Rentier Debt and the Collapse of Debt-Based Finance

At the Age of Limits conference near Artemis, Pennsylvania on May 25-28, I was asked to speak on rentier debt and the collapse of debt-based finance. This is a somewhat difficult subject, so I decided to talk about the subject more generally–how growing debt fits in with economic growth and growth of energy supplies, and how inability to keep increasing this debt makes any existing tendency toward collapse worse. In this post, I would like to share this presentation with readers.

Slide 1

Let’s start by talking first about a subject fairly far removed debt–the difference between the systems created by nature and systems created by humans. The reason why I bring this difference up is because if we were only dealing with natural systems, there would be no need for debt. It is only when we start dealing with man’s systems that debt becomes an issue.

Natural System vs. Humans’ Growth Based System

Slide 2 – Natural system vs humans’ system

We all know what the natural system looks like: the combination of birds, animals, trees, the sky, the many tiny organisms, the soil, rocks, and everything else in the world that is present without man’s intervention. Human systems represent things that humans make, such as trucks and roads, and cars, and buildings, and electrical transmission systems. In a way, all human systems are interconnected, so we can think of them as one big system, created by humans.

Slide 3. Natural systems don’t grow

Natural systems don’t expand in size over time. Individual plants and animals grow and mature, and in the process become larger. But then they die, their bodies decompose, and eventually different organisms grow. Rocks decompose and form soil. This soil erodes, but, in time, it is replaced with new soil through the erosion of rocks.

There can be an expansion in the number of one type of animal, but eventually these animals will tend to eat too many of their prey, and the number of predators will drop, to stay in line with the amount of their food source. There can be a shift in mix of types of plants and animals, but the change is in the mix, not a long term growth in the overall quantity of plant and animal life.

Natural systems don’t need any assistance from humans. They have been around for billions of years. There is no need to finance anything.

Outsmarting the Natural System

Slide 4. Human systems are very different

In the natural system, each type of plant or animal produces more offspring than is needed to replace itself. The normal order of the natural system is such that only the best adapted plants or animals relative to the particular surroundings will survive. Many of the offspring do not survive to maturity.

Humans, since the earliest times, have had difficulty with this arrangement. Humans, because of their intelligence, have found ways to outsmart at least part of the “survival of the fittest” arrangement that would keep our numbers similar to those of other primates, such as gorillas or chimpanzees–probably fewer than 1,000,000 humans in total in the whole world.

Well over 100,000 years ago, humans discovered the use of fire, and the fact that fire could be used in many ways–to cook food so that new types of food could be eaten, and so that more nutritional value could be extracted from food that was eaten, to keep warm, and to drive animals from one area to another, so that animals could be more easily killed and eaten. In the same time-frame, humans began using spears to better kill prey. About 35,000 to 45,000 years ago, humans learned to hunt with dogs, and thus increased the amount of prey they could kill.

This pattern of finding ways around natural limits has continued to this day. The use of farming, starting about 10,000 years ago, allowed a great expansion in population. The use of trade to import food from a distance further increased the number of humans who could live on the earth. There were numerous other discoveries, including burning peat moss, and the use of water power and wind power, before coal was brought into common use in the 18th century. In the 20th century, the petroleum use surpassed coal. There were also many other advances that helped humans avoid natural limits–for example, the discovery of antibiotics, and the widespread use of electricity.

At the bottom of Slide 4, I have represented the long-term pattern of growth by a line that gradually slopes more and more upward, as we move to later periods. Even in the earliest period, there was some upward slope, but this may have been offset by setbacks. The amount of growth gradually increased, but still was not particularly evident to those living at the time, because of inherent fluctuations. The greatest growth has come in the last 100 years.

Slide 5. Reasons human system is growth based

There are two basic reasons why human systems are growth based:

(1) Humans find ways to get around “survival of the fittest”.

