goods a long distance without external energy, we can only push a cart at the speed at which we can walk. Oil or another other modern fuel allows inexpensive long-distance transport of goods.
Adding energy use changes costs. There is a two-way tug on costs:
1. Costs are typically reduced when fossil fuel energy or electricity from any source can be substituted for human energy. This allows greater leverage of the energy of the remaining humans doing the “work”.
2. Costs tend to increase, as the cost of the energy source in (1) increases. Such an increase in costs occurs as we approach limits of a finite world, partly because extraction is from more depleted resources (farther down in the resource triangle shown in Figure 1), and partly because we reach increased problems with pollution, such as the BP Deepwater Horizon well blowout in 2010. The cost of mitigating pollution problems also adds to energy costs.
Up until about the year 2000, this tug of war had a favorable outcome. An increased amount of fossil fuel energy was substituted for human energy, leading to lower costs. As mentioned previously, improved technology and additional debt enabling this substitution played a role as well.
In recent years, the tug of war has started to go the other direction. The cost, particularly for oil energy, has tended to rise far more rapidly than costs in general (Figure 3). This has produced many dislocations within the economy, making countries that use a lot of oil less competitive in the world marketplace and reducing economic growth rates, especially among countries no longer able to complete. The higher cost of oil products reduces disposable income of citizen, leading to recession and to deficit spending by governments.
FIGURE 3 – World Oil Price in Current $
Figure 3. Brent-equivalent oil price in current $, based on data from BP 2012 Statistical Review of World Energy.In future years, we can expect that two way tug on costs will increasingly be lead to higher costs, because of greater impact of limits of a finite world. This will tend to send economies increasingly into recession.
Our financial system has been built assuming that economic growth will continue indefinitely. There is significant risk that the recessionary influences of high oil costs will bring down the current economy. We know from a recent analysis by Peter Turchin and Sergey Nefedov (Secular Cycles, Princeton University Press, 2009) that historically, when civilizations collapsed, they did so for financial reasons, as the cost of government became too great for citizens to fund with tax revenue. There would seem to be a significant risk that today’s economy will reach the same end.
Why didn’t others recognize this issue?
Reaching limits of a finite world is a subject that does not easily fit into any one subject area, so the subject tends to be missed by researchers concentrating on one field of study.
The closest fit came in the analysis The Limits to Growth (Donella Meadows et al, Universe books, 1972). This analysis came very close, but did not quite hit the nail on the head because it missed the connection of debt to limits to growth. (The model was of course not expected to be complete.) More recent analyses along this line to miss the debt connection as well, pushing the likely date of collapse forward.
There is much confusion about the question of what limits, such as oil limits, mean. Many people believe that rising oil reserves (which are a given when the problem is ever-more expensive to extract oil, as illustrated in Figure 1) mean that our oil problems are solved. Our problem is not a lack of oil reserves; our problem is that the selling price needs to keep rising, to cover the rising costs of extraction and to cover government dependence on tax revenues. This increase in selling price makes oil ever less affordable, which is our real problem.
Even when oil price drops, this is not necessarily a good sign. It may mean that some oil extraction companies will no longer be able to afford to add new wells, because production will not be sufficiently profitable at the new lower price. It may also mean that some oil exporting nations will
not be able to get enough tax revenue from oil operations to fund programs (food subsidies, for example) that prevent revolt.
Reaching limits in a finite world is a scary issue. The book Limits to Growth was not well received when it was published. Governments have tried their best to avoid the issue. No president or prime minister wants to announce, “We have a problem that we have no way to solve.”
Why might I be able to shed light on the real impact of finite world limits?
My background is as a casualty actuary, doing financial forecasting for insurance companies. Thus, I started with somewhat of a financial background, but did not have the usual “brainwashing” that comes when a person has studied the economy from the perspective of today’s economists. My background gave me a great deal of experience hunting for publicly available databases, making graphs, doing analyses, and explaining the results to lay audience.
I got interested in the issue of oil limits and what impact they might have when read the book, The Empty Tank: Oil, Gas, Hot Air, and the Coming Global Financial Catastrophe (Jeremy Leggett, Random House, 2005). His view comes from the “peak oil” view, which is close to my view, but not quite the same.
When I read Leggett’s book, it hit a responsive chord because I had had first hand experience with the impact that high oil prices had on insurance companies in the 1973-1974 period. In 1973, I was the actuary for a small insurance company that ultimately went bankrupt, at least partly because of the indirect impact of higher oil prices. Reporting to the president of the company, I got to see up close what kind of havoc high oil prices could cause in the financial world.
After I read Leggett’s book, I started researching the issue on my own. I wrote an article for insurance executives in early 2006 and an article for actuaries in early 2007. In March 2007, I decided to take early retirement, and work on the issue full time.
I set up my blog site, OurFiniteWorld.com in March 2007. I soon was asked to help with the website TheOilDrum.com, where I wrote under the name, “Gail the Actuary,” and made many contacts with others interested in the issue of limited oil supply.
To make a long story short, over the past several years, I have made many contacts with researchers who have discovered at least part of the story of oil limits and energy limits. Through my blog posts, I also received much valuable input, including suggestions from readers regarding academic books that might be helpful.
My work is now being published in the academic world as well. I wrote a paper, “Oil Supply Limits and the Continuing Financial Crisis,” published in the journal Energy in January 2012. It has so far been cited by 10. I was also a co-author of “An analysis of China’s coal supply and its impact on China’s future economic growth” (Energy Policy, June 2013). My most recent publication is an article called, “Financial Issues Affecting Energy Security” in the soon-to-be published book, Energy Security and Development–The Changing Global Context, (B. S. Reddy and S. Ulgiati Eds., Cambridge Scholars Publishing, 2013).
Reaching Oil Limits – New Paradigms are Needed
Off the keyboard of Gail Tverberg
Published on Our Finite World on April 30, 2013
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I have written in recent posts that oil limits are more complex than what many have imagined. They aren’t just a lack of a liquid fuel; they are inability to compete in a global economy that is based on use of cheaper fuel (coal) and a lower standard of living. Oil prices that are too low for oil exporting nations are a problem, just as oil prices that are too high are a problem for oil importing nations.
Debt limits are also closely tied to oil supply limits. It is actually debt limits, such as those we seem to be reaching right now, that may bring the whole system to a screeching stop. (See my posts How Resource Limits Lead to Financial Collapse, How Oil Exporters Reach Financial Collapse, Peak Oil Demand is Already a Huge Problem, and Low Oil Prices Lead to Economic Peak Oil.)
We have many Main Street Media (MSM) paradigms that mischaracterize our current predicament. But we also have what I would call Green paradigms, that aren’t really right either, because they don’t recognize the true state of our predicament. What we need now is new set of paradigms. Let’s look at a few common beliefs.
Inadequate Oil Supply Paradigm
As I stated above, indications that oil supply is a problem are confusing. MSM seems to believe, “If the US can be oil independent, our oil supply problems are solved.” If a person believes the goofy models our economists have put together, this is perhaps true, but this is not true in the real world.
Without a huge, huge increase in US oil production (far more than is being proposed), being “oil independent” simply means that we are unable to compete in the world market for buying oil exports. US oil consumption ends up dropping, and we end up on the edge of recession, or actually in recession. Oil exports instead go to the countries that have lower manufacturing costs (that is, use oil more sparingly). See Figure 1 below. In fact, even some of the oil products that are created by US refineries end up going to users in other countries, because it is businesses in other countries that are making many of today’s goods, and it is these businesses and the workers they hire who can afford to buy products like gasoline for their cars or diesel for their irrigation pumps.
Figure 1. Oil consumption by part of the world, based on EIA data. 2012 world consumption data estimated based on world “all liquids” production amounts.
The Green version of this paradigm seems to be, “If world oil supply is rising, everything is fine.” This is related to the idea that our problem is “peak oil” production caused by geological depletion, and if we haven’t hit peak oil production, everything is more or less OK. In fact, the limit we are reaching is an economic limit, that comes far before world oil supply begins to decline for geological reasons. See my post, Low Oil Prices Lead to Economic Peak Oil.
The real paradigm is, “Limited oil supply leads to financial collapse.” This is true for both oil exporters and for oil importer. For oil importers, the problem occurs because they cannot import enough oil, and oil is needed for critical parts of the economy. The belief by economists that substitution will take place is not happening in the quantity and at the price level (very low) that it needs to happen at, to keep the economy expanding as it has in the past.
Limited oil supply first leads to high oil prices, as it did in the 2004 to 2008 period; then it leads to government financial distress, as governments try to deal with less employment and lower tax revenue. By the time oil prices start falling because of the poor condition of oil importers, we are well on our way down the slippery slope to financial collapse.
Growth Paradigm
The MSM version of this paradigm is, “Growth can be expected to continue forever.” A corollary to this is, “The economy can be expected to return to robust growth, soon.”
In a finite world, this paradigm is obviously untrue. At some point, we start reaching limits of various kinds, such as fresh water limits and the inability to extract an adequate supply of oil cheaply.
Economists base their models on the assumption that the economy only needs labor and capital; it doesn’t need specific resources such as fresh water and energy of the proper type. Unfortunately, substitutability among resources is not very good, and price is all-important. In the real world, growth slows as resources become more expensive to extract.
The Green version of the growth paradigm seems to be, “We can have a steady state economy forever.” Unfortunately, this is just as untrue as the “Growth can be expected to continue to forever.” Even to maintain a steady state economy requires far more cheap-to-extract oil resources than the earth really has. (US shale oil resources, which are the new hope for oil growth, can only grow if oil prices are sufficiently high.)
We are very dependent on fossil fuels for making our food supply possible and for our ability to make metals in reasonable quantity. Fossil fuels are also necessary for making concrete and glass in reasonable quantities, and for making modern renewable energy, such as hydroelectric dams, wind turbines, and PV panels. We cannot keep 7 billion people alive without fossil fuels. Perhaps the quantity of fossil fuels consumed can be temporarily reduced from current levels, but with continued population growth, any savings will be quickly offset by additional mouths to feed and by the desire of the poorest segment of the population to have the living standards of the richest.
Unfortunately, the correct version of the paradigm seems to be, “Overshoot and collapse is to be expected.” This is what happens in nature, whenever any species discovers a way to way to increase its energy (food) supply. Yeast, when added to grape juice will multiply, until the yeast have consumed the available sugars and turned them to alcohol. They then die.
The same pattern has happened over and over with historical civilizations. They learned to use a new approach that allowed them to increase food supply (such as clearing land of trees and farming the land, or adding irrigation to an area), but eventually population caught up. Research shows that before collapse, they reached financial limits much as we are reaching now. The symptoms, both then and now, were increasingly great wage disparity between the rich and the working class, and governments that needed ever-higher taxes to fund their operations.
Eventually a Crisis period hit these historical civilizations, typically lasting 20 to 50 years. Workers rebelled against the higher taxes, and more government changes took place. Governments fought wars to get more resources, with many killed in battle. Epidemics became more of a problem, because of the weakened condition of workers who could no longer afford an adequate diet. Eventually the population was greatly reduced, sometimes to zero. A new civilization did not rise again for many years.
Figure 2. One possible future path of future real (that is, inflation-adjusted) GDP, under an overshoot and collapse scenario.
It seems to me that unfortunately overshoot and collapse is the model to expect. It is not a model anyone would like to have happen, so there is great opposition when the idea is suggested. Overshoot and collapse is very similar to the model described in the 1972 book Limits to Growth by Donella Meadows and others.
Role of Economics, Science, and Technology Paradigm
The MSM paradigm seems to be, “Economics and the businesses that make up the economy can solve all problems.” Growth will continue. New technology will solve all problems. We don’t need religion any more, because we now understand what makes people happy: More stuff! As long as the economy can give people more stuff, people will be satisfied and happy. Economics even can allow us to find “green” solutions that will solve environmental problems with win-win solutions (assuming you believe MSM).
The Green version of the paradigm seems to be, “Science and technology can solve all problems, and can properly alert us to future problems.” Again, we don’t need religion, because here we can put our faith in science to solve all of our problems.
I am not sure the Green version of the paradigm is any more accurate than the MSM media version. Science is not good at figuring out turning points. It is very easy to miss interactions that are outside the realm of science, and more in the realm of economics–for example, the fact high-priced oil is not an adequate substitute for cheap-to-extract oil, and it is the lack of cheap oil that is causing a major portion of today’s problem.
It is also very easy to put together climate change models that are based on far too high assumptions of the amount of fossil fuels that will be burned in the future, because economic interactions are missed. If debt collapse brings down the economy, it will bring down all fossil fuels at once, meaning that the vast majority of what we think of as reserves today will stay in the ground forever. A debt collapse will also affect renewables, by cutting off production of new renewables, and by making maintenance of existing systems more difficult.
The real paradigm should be, “Neither science and technology, nor economics can solve the problems of humans. We have instincts similar to those of other species to reproduce in far greater numbers than needed for survival, and to utilize all resources available to us. This leads us toward overshoot and collapse scenarios, even though we have great knowledge.“
Because of our propensity toward overshoot and collapse scenarios, humans have a real need for a “moral compass” to tell us what is right and wrong. If there is no longer enough food to go around, how do we decide which family members should get it? Is it OK to start a civil war, if there are not enough resources to go around? There is also a need to deal with our many personal disappointments, such as finding that the advanced degrees we worked so hard on will have little use in the future, and that life expectancies are much lower. Perhaps there is still a need for religion, even though many have abandoned the idea. The “story line” of religions may not sound exactly reasonable, but if a particular religion can provide reasonable guidance on how to handle today’s problems, it may still be helpful.
Climate Change Paradigm
The MSM view of climate change seems to vary with the country. In the US, the view seems to be that it is not too important, and that it can be adapted to. Perhaps the models are not right. In Europe, there is more belief that the models are right, and that local cutbacks in fossil fuel consumption will reduce world CO2 production.
The Green view of climate change seems to be, “Of course climate change models are 100% right. We should rationally be able to solve the problem.” There is only the minor detail that humans (like other species) have a basic instinct to use energy resources at their disposal to allow more of their offspring to live and to allow themselves personally to live longer.
Unfortunately, a more realistic view is that climate change may indeed be happening, and may indeed by caused by human actions, but (1) we are already on the edge of collapse. Moving collapse ahead by a few months will not solve the climate change problem, and (2) collapse itself is an even worse problem than climate change to deal with. By the time rising ocean levels become a problem, population is likely to be low enough that the remaining population can move to higher ground, and agriculture can move to where the climate is more hospitable.
Climate change may indeed cause population to drop even more than it would if our only problem were overshoot and collapse. But because the cause is related to human instincts (having more offspring than needed to replace oneself and the drive to use energy supplies that are available), changing the underlying behavior is extremely difficult.
Over the eons, the earth has been cycling from one climate state to another, with one species after another being the dominant species. Perhaps natural balances are such that the time has now come that humans’ turn as the dominant species is over. The earth is now ready to cycle to a state where some other species is dominant, perhaps a type of plant that can use high carbon dioxide levels. If this is the case, this is another disappointment that we will need to deal with.
Nature of Our Problem Paradigm
The MSM’s paradigm seems to be, “Our problem is getting the economy back to growth.” Or, perhaps, “Our problem is preventing climate change.“
In a way, the MSM paradigm of “Our problem is getting the economy back to growth,” has some truth to it. We are slipping into financial collapse, and in a sense, getting the economy back to growth would be a solution to the problem.
The underlying problem, however, is that oil supply is getting more and more expensive to extract. This means that an increasing share of resources must be devoted to oil extraction, and to other necessary activities (such as desalinating water because we are reaching fresh water limits as well). As a result, the rest of the world’s economy is getting squeezed back. See my post Our Investment Sinkhole Problem. Squeezing the world’s economy creates great problems for all of the debt outstanding. The likely outcome is widespread debt defaults, and collapse of the world economy as we know it.
The Green paradigm seems to be, “We have a liquid fuel supply problem.“ If we can solve this with other liquid fuels, or with electricity, we will be fine. Many Greens also emphasize the climate change problem, so their big issue is finding electric solutions for the liquid fuel supply problems. There is also an emphasis on local food production, especially with respect to perishable foods.
Unfortunately, the real problem seems to be, “We are facing a financial collapse scenario that is likely to wreak havoc on all energy sources at once.” Using less oil products may be helpful for a while, but in the long term, we are dealing with an issue of major system collapses. Using less of a particular product “works” as long as the supply chain for that product is still intact, including the existence of all of the factories needed to make the product, and the existence of trained workers to operate the factories. Banks also need to remain open. World trade needs to continue as well, if we are to keep our supply chains operating. The real danger is that supply chains for many essential services, including fresh water, sewage disposal, medicines, grain production, road repair, and electricity transmission repair will be interrupted. As a result, we will need to find local solutions for all of them.
The situation we are facing is not at all good. While we can do a little, it will be very challenging to build a new system that does not use fossil fuels. In the past, when the world did not use fossil fuels, the population was much lower than today–one billion or less.
Also, in the past, we started simple, and gradually added complexity to solve the problems that arose. This time around, we need to do the reverse. We already have very complex systems, that are too difficult to maintain for the long term. What we need instead is simpler systems that can be maintained with local materials. This is not a direction in which science and technology is used to working.
Creating new systems that require only local resources (and a few other resources, if transport can be arranged) will be a real challenge. Areas of the world that have never adopted modern technology would seem to have the bast chance of making such a change.
Importance of Tomorrow Paradigm
MSM seems to assume that we can save and plan for tomorrow. Greens have a similar view.
Perhaps, given the changes that are happening, we need to change our focus more toward to day, and less toward tomorrow. How can we make today the best day possible? What are the good things we can appreciate about today? Are there simple things we can enjoy today, like sunshine, and fresh air, and our children?
We have come to believe that we can and will fix all of the problems of tomorrow. Perhaps we can; but perhaps we cannot. Maybe we need to simply take each day as it comes, and solve that day’s problems as best as we can. That may be all we can reasonably accomplish.
Gold Crash + Oil Crash = Recession
Off the keyboard of Michael Snyder
Published on Economic Collapse on April 17, 2013
Discuss this article at the Economics Table inside the Diner
Is the United States about to experience another major economic downturn? Unfortunately, the pattern that is emerging right now is exactly the kind of pattern that you would expect to see just before a major stock market crash and a deep recession. History tells us that when the price of gold crashes, a recession almost always follows. History also tells us that when the price of oil crashes, a recession almost always follows. When both of those things happen, a significant economic downturn is virtually guaranteed. Just remember what happened back in 2008. Gold and oil both started falling rapidly in July, and in the fall we experienced the worst financial crisis that the U.S. had seen since the days of the Great Depression. Well, a similar pattern seems to be happening again. The price of gold has already crashed, and the price of a barrel of WTI crude oil has dropped to $86.37 as I write this. If the price of oil dips below $80 a barrel and stays there, that will be a major red flag. Meanwhile, we have just seen volatility return to the financial markets in a big way. When volatility starts to spike, that is usually a clear sign that stocks are about to go down substantially. So buckle your seatbelts – it looks like things are about to get very, very interesting.
Posted below is a chart that shows what has happened to the price of gold since the late 1960s. As you will notice, whenever the price of gold rises dramatically and then crashes, a recession usually follows. It happened in 1980, it happened in 2008, and it is happening again…
A similar pattern emerges when we look at the price of oil. During each of the last three recessions we have seen a rapid rise in the price of oil followed by a rapid decline in the price of oil…
That is why what is starting to happen to the price of oil is so alarming. On Wednesday, Reuters ran a story with the following headline: “Crude Routed Anew on Relentless Demand Worries“. The price of oil has not “crashed” yet, but it is definitely starting to slip.
As you can see from the chart above, the price of oil has tested the $80 level a couple of times in the past few years. If we get below that resistance and stay there, that will be a clear sign that trouble is ahead.
However, there is always the possibility that the recent “crash” in the price of gold might be a false signal because there is a tremendous amount of evidence emerging that it was an orchestrated event. An absolutely outstanding article by Chris Martenson explained how the big banks had been setting up this “crash” for months…
In February, Credit Suisse ‘predicted’ that the gold market had peaked, SocGen said the end of the gold era was upon us, and recently Goldman Sachs told everyone to short the metal.
While that’s somewhat interesting, you should first know that the largest bullion banks had amassed huge short positions in precious metals by January.
The CFTC rather coyly refers to the bullion banks simply as ‘large traders,’ but everyone knows that these are the bullion banks. What we are seeing in that chart is that out of a range of commodities, the precious metals were the most heavily shorted, by far.
So the timeline here is easy to follow. The bullion banks:
- Amass a huge short position early in the game
- Begin telling everyone to go short (wink, wink) to get things moving along in the right direction by sowing doubt in the minds of the longs
- Begin testing the late night markets for depth by initiating mini raids (that also serve to let experienced traders know that there’s an elephant or two in the room)
- Wait for the right moment and then open the floodgates to dump such an overwhelming amount of paper gold and silver into the market that lower prices are the only possible result
- Close their positions for massive gains and then act as if they had made a really prescient market call
- Await their big bonus checks and wash, rinse, repeat at a later date
While I am almost 100% certain that any decent investigation by the CFTC would reveal that market manipulating ‘dumping’ was happening, I am equally certain that no such investigation will occur. That’s because the point of such a maneuver by the bullion banks is designed to transfer as much wealth from ‘out there’ and towards the center, and the CFTC is there to protect the center’s ‘right’ to do exactly that.
You can read the rest of that article right here.
There are also rumors that George Soros was involved in driving down the price of gold. The following is an excerpt from a recent article by “The Reformed Broker” Joshua Brown…
And over the last week or so, the one rumor I keep hearing from different hedge fund people is that George Soros is currently massively short gold and that he’s making an absolute killing.
Once again, I have no way of knowing if this is true or false.
But enough people are saying it that I thought it worthwhile to at least mention.
And to me, it would make perfect sense:
1. Soros is a macro investor, this is THE macro trade of the year
so far(okay, maybe Japan 1, short gold 2)2. Soros is well-known for numerous market aphorisms and neologisms, one of my faves being “When I see a bubble, I invest.” He was heavily long gold for a time and had done well while simultaneously referring to it publicly as a speculative bubble.
3. He recently reported that he had pretty much exited the trade in gold back in February. In his Q4 filing a few weeks ago, we found out that he had sold down his GLD position by about 55% as of the end of 2012 and had just 600,000 shares remaining. That was the “smartest guy in the room” locking in a profit after a 12 year bull market.
4. Soros also hired away one of the most talented technical analysts out there, John Roque, upon the collapse of Roque’s previous employer, broker-dealer WJB Capital. No one has heard from the formerly media-available Roque since but we can only assume that – as a technician – the very obvious breakdown of gold’s long-term trend was at least discussed. And how else does one trade gold if not by using technicals (supply/demand) – what else is there? Cash flow? Book value?
5. Lastly, the last public interview given by George Soros was to the South China Morning Post on April 4th. He does not mention any trading he’s doing in gold but he does reveal his thoughts on it having been “destroyed as a safe haven”
It is also important to keep in mind that this “crash” in the price of “paper gold” had absolutely nothing to do with the demand for physical gold and silver in the real world. In fact, precious metals retailers have been reporting that they have been selling an “astounding volume” of gold and silver this week.
But that isn’t keeping many in the mainstream media from “dancing on the grave” of gold and silver.
For example, New York Times journalist Paul Krugman seems absolutely ecstatic that gold has crashed. He seems to think that this “crash” is vindication for everything that he has been saying the past couple of years.
In an article entitled “EVERYONE Should Be Thrilled By The Gold Crash“, Business Insider declared that all of us should be really glad that gold has crashed because according to them it is a sign that the economy is getting better and that faith in the financial system has been restored.
Dan Fitzpatrick, the president of StockMarketMentor.com, recently told CNBC that people are “flying out of gold” and “getting into equities”…
“There have been so many reasons, and there remain so many reasons to be in gold,” Fitzpatrick said, noting currency debasement and the fear of inflation. “But the chart is telling you that none of that is happening. Because of that, you’re going to see people just flying out of gold. There’s just no reason to be in it.Traders are scaling out of gold and getting into equities.”
Personally, I feel so sorry for those that are putting their money in the stock market right now. They are getting in just in time for the crash.
As CNBC recently noted, a very ominous “head and shoulders pattern” for the S&P 500 is emerging right now…
A scary head-and-shoulders pattern could be building in the S&P 500, and this negative chart formation would be created if the market stalls just above current levels.
“It’s developing and it’s developing fast,” said Scott Redler of T3Live.com on Wednesday morning.
