(This is Part 3 of my series – A New Theory of Energy and the Economy. These are links to Part 1 and Part 2.)
Many readers have asked me to explain debt. They also wonder, “Why can’t we just cancel debt and start over?” if we are reaching oil limits, and these limits threaten to destabilize the system. To answer these questions, I need to talk about the subject of promises in general, not just what we would call debt.
In some sense, debt and other promises are what hold together our networked economy. Debt and other promises allow division of labor, because each person can “pay” the others in the group for their labor with a promise of some sort, rather than with an immediate payment in goods. The existence of debt allows us to have many convenient forms of payment, such as dollar bills, credit cards, and checks. Indirectly, the many convenient forms of payment allow trade and even international trade.
Each debt, and in fact each promise of any sort, involves two parties. From the point of view of one party, the commitment is to pay a certain amount (or certain amount plus interest). From the point of view of the other party, it is a future benefit–an amount available in a bank account, or a paycheck, or a commitment from a government to pay unemployment benefits. The two parties are in a sense bound together by these commitments, in a way similar to the way atoms are bound together into molecules. We can’t get rid of debt without getting rid of the benefits that debt provides–something that is a huge problem.
There has been much written about past debt bubbles and collapses. The situation we are facing today is different. In the past, the world economy was growing, even if a particular area was reaching limits, such as too much population relative to agricultural land. Even if a local area collapsed, the rest of the world could go on without them. Now, the world economy is much more networked, so a collapse in one area affects other areas as well. There is much more danger of a widespread collapse.
Our economy is built on economic growth. If the amount of goods and services produced each year starts falling, then we have a huge problem. Repaying loans becomes much more difficult.
In fact, in an economic contraction, promises that aren’t debt, such as promises to pay pensions and medical costs of the elderly as part of our taxes, become harder to pay as well. The amount we have left over for discretionary expenditures becomes much less. These pressures tend to push an economy further toward contraction, and make new promises even harder to repay.
The Nature of Debt
In a broad sense, debt is a promise of something of value in the future. With this broad definition, it is clear that a $10 bill is a form of debt, because it is a promise that at some point in the future you, or the person you pass the $10 bill on to, will be able to exchange the $10 bill for something of value. In a sense, even gold coins are a promise of value in the future. This is not necessarily a promise we can count on though. At times in the past, gold coins have been confiscated. Derivatives and other financial products have characteristics of debt as well.
To understand how important debt is, we need to think about an economy without debt. Such an economy might have a central market where everyone brings goods to exchange. But even in such an economy, there will be a problem if there is not a precise matching of needs. If I bring apples and you bring potatoes, we could exchange with each other (“barter”). But what if I don’t have a need for potatoes? Then we might need to bring a third person into the ring, so each of us can receive what we want. Because barter is so cumbersome, barter was never widely used for everyday transactions within communities.
An approach that seemed to work better is one mentioned in David Graeber’s book, Debt: The First 5,000 Years. With this system, a temple would operate a market. The operator of the market would provide a “price” for each object, in terms of a common unit, such as “bushels of wheat.” Each person could bring goods to the market (and perhaps even services–I will work for a day in your vineyard), and have them exchanged with others based on value. No “money” was really needed because the operator would take a clay tablet and on it make a calculation of the value in “bushels of wheat” of what a person brought in goods, The operator would also calculate the value in “bushels of wheat” that the same person was receiving in return, and make certain that the two matched.
Of course, as soon as we start allowing “a day’s worth of labor ” to be exchanged in this way, we get back to the problem of future promises, and making certain that they really happen. Also, if we allow a person to carry over a balance from one day to another–for example, bringing in a large quantity of goods that cannot be sold in one day–then we get into the area of future promises. Or if we allow a farmer to buy seed on credit, with a promise to pay it back when harvest comes in a few months, we again get into the area of future promises. So even in this simple situation, we need to be able to handle the issue of future promises.
Future Promises Even Before Debt
Whenever there is division of labor, there needs to be some agreement as to how that division will take place–what are the responsibilities of each participant. In the simplest case, we have hunters and gatherers. If there is a decision that the men will do the hunting and the women will do the gathering and care for children, then there needs to be an agreement as to how the arrangement will work. The usual approach seems to have been some sort of “gift economy.” In such an economy, everyone would share whatever they were able to obtain with others, and would gain status by the amount they could offer to share.
Instead of a formal debt being involved, there was an understanding that if people were to participate in the group, they had to follow the rules that the particular culture dictated, including, very often, sharing everything. People who didn’t follow the rules would be thrown out. Because of the difficulty in living in such an environment alone, such people would likely die. Thus, participants were in some sense bound together by the customs that underlay gift economies.
At some point, as more of an economy was built up, there would be a need for one or more leaders, as well as some way of financially supporting those leaders. Thus, there would need to be some sort of taxation. While taxation to support the leader would not be considered debt, it has many of the same characteristics as debt. It is an ongoing payment obligation. The leader and the other members of the group plan their lives as if this situation is going to continue. In a way, the governmental services and the resulting taxation help bind the economy together.
Benefits of Debt
The benefits of debt are truly great, including the following:
- Debt allows transactions to take place that are not precisely at the same time and place. I can order goods and have them delivered to my home. An employer can pay me for a month’s work with a check, rather than needing to give me food or some other barter item corresponding to each hour I work. There is no need to have billions of gold coins (or other agreed up metal currency) to facilitate each and every transaction, and to transport around. We can each have bank accounts. From the bank’s perspective, the amount in a bank account is a liability (debt) owed to the depositor.
- Additional debt gives additional purchasing power to individuals, governments or businesses. The additional funds available can be spent immediately. Very often, repayment (with interest) is spread over several years, making goods that would not be affordable, affordable. Thus debt raises “demand” for goods and also for the commodities used to create these goods.
- Because debt makes goods more affordable, additional debt tends to “pump up” the price of commodities. These higher prices make it worthwhile for businesses to extract more minerals (including fossil fuels) from the earth, and make it worthwhile to plant more acres of food. Debt, particularly cheap debt, makes building new factories and opening new mines more affordable for businesses.
- Debt allows a steep step-up in standard of living, such as that obtained by adding coal or oil to an economy. Debt allows goods to be purchased that will substantially change a person’s future, such as transit to a new country, or purchase of a college education, or purchase of a delivery vehicle that can be used to start a business. Without debt, it is unlikely that fossil fuels could ever have been extracted; consumers would never have been able to afford the goods provided by fossil fuels, and businesses would have had difficulty financing the many new factories required to make goods using these fuels. See my post, Why Malthus Got His Forecast Wrong.
- Adding debt is self-reinforcing. Suppose a considerable amount of debt is added for what is deemed a good purpose, such as extracting oil in North Dakota. Oil companies will use the debt they receive for many different purposes–including paying employees, paying royalties to land owners, and paying taxes to the state. Employees will buy new houses and cars, taking out loans in the process. North Dakota residents who receive royalty payments may decide to take out home improvement loans to fix up their homes, expecting that the royalties will continue. The state may fix its roads with its revenue, giving additional income (which may lead to more debt) to road workers. A grocery chain may decide to build a new store (borrowing money to do so), further pushing the chain along. What happens is that indirectly, the new oil company debt makes a lot of people at least temporarily wealthier. These temporarily wealthier individuals can then “qualify” for more in loans than would otherwise be the case, giving them more to spend, and allowing yet others to qualify for loans.
- Arrangements that are not debt, but more of the nature of contingent debt, make people feel more confident of the current system. There are insurance programs for pension programs and for bank accounts, up to a selected balance per account. These insurance programs generally don’t have very much money in them, relative to what they are insuring. But they make people feel good, especially if there is a government that might come in and take over, beyond the actual funding of the insurance program.
What Goes Wrong with Debt and Other Financial Promises
1. As mentioned at the beginning of the post, debt works very badly if the economy is contracting.
It becomes impossible to repay debt with interest, without reducing discretionary income. Government programs, such as health care for the elderly, become more expensive relative to current incomes as well.
2. Interest payments on debt tend to transfer wealth from the poorer members of society to the richer members of society.
Economists have tended to ignore debt, because it represents a more or less balanced transaction between two individuals. The fact remains, though, that the poorer members of society find themselves especially in need of debt, and many pay very high interest rates. The ones lending money tend to be richer. Because of this arrangement, over time, interest payments tend to increase wealth disparities.
3. All too often, the payment stream upon which debt depends proves unsustainable.
In the example given above, everyone thinks the North Dakota oil will continue for a while, so takes out loans as if this is the case. If it doesn’t, then this is an “Oops” situation.
In the case of US student loans, many students are never able to get jobs with high enough wages to pay back the loans they were given.
4. Governments tend to put programs into place that are more expensive than they really can afford, for the long term.
As an economy gets wealthier (because of more fossil fuel use), there is a tendency to add more programs. Representative government is used instead of a monarch. Medical care and pensions for the elderly are added, as are unemployment benefits, and more advanced levels of schools.
Unfortunately, it is hard to properly estimate what long-run cost of these programs will be. Also, even if the programs were affordable with a high level of fossil fuels, they almost certainly will not be affordable if energy availability declines. It is virtually impossible to roll programs back, even if they are not guaranteed, once people plan their lives on the new programs.
Figure 3 shows a graph of US government spending (all levels) compared to wages (including amounts paid to proprietors, including farmers). I use this base, rather than GDP, because wages have not been keeping up with GDP in recent years. The amounts shown include programs such as Social Security and Medicare for the elderly, in addition to spending on things such as schools, roads, and unemployment insurance.
Clearly, government spending has been rising much faster than wages. I would expect this to be true in many countries.
5. There is no real tie between amounts of debt issued and what will actually be produced in the future.
We are told that money is a store of value, and that it transfers purchasing power from the present to the future. In other words, we can count on balances in our bank accounts, and in fact, in all of the paper securities that are outstanding.
This story is only true if the economy can continue to create an increasing amount of goods and services forever. If, in fact, the production of goods and services drops off dramatically (most likely because prices cannot rise high enough to encourage enough extraction of commodities), then we have a major problem.
In any year, all we have available is the actual amount of resources that can be pulled out of the ground, plus the actual amount of food that can be grown. Together, these amounts determine how many goods and services are available. Money acts to distribute the goods that are available. Presumably, the people who work at extraction and production of these goods and services need to be paid first, or the whole process will stop. This basically leaves the “leftovers” to be shared among those who are now being supported by tax revenue and by those who hold paper securities of some sort or other. It is hard to see that anyone other than the workers producing the goods and services will get very much, if we lose the use of fossil fuels. Workers will become less efficient, and production will drop by too much.
6. Derivatives and other financial products expose the financial system to significant risks.
Certain large banks have found that they can earn considerable revenue by selling derivatives and other financial products, allowing people or businesses to essentially gamble on certain outcomes–such as the price of oil falling below a certain price, or interest rates rising very rapidly, or a certain company failing. As long as everything goes well, there is not a huge problem. The concern now is that with rapidly changing commodity prices, and rapidly changing levels of currencies, companies may fail and there may be major payouts triggered.
In theory, some of these payments may be offsetting–money owed by one client may offset money owed to another client. But even if this is the case, these defaults can sometimes take years to settle. There may also be issues with one of the parties’ ability to pay.
One particular problem with many of the products is the use of the Black-Scholes Pricing Model. This model is applicable when events are independent and normally distributed. This is not the case, when we are approaching oil limits and other limits of a finite world.
7. Governments tend to be badly affected by a shrinking economy, so may be of little assistance when we need them most.
As noted previously, payments to governments act very much like debt. As an economy shrinks, programs that seemed affordable in the past become less affordable and badly need to be cut. Thus, governments tend to have problems at the exactly same time that banks and other lenders do.
Governments of “advanced” countries now have debt levels that are high by historical standards. If there is another major financial crisis, the plan seems to be to use Cyprus-like bail-ins of banks, instead of bailing out banks using government debt. In a bail-in, bank deposits are exchanged for equity in the failing bank. For example, in Cyprus, 37.5% of deposits in excess of 100,000 euros were converted to Class A shares in the bank.
This approach has a lot of difficulties. Businesses have a need for their funds, for purposes such as paying employees and building new factories. If their funds are taken in a bail-in, the ability of the business to continue may be damaged. Individual consumers depend on their bank balances as well. As noted above, deposit insurance is theoretically available, but the actual amount of funds for this purpose is very low relative to the amount potentially at risk. So we get back to the issue of whether governments can and will be able to bail out banks and other failing financial institutions.
8. More debt is needed to hide the lack of economic growth in an ailing world economy. This debt becomes increasingly difficult to obtain, as wages stagnate because of diminishing returns.
If wages are rising fast enough, wages by themselves might be used to pump demand for commodities, and thus raise their prices. Our wages are close to flat—median wages have been falling in the US. If wages aren’t rising sufficiently, increasing debt must be used to raise demand. Debt is growing slowly in the household sector, according to figures compiled by McKinsey Global Institute. Household debt has grown by only 2.8% per year between Q4 2007 and Q4 2014, compared to 8.5% per year in the period between Q4 2000 and Q4 2007.
Even with business demand included, debt isn’t rising rapidly enough to keep commodity prices up. This lack of sufficient growth in debt (and lack of growth in demand apart from growing debt) seems to be a major reason for the drop in prices since 2011 in many commodity prices.
9. Differing policies with respect to interest rates and quantitative easing seem to have the possibility of tearing the world financial system apart.
In a networked economy, not moving too far from the status quo is a definite advantage. If the US’s policies have the effect of raising the value of the dollar, and the policies of other countries have the tendency to lower their currencies, the net effect is to make debt held in other countries but denominated in US dollars unpayable. It also makes goods sold by American companies unaffordable.
The economy, as it exists today, has been made possible by countries working together. With sanctions against Iran and Russia, we are already moving away from this situation. Low oil prices are now putting the economies of oil exporters at risk. As countries try different approaches on interest rates, this adds yet another force, pulling economies apart.
10. The economy begins to act very strangely when too much of current income is locked up in debt and debt-like instruments.
Economic models suggest that if oil prices drop, demand for oil will grow robustly and supply will drop off quickly. If oil producers are protected by futures contracts that lock in a high price, they may not respond in the manner expected. In fact, if they are obligated to make debt payments, they may continue drilling even when it may not otherwise make financial sense to do so.
Likewise, consumers are also affected by prior commitments. If much of consumers’ income is tied up with condominium payments, auto payments, and payment of taxes, they may not have much ability to respond to lower oil prices. Instead of increasing discretionary spending, consumers may pay off some of their debt with their newfound income.
If the current economic system crashes and it becomes necessary to create a new one, the new system will have to deal with having an ever-smaller amount of goods and services available for a fairly long transition time. This is one chart I have shown in the past of how the growth in energy products, and thus growth in goods and services, might look.
Because of this, the new system will have to be very different from the current one. Most promises will need to be of short duration. Transfers among people living in a particular area might still be facilitated by a financial system, but it would be hard to have long-term or long-distance contracts. As a result, the new economy will likely need to be much simpler than our current economy. It is doubtful it could include fossil fuels.
Many people ask why we can’t just cancel all debt, and start over again. To do so would probably mean canceling all bank accounts as well. Most of our current jobs would probably disappear. We would probably be without grid electricity and without oil for cars. It would be very difficult to start over from such a situation. We would truly have to start over from scratch.
I have not talked about a distinction between “borrowed funds” and “accumulated equity”. Such a distinction is important in terms of the rate of return investors expect, but it is not as important in a crash situation. Similarly, the difference between stocks, bonds, pension plans, and insurance contracts becomes less important as well. If there are real problems, anything that is not physical ends up in the general category of “paper wealth”.
We cannot count on paper wealth (or for that matter, any wealth) for the long term. Each year, the amount of goods and services the economy can produce is limited by how the economy is performing, given limits we are reaching. If the quantity of these goods and services starts falling rapidly, governments may fail in addition to our problems with debts defaulting. Those holding paper wealth can’t count on getting very much. Workers producing whatever goods and services are actually being produced will likely need to be paid first.
Dear Gail and All
I have posted many links to videos and articles telling you that the future is going to be tough, and giving you advice about how to be even tougher so that you make it through the bottleneck.
(You will have to figure out for yourself if what follows is really serious)
See Geoff Lawton’s visit to a permaculture house in Santa Barbara. This place must have a market value of millions, but they harvest their greywater!
In all seriousness, the hammock IS a feature of many serious gardens. David Kennedy, author of Eat Your Greens, has worked in some of the poorest places on the globe. Yet his book features a picture of a mother and child sitting in the garden on a hammock reading a book together. I’d post the picture, but I can’t figure out how to do it. Trust me, it’s as inspirational as this rich place in Santa Barbara.
So, for all you cynics If you are currently shoveling snow in Boston, you too could be sitting under the palm trees in Santa Barbara if you just took up permaculture! You have to believe.
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“Seven years after the bursting of a global credit bubble resulted in the worst financial crisis since the Great Depression, debt continues to grow. In fact, rather than reducing indebtedness, or deleveraging, all major economies today have higher levels of borrowing relative to GDP than they did in 2007. Global debt in these years has grown by $57 trillion, raising the ratio of debt to GDP by 17 percentage points (Exhibit 1). That poses new risks to financial stability and may undermine global economic growth.”
– The global debt clock: http://www.economist.com/content/global_debt_clock
We fear the atomic bomb, but in the end it will be the debt bomb that kill us all.
From the Economist’s Clock:
“The clock is ticking. Every second, it seems, someone in the world takes on more debt. (…) Does it matter? After all, world governments owe the money to their own citizens, not to the Martians.”
Really?? a handful of borderless law-cheating bankowners can be described as being “the citizens”??
Never forget that resource shortages can lead to war. Given debt’s relation to resources, the debt bomb could, at least indirectly, lead to nuclear bombs falling as people start to worry about the next week, but not the next decade.
“Unchecked climate change, global nuclear weapons modernizations, and outsized nuclear weapons arsenals pose extraordinary and undeniable threats to the continued existence of humanity, and world leaders have failed to act with the speed or on the scale required to protect citizens from potential catastrophe. These failures of political leadership endanger every person on Earth.” Despite some modestly positive developments in the climate change arena, current efforts are entirely insufficient to prevent a catastrophic warming of Earth. Meanwhile, the United States and Russia have embarked on massive programs to modernize their nuclear triads—thereby undermining existing nuclear weapons treaties. “The clock ticks now at just three minutes to midnight because international leaders are failing to perform their most important duty—ensuring and preserving the health and vitality of human civilization.”
As usually, they forget the debt problem! Only Tverberg understands this.
Yes, I saw that. Of course, we have to have increasing debt to buy fossil fuels. If debt stops growing as fast, oil prices drop. Oops, that is already happening.
More on FX and derivatives and globalized supply chains.
Is there a supply chain which doesn’t involve China? China now performs roughly half of the manufacturing in the world. Here Charles Hugh Smith and Gordon T. Long discuss the potential unpegging of the Renminbi from the US dollar. It’s hard to imagine any large business that wouldn’t like to buy some protection, even if they equate bankers with the Mafia….Don Stewart
Thank you Don.
