Discontinuity Ahead – Oil Limits will Adversely Affect the Economy

What will the world economy be like ten years from now? Or fifty years from now? Is it something that we can forecast by looking at the past, assuming that past tends will continue?

GDP Assuming 3pct Annual Growth

Figure 1

Most economists today seem to think we can rely heavily on past patterns. If we can really assume that the economy will grow at 3% per year (over and above inflationary increases), then in 50 years, GDP (Gross Domestic Product) will be 4.38 times as high as it is today. Economists might assume a 3.0% growth rate in a developed country, like the US, and a higher annual growth rate in a country like China, India or Brazil.

It seems to me that this standard view is incorrect. There is a substantial chance of a sudden shift toward a less favorable growth pattern (which I refer to as a “discontinuity”). This possibility is not obvious though, if a person bases his models on the growth that took place between 1940 and 2000, as economists today often seem to. In this post, I describe an alternate view showing how such discontinuities can occur.   

The Current (or Recent Past) “Standard” View of the Economy

Most economists today seem to believe a whole collection of theories and models that basically support the view that humans (and in particular, politicians and Federal Reserve Officials) are in charge of the economy. With this view, natural resources are not very important. If there is a shortage, either (a) alternatives will take over quickly or (b) prices will rise for a short time, leading to more extraction, thereby eliminating the shortage.

Productivity is expected generally to trend upward. In other words, the expectation is that there will be increasing output per unit of input. Part of this increase in output comes from improvement in technology. This improvement in productivity is expected to lead to increased profits for companies and higher wages for workers.

If the economy is not performing optimally, demand (that is, the ability and willingness to buy more “stuff”) can be increased through deficit spending or by very low interest rates, or both. For example, deficit spending might be used to give a worker who has been laid off unemployment benefits, so he can buy food, clothing, and other goods and services. (Without money, the laid-off worker has no demand, according to the standard economic definition.) Very low interest rates tend to make a new car or new home more affordable, or might allow an oil and gas producer to drill more wells inexpensively.

Debt, or “leverage” as it is often called, seems to be seen as beneficial. Debt is seen to being able to increase indefinitely. The primary measure of how the economy is functioning, GDP, completely ignores debt. For example, if a person goes to college for a year, tuition will be part of GDP, whether or not the individual takes out a loan to pay tuition, room, and board. If the college builds a football stadium, the amount paid to the contractors for building the stadium is part of GDP, but the loan the college takes out to finance the stadium is not considered in the calculation.

Needless to say, if politicians want to increase GDP, the easiest way to do so is to encourage everyone to “max out all their credit cards,” or do the equivalent with other types of loans. Of course, doing this in the early 2000s helped lead to the subprime debt bubble–not exactly the effect one wants.

With the foregoing view of the economy, economists can talk about substituting one energy source for another over a very long time frame. The reason economists can think in these very long time frames is because the economy is seen to always be growing, thanks to productivity growth, more human laborers, technology growth, and occasional stimulus, if needed. In this model, there is nothing to challenge the growth of the economy, so no turning points are anticipated. Thus, we can undertake very long projects, such as trying to swap low-carbon energy sources for other energy sources.

Discontinuity: Why might economic growth “misbehave” going forward?

We are aware of many situations in the physical world where there is a sudden change of behavior. We pull on a rubber band for a while. At first it stretches; then it breaks. We skate on thin ice for a while. At first the skating goes fine; then we fall through the ice, into the water. We throw a ball up in the air. It rises for a while; then it stops and falls back to the ground.

Another example is a little closer to the economic growth model we are looking at here. Yeast transforms sugars in grape juice into alcohol. Alcohol is in fact a waste product, made by the yeast, as it metabolizes the sugar. At some point, the concentration of alcohol in the wine becomes too high for the yeast to survive, and the yeast die off. Growth of yeast population, instead of continuing to rise rapidly, suddenly turns negative and the population falls to zero.

In a model such as the wine and yeast model, it is not until the pollution level becomes too high that the adverse effects are seen. We can encounter somewhat of a similar problem with our economy, with pollution of various kinds.

A similar turning point can appear with resource extraction of various kinds, such as oil. When we begin extracting resources, the cost of extracting those resources is not very high. In fact, the cost of extracting the resource may even fall, with greater use of fossil fuels and improved technology. This growing productivity enables a rising standard of living.

