Wages

Why we have a wage inequality problem

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Published on the Our Finite World on March 29, 2016

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Wage inequality is a topic in elections around the world. What can be done to provide more income for those without jobs, and those with low wages?

Wage inequality is really a sign of a deeper problem; basically it reflects an economic system that is not growing rapidly enough to satisfy everyone. In a finite world, it is easy for an economy to grow rapidly at first. In the early days, there are enough resources, such as land, fresh water, and metals, for each person to get a reasonable-sized amount. Each would-be farmer can obtain as much land as he thinks he can work with; fresh water is readily available virtually for free; and goods made with metals, such as cars, are not expensive. There are many jobs available, and wages for most people are fairly similar.

As population grows, and as resources degrade, the situation changes. It is still possible to grow enough food, but it takes large farms, with expensive equipment (but very few actual workers) to produce that food. It is possible to produce enough water, but it takes high-tech equipment and a handful of workers who know how to use the high-tech equipment. Metals suddenly need to be lighter and stronger and have other characteristics for the high tech industry, thus requiring more advanced products. International trade becomes more important to be able to get the correct mix of materials for the advanced products needed to operate the high-tech economy.

With these changes, the economic system that previously provided many jobs for those with limited training (often providing on-the-job training, if necessary) gradually became a system that provides a relatively small number of high-paying jobs, together with many low-paying jobs. In the United States, the change started happening in 1981, and has gotten worse recently.

Figure 1. Chart comparing income gains by the top 10% to income gains by the bottom 90% by economist Emmanuel Saez. Based on an analysis IRS data, published in Forbes.

 

Figure 1. Chart comparing income gains by the top 10% to those of the bottom 90%, by economist Emmanuel Saez. Based on an analysis of IRS data; published in Forbes.

 

What Happens When an Economy Doesn’t Grow Rapidly Enough?

If an economy is growing rapidly enough, it is easy for everyone to get close to an adequate amount. The way I think of the problem is that as economic growth slows, the “overhead” grows disproportionately, taking an ever-larger share of the goods and services the economy produces. The ordinary worker (non-supervisory worker, without advanced degrees) tends to get left out. Figure 2 is my representation of the problem, if the current pattern continues into the future.

Figure 2. Authors' depiction of changes to workers share of output of economy, as costs keep rising for other portions of the economy keep rising.

 

Figure 2. Author’s depiction of changes to workers’ share of output of economy, if costs keep rising for other portions of the economy. (Chart is only intended to illustrate the problem; it is not based on a study of the relative amounts involved.)

 

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Our economic growth system is reaching limits in a strange way

Economic growth never seems to be as high as those making forecasts would like it to be. This is a record of recent forecasts by the International Monetary Fund:

Figure 1. World GDP Forecasts by the International Monetary Fund.

 

Figure 1. World GDP Forecasts by the International Monetary Fund.

 

Figure 2 shows world economic growth on  a different basis–a basis that appears to me to be very close to total world GDP, as measured in US dollars, without adjustment for inflation. On this  basis, world GDP (or Gross Planetary Product as the author calls it) does very poorly in 2015, nearly as bad as in 2009.

Figure 2. Gross Planet Product at current prices (trillions of dollars) by Peter A. G. van Bergeijk in Voxeu.

 

Figure 2. Gross Planet Product at current prices (trillions of dollars) by Peter A. G. van Bergeijk in Voxeu, based on IMF World Economic Outlook Database, October 2015.

 

The poor 2015 performance in Figure 2 reflects a combination of falling inflation rates, as a result of falling commodity prices, and a rising relativity of the US dollar to other currencies.

Clearly something is wrong, but virtually no one has figured out the problem.

The World Energy System Is Reaching Limits in a Strange Double Way

We are experiencing a world economy that seems to be reaching limits, but the symptoms are not what peak oil groups warned about. Instead of high prices and lack of supply, we are facing indirect problems brought on by our high consumption of energy products. In my view, we have a double pump problem.

Figure 3. Double gasoline pump from Torrence Collection of Auto Memorabilia.

 

Figure 3. Double gasoline pump from Torrence Collection of Auto Memorabilia.

 

We don’t just extract fossil fuels. Instead, whether we intend to or not, we get a lot of other things as well: rising debt, rising pollution, and a more complex economy.

The system acts as if whenever one pump dispenses the energy products we want, another pump disperses other products we don’t want. Let’s look at three of the big unwanted “co-products.” Continue reading

 

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Why Globalization Reaches Limits

We have been living in a world of rapid globalization, but this is not a condition that we can expect to continue indefinitely.

Figure 1. Ratio of Imported Goods and Services to GDP. Based in FRED data for IMPGS.

 

Figure 1. Ratio of Imported Goods and Services to GDP. Based in FRED data for IMPGS.

 

Each time imported goods and services start to surge as a percentage of GDP, these imports seem to be cut back, generally in a recession. The rising cost of the imports seems to have an adverse impact on the economy. (The imports I am showing are gross imports, rather than imports net of exports. I am using gross imports, because US exports tend to be of a different nature than US imports. US imports include many labor-intensive products, while exports tend to be goods such as agricultural goods and movie films that do not require much US labor.)

Recently, US imports seem to be down. Part of this reflects the impact of surging US oil production, and because of this, a declining need for oil imports. Figure 2 shows the impact of removing oil imports from the amounts shown on Figure 1.

Figure 2. Total US Imports of Goods and Services, and this total excluding crude oil imports, both as a ratio to GDP. Crude oil imports from https://www.census.gov/foreign-trade/statistics/historical/petr.pdf

 

Figure 2. Total US Imports of Goods and Services, and this total excluding crude oil imports, both as a ratio to GDP. Crude oil imports from https://www.census.gov/foreign-trade/statistics/historical/petr.pdf

 

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The Physics of Energy and the Economy

I approach the subject of the physics of energy and the economy with some trepidation. An economy seems to be a dissipative system, but what does this really mean? There are not many people who understand dissipative systems, and very few who understand how an economy operates. The combination leads to an awfully lot of false beliefs about the energy needs of an economy.

The primary issue at hand is that, as a dissipative system, every economy has its own energy needs, just as every forest has its own energy needs (in terms of sunlight) and every plant and animal has its own energy needs, in one form or another. A hurricane is another dissipative system. It needs the energy it gets from warm ocean water. If it moves across land, it will soon weaken and die.

There is a fairly narrow range of acceptable energy levels–an animal without enough food weakens and is more likely to be eaten by a predator or to succumb to a disease. A plant without enough sunlight is likely to weaken and die.

In fact, the effects of not having enough energy flows may spread more widely than the individual plant or animal that weakens and dies. If the reason a plant dies is because the plant is part of a forest that over time has grown so dense that the plants in the understory cannot get enough light, then there may be a bigger problem. The dying plant material may accumulate to the point of encouraging forest fires. Such a forest fire may burn a fairly wide area of the forest. Thus, the indirect result may be to put to an end a portion of the forest ecosystem itself.

How should we expect an economy to behave over time? The pattern of energy dissipated over the life cycle of a dissipative system will vary, depending on the particular system. In the examples I gave, the pattern seems to somewhat follow what Ugo Bardi calls a Seneca Cliff.

Figure 1. Seneca Cliff by Ugo Bardi

 

Figure 1. Seneca Cliff by Ugo Bardi

 

The Seneca Cliff pattern is so-named because long ago, Lucius Seneca wrote:

It would be some consolation for the feebleness of our selves and our works if all things should perish as slowly as they come into being; but as it is, increases are of sluggish growth, but the way to ruin is rapid.

The Standard Wrong Belief about the Physics of Energy and the Economy

There is a standard wrong belief about the physics of energy and the economy; it is the belief we can somehow train the economy to get along without much energy. Continue reading

 

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Why oil under $30 per barrel is a major problem

A person often reads that low oil prices–for example, $30 per barrel oil prices–will stimulate the economy, and the economy will soon bounce back. What is wrong with this story? A lot of things, as I see it:

1. Oil producers can’t really produce oil for $30 per barrel.

A few countries can get oil out of the ground for $30 per barrel. Figure 1 gives an approximation to technical extraction costs for various countries. Even on this basis, there aren’t many countries extracting oil for under $30 per barrel–only Saudi Arabia, Iran, and Iraq. We wouldn’t have much crude oil if only these countries produced oil.

Figure 1. Global Breakeven prices (considering only technical extraction costs) versus production. Source:Alliance Bernstein, October 2014

 

Figure 1. Global breakeven prices (considering only technical extraction costs) versus production. Source: Alliance Bernstein, October 2014

 

2. Oil producers really need prices that are higher than the technical extraction costs shown in Figure 1, making the situation even worse.

Oil can only be extracted within a broader system. Companies need to pay taxes. These can be very high. Including these costs has historically brought total costs for many OPEC countries to over $100 per barrel.

Independent oil companies in non-OPEC countries also have costs other than technical extraction costs, including taxes and dividends to stockholders. Also, if companies are to avoid borrowing a huge amount of money, they need to have higher prices than simply the technical extraction costs. If they need to borrow, interest costs need to be considered as well.

3. When oil prices drop very low, producers generally don’t stop producing.

 

 

 

 

 

 

 

 

 

Why Globalization Reaches Limits

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Published on the Our Finite World on March 1, 2016

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We have been living in a world of rapid globalization, but this is not a condition that we can expect to continue indefinitely.

Figure 1. Ratio of Imported Goods and Services to GDP. Based in FRED data for IMPGS.

 

 

 

Figure 1. Ratio of Imported Goods and Services to GDP. Based in FRED data for IMPGS.

 

 

 

Each time imported goods and services start to surge as a percentage of GDP, these imports seem to be cut back, generally in a recession. The rising cost of the imports seems to have an adverse impact on the economy. (The imports I am showing are gross imports, rather than imports net of exports. I am using gross imports, because US exports tend to be of a different nature than US imports. US imports include many labor-intensive products, while exports tend to be goods such as agricultural goods and movie films that do not require much US labor.)

Recently, US imports seem to be down. Part of this reflects the impact of surging US oil production, and because of this, a declining need for oil imports. Figure 2 shows the impact of removing oil imports from the amounts shown on Figure 1.

Figure 2. Total US Imports of Goods and Services, and this total excluding crude oil imports, both as a ratio to GDP. Crude oil imports from https://www.census.gov/foreign-trade/statistics/historical/petr.pdf

 

 

 

Figure 2. Total US Imports of Goods and Services, and this total excluding crude oil imports, both as a ratio to GDP. Crude oil imports from https://www.census.gov/foreign-trade/statistics/historical/petr.pdf

 

 

 

If we look at the years from 2008 to the present, there was clearly a big dip in imports at the time of the Great Recession. Apart from that dip, US imports have barely kept up with GDP growth since 2008.

Let’s think about the situation from the point of view of developing nations, wanting to increase the amount of goods they sell to the US. As long as US imports were growing rapidly, then the demand for the goods and services these developing nations were trying to sell would be growing rapidly. But once US imports flattened out as a percentage of GDP, then it became much harder for developing nations to “grow” their exports to the US.

I have not done an extensive analysis outside the US, but based on the recent slow economic growth patterns for Japan and Europe, I would expect that import growth for these areas to be slowing as well. In fact, data from the World Trade Organization for Japan, France, Italy, Sweden, Spain, and the United Kingdom seem to show a recent slowdown in imported goods for these countries as well.

If this lack of demand growth by a number of industrialized countries continues, it will tend to seriously slow export growth for developing countries.

Where Does Demand For Imports Come From?

Many of the goods and services we import have an adverse impact on US wages. For example, if we import clothing, toys, and furniture, these imports directly remove US jobs making similar goods here. Similarly, programming jobs and call center jobs outsourced to lower cost nations reduce the number of jobs available in the US. When US oil prices rose in the 1970s, we started importing compact cars from Japan. Substituting Japanese-made cars for American-made cars also led to a loss of US jobs.

Even if a job isn’t directly lost, the competition with low wage nations tends to hold down wages. Over time, US wages have tended to fall as a percentage of GDP.

Figure 3. Ratio of US Wages and Salaries to GDP, based on information of the US Bureau of Economic Analysis.

 

 

 

Figure 3. Ratio of US Wages and Salaries to GDP, based on information of the US Bureau of Economic Analysis.

 

 

 

Another phenomenon that has tended to occur is greater disparity of wages. Partly this disparity represents wage pressure on individuals doing jobs that could easily be outsourced to a lower-wage country. Also, executive salaries tend to rise, as companies become more international in scope. As a result, earnings for the top 10% have tended to increase since 1981, while wages for the bottom 90% have stagnated.

Figure 4. Chart by economist Emmanuel Saez based on an analysis IRS data, published in Forbes.

 

 

 

Figure 4. Chart by economist Emmanuel Saez based on an analysis IRS data, published in Forbes. “Real income” is inflation-adjusted income.

 

 

 

If wages of most workers are lagging behind, how is it possible to afford increased imports? I would argue that what has happened in practice is greater and greater use of debt. If wages of American workers had been rising rapidly, perhaps these higher wages could have enabled workers to afford the increased quantity of imported goods. With wages lagging behind, growing debt has been used as a way of affording imported goods and services.

Inasmuch as the US dollar was the world’s reserve currency, this increase in debt did not have a seriously adverse impact on the economy. In fact, back when oil prices were higher than they are today, petrodollar recycling helped maintain demand for US Treasuries as the US borrowed increasing amounts of money to purchase oil and other goods. This process helped keep borrowing costs low for the US.

Figure 5. US Increase in Debt as Ratio to GDP and US imports as Ratio to GDP. Both from FRED data: TSMDO and IMPGS.

 

 

 

Figure 5. US Increase in Debt as Ratio to GDP and US imports as Ratio to GDP. Both from FRED data: TSMDO and IMPGS.

 

 

 

The problem, however, is that at some point it becomes impossible to raise the debt level further. The ratio of debt to GDP becomes unmanageable. Consumers, because their wages have been held down by competition with wages around the world, cannot afford to keep adding more debt. Businesses find that slow wage growth in the US holds down demand. Because of this slow growth in the demand, businesses don’t need much additional debt to expand their businesses either.

Commodity Prices Are Extremely Sensitive to Lack of Demand

Commodities, by their nature, are things we use a lot of. It is usually difficult to store very much of these commodities. As a result, it is easy for supply and demand to get out of balance. Because of this, prices swing widely.

Demand is really a measure of affordability. If wages are lagging behind, then an increase in debt (for example, to buy a new house or a new car) can substitute for a lack of savings from wages. Unfortunately, such increases in debt have not been happening recently. We saw in Figure 5, above, that recent growth in US debt is lagging behind. If very many countries find themselves with wages rising slowly, and debt is not rising much either, then it is easy for commodity demand to fall behind supply. In such a case, prices of commodities will tend to fall behind the cost of production–exactly the problem the world has been experiencing recently. The problem started as early as 2012, but has been especially bad in the past year.

The way the governments of several countries have tried to fix stagnating economic growth is through a program called Quantitative Easing (QE). This program produces very low interest rates. Unfortunately, QE doesn’t really work as intended for commodities. QE tends to increase the supply of commodities, but it does not increase the demand for commodities.

The reason QE increases the supply of commodities is because yield-starved investors are willing to pour large amounts of capital into projects, in the hope that commodity prices will rise high enough that investments will be profitable–in other words, that investments in shares of stock will be profitable and also that debt can be repaid with interest. A major example of this push for production after QE started in 2008 is the rapid growth in US “liquids” production, thanks in large part to extraction from shale formations.

Figure 6. US oil and other liquids production, based on EIA data. Available data is through November, but amount shown is estimate of full year.

 

 

 

Figure 6. US oil and other liquids production, based on EIA data. Available data is through November, but amount shown is estimate of full year.

 

 

 

As we saw in Figure 5, the ultra-low interest rates have not been successful in encouraging new debt in general. These low rates also haven’t been successful in increasing US capital expenditures (Figure 7). In fact, even with all of the recent shale investment, capital investment remains low relative to what we would expect based on past investment patterns.

Figure 7. US Fixed Investment (Factories, Equipment, Schools, Roads) Excluding Consumer Durables as Ratio to GDP, based in US Bureau of Economic Analysis data.

 

 

 

Figure 7. US Fixed Investment (Factories, Equipment, Schools, Roads) Excluding Consumer Durables as Ratio to GDP, based in US Bureau of Economic Analysis data.

 

 

 

Instead, the low wages that result from globalization, without huge increases in debt, make it difficult to keep commodity prices up high enough. Workers, with low wages, delay starting their own households, so have no need for a separate apartment or house. They may also be able to share a vehicle with other family members. Because of the mismatch between supply and demand, commodity prices of many kinds have been falling. Oil prices, shown on Figure 9, have been down, but prices for coal, natural gas, and LNG are also down. Oil supply is up a little on a world basis, but not by an amount that would have been difficult to absorb in the 1960s and 1970s, when prices were much lower.

Figure 9. World oil production and price. Production is based on BP, plus author's estimate for 2016. Historical oil prices are calculated based on a higher than usual recent inflation rate, assuming Shadowstats' view of inflation is correct.

 

 

 

Figure 9. World oil production and price. Production is based on BP, plus author’s estimate for 2016. Historical oil prices are calculated based on a higher than usual recent inflation rate, assuming Shadowstats’ view of inflation is correct.

 

 

 

Developing Countries are Often Commodity Exporters 

Developing countries can be greatly affected if commodity prices are low, because they are often commodity exporters. One problem is obviously the cutback in wages, if it becomes necessary to reduce commodity production.  A second problem relates to the tax revenue that these exports generate. Without this revenue, it is often necessary to cut back funding for programs such as building roads and schools. This leads to even more job loss elsewhere in the economy. The combination of wage loss and tax loss may make it difficult to repay loans.

Obviously, if low commodity prices persist, this is another limit to globalization.

Conclusion

We have identified two different limits to globalization. One of them has to do with limits on the amount of goods and services that developed countries can absorb before those imports unduly disrupt local economies, either through job loss, or through more need for debt than the developed economies can handle. The other occurs because of the sensitivity of many developing nations have to low commodity prices, because they are exporters of these commodities.

Of course, there are other issues as well. China has discovered that if its coal is burned in great quantity, it is very polluting and a problem for this reason. China has begun to reduce its coal consumption, partly because of pollution issues.

Figure 10. China's energy consumption by fuel, based on data of BP Statistical Review of World Energy 2015.

