The United States’ 65-Year Debt Bubble

When I write about high oil prices having an adverse impact on the economy, quite a few readers respond by saying, “No, most (or all) of the problem is a debt bubble.” They seem to think that poor underwriting of mortgages a few years ago allowed a debt bubble. Once this bubble is past, or some similar bubble, our problems will be over.

I decided to see when the debt bubble really started. The answer surprised me–it appears that we have been building a debt bubble since at least 1945 (Figure 1 – based on Federal Reserve data).

Figure 1. US Non-Governmental Debt, Divided by Nominal GDP

Furthermore, it appears that this 65-year bubble is beginning to deflate. I believe that this is occurring because high oil prices are putting a cap on economic growth. If I am right, it seems to me that the drop in non-governmental debt shown in Figure 1 can be expected expect to continue, possibly eventually dropping all the way back to the 1965 debt level–that is, about 15% of today’s debt level.

There is a close link between growing debt and growing GDP. GDP growth is a gross measure; it does not take into account the amount of debt required to finance this growth. The increasing level of debt since 1945 has enabled economic growth to be higher than it otherwise would be, and has allowed the US to buy goods and services from abroad that we could not otherwise afford. If high oil prices cause economic contraction, as I believe is the case, we may see the situation reverse itself. Instead of rising debt leading to growing GDP and growing imports, we may instead see shrinking debt leading to declining GDP and declining imports.

Such a situation would be bad from many perspectives–stock market prices, bond defaults, and ability to purchase needed goods from abroad. Commodity prices may drop as well, because many people are likely to be out of work.

Two Views of Debt

It seems to me that there are two basic views of debt:

Modern View. If the economy is expected to keep growing indefinitely, debt is viewed as  helpful–something that will allow consumers to buy goods, and pay for them over the life of the goods and will allow businesses to build new facilities, and pay for them over the lives of the facilities. The existence of debt products also facilitates pension plans, since bonds are often used to fund pension plan.  The Modern View also permits governments to offer “Social Security” plans to citizens, since the expectation is that the future will be at least as good as it is today.

Traditional View. If people believe that life is a roller coaster, with some good years, and some bad years, but no clear upward trend, then debt plays a more limited role. The expectation is that citizens will set aside funds in the good years, so that they will be able to take care of themselves in the bad years. If new businesses are formed, accumulated savings rather than debt will tend to be the major source of funding. Debt will still be used to a limited extent, for example, by governments to finance wars; by businesses to cover goods in transit; and by families who truly hit hard times. But citizens and businesses will generally be wary of debt, because of the frequency of debt defaults.

Admittedly, this summary is somewhat subjective, but it is tied to an observation I have made many times before: it is much easier to pay back debt with interest in times of economic growth than it is in times of economic contraction, as illustrated in Figure 2.

Figure 2. Repaying loans is easy in a growing economy, but much more difficult in a shrinking economy.

The Modern View of debt has gradually developed, as the world has expanded its use of fossil fuels, and as a result seemed to be on a never-ending growth path. Economists, actuaries, and financial planners have all built models assuming that growth will continue, and as a result, debt, and perhaps even growing debt, is possible. But back in 1945, many people in the United States still held the Traditional View of debt. Because of this, the level of debt was much lower than today, as illustrated in Figure 1.

What Happened after World War II

At the end of World War II, the US government found itself in the uncomfortable position of no longer needing as many workers, once the war effort was over. At the same time, it needed to repay the debt it used to finance the war. If no change were made in people’s spending habits, the result would have been a high unemployment rate (because of the layoffs) and a high tax rate (because of the need to repay the debt, with many unemployed).

Figure 3. US Governmental Debt (Including state and local debt) divided by nominal GDP, based on Federal Reserve and Bureau of Economic Analysis Data. Excludes internal governmental debt, such as Social Security Debt.

There was an obvious way to “fix” this problem: encourage citizens to borrow more.  If people could be encouraged to borrow money to buy a new refrigerator or a new car or even a new home, then many more of these goods could be manufactured and sold. Businesses could also borrow to set up new manufacturing facilities. Little by little, what I have described as the Modern View of debt took over, and the ratio of non-governmental debt to GDP soared. GDP measures the cost of the new “stuff” sold, not whether the goods were bought on credit, so this approach greatly ramped up GDP.

Figure 4. Average annual increase in real GDP, for 10 year periods, based on Bureau of Economic Analysis data.