I watched the video, and my takeaway is in 2 points:
a- the FX market, with 4.5 trillon traded per day, is too big to control.
b- Gordon T.Long’s conclusion: “We’re no longer in a capitalistic system, we’re in a credit-driven-only system, and it’s a game of central planning” (controlled by humans).
Looks like we’re very close to the perfect recipee for a major accident (according to Charles Perrow’s definition). Everybody is printing money, but that doesn’t create any wealth, there’s no such thing as fiat energy.
“Everybody is printing money, but that doesn’t create any wealth, there’s no such thing as fiat energy.”
That just means every dollar buys less energy as more is printed. It is just a way of masking diminishing and declining returns. The paper is just claims on energy, not real energy.
The real problems are that there is a finite supply of energy, and as a result, total net flow of energy will decline, and secondly the problem of debt and a consumption based society that requires growth.
The paper games let us pretend there is growth when there is not, to prevent mass panic and a rapid breakdown in the system. Since exponential growth cannot go on forever, the system inevitably needs to be replaced.
However, even if we did not have the social/political/economic system we have today, even if tomorrow we wake up and the whole world acknowledged the problems and we replaced the entire system, that would not address the problem that we are approaching maximum flow rate, and that flow rate must decline. If it was possible to sustain current energy flow rates indefinitely, then we could wipe the debts, reset the nominal values of things, and maintain current life styles forever.
Regarding FX and risk and derivatives. From Zero Hedge a few minutes ago:
‘The Federal Reserve Bank of Cleveland earlier this week tweeted out a notice of a working paper titled: U.S. Intervention during the Bretton Woods Era:1962-1973… a detailed report on the massive interventions in currency markets that the Treasury and the Federal Reserve conducted and is exceptionally critical of the market manipulations that took place during that period. It is probably no surprise then that the paper is no longer featured at the Cleveland Fed, and the tweet was quickly deleted.’
If you are a company assembling a product with a low profit margin, for pieces and raw materials sourced all over the globe, do you want to fight the Fed? try to predict what the Fed will do? Give up an pay the protection money?
Isn’t in interesting how day after day, year after year, we learn in so many diverse aspects (not only political economy) how it is all just a charade. Now that paper by mid level insiders which is from 2011 confirms the modus operandi of the corrupt system.
Basically, given the evidence one has to come to the conclusion nothing has changed, yes we got some “free” energy slaves for the past couple of decades/centuries, so sheeple are placated with illusionary concepts like “democracy/free speech/liberty/free enterprise/propert rights” but in fact the nature of “civilized man” is quite opposite and still the same, struggles of violent barbarous opressive naked chimps, especially at top of the food chain.
I don’t subscribe to the idea in your last paragraph, that seems to imply that morality would be typically human (as opposed to “animal”).
I think that our ability to use external fuels has leveraged our powers, obviously mechanical and informational, but also our agressivity and compassion and many other characteristics that pre-existed in our brains even long before we “became sapiens” and/or learned how to burn wood.
Pls see this pleasant 15min TED talk by Frans de Waal:
“Empathy, cooperation and fairness seem like distinctly human traits. But biologist Frans de Waal explains why other animals might share those same qualities.”
A short presentation of one of his books:
“Frans de Waal’s Bottom-Up Morality: We’re Not Good Because Of God”
Dear Gail and All
This will address the general issue of whether our society can become simpler, without crashing to Stone Age levels. I won’t try to make a water-tight case, just some reference points.
First, take a look at the Avis family in Alberta, who have turned their barren suburban lot into a food forest:
The basic life support for our planet depends on sunshine and rainfall and water stored in humus in the soil and the recycling of mineral nutrients through the soil food web plus the accumulation over billions of years of knowledge in the form of the living creatures we see around us. In the words of Mobus and Kalton, we see a complex adaptive system composed of sub-systems…systems of systems. Humans have brains and guts, which are systems in themselves. Almost all of the subsystems we inherit from our evolutionary ancestors.
Running parallel to the basic life support system we have systems designed by and for humans which are, now, mostly driven by fossil sunlight, are very much simpler than the complex adaptive systems built by Nature, generate pollution, and are very brittle to disruptions of the monetary system, the fossil energy system, wars, mineral depletion, and the like. This parallel system gets 99 percent of the attention on this site.
The Avis family occupies a middle ground. They are using Permaculture design principles plus certain tools from the industrial system to enhance the operation of the sunlight system to increase its yield for humans. Hunters and gatherers could not begin to get much food from the short grass prairie in a plot the size of the Avis homestead, but the Avis family is able to harvest quite a lot of food, medicinals, and fibers. While doing so, they also increase all sorts of life of other species…note the barren lawns of the neighbors as compared to the abundant life on the Avis property.
Now, switch gears to George Mobus current post on the crisis facing higher education in the US:
Do you see evidence that the brittle system I described earlier is having effects on our higher education system?
A friend of mine, retired from higher education, commented on the Mobus piece as follows:
‘I stay abreast of all of this through my cronies who are scattered throughout universities all over the country. One friend was a theoretical physicist who gave up his position for rehabbing houses in Colorado….And he is a great educator which is the worst part of it.’
I would say that rehabbing houses in Colorado is a complex adaptive system that needs considerably less energy throughput than being a professor of theoretical physics. Rehabbing houses is not very similar to finding a cave to sleep in…it’s more like the Avis family using PVC pipe to manage water in arid Alberta.
I don’t know whether the ‘simplification’ of the type practiced by the Avis family and the former professor will work in the long term or even in 2016 if things go horribly wrong. My experience tells me that they are vastly superior to despair.
I know university budgets are being cut. Doesn’t help keep up the price of commodities.
Gail you have it right talking about the expectations and promises that underly debt. I advised my nephew to look for ‘integrity’ as the most important quality in a potential marriage partner and I think it applies to all relationships between living systems – as laws of nature. Probability of an expected outcome in the long term is intrinsic to the economy as well. When rules are changed at will and lies become normal, our society crumbles irrespective of how much oil is in the ground. I lived in Africa where political or other agreements could not be relied upon for the future – everything is now. They have all the resources in the world but it has not brought much economic advancement there. Now the so called first world is going the same way – breakdown of future trust.
In some ways, it takes fossil fuels to provide the stable situation that allows people to depend on future promises. I have heard that in some parts of Africa, wealthy people keep their wealth in herds of cattle. In many ways, this seems more sensible than keeping the money in a bank account that could disappear if something goes wrong. Perhaps we could learn something from Africa. I have sometimes remarked that perhaps the Peace Corps worked the wrong direction.
Gail you are a mumsy person to answer every comment from your flock and yes I liked your flip idea on cattle banks. I also liked the peace corps, such naive idealistic people trying to save the world could only come from an affluent society, but that is good in some ways because the concept would not exist otherwise. Poor people trying to survive don’t do childhood and naivety – they have to get smart or die young. I was simply trying to indicate that trustworthy values are the most important factor when 2 or more people work together and everything follows from that.
What you write here is crucial:
With this system, a temple would operate a market. The operator of the market would provide a “price” for each object, in terms of a common unit, such as “bushels of wheat.” Each person could bring goods to the market (and perhaps even services–I will work for a day in your vineyard), and have them exchanged with others based on value. No “money” was really needed because the operator would take a clay tablet and on it make a calculation of the value in “bushels of wheat” of what a person brought in goods, The operator would also calculate the value in “bushels of wheat” that the same person was receiving in return, and make certain that the two matched.
But now you have to ask your self what is a bushel of wheat? It is energy! It all goes down to energy! Also now. Debt is only energy consumption in advance.
Don’t know if fully convincing, but please have a look at the “Rorschach spots” made by Olivier Rech (ex-IEA) and reported by Matthieu Auzanneau in Apr.2013 in his blog Oil-Man in an post titled “Growth = debt = Energy bill?” (for FR, DE and “PIIGS” (we hate this acronym!))
Google translation (uncorrected): https://translate.google.com/translate?sl=fr&tl=en&js=y&prev=_t&hl=en&ie=UTF-8&u=http%3A%2F%2Fpetrole.blog.lemonde.fr%2F2013%2F04%2F11%2Fcroissance-dette-facture-energetique%2F&edit-text=
Original in French: http://petrole.blog.lemonde.fr/2013/04/11/croissance-dette-facture-energetique/
Thanks! I remember seeing those charts before. That is a good point. I also believe that the US suddenly started to need to borrow a whole lot more, once its own oil supply began to deplete in 1970. There is also the point that the countries with the big debts are the countries that use a lot of fossil fuels. (Emerging markets tend to have a lot less debt.) Debt is what buys both oil products and goods that use oil products. China has greatly ramped up its coal use, but has also greatly ramped up its debt use.
Post 1970 gave us a double whammy. Not only did oil production peak, but we also had to pay for Vietnam and the Great Society. We were demanding more and producing less oil. This led to the Nixon Shock.
IMO, 1971 or thereabouts was the pinnacle of this civilization, maybe 1969 with the man on the moon. In 1971 not only did US oil production peak [not really important] but we went into planetary overshoot beyond sustainability. It also coincided with the rise to dominance of credit money.
The Club of Rome’s report “The Limits To Growth” came out in 1972, and the standard graph has borne up remarkably well in the years since.
We’ve been in a decline ever since, masked by the growth in credit fuelled consumerism.
It is easy to make promises when things look good–hard to reel them back in, when it becomes clear that things are not as good as hoped.
Developed countries are much more in debt than undeveloped countries. This is the way that it works. Industrial societies are created by debt. Debt equals wealth in the developed world. Industrial society creates debt. It does not create profit. The people at the top of the debt pyramid skim off the most and leave the rest for the poor. http://www.economist.com/content/global_debt_clock/
This is just Government debt, owed to the public. (It wouldn’t even include funds collected as Social Security taxes, and spent by the US for other purposes–those are not public debt–they are simply a non-marketable IOU.)
Everybody who takes a loan becomes a slave. As we have less and less energy per capita, more and more people are forced to become slaves via taking loans. Initially to preserve the status quo and later just to survive. The missing energy causes that the wages stagnate and later the purchasing power goes down.
The debt is harder and harder to be repaid with less energy.
It is as if we lose our energy slaves, and we ourselves become slaves to debt.
Debt slavery can be seen as the normal consequence of the interconnection that has become interdependance (as I tried to describe in comments of Part-2: http://ourfiniteworld.com/2015/02/05/charts-showing-the-long-term-gdp-energy-tie-part-2-a-new-theory-of-energy-and-the-economy/comment-page-1/#comment-53306)
Gail’s image is striking:
“It is as if we lose our energy slaves, and we ourselves become slaves to debt.”
As for interest-levels, let me link again to part-2: http://ourfiniteworld.com/2015/02/05/charts-showing-the-long-term-gdp-energy-tie-part-2-a-new-theory-of-energy-and-the-economy/comment-page-3/#comment-53644
NB: don’t miss one of Gail’s bests:
“What is a trillion or two in interest payments, when you are with friends?”
Seriously, I was surprised that the percentage of “total interest” could vary so much, eg from >30% to <15% in just a few years. Looks like such volatile figures wouldn't take into account all of the interests (!!), and actually in your following comment you talk about an "imputed interest" that should be added, and a "net interest" that would hopefully be more representative.
Is it -ever- possible to get a clearer picture about the real amounts of interests we're paying?
Finally found the name of the guy who said that total interests we pay are in the range of 30-40% (thanks to Paul Jorion’s blog).
It’s the German eco-analyst Helmut Creutz (inspired by Silvio Gesell and JM Keynes), who wrote the book “The Money Syndrome” and holds a blog that has same name in its english version:
Unfortunately, I can’t find this figure of 30-40% as interests (I haven’t digged much), but I fear it was based on calculations made in the 1990’s. If it’s the case, I would expect this level to be (much?) higher today. You might find interesting insights and charts in this 2001 paper:
(as you can see it all comes down to a necessary revision of the definition of ownership or private property, as you suggested in an earlier comment)
That paper is, at least at first sight, a truly insightful analysis of the dynamics of the monetary system. Certainly the fundamentals are well though out. And, as he says, exponential growth cannot continue very much longer. Whether we have the time to make much difference to the outcomes is something I need to think about much more, and I would suggest broadening the search for solutions. (If I read it correctly, nationalisation and taxation, to use emotive phrases, are the way forward)
may I recommend you not to lose your time looking for “solutions”. The only possible outcome is the consequence of the dramatic overshoot we’re in: collapse. Today we’re 100 years (at least 40, acc. to LTG) too late for implementation of anything that coud have slowed down our course.
So, either you follow Don Stewart’s philosophy, or you just enjoy the day!
Thanks Stefeun, I’ll quote Macaulay here:
“And how can man die better
Than facing fearful odds,
For the ashes of his fathers,
And the temples of his gods, “
IMO, fighting for your moral values is always worth doing, but it should not be confused with desperate attempt to maintain a situation that is doomed to failure.
What is gone… is gone, and you have to restart something new from what remains, not try to revive what is lost. That’s the way Evolution works. In the present situation, I think the best one can do is try to make his life apart from the collapsing system, and hope to get through the storm and be a seed for the next phase (which is too early to know how it will look like).
I notice one thing Helmut Creutz says is
That is an interesting paper Creutz wrote as well. As I recall, in Germany, most people rent rather than own, so these interest payment would presumably not include a lot of mortgage interest.
I will have to look at these figures more to try to figure out.
There are some things that are hard to understand. For example, if a person looks at disposable personal income, it supposedly includes a fairly large amount of interest income. Is this interest income related to pensions–perhaps imputed interest, earned over the years, on amounts that are being distributed as pensions or annuities now? Also, how is interest income on 401k plans treated? I am not sure I will figure all of these things out.
I understand it’s very difficult to get a clear picture, moreover because there seems to be different types of interests. I think the question that motivated my demand is “how much of what we’re paying goes into the rentier-system?”
Helmut Creutz in his paper gives several examples with calculations (that I just do not understand) and comes out with astounding figures. In § 1.8 he writes:
“This means, any taken Deutschmark or any Euro meanwhile include about 42 per cent of interest burdens. Related to all budget expenditures which are left after deduction of savings from the disposable incomes, it makes arithmetically even 46 per cent even if a part of this amount is collected apart from the expenditures, e.g. via taxes. Or, in other words: since all costs, interest costs as well, have a direct or indirect influence on final prices, almost half of all expenditures go either directly or indirectly into interest payments. In the prices of particularly capital-intensive goods, e.g. rents or refinery products, the interest shares mount up to even 60 to 80%!”
Sounds totally crazy to me.
If we live on wind turbines, solar panels, and other goods that are heavily front-ended in costs, the interest cost is disproportionately higher. (EROI calculations do not include interest costs at all.) Of course, governments subsidize the interest rates, so as to hide this effect. Interest rates have a disproportionate effect in this–the proportion of interest is much higher at an 8% interest rate than at a 1% interest rate.
“If we live on wind turbines, solar panels, and other goods that are heavily front-ended in costs, the interest cost is disproportionately higher.”
Unless Google, Apple, etc keep expanding their build-outs of solar power, funded from their hundreds of billions of dollars of cash sitting on their balance sheets.
Exactly! Everything is priced in units of energy, because that is the way the world works.
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Dear Gail and All
Chris Martenson has an interesting interview with Charles Hugh Smith today. The interview is behind a paywall, but sometimes these show up as free reads in the next few days. It’s worth your time.
Smith offers this explanation for why Greece took such an excessive amount of loans:
1. The country is a kleptocracy.
2. The TBTF banks were dangling money in front of them.
3. The downside of kleptocracy is that the peasants get restless. But if you take the loans, the kleptocracy can not only skim the loans, but also throw some crumbs to the peasants.
Finally, of course, it breaks down. Chris and Charles are cheering for the new Greek government simply because they are telling the truth…quite unlike the power structure in almost all countries.
Telling the truth in the land of the lying is a dangerous activity.
John Kennedy signed an EO that said the US would no longer allow the “global bankers” to enslave the US with ever increasing debt. Five months later he was dead. The young leaders in Greece might with great luck get by because Greece is too small and unimportant. More likely they will pressured (i.e. we will kill your kids) or will be killed. So the “global bankers” continue to rule the world.
Because the whole world is a kleptocracy with the biggest thieves in charge.
Thanks! The Greek government also represents the situation that a lot of other governments are headed toward.
Greek FinMin Prof. Varoufakis almost 2yrs ago explains the nature of the beast (situation) and the desperate but only strategy forwards, quite amazing because this is exactly what’s going on now..
(watch that segment cca 1:08-1:17min)
Frankly, the guy is either the real deal or one of the best moles on the international scene since Lenin was sent on the train to Russia via german spook agency to make chaos and close that eastern front for them as soon as possible.
Rodger Malcolm Mitchell from “Monetary Sovereignty” write disparagingly about the situation in Greece here;
fascinating talk – 50 year depression?
Interesting talk. No understanding of resource depletion and over population.
No politician who understands resource depletion and over population will get elected if he or she talks about it. People don’t want to hear it because it paints a very grim picture of the future, and they want to believe that the future consists of continued growth and life being better for one’s children.
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I’ve been reading your articles for years and have always appreciated your incisive analysis. Recently I’ve come upon one problem with your analysis and others’. Crucial to your thesis is that our global industrial society no longer has the advantage of cheap oil, and cannot continue with increasingly more expensive oil. This has always made sense to me, given the consistently growing cost of oil production and the fact that a growing number of oil-producing nations have entered into depletion. But the charts you and other analysts use to demonstrate this point do not seem to correct for inflation in your historical comparison of oil price. For example, in “Part 2 – A New Theory of Energy and the Economy” you state “Oil prices were brought down, but not to the $20 per barrel level that had been available prior to 1970. Most of the infrastructure (roads, pipelines, electrical transmission lines, schools) in the USA, Europe, and Japan had been built with oil at a $20 per barrel level. Changing to a higher price level is very difficult….” and this article’s chart 12 shows change in oil prices from 2000 to approximately Jan. 2015 but your oil price figures I assume are not corrected for inflation. It would be instructive to see a historical oil price chart corrected for inflation to help assess the true effect of oil prices on society. Can you supply such information?
Figure #9 is oil in 2013 inflation adjusted dollars. Inflation from 2012 to 2014 is pretty negligible.
All of the long term oil price series I show are adjusted for inflation. BP has an oil price series that is adjusted for inflation–(FRED does not). The $20 price prior to 1970 is adjusted for inflation. There are some short term ones that are not (as in after 2000), but I didn’t think the amount of inflation was important in that case. Figure 9 in Part 2 is in 2013$, so has been adjusted for inflation.
Yes, I realize now that if I had just done a little pecking around the internet I could have answered my own question; here’s a useful chart I found:
http://chartsbin.com/view/oau which shows that a barrel of oil cost 96 cents in 1900.
“which shows that a barrel of oil cost 96 cents in 1900.”