 

 

 

Figure 10. China’s energy consumption by fuel, based on data of BP Statistical Review of World Energy 2015.

 

 

 

There are many other limiting factors. Fresh water is a major problem, throughout much of the developing world. Adding more people and more industry makes the situation worse.

One problem with globalization is a long-term tendency to move manufacturing production to countries with ever-lower standards in many ways: ever-lower pollution controls, ever-lower safety standards for workers, and ever-lower wages and benefits for workers. This means that the world becomes an ever-worse place to work and live, and the workers in the system become less and less able to afford the output of the system. The lack of buyers for the output of the system makes it increasingly difficult to keep prices of commodities high enough to support their continued production.

The logical end point, even beyond globalization, is for automation and robots to perform nearly all production. Of course, if that happens, there will be no one to buy the output of the system. Won’t that be a problem?

Adequate wages are critical to making any system work. As the system has tended increasingly toward globalization, politicians have tended to focus more and more on the needs of businesses and governments, and less on the needs of workers. At some point, the lack of buyers for the output of the system will tend to bring the whole system down.

Thus, at some point, the trend toward globalization and automation must stop. We need buyers for the output from the system, and this is precisely the opposite of the direction in which the system is trending. If a way is not found to fix the system, it will ultimately collapse. At a minimum, the trend toward increasing imports will end–if it hasn’t already.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Low Oil Prices – Why Worry?

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Published on Our Finite World on September 29, 2015

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Most people believe that low oil prices are good for the United States, since the discretionary income of consumers will rise. There is the added benefit that Peak Oil must be far off in the distance, since “Peak Oilers” talked about high oil prices. Thus, low oil prices are viewed as an all around benefit.

In fact, nothing could be further from the truth. The Peak Oil story we have been told is wrong. The collapse in oil production comes from oil prices that are too low, not too high. If oil prices or prices of other commodities are too low, production will slow and eventually stop. Growth in the world economy will slow, lowering inflation rates as well as economic growth rates. We encountered this kind of the problem in the 1930s. We seem to be headed in the same direction today. Figure 1, used by Janet Yellen in her September 24 speech, shows a slowing inflation rate for Personal Consumption Expenditures (PCE), thanks to lower energy prices, lower relative import prices, and general “slack” in the economy.

Figure 1. Why has PCE Inflation fallen below 2%? from Janet Yellen speech, September 24, 2015.

 

 

 

Figure 1. “Why has PCE Inflation fallen below 2%?” from Janet Yellen speech, September 24, 2015.

What Janet Yellen is seeing in Figure 1, even though she does not recognize it, is evidence of a slowing world economy. The economy can no longer support energy prices as high as they have been, and they have gradually retreated. Currency relativities have also readjusted, leading to lower prices of imported goods for the United States. Both lower energy prices and lower prices of imported goods contribute to lower inflation rates.

Instead of reaching “Peak Oil” through the limit of high oil prices, we are reaching the opposite limit, sometimes called “Limits to Growth.” Limits to Growth describes the situation when an economy stops growing because the economy cannot handle high energy prices. In many ways, Limits to Growth with low oil prices is worse than Peak Oil with high oil prices. Slowing economic growth leads to commodity prices that can never rebound by very much, or for very long. Thus, this economic malaise leads to a fairly fast cutback in commodity production. It can also lead to massive debt defaults.

Let’s look at some of the pieces of our current predicament.

Part 1. Getting oil prices to rise again to a high level, and stay there, is likely to be difficult. High oil prices tend to lead to economic contraction.  

Figure 2 shows an illustration I made over five years ago:

Figure 1. Chart I made in Feb. 2010, for an article I wrote called, Peak Oil: Looking for the Wrong Symptoms.

 

 

 

Figure 2. Chart made by author in Feb. 2010, for an article called Peak Oil: Looking for the Wrong Symptoms.

Clearly Figure 2 exaggerates some aspects of an oil price change, but it makes an important point. If oil prices rise–even if it is after prices have fallen from a higher level–there is likely to be an adverse impact on our pocketbooks. Our wages (represented by the size of the circles) don’t increase. Fixed expenses, including mortgages and other debt payments, don’t change either. The expenses that do increase in price are oil products, such as gasoline and diesel, and food, since oil is used to create and transport food. When the cost of food and gasoline rises, discretionary spending (in other words, “everything else”) shrinks.

When discretionary spending gets squeezed, layoffs are likely. Waitresses at restaurants may get laid off; workers in the home building and auto manufacturing industries may find their jobs eliminated. Some workers who get laid off from their jobs may default on their loans causing problems for banks as well. We start the cycle of recession and falling oil prices that we should be familiar with, after the crash in oil prices in 2008.

So instead of getting oil prices to rise permanently, at most we get a zigzag effect. Oil prices rise for a while, become hard to maintain, and then fall back again, as recessionary influences tend to reduce the demand for oil and bring the price of oil back down again.

Part 2. The world economy has been held together by increasing debt at ever-lower interest rates for many years. We are reaching limits on this process.

Back in the second half of 2008, oil prices dropped sharply. A number of steps were taken to get the world economy working better again. The US began Quantitative Easing (QE) in late 2008. This helped reduce longer-term interest rates, allowing consumers to better afford homes and cars. Since building cars and homes requires oil (and cars require oil to operate as well), their greater sales could stimulate the economy, and thus help raise demand for oil and other commodities.

Figure 2. World Oil Supply (production including biofuels, natural gas liquids) and Brent monthly average spot prices, based on EIA data.

 

 

 

Figure 3. World Oil Supply (production including biofuels, natural gas liquids) and Brent monthly average spot prices, based on EIA data.

Following the 2008 crash, there were other stimulus efforts as well. China, in particular, ramped up its debt after 2008, as did many governments around the world. This additional governmental debt led to increased spending on roads and homes. This spending thus added to the demand for oil and helped bring the price of oil back up.

These stimulus effects gradually brought prices up to the $120 per barrel level in 2011. After this, stimulus efforts gradually tapered. Oil prices gradually slid down between 2011 and 2014, as the push for ever-higher debt levels faded. When the US discontinued its QE and China started scaling back on the amount of debt it added in 2014, oil prices began a severe drop, not too different from the way they dropped in 2008.

I reported earlier that the July 2008 crash corresponded with a reduction in debt levels. Both US credit card debt (Fig. 4) and mortgage debt (Fig. 5) decreased at precisely the time of the 2008 price crash.

Figure 3. US Revolving Debt Outstanding (mostly credit card debt) based on monthly data of the Federal Reserve.

 

 

 

Figure 4. US Revolving Debt Outstanding (mostly credit card debt) based on monthly data from the Federal Reserve.

Figure 6. US Mortgage Debt Outstanding, based on Federal Reserve Z1 Report.

 

 

 

Figure 5. US Mortgage Debt Outstanding, based on the Federal Reserve Z1 Report.

At this point, interest rates are at record low levels; they are even negative in some parts of Europe. Interest rates have been falling since 1981.

Figure 6. Chart prepared by St. Louis Fed using data through July 20, 2015.

 

 

 

Figure 6. Chart prepared by the St. Louis Fed using data through July 20, 2015.

I showed in a recent post (How our energy problem leads to a debt collapse problem) that when the cost of oil production is over $20 per barrel, we need ever-higher debt ratios to GDP to produce economic growth. This need for ever-rising debt contributes to our inability to keep commodity prices high enough to satisfy the needs of commodity producers.

Part 3. We are reaching a demographic bottleneck with the “baby boomers” retiring. This demographic bottleneck causes an adverse impact on the demand for commodities.

Demand represents the amount of goods customers can afford. The amount consumers can afford doesn’t necessarily rise endlessly. One of the problems leading to falling demand is falling inflation-adjusted median wages. I have written about this issue previously in How Economic Growth Fails.

Figure 7. Median Inflation-Adjusted Family Income, in chart prepared by Federal Reserve of St. Louis.

 

 

 

Figure 7. Median Inflation-Adjusted Family Income, in chart prepared by the Federal Reserve of St. Louis.

Another part of the problem of falling demand is a falling number of working-age individuals–something I approximate by using estimates of the population aged 20 to 64. Figure 8 shows how the population of these working-age individuals has been changing for the United States, Europe, and Japan.

Figure 8. Annual percentage growth in population aged 20 - 64, based on UN 2015 population estimates.

 

 

 

Figure 8. Annual percentage growth in population aged 20 – 64, based on UN 2015 population estimates.

Figure 8 indicates that Japan’s working age population started shrinking in 1998 and now is shrinking by more than 1.0% per year. Europe’s working age population started shrinking in 2012. The United States’ working age population hasn’t started shrinking, but its rate of growth started slowing in 1999. This slowdown in growth rate is likely part of the reason that labor force participation rates have been falling in the United States since about 1999.

Figure 9. US Labor force participation rate. Chart prepared by Federal Reserve of St. Louis.

 

 

 

Figure 9. US Labor force participation rate. Chart prepared by the Federal Reserve of St. Louis.

When there are fewer workers, the economy has a tendency to shrink. Tax levels to pay for retirees are likely to start increasing. As the ratio of retirees rises, those still working find it increasingly difficult to afford new homes and cars. In fact, if the population of workers aged 20 to 64 is shrinking, there is little need to add new homes for this group; all that is needed is repairs for existing homes. Many retirees aged 65 and over would like their own homes, but providing separate living quarters for this population becomes increasingly unaffordable, as the elderly population becomes greater and greater, relative to the working age population.

Figure 10 shows that the population aged 65 and over already equals 47% of Japan’s working age population. (This fact no doubt explains some of Japan’s recent financial difficulties.) The ratios of the elderly to the working age population are lower for Europe and the United States, but are trending higher. This may be a reason why Germany has been open to adding new immigrants to its population.

Figure 9. Ratio of elderly (age 65+) to working age population (ages 20 to 64) based on UN 2015 population estimates.

 

 

 

Figure 10. Ratio of elderly (age 65+) to working age population (aged 20 to 64) based on UN 2015 population estimates.

For the Most Developed Regions in total (which includes US, Europe, and Japan), the UN projects that those aged 65 and over will equal 50% of those aged 20 to 64 by 2050. China is expected to have a similar percentage of elderly, relative to working age (51%), by 2050. With such a large elderly population, every two people aged 20 to 64 (not all of whom may be working) need to be supporting one person over 65, in addition to the children whom they are supporting.

Demand for commodities comes from workers having income to purchase goods that are made using commodities–things like roads, new houses, new schools, and new factories. Economies that are trying to care for an increasingly large percentage of elderly citizens don’t need a lot of new houses, roads and factories. This lower demand is part of what tends to hold commodity prices down, including oil prices.

Part 4. World oil demand, and in fact, energy demand in general, is now slowing.

If we calculate energy demand based on changes in world consumption, we see a definite pattern of slowing growth (Fig.11). I commented on this slowing growth in my recent post, BP Data Suggests We Are Reaching Peak Energy Demand.

Figure 11. Annual percent change in world oil and energy consumption, based on BP Statistical Review of World Energy 2015 data.

 

 

 

Figure 11. Annual percent change in world oil and energy consumption, based on BP Statistical Review of World Energy 2015 data.

The pattern we are seeing is the one to be expected if the world is entering another recession. Economists may miss this point if they are focused primarily on the GDP indications of the United States.

World economic growth rates are not easily measured. China’s economic growth seems to be slowing now, but this change does not seem to be fully reflected in its recently reported GDP. Rapidly changing financial exchange rates also make the true world economic growth rate harder to discern. Countries whose currencies have dropped relative to the dollar are now less able to buy our goods and services, and are less able to repay dollar denominated debts.

Part 5. The low price problem is now affecting many commodities besides oil. The widespread nature of the problem suggests that the issue is a demand (affordability) problem–something that is hard to fix.

Many people focus only on oil, believing that it is in some way different from other commodities. Unfortunately, nearly all commodities are showing falling prices:

Figure 12. Monthly commodity price index from Commodity Markets Outlook, July 2015. Used under Creative Commons license.

 

 

 

Figure 12. Monthly commodity price index from Commodity Markets Outlook, July 2015. Used under Creative Commons license.

Energy prices stayed high longer than other prices, perhaps because they were in some sense more essential. But now, they have fallen as much as other prices. The fact that commodities tend to move together tends to hold over the longer term, suggesting that demand (driven by growth in debt, working age population, and other factors) underlies many commodity price trends simultaneously.

Figure 13. Inflation adjusted prices adjusted to 1999 price = 100, based on World Bank

 

 

 

Figure 13. Inflation adjusted prices adjusted to 1999 price = 100, based on World Bank “Pink Sheet” data.

The pattern of many commodities moving together is what we would expect if there were a demand problem leading to low prices. This demand problem would likely reflect several issues:

  • The world economy cannot tolerate high priced energy because of the problem shown in Figure 2. We have increasingly used cheaper debt and larger quantities of debt to cover this basic problem, but are running out of fixes.
  • The cost of producing energy products keeps trending upward, because we extracted the cheap-to-produce oil (and coal and natural gas) first. We have no alternative but to use more expensive-to-produce energy products.
  • Many costs other than energy costs have been trending upward in inflation-adjusted terms, as well. These include fresh water costs, the cost of metal extraction, the cost of mitigating pollution, and the cost of advanced education. All of these tend to squeeze discretionary income in a pattern similar to the problem indicated in Figure 2. Thus, they tend to add to recessionary influences.
  • We are now reaching a working population bottleneck as well, as described in Part 4.

Part 6. Oil prices seem to need to be under $60 barrel, and perhaps under $40 barrel, to encourage demand growth in US, Europe, and Japan. 

If we look at the historical impact of oil prices on consumption for the US, Europe, and Japan combined, we find that whenever oil prices are above $60 per barrel in inflation-adjusted prices, consumption tends to fall. Consumption tends to be flat in the $40 to $60 per barrel range. It is only when prices are in the under $40 per barrel range that consumption has generally risen.

Figure 8. Historical consumption vs price for the United States, Japan, and Europe. Based on a combination of EIA and BP data.

 

 

 

Figure 14. Historical consumption vs. price for the United States, Japan, and Europe. Based on a combination of EIA and BP data.

There is virtually no oil that can be produced in the under $40 barrel range–or even in the under $60 barrel a range, if tax needs of governments are included. Thus, we end up with non-overlapping ranges:

  1. The amount that consumers in advanced economies can afford.
  2. The amount the producers, with their current high-cost structure, actually need.

One issue, with lower oil prices, is, “What kinds of uses do the lower oil prices encourage?” Clearly, no one will build a new factory using oil, unless the price of oil is expected to be sufficiently low over the long-term for this use. Thus, adding industry will likely be difficult, even if the price of oil drops for a few years. We also note that the United States seems to have started losing its industrial production in the 1970s (Fig. 15), as its own oil production fell. Apart from the temporarily greater use of oil in shale drilling, the trend toward off-shoring industrial production will likely continue, regardless of the price of oil.

Figure 15. US per capita energy consumption by sector, based on EIA data.

 

 

 

Figure 15. US per capita energy consumption by sector, based on EIA data. Includes all types of energy, including the amount of fossil fuels that would need to be burned to produce electricity.

If we cannot expect low oil prices to favorably affect the industrial sector, the primary impact of lower oil prices will likely be on the transportation sector. (Little oil is used in the residential and commercial sectors.) Goods shipped by truck will be cheaper to ship. This will make imported goods, which are already cheap (thanks to the rising dollar), cheaper yet. Airlines may be able to add more flights, and this may add some jobs. But more than anything else, lower oil prices will encourage people to drive more miles in personal automobiles and will encourage the use of larger, less fuel-efficient vehicles. These uses are much less beneficial to the economy than adding high-paid industrial jobs.

Part 7. Saudi Arabia is not in a position to help the world with its low price oil problem, even if it wanted to. 

Many of the common beliefs about Saudi Arabia’s oil capacity are of doubtful validity. Saudi Arabia claims to have huge oil reserves, but as a practical matter, its growth in oil production has been modest. Its oil exports are actually down relative to its exports in the 1970s, and relative to the 2005-2006 period.

Figure 16. Saudi Arabia oil production, consumption, and exports, based on BP Statistical Review of World Energy 2015 data.

 

 

 

Figure 16. Saudi Arabia’s oil production, consumption, and exports based on BP Statistical Review of World Energy 2015 data.

Low oil prices are having an adverse impact on the revenues that Saudi Arabia receives for exporting oil. In 2015, Saudi Arabia has so far issued bonds worth $5 billion US$, and plans to issue more to fill the gap in its budget caused by falling oil prices. Saudi Arabia really needs $100+ per barrel oil prices to fund its budget. In fact, nearly all of the other OPEC countries also need $100+ prices to fund their budgets. Saudi Arabia also has a growing population, so it needs rising oil exports just to maintain its 2014 level of exports per capita. Saudi Arabia cannot reduce its exports by 10% to 25% to help the rest of the world. It would lose market share and likely not get it back. Losing market share would permanently leave a “hole” in its budget that could never be refilled.

Saudi Arabia and a number of the other OPEC countries have published “proven reserve” numbers that are widely believed to be inflated. Even if the reserves represent a reasonable outlook for very long term production, there is no way that Saudi oil production can be ramped up greatly, without a large investment of capital–something that is likely not to be available in a low price environment.

In the United States, there is an expectation that when estimates are published, the authors will do their best to produce correct amounts. In the real world, there is a lot of exaggeration that takes place. Most of us have heard about the recent Volkswagen emissions scandal and the uncertainty regarding China’s GDP growth rates. Saudi Arabia, on a monthly basis, does not give truthful oil production numbers to OPEC–OPEC regularly publishes “third party estimates” which are considered more reliable. If Saudi Arabia cannot be trusted to give accurate monthly oil production amounts, why should we believe any other unaudited amounts that it provides?

Part 8. We seem to be at a point where major debt defaults will soon start for oil and other commodities. Once this happens, the resulting layoffs and bank problems will put even more downward pressure on commodity prices.

Wolf Richter has recently written about huge jumps in interest rates that are being forced on some borrowers. Olin Corp., a manufacture of chlor-alkali products, recently attempted to sell $1.5 billion in eight and ten year bonds with yields of 6.5% and 6.75% respectively. Instead, it ended up selling $1.22 billion of bonds with the same maturities, with yields of 9.75% and 10.0% respectively.