At some point, however, the cost of extraction begins to rise, because the easy-to-extract resource (such as oil) has already been extracted. This higher cost of extraction may set up negative feedback loops, throughout the economy. This occurs partly because resources must be diverted toward oil extraction, rather than being used for other productive purposes. From the point of view of the worker, he finds it necessary to lower his standard of living, because he spends more of his total income on the same (or a lesser amount) of oil, leaving less income for other purchases.

The original factors of production were land, labor and capital. This simplified model did not consider natural resources, or pollution caused in extracting and using the natural resources, or the role of debt. It also did not consider the fact that we live in a finite world, so that even if growth can go on for a while, there are likely to be barriers at some point. If the economic model economists are using misses important variables, it is easy for the model to miss problems that haven’t come up to date, but can be expected to come up in the future. The model may have, in fact, worked well in the 1940 to 2000 period, because resource limits did not start raising resource prices significantly until after the year 2000.

A related issue is that if economists are overly convinced that their models are correct, they may miss seeing important trends that suggest their models are incomplete.

Figure 2. US Ten Year Average Real GDP growth, based on BEA data.

Figure 2. US Ten Year Average Real GDP growth, based on BEA data.

If we look at the trend line related to US GDP growth (Figure 2), we see that there is a decided downward trend to it. While an estimate of 3% per year going forward might have made sense based on the experience through 2000, this estimate seems increasingly  less likely, based on recent experience. In fact, if experience since 2010 were included, it would further emphasize the downward trend. The IMF projects that US economic growth in 2013 will amount to 1.7%, and for advanced economies together will amount to 1.2%.

Besides slower than expected economic growth, there are many other parts of the theory that are not holding up very well now, either. Wages of the common worker have not been rising as planned. Oil prices have not come down, even with considerable success in US oil production. The Federal Reserve has needed to keep interest rates very low, and even with that, the economy is limping along. The Federal Reserve keeps printing money. In fact, it announced today that it is continuing its Quantitative Easing at $85 billion a month, because the economy is not yet doing well enough to get along without it.

What is Missing in Economic Models

What is missing is a broader view of how the economy really works. The economy is far more than land, labor, and capital. The economy includes a huge number of players–governments, businesses, and individuals, each deciding what action to take based on how the system behaves at a given time–for example, what products and services are available at a given time, at what prices. Resources of many different types play a role in this system, as does pollution, and the cost of mitigating this pollution. This complex economy has been built up over the years, by the gradual addition of new layers of businesses, governments, government rules, and consumers. Unneeded older parts drop out, as new parts are added. A system such as this is sometimes referred to as a Complex Adaptive System.

There are two parts of this system that play a special role. One part is energy products that are needed to make anything “happen.” These energy products are of many different types, including oil, natural gas, coal, geothermal energy, captured wind energy, even food. For example, if goods are to be transported, some sort of energy product is needed. It might be oil used to fuel a car or truck. Or it might be food fed to a horse pulling a cart. It might even be food fed to a human being, who is then able to carry the goods as he walks.

As another example, if heat is to used for some process such as baking, some energy product is required. It might be heat from burning oil or coal, or it might be heat from the sun captured by a solar cooker. Energy for heat might even come from food. For example, a chicken, after eating appropriate food, is able to sit on an egg and provide heat to incubate it.

Another critical part of the system, besides energy resources, is the financial system. The financial system ties everything else together through its pricing mechanism. By knowing prices, we can tell how society values many very different types of resources and products (such as a bushel of wheat, a barrel of oil, and an hour of a common laborer’s time). Because of its tie to all of the other resources, the financial system is likely to be one of the systems that is stressed earliest, if there is a major change to the system.

Besides tying the system together, money produced by the financial system also acts a “pseudo resource”. It is not the money itself that has value–it is the fact that it can be exchanged for a resource of real value, such as a bushel of wheat, a barrel of oil, or an hour of a common laborer’s time. When the amount of resources is not expanding rapidly, printing money can temporarily inject pseudo resources into the system, making things temporarily look better than they are. Of course, when this money printing stops, the temporary improvement is likely to disappear.