This approach of getting people to borrow more so as to ramp up economic growth worked very well in the early years, but less well recently, as can be seen from Figure 4. Part of the problem was that US oil supply started to decline in 1970, so that the US had to import more oil. The US also cut back on the kinds of goods it manufactured, with much of the heavy industry moving to other countries, necessitating more imports of such goods.

Figure 5. US imports and exports divided by GDP, based on BEA data.

The existence of all of the debt, and the fact that buyers in other countries would take government bonds in payment for goods and services, allowed Americans to continue to buy more goods and services imported from abroad, even though we did not have enough to trade in exchange.

A person might think our trading partners would have objected, but because US debt was considered a good investment, the system continued. For each year since 2001, the percentage growth in real GDP has been greater than the gap between exports and imports as a percentage of GDP–a hint that perhaps the situation was not really sustainable.

We saw in Figure 4, above, that over time, growth in real GDP decreased. At the same time, the amount of debt required to create each increment in GDP increased, as shown in Figure 6, below.

Figure 6. Increase in US Debt (all types including governmental) divided by increase GDP, for 10 year periods, based on Federal Reserve and BEA data.

Part of what happened was that a limit was being reached on how much debt reasonably could be carried. Almost everyone who could afford a house already had one. Businesses had expanded as much as they felt was prudent. Other kinds of debt that were added, but the new kinds of debt weren’t as efficient in providing funds to for citizens to actually buy things–securitization of mortgages, for example, and the interest rate “carry trade. ” In the early 2000s, some of the debt that was added was really ill-advised–allowing people with inadequate incomes to purchase homes, for example.

I don’t have figures for other parts of the world, but my impression is that many other countries followed a similar pattern of rising debt levels, as the Modern View of debt became the norm in economies around the world.

Where Do We Go From Here?

One popular view is that all we have to do is unwind some of the badly made loans, and the financial system can go on as before. Or perhaps we have raised the amount of debt too high, and the interest payments are now a drag on the economy. In this view, if we keep interest rates low, and bring the debt level down to that of a few years ago, maybe the economic system will work as before.

It seems to me that the real issue is that we live in a finite world. The idea that debt can continue to expand is simply false. The world economy will hit limits of many kinds–for example, the amount of low-cost oil that can be extracted; the amount of fresh water than can be obtained, without resorting to high-priced desalination; the amount of pollution that we can deal with, without huge health problems; the amount of CO2 that the atmosphere can absorb, without huge climate and ocean difficulties.

Because of these issues, the Modern View of debt is simply false. It is based on a temporary phenomenon. Debt can only expand for a while, in a finite world. Once we start hitting limits, debt expansion at first does less and less, and ultimately falls apart under its own weight.

It seems to me that the limit we hit first is that of adequate low-priced oil. There is plenty of oil theoretically available–but it is high-priced oil, that puts the economy into recession, as more resources need to be devoted to oil extraction, and fewer resources to other endeavors. Saudi Arabia and rest of OPEC claim the ability to provide more oil quickly, but when oil prices rise, they don’t really come through (Figure 7).

Figure 7. World and OPEC crude oil production, and Brent spot oil price, based on EIA data.

High-priced oil has caused financial difficulties for many governments around the world, because when oil prices rise, food prices tend to rise as well. Citizens cut back on discretionary goods when food and oil prices rise, causing recession. During recession, governments collect less taxes at the same time they are spending more on unemployment benefits and stimulus funds. As a result, governments are increasingly prone to debt defaults, such as those now being discussed for Greece and other European countries.

What I expect to see next is one country after another defaulting on its debt. Each default will set off a chain reaction of under-capitalized banks needing bail outs, and, as a result, more governments getting into financial difficulty. The IMF will try to fix the problems, but eventually the level of difficulty will be more than it can handle.

Where will the deleveraging stop?

This is the big question. More debt helps keep demand for goods and services up, and helps keep GDP growing. But the economy needs to be expanding, in order for it to make sense for debt levels to rise. If the economy is shrinking (or even flat), businesses don’t see a need to expand, so have no reason to borrow more money. Homeowners are worried about their jobs, so are not interested in buying more expensive homes. If high oil prices are part of the equation, higher prices for oil products and food cut back on the funds people have to pay for discretionary goods of all types.

