The Bumpy Road Down, Part 2

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Published on The Easiest Person to Fool January 7, 2018

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In the last post in this series I started talking about the bumpy road down—the cyclic pattern of crash and partial recovery that I believe will characterize the rest of the age of scarcity and make for a slow step by step collapse, rather than a single hard and fast crash. Because I expect this to take place differently in various parts of the world and for people of various social classes, I guess it should really be "The Bumpy Roads Down".

At any rate, this led to looking at the next expected bump in the process—a financial crash of even greater magnitude than the global financial crisis in 2007-8. We looked at what's leading up to this (a huge debt bubble), how it might start (with one or more currency crashes) and what might trigger the process (a spike in the price of oil).

From where I sit this crash seems essentially inevitable. We are living beyond our means—the available surplus energy is simply not enough to support the continued growth that our economy requires. Some degree of "degrowth" is going to happen, whether we like it or not. The only uncertainly is exactly when it will occur, how far it will take us down and by what route. I'd be surprised if it started sooner than the fall of 2018. I don't really care to guess how much longer it might take to get started—years, easily.

Of course, as we learned in the Global Financial Crisis of 2007-08, these things tend to teach us new things about how they work as they are happening. While we learn more with each crisis, there are things about each one that we would never have guessed in advance. And I am certainly not claiming to be exempt from this.

Since I wrote that last post, I read David Korowicz's "Financial system supply-chain cross contagion – a study in global systemic collapse", and much of what I have to say in this post has been influenced by Korowicz's ideas.

His essay directly addresses how things may proceed once a crash gets started, and how difficult it will be to do something about it. He focuses on the degree of interconnection in our modern world and how a financial crash can spread to other parts of the economy. He also looks closely at how fragile our globalized economy is, with many supply chains based on "just in time delivery" and minimal inventories of important supplies.

Before going on with the rest of this post, I'd like to share some thoughts that came to me as I was reading Korowicz's essay. It seems to me that when talking about such subjects, one has to consider one's audience and what one is trying to achieve.

Korowicz clearly feels he is speaking to a doubtful audience and he is eager to convince them. As he says, "The consensus view, even if backed by experts is not, in and of itself, a justification for the consensus view." I sympathize with him in that—the majority of people today are functioning at a high level of complacency and denial. They will latch onto any morsel of hope and use it to convince themselves that everything is going to be fine and that no extraordinary action is required. If you give them that morsel, the rest of what you have to say may well be lost on them.

And so it is very tempting to spin (and Korowicz has spun) a rather one sided story, lacking the sorts of subtleties and nuances that are needed for a solid understanding of any subject and which I have tried to make an identifying characteristic of this blog. I am not going to change that goal, and so some of my readers will see what follows, in this and my next few posts, as unreasonably optimistic. If that is what is necessary to take a balanced approach to the subject, then so be it.

David Korowicz is an intelligent and well informed man and so even he makes some qualifying statements about the solidly gloomy picture he paints: "a collapse could have intermediate states, characterised by partial breakdown and semi-stable states." And near the end of his essay he suggests that we should classify countries as red, amber and green, according to the likelihood of their suffering severely in the crash he is talking about. And he admits that there are indeed some green countries, and interestingly (to me) includes the U.S. in that group. But the essay was written in 2012 and things have changed in the U.S. since then.

For those looking for nothing but hope and reassurance, I'm sorry, but I must make it clear that the bump I am talking about here is likely to be a big one and solidly jarring, especially to those who aren't expecting it. When I say that this shouldn't be considered a fast collapse, I mean that a significant number of people will still be able to get food, shelter, clothing—that "just enough" will still be attainable for most of us. I meet people quite regularly who clearly consider that any change in their lifestyle, however minor, amounts to "the end of the world", and who are simply unwilling to consider that such things may happen. I know they find most of what I have to say to be way too pessimistic. I think they are in for a rude awakening.

But enough of that, let's take a closer look at how the coming crash is likely to proceed. Tim Morgan predicts that it will start with a "currency crash?" What does he mean by this? Simply that at some point currency traders will lose faith in the value of some particular currency. They will all start selling out of it pretty much at once—what is known as a "run". This would cause the price of that currency to drop drastically compared to others, with negative effects on the economy of the effected country, perhaps leading it to default on its debts. But why this loss of trust? In the case of Britain, Morgan (a Brit himself) points to a lack of economic growth, high debt, Brexit and poor economic management by governments over the last couple of decades, including a laisser faire approach to regulating business and the financial industry.