Oil Has Caused Recent Stresses to the Financial System

When recession hits, the financial system gives a hint that this networked system of businesses, governments, consumers, and resources is being stressed. What causes this stress on the financial system? Recently, evidence seems to suggest that rising oil prices are a major contributor.  For one thing, economist James Hamilton has shown that 10 out of the last 11 US recessions were associated with oil price spikes. He has also directly shown that the oil price in the run-up in the 2005-2008 period was sufficient to explain the Great Recession. I have also written an academic article called, Oil Supply Limits and the Continuing Financial Crisis.

Oil is part of the constellation of energy resources that allows things to happen within this complex networked system. It is not easy to substitute away from oil in the short term, because the cost of the vehicles and other equipment that we have today is extremely high. If we were to transition to other types of vehicles (say natural gas operated or electric), the cost of building new fueling stations and vehicles would be very high, and take many years. Customers would also find the new vehicles unaffordable, unless the old ones could be phased out as they wore out.

What Can Go Wrong In This More Complex System?

The problem with this more complex system is that everything depends on everything else. Things that seem obvious, such as how much oil reserves a company can expect to extract in the future, no longer are obvious, because the prices of resources can go down as well as up.  This happens because prices of resources depend upon (a) the amount buyers can afford to pay for these resources, as well as (b) how much it costs to extract the resources. If the cost of extracting resources increases, the question is whether workers will really be able to afford the cost of higher-priced resources.

There can also be conflict between the amount of debt outstanding and the amount of products (made from resources) available to repay that debt. There is no limit on debt issued, but the amount of resources extracted in a given year eventually slows down, as the inexpensive to extract resources are depleted.

Interest rates on debt are important as well. If interest rates remain very low, interest payments do not “squeeze” prospective buyers of goods too much, so they can afford additional goods. But if interest rates rise, then the financial situation changes at many points in the system. The cost of buying homes and cars increases. The resale value of homes likely drops.

Another issue with the networked system that we are operating in is that shortages in one area tend to get transferred to other parts of the system, stressing the system as a whole. For example, when we discovered a few years ago that oil supply could not grow as rapidly as desired, we started using food crops (primarily corn and sugar) to produce ethanol, as a substitute for oil. When we did that, the additional demand for food tended to raise food prices. Thus the stresses from one part of the system were spread more broadly. This can be a temporary help to oil prices, but it can eventually lead to  widespread system failure.

Because of the interlinkages in the system, we should not be surprised if what looks like a problem in one part of the system–high oil prices–has an adverse impact on other parts of the system. The financial system, since it connects everything else together, would be especially likely to be  stressed. Governments, because they act as a safety system for unemployed workers, would also seem to be at risk.

We have many real-life examples of civilizations that grew for a time, then reached limits and collapsed. These civilizations were agricultural civilizations, so admittedly not exactly like ours. But the symptoms prior to collapse were disturbingly similar to the symptoms we are seeing today. As I have discussed previously, there was a growing disparity of wages between the common workers and the elite, and increasing use of debt. Food prices often spiked. Eventually, it was the inability of governments to collect enough taxes from increasingly impoverished workers that brought the system down. Workers also became more subject to disease, because low pay and high taxes did not allow for adequate nutrition. The collapse came over a period of years–typically 20 to 50 years.

We don’t know exactly what kind of discontinuity we are headed for, but we have some clues, based on the risks we are facing and on what happened in the past. The discontinuity will likely play out over a period of years. Financial systems and political systems are likely to be involved. Because of the networked nature of the system, it will not be just one type of energy that will be in short supply–more likely, there will be problems affecting nearly all types of energy.

I have been putting pieces of this story together over time. Some posts related to this story include the following:

Oil Prices Lead to Hard Financial Limits

Humans Seem to Need External Energy

The Long-Term Tie Between Energy Supply, Population, and the Economy

Energy and the Economy–Basic Principles and Feedback Loops

Reaching Limits in a Finite World

Oil Limits Reduce GDP Growth; Unwinding QE a Problem

Reaching Debt Limits

Inflation, Deflation, or Discontinuity?

Low Oil Prices Lead to Economic Peak Oil

Energy Products: Return on Investment is Already Too Low

Peak Oil Demand is Already a Huge Problem

How Oil Exporters Reach Financial Collapse

Networked Resources, Declining Quality and Peak Oil (Guest post by aeldric)

Human population overshoot–what went wrong?