It seems to me that there is a significant chance that we will find ourselves transitioning back from a Modern View of debt to a Traditional View of debt. If this happens, we are at risk of the ratio of debt to GDP dropping way back–not to 2005 levels, or 2000 levels, but to 1945 levels, or even lower. A big part of this slide downward might come through debt defaults. Such a change would greatly reduce this country’s ability to buy imported goods, and could result in huge economic dislocations.

I have not said much about governmental debt. The US Federal Government uses “cash-basis” accounting, rather than accrual accounting, so I don’t see its supposed debt level as being all that helpful in understanding its financial position.  The US Federal Government’s liabilities are much higher than its stated debt level would suggest, since it makes many promises which it does not set up reserves to handle. For example, it guarantees bank deposits and pension plan payments, up to prescribed limits, but these guarantees are not reflected in its financial statements. The US government can theoretically issue more debt to meet its obligations, but there is no guarantee that Congress will continue to approve ever-rising debt levels, or that willing external buyers can be found for the debt.

I expect that the world will need to develop an entirely new financial system to fix the 65-year debt bubble. Our current debt-based approach simply is not workable without long-term growth. But making such a transition will very difficult–perhaps impossible. Individual countries can perhaps each set up their own system, but trying to integrate them would seem to be very difficult. It is possible that at some point we may find ourselves without an operating international financial system.

This is why I see the near-term outlook for the world financial system as very ominous. We have a seriously broken system, but no good way of fixing it.

About Gail Tverberg

My name is Gail Tverberg. I am an actuary interested in finite world issues - oil depletion, natural gas depletion, water shortages, and climate change. Oil limits look very different from what most expect, with high prices leading to recession, and low prices leading to financial problems for oil producers and for oil exporting countries. We are really dealing with a physics problem that affects many parts of the economy at once, including wages and the financial system. I try to look at the overall problem.
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90 Responses to The United States’ 65-Year Debt Bubble

  1. Allen says:

    Gail, I’ve been having doubts about the growth-model economics for a long time, for all the reasons you mentioned and more. However, there just isn’t another economic model that would supply humans with what the need and what they want. Of course, if we could convince people to modify their needs and wants to be in better balance with the finite planetary resources, a new model could emerge. But given human nature, expectations, desires and values, it;s just isn’t likely to happen, so we’er are stuck with the growth model until the bitter end, whenever that may be.
    There’s a passage in Paul Erdman’s THE CRASH of ’79 that explains why there’s no alternatives to the growth model in the modern age, which I find impossible to argue with.

    As a new reader, I’d like to say that I very much enjoy your thoughtful, balanced, well researched and reasoned articles, and look forward to each new installment.

    Allen in Ohio

    • I’m glad you like my approach to things. When I studied to become an actuary, I learned all of the formulas for modeling the future. But fairly early on, I had questions as to whether all of these things could really be true. Theoretically, I could retire at an early age, and have plenty of money to live on. But it didn’t really follow common sense–at least it didn’t to me. It seemed like in a finite world, we couldn’t expect rapid growth to go on forever.

      I am afraid I haven’t read Paul Erdman’s, The Crash of ’79, but it is hard to see a way to go back to the non-growth model.

  2. All of these are fine comments, but the fact remains that ultimately, there is only one solution: a dramatic reduction in the number of people on the planet. As the very title of this blog proclaims, we live on a finite planet with finite resources. There are now 7 billion people on our finite world. That’s at least six billion more than we ever had prior to the development of fossil fuels. Fossil fuels allowed the human race to enter into “overshoot” big time. There was an excellent post on this topic on The Oil Drum a few years ago (although for some unexplained reason the author has since distanced himself from it.). There can be no doubt that as we run out of easy and cheap to access fossil fuels, the number of humans will decline as fossil fuels are the literal fuel behind this fantastic growth in our population. The only question now is how quickly the decline will occur. It doesn’t matter what percentage of the population is farming if there are no fertilizers and pesticides (fossil fuel derived). It doesn’t matter how much we invest in alternative energy if all of those require fossil fuels to build and or utilize.

    Theoretically, the per capita debt declines as the number of people increases (assuming debt remains static). So, from that viewpoint, there is a vested interest in an ever-increasing population.

    • There is also an interest in an increase in population from a point of view of Social Security planning. The more young people working to pay for the older people, the better off society will be–or so the reasoning goes. (Rising population also helps keep debt up, as you mention.) The problem is if we are dealing with limited resources, dividing them among more and more people doesn’t really work. There are other variables besides the number of young people supporting the old folks that are important in the equation.