So, you wanted the nominal price, not the inflation adjusted price that you were asking for.
I didn’t understand that Gail’s historic oil price figures were inflation-adjusted, but they are; now the the recent high cost of oil’s growing economic burden is more clear to me.
Good one Gail, I’ll make some comments soon. Meanwhile I see we were misleaded on the nuclear issue.
The long requirement of wet cooling is just a mith, partially boosted by the atomic industry itself because it helps postponing any decision and spending in dry casking or final destination. And of course there is the fact that handling cooler stuff is more relaxed than hotter one. So, as they say in Wikipedia, IAEA and other sites, there is no reason to hurry to empty the pools. But reality is there is no intrinsical reason for the rods remainging 15 years there, and the NRC has authorised dry casking within a 3 years period.
Nearest plant from my house and some others around the world use to dry the suff in year 6, when decay curve starts flatening
So, if Japanese would be willing they could have everything (excepting Daichi’s coriums) dry casked by 2020. They have some experimentation in a cave, and if they take this path it seems they will be able to wonder safely through almost the whole arhipelago forever. And MOX fuel will have totally decayed circa year 1000.
How long would last dry casks? 100 years according no NRC, 200 in the words of IAEA. Here they use 3 feet width walls concrete silos, so I think 3 or 4 centuries could elapse before significant fuel exposure; by that time, strontium 90 and cessium would have been long gone at least.
And on a fast collapse scenario, what could we really be scared about? Chernobyl was an atypical accident, because of the temperature the core reached (30 times above usual output) and of reactor design (full of graphite, responsible for the big fire that sent so much particles to the atmosphere). If the reactor was scramed (and all reactors will be no matter how fast the grid goes off) temp would have been 500 lower than it actually was. And if it was cooled at least 21 days by diesel reserves, temp would have easily been 5K lower. After Daichi’s scram cores were coolled just one day, so even 21 days could make a difference.
Power reactors and plants are very heterogeneous (for exemple, some are located next to hydro plants), and Daichi is the more likely average worst outcome of a speedy abandonment of the facilities: some melted cores, hydrogen and steam explosions, zirconium and other fires. Generally speaking, a reduced, localized and short lived ejection of radioactive materials to the atmosphere; but some criticallity is not impossible in case a crowded and undryed pool gets smashed its boron neutron absorbing rack -by explosion, fire, roof collapse…
All of this is easy to prevent. It depends on the particulars, but as a last move it’s even possible to dry off pipes and pools to prevent even harsher situations.
A different point is contamination of groundwater in case a crowded pool is left to its own, given the heat would rapidly melt its floor. Corium solubitily in water seems to be reduced, anyway, according to Chernobyl’s experience. It is interesting noting Chernobil’s medusa was never cooled, was very hot, but seems to have not leaved the enclosure. But I am affraid pools floors are thinner than reactor’s.
Japan seems to be decided leaving all this behind, what will do the rest?
Here are some thoughts from someone that has expressed in the past that “Reagan proved deficits do not matter”. The Darth Vader Dick Cheney
During an event sponsored by Politico, Cheney said the next president needs to “turn around the whole trend” of cutting defense dollars.
“That ought to be our top priority for spending. Not food stamps, not highways or anything else,” Cheney said. “Your No. 1 responsibility as president is to support and defend the Constitution of the United States. [Obama] is the commander-in-chief and he’s absolutely devastating the United States military today.”
Cheney was a leading advocate of invading Iraq in 2003. He said last month that he has no regrets about waging that war, which carried a price tag of an estimated $2.2 trillion and 190,000 lives.
Thought that the war would “pay” for itself and our military would be greeted with flowers.
Maybe the military will protect Cheney and his own after they stop the food stamps!
I was shocked when I saw how much financial benefit World War II provided to the US. I think some of these folks see wars as a way to employ young people who would have a hard time finding jobs, plus pumping up the “defense” industry. War can also be the justification for more debt.
Of course, the vast majority of the spending is non-discretionary–all the programs that have been promised over the years. And the military spending provides jobs as well (or that may be how they think of it). The military provides jobs both directly and indirectly–hire subcontractors, and buy all kinds of goods. Go shoot your neighbor, to get more jobs–just like go sue your neighbor to get more jobs. It seems like there should be a better way.
WWII ended FDR’s price controls. Both he and Hoover had been worried about deflation, and under FDR, price controls went into place to ensure that people didn’t undercut other businesses by lowering prices. Like all price controls, this didn’t work like they thought it would. Then you had all of the soldiers where who employed, and compared to a lot of other countries, not killed at the same rate. You also had the USD becoming the official world reserve currency. On top of all of that, Europe’s and Japan’s production had been largely destroyed, while the US remained untouched. We were able to produce goods that the world wanted and needed, and due to allied bombing, the rest of the world was not. (This, combined with Bretton Woods was probably the biggest thing.) All of this happened before US oil production had peaked.
This is why WWII was good for the US economy. WWIII, even if it didn’t go nuclear would not have all of these benefits for us. Keeping supply chains running while fighting a real foe would probably kill us financially.
Thanks! Also, we had the oil available we could ramp up to support all of this. Japan and Germany did not.
We do need to agree on international law for bankruptcy of nations. Saying they become slaves of the creditors is not an acceptable system.
My choice if a majority of voters in a country vote to repudiate the sovereign debt then it is gone. This will of course make lenders more responsible and disciplined.
Let us remember that John Keynes went to Bretton Woods suggesting a system of tax and development subsidies. If a country exported more than they imported they would be taxed. If a country imported more than they exported they would receive development funding paid by the tax to develop their economy. Of course Keynes did not imagine the US limitless spending on military. We would need to add a tax on excessive military spending for the common good of the whole world.
We would need to add a tax on excessive military spending for the common good of the whole world.
And then the US would need to elect a government that would actually agree to pay it. Never. Gonna. Happen.
“We would need to add a tax on excessive military spending for the common good of the whole world.”
When nations or empires are of more equal strength, war happens more often. Having one or two superpowers drastically reduces the frequency of major conflicts.
Thank you Gail for the overview of debt as related to our crisis
Thought I would share this with readers here on the situation in Greece today from the Economist
Debt and Austerity in Greece:
Greece’s new creditors are both generous and demanding. The country’s interest rates have been slashed: its total interest payments in 2014 were just 2.6% of GDP, according to Zsolt Darvas of Bruegel, a think-tank. That is lower than several less indebted European countries (see chart).
But the money comes with conditions aimed at stabilising Greece’s finances. These include cuts to Greece’s minimum wage and pensions, lay-offs of civil servants and the privatisation of various assets, including ports and state-owned buildings. Creditors like Mr Schäuble hope the package will make Greece more competitive and thus spur economic growth, as well as generating a budget surplus to be used to pay down debt. The bail-out plan foresees Greek debt falling to 120% of GDP by 2020.
……To balance the books Mr Tsipras is pinning his hopes, optimistically, on a tax crackdown. Smuggling cigarettes and fuel costs the government around €1.5 billion a year. Tax-dodging tycoons could furnish some extra income too. Panayotis Nikoloudis, a former anti-money-laundering tsar who heads a new anti-corruption ministry, says there are 3,500 cases of large-scale tax evasion amounting to €7 billion; they could yield €2.5 billion in 2015. But in the unlikely event that all this money were collected, Greece would still be €4 billion short.
…Greece’s creditors can give some ground. Despite the low interest rates the country is being charged, the loans are profitable, since most European governments can borrow at even lower rates
This article points out the close relationship between promises made by governments (which aren’t considered debt) and the ability to pay back debt of other kinds. Ultimately, it is paychecks that have to pay both taxes and debt payments, and taxes have to make debt payments as well.
I look at growth in debt as the net difference between expectations of growth and the actual capability of the growth to occur. Let’s say the world, its resources and systems, can figure a way to squeeze out 1% growth from the planet. However, if the politicians, economists and business leaders inherently believe the planet is capable of 5% growth (or need that amount of growth to save their jobs), then they create programs to stimulate growth, or borrow more money thinking they are going to get that larger return on investment.
Perception vs. reality may be the problem. Growth is much easier in economic textbooks than it is in the real world of energy and resources.
There certainly is some difference in debt based on the philosophy of governments. Communist governments did not make much use of debt, so growth was lower. Countries wanting to grow as fast as possible tended to use a lot of debt. It seems like the thing that made debt work was the availability of the combination of resources needed to put that debt to work. This would include (1) a cheap source of energy that could be extracted or purchased with more debt (2) workers who were not at full capacity (or could be moved away with increased automations of their current jobs), (3) adequate resources of other types so that the economy is not up against, say, water limits, or arable land limits, or pollution limits, that affect how much the economy can expand in a new direction.
Gail, could you please follow up this post with one addressing some more nuances in this whole thing? For instance:
Today’s debt is called a bubble. Conventional economic theory says that it causes less pain to burst a bubble earlier when it is smaller rather than later when it is bigger. Does this not apply to the debt bubble, or is today’s debt not a bubble at all?
Sovereign governments can break promises and cancel debt through inflating or debasing their currency. It is the current official policy of the US government and international bankers at the Federal Reserve to see that inflation runs at about 2% a year, which reduces the buying power of the dollar by half every 30 years or so. (And many say that the official rate of ‘core inflation’ much understates the true rate.) Given this, do you think that what the Fed is trying to do is deflate the bubble over an extended period of time? Can this work? If the current indebtedness is actually rising in spite of current inflation, would it be possible to let the air out of the bubble and gradually deflate it by increasing actual inflation to a higher rate?
Currently, in the US, promises and debt are being erased all the time, as others have commented. But the promise-breaking proceeds unevenly: some promises are enforced, others are allowed to lapse. We have thus a problem with unevenly canceling debt and breaking promises, done in an ad hoc, hodge-podge fashion. Might it be better to address the issue fully and see to it that debt forgiveness happens more uniformly? (I ask this as theory only, since in any political system, those with the power will protect their interests, and the weak will suffer more, no matter what the circumstances.)
I would say it is more like the real inflation rate is about 5% and the US is allowed to take 5% per year in new debt. Maintaining a constant level of debt.
Thanks for the ideas.
To answer part of your question now, the big difference a person has to be aware of is the difference between a little problem and a big problem. When we have a little problem–a spike in debt in one country, say because of highly valued tulip bulbs, then bursting the bubble makes sense. Even if the one country fails, the rest of the world can go on.
If we are dealing with a big interconnected system, then there is a real question of what failure looks like. If it looks like the population of the earth will have to be much smaller and each individual on the earth must be a lot poorer, then as least some of us would rather wait as long as possible until the bubble collapses.
Hi Gail, and thanks for another interesting post. I think I can simplify some of it, and the comments to date:
What the economy is.
What is going to happen if nothing is changed.
What might be achieved if the best choices are made.
Taking just the first topic, you describe economic growth and economic contraction as if they were different systems. The system is exactly the same. The initial conditions are different, particularly the amount of debt. Take any of the ancient civilisations that grew, matured and died. Initial and final conditions were not that different once debt disappeared. Today we see problems with finite resources, but we need to see that somewhat as a separate issue as todays resources could have been available to earlier civilisations. We have fewer, if any, good choices, and we need to be clear what the choices are. The immediate problem is Debt. Is there good debt and bad debt? What is the difference? Can “we” dump the bad and keep the good?
After these are answered we can move on …
You mean give people who borrow money and are stupid and lazy a pass while we hold borrowers who are thrifty, frugal, smart and disciplined to pay back their loans. That does seem to be the government of corny capitalism.
“You mean give people who borrow money and are stupid and lazy a pass while we hold borrowers who are thrifty, frugal, smart and disciplined to pay back their loans. That does seem to be the government of corny capitalism.”
You are a reckless gambler. You bet you would get paid back more than you lent out, and you lost, because the other party is unable or unwilling to pay. All debts have risk. Perhaps you miscalculated the risk, or perhaps you thought you could beat the odds. Either way, you were wrong. Take your loss and move on.
“You mean give people who borrow money and are stupid and lazy a pass”
And you have a better, and less judgemental proposal for NINJA (no income, no job or assets) debtors? Also, arguing from the specific to the general prejudges the matter, so I suggest that you should look at the system, not the components. If, for example you find that the system is designed to fail, then does it matter if some loans are fraudulent?
“You mean give people who borrow money and are stupid and lazy a pass”
Just as a thought experiment, think back to a time when your employer would give you your wages in gold or silver coins contained in a stiff brown envelope at the end of the week. Do you really want to lend this money that you worked hard for, to a potentially “lazy and stupid” bank?
“You mean give people who borrow money and are stupid and lazy a pass while we hold borrowers who are thrifty, frugal, smart and disciplined to pay back their loans. That does seem to be the government of corny capitalism.”
The virtuous deserve the money? The dark evil lords of crony capitalism have clouded the waters but the virtuous smart and hard working remain? The chief reason the term “crony capitalism” exists is to imply that there is a pure and virtuous system of non crony capitalism that exists
If you want to reward the hard working then the oil fields should have all the $. Oil has done all the work.
Not that there isnt virtue in hard work. IMHO there is. Making it the primary issue while disregarding the fact that all wealth derives from exploitation of resources is a very common justification for various behaviors.
In the time of Magna Carta, it was the barons that held the King to account. Today those barons would be described as crony capitalists. The point I am making here is not about today, it is that if or when collapse comes, it would be better to have the robber barons on our side rather than the King’s.
The issue, both in prior civilizations that collapsed and now, is diminishing returns. Diminishing returns can come simply from rising population relative to a fixed amount of arable land–the amount of land per farmer starts dropping. Or it can come from a combination of factors, such as rising population and eroding soil, or rising cost of producing fossil fuels. Any of these things makes per capita wages tend to drop, especially for the common workers. It is the drop in per capita wages that causes the system to collapse. This will happen regardless of whether the best choices are made–at best they might push off the inevitable. The debt makes the system very brittle. It is impossible for the system to shrink back, when it needs to.
Don’t know if you have seen Rune Likvern latest article, but I thought it was very good:
This is the reply we gave to it at PO News:
The reality becoming that the costlier oil gradually becomes less affordable for them.
The author seems to have hit most of the bases. The last graph gives “growth fueled by credit/debt expansion”, “consumer affordability”, “cost for the incremental barrel” and “slow down”. Sort of looks like this graph:
The one area he misses is what happens when producers begin to shut-in as a result of lower prices. Half of the demand for oil is now generated by the production process itself. As production goes into decline, so will half of the demand for oil. A significant portion of the credit formation over the last decade has been created by the producers themselves. Shale has required over $1 trillion in new credit formation. Without that credit creation what happens to the debt based monetary system, and what happens to interest rates if no one wants to, or can borrow money?
Demand has actually already started to fall, as published numbers are greatly influenced by the amount of oil that is now going into storage. That oil shows up as demand. When the demand from producers themselves begins to fall, as they start to shut-in operations as credit disappears, the credit markets will be crushed. It seems likely that interest rates will plummet as Central Banks use their only tool for response; they will continue to print. Thus flooding the economy with more money that no one can, or will want to borrow.
The article is a good start, but it is not the end of the story!
I think that the monetary system is much more dependent on oil than is commonly believed. Petroleum directly powered $6.22 trillion of economic activity in the US in 2012. Even a 10% decline in that number would have a crushing effect on the monetary system. It might be enough to completely crush the credit markets as the CBs money printing is now having little, or no impact. At ZIRP you are left with no place to go, and negative rates would eventually bring down the whole debt based system.
Good luck on your trip. You will be missed.
I think both Rune Likvern’s article and your response are important articles to read and ponder. In addition, it seems to me that this article describing the risk averse behavior of consumers is important:
I have lost the reference, but the only two categories of household debt which are higher now than they were in 2007, in the US, are student debt and auto loans. Both those categories have, I think, some peculiarities which have kept them growing.
If we combine a high debt level for consumers with risk averse behavior because of suspicions about the stability of the economy, with the addition of higher interest rates and the steady erosion of low cost oil. then it seems that the stage for a financial collapse is set.
Francis Fukuyama wrote a book “Trust”. His point, societies with high levels of trust become wealthy societies. Debt is powered by trust. When that breaks the debt tool becomes less effective maybe even useless.
Finance has become a quagmire of unregulated deception. We just have to wait to see what gives first.
Not having economic growth also makes debt payback difficult. Even if the trust was there initially, as economic growth disappears (even on a per-capita basis), more defaults take place, making trust disappear.
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Dear Gail and All
Your article and several commenters have touched very lightly on the subject of the mountain of derivatives. I would like to look more closely at the mountain.
In a world of globalized supply chains, there is not a true global currency. The dollar comes closest, but there are still many local currencies which play important roles.
If you look at how much money FoxConn gets for making an iPhone, it is less than 5 dollars. While I am not privy to the contract between Apple and FoxConn, I would expect that it stipulates the production of the iPhone, in return for which FoxConn will receive, let’s say, 5 US dollars. But FoxConn has to deal with suppliers all over the globe. The prices of the inputs that FoxConn uses are constantly changing. The profit margin on the 5 dollars is very low, as there is intense competition in manufacturing.
Some minor fluctuations in the relative values of currencies, and in the price of commodities, can easily wipe out all the anticipated profit for the manufacture of the phone. Therefore, FoxConn buys a huge volume of futures covering themselves against FX and commodity fluctuations. The financial industry makes money by matching those who do something real (such as FoxConn) with those who like to speculate and have billions in assets.
My point is that the derivatives, and the systemic risk they pose, are inevitable by-products of globalization of supply lines with localized currencies and volatile commodity markets. If a supply chain is entirely inside one monetary system (the Euro, the US dollar, the Ruble, etc.), then the risk of FX fluctuations is greatly reduced. What would be left is commodity fluctuations, such as agricultural crops.
Therefore, the costs and the systemic risk posed by the gargantuan derivatives market should be seen as a cost of doing business the way we are doing it. IF governments cared about it, I suppose they would impose a small tax on such financial transactions to supply a reserve which could be used to bail the system out in the inevitable eventual failure. But we all know that won’t happen.
Great post, and I’d add it is not just about the FX.
For the midterm, meaning next 2-3decades, global financial crash/rest would still leave in its wake “intact” factories, mass transit, natural resources and skilled people, especially in places like Russia and China. They could barter energy resources for goods and or even cooperate on some projects where both parties add knowhow to the final outcome etc. Wait a minute, they are already doing it on some scale and perhaps might scale it up against a drop of export in to non-aligned countries i.e. their former import markets in the west..
Consult Orlov, financial crash will at least in the begining take much different path in US/W. Europe than elsewhere. It could be speculated that some of TPTB in the US/W. Europe will have to after some basic consolidation of order adopt some similar strategies how to govern after the event.
Powerfull people and the giant inertia of past many centuries won’t simply go into the night quickly, it will be a bumpy process. I’m not saying this attempt won’t be temporary fix, but for sure will be tried at least for the time scale major energy infrustructure could be maintained, coal, large hydro and nuclear are for several big players nearly 100% domesticaly sourced affairs.