Why Malthus Got His Forecast Wrong

Twelve Reasons Why Globalization is a Huge Problem

Reaching Oil Limits – New Paradigms are Needed

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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119 Responses to Discontinuity Ahead – Oil Limits will Adversely Affect the Economy

  1. Edwin Pell says:

    Gail, we need a new limits to growth computer model that include financial considerations. Do you know of anybody who is doing this? Have you ever considered leading such an effort? I think you would be ideal.

    Ed Pell

    • Good question.

      An actuarial group in the UK set aside 50,000 pounds, to award to a group that would use the money to do improved modeling regrading Limits to Growth. I talked to the current Limits to Growth modelers, and tried to get them to apply for the money to use toward adding some financial considerations to the model, but I am not sure they really understood the exactly what was wrong, and how to fix it. (They did not have financial backgrounds.) I am also not sure that the people I talked to (which included the lead programmer) had the ability to go ahead without the approval of Jorgen Randers, whom I did not talk to.

      Eventually, the 50,000 pounds were awarded to some actuaries in the Uk, working without the Limits to Growth model. I have talked to them and sent them links to some of my work. My impression was that they were starting at a pretty basic level of understanding. I haven’t seen any of their output.

  2. Economists assume that 3% is a “reasonable” annual growth rate, usually without even understanding what it means (e.g. an 2^3=8-fold increase in 70 years). Quantitative literacy urgently wanted. It is still a truism that most people don’t understand the basics of exponential growth.

    http://www.slideshare.net/amenning/growth-in-a-finite-world-sustainability-and-the-exponential-function
    http://www.slideshare.net/amenning/exponential-growth-8340189

  3. Stilgar Wilcox says:

    Ok, so this is off topic, sort of, but are you shocked like many others are by Bernanke’s ‘hold em’ position on QE absent any tapering. Why leak Fed plans to taper, with markets making their adjustments to a predicted 10-15 billion reduction, if they don’t actually follow through? What happened between the time they leaked taper and rejected taper? Is the economic situation really that desperate?

    • Scott says:

      Hello, Not off topic at all, this is the heart of our problem. They are trying to hold down rates and especially with the all the trillions in debt they have to roll over, if the rates go even a point or two higher the interest will eat up all our national money. It seems once the printing press starts and we go down that path, they will be unable to stop it without a severe depression which we almost had in 2007-08.

      No politician wants to be responsible for starting another Great Depression so they will continue to print, they must or die. The question is whether the inflation will show sooner or later. New Bubbles forming already since 2008 especially in Bonds, stocks and Student loans and now just a bit in housing.
      Regards,
      Scott

      • Stilgar Wilcox says:

        We’re on the same page on that one. Since Helicopter Ben has made his play, what’s now going to be a wild west show is the debt ceiling collision coming up here in the next few weeks/months. It sort of hits the same nerve, i.e. a form of stimulus the economy can apparently not do without. It’s down to 700 billion in the red vs. over a trillion last year, but still an enormous amount to try and sizably reduce, since all they ever agree on is a few measily hundreds of millions. Obamacare is being dangled as a carrot from a stick for Obama to nix to avoid a govt. shutdown. Should make for great political theatre and the effects it has, like a credit rating decrease or striking govt. workers or unrest.

        The pressure has been building for a while and the following six to 12 months should build to some kind of tempest in stocks or bonds, commodities or who knows what but I sure wouldn’t want to be Ben or O.

    • Perhaps Bernanke’s ‘hold em’ position relates to the news that the House wants to make drastic cuts to food stamp expenditures as well as eliminating all funding for Obama care, and thinks they can get their way on the budget by refusing to pass it thus shutting down the government, or taking us into default by refusing to extend the debt ceiling. We’ve been on this cliff before. I doubt Bernanke wants to add more stress to the situation so he will allow the QE to continue until he leaves in January.

      • Scott says:

        Hello, Jody I do not see QE ending in January, but they may taper to test the waters, markets will crash etc and then they will see disaster and will be right back at it again – Pedal full metal to the floor. They took a path of no return it seems to me with the QE, a few good years for a price to pay later.