    • St. Roy says:

      Dr. House:
      Amen. The author you may be referring to is William Catton. In his 1980 book “Overshoot”, he clearly articulates the problem of overpopulation. In his latest book “Bottleneck”, referring to the 21st Century, he provides a good argument for why there will be a good many fewer of us at the end of this period. Probably less than 2 Billion since that is about the carrying capacity without the fossil fuel subsidy. And, I don’t think mankind is cooperative enough to get there through some orderly reduction in the birth rate.

      • Here’s the link to the article to which I referred:
        Actually, it was posted to TOD by our host here on this blog but she is not the author.

        The problem with reducing the birth rate is that the decline in energy will be much faster than the natural death rate. The death rate is estimated at 0.883, or roughly 56,000,000 deaths per year. That translates into about 3.9 billion deaths in 70 years. I can’t seem to find any projections of oil productions 70 years from now, but extrapolating forward using the Hubbert model, it appears oil production would be less than 2 mm/bpd. That seems too optimistic of an estimate to me as our current economy would totally collapse with oil production at such a low level. So even if all births stopped (which would lead to extinction in one generation) the decline in population wouldn’t be fast enough to keep pace with the decline in energy.

        • St. Roy says:

          Dr. House:
          Thank your for alerting me to this article. I have been looking for an analysis and projection of the death rate during this Century that would get us the 1.5 billion people the Earth is able to support without the FF subsidy. The average number of unnatural deaths per year (100 million) sounds horrific, but Nature has her way in dealing with overshoot.

    • Bicycle Dave says:

      Hi Doc,

      there is a vested interest in an ever-increasing population.

      It seems there are three main “vested interests” that tend to selfishly exploit the basic human instinct to reproduce:

      – Economic interests of all sorts – especially large corporations that rely on the growth paradigm to manage their debt and increase profits by continued expansion.

      – Political interests – the easiest way to create a new party member is to breed them in families already loyal to the party.

      – Religious interests – most religions require a growing power base to remain viable. More babies translates to more power.

      If Gail (plus myself and many others here) are correct that sometime in the next couple of decades (maybe sooner than later) that population levels in many parts of the world will need to “adjust downward”, – then the various interest groups listed above will very quickly need to make a 180 reversal of their population/growth advocacy – OR, the 4 horsemen will enjoy free reign. This “adjustment” could be counted in hundreds of millions if not billions. The choice between utter misery and a more orderly and humane decent would appear to be a matter of simple math, science and rational decision making by the planet’s first species that is technically capable of making this kind of choice.

      In a comment below you mention:

      The problem with reducing the birth rate is that the decline in energy will be much faster than the natural death rate…if all births stopped … the decline in population wouldn’t be fast enough to keep pace with the decline in energy.

      Perhaps you are right, but I’d like to see some in-depth analysis of this proposition. Just for the sake of the argument, let’s say that the biggest per-capita energy users (like the USA) implemented policy measures that resulted in something like one child per group of 50 adults per generation (say every 20 years). And further, that all kinds of other measures were implemented to dramatically reduce FF usages (really drastic stuff). And just for fantasy sake, assume most of the developed world also adopted these measures. In this scenario, would it be possible to “power down” somewhat gracefully? For this thought exercise, put aside the impact on financial systems and other such cultural structures.

      Although this is an academic exercise, it poses the question: “is it totally inevitable that the human race will experience a significant die-off much as any other species does in overshoot scenarios”. Or, as others have put it “are we smarter than yeast?”. We’ve all heard the POV that humans have evolved to breed to the maximum extent possible (like any other species) and it’s hopeless to think that we have the capability to rationally engineer our way out of a collapse as the finite resources we depend upon deplete. It seems to me that it is technically possible to engineer a graceful descent scenario – that it is actually not too late.

      I see two major issues:

      1 – Is Gail’s hypothesis correct that sometime in the next couple of decades that BAU will not only be unsustainable but also a significant portion of the human population will have great difficulty just surviving and many may die early? If she is correct, then radical mitigating strategies will be necessary if we choose to soften this outcome. If she is not correct, then how is her hypothesis disproved? Hoping human ingenuity will conquer all is not a valid disproof.