Richter also mentions existing bonds of energy companies that are trading at big discounts, indicating that buyers have substantial questions regarding whether the bonds will pay off as expected. Chesapeake Energy, the second largest natural gas driller in the US, has 7% notes due in 2023 that are now trading at 67 cent on the dollar. Halcon Resources has 8.875% notes due in 2021 that are trading at 33.5 cents on the dollar. Lynn Energy has 6.5% notes due in 2021 that are trading at 23 cents on the dollar. Clearly, bond investors think that debt defaults are not far away.

Bloomberg reports:

The latest round of twice-yearly reevaluations is under way, and almost 80 percent of oil and natural gas producers will see a reduction in the maximum amount they can borrow, according to a survey by Haynes and Boone LLP, a law firm with offices in Houston, New York and other cities. Companies’ credit lines will be cut by an average of 39 percent, the survey showed.

Debts of mining companies are also being affected with today’s low prices of metals. Thus, we can expect defaults and cutbacks in areas other than oil and gas, too.

There is a widespread belief that if prices remain low, someone will come along, buy the distressed assets at low prices, and ramp up production as soon as prices rise again. If prices never rise for very long, though, this won’t happen. The bankruptcies that occur will mean the end for that particular resource play. We won’t really be able to get prices back up to where they need to be to extract the resources.

Thus low prices, with no way to get them back up, and no hope of making a profit on extraction, are likely the way we reach limits in a finite world. Because low demand affects all commodities simultaneously, “Limits to Growth” equates to what might be called “Peak Resources” of all kinds, at approximately the same time.

Why Demand is Collapsing for Everything

Off the keyboard of Gail Tverberg

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Published on Our Finite World on May 6, 2015

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Why We Have an Oversupply of Almost Everything (Oil, labor, capital, etc.)

The Wall Street Journal recently ran an article called, Glut of Capital and Labor Challenge Policy Makers: Global oversupply extends beyond commodities, elevating deflation risk. To me, this is a very serious issue, quite likely signaling that we are reaching what has been called Limits to Growth, a situation modeled in 1972 in a book by that name.

What happens is that economic growth eventually runs into limits. Many people have assumed that these limits would be marked by high prices and excessive demand for goods. In my view, the issue is precisely the opposite one: Limits to growth are instead marked by low prices and inadequate demand. Common workers can no longer afford to buy the goods and services that the economy produces, because of inadequate wage growth. The price of all commodities drops, because of lower demand by workers. Furthermore, investors can no longer find investments that provide an adequate return on capital, because prices for finished goods are pulled down by the low demand of workers with inadequate wages.

Evidence Regarding the Connection Between Energy Consumption and GDP Growth

We can see the close connection between world energy consumption and world GDP using historical data.

Figure 1. World GDP in 2010$ compared (from USDA) compared to World Consumption of Energy (from BP Statistical Review of World Energy 2014).

 

 

 

 

Figure 1. World GDP in 2010$ compared (from USDA) compared to World Consumption of Energy (from BP Statistical Review of World Energy 2014).

 

 

 

 

This chart gives a clue regarding what is wrong with the economy. The slope of the line implies that adding one percentage point of growth in energy usage tends to add less and less GDP growth over time, as I have shown in Figure 2. This means that if we want to have, for example, a constant 4% growth in world GDP for the period 1969 to 2013, we would need to gradually increase the rate of growth in energy consumption from about 1.8% = (4.0% – 2.2%) growth in energy consumption in 1969 to 2.8% = (4.0% – 1.2%) growth in energy consumption in 2013. This need for more and more growth in energy use to produce the same amount of economic growth is taking place despite all of our efforts toward efficiency, and despite all of our efforts toward becoming more of a “service” economy, using less energy products!

Figure 2. Expected change in GDP growth corresponding to 1% growth in total energy, based on Figure 1 fitted line.

 

 

 

 

Figure 2. Expected change in GDP growth corresponding to 1% growth in total energy, based on Figure 1 fitted line.

 

 

 

 

To make matters worse, growth in world energy supply is generally trending downward as well. (This is not just oil supply whose growth is trending downward; this is oil plus everything else, including “renewables”.)

Figure 3. Three year average percent change in world energy consumption, based on BP Statistical Review of World Energy 2014 data.

 

 

 

 

Figure 3. Three-year average percent change in world energy consumption, based on BP Statistical Review of World Energy 2014 data.

 

 

 

 

There would be no problem, if economic growth were something that we could simply walk away from with no harmful consequences. Unfortunately, we live in a world where there are only two options–win or lose. We can win in our contest against other species (especially microbes), or we can lose. Winning looks like economic growth; losing looks like financial collapse with huge loss of human population, perhaps to epidemics, because we cannot maintain our current economic system.

The symptoms of losing the game are the symptoms we are seeing today–low commodity prices (temporarily higher, but nowhere nearly high enough to maintain production), not enough good paying jobs for common workers, and lack of investment opportunities, because workers cannot afford the high prices of goods that would be required to provide adequate return on investment.

 

How We Have Won in Our Contest with Other Species–Early Efforts 

The “secret formula” humans have had for winning in our competition against other species has been the use of supplemental energy, adding to the energy we get from food. There is a physics reason why this approach works: total population by all species is limited by available energy supply. Providing our own external energy supply was (and still is) a great work-around for this limitation. Even in the days of hunter-gatherers, humans used three times as much energy as could be obtained through food alone (Figure 1).

Figure 1

 

 

 

 

Figure 4

 

 

 

 

Earliest supplementation of food energy came by burning sticks and other biomass, starting one million years ago. Using this approach, humans were able to gain an advantage over other species in several ways:

  1. We were able to cook some of our food. This made a wider range of plants and animals suitable for food and made the nutrients from these foods more easily available to our bodies.
  2. Because less energy was needed for chewing and digesting, our bodies could put energy into growing a larger brain, thus giving us an advantage over other animals.
  3. The use of cooked food freed up time for such activities as hunting and making clothes, because less time was needed for chewing.
  4. Heat from burning plant material could be used to keep warm in cold areas, thereby extending our range and increasing total human population that could be supported.
  5. Fire could be used to chase off predatory animals and hunt prey animals.

Our bodies are now adapted to the need for supplemental energy. Our teeth our smaller, and our jaws and digestive apparatus have shrunk in size, as our brain has grown. The large population of humans that are alive today could not survive without supplemental energy for many purposes, such as cooking food, heating homes, and fighting illnesses that spread when humans are in as close proximity as they are today.

Our Modern Formula For Winning the Battle Against Other Species

In my view, the formula that has allowed humans to keep winning the battle against other species is the following:

  1. Use increasing amounts of inexpensive supplemental energy to leverage human energy so that finished goods and services produced per worker rises each year.
  2. Pay for this system with debt, because (if supplemental energy costs are cheap enough), it is possible to repay the debt, plus the interest on the debt, with the additional goods and services made possible by the cheap additional energy.
  3. This system gradually becomes more complex to deal with problems that come with rising population and growing use of resources. However, if the output of goods per worker is growing rapidly enough, it should be possible to pay for the costs associated with this increased complexity, in addition to interest costs.
  4. The whole system “works” as long as the total quantity of finished goods and services rises rapidly enough that it can fund all of the following: (a) a rising standard of living for common workers so that they can afford increasing amounts of debt to buy more goods, (b) debt repayment, and interest on the debt of the system, and (c) and an increasing amount of “overhead” in the form of government services, medical care, educational services, and salaries of high paid officials (in business as well as government). This overhead is needed to deal with the increasing complexity that comes with growth.

The formula for a growing economy is now failing. The rate of economic growth is falling, partly because energy supply is slowing (Figure 3), and partly because we need more and more growth of energy supply to produce a given amount of economic growth (Figure 2). With this lowered world economic growth, the amount of goods and services being produced is not rising fast enough to support all of the functions that it needs to cover: interest payments, growing wages of common workers, and growing “overhead” of a more complex society.

Some Reasons the Economic Growth Cycle is Now Failing

Let’s look at a few areas where we are reaching obstacles to this continued growth in final goods and services. An overarching problem is diminishing returns, which is reflected in increasingly higher prices of production.

1. Energy supplies are becoming more expensive to extract.

We extract the easiest to extract energy supplies first, and as these deplete, need to use the more expensive to extract energy supplies. We hear much about “growing efficiency” but, in fact, we are becoming less efficient in the production of energy supplies.

In the US, EIA data shows that we are becoming less efficient at coal production, in terms of coal production per worker hour (Figure 5).

Figure 5. US coal production per worker, on a Btu basis based on EIA data.

 

 

 

 

Figure 5. US coal production per worker, on a Btu basis based on EIA data.

 

 

 

 

With oil, growing inefficiency is shown by the steeply rising cost of oil exploration and production since 1999 (Figure 6).

Figure 6. Figure by Steve Kopits of Westwood Douglas showing trends in world oil exploration and production costs per barrel.

 

 

 

 

Figure 6. Figure by Steve Kopits of Douglas-Westwood showing trends in world oil exploration and production costs per barrel.

 

 

 

 

Thus, it is for a fairly recent period, namely the period since about 2000, that we have been encountering rising costs both for US coal and for worldwide oil extraction.

The extra workers and extra costs required for producing the same amount of energy  counteract the tendency toward growth in the rest of the economy. This occurs because the rest of the economy must produce finished products with fewer workers and less resources as a result of the extra demands on these resources by the energy sector.

2. Other materials, besides energy products, are experiencing diminishing returns. 

Other resources, such as metals and other minerals and fresh water, are also becoming increasingly expensive to extract. The issue with mineral ores is similar to that with fossil fuels. We start with a fixed amount of ores in good locations and with high mineral percentages. As we move to less desirable ores, both human labor and more energy products are required, making the extraction process less efficient.

With fresh water, the issue is likely to be a need for desalination or long distance transport, to satisfy the needs of a growing population. Workarounds again involve more human labor and more resource use, making the production of fresh water less efficient.

In both of these cases, growing inefficiency leaves the rest of the economy with less human energy and less energy products to produce the finished goods and services that the economy needs.

3. Growing pollution is taking its toll.

Instead of just producing end products, we are increasingly finding ourselves fighting pollution. While this is a benefit to society, it really is only offsetting what would otherwise be a negative. Thus, it acts like overhead, rather than producing economic growth.

From the point of view of workers having to pay for higher cost energy in order to fight pollution (say, substitution of a higher cost energy source, or paying for more pollution controls), the additional cost acts like a tax. Workers need to cut back on other expenditures to afford the pollution control workarounds. The effect is thus recessionary.

4. The amount of “overhead” to the world economy has been growing rapidly in recent years, for a number of reasons: 

  • The amount of overhead is growing because we are reaching natural barriers. For example, population per acre of arable land is growing, so we need more intensity of development to produce food for a rising population.
  • With greater population density and increased bacterial antibiotic resistance, disease transmission becomes a more of a problem.
  • Increasing education is being encouraged, whether or not there are jobs available that will make use of that education. Education that cannot be used in a productive way to produce more goods and services can be considered overhead for the economy. Educational expenses are frequently financed by debt. Repayment of this debt leads to a decrease in demand for other goods, such as new homes and vehicles.
  • We have more elderly to whom we have promised benefits, because with the benefit of better nutrition and medical care, more people are living longer.

5. We are reaching debt limits.

As economic growth has slowed, we have been adding more and more debt, to try to mitigate the problem. This additional debt becomes a problem in many ways: (a) without cheap energy to leverage human labor, there are not many productive investments that can be made; (b) the addition of more debt leads to a need for more interest payments; and (c) at some point debt ratios become overwhelmingly high.

At least part of the slowdown in economic growth that we are seeing today is coming from a slowdown in the growth of debt. Without debt growth, it is hard to keep commodity prices high enough. Investment in new manufacturing plants is also affected by low growth in debt.

Reasons for Confusion in Understanding Our Current Predicament

1. Not understanding that all of the symptoms we are seeing today are manifestations of the same underlying “illness”. 

Most analysts think that the economy has stubbed its toe and has a headache, rather than recognizing that it has a serious underlying illness.

2. Academia is focused way too narrowly, and tied too closely to what has been written before. 

Academics, because of their need to write papers, focus on what previous papers have said. Unfortunately, previous papers have not understood the nature of our problem. Academics have developed models based on our situation when we were away from limits. The issues we are facing cover such diverse subjects as physics, geology, and finance. It is hard for academics to become knowledgeable in many areas at once.

3. Models that seemed to work before are no longer appropriate.

We take models like the familiar supply and demand model of economists and assume that they represent everlasting truths.

Figure 7. (Source Wikipedia). The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.

 

 

 

 

Figure 7. (Source Wikipedia). The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.

 

 

 

 

Unfortunately, as we get close to limits, things change. Both wage levels and debt levels have an impact on demand; the quantity goods available is also affected by diminishing returns. The model that worked in the past may be totally inappropriate now.

Even a complex model like the climate change model being used by the IPCC is likely to be affected by financial limits. If near-term financial limits are to be expected, IPCC’s estimate of future carbon from fuels is likely to be too high. At a minimum, the findings of the IPCC need to be framed differently: climate change may be one of a number of problems facing those people who manage to survive a financial crash.

4. Too much wishful thinking.

Everyone would like to present a positive result, especially when grants are being given for academic research will support some favorable finding.

A favorite form of wishful thinking is believing that higher costs of energy products will not be a problem. Higher cost energy products, whether they are renewable or not, are a problem for many reasons:

  • They represent growing inefficiency in the economy. With growing inefficiency, we produce fewer finished goods and services per worker, not more.
  • Countries using more of the higher cost types of energy become less competitive in the world market, and because of this, may develop financial problems. The countries most affected by the Great Recession were countries using a high percentage of oil in their energy mix.
  • The amount workers have available to spend is limited. If a worker has $100 to spend on energy supply, he can buy 100 times as much in energy supplies priced at $1 as he can energy supplies priced at $100. This same principle works even if the cost difference is much lower–say $3.50 gallon vs. $3.00 gallon.

5. Too much faith in, “We pay each other’s wages.”

There is a common belief that growing inefficiency is OK; the wages we pay for unneeded education will work its way through the system as more wages for other workers.

Unfortunately, the real secret to economic growth is not paying each other’s wages; it is growing output of finished products per worker through increased use of cheap energy (and perhaps technology, to make this cheap energy useful).

Increased overhead for the system is not helpful.

6.  An “upside down” peak oil story.

Most people in the peak oil community believe what economists say about supply and demand–namely, that oil prices will rise if there is a supply problem. They have not realized that in a networked economy, wages and prices are tightly linked. The way limits apply is not necessarily the way we expect. Limits may come through a lack of good paying jobs, and because of this lack of jobs, inability to purchase products containing oil.

The connection between energy and jobs is clear. Good jobs require the use of energy, such as electricity and oil; lack of good-paying jobs is likely to be a manifestation of an inadequate supply of cheap energy. Also, high paying jobs are what allow rising buying power, and thus keep demand high. Thus, oil limits may appear as a demand problem, with low oil prices, rather than as a high oil price problem.

In my opinion, what we are seeing now is a manifestation of peak oil. It is just happening in an upside down way relative to what most were expecting.

Conclusion

One way of viewing our problem today is as a crisis of affordability. Young people cannot afford to start families or buy new homes because of a combination of the high cost of higher education (leading to debt), the high cost of fuel-efficient new cars (again leading to debt), the high cost of resale homes, and the relatively low wages paid to young workers. Even older workers often have an affordability problem. Many have found their wages stagnating or falling at the same time that the cost of healthcare, cars, electricity, and (until recently) oil rises. A recent Gallop Survey showed an increasing share of workers categorize themselves as “working class” rather than “middle class.”

It is this affordability crisis that is bringing the system down. Without adequate wages, the amount of debt that can be added to the system lags as well. It becomes impossible to keep prices of commodities up at a high enough level to encourage production of these commodities. Return on investment tends to be low for the same reason. Most researchers have not recognized these problems, because they are narrowly focused and assume that models that worked in the past will continue to work today.

 

 

 

 

Oil Glut, Low Prices & Affordability

Off the keyboard of Gail Tverberg

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Published on Our Finite World on March 9 2015

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The oil glut and low prices reflect an affordability problem

For a long time, there has been a belief that the decline in oil supply will come by way of high oil prices. Demand will exceed supply. It seems to me that this view is backward–the decline in supply will come through low oil prices.

The oil glut we are experiencing now reflects a worldwide affordability crisis. Because of a lack of affordability, demand is depressed. This lack of demand keeps prices low–below the cost of production for many producers. If the affordability issue cannot be fixed, it threatens to bring down the system by discouraging investment in oil production.

This lack of affordability is affecting far more than oil products. A recent article in The Economist talks about LNG prices being depressed. LNG capacity ramped up quickly in response to high prices a few years ago. Now there is a glut of LNG capacity, and prices are far below the cost of extraction and shipping for many LNG suppliers. At least temporary contraction seems likely in this sector.

If we look at World Bank Commodity Price data, we find that between 2011 and 2014, the inflation-adjusted price of Australian coal decreased by 41%. In the same period, the inflation-adjusted price of rubber is down 58%, and of iron ore is down 59%. With those types of price drops, we can expect huge cutbacks on production of many types of goods.

How Does this Lack of Affordability Come About?

The issue we are up against is diminishing returns. Diminishing returns mean that as we reach limits, it takes increased resources (usually both physical resources and human labor) to produce some type of product. Oil is product subject to diminishing returns. Metals of many kinds also are becoming increasingly expensive to extract. In many parts of the world, a shortage of water makes it necessary to use unusual techniques (desalination or long distance pipelines) to obtain adequate supply. The higher cost of pollution control can have a similar effect to diminishing returns on products with pollution issues.

When we graph of the cost of production of resources subject to diminishing reserves, the result is similar to that shown in Figure 1.

Figure 1. The way we would expect the cost of the extraction of energy supplies to rise, as finite supplies deplete.

What happens with diminishing returns is that cost increases tend to be quite small for a very long time, but then suddenly “turn a corner.” With oil, the shift to higher costs comes as we move from “conventional” oil to “unconventional” oil. With metals, the shift comes as high quality ores become depleted, and we need to move to mines that require moving a great deal more dirt to extract the same quantity of a given metal. With water, such a steep rise in diminishing returns comes when wells no longer provide a sufficient quantity of water, and we must go to extraordinary measures, such as desalination, to obtain water.

During the time when cost increases from diminishing returns were quite minor, it generally was possible to compensate for the small cost increases with technological improvements and efficiency gains elsewhere in the system. Thus, even though there was a small amount of diminishing returns going on, they could be hidden within the overall system.