Even worse, volatility has returned to Wall Street in a huge way. This is usually a sign that a significant downturn is on the way…
Call options buying recently hit a three-year high for the CBOE’s Volatility Index, a popular measure of market fear that usually moves in the opposite direction of the Standard & Poor’s 500 stock index.
A call buy, which gives the owner the option to purchase the security at a certain price, implies a belief that the VIX is likely to go higher, which usually is an ominous sign for stocks.
“We saw a huge spike in call buying on the VIX, the most in a while,” said Ryan Detrick, senior analyst at Schaeffer’s Investment Research. “That’s not what you want to hear (because it usually happens) right before a big pullback.”
The last time call options activity hit this level, on Jan. 13, 2010, it preceded a 9 percent stock market drop that happened over just four weeks, triggered in large part by worries over the ongoing European debt crisis.
And according to Richard Russell, the “smart money” has already been very busy dumping consumer stocks…
What do billionaires Warren Buffet, John Paulson, and George Soros know that you and I don’t know? I don’t have the answer, but I do know what these billionaires are doing. They, all three, are selling consumer-oriented stocks. Buffett has been a cheerleader for US stocks all along.
But in the latest filing, Buffett has been drastically cutting back on his exposure to consumer stocks. Berkshire sold roughly 19 million shares of Johnson and Johnson. Berkshire has reduced his overall stake in consumer product stocks by 21%, including Kraft and Procter and Gamble. He has also cleared out his entire position in Intel. He has sold 10,000 shares of GM and 597,000 shares of IBM.
Fellow billionaire John Paulson dumped 14 million shares of JP Morgan and dumped his entire position in Family Dollar and consumer goods maker Sara Lee. To wrap up the trio of billionaires, George Soros sold nearly all his bank stocks including JP Morgan, Citigroup and Goldman Sachs. So I don’t know exactly what the billionaires are thinking, but I do see what they’re doing — they are avoiding consumer stocks and building up cash.
… the billionaires are thinking that consumption is heading down and that America’s consumers are close to going on strike.
So what are all of those billionaires preparing for?
What do they know that we don’t know?
I don’t know about you, but when I start putting all of the pieces that I have just discussed together, it paints a rather ominous picture for the months ahead.
At some point, there will be another major stock market crash. When it happens, we will likely see even worse chaos than we saw back in 2008. Major financial institutions will fail, the credit markets will freeze up, economic activity will grind to a standstill and millions of Americans will lose their jobs.
I sincerely hope that we still have at least a few more months before that happens. But right now things are moving very rapidly and it is becoming increasingly clear that time is running out.
Wheels Falling Off…
Off the keyboard of Steve from Virginia
Published on Economic Undertow on April 14, 2013
Discuss this article at the Economics Table inside the Diner
In 2013 it is 2007 all over again, there is a sense of foreboding. Markets are breaking down except for the self-funded stock markets. When these markets begin to break … ?
A difference between now and the ‘good old days’ is that management has already deployed its reserves, its props to support key men. There is little left to deploy: policy rates around the world are near zero and cannot be effectively lowered. Torrents of cheap credit flow from central banks toward commercial finance. Bad loans have been shifted from the private sector to the public’s accounts. Trillions in all currencies have been borrowed and spent by governments … largely to benefit finance. Every one of these are rear-guard efforts, behind them there is nothing, only desperate flailing, arbitrary confiscation, stealing what remains to steal … capitulation to reality … and ruin.
Figure 1: What a fuel price hedge looks like along with its collapse, the Incredible US Housing Recovery compared to the monumental surge in housing churn that took place from 1990 to 2007. The ‘recovery’ is the tendril on the far right. Realtors want Americans to believe what is underway right now is the start of another ramp-up in house building and selling. This is a lie: Americans are broke, suburbia is too expensive to duplicate. A palatable alternative to suburbia in 2013 does not exist.
What would make a ‘recovery’ sustainable? Fuel prices returning to sub-$20 per barrel of crude oil. Otherwise, most of what is seen on the chart is a stranded ‘investment’.
What would derail any hope of recovery and leave the world a sustainable ruin? Fuel prices returned to sub-$20 per barrel of crude oil. At that price there would be very little crude oil available, there would be insufficient buying power to lift the hard-to-reach petroleum that now remains.
Energy Commodity Futures
| Commodity | Units | Price | Change | % Change | Contract |
|---|---|---|---|---|---|
| Crude Oil (WTI) | USD/bbl. | 91.29 | -2.22 | -2.37% | May 13 |
| Crude Oil (Brent) | USD/bbl. | 103.11 | -1.16 | -1.11% | May 13 |
| RBOB Gasoline | USd/gal. | 280.18 | -2.92 | -1.03% | May 13 |
| NYMEX Natural Gas | USD/MMBtu | 4.22 | +0.08 | +2.01% | May 13 |
Precious and Industrial Metals
| Commodity | Units | Price | Change | % Change | Contract |
|---|---|---|---|---|---|
| COMEX Gold | USD/t oz. | 1,501.40 | -63.50 | -4.06% | Jun 13 |
| Gold Spot | USD/t oz. | 1,482.75 | -78.75 | -5.04% | N/A |
| COMEX Silver | USD/t oz. | 26.33 | -1.37 | -4.93% | May 13 |
| COMEX Copper | USd/lb. | 335.00 | -8.35 | -2.43% | May 13 |
| Platinum Spot | USD/t oz. | 1,486.75 | -45.55 | -2.97% | N/A |
Bloomberg commodities: precious metals and US petroleum were hammered on Friday. Metals have been leading indicators, petroleum is declining to the price level where drilling becomes unprofitable. Without new drilling there is no replacement for rapidly depleting existing reserves.
As reserves are exhausted so is the ability pay for them. The fuel waste process is collateral for fuel extraction, not the fuel itself. The reason for this should be obvious: as soon as fuel is extracted it is destroyed, it is useless as collateral. Instead, the fuel wasting implements become collateral for the funds used to waste more. As credit expands, it first becomes more costly then unaffordable. Industrial output — which is nothing more than non-remunerative waste — becomes impossible to finance. Ultimately, credit contracts, the nominal prices decline … as the ability to meet prices declines faster … we are entering into the credit contraction phase now.
This is a dynamic that escapes conventional analysis, which assumes an economy running normally in the background and providing credit … even as its fuel supply is depleted. Meanwhile, the economy runs down in real time, credit is diminished and analysts are perplexed.
Figure 2: (Click for big), Brent crude @ $118 in February accompanied the robbery/crash of Cyprus, panic in Japan and deflation. Brent crude today is $103.11, nearing the marginal level where extraction becomes unprofitable. Chart by TFC Charts.
Since 2008 the world has been in the grip of deflation which reflects facts on the ground. With depleting resources, multiplying claims against these same resources or adding wasting implements does not create anything new but depletes what we have access to, faster. Deflation exposes claims as worthless, the fuel extraction process itself is stranded. We have so successfully cannibalized ourselves that it is becoming too late to do anything useful about it.
Figure 3: (ZeroHedge) Japan 20 year bond yields have become massively volatile: bonds are offered for sale driving up yields which retreat as the Bank of Japan steps up to buy. For Japan’s central bank to meet its targets it must flood the world’s markets with … more credit. This credit-for-credit exchange is a charade, it cannot alter the trajectory of Japan’s fuel- and resource reality, it cannot even change Japan’s finance reality … it is capitulation, the wheels finally coming off in Japan.
Bond-holders ‘sell’ their holdings for yen then swap these for dollars or euros in forex markets. Volatility is increased because of the enormity of the trades required to move the generally liquid bond markets. Large lenders to Japan such as banks and insurance companies appear to be dumping bonds, exiting their positions. These lenders become yen sellers as well: because there are more sellers than buyers, the currency is depreciated. There is no real increase in the overall supply of money. Sean Corrigan @ Diapason Commodities Management, (ZeroHedge):
Net new debt issues are currently being penciled in at around the Y42 trillion mark a year and, with the BOJ scheduled to buy Y70 trillion p.a., it might seem that JGBs offer a one-way bet even here, but with a current overhang of Y942 trillion as we write, the possibility is not to be overlooked that while the Bank may be comfortably able to mop up the new flow, it might have its work cut out if others decide to use its resting bid to get rid of some of their enormous existing stock of claims.Prime candidates would be foreigners (with Y87tln to hand and steep currency losses to hazard), the banks (which, we have seen, hold Y425tln in government claims, of which Y360tln in JGBS per se), and insurance companies (with Y222 trillion in debt and Y184 trillion in JGBs & TBs combined). In its last concerted attempt at re-inflation, conducted in 2002-3, the BOJ briefly pushed up both the monetary base and overall M1 by around 30%. The response of prices was modest to say the least: CPI moved from -1.4% to +0.5% three years later. If the same thing were to happen again, all that would have been achieved would be to have introduced an unnecessary disturbance of the pricing structure between inland and foreign trade and, at the margin, between those living off current income and those reliant upon stored past income. Debt would, of course, have climbed inexorably skyward, as would the debt/nominal income ratio.
The reason for the gambit is Japan’s vanished trade surplus which had overseas customers subsidizing resource waste by the Japanese. Exports never provided any return for Japan’s customers: they are now broke, they cannot subsidize anyone. The depreciation is a futile attempt to retrieve the irretrievable.
There are two potentially market moving sections in the report. The Treasury Department planted a “dirty bomb” at the Bank of Japan, and tossed a grenade at the Swiss National Bank. I’m thinking of all the folks who are big long USDJPY. They are going to have to sweat the next 50 hours. They have to hold their cards and wait. I suspect that quite a few FX players will have their weekends ruined.The key words on Japan (from US Treasury Secretary Jack Lew):“We will continue to press Japan to adhere to the commitments agreed to in the G7 and G 20, to remain oriented towards meeting respective domestic objectives using domestic instruments and to refrain from competitive devaluation and targeting its exchange rate for competitive purposes.”
“I think we just had the Jack Lew moment that I was anticipating. I believe that Jackie Boy has made a mistake. He picked a public fight with Japan that he can’t win. Having picked the fight, he can’t back off. When the BOJ and the markets make him look silly (USDJPY = 110+) there is going to be pressure on him. Jackie has set himself up for a fall.
In all my years of watching (and participating) in the FX markets I have never once seen a situation where “talk” accomplished a damn thing. In fact, idle talk often creates the opposite reaction to what was intended. So for those who are having sphincter problems this weekend over a long USDJPY book, and the 50 hours you have to wait to find out what happens, I say relax. By the opening in NY on Monday, you will be okay again. In a few weeks you’ll be buying hot cars and houses.”
Keep in mind, the Treasury Secretary doesn’t act by himself, he has a fleet of ‘associates’ at the Big Banks pulling his strings. If he makes a mistake they lose and they don’t like to lose = they pull the strings as needed.
Meanwhile, the fundamentals are ignored: the effects of Japan’s maneuvering are likely to be negligible. Management has already deployed its reserves, its props to support key men. There is little left to deploy: policy rates around the world are near zero … torrents of cheap credit flow, etc. Things cannot be improved, only be made worse.
Japan — like all the other countries — has no independent monetary policy. This is because the price of money has nothing to do with interest rates or trades on forex markets. Rather, it’s priced at gasoline stations around the world by millions of motorists every single day. If gas prices are too high — because of currency depreciation or some other reason — drivers buy less and economies deflate. This undoes the efforts of the money-managers.
Enter the post-1998 peak oil paradigm shift: when gas prices fall drivers buy more fuel but there is quickly less available, prices either increase again or shortages occur. The real price of fuel — that relative to other goods and services — increases relentlessly. Eventually, this real price bankrupts countries like Japan!
Think of the old-fashioned ‘gold standard’ constraining the money supply as well as industry and commerce as it did during the 1930s. With the ‘gasoline standard’ there are the same constraints except it is impossible to go off petroleum and grow the economy as could be done by ‘going off gold’. The only way to escape the gas standard is to jettison cars and other fuel-guzzling gadgets, this also annihilates economic growth which is dependent upon more and more of these things being sold. Meanwhile, in the background where the analysts pretend not to notice, the gasoline standard strands cars and other fuel guzzling gadgets anyway: at the end of the modernity’s ever-shortening gangplank there is no room to maneuver.
Fiddling with nominal prices is pointless: any possible currency-driven export gains are offset exactly by currency-driven import costs. Because Japan is nothing more or less than a car factory with radioactive beaches it cannot gain anything by depreciating its currency. Its export prices are determined entirely by what it pays for imports … including fuel! The only effect of so-called monetary ‘policy’ is steal funds from workers and shift them to plutocrats. Everything else remains the same.
The blowup in Japan is part of the de-carring process which is underway right now everywhere in the World. Depreciating the yen does not bring one drop of petroleum fuel onto the market. The only question is how soon the ‘Abenomics’ experiment will fail and what form the failure will take. As holders of yen and yen-denominated bonds reduce their ‘exposure’ and dump their bonds there is less credit available rather than more. Prices for fuel decline … as they are doing so now! This does not help the Japanese exporters because their customers are still broke … regardless of the price of credit.
When the price of crude declines below the cost of extraction there will be physical shortages. These will reduce credit further which will in turn shut in more crude in a vicious cycle. There will be a return to recession with no way to end it: conservation by other means.
What sort of country does Japan become? A place to look is Egypt which has its own currency but depends upon foreign exchange same as Japan:
Short of Money, Egypt Sees Crisis on Fuel and FoodDavid D. Kirkbpatrick (NY Times)A fuel shortage has helped send food prices soaring. Electricity is blacking out even before the summer. And gas-line gunfights have killed at least five people and wounded dozens over the past two weeks.The root of the crisis, economists say, is that Egypt is running out of the hard currency it needs for fuel imports. The shortage is raising questions about Egypt’s ability to keep importing wheat that is essential to subsidized bread supplies, stirring fears of an economic catastrophe at a time when the government is already struggling to quell violent protests by its political rivals.
The establishment insists that the fuel shortage is the result of a money-credit shortage. Instead, the reverse is true: there is a shortage of fuel; there is no useful collateral for new credit, only (obsolete) waste enablers.
Japan can also become Portugal:
Portugal’s elder statesman calls for ‘Argentine-style’ defaultAmbrose Evans-Pritchard (Telegraph UK)Mario Soares, who steered the country to democracy after the Salazar dictatorship, said all political forces should unite to “bring down the government” and repudiate the austerity policies of the EU-IMF Troika.“Portugal will never be able to pay its debts, however much it impoverishes itself. If you can’t pay, the only solution is not to pay. When Argentina was in crisis it didn’t pay. Did anything happen? No, nothing happened,” he told Antena 1.The former socialist premier and president said the Portuguese government has become a servant of German Chancellor Angela Merkel, meekly doing whatever it is told.“In their eagerness to do the bidding of Senhora Merkel, they have sold everything and ruined this country. In two years this government has destroyed Portugal,” he said.
Raoul Ruparel from Open Europe said Portugal had reached the limits of austerity. “The previous political consensus in parliament has evaporated. As so often in this crisis, the eurozone is coming up against the full force of national democracy.”
The rallying cry by Mr. Soares comes a week after Portugal’s top court ruled that pay and pension cuts for public workers are illegal, forcing premier Pedro Passos Coelho to search for new cuts. The ruling calls into question the government’s whole policy “internal devaluation” aimed at lowering labour costs.
A leaked report from the Troika warned that the country is at risk of a debt spiral, with financing needs surging to €15bn by 2015, a third higher than the levels that precipitated the debt crisis in 2011. “There is substantial funding risk,” it said.
To operate its massive fleet of cars, Portugal must compete with China and America for fuel. These countries’ can generate their own credit, Portugal cannot, in fact none of the eurozone nations are able do so. Right now Portugal must borrow from Wall Street by way of EU banks, so as to repay Wall Street. Portugal has borrowed to buy fuel, it must borrow additional amounts to buy more fuel at the same time service and repay its dead-money debts.
The end result for all these countries is the same: there are debts that cannot be retired, industrial obligations that cannot possibly be met. As during the early years of the 20th century, the wheels are falling off all over the world … we shall not see them turn again in our lifetime …
How Resource Limits Lead to Financial Collapse
Off the keyboard of Gail Tverberg
Published on Our Finite World on March 29, 2013
Discuss this article at the Epicurean Delights Smorgasbord inside the Diner
Resource limits are invisible, so most people don’t realize that we could possibility be approaching them. In fact, my analysis indicates resource limits are really financial limits, and in fact, we seem to be approaching those limits right now.
Many analysts discussing resource limits are talking about a very different concern than I am talking about. Many from the “peak oil” community say that what we should worry about is a decline in world oil supply. In my view, the danger is quite different: The real danger is financial collapse, coming much earlier than a decline in oil supply. This collapse is related to high oil price, and also to higher costs for other resources as we approach limits (for example, desalination of water where water supply is a problem, and higher natural gas prices in much of the world).
The financial collapse is related to Energy Return on Energy Invested (EROEI) that is already too low. I don’t see any particular EROEI target as being a threshold–the calculations for individual energy sources are not on a system-wide basis, so are not always helpful. The issue is not precisely low EROEI. Instead, the issue is the loss of cheap fossil fuel energy to subsidize the rest of society.
If an energy source, such as oil back when the cost was $20 or $30 barrel, can produce a large amount of energy in the form it is needed with low inputs, it is likely to be a very profitable endeavor. Governments can tax it heavily (with severance taxes, royalties, rental for drilling rights, and other fees that are not necessarily called taxes). In many oil exporting countries, these oil-based revenues provide a large share of government revenues. The availability of cheap energy also allows inexpensive roads, bridges, pipelines, and schools to be built.
As we move to energy that requires more expensive inputs for extraction (such as the current $90+ barrel oil), these benefits are lost. The cost of roads, bridges, and pipelines escalates. It is this loss of a subsidy from cheap fossil fuels that is significant part of what moves us toward financial collapse.
Renewable energy generally does not solve this problem. In fact, it can exacerbate the problem, because the cost of its inputs tend to be high and very “front-ended,” leading to a need for subsidies. What is really needed is a way to replace lost tax revenue, and a way to bring down the high cost of new bridges and roads–that is a way to get back to the cost structure we had when oil (and other fossil fuels) could be extracted cheaply.
The Way Resource Extraction Reaches Financial Limits
Figure 1. Illustration of why resource limits are very hard to seeWhen a company decides to extract a resource such as oil, gold, or fresh water, it looks for the least expensive source available. After many years of extraction, the least expensive sources become depleted, and the company must move on to more expensive resources. It always looks like there are plenty of resources left; they are just increasingly expensive to extract. Eventually an extraction limit is reached; this limit is a price limit.
As easy to extract resources become more depleted, it becomes necessary to invest more resources of every type in extraction (for example, manpower, oil, natural gas, fresh water), in order to extract a similar amount of the resource. I have called this the Investment Sinkhole problem.
The need to use greater resources in the process of resource extraction leaves fewer resources available for other purposes. Prices adjust to reflect this out of balance. If there is no substitute available for the resource that is reaching limits, the economy adjusts by contracting to match the amount of resource that is available at an affordable price. Some economists might call the situation “reduced demand at high price”. What the situation looks like, in terms most of us are used to using, is recession or depression.
Part of the confusion is that many people completely miss the fact that there is a close connection between cheap energy supply of the exact type needed (for example, gasoline for cars, diesel for trucks, electricity for many factory applications) and the ability of the world economy to make goods and services.
If the price of energy of the type a particular manufacturer or service provider uses increases (say gasoline or diesel or natural gas or electricity), that manufacturer or service provider in the short term has no choice but to pay the increased price, because there is no substitute for energy of the right type. If the manufacturer or service provider tries to pass these higher costs on to its customers, there is likely to be a cutback in demand, leading to a need for layoffs. Alternatively, with longer lead time, the company may be able to find a way around the problem of increased costs, by using more automation, or by outsourcing production to a country where costs are cheaper. Any of these responses leads to reduced US employment and recessionary impacts.
What History Says about Prior Collapses
Until fossil fuels came into widespread use, civilizations regularly grew until they reached limits of some sort, and then collapsed. There are many books looking at this issue. David Montgomery, in Dirt: The Erosion of Civilizations talks about the role soil erosion and soil degradation play in bringing civilizations down. Sing Chew, in The Recurring Dark Ages, talks about how ecological stress, deforestation, and climate change have led to long periods of collapse and low economic activity. Joseph Tainter, in The Collapse of Complex Societies, talks about how increasingly complex solutions to the problems of the day lead to ever-higher administrative costs that eventually become too expensive to afford.
Peter Turchin and Surgey Nefedov in the book Secular Cycles take more of an analytical approach. They look at how cycles actually played out, based on financial and other detailed records of the day. Their analysis considered eight economies, the earliest of which began in 350 B. C. E.. The pattern they found looks disturbingly like the pattern that the world has been going through since the widespread use of fossil fuels began about 1800: A civilization starts its existence when a new resource becomes available, for example by deforesting land to be used for agriculture (or in our case, finding ways fossil fuels could be used). A civilization experiences Growth for 100+ years as the population is able to grow with the new resource available to it.
Eventually the civilization reaches a Stagflation period. This happens when the civilization starts reaching limits. Population is much higher, the size of the governing class is much larger, and feedbacks like erosion and soil depletion start to play a role. In my view, Stagflation period began for the United States around 1970, when US oil production began to fall.
Turchin and Nefedov found that during the Stagflation period, population growth slows and wages stop rising. Wage disparity increases, and debt grows. The cost of food and other resources becomes more variable, and begins to spike. The level of required taxes grows, as the number of government administrators grows and as armies increase in size. (Joseph Tainter refers to this growth in government services as a product of increased complexity.)
Eventually, after 50 or 60 years, a Crisis Phase begins, when it is no longer possible to raise taxes enough to cover all of the governmental costs. In this period, wages of commoners drop to such a low level that nutrition declines, leading to epidemics and a higher death rate. Commoners often revolt, leading to government collapses. Wars for resources are sometimes fought. The Crisis Phase lasts a variable length of time, typically 20 to 50 years, with the length of time seeming to be shorter in the more recent cycles analyzed. There is considerable die-off from illness and warfare in the Crisis Phase.
It seems to me that the United States, most of Europe, and Japan are now very close to the point where they will enter the Crisis Phase of a similar cycle.
The Nature of the Financial Predicament We Are Reaching
At the beginning of this post, I mentioned that rising investment costs lead to what I call an investment sinkhole problem, as we extract fuels and ores that require increasingly expensive inputs near the bottom of Figure 1. An examples might be tight oil, that is extracted using “fracking”. While we hear much about the hoped-for higher supply, we don’t hear that the newer types of oil are available only because oil prices are high. They can’t be expected to bring oil prices down. An investment sinkhole means that our dollar of investment doesn’t go as far; it is precisely the opposite of increased productivity.
When we were still far from reaching resource limits, efficiency improvements could more than make up for the loss of efficiency that comes from the Investment Sinkhole effect. But as we get closer to limits, the situation is reversed. Efficiency improvements are outweighed by the ratcheting up of extraction costs, because of the Investment Sinkhole effect. This means that instead of increased wealth being added to the system by efficiency improvements over time, we find the Sinkhole effect predominates. The common worker needs to spend an increasing proportion of his paycheck on necessities, leaving less for discretionary items. The result is recession, or very slow economic growth.
When the Investment Sinkhole problem starts to predominate, financial models suddenly don’t work very. Central banks react by cutting interest rates, in an attempt to stimulate economic growth. They also try to stimulate the economy by Quantitative Easing. This adds more money to the economy, and attempts to reduce longer-term interest rates. Of course, if the problem is really structural, there is no bounce-back to economic growth. The temporary fix becomes a bridge to nowhere.
A Long-Term View of our Financial Problems
In the previous section, we talked about our immediate problems. But what about our longer-term problems?
Figure 2. Author’s view of how various limits might work together to produce different symptoms, of the type seen by Turchin and Nefedov.Today’s financial system is based on the assumption that individuals and businesses can make and keep financial promises. This system worked well, when resource prices were flat or declining, as was the case prior to 2000. It was possible for businesses and governments to take out loans under the expectation of continued prosperity, and for individuals to buy houses and cars under the expectation that they would continue to have jobs, so that they could continue to make auto loan or mortgage payments.
The situation changes dramatically, if the long-term expectation is for oil prices and other commodity prices to keep ratcheting upward. We don’t really have substitutes for oil and other commodities, so if we want to keep obtaining them, we need to pay the ever-higher cost. Even devices such as more efficient cars are affected by higher prices, because they too, use fossil fuels in their construction, and depend on ever more expensive technology.