      2. – Assuming Gail’s basic hypothesis is correct and that only fairly radical actions can mitigate massive human suffering, then are there potential scenarios whereby the powerful interest groups listed above might actually take appropriate action in a timeframe that might avoid serious collapse? If not, then should we “eat, drink, and be merry for tomorrow we die”?

      • I think the number one interest in having children are those who would be potential parents, because people generally need someone younger to help take care of them in their declining years. Right now, there is the belief that Social Security / Medicare will care for older members of society, but if this is really mostly an illusion, the pressure will rise to have more children. I think that the primary reason for the religious view that having children was important really related to the problem that occurs when elderly people do not have children of their own. (My husband and I took care of my sister’s spinster aunt in our home for two years prior to her death, so I can relate to this issue.)

        It would be possible to model things out, but I am pretty sure the results are that you cannot get population down quick enough, because we are talking about a fairly rapid drop of in production (due, probably to the “system breaking” more than geological decline).

        With 7 billion people around the world, without common religion/political party / economic view, I am not optimistic that any interest group anywhere could make a big difference in the outcome. But it is an interesting idea, nevertheless.

  3. Jamesneo says:

    Hi great post and i agree with most of it but i think you could be wrong on this aspect : “Commodity prices may drop as well, because many people are likely to be out of work.” You are thinking in terms of deflationary pressures and only by restricting to US. However, the likely chance is that commodity prices will instead increase over the long term in a stagflationary or hyperinflation environment with occasional price drops during short bouts of deflationary pressures. Here is a article on peak silver and its argument is compelling and includes effects of peak oil and EROI and also include how a great depression affects prices. My opinion is that this can be extended to most essential commodities including agriculture( non essential commodities like copper lead might drop but if they also reach their own peak copper or peak lead things will reserve) . Yes demand destruction can lead to lower prices but this discount the huge supply drop which will instead lead to even higher prices due to supply dropping faster than demand. (And i have not even include the huge inflationary pressure once the excess reserves the big banks deposit at the Fed leaks out.)

  4. Jamesneo says:

    Sorry forgot to put the peak silver link:

  5. On Wednesday, October 19, Max Keiser will be interviewing me with respect to this post. The interview will be over Skype, and will be recorded, so I don’t know when it will actually be available.

    • Iaato says:

      If one views the world through a macroscope at the larger scale, the impact of energy inputs and flowthroughs and how they impact the smaller systems. Our human economic system is not separate from Ma Nature; the information economy as the highest point of the food chain is perched on top of the lower manufacturing economy, which is perched on top ecosystem services and resources, which is all run by renewable solar and nonrenewable fossil fuel energy. Each step up the food chain requires massive amounts of additional energy to develop and maintain complexity and bureaucracy. Thus, beginning to turn down the handle of the faucet for nonrenewable energy flow for the first time in 200 years has some pretty serious ramifications for the stuff at the top of the hierarchical food chain, of which Wall Street is a major part.

      Go get ’em, Gail.

      • schoff says:

        The information economy’s infrastructure (the Internet) unfortunately now supports the manufacturing economy’s processes (for instance just in time), agriculture (try ordering 55 gallon barrels of pesticides by usmail), education (how much is now online?), publishing (what % of books did you buy last year by driving to a book store?), etc…..

        Gail has done a wonderful job of connecting the peak oil and peak money/debt together, which I think of as substrates. It is time to talk about “Peak Internet”, the information substrate.

        At this moment in time, GE Transport cannot fix a locomotive in the field without establishing a wireless LAN to the technician tablets and to the Internet (via satellite).
        Consider any parts based repair location in the US operating without the Internet… In 2005, 1.2% of the US electrical power was used by Internet servers, it had been growing by 14% per year. It is considerably higher today.

        How does one backout critical business processes from 100% dependance on the Internet?

        • schoff,

          Very interesting question and one which I’ve been thinking about recently – at least on a smaller scale, anyway.

          When I set up my clinic, I put my electronic medical record (EMR) server in California at a data center. That’s some 1,500 miles away from me. Without my EMR I can’t do anything. I can’t see the schedule, know the names of my patients, see what medicines they are on – I’m practicing in the dark.

          When the Arab spring started earlier this year and we saw some governments “turning off” their internet, it drove home just how dependent my clinic is on the internet. I still haven’t done anything about the main clinic, but in my smaller clinic in which we barter for goods and services, we now use paper charts (return to the older ways in every fashion). It’s by no means a solution to collapse – when that happens, medicine will be practiced VERY differently. But as far as the internet goes, I’m a little less dependent on it now than I was even a few months ago.