Once the effect of diminishing returns becomes greater (as it has since about 2000), it becomes much harder to hide cost increases. The cost of finished products of many kinds (for example, food, gasoline, houses, and automobiles) starts rising, relative to the income of workers. Workers find that they must cut back on discretionary expenditures in order to have enough money to cover all of their expenses.

How Diminishing Returns Affect the Economy 

There are at least three ways that diminishing returns adversely affects the economy:

  1. Lower wages
  2. Less ability to borrow
  3. Squeezing out other sectors of the economy

The reason for lower wages relates to the fact that, as the cost of producing a commodity rises, the worker is, in some sense, becoming less and less productive. For example, if we calculate wages per worker in units of oil, as oil becomes more expensive to extract, we get something like this:

Figure 2. Wages per worker in units of oil produced, corresponding to amounts shown in Figure 1.

A similar chart would hold for other resources that are becoming more difficult to extract, or whose cost of production is becoming higher because of greater pollution controls. For example, we would expect the wages of coal workers to be falling as well.

Also, as we shift to higher cost types of energy, we become increasingly inefficient in energy production. Based on a 2013 analysis, in the United States, there are more solar energy workers than coal miners, even though we use far more coal than solar energy. The large number of workers required to produce solar energy is one of the reason that solar energy tends to be high-priced to produce.

When we look at wages of workers, we indeed see a pattern of falling wages, especially for workers below the median wage. Figure 3 from the Economic Policy Institute shows that even the most educated workers are experiencing declining inflation-adjusted wages.

Figure 3. Source:  Elise Gould, Even the Most Educated Workers Have Declining Wages.

A second major issue affecting affordability is debt saturation. Affordability is favorably affected by rising debt–for example, it is a lot easier to buy a new car or house, if the would-be purchaser can obtain a new loan. If debt levels stay the same or fall, this becomes a problem–fewer goods can be purchased.

Governments in particular are reaching the limits of their borrowing capacity. They cannot keep adding new debt, and remain within historic debt to GDP ratios.

Another way debt saturation occurs relates to young people with student loans. They find it too expensive to borrow more money for a new car or for a home. Furthermore, the fact that wages are not keeping up with price increases for many workers reduces the borrowing ability of the workers with lagging wages. This is true, even if no student loans are involved.

As mentioned above, a third issue is the fact that the inefficient sectors tend to squeeze out other portions of the economy by gobbling up a disproportionate share of workers and resources. The use of all of these resources doesn’t produce a lot of goods in the traditional sense–a desalination plant is expensive, but the amount of water produced per dollar of investment is not large. To the extent that the high costs of inefficient sectors are passed on to consumers, consumers find that they must cut back on discretionary spending. This cut-back in spending squeezes out discretionary spending, leading to cutbacks in discretionary sectors, and to reduced employment overall.

Figure 4. Author's view of the effect of diminishing returns on economy.

Wishful Thinking by Economists

Back before diminishing returns started becoming a major problem, economists created models regarding how the economy would react to higher cost of energy production and other symptoms of diminishing returns. In their view, if the cost of oil extraction rises, oil prices will rise to match these higher costs. Alternatively, substitution will take place, or technological changes will allow greater efficiency, or customers will cut back on their use of the high cost product. Somehow, these changes will take place without a particularly adverse impact on the economy.

Unfortunately, the models don’t correspond very well to what happens in practice–at least not for very long. It takes inexpensive energy to produce goods that workers can afford. Higher priced energy does not work well in this regard. Feedbacks that are not reflected in economic models reduce both wages and debt, making it harder to buy goods requiring the use of more-expensive energy products.

Furthermore, if the price of one commodity, for example oil, rises, then countries with very much oil in their energy mix find themselves handicapped in trade with other countries that use less oil in their energy mix. For example, a country that depends on tourism (which depends on oil use) for very much of its revenue, such as Greece, finds it difficult to find customers when oil prices are high. Lack of revenue can lead to financial problems for the country.

Because of the networked way the economy really works, prices for commodities can’t rise for the long-term. They may rise for a while, as consumers and governments borrow more, in an attempt to continue business as usual. Ultimately, though, the situation can’t “work.”  Customers can’t afford to buy more homes and cars, unless their own wages are rising in inflation adjusted terms, and governments can’t collect enough tax revenue.

The issue we are dealing with here is lack of affordability. This is what will bring the system down–not the high priced scenario imagined by many. Decline will come through low prices, and a glut in oil supply, even if we are not looking for it from that direction.

Can commodity prices rise again?

It is not all that clear that they can rise again. It would be a lot easier for commodity prices to rise, if the problem were simply inadequate prices of one commodity, leading to a lack of that commodity. If the problem is inadequate demand for crude oil, coal, LNG, and iron ore the problem is much greater–especially if wages are still lagging.

WHAT THE FED HAS WROUGHT

Off the keyboard of Jim Quinn

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Published on The Burning Platform on November 16, 2014

shirt_FederalReserve_2

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The chart below might be the most powerful indictment of the Federal Reserve and our corporate fascist empire of debt ever created. Some people don’t get charts. Charts tell a story. This chart tells the story of elitist bankers supporting the agenda of a corporate fascist state, resulting in the gutting of the middle class. Anyone who views this chart in a positive manner is either a Federal Reserve banker or their paycheck is dependent upon the continuation of the pillaging of the working class. Corporate profits are at all-time highs. Profit margins have always reverted to the mean throughout modern history. If they remain at all-time highs then something is terribly wrong.

“Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system and it is not functioning properly.” – Jeremy Grantham, Barron’s

Here is the story I see in that chart. Corporate profits as a percentage of GNP have averaged 6.5% over the last 67 years. As you can see, it is a volatile figure. Corporate profits rise during expansions and fall during recessions. That has been a given over time. The reason corporate profits have always reverted to the mean was due to the basic tenets of free market capitalism. When a company is generating outsized profits, that industry will then attract new competitors, resulting in price competition and lower profits. From 1950 through 1971, corporate profits as a percentage of GNP fluctuated in a narrow range between 5% and 7%. This was a reflection of a market driven by competition, a non-interventionist Federal Reserve, and a government not captured by corporate interests.

It is no coincidence since Nixon closed the gold window in 1971 and unleashed greedy bankers, feckless politicians, and self serving corporate executives to utilize easy money and prodigious amounts of debt to financialize our economic system and deform capitalism. The Fed created booms and busts are clearly evident on the chart. Nixon toady Arthur Burns created an inflationary boom in corporate profits to 8% of GNP in the late 70’s followed by the collapse to 3% caused by Volcker having to raise rates to extreme levels to crush the Burns created runaway inflation.

You can see exactly when the Maestro assumed command at the Fed and proceeded to introduce the Greenspan Put, encouraging speculation, borrowing and mal-investment. His easy money boom led to the dot com bubble that doubled corporate profits from their 1987 low. Of course the profits vaporized in an instant and plunged to 4% of GNP in 2001. Greenspan and then Bernanke  proceeded to drive interest rates to record lows creating a prodigious housing bubble resulting in the greatest level of mal-investment and financial fraud in world history. Corporate profits as a percentage of GNP skyrocketed from 4% to 10% in the space of six years. The banking cabal had captured the system.

The Fed orchestra kept the music playing and Wall Street kept dancing the rumba with their corporate CEO dates. The Keynesian acolytes were ecstatic. The Austrians warned of the impending bust. No one listened. The collapse of the worldwide financial system was portrayed by the corporate mainstream media, bankers like Dimon, corporate CEOs like Immelt, billionaires like Buffet, captured government bureaucrats like Paulson, and politicians like McCain and Obama, as a systematic risk that required a taxpayer rescue of criminals.

The $800 billion gift to bankers and mega-corporations by the Washington DC Party of captured politicians was chicken feed compared to the $3.5 trillion of newly printed fiat handed to Wall Street and corporate America by Bernanke and Yellen. Five years of 0% interest rates have impoverished senior citizens and savers, but they have done wonders for Wall Street and mega-corporation profits, along with executive bonuses. Corporate profits soared from 4.5% of GNP to an all-time high of 10.5% in the space of three years and have remained at this elevated level.

Who Needs Wage Earners Anyway?

Is it a coincidence that corporate profits as a percentage of GNP are at record highs while employee compensation as a percentage of GNP is at record lows? Is it a coincidence that employee compensation as a percentage of GNP peaked at 51% in 1971? That year certainly seems to be a turning point in U.S. economic history. Gold’s purpose as a check on statists, Keynesians, politicians, bankers, and the military industrial complex couldn’t be any clearer. The decline has multiple causes, but the storyline about technology being the major cause is patently false. My observations are as follows:

  • From the end of World War II until the mid-1970s employee compensation as a percentage of GNP was consistently between 49% and 51%. The middle class saw their standard of living rise as wages outpaced inflation, savings rates were high and led to capital investment, debt was used for long term purchases like a home or automobile, and bankers accepted deposits and made safe loans. Technological progress over the thirty years was constant, but did not result in declining wages.
  • From the moment Nixon closed the gold window, employee compensation as percentage of GNP relentlessly declined for the next quarter of a century from 51% to 44%. Over this time frame our economy deformed from a goods producing system driven by savings and capital investment into a service/financial economy built upon consumer debt, conspicuous consumption and market gambling. Our iconic mega-corporations fired Americans and hired Chinese slave laborers, lobbied for tax breaks, invested in their own stock, kept wage increases below the level of true inflation, and paid extravagant compensation packages to their Harvard MBA executives.
  • The brief upturn created by Greenspan’s irrational exuberance 90’s boom was short lived. The relentless decline resumed after the dot com collapse, even as Greenspan and Bernanke blew their epic bubble. Their financial engineering machinations on behalf of Wall Street did nothing for the average worker on Main Street. Employee compensation as a percentage of GNP declined from 47% to 44% BEFORE the financial collapse.
  • Unequivocal proof that Bernanke’s sole purpose of QE and ZIRP was to benefit his Wall Street owners can be seen in the continued decline from 44% to 42% since 2008. There has been no recovery for the average American. Wall Street is rolling in dough. Corporate America is rolling in dough. Politicians are rolling in dough. The average American worker is rolling in dog shit.

The mouthpieces for the Deep State insist corporate profits have reached a permanently high plateau. It’s another new paradigm. Just like 1929, 1999, and 2007. Jeremy Grantham is right. The system is broken. The inmates are running the asylum. But financial engineering will not work permanently.  Baijnath Ramraika and Prashant Trivedi in their outstanding article Why Jeremy Grantham is Right about Corporate Profit Margins prove that corporate gross margins have not grown, technological advancement has not been a major factor, innovation and capital investment are non-existent, and corporate CEOs have utilized one time schemes to boost profits.

There are a few major reasons for record corporate profits. The Fed’s gift to banks and mega-corporations of zero interest rates have allowed S&P 500 corporations to refinance their existing debt and take on new debt at below market interest rates. The average interest rate paid by S&P 500 companies is now at all-time lows. Any normalization of interest rates would crush corporate profits.

Even though you hear constant propaganda from the corporate MSM, corporate CEOs, and captured politicians about the dreadful level of corporate taxes, the truth is that mega-corporations are paying record low levels of actual taxes. When profits are at record highs and tax payments at record lows you know they have captured the system. “Creative” tax avoidance and the FASB allowing banks to mark their assets to fantasy have played an enormous role in record profits.

The short term oriented casino mentality of corporate CEOs can be plainly seen in the fact depreciation expense as a percentage of revenue is at 25 year lows, resulting in short term profits but long-term decline. Instead of investing in capital to increase efficiency or expand their business, greedy myopic CEOs have chosen to buy back their own stock at all-time high prices. They did the same thing in 2005 – 2007. Driving up quarterly earnings per share to boost their own stock option compensation is how it rolls in corporate America today. Investing in their workers through higher wages isn’t even a consideration. They don’t teach that in Ivy League MBA programs. SG&A expenses as a percentage of revenue have been driven to all time lows, as outsourcing, downsizing, and working people to death have done wonders for corporate profits.

Ramraika and Trivedi reach damning conclusions of corporate America, based on their detailed unbiased research:

As the world moved increasingly towards the idea of shareholder-value maximization, time horizons for management and the shareholders have shortened. As Montier shows, the average lifespan of a company in the S&P 500 in the 1970s was about 27 years and is down to about 15 years now. In tandem, the average tenure of CEOs is down from about 10 years in the 1970s to about 6 years now. Combine this with the incentive systems prevalent today (think stock options), and it is only logical that a CEO who is going to be around for as few as six years and is going to get a large chunk of her rewards in stock options will want to see higher stock prices.

Cutting SGA expenses and postponing capital investments — actions that carry positive short-term earnings impact at the expense of a business’ competitiveness in the long-term — look promising to managers whose payoffs depend on stock prices in the short-term. Not surprisingly, the renters (there are hardly any owners any more) clamor for just such actions. The problem with this thinking is that the long-term eventually shows up. And when it does, profit margins will have no choice but to remember their long forgotten tendency to revert to mean.

Are interest rates going to be driven lower for corporations? Are taxes going to be driven lower? How many more people can corporations fire? Have economic downturns been eliminated by the Federal Reserve? Will record profits not result in increased competition and price wars? Can wages be driven even lower?

The financial, economic and political system has been captured by corporate fascist psychopaths. The Federal Reserve has aided and abetted this takeover. Their monetary manipulations have resulted in this deformity. Psychopaths always go too far. The American middle class has been murdered. Decades of declining real wages have left them virtually penniless, in debt up to their eyeballs, angry, frustrated, and unable to jump start our moribund economy by buying more Chinese produced crap. Yellen, her Wall Street puppeteers, and the corporate titans should enjoy those record profits and record stock market highs. It won’t last. Short-term profits will be wiped out, as long-term consequences always arrive when you least expect it. The artificial boom will lead to a real depression. Luckily for the oligarchs, most middle class Americans are already experiencing a depression and won’t notice the difference.

“True, governments can reduce the rate of interest in the short run. They can issue additional paper money. They can open the way to credit expansion by the banks. They can thus create an artificial boom and the appearance of prosperity. But such a boom is bound to collapse soon or late and to bring about a depression.” – Ludwig von Mises

Trans-Pacific Collapse Partnership

logopodcastOff the microphone of RE

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Aired on the Doomstead Diner on November 15, 2014

Trans-Pacific

Some background from Michael Snyder…

Obama’s Secret Treaty Would Be The Most Important Step Toward A One World Economic System

Barack Obama behind Resolute Desk in the Oval Office - Public DomainBarack Obama is secretly negotiating the largest international trade agreement in history, and the mainstream media in the United States is almost completely ignoring it.  If this treaty is adopted, it will be the most important step toward a one world economic system that we have ever seen.  The name of this treaty is “the Trans-Pacific Partnership”, and the text of the treaty is so closely guarded that not even members of Congress know what is in it.  Right now, there are 12 countries that are part of the negotiations: the United States, Canada, Australia, Brunei, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam.  These nations have a combined population of 792 million people and account for an astounding 40 percent of the global economy.  And it is hoped that the EU, China and India will eventually join as well.  This is potentially the most dangerous economic treaty of our lifetimes, and yet there is very little political debate about it in this country.

Even though Congress is not being allowed to see what is in the treaty, Barack Obama wants Congress to give him fast track negotiating authority.  What that means is that Congress would essentially trust Obama to negotiate a good treaty for us.  Congress could vote the treaty up or down, but would not be able to amend or filibuster it.

Of course now the Republicans control both houses of Congress.  If they are foolish enough to blindly give Barack Obama so much power, they should all immediately resign.

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Snippet:

…The latest Hubbub in Economic disasters waiting to happen is the Double Super Secret Trans-Pacific Partnership agreement which Obama-sama is Front Man for, which from all indications appears to be something like NAFTA on Steroids. I say “from all indications” because nobody seems to know precisely what is in this agreement, not even the lower level of Puppets in Congress. The general idea is well known though, which is to establish yet another bigger and more comprehensive “Free Trade” Zone amongst a whole bevy of countries surrounding the Pacific Sewer, from Chile and Peru on the Left Coast of South America up around through the FSoA and back down the other side through Japan to SE Asia and on to Oz and Kiwiland. The “hope” here amongst the Globalist Pigmen who are drafting this thing up is that China too will buy in here to this NEW & IMPROVED agreement designed basically to make Corporate Oligarchs even richer than they already are while sucking the last of whatever resource wealth is still left anywhere around this ring out of the ground and driving down the rest of the population into even more desperate poverty than so far achieved here with NAFTA and the rest of the Globalization meme.

The Buzzword here is “FREE TRADE”, and who can be against something FREE, right? You the Konsumer are going to BENEFIT from still more FREE TRADE! The Low, Low Prices Every Day at Walmart will get even LOWER!

For the rest, LISTEN TO THE RANT!!!

CHRISTMAS IN OCTOBER – DESPERATE MEASURES

Off the Keyboard of Jim Quinn

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Published on The Burning Platform on October 25, 2014

Black Friday riot 1

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The desperation of retailers grows by the day. I head to Wal-Mart and Giant in Harleysville every Sunday morning at 7:00 am. to do my weekly grocery shopping. I go to Wal-Mart at opening to avoid the freaks we see weekly on the People of Wal-Mart post. The workers at Wal-Mart are only a small step above the customers. They can barely communicate, rarely look you in the eye, and generally act like they are prisoners in an asylum.

I’m in winter/bad times ahead prep mode. I had a load of fire wood delivered yesterday which I wheelbarrowed to the back yard and stacked with my already decent sized stack. Last week I took an empty propane canister back to Wal-Mart to replace it with a full canister. That would give me three full propane tanks. I left the empty tank outside next to the propane cage and went in to pay. The old lady cashier with the gravelly smoker voice told me she would call for someone to get me a new tank.

I went over the cage and patiently waited for a Wal-Mart drone to come out, unlock the propane cage and give me a full tank. Two minutes, five minutes, and eventually ten minutes go by with no one coming out to help me. The cashier pokes her head out the door and shrugs her shoulders and says no one is responding to her calls. What a well oiled machine they have at Wal-Mart. Eventually the old lady abandoned her cashier post and in a painstakingly slow manner proceeded to unlock one bin after another until she found a full tank. I’m sure a line of unhappy customers were piling up at the only register in the garden center while she spent ten minutes getting me my propane tank.