In a period when commodity prices are ratcheting upward, businesses find it increasingly difficult to forecast whether new facilities will continue to be economic 10, 20 or 40 years. Businesses find that customers gradually have less discretionary income, instead of more, so it becomes increasingly difficult for these customers to afford the products which are being sold. This makes business planning much more difficult.
If a bank makes a long-term loan, it needs to include a much larger provision for the expected cost of loan write-offs. These higher loan write-off provisions causes interest rates to rise, making long-term loans unaffordable for many (or most) people and businesses. Governments are hugely affected as well.
Without access to cheap loans, and with resource prices (especially oil, but sometimes desalinated water instead of well water, and natural gas) ratcheting upward, business failures rise. This leads to more layoffs, and more defaults on mortgages and auto loans. Interest rates on these can be expected to rise as well.
All of these effects mean that debt-financing becomes much less attractive. Debt defaults, such we have just seen in Cyprus and Greece, become more common. This is not a temporary passing phase; it is a permanent long-term situation, caused by the ratcheting up of oil and other commodity prices, as resource extraction becomes more expensive.
In such an environment, the amount of goods and services available tends to decline over time. Continued economic growth changes to continued economic contraction. If governments issue fiat money, it declines in value over time as well. (Money is sometimes defined as a “store of value,” but this becomes less possible.) One way this decline could occur is if those holding money have an expectation for continued inflation. Alternatively, money can be subject to an automatic downward adjustment that reduces its value on a monthly or annual basis.
With such a system, individuals discover that if they have money, the best strategy is to spend it immediately, rather than to try to save for retirement or some distant goal. Investments in stock markets, or in stocks of new companies, are likely to decline.
Without the availability of debt at a reasonable cost, businesses find it much more difficult to expand or to begin from scratch. New businesses tend to be small ones, that can finance their own operations by bootstrapping–that is, self-financing by using the profits on early sales to pay for materials needed for later sales, and hopefully for a little expansion as well.
All of these issues mean that if there is a financial collapse, picking ourselves up afterward will be quite difficult. Our current financial system would need substantial modification to work in such a system. The size of the current financial sector would likely shrink dramatically.
If the various countries of the world set up different financial systems to deal with the new realities, connecting them into a world system is likely to be difficult. Political stability is likely to be lower in a system such as this. How does one arrange long-term contracts, when there is a very real possibility that the government of the country that is party to an agreement may have collapsed, prior to the end of the contract?
What Brings the Whole System Down?
It is easy to think of a long list of things that might bring the system down. In fact, there are so many contenders that if any one of them starts the collapse, it seems likely others will push it on its way.
Clearly one of the issues is the wide gap between US Federal Government revenue and government expenditures.
Figure 3. US Federal Government Receipts and Expenditures (including Social Security, etc.) based on Table 3.2 of the US Bureau of Economic Analysis.If the US government (or the government of any of the many countries who are having difficulty balancing their budgets) tries to raise taxes or cut benefits, to get revenue and expense back in line, the outcome is likely to be more recession and more layoffs. Debt defaults are likely to rise, putting banks into financial difficulty. There will then be a need for more bank bailouts, and a rerun of the problems we saw in 2008, but with governments in poorer financial condition to solve these problems.
Another possible way the system could be brought down is by rising interest rates for governments, perhaps because of all of the failures elsewhere around the globe. Rising interest rates will mean that a government’s budget is even more unbalanced than it was before, because the higher interest rates translate to higher government expenses.
These higher government interest rates would quickly be reflected in other interest rates, such as mortgage interest rates and interest on corporate loans. Sale of homes would drop dramatically, as interest rates rise. Prices of homes would likely drop as well. Business investment would drop dramatically. Much of the “stimulus” that the government has put in place would disappear. We likely would be headed back into major recession.
A third possibility relates to the Quantitative Easing that has been done recently, and the artificially low interest rates that have resulted, even for longer-term loans. Investors who have to contend with these low interest rates will try to find ways around them, and in the process, create bubbles in asset prices. These bubbles invariably burst, with bad outcomes. For example, the WSJ recently published an article titled, “Investors pile into housing, this time as landlords.” Of course, when something goes wrong (like mis-estimating returns, or oil prices rising higher, leading to more pressure on renters’ ability to pay), the same investors are likely to pile right back out, puncturing the new bubble. Commercial investors rushing out will pull down property values, leading to yet more mortgage defaults as homeowners again find their loans “underwater”.
A fourth possibility is that oil prices will ratchet upward again. Alternatively, natural gas may rise from its current artificially low price level in the US, to more like European or Japanese levels. Either of these would lead to more financial pressures on citizens, and more debt defaults. Banks would likely again be in difficulty, needing bail outs.
A fifth possibility is that the Euro ceases to be a currency. Alternatively, some of the debtor nations could drop out of the Euro, allowing the Euro to rise for remaining nations, thus putting the remaining nations in a worse position for selling their exports. In either of these scenarios, the European crisis could be exported to the US, partly as reduced demand for our goods, and partly through exposure of banks to European defaults.
A sixth possibility is the effects of ObamaCare will destabilize an already weak economy, as businesses attempt to circumvent its effects by substituting more part-time workers for full-time workers.
A seventh possibility is that pensions start running into real financial difficulty, because of artificially low interest rates. The US government may be called in to bail out pension funds, or the Pension Benefit Guaranty Corporation, at high cost.
An eighth possibility is that states start leaving the United States, because they feel that they would be better off on their own, as taxes and mandatory programs (such as ObamaCare) become increasingly difficult to deal with.
What does the shape of the decline look like?
Many people who base their views on geological depletion of oil expect that the decline will be somewhat slow, matching geological decline. I don’t think geological decline rates will have much to do with the shape of the decline, except for perhaps setting an upper bound as to how well things might, in theory, work out.
The big question in my mind is how well the international financial system will hold together. There is a close corollary question: How successful will be at replacing it on a timely basis if it does fall apart? My concern is that if banks are suddenly closed, businesses of all types will fail. This could include companies extracting oil as well as companies selling electric power and companies providing fresh water.
If there are long-term problems with the financial system, international trade is likely to be greatly reduced. Businesses making trades are likely to want greater assurances that they will actually be paid than is the case today. This could take the form of bilateral trade with trusted partners, or “I’ll ship you Product A if you will ship me Product B,” as a form of barter.
A slowdown in world trade could have dramatic repercussions quickly with respect to our ability to keep basic services in good repair, because we are now dependent on international trade for replacement parts of products we use every day (such as cars and trucks). Nearly everything that is manufactured today incorporates raw materials from around the world, and uses machines that depend on parts from around the world.
Another question is whether there will be huge political disruptions. If banks are closed, someone usually is blamed. We have seen many ways these political disruptions can take place. Some examples might include Syria, Egypt, the Former Soviet Union, and Greece.
One scenario I can imagine is that some parts of a country are subject to more disruption than others. In one part of the country, banks may be closed, while in another part, states may be able to reopen closed banks. Or electricity outages may occur following a storm, and never be repaired, while other locations nearby are doing fairly well. There may be political riots, but these are often located in areas where politicians are located, not in other areas.
Perhaps it is just as well that we don’t know exactly what the decline will look like. Not knowing gives us some chance for optimism.
Default in Europe
Off the keyboard of Steve from Virginia
Published on Economic Undertow on March 24, 2013
Discuss this article at the Economics Table inside the Diner
The world’s economic enterprise is a tightly-coupled, massively complexarray of interlocking establishments, each highly complex in their own right. The failure of one component effects all the others. The analog is removing a pinwheel from a watch: the watch will still appear to be a watch but it won’t keep time.
The relative scale of the European economic enterprise compared to Cyprus is the same as the gigantic balloon relative to the tiny pin … any hole the pin might cause has consequences to the balloon wildly out of proportion to its size.
The Russians can simply refuse to accept euros, they will accept only dollars, instead!
The David Whitney house in winter, 1955, on Woodward and Canfield Street in Detroit, Michigan, from the Burton Historical collection, Detroit Public Library, University of Michigan. In our shiny new zero-sum post-petroleum world, some places succeed because other places are disposable. Detroit is the way Detroit is because New York City is the way New York City is.
Germany is the way Germany is because Spain, Portugal, Ireland, Greece — and Cyprus — are they way they are. The worse it is for them, the better it is for Germany.
There are references to Archduke Ferdinand and the cold war all over the Internet. Somewhere in abeyance the gauntlet has been thrown down. What is absent is any understanding of … why.
Bruce Krasting channels Barnum instead of Armageddon:
On the Circus in Europe
I’m flabbergasted that Cyprus is the cause of the circus in Europe. Cyprus was an avoidable problem in my opinion. That view is supported by the fact that all of the words, actions (and threats) by the deciders in Northern Europe have been decidedly negative. There was no “Can Do” talk. All I heard was, “We won’t do” or “Here is a deadline” – “Here’s a gun to your head”.
Two possibilities – Either this was a completely bungled effort in Brussels. Or this this was a deliberate effort to weed out the weak members of the EU. If the intent was the latter, this will not stop with little Cyprus.
Next week there will some broad confusion following the resolution in Cyprus. Either Cyprus is out of the Euro zone by Wednesday, or the +E100k depositors are going to get whacked big. There is no soft landing potential any longer. If the folks in Brussels and Berlin who are pulling the strings are really serious about stabilizing the Euro zone they will respond with a series of “positive” measures next week. Things that might be considered to ring-fence Cyprus include:
- Doubling the deposit guaranty to E200.
- Creating a Transaction Account Guarantee. This would insure all accounts that were related to the settlement of goods and trade. (protect the economy)
- Financial measures – From some minor stimulus stuff, to monetary measures like LTRO or a cut in % rates.
These would be “calming” steps. They would be proactive in that the intent would be to get ahead of any contagion. We could also see “nothing” from Brussels. That silence would be a “tell” that “they” don’t want to resist gravity any longer. The most significant sign would be if capital controls were established more broadly in Europe over the next few weeks. These will scare the crap out of folks, especially those in Spain and Italy.
If the EU was serious about managing the currency/credit flows there would be some discussion of the foregoing already. In fact there would have been discussions along these lines long before last weekend.
Instead there is noise about confiscating deposits in Italy and Europe-wide capital controls. In a currency union, capital controls are a death sentence. The ‘natural’ form of control is different currencies for each state. Under the condition of currency controls there are de-facto independent ‘euros’ with different prices for each. The next step — toward independent currencies — is a very small one.
What is underway is beyond the reach of language to adequately describe. Not only have best practices for deposit banking for 200 years been undone but so has long-standing management policy of money-capital flows across national boundaries. It can be inferred that every euro sent to Russia since 2000 has been a fraudulent instrument. Why would Russia sell more fuels to Europe under current uncertain circumstances? If the Russians do not accept euros, why would Saudi Arabia or any other oil producer?
Apoplectic Steve Keen says the Russians can cut off European natural gas supply.
Steve from Virginia says the Russians can simply refuse to accept euros, they will accept only dollars, instead! How retro! How … 1990!
Why would the Russians accept euros when they are subject to confiscation? Why would they accept French francs or Spanish pesetas? It’s the same bunch of thieves … the same bankrupt national economies!
The entire euro-as-energy-hedge is undone in an instant. By stiffing bank depositors, the EU has defaulted. There are no two ways around it.
The Chinese bosses are reaching for those Maalox bottles right now. China holds a trillion in euro-denominated debt instruments, so does Japan. Germany appears not to have thought this through. Regardless of what happens in/with the eurozone, Germany is on the hook for the overseas euro-trillions. Germany is the only EU country with money: it is responsible for all those Target 2 liabilities as well — this is another trillion euros. If not Germany, who picks up the tab?
Germany is declaring that overseas holders of euro currency are going to pick it up — starting with the Russians! Off the hook is the euro-establishment itself and its pet tycoons. High-level finance acumen is not necessary to understand how outrageous and destabilizing such an arbitrary action is: head-loppage was never part of the euro sales pitch! The euro was to be a ‘better, sounder’ dollar, always ‘good as gold’. Now, its fairy money, worthless in the hands of ‘not-quite-special friends’ who only discover they are so after the fact.
Exposure to currency derivatives presently denominated in euros is another liability. According to the Bank for International Settlements, the current derivative exposure including options and futures is twenty-four trillion euros. Who is on the hook for that? If the answer is ‘nobody’ then the entire edifice comes crashing down.
From here is looks like a lot of agony to come around the world: if Germany doesn’t default it is ruined by its ‘share’ of EU liabilities. If Germany defaults then China’s finance system is bankrupted along with Japan’s.
Don’t be surprised to see the European ‘bank run’ materialize over the next few weeks in the foreign exchange markets as countries seek to offload their euro risk onto suckers and market fools as quickly as possible. Unlike the bond and equities markets, F/X markets are difficult to manipulate. One reason is because they are too large: trillions of dollars and other currencies are exchanged every day. Who would volunteer to be the sucker? Not even the Fed is large enough — or dumb enough — to take over China’s or Japan’s massive euro positions.
Who is going to take over these positions? If the answer is nobody China and Japan — along with Russia — are left with with massive, instant F/X risk.
One outcome of this risk would be an increase in interest rates! Such a rate increase in the US and elsewhere would be very unpleasant: there would be instant hits to government spending as borrowing would become less affordable. Government bond holders would face immense losses. Eventually, the governments would be forced to bail out their bond markets simply to function!
Sacre Bleu! Capital flight to support the dollar and bond prices would only last as long as the euro was a viable currency. If the euro fails there is no readily available substitute for it. If Germany made good euro liabilities with d-marks … it would be for show only. The European euro-liabilities are simply too enormous. The end-game would be Germany refusing all non-German liabilities and restricting d-mark circulation to native Germans within Germany. Euro-credit everywhere would be re-denominated into (worthless) local currencies. There would be intense competition for international dollars, a massive deflationary contraction as these dollars vanish from circulation.
Believe it or not the Fed cannot ‘print money’. It can only make loans against ‘good’ collateral. The demand for US dollar currency would become overwhelming … Congress would have to act … in the highly complex, interconnected finance universe, the smallest perturbation effects everything else.
All of this could take place next month week! Look to the world’s money authorities to start leaning on the eurozone to put the genie back into the bottle. Matters could spiral rapidly out of control.
The motive behind this nonsense is presumably ‘bailout fatigue’: to spare the Germans the minuscule cost of keeping Cyprus banks functioning until after the German elections in September. There is no reason why the ECB could not continue to fund these banks by way of ELA and use the time to craft a solution that leaves depositors intact.
Export of petroleum consumption is the real reason behind the onrushing European default. When countries fail their allotment of petroleum is exportable. There is no substantial difference between the thievery underway in Cyprus and that in Libya or Egypt. Ultimately, all of Europe’s petroleum consumption is exportable leaving the various citizens in distress. The hope is to default on the small scale and hive Cyprus’ petroleum consumption and divert it toward the rest of Europe. The hope is that the default is contained and that the loss in Cyprus can be offset by more affordable fuel for the rest of Europe.
Cyprus is a test case. If the Cypriots can be jettisoned from the EU energy hedge then other countries can be safely ejected such as Spain and Italy. These countries can fend for themselves in the fuel-for-dollar market while the ‘core’ uses the hard euro to gain that fuel price discount and a guaranteed supply.
Europe’s strategy can only work if the euro-establishment is able to convince the Russians there are currency gains to offset depositor losses. The problem is that deflation follows its own rules: harder currencies cut into consumption which in turn presses the fuel suppliers. When customers hoard hard currency they do not buy fuel, the fuel suppliers go out of business. This is the reason why fuel prices have been declining since February.
Figure 1: Brent spot crude from yCharts (click on for big). Along with consumption export is the recent rise in fuel price to near $120 per barrel on Brent market. $120 is the new $147: the fuel price is too high, there are the ugliest of all possible noises coming out of Europe …
Cyprus imports 95% of its fossil fuel energy. The euro- and euro denominated credit have been the means by which Cyprus could afford fuel and the thousands of cars needed to waste it. Cyprus earned exactly nothing by driving those cars: nothing remains to retire the multi-billion-euro debts taken on to facilitate the waste. Meanwhile, the country fashioned itself into a mercantile (banking) state so as to arbitrage fuel like Japan. Its banking products have now been deemed redundant and expendable to the European mercantilists. Cyprus’ arbitrage has been devoured by the greater European version. Cyprus was a poor relative to the rest prior to the euro, it is on the way to becoming a poor relative again.
What is occurring in Cyprus is destruction of purchasing power by administrative fiat: this is, conservation by other means. Cyprus’ consumption is exported, its citizens will drive less because they will have less money, what money remains will be hoarded. Fuel not purchased in Cyprus will be available elsewhere so that others can drive in the Cypriots’ place.
Right now it is clear that the establishment will sacrifice anything — good relations with other countries and peoples, economic stability and predictability and best financial practices — to be able to continue to drive automobiles.
– One casualty of default is the media-promoted pseudo-recovery in America and elsewhere. This farce is now a child’s fantasy that can be safely dumped into the trash. Economies that required more easy credit last month now require human sacrifices. Today Cyprus gets the Black Spot, next month’s fall guy is France. Who’s next?
– Bernanke could come up with the ten-billion-or-so euros needed by the EU and end the panic. If he was smart he would do so — very publicly — tomorrow morning. This would buy some time and allow a chance for a comprehensive … etc. round of can kicking.
– If there is an EU ‘handshake’ with Russia => Panic in Southern Europe => contagion and derivatives implosion. This does not have to happen, but avoiding it will require extraordinary efforts, that will cost much more than anything gained at Cyprus’ — and Russia’s — expense.
– If there is no handshake — which seems likely as the European establishment is incompetent — Default in Cyprus is part of generalized euro default => failure of the euro, contagion in China and Japan => severe worldwide recession => collapse of fuel prices and physical shortages.
– Right now, Europeans are busy, opening new bank accounts in Norway, UK, Miami, Panama City and even Switzerland … It takes time to set up yr bank run, there has to be a place to run to.
– The Cypriots are trying to figure out how to evade the capital controls sure to come. Russians are trying to figure out how to remove their funds … Greeks are figuring out how to emulate the Cypriots who in turn are reading about the Icelanders. There is a lot of scheming — and fretting — going on right now.
– Nobody on Planet Earth wants a Greater Depression, everyone knows the score, this is the ‘Big One’ and people have their game face on. If a crisis can be avoided with a small payment most people will make the payment and not complain. It is the analysts who are upset about the consequences of the past few days. Most of the analysts are wrong about which consequences matter the most. They are wrong b/c they ignore the big energy story right under their noses.
– Citizens generally aren’t libertarians and they don’t take ideological positions, they are flexible. Right now the system does not appear to be ruined. That it is indeed ruined has to be proven by events.
The David Whitney house in Detroit in 2013. Out of the current wreckage some fragments will survive.
The only possible exit from currency death by energy strangulation is stringent conservation. Europe needs to cut its fuel bill in half right now. So does the rest of the world. This word ‘conservation’ is never mentioned, the conservationist is excluded from the management dialog. The conservationist offers options that are unhappy for the capital wasters. What the system managers refuse to understand is this: if nothing is done to conserve voluntarily there will be conservation by other, ongoing, extremely unpleasant means.
Big Ideas…
Off the keyboard of Steve from Virginia
Published on Economic Undertow on March 7, 2013
Discuss this article at the Epicurean Delights Smorgasbord inside the Diner
It’s hard to miss the Big Idea that the wheels are coming off the grand twentieth-century capitalist experiment; waste for its own sake, or waste for the sake of moving all-important ‘economic indicators’, waste for the purpose of enriching the even-more-important ‘entrepreneurs’ and ‘innovators’. The list of falling wheels would have to include China, Japan and Europe, but there are many more on a long list. It’s hard to think of a country in this world that doesn’t have major problems, the countries are interconnected by trade, treaty or finance so all are infected with each others’ problems in addition to their own: (Washington Post):
CDC says ‘nightmare bacteria’ a growing threat
Lena H. Sun
Federal officials warned Tuesday that “nightmare bacteria” — including the deadly superbug that struck a National Institutes of Health facility two years ago — are increasingly resistant to even the strongest antibiotics, posing a growing threat to hospitals and nursing homes nationwide.
Thomas Frieden, director of the Centers for Disease Control and Prevention, said at a news conference: “It’s not often that our scientists come to me and say we have a very serious problem and we need to sound an alarm. But that’s exactly what we are doing today.”
He called on doctors, hospital leaders and health officials to work together to stop the spread of the infections. “Our strongest antibiotics don’t work, and patients are left with potentially untreatable infections,” he said.
Just like the finance economy, the biosphere, the political economy; there are “potentially untreatable … infections”. The treatments remaining in the pharmacy are the same treatments that spawned the problems in the first place: repeat applications of MORE, everywhere in the world. If MORE cannot be had immediately there are earnest promises of MORE to come … tomorrow!
A ‘Big Idea’ that is making the rounds has the various countries engaged in a currency war. Nations actively depreciate their own currencies so that they might gain export trade advantage at the expense of others.
Instead, the nations are engaged in a war for petroleum that is being waged with currency. As in all wars there are the winners who will gain fuel imports, the losers will have limited access to petroleum, their domestic fuel consumption will be exported to the winners.
In this war all the countries are engaged, to do otherwise would be to give up claims on petroleum in the future. To have a seat at the table or have any chance of winning, the countries must waste as much- as fast as possible, as waste is the collateral for the needed (depreciated) currency. The advantage lies with the United States, not only does it waste more than the others, but it produces as a consequence much of the world’s credit. The waste of other countries such as China is collateral for American credit, that is, collateral for even more American waste.
Figure 1: China crude oil imports vs. exports from Mazama Science (click on for big). So far, China is winning, it must waste or be left behind: China currency is tethered to the dollar, its fate is intertwined with ours. To run in place the Chinese must waste more than the Americans, adding to both countries’ prodigious waste- costs.
As in America, China’s waste is promoted to the citizens as ‘progress’. These ‘improvements’ never acknowledge China’s multi-thousand-year traditions or even meet any real human needs. Instead, grandiose follies are heaped upon monstrous excesses … the process serves to rationalize the excesses’ so-called ‘value’. As with the other developed countries, sunk capital has the country by the neck. China’s vast waste is collateral for China’s vast debts, to service the debts it must add to collateral. The country devours energy today so that it might devour even more tomorrow. It’s always tomorrow, good or ill, China must devour otherwise the hated Americans will do so in its place.
The bravado of the xenophobic industrialism rings hollow, to win this war over resources is to lose: permanent smog, water pollution, desertification, land theft, an out of control loan-shark economy and high level capital flight. China growth is gained by constructing buildings rather than using them: ‘growth’ is thousands upon thousands of gigantic stone heads concrete towers.
Credit-driven speculation in apartments and office towers in China is intended to be a hedge against rising energy costs, just like recent credit-speculation in tract houses in the US and Tokyo office buildings twenty years ago. The Big Idea is that building prices will rise faster than the credit-inflated fuel prices. By this way of thinking, fuel is always affordable because what sets the price — credit — is the means to meet the price — credit driven momentum-chasing in asset markets. Fuel is simply another asset, rationed by access to credit.
These kinds of hedges arbitrage stupidity, they live in the hedgers’ minds and nowhere else. On Planet Earth fuel is either plentiful or not: what sets the price of fuel is the credit-cost to pull it from the ground plus a supply-and-demand driven scarcity premium. The real cost of fuel increases relentlessly over time because of depletion, meanwhile, the internal costs of the hedges increase as well. Even when fuel costs remain low, as they were from the mid-eighties to the end of the millennium, the hedges become unprofitable and collapse.
For hedgers to gain their fuel, the asset(s) must be sold to others more effectively greedy than the hedger. Whether they sell to actual customers or take out loans against their investment doesn’t matter. The selling reduces the number of potential customers: sooner or later they run out, even in populous China! That is the end of the hedge.
The Chinese who buy these buildings are unwitting conscripts in the great global currency war over petroleum. Millions of relatively prosperous Chinese have invested the life-savings of generations in future energy waste. In a world with diminishing energy supplies, the investments are stranded. The Chinese cannot afford to make use of all the currently empty buildings and the cities that contain them, otherwise they would be doing so! The Chinese would have been much better served to invest in conservation, instead they have invested in ‘conservation by other means’.
Another reason for the Chinese building frenzy is to literally set in concrete the claims of developers and urbanites over prior occupants of China’s countryside. This Big Idea is no different from Anglo-American claims that were perfected on native lands in the 19th century with farms and mines, railroads, towns and barbed wire cattle fences. There are certainly less costly ways that are equally effective and more equitable than the Big Stone Head approach.
