Role of Wages of the Common Worker in Oil Prices, Collapse

In their book Secular Cycles, Peter Turchin and Surgey Nefedov point out the important role falling wages of the common workers played in early collapses. I got to thinking that this might be an issue with our current situation as well, including the low level of oil prices.

I explain this in two presentations. The first one is called “Overview of a Networked Economy“. The second one is called, “Economic Growth and Diminishing Returns.”

A couple of (amateurish) slides that need explanation are the following ones:

Standard definition of economic growth

The cloud above my representation of the economy is supposed to represent the cloud of goods and services that the economy makes. Many people would like us to believe that as long as this cloud is growing, everything is fine.

What Peter Turchin discovered is that there is a smaller cloud that really needs to be growing, as well. Continue reading

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The Problem of Debt as We Reach Oil Limits

(This is Part 3 of my series – A New Theory of Energy and the Economy. These are links to Part 1 and Part 2.)

Many readers have asked me to explain debt. They also wonder, “Why can’t we just cancel debt and start over?” if we are reaching oil limits, and these limits threaten to destabilize the system. To answer these questions, I need to talk about the subject of promises in general, not just what we would call debt.

In some sense, debt and other promises are what hold together our networked economy. Debt and other promises allow division of labor, because each person can “pay” the others in the group for their labor with a promise of some sort, rather than with an immediate payment in goods. The existence of debt allows us to have many convenient forms of payment, such as dollar bills, credit cards, and checks. Indirectly, the many convenient forms of payment allow trade and even international trade.

Figure 1. Dome constructed using Leonardo Sticks

Figure 1. Dome constructed using Leonardo Sticks

Each debt, and in fact each promise of any sort, involves two parties. From the point of view of one party, the commitment is to pay a certain amount (or certain amount plus interest). From the point of view of the other party, it is a future benefit–an amount available in a bank account, or a paycheck, or a commitment from a government to pay unemployment benefits. The two parties are in a sense bound together by these commitments, in a way similar to the way atoms are bound together into molecules. We can’t get rid of debt without getting rid of the benefits that debt provides–something that is a huge problem.

Continue reading

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Charts showing the long-term GDP-energy tie (Part 2 – A New Theory of Energy and the Economy)

In Part 1 of this series, I talked about why cheap fuels act to create economic growth. In this post, we will look at some supporting data showing how this connection works. The data is over a very long time period–some of it going back to the Year 1 C. E.

We know that there is a close connection between energy use (and in fact oil use) and economic growth in recent years.

Figure 1. Comparison of three-year average growth in world real GDP (based on USDA values in 2005$), oil supply and energy supply. Oil and energy supply are from BP Statistical Review of World Energy, 2014.

Figure 1. Comparison of three-year average growth in world real GDP (based on USDA values in 2005$), oil supply and energy supply. Oil and energy supply are from BP Statistical Review of World Energy, 2014.

In this post, we will see how close the connection has been, going back to the Year 1 CE. We will also see that economies that can leverage their human energy with inexpensive supplemental energy gain an advantage over other economies. If this energy becomes high cost, we will see that countries lose their advantage over other countries, and their economic growth rate slows.

A brief summary of my view discussed in Part 1 regarding how inexpensive energy acts to create economic growth is as follows:

The economy is a networked system. With cheap fuels, it is possible to leverage the expensive energy that humans can create from eating foods (examples: ability to dig ditches, do math problems), so as to produce more goods and services with the same number of workers. Workers find that their wages go farther, allowing them to buy more goods, in addition to the ones that they otherwise would have purchased.

The growth in the economy comes from what I would call increasing affordability of goods. Economists would refer to this increasing affordability as increasing demand. The situation might also be considered increasing productivity of workers, because the normal abilities of workers are leveraged through the additional tools made possible by cheap energy products.

Thus, if we want to keep the economy functioning, we need an ever-rising supply of cheap energy products of the appropriate types for our built infrastructure. The problem we are encountering now is that this isn’t happening–more energy supply may be available, but it is expensive-to-produce supply. Our networked economy sends back strange signals–namely inadequate demand and low prices–when the cost of energy products is too high relative to wages. These low prices are also a signal that we are reaching other limits of a networked economy, such as too much debt and taxes that are too high for workers to pay.

Looking at very old data – Year 1 C. E. onward

Some very old data is available. The British Economist Angus Maddison made GDP and population estimates for a number of dates between 1 C. E. and 2008, for selected countries and the world in total. Canadian Energy Researcher Vaclav Smil gives historical energy consumption estimates back to 1800 in his book Energy Transitions – History, Requirements and Prospects.

If we look at the average annual increase in GDP going back to the Year 1 C. E., it appears that the annual growth rate in inflation-adjusted GDP peaked in the 1940 to 1970 period, and has been falling ever since. So the long-term downward trend in world GDP growth has lasted at least 44 years at this point.