A transaction that should have taken five minutes from start to finish ended up taking closer to twenty five minutes, with another five or six customers also dissatisfied with their extra long wait. This is a perfect example of how not to do business. Maybe Wal-Mart’s problems are bigger than households having less to spend. They are attempting to maintain their profit margins by reducing staff hours, hiring low quality people, and paying them shit wages. In the short run it may keep profits higher, but in the long-run customers will go elsewhere. Except most of the elsewhere stores closed up years ago when Wal-Mart arrived and underpriced them into bankruptcy.

My shopping experience at Giant is generally pleasant. The staff are nice, competent, and have been there for years. They know what they are doing and serve you with a smile. But their store is part of a worldwide conglomerate, so things have changed for the worse over the last four months. They renovated the entire store, creating bigger aisles and moving stuff around. That’s annoying, but after a while you figure out where they moved the stuff you want. The real negative change was the dreaded “Everyday Low Pricing”. This weasel phrase means you will be paying more. This is what the Apple idiot CEO – Ron Johnson – did at JC Penney. It put them on a rapid path to bankruptcy.

The weekly sale items at Giant have virtually disappeared. This has coincided with the drastic increase in beef, pork and fresh produce prices. Since “Every Day Low Pricing” went into affect our weekly grocery bill has gone up 20%. And I am buying far less beef and more chicken. In the past I would stock up on sale items and put beef, pork and whatever was on sale in our storage area freezer. Now I am stuck buying what we need that week. No bargains, just fully priced food items. Be forewarned, whenever you see a store announce “Everyday Low Pricing” you are getting screwed.

The Boos Begin in August & Bells Start Jingling in October

The desperation of Wal-Mart and most of the other mega-retail chains is no more clearly evident than in their relentlessly ridiculous acceleration of holiday marketing displays. I was flabbergasted when I saw Halloween candy, decorations and costumes in row after row BEFORE Labor Day at my local Wal-Mart. Selling Halloween candy two months before Halloween is idiotic and a sure sign of desperation. Retailers have run out of merchandising ideas. I wouldn’t even consider buying Halloween candy until the week before Halloween. Do Wal-Mart freaks of the week actually buy Halloween merchandise in September?

Holidays used to be special occasions that lent a sense of sales urgency for retailers for a week or two, to pump up sales. Now Wal-Mart and the rest of the dying retailers have Christmas, Easter, Fourth of July, and Halloween displays up for 80% of the year. There is no sense of urgency to buy. From September 1 though October 31 there are rows and rows of bags of corporate produced chemicals disguised as candy. I suppose the obese masses buy this crap in anticipation of Halloween, tell themselves they’ll only take one, and then shovel the entire bag down their gullets.

So last week, still a full two weeks before Halloween, Wal-Mart had already converted their entire garden center into a Christmas wonderland of cheap mass produced Chinese cookie cutter Christmas decorations and lights that will blow out after three hours of use. They had also converted aisles at the front of the store to Christmas displays. Who the hell shops for Christmas crap in October? There is nothing like having cheap Chinese Christmas crap available for over two months to create a sense of urgency to buy. Wal-Mart and the rest of the mega-retailers have got nothin. They have no original merchandising ideas. They don’t even try anymore. They source low quality goods from China and compete solely on price. I can’t wait for the Easter candy to appear on Wal-Mart’s shelves in late December.

Black Thanksgiving

Black Friday is dead. Long live Black Thanksgiving. The riots and stampedes by the ignorant masses for toasters and HDTVs on Black Friday are now being replaced by retailers and malls across America opening at 6:00 pm on Thanksgiving. It actually seems fitting. How better to give thanks for our mass consumption, debt financed, materialistic, iGadget addicted society than to open stores on Thanksgiving. Spending time with family is overrated anyway. If you had to spend six hours with cousin Eddie and aunt Bethany, you’d be looking forward to an early opening at Macy’s.

The bullshit message from the mega-retailers is: “We’re not opening on Thanksgiving out of desperation or greed. We’re doing it simply to satisfy the demands of our customers”. It’s a racist national holiday anyway. We should be going to an Indian run casino on Thanksgiving to make up for our past sins. Opening stores and forcing workers to work on Thanksgiving is pathetic, disgusting and a truly desperate measure in this consumer empire in decline. The law of diminishing returns has been invoked upon the mega-retailers that dominate our suburban sprawl paradise.

These retailers can start holiday merchandising three months before the actual holiday. They can open their doors on Thanksgiving, Easter and Christmas. It’s nothing more than shuffling the deck furniture on the Titanic. We’ve allowed bankers, politicians and corporate titans to financialize our economy, gutting the once thriving middle class, sending manufacturing jobs overseas, and convincing the clueless masses that consumer goods purchased with debt is equal to wealth. But, we’ve reached the point of no return. There are 248 million working age Americans and 102 million of them are not employed. Of the 146 million working Americans, 82 million of them make less than $30,000 per year.

While retailers have added billions of square feet since 1989, real median net worth is 5% lower over 24 years. Retailers are attempting to get blood from a stone. The stone is in debt, approaching retirement with no savings and dead broke.

We have one entity that deserves the most credit for destroying the American Dream. Real median household income is lower than it was in 1989. The 2008 collapse was caused by the easy money bubble machine at the Federal Reserve. We had the opportunity to hit the reset button, implement rational economic and monetary policies, take our lumps, and make the banking culprits pay for their crimes. Instead, the easily manipulated masses believed the Wall Street storyline and allowed the Federal Reserve and feckless politicians to save the banking cabal with extreme money printing and debt creation. This has pushed the middle class closer to the breaking point, while further enriching the oligarchs. The Federal Reserve saved their owners and lured the masses further into debt.

The Fed, Wall Street, and Washington DC have successfully driven consumer debt to an all-time high, blasting through the $3 trillion level. Declining real incomes and rising debt are a sure recipe for success.

Our entire economic paradigm is built upon desperate measures. Zero interest rates, $3 trillion of QE, systematic accounting fraud, fudged economic data, and doling out subprime loans to auto renters and University of Phoenix wannabes have failed to revive our moribund economy. Delusions don’t die easily. But they do die. We are reaching the limit of this delusionary dream built upon debt, denial, and deception. Make sure you wolf down that Thanksgiving feast before 5:00 pm. There are HDTV’s to fight for at 6:00 pm.

Your Recovery Without Drugs

Off the keyboard of Jim Quinn

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Published on The Burning Platform on August 18, 2014

brain-drugs

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“If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks…will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered…. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.”

Thomas Jefferson

Does this chart portray an economic recovery in any way? Wages have been stagnant since the START of the supposed recovery in 2010. Real median household income, even using the highly understated CPI, is on a glide path to oblivion. You just need to observe with your own two eyes the number of Space Available signs in front of office buildings, strip centers and malls across America to realize we have further to fall. Low paying, part-time burger flipping jobs aren’t going to revive this debt saturated economic system. But at least the .1% are enjoying their Federal Reserve created high. Fiat is a powerful drug when administered in large doses to addicts on Wall Street.

The S&P 500 has risen from 666 in March of 2009 to 1,972 today. That is a 196% increase in a little over five years. During this same time, real household income has fallen by 7%. There have been a few million jobs added, while 11 million people have left the labor market. According to Robert Shiller’s CAPE ratio, the stock market valuation has only been higher, three times in history – 1929, 1999, and 2007. He seems flabbergasted by why valuations are so high. Sometimes really smart people can act really dumb.

The Federal Reserve balance sheet was $900 billion before the 2008 financial crisis. Today it stands at $4.4 trillion. The Fed has increased their balance sheet by 220% since the March 2009 market lows. Do you think there is any correlation between the Fed puppets printing $2.4 trillion and handing it to their Wall Street puppeteers, who used their high frequency trading supercomputers and ability to rig the markets so they never lose, and the third stock bubble in the last 13 years? It’s so self evident that only an Ivy League economist or CNBC anchor wouldn’t be able to see it.

sp500fedbal

 

Let’s look at the amazing stock market recovery without Federal Reserve heroine pumped into the veins of Wall Street banker addicts. If you divide the S&P 500 Index by the size of the Federal reserve balance sheet, you see the true purpose of QE1, QE2, and QE3. It wasn’t to save Main Street. It was to save Wall Street. Without the Federal Reserve funneling fiat to the .1% banking cabal and creating inflation in energy, food, and other basic necessities for the 99.9%, there is no stock market recovery. The recovery has occurred in Manhattan and the Hamptons. It’s been non-existent for the vast majority of people in this country. The wealth effect and trickle down theory have been disproved in spades. The only thing trickling down on the former middle class from the Fed is warm and yellow.

sp500fedbalratio

The entire stock market advance has been created on record low trading volumes and record high levels of monetary manipulation. Even though the Federal Reserve has driven senior citizens further into poverty with 0% interest rates, those with common sense have refused to be lured back into the lion’s den. They have parked record levels of fiat in no interest bank and money market accounts. They are tired of being muppets led to slaughter.

Quantitative easing was supposed to force little old ladies into the stock market and consumers to spend their debased dollars before they lost more value. The spending would revive the dormant economy just as the Keynesian text books promised. It didn’t happen. The peasants haven’t cooperated. Quantitative easing and ZIRP sapped the life from the middle class as their wages have stagnated and their living expenses have skyrocketed. Mission Accomplished by the Fed. Of course, the CNBC bimbos and shills would declare this $10.8 trillion to be money on the sidelines ready to boost the stock market ever higher. I love that storyline. It never grows old.

The MSM, government and Wall Street continue to flog the story about a housing recovery. It’s been nothing but a confidence game based upon the Fed’s easy money and the Wall Street scheme to buy up foreclosed properties with the Fed’s money. The scheme was to artificially boost home prices by restricting home supply through foreclosure manipulation, in order to allow the insolvent Wall Street banks to get out from under their billions in toxic mortgage loans.

Shockingly, the Case Shiller home price index has soared by 25% since 2012 despite first time home buyers being virtually non-existent and mortgage applications plunging to 14 year lows. How could that be? Don’t people need mortgages to buy houses? Isn’t real demand necessary to drive prices higher? Not when Uncle Ben and Madam Yellen are in charge of the printing press. Housing bubble 2.0 has arrived. I wonder if the Federal Reserve balance sheet increase of 50% since 2012 has anything to do with the new housing bubble.

It seems a similar result is obtained when dividing the Case Shiller Index by the size of the Fed’s balance sheet. The real housing market for real people is worse than it was in 2009. The national home price increase has been centered in the usual speculative markets, aided and abetted by the Fed’s easy money, managed by the Wall Street hedge funds, and exacerbated by the late arriving flippers who will be left holding the bag again. The Fed/ Wall Street scheme has priced young people out of the market and has failed to ignite the desired Keynesian impact. Investors/flippers account for 34% of all home sales. Foreigners with no knowledge of value metrics account for 30% of all home sales. The lesson of history is that most people don’t learn the lessons of history. The 2nd housing bubble in seven years is seeking a pin.

If ever you needed proof of the confidence game in its full glory, the chart below from Zero Hedge says it all. Mortgage rates have been falling for the past year, home builders have been reporting soaring confidence about the future, and the National Association of Realtors keeps predicting a surge in home buying any minute now. One small problem. Mortgage applications are in free fall, new home sales are at 1991 levels, and existing home sales are falling. Home prices have peaked and are beginning to roll over. The Wall Street hedgies are all looking to exit stage left. Young people are saddled with over a trillion of government issued student loan debt and millions of older subprime borrowers have been lured into more auto loan debt. Home sales will be stagnant for the next decade.

 

Quantitative easing will cease come October, unless Yellen and Wall Street can create a new “crisis” to cure with more money printing. By every valuation measure used over the last 100 years, stocks are overvalued by at least 50%. By historical measures, home prices are overvalued by at least 30%. Ten year Treasuries are yielding 2.4%, while true inflation is north of 5%. With real interest rates deep in negative territory, the bond market is even more overvalued than stocks or houses. These simultaneous bubbles have been created by the Federal Reserve in a desperate attempt to keep this debt laden ship afloat. Their solution to a ship listing from too much debt was to load it down with trillions more in debt. The ship is taking on water rapidly.

We had a choice. We could have bitten the bullet in 2008 and accepted the consequences of decades of decadence, frivolity, materialism, delusion and debt accumulation. A steep sharp depression which would have purged the system of debt and punishment of those who created the disaster would have ensued. The masses would have suffered, but the rich and powerful bankers would have suffered the most. Today, the economy would be revived, saving and investing would be generating needed capital for expansion, and banks would be doing what they are supposed to do – lending money to businesses and individuals. Instead, the Wall Street bankers won the battle and continue to pillage and loot the national wealth while impoverishing the masses.

The arrogance, hubris and contempt for morality displayed by the ruling class is breathtaking to behold. They think they are untouchable and impervious to norms followed by the rest of society. They may have won the opening battle, but will lose the war. Discontent among the masses grows by the day. The critical thinking citizens are growing restless and angry. They are beginning to grasp the true enemy. The system has been captured by a few malevolent men. When the stock, bond and housing bubbles all implode simultaneously, all hell will break loose in this country. It will make Ferguson, Missouri look like a walk in the park. I wonder if the occupants of the Eccles building in Washington DC will get out alive.

“It is well enough that people of the nation do not understand our banking and money system, for if they did, I believe there would be a revolution before tomorrow morning.”Henry Ford

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What’s Ahead? Lower Oil Prices, Despite Higher Extraction Costs

Off the keyboard of Gail Tverberg

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Published on Our Finite World on November 15, 2013

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Discuss this article at the Energy Table inside the Diner

Nearly everyone believes that oil prices will trend higher and higher, allowing increasing amounts of oil to be extracted. This belief is based on the observation that the cost of extraction is trending higher and higher. If we are to continue to have oil, we will need to pay the ever-higher cost of extraction. Either that, or we will have to pay the high cost of some type of substitute, if one can be found. Perhaps such a substitute will be a bit less expensive than oil, but costs are still likely to be high, since substitutes to date are higher-priced than oil.

Even though this is conventional reasoning based on experience with many substances, it doesn’t work with oil. Part of the reasoning is right, though. It is indeed true that the cost of extracting oil is trending upward. We extracted the easy to extract oil, and thus “cheap” to extract oil, first and have been forced to move on to extracting oil that is much more expensive to extract. For example, extracting oil using fracking is expensive. So is extracting Brazil’s off-shore oil from under the salt layer.

There are also rising indirect costs of production. Middle Eastern oil exporting nations need high tax revenue in order to keep their populations pacified with programs that provide desalinated water, food, housing and other benefits. This can only be done though high taxes on oil exports. The need for these high taxes acts to increase the sales prices required by these countries–often over $100 barrel (Arab Petroleum Investment House 2013).

Even though the cost of extracting oil is increasing, the feedback loops that occur when oil prices actually do rise are such that oil prices tend to quickly fall back, if they actually do rise. We know this intuitively–in oil importing nations, deep recessions have been associated with big oil price spikes, such as occurred in the 1970s and in 2008. Economist James Hamilton has shown that 10 out of 11 US recessions since World War II were associated with oil price spikes (Hamilton 2011). Hamilton also showed that the effects of the oil price spike were sufficient to cause the recession of that began in late 2007 (Hamilton 2009).

In this post, I will explore the reasons for these adverse feedback loops. I have discussed many of these issues previously in an academic paper I wrote that was published in the journal Energy, called “Oil Supply Limits and the Continuing Financial Crisis” (available here or here).

If I am indeed right about the path of oil prices being down, rather than up, the long-term direction of the economy is quite different from what most are imagining. Oil companies will find new production increasingly unprofitable, and will distribute funds back to shareholders, rather than invest them in unprofitable operations. In fact, some oil companies are already reporting lower profits (Straus and Reed 2013).  Some oil companies will go bankrupt. As an example, the number two oil company in Brazil, OGX, recently filed for bankruptcy, because it could not profitably find and extract Brazil’s off-shore oil (Lorenzi and Blout 2013).

Oil companies will increasingly find that the huge amount of debt that they must amass in the hope of producing profits sometime in the future is not really sustainable. The Houston Chronicle reports that an E&Y survey of Oil and Gas Companies indicates that the percentage of companies that expect to decrease debt to capital ratios jumped to 48% in October 2013 from 31% a year ago (Eaton 2013). If companies with huge debt loads cut back production to the amount that their cash flow will sustain, oil extraction can be expected to fall–just as it can be expected to fall if oil and gas companies go bankrupt or give back investment funds to shareholders.

The downward path in oil production is likely to be steep, if oil prices do indeed drop. The economy depends on oil for many major functions, including most transportation, agriculture, and construction. Increasingly expensive to extract oil is a sign of diminishing returns. As we utilize more resources for extracting oil (oil, steel, water, human labor, capital, etc.), there will be fewer resources to invest in the rest of the economy, reducing its ability to grow. This lack of economic growth feeds back as low demand, bringing down the prices of commodities, including oil. It is because of this feedback loop that I believe that the path of oil prices is generally lower. This path is the opposite of what a naive reading of “supply and demand” curves from economics textbooks would suggest, and the opposite of what we need if the economy is to continue on its current path.

Adverse Feedback 1: Wages stagnate as oil prices rise, tending to slow economic growth.

Suppose we calculate average US wages over time, by dividing “Total Wages” by “Total Population,” (everyone, not just those working) and bring this amount to the current cost level using the CPI-Urban inflation adjustment. On this basis, US wages flattened as oil prices rose, both in the 1970s and in the 2000s. The average inflation-adjusted wage is 2% lower in 2012 ($22,040) than it was in 2004 ($22,475), even though labor productivity rose by an average of 1.7% per year during 2005-2012, according to the US Bureau of Labor Statistics. Between 1973 and 1982, average inflation-adjusted wages decreased from $17,294 to $16,265 (or 6%), even though productivity reportedly grew by an average of 1.1% per year during this period.

Figure 1. Average US wages compared to oil price, both in 2012$. US Wages are from Bureau of Labor Statistics Table 2.1, adjusted to 2012 using CPI-Urban inflation. Oil prices are Brent equivalent in 2012$, from BP's 2013 Statistical Review of World Energy.

Figure 1. Average US wages compared to oil price, both in 2012$. US Wages are from Bureau of Labor Statistics Table 2.1, adjusted to 2012 using CPI-Urban inflation. Oil prices are Brent equivalent in 2012$, from BP’s 2013 Statistical Review of World Energy.