(2) Entropy–Whatever humans build eventually falls apart. Humans have to keep to keep building more, just to stay even. Even advances like discovering antibiotics and herbicides have to keep being repeated, or nature finds ways around our advances.

The combination of these factors means that humans have been, and continue to be, on a constant growth tread-mill. There have been examples of small societies that have managed to keep populations flat for relatively long periods, and there have been many  societies that have collapsed while others have expanded.  The overall aggregate impact of human has been, however, has been one of gradual growth in numbers and material wealth.

Graphic Representation of Natural System and Humans’ System

Slide 6. Humans’ system started out as a tiny part of nature’s system.

Slide 6 shows my view of how very early humans fit in with the natural system, back in the days before man discovered fire and spears and learned how to hunt with dogs. Humans were part of the natural system, just like other animals. Their population was no doubt relatively low, and stayed low, perhaps varying with climate change and food availability.

Slide 7. Humans’ system grew to overwhelm nature’s system

Slide 7 shows my view of what humans’ system looks like now. It has grown in size, so that in many places it overwhelms the natural system. Humans’ system takes resources from nature, and sends its pollution back to nature. Thus it is tied to the natural system, whether we recognize the situation or not.

The Nature of Growth

Slide 8. World population growth

If we look at a graph of world population, we see that growth has been particularly evident in the last 100 or 200 years.

Slide 9. Nature of growth

It appears to me (based on GDP statistics of Angus Maddison for the last 2000 years) that prior to the use of fossil fuels, most of the growth was simply population growth, as humans were able to increase their food supply. It was not until fossil fuels were added that there was a big increase in standard of living.

Slide 10. Growth provides many benefits.

Economic growth of the type we have had since the growth in the use of fossil fuels provides many benefits. If the economy is growing fast enough, there is rising demand for homes, so home prices tend to rise. The prices of individual stocks rise, and there are more jobs available, some of which pay well. Governments find that the taxes that they collect rise, even without raising the tax rate. This helps governmental stability.

Slide 11. What is needed for a growth-based system?

How can humans’ system be made to grow? Clearly one thing that is needed is increasing amounts of materials from the natural world; another is a way of transforming these materials into goods and services that people want or need.

A less obvious thing that is needed is a way for people to be able to pay for the goods and services, in advance of the time that they earn the money to buy these things. This is where “rentiers” come into play. Rentiers provide the credit that allows people to buy goods and services that would normally require a large accumulation of wealth.

Debt was first used about 5,000 ago, back in the days of early agriculture, according to David Graeber’s Debt: The First 5,000 Years. At that time, large temples acted as purchasers and sellers of goods and services. People brought goods to the temple to sell, and also bought other goods. The temples kept running tabs. Those who bought more than they sold were in debt.

Rentiers and Debt

Slide 12. Who/ what are rentiers?

Rentiers are enablers of debt. They allow people to buy things that they couldn’t otherwise pay for. Rentiers include banks and other parts of the financial system.

There have been rentiers for 5,000 years, but the growth in rentiers has been greatest since World War II. The need for debt is greatest when one wants to increase the rate of growth.

Think of the United States after World War II. The world had come through the long economic depression, and things were finally looking better after World War II. The soldiers were coming home again, and would soon be unemployed. If only citizens could afford to buy new cars and new homes, there might be jobs for these returning soldiers.

Slide 13. Non-government debt growth after World War II.

Government debt had been ramped up prior to World War II (allowing it to buy tanks and airplanes and to employ more soldiers), and now was being paid down (not shown on Slide 13). If demand was to be kept up, and even raised, private citizens and businesses needed to be encouraged to go into debt, allowing citizens to buy things like cars, refrigerators, and new homes. Slide 13 shows that non-government debt was ramped up  after World War II. This stimulated the economy because it allowed more people to buy “big ticket” items, and helped ramp up job growth and energy use.

Slide 14. World Energy Consumption

If we look at a graph of world energy use (from my post, World Energy Consumption Since 1820 in Charts) we see that world energy consumption really began to rise after World War II–that is, the same time non-government debt was being added.

