The global situation is in its deflationary, cascading-default phase, where entire countries can go broke from bad petrodollar-denominated debt.
“Every time history repeats itself, the price goes up” — Anonymous, as quoted in Tainter, The Collapse of Complex Societies
The deflation monster has arrived onstage, and is playing out its role as an influential actor in our history right now. Hang out on Zero Hedge for daily news of the important details.
This global situation is in its deflationary, cascading-default phase, where everything, including entire countries like China, can go broke because of the mountain of bad petrodollar-denominated debt haunting their balance sheets. We can see a global tendency to cash out going right now. Not at all what the Fed had in mind, but the logical outcome of delaying structural reform in an era of falling profits and slower growth, which are actually rooted in global resource depletion.
Keynesianism got a ‘free lunch’ image that became associated with Democrats.
After WWII, Keynesian economists were considered to be able to fix depressed capitalist economies, basically by giving out public money, even to poorer citizens during hard times. This was a policy intended to stabilize market demand through the periodic boom and bust phases of capitalist economic expansion. FDR may have used Keynesianism, but it has gotten a “free lunch” image that became associated with Democrats. Such grassroots and civic project spending under Obama, except for the military, became too politically unpopular to pass and was discontinued, whereas bailouts for banks on a much greater scale was not.
Even when Keynesian stimulus to the grassroots can survive political challenge, however, this method of stabilizing capitalism is also a policy subject to diminishing returns due to natural resource limits.
A vital part of our system of global finance capitalism and its related international trade is the use of organized human labor to generate more than enough energy to sustain the existing population. The energy return on energy investment (EROEI) must be something like five-to-one payback or civilizations that rely on this energy surplus tend to break down, an important insight developed by Dr. Charles Hall.
In the days of the ancient Roman economy, the wealth of the empire waxed and waned according to the prevailing economic cost of its grain. Over time, the market exchange value of grain must always average less than the cost of feeding the slaves who grow and harvest the grain, and also the armies of enforcers who keep it coming in. If net grain production is ever interrupted longer than the Emperor’s grain reserves can hedge against, the population gets hungry, and the Empire is liable to undergo management change.
During the start of the industrial revolution, England prospered too using cheap energy, by using cheap coal to power its steam engines that wove the cotton cloth made from cotton. This helped the USA prosper too because the cotton was grown with slave labor in the USA. Steam power set the stage for an expansive capitalist investment process. This was made highly profitable by means of a combination of cheap coal-based mechanical energy, in combination with a system of finance capital like London banks seeking to continually reinvest the profit on continued expansion, both domestic and abroad.
The economy prospered based on the U.S. being a large nation with abundant mineral reserves.
And so did the economy prosper for the past century, largely based on the U.S. being a physically large nation with abundant mineral reserves, including fossil fuels like oil to supply cheap abundant energy, and a secure base of imperial and military control throughout Latin America. It was not until the energy crisis of the 1970’s, after the U.S. peak in oil production, that a sudden global oil price shock forced serious consideration of resource limits to growth.
It was about this time that the 1972 book, The Limits to Growth, came out, with a famous chart, a picture of interacting resource limits on things like total human population and longevity, factors which have enormous human implications. This same chart with a recently added timeline still looks reasonably accurate today in its warning of the natural limits to exponential growth, which together imply hard times to come. Global warming has rather unexpectedly added to these limits since the work was published.
As Jared Diamond wrote in Collapse: How Societies Choose to Fail or Succeed,
One of the disturbing facts of history is that so many civilizations collapse. Few people, however, least of all our politicians, realize that a primary cause of the collapse of those societies has been the destruction of the natural resources on which they depend. Fewer still appreciate that many of those civilizations share a sharp curve of decline. Indeed, a society’s demise may begin only a decade or two after it reaches its peak population, wealth and power.
Insufficient cheap energy to maintain profits on investments on anticipated growth implies “stagflation.” This describes a combination of inflation and stagnation which unexpectedly appeared during the energy crisis of the 1970s, to the great frustration of the Keynesian economists.
Stagflation can play out in two contrary ways. During our energy crisis of the 1970s, roughly 1973-1982, insufficient oil supply to maintain the anticipated real growth on investments revealed itself as oil price-related “cost-push” inflation, where everything moved by burning oil; in other words, practically everything material, went up in price.
This fuel cost-centered energy crisis was finally resolved primarily by a surge in Alaskan oil production. That plus a the guarantee of cheap OPEC oil in exchange for military protection forever, a deal made with the Saudi King.
Global oil production from OPEC soon
overshot market demand.