It will probably only take one currency crash (or maybe not even that many, if the price of oil spikes high enough) to trigger a loss of faith in debt and start a wave of bankruptcies and government defaults. Banks and other financial institutions will be at the head of that wave. Modern banking is based on the idea of a fractional reserve—banks are allowed to create money out of thin air when they make a loan, rather than just loaning out money they already have. The loan itself then becomes an asset, a claim on the future productivity of the debtor, based on trust that the debtor will prosper and be able to pay back the money he has borrowed, with interest. Under this system banks' real assets amount to only 2 to 9% of their total assets. The rest is debt, or from the viewpoint of the bank, credit they have extended as loans. It is normal to have a very small percentage of debtors default on their loans, but according to Korowicz, defaults of around 4% are enough to leave a bank in big trouble, and it may end up going out of business, as the financial community loses faith in the debts it holds.

Since the amount of risky debt is much larger than ever before, it seems likely that many of those "too big to fail" banks will indeed be in trouble this time around. In 2008 governments took steps to prevent this, but governments whose currency has crashed and/or who have defaulted on their debts, won't be able to be of much help. Even governments which aren't in financial trouble themselves will face a bigger challenge than they did in 2008, since interest rates are already pretty much as low as they can go. And also because more banks (and other businesses) will need help, in the form of loans on very favourable terms, or outright bailouts. Still, because the effect of a crash like this touch on pretty much everyone, there will be immense pressure on governments to do whatever they can.

As I understand it, what governments have done and will no doubt do in the next crash is to print money to offset the bad debts of failing financial institutions and other businesses. This has been done indirectly, by borrowing money from the central bank of the country. Because it ends up on the government's balance sheet as debt, owed to the central bank, paying the interest is a big budgetary problem. Paying back the principle is a problem for future generations.

Conventional economic wisdom holds that printing too much money causes inflation—the price of goods goes up to match the excess money circulating in the market. This didn't happen to any significant extent in the years following 2008, perhaps because that excess money, rather than going into circulation, was poured into the black holes of the banks' balance sheets.

It seems likely to me that central banks will take a lot of blame for "letting" this next crash happen. There is actually no reason that governments have to borrow money for bailouts from independent central banks. Those banks could be eliminated and governments could take on their role themselves, creating money without incurring debt or interest charges. And as long as that money goes straight to paying off bad debts, the amount in circulation won't increase, and it shouldn't cause inflation.

If this disaster was limited to the financial industry alone it would be bad enough. It is important to realize that in our capitalist system if a business is not profitable, or if investors lose hope of it eventually becoming profitable, it's not going to be running for long, especially in the middle of an economic crash. Even if it is the sole provider of goods and services that folks like you and I consider to be necessities. One would hope that governments would step in to preferentially bail out companies that really do have a vital role to play.

The financial sector also provides many critical services to businesses and in a crash such as we're talking about, those services may not be readily available, thus hurting businesses that would otherwise still be viable.

Perhaps the most basic of those services is moving wealth from what we think of as "investments" (where the point is to earn a return) to ordinary money with which one can buy goods and services. We take this for granted in "normal" times and are largely unaware of what is going on in the background to make it happen so smoothly. During a crash and in its aftermath, this will no longer be the case and without that ready access, businesses and individuals will find it difficult to continue operating as usual.

To judge from what happened in 2008, those banks that are still in business will also get very conservative in their lending practices and much less trusting of the banks at the other end of transactions. The free flow of credit and funds that the commercial world counts on would grind to a halt, at least temporarily, and so the financial crash would spread to the commercial sector. From the viewpoint of ordinary people this is very bad news.

Mind you, in 2008 things were pretty serious. Many people lost their houses because they couldn't pay their variable rate mortgages when the payments went up—indeed that was what started that crash. In the recession that followed, many businesses downsized or went bankrupt and laid people off. Some of the unemployed fell through the cracks in the social/community/family safety nets and ended up homeless and destitute. A lot of wealth and savings disappeared into thin air. But despite all this, the supply of consumer goods continued unabated. If you could afford to shop, the shelves were far from bare.

I think this is likely not to be the case in the upcoming crash. There will be some noticeable effects in the day to day lives of ordinary people, beyond the obvious increasing unemployment, tighter credit and a decrease in the value of whatever savings you may have left.

