Thursday, November 20, 2008

Sorry, Out of Gas: the recession and the oil crisis...

This is an excerpt from a short essay written by Gail E. Tverberg of Oil Drum about the link between the actual recession and the oil crisis. Ms.Tverberg is an actuary who writes articles on finite world issues and the impact of the oil crisis on different industries.

We Are Reaching Limits

No matter what kind of resources we are working with, they don’t simply “run out”, as we use more and more of them. Instead, they become more and more difficult to extract. In the case of minerals, the ore concentrations become lower and lower. Mines need to be built deeper and deeper. Fossil fuels become of lower quality and more difficult to extract quickly.

For many years, depletion was not really an issue. Resources were so vast, and the leverage provided by energy from fossil fuels was so great, that we could extract as much of almost anything we wanted (oil, natural gas, coal, uranium, copper, phosphorous, gold, platinum, indium, gallium, fresh water, and many other things) very cheaply, in the quantities needed for whatever use was desired.

What has happened in the last few years is that we have started reaching the point where extraction of many of these resources is becoming much more difficult. In April, 2007, the CEOs of Royal Dutch Shell and of French oil company Total SA were quoted as saying that the days of “easy oil” are gone. Just this past week, the International Energy Agency released a report whose executive summary begins, “The world’s energy system is at a crossroads. Current global trends in energy supply and consumption are patently unsustainable environmentally, economically, socially.”

Our Current Economic Crisis

Now that we are reaching a point where the extraction of fossil fuels and minerals of all types are starting to reach limits, we find that if the economy starts to heat up, the price of many commodities starts to skyrocket. Part of this is competition for limited resources. Part of this is the high cost of extraction of these resources, now that we are increasingly reaching limits. Food prices are affected as well, partly because oil (for machinery) and natural gas (for nitrogen fertilizer) are used in food production, and partly because competition with corn production for ethanol drives land prices up.

Once food and fuel prices rise, people find it difficult to repay debt, and debt defaults rise. Now debt defaults are rippling through the economy. The poor financial condition of banks makes them unwilling to lend. This lack of credit is making it difficult for many direct and indirect buyers of commodities to buy products of many types (oil, natural gas, uranium, and copper, for example). Prices are plummeting for a wide range of products because prices are relatively inelastic.

These lower prices have a feedback effect on new production of commodities. In a paper to be published in Journal of Energy Security shortly, I show that the credit crisis and the resulting lower commodity prices are leading to cut backs in planned production of energy products of all types (fossil fuels, renewables, and uranium). As a result, if the economy does start to heat back up again, we will have another round of commodity price increases. This, of course, will be followed by another round of debt defaults.

What Is the Solution?

In a finite world, we will soon find ourselves in a level or declining economy, simply because there are not enough easily-extractible resources to support growth without causing huge price spikes, followed by debt defaults, and another round of credit contraction and commodity price crashes. The only solution I can see is to develop a new monetary system that is not debt based, and is not expected to grow. Ideally, it would decline as there are fewer resources, and as the economy naturally declines.

With a flat or declining economy, long-term debt no longer makes sense. The likelihood that borrowers will be able to repay loans with interest becomes quite low, because the economic system as a whole is not growing and producing a surplus that can be used toward interest payments. It is much easier for a borrower to repay a 20-year mortgage with interest when he is getting promotions and salary increases than when his employer is downsizing and cutting hours.

Somehow, a monetary system needs to be devised which operates without debt, except for very short-term debt to facilitate commercial transactions. In addition, we need to extract ourselves from the debt morass we have created. ..."

I'm not saying I approve of all of her ideas. But your banker probably do. If so, what is going to happen and what will replace the defunct system of the Masters of the Universe?

Also, she touches here the problematic question of the reform of the Fed. Seriously this is way over my head, but there is a big debate about what to do with the greenbacks when it will be so devalued as to be almost worthless. With the economical power of the United States evaporating, the other nation won't see our currency as a golden etalon anymore. Interesting quote from the Hard Truth of Money web site:

"...Fed Chairman Paul Volcker also complied with President Reagan's wishes by supplying rapid growth initially and then slower growth. Fed Chairman Alan Greenspan also was accommodating to both Presidents Clinton and Bush. These figures would seem to explain the close relationship between the president and the Fed chairman. In 2003, President George W. Bush heaped praise on Alan Greenspan and told the press his wish that Greenspan could serve another term, despite the fact that under Greenspan's tenure, prices increased 71 percent (compare this to the fact that the price level was relatively the same in 1900 as it was in 1800). And over the course of Greenspan's tenure, the money supply rose from $3.62 trillion to over $10 trillion, a 179-percent increase!

For nearly the first 100 years of our nation's history, presidents debated central banking and monetary policy. A titanic struggle was waged between free bankers and central bankers, with the pendulum swinging back and forth in their struggle. This public debate came to an end in the 20th century when both major parties adopted the inflationist line. Today, the Fed is an unquestioned money machine that supplies the president with enough cash to fund his extravagant government programs, be they vast expansions abroad or at home or both. The presidential candidates rarely question what effects these large increases in the money supply might have on future generations as the dollar is devalued and Fed-manufactured booms and busts rock our economy."

Any ideas?

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