03 December 2009

Roger Baker : Can the Economy Recover?

Cartoon from Talking Union.

Can the economy recover?
And, for that matter, should it?

By Roger Baker / The Rag Blog / December 4, 2009
[Steven Chu, U.S. Secretary of Energy] was my boss. He knows all about peak oil, but he can't talk about it. If the government announced that peak oil was threatening our economy, Wall Street would crash. He just can't say anything about it." -- David Fridley, scientist at Lawrence Berkeley National Laboratory.
Can the U.S., or indeed the global economy, ever recover? Concerning this issue, and it is an issue likely to effect most people now living, there is both bad news and good news.

First the bad news. There has been a growing awareness within the scientific community for more than a decade, that if the inherently expansive global capitalist economy as we have known it does recover, it will probably continue to disrupt nature and inflict human misery on a massive global scale.

The global economy has been increasingly bumping into the natural limits of all the human beings the planet can support, assuming they are to live under tolerable civilized conditions. Peak oil, global warming, water shortages, deforestation, polluted oceans, species extinction. You name it, we are now bumping into many kinds of natural limits.

If we do not somehow turn away from exponential growth as usual, and shift toward a more localized, sustainable economy, then wars over limited resources will become increasingly likely. A growing global population can easily overshoot the long term food limits of the environment. Famine has happened locally throughout history, but with a global economy, global hunger becomes possible. When food runs short, tempers flare.

Here's Walter Youngquist from The Oil Drum:
In various contexts throughout this volume [GeoDestinies] it is pointed out that we now live in unique times, unlike any in the past, and unlike what any will be in the future. Yet many people in developed countries do not realize the unique years we have had since the beginning of the Industrial Revolution. This fact, as a framework to understand the present and what lies ahead cannot be overemphasized.

We have developed technology by which we have exploited the Earth’s resources to a degree never before seen and which, in the case of non-renewable resources – fossil fuels, and metals as well as nonmetals, can never be repeated. We have drawn both from the past, and also mortgaged the next few centuries at least by degrading the vital renewable resources of soil and freshwater, which are not renewable within the span of several lifetimes. This is in contrast to many centuries of history when, lacking technology of today, things changed very slowly...
Top climate scientists like NASA head James Hansen are now pleading with us to tax the carbon we burn, and then to use the tax revenue to help restructure the economy on a wiser, sounder basis.
...Governments must place a uniform rising price on carbon, collected at the fossil fuel source -- the mine or port of entry. The fee should be given to the public in toto, as a uniform dividend, payroll tax deduction or both. Such a tax is progressive -- the dividend exceeds added energy costs for 60% of the public...
So what about the good news? The good news is that neither the U.S. economy, nor the global economy, will recover, because they can't. (Read on to learn why this is good news.) They cannot keep expanding in the profitably rapacious way that until recently was considered quite normal. The immediate problem is that nobody has figured out a way to have the global economy, as presently configured, expand without a corresponding increase in the supply of liquid fuel, and for a long time to come.

All things considered, where does this lead?

It is a major challenge to try to rationally convince most people that their total pile of material goods, and that accessible to their children, will by necessity have to shrink, no matter what. The way humans tend to think, selling bad news through intellectual persuasion is never easy. Not easy as compared to selling optimistic snake oil approaches that promise a relatively painless alternative to facing hard choices.

The USA now has a conspicuously dysfunctional political system. A system which allows the banker class to force the (previously) U.S. working class to assume the economic burden of somehow paying off their global finance gambling debts, including the gloriously reckless sub-prime loans made by the world's giant investment banks up to mid-2007. Think Dubai. (Some of us aware of peak oil have been trying to warn the world for over a decade that global investment trends were unsustainable from an oil perspective alone.)

From current trends, the U.S. public consciousness, in its political and economic perspective, is being forced to shift from the Clinton-Bush-era standard of reasonably assured economic well-being, toward an economic perspective of basic survival. The numbers of those concerned with basic survival, like the jobless and homeless, are already intolerably high by recent U.S. standards. These numbers will probably have to increase further before now-unemployed labor shifts toward local manufacture, agriculture, etc.

In the face of crisis, the public elected Obama to revive a troubled economy. If FDR made the Great Depression go away (with the help of WWII), then the right president acting in the right way should be able to make that happen again, right?

