‘The best outcome is probably for humans to hit the wall soon and hard.’
By Roger Baker / The Rag Blog / October 2, 2008
Is industrial collapse the BEST way out of our current economic mess?
Arguably yes and here is why. But does it even matter? Perhaps not. Capitalism, in its global form and as we now know it, is likely finished in any case, so the choice is likely to be an illusion. But the best outcome is probably for humans to hit the wall soon and hard.
The Economic Context
Capitalism as an economic system depends on an endless expansion of material goods production at a rate that allows lenders to earn interest on money saved and invested. The only way to get potential lenders to lend rather than spending their money immediately is to reward them with a real rate of return on their savings. This is done by promising lenders that they will be rewarded with the ability to buy more material goods in the future. A reward must be offered to lenders for not buying and stockpiling bars of gold, barrels of oil, or any other desirable goods or services now as opposed to putting their money in banks or investing it in stocks or bonds or whatever else can earn them a real rate of interest as a reward for offering their savings up for investment by others.
Keynesian economics tries to maintain a mild inflation rate of a percent or two in order to encourage people to save their money in banks and other alternatives that offer a return above the rate of inflation. This is necessary to keep people from simply putting their money under a mattress. If the rate of inflation is one percent and they can earn three percent in a bank, they will bank their spare funds and will, in theory, be able to come out ahead and buy two percent more in the amount of physical goods or services than they had originally put in.
That is how those managing the economic system (like the Federal Reserve representing the banks) try to set things up. It is meant to encourage people to behave predictably and to keep them saving and investing. Under conditions in which in which it is possible to keep the material world always expanding and yielding a production of desirable goods at or above the rate of interest on money saved, this system remains viable and stable. This assumes that the financial system has been well-managed, and that there are no external limiting factors.
Enter Peak Oil
We now live in a world economy that is rapidly approaching the limiting factor of fossil fuel energy sources. The specific limiting factor that is most relevant is a looming shortage of liquid fuel based on petroleum as the total world oil production peaks and declines.
The peaking of world oil production strongly affects the investment equation that underlies the global capitalist economy and rewards investments and savings. The global economy is based on a cheap-oil-related infrastructure for its expansion of the production of real goods. Capitalism requires cheap energy to deliver the exponential expansion of material goods through investments that can pay real interest rates on loans. But this expectation is probably more than the expansion an oil-addicted global production system can really deliver. It changes the system’s economic potential by making it impossible to earn a real rate of return on the money saved by lenders, who in the case of the United States have increasingly been foreign lenders.
The underlying problem is that nobody can think of a way to keep expanding the material production of a global economy that is experiencing a shrinking supply of liquid fuels. These oil-based fuels move almost all goods in our global economy. This economy is based everywhere on the cheap transport of people, goods, and the capital goods needed to expand global production, whether it be by ship, by rail, by road, or by air. When the ability to move almost all goods declines, the expansion of the ability of capitalist investments to exploit nature for human uses must also decline.
Economic Response to an Oil Shock
The global and also the US economy may be roughly divided into two sectors: necessary spending versus spending that is unnecessary or can be postponed. The necessary spending sector corresponds to spending on vital goods such as food, shelter, the fuel needed to heat or cool a home, and the fuel needed to commute to work. Spending of this kind in the United States cannot be reduced very much or very fast without a long and painful restructuring of the economy to reduce suburban sprawl trends, etc.
If such necessary expenditures rise in cost, spending will be transferred to this sector at the expense of the second sector. We may term the latter the discretionary spending sector. This is a sector of the economy devoted to jewelry, fancy cars, iPods, trips to the movies, vacations, eating out, etc. But it must also include voluntary savings, which are vital for the functioning and expansion of global capitalism.
The discretionary spending sector is a big enough part of the total US and global economy that there are job losses and severe disruptions throughout the total economy if the discretionary spending sector contracts. If foreigners will not lend money and if US consumers are also strapped for cash, then the whole system is soon in trouble.
If there is only enough oil to keep the vital spending sector of the economy functioning, even as it gradually and painfully tries to adjust itself, then no possible kind of economic manipulation, whether by the federal reserve or the US treasury or even the most creative economist can prevent an even steeper contraction of the discretionary spending sector as consumer spending shifts over to the vital spending sector. If we are ever to shift to wind and solar energy, this implies that somebody has money enough left over after paying for food and gasoline and house payments to lend to the companies that expand their output of wind turbines and solar panels.
Thus oil production, whether it is stagnating on a level production plateau or actually contracting as population increases, forces a deep restructuring of the global economy. This raises prices in the vital goods sector and forces a restructuring of the vital spending sector of the economy, which is now additionally called upon to feed those thrown out of work by a contraction throughout the discretionary spending sector. This is basically why we are now in a state of slow economic collapse. Those parts of the economy that cannot be restructured to accommodate permanently higher food and fuel prices must shrink. The discretionary sector of the economy shrinks in terms of total spending (although not necessarily in all cases) as the vital necessity sector restructures itself to require less fossil fuel energy input. In doing so it often has to become more labor intensive.