          • Bicycle Dave says:

            Hi Doc,

            in my smaller clinic ….return to the older ways in every fashion

            Last week, while visiting far northern Wisconsin, my wife suffered a very nasty cut that required immediate stitching. The only medical facility for many miles was an Indian Clinic on their reservation. Besides getting excellent treatment, the warmth and personal attention she received reminded me of earlier times in small clinics. Our regular medical facility in our home town is very modern and fully equipped with the latest stuff – plus the staff is very friendly and competent. But, somehow the little Indian clinic reminded me how important the “human touch” is when dealing with a traumatic event – even without a CT or MRI scanner. BTW, I didn’t have her insurance card along and that did not slow them down one minute.

          • schoff says:

            That is excellant news. Amongst my passed professions I was an engineer, and we use to think about redundancy and simplicity in design and operation. Those things cost money and so they seemed to have slowly been removed from a lot of process. Not necessarily nuclear reactors but the necessary things of life none the less.

            I remember a conversation with the people who were involved in installing the fuel tanks on my farm when I told them i wanted manual pumps not electric ones. “But they are slower and it takes physical labor!” they said in astonishment, i asked them what if the power wasn’t available, how was I going to fill the genset 20 feet away. They had never conceived of the idea of “bootstrapping” a system….what it might take. that was about 900 power outages ago.

            It would be fascinating to consider the changes in things that you do or buy if there was no internet for a week, a month, or forever. Imagine the grocer trying to source local vegetables (if they exist) from a market that previously was retail and only open 2 days a week, or the soccer club that can no longer put on it’s web site that the games are canceled due to field condition.

        • Who gathers information on how much power internet servers are using?

          • St. Roy says:


            John Michael Greer, in his book “The Wealth of Nature”, has some interesting views on the of the survival of the Internet when cheap abundant energy wanes. It’s a very energy intensive communications medium and maybe not that vital when industrial society begins to collapse.

            • Jean-Luc says:

              The overall power consumption of datacenters and internet clients will probably go down massively overtime, since they are starting to roll-out servers that consume much less power than before (up to 90% less). Same thing for computers, displays and other devices.

            • What seems to happen, though is that people buy what they can afford. Computer users will have several monitors, if that is helpful (both my husband and I have extra monitors–my extra monitor was bought by my son, who has an extra monitor where he works). And a lot of people have multiple gadgets–phones, I-pods, I-pads, etc.

  6. Pingback: Casa Food Shed » Blog Archive » High oil prices threaten global dreams

  7. Shunyata says:

    There are two root questions here:

    In the absence of money and ownership (imagine a Star Trek society) how many goods and services are we physically capable of producing?

    I don’t see any immediate impediment to producing as many goods and services as we did during better times, say 2005. Over the long haul contraction seems inevitable, but not today. As Gail notes, however, the immediate problem is that physical production is not increasing at the same rate as demand for goods and services.

    When demand exceeds supply, how are claims to goods and services allocated?

    Our present financial system has encouraged the many to naively pledge their future productive capacity to a few (via debt). This imbalance has reached a point that is no longer socially or financially sustainable. Sustainability requires that pledges grow at about the same rate as productive capacity, which obviously has not been happening. The problem made worse because technology and efficiency advances have devalued human productive capacity, leading to under/un-employment, making it even harder to repay debt.

    Overall, the physical system is constraining the financial system and creating financial instability. And this financial instability has the potential to impair the physical system. As matters stand, cataclysm is not the most likely outcome, although possible, but leveling standards of living and consumption seems inevitable. This means a big change for the Western world.

  8. RobM says:

    Excellent article Gail, thanks.

    For those wanting to understand more about debt, solutions to our financial predicament, and policies required to prevent another bubble I recommend you study Steve Keen. He makes a living showing how the majority of economists don’t know what they are talking about and he gets peak oil. I think he is the smartest and wisest economist in the world.

    Steve’s got some great video lectures and other material on his web site.

  9. Dr. Robert Goldschmidt says:

    Gail, I agree with your article, but I believe that by taking a resource limitation view, your results are incomplete. I prefer to look at the US and global financial problem as being caused by wage demand destruction. Clearly, the need to purchase more expensive imported oil is a significant contributor to this. But there are two other factors that are not related to resource depletion that are as least as important — outsourcing and automation.