Keep in mind, when the Chinese property bubble unravels like all the others, the banking system will be ruined. So too if one of the major currencies such as the euro, sterling or yen fails … that is, if China wins the currency war. China holds hundreds of billions- or trillions of these currencies as reserves, its positions are far too large to unwind. A currency failure, a run out of banks or a bond market hiccup would bankrupt China finance … which in turn would bankrupt the rest of the world’s finance.
Mercantilism is another Big Idea energy hedge. A country obtains petroleum at a price and uses some of it to make high-worth goods such as (fake) Gucci handbags or Lexuses which are sold to customers overseas. The gains from the sale pay for the country’s fuel plus profits to the manufacturers.
The mercantile country and its firms borrow against the overseas trading partners’ accounts. Exporter’s fuel consumption grows larger than what it ordinarily would be without the trade. This is the presumed intent of today’s currency combatants, for each become successful mercantilists and have ‘others’ subsidize their fuel waste.
Figure 2: Japan is going broke because its fuel imports are too costly to be met by export of its goods to increasingly broke customers. The reason the customers are broke is high fuel prices! They cannot find any countries to subsidize their own fuel waste.
If Japan doesn’t depreciate its currency it cannot export or win the petroleum war. At the same time, if it depreciates any gains from exports will offset by increased fuel cost. If the yen is sufficiently beaten down the world’s fuel suppliers will not accept it and demand dollars instead.
Japan has large foreign currency reserves but these are collateral for domestic debt. Like China, Japan has few options to free up its collateral: whatever collateral it can access is over-committed.
Japan is orbiting the drain, the recent trade deficit is the last straw, the country has too many obligations to meet … all of them coming due at once. The inflow of overseas funds into Japan and the carry trade have been the means by which the country has endured deflation without the associated depression. Japan now needs more waste — growth — or a return to the inflow of overseas funds.
Depreciating the yen is a symptom of Japan’s “potentially untreatable infection” — its past success is now killing the country. Japan is beyond desperate: on deck is nominal GDP (NGDP) targeting. This is the Bank of Japan making unsecured loans (because the Japanese private sector finance is not making any).
Sadly, the Japanese establishment does not understand why the private finance does not lend … they are in denial like the rest of the industrialized world. The private sector is bankrupt, it cannot borrow! So are Japan’s overseas customers, they just aren’t announcing it. Instead, they pretend and hope nobody is paying attention.
Deflation feeds on remedies designed to defeat it. All avenues here lead to entropy: if the private sector delevers, the government itself becomes insolvent. If Japan’s central bank leverages itself, it too becomes insolvent and there is no lender of last resort. The result is a run on Japanese banks and out of yen.
Around the world, various finance markets are pressurized, the Big Idea is to wring out volatility and create a Potemkin market that can pass as the real thing; ditto commodities, particularly gold, copper, foodstuffs and petroleum.
Time marches on and costs of volatility suppression are added to other ex-market costs, volatility emerges where the suppression forces are weakest. Right now, this is the currency markets. Switzerland can peg its currency to the euro at an affordable cost, just like the Chinese can peg its currency to dollars. Today’s question is where and how does Japan fit in particularly with its new trade deficit?
Japan has its own currency, unlike Europe, its treasury can issue yen to retire debt, extinguishing the self-created currency along with the debt. However, this remedy is likely too late to apply b/c the Japanese banking system is insolvent. An issue of government notes sufficient to effect Japan’s debt market would cause the banks to collapse.
Meanwhile, the Big Idea in Europe is the purposeful absence of any ideas at all! The technocrats are disappearing leaving a vacuum, to be filled by demagogues.
Figure 3: Europe produces about twenty-percent of its own petroleum fuel from rapidly depleting native sources, the rest must be imported. The mercantile states Germany and Italy export energy waste to others to meet their expenses, however, these customers cannot use the exporters’ waste to meet theirs. Like Japan, Europe is bankrupt.
The big difference between Europe and Japan the euro non-currency. Factionalism suggests Europe is set to lose the currency war and have its petroleum consumption shifted to others such as China and the United States. In other words, Europe cannot afford the euro, any currencies it can afford are nut suitable for the petroleum import trade. Because the euro is the currency of none of Europe’s states, there is no real issuer nor any lender of last resort, only a pretender.
Europe’s approach to the euro has been typical of the humans’ approach to everything else: to grasp what is immediately wanted then ignore life-cycle consequences. Europe wanted the euro as an energy hedge: it gave smaller countries the means to import waste from both Germany and OPEC. Now, these small countries cannot pay for the imports and the currency does not allow for the transfer of these costs to ‘others’. The waste — of course — is worthless, it cannot be ‘repossessed’.
The outcome is a Europe frozen on the spot. If it tries to pay for the expensive euro the entire continent will be ruined and unable to afford petroleum. This is the ‘austerity’ dynamic in force currently. If any country abandons the euro, the entire enterprise falls apart and there is nothing left to the Europeans with which to gain fuel. It is hardly likely that any petroleum supplier will accept a national currency from a bankrupt nation if the same nation’s bankruptcy has fatally undermined the euro! Of course, if the euro fails so will China finance, which holds massive amounts of euro-denominated debt as reserves, far too many to be readily rid of … without precipitating the disaster that it so desperately seeks to avoid.
Like so many other countries, Europe has an unraveling property bubble/energy hedge that also failed.
Meanwhile, the exit of the technocrat is the last step in post-petroleum down escalator toward chaos. After the technocrat comes zero-government, factionalism or abdication of governing authority. This is not to say that political and administrative reform is not possible; without new resources or an ‘upside down’ approach that husbands capital there is no foundation for reforms. The factions all promise MORE and a return to waste: the broken government is able to export fuel consumption elsewhere more efficiently and with less cost than do the factions, technocrats or ineffective government.
The problem in Europe and elsewhere is at the end of the everyone’s driveway. Every single day the Europeans must import twelve million barrels of crude oil at staggering cost, they must borrow from New York and London financiers to do so, as they have for ever day since the end of World War Two. Europe’s pathetic car industries cannot pay their own way much less the wasteful continent’s gigantic fuel bill. Europe is beyond insolvent, beyond broke, by rights it should never borrow again, ever, from this point in time until the sun consumes itself and balloons to fill the solar system. Europe’s bosses believe with this bit- or that bit of beautifully embellished central bank promises it can claim a good that is vanishingly rare and valuable … so that this good might be burned up for time-wasting entertainment purposes and economists’ reputations only.
This is the real Big Idea, it has not materialized in the imagination of the modern world … yet. It emerges from a concrete Big Reality that the modern human works hard to ignore. Modernity is intrinsically dysfunctional, its products are entropy and ruin. Its managers defend their right to waste as they please at the expense of the rest, the non-managers demand the right to waste along with the managers: this is madness! That a war might be waged with competitive waste as a tactic speaks to the inherent moral and physical bankruptcy of the ‘modern’ idea: it has hollowed itself out. At the end of the day the competitors are all smashed, together. There can realistically be no other outcome.
The next Big Idea must be an economy that rewards conservation and the husbandry of capital by every and all means, that treats all of capital as precious, rather than a substitutable ‘input’. It isn’t such a hard idea to grasp, its application is becoming a desperate necessity. Stewardship is less difficult than competitive depreciation financed by increased resource waste. In a well-functioning conservation economy shepherds of capital become rich and by so doing the others would become rich along with them. There is still entropy, but not the Hammer of Thor.
Time is running out … we adapt or else.
Different this time…
Off the keyboard of Steve fromVirginia
Published on Economic Undertow on February 10, 2013
Discuss this article at the Epicurean Delights Smorgasbord inside the Diner
The North Dakota Department of Mineral Resources made a presentation to native peoples’ tribal leaders in the state last fall regarding oil and gas production in the Bakken area, (PDF alert). It’s a comprehensive report and worth the time to examine it. This jumped out:
Figure 1: “Oil price could fall enough to make some areas uneconomic” (click on for big). At issue is whether prices in certain areas of the US are low enough to shut in marginal production already.
Figure 1: the cost of Brent crude vs. the ability of crude customers to pay for it made graphic, from TFC Charts. What the chart can’t say is that the industrial world is impoverished by the high cost of crude in a vicious cycle. What it also doesn’t show is that real fuel prices will increase relative to other costs, even when nominal prices decline. Funds must be diverted toward obtaining fuel away from the purchase of non-fuel goods and services. When the drillers gain credit the customers are deprived of it … the alternative is less fuel.
Little has changed over the past two weeks except that Brent prices are a little higher due to war fears in the Middle East, moral hazard by central banks and nonsense bullish frenzy that has overtaken asset speculators. Right now, customers are borrowing at the expense of drillers. If the prices climb high enough, listen for ugly noises from the euro-zone or Japan as the higher prices bite hard … and businesses (banks) start to fail. That will be the end of the bullishness.
Keep in mind if the economy starts deleveraging (again), there is little the establishment and central banks can do but stand aside and wring their hands. Everything has been committed already: interest rates are at near zero, governments are at the borrowing limit, there is little in the way of collateral remaining for central banks to take on as security for new loans.
Speculators don’t realize conditions are fundamentally different this time … nations, regions, individuals and firms have experienced temporary shortages of fuel, credit and other resources in the past due to wars, droughts and other disruptions: the world in its entirety has never run out of energy before, which is what is underway right now.
| Commodity | Units | Price | Change | % Change | Contract | Time(ET) |
|---|---|---|---|---|---|---|
| Crude Oil (WTI) | USD/bbl. | 95.72 | -0.11 | -0.11% | Mar 13 | 17:15:00 |
| Crude Oil (Brent) | USD/bbl. | 118.90 | +1.66 | +1.42% | Mar 13 | 18:00:00 |
| RBOB Gasoline | USd/gal. | 305.88 | +5.89 | +1.96% | Mar 13 | 17:15:00 |
Is $118 the new $147? Here is another look from Stuart Staniford:
Figure 2: Brent and WTI performing together on the same stage (click on for big). The lower West Texas Intermediate price is good for refiners who can sell products outside the Midwest at the world price. This is a burden for drillers as Bakken formation supports the most expensive, fastest depleting wells on Earth. Landlocked wells put the squeeze on drillers: if the Bakken oil field was near the Gulf coast, drillers could sell their crude at the Brent price, putting the squeeze on refiners instead.
– Drillers have to keep pace with depletion in the Bakken and similar tight fields so large numbers of wells have to be drilled continuously.
– Drillers also have to keep pace with depletion in conventional formations which is occurring at a rate + 4% per year.
– Drillers in the US face an inhospitable environment: oil-field labor shortages, skeptical regulators, anti-fracking activists and the price squeeze.
Rune Likvern (Oil Drum) called keeping up with Bakken depletion rates ‘Running With the Red Queen’ Drillers need to punch holes in the ground at ever-increasing rates just to maintain current rates of output. Any slacking in efforts and flows of product decline sharply, says Likvern:
In reality, it was the growth in the oil price to an apparent structurally higher level that secured commercial support for crude oil production from shales. In that respect it was the oil price that was the true game changer and unleashed the “shale/tight oil revolution”. There is a saying that goes like; “Do not listen to what they say (technology). Look at what they are doing! (spending borrowed money)”. This may as well go for the Bakken formation. The oil service giant Baker Hughes recently expressed concerns about slowing activity levels in shale plays if oil prices moved below $80/Bbl. Further the oil companies Marathon and Occidental recently cut back on their activities in the Bakken formation. Oil and gas companies still care about the colors of the numbers at the bottom line for their projects.
How landlocked is the Bakken crude? Most of the product is shipped by truck to pipeline terminals and railheads, (from the Mineral Resources presentation):
Figure 3: Running with the Ace of Spades: by the time the transportation mess is straightened out the Bakken fields will be depleted.
Coastal refiners must pay world prices for crude while selling high cost products. As a result of the squeeze, coastal refiners are going out of business. Here is a clip from Stillwater Associates:
US East Coast Refinery for Sale: Who’s Buying? Earlier in September, Sunoco had announced plans to sell its Marcus Hook and Philadelphia, PA refineries, noting that the refineries had been profitable for only two of the last 10 quarters, and stating that both refineries would be idled in July 2012 if buyers have not been found. However, in an early November conference call with analyst, Lynn Elsenhans, Sunoco’s CEO and Chairman, stated that “…if at any point we believe it’s in the best interest of the shareholders to either stop operating (Marcus Hook and Philadelphia) or change their utilization rate, up or down, even if that’s before July, 2012, we would take the appropriate action.” Sunoco Refining and Supply reported a $17 million pretax loss for 3Q 2011, the ninth quarter out of the last 11 for which Sunoco Refining and Supply lost money.When ConocoPhillips announced that it was seeking a buyer for the Trainer refinery, Willie Chiang, then ConocoPhillips’ Senior Vice President of Refining, Marketing, Transportation and Commercial, noted that their decision to sell, like Sunoco’s, was based on unfavorable economics caused by a competitive and difficult market environment characterized by “…product imports, weakness in motor fuel demand, and costly regulatory requirements.”So, who will buy these refineries?Valero has been mentioned by some as a possible buyer, but Valero exited the refining business on the US East Coast when it sold its Paulsboro, NJ and Delaware City, DE refineries in 2010. Valero has said it plans to move gasoline from its recently acquired Pembroke, UK refinery, which can process heavier sour crude, to the US East Coast.
Keep in mind, the transport bottleneck is the reason for so much gas flaring in tight oil formations. Gas does not command a price high enough to support a crash program to build out distribution infrastructure. Meanwhile, enough gas to heat a big city like Minneapolis is wasted.
Keith Schaefer @ Oil and Gas Investment Bulletin says:
A vertical well into a conventional oil field costs something like $1 million. The Bakken’s horizontal, multi-stage frack wells cost an average of $9 million, according to the North Dakota Department of Mineral Resources. That’s a huge upfront cost. Each well produces approximately 615,000 barrels of oil, meaning the breakeven price for each Bakken well ends up in the $70-$90/barrel range, once taxes, royalties, and expenses are included. If oil prices slump below that level, a lot of people say Bakken wells aren’t worth the cost.
A lot of people like grade school arithmetic teachers. Because businesses cannot lose money perpetually, low prices keep crude in the ground … conservation by other means.
As the wells in the Bakken grow closer together, initial production rates are sliding. According to some sets of data, average first year well output climbed steadily from 2005 to a peak in mid-2010, then declined almost 25% over the following 12 months. With more wells tapping into the same resources, there is simply less oil pressure available to each well. And when initial well output starts to fall, an accelerating number of new wells must be brought online to sustain overall production volumes.Such is the heart of the pessimist argument: that sliding initial flow rates will tag-team with the Bakken’s high decline rates to mean that, no matter how many new wells are drilled, production will stagnate.
One thing to keep in mind is when oil-bearing rock is fractured, it is turned into gravel, the stones held apart by propants: sand or ceramic grains. Once rock is fractured, it cannot be fractured a second time. Fracking is ‘one and done’.
Of course, the real problems are on the consumption side, not the production. Consumption is waste, it does not and cannot pay for itself. What does the heavy lifting is debt and lots of it. We’ve had debt around for so long we’ve gotten used to it. What we are starting to realize is the monumental cost alongside the impossible debt dynamic. The debts are too large to repay only refinance with new debts. Meanwhile, costs including repayment obligations compound exponentially. We ‘fix’ debt problems by taking on new debts, falling deeper into a hole with each round of debt.
The outlines of our condition are becoming more defined, the clock is ticking … Numerian says (Economic Populist) HT Usman:
Even if another credit blow-out occurred, we all know how that would end – very badly, as in 2008 credit crisis all over again. Unfortunately, without another credit splurge the results are the same. When the credit stops flowing, income is hit hard, because most of the growth in income in the economy is produced by debt, and it is not organic growth that would result from a normal recovery generated through capital investment, wage and benefit increases, revenue advances, and expanded global trade. This is precisely what the Fed understands, and why it is expanding its balance sheet ceaselessly, and enabling the Congress and Administration to build up debt at the tune of a trillion dollars a year. All this credit is the lifeblood of the economy, allowing the government to make Social Security and Medicare/Medicaid payments, feed 48 million people through food stamps, fight wars in multiple hot spots around the world, pay interest on the debt to keep bondholders happy, and shift unemployment money to the states. The problem for the Fed is that the unraveling is already beginning. The stock market may be testing its highs, and 50 out of 50 economists may be anticipating a solid economic recovery, but without new sources of credit that is going to be impossible to achieve. Credit has already dried up in the real economy, which is why you hear so many retailers say “nobody has any money” …
“Nobody has any money …” should be familiar: What the chart can’t say is that the industrial world is impoverished by the high cost of crude in a vicious cycle.
When credit stops flowing, income is hit hard because ALL of the growth in income in the economy is produced by debt … without it there is no industry!
What we are experiencing are two interrelated phenomena: an energy shortage due to our wonderful economic ‘success’ over a period of 400 years and the consequences of exponential growth of loans needed to ‘buy’ this success..
Debt is taken on to capitalize industries and their customers. More debt is taken on later to fill the pockets of the industrialists and roll over the first rounds of debt. Finally, debt is taken on the service the previous rounds and nothing more, the economy is saturated with debt.
The first round of debt gains the industrialist tools to produce goods and provides customers with purchasing power. The second round gives the industrialist his fortune and repays the venture capitalist: during this round fewer tools are gained and less in the way of goods are produced. The third round pays the moneylenders’ interest and nothing more, customers and industries are bankrupted by their debts.which are unproductive. Eventually, the moneylenders also fail.
‘Moneylenders’ here must also include the central banks.
Our economy is in the third stage and has been here for awhile, perhaps since 1980 and the ‘Reagan Revolution’.
Added to this is the ongoing shortage of liquid fuels which results in higher prices which must be met with debt. The cost of new fuel rises past what customers can borrow using fuel waste … as collateral. Waste of the fuel does not provide an organic return so all returns must be borrowed adding to the demand for debt… during a period when productivity of debt is diminished.
More about central bank-n-market head-fakery and wishful thinking, (Naked Capitalism):
Is the Euro Crisis Over? By Robert Guttmann, Professor of Economics at Hofstra University and a visiting Professor at University of Paris, Nord. Cross posted from Triple Crisis.A strange calm has settled over Europe. Following Mr. Draghi’s July 2012 promise “to do whatever it takes” to save the euro, which the head of the European Central Bank followed shortly thereafter with a new program of potentially unlimited bond buying known as “outright monetary transactions,” the market panic evaporated. Since then super-high bond yields have come down to more reasonable levels, allowing fiscally and financially stressed debtor countries in the euro-zone to (re)finance their public-sector borrowing needs a lot more easily than before. Even Greece has been able to borrow in the single-digits for the first time in three years.This calming of once-panicky debt markets has led to optimistic assessments that the worst of the crisis has passed. Draghi himself declared at the beginning of the new year that the euro-zone economy would start recovering during the second half of 2013. He talked of a “positive contagion” taking root whereby the mutually reinforcing combination of falling bond yields, rising stock markets and historically low volatility would set the positive market environment for a resumption of economic growth across the euro zone. Christine Lagarde, as the head of the IMF part of the “troika” (i.e. ECB, IMF, and European Commission) managing the euro-zone crisis, declared at the World Economic Forum in Davos a few weeks ago that collapse had been avoided, making 2013 a “make-or-break year.”
Here is conventional economic analysis that never gets around to mentioning energy.
– A strange calm has settled over Europe … following Mr. Draghi’s July 2012 promise “to do whatever it takes” to save the euro,
Draghi didn’t actually do anything, he talked about it.
– the market panic evaporated.
That’s an assumption. The more likely is credit strangulation eased a bit.
– This calming of once-panicky debt markets has led to optimistic assessments that the worst of the crisis has passed.
Not by a long shot, the crisis is the cost of energy and the inability of the Europeans to earn anything by wasting it.
– we can see that Ireland, Spain, Portugal or even Greece have been able to lower their current-account deficits substantially,
Automobile sales in these countries along with France have collapsed, petroleum use has significantly declined. Consequently, there is less fuel being imported by these countries. Keep in mind, their fuel use will decline to zero if they do not effect conservation measures. What is underway is not a rehearsal, it is the effects of entropy being felt along with diminishing supply of fuel overall. Fuel is being rationed, conservation by other means.
– renewed turmoil in the sovereign-bond markets will be just a matter of time. Most troubling in this context is the doom-loop dynamic of persistent fiscal austerity across the continent.
Withholding credit is a way to compel the export of European fuel consumption to credit issuers such as the US. Any fuel not burned in Italy or Spain is available to be burned in Los Angeles. America’s energy ‘surplus’ is by way of theft from Europe and elsewhere, not fracking. The problem with the professor is he is not cynical enough!
– This dialectic centers above all on the euro’s trade-adjusted exchange rate.
Not in the sense that the professor implies: the more deflation-priced euro gives those who hold it the means to buy fuel at a bit of a discount … and an incentive to keep the euro. Any replacement currency would be depreciated violently, there would be small likelihood of any petroleum exporter accepting any replacement currency other than d-marks.
– will undermine the competitiveness of the euro-zone’s economies,
The assumption is that countries like Greece or Portugal are industrial countries with factories filled with overpaid proletarian workers like China. Instead, they are senior centers filled with retirees. Peoples’ pensions are being looted, this is called ‘competitiveness’, stealing on a grand scale is what is showing up on the ‘stats’.
– But the euro-zone cannot afford this stop-go pattern of policy-making in the face of a systemic crisis. It will have to undertake far-reaching reform on several fronts beyond what Europe’s leading politicians have been willing to entertain.
Europe is being de-carred by pauperizing the populations. The necessary reform is for governments to take charge of this dynamic and decar the continent on purpose while sparing the citizens. Europe can stand to jettison its useless cars and the fuel waste these things represent. It is the waste that has undermined the European — and world — economies, not trivial real interest rate movements or currency exchange rates. These last are abstractions, petroleum waste is permanent: when the fuel is gone baby, it’s gone, forever.
Small Bizness in the Sea of Irredeemable Debt
Off the keyboard of RE
Published originally on the Doomstead Diner
Discuss this article at the Epicurean Delights Table inside the Diner
My good friend and Cross Posting Blogger here on the Diner Steve from Virginia published an article this week called Watch the Banks…. on his Blog Economic Undertow. It’s one of Steve’s trademarks to title many posts with three Periods after them….LOL. I cross posted the article here on the Diner yesterday. It touches on many themes explored here on the Diner with respect to the Creation of Money, and how Biznesses function in this economy, both Large & Small.
Indeed, watching the Banks is the KEY element in following the progress of the collapse. The “System of the World” as Neal Stephenson put it, the Monetary system we all depend on is run by a few Large Banking Houses, JP Morgan Chase, Bank of America, Goldman Sachs et al, and the Central Banks they control like the ECB, the BoJ, the BoE, the PBoC and of course Da Fed as well. All coordinated through the Bank for International Settlements Headquartered in Basel, Switzerland. The BEST way to follow the Collapse in Progress is to watch the machinations and currency manipulations being undertaken to keep this very large and complex stucture floating another day.
One of the Key Points Steve touches on in his article relates to the primacy of “Small Bizness” as an Economic Driver, in a sense making the postulate that Small Biz preceeds Big Biz in the development of an Economy. Does it REALLY though? As I see it, perhaps in the Dawn of History for Homo Sapiens Small Biz preceeded Big Biz, but since the development of large scale Agiculture around 8000 years ago, the opposite has been true, and the main economic drivers for this period were the large scale generally Slave Driven Ag enterprises and the War Machine they support and which supports it in a synergistic relationship.
Steve and I have already gone a few rounds in debating how this economy develops on Economic Undertow, I will include these posts as a preface to better grasp the global issues.
From RE:
I don’t think any “small bizness” earns any “organic returns”, at least not while all biznesses operate under a failing currency structure.
Small Biz is essentially Parasitical off of Big Biz. If Big Biz borrows Capital to put up say a GM Auto Plant in Janesville, Doctors, Dentists, Property Sellers, Retailers and Restaraunters all open up small biz that sieve off the central source of money.
When the Big Factory shuts down, all the Small Bizmen go Broke too, even if they took out no Loans to grow the Biz. Customers with MONEY are no longer in the neighborhood buying their goods or bidding up the price of housing. Just the monthly overhead of the Restaraunt makes them insolvent.