To see one reason why wages might flatten, consider the situation of a manufacturer or other company shipping goods. The cost of goods, with shipping, would rise simply because of the cost of oil used in transport. Companies using oil more extensively in producing their products would need to raise prices even more, if their profits are to remain unchanged. If these companies simply pass the higher cost of oil on to consumers, they likely will sell fewer of their products, since some consumers will not be able to afford the products at the new higher price. To “fix” the problem of selling fewer goods, companies would likely lay off workers, to reflect the smaller quantity of goods sold–one reason for the drop in wages paid to workers shown on Figure 1. (Note that Figure 1 will reflect reduced wages, whether it results from fewer people working or lower wages of those working.)

Another approach businesses might use to deal with the problem of rising costs due to higher oil prices would be to reduce costs other than oil, to try to keep the total cost of the product from rising. Wages are a big piece of a business’s total costs, so finding a way to keep wages down would be helpful. One such approach would be a wage freeze, or a cut in wages. Another would be to outsource production to a lower cost country. A third way would be to use increased automation. Any of these approaches would reduce wages paid in the United States. The latter two approaches would tend to have the greatest impact on the lowest paid workers. Thus, we would expect increasing wage disparity, together with the flattening or falling wages, as companies try to hold the cost of goods and services down, despite rising oil prices.

The revenue received by businesses and governments ultimately comes from consumers. If the wages of lower-paid consumers flattens, these lower wages can be expected to reduce economic growth, because with lower wages, these workers will have less income to buy discretionary goods and services. The higher-paid workers may have more income, but this won’t necessarily feed back into the economy well–it may inflate stock market prices, but not feed back as spending on goods and services, necessary for growth.

There is even a feedback with respect to debt. The portion of the population with falling inflation-adjusted wages will find it harder to borrow, making it more difficult to buy big-ticket items such as cars and houses.

Adverse Feedback 2: Consumers cut back on discretionary spending because of the higher cost of food and oil, leading to more layoffs and recession.

Clearly, based on Figure 1, consumers cannot expect wage increases to match oil price increases. Even workers who work in the oil industry cannot expect wage increases equal to the increase in the price of oil, because part of the increase in cost comes from the need for more workers per barrel of oil. For example, it is more labor-intensive to extract oil from a large number of small wells, each of which require fracking, than it is to extract oil from a few larger wells, none of which require fracking.

One cost that tends to increase with the cost of oil is the cost of food (Figure 2). The cost of food and the cost of commuting are necessities for most workers. They will cut down on discretionary expenditures, if necessary, to make certain these costs are covered.

Figure 2. FAO Food Price Index versus Brent spot oil price, based on US Energy Information Agency.

Figure 2. FAO Food Price Index versus Brent spot oil price, based on US Energy Information Agency. *2013 is partial year.

If wages are inadequate, workers will cut back in such area as restaurant meals, vacation travel, and charitable contributions, leading to even more problems with a lack of jobs in these and other discretionary sectors.

It might be noted that even countries that export oil can encounter difficulties as oil prices rise. These countries need a way to get the extra revenue from selling high-priced oil over to the many residents who must buy higher-priced food, but do not benefit from the wages paid to oil workers. It is not a coincidence that the Arab Spring uprisings took place in several oil exporting nations in early 2011, when food prices peaked on Figure 2.

Adverse Feedback 3: Higher oil and food prices together with stagnating wages lead to cutbacks in spending for new cars and new homes, falling prices for new homes, defaults on home and car loans, and banks in need of bailouts.

Purchasing more-expensive homes and new cars are types of discretionary spending. If consumers find their incomes are squeezed by high oil prices, they will cut back on  expenditures such as these as well, leading to layoffs in the home construction and auto manufacturing industries.  Such cutbacks can also result in bankruptcies of auto and home builders.

If people buy fewer move-up homes, the price of resale homes will tend to fall. This in turn makes defaults on mortgages more likely. Layoffs will also tend to make defaults on mortgages more likely, as well as missed payments on auto loans.

Figure 3. S&P Case-Shiller 20-City Home Price Index, using seasonally adjusted three month average data. April 2006 is the peak month.

Figure 3. S&P Case-Shiller 20-City Home Price Index, using seasonally adjusted three month average data. April 2006 is the peak month. Data is latest shown on website as of November 2013.

Most people do not associate the drop in US home prices with the rise in oil prices, but the latest rise in oil prices began as early as 2003 and 2004 (see Figure 2), and the drop in home prices began in 2006. Some of the earliest drops in home prices occurred in the most distant suburbs, where oil prices played the biggest role.

Banks increasingly found themselves in financial trouble, as defaults on mortgages and other loans grew. These defaults are often blamed on bad underwriting. While bad underwriting may have played a role (and may also have helped prevent the US from falling into recession even earlier, when oil prices began rising), the falling prices of homes created part of the default problem, as did job layoffs associated with higher oil prices.

All of these feedbacks led to a need for more government involvement–lower interest rates to try to hold the economy together, get spending back up, and raise home prices.

Adverse Feedback 4: Cutbacks in consumer debt combined with flat wages appear to have led to the decline in spending that precipitated the July 2008 drop in oil prices. Consumer debt still remains depressed.

Oil prices started falling in July 2008, and did not hit bottom until the winter of 2008 (Figure 4).

Figure 4. West Texas Intermediate Monthly Average Spot Price, based on us Energy Information Administration data.

Figure 4. West Texas Intermediate Monthly Average Spot Price, based on us Energy Information Administration data.

What could have precipitated such a fall? Many people consider the bankruptcy of Lehman Brothers on September 15, 2008 to be pivotal in the financial crisis of 2008, but the drop in oil prices started months earlier. What could have precipitated such a steep drop in oil prices?

It seems to me that the real underlying cause was a mismatch between what goods cost (such as high food and oil prices) and the amount consumers had available for spending. There are two basic sources of consumer spending–wages and increases in debt. If consumer debt suddenly starts decreasing, rather than increasing, consumer spending can be expected to fall (especially if wages are not rising).

In fact, consumer debt did start falling at precisely the time that oil prices crashed. Mortgage debt started falling in the third quarter of 2008, reflecting a combination of falling home prices and mortgage defaults. As noted previously, both of these were indirectly related to high oil prices.

Figure 5. Us Home Mortgage Debt, based on Federal Reserve Z.1 data.

Figure 5. US Home Mortgage Debt, based on Federal Reserve Z.1 data.

Other consumer debt fell at the same time. Revolving credit (primarily credit card debt) hit a peak in July 2008, and began to fall (Figure 6).

Figure 6. US Revolving Credit outstanding (primarily credit card debt), based on Federal Reserve G.19 Report.

Figure 6. US Revolving Credit outstanding (primarily credit card debt), based on Federal Reserve G.19 Report.

Adverse Feedback 5: Even after high oil prices have been in place for several years, many governments find themselves trapped by the need for deficit spending and ultra-low interest rates to cover up problems with stagnant wages and inadequate demand for homes and cars at “normal” interest rates. 

With the slack in consumer debt, US government debt soared (Figure 7). Governments in Europe and Japan found themselves in a similar bind.

Figure 7. US government publicly held debt, based on Federal Reserve Z.1 data.

Figure 7. US government publicly held debt, based on Federal Reserve Z.1 data.

Even as US Federal Government debt soared, it was not enough to fully make up for the cutback in debt elsewhere in the economy (Figure 8).

Figure 8. US Debt based on Federal Reserve Z.1 data.

Figure 8. US Debt based on Federal Reserve Z.1 data.

How do governments get themselves caught in such a bind? Businesses can to a significant extent overcome their problems with high oil prices by laying off workers and finding lower cost methods of production. Individuals, however, find that the wage problems persist as long as oil prices remain high and businesses have the option of replacing their services with lower cost workers elsewhere. Globalization definitely makes this problem worse.

When workers have job problems, governments find themselves in the unfortunate position of trying to fix the situation by providing more unemployment benefits, food stamps, and disability benefits. Governments also find themselves with lagging tax revenue, because businesses increasingly are located in offshore tax havens, and workers’ incomes are lagging.

Adverse Feedback 6: Rising prices of oil have contributed to long term inflation. If oil prices start falling, this tends to create the opposite problem–deflation. Once oil price deflation starts, it may lead to a self-reinforcing debt default cycle.

Not all inflation is related to higher energy prices, but some of it is. This is one reason the US government sometimes gives an inflation estimate “excluding volatile food and energy prices.” Inflation over the years appears to be one way that a small amount of diminishing returns has fed into the economy.

The concern a person has is that deflation will tend to lead to debt defaults. Clearly lower oil and gas prices mean that oil and gas businesses will become less profitable, and loans in this area will tend to default. But loans related to other types of commodities may tend to default as well. There will also tend to be layoffs in these industries, and in surrounding communities.

Also, with deflation, the low interest rate policies of governments no longer have the stimulating impact that they would have without deflation. So governments will have to concoct negative interest rate plans, and see if they can make these work, to take the place of current plans.

One question is how effective today’s Quantitative Easing and ultra-low interest rate programs have been. We know that they have tended to blow bubbles in asset prices, such as stock market prices. But are ultra-low interest rates part of what allowed oil prices to re-inflate after the July 2008 drop? Certainly, they have helped hold up auto and home sales, and have supported oil drilling operations that rely heavily on debt.

To some extent, the current system appears to be held together with duct tape. It looks like it could fall apart on its own, or it could fall apart as governments try to reduce their deficits by higher taxes and lower spending (See Figure 7). Adding deflation to the combination would seem to be another way of making the current approach for covering up our problems even more vulnerable to collapse.

The frightening thing is that there is already some evidence that oil prices (and commodity prices in general) are starting to trend downward. The chart I showed in Figure 4 showed West Texas Intermediate (WTI) oil prices–a price that is often quoted in the US. On Figure 9, I show WTI oil prices alongside Brent, another oil benchmark. Brent reflects world oil prices to a greater extent than WTI price does. It seems to be showing a recent downward trend in world oil prices. To the extent that this downward trend in prices feeds back into inflation rates and makes Quantitative Easing work less well, this downward trend becomes a potential problem. Its effect would tend to offset the stimulating effect on economies that lower oil prices would normally have.

Figure 9. Brent oil price compared to West Texas Intermediate oil price, based on EIA monthly average spot prices.

Figure 9. Brent oil price compared to West Texas Intermediate oil price, based on EIA monthly average spot prices.

Conclusion

Oil and other fossil fuels are unusual materials. Historically, their value to society has been far higher than their cost of extraction. It is the difference between the value to society and their cost of extraction that has helped economies around the world grow. Now, as the cost of oil extraction rises, we see this difference shrinking. As this difference shrinks, the ability of economies to grow is eroding, especially for those countries that depend most heavily on oil–Japan, Europe, and the United States. It should not be surprising if the growth of these countries slows as oil prices rise. The trend toward globalization can only make this trend worse, because it gives businesses an opportunity to lower wage costs by outsourcing part of their production to lower-cost countries (that use less oil!). When costs are reduced in this manner, businesses are also able get the “benefit” of more lax pollution laws overseas.

We saw in Figure 9 that global oil prices seem already to be trending downward, as growth in countries such as China, Brazil, and India is faltering. At the same time, oil from easy to extract locations is depleting, and oil companies have no choice but move on locations where more resources of all kinds are required, leading to diminishing returns and ever-higher cost of extraction. The way I view our predicament is shown in Figure 10.

Figure 10. Our Oil Price Predicament. Over time, the amount affordable by consumers at a given price falls, while the price required by producers to earn a profit rises.

Figure 10. Our Oil Price Predicament. Over time, if we want to maintain constant oil consumption, the price consumers can afford tends to fall, while the price required by oil producers in order to earn a profit tends to rise.

Over time, in order to maintain constant oil production, the price consumers can afford tends to fall, because governments need to “take back” the huge deficit spending they are using now to prop up the system. At the same time, prices required by producers tend to rise, as the mix of oil production moves to more difficult locations.

While in theory oil prices could spike again because of rising demand of the less developed countries, it is hard to see how this price spike could be sustained. We would likely run into the same problems we had before, with more layoffs and plus credit contraction leading to a cutback in demand in the US, the European Union, and Japan. These users represent a big enough share of the total that their drop in demand would tend to bring world prices back down.

The problem this time, though, is that governments seem to be getting close to being “out of ammunition,” in trying to fight what is really diminishing returns of one of the major drivers of our economy. I don’t know exactly how things might play out, but experience with prior civilizations suggests that “collapse” might be a reasonable description of the outcome.

Energy Products: Return on Investment is Already Too Low

Off the keyboard of Gail Tverberg

Published on Our Finite World on June 24, 2013

oilwell

Discuss this article at the Epicurean Delights Smorgasbord inside the Diner

My major point when I gave my talk at the Fifth Biophysical Economics Conference at the University of Vermont was that our economy’s overall energy return on investment is already too low to maintain the economic system we are accustomed to. That is why the economy is showing signs of heading toward financial collapse. Both a PDF of my presentation and a podcast of the talk are available on Our Finite World, on a new page called Presentations/Podcasts.

My analysis is with respect to the feasibility of keeping our current economic system operating. It seems to me that the problems we are experiencing today–governments with inadequate funding, low economic growth, a financial system that cannot operate with “normal” interest rates, and stagnant to falling wages–are precisely the kinds of effects we might expect, if energy sources are providing an inadequate energy return for today’s economy.

Commenters frequently remark that such-and-such an energy source has an Energy Return on Energy Invested (EROI) ratio of greater than 5:1, so must be a helpful addition to our current energy supply. My finding that the overall energy return is already too low seems to run counter to this belief. In this post, I will try to explain why this difference occurs. Part of the difference is that I am looking at what our current economy requires, not some theoretical low-level economy. Also, I don’t think that it is really feasible to create a new economic system, based on lower EROI resources, because today’s renewables are fossil-fuel based, and initially tend to add to fossil fuel use.

Adequate Return for All Elements Required for Energy Investment

In order to extract oil or create biofuels, or to make any other type of energy investment, at least four distinct elements described in Figure 1: (1) adequate payback on energy invested,  (2) sufficient wages for humans, (3) sufficient credit availability and (4) sufficient funds for government services. If any of these is lacking, the whole system has a tendency to seize up.

Figure 1. One sheet from Biophysical Economics Conference Presentation

Figure 1. One sheet from Biophysical Economics Conference Presentation

EROI analyses tend to look primarily at the first item on the list, comparing “energy available to society” as the result of a given process to “energy required for extraction” (all in units of energy). While this comparison can be helpful for some purposes, it seems to me that we should also be looking at whether the dollars collected at the end-product level are sufficient to provide an adequate financial return to meet the financial needs of all four areas simultaneously.

My list of the four distinct elements necessary to enable energy extraction and to keep the economy functioning is really an abbreviated list. Clearly one needs other items, such as profits for businesses. In a sense, the whole world economy is an energy delivery system. This is why it is important to understand what the system needs to function properly.

 

What Happens as Oil Prices Rise

When oil prices rise, wages for humans seem to fall, or at least stagnate (Figure 2, below). The comparison shown uses per capita wages, so takes into account changes in the proportion of people with jobs as well as the level of wages.

Figure 2. High oil prices are associated with depressed wages. Oil price through 2011 from BP’s 2012 Statistical Review of World Energy, updated to 2012 using EIA data and CPI-Urban from BLS. Average wages calculated by dividing Private Industry wages from US BEA Table 2.1 by US population, and bringing to 2012 cost level using CPI-Urban.

Figure 2. High oil prices are associated with depressed wages. Oil price through 2011 from BP’s 2012 Statistical Review of World Energy, updated to 2012 using EIA data and CPI-Urban from BLS. Average wages calculated by dividing Private Industry wages from US BEA Table 2.1 by US population, and bringing to 2012 cost level using CPI-Urban

In fact, if we analyze Figure 2, we see that virtually all of the rise in US wages came in periods when oil prices were below $30 per barrel, in inflation-adjusted terms. The reason why this happens is related to the drop in corporate profits that can be expected if oil prices rise, and businesses fail to respond. Let me explain this further with Figure 3, below.

Figure 3. Illustration by author of ways oil price rise could squeeze wages. Amounts illustrative, not based on averages.

Figure 3. Illustration by author of ways oil price rise could squeeze wages. Amounts illustrative, not based on averages.

Figure 3 is a bit complicated. What happens initially when oil prices rise, is illustrated in the black box at the left. What happens is that the business’ profits fall, because oil is used as one of the inputs used in manufacturing and transportation. If the cost of oil rises and the sales price of the product remains unchanged, the company’s profits are likely to fall. Additionally, there may be some reduction in demand for the product, because the discretionary income of consumers is reduced because of rising oil prices. Clearly, the business will want to fix its business model, so that it can again make an adequate profit.

There are three ways that a business can bring its profits back to a satisfactory level, illustrated in the last three columns of Figure 3. They are

  • Automation. Human energy is the most expensive type of energy a business can employ, because wages to paid to humans to do a given process (such as putting a label on a jar) are far higher than the cost of an electricity-based process to perform the same procedure. Thus, if a firm can substitute electrical or oil energy for human energy, its cost of production will be lower, and profits can be improved. Of course, workers will be laid off in the process, reducing total wages paid.
  • Outsourcing to a Country with Lower Costs. If part of the production cost can be moved to a country where wage costs are lower, this will reduce the cost of manufacturing the product, and allow the business to offset (partially or fully) the impact of rising oil prices. Of course, this will again lead to less US employment of workers.
  • Make a Smaller Batch. If neither of the above options work, another possibility is to cut back production across the board. Even if oil prices rise, there are still some consumers who can afford the higher prices. If a business can cut back in the size of its operations (for example, close unprofitable branches or fly fewer airplanes), it can cut back on outgo of many types: rent, energy products used, and wages. With reduced output, the company may be able to make an adequate profit by selling only to those who can afford the higher price.

In all three instances, an attempt to fix corporate profits leads to a squeeze on human wages–the highest cost source of energy services that there is. This seems to be Nature’s  attempt way of rebalancing the system, toward lower-cost energy sources.

If we look at the other elements shown in Figure 1, we see that they have been under pressure recently as well. The availability of  credit to fund new energy investment is enabled by profits that are sufficiently high that they can withstand interest charges incurred in the payback of debt. Debt use is also enabled by growth, since if profits will be higher in the future, it makes sense to delay funding until the future. In recent years, central governments have seen a need to put interest rates at artificially low levels, in order to encourage borrowing. To me, this is a sign that the credit portion of the system is also under pressure.