    Every time we outsource a US median job at $3500/month to one in China for less than $200/month, we destroy over $3,000/month of demand, not only in the US but globally. There is a similar destruction of demand when we replace a job with automation. Repeat this tens of millions of times and it is no wonder that sovereign nations are on the brink of default all over the world.

    Let’s look at a prototypical company Apple. Their 2009 figures show an income of $65 billion and 50,000 employees for a ratio of $1,300,000 sales per employee. This includes all the employees that staff their retail stores worldwide. Clearly, they are not contribution much to the demand for goods and services compared to their sales level. But, you say, they must contract out most of their manufacturing — what about those employees. Well Foxconn in China is their principal contractor with about one million employees. They pay them between $130 and $200 a month. Still no significant contribution to demand. A month ago, Foxconn announced that they are purchasing one million robots and plan to replace most of their employees! So you see that demand destruction really is a global issue — even in the manufacturing sector.

    The cures for this are:

    Phase in a US import tariff of at least 30% on all imports except food, clothing and non-strategic raw materials. Protectionism! you say, but are we really doing ourselves and our trading partners a favor if the end point of our present path is worldwide economic collapse? Also, any historical look at the largest economies will show that their aggregate demand grew most rapidly when they had high tariffs. For example, we had tariffs of over 30% during the roaring ’20s.

    Shorten the work week to four 9-hour days at the same pay. This would mean that employers will have to hire more workers to get the same amount of work done which will reduce unemployment and grow aggregate demand. Also, there would be less usage of oil and it would allow a young family to have a parent with their children two additional days a week.

    Of course, one argument against these steps is that they will be counterproductive since they will raise the cost of living. I believe that these effects are small compared to the gains. For example, GM now has labor at 10% of the cost of a car. Implementing shorter work weeks would raise the price of a car by 2.5% and increase their workforce by 25%. The gain to the economy would be not only the salaries of these additional workers, but the correspnding reduction in government expenses and the long chain of secondary gains due to the money they spend. Is this worth an additional $4 a month on a car payments? — I believe so. It is certainly more effective than trying to reduce our deficit with a VAT.

    This does not mean that we should ignore the resource issue — we clearly need massive public and private investment in natural gas and electric transportation and renewable power. Would love to read your thoughts on this.

    • Dr. Robert Goldschmidt says:

      In the above statement, the increase in GM employment would be 10%, not 25%.

    • That is a good point about demand disappearing as work is transferred to lower wage workers and automation. Without tariffs, our workers are now more in direct competition with low-wage workers from around the world–part of what is holding wages down in many sectors.

      I have had the same thought about needing tariffs, but I would include food, clothing, and non-strategic raw materials. If we have energy shortages, we need to be thinking about sourcing things using local materials. The current situation is silly, where we import almost all of our clothing and quite a bit of our food. (Farmers often grow mostly corn and soybeans for animal food, and nothing for humans.) We need incentives back to grow food and make clothing locally.

      I am not convinced that we have the time/financial resources / energy resources to make a changeover to a different transportation system at this time. I think we are hitting Limits to Growth right now. At current high oil prices, the economy goes into “contraction” mode. Any transportation system we replace our current system with needs to be cheaper than our current one, to fit with the fact that the world is becoming poorer, not richer. So maybe we should be thinking about bicycles instead of fancy new more-expensive systems. If nothing else, workers are not going to be able to afford new $35,000 cars.

      I have my doubts about renewable power as well. Our electrical power system was built for local transmission, but with renewable power, long distance transmission is needed, to smooth out fluctuations in production and to transport the electricity where it can be used. A very small amount or renewable power can be added to the grid without difficulty, but the more that is added, the more upgrading the grid needs. It will be difficult to maintain what long-distance transmission capability we have in years ahead, as oil supplies get tighter, because maintaining transmission lines requires roads and trucks (or helicopters with fuel), plus manufacture of appropriate parts. My fear is that adding very much renewable electricity is going to make the system as a whole fail faster than it would otherwise, so will in the end leave us worse off, rather than better off.

      If the renewable power were hydroelectric, added where it is to be used, I would have no problem with it. In fact, that is what our electricity system originally started out with, and likely will ultimately end up with. We need to be looking for inexpensive ways of making (and transporting) electricity with local materials, not high tech ways of making electricity, using approaches that require replacement parts from China.

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