Without Large Public Works feeding money at great scale out into the economy, the ancillary small biz all goes broke too. I wrote about this on the Diner in the Large Public Works Project series.
For the recent Generation in the Age of Oil, the BIG LPWP was the Interstate, and then the Shopping Malls and McMansions that built up around the Ring Roads.
Without such LPWPs, there is no way to distribute out centrally created “money” which has any value. There is nothing for Small Biz to sieve off.
It is unlikely we will create any new LPWP to replace the one built courtesy of the thermodynamic energy of fossil fuels over the last 3 centuries or so. In the absence, Money on the Grand Scale of International Finance will irretrievably FAIL.
Whether any more Local forms of Money can be substituted remains an Open Question.
RE
From Steve
RE, there is a big information gap before industrialization.
The Middle Ages were as prosperous as Roman period and succeeding modern periods, not for all at all times but the same can be said of the present. Americans live better than Kenyans, Venetians lived better than Saxons in England after William arrived. What mattered most in Europe was tide of war.
Post-Constantine, the wealth of the Western Roman Empire was directed toward the church and away from government and the private sector: this was a big reason for the decline then collapse of the empire. The church made itself the beneficiary of all estates without heirs or issue, over centuries it absorbed vast amounts of property from extinct estates. It became property recorder and mediator of disputes great and small, which gained it fees. The Western Roman government became unable to compete with the church as a business enterprise.
The militaristic Franks eventually absorbed and reorganzed Roman activities in Western Europe, trade was continuous from Asia to Spain, trade centers such as Genoa, Siena, Venice, Constantinople became rich.
The traders in the 8th century were wealthy and successful … as any number of ‘entrepreneurs’ today. They borrowed their fortunes and hived to costs onto their trading partners!
The Romans understood steam power but not plate glass or railroads. Franks understood printing but not moveable type or firearms. The Chinese understood rocketry but not airfoils. Information was hard to come by, in the West the church had a monopoly on education as well as on books. It took moveable type — and a series of bloody wars — to break the church’s information cartel.
The war periods inform the public imagination of European life, up until the rise of publicly available information in 15th century.
This is also when looted gold from the Western Hemisphere began to arrive on European shores by the shipload:
– It financed the renaissance,
– it triggered the largest, longest-duration bout of hyperinflation in history, over 100 years, over America, Europe and Asia,
– it financed the industrial revolution,
– it financed the rise of Netherlands and UK as naval powers to rival Spain,
– it also financed the 13 British colonies,
– it financed 2 centuries of religious wars in Europe which ended with the collapse of the papacy’s temporal power.
Spain ended up bankrupt, Portugal and Netherlands were severed from Spain, both France and Italy expelled entrenched foreign influences to become powerful nation-states, the Holy Roman Empire dissipated to reformulate itself over time as modern Germany … Ireland became a slave state of England, which itself endured a violent revolution and civil war to become a military power … the English civil war extended overseas to North America ending with the American Revolution, then a revolution against the French monarchy. Afterwards came Bonaparte. All of this and much more besides was paid for with Peruvian and Mexican gold (some Eastern European silver, too).
Between wars and recoveries there was a lot of room for enterprise. Both Europe, China and South Asia were wealthy, during the Middle Ages there was strong demand for consumer goods such as sumptuous clothing, carriages, villas and town houses, exotic foods, private botanical gardens and arboretums, paintings and sculpture, illuminated books, lavish public entertainments, theater productions, permanent installations such as public parks, fountains, bridges, stone-paved roads, elaborate structures such as enclosed markets and forums for public gatherings, gigantic cathedrals (filled in places with Roman articles), private galleys, teams of horses, livestock, etc. A common complaint was that people could not determine who was wealthy or a noble and who was not because the commoners wore the same or better clothing. All of these things were made by more or less small-scale craft level workshops, lots of them.
Any town would have stone-and brick masons, a quarry, a brick maker, a foundry, a tannery, a carpenter, a blacksmith, a tinker (make pots and pans), silver- and gold smiths, embroidery shops, tapestry weavers, yarn spinners, shoe-and boot makers, stable hands, street pavers, armorers, arborists, vintners and brewers, gardeners, window makers, musical instrument makers, cabinet makers, roofers, livestock tenders, butchers, barbers, etc. Regardless of ones’ station there was always something to do. Most did not have to toil incessantly, there were many holidays and feasts. The grim peasants in rags … Monty Python or Lord of the Rings.
Most towns in America or Europe do not have any of these things at all: we are dependent upon welfare and television … the poorest medieval town was more prosperous than any of our towns today!
From RE:
Steve, you won’t get an argument from me that Medieval Towns were more self-sufficient than modern cities, of course they were. From an economic standpoint though, all those Craftsmen you revere so much STILL were parasites off the Big Biz of the era, which was mainly Ag and Warfare.
First off, the fact most goods and services were produced locally meant that commoners used little money at all, they bartered. If you needed the services of the local Quack to Bleed you due to contacting Plague, you paid him 2 chickens. If you Tanned nice skins, you traded them for a bushel of potatoes. etc.
The main way money got into the economy was from Soldiering and Plundering. The local Lord would conscript up promising to Pay in Silver, after they got back from stealing the silver from the next county over. Eventually of course they consolidated up to Kingships and incipient Nation-States of course, then went about ripping off Gold wholesale from the New World, leading to the inflationary period you spoke of. VERY Big Bizness there!
The other way money got distributed out was through the Holy Roman Catholic Chuch (the Mega-Corp of the Era) in the building of Cathedrals, the Large Public Works Projects of the era. This of course provided lots of work for Stone Masons, Carpenters, Stain Glass Window artists, etc. If your Community could get the HRCC to build a Cathedral in your nabe, it was a thriving little Metropolis. No Cathedral, you were a dirt poor backwater town.
As it further evolved, the Big Biz of Plundering via Tall Ships equipped with Cannon led to those next Massive Corps, the Brit and Dutch East India Companies. Said Big Biz of course provided tons of work for Shipwrights, Carpenters, Sail Makers, yadda yadda not to mention the guys forging the 20 pounder Cannon, which was NOT done in a small Blacksmith’s shop.
In the background of all of this of course were the Financiers, floating Stock Issues in Amsterdam and London, and in fact in 1692 when the BoE was chartered, they were pretty much Fresh Out of Gold, as the Spanish had nailed down the best Gold Theft locations and they got stuck with North America, which until the Railoads got built into the interior did not offer up much gold. They got their money for financing up their colonial adventures courtesy of Master of the Mint Sir Isaac Newton, and began to do well providing Letters of Marque to Pirates who would hit on the Spanish Cargo ships on the High Seas. Their Big Biz controlling the Sea Lanes with the Brit Navy brought in the money that all those local craftsmen used fo commerce.
In all cases going right back to Ancient Egypt and Mesopotamia, It was the Big Biz of Ag centrally controlled which got the Money going, and the Big Biz of Warfare which brought in the PMs to use for coinage. Large Public Works projects such as the Great Wall(s) of China, the Pyramids, Cathedrals et al were symbols of successful cultures running the Ag-War Economy. All the small craftsmen and small biz expanded to sieve off this economy. They don’t exist independent of it.
RE
From Steve:
Various non-industrial employments in the 18th century:
A Treatise On Indigence: Exhibiting A General View Of The National Resources …
By Patrick ColquhounProfessional soldiery was a tremendous burden to the state prior to Spanish gold which meant most militaries fielded militias, irregulars or mercenaries. Governments offered letters of marque to privateers to augment their navies.
Another list of medieval (pre-industrial) employments which saves me the effort of making one:
http://www.svincent.com/MagicJar/Economics/MedievalOccupations.html
There was another list over on Guy McPherson’s web site but I can’t find it …
Globe Town
To the east of Bethnal Green (London) lies Globe Town, established from 1800 to provide for the expanding population of weavers around Bethnal Green attracted by improving prospects in silk weaving. The population of Bethnal Green trebled between 1801 and 1831, operating 20,000 looms in their own homes. By 1824, with restrictions on importation of French silks relaxed, up to half these looms became idle and prices were driven down. With many importing warehouses already established in the district, the abundance of cheap labor was turned to boot, furniture and clothing manufacture. Globe Town continued its expansion into the 1860s, long after the decline of the silk industry.
http://en.wikipedia.org/wiki/Bethnal_Green#The_Green_and_Poor.27s_Land
The 20,000 looms supported 20,000 households and employed at least that many along with suppliers to the trade, the makers of looms and the houses, the merchants and peddlers of silk goods. This was during periods when population in England was relatively small. Beside Bethnal Green there were other districts in London and in other cities and countries weaving all kinds of cloths … this took place over long periods of time … the citizens always require things to wear. The customers of a country’s goods were often overseas and there was a money trade in even the old Byzantine, Frankish and Roman issues. Before 1520 funds flowed from the East as the Venetians and other Italians traded with the Chinese, the Caliphates, the Turks and Mongols. Afterward the flow was from the West and there was no outbound trade: there was quickly too much money and nothing flowing out to balance it.
The customers of distributed production were pilfered by manufacturers with credit and steam-driven machines, ‘low prices’ and uniformity, the distributed producers working in their houses became little more than serfs.
From RE:
“Professional soldiery was a tremendous burden to the state prior to Spanish gold which meant most militaries fielded militias, irregulars or mercenaries. Governments offered letters of marque to privateers to augment their navies. “-Steve
The great expense of the non-stop warfare in Europe didn’t prevent it from occurring and driving big bizness. It certainly bankrupted a few treasuries and indebted these Kings to the Banksters also.
The Medieval towns you talk about all grew up around Feudal Estates owned by the Nobility, the Pigmen of their time. Ag was the Energy Driver of this economy, and was Big Monopolized Bizness. War was the other Big Bizness, and there is a good reason those medieval castles had 5 foot thick stone walls around them with Moats, Drawbridges and Porticullises. The townees hadda run there every time some neighboring warlord needed to replenish the Treasury. They didn’t build those castles just for show.
“To the east of Bethnal Green (London) lies Globe Town, established from 1800 to provide for the expanding population of weavers around Bethnal Green attracted by improving prospects in silk weaving. The population of Bethnal Green trebled between 1801 and 1831, operating 20,000 looms in their own homes. ”
Steve,from 1803-1815 the Brits were fighting the Frogs in the Napoleonic Wars!! I’m sure the women were doing fine at home on the loom, but a whole lotta poor limeys were being Bayonetted in the French countryside.
If they weren’t conscripted to fight on French soil, they were being Press Ganged to serve as Gunners on the Frigates of Her Majesty’s Royal Navy, consisting mainly of Privateers aka Pirates, a VERY Big Bizness indeed.
Anyhow, I am all for distributed production over Industrial production, but said societies STILL were Central Control Ag-War societies, and the individual craftsmen sieved off of the surplus created by that society.
Anyhow, more tonight, I am just about done with a response article “Small Bizness in the Sea of Irredeemable Debt ” I’ll publish later tonight.
While just about everyone Loves to Hate Big Biz and Corporations, at least in the Heart of most Americans is a Reverance and Respect for the Small Bizman. The Plucky Guy who started with nothing, works for himself Independently and makes a Good Living, even if not getting Rich off of it.
There is the notion that the Small Bizman is the “Backbone of Amerika”, Small Bizmen “Built this Country” etc. Although this is a popular meme and one promulgated in the History Books and the MSM, and even on the pages of numerous Blogs, it is not the TRUTH by any stretch of the imagination.
In any country which runs a Centrally Controlled Monetary System, the plucky Small Bizman is just engaged in the process of trying to accumulate the Accepted Currency of the Nation-State. To Sell at a price higher than he buys at, to pay workers less than the total Value Added to the product so that there is some PROFIT to be made in the extant Currency, against which ALL things, both labor and resource are measured.
Where does this MONEY come from though? If you look at the Dollar for instance, prior to the end of the Revolutionay War separating the Colonies from Jolly Old England, there were ZERO Dollars in existence. War is finished, Founding Fathers get their OWN Printing Press, now Dollars EXIST!
In order to have REAL value of course, these Dollars have to Buy stuff in the real economy. The stuff is the products of the land, through farming, mining and logging to begin with. It gets more complicated as time goes by and more things are created, but even by itself this is enough to understand what goes on here in Money Creation. It is essentially coming from the total resources available to the Political Construct of the Nation-State that Rules over those resources. The Nation-State operates in Synergy with the Money Masters, Banking Houses established long ago which control all Trade and Valuation of any Currency a given Nation-State will create. This is done through Privatization of the Resource Base for any given country, as well as Privatization of the Industrial Infrastructure since the beginning of the Industrial Revolution.
The newly created dollars get valued against already extant currencies circulating in Europe, Brit “Sterling”, Frog Franks, Kraut Marks, whatever.
The main constraint any given country has in how much currency it can create depends on how the International market will value said currency. When just based on Resources it isn’t horrifically complicated, but once you factor in labor and trade of manufactured goods it gets VERY complicated.
Anyhow, what were only a few Dollars created in 1789 at the end of the Continental CONgress has morphed over the last 200+ years into TRILLIONS of them, and that is just what is listed on the Balance Sheet of Da Fed. Thing is, not JUST Da Fed can create new Dollars, anybody with a Big Enough Bank can do it too! They do it by creating Paper Contracts which have some Notional Worth attached, say a contract to pay off $1M if some company or Nation-State goes BK. These contacts are called Credit Default Swaps, or CDS. Said contract is now traded about as though it is worth $1M, or some fraction of that. It is more “Money” flowing around the notional economy of traders, though it never shows up in the real economy until somebody goes Belly Up, somebody ELSE has to Pay Off on that and then since they can’t because they don’t REALLY have enough to pay off it gets tacked onto the Taxpayer Balance Sheet. IOW, the way this shows up in the real economy in the end is as a LOSS, a BIG ONE.
To return here to our Friend & Hero the Small Bizman, the money this fellow is using to conduct Bizness is all subject to the grand pressures created in the International Money Markets. At any time if/when confidence is lost in a given currency, even the most Prudent Small Bizman can go OUTTA BIZ in an INSTANT.
Let’s take the example of our friends the Nipponese, who make their living converting Oil into Carz and Electronic Gadgets. Because the Demand is falling oveseas for their products, in order to remain “competitive” in the market the Nips want to Devalue their currency. Except if they do that, it will make the Oil Import necessary for production MORE expensive, so no matter how Efficient he is or How Low he can Go on Salaries or how many Robots he can substitute for Homo Sapiens Workers, he STILL will LOSE MONEY!
Every Small Bizman is going to be subject to the FACT that money on the Grand Scale is NOT being loaned out into the general economy. Why not? Because it no longer makes any SENSE for the folks in CONTROL of the resources to do so! The game NOW is to CUT OFF access to the resources, which occurs either by the currency not being distributed (deflation), or excessive currency being distributed (inflation). Either way, the Small Bizman is OUTTA BIZ.
The ONLY folks with access to the Money to keep on going here with this paradigm at the moment are those at the very TOP, closest to the Center of Money Creation. Since the Industrial Age began, this Center began in Venice under the Medici Banking Family, moved to Amsterdam and London, then to Wall Street and after that to Hong Kong, Singapore and Beijing. In the end of course, it will all collapse. The resources are no longer there to back it up. The debt cannot be collected anymore. It is IRREDEEMABLE Debt.
To try to simplify this, imagine the entire World Economy as the Big Island of Hawaii right after the first Catamaran rigged Sailing Canoe made it there from the Marquesa Islands around a Millenia Ago. The Island is the WHOLE ECONOMY, which the smart Navigator who piloted the Canoe claims as HIS OWN. The way he Distributes out HIS resources to everybody elso is to LOAN them Money to buy said resource. Which he does, with an Interest Charge attached of course, so that a percentage of the exploited resource he controls always flows back to him, keeping him (and his heirs) wealthy in perpetuity. The more of the resources that get exploited, the larger the population gets, the RICHER he gets!
He keeps floating out MORE credit endlessly so he can sell the resources of Hawaii to other Hawaiians and it works JUST GREAT until Hawaii is Chock FULL of People and FRESH OUT of resources. They have fished out the local waters and the Lagoons are stinking sewers filled up with Human Waste.
This of course did not occur in Hawaii because it was not a closed system, but something similar did occur on Rapa Nui (Easter Island), populated by the same extraordinary Polynesian Navigators who found the Big Island of Hawaii a good 500 years before Cook found it.
The entire Earth though IS a closed system, so no matter how much Credit you issue, if you no longer have resource to sell, the Credit is worthless. Creating more Dollars does not make more Cheap easy to pump up Oil available, and it doesn’t replenish the Ogalala aquifer either. When you are Out, you are OUT, nothing left to sell here.
In fact we are not COMPLETELY out of Oil or Water, but relative to the size of the population that ballooned up here through Rapid Exploitation of these resources, they are becoming scarce and so the Credit necessary to buy them is being Triaged off, most obviously in places like Greece and Spain, but really occuring everywhere now. It shows up here in the FSoA as 50M people on Food Stamps and an ever decreasing percentage of people participating in the Workforce, because just about ALL jobs are not productive of ANYTHING! You waste more energy getting to work each day in your SUV or even on the Subway than any “value” you add to the economy in ANY job in the Industrial Economy. All you do by participating in it is waste the energy of fossil fuels a bit faster.
In such an environment, the Small Bizman is the Individual Version of the Small Country like Greece. You get Triaged Off the Credit Bandwagon first here. You can’t make a profit, first because your customers ALSO are outta credit to buy your stuff; second because some TBTF Big Bizness still DOES have access to credit, so they can dump products on the market cheaper than it costs you the Small Bizman to make them and drive you outta biz! This of course has been the meme of Capitalism since the beginning of the Industrial Revolution at least, though it really does go back to the Dawn of Agriculture and Money.
At NO TIME in the last 8000 years or so has Small Biz been the Driver of Economics, only a Passenger in the Back Seat. The driver during the Ag Era was Big Ag utilizing Slave Labor and in the Industrial Era, Factories burning copious quantities of Fossil Fuels. Through BOTH eras, the Banksters controlling the flow of credit directed it in such a way to bring the maximum Benefits to themselves at the expense of everybody else, and Mother Earth as well.
Nothing lasts forever of course in a world of Finite Resources, and this paradigm is coming to a close. The only question remaning here is how long the Triaging of the Small Bizman and the Small Countries can go on before Billions of People with Nothing Left to Lose get very, VERY angry.
RE
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.
By Design: French Mali Invasion Spills into Algeria
Off the keyboard of Anthony Cartalucci
Published on Land Destroyer on January 17, 2013
Discuss this article at the Epicurean Delights Smorgasbord inside the Diner
January 17, 2013 (LD-Tony Cartalucci) – Exactly as predicted, the ongoing French “intervention” in the North African nation of Mali has spilled into Algeria – the next most likely objective of Western geopolitical interests in the region since the successful destabilization of Libya in 2011.
In last week’s “France Displays Unhinged Hypocrisy as Bombs Fall on Mali” report, it was stated specifically that:
“As far back as August of 2011, Bruce Riedel out of the corporate-financier funded think-tank, the Brookings Institution, wrote “Algeria will be next to fall,” where he gleefully predicted success in Libya would embolden radical elements in Algeria, in particular AQIM. Between extremist violence and the prospect of French airstrikes, Riedel hoped to see the fall of the Algerian government. Ironically Riedel noted:Algeria has expressed particular concern that the unrest in Libya could lead to the development of a major safe haven and sanctuary for al-Qaeda and other extremist jihadis.And thanks to NATO, that is exactly what Libya has become – a Western sponsored sanctuary for Al-Qaeda. AQIM’s headway in northern Mali and now French involvement will see the conflict inevitably spill over into Algeria. It should be noted that Riedel is a co-author of “Which Path to Persia?” which openly conspires to arm yet another US State Department-listed terrorist organization (list as #28), the Mujahedin-e Khalq (MEK) to wreak havoc across Iran and help collapse the government there – illustrating a pattern of using clearly terroristic organizations, even those listed as so by the US State Department, to carry out US foreign policy.”
Now, it is reported that “Al Qaeda-linked” terrorists have seized American hostages in Algeria in what is being described by the Western press as “spill over” from France’s Mali operations.
The Washington Post, in their article, “Al-Qaida-linked militants seize BP complex in Algeria, take hostages in revenge for Mali,” claims:
“As Algerian army helicopters clattered overhead deep in the Sahara desert, Islamist militants hunkered down for the night in a natural gas complex they had assaulted Wednesday morning, killing two people and taking dozens of foreigners hostage in what could be the first spillover from France’s intervention in Mali.”
The Wall Street Journal, in its article, “Militants Grab U.S. Hostages in Algeria,” reports that:
“Militants with possible links to al Qaeda seized about 40 foreign hostages, including several Americans, at a natural-gas field in Algeria, posing a new level of threat to nations trying to blunt the growing influence of Islamist extremists in Africa.
As security officials in the U.S. and Europe assessed options to reach the captives from distant bases, Algerian security forces failed in an attempt late Wednesday to storm the facility.”
The WSJ also added:
“Defense Secretary Leon Panetta said the U.S. would take “necessary and proper steps” in the hostage situation, and didn’t rule out military action. He said the Algeria attack could represent a spillover from Mali.”
And it is military action, both covert and incrementally more overt, that will see the West’s extremist proxies and the West’s faux efforts to stem them, increasingly creep over the Mali-Algerian border, as the old imperial maps of Europe are redrawn right before our eyes.
Image: The French Empire at its height right before the World Wars. The regions that are now Libya, Algeria, Mali, and the Ivory Coast all face reconquest by the French and Anglo-Americans, with French troops literally occupying the region and playing a pivotal role in installing Western-friendly client regimes. Also notice Syria too, was a French holding – now under attack by US-British-French funded, armed, and backed terrorists – the same terrorists allegedly being fought in Mali and now Algeria.
Meanwhile, these very same terrorist forces continue to receive funding, arms, covert military support, and diplomatic recognition in Syria, by NATO, and specifically the US and France who are both claiming to fight the “Free Syrian Army’s” ideological and very literal allies in North Africa.
In reality, Al Qaeda is allowing the US and France to intervene and interfere in Algeria, after attempts in 2011 to trigger political subversion was soundly defeated by the Algerian government. Al Qaeda is essentially both a casus belli and mercenary force, deployed by the West against targeted nations. It is clear that French operations seek to trigger armed conflict in Algeria as well as a possible Western military intervention there as well, with the Mali conflict serving only as a pretense.
2013
Off the keyboard of Monsta666
Discuss this article at the Diner Newz Channels Table inside the Diner.
So 2012 has ended and we can look forward to another year tentatively wondering if 2013 will finally be the year when TEOTWAWKI arrives. In a morbid kind of way we find ourselves in a most peculiar position; on the one hand we wish for extra time to get some extra preps in but on the other we almost wish for it to come and finally get rid of the doomer fatigue that seems to plaguing the old veteran doomers. I know it is next to impossible predicting what will come in 2013 with any degree of certainty. In fact predicting such stuff is largely a fool’s game which could explain why economists and politicians like to base their careers on such predictions. Still, despite this fact I am willing to lay my neck on the line and try and predict what may come about in the following year. I just hope my predictions are not so bad so I end up being a head shorter.
USA
The beginning of the year promises to start with a bang as we get front row seats on how the fiscal cliff will be handled. Even now I wonder as I type this on December 30th whether I have started too early with the guessing game and should allow the year to end properly before dishing out the predictions to see if a deal is finally made on the eleventh hour. If the worst does indeed come to pass we can expect a series of ($370 billion) tax hikes and ($230 billion) spending cuts which will amount to about $600 billion.[1] Seeing as that is half the entire deficit one has to wonder how that will affect the economy. I should add that the main thing that has kept the US afloat has been this wild deficit spending, without it we are likely to see a big plunge in growth rates if we can even believe the massaged GDP numbers. According to Filch Ratings they are saying that this fiscal cliff could cut world GDP growth in half.[2] And toadd to all these fiscal cliff dramas is the fact that Timothy Geithner recently stated that the US will hit its debt ceiling of $16.394 trillion on December 31st 2012 and can only extend this limit by two months at which point the US would default so at this point congress will have to decide on what to do about the fiscal cliff AND debt ceiling.[3]
What seems most likely to me is the debt ceiling will be raised while the payroll tax holiday will be allowed to expire; people will need to make more payments towards Medicare, long-term unemployed benefits will end and people will see a hike in personal taxes. To me I predict and this is only based on a hunch that the Bush-cuts, at least for the vast majority of Americans, will be extended for a little longer. However if we are to assume the worst then the combination of taxes rises will cost the average American $3,500 or $2,000 for middle-earners which consist of 60% of the population.[4] Scary numbers and the results should be pretty predictable if this cliff really comes to pass. One need only look at the experiences of the UK and other European countries who engaged in cuts to see what will happen. Not only did those cuts cause a recession but they did not even reduce the budget as much as promised. In fact if the subsequent recession is bad enough then deficits could even rise on the count of lower tax revenues and higher expenses that need to be paid for the rising unemployment. On this end I predict the deficit will be cut but only to about $900-800 billion.