        Scott

        • Danny says:

          Well, I think they lost some credibility by not tapering last week…If they are following congress and making plans based on what congress will or will not do; It shows how fragile they and we all are in this system. It is no way to base your decision; but then again I don’t agree with what they have done. It has only helped the 1 percent…people don’t realize yet what is happening to their future; if they did they would be much more angry…

      • I agree with you about where Bernanke is now. If he is leaving in January, and the US is facing debt limits near term, there is no reason for him to reduce QE. Let his successor deal with the problem (unless some implosion happens before then).

  4. Chris Johnson says:

    Scott and Stilgar:
    It strikes me that Scott’s response may not assign sufficient onion juice to the entire affair. I believe a strong case can be made that this is merely BB’s method of marking his territory, like an old wolf dog, saying, “I can do anything I please. You can complain, but in complaining you’re hurting yourself…” Have you read the STRATFOR paper on the Fed’s impact on international affairs?

    • Scott says:

      Hi Chris, Which post were you referring to here, the one I just wrote about print or die?

    • Scott says:

      Hi Chris and everyone interested in this subject… I am still not sure which post you were talking about the Fed, I noticed on Wednesday when they announced QE would continue, all the world markets rose on expectations of inflation.

      The money lenders connected to the Fed it seems are in every country almost and they have become the bankers that are owed by many nations, they have gone into countries and bought roads, infrastructure that pledged for loans made to ailing nations and now it may be time to pay.

      My recent point was all of these nations that owe Goldman or some other bank like JP Morgan now may have to pay with higher interest leaving less money for its citizens and programs that support the poor.

      Since the world as a whole has used credit to the maximum in recent years this presents a problem and it seems to be almost everywhere.

      If the rates rise in the next few years, then we will see much Austerity and perhaps another Depression. But my case is that I believe that they will have to continue QE world wide and print otherwise face the deflationary depression, So I see hyperinflation first then perhaps our deflationary depression, the balloon blows up then deflates.

      During the hyper inflationary period it would be good to own assets that have inflated and sell them so they can be converted into needed things to weather the deflationary depression.
      Still not exactly sure on this but that is kind of how it is looking to me now. A rise in asset prices then a severe deflationary blow off….

      Scott

      • The assets that inflate include a lot of paper assets, whose value is ultimately going to $0. I am not sure you want to get into the business of figuring out how to play this market.

        We can argue about how much a wheel barrow will cost now, versus how much it will cost later. The point is that if you need a wheel barrow, buy a wheel barrow. Don’t depend on accounts which may or may not be there to provide the funds to buy one later.

    • Stilgar Wilcox says:

      Have you read the STRATFOR paper on the Fed’s impact on international affairs?

      Not yet, but will do a google search and get back on here with something after reading it.

      • Scott says:

        Hello, As much as we would like this – I do not think we will see anything like Glass Steagall reinstated as the bankers are now in charge of our governments more or less and this would prevent them from continuing to fleece us as much. It would hurt their game. People would really need to force this one through, not a chance right now from my view. Wall Street is in charge.

        Scott

        • xabier says:

          I agree Scott. Voting is something of a farce these days, whoever you vote for you get the bankers’ party and the surveillance state as one package: however, if an open dictatorship without elections were to be put in place, the corruption would rise to levels hard to imagine now. A vestige of the rule of law still remains to us.

  5. Ikonoclast says:

    After I mentioned early in this thread why hydrogen is not an energy source for us (little free hydrogen on earth to react chemically and the fusion reactor is still a dream), it might be worth going the next step up the periodic table.

    The world faces a looming helium shortage. It’s Liebig’s Law of the Minimum once again. This issue (Liebig’s Law) is cropping up everywhere now.

    http://www.livescience.com/38990-looming-helium-shortage.html

    • The helium shortage is a good point. Each problem of this type causes a cascading set of failures–businesses bought MRIs, thinking that they would be able to use them for many years; now find that they can’t. Manufacturers of MRIs go out of business. Other businesses, for example providing educational material about how to use MRIs need to find some new business as well. Many doctors have forgotten (or never learned) what other diagnostic techniques were used before MRIs, so end doing less well at diagnosing issues than they did, prior to adding MRIs. Former MRI technicians are laid off.

      And I am sure helium is vital for number of other technical purposes as well, each with their own set of issues.