The bottom line is that the current production and the depletion numbers associated with peak oil are, by themselves, enough to indicate that we are headed toward an economic crisis. Getting the global economy back on its old expansionist track is likely to prove impossible, no matter how hard we try. We are now faced with the challenge of restructuring our economy in a way that would normally take decades. Yet we face other additional handicaps. We have an industrially hollowed-out U.S. economy, an aging U.S. population, and a conspicuously dysfunctional political system.

Tom Tomorrow on Peak Oil.

The cheap liquid fuel-based energy needed to transport the goods of global commerce on the previous scale is not there anymore. It is now cheaper to make steel in the USA than to try to ship it here from China. Conventional oil production on land probably peaked in 2005. We are now using expensive conventional oil alternatives like heavy oil, oil sands, and deep-water oil as a cushion to try to buy time before oil production, and thus the global economy, starts shrinking, and fast. The previously silent oil industry itself is now starting to admit as much:
Groups and individuals speaking out about forthcoming world oil supply challenges are frequently stereotyped as a fringe element with little knowledge about the oil industry. But their warnings are increasingly supported by some surprising allies: senior petroleum industry officials, consultants and analysts. Call these serious-minded critics the HarshRealists...
The bad news related to the peak oil situation is especially hard for politicians to publicly acknowledge, but even among such leaders, the word is spreading.

What would it take for average Americans to cut back drastically on their total oil use? I suspect that many readers would be amazed to hear that this has already happened! Without most folks paying too much attention, U.S. oil consumption dropped from about 21.7 million barrels a day in August 2005 to about 18.8 million barrels in recent months. An almost 3 million barrels a day decrease on a base of about 20 million is about a 15% percent decrease over the past four years, with 9% of that being in just the last two years.

These last four years were the years when we made the relatively easy cuts in excess driving, etc., in response to rising oil price and a depressed economy. Now it will get harder, because it looks like we are facing an oil-less recovery.

From Steven R. Kopits:
...Consumption is not much changed since the end of the recession. And before the recession, demand in the United States was falling at around $75/barrel. Therefore, based on the most recent observed period, we would expect US consumption to stagnate around recent prices approaching $80...

Overall, then, U.S. consumption is unlikely to ever recover levels seen in 2007. In the best of cases, consumption could close half the last years’ decline and increase by about 5%, or 1 mbpd. As likely is the possibility that consumption will stagnate at or near current levels, and may be significantly sensitive to prices at or near those seen recently. U.S. consumption is perhaps most likely to increase modestly by perhaps 0.5 mbpd, reaching approximately 19.0-19.5 mbpd.

As the country looks to recovery, policy makers must face the very real possibility that economic growth cannot depend on very much extra oil, and perhaps none at all. It may well prove an oil-less recovery, with all the implications that brings for employment and the economic outlook.
Given the current situation, the world's major economies might encourage easy credit and steer the global economy in such a way that it is successfully stimulated, meaning that aggregate demand for traded goods and commodities revives sooner. But this only means that we in the U.S. will try to bid against China for a global daily supply of oil falling somewhere short of 90 million barrels per day. Aggressive oil bidding is likely to be soon followed by another oil price spike,

Thereafter, we would likely see a return to the sort of stalling-out of the U.S. economy and rapid deflation that we saw after gasoline hit $4 a gallon in mid-2008, when GM went broke, etc. There is probably now less than five million barrels a day of global reserve oil capacity, mostly with OPEC, to cushion the system from another oil price spike, and this cushion is shrinking.

The current global recession combined with stagnant oil production can postpone the return of a tight market for the global oil supply, but not for a lot longer. A smart guess is that by 2012, global oil depletion in excess of five percent a year will cause serious economic problems through falling oil production -- no matter what we do.

Regarding this unhappy situation, here is what a distinguished retired CIA analyst, Tom Whipple, who writes a weekly (and also daily) column on the ASPO-USA website, has to say about the potential for recovery of the global economy. He points out the the numbers indicate that we are now apparently in a sort of economic trap.
...We can't have it both ways. It will either be a really deep global recession and cheap gas or some sort of start at recovery and spiking oil prices. Discussions have already started as to what level of oil prices causes serious damage. In the past an inflation adjusted $80 a barrel was a favored recession inducing number as this was the price that seemed to cause recessions back in the 1970s and 80s when Middle Eastern wars and embargos restricted supplies.