As for broader US energy situation, I foresee softening prices for oil with WTI oil prices likely to remain around the $90 mark and may even dip as low as $75 if the fiscal cliff induced recession really bites hard, a bold prediction perhaps especially coming from a peak oiler. The shale gas situation should see some more dramas developing here as the rig count for gas has consistently been dropping throughout this year.
US Active rigs engaged in oil/gas drilling, according to Baker Hughes.[5]
Seeing as these shale gas wells have such steep decline rates it seems quite possible that a peak of natural gas production will come at some point in 2013. As a result I predict natural gas prices to exceed $5 per million BTUs. These higher natural gas costs are likely to raise energy bills for the average US consumer thus reducing discretionary incomes even further. Speaking of high costs the drought of 2012 is also likely to lead to an inflation in food prices although I do not expect it to hit the wallets of the American too badly, the ones that are likely to suffer the most from these food price hikes are the people who live in poorer nations that rely on US food exports.
So with all those points put into consideration, I predict a recession coming (official one that is) for the US how big it will be is an interesting question…
UK
2013 promises to offer much of the same as 2012, despite an almost year long recession that only showed growth in the quarter following the Olympics Cameron seems hell bent on carrying out further austerity measures. It is all done under the misguided belief that spending cuts will reduce the colossal deficit. It doesn’t take a genius to see this strategy has clearly failed in mainland Europe but in typical Tory fashion which takes clear abandon of common sense they will consider the UK a special case that is different to the irresponsible pigs. Problem is the fundamentals of high debt:
UK Public Debt with growth projections until 2015.[6]
And exploding deficit says there is not much difference between the two and despite assertions to the contrary these cuts have done nothing to bring the deficit down. England’s deficit for the financial year of 2012/13 is projected to be even higher than the financial year of 2011/12. For those unfamiliar the austerity measures only began in earnest in 2012.
UK budget deficit according to ONS sources[7] with projected 2012/13 deficit calculated by extrapolating current deficits from first seven months of 2012/13 financial year.[8]
In fairness to Cameron as big as the public debt problem is it is not the main issue. You see if you aggregate British private and public sector debt then the amount comes to 507% GDP![9] What’s more it maybe even as high as 900% if you want to include liabilities and obligations such as public sector pensions.[10] That is no typo! It is all the product of an economy that is too heavily centred on banks not to mention having a debt based monetary system (again no word in the media or schools about how money is REALLY made) but that is another story that deserves its own tale… To put this into perspective the PIIGS states of Portugal, Ireland, Italy, Greece and Spain have total debt loads of 356%, 663%, 314%, 267% and 363% respectively.[9] The only thing staving Britain from bankruptcy is the low interest rates it pays on bonds but those low rates can’t last forever especially if foreign investors finally catch on we are broke… It would seem the EU crisis can have some unintended benefits for Britain!
In any case with higher energy bills, petrol, housing and food prices coupled with anaemic growth in wages it is hard to see anything but another year of recession. Overall I predict the economy will contract over the full course of the year but “official” unemployment will hover around the same total which is 7.8% or 2.51 million people.[11] I should add however that this unemployment is clearly massaged as many unemployed people will be shifted into training programs that go nowhere or the unemployed will be encouraged to become “self-employed” for one hour a week… In addition some of the people on job seekers will be booted out of their benefits. Nothing will really change as a result of these shenanigans but Cameron can at least look smug with the outstanding improving figures these games will produce.
I can see the papers trumpeting any news that suggest extra jobs are being created; the thing they will be loath to mention is the fact most of these jobs are part-time or worse zero contract hour jobs which pay hardly anything. It continues to amaze me how senior economists such as Stephanie Flanders can continue to be baffled that service jobs paying £6 an hour for 30 or less hours a week cannot create a recovery! It is times like this where I almost want to hide the fact I studied economics…
As for the energy situation in England well the island is mostly tapped out. The North Sea continues to post double digit decline rates (this year it is 18%) and could even dip below 1mb/d next year which is a far cry from its peak of 2.7 mb/d in 1999.[12] Hardly any mention of this in the media but it will have a significant effect on the economy as we will need to import more expensive oil (assuming demand does not fall) and that will increase the trade AND fiscal deficit. The same story holds true for natural gas although as usual the government has the hair brained idea that UK fracking of shale gas can somehow solve that problem. In any case the overall energy strategy for the UK can at best be described as muddled and the name of the game seems to be denial. If we can deny the worsening energy situation hard enough then maybe, just maybe, it will go away and solve itself. Alas it is never so. My advice, look at the energy bills as an indicator of how much gas and oil this country has. The onward trend is up. Oil prices have only levelled off recently due to the poor economy and the continued postponing of the planned rises in fuel tax duty. We can expect those breaks in fuel duty to end going into January 2013 however.[13] My prediction for UK gas prices is it will top £1.50 a litre for unleaded petrol at some point in 2013.
EU
I am almost at a loss to say what will happen in the EU. Upon reflection of 2012 I am actually a little surprised by how well the people from the PIIGS nations are taking austerity considering the sky-high unemployment and worsening future outlook. It cannot last and it is only a matter of time before Europe experiences its own “Arab Springs”. Saying that I do not see an implosion of the Euro as an imminent event so I am predicting there will still be a Euro come the end of 2013. Super Mario has made his intentions very clear that he will buy bonds in unlimited quantities to keep European banks afloat.[14] While I am not suggesting this can ever be the ultimate solution I do think if Mario keeps true to his words then the sinking ship should hold for another year. Italian and Spanish bonds which are arguably the most important factors to consider have declined in recent months in light of this news so it is having its intended effect.[15]
What’s more the temporary rescue funds provided used to help Greece, Ireland and Portugal will become permanent with the establishment of the European Stability Mechanism (ESM). This coupled with the relaxation of meeting various fiscal targets and the likely restructuring (politically correct way of describing a default) of Greek debts should ensure some measure of stability so that this charade can go on a little longer. Sure these measures are never a REAL solution but they do buy time which is what can kicking is all about. I am sure if need be extraordinary measures will be taken to safe to the Euro as there is no way the Euro will collapse on the year Merkel runs for election this coming November.
As always though, it is the issue of growth that will continue to be an issue that can undermine all the plans mentioned above. I don’t think it really counts as a prediction to say Greece, Spain and Italy will experience further recessions as austerity measures continued to bite. What becomes harder to predict is how Germany and some of the northern states will fair. The Bundesbank currently projects that growth for the German economy will be around 0.4% in 2013.[16] Considering how these predictions are invariably over optimistic I will stick my neck out on this one and predict an overall recession for Germany in 2013. Could get burnt as the call is a little dicey but let us see how things fair out, eh?
Far East
The Far East, which for the purpose of this article consists of the Asian tigers (Hong Kong, Singapore, South Korea and Taiwan) plus China and Japan. These economies are generally regarded by many pundits as the future of the world economy with the influence of west waning in favour of the east. Indeed some go so far to claim that the 21st century will be the Asian century in the same token the 20th century was the US and 19th UK. Yet when we look back on 2012 we find the growth rates of several of these economies have been slipping.
To take the poster child of Asia let us look at China which posted a robust growth rate of 7.2% for the last quarter (if you can even believe the numbers). While this may sound impressive it has been the seventh consecutive quarter of declining growth.[17] However seeing as much of their governmental figures are manufactured to the extent that even Li Keqiang – the favourite to become the next head of state – suggests that the figures are manmade[18] we might need to consider that maybe, just maybe these numbers are bogus. As usual most of the mainstream press seem to ignore this inconvenient fact preferring to side with the China bulls. Fact is the best way to gauge China’s economic performance is not through GDP numbers but by monitoring electricity production/consumption, rail cargo volume and bank lending (as recommended by Li Keqiang).[18] On that front China’s performance has not been doing so well with some regions reporting a 10% year-on-year decline. It remains to be seen how accurate this form of measuring is but what we can say is that since 2008 China has depended less on exports and more on investments to drive its economy. What is more investment now makes up a whopping 48% of GDP. To put this into context Japan and South Korea; who are other export driven economies that are also heavily dependent on fixed capital investments reached a peak investment rate of just under 40% of GDP.[19]
Such a high investment figure suggests there is likely to be numerous bubbles as there an oversupply AND misallocation of capital, witnesses the ghost cities, bridges to nowhere and empty malls as proof of this wasted industrial capacity. So what do I predict for 2013 for China you ask? Well the Chinese government will NEVER report negative growth numbers so I can only predict growth if I hope to be right. However I do think China will actually grow in real terms not by much but some however since we can say the numbers are so fudged we will never really know how right (or wrong) my prediction will be, well I suppose there is always the chance of another Chinese revolution and in that case I would definitely be wrong if I predicted growth. But I don’t think the time has come for that… Yet!
As for the other economies of Asia Japan continues to experience more woes with recessions and more surprising their balance of trade going negative for a number of quarters. For an export nation to have the value of their imports exceed exports for numerous months can only be described as a disaster. To stop the rot newly elected president Shinzō Abe has pledged to fully open the money printing press spigot to devalue the yen.[20] In addition in an attempt to shore excess imports of fossil fuels and bring back the trade deficit to the positives he has foolishly pledged to restart Japan’s nuclear plants. I guess nuclear disasters don’t have the impact they once had or consensus based group think is unusually strong in Japan… In any case despite such measures I do not predict many good things for the land of the rising sun and see another recession in 2013 with Abe being the next prime minister to pass through the revolving doors of Kantei soon after 2013. Some people suggest that Japan will be the surprise package that implodes financially due to its burgeoning public debt levels of 235.8% GDP but I do not see that crisis happening in 2013 later certainly but not now.[21] For the crisis to really take effect bond rates need to rise and since about 90% of bonds are held by Japanese investors [22] the risk of interest rates rising quickly are not high, for now. The number of foreigner holders of Japanese bonds is rising however due to the fact that Japanese pension pay-outs to pensioners now exceeds pension contributions from existing employed workers so in time interest payments on bonds will rise.[23]
The Asian tigers should see more promising growth and I expect them to show more positive results for 2013 so I will make a fairly bullish prediction and say that growth for these economies will exceed about 3%. A fun fact to keep in mind is that South Korea’s economy is heavily based on big conglomerates which are known as chaebol in South Korea. In fact the five largest chaebol control 57% of the GDP of South Korea so if you want to monitor the countries fortunes just look out for how Samsung, Hyundai, LG, SK and Lotte are performing.[24]
Global Summary
It is hard to make any firm bets on what the outlook for the global economy will be for 2013 especially since the whole fiscal cliff issue has yet to be resolved. What we can say with some degree of certainty is the economic conditions in Europe are likely to worsen as further austerity measures are applied. Greece has been in a solid recession for many years and there is little evidence to think why this should not continue. As for the other PIIGS nations, wage reductions will be made in order to make the southern European states more competitive but this will lower economic output and increase unemployment. Expect to see more protests and strained nerves as the economic troubles we have seen in Greece begin to spread in earnest to Spain and Italy and as always low economic growth will lead to more bank problems/bails outs. These lower wages will also harm Germany who is a major exporter to these regions and since those nations are poorer they will buy less BMWs.
Poor performances in Europe is also likely to negatively impact other exporting nations such as China and the Asian tigers so growth is likely to slow there as well. Japan on the other hand will continue losing ground to its competitors so at best they will see further stagnation but more likely there will be another recession. The low interest rates in Japan and its perception as a safe haven will insure the Yen remains strong much to the chagrin of its exporting industries.
As for overall growth of the world economy, it is likely that there will be some growth overall but it will be small and it will be less than what we have seen for 2012. I will not discount the possibility of an outright global recession especially if the fiscal cliff is handled poorly in the US. Other issues to be aware of is the effects of the 2012 drought which is likely to lead to food inflation across the globe. The poorer countries in Africa the Middle-East and India will suffer to a disproportionate degree to these higher food prices. This will lower growth in those regions as incomes become squeezed and we cannot discount the possibility of food riots erupting in localised regions if prices rise high enough.
On the energy front 2013 should mark a few interesting landmarks namely that global coal consumption is likely to exceed oil for the first time in 60 years. This has come about because oil production since 2005 has roughly plateaued at 74mb/d while coal production has ramped up due to high growth of Asian nations which primarily use coal for electricity generation.
However these Asian nations have not just increased their consumption of coal, they have also increased their thirst for oil and 2013 should also mark the time when total oil consumption of the developed OECD countries will fall below 50% which will be an unprecedented event.
Predicting oil prices for 2013 will be a challenge, on the one hand you have rising demand with a constrained supply which will serve to higher prices but at the same time the on-going demand destruction in the West will lower prices. As a result I predict that average Brent prices of oil will for the most part stagnant at around $110 for the year which has been the average price for 2012. I cannot say with any certainty when we will leave the plateau in global crude oil production but according to the grapevine the year I keep hearing is 2015 which finally enough is what a former expert in the IEA is suggesting.[25] In any case, global oil net exports are likely to decrease over 2013 as has been the general trend since 2005.[26]
References:
[1] = US Senate leader Harry Reid voices fiscal cliff fear (BBC)
[2] = All-out U.S. ‘fiscal cliff’ could cut world growth in half: Fitch (REUTERS)
[3] = Geithner: Debt Limit of $16.39 Trillion Will Be Met New Year’s Eve (CNSNews)
[4] = Q&A: The US fiscal cliff (BBC)
[5] = Rotary Rig Count (Baker Hughes)
[6] = Total Planned* Public Spending (UK Public Spending)
[7] = Office for National Statistics (ONS) data
[8] = Osborne Says He Needs More Time to Rid U.K. of Budget Deficit (Bloomberg)
[9] = Total Debt in Selected Countries Around the World (Global Finance)
[10] = The End of Britain (MoneyWeek)
[11] = UK unemployment falls by 82,000, says ONS (BBC)
[12] = North Sea oil tax revenues fall offers glimpse into a diminishing future (the guardian)
[13] = Labour loses fuel rise delay vote (BBC)
[14] = All hope not lost (The Economist)
[15] = Spanish Bond Yields Drop to 8-Month Low (Bloomberg)
[16] = Bundesbank Slashes 2013 German Growth Forecast to 0.4% (Bloomberg)
[17] = China’s economy slows but data hints at rebound (BBC)
[18] = China’s GDP is “man-made,” unreliable: top leader (REUTERS)
[19] = Capital controversy (The Economist)
[20] = Yen Weakens to 20-Month Low on Abe BOJ Pledge; Euro Drops (Bloomberg)
[21] = IMF urges Japan to tackle debt problem (Financial Times: Google headline name to see full story)
[22] = OECD: Japan Public Debt in ‘Uncharted Territory’ (Wall Street Journal)
[23] = Japanese pension assets fall as payouts exceed contributions (Pensions & Investments)
[24] = Business as usual for South Korea’s chaebol under Park (Yahoo! News)
[25] = Oil will decline shortly after 2015, says former IEA oil expert (The Oil Drum)
[26] = Updated “Gap” Charts, using annual data through 2011 (The Oil Drum: westexas)
Kelly’s Last Stand…
Off the keyboard of Steve from Virginia
Published on Economic Undertow on December 29, 2012
Discuss this article at the Epicurean Delights Table inside the Diner
The universe is a monstrous thing populated by demons, where nothing perishes but everything is perpetually diminished … virtues are deceptions … honesty is a paradox … nothing is what it seems: the human enterprise labors tirelessly at its own extinction in an ironic attempt to ‘improve’ itself. (All of) this is the manifestation of the universe’s malevolent design. Our endeavors are a part of the greater whole, most of which we cannot see or hope to understand. Individuals are blind and dumb … our wit would save us but it vanishes when we need it the most …
America is clinically depressed … the holidays make people crazy. The world is crazy and sad: it is afraid, the way for humans to manage fear has always been to lie to themselves … this is what courage is, a peculiar kind of lie.
The human race is confronted with gigantic resource imbalances and excess consumption: the public ignores the problem or denies it, preferring to watch television. We don’t know how to discuss it so we don’t try:
‘Fairytale of New York’ by Jeremy Finer and Shane MacGowan
It was Christmas eve babe
In the drunk tank
An old man said to me: won’t see another one
And then he sang a song
The rare Old Mountain Dew
Honesty is found in a song imagining two pieces of human wreckage wheezing through Christmas in a drunk tank …
I turned my face away and dreamed about you.
Got on a lucky one
Came in eighteen to one …
Nobody earns a living, everyone gambles, just like on Wall Street …
I´ve got a feeling
This year´s for me and you.
So happy Christmas,
I love you baby
I can see a better time
Where all our dreams come true.
Enter the ad men …
They got cars big as bars
They got rivers of gold …
Don’t they always? Here comes the truth …
But the wind goes right through you
It´s no place for the old …
… they end up in the tank!
When you first took my hand on a cold Christmas eve
You promised me Broadway was waiting for me
You were handsome — you were pretty –
Queen of New York City when the band finished playing they yelled out for more,
Sinatra was swinging all the drunks they were singing.
We kissed on a corner,
Then danced through the night. And the boys from the NYPD choir were singing Galway Bay
And the bells were ringing out for Christmas day.
So it goes, the improbable chemical-fueled combination of ecstasy and infatuation that lasts for an instant then vanishes forever … as rare in iron-bound Mordor as a diamond necklace in the sewer. Humans turn their entire lives for a chance at these instants, these unforeseen moments … gambling everything in the chase or in fruitless attempts to buy ecstasy in a store. By this process the world is destroyed.
You´re a bum you´re a punk,
– You´re an old slut on junk
Lying there almost dead on a drip in that bed …
– You scumbag you maggot
You cheap lousy faggot
Happy Christmas your arse I pray god it´s our last.
We can’t discuss our self-inflicted misery but we can write songs about it. How the message is delivered matters more than what it is. Shane MacGowan should write about the unraveling of the world, about climate change and Peak Oil, about financial collapse … the rest of us would sing along in bars on St. Patrick’s Day …
John Hussman discusses interest rates, debts and the insanity of it all:
Since 2009, both the stock market and the broad U.S. economy have been dependent on perpetual support from massive federal deficits and unprecedented money creation. Meanwhile, Wall Street is content to ignore the extent of this support, and looks on every movement of the economy as a sign of intrinsic health – which is a lot like admiring the graceful flight of a dead parrot swinging by a string from the ceiling fan.
Our economy is fundamentally string!
A quick look at how the deleveraging of the U.S. economy is going – total credit market debt has now reached $55 trillion, including government, corporate and household sectors, representing 3.5 times GDP (down only slightly from the 3.8 multiple observed at the recession trough of early 2009). To put this in perspective, every 100 basis point change in interest rates on maturing and refinanced debt now implies a redistribution of income between borrowers and lenders on the order of $500 billion annually. The Fed has worked tirelessly to ensure that borrowing is as cheap as possible – the risk being that any departure from that would give every interest rate change of one percent an annual economic effect the same size as the “fiscal cliff.”
Figure 1: total government and private sector debt in credit market @ $55 trillion — this amount does not include off-balance sheet credit, shadow banking or forex/currency claims which are an order of magnitude greater. The Fed offers a willingness to push down credit costs … to do so it must be prepared to lend indefinitely.
This is more madness, the Fed works against itself!
Optimally: the private sector offers unsecured loans to firms as a matter of faith. The expectation is for general increase in the amount of credit/economic growth and serviceable cash flow. Growth’s ‘utility’ is the ability of the firms to borrow over time and to use these loans to refinance prior loans as they become due. Unsecured loans exceed the worth of collateral by ten-times or (much) more. The central bank does little but manage the flows of currency and foreign exchange.
Currently: the private sector has lent stupendous amounts to firms, this represents most of the blue line in the chart. Collateral is worthless or worth very little. Leverage is now 100x or more. The borrowers are unable repay because they do not earn anything and never have. The lenders are over-leveraged/insolvent and borrowers are unable to borrow any longer. There is no more growth, it was all fake anyway.
Remedy: the central bank lends to private sector banks, taking their impaired collateral onto its own balance sheet at ‘face price’ which provides the banks a temporary reprieve from insolvency. The bank bailout is done with a straight face ‘to end unemployment’! There is no economic growth because there is no credit expansion … central banks cannot expand the credit base by offering unsecured loans. This remedy has been applied in Japan since 1990 and has failed. The more central bank credit is offered, the less private sector credit … the central banks’ actions are self-defeating. The Fed lends to push down rates: the lowering of rates reduces private sector profits as well as incentives to lend! As with the petroleum biz … rates that are profitable to the bankers are unaffordable to borrowers.
The ‘More Stupid’ remedy: the central bank targets nominal GDP (NGDP), lending in excess of collateral or accepting fraudulent collateral as security for loans in an attempt to create credit expansion by itself.
Outcome of the ‘More Stupid’ remedy: the offending central bank becomes instantly insolvent just like all the private sector lenders and for the same reason. There is a ‘run on the banks’ as depositors remove deposits: currency is the only real collateral for the Mount Everest of claims laid against it.
Insanity is contagious: watch all the central banks attempt nominal GDP targeting at the same time! No central banker wants to be blamed for a recession: all the bankers are easing as much as possible.
Hussman:
The Federal Reserve under Bernanke is like a bad doctor facing a patient with a broken femur. Being both unable and unwilling to restructure the broken bone, he announces that he will keep shoving aspirin down the patient’s throat until the bone heals. Despite virtually no relationship between the injury and the treatment, that femur might eventually heal enough on its own to allow the patient to hobble out of bed. But by then, the patient will need to be treated for liver failure. What’s even more bizarre is that everybody quietly knows this, but as he shoves another handful of aspirin down the patient’s throat, nobody proposes restructuring the broken bone, and they instead stand around helplessly saying “well, ya gotta do somethin’ don’t ya?” I continue to believe that most of the economic impact of policy changes in the past few years can be traced to a) the abandonment of accounting transparency by changing FASB rules, which allowed banks to suspend mark-to-market accounting and effectively relieved them of capital requirements, and; b) the U.S. guarantee of bad mortgage debt extended by Fannie and Freddie. Both of those policy changes will impose enormous costs over the long-term, but they did allow the financial system to abandon the immediate need to actually restructure bad debts.
He leaves out energy costs, but no matter. The central banks have to cease lending at some point … it’s pointless … the patient is dead … As Hussman suggests, the only workable remedy is for the private sector to delever/write off bad loans.
At the same time, perhaps the establishment can begin allow those at the bottom of the economic food chain to earn. This requires less credit not more. Credit allows those with access to it to pretend to outperform those without … who are consequently exposed to ruinous competition. By borrowing, the government competes with its own citizens: by doing so it gives cause to those who would purposefully become dependent upon the government and thereby destroy it …
Speaking of energy, from the New York Times, Alan Riley counts his natural gas chickens right now!
The shale energy revolution is likely to shift the tectonic plates of global power in ways that are largely beneficial to the West and reinforce U.S. power and influence during the first half of this century. Yet most public discussion of shale’s potential either focuses on the alleged environmental dangers of frakking or on how shale will affect the market price of natural gas. Both discussions blind policy makers to the true scale of the shale revolution. The real impact stems from its effect on the oil market. Shale gas offers the means to vastly increase the supply of fossil fuels for transportation, which will cut into the rising demand for oil — fueled in part by China’s economic growth — that has dominated energy policy making over the last decade.There are two major factors in play here. First, the same shale extraction technology of horizontal drilling and hydraulic fracturing can be employed whether the rocks are oil-bearing or gas-bearing. We have already seen over half a million barrels of oil a day flowing from the Bakken field in North Dakota. The recent Harvard-based Belfer Center report — “Oil: The Next Revolution” — suggests that shale oil could be providing America with as much as 6 million barrels a day by 2020. The United States imported only 11 million barrels of crude oil a day in 2011. Given the potential for offshore and conventional domestic oil production, this would suggest that by 2020 America could be near energy independence in oil.
Then again, perhaps not … Maugeri’s report and others- similar have been holed below the waterline in the NY Times and elsewhere. What isn’t discussed is how broke Americans are to pay for the extra billions of barrels of frakked crude. It sez here — declining real wages — they can’t.