Figure 2. Average annual increase in GDP per capita, based on work of Angus Maddison through 2000; USDA population/real GDP figures used for 2000 to 2014.

Figure 2. Average annual increase in inflation-adjusted GDP, based on work of Angus Maddison through 2000; USDA population/real GDP figures used for 2000 to 2014.

Continue reading

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A new theory of energy and the economy – Part 1 – Generating economic growth

How does the economy really work? In my view, there are many erroneous theories in published literature. I have been investigating this topic and have come to the conclusion that both energy and debt play an extremely important role in an economic system. Once energy supply and other aspects of the economy start hitting diminishing returns, there is a serious chance that a debt implosion will bring the whole system down.

In this post, I will look at the first piece of this story, relating to how the economy is tied to energy, and how the leveraging impact of cheap energy creates economic growth. In order for economic growth to occur, the wages of workers need to go farther and farther in buying goods and services. Low-priced energy products are far more effective in producing this situation than high-priced energy products. Substituting high-priced energy products for low-priced energy products can be expected to lead to lower economic growth.

Trying to tackle this topic is a daunting task. The subject crosses many fields of study, including anthropology, ecology, systems analysis, economics, and physics of a thermodynamically open system. It also involves reaching limits in a finite world. Most researchers have tackled the subject without understanding the many issues involved. I hope my analysis can shed some light on the subject.

I plan to add related posts later.

An Overview of a Networked Economy

The economy is a networked system of customers, businesses, and governments. It is tied together by a financial system and by many laws and customs that have grown up over the years. I represent the economic network as a child’s toy made of sticks that connect together, but that can, if disturbed in the wrong way, collapse.

Figure 1. Dome constructed using Leonardo Sticks

Figure 1. Dome constructed using Leonardo Sticks

Continue reading

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Oil and the Economy: Where are We Headed in 2015-16?

The price of oil is down. How should we expect the economy to perform in 2015 and 2016?

Newspapers in the United States seem to emphasize the positive aspects of the drop in prices. I have written Ten Reasons Why High Oil Prices are a Problem. If our only problem were high oil prices, then low oil prices would seem to be a solution. Unfortunately, the problem we are encountering now is extremely low prices. If prices continue at this low level, or go even lower, we are in deep trouble with respect to future oil extraction.

It seems to me that the situation is much more worrisome than most people would expect. Even if there are some temporary good effects, they will be more than offset by bad effects, some of which could be very bad indeed. We may be reaching limits of a finite world.

The Nature of Our Problem with Oil Prices

The low oil prices we are seeing are a symptom of serious problems within the economy–what I have called “increased inefficiency” (really diminishing returns) leading to low wages. See my post How increased inefficiency explains falling oil prices. While wages have been stagnating, the cost of oil extraction has been increasing by about ten percent a year, described in my post Beginning of the End? Oil Companies Cut Back on Spending.

Needless to say, stagnating wages together with rapidly rising costs of oil production leads to a mismatch between:

  • The amount consumers can afford for oil
  • The cost of oil, if oil price matches the cost of production

The fact that oil prices were not rising enough to support the higher extraction costs was already a problem back in February 2014, at the time the article Beginning of the End? Oil Companies Cut Back on Spending was written. (The drop in oil prices did not start until June 2014.)

Two different debt-related initiatives have helped cover up the growing mismatch between the cost of extraction and the amount consumers could afford:

  • Quantitative Easing (QE) in a number of countries. This creates artificially low interest rates and thus encourages borrowing for speculative activities.
  • Growth in Chinese spending on infrastructure. This program was funded by debt.

Both of these programs have been scaled-back significantly since June 2014, with US QE ending its taper in October 2014, and Chinese debt programs undergoing greater controls since early 2014. Chinese new home prices have been dropping since May 2014.

Figure 1. World Oil Supply (production including biofuels, natural gas liquids) and Brent monthly average spot prices, based on EIA data.

Figure 1. World Oil Supply (production including biofuels, natural gas liquids) and Brent monthly average spot prices, based on EIA data.

The effect of scaling back both of these programs in the same timeframe has been like a driver taking his foot off of the gasoline pedal. The already slowing world economy slowed further, bringing down oil prices. The prices of many other commodities, such as coal and iron ore, are down as well. Instead of oil prices staying up near the cost of extraction, they have fallen closer to the level consumers can afford. Needless to say, this is not good if the economy really needs the use of oil and other commodities.

It is not clear that either the US QE program or the Chinese program of infrastructure building can be restarted. Both programs were reaching the limits of their usefulness. At some point, additional funds begin going into investments with little return–buildings that would never be occupied or shale operations that would never be profitable. Or investments in Emerging Markets that cannot be profitable without higher commodity prices than are available today.  Continue reading

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