Addendum, yep for the formerly pretending affluent countries the drop of scale in international market/demand will be horrific in very short time.. avoid such places like a plague..
I suppose the derivatives program could be considered a cost of doing business, but if that was its role, it could have been set up as an insurance program, with true reserves in place. Also, with insurance, there needs to be an “insurable interest.” There doesn’t need to be an insurable interest–people who want an “inflation hedge” can buy ETF’s and the ETF’s can invest in derivatives. Or folks who think the ruble is collapsing can bet against the ruble.
In many ways, I think we would have been better off without a derivatives program. There would need to be larger margins in cost structures, admittedly, but I think a lot of this was done to squeeze margins to the limit, and to be able to borrow as much as possible (by somewhat insulating the lender from risk). The problem with this approach is that it interferes with the normal relationship between supply and demand, making demand pretty much independent of what happens with prices. It hides problems for a while, until they reappear in a much bigger form and explode.
‘derivatives as a cost of doing business’
The bulk of derivatives are in the FX markets and interest rates. The amount of derivatives traded in two days exceeds the GDP of the world for one year. Why are FX and interest rates such crucial items? With FX, it’s clearly because those companies in the supply chain want to offload the risk of currency fluctuations. With farmers, it’s because they want to offload the risk of commodity fluctuations. A few producers think they are smarter than the markets (Southwest Airlines, for example) and actively gamble (SWA on the price of jet fuel).
A few years ago my sister, who worked for an automobile company, said that the company made more money by selling premium seats than it made on the automobile. Since the automobile is assembled from raw materials and intermediate products from all over the world, with a hundred different monetary systems or more, small fluctuations in FX can have disastrous effects on profitability. Many companies would rather simply pay a percent or two to get ‘certainty’. The ‘certainty’, of course, is problematic. Governments have tried to increase the ‘certainty’ by putting derivatives in front of deposits in a crisis…but there are real questions about the hugeness of the derivatives against the relatively small amount of deposits.
I am not sure that insurance companies have the financial strength to provide reliable insurance for derivatives. Consider AXA, the French insurance giant, which bought Equitable Life of New York some years ago. AXA offered retirement accounts which were ‘guaranteed’ not to lose value, even as the depositor withdrew 6 percent per year from the principal. Needless to say, AXA no longer sells those products, but they sold a lot of them. So consider the risks…stock market crashes, the possible crash of the Euro, the possible disappearance of the Euro, the risk that the dollar will continue to rise. Such concerns are a long way from finding out someone’s age and looking at a mortality table to figure out how much insurance you can sell them.
These AXA policies are guaranteed by the State of North Carolina (in my case), which state hasn’t got a nickel to its name.
I understand that an awfully lot of derivatives have been sold with respect to municipal bonds, guaranteeing that the rates wouldn’t go up. Those selling the guarantees pocketed a lot of money from municipalities that, in retrospect, would have been better off not buying the derivative. But it is hard to know, and a guarantee sounds good in advance.
There have been a lot of guaranteed accounts sold over the years. Actuaries looked at past patterns, and were certain they knew how to forecast the future. If things go down slowly, things like this will be harder to sort out than if they go down quickly.
Thank you very much Gail, for your post that helps me better understand how debt is bounding the system together, how it is connected to specialization, and why it has to grow.
As for money, I agree with Matthew that it’s a claim on energy, but it definitely is a kind of debt by itself: when I have money it means that someone owes me some good or service for it. I can “unstore its value” (value = energy) now or in the future, or even in the past, if I’m using this money to pay back a loan.
Moreover, it seems to me that today most part of the money exists only in the form of debt, with no real -or even realistic- counterpart in real stuff. This is due to the possibilities of leveraging, cumulated with coumpounded interest (that pumps money up the wealth pyramid).
So from this point of view we can avoid talking about money, as monetary tricks can help improve the situation in one place (thus making it worse elsewhere) but don’t change the picture in the aggregate.
Then, because of diminishing returns, the real cost of things is increasing, ie the amount of energy needed for extraction is raising (also for production but for other reasons), and less energy is available to flow into the system, in the form of wages for example.
With low wages the demand/consumption weakens and debt is getting more difficult to obtain (if we force private debt to increase artificially we eventually get 2008 GFC). Unsufficient increase of debt can’t keep up the price levels, which then have to decrease in order to match the affordability level. Low prices tend to stop new investments and make it more difficult to pay back the loans, leading to defaults that have to be absorbed by the rest of the system (in 2008 the loss has been reported on governments, but taxpayers have hard time paying back huge interests; that also adds to decreasing demand/consumption).
At some point the benefits of the debt disappear, letting only the burden of rolling it (borrow to pay back old loans) whilst paying neverending interests. As if the real cost of things (linked to accessibility to the resource) becomes bigger than max affordable selling price (linked to emergy). The surplus is becoming negative.
The debt is then used -no longer to increase production earlier- to borrow from the future, thus making increasing promises on decreasing possibilities of pay-back. It cannot go on forever, because once all the money goes for paying interests, we have nothing left to live (I remember someone has calculated that more than 40% of any sales price goes into payment of interests; that was few years ago, can’t find the link). The debt cannot be repaid, only the interests keep going on, sucking the real economy’s depleting blood into the financial sphere.
Writing off ALL debt is clearly not an option, as it would mean suppressing money itself, but I don’t know if SOME debt could be canceled, in order to give some oxygen to the real economy and get BAU to last a bit longer (I can see John Doyle, RobM and others here are making good points about that). Since confidence (blind faith?) is playing a big role in holding the -increasingly brittle- system together, I fear a write-off could trigger a fatal avalanche of defaults, unfortunately. We don’t seem to be heading for such direction, though ; as Ben Van Beurden declared 2 weeks ago:
“The dividend is an iconic item at Shell and I will do everything to protect it.”
(“everything” means cut capex, lay-off people, pressurize suppliers, buy-back shares, etc… ie take the money and run, what a nice sacrificial religion!) http://www.bloomberg.com/news/articles/2015-01-29/shell-chief-pledges-everything-to-maintain-its-iconic-dividend
Sorry if this long comment repeats most of what is already better said in Gail’s post, but the implications of debt are difficult to grasp, for me. Do not hesitate to discuss if there’s something wrong in my interpretation.
I think you are pretty much right. I am sure that the powers that be will try to do anything they can to keep things going. Writing off debt for some countries that would fail otherwise might possibly be helpful. It is hard to see anything that will really fix the system. Diminishing returns is a formidable opponent. It has been operating in force since about the year 2000–from the time we hit “trough” oil prices, and also maximum employment as a percentage of the population. I need to write about this as well.
“Writing off ALL debt is clearly not an option”
I’d question your ‘clearly’. A bank’s loans (debts) are its assets, so writing off all debt would make every bank in the world insolvent. It is arguable that in a world of zero interest rates (set aside NIRP for now) banks, as we know them cannot survive. Solvency for some banks seems to depend entirely on government paper, and some have commented that depositors are no longer essential for banks to function. So some of the concepts being tossed about imply exactly wiping out the banks and extinguishing debt.
That cannot happen. More precisely, it cannot happen in time to significantly ease the incoming problems of the finite world.
Before all that can happen it would be wise to cancel all derivatives. Derivatives are bets, and usually appear as a ‘net’ position in those darkets of papers, bank balance sheets. So just cancel all the bets? by 2016? That would take one or more international trade agreements, good luck getting that done within ten years.
Richard, you write:
“Derivatives are bets, and usually appear as a ‘net’ position in those darkets of papers, bank balance sheets. So just cancel all the bets? by 2016? That would take one or more international trade agreements, good luck getting that done within ten years.”
Until 1885 the speculation was forbidden in France, by a simple law that prohibited the bets (with a few exceptions); I don’t know for other countries but I guess the situation was similar. Then the law was abrogated (by Jules Ferry, the same who made school mandatory for all kids), probably in order to accelerate the process of colonization.
Technically-wise, it’s very simple and the whole law holds on 1 page. With sufficient and coordinated political will, “closing the casino” could be made overnight.
Now, I don’t think it’s realistic because we’re so interdependant that you cannot bring down one part of the system without -at least- damaging the others, and anyway we’re running short of net energy, which prevents us from re-buiding some different structure that would give same output.
So yes, we can imagine to cancel derivatives and money itself or any other part of our obese system, and that will happen soon anyway (but not because of our will, IMO), but we must be aware that next system (if ever) will be totally different, based on the ruins of the current one, and will have to operate under a much much lower “carrying capacity”.
Derivatives : A thought experiment.
Have you ever made a will? If like me, you decided who will inherit your house, your car, the money in your bank account, and what to do if the foreseeable happens. But suppose before you sat down to write your will you had been out drinking with some friends, Ann and Bert (you are Charlie), all sports fans, though you favour different sports, and you decided to each bet on the Superbowl, the Grand National, and the Tour de France. You each decided, among yourselves to place US$1000 on accumulator bets that each winner in 2020 would win each successive year until 2040. How are you going to write that into your will? That when you die no property can be transferred until Ann and Bert find another Charlie to take on your bet?
That may sound absurd, but as far as I know, that is a reasonable approximation to the legal position of derivatives.
The “problem” here is that without this “guarantee” there would be fewer and more costly derivatives. Hence you may pay more for your iPhone6, or you may not be able to get it at all.
So, iPhone6, or your children’s inheritance, which will it be?
The smartest phone NOW, undoubtedly. Tomorrow is another day and the kids will have to deal with the world as it will be then, not my business, I already got my share of struggle (speaking in general, not for myself).
The maximum power is needed in the present time, according to the Max Power Principle (see Jay Hanson’s “Overshoot”: http://www.dieoff.org).
For example, just look at the choices we made with respect to nuclear. If we were reasonable, we’d never have decided to go for it (see e.g. Charles Perrow’s “Normal Accidents” http://www.ohio.edu/people/piccard/entropy/perrow.html, tight coupling and complexity lead to inevitable accidents)
It requires a very strong determination to make reasonable choices, as well as some kind of strategy because by doing this you put yourself in weak position. IMO it’s possible for small communities and under particular conditions, but not scalable, unfortunately.
“For example, just look at the choices we made with respect to nuclear. If we were reasonable, we’d never have decided to go for it”
I’m old enough th remember to promise of “electricity too cheap to meter” when Calder Hall went online. That was “propaganda” to conceal the production of fissile material, but there was some truth, the electricity was just a useful by-product of the process.
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The debt is the distance that needs to be to overcome so that the man-made system can continue functioning depending on external resources.
That is why the role of the communication technology is so important now: it is needed for reassuring that the promises will be kept, as it takes longer and longer to keep the promises. Which means that various promises gradually become obsolete as they will never come true.
We live in the world of more and more fantastic marketing of the future that will be much different than advertised, as there are more and more promises, but, at the same time, less and less energy available.
We will see what happens when the debt to be paid is dependent on the real creditors as regards the Greece, i.e. not “anonymous money”, but “money of somebody”:
Slovakia mulls referendum on Greek debt
The countries in colder regions are more sensitive to debt, as their inhabitants need to have stocks for worse times, i.e. surviving the winter. I think that this is something that Greeks do not fully realize, which means, that the Greeks have less and less space for further debt from the Northern Europe.
Can we say that the currency issued by the countries in colder regions has to be more stable, as this currency must “endure bad weather”, i.e. longer periods when the soil is not providing food, or the crops are lower due to cold and lower fertility of the soil?
We can see that the countries in warmer regions are more prone to inflation:
hi there from Slovakia, even if I work in Czech Republic. In my country, debt is also a huge problem and if you are a young person and want to have a family, you are surely going to go into debt. Debt is a refusal to accept the limits to growth, and declining living standards. I try to avoid debt, but I have no children, nor house…
we have already communicated regarding one of your blogs on sme.sk via e-mail. I find Gails blog a great place for exchanging deep ideas for true insiders…
I haven’t really studied inflation. Rising “demand” = more inflation. Adding more high priced fuel, if an economy can afford the higher price, leads to inflation. High oil prices cycle through to higher food prices.
The cold countries have not been doing well–wages are stagnant, and “real” growth rate is low. This may contribute to low inflation rates.
“I haven’t really studied inflation. Rising “demand” = more inflation. Adding more high priced fuel, if an economy can afford the higher price, leads to inflation. High oil prices cycle through to higher food prices.”
Inflation has different understandings in different schools of economics; some say it is rising CPI (price of goods excluding food and energy) while others use inflation to mean dilution of the currency.
In the second case, rising CPI is simply an indication that the purchasing power of the currency may be being diluted. Prices can rise for other reasons, such as shortages. A bad year for corn leading to higher corn prices does not indicate a change in money supply and velocity.
Defining what you mean when you say inflation seems to really reduce the amount of time people spend arguing in circles when they are in fact both agreeing.
Inflation in its purest sense is an expansion in the quantity of money, akin to a bubble inflating. The common use of the word inflation is “price inflation”, the visible sign of more money circulating in the economy. Government needs standardised measurements of the quantity of money, and its effects, typically referred to as Consumer Price Inflation and Retail Price inflation, within the economy.
Everyone in an economy sees price inflation differently. Some spend most of their income on food, others spend more on shelter, and so on, but the expansion of the money supply affects the entire economy.
The monetary sovereign EU can pay for Greece. Other countries are not involved, nor need to be involved, in spite of all the false opinions by know-nothing politicians and journalists. Just don’t believe the crap.
Dear John Doyle,
yes, the monetary sovereign EU can pay for Greece, which means that there is less resources for others, as these are consumed by the life-support of the Greece, which is heavily dependent on energy imports.
You must take resources from somebody in order to give it to somebody else. And you need energy for the economic growth. The debt from the past is a kind of brake here: you have less money to buy resources and spend them at home (i.e. in Greece).
Is there a will to allow the Greeks spend more resources instead of others?
It does indeed depend on what resources are available across the Eurozone. IMO there is plenty of untapped capacity space for supporting such a plan.
I don’t know the EU data, but using US data for a comparison the spare capacity is at least 1/3rd of the potential GDP for the EU. with full employment.
Do you have any figures to support your concern?
The debt from the past is a non event, irrelevant.
Remember Greece is now just a state like say Kansas is within the USA.
I think that the big players in the EU, who are in the similar situation as the Greeks (Italy, France and Spain) want their share, too and that is why I do not see much space for the creative ideas of the Greeks. The common policy is common policy. Enough is enough. It is childish to think that France, Italy or Spain with their millions of the unemployed would be glad to hear about the debt jubilee for the Greeks…
You have gone off target. Greece is now just one state in the EU. Why are you imagining what’s good for Greece won’t apply to every other state when and if such necessity arises? But it will apply across the EU. It has to. You childish comment is pure rubbish
With the full rights to succeed just like Kansas. Regardless of the dictatorial self justifications offered by Lincoln or Barroso.
“Remember Greece is now just a state like say Kansas is within the USA.”
Europe is not a true federation, it does not have the fiscal and monetary structure in place to have a single currency. It is halfway between being a United States of Europe, and being a bunch of independent countries.
Maybe, but it is a currency union and if some structures are missing, which I have heard of then they need to be sorted. In any event only Brussels can create Euros, just the way we do in Oz or you in the US or UK. So they can still buy, QE style if they choose, toxic assets from any member country.
A lot of the spare capacity in Euorpe is for making cars that people can’t afford, and operating refineries that no longer have enough oil coming into them. They really represent assets that need to be written off. They are not true untapped capacity–they cannot provide goods cheaply enough that citizens can buy them.
I think EROEI calculations missed the important point about time being very important in energy payback. It is precisely as you said-there is more and more lag between investment and return, so more investments won’t work out. This also true for things like electric cars–longer payback period than gasoline powered, unless subsidized, or high price for gasoline.
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Several people above have commented that part of the solution should be to redistribute wealth from the rich to the poor.
It is counterintuitive but this policy would probably make things worse.
Most of the wealth owned by rich people is sitting idle. If this wealth was redistributed to the poor it would be immediately spent. This would increase the demand for energy which would increase it’s cost and the cost of almost everything else (since you need energy to make almost everything).
Wealth redistribution would therefore more rapidly deplete non-renewable resources that should be saved, for example, to maintain water systems and to build community food processing facilities, and inflation would return the poor to their original state.
On the other hand, confiscating the wealth of the rich and burying it, would help a lot.
Credit to Nate Hagens for introducing me to this troubling idea.
That’s known as Jevon’s paradox, or very similar to it. As efficiency improves one uses more of it.
I agree that most of the wealth of the rich exists in “promises” that won’t ever be spent. Burying this wealth in theory might help.
A large share of wealth is in pension funds and IRAs. A person could make the same argument about them, except that a lot of the owners are fairly poor, apart from these funds. They would be quite unhappy about the funds being taken away.
Presumably most of the wealth of the very rich sits in banks and gets lent out to other people and businesses which helps the economy. The rest of it gets spent by the rich which stimulates demand, jobs, growth etc. It is best to leave things as they are. 😉
I agree. It’s morning in America and we can count on trickle down plus broken windows plus Twitter growth to rebuild the economy and restore everyone’s god given right to fly to Disneyland once a year. 🙂
I know, the masses have such common tastes that money is wasted on them.
I think a “new poverty” would be worth considering. Zero material aggrandizement, but allowing dignity regardless of level of possessions. Also would include leaving people in Africa, rural China, India alone. Just as if they didn’t exist. They made it this far without help. So why go messing with them?
Yes that seems to be a case of where good is evil. We maintain third world populations which then expand and deplete more resources, add further pollution, wipe out more species etc.
Clearly we need a more sophisticated ethics than simpleton humanitarianism but the plan seems to be to incorporate more and more people into the global economy so that they can maintain the profit/ debt system.
Our “leaders” send off foreign aid, our media encourage us to donate to charities, and all the time they suggest that they care about people and that we should too. Really all they care about is money and arguably capitalism forces them to think like that. Charity is an investment in global economic growth.
It is obvious that society manipulates our perception of the world, our thoughts, feelings and “conscience” to keep the system going. All societies do that, from medieval Christianity to atheist Russia, it is all the same. “Imitate Christ! Be a good worker! Ahh, look at the babies crying in Africa, phone your card through now.”
I like to think that I have a fairly independent perception of reality and I am content to say that I really don’t care when people starve to death. All human values are an illusion. Just don’t let the herd find out what you think because they wont like it!
From a post on Nature Bats Last today:
Satish Musunuru Says:
February 13th, 2015 at 3:05 am
Complaints with 3 things that Paul Ehrlich said:
Not including the fact that he talked too much and didn’t let Guy add his bits.