Government’s ability to fund its own needs has been under severe stress as well. Part of the problem comes from the inability of workers to pay adequate taxes, because their wages are lower. Part of the problem comes from a need for governments to pay out more in benefits, such as disability income, unemployment, and food stamps. The part that gets most stressed is the debt portion of government funding. This really represents the intersection of two different areas mentioned in Figure 1: (3) Adequacy of credit availability and (4) Funding for government services.

The constellation of energy problems we are now experiencing seems to me to be precisely what might be expected, if energy return is now, on average, already too low.

The Role of Energy Extraction in this Squeeze

When any energy producer decides to produce energy of a given type (say oil or uranium), the energy producer will look for the resource that can be extracted at lowest cost to the producer.

Figure 4. Resource triangle, with dotted line indicating uncertain financial cut-off.

Figure 4. Resource triangle, with dotted line indicating uncertain financial cut-off.

Initially, production starts where costs are most affordable–not much energy is required for extraction; governments involved do not require too high taxes; and the cost of human labor is not too high. The producer may need debt financing, and this must also be available, at an affordable cost.

As the least expensive energy is extracted, later producers wishing to extract energy must often settle for higher cost extraction. In some cases, technology advancements can help bring costs back down again. In others, such as recent oil extraction, the higher costs are firmly in place. Higher sales prices available in the market place enable production “lower in the triangle.”  The catch is that these higher oil prices lead to stresses in other systems: human employment, government funding, and ability for credit markets to work normally.

What Is Happening on an Overall Basis

Man has used external energy for a very long time, to raise his standard of living. Man started over 1,000,000 years ago with the burning of biomass, to keep himself warm, to cook food, and for use in hunting.  Gradually, man added other sources of energy. All of these sources of energy allowed man to accomplish more in a given day. As a result of these greater accomplishments, man’s standard of living rose–he could have clothes, food which had been cooked, sharper tools, and heat when it was cold.

Over time, man added additional sources of energy, eventually including coal and oil. These additional sources of energy allowed man to leverage his own limited ability to do work, using his own energy.  Goods created using external energy tended to be less expensive than those made with only human energy,  allowing prices to drop, and wages to go farther. Food became more available and cheaper, allowing population to rise. Money was also available for public health, allowing more babies to live to maturity.

What happened shortly after the year 2000 was a sharp “bend” in the system. Instead of goods becoming increasingly inexpensive, they started becoming relatively more expensive relative to the earnings of the common man. There seem to be two reasons for this: (1) In the early 2000s, oil prices started rising, and these higher prices started exerting an upward force on the price of goods. At the same time, (2) globalization took off, providing downward pressure on wages. The result was that suddenly, workers found it harder to keep a job, and even when they were working, wages were stagnant.

It seems to me that prior to the year 2000, part of what buoyed up the system was the large difference between:

A. The cost of extracting a barrel of oil

B. The value of that barrel of oil to society as a whole, in terms of additional human productivity, and hence additional goods and services that barrel of oil could provide.

As oil prices rose, this difference started disappearing, and its benefit to the world economy started going away.  The government became increasingly stressed, trying to provide for the many people without jobs while tax revenue lagged.  Slower economic growth made the debt system increasingly fragile. The economy was gradually transformed from one which provided perpetual growth, to one where citizens were becoming poorer and poorer. This pushed the economy in the direction of collapse.

A More Complete List of Inputs that Need Adequate Returns

My original list was

  1. Energy counted in EROI calculation–mostly fossil fuels, sometimes biomass used as a fuel
  2. Human labor
  3. Credit system
  4. Cost of government

To this we probably need to add:

  1. Profits for corporations involved in these processes
  2. Rent for land used in the process – this cost would be highest in biofuel operations.
  3. Costs to prevent pollution, and mitigate its effects – not charged currently, except as mandated by law
  4. Compensation for mineral depletion and degradation of soil. Degradation of soil would likely be an issue for biofuels.
  5. Energy not counted in EROI calculations. This is mostly “free energy” such as solar, wind, and wave energy, but can include energy which is of limited quantity, such as biomass energy.

Given the diversity of items in this list, it is not clear that simply keeping EROI above some specified target such as 5:1 is likely to provide enough “margin” to cover the financial return needed to properly fund all of these elements. Also, because the need for government services tends to increase over time as the system gets more stressed, if there is an EROI threshold, it needs to increase over time.

It might also be noted that the amounts paid for government services are surprisingly high for fossil fuels. Barry Rodgers gave some figures regarding “government take” (including lease fees as well as other taxes and fees) in the May 2013 Oil and Gas Journal. According to his figures, the average government take associated with an $80 barrel of US tight oil is $33.29 per barrel. This compares to capital expenditures of $22.60 a barrel, and operating expenditures of $7.50 a barrel. If we are to leave fossil fuels, we would need to get along without the government services funded by these fees, or we would need to find a different source of government funding.

Source of the EROI 5:1 Threshold

To my knowledge, no one has directly proven that a 5:1 threshold is sufficient for an energy source to be helpful to an economy. The study that is often referred to is the 2009 paper, What is the Minimum EROI that a Sustainable Society Must Have? (Free for download), by Charles A. S. Hall, Steven Balogh, and David Murphy. This paper analyzes how much energy needs to provided by oil and coal, if the energy provided by those fuels is to be sufficient to pay not just for the energy used in its own extraction, but also for the energy required for pipeline and truck or train transportation to its destination of use. The conclusion of that paper was that in order to include these energy transportation costs for oil or coal, an EROI of at least 3:1 was needed.

Clearly this figure is not high enough to cover all costs of using the fuels, including the energy costs to build devices that actually use the fuels, such as private passenger cars, electrical power plants and transmission lines, and devices to use electricity, such as refrigerators. The ratio required would probably need to be higher for harder-to-transport fuels, such as natural gas and ethanol. The ratio would also need to include the energy cost of schools, if there are to be engineers to design all of these devices, and factory workers who can read basic instructions. If the cost of government in general were added, the cost would be higher yet. One could theoretically add other systems as well, such as the cost of maintaining the financial system.

The way I understood the 5:1 ratio was that it was more or less a lower bound, below which even looking at an energy product did not make sense. Given the diversity of what is needed to support the current economy, the small increment between 3 and 5 is probably not enough–the minimum ratio probably needs to be much higher. The ratio also seems to need to change for different fuels, with many quite a bit higher.

The Add-On Problem for Fossil Fuel Based Renewables

With renewables made using fossil fuels, such as hydroelectric, wind turbines, solar PV, and ethanol, the only way anyone can calculate EROI factors is as add-ons to our current fossil fuel system. These renewables depend on the fossil fuel system for their initial manufacture, for their maintenance, and for the upkeep of all the systems that allow the economy to function. There is no way that these fuels can power the whole system, based on what we know today, within the next hundred years. Thus, any EROI factor is misleading if viewed as the possibility what might happen if these fuels were to attempt to operate on a stand-alone basis. The system simply wouldn’t work–it would collapse.

A related issue is the front-ended nature of the fossil fuels used in creating most of today’s renewables. People today think of “financing” any new investment, with easy payments over a period of years. The catch (as Tom Murphy pointed out in his BPE talk) is that Nature Doesn’t Do Financing. Nature demands up-front payment in terms of any fossil fuels used. Thus, if we build a huge new hydroelectric dam, such as the Three Gorges Dam in China, the fossil fuels required to make the concrete and to move huge amounts of soil come at the beginning of the project. This is also true if we make a huge number of solar panels. The saving we get are all only theoretical, and will take place only if we are actually able reduce the use of  other fossil fuel energy sources in the future, because of the energy from the PV panels or other new renewable.

In nearly all cases, adding renewables requires increasing fossil fuel use for this reason. We could, in theory, reduce fossil fuel use elsewhere, to try to cover the greater fossil fuel use to add renewables, but this would mean cutting industries and jobs currently using the fuel, something that many find objectionable. Several readers have suggested that we could greatly ramp-up solar PV. Yes, we could, but we would have to greatly ramp up fossil fuel usage (mostly coal in China, if current manufacturing approaches are used) to create these panels. Any future savings would be theoretical, depending on how long we keep the new system operating, and how much fossil fuel energy consumption is actually reduced as a result of the new panels.

How High Oil Prices Lead to Recession

Off  the keyboard of Gail Tverberg

Published on Our Finite World on January 24, 2013

Discuss this article at the Epicurean Delights Smorgasbord inside the Diner

There is ample evidence that spikes in oil prices leads to recession, at least in the US, which is an oil-importing nation. James Hamilton has shown that 10 out of the last 11 US recessions were associated with oil price spikes. How does this happen? An analogy can perhaps help explain the situation. This analogy also sheds light on a number of related economic mysteries:

  1. How can oil have a far greater impact on the world economy than its share of the world GDP would suggest? After all, BP’s World Energy Outlook to 2030 shows the world cost of oil is only a little over 4% of world GDP.
  2. How can high oil prices continue to act as a “drag” on the economy, long after the initial spike is past?
  3. Why isn’t a service economy insulated from the problems of high oil prices? After all, its energy use is relatively low.

The Oil Analogy

An oil product, such as jet fuel, is in some ways analogous to a specialized employee, with skills different from what human employees have. Let’s think of an airline. It has human employees–pilots, copilots, flight attendants, baggage workers, mechanics, and airport check-in personnel. None of these human employees can actually provide the energy to make the jet fly, however. It takes jet fuel to do that.

What happens if the price of jet fuel triples? Jet fuel is now more that than triple the price (near $3.00 gallon) it was in the late 1990s (under $1.00 gallon, at today’s prices).

Figure 1. Jet fuel price in December 2012 $. Jet fuel price per gallon is Spot Gulf Coast price from EIA; price adjustment based on CPI-Urban, from US Bureau of Labor Statistics.Figure 1. Jet fuel price in December 2012 $. Jet fuel price per gallon is Spot Gulf Coast price from EIA; price adjustment based on CPI-Urban, from US Bureau of Labor Statistics.

The high cost of jet fuel is analogous to the jet fuel employees’ union demanding triple the wages they were paid previously. So what is the airline to do? With very high aviation fuel prices, many tourists who might buy airline tickets will be “priced out” of the market for long distance travel. The airline can sell some airline tickets at higher prices, but not as many.

One thing airlines can do is to cut the number of flights, taking the least fuel-efficient planes out of service and reducing flights on routes with the most unfilled seats. According to a recent Wall Street Journal article, airlines spend 34% of revenue on fuel. With such a high fuel cost, even with these changes, airline ticket prices will remain high. But perhaps with fewer flights, the airline can make a profit.

If an airline cuts its number of flight, this leads to an “across the board” cut in the goods and services the airline buys. The airline will use less jet fuel (and thus use fewer “jet fuel employees”). If it is able to retire quite a few fuel-inefficient jets, “jet fuel employees” will be cut to a greater extent than human employees. It will use fewer human workers, at all levels: pilots, copilots, flight attendants, and ground workers of all types. The airline will reduce its electricity usage because it needs fewer gates in airports for its operations. The airline will also need less gasoline because it will operate fewer baggage-transport vehicles and other ground vehicles.

In many ways, the airline is simply shrinking in size to reflect reduced demand for its high-priced services. When this happens in multiple industries, the result looks very much like recession. I described this situation earlier in a post called How is an oil shortage like a missing cup of flour?. In that post, I said that if oil supplies are short, the situation is not too different from a baker who does not have enough flour to make a full batch of cookies. If he still wants to make cookies, he needs to make a smaller batch, and so needs to cut back on all of the other ingredients as well.

 

Other Changes an Airline Can Make to Fix Profitability

Apart from cutting back on the number of flights and retiring inefficient jets in the process, there are other things an airline can do to offset the higher “wages” demanded by the jet fuel employees union. One is to reduce the wages of human workers. For example, wages and pension plans of pilots can be cut back, or hours lengthened. Wages of other workers can be frozen or cut back.

Another approach is a merger with another airline, so that “redundant” employees can be eliminated, and flights can perhaps be cut back further. Of course, these layoffs and cutbacks in wages will add to recessionary impacts, because these workers will have less discretionary income.

A third approach to restoring profitability is to automate some of the functions previously handled by human employees. In this case, electricity is used to substitute for human workers. We can think of this automation as substituting new “electrical employees” (analogous to the “jet fuel employees”) for human employees. Relative to the amount of physical work (pushing buttons, moving luggage, etc.) humans can do, humans are far higher paid than either “oil employees” or “electricity employees”. If we assume that the energy of humans is similar to that used by a 100 watt light bulb, at $20,000 a year, humans are paid roughly 1,500 times as much as “oil employees” and 3,500 times as much as “electricity” employees, to do equivalent physical work. So if automation is an option, it almost always saves money.

A fourth way an airline can reduce costs is by purchasing lighter, more fuel-efficient jets. Making a transition of this type takes a long time. Boeing’s Dreamliner 787 is an attempt in this direction, with a 20% fuel savings anticipated. Boeing has over 800 jets of this type on order, but the 50 already in use have been grounded until battery problems are resolved. Quite a few changes have been made in the new jet, so there is a possibility of additional problems also needing to be ironed out, before production ramps up as planned.

Another Example: Asphalt

Asphalt is another product whose consumption has dropped in recent years.

Figure 2. Trends in US Fuel Consumption by Type, with 1994 = 1.0, based on EIA data.Figure 2. Trends in US Fuel Consumption by Type, with 1994 = 1.0, based on EIA data.

The amount of asphalt produced in 2012 was only about 70% as much as was produced in 1994. The reason for the shortfall in asphalt is partly because at current high oil prices, refineries can make more profit by selling high-valued products like gasoline, diesel, and jet fuel than they can make by selling asphalt. A recent EIA article titled, Hydrocracking is an important source of diesel and jet fuel, makes the statement, “A refinery’s ability to upgrade low-value products into high-value products and convert high-sulfur material to low-sulfur material with a secondary unit like a hydrocracker plays a key role in determining its economic fate.”

State budgets are tight for a variety of reasons, including inadequate gasoline taxes to cover the cost of maintaining roads. While part of the need for asphalt can be obtained from recycling, many governments are finding that today’s asphalt costs are so high that concrete roads would be cheaper in the long run. Many states have found it necessary to go back to gravel on some of the smaller roads, because of the high cost of paving today. State and local budgets are likely to be stretched even farther if the US government solves its budget woes by sending programs back to the states, and lets the states work out the funding.

What happens when a state decides move some roads from asphalt back to gravel? For one thing, jobs lost in the road paving business. Also, the new gravel roads have an uneven surface, providing more rolling resistance, so automobile and truck mileage is poorer. In addition, roads tend to degrade more quickly, keeping long-term maintenance costs high. If budgets are tight and roads are not maintained, there is a chance gravel roads will become unusable.

If local governments continue to use asphalt for paving (or switch to concrete, which has even higher initial costs, but lasts longer), they find a need to cut back on other types of services they provide, if they are to avoid a tax increase. This leads to services such as library hours being cut. Cutting back on services reduces both wages and energy costs (lighting and heating/cooling costs). The effect is not all that different from what happens in the airline industry: cuts are made that affect both wages and energy usage of many types. Employee wages seem to be especially affected because changes in employee hours can be made more easily than, say, closing a building or running fewer school buses.

The More General Problem

It is not just airlines and users of asphalt that cut back because of high oil prices. The story plays out in different ways in many industries. Clearly any restaurant is at risk if high oil prices cause consumers to cut back on discretionary purchases, because reducing the frequency of eating out is an easy way of reducing discretionary expenditures. If restaurants have fewer customers, some restaurants will close and are not replaced. This is the restaurant industry’s way of “making a smaller batch”. The result is fewer jobs, less oil use, and less use of resources in general.

Another type of discretionary purchase that gets cut when oil prices are high is the purchase of a new car. A recent article by the New York Times says that the recovery of auto sales since the recent recession has been very slow, with charts for several countries. Reduced car sales is yet another example of making a “smaller batch.” The result is fewer jobs, less use of oil, and less use of many other types of resources.

A similar story can be told about new home sales. These dropped in the recent recession, and have been slow to recover. The drop-off is frequently attributed to the housing bubble bursting, but rising oil prices played an important role as well. When oil prices increased in the 2004-2005 period, the Federal Reserve raised interest rates, trying to cut oil prices. Instead, the higher interest rates together with lower discretionary income from high oil prices led to lower housing prices, starting in 2006. (See my article from the journal Energy, here or here.)

The Economic Implications of High Oil Prices

Our economy is all about “adding value”. But where does this value added come from? To a significant extent, this value comes from adding external energy of some sort. It is really the “energy employees” I mentioned earlier that add this value. Human workers are needed as well, but with automation, the number of human workers required tends to decline.

The ability of external energy to add value is what causes the link between GDP, energy consumption, and oil consumption. Oil plays a special role, because it is easily transported, and can be used in many situation where electricity or some other form of energy (such as human energy, wind energy, or natural gas) would not work.

If we look at a graph of changes GDP compared to changes in world oil and energy usage, (Figure 3, below), we see that all three tend to rise and fall together. In fact, changes in oil and energy usage appear to slightly precede GDP changes. This is the pattern we would expect, if economics are causing a “smaller batch” to be made when oil prices are high.

Figure 3. World growth in energy use, oil use, and GDP (three year averages). Oil and energy use based on BP's 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.Figure 3. World growth in energy use, oil use, and GDP (three-year averages). Oil and energy use based on BP’s 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.

Part of this change may simply reflect a transfer of energy use from less efficient industries (ones using more high-priced oil in their fuel mix) to more efficient industries (ones using less high-priced oil in their fuel mix). If could also reflect a shift in oil and energy distribution to more less efficient countries (ones using more high-priced oil in their fuel mix) to more efficient countries (ones using less high-priced oil in their fuel mix). For example, Greece (which specializes in vacation tourism, and which uses much oil in its energy mix) would be expected to be an oil/energy loser (Figure 4, below).

Figure 4. Greece's growth in energy use, oil use, and GDP (three year averages). Oil and energy use based on BP's 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.Figure 4. Greece’s growth in energy use, oil use, and GDP (three-year averages). Oil and energy use based on BP’s 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.

China (which uses much coal in its energy mix and thus keeps costs low, and specializes in inexpensive manufacturing) would be expected to be an oil/energy gainer (Figure 5, below). See my posts, Energy Leveraging: An Explanation for China’s Success and the World’s Unemployment and Why Coal Consumption Keeps Rising, for discussion of this issue.

Figure 5. China's growth in energy use, oil use, and GDP (three year averages). Oil and energy use based on BP's 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.Figure 5. China’s growth in energy use, oil use, and GDP (three-year averages). Oil and energy use based on BP’s 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.