Slide 15. Per capita energy consumption since 1820

The growth in energy consumption since World War II is even larger on a per-capita basis. Most of this growth was in fossil fuels–in oil and natural gas, and, recently, in coal. Without fossil fuels, our per capita energy consumption in 2012 would be below that in 1820, and our lifestyles would be much different.

Slide 16. World population grew at the same time as non-governmental debt and energy.

Slide 16 shows that if a person looks at a graph of world population growth, there is a very distinct upward “bend” after World War II. This is precisely the time that energy use grew rapidly, and debt use grew rapidly.

How Debt Growth Works – And Eventually Doesn’t Work

Slide 17. How the debt-based system works

The basic way our financial system works is that when a person or business or government needs money, that money is loaned into existence. This allows a business to expand, or a person to afford to buy a car or home that he or she had not saved up money for.  What happens is that increasing debt allows demand to be higher than it would otherwise be, so that natural resources (including oil, gas, and coal) are extracted more rapidly than they otherwise would be. This allows what we measure as the “economic growth” rate to be higher than it would otherwise be.

There are a couple of catches with this system:

1. The money to repay the debt is not loaned into existence at the same time the principle is loaned into existence. As long as the economy is growing fast enough, this is not a problem, because economic growth allows future production to be enough higher than current production to pay back debt with interest. But if the economy ever slows down, there is a problem.

2. The process of increasing extraction of natural resources through the use of increased debt doesn’t work indefinitely, because at some point resource extraction starts getting constrained, and pollution becomes more of a problem.

Slide 18. Our debt-based system depends on growth

Slide 18 illustrates the way that a growing economy helps to make repaying debt easier. With a growing economy, the size of the “economic pie” grows pretty much every year. This growth means that even if a fixed amount of debt plus interest needs to be paid back, relative to the growing base, it is less of a problem. It is easy to see this situation for a government, but a similar situation exists for individuals. If the economy is growing, on average, people will find themselves getting promotions and will find new jobs available when they lose old ones, so that, for example, repaying home loans tends not to be a problem.

Clearly, the reverse is true if the economy is shrinking. Even if the economy shows zero growth these is a problem, because there is not enough to growth to cover the interest. If interest rates are lowered to almost zero (do very low interest rates sound at all familiar?), the inability to cover the additional cost relating to paying back interest, but even this becomes burdensome.

It might also be pointed out that with a flat or shrinking economy, it becomes more and more difficult to pay for promised social programs, such as social security retirement programs and unemployment programs. These programs become a larger portion of a stable or shrinking pie, and thus become harder and harder to fund. European countries (which have been very generous with their social programs) are having particular difficulty with these problems now, as well as difficulty with repaying their debt.

Slide 20. Humans’ system can’t keep growing forever

The reason why growth in resource extraction cannot continue forever is related to Figure 20, whch I also showed earlier. At some point, resource extraction becomes constrained. Higher demand for oil tends to lead primarily to higher prices for oil, rather than to much more oil actually coming out of the ground. Pollution of various kinds, including carbon dioxide pollution, becomes more and more of a problem.

Everything I can see says we started reaching the point where oil resources became restrained about 2004 – 2005, when oil prices started going up, and oil extraction did not rise by much. Since that time, world oil extraction has grown very slowly, constraining economic growth. The 2008-2009 recession seems to me to be very much associated with this constriction, as are the debt problems we are now seeing around the world, especially in Europe.

Slide 21. Slowdown occurs when oil prices rise

The reason why an economic slowdown occurs when oil prices rise relates to the fact that oil is used for necessities–growing food and for commuting to work. A rise in oil prices does not result in a rise in families’ incomes, especially in oil importing countries, which is what the United States and most of Europe are. A family will tend to cut back on discretionary spending, such as going out to restaurants, or buying a new car, or buying a more expensive home.