The foregoing is a description of the general trends forced on the global economy by the end of cheap oil, but it still ignores important details in how US and global capitalism, increasingly organized as a global corporate empire, is likely to respond.
Global oil supply and demand are both relatively inflexible. That means that when oil demand rises faster than its world supply (there is essentially one world oil market with all humans bidding for a shrinking supply of what is left), even a slight imbalance tends to cause a sharp price rise. If oil demand falls, then oil price will fall rapidly too.
In much the same way, if a ship in the ocean runs short of potable water available for sale to the passengers, they are likely to try to bid a very high price for whatever water remains. A graph of the water consumed by the ship’s passengers may reflect a slow decline in water consumption as some passengers die of thirst. But this graph of water consumption would not reveal a sharp increase in the water price as the remaining passengers attempt to buy whatever water remains for sale. If they run short of money, then the price will fall even as they remain thirsty.
The same economic dynamic applies to worldwide bidding for what remains of the global oil supply and explains why the price has fallen modestly due to conservation and demand destruction even as production remains flat. As the dollar is devalued further, people will bid up the price of fuel, and food made from fuel, as much as they are able at the expense of savings and discretionary spending.
The Credit Crisis
The current US economic crisis, sometimes termed a credit meltdown, is actually due to a combination of several factors. First banking deregulation has led to the extreme over-leveraging of debt and credit, based on the Greenspan bubble expectation that the economy can and will continue to grow “normally” (that is exponentially) forever into the future. Billions have been lent to expand the production of Chinese toys and Christmas ornaments and similar discretionary sector goods. These debts, and indeed the smooth functioning of the entire global economy, have been insured by the massive issuing of derivatives such as credit default swaps (default insurance), paper created by the investment banks and AIG on a scale in which their total dollar value dwarfs the annual global economy.
The credit market and the highly profitable derivative market were allowed to expand, primarily after the deregulation of investment banks by Phil Gramm under President Bill Clinton. This paper was issued to the degree that seemed prudent by those who stood greatly to benefit by an enormous expansion, including not only the investment banks, but also their clients, the hedge funds.
It was imagined until about a year ago, that if the US or global economy ever threatened to contract, that a Wall Street or global bank run could be calmed by stimulating the global and national lenders with temporary injections of liquidity, through government lending and bailouts, and in accord with the principles of traditional Keynesian economic theory. Whereas total US bank reserves now equal only about three percent of what has been lent, and whereas the usual guidelines are to keep about eight per cent in reserve to calm the markets it was imagined that the Federal Reserve could come to the rescue and calm investors until the crisis subsides. Failing such assistance, the US and probably the entire global lending system is now grotesquely over-leveraged and subject to collapse as investors seek to withdraw their loaned funds on a large scale.
Reaching for the Right Levers
For the Federal Reserve and the Treasury Department, the crisis continues.
Without the broad bailout plan they invented and lobbied hard for, the two agencies are once again forced to careen from one desperate path to another, and to dig deep into their toolkits to rescue the global financial system. Even before the House stunned the world on Monday by rejecting the Bush administration’s bailout bill, the Fed was already resorting to the oldest action in its book: printing money.
With money markets around the world seizing in fear, the Fed on Monday announced that it would provide an extra $150 billion through an emergency lending program for banks, and an additional $330 billion through so-called swap lines with foreign central banks to help money markets from Europe to Asia.
It was an extraordinary display of financial power, and it reflected acute new anxiety at the Fed and central banks around the world that the crisis of confidence in American financial markets had metastasized to money markets everywhere…
Reaching for the Right Levers in an Anxious Situation by Edmund L. Andrews and Mark Landler / New York Times / September 29, 2008.
The People vs. the Banksters
The financial system is blowing up. Don’t listen to the experts; just look at the numbers. Last week, according to Reuters, “U.S. banks borrowed a record amount from the Federal Reserve nearly $188 billion a day on average, showing the central bank went to extremes to keep the banking system afloat amid the biggest financial crisis since the Great Depression.” The Fed opened the various “auction facilities” to create the appearance that insolvent banks were thriving businesses, but they are not. They’re dead; their liabilities exceed their assets. Now the Fed is desperate because the hundreds of billions of dollars of mortgage-backed securities (MBS) in the banks vaults have bankrupted the entire system and the Fed’s balance sheet is ballooning by the day. The market for MBS will not bounce back in the foreseeable future and the banks are unable to roll-over their short term debt.
…If there’s going to be a bailout, let’s get it right. Paulson’s $700 billion bill does nothing to fix the deep structural problems in the financial markets; it merely pushes the day of reckoning a little further into the future while shifting the burden of payment for toxic assets onto the taxpayer.
The People vs. the Banksters by Mike Whitney / counterpunch / September 27, 2008.