Figure 2: Wages have fallen in real terms for over fifty years! More costly fuel against declining wages = unaffordable. Credit flows toward the fuel extraction- and finance industries away from workers, who cannot buy products … houses, automobiles, service ‘goods’ … or the fuel needed to run them. As business operating margins shrink and the bosses take more for themselves worker pay falls further, impacting sales in a vicious cycle.
As an expedient, the government borrows in the workers’ place. Because the workers are unproductive in the sense they cannot- and will not earn, the government must borrow exponentially greater amounts, and do so indefinitely … None of the energy promoters are able to explain how energy ‘production’ without customers is supposed to work.
Riley:
The second factor is the potential to use natural gas for transportation. Some analysts suggest that this will only be a realistic prospect for fleet and long-haul road transportation. But they are overlooking the immense advantage that natural gas has as a transportation fuel in America and Europe, which have both developed a natural gas infrastructure in urban areas that takes piped natural gas into homes, offices and supermarkets. Once gas is cheap and widely available, it is possible to consider dealing with the “last mile” problem of providing home refueling kits so consumers can fill up natural-gas powered cars in their own garages.
Riley is a professor of energy law at The City Law School at City University London. Riley sees gas fueling the cars in the immediate future … despite uncertainties about the gas supply. Meanwhile, there is no sign of a generalized shift by the auto industry toward producing natural gas powered vehicles or the means to adapt the current fleet to natural gas use. With more than 270 million vehicles in US service alone, such a switch-over would be very costly and time consuming.
Meanwhile, there are questions about how much gas will be available over time. If fuel is affordable, there are insufficient returns for drillers. A recent New York Times article calls the natural gas frakking enterprise a “Ponzi Scheme”. Drillers cannot earn by selling fuel, they must borrow from Wall Street.
China has even greater incentives to develop its shale gas resources. According to the U.S. Energy Department’s Energy Information Administration, the country’s recoverable resources are larger than those of the United States at 36 trillion cubic meters. The main geostrategic reason for Beijing to develop shale gas for transportation is that the U.S. Navy controls the Pacific and most Chinese oil arrives by tanker. Large scale use of natural gas for transportation would protect China from much of the effect of a U.S. blockade.
It is good to learn from the Times the US is planning to blockade China … The only remedy that will actually work is to get cars off the road. They cost too much. One way or the other the cars are gone, so are the roads. Once gone we will discover we really didn’t need them, that they ruined our lives, instead.
Figure 3, from BP’s 2010 World Energy Outlook with data from the International Energy Agency: the ‘Blue Triangle of Death’, oil fields — presumably large, conventional deposits — that have not been discovered that are needed to make up for declines elsewhere. The shortfall indicated here is about 30 million barrels per day by 2035.
Figure 4, here is the Mother of All Oil Shortfall Graphs by EIA’s Glen Sweetnam (2009) by way of Kurt Cobb. He points out that any gains from tight oil formations will be overtaken by ongoing declines in conventional fields. Sweetnam calls for 40+ million barrel shortfall by 2030.
Figure 5: Petrobras in 2010 calculated a man-sized shortfall in production of sixty to seventy million barrels per day — or more — by 2030! The marginal increases from frakking and even Iraq will not change the outcome significantly. Says Cobb:
… many people will say that we already have a large new resource of tight oil (often mistakenly referred to as shale oil) which can be extracted through hydraulic fracturing or fracking. But even if the optimists are correct — and there can be no guarantee that they will be — this source of oil will only add 3 to 4 million barrels of daily production. What Sweetnam’s chart tells us is that we must find and bring into production the equivalent of five new Saudi Arabias between now and 2030 in order to meet expected demand even if the volume of tight oil reaches its maximum projected output.
Maybe Shane MacGowan can write a song …
“Kelly’s Last Stand” … about delusional central bankers, government officials and fracking shills looking for a miracle.
I could have been someone
– Well so could anyone
You took my dreams from me
When I first found you.
– I kept them with me babe
I put them with my own.
Can´t make it out alone
I´ve built my dreams around you … And the boys of the NYPD choir’s still singing Galway Bay
And the bells are ringing out
For Christmas day.
Energy: Part I
Off the keyboard of Monsta666
Discuss this article at the Energy Table inside the Diner
Energy despite its utmost importance is a topic that doesn’t receive much attention and is a subject that is poorly understood particularly in the mainstream media or even economics. It is curious to think that this is the case especially if we consider that without energy nothing would literally happen. Taken in this context it is easy to see why energy could be regarded as the most critical resource for without it there would be no life on planet Earth.
It seems that one of the major reasons we forget about the importance of energy and take it for granted is the fact energy is ubiquitous in modern day society. If one cares to look outside their window it is likely they will see numerous cars whizzing around at high speeds (they are high if we compared their speeds to humans and animals which was the historic norm before the industrial age). If one thinks about this last point it can be quite an enlightening process; how much energy does it take to cart an object that weighs in excess of 1000kg at around 30MPH? Then think all this energy can be found in a single gallon of gasoline/diesel. And as startling as this thought maybe we can say we consume even more energy in total in our homes and workplaces and that is despite the fact there are over one billion cars – which nearly all run on oil – running across our planet. Quite a thought isn’t it? [1]
So in short we can say we are addicted to using energy. However this should not come as any surprise because man has always needed SOME energy to ensure his survival. The amount needed for basic survival is relatively modest however since the only real energy source man needed at first was direct consumption through food to stay alive. However through time man found other external inputs of energy that made life easier for him. The heat from fire allowed man to keep warm not to mention allowed him to cook and provide a source of light in the dark. Domesticated animals also reduced the burden of labour in the fields and allowed great productivity not just in hunting but also in managing the fields when man shifted to agriculture.
These external inputs of energy not only allowed man to extend his natural range of environments he could live on but it also spurred growth in population and prosperity as external energy meant more of the burden of labour could be shifted away from man. As time went on the number the external sources of energy increased and so did the amount of energy used by man. It was not until man began harnessing fossil fuels in earnest however that his energy use suddenly exploded. The graph below can clearly attest to this fact.
While this final fact is widely known it is still quite difficult to fully grasp and appreciate how much of a boon these fossil fuels were to mankind. To illustrate just how much energy we can obtain from these fossil fuels I feel it is best to apply a little maths. To make comparisons between different energy sources it is necessary to know what a BTU is. For people unfamiliar with the term a BTU stands for British Thermal Unit and one BTU represents the energy required to heat one pound (454g) of water by one degree Fahrenheit which comes to approximately 1055 joules. [2] Now if we consider the most expensive fossil fuel, which is oil, then we will find that burning one barrel of oil (42 US gallons or 159 litres) releases 5.8 million BTUs or 6.1 gigajoules of energy. [3] These large numbers may seem rather abstract and arcane but if we covert this total energy content into man hours then the facts can be more easily absorbed. The energy delivered from 6.1 gigajoules would equate to a man spending 1.45 million kilocalories. If we assume a man consumes somewhere between 100-200 kilocalories an hour then that would mean a barrel of oil produces the equivalent amount of energy as 7,290-14,597 hours of labour depending on how hard the man works. Assuming there are 48 forty hour weeks a year that equates to 3.8-7.6 years of human labour. Armed with this information it makes you wonder how we can ever consider a barrel of oil is overpriced at $90 dollars a barrel when one barrel delivers the equivalent of 3.8-7.6 years labour!
To put this into an even greater context if we decided to pay the man a decent wage of $10 an hour then we would need to pay him anywhere between $73,000-$146,000 to deliver the same amount of work as a barrel of oil. With this perspective it becomes clear what a boon fossil fuels have been proven to be as effectively we have been using these fuels as “energy slaves” due to the fact they produce so much energy at such a low cost. With energy being so cheap it becomes obvious just how profitable the exercise of replacing man and animal labour with capital powered by cheap fossil fuels has been as the price differential between the two markets is simply enormous. And let us not forget in all this that oil is the most expensive fossil fuel in today’s market and its price is abnormally high when compared to historical prices so it was even more economical in the past than it is today.
Saying all that we do need to recognise the flaws in making such comparisons or more generally, using BTUs in general. That is not all work achieved with a certain resource can be easily substituted with another resource for example no amount of men dragging a car would make it travel at 30MPH as could be achieved if the car was powered by oil. Therefore the figures above can only deal with the total energy expenditure and allow comparisons on that end but they say nothing about the quality of the work achieved nor can they describe how easily the work can be substituted with another resource. This is an important concept to grasp as quite often it is stated that we can substitute oil consumption with renewable, nuclear or even coal and gas energy which while such statements are true to a certain extent, not all uses can be substituted for. Coal, renewables and nuclear energy cannot be easily made into a liquid fuel as these energy inputs are primarily used for electrical generation or home heating. It is this lack of fungiblity which results in people often making the distinction between a liquid fuel crisis and an energy crisis as these are two distinct phenomenon as each crisis poses a different set of problems and will therefore require a different set of solutions (assuming solutions even exist) to solve or manage if there are no viable solutions.
Despite these limitations or perhaps because of them we can reach certain conclusions. The increase in the availability and affordability of energy has done more than reduce the cost and amount of work that can be achieved. It has also played a big part in increasing productivity. This increase in productivity comes because, as described in the previous paragraph, there are certain forms of work that can only be utilised with fossil fuels and these activities cannot be done regardless of the amount of men employed in particular tasks. Jobs that are energy intensive such mining, steel production or heavy vehicle transport all require intense and constant inputs of energy. Since they require intense AND constant energy inputs these tasks cannot easily be substituted into labour nor is renewable energy a suitable candidate for substitution due to its intermittent nature. However it cannot be denied all these economic activities contribute to increased productivity as less labour will be needed to be deployed to accomplish these tasks (assuming these tasks could be completed at all without fossil fuels).
Many mining operations such as the tar sands mining operation in Canada would be much harder if not outright impossible without cheap abundant energy inputs provided by fossil fuels.
A more troubling fact does emerge from this however and that is it becomes apparent that our modern industrial society is heavily dependent on not just abundant energy but cheap energy to remain viable. Even today with oil priced at $90 a barrel which is still an excellent deal when taken in the context described above this price is sufficiently high that many developed economies struggle to grow quickly due to the “high” energy costs as we are repeatedly reminded by the media. In fact these high energy costs have resulted in much demand destruction in the major OECD countries for oil that are most sensitive to price changes as demonstrated in graph below.
This demand destruction primarily manifests itself through higher unemployment and reduced oil consumption from remaining employed workers due to a decline in real wages. This high price of oil has not curbed demand in all countries as the developing economies, which are less sensitive to price increases, continue to demand more of the product. This demand increase of the non-OECD countries is roughly equal to the decreased demand in the OCED countries so overall global oil demand has remained constant at around 30 billion barrels per annum.
The more significant trend has not been with changing patterns in oil consumption but with the changing energy mix in which the global economy utilises. Since oil is priced at $90 it is the most expensive fossil fuel in the market. In the US the next most expensive fossil fuel is coal which is priced at $68.15 per short ton.[4] Seeing as one short ton on average releases 19.6 million BTUs[5] of energy which is roughly three times that of a barrel of oil we see that coal is just over 4 times cheaper than oil on BTU basis. In light of this fact it would be natural to think and expect coal consumption to rise rapidly during this period however coal consumption has actually declined in recent years (for the US at least) because the cheapest fuel in recent years has been natural gas which reached levels as low as $1.90 per million BTUs earlier this year. Seeing as coal has been priced generally been priced at around $3 per million BTUs for the last three years[6] it is easy to see how natural gas consumption has surged.
It should be noted however that at this present moment natural gas is currently priced at $3.48 per million BTUs (accurate at time of writing)[7] and seems to be rising in the past few months. If natural gas price rise much further then coal will become the cheapest fossil fuel in the US and demand for this fuel should increase provided the trend of rising natural gas prices continues. If we talk about fuels on a global basis the story is quite different as globally coal is by far the cheapest commodity and it is these cheap prices that have caused global coal demand to surge in recent years. The high price of oil and the fact that main users of coal (Eastern Asia) have seen rapid economic growth in recent years have been other contributing factors in the increase in the amount of coal demanded.
If this trend of growing coal consumption continues it will not be long before coal becomes the top source of energy in the world and this is a fact that is likely to catch many people by surprise. Saying that, one should throw some caution to this current trend of surging coal demand as it is quite likely that growth in the global economy will slow down and may even decline. If that is the case then the rate of increase in demand will decline or demand may even decline entirely should the world enter a global recession.
Another important consideration and one that is almost universally overlooked in the mainstream is the concept of Energy Return on Energy Invested (ERoEI). In the second part of this topic I will discuss this concept in more detail and also explore the laws of thermodynamics that is largely neglected in the media and economics in general. Do not worry; it will not be a boring physics session with lots of large scary numbers. In any case I wish all diners a merry Christmas and a happy new year.
References:
[1] = World Vehicle Population Tops 1 Billion Units (WARDSAUTO)
[2] = British thermal unit (Btu) (Business Dictionary)
[3] = Barrel of oil equivalent (Wikipedia)
[4] = Coal News and Markets (EIA)
[5] = What is the average heat (Btu) content of U.S. coal? (EIA)
[6] = Coal News and Markets Archive (EIA)
[7] = Commodity Prices (CNN Money)
Japan=Detroit
Off the keyboard of Steve from Virginia
Published on Economic Undertow on November 22,2012
Discuss this article at the Epicurean Delights Smorgasboard inside the Diner
When you wish upon a star … the auto industry … you don’t get a pony you get Detroit. This is the lesson the world is in the process of learning right this minute.
Kyle Bass speaking about debt. Like most analysts, Bass blames Japan’s fix on excessive debt …
“Thematically, the bottom line is … the total credit-market debt to GDP globally is 350%, it’s $200 trillion dollars worth of debt … against global GDP of roughly $62 trillion … “
Nobody bothers to ask why there is so much debt in the first place. The question is a finance analyst taboo … something not discussed, like underwear with dollar-signs printed on it.
The reason for the silence is that industrialization is unable to retire its debts. If machines could pay for themselves and ‘earn’ a profit they would be doing so already and there would be no debts at all. That machines cannot pay their own way is self-evident.
The debts taken on to make the ‘machine idea’ work are impossible to retire because they are too large. @ $200 trillion and 350% — plus additional hundreds of trillions in non-tendered liabilities — even if the world’s industries were to function magically ‘properly’ the debt burden is out of reach. What is available to service and retire debt is the modest marginal increase in GDP year-over-year: this increase itself is borrowed!
Debts cannot be serviced — much less retired — with the economies at death’s door: future GDP growth is theoretical.
Repayment is a fairy tale … it is also the cudgel of creditor repression. If there was the merest prospect of growth, economies would not bother with debt repayment but would take on even more … Not only does industry require debt but the waste-based industrial economy will always and under every circumstance increase its debts until it is physically incapable of doing so.
More Kyle Bass:
“So … this is a debt super-cycle that is coming to an end. It’s coming to an end at different end-points for different countries … A lot has happened in Japan in the last 12 months, in fact, in the last two months we believe they crossed that proverbial Rubicon … we think that you’ve seen 20 years … of conjecture regarding Japan’s eventual demise and now we see a point where in the last couple of months what you see a continued deterioration in their balance of trade. It’s actually running at about negative- $100 billion on-the-dollar … a hundred-billion dollars, or close to ten-trillion yen … and we think given this resurgence of Chinese nationalism over the Senkaku crisis … you are going to see that (trade imbalance) move another … one-and-a-half or two percentage of GDP … or another $100 billion dollars. To put that into perspective, what that means is we could see full current-account negativity in Japan in October (actually, November)… that’s something nobody is ready for … We think about it: we have a secular decline in the population happening, you have a balance of trade literally being re-written and falling off a cliff … and their GDP is tracking negative 3.5, negative 4 percent.
In other words, Detroit.
Japan has reached the point where it cannot borrow any more because it has already borrowed as much as it possibly can. As long as Japan borrows the (borrowing) cost is manageable. Debt is a treadmill, once on you can never step off or slow down. Japan will learn that as the borrowing slows the real cost ramps. Repayment does not work because doing so increases the worth of the money used to repay. Returns on Japan’s industries are not an issue: they never did matter because they never existed. What matters is the narrative of ‘progress’ and ‘innovation’ which for Japan has soured: the narrative is collateral. The country has become hopelessly old-fashioned … passé and unworthy of credit. Japan tries on new narratives but the only ‘innovation’ in the cupboard is more quantitative easing (QE).
Like the Motor City, Japan hitched its fortunes to the automobile industry. The car business has succeeded by more efficiently devouring its own capital basis. Since the ‘peak oil’ low in 1998, the incredible basis has been repriced, there is a scarcity premium added. It does not matter whether capital is officially recognized as scarce or not! What matters is the market price of capital relative to other goods. Resource capital is now too pricey to waste. The waste-based enterprise is stranded by its capital costs and there is nothing the establishment can do about it!
In Japan and elsewhere, the strategy to ‘manage’ debt has been to always add more of it until the cost becomes prohibitive ridiculous. Instead of debt, labor costs are cut by eliminating jobs … even though labor costs have little to do with the debt and are not the cause of it. Businesses borrow to pay executives and business owners, not labor which is expendable.
Michael Hudson suggests that the burden of taxation has been swapped for interest payments/economic rents to financiers. Instead of flowing toward governments- then cycling back toward the public, funds flow toward banks and to tycoons. The consequence is not taxation without representation, there is taxation without the means to pay the taxes: a strategy of pauperization that leaves the labor force dependent on meager handouts and indebted to both business and government.
– Detroit is a ‘company town’ dependent upon a single industry. It gained net cash flow from outside the city/the rest of the world. Japan is a ‘company country’ dependent upon manufacturing of so-called ‘high value’ goods including automobiles.
– Japan requires export trade income — net cash flow from the rest of the world — in order to service debts and subsidize their industries. The government can borrow from the central bank but for only a short time. Then it must either stop borrowing or pay higher prices on international credit markets and subject itself to credit embargo. Detroit obviously cannot borrow from its central bank because it does not have one. It is already subject to credit embargo.
– Detroit and Japan ‘play the resource spread’: buying resources then repackaging a portion of these into costlier forms so as to subsidize their own consumption. The increase in input costs has made spread(s) impossible to finance as the needed debt is too costly.
– Detroit is almost 90% African-American, Japan is 90% Japanese. Both cultures are rigidly resistant to changes in the status-quo. In Detroit, difficulties are blamed on Negroes rather than automobiles. Time will tell whom the Japanese will blame their difficulties on … certainly not the automobiles, which are the real culprit.
– Aging Detroit’s population is entering retirement, workers have few assets outside of real estate (personal homes). Japan’s population is nearing retirement, workers are converting non-monetary assets into currency by selling Japanese bonds, that is, they are not lending as much.
– Both Detroit and Japan have little in the way of native resources, both seek to exhaust the resources of others. Detroit has exhausted available resources and Japan is on the way to doing so.
– Both economies feature smokestack-manufacturing industries that have migrated to China and other low-wage countries … associated wage arbitrage has reduced discretionary incomes of both Detroit- and Japanese workers.
– Managements of both places are inept and cruel, beset with cronyism and corruption … leading to catastrophic consequences. It is hard to say which place is more ruined. Neither ‘systems’ allow imagination or risk, any persons exhibiting imaginative tendencies are excluded. Conventional managers are allowed to fail conventionally until they are unable to do so by the extent of their failures.
– Legacy obligations are carried forward with increasing amounts of new debt required to service and retire (roll-over) the older maturing debts. Japan’s lending capacity is entirely consumed meeting the burdens of existing debt. Detroit has almost no capacity to borrow at all and is dependent upon begging.
– Japan’s so-called ‘Bubble Economy’ was a hedge against rising energy costs … a hedge that was unraveled by increased energy costs. Hedge versus expedient: Detroit’s success was the reason for Japan’s economic strategy in the first place. The auto industry’s destroys the capital the industry requires over the longer term. It has also foreclosed the future, destroying capital that was-and is needed for actual productive enterprises … that have not be imagined yet! Motown’s strategy has been to deploy successive expedients .. good for the moment and costly afterward.
– Monetary policy — in the form of multiple rounds of bond-buying/quantitative easing and super-low interest rates — has failed/is irrelevant. The desire has been to create monetary/currency inflation: Japan is mired in deflation! The end-game for Japan is identical to the end-game in deflationary Detroit: ruin.
Figure 1: Japan’s crude oil consumption: the failure at Fukushima and the resulting shutdown of the country’s nuclear park left an expensive energy deficit that the country must close by importing petroleum and liquified natural gas. Every yen diverted to the petroleum suppliers is a yen extracted from other sectors of the Japanese economy … including debt service.
The world is not in danger of becoming Japanese with its 20-year deflation. Instead, the danger is Japan becoming Detroit, (James Howard Kunstler):
Finally, I have one flat-out prediction, one I have made before but deserves repeating: Japan will be the first society to consciously opt out of being an advanced industrial economy. They have no other apparent choice really, having next-to-zero oil, gas, or coal reserves of their own, and having lost faith in nuclear power. They will be the first country to enter a world made by hand. They were very good at it before about 1850 and had a pre-industrial culture of high artistry and grace – though, granted, all the defects of human psychology.
Japan is trapped. It must maintain enough of a functioning industrial economy to support its fleet of crumbling nuclear reactors for an indeterminable period of time, perhaps centuries. Imagine Detroit with reactors.
Industrialization is supposed to bring more goods at lower costs to customers who have to work less in order to enjoy more. From cradle to grave, modernity promises more of everything for everyone.
Goods are not enjoyable or useful. For example: the promised mobility has degenerated in a set of unremarkable yet rigid rules. It is the traveling in drainage canals from noplace to noplace, from one slum to another slum in pursuit of … low quality, unsatisfactory goods!
The systemic costs of ‘goods’ are unaffordable to the system. The customers discover they cannot work because they are unemployed or they find the work is too hateful to bear. There is no enjoyment utility: the ever-multiplying poor struggle to survive while the rich increasingly and for good reason fear the poor.
Meanwhile, waste — which is the real product of modernity — overwhelms the natural life-support system for rich and poor alike. Modernity cannibalizes the capital the system needs to run. The waste products and the loss of capital — and their associated increase in costs — is why modernity is failing. The problems discussed by Kyle Bass and other analysts are all symptoms of extinguished capital.
The managers desperately seek solutions that don’t change anything because of the perceived costs of change. What they miss right under their noses is to resist change is to become Detroit … or worse. Changes are inevitable, they will occur as a result of intent or as a result of system breakdown … which in turn forecloses the possibilities of creative alternatives. It is best to seize the day … to assign costs where they belong and start making the hard choices about what we need to give up … so what remains can be made available to ourselves and our offspring. What is needed isn’t anything extraordinary, only restraint.
The establishment has nothing left, they are scraping the bottom of the ‘solution’ barrel. Everything is offered but energy conservation and doing with less. This is total nonsense … the end of it is at hand. There isn’t enough room on Planet Earth for unlimited humans + cars + associated ‘other goods’. Something has to go, otherwise, the world = Detroit.
Waste Based Society V: The fallacy of cutting waste
Off the keyboard of Monsta666
Discuss this article at the Energy Table inside the Diner
A prevailing viewpoint we often encounter in the mainstream media is the view that our current society is very wasteful with its use of resources and if we were more efficient then we can live an equitable life with a tiny fraction of resources consumed. This view is so prominent that it is quite commonly supported even in the doom blogosphere. However this belief that we can transition to an efficient waste free society without large scale economic and social implications is a wrong one.
While the first statement is correct; we do indeed live in a wasteful society what follows next is not so achievable under our current economic system. What people need to understand when making such statements of cutting “waste” is that all people employed produce either goods or services. If we wish to cut on wasteful production then we must cut the total amount of goods/services produced and since labour is involved in this said production then in effect by cutting on waste we are also cutting on jobs. After all, one man’s waste is another man’s job. That extra hot dog the average overweight American consumes (and does not need) is providing a job to some J6P albeit a poor paying job. While this is just one example it can extend too many occupations in our society.
Now cutting on jobs may be a necessary evil to saving the planet/future generations but one should fully consider the implications such actions would entail on the global economy. We live in an economy that requires infinite growth and one of the big drivers of this growth comes from our monetary system that is all debt based. To service this ever expanding debt load we must increase production even if this production is not needed. Indeed this need to continually expand production has caused the long-standing issue of overproduction.