1. Grameen bank and World Bank: Paul actually “approves of” these institutions except that they don’t work, which he acknowledges. Fact is they actually work quite well for what they are designed to do: throw millions of rural farmers and others into debt peonage and coerce them into the money economy. Paul must not have read John Perkins and other economic hitmen and he seems to misunderstand the role of banking institutions. I often hear people saying (including the Chief Economist at Google) “we got to take care of those poor people, you know, those who are living on less than two dollars a day, blah blah…” They are either ignorant or lying. For those of us who live on dollars and other modern currencies, the poor people’s situation sounds pitiable. The fact is they don’t need dollars or pounds. They meet most of their subsistence needs in their communities, trading and exchanging with each other in informal ways, before the long hand of the market starts interfering with their lives and puts a value on everything they do. And when that starts, of course, they are living on less than two dollars a day. It’s like we go to a tribal person and say he must be poor and starving because he doesn’t make any money. No, thank you, the forest provides his family everything they need, including the best tasting sweetest honey civilized city dwellers could only dream of. And 200 different types of foods. Talk about a wholesome diet. McDonalds, anyone? Imagine an Asian upon finding out that people in the West don’t eat much rice exclaiming, “what? you eat less than a cup of rice a week? you must be poor? we must do something… let’s send you some rice”. Money is not part of their lives. We impose it on them.
That’s what imperialism and development aid are about: take away local subsistence sources of people in the “third world” and the “global south” and force them to work for money. Force them to replace their food crops with cash crops that will fetch a “market rate” in the “free market”. Oh, here’s a cellphone that will help you find the best price for your palm oil and soy that we will buy and burn in our cars and feed to our pigs, respectively. Come join the party! The prices we decide for your products in our glass-walled skyscrapers in Chicago and London should take care of you. What? Your kids are starving? You can always move to the city and sleep on the sidewalks until you find a “job”. This is what the Grameen bank and the World Bank are about. You can do better, Paul.
Finally. Someone speaking in terms I can understand! Maybe I wouldn’t say I don’t care if people starve. I don’t see the starving as the essential issue, and I would caution against opening oneself up to the charge of callousness. What I see as important is OUR need to stop meddling in things that don’t concern us. We have brought the entire creation to the brink of extinction (through meddling with and exploiting everything.) That is infinitely more atrocious than distant people somewhere starving. WE are the problem. We need to sit down and keep our damn selves quiet, and live within our means. Just my 2 cents.
“At the end of it all, defenders of the status quo are not defending life, they are defending lifestyle. Proponents of the dominant culture and its myths of progress are really arguing for their own comfort, of both body and mind. Changing nothing presents no difficult ethical questions or messy physical conflicts.” (Quote from latest NBL article)
I’m not sure change has to be mostly based on conflict and incrimination. (Not saying there aren’t extremely bad actors out there to be dealt with.) But as an old person who for decades has been a voice in the wilderness, I see signs of change that I could never have anticipated.
I’ll list just one. I’ve long been interested in the Tiny House movement, in how it can save money, and how it can save space by using it more creatively. Twenty years ago, I came across a book–Tiny, Tiny Houses I think was the name–but I doubt there was a great deal of small house promotion then, apart from a very few books like that. Now, without even searching, I can watch a great quantity of small-house projects on TV.
Today it was Small House Builders. The head honcho (very much in charge) was close to the age of my grandchildren. The depth and diversity of his knowledge was astonishing. He knew all about regular house construction, while being able to apply that knowledge to small-houses. True, he and his cohorts were considerably more rah rah (sp) than I would have liked, but I was able to get past that. Everybody used power tools. Not to my liking, but I could overlook that. What struck me as profound was the coming together of mainstream godawful industrial technology with a change-consciousness that respected (significantly) pristine surroundings, including the towering trees to which their tiny house was tethered.
They knew how to stagger the connecting bolts so that the trees could move as needed. A bunch of different-size antique windows, which the boss guy picked out and had assembled, comprised an entire wall of the under 200 square foot house. An antique metal milk crate functioned as a chandelier. Old hinges were preserved. A glass panel was installed to allow a floor view of the creek the house was suspended over. Here was somebody with a great eye and sensibility; yet he was 100 percent hip with the Home Depot way of doing things. An ordinary electric heater served as the fireplace (I didn’t see what powered it or anything else–there was a compost toilet, however) which was framed by a commercial faux rock wall as light as a feather. I wondered about the ghastly processes that produce such thing. And I made the balancing assumption that combining things industrial in minute quantities with scavenged material, like in a favela, might well be near-term sustainable. It struck me as a case of selectivity, practicality, technology, preservation, environment coming together. The emphasis might be on distributing small amounts of “good” and “bad” in smart combinations so as to end up with the most good and the least bad.
This isn’t to promote interfering with third world people who are managing quite OK by their own terms. It doesn’t mean trying to keep everyone alive everywhere. But it might be indicative of options yet to play out for mainstream industrial society.
No, I disagree. Their money may be in banks, but for almost every member of the 0.1% that money is unproductive money. Money gained from speculation, derivative wagers, property speculation etc. Or from consumption. Neither way is anything but wasted resources.
An awfully lot of the wealth is in pension funds and in IRAs. If it is not there, it is in Endowment Funds and in the hands of the very rich. If I remember correctly, 50% of securities are in pension funds alone.
Your argument seems to hinge on that it would expend more resources if the poor had more money. So why not bury the wealth of the poor instead? That way there would be fewer poor and they would consume less and there would be more left. If the argument is counterintuitive, the conclusion is plain dumb. What have you got against the rich anyway?
I have nothing against the rich.
I am looking for solutions that might reduce unnecessary suffering and wars.
My favorites are a global one child policy plus government policies to drive down consumption of non-renewable resources faster than their depletion rate.
Suffering and war are a part of life, we need to get over that. Every species evolved through competition within its own species and against others through the survival of the fittest. There would be no life without suffering and war, no new faculty without selection and death, no good that does not depend on evil. In that sense evil is good, suffering the cause of every joy.
All higher civilization has depended on exploitation and appropriation for its growth. Britain had slave islands in the Caribbean with millions of African slaves for centuries. Nearly everyone was a slave in Greece and Rome yet they laid the foundation of our civilization with its art, music, poetry, science, drama, philosophy, law, etc.
Every civilization comes to an end. It would crash the entire economic system if governments enforced a reduction in consumption and billions would then die. Collapse is coming soon enough anyway, so why hasten it? Like you said, enjoy life while you can! I see the rich in the same way, if a few of us can live without the stress and indignity of everyday life then why deny it to them?
I agree with you though that we should think about protecting the forests as our final retreat when the collapse happens and the starving urban masses flood out of the cities and devour all in their path like a plague of locust. The state may have to then aerial bomb the cities, like they did to Dresden, as damage control. And yes, hopefully we can learn some useful lessons from this period, reduce the human quantity, increase its biological quality to something sustainable.
I feel inspired to a song, The Beautiful Western Woods, if our friend Paul with forgive my ‘koombya’. (Paul where are you?)
Today we want to march
To try out a new march
In the lovely Westerwald
Yes, there the wind whistles so cold
Oh, you lovely Westerwald
Over your heights the wind whistles so cold
However, the smallest sunshine
Thrusts deep into the heart
And Gretel and Hans
Gladly go dancing on Sunday
Because dancing makes joy
And the heart in the body laughs
When the dancing is over
There is mostly fighting
And the lad whom that does not please
Is accused of having no grit
Oh, you lovely Westerwald
Are known far and wide
True people of nature
Of falsehood no trace
I wouldn’t worry over much about the masses flooding out of the cities. They would mostly begin preying on each other before they made it a few miles and what few survived the feeding frenzy would be devoured by the vastness that is rural America. Your average urban American can’t walk five miles on a pleasant day with a paved road. They would lay down and starve to death long before they got out to 90% of the rural areas.
I am on the South Island of New Zealand in a remote farming region enjoying the superb climate, the traffic-free roads and the incredibly welcoming community.
Around here many people have what are referred to as ‘honesty shops’ — people put fruit, veg, eggs etc… from their farms on tables out front of their homes with prices… and a tin can… you take what you need and drop your coins into the can… I am told that almost never is there any sort of theft…
I suppose that is a result of a very low population density + an abundance of food…
I remain pessimistic regarding the future … but if there is any place that might come out of this in reasonable shape I suspect this will be it.
And regardless of the outcome … without a doubt it was an outstanding decision to come to this part of the world… in some respects it feels frozen in time… a better time…
It is so far away from the troubles of the world that I have mostly detached … I have a peek at zero hedge and read the Gail’s articles…. but the few times I browse the comments I do not feel compelled to participate…
It looks as though the journey and the adventure will end here… not a bad result I suppose….
Welcome back. I am headed for China on March 13, and will be there for a month. I know I won’t be able to post from China–Wordpress is blocked. Right now I am busy getting ready for the trip, so I may not have as much time to post as before.
Ahhh!!!…to be part of the rich elite and going to New Zealand to “hide out” and be holier than thou..I first saw this movement when Nicole Foss mentioned it on Automatic Earth for only $367,000 you can buy in…….makes me sick….people with money and power propagate a system for as long as they can profit from it then they run off to Islands trying to hold on to their precious lives. How do you expect the stop the invasion of starving people heading your way…
Oh well same song different verse…. when the peasants starve it eventually spills into the rich elites…enjoy while you can!!
If you want to understand this a bit more (and get even more depressed) read “Perfect Storm”. A research paper by London based financing firm Tullet Prebon. They cover pretty much all the bases.
Yes, that’s a really good paper.
I also like Nate Hagen’s talks:
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Hi Gail, thanks for another good read. Just a couple quibbles and a question/comment.
You say, “The two parties are in a sense bound together by these commitments, in a way similar to the way atoms are bound together into molecules. ”
Not really accurate. Atoms abide by the laws of nature–even if we don’t fully understand those laws. Commitments, including debts, are a sociocultural notion, based on values and norms that can change at any time, and vary across cultures. Even debt, for example, isn’t a financial concept in origin. You mentioned Graeber’s book, which spends a good deal of time in early chapters discussing the concept of debt as a one type of the larger category of social obligation.
Later, you say this, “Economists have tended to ignore debt, because it represents a more or less balanced transaction between two individuals.”
Also not really quite true, not when banks are involved. Steve Keen had a long-running debate with Krugman over this last year, which Keen ‘won’ (the Bank of England even issued an explanation supporting Keen’s position). In fact, Keen just posted about it recently. Keen notes that debts do not balance out when banks are involved.
Keen’s post, which includes links to the debate with Krugman, as well as the BOE release.
Lastly, a comment, connected to my first quibble. You seem to assume some sort of clockwork financial system, one operating based on fixed rules and without Marxian power dynamics. I enjoy your posts, but they remind me of the Peak Oilers 15 years ago who could only see the world through the lens of geology. They’re right, of course, directionally, but fixated too much on one factor, and missed the others, such as technology, finance, and political expediency. Many have since modified and improved their arguments via the experience. I think maybe your lens is too narrowly focused on finance. However, I’ll stop there as I’ve posted on this before and don’t want to eat up more of your time on it.
Thanks again for your hard work and contributions. Really enjoy the blog.
I completely agree with Graeber on debt being a social obligation. I tried to bring in this issue as well. I think all of these things to a significant extent merge together.
I don’t know if you read Part 1 of this series. In it, I tried to explain that the way our economy behaves is very much like a physical system behaves. Our economy is a complex adaptive system and a dissipative structure–it grows as additional energy is added. Whether or not we think of the cultural commitments in the same way we think ties that bind physical structures, at a given point in time, there is a lot of similarity.
I am not quite sure what you mean by Marxian power dynamic, other than perhaps the tendency of the wealthy to accumulate an increasing share of the wealth. In fact, what seems to be happening now is the bigger corporations are accumulating ever more of the wealth in a similar manner to the way some individuals are accumulating wealth. Thus, we end up with whatever wealth is available increasingly concentrated in the hands of a few individuals and businesses. International oil companies have always been among the very largest companies. Some of the largest ones (like Saudi Aramco) are not traded, so often get missed in comparison of company sizes. If we lose the big oil companies, the whole system likely goes down. Other very large companies (Wal-Mart, Volkswegon Group, Toyota, Samsung, Apple, Daimler, GM) are very dependent on oil as well.
I expect that some of the wealth of the very rich individuals comes from the wealth of the very large corporations, so there would be a tie involved.
There is much confusion around money and debt. This is my take.
Money is a digital (or paper) proxy for physical wealth and consists of cash plus credit. There are two types of monetary systems: full reserve and fractional reserve.
In a full reserve system, the total value of money approximately equals the total value of physical wealth in existence. It is possible to have debt with this system, however every loan to a borrower transfers an equal amount from savers.
In a fractional reserve system, the total value of money is greater than the total value of physical wealth in existence. When you obtain a loan the bank creates new money out of thin air on the understanding that you will repay the loan plus interest from future surplus income. The total value of money in a fractional reserve system therefore equals the total value of all physical wealth that exists today PLUS the total value of physical wealth that will be created in the future equal to the total debt plus interest.
Every country in the world uses a fractional reserve system because:
– It permits us to spend now, what we expect to create in the future, and therefore enables a much higher standard of living.
– Consumers can borrow money to purchase homes and cars and other things now rather than waiting until they have accumulated enough savings.
– Politicians can get elected by promising more benefits than current tax revenue permits.
– Citizens receive more government benefits than the taxes they pay.
– Businesses can be created and/or grow more quickly because more credit is available for investment.
– Banks are more profitable because they can make more loans than there are savings.
– When the total pie is growing, everyone can have more stuff, and the rich don’t have to sacrifice to help the poor.
The mathematics are such that a fractional reserve system works well provided we produce more physical stuff next year than this year, or in other words, provided that the economy grows exponentially.
Starting around 1980, the physical world began struggling to keep up with our population and consumption growth demands. We papered over this reality and pretended we were getting richer by increasing the amount of debt.
Today physical growth has hit the immovable wall of high and still increasing costs of producing energy. It takes energy to make and/or maintain almost everything we value. Lest you lust for thorium, other immovable objects lurk on the other side of this wall including water, minerals, soil, climate, and pollution.
It is now clear that the unavailability of future affordable energy will make it impossible to create the physical wealth that is required to repay our current debts. This means there are three possible outcomes.
The first possible outcome is deflation: debts default, which means paper wealth vaporizes, which means there is less money for everyone. Feedback loops in this scenario could cause the global system to collapse very quickly.
The second possible outcome is inflation: money is loaned at zero or negative interest, which permits current debts to be serviced with less physical wealth production, which increases the ratio of money to physical wealth, which makes money worth less. Our governments prefer inflation because it reduces the chance of social unrest and guillotines. This is why they are all using quantitative easing. A problem with inflation is that it tends to increase the wealth gap between rich and poor. So the guillotines may appear regardless. Another problem is that extreme debt levels cause a system to become unstable and hard to control. Think house of cards and random breezes. So it remains to be seen if governments can engineer a smooth reduction in our standard of living, or if we will collapse to poverty quickly.
The third possible outcome is a combination of deflation and inflation. In this scenario some random event (think Greece) triggers a series of debt defaults which panics governments into borrowing and spending or distributing new money that everyone now clearly understands cannot be repaid, which causes people to exchange their money for physical stuff, which cause the value of money to collapse. I vote for this scenario.
In summary, there is much more money than the current plus future physical wealth required to support it, and therefore one way or the other, we will be a lot poorer soon.
Note that it is not necessary to assume evil people or conspiracies to explain our predicament. Almost everyone was complicit in wanting the benefits of a fractional reserve system. Unfortunately, a fractional reserve system, by design, must blow up on a finite planet.
Thank you, Rob M – I agree with almost all of your post. With one exception.
If all debts were cancelled, we would (collectively) be no less poor than we are now: all the real wealth in the world would still exist. However, the distribution would change. For instance, fiat money creates a false claim on wealth. If that money is then used to buy real wealth, then in effect the system is transferring wealth from those who produce it to those who produce no wealth, but only money. In my book, the destruction of such a system would be a public good, and if the banksters ended up either dirt poor or headless, so much the better.
It seems to me that Samuel Smiles’ “Thrift” is as true now as it was in 1875.
Real wealth exists as stocks and flows. We need both.
You are right that if all debts defaulted then the stocks would still exist. That would include farmland, homes, cars, tools, etc. However, in the absence of credit, most long distance flows would decrease or stop. That would include food, medicine, fertilizer, spare parts, electricity, diesel, gasoline, natural gas, telecommunications, internet, etc.
So you might own a small acreage producing food for your community but because you can’t buy diesel for your efficient walk behind tractor, and gas for your irrigation pump, and fertilizer for your crop, your total production drops, and the price per pound you get also drops because your customers are poor, so you may not earn enough surplus to pay your property taxes, so you may lose your “self-sufficient” property.
Or you might have a nice home but because you can’t get natural gas to keep the pipes from freezing, nor replacement plumbing parts made in China, nor roof shingles made in another state, it quickly becomes run down and loses most of its value.
I agree, stocks don’t last long without the flows.
I agree mostly with your view. I would add a fourth possible outcome to your list, which is government failure. A related one might be disappearance of a currency completely, perhaps because of a lack of central grid electricity.
What makes it hard to replace our current system with another one like it is the likelihood that we are changing from an upward slope in energy production to a steep downward slope in energy production because of diminishing returns, and the way those diminishing returns feed through the system.
The Australian situation:
Paying $30m a day in interest: Abbott warns of ‘second rate’ risk if budget measures fail
Prime Minister Tony Abbott yesterday said Australia was at risk of becoming a “second-rate country” if budget saving measures were not passed to ease the out of control debt, with annual interest payments adding up to nearly $11 billion.
It is interesting that this news paper complains: “The national debt is enough to build the WestConnex [a road tunnel] more than 20 times.”
The unpopular budget saving measures cost the Australian Prime Minster almost his job
Abbott survives vote [61:39] but put on notice
Tony Abbott has six months at the most to turn around the coalition’s political fortunes and listen more to his MPs after surviving a leadership spill motion.
The prime minister is understood to have told colleagues after surviving the vote it was a “big shot across my bow” and a “near-death experience”, and he would take the message on board.
All this cannot stop the Federal and State governments to waste AU$ 800 million as subsidy to a private toll-road operator, Transurban, which also runs Pocahontas 895 and 495 Express Lanes in the US. Research from my website:
NorthConnex road tunnel contract signed only days after USD 150-200 oil price warnings in Davos
Abbott has become a figure of ridicule. What you are saying here just confirms his arrogant incompetence. Unfortunately as PM he can do a lot of damage to the Country.
Rising governmental debt is a problem pretty much everywhere. It is a major reason interest rates can’t rise, because governments can’t pay their debt, if interest rates are too high.
Yes they can, unless they were idiotic enough to not have all debts in their own currency.
Printing money to pay debts is the same as creditors taking a haircut. Seigniorage is the word for that. Do it too much, and you will eventually destroy your own currency, though, how much it will take to do that is going to vary widely from currency to currency.
“Printing money to pay debts is the same as creditors taking a haircut. ”
Similar, but not the same. If I owe you $100, would you rather I pay you $50, or pay you $100 that now has the purchasing power of only $90?
It is not just the creditors, but all savers and workers that pay into inflation. Plus it can be done more gently over time, rather than the sudden shock of a debt write down or write off. As well, since the nominal amount is paid, you can in turn pay your creditors, whereas if I only pay you $50, suddenly you cannot pay your creditors and it causes a chain-reaction of destruction.