As a result, there will be layoffs in discretionary industries–for example, restaurants, car manufacture, and home building. People in these industries will be laid off from work. Some of those laid off from work will default on loans. Value of homes will tend to fall, as few people are in the market for a move-up home. Government spending on unemployment claims will increase, at the same time that tax revenue drops (or flattens) because fewer workers are employed. Governments find themselves in increasingly distressed financial condition, because they cannot afford to pay promised benefits, and their debt burden gets higher and higher. If this all sounds like the economic news of the last few years, in both Europe and the United States, it shouldn’t be too surprising, given the high price of oil, and our the dependence of our economies on oil.

Problems with the Rentier Debt System

Slide 22. Issues of the debt-based system

The biggest issue with our debt-based system is the system tends to collapse, once adequate growth to sustain the whole system occurs. We appear to be rapidly approaching this point. It will also collapse at a closely related point-—when the amount of debt becomes so high that the governments cannot afford to pay the interest on debt, and keep up other programs.

Another issue is that as the economic condition of people in oil importing counties is reduced, governments of these countries find themselves less able to collect taxes, at the same time they would like to stimulate the economy. Promised retirement programs also become harder to fund. This means that the governments of oil-importing economies will find themselves under increasing tendency to collapse, as high oil prices lead to recessionary tendencies.

Another issue of the rentier debt system is that too much money is transferred to the finance system and to those collecting interest (as opposed to paying interest). People at the bottom of the economic order find themselves barely able to make ends meet, and borrow to try to cover necessities. The interest rates these individuals are charged are far higher than the interest rates paid by borrowers who are deemed more “credit-worth”, such as governments.

Another issue is that as the price of oil rises, too much money is transferred to countries involved with oil extraction, at the expense of oil-importing countries. This transfer of funds to oil exporting nations tends to depress the economies of oil importing nations. There are theoretical ways that the funds of oil exporting nations might be recycled, but increasingly, these countries find that they need these funds to pacify the demands of their own populations, so that recycling occurs less.

What Is Ahead?

Slide 23. Some possible impacts of defaults

We have already talked about some of impacts that are already occurring–financial systems under stress, with some countries appearing to be near default. The question is what may happen next.

If there are defaults in one or two countries–say Greece and Spain–the financial problems seem likely to  spread to banks in other parts of the world, through derivatives and through banks carrying debt relating to the defaulting countries. There also seem to be any number of countries in weak condition–for example, Egypt–and the problems of these countries may worsen as well.

Another likely outcome would seem to be that new loans will become less available.  If a particular country has recently defaulted and seems to have no way of paying for new oil imports, they may have difficulty getting loans. But even those not directly involved with defaults may find it much more difficult to get loans, because the financial condition of banks will be worse, and some banks may fail. A reduction in available loans will tend to lead to economic contraction, and make any tendency toward collapse worse.

We can speculate on all kinds of other things that happen. I will not elaborate on the Items shown on Slide 23, except to say that cheap oil has enabled a lot of what we have today–an international trade system that allows the formation of large countries, and that allows large countries to interact to a much greater extent than a few hundred years ago. There would seem to be a possibility that most of the advances of the last few hundred years will disappear as the availability of cheap oil disappears.

Can we solve our problems by getting rid of rentier debt?

Unfortunately, no. We are now reaching resource limits, primarily in oil, but also in other resources, such as fresh water, and also with respect to pollution. Humans were on a growth trajectory to reach these limits, with or without rentier debt. Rentier debt allowed us to reach these limits faster than we might otherwise have reached them.

Now that the bubble has been inflated, and we seem to be near collapse, getting rid of rentier debt won’t really “fix” the situation. It is basically too late. The future direction would seem to be contraction, and this will almost certainly eliminate most rentier debt.  Our task now would seem to be to deal with all of the dislocations that occur when defaults occur and to develop new financial system(s) that can handle continued contraction.

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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