…Now that the market is finally adjusting the price bubble downward and a lot of firms that were incredibly profitable on the way up are falling like leaves in autumn in a bear market. The Fed is merely trying to inject money to keep the prices not supported by fundamentals from falling. It is a prescription for hyperinflation. The only way to keep price of worthless assets high is to lower the value of money. And that appears to be the Fed’s unspoken strategy…
Inflation is effectively a hidden form of governmental taxation that substitutes for the more honest approach of openly raising taxes. A global or national bank run can be calmed by, in effect, printing money to fill the liquidity gap. This is the gap between the material reward promised on money deposited, which the investment system has promised as a reward for saving, versus what the system can actually deliver to lenders in terms of real goods that can be purchased with the money withdrawn. Over the short run, printing bailout money charged to taxpayers can bridge the gap between the liquidity problems and appear to make them seem to go away.
Thus the Federal Reserve is injecting large amounts of bailout money into the economy in order to stop a widening global bank run and financial panic. But this added money will soon diffuse throughout the general economy and start bidding for real commodities. That means inflation as the bailout money starts chasing vital necessity goods tied to oil and energy, or other commodities, or the traditional physical means of preserving wealth, gold.
The reaction by the Federal Reserve has been more or less predictable, traditional, and automatic. If a credit crisis threatens a bank run, the solution is for the US government to print up enough money to make the immediate crisis go away long enough so that the economic downturn ends, the system can recover, and business confidence restored. This is a stopgap measure, much like stalling creditors while looking for a job. It has tended to work in the past, keeping the high tech and housing bubbles expanding during the last decade. But there is only so long that the US economic bubble can be kept expanding by lowering interest rates or using bank bailouts.
During normal times, it tends to work, and the government can make up its own rules to keep things expanding. To use an analogy, not only is it harder to keep a party going past a certain point no matter how much free liquor is on hand, but the situation is made more complicated by the fact that the liquor supply is running short. The attempt to stimulate the system and keep the investment bubble expanding will not work under conditions in which the real economy can never recover because the material world on which it is based can no longer expand and recover over time because a contraction of its economic base is dictated of declining oil-based fuel production.
In the real world this combination of a credit crisis and peak oil strongly implies stagflation; the serious stagflation we saw in the 1970’s during our first big energy crisis was not a random event due merely to bad luck. Stagflation is characterized by a simultaneous economic contraction in the discretionary spending sector of the economy, along with cost-push inflation caused by competitive bidding for a limited supply of goods in the vital necessity sector of the economy. During a time of stagflation, people transfer spending in favor of bare necessities like housing, food, and the fuel needed for vital transportation. The only good news is that base housing prices are falling, but this comes only after many people have been locked into ballooning housing loans. Something has got to give in terms of consumer spending, and the main option is to sharply reduce spending in the discretionary sector of the economy.
No amount of additional money printed by the government can successfully stimulate a renewed expansion of the discretionary sector of the economy if the added money is mostly used to bid for a limited supply of fuel, and food costs heavily based on fuel. The current economic crisis will unfold as some inflationary variety of economic collapse shaped by political reality. The rate of decline and the severity of such an oil-price triggered crisis is made more abrupt and severe than the gradual decline in oil production itself by its interaction with the credit crisis.
The end result, no matter how the details play out, will be predictably contrary to the continued expansion of the capitalist economic system. The end result is unavoidable but will have a strong tendency toward inflation or hyperinflation in the stages that precede the final economic collapse, in accord with the historical experience elsewhere.
Infinite expansion in a finite world
“Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist.” — Kenneth Boulding, economist.
The situation we face now, on a global scale, is the predictable economic consequence of a deeply dysfunctional economic organization; a system predicated on infinite exponential expansion, struggling to pay the compound interest rates expected by those who have lent their savings to a global capitalist economy:
The global economy is deeply structured in such a way as to be resistant to abrupt change by its national political institutions. The economy and the Wall Street financial institutions are likewise structured in such a way as to always guarantee a real return on long term investments. Something has got to give; a deep and universal economic shock is necessary to reflect the required change on the required time scale. This means the end of exponential economic growth for a long time, assuming the capitalist economic system can ever recover in anything like its current form. Human survival probably now implies reverting to the simpler ways of the past.
If the ultimate limit to continuing economic growth were not liquid fossil fuel, it would be potable water, or arable land, or global warming, or pandemics or some combination of such limiting factors. Given the current world population of six billion people, the current level of human technology, and the powerful ability of that technology to disrupt nature, important limiting factors would soon be reached in any case.
The necessary result must involve a deep restructuring of the entire global economy to reflect the new material reality of declining world energy production. And it must somehow reduce human population growth and reduce the current human population bubble and its unsustainability.
Why should such a painful outcome be encouraged as soon as possible? Few humans can or will change their behavior in response to intellectual arguments or warnings or predictions until they are forced to do so by external factors. If the current reality seems to succeed for those who benefit most, even though they may live in luxury within gated communities, it is human nature for them to attempt to resist change and to try to assure that things continue along the same path as long as possible. But now the global economy system is obliged to change, and to accommodate the new material reality of much reduced energy availability. The faster the accommodation to the limits of nature the better, or else the end result will undoubtedly be worse for humans everywhere.
Faster restructuring now, though it amounts to an industrial collapse, means that we will hit the wall of material reality dictated by the limits of the natural world soon and hard. To hit the wall now, however painful, is preferable to hitting it later, with an increased risk of war and famine if the crisis could somehow be postponed. We probably have little choice in any case.