  6. Don Stewart says:

    Dear Gail
    David Holmgren responded to an article which claimed that simple household tasks such as making compost for the garden were ‘meaningless’ and the world needed political action. I think my earlier response to the Australian articles is pretty much in line with David’s views…. Granted that there is going to be a train wreck, what do you do about it?…Don Stewart

    http://holmgren.com.au/household-economy-counts-full-text/

    Without vibrant household and community economies providing the most basic needs of water, food and shelter, relatively independent of current centralised monetary structures, people will be powerless to develop localised systems of finance, healthcare, education, governance and security that are also necessary in some form. In the absence of any effective reformation of centralised systems, the ability to effectively salvage the wreckage of industrial modernity will depend on the relatively sophisticated evolution of localised systems.

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  8. Danny says:

    Gail, what can you tell us about peak coal as we go into either deflation or inflation wont people use more coal because it is cheaper? Is there a chance of peak coal in the US? ..I too think that the financial collapse is closer than we think…I am amazed we made it this far. I am not sure about the current congress either are they playing chicken with each other or is there some other game they are playing? I think if we are going to have a financial crash we need to have it now; putting out all these small fires everywhere is just setting up a system for a really large fire to burn.

    • I don’t think people will use more coal. The system we are using is interconnected. Loss of one part of the system leads to loss of other parts of the system (maybe not at the same time, but in a short time frame).

      For one example, the financial system is needed to keep all kinds of businesses open. They use credit in many ways–from long term financing to assuring that payment will be made when goods are delivered. Just a cut-back in the credit system would lead to a problem for businesses of all types, including coal extraction. Also, with fewer people having jobs, they wouldn’t be able to buy goods and services using coal, such as electricity. So demand for coal would drop, and thus price, making it unprofitable to extract coal.

      As another example, oil is required for electricity production, because of the interconnectedness of the system. For example, oil is needed to power the vehicles used to repair electric transmission lines, and to transport solar PV cells, inverters, and batteries. Oil is used to lubricate parts of electrical generating plants, including coal-fired plants. If there are gaps in oil availability, demand for coal to run electric power plants will disappear.

      Most coal mines today are deep mines, that require high tech equipment to operate them. To keep these mines operating requires a constant flow of replacement parts. If these are lacking, the plants will close down. Workers also have to get to the plant. If key workers are absent, the mine may need to close. Admittedly, there are some landlocked parts of the world where there are low tech mines where someone with a shovel and a beast of burden can harvest coal by the bushel full. But extracting coal in this way can never amount to much. The fact that these places are landlocked (which is why they were never developed previously) means that transport away will still be very difficult. The little coal that is produced will be used very locally.

      • Gail,
        “For one example, the financial system is needed to keep all kinds of businesses open. They use credit in many ways–from long term financing to assuring that payment will be made when goods are delivered.”

        I agree this is true for big business, which depends on growth and leveraging of debt. But small businesses, such as the one I own, are less affected by disruptions in the financial system. My husband and I are the only shareholders and we have chosen to leave most of the profit in the business helping it to grow without external financing. This allowed us to rapidly pay off business loans in about 4 years. For the first 6 years of operation we used a line of credit to pay for goods when they were delivered, but for the last 4 years the business savings account has replaced this need. We will use savings when we eventually need to replace equipment, making financing less necessary. A large down payment reduces interest on loans.

        Whenever we make repairs on the equipment we buy extra parts to keep in stock. We buy lubricants in large quantities so we will have them on hand. Same for fuel. All of my raw materials for making my products are from local sources. All of my customers are local. Even during the Great Recession when sales dropped by 50% I did not have to increase prices or lay off employees.

        As more and more people were laid off after the Great Recession and unable to find work, some of them started up small businesses. Service providers such as electricians, plumbers, carpenters, landscapers, repair shops, used clothing stores, and used book stores, consignment stores, etc. are growing in our community. These are locally owned, locally operated businesses that don’t rely on a lot of debt. Restaurants offer meals made from locally grown food. Lafayette now has several micro breweries and a winery, and specialty stores that sell only locally made arts, crafts, and hand crafted foods such as cheese, popcorn, breads, jams, and yogurt, and hand soap.

        My point is that a small local business can be operated without excessive dependence on financing and debt. We don’t need to be at the mercy of today’s financial marketplace or follow the model of “just-in-time’ delivery of parts and materials. We don’t have to follow the mantra of ‘bigger is better’. Small can be very flexible and resilient. Market farmers follow a similar business path as mine, which means their food supplies won’t be disrupted by finance. The are more opportunities for farmer to market their products though local stores and restaurants or on websites. The more a business relies on local producers the less vulnerable they are to disruptions.