The trouble with $80 oil, of course, is that we are already there and no analyst that draws a paycheck from Wall Street wants to say flat out that another leg of a recessionary downturn is inevitable unless oil prices decline soon. A typical example was a Dow Jones story earlier this week entitled "Oil Price Rise Poses Little Threat, Yet, To Economic Recovery." The article points out that the danger to economic recovery won't start until we get to $90 or $100 a barrel or $3 a gallon gasoline... The current situation is clearly unsustainable. If the dollar continues to sink, oil is going to move so high that all sorts of economic consequences are inevitable. OPEC is already in a dilemma for no matter how much they like the increasing revenues, the smarter governments realize that if prices move much higher, it will trigger off even worse economic times...
At this point, many environmentally conscious readers are quite likely to suggest that alternative energy will come to the rescue, offering a relatively painless landing. But alternative energy probably won't be there in the needed quantity and on time; this outlook echoes the "Hirsch Report." Alternative energy is without question an important step in the right direction, but we need to understand the possible limits.

These limits are related to the time required and the scale of (now treasury deficit) financing needed to make the tons of steel, copper, and aluminum that would be required in another five years. Currently, we can't manage GM very well because we don't know the proper industrial production targets, or even whether it makes any sense to subsidize the building of cars instead of rail. The devil is very much in such details. How fast it is possible to shift the inputs and outputs of an industrial economy to meet new needs are already known to good economists.
An alarming new study jointly released by two prominent California-based environmental/economic think tanks, concludes that unrelenting energy limits, even among alternative energy systems, will make it impossible for the industrial system to continue operating at its present scale, beyond the next few decades. The report finds that the current race by industries and governments to develop new sustainable energy technologies that can replace ecologically harmful and rapidly depleting fossil fuel and nuclear technologies, will not prove sufficient, and that this will require substantial adjustments in many operating assumptions of modern society.

The new study (“Searching for a Miracle: Net Energy Limits and the Fate of Industrial Society”) is the first major analysis to utilize the new research tools of “full life cycle assessment” and “net energy ratios” (Energy Returned on Energy Invested, EROEI), to compare all currently proposed future scenarios for how industrial society can face its long term future..
After oil peaks, which is likely already, per capita metal extraction will also have to shrink soon thereafter.

Per capita food will also have to shrink soon, as the Worldwatch Institute's Lester Brown's latest book documents in detail:

End Game?

Things are not so bad at the moment. At least for the short run, and from appearances, the U.S. economy is restructuring itself in an environmentally healthy direction. Consumer spending on waste is contracting to a new mode based on meeting minimal but essential needs. People faced with foreclosure and high credit card debt have cut back their spending and credit obligations as much as possible. The arrival of hard times means people giving up many kinds of culturally induced needs that Thorton Weblen once classified as conspicuous consumption status symbols; travel to business conventions, vacation homes, big SUVs, the alluring ephemera sold in malls, etc. People are making do and hoping for relief.

A key issue now on the minds of many U.S. citizens is whether the U.S. economy can be put back on track through Obama's use of Keynesian deficit spending to stimulate the economy. In effect a shot of economic speed to get the stalled U.S. economy activated again, after which it is imagined that this stimulus can gradually be withdrawn without the economy relapsing into its previous state of stagnation.

Assuming that the U.S. finance system is required to stay solvent, and that it must be kept from falling victim to a sudden, panicky dollar devaluation, the obvious way the economy can be stimulated at the same time that the hidden mountain of bad debt the banks owe can be paid off is by printing up lots of money. Lacking an adequate supply of willing foreign lenders, this is done through mutual cooperation of the Treasury and the Fed, resulting in bond debt to be paid back later.

The Fed printing lots of money. Drawing from Cervantes.

But trying to revive the economy by means of printing up enough fiat currency to revive spending plus balance the books is akin to running up a big bar tab which eventually must be repaid. Think paper debts paid back with devalued dollars. This risky process is clearly underway, as famous investor Warren Buffett notes, although Buffett does endorse the use of temporary Keynesian economic stimulation to avert an immediate crisis:
...Buffett details his ongoing warning that the "enormous dosages of monetary medicine" being used to rescue the U.S. economy will eventually produce a dangerous "side effect." He worries there won't be enough lenders ready and able to absorb the nation's growing debt relative to its economic output over the years, forcing Washington's "printing presses" to work overtime churning out paper money. All those "greenback emissions" will, he fears, feed potentially "banana-republic" style rates of inflation...
We can see signs of inflation already if we know where to look. Economic demand, reflected in prices, for real commodities like important industrial metals, oil, and food has been steadily rising since early 2009. We can see this bumpy but steady average commodity price inflation by looking at this chart of Bloomberg's commodities indexes. This steady increase can easily encourage other commodity speculation. Consider what the price of gold is doing right now, as a relatively inflation-proof asset that historically preserves wealth well during troubled times.