If I owe you $100, would you rather I pay you $90, or would you rather me pay you $100 in nominal terms that is worth $90 when I took out the loan? Using $50 for one and $90 for the other is comparing apples and oranges. On top of that, there have been instances where 100 units of money have come to be worth zero from the time of loan origination to the time that the loan was to be repaid. During those instances, shelves went bare and people went hungry.
“Using $50 for one and $90 for the other is comparing apples and oranges. ”
This is the choice we have now, and the choice made each time has been quantitative easing, paying the nominal amount with reduced purchasing power. The other alternative was maybe the $50, or maybe $0. Just ask how much money MF Global or Lehman or Bear Stearns creditors got, compared to AIG’s creditors. Without the bailout, you might only get pennies on the dollar, never mind a 50% haircut.
Even if it was $90 cash or $100 nominal with only $90 purchasing power, if I only take the $90, I’d have to pass on the losses to my creditors, which could cause more blow-ups along the way. If that missing $10 was leveraged 20:1, that’s a $200 loss for someone.
Yet history is clear: Turning to the printing presses to fund chronic deficits does not end well for the currency.
Running chronic deficits ends badly every time, regardless of how you fund it.
Then why the insistence on using $90 and $50 when you know that printing money and trying to inflate your way out of debt only works short to medium term?
“Then why the insistence on using $90 and $50 when you know that printing money and trying to inflate your way out of debt only works short to medium term?”
It has been working for over a hundred years, what do you define as medium term? No system made by humans really has lasted more than a couple thousand years, and I don’t think having a Pharaoh rule as god-king over all of us is really something most people would go for.
No, that’s wrong too,
Seigniorage is the profit from printing notes and coins face value over the production expenses.
It’s piddling sum, relatively speaking, since notes etc are less than 3% of the money supply. It certainly doesn’t pay debts. The CB sorts that out directly. Creditors are in no danger as long as transactions were all in the local currency. In fact with QE they gain as the banks are rid of drags on the accounts.
That is a very limited definition of seigniorage and not at all consistent with today’s monetary system because it is not consistent with how the monetary system actually works. The Fed’s open market operations and then remitting the interest back to the treasury is seigniorage. They are, in fact, expanding the money supply when they do this, and the government gets to spend this money first.
And actually creditors are in danger because of QE. It has removed so many USTs from the markets that they have very little “high quality” collateral to pledge in their rehypothication shadow banking schemes. This is why the Fed has enormous (i.e. several hundred billion dollars worth) reverse repo operations on the last day of any given quarter. It’s so that the banks can shore up their poor balance sheets and report good things to investors and regulators.
Gail: I’ve got to say I’m a bit underwhelmed by your treatment, though it’s attempting to address a question that’s been bothering me for quite a while. I’m someone who has gone through the economics education “brainwashing” process, as you call it (I largely agree with that description), but finance and debt have long been impenetrable to me.
I think Matthew Krajcik really hits a few major points that you would have done well to include:
Debt can be written down or written off, and is all the time. This is a point that much of the discussion from you, Chris Martenson, Richard Heinberg, James Kunstler, et al, which I’m increasingly unsatisfied with. I could be wrong, but somehow the story you’re telling doesn’t quite add up. Introducing the elements of debt write-off: forgiveness, bankruptcy, default, etc., would help this piece greatly.
As Krajcik correctly notes, “government issued pieces of paper are poor stores of value, but useful in the short term as a medium of exchange”. In fact most currencies are poor long-term stores of value. Joseph Tainter details in depth te devaluation of the Roman denarius from 3.8g @ 98.99% pure silver to 1% or less over a period of about 260 years. Adam Smith writes of the devaluation of the tri-metallic standard of English currency (copper pennies, silver pounds, and gold guineas). The problem isn’t that fiat currencies inflate, it’s that all currencies inflate. Especially where the sovereign incurs debts it cannot pay.
There are alternatives to a one-time jubilee. Steve Keen addresses a few of these, though I need to revisit his work in more detail. Among them: a government grant. For debtors, it would have to go to paying down debt, for those without debts, it would be effectively a free and unrestricted grant. In effect it is a transfer of wealth from those with large money holdings to those without.
A currency reissue would accomplish much the same. Old financial debts wiped out, new currency issued, game starts over.
A tax on loans combined with expenditures would be another reallocation mechanism.
Putting a sunset date on all loans, after which they are considered no longer collectable, would mean that loans would age out over time. What debt is, in effect, is a projection of future wealth, and faulty predictions in this scenario would be penalized. This is similar to some proposals for student loans reform in the U.S.
Tying debts to income or wealth would be another option. Setting a maximum repayment schedule (both amount per year and years per loan) would again set limits on total indebtedness.
Another factor that I’ve been mulling over: that money is more like insulin or adrenaline than blood or transport. It isn’t energy itself but rather a signalling mechanism that mobilizes energy (or other resources). In that sense, you can increase or decrease the amount of signalling. But what’s most important is that 1) the signalling data circulate and that 2) not too much accumulates in any one area. That’s an idea in progress, so yes, it’s a tad sketchy.
What I am trying to describe is a financial system that is about to fail, because of mismatch between the underlying situation we face and the nature of the promises that have been made. I probably need some more diagrams. In particular, I need to show resources available as in this chart:
If the amount of actual goods and services falls precipitously, then the nature of the system–borrowing from the future, and paying back at least as much as we borrowed, simply doesn’t work, because we are moving from a time period with a positive slope to one with a steeply negative slope.
The problem is really a cheap energy problem–there is not enough cheap energy to fill all of the promises that have been made, and in fact, to keep the whole system going. We can write down how much energy each of the past debts is worth, and re-issue a new currency that is worth less. That sort of works, if we are to the left of the time period when the energy cliff takes place. In fact, that is why it worked in the past.
If we do it now, the new currency will still have problems, because of the continued steep downslope. In fact, it will need to be replaced almost yearly or the system done away with altogether. That is why today’s situation is different, and why I didn’t suggest the solution you proposed.
Obviously, I am not describing the situation sufficiently well, because other commenters are also confused. They keep talking about inherent deficiencies of the fractional reserve banking system, which I am not talking about. The fractional reserve banking system has “hung around” for quite awhile, despite changes in currencies.
It is difficult to talk about debt and not have fractional reserve banking pop into one’s mind simply because debt is inherent in modern fractional reserve banking. Debt *must* continue to grow in our current system, else loans don’t get repaid, shadow banking goes kaput and the financial system comes to a grinding halt. Get rid of fractional reserve lending and other possible schemes like it, and it can drastically change the nature of how debt is issued and repaid. If you are talking about a very strict gold and/or silver standard where you have coins of a high purity, then paying debts back that have interest attached involve doing something to increase the money velocity enough to give you a chance to make the principal plus interest back. Under such a system, coin that you lend somebody would not be available to you until it is paid back. There would not be much debt in such a system, and I suspect that the relative values of goods and services would look very different from what they are today. The other option is to debase the currency, which has happened countless times in history.
But much of that is academic, because as I stated, we have a fractional reserve system that requires growth, else it will come collapsing down upon itself. It is a pyramid scheme. We are reaching the limits of growth, but all of those interest payments are still there.
No, we don’t have a FRS now. Richard Werner writes about this as one of 3 theories about money creation;
1] Financial Intermediary Theory; banks collect deposits which are then lent out.
2] Fractional Reserve Lending; individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction.
3] Credit Creation Theory; Each individual bank has the power to create money “fairy dust” by extending credit.
3 is the accepted way , endorsed by the BoE.
Banks don’t lend their deposits. They may park deposits in the Central bank if having such reserves is required [not in Australia since 1988]
Oddly enough there is no law, statute or regulation which explicitly grants the right to create and allocate the money supply. Yet is an amazingly powerful instrument of the money supply and the banking industry!
Agreed. Currencies have been devalued many times to fix the problem for another 30 or 40 years. Even if this is still a problem, I don’t think that the standard fix, fixes the problem we have now.
Re this: “The problem is really a cheap energy problem–there is not enough cheap energy to fill all of the promises that have been made, and in fact, to keep the whole system going. We can write down how much energy each of the past debts is worth, and re-issue a new currency that is worth less. That sort of works, if we are to the left of the time period when the energy cliff takes place. In fact, that is why it worked in the past.”
That plays into my comment on debt above: that it’s a _forecast_ and _prediction_ about the future. And that the bet, in general, is on growth.
I get the part about energy not being there. Very much so. That’s not the question.
Instead, it’s how to unwind those predictions which are proving false — who takes the hit for the unwarranted optimism?
There’s a related but distinct question of how to accomplish finance in the future. Debt-based finance worked for a growing economy, it’s … at the very least … problematic in a steady-state or shrinking economy. Though it seems to me that there should be some historical precedent to help us here. Discussion of steady-state economic systems goes back (for modern economics) to John Stuart Mill (cited by Herman Daly). And I’d think there’ve got to be cases of civilizations which have ebbed and flowed without collapsing. Tainter describes the Byzantine empire as managing to pull of a slow fade, and that might prove to be a useful model to look at. You’ve got the Maddison dataset you’ve used in a number of posts which might also show similar periods of interest.
One risk of a financial economy is that as things slow it exhibits a liquidity crunch. I’ve been going over the history of this as regards the Great Depression (Galbraith’s book is a highly useful study). In some regards it is a reflection of the present: a period of rapid and exuberant growth — arguably from the 1890s through the 1920s — coming to a sudden end. Precipitated among other things by uncertainty over the future of petroleum. The early finds in Pennsylvania were playing out, and the big strikes — the East Texas oilfield — weren’t made until after the Depression had hit. There was also a problem of oil _overextraction_ that wasn’t resolved until after the Oklahoma and Texas governors mobilized their respective National Guards, and the Texas Rangers, to seize at gunpoint oil wells, ultimately creating an extraction quota system under the Texas Railroad Commission that persisted until 1972. See Chapter 13 of Yergin’s The Prize.
And while we face future energy uncertainty — possibly in a few years, though I think it may yet be a decade off — that’s not fully the problem now. Instead it’s dysfunctions within the financial system itself.
As to what to do about it…. That’s where I have to shrug. I’m not sure. I’m well aware that there are many who claim we’ve got to raise the entire world out of poverty. I don’t see that as possible. The alternatives aren’t particularly good though. And the question becomes: when and how do we make decisions and allow what’s going to happen happen.
But those debts? They’re going to fail one way or the other.
“I’m well aware that there are many who claim we’ve got to raise the entire world out of poverty. I don’t see that as possible. ”
For every 100 million people living on $100 per day, we could instead with the same amount of wealth have $1 billion people living on $10 per day. The bottom 2 billion or so live on $1 or $2 per day, which is extreme poverty. I don’t see 4 billion more people getting over $50 per day as being probable with currently available resources.
As a clue as to who gets left out, who is going to pay for all of the people who are currently retired? Governments likely aren’t going to be able to do it. Pension plans are filled with defaulting bonds and stocks that won’t be any good. I have been told that “intergenerational debt” was a problem in prior collapses–I expect that will be a problem here as well.
Sunshine is the only income we’ve got.
Pretty much true. There is some gradual erosion of rocks into new soil as well.
Any asset, Gold Coin or otherwise can be STOLEN or Confiscated. Pensions, accounts etc.
And yet specie is part of the way to de-fang the horrible beast that once honest debt has morphed into. Confiscation and theft are immoral and illegal, mal insensia, so it is a threat to EVERY ASSET.
You are right. What we consider wealth can be stolen or confiscated. The less we can make ourselves dependent on it, the better.
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In “Debt – The first 5000 years” David Graeber reluctantly suggests the way forward is the debt jubilee, long overdue, he writes. He points out that the principle behind debt has been exposed as a “flagrant lie”. “We don’t ‘all’ have to pay our debts. Only some of us do”. He calls debt the “perversion of a promise”, corrupted by maths and violence.
It would of course severely damage belief in credit, but maybe we need some of that.
IMO, the debts we need to put first through the jubilee are those in the parallel world of interbank dealings, where a lot of money is bet on future events, Derivatives are wagers, pure and simple.
That sort of debt has no protection at law although the banks have made inroads there in the last 20 years, such that the insurance part now has some legal protection. Estimates of this are up to 1.4 quadrillion dollars, a great multiple of the world’s economy at c.$84Trillion. In any event credit belief would likely survive a wipeout of wagered money, as long as it was understood.
Then comes what to do about most regular credit, such as mortgages. That’s a strange one as well.
I believe that in all the slicing and dicing that goes on within the banking sector, the ownership of mortgages has been ceded to others, possibly the DTCC, which is supposed to have all the records but doesn’t in fact. This loss of ownership is also mentioned by Ellen Brown. who is a great proponent of a government owned bank, [for good reason]. It means any jubilee would leave the public mortgage debtors free from liability. They would outright have title to their properties.
Even without that, in the event of a crash it would be pointless foreclosing as few could buy the properties from the banks and in any event having the owners staying on would save the properties from destruction, like we have seen in Detroit. at least in the short term.
The final authority would be the central government. With their Sovereign right to create money they might be able to continue to create money to pay for maintenance of essential services and the could issue coupons as was done in wartime to ration essentials, food, fuel, etc.
Normally money creation depends on the space in the economy after existing costs etc are factored in. The only figures I have seen are in USA from 2006: GDP was $12.98 Trillion, National income,$T10.23, Available purchasing power, $T9.21 and Potential GDP, $T14.75 at full employment. So the space was $T3.77 between GDP and Available purchasing power, but against potential GDP the space was $T5.54. That would pay a lot of bills!
In a deflationary environment no one can say how much space would remain, but probably not much even in the short term. Nevertheless we can’t be choosers and we have to hope governments survive to try to manage the decline, because if they also go the crash will be much messier and deadlier.
I am doubtful we will have a lot of control over this process.
I looked up what the Congressional Budget Office is claiming as Potential GDP. Let me see if I can make this graph appear. It doesn’t seem to appear, but at least you can get it buy clicking on the link.
As far as I am concerned, potential GDP is going away, as we lose our ability to keep the economy going sufficiently to extract fossil fuels. Their graph shows a slight bend in the trend, but in fact, I expect there will be a sharp bend.
Depending on who you believe “we” to be, we absolutely have total control over it. Even more control, in fact, than Graeber suggests. Jubilee or any other debt forgiveness is just a resetting of the game. We can instead choose to end the game and we don’t need permission to do so. Governments and corporations–including banks–can’t prevent it. The choice to end the global societal/cultural use of money and the concept of exchange is and always has been available to us. It would end the game, leaving us all to live like other species, using our capabilities without wrapping them in a story. The awareness of this choice is the first step, to be followed by increased understanding of the implications, rejection of negative scenarios, planning for a positive one, and then abandonment of money and exchange on a date certain, after which life would continue without the ‘overhead’ of moneydom and the stress of money-think. We already live that way, we just add an unnecessary, arbitrary layer of activity and beliefs on top of it.
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Gail I think you are saying in a very logical way that we are all pretty much screwed in which case I agree with you. The real economy is and always will be energy. Not paper. This is the bit that economists miss. I think it gets too confusing for them. Infinite growth with finite resources + 7 Billion people. I don’t think so!
I tried to say that the economy is always energy in both post 1 and post 2 in this series. I may not have mentioned that issue enough in Post 3, but it is really the issue underlying the collapse I am talking about.
Dear Gail and All
In the previous post I discussed a South Carolina dairy farmer who has successfully substituted sunshine powered grass for industrial feed. That is an example of a ‘regression’ from a complex industrial solution to an equally complex biological solution, but involving quite a bit simpler industrial organization. So ‘regressions’ are possible and sometimes profitable.
Here is a current comment by Rockman at Peak Oil News:
‘ Folks tend to focus on Big Oil but it hasn’t been the heart of the US oil patch for decades. it’s been the independents driving the train. And many of them look like they’re about to derail:’
Now I suspect that Big Oil is more complex than the independents, although both are doing complicated industrial things. But shedding some of the regulatory rigidities of big corporations seems to have been the winner of the Darwinian Selection sweepstakes in the US oil patch.
I do not see any reason to fear simplification.
Don I think you are missing one salient point. Yes there are numerous ways of creating a self sustaining society. (we should have been doing it 100 years ago) How exactly do you think it is going to work with 7 Billion starving people? The US in particular will be a nightmare. How long will you or your farm last when the crunch really hits. It’s all too little and far too late. The system reset button is about to be pushed.
By the way I have yet to see a so called greeny solution that is not completely dependent on oil. Google “greenwashing”. If you examine the EROEI of these so called solutions you often discover that not only are they not self sustaining, in many cases they make the problem worse.
I have explained many times that I see a kitchen garden as the most immediate and biggest payback ‘green solution’. Along with things like harvesting water from your roof and composting humanure. And relearning how to get along without air-conditioning and without much room heating. These are not the sorts of solutions that ‘greenwashing’ companies promote.
They do require that one have some land with no debt and neighbors that one can cooperate with. And a mental adaptation to the small pleasures in life.
I understand your point completely Don and I agree. But what I’m talking about is scale. Our entire society has to change and it’ still not doable with our current population levels. Not even close. It’s possible at the moment because of fossil fuels and other very finite resources. The future is of course sustainability as you describe. Getting there in one piece will be the hard part.
“How exactly do you think it is going to work with 7 Billion starving people?”
Properly implemented, permaculture should result in more food, not less, while requiring little or no fossil fuel or industrial inputs. The trade-off is that you end up with a great deal more people working really hard at producing food.
“By the way I have yet to see a so called greeny solution that is not completely dependent on oil.”
The problem is that the mainstream “green movement” is based on “sustainable growth”. The goal is to consume more, sustainably. Try to wrap your head around that. Its like a Buddhist Koan or something.
Yes agreed, sustainable growth. That’s an oxymoron if ever I heard one. I disagree that it’s possible for current population levels. Every analysis and research paper I’ve read puts our sustainable pop level at <1 Billion. And that still means 80% of the population is engaged in farming of some sort. Exactly what we were doing before coal and oil. Some poignant questions we should all ask ourselves is do we want to live on a planet completely covered in farms? Should our population level be 7 Billion? Do you want to struggle every day of your life to have a meal assuming it's even possible with that pop level?
You can feed 10 people on 4000 square feet, so under optimal conditions, 100 million acres of intensive gardens would feed everyone pretty well. That’s with a decent investment and 3 or 4 people working full time on that plot. Obviously not everywhere is optimal, but the amount of land is greater, plus you have pasture and fishing, etc.
I don’t think anywhere near 100 percent of current population will survive, but it would be technically possible, if the whole world had started converting towards true sustainability 40 years ago.
“Do you want to struggle every day of your life to have a meal assuming it’s even possible with that pop level?”
20 to 40 hours per week gardening or herding animals is probably not that terrible of an existence, really. I suppose some think so, and will choose not to try to survive when the time comes. Or will aspire to be warlords or bandits and try to take rather than produce.