        I grant you, there are resources, parts and supplies we still buy from the wider market, energy being one of them, but from the things I am seeing locally I think our community is really trying to make itself less dependent on oil. For example, the city is building extensive biking paths connecting downtown with residential areas. The city is buying electric hybrid buses and they installed wind turbines to provide energy for their terminal and eventually to charge newer all-electric buses. There are more and more solar arrays being installed. Storm drains that are being directed through rain gardens to clean the water, require no energy for operation. Many new municipal buildings have passive solar lighting. Most large building projects include storm water detention ponds with native cat tail plantings to clean the water and then recharge ground water. There are more and more community gardens being established along with county extension classes on gardening.

        All these innovations take time, but as their numbers grow their impact grows and over time they are making us more resilient in the face of financial or economic disruptions. And many of these efforts are being done under the watch and cooperation of a Republican and a Democratic mayor. The Republican mayor spoke at our Unitarian church forum last Sunday and was given great applause by a mostly liberal audience. It’s almost a miracle!

        regards,
        Jody

        • Maybe you can are able to be more independent than most. There may very well be some parts of the economy that last longer than others.

          It is really Liebig’s Law of the Minimum that is the problem. If there is anything that is essential is missing, then there is a problem. Most businesses are dependent on banks–for access to their savings accounts, for examples. There has been a long history of banks in financial difficulty only giving customers very limited access to their funds, even if the banks supposedly still hold the full amount. Cyprus is the latest example.

          Customers need to have a way to get to your place of business, or there needs to be a way of transporting the goods to them. Wheelbarrows work only for small quantities for short distances. Bicycles work for small quantities, as long as we can keep them repaired. The last recession was only a small test of what is coming, I am afraid.

          It is good to try to be prepared, but it is not clear that you can ever do enough.

          • Scott says:

            Hi Gail, Now I know why you were mentioning buying a wheel barrow now sooner than later.
            I got new wheel on mine the kind that does not go flat. So I am ready. I just wish I was not in my fifties and the kids have not all moved out! But if they return home they will have to work the gardens!

            Scott

  9. Don Stewart says:

    Dear Gail

    I was watching Ray Dalio’s primer on how debt drives the economy:

    http://www.zerohedge.com/news/2013-09-21/how-economic-machine-works

    I’m sorry, but it’s 30 minutes long. If you trust my summary, it says that the long term is governed by productivity, but that decadal swings are governed by debt accumulation and deleveraging cycles. Dalio says that, if government fiscal policy and central bank money printing get it in the Goldilocks Zone, we have a period of slow growth which then reverts to normal as debts are worked down.

    I am suspicious of ‘explanations’ which do not take into account the physical nature of resources. Which caused me to consider whether the evidence supports a simple debt cycle explanation or, alternatively, a debt cycle which has been undercut by resource limitations. If we look at Shadowstats:

    http://www.shadowstats.com/

    we find that the traditionally defined inflation rate has been running at around 6 percent per year–far above the 2 percent per year rate of the current ‘officially blessed’ statistics. That higher inflation rate would put the real economy decidedly into ‘contraction’ mode since 2008. If you look on the left side of his page, you will see that his calculation of real median household incomes have fallen around 8 percent since 2000.

    Recent years have seen very large increases in money creation by private institutions and by governments. Most of this flows to the top one percent. There is no evidence that the money created is actually helping the median household, much less lower income households. Instead, the nominal incomes of the top tiers have increased substantially, but the distorted measurements of inflation are creating the illusion of slow growth where there is actually decline. Consequently, when we calculate the percentage of income going to corporations and the top tiers of households, we find it increasing to record levels. While we are tempted to search for underlying fundamental reasons for such a development, perhaps it is just an illusion created by the understatement of inflation, the overstatement of real GDP, and the nature of money printing. Of course the big guys are getting the money…but it’s not coming from actual production.

    Now the hedonic potential of incomes can fall for three reasons:
    1. the income itself falls
    2. the household earning the income must deal with increasing levels of ‘externalities’, which we can label ‘pollution’
    3. an increasing percentage of the income is derived from activities which don’t yield anything with hedonic potential, such as the oil spent drilling for oil, which we might call ‘overhead’.