Currently, among average consumers, we see an interesting economic split. There is a discretionary spending sector in a state of relative deflation and decline as compared to spending on basic needs. Satisfying basic needs takes real stuff like food and energy. In other words, we now have sort of a dual economy in which the unnecessary spending is shrinking. The "real stuff" sector tied to things people really need is seeing price inflation, while the other discretionary spending sector is severely depressed and seeing price deflation.

However, we have a CPI (inflation) index that averages the real basic needs together with the arbitrary and artificial consumerist needs. These two consumer spending categories can sometimes cancel out and appear to indicate zero inflation. Thus we get "apples and oranges" economic nonsense that is blind to the underlying structure and causes of inflation. No inflation index that arbitrarily excludes food and energy, like our CPI does, can be very realistic. (It would be better to have an index based on ONLY these two items, because when the economy is in real trouble, these spending categories will tend to prevail).

Referring back to the troubling choice that Tom Whipple outlined above, the choice between global deflation and a start at recovery with another debilitating oil price spike, the fact is that nobody can accurately predict the economic outcome very well, and this is now leading to an ongoing debate between the deflationists and inflationists. But as we have seen, it is possible to have deflation in one important sector of the economy and simultaneous inflation in another, due to quite different factors.

"Stagflation" was the term they used for this nearly impossible-for-economists-to-remedy situation during the energy crisis of the 1970s. As the price of a limited supply of oil was bid up, it pushed up the price of everything economically tied to oil, meaning nearly all commodities, which is termed cost-push inflation.

It is likely that with the U.S. and other countries trying to restimulate their economies through deficit spending, they will succeed at some point. In a situation where they are trying to use monetary expansion to stimulate otherwise unresponsive economies, there is a real but unpredictable risk of economic disaster through hyperinflation, as Buffet observes.

There is now a lot of fresh new money sitting idle on the sidelines. Banks are managing to appear more sound by borrowing at near zero interest and then using the cash to buy interest-bearing U.S. treasury bonds; what a racket! When there is a lot of idle money around, they start looking for profitable investments. Where there is a lot of money but a deficiency of important commodities that everyone needs or wants, you get self-perpetuating speculative bubbles. Given the apparent tendency of the U.S. political system to take the easy way out, as indicated by the federal government's inability to reinstate basic banking reform, the odds look good that we will see the continuation of inflation in the commodity sector.

When you have rising commodity prices, the markets soon notice. Soon rising prices stimulate the public willingness to buy and invest. This means the "velocity of circulation of money" increases. As soon as the public starts spending more freely, it becomes apparent how easy it is for the creation of printed money to exceed the availability of real goods.

This increased willingness for average consumers to spend in the face of rising prices has a self-perpetuating effect; money chasing goods leads to hyperinflation, finally, in general, ending in a collapse of some sort. Since this is based on something as unpredictable as consumer and investor psychology on a global scale, it is almost impossible to time or predict.

My own forecast is for continuing dollar devaluation, worsening stagflation, and finally an oil price spike that ushers in a permanently downsized economy. I would like to predict better, but the facts are stubborn.

In a sense, these details are academic. The facts by themselves seem to argue that before long we will have to accept a continuing downsizing of our average U.S. lifestyle and economic footprint. The sooner we face these jarring economic transitions, and assuming we remember our sense of humanity, the transition to a sustainable future will be all the easier and more tolerable.

[Roger Baker is a long time transportation-oriented environmental activist, an amateur energy-oriented economist, an amateur scientist and science writer, and a founding member of and an advisor to the Association for the Study of Peak Oil-USA. He is active in the Green Party and the ACLU, and is a director of the Save Our Springs Association and the Save Barton Creek Association. Mostly he enjoys being an irreverent policy wonk and writing irreverent wonkish articles for The Rag Blog.]

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