Dear Gail and All
One cannot intelligently discuss debt, without also looking at it’s shadow, which is a sort of ecstatic relationship to the universe. Debt is supposed to give us ‘stuff’, which will make us happy. That is financial capitalism in a nutshell. Soviet style communism was about the laboring masses making the stuff which would make us happy. Neither financial capitalism nor soviet communism are able to abide the ‘ecstatic relationship to the universe’ concept. People like Jesus, Buddha, and Thoreau, who sought the ecstatic relationship, each in their own way, are simply incompatible with the dominant culture of the 20th and early 21st centuries.
There was a brief moment in the 1950s and 1960s when an alternative appeared and then was crushed under the boot of the War on Drugs: psychedelic drugs. (Full disclosure: when psychedelics were popular, my wife and I were knee deep in dirty diapers and didn’t have time for such nonsense.) Richard Nixon began his presidency with a sane drug policy: drug addicts needed treatment. But then, as part of his ‘Southern Strategy’, he found that he needed to appeal to suburban voters, who objected mightily when their teenagers spent more time with marijuana than they did on studying to become doctors and lawyers and other respectable professions. So Nixon changed direction abruptly, and, since that time, the US has been willing to kill and imprison countless millions of people in the name of stamping out drugs.
Now, the wheel seems to be turning again. This time, the opening leverage is provided by treatment of the terminally ill…cancer patients and the like. Financial capitalism says that the terminally ill must be kept alive at all costs, even if they prefer to die. The new psychedelics says that the terminally ill can have ecstatic experiences from one or two cheap treatments with psychedelic drugs, which causes them to perceive their situation in new ways. ‘It’s all about love’, ‘I met my cancer, and I’m not afraid any more’….those kinds of changes.
Here is Michael Pollan’s article:
What does this have to do with debt? You will notice that the people doing the experiments are quite circumspect when they talk about ‘making things better for people who are not dying or addicted to cigarettes or other dread conditions’. Suppose teenagers once again became enthused about drugs as a way to open their minds to what Jesus and Buddha and Thoreau talked about…and didn’t see the point in piling up lots of student loan debt and buying a McMansion on credit and all those other aspects of debt that keep the One Percent rolling in digital wealth? Would the US go through another Nixon episode?
This is a point which has fascinated me for a long time. We can buy a Maserati trying to be happy, or we can get our cane pole and dig some worms and go fishing. Financial capitalism depends on us choosing the first option. Debt is the devil that goes along with the Maserati.
I think you’re using “debt” here where “consumerism” would be a better fit. The expensive high-end products are there to tempt the wealthier individuals, since there is no reason to own twenty corollas just because you earn twenty times as much as an average worker.
The idea is that owning stuff equals happiness. Debt just lets you get the stuff sooner, but in the long run being in debt means you will actually consume less than if you only purchased from savings.
Of course, I guess it all depends on how the bank credit creation flows multiply the money base, perhaps more money is created with more borrowing, so somehow they end up with a larger percent of the total real assets?
I don’t think it is all a sinister plan to steal all the wealth. I think the debt system and drive to get people into a well-paid profession, a big house with two cars and loads of debt, is more to do with getting people away from having eight children, and relying on a pension system instead.
If a generation ran off and became ascetics, the preceding generation would suddenly be left with no funding for their retirements. It is the old enslaving the young, not a hand full of rich people enslaving the poor. It is just an artifact of the system that the wealth collects into fewer and fewer hands at the very top, I think.
Now, we are stuck with no room to grow, and a difficult path to shrink.
If you read Pollan’s article, you will see that the people with cancer taking the psychedelic drugs do not consider themselves ‘ascetics’. They see themselves as living lives of abundance.
Note the description of the man dying of cancer, right at the end of the article. Just two days before his death, he is happy. What has changed is his mental model.
Mark Twain wrestled with these issue in Huckleberry Finn. At the end, Huck ‘lights out for the territory’, while Tom Sawyer remains behind in civilization.
“If you read Pollan’s article, you will see that the people with cancer taking the psychedelic drugs do not consider themselves ‘ascetics’. They see themselves as living lives of abundance.”
I did not mean from their perspective, but from the perspective of a system that desires people consume and in-debt themselves as much as possible, in order to best sustain the system.
I suspect a lot of this debt and consumption causes great results in the short term, but nets out as a loss in the long run.
Let’s engage in a little fantasy. One of the Debt Jubilee advocates who writes here becomes the Supreme Ruler, and cancels all the debts.
Then, to resurrect the old Urban Legend from the late 1960s, some hippie group gets control of the water supply and laces it with LSD (I don’t think it would work, but this is fantasyland.)
Then the 7 billion would be transformed from a greedy, nasty, snarly bunch to a group spreading peace and love.
I don’t want to hear all the reasons it won’t work. Some have their thorium reactors, I will cling to the psychedelic dream.
Slightly tongue in cheek
My experience is that it is often not the person who is ill who wants the advanced treatments, it is relatives who have some reason to keep the treatments going. Also, the “system” tends to lock a person into this outcome, because that is what is expected.
The use of debt in our financial system is based on trust that it will be paid back. That is why transgressions such as passing bad checks is dealt with so quickly. The person who has passed the bad check has violated the trust factor. Without that trust the system unravels pretty fast. The recent death of William Catton has spawned a number of commentary and articles about him and his 1980 book OVERSHOOT. Since I did not read it when it came out, I am reading it now. Catton looks at our predicament through the prism of ecological principles. He sees our undisciplined use of limited resources as stealing from the future. It is a form of debt we can never repay.
In fact, pretty much all resources are limited. Each kind of mineral has ores over differing degrees of concentrations. We are given the high concentration ores as a one-time gift. Once they are gone, they are gone. So the problem exists with fossil fuels, minerals, and plants and animals that we are killing off. The pollution we are spreading is another issue.
These folks propose building 100 1GW thorium reactors per year.
Love the concept of Thorium reactors but keep in mind electricity only solves one small part of the problem. Oil is a lot more to our current civilisation than just electricity.
“Love the concept of Thorium reactors but keep in mind electricity only solves one small part of the problem. Oil is a lot more to our current civilisation than just electricity.”
If we have abundant sources of energy at 100:1 EROEI, we can synthesize oil and its products. Synthetics are purer, without sulfur, and are generally superior and more desirable than natural products. The trade off is of course increased cost, in both money and energy.
I will believe it when I see it. Security is one of the big issues. With this size installation, I doubt there will be much security.
“We can’t get rid of debt without getting rid of the benefits that debt provides–something that is a huge problem.”
I think you may be overlooking something here. The logical end of capitalism is that one person “owns” everything and everyone else is “in their debt”. We’re not quite there yet but very close. It’s reckoned that in London UK there are 4000 BILLIONaires and a million people who are on the verge of being unable to pay for food and shelter. If those billionaires were somehow “got rid of”, or at least their “ownership” no longer recognised by the vast majority (thus the debt got rid of), then would that be such a big deal? I believe something similar happened in France 1789 and Russia 1917 without total collapse as a result. A lot of “privately owned” golf courses could get dug up for a start.
Oh and the value (credibility) of “wealth” and “ownership” only holds as long as enough people believe in it, and an increasingly huge number have very little motivation to believe in it any longer. At some point soon, money is voted out of office.
“The logical end of capitalism is that one person “owns” everything and everyone else is “in their debt”. ”
I think that would happen with or without debt, on a long enough timeline for a stable enough civilization without wealth redistribution. Usually, Oligarchy Churn helps take care of it, and it seems a lot of rich people split their wealth among several heirs, who tend not to have the same drive to acquire wealth as their predecessors. Debt certainly speeds the process, particularly with compounding interest.
Gail we are going to start over from scratch anyway. Might as well plan it properly.
I agree, but I am not sure that we could communicate our view of what the “right way” might be to the group that turn out to be survivors.
France 1789 and Russia 1917 is the final outcome; but we can buy time by:
By MEFOBILLS, at Zero Hedge:
We will need a legal entity to be formed to then look at the DEBTS and figure out which ones are onerous and illegal. Those debts need to be erased. ERASED not paid off. Legally torn up and flushed.
Then we will need a new type of money system. I prefer a sovereign money system. This changes the nature of money from “credit” to “wealth” and would have tremendous knock on effects, remaking society. Private Creditors have shown their hand, the money power should be stripped away from them.
Yes, yes, yes. 100% agree. The Hamiltonian system of a national bank emitting credit. Not the global bankers system of ever deepening debt slavery.
If we had a legit system we would be much poorer. We are as wealthy as we are because we are still in the beginning stages of the debt collapse. There are no longer the resources to live even as well as we did in the 50s when the system was probably more solvent. The huge amount of debt allows us to live beyond our means and will go away given enough time.
In the uk a group called Positive Money started up. I tried to explain to them that they have zilch chance of getting a reform which would undermine the most powerful people on the planet. And even if they did it would soon be subterfuged. And anyway fails to address the finite earth problems. But they are carrying on with their pointless efforts anyway.
What it really would be better to do is go back to is the situation before land ownership and goods ownership (other than what you could carry). Then everything would be owned in common. The only restraints would be restraints handed down through the culture that explained how you and others should act. We would probably be back to small “gift economies,” or perhaps a step or two up from that–land ownership schemes that didn’t encourage each person to overuse their own plot, so as to maximize production each year. Also, the few animals owned could be rotated among the plots, to help with fertilization.
When I made the comment near the end that there is really no wealth that is permanent for the long run, I was referring to the fact that our ownership of land and houses depends on a governments continuing to recognize this ownership. There is also the issue of being able to continue to pay taxes, without fossil fuels. Many countries have confiscated land from the wealthy, and redistributed it to the common people. I saw an apartment in St. Petersburg, Russia, that was a subdivided part of a much larger old apartment.
I was happy to see your comment here, for it touches on the primary critique I perceived as I read your article. The problem, fundamentally, is civilization itself. Not our form or version of it, but the very concept itself. When you state, “it really would be better to … go back to … before land ownership and goods ownership (other than what you could carry). Then everything would be owned in common,” you describe the prevailing systems prior to the advent of stationary collectives – whether they be farms or fishing villages – which required for sustenance the importation of goods not immediately available locally. Absent this dynamic, or in other words, if any particular group is self-sufficient in its environment, there is no need for “debt,” no need to artificially divide and “own” land, no need to aggregate capital beyond one’s personal tools and possessions. This state of affairs obtained among most North American indigenous peoples prior to the European invasions, which were the classic expression of “civilization” — the conquest and theft of resources (including production, eg. enslavement) from others by a people who had denuded their own continent by virtue of its hyper-efficient collectivist organization. This state of affairs, however, is very unlikely to be viable in any meaningful projected future, because the collectivist organization has now overrun everywhere on the globe, and there is nowhere else to draw resources from in that closed system. We have reached overshoot, and now those “debts” must be repaid.
In some ways, the Biblical injunction to forgive debt every 7 years (and also every 50 years) is an injunction on the amount of debt that can be used–practically none, because it would be hard to forgive that often.If we basically live within resources, and just use debt to facilitate a few trades, it seems like the amount of debt required would be way down.
Property isn’t a problem, Gail. The concept of exchange is the problem. It’s behind all that you describe in your piece, including those “Benefits” that really aren’t. Choosing to no longer believe in it is an option that The Money Choice attempts to explain. We live in an emperor-wears-no-clothes culture. We can consciously acknowledge that exchange, promises, debt, etc. only exist in our minds, choose en masse (by a critical mass, not necessarily a majority) to end the use of money, and still enjoy what we’ve produced and can continue to produce without the waste inherent in exchange and its attendant activities (think paperwork).
There is a book titled: “The Mystery of Capitalism” by Hernando de Soto in which he espouses that the reason capitalism works in certain parts of the world and not others is due to ownership of assets such as land. By having land deeded to a person or entity, the person or entity can use that land to back up a loan. There is more trust if a defaulting party has some assets to which there is a clear paper trail to which a claim can be generated.
We have seen the chaos in the recent collapse of the housing bubble where where clear and clean title were not to be found due to malfeasance. This destroyed capital for some and the banks and mortgage companies have not finished sorting out the problem.
I agree with you that derivatives and other such instruments are not backed by assets and will be a problem going forward. It will be interesting to see what happens when Greece defaults on their loans. Who will be left holding the “bag of derivatives”? This may cause a cascade of paper asset collapses. The last time bond holders took a haircut, there were a lot of people in the derivative market saying it was not a “default” when it clearly was a “default”. This time there will be no doubt. No mincing or weasel wording of terms.
How does one protect one’s capital given a corrupt banking and financial system? The idea is to move one’s capital to where it is supported by sound practices and foresight. To invest it where it will do the most good going forward. Who makes shoes? How do you protect leather and/or repair shoes? Who makes clothing? How do you darn a sock? What does it take to produce food? What uses less energy per unit (e.g., railroads vs trucks, bicycles vs cars, etc.)?
What do I need to do to make myself a future asset to my family and community? What changes in infrastructure need to take place in order to have a viable home? a viable community? How do we invest in that type of infrastructure? And what is that infrastructure?
Greer mentions going back to a life style of the 1950’s and even the 1920’s. I would add we need to replace firewood consumption with solar PV and solar thermal wherever we can. It’s going to take a lot of capital investment to do so but we will save our forest for better uses like taking off the chill when it is cloudy at 20 below.
Lots of challenges and lots of idea. Some may even work.
I can see that deeding land to individuals would help a lot in making it possible to create loans. Also, quite a lot of debt is real estate related. Part of what China has been doing is selling people condominiums for the first time. This has generated a huge amount of debt.
I don’t recommend putting the solar PV on the electric grid. If you want to buy solar PV for your private use, perhaps with backup batteries, that is fine.
I must confess I wonder just when the “Go Back To” portion of your comment is suppose to have been. Aside from a few isolated pockets of failed attempts at communal land ownership I cannot think of any time in recorded history where ownership of property was not the norm. Someone owned it or had sway over it that amounted to the same thing and in most cases the systems worked although some lower strata people weren’t too happy about it.
The current idea that the government owns the land and can seize it if taxes are not paid is not as old or traditional as many people seem to think. Before the US system began to evolve into the tyrannical government owning everything beast it is today many land owners owed taxes and even outright ignored the fact with little retaliation by the various governments because there was little they could do about it. The idea was that the land belonged to the family and the fact that they owed taxes meant they owed taxes not that the land could be taken. Often times tax burdens were carried for generations and only finally paid back when the family came on a windfall of some sort.
I would even go so far as to say that the increase in easy, cheap energy is the only thing that allows governments to claim and enforce the current view on land ownership and once those resource levels decline we will revert back to a more permanent property ownership idea. The governments may not like it but they won’t have much choice int he matter.
Your memory is very Western centric. China has not historically had ownership of land by farmers. Neither has China. It is fairly recently that India adopted ownership of land by peasants. I know when Hawaii was settled by Westerners, the first thing done was to try to get land ownership. I doubt that Africa had much individual ownership of land a couple of hundred years ago, either.
Your memory is very Western centric.
Not really although I will grant you that most of Africa and the Americas that remained stuck in the stone age as far as technology and culture did not have much as far as land ownership, them being mostly tribal and all. China and the rest had a more feudal system (for lack of a better word) which is of itself ownership of a type although not ideal for the lower classes I will grant you.
However you did fail to answer my question if I may be so bold. What point are you referring to that we should go back to? Land and property ownership is the building block for almost any form of civilization, especially if you want one that will work, so I am just curious.
I don’t think we will be given a choice in the matter. I imagine different people in different parts of the world will try different approaches, and perhaps some will work. I don’t know whether or what kind of land ownership. Group ownership of land seems to have better possibilities for keeping land in somewhat reasonable shape for longer, but farming (row crops, plowing land, individual owners trying to maximize production, etc) is not in general sustainable–it is too hard on the soil.
The tragedy of the commons is relevant here. It also applies to population movements. Each country’s excess population moves to colonise new areas and destroys them in time as well.
If Easter Island had had a neighbouring island to move to that island would eventually looked just like it. The exodus from the Middle East and Africa will add stress to Europe’s future prospects.
You probably are right. Population tends to move to where their prospects are best.
Land Ownership: Prof Michael Hudson writes favourably of the Temples owning land in Mesopotamia circa 2000BC IIRC. Whether such a system could be introduced today would be a subject for debate.
If we look at everything that exists as energy – either potential energy (coal, oil) flowing energy (electricity, cooked food) embedded energy (appliances, factories), money is a claim on energy, but not a debt.
Debt is simply moving energy through time and/or space at a cost.
All debts include return for time, plus risk premium, otherwise everyone would be able to borrow unlimited amounts at the same rate of interest as the federal government. The lenders have chosen, of their own free will, to accept the risk of a default, in exchange for the higher premium.
Even with federal government debts, since everything is priced via auction, it is possible people make errors and count the risks incorrectly, and thus misprice the debt.
Writing down or even writing off debts does not mean abolishing money. As far as store of value goes, this is exactly why many people argue that government issued pieces of paper are poor stores of value, but useful in the short term as a medium of exchange. The USD has lost 98% of its purchasing power in the last 100 years. Inflation is one way of slowly writing down a debt in real terms, while paying it back with interest in nominal terms.
Doing anything suddenly creates a shock; preferably, major changes should occur slowly overtime, such as slowly inflating away debts. Unfortunately, we may not have the time to do that.
Rather than forcing private banks to write off debts for a jubilee, I suspect it would be better for the government to buy up all the debt with money created through quantitative easing, perhaps at zero percent interest. The operating profits from central banks – interest paid minus expenses – is returned to the national treasury anyways.
With a national full reserve checking and debit system, there would be zero risk of loss, since there would be $1 physical for every $1 electronic, rather than having $2 in assets for every $100 in debts. Along with that, the target could be moved from 2 percent inflation to 0 percent, as a soft target with a +/- 2% range.
Several countries have gone through hyperinflations without everyone losing their energy supplies and starving or freezing to death. Paper currencies die all the time.
“Debt is simply moving energy through time and/or space at a cost.”
If this is correct, it presents my first little glimmer of understanding of debt. I would welcome a kind of literary form where most debt/money issues are explained at this extremely simplified level. 🙂
Or maybe it should be rephrased, “Debt is claiming to move energy through time or space at a cost.” As long as there is plenty of cheap energy, the process mostly works–the economy can grow enough that this happens. It stops working as we hit diminishing returns. Then, debt becomes a vanishing act.
Some excellent points here, I’ve touched on them in a reply further down.
In particular I wish Gail had addressed the matter of writing off / writing down debt. She (and Chris Martenson, and Richard Heinberg, and others) write as if debt was forever and eternal. It simply isn’t.
Yes, writing off debt does mean a transfer of wealth occurs. But that really isn’t a bad thing in all cases.
I also like your distinction between money as a means of exchange (its primary role) and as a store of wealth (secondary).