    It seems to me that the evidence supports the notions that:
    A. The economic limits to real growth are resulting in a declining level of economic activity per household
    B. If we examine other data not presented here, we can see that both pollution and overhead have been increasing.
    Therefore, the hedonic potential inherent in what households are actually earning has diminished substantially as we are hitting resource limitations and as pollution and overhead increase. So I conclude that we are not simply in a deleveraging phase, we are in a Limits to Growth predicament.

    Any thoughts?
    Thanks…Don Stewart

    • Don Stewart says:

      Gail
      On second thought, perhaps I should relabel ‘pollution’ as ‘God’s Gift to Actuaries’…since it is the existence of bad things which might happen that give employment to actuaries. Floods, fires, droughts, hospitals, nursing homes, etc. are really good news if you are in the right business.

      Don Stewart

      • That is a good point, LOL. In fact, we could say that plumbers and electricians also get more work that way. In fact, doctors see patients mostly when they are sick. Grocery stores get customers because people are afraid they will be hungry. People go to stores to buy coats when the wether turns cold. I suppose television and video game sales are driven by fear of boredom (or having to think).

    • I haven’t listened to Ray Dialio’s primer, but productivity certainly includes a large component of fossil fuels acting as leverage for what humans are doing. When oil was cheap, it was easy to get productivity gains. When oil is expensive, it is much harder to do.

      Declining interest rates have been playing a big role in making profitability look better than normal (since about 1981). It is possible this is even making productivity gains better than they would otherwise be.

      I honestly don’t know about Shadow Stats. Somehow, super low interest rates need to be factored into what people are paying for houses and cars. I don’t think any of the inflation statistics consider this. It is Super Low Interest Rates and all of the government programs for the poor (run without collecting enough tax revenue) that have been keeping the system going.

      I agree with you that we are in a Limits to Growth situation.

  10. justnobody says:

    Few people are talking about supply chain. If Japan were to collapse completly we will be without car electonic sensors. We will not be able to keep the car fleet running. I believe a supply chain disruption could cause the collpase of the financial system.
    The global supply chain is highly depends upon trust that people put in monetary currencies. Politician and financial elite seems to be working very hard at killing the few credibility that are left with.

    • You are right that we really don’t know how dependent the economy is on a particular country, like Japan, or on other potential breaks in the system. I don’t know about the car electronic sensors–if these are something needed in every new vehicle. If we were missing an essential part of every new vehicle, it would be a problem. Things get buried in greater layers of technical knowledge, where not too many even understand the problem.

      • xabier says:

        Hyper-complexity is the problem for us now. It works wonders when there are no serious disruptions, but if they occur we are clearly in deep trouble. I often feel that the astonishing recovery from the destruction of WW1 and 2 has given a false impression of the strength and resilience of modern technological societies. We are now infinitely more integrated and complex than in, say, 1950.

        The hypothetical car sensor issue can be contrasted with the fact that as we know the Roman Empire fell quite rapidly to a very much less complex economic and technological structure, but some 1500 years later, Roman-style carts with solid wooden wheels were still being used regularly in Spain and other European countries, entirely unchanged. The trade would have passed from father to son all that time, like bookbinding my own craft (although more just man to man as the monasteries supported it!) and other skilled trades.

        Moreover, the knowledge and capacity to make many complex items has been eliminated in whole regions which used to be fully productive in manufacturing, by our old friend, thoughtless Globalization. In the last days of the Empire, there was probably always someone somewhere who knew how to make the carts, and probably the tools to make them, too. Or you could seize and enslave him, or entice him with a promise of wife and hut and a pig, as he would have been highly valued. Now, when outsourcing takes place, the most skilled person is cast aside without a thought, regardless of the training investment and possible future needs. It all makes sense to speculators and financiers, but not to those who would wish to plan a stable society.

        Our vulnerability is staggering when one takes it in fully…..

    • justnobody says:

      I could not sleep last night. So I watch some videos on youtube. I found this video that I thinks some people might like.

      For the few people curious about supply chain. The following is a nice video. Notice how the young man stock up the ship from a computer in a office. Notice to use of computers everwhere. Notice the few people working on the ship. Notice how computerized and integrated things are now.

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