In other words, the end of our 1982 inflationary crisis could not have been resolved by financial means, despite the credit sometimes given to Paul Volker. It took real oil to reduce inflation. Global oil production from OPEC soon overshot market demand, global oil prices collapsed in 1986, and our long-term global fossil fuel addiction problem seemed to disappear, with the price hitting a low about 1998. In truth, our universal economic dependence on cheap oil was hidden by its low price, and the problem of an economic limit to oil production was postponed, rather than the problems being resolved.
This time, the underlying energy deficiency is revealing itself primarily through stagnation, papered over with credit expansion to maintain the illusion of business as usual. And now in the end, deflation.
As James Kunstler recently noted in a podcast interview he did with Gail Tverberg, it appears that oil at less than $75 a barrel breaks oil companies. At the same time, oil at more than $75 breaks economies, leading to stagnation and deflation. Take your choice, keeping in mind that oil companies can probably be resuscitated more easily than deflation-ravaged economies.
Deflation by its nature implies a massive uncontrolled and disorderly wave of demand destruction. A world of reduced expectations, of stranded investments, rusting machines, cheap energy-dependent capital invested in the boom era, the high-water mark of a world aiming for maximum commodity production, ghost town suburbs without residents.
An ominous sign of things to come is seen in massively idle ocean freight capacity. Through a depression in the heavy construction equipment industry. Capital investment that played an essential role in making our current lifestyle possible and secure.
Wall Street, unlike Main Street, still holds a great accumulation of hibernating cash reserves.
However, there is still an important act to follow. Wall Street, unlike Main Street, still holds a great accumulation of hibernating cash reserves, a mountainous cyber-tangle of derivatives and legally-binding credit obligations. The cash doesn’t exist in any material form. If it were all in the form of real cash, there probably wouldn’t be enough room on Manhattan to store it all.
Something like $100 trillion of new interconnected global debt obligations have been added by the world’s central banks since the great recession of 2008-2009. This Wall Street stockpile of dollar reserves and legally binding obligations is mostly comprised of the accumulated wealth of the top .01% of income earners, but it represents theoretical debt obligations. These obligations are far too great to be repaid in real dollars with anything like their current buying power.
Our national wealth is comprised of computer bits, of all the super-secure digits in the computers of those with power. A priestly power that the banks and the Fed can deploy to influence the outside world. As things are now structured, a power that can field armies, a power that politicians instinctively fear, a vast global money power system maintained through a complex network of established legal and political procedures, through salaries, friendships, and official credentials.
As Chris Martenson writes, “The Deflation Monster has arrived and it sure looks angry”:
… At Peak Prosperity we favor the model that predicts ‘”first the deflation, then the inflation’” or the “Ka-Poom! Theory” as Erik Janszen at iTulip described it. While it may seem that we are many years away from runaway inflation (and some are doubting it will or ever could arrive again), here’s how that will probably unfold.
Faced with the prospect of watching the entire financial world burn to the figurative ground (if not literal in some locations), or doing something, the central banks will opt for doing something.
Given that their efforts have not yielded the desired or necessary results, what can they realistically do that they haven’t already?
The next thing is to give money to Main Street.
That is, give money to the people instead of the banks. Obviously puffing up bank balance sheets and income statements has only made the banks richer. Nobody else besides a very tiny and already wealthy minority has really benefited. Believe it or not, the central banks are already considering shifting the money spigot towards the public.
You might receive a credit to your bank account courtesy of the Fed. Or you might receive a tax rebate for last year. Maybe even a tax holiday for this year, with the central bank monetizing the resulting federal deficits.
Either way, money will be printed out of thin air and given to you. That’s what’s coming next. Possibly after a failed attempt at demanding negative interest rates from the banks. But coming it is.
This “helicopter money” spree will juice the system one last time, stoking the flames of inflation. And while the central banks assume they can control what happens next, I think they cannot.
Once people lose faith in their currency all bets are off. The smart people will be those who take their fresh central bank money and spend it before the next guy.
This probably describes the one last Krugman-esque move that the Fed has an ability to make, the last lever that it can pull to make important things happen in the real outside world. Finally, they see a surefire way to rekindle inflation and make debt disappear.
So it looks like the stage is set for a deflationary bust and then later, as part of the same process, hyperinflation, with approximately the results to be expected from Martenson’s description.
Read more articles by Roger Baker on The Rag Blog.
[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 Alliance and the Save Barton Creek Association in Austin. Mostly he enjoys being an irreverent policy wonk and writing irreverent wonkish articles for The Rag Blog. ]