The basic issue is that today, more than at any time in our history or prehistory, we rely on a complex, internationally networked economy to provide us with the necessities of life. Supply chains have been optimized, with minimal inventories and "just in time" delivery so that they are very efficient, but also very fragile. One little thing can go wrong, a long way down the chain, and within days (sometimes within hours), the whole supply chain begins grinding to a halt.

The global economy relies of a few critical systems, which enable supply chains to function.

The first of those systems is banking itself. The sort of day to day transactions that all of us take part in really are necessary to keep the world working. Most individuals and businesses rely on chequing accounts, over draughts, lines of credit, debit cards, credit cards and so forth, all of which will stop working if your bank fails. At the international level, banks issue letters of credit that facilitate the shipping of goods from one country to another.

Shipping is itself a critical system, and is dependent not just on banking but also, among other things, on energy, mostly in the form of petroleum products: bunker fuel for ships, diesel fuel for trucks and jet fuel for air freight. I suspect that shipping will suffer a good deal of disruption during this crash, not just at the international level, but also among the trucking companies who move goods around within countries, and on which we are very dependent.

Even if mining, forestry, fishing, agriculture, the electric grid, manufacturing and retail remain untouched in a crash (which is by no means certain), problems with just banking and shipping can make for very unreliable supplies of things that we have come to take completely for granted.

When it comes to necessities, water seems straightforward, right? It comes out of the tap. But most municipal water treatment facilities keep only a very few day's supply of treatment chemicals on hand. If deliveries of those chemicals stop, it won't be long—as very few days—before you can no longer rely on the safety of your water supply.

And there is always food on the supermarket shelves, right? But that's only because of daily deliveries that rely on many long and complex supply chains. If those deliveries stop, there is probably only about three days of food available in most communities, less than that of perishable items.

In the developed world, and even many areas in the developing world, access to medical care is taken for granted (the U.S. is an exception). But modern medicine relies on pharmaceuticals and other consumable supplies of which hospitals keep a very limited inventory, relying instead on regular deliveries.

I mention those three areas because they are necessities for everyone, and the supply chains that provide them to us are likely to be negatively affected during a financial crash. In fact, it will be hard to find any industry that isn't affected to some degree.

Now the conventional thing for a collapse writer to do at this point is to suggest that once this starts, it will be impossible to stop and everything will grind to a halt, bringing industrial civilization to an abrupt end and likely enough the human race with it. When you've been studying collapse for a while and coping with disbelief from most of those around you, it is natural, I suppose, to be eager for something to finally happen that will prove you right beyond all doubt.

But I am not that sort of kollapsnik. I'm pretty sure that collapse has been going on for decades not and that it will take a few decades more before it is complete. And along the way, what is happening will be far from obvious to the many people.

To understand why I hold this opinion, we need to do a couple of things:

1) take a systems dynamic approach to the events we are talking about. First off, the model of a fast collapse with a catastrophic impact at the "bottom" is fundamentally flawed. It may portray fairly accurately what happens when you jump (or are pushed) off a cliff, but that is not exactly the situation our civilization faces. We need to look at what happens when overshoot occurs in nature, in systems more like the one we inhabit. Which is, after all, a subset of the ecosphere. Overshoot is a common enough phenomenon and usually works in fairly predictable ways.

2) look at the sort of things governments, communities and individuals can do to limit the damage when a financial crash spreads to other critical systems.

I set out recently to draw some graphs illustrating overshoot and pretty quickly gained some new insights into this process—insights that I think are worth sharing.

So I'll wrap this post up now and carry on with points 1 and 2 above next time.

2 Responses to The Bumpy Road Down, Part 2

  • mo flora says:

    This is a thoughtful and persuasive piece.  If economic crises are all we face in the coming years I would expect the author to be largely correct in his projections. 

    However, the list of additional factors that will/may accelerate collapse is long.  Add a new war or two, some climate related crop failures, increasing frequency of severe natural disasters, massive political upheaval and we will see an acceleration of collapse.

    I agree that collapse will not be shared equally – at least not at first.

    I'm looking forward to the next installments

  • Irvine Mills says:

    Thanks, mo flora, for your kind words.
    I am aware of and indeed expecting that list of additional factors. No doubt we are, in the end, going "all the way down", and those factors will contribute to some of the steps we take downwards. The eventual failure of industrial agriculture is a major concern.
    Of course, exactly how far down "all the way" is, remains to be seen. I addressed this in an earlier post:
    http://theeasiestpersontofool.blogspot.ca/2017/06/collapse-step-by-step-part-2-end-points.html

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