As the industrial revolution took hold in the western economies and many industrial factories were built (using debt) it soon became apparent that more goods were being produced than what J6P needed or could even afford. To overcome this problem of overproduction the industry of advertising grew in earnest to generate new demand for unneeded items. It is should be noted that it is important these unneeded goods were sold because many of these new factories were built using credit so they needed to be fully utilised to pay back the debt WITH interest.
This dynamic of increasing production has created further issues however even with the aid of a large advertisement industry as demand for products has struggled to keep up with supply. The reason for this struggling demand comes from the fact that real income of households needs to rise in tandem with the increasing amount of goods produced. This issue of slow growth in real incomes became quite acute during the 1970’s oil crisis as this period marked the time that the average incomes in the US no longer rose significantly in real terms and have made up a smaller percent of total US GDP.
To compensate for this development a range of actions were deployed the two most notable being globalisation and easier access to credit. Globalisation allowed goods to be produced at a lower price as the main manufacturing bases were moved to cheaper regions were the cost of capital and labour was lower so the prices of goods sold would be lower and this would serve to prop up demand. The process of globalisation also had the benefit of increasing the numbers of potential consumers so while there was no longer great returns in the western world more countries were sucked into the debt machine and the costs could be spread over a wider base.
Obtaining credit was also made easier so J6P could still keep buying his cars and maintain his American lifestyle even though his wage was not going up and the cost of items were rising faster than his wages. Other more insidious methods to maintaining demand included such things as planned obsolesce. By having items designed to break after a set period of time J6P could no longer buy durable goods such as washing machine that would last for 20 years as they were designed to breakdown within a planned timeframe usually shortly after the warranty period. All these measures while effective, at least for a time, do not solve this problem of overproduction. It merely postpones the day of reckoning and due to the nature of credit expanding over time the problem is actually compounded (literally) when it is delayed.
What I have stated thus far maybe already widely known to people but it is important to realise the dynamic of why all this overproduction is necessary because in essence since nearly all major capital investments are financed by credit there is always a need to expand production to cover the interest on the loans. By cutting the waste in society what happens is all the capital currently being deployed will be underutilised and the loans this capital were backed by will no longer be honoured. This is likely to lead to large scale defaults and large unemployment.
The most notable example of capital investment that serves as the basic platform that makes most of our economic activities viable is that of basic infrastructure. This form of capital investment is most susceptible to the issues described above as nearly all major public works cannot be supported on their own merits and must therefore require finance to be sustained. This issue has been discussed previously in the diner and if you are interested in learning more about this subject please refer to the Large Public Works Projects series here, here and here.
Like most capital investments, major public infrastructure projects are financed by debt. Not only is ever increasing expansion credit a needed condition but as an extension to this fact is that the number of service users using the said infrastructure needs to increase or if the number of users do not increase then the average usage per customer has to rise. This increase of the amount of service user’s makes the infrastructure more viable as economies of scale can be achieved meaning the cost per unit production declines but more important is the fact the cost per user decreases.
This need for greater infrastructure usage does generate much wasteful economic activities and much is said about reducing such wasteful activities. After all how many articles have you read about reducing the amount of wasted water or electricity per customer? The issue with reducing demand is that while it can be a positive thing on an individual level on a more macro level it will lead to a more negative outcome as it would mean a drop in aggregate demand.
Since the infrastructure is financed by debt a decrease in aggregate demand would mean the overheads can no longer be covered and the price per user will have to rise. This last point is important because when it comes to covering costs “wasteful” activities cannot be discounted as unneeded. For example much of the telecommunications infrastructure achieves its low price because certain users using it frivolously for unneeded economic activities such as the child playing on a XBOX 360 using gigabytes of bandwidth. This unneeded activity allows the small business round the corner to enjoy cheaper prices. If you removed the wasteful user in this case then the costs imposed on the needed users would rise and their economic activities are less likely to remain viable. This is the big issue, as prices rise the user base will decline leading to more users being unable to afford using the infrastructure. If this process were to continue then the infrastructure would suffer tremendously as the same expensive overheads would still need to be paid but with fewer users. Even if such structures could remain intact they would begin suffering from diseconomies of scale; that is the costs per unit production would rise as the number of users decline. In short if the number of users decline sufficiently it is likely the whole project will lead to some kind of death spiral.
While the issue is most acute in basic infrastructure works the dynamic remains largely the same for any good produced; the wasteful demand cannot be dismissed as disregarding that demand not only leads to direct unemployment (people responsible for that production are laid off), it also means the cost borne on the remaining users who demand the product rises as the total costs are spread over fewer users. This then results in even less people who can afford buying the goods/services at this new higher price leading to even higher prices as there are even less users to support the cost of overheads. Thus this process leads to a destructive feedback loop developing that is likely to result in dire outcomes.
If we want to reduce wasteful activities we need to recognise a reduction in waste will lead to mass unemployment and large scale defaults since many assets are backed by the debt which would no longer be met if the factories were only working at low utilisation rates. Another important point to consider is that since much of the upper class hold assets in these factories a large scale default is going to hurt them disproportionately hard so it seems unlikely such reductions would be tolerated even if the lower classes could recognise the issue which is unlikely since their jobs depend on these wasteful activities.
An argument often made to make such investments more viable is to increase the efficiency of such capital so the cost per unit output is less even if the number of users or usage per user remains the same. Therefore as a result of this the reduced costs will be passed onto the consumer. While there are definite merits to this approach, which should be pursued, it must be noted that none of these actions will provide an ultimate solution to the problems faced.
The issue with greater efficiency in resource consumption actually lies in its perceived strength that is the lower cost in using the said item. For example if we can provide an infrastructure that produces electrical energy 5% more efficiently the cost per user will decrease. This decrease in costs will result in demand rising negating some of the efficiency gains made. This effect is known as a rebound effect and any increase in efficiencies will cause some kind of rebound effect. As a result of this one must be wary of any claims that suggest that all efficiency gains will result in the same reduction in total usage. It may still bring total demand down but it will always be more marginal than hoped on account of the rebound effect.
Indeed in some cases increase in efficiencies can actually result in greater resource consumption and these occurrences are known as the Jevons paradox. This issue of rebound effect and possible Jevons paradox is not a new topic; it was first in early 1865 and was covered in Jevons book: The Coal Question. It should be noted however this effect only applies if demand is highly elastic where demand rises disproportionally to price decreases. Thus this paradox is more likely to occur in competitive markets were small price differences can lead to significant gains in market share or the amount of users consuming the said commodity. This final point of expanding user bases should be considered in an expanding world of globalisation.
Inelastic Demand resulting in only the rebound effect
Elastic Demand Resulting in Jevon’s Paradox
There are also further issues with increase efficiencies and this issue of increasing efficiencies, like many other things, suffers from diminishing returns. That is over time the returns per unit investment declines and there will come a point that further gains will become prohibitively expensive and even if such expensive gains were pursued the return would be smaller. In other words there will be a limit to how much efficiency can be gained before it reaches some hard limits either from an economic standpoint (which is likely to come first) or a thermodynamic limit. After all it is impossible for us to have 100% efficiency!
The final issue, and one that is perhaps most pressing, is that most cases made for pursuing wide scale adoption of efficiency gains requires extensive use of credit. It is likely going forward that credit will become increasingly constrained so the amount of available credit necessary to fund aggressive efficiency projects will not be available. Without widespread credit the chances of rapid increase in efficiencies being developed are considerably less. This issue of a lack credit is often avoided or implicitly assumed by strong advocates of making things more efficient but it is an assumption that is likely to prove false.
In short while increasing efficiencies can buy some time and keep capital investments particularly basic infrastructure projects viable for a longer period of time there are limits to this process and increased efficiency cannot provide the ultimate solution. At some point efficiency gains will cease occurring in any meaningful level and due to the required need for further credit expansion those issues will have to addressed at some point even if efficiencies could be maximised which is unlikely considering that further credit is likely to become more limited going forward.
The other solution of outright demand destruction as commonly suggested will lead to very negative outcomes as explained above to the investments in question and more generally the global economy. What needs to be recognised is our current economic and monetary systems are not suitable for dealing with declines in demand or credit. They only function well in world of expanding demand and credit as this is how the system was designed for. If we wish to cut all waste then we need to devise a system that can operate under the condition of perpetual demand destruction.
IEA Oil Forecast Unrealistically High; Misses Diminishing Returns
Off the keyboard of Gail Tverberg
Published on Our Finite World on November 13, 2012
Discuss this article at the Epicurean Delights Smorgasboard inside the Diner
The International Energy Agency (IEA) provides unrealistically high oil forecasts in its new 2012 World Energy Outlook (WEO). It claims, among other things, that the United States will become the world’s largest oil producer by 2020, and will become a net oil exporter by 2030.
Figure 1. Author’s interpretation of IEA Forecast of Future US Oil Production under “New Policies” Scenario, based on information provided in IEA’s 2012 World Energy Outlook.
Figure 1 shows that this increase comes solely from the expected rise in tight oil production and natural gas liquids. The idea that we will become an exporter in later years occurs despite falling production, because “demand” will drop so much.
The oil price forecasts underlying these and other forecasts in the report are approximately as follows:
Figure 2. Author’s interpretation of future average world oil prices, as provided by IEA in their 2012 WEO report. (Forecast provided by IEA is more “concave downward”.) Historical amounts are based on BP 2012 Statistical Review of World Energy amounts.
One reason the WEO 2012 estimates are unreasonable is because the oil prices shown are unrealistically low relative to the production amounts forecast in the report. This seems to occur because the IEA misses the problem of diminishing returns. As the easy-to-produce oil becomes more depleted, and we need to move to more difficult reservoirs, the cost of extraction increases.
In fact, there is evidence that the “tight” oil referenced in Exhibit 1 is already starting to reach production limits, at current prices. The only way these production limits might be reasonably overcome is with higher oil prices–much higher than the IEA is assuming in any of its forecasts.
Higher oil prices cause a huge problem because of their impact on the world economy. The IEA in fact mentions that current high oil prices are already acting as a brake on the global economy in its first slide for the press. Higher oil prices also mean that investment costs required to reach target production levels will be even higher than forecast by the IEA, adding another impediment to reaching its forecast production levels.
If higher prices put the economies of oil importing nations into recession, then oil prices will drop lower, reducing the incentive to invest in new oil production infrastructure. In fact, we could find ourselves reaching “peak oil” because of an economic dilemma: while there seems to be plenty of oil available, the cost of extracting it may be reaching a point where it is more expensive than consumers can afford. As a result, some oil that we know about, and have been counting as reserves, will have to be left in the ground.
The IMF has recently done modeling that is relevant to this issue in a working paper called “Oil and the World Economy: Some Possible Futures.” This analysis may provide some insight as to what the real situation will be.
The Problem of Diminishing Returns
One issue that the IEA has not properly modeled is the issue of declining resource quality, leading to diminishing returns and a rising “real” (inflation adjusted) cost of production. This situation is often described as reflecting declining Energy Return on Energy Invested (EROEI).
The reason diminishing returns are a problem is because when a producer decides to extract oil, or gas or coal, the producer looks for the cheapest, easiest to extract, resource first. It is only when this resource is mostly depleted that the producer will seek locations where more expensive, harder to extract resource is available. Thus, over time, the inflation adjusted cost of extracting a resource tends to increase.
Figure 3. Author’s illustration of impacts of declining resource quality.
In terms of the triangle shown, producers tend to start at the top, with the “best” of the resource, and work their way toward the bottom. One result of this approach is that the cost per unit of production tends to rise, even as there are technology advances and efficiency gains, because the quality of the resource is declining.
Reserves tend to increase over time with this approach, because as producers work their way down the triangle in the diagram, they always see an increasing quantity of lower quality resources. The new reserves are increasingly expensive to extract, in inflation adjusted terms. There is no flashing light that says, “Above this price, customers won’t be able to afford to purchase this resource any more,” though. As a result, the increasingly low quality reserves get added to reported amounts, even though in some cases, the cost of products made with these reserves (say gasoline or diesel) will send economies into recession.
It should be noted that the issue of diminishing returns exists for almost any kind of resource. It exists for uranium extraction, since there is always more available, just harder to reach, or in lower concentration. Diminishing returns exists for gold, copper, and for nearly any other kind of metal. This means we often need more oil for metal extraction and processing, as we dig deeper or find ore that is mixed with a higher proportion of waste product.
The problem of diminishing returns also seems to hold for renewables. The first biofuel developed was ethanol from corn, since the process of making alcohol from corn has been known for ages. Newer approaches, such as ethanol from biomass and biofuel from algae, tend to be much more expensive. As a result, when we add new biofuel production, it is likely to be more expensive, and thus harder for the customer to afford. If we want it, we will need increasingly high subsidies.
Wind energy is also subject to diminishing returns. Onshore wind was developed first, and it is far less expensive than offshore wind, which was developed later. Early units of wind added to an electric grid do not disturb the electric grid to too great an extent. Later units of wind energy add increasingly large costs: long distance transmission lines, electrical storage, and other balancing–something that is generally overlooked in making early cost analyses.
Diminishing returns seem even to happen for energy efficiency. We have been working on energy efficiency a very long time. We have a tendency to pick the low-hanging fruit first. Later expenditure for efficiency may be less cost-effective.
Why Light Tight Oil Won’t Increase as in Figure 1
Tight oil, also referred to as “shale oil,” is supposed to be the United States’ oil savior, if we believe the IEA. The Bakken and Eagle Ford plays are the best known examples.
Rune Likvern of The Oil Drum has shown that drilling wells in the Bakken already seems to be reaching diminishing returns. The choicest locations appear to have been drilled first, and the locations being drilled now give poorer yields. He has also shown that the average well in the Bakken now requires a price of $80 to $90 barrel, which is close to the recent selling price. If increased production is desired, the price of oil will need to start increasing (and keep increasing) to provide the incentive needed to drill wells in less-choice location.
There are other issues as well. If there is a need to drill an increasing number of wells just to stay even, or an even larger number, to increase the amount of oil produced, we start to reach limits on many kinds: number of rigs available, number of workers available, miles driven for water to be used for fracking. Perhaps the issue that will limit production first, though, is limits on debt available to producers. Rune Likvern has also shown that cash flows from tight oil extraction tend to run “in the red,” so an increasing amount of debt financing is needed as operations ramp up. At some point, companies hit their credit limit and have to stop adding new wells until cash flow catches up.
Evidence Regarding Rate of Growth of Oil Extraction Costs
Bernstein Research recently published information showing that the marginal cost of oil production was $92 barrel in 2011 for non-OPEC, non Former Soviet Union oil producers at the 90th percentile of production. This cost is increasing at 14% per year (or about 12% a year in inflation adjusted terms). Even at the median marginal cost level, costs appear to be increasing at a compound annual growth rate of 9% (or about 7% in inflation adjusted terms). See also this FTAlphaville post.
If we take the $92 barrel cost in 2011 at the 90th percentile of production and increase it by 7% a year (arguably we should be using 12% per year), the real cost will be $169 barrel in 2020, and $467 a barrel in 2035. These are far in excess of the IEA oil price estimates shown on Figure 2. There is no reason to believe that Bakken and other tight oil production costs would be substantially cheaper.
Other Issues That Appear Not to be Handled Well by IEA WEO 2012
There are three other issues that the IEA has not handled well, in my opinion.
1. Rising Real Need for Fuels of Some Sort
WEO 2012 shows falling “demand” for fuel. Demand, as economists define demand, has to do with how much customers can afford. It is quite possible that demand will fall because people can’t afford the fuel.
It seems to me would be better to start by analyzing how the real need for fuels is changing. Once this is determined, adjustments can be made to reflect other ways the same benefits can be provided, assuming this is possible.
Regarding the real need for fuel, if we look at species that are in some ways similar to humans, such as chimpanzees and gorillas, we find that these animals have no need for fuels, because they live in the way that they are biologically adapted: There are only a relatively small number of them (less than 1,000,000 per species) living in territory which is restricted to their biological adaptation. They do not need their food cooked, or spears or other tools to keep away predators, or shelter from the elements.
Humans don’t live in the way that we are biologically adapted. Because there are so many of us, we need to grow our own food, and gather water from natural sources. Because we do not have big heavy jaws because there is little easy-to-chew food available, we need to cook much of our food. Because we live in diverse areas of the world, we need shelter and adaptive clothing. As humans move to cities, we have even greater needs. We need antibiotics and immunizations to prevent epidemics. We need fuel for commuting, unless we sleep on the floor of the factory where we work. We need fossil fuel for cooking, because traditional fuels such as dung or twigs are not available in sufficient quantities in urban areas.
Another need for fuel, besides directly responding to human needs, is to offset the continued degradation (entropy) of built infrastructure. As the number of humans expands, so do the miles of roads, the number of bridges, the miles of pipelines, the number of homes and schools, and many other kinds infrastructure. All of this infrastructure wears out. Roads need to be repaired almost every year, especially in cold climates. Electrical transmission lines need to be put back in place after every major storm.
Population is also, of course, rising. When we put these issues together (rising fuel need with urbanization, rising population, and increasing entropy), it is clear that the services humans need from fuels will continue to rise, whether or not “demand” as economists measure it appears to rise.
Most of these fuel services will need to come from fossil fuels, rather than renewables, for two reasons: (1) This is the way our infrastructure now is built, and it is expensive and time-consuming to change it. (2) Biological sources are quite limited compared to the needs of 7 billion humans. According to Chew in The Recurring Dark Ages, deforestation started to occur in multiple locations 6,000 years ago, when the world population was about 20 million people.
2. Substitution for Oil
The IEA seems to err in the direction of assuming that substitution can be made more quickly than it really can be. In general, whenever substitution is done, new devices need to be created that use the new fuel, or new plants need to be developed that transform one type of fuel to another type of fuel. Doing either of these things will temporarily add to demand for fossil fuels. There is also a cost involved.
Only the heavier portion of natural gas liquids can be added directly to gasoline supply. Most natural gas liquids are used for other purposes, such as making plastics, or propane for home heating, or making liquid petroleum gas (LPG). LPG is used for cooking in some parts of the world and for operating vehicles that have been designed to use it.
The IEA seems to assume that efficiency gain can have a big impact on the need for oil. The issue it seems to lose sight of is that efficiency gains are a two-edged sword. When a device is made more efficient, the usual effect is that it can be operated more cheaply. This means that more people can afford it, and demand may increase. In the early days, electricity was very expensive. As its cost came down with efficiency gains, its use went up dramatically.
Putting All of These Issues Together
It is very clear to me that the IEA oil estimates way too high, unless prices are much higher. Of course, prices can’t really be much higher, or the economy will go into recession. As a result, production both for the US and the rest of the world is likely to be much lower than forecast by the IEA.
It would be useful to have a better estimate of exactly where the world is headed. One way this might be done is by adapting the indications of a new IMF working paper called Oil and the World Economy: Some Possible Futures. The working paper considers some unknown time, between now and 2020, when the rate of increase in oil supply is assumed to decrease by 1%. While it is not stated in the report, it appears to me that this is similar to what actually happened about 2005, when the rate of oil production increase dropped from 1.3%” annual increase to 0.1%, a 1.2% decrease. (Figure 4, below).
Figure 4. World crude oil production (including condensate) based primarily on US Energy Information Administration data, with trend lines fitted by the author.I have a few observations regarding such an adaption:
(a) The model could be adjusted to consider the fact that a drop in the trend rate of about 1.2% actually took place in 2005, rather than simply assuming that a 1% decrease will happen at some unspecified point in the future. It appears to me that shift in the oil extraction trend line underlies many of the world’s problems in the last several years.
(b) The treatment in the model of diminishing returns should be adjusted. It is my understanding that this is currently handled assuming a 2% annual increase in real costs of production. The model could be adjusted to reflect a more realistic (higher) annual cost in oil production, and indirectly, required selling price.
(c) The authors of the IMF report suggest building a more resource-based model, and I would agree that this would be helpful. There are many interlinkages that the current model cannot adequately capture. A more resource-driven model, especially one that considers balance sheets of world governments, would appear to be better.
My View of What is Happening Now
As noted above, world crude oil production seems to have hit a plateau, starting about 2005. This is working its way through the economy with varying effects over time. The major effect at this point of time seems to be on the finances of governments that import oil, although it started earlier, with different aspects more apparent.
In general, what happens as we reach a situation of diminishing returns, and thus rising real oil prices, seems to be as follows:
As the price of oil rises, the price of food and commuting tend to rise. Both of these are considered essential by most consumers, so consumers cut back in discretionary spending, to have sufficient funds for the essentials. This leads to layoffs in discretionary industries, such as vacation travel and restaurant eating. The rise in laid off workers leads to an increase in debt defaults, and problems for banks. Housing and commercial real estate prices tend to fall, because of reduced demand, further adding to debt default problems.
Governments of oil importers get drawn into this in many ways: (1) Their revenues are reduced, because they receive less tax revenue from people who are laid off from work and from businesses with fewer sales. (2) They are asked to prop up failing banks, and to stimulate the economy. (3) They are also asked to pay workers who have been laid off from work. The net of all of this is that the governments of many oil importers find themselves with huge budget deficits, and declining ability to fix these deficits. This pattern is precisely what we are seeing today in many of Eurozone countries, the United States, Japan.
The statements about rising oil production in the US are just a distraction. Diminishing returns mean that US oil production will never increase very much. Oil costs will remain high, and this will be the real issue disturbing economies around the world.
Financial Issues Affecting Energy Security
Off the keyboard of Gail Tverberg
Published on Our Finite World on November 6, 2012
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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.
OIL KILLING: Are we about to witness an era of gang warfare in energy?
Off the keyboard of John Ward
Published on The Slog on October 27, 2012
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News blackout on Belgian shooting can’t disguise signs of assassination
Hazy….the facts surrounding mob-style killing of Nick Mockford (left)
I wonder how many people reading the rapidly petering-out Belgian oil ‘hit’ story realise that the incident took place fifteen days ago. Although Belgian police insist that this is normal, it isn’t. That is, news blackouts about eurodisaster may be normal, but a ban on news about this serious a hit is about as abnormal as they come.
Death scene…the Da Marcello restaurant in suburban Brussels
Thus far, a near-Stepford Wife headline has appeared almost everywhere along the lines of ‘A British oil executive gunned down in Brussels could have been the victim of a targeted assassination’.
Sorry to be obvious here, but WTF else does anyone think it might have been….a deranged waiter who thought Mockford’s derisory tip was the last straw in a life going bad?
“It could’ve been a random mugging and car-jacking attempt,” Belgian police told a prominent UK news agency yesterday. As the two assassins ran away like the clappers in bike gear carrying crash helmets – having poured four shots into the bloke – I’m scoring this minus 53 on a probability scale of ten. Yesterday, Nick’s employer Exxon came out with this belter attempting to beat that with a score of minus 97:
“We were shocked by the tragic death of Nick Mockford, one of our employees a fortnight ago in Brussels. Mr Mockford was a department manager at our office close to Brussels, but we have no indication that the incident was work-related.”
Well hell, that’s the way it is in Brussels – it’s the Wild West out there guys, Abilene has nothing on your eurocrat suburb. Here are some equally relevant clues:
This is Nick Mockford, Aussie-rules star from Melbourne Australia. Nick is half the Belgian victim’s age, not entirely caucasian, 18,000 miles from the slaying, and still alive. Belgian police have ruled him out of their enquiries at this stage.
Should we all try and get real here? A senior Exxon executive goes out for dinner with his wife in a town where the most dangerous thing about the place is that it smells of chips. On leaving – and let’s be clear about this – he was shot to death by two blokes who had clearly taken the trouble to work out what he was doing there, and waited for him to exit the eaterie. They ran off. A news blackout was then declared for fully 240 hours. Are any of us (even people like me who dismiss 90+% of all known conspiracy theories) expected to believe that, on closer examination, this appears to have been an attempt to steal the guy’s company car? I sincerely hope not, as otherwise all hope for the human species has left the theatre.
Nichlas Mockford wasn’t just some two-bit ‘departmental manager’. He was the Head of Marketing for interim technologies for Exxon. For interim technologies read ‘Green=alternatives to oil=end of Texas, Middle East, East Med undersea’…..and indeed any region whose current or future wealth might be based on black gold. For example, Russia.
Or, for interim technologies read ‘Green=eco-warriors seeing him as an ‘earth-traitor’=possibly persons of Kiwi/Hard Left/libertarian persuasion’.
The escaping motor-cyclists so clearly hell-bent on nicking Mr Mockford’s car were described by witnesses as “looking East European”.
So there we have it. I’m hoping that tomorrow’s (Sunday) papers have some intriguing leads re this one, otherwise I’d be inclined to write off MSM journalism for good.