High prices work together with a number of other factors (including increased automation and increased competition from countries with lower wages) to force wages of humans down, and to reduce the number with jobs. The proportion of US citizens with jobs started declining about the year 2000 and accelerated with the recent recession:

Figure 6. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census.  2012 is partial year estimate.Figure 6. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census. 2012 is partial year estimate.

If we look at the ratio of wages (broadly defined, including proprietors’ income and taxes paid on behalf of employees by employers, but not including transfer payments, such as Social Security payments and Unemployment Insurance) to GDP in Figure 7, below, we see that the ratio of wages to GDP has been dropping since 2000–another indication that human wages are not keeping up with the rest of the economy.

Figure 7. 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.Figure 7. Wage Base (defined as the 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 “Energy Employees” Are Really Doing Most of the Work

If it is really the “energy employees” doing most of the work, then the models used by many economists today are not really correct, and some of the standard beliefs based on these model aren’t right either. For example:

1. The idea that the value of oil or other energy to the economy is proportional to its price doesn’t hold. This can be seen from the examples provided. In fact, if oil or another needed energy product is removed, very close to no work gets done. Humans can provide a little energy, but compared to the energy of oil or electricity, our efforts are puny, and very high-priced. Without external energy, humans’ efforts are limited to tasks like digging with a stick in the ground, or making baskets with reeds that they have gathered.

2. One type of energy doesn’t necessarily substitute easily for another type of energy. Just as one type of employee (mechanic, airline pilot, or flight attendant) can’t necessarily be substituted for another, one type of energy cannot necessarily be substituted for another. Dreamliner’s battery problems illustrate that even trying to substitute a little more electrical energy for oil energy can provide a technological challenge.

3. Somewhat surprisingly, high oil prices remain a drag on the economy permanently, because the high wages of the “oil employees” remain. Output isn’t any higher with these higher wages, so there is not a proportional benefit to society from these higher oil wages. More human workers may be hired in the oil extraction process (often in another country). But even if more workers are hired in the same country, their output does not replace the entirely different kind of output that is provided by the (now-unaffordable to many) high-priced oil.

Another factor in the slow uptake of high oil prices is the fact that governments can temporarily hide some of the effects of high-priced oil through unemployment benefits and stimulus programs. This temporary cover-up cannot continue for long, though, because governments (such as the US and other oil importers) soon run into problems with high deficits (as is happening now). When governments raise taxes or reduce benefits to solve their financial problems, the deferred high-priced oil problems return, showing that the problem never really left.

4. An economy which is mostly services, is not insulated from the problem of high oil prices. Both the airline and asphalt examples illustrate how high oil costs can circulate through the economy and disrupt discretionary spending, even in the US. (Also see Ten Reasons Why High Oil Prices are a Problem.)

Services tend to be the “fluff” of society because for the most part, because we could live without them, at least temporarily. For now, we have a temporary respite from oil-price impacts because of high deficit spending by governments. If governments are forced to balance their budgets, cutbacks seem likely in many areas of services, including medicine for the elderly, higher education, and government-sponsored research programs. If cutbacks occur in areas such as these, we can expect that GDP will shrink faster than savings in oil and energy use–a reversal of what has happened in the past, and a reversal of what many economists have come to expect in the future.

Also, contrary to popular belief, we cannot increase the economy very much by simply selling services that do not require energy to one another. It really takes “energy employees” to play their role as well. Without external energy, we can dig in each others’ back yards with sticks, but this activity doesn’t add much to the economy. We need “energy employees” playing their role as well, if we are to have computers, and metal scissors, and the many other tools we expect, even in a service economy.

2013: The End of the Beginning

Off the keyboard of Gail Tverberg

Published on Our Finite World on January 6, 2013

Discuss this article at the Epicurean Delights Smorgasboard inside the Diner

We have been hearing a lot about escaping the fiscal cliff, but our problem isn’t solved. The fixes to date have been partial and temporary. There are many painful decisions ahead. Based on what I can see, the most likely outcome is that the US economy will enter a severe recession by the end of 2013.

My expectation is that credit markets are likely see increased defaults, as workers find their wages squeezed by higher Social Security taxes, and as government programs are cut back. Credit is likely to decrease in availability and become higher-priced. It is quite possible that credit problems will adversely affect the international trade system. Stock markets will tend to perform poorly. The Federal Reserve will try to intervene in credit markets, but if the US government is one of the defaulters (at least temporarily), it may not be able to completely fix the situation.

Less credit will tend to hold down prices of goods and services. Fewer people will be working, though, so even at reduced prices, many people will find discretionary items such as larger homes, new cars, and restaurant meals to be unaffordable. Thus, once the recession is in force, car sales are likely to drop, and prices of resale homes will again decline.

Oil prices may temporarily drop. This price decrease, together with a drop in credit availability, is likely to lead to a reduction in drilling in high-priced locations, such as US oil shale (tight oil) plays.

Other energy sources are also likely to be affected. Demand for electricity is likely to drop. Renewable energy investment is likely to decline because of less electricity demand and less credit availability. By 2014 and 2015, less government funding may also play a role.

This recession is likely be very long term. In fact, based on my view of the reasons for the recession, it may never be possible to exit from it completely.

I base the foregoing views on several observations:

1. High oil prices are a major cause of the United States Federal Government’s current financial problems. The financial difficulties occur because high oil prices tend to lead to unemployment, and high unemployment tends to lead to higher government expenditures and lower government revenue. This is especially true for oil importers.

Figure 1. US Government Income and Outlay, based on historical tables from the White House Office of Management and Budget (Table 1.1). *2012 is estimated. http://www.whitehouse.gov/omb/budget/HistoricalsFigure 1. US Government Income and Outlay, based on historical tables from the White House Office of Management and Budget (Table 1.1). *2012 is estimated by OMB. http://www.whitehouse.gov/omb/budget/Historicals

2. The United States and world’s oil problems have not been solved. While there are new sources of oil, they tend to be sources of expensive oil, so they don’t solve the problem of high-priced oil. Furthermore, if our real economic problem is high-priced oil, and we have no way of permanently reducing oil prices, high oil prices can be expected to cause a long-term drag on economic growth.

3. A cutback in discretionary spending is likely. US workers are already struggling with wages that are not rising as fast as GDP (Figure 2). Starting in January, 2013, US workers have the additional problem of rising Social Security taxes, and later this year, a likely cutback in government expenditures. The combination is likely to lead to a cutback in discretionary spending.

Figure 2. 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.Figure 2. Wage Base (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.

4. The size of our current financial problems, both in terms of US government income/outgo imbalance and debt level, is extremely large. If high oil prices present a permanent drag on the economy, we cannot expect economic growth to resume in a way that would fix these problems.

5. The financial symptoms that the US and many other oil importers are experiencing bear striking similarities to the problems that many civilizations experienced prior to collapse, based on my reading of Peter Turchin and Sergey Nefedov’s book Secular Cycles. According to this analysis of eight collapses over the last 2000 years, the collapses did not take place overnight. Instead, economies moved from an Expansion Phase, to a Stagflation Phase, to a Crisis Phase, to a Depression/Intercycle Phase. Timing varies, but typically totals around 300 years for the four phases combined.

It appears to me that the corresponding secular cycle for the US began in roughly 1800, with the ramp up of coal use. Later other modern fuels, including oil, were added. Since the 1970s, the US has mostly been experiencing the Stagflation Phase. The Crisis Phase appears to be not far away.

The Turkin analysis started with a model. This model was verified based on the experiences of eight agricultural civilizations (beginning dates between 350 BCE and 1620 CE). While the situation is different today, there may be lessons that can be learned.

Below the fold, I discuss these observations further.

 

Issue 1. High oil prices tend to lead to government financial problems.

Food prices tend to rise at the same time as oil prices, partly because oil is used in the production of food (for example, plowing, irrigation, herbicides and insecticides, harvesting, transport to market). Also, because oil is in short supply, corn is now being grown for use as ethanol to be used as a gasoline-extender. Growing additional corn puts pressure on food prices, because it drives up the price of land and encourages farmers to put more land into corn production, and less into other crops.

The reason governments are affected by high oil and food prices is as follows. When oil and food prices rise, buyers cut back in discretionary spending, so as to have enough for “basics,” including food and commuting expenses. Workers are laid off in discretionary industries, such as vacation travel and restaurants. These laid off-workers pay less taxes, and sometimes default on loans. Governments are quickly drawn into these problems, for two reasons:

  1. Their tax revenue is lower, because of layoffs in discretionary sectors.
  2. Their expenditures are higher, because of the need to pay more unemployment benefits, provide economic stimulus, and bail out banks.

Oil importers are especially affected, because they are also paying out funds to oil exporters. The countries with well-publicized financial problems (including several European countries, the United States, and Japan) tend to be major oil importers.

Oil exporters are not adversely affected to the same extent, because they have additional revenue from higher prices on oil they are exporting. They may still be somewhat affected because of rising food prices, and the fact that higher oil revenues do not necessarily go to those buying food. A recent study shows that food shortages helped trigger the Arab Spring protests.

Part of the reason that the impact of high oil prices is as severe as it is, is because there are many follow-on effects. For example, if oil prices rise, the price of shipping goods of all types rises. If businesses are able to pass through these higher costs, discretionary income of buyers for other goods falls. If not, businesses find that their higher costs lead to lower profits. To bring profit margins back up to an acceptable level, businesses may lay off workers.

As another example, prices of homes are likely to be adversely affected by high oil prices, because a family with inadequate discretionary income will forgo moving to a larger home, and may even default on a mortgage.

It should be noted that the impact of high oil prices doesn’t completely go away unless oil prices go down and stay down. Businesses can partly mitigate the impact of high oil prices by laying off workers in discretionary segments. Some businesses will fail completely, however. Replacement may be by an overseas company, with a lower cost structure that uses less oil. See my post on energy leveraging.

Workers generally must permanently adjust their budgets to higher food and oil prices. This is often difficult to do. The lack of jobs is a particular problem–something that workers cannot fix by themselves. Government programs can mitigate the job shortfall, by paying benefits to unemployed workers and by reducing interest rates, so that businesses can more easily make investments that will lead to more employment. These programs are costly, though, and are a major cause of the current mismatch between government income and expense.

Issue 2. World oil problems have not been solved.

There have been a number of reports this years, such as one by the International Energy Agency, seeming to suggest that the world oil problem has been solved. These analyses are incomplete. They do not recognize that our real problem is a financial problem. Our economy (everything from interstate highways to electric transmission to Social Security programs) was put in place using cheap ($10 or $20 barrel) oil. Shifting to today’s high cost of oil (up near $100 barrel) causes severe economic dislocations. There is no more cheap oil to be found, however, because oil companies extracted the cheapest to extract oil first and now the “easy oil” is gone.

The impression one gets from reading the papers is that US oil production is having a huge impact on world oil production. If a person looks at the numbers, world oil production is close to flat. Rising US production makes up for falling European production, but doesn’t do a whole lot more.

Figure 3. World crude oil production, based on EIA data. *2012 estimated based on partial year data.Figure 3. World crude oil production, based on EIA data. *2012 estimated based on partial year data.

The rise in United States oil production is indeed somewhat helpful, but we are still many years away from being “energy independent” and even farther from becoming “oil independent.” The real issue is high oil prices, and these are not being fixed.

Figure 4. 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. Figure 4. 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.

Our financial problems are here and now, in 2013. Promises of hoped-for higher oil production in several years at a still very high price don’t fix today’s financial problems. In fact, they will likely continue to contribute to financial problems in the future.

Issue 3. Declining wages and increased taxes can be expected to lead to a decline in discretionary spending.

As indicated at the beginning of the post, wages (including earnings of businesses owners considered as “proprietors,” but not including “transfer payments” such as Social Security and unemployment insurance) have not been growing as fast as GDP since 2000. Below is a repeat of Figure 2 shown at top of post.

Figure 2. 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.Figure 2. Wage Base (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.

There seem to be several reasons behind this decline. One reason, already mentioned, is high oil prices leading to US layoffs, because of decreased discretionary expenditures.

Another reason for the decline is increased automation. Electricity can often be substituted for human labor, reducing costs, but also reducing jobs. Economists seem to term this change higher labor productivity. They also seem to believe that new jobs will appear from somewhere, but in practice, this is not happening. Instead, lack of jobs is part of what is leading to recessionary influences.

Another reason for the decline is increased competition from countries with lower labor costs and lower fuel costs. China joined the World Trade Organization in December 2001, and its manufacturing (and thus use of fuels) increased dramatically shortly thereafter.

Figure 5. China's energy consumption by source, based on BP's Statistical Review of World Energy data. Figure 5. China’s energy consumption by source, based on BP’s Statistical Review of World Energy data.

Another reason is demographic. Baby boomers are reaching retirement age. This has already begun affecting the number of individuals who retire each year. In the future, the number of retirees can be expected to increase further.

In total, we see a very large drop in the percentage of US citizens with jobs, starting about 2000 (Figure 6). This is very close to the time that China ramped up its growth (Figure 5).

Figure 6. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census.  2012 is partial year estimate.Figure 6. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census. 2012 is partial year estimate.

In calendar years 2011 and 2012, workers’ contributions for Social Security funding were temporarily reduced by 2% of wages, as a way of stimulating the economy. As of January 1, 2013, this temporary reduction was removed. For a couple with combined wages of $100,000, take-home pay is thus being decreased by $2,000 per year. With less disposable income, workers can be expected to cut back somewhere–buying a larger home, buying a new car, or going out to eat.

So far, only a small amount of other tax increases have been put in place, and only a few cuts have been made. More tax increases or benefit cuts will be needed later this year to bring revenue and expense into better alignment. Any such change will tend to have a recessionary impact, because citizens’ discretionary incomes will be affected.

Issue 4. The spending gap and the amount of debt look too big to be fixable without excellent economic growth.

As noted above, wages have not been keeping up with GDP. The majority of federal taxes are based on wages, so in my comparisons, I use wages, rather than GDP, as a base.

If we use the wage base from Figure 2, the amount of government outgo vs income (all levels, not just federal) is as follows:

Figure 7. US Government Spending (all levels) as percentage of Wage Base, as defined in Figure 2, above. Figure 7. US Government Spending (all levels) as percentage of Wage Base, as defined in Figure 2, above, based on US Bureau of Economic Analysis data.

Based on Figure 7, the issue in recent years has been primarily rising expenditures. These higher expenditures would seem to be partly because of high-priced oil, but also because of other influences noted above that are leading to declining employment. The amount of the gap is close to 15% of wages–something that is very hard to fix. Even the current increase in Social Security taxes (“only” 2% of wages) will exert downward pressure on discretionary spending.

A related issue is that compared to wages (using the same wage base as in Figure 2), debt of all kinds is extremely high.

Figure 8. US Debt as a Percentage of the Wage Base, where the Wage Base is as defined in Figure 2, and Federal Debt is from Treasury Direct, and other types of debt are from the Federal Reserve Z.1 report. Figure 8. US Debt as a Percentage of the Wage Base, where the Wage Base is as defined in Figure 2, and Federal Debt is from Treasury Direct, and other types of debt are from the Federal Reserve Z.1 report.

Government debt is in now more than household debt of all kinds, including mortgage, credit card, auto, and student loans. It is close to two times the wage base used in this analysis.

One issue with paying down debt is that during the pay-down period, the government (or individual) reducing the debt “feels poorer,” because funds available for spending on goods and services needed today is lower. This happens because some current tax revenue, or some current wages, must be used to pay down debt, and thus is not available for today’s spending. This is a turn-around from the increasing debt situation experienced many times in the past. For example, part of the reason times seemed good in the 2002-2006 period was because people were able to refinance their homes and use the funds to buy a new car or add on a family room. If we are forced to pay down debt, we have the reverse effect.

Issue 5. Similarity to “Secular Cycles” of Peter Turchin and Sergey Nefedov.

Throughout the ages, many economies that have experienced long-term expansion. Eventually, they reached limits of some sort and collapsed. The book Secular Cycles by Peter Turchin and Sergey Nefedov takes an analytical approach to looking such past cycle. They developed a fairly complex model of what they would expect over time, in terms of trends in wages, prices, population, income inequality, and other variables. They then examine historical records (relating to eight civilizations in four countries, with “start dates” between 350 BCE and 1620 CE) to see whether this predicted pattern was born out in practice. In general, the authors found good agreement with the predicted model.

Typically, civilizations analyzed were reaching upper limits in population growth because of limits on food availability, but sometimes limits on water or fuel also were important. The model predicted four phases (expansion, stagflation, crisis, and depression/ intercycle). The typical length of the entire cycle was 300 years. The length of the various segments was fairly variable. The stagflation stage often lasted 50 or 60 years. The crisis stage tended to be shorter, more often in the 20 to 50 year range. There often was overlap between phases, with a civilization seeming to cycle back and forth between, say, expansion and stagflation.

In the model, there are various feedback loops. For example, as the number of workers rises relative to the amount of land, the price of land and food tends to rise. Jobs outside of agriculture do not rise proportionately, so wages of common workers tend to fall in inflation adjusted terms. With lower wages for common workers, nutrition declines. Eventually, the population becomes weakened, and population declines. There are also other players–the elite and the state itself.

Some characteristics of the four phases are as follows:

  1. Expansion phase (growth) – Increasing population, relatively low taxes, political stability, low grain prices, and high real (inflation-adjusted) wages.
  2. Stagflation phase (compression) – Slowing population growth, much heavier taxes needed to support a growing elite class, low but increasing political instability, rising grain prices, declining real wages for most workers, increasing indebtedness, and increasing urbanization.
  3. Crisis phase (state breakdown) – Population declining from the peak (typically by disease or by deaths from warfare), high income inequality, political instability increasing to a peak, high but very variable grain prices, high urbanization, tax system in a state of crisis, peasant uprisings.
  4. Depression/intercycle – Low population, attempts to restore state, declining economic inequality, grain prices decreasing but variable.

It seems to me that the United States and much of the world are going through a cycle much as described by Turchin. The Growth Phase of our current cycle seems to have begun around 1800, with the rise of coal use. Stagflation in the United States seems to have started with the drop in US oil production in 1970. All of the government budget and debt problems now seem to suggest that we are reaching the Crisis Phase.

Obviously, there are differences from the civilizations modeled, because we now live in a much more integrated world. Furthermore, earlier societies did not depend on oil and other modern fuels the way we do today. We do not know how the current situation will play out, but the comparison is concerning.

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