When debt is written off it is the same as saying that your collateral is no good, the system breaks down. That is what is now happening in Greece and what will happen world wide given enough time. I used to think that the fiat money was free money that could go on for ever, but I now understand that their are limits to what they can do and in actuality they are up against those limits now. They can not in reality get a return on their debt, but the world has not figured it out yet. The system, in a way, is held together by faith. We still all believe that it works so it does. As more and more evidence mounts that it doesn’t really work anymore, for example the oil drillers can not sell their oil for what they want to sell it for, they beg their financiers for more money and they give it to them but after enough years the system begins to wear itself our and to break down.
Money is certainly a financial promise, and that is what I am talking about.
We can segregate out a piece of financial promises, and call them “debt”. Debt has interest rates attached to them. (Some of these interest rates are even negative.) But that doesn’t mean that the others aren’t promises just as much.
A big source of our problems is what is sometimes called intergenerational debt. I didn’t end up talking about this. It has to do with the real problem of supporting the elderly. A large share of stocks and bonds end up in pension funds, precisely for this purpose. But the vast majority of intergenerational debt is funded on a “pay as you go basis,” with no interest rates attached. It is hidden in the cost of government, and is why governmental costs keep going up. We can tell ourselves that this isn’t a debt, and it doesn’t have an interest rate attached, but it is still a major problem. If the number of children per household goes below 2.0, it is a real problem for funding, whether this is done through taxes or through children taking care of parents.
Financial instruments could be characterized as money, debt, equity, and other contingent payment contracts. According to economist Hyman Minsky prices must carry profits, where profits are generated by long term investment activity financed via banks and markets, or by government deficit spending. Therefore to validate past debts and equity investments when investment activity dries up the government must run a deficit or else many financial assets must be written-down as bad debt. This will cause the market price of equity claims to plunge in value. The problem of energy is financing the research, development, demonstration, and commercialization of clean renewables so future generations will have the necessary technology to live without destroying the natural environment (there are no $ signs in thermodynamic equations). The problem of debt cancellation is forcing the super-wealthy households to take an equity stake rather than a debt stake in financial assets via corporations, governments, and financial intermediaries, therefore in a financial crisis those who can bear the loss take the loss, and still have more wealth than anyone needs to live other than to feed one’s ego.
I am afraid Hyman Minsky and other economists will have to be disappointed. The deficit spending for governments at some point stops working, and we seem to be pretty close to that point. If nothing else, the interest on that debt becomes a problem. There is also a problem of likely falling future production with which to pay back that debt, because of diminishing returns.
The problem of energy is diminishing returns. Many people would like to believe that “clean renewables” can fix the problem with energy supplies, but it really can’t as far as I can see. Diminishing returns means that the cost of production of things like oil and coal are rising. We badly need cheap substitutes for oil and coal. Electricity does not fill the bill by itself, because we need a cheap liquid fuel. “clean renewables” have many issues–they are part of the fossil fuel system. They need a price down with coal, to fix our problems–this isn’t going to happen, their current prices are far too high. See my post Ten reasons intermittent renewables (wind and solar PV) are a problem. Also, Eight Pitfalls in Evaluating Green Energy Solutions.
I agree the energy problem is based on diminishing returns in the thermodynamic reality where it takes more and more primary energy just to develop the same amount of desirable heat and work for society. Nature is an “electron ecosystem” powered by sunlight.There is reason to believe that we can develop an “electron economy” with sufficient research, The US government is not budget constrained because other units in the economy demand FDIC insured bank deposits and Treasury securities as financial security systems in saving portfolios. I make this argument on pages 13-19 of this paper: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2458563.
Renewables: A recent solar project in Dubai was priced (and expected to be profitable)
at 6.5 US cents per KWh.
I doubt we have reached the limits to economies of scale for solar pv, and there are perhaps technical improvements still to come, hopefully to be the subject of debate sometime soon.
I don’t know, for instance, what kind of financing allows this to happen. There is a huge front end cost, which must be financed. If interest rates are sufficiently subsidized, this issue “goes away.”
My other question would be at what prices Dubai can really sell this intermittent energy, integrated with the other backup facilities, to the grid. We need products that reduce the selling price of electricity and increase the total quantity, without subsidies from the government.
“I don’t know, for instance, what kind of financing allows this to happen. There is a huge front end cost, which must be financed.”
Why MUST it be financed? If an oil rich country uses its sovereign wealth fund, or an energy company that has amassed a pile of cash and treasuries in oil production, decides to get into solar, they can just dip into their tens or hundreds of billions of dollars in reserves.
We are working on energy products borrowed from future use. There is a huge front-end cost. Graham Palmer looked at the “energy flows” of a system that consists only of solar PV of the type sold recently and back=up batteries. His system didn’t even include inverters. He found that it took 25 years, just to recapture the energy used in making the panels and batteries–never mind other things, like human labor costs, and energy costs associated with the original and replacement inverters.
Creating solar panels causes coal (especially, if panels are built in China) and natural gas to be extracted more quickly than they otherwise would be. So we are worse off, for a while, than we otherwise would be, in terms of fossil fuel use.
“We are working on energy products borrowed from future use. There is a huge front-end cost. Graham Palmer looked at the “energy flows” of a system that consists only of solar PV of the type sold recently and back=up batteries. His system didn’t even include inverters. He found that it took 25 years, just to recapture the energy used in making the panels and batteries–never mind other things, like human labor costs, and energy costs associated with the original and replacement inverters.”
From this study here, we can clearly see the huge loss is in the batteries. This doesn’t say what kind of batteries he used in his study.
Was he looking at lithium-ion batteries, or heavy duty lead-acid batteries? If the latter, was he looking at the energy cost of constructing brand new batteries from virgin materials, including extraction, every 7.5 years, or was he looking at recycling? Was he using stationary or tracking panels? So many variables that can drastically alter the results, there should be something like a dozen versions of the chart for all the variables. It sounds like he is also looking at a system for one person, rather than looking at an industrial scale project producing megawatts.
The only way for the technology to get better, is for more solar to be made and used and iterated upon. You cannot have your Ford Mustang before you have your Ford Model T.
“Creating solar panels causes coal (especially, if panels are built in China) and natural gas to be extracted more quickly than they otherwise would be. So we are worse off, for a while, than we otherwise would be, in terms of fossil fuel use.”
If natural gas and coal companies are leveraged like shale oil, we can see that less consumption would actually be far worse. If demand ever falls below supply by a large amount for a long time, it may leave a lot of coal and gas in the ground never to be used, and bring about collapse sooner, so consuming more now means more total consumption over all.
I doubt this was the project I was referring to, but the trend is clear. Disruption in the supply chain in the sand belt, including California, where peak power demand is linked to air-conditioning.
Perhaps the real problem is that society has become severely risk averse, to the point that people do not want to accept the fact that all debts have risk. A form of mass delusion, where everyone believes that all debts will be paid, no matter what, because the have become so dependent on the debts.
Defaulting on the debts would not violate everyone’s trust and faith in the system, it would shock them awake to realize they have been delusional all along. The emperor wears no clothes.
I suggest you take a look at Steve Keen’s article:
He accuses Krugman of mistakenly equating a loan from real person A to real person B, with a loan by a bank (a fake person) to a real person B.
I agree with Keen’s criticism, and you will see that some of the Central Banks likewise agree with the criticism. I think that the differences undermine some of your reasoning.
Krugman is the same person who suggested we fake an alien invasion to spur the economy or mint $trillion coins to pay off our debt. The guy to put it mildly is a GOOFBALL.
I was being kind about Krugman so, no ad-hominems from me. If I had used the word I really wanted to express instead of goofball, the comment would have been removed. Krugman, is a dangerous individual in that he’s all academia and is 100% “CLUELESS” about the real world. He’s a dangerous man who disguises himself as a so-called economist. If you disagree with Krugman, I can guarantee you he doesn’t use ad-hominems. He’s like a pit-bull. I have no problems with that if you are skilled at what you do and have a good track record on fixing problems. That doesn’t apply to Paul Krugman.
Krugman, is not a fixer. He’s a destroyer who causes more problems when he advises on economic policies. Listening to Krugman will get you much faster to the edge of the cliff.
That’s a very good article. In theory, under the Bank Lending model, Patient would have deposited $299 into a checking account in order for the bank to lend the $299 to Impatient, and then Patient could not withdraw or spend more than $293 or the bank would go under, unless Apple happens to bank with the same bank.
This is a big part of why they want people to use debit or credit cards instead of withdrawing cash, so the money just moves around on the ledgers without changing their reserves.
It is actually worse than that.
Professor Richard Werner:
What is written in the newspapers and even in financial economic text books (about bank deposits) are wrong….
If this version of a $100 deposit in a checking account, becoming a $100 deposit at central bank, becoming $9900 in new loans was correct, I would expect inflation rates to be much higher, and deflation much more severe when a deleveraging cycle occurs. I suppose as long as total debt outstanding only changed by a little bit over time, it might be possible. Would be nice to see bank balance sheets to see which way it actually works in real life.
Why do you think the Central Banks are so terrified of deleveraging? It is like musical chairs, except that 100 people are circling around and there is only one chair.
“It is like musical chairs, except that 100 people are circling around and there is only one chair.”
That’s what happens in a bank run. In deleveraging, there would be more and more money in the bank, so your deposits would be safer. The real problem is that the economy shrinks pretty quickly if new debt is not created as fast as the old debt is paid down / written off/down.
Except, if we really do have problems with oil, the environment, etc, shrinking the economy is exactly what we should be doing.
I was thinking of deleveraging as being through defaults. Defaults are not good for banks.
“I was thinking of deleveraging as being through defaults. Defaults are not good for banks.”
Defaults, write downs and write offs would certainly be bad for banks. By deleveraging, I was referring to simply less new debt being created than is being paid off, as consumers and businesses pay down debts and either are unable or unwilling to borrow more, in aggregate.
I’ve seen it suggested here that the economy doesn’t have to shrink to do better by the environment. Economic activity could go to something better that also produces growth. But maybe I didn’t understand what Matthew and Don (especially) were saying.
Have a look at the Richard Werner videos linked in this blog. He suggests a government owned bank which can lend without interest. He also suggest incentivising the private banks to only lend productively, and not fund speculation etc.
That is the important point. The amount of equity in banks is small relative to what they have lent out. Small problems become big problems quickly.
It seems to me that you still believe in the model that banks can print money. Steve Ludlum makes the point in his debtonomy series that central banks are collateral restrained. When a central bank “prints” money they are buying government bonds. In the case of Greece the ECB has now told the Greeks that their collateral is no longer of any value. When the collateral loses all value, they can no longer “print money”. Steve Ludlum, by the way says that the dollar will be the last man standing. The other currencies world wide will lose their value first because we are the country with the instruments of credit creation and the world’s reserve currency also is tied to oil. Dollars equal oil. As Escravaisaurabr has said the Empire, dollar and oil is going to go down together.
Central Banks can create money and purchase other assets besides federal government bonds, such as equities, or foreign currency, like the Swiss National Bank was doing, creating Swiss Francs out of thin air and selling them for Euros to try to keep the value of the Swiss Franc down. It is only when there is a QE program going on that the central bank buys government bonds.
Exactly. The problem is not “debt”. If every euro lent to a borrower was matched by a euro saved by a depositor, the system would be in a stable balance. All debt would be matched by real wealth. But when the bank lends what has not been deposited, we have toxic debt: a pretend claim on real wealth that does not exist.
The problem, quite simply, is fractional reserve banking, which is a certain way to destroy an economy eventually. Add to this toxic mix the fiat money fabricated by governments, which is a claim on the wealth their citizens have yet to create – and may never be able to create – and we are on the road to ruin.
Robert, that’s not quite right in detail although I agree with the sentiment you express.
Bank trading is strictly double entry book keeping. So for every dollar they lend there is a matching dollar deposit in the customer’s account. That’s why these transactions don’t appear in national accounting.
Fractional reserve lending is not really relevant today. Banks don’t lend reserves. The relevant way today is Credit Creation Theory, which is endorsed by the BoE. Bank lending is limited by their total assets. Otherwise they are free to choose what and whom to lend to.
You say governments create money, which is not quite true. Governments create deposits in private banks accounts at the fed and it becomes money when the banks pass this into their customers’ accounts.
We are on the road to ruin because banks are lending in ways which damage the countries economies and drains resources unnecessarily. By this I mean that instead of productive lending, like for infrastructure, its lending for consumption and speculation. That lending needs to be curtailed. Governments could do it but no one has. They are all ignorant idiots everywhere!
We have many problems. The problem I am writing about is different from problems with the fractional reserve banking system. That is why I never mentioned it. In some sense, it has nothing to do with what I am talking about. The financial system does end up needing to be “reset” frequently, but that also is a different issue from what I am writing about.
I am writing about an issue that doesn’t go away with resetting. It has to do with the issue of not being able to repay debt with interest in a shrinking economy.
An important point is that debt-money’s value is based upon the imputed compounding interest accrued to the issuer and owner of the debt-money at what is effectively an infinite term. Depending upon the debt-money outstanding and the current and future net interest, there is a minimum rate at which debt-money must grow via bank lending in order to just service the interest on the outstanding debt-money. If the rate of growth of debt-money is insufficient to service the outstanding debt-money, debt-money and debt/asset deflation occurs.
Today in the US, that minimum rate of growth of debt-money is ~2.3%. However, since QE and the surge in bank cash assets/bank reserves, correcting for those reserves, US total debt-money supply is growing at just fast enough to service the existing debt-money and has experienced virtually no growth since 2007-08 (and the same for real final sales per capita).
Combining US and EZ debt-money supply less bank reserves, debt-money supply began contracting in Q4 2014, which is why the ECB HAD TO initiate QE, i.e., in order to prevent nominal GDP and total debt-money supply (M3) from contracting and deleveraging occurring. But if private lending and growth of debt-money deposits and supply does not increase, and net flows from QE (central bank crediting TBTE banks’ balance sheets) only flows to financial assets, the debt-money supply ex reserves will be insufficient to service the existing debt-money obligations, and EZ real GDP will not accelerate and might again contract.
Effectively, the vast majority of us do not REALLY “own” anything, including “our money”, as it ACTUALLY is a debt-money claim on future production, labor product, profits, and gov’t receipts. We only borrow at interest and circulate the debt-money claims for our subsistence after taxes, debt service (“rentier taxes”), and price changes, if we’re lucky.
Finally, in this context, total annual net flows to the US financial sector now equal, and periodically exceed, total annual GDP growth. Moreover, total imputed compounding interest to total credit market debt outstanding to average term equals US GDP in perpetuity. IOW, all production, wages, profits, and gov’t receipts are pledged to the owners of the debt-money, i.e., the top 0.001-0.1%, and its imputed compounding interest claim in perpetuity.
Therefore, no growth of real GDP per capita is possible after total annual rentier claims to the top 0.001-0.1%. This is not an ideological position; it’s math.
This begs the question of whether or not it would matter if a sufficiently large enough plurality of Americans knew that virtually all of our earned and transfer income, business profits, and taxes we pay are already claimed by the rentier top 0.001-0.1% indefinitely into the future. The net claim is so large, no growth of output is possible after price changes and accounting for population growth.
The more central banks/TBTE banks print bank reserves and lever up financial asset values to increasingly bubbly valuations to wages and GDP, the larger the rentier claim, the longer it will persist, and longer and lower labor’s share of GDP will decline, wealth and income inequality will persist and worsen, real GDP per capita will decelerate, and the poorer the bottom 90%+ of American households will become.
This is why historically eras during which financial asset bubbles occurred and persisted have been harbingers of financial panics/crises, eras of slow or no real GDP per capita growth, inequality, economic hardship, social and political instability, gov’t reaction, and war.
Therefore, stock bull markets that result in financial bubbles from increasing debt to wages and GDP are not desirable, unless the objective is the aforementioned social-pathological outcomes.
Thus, ZIRP, QE, forward “guidance”, and levering up financial asset bubbles is a desperate attempt to solve a problem with more of what caused the problem, which it has been said is symptomatic behavior of insanity.
You are probably right about the need for ECB to initiate QE. The question is whether it will be too little, too late. It would seem like the recent low commodity prices would be pulling money supply down further. Also, I wonder if the low velocity of money in the US (Europe too?) plays into this as well. If there is money, but it isn’t circulating, it doesn’t do much good.
TBTE=Too Big to Exist, I believe. The interest on debt is truly astounding at this point, especially if interest rates go up at all.
“It has to do with the issue of not being able to repay debt with interest in a shrinking economy.”
In such a case, interest rates would be higher and loans would need to be collateralized, since there would necessarily be a higher frequency of defaults.
I agree that the interest rates would need to be higher, which would add to the diminishing returns problem we already have. Not many could afford the higher interest rates. Collateralization wouldn’t help a lot, because the value of collateral would be eroding at the same time, with the loss of fossil fuels.
“I am writing about an issue that doesn’t go away with resetting. It has to do with the issue of not being able to repay debt with interest in a shrinking economy.”
Simple and Fundamental.
Once this is generally understood, there is some hope of change for the better.
Unfortunately, there is never a good time to reset, and no alternatives short of changing human nature.
I am writing about an issue that doesn’t go away with resetting. It has to do with the issue of not being able to repay debt with interest in a shrinking economy.
What you have stated is certainly the ISSUE. I see that this was posted over at PO News this morning, and it gets to the heart of the situation:
According to EIA, and Goldman released data, between 2008, and 2013 the shale industry produce 3.21 Gboe while accumulating $960 billion in debt. That is a debt formation of $299/boe produced, or more than 3 times what the producers received for their production. Obviously, shale is not even remotely economically viable, and yet in every article there is a reference to the incredible production gains it has experienced. To believe that this can continue one would literally have to be an idiot, and yet the industry continues its mantra!
This represents a $trillion dollar debt that is not going to be repaid! If it was leveraged in the derivatives market, as most of this debt is, it could easily represent the annual GDP of the US. With the FED now collateral constrained, one collapse of this magnitude could reek havoc in the banking industry. In such a case the “interest” may be the least of our worries, as neither the interest, or the principal will ever be returned to the investors. This situation could be the black stick on the bottom of your pick-up sticks constructed economy.
“According to EIA, and Goldman released data, between 2008, and 2013 the shale industry produce 3.21 Gboe while accumulating $960 billion in debt. That is a debt formation of $299/boe produced, or more than 3 times what the producers received for their production.”
How much future production will come from those investments? That debt represents more than just the barrels themselves, but infrastructure, land rights, exploration. Presumably, if they didn’t start new projects and just operated within their existing ones, even with rapid declining production, they should get a much lower cost per barrel equivalent than $299.
Of course, some debts will not be paid; if the debts were risk-less, there would be no risk premium and energy companies would be able to borrow near 0% like the US Treasury.
You may have put your finger on a solution [of sorts] to keep the wheels moving for longer.
The Federal [all the sovereign] governments can “print” money at no cost to itself. Someone, usually a bank has to buy the bonds, but that in future will be amended. So in spite of ever increasing costs of oil the government will pay for whatever they need to keep operating. Of course money will become worthless, but that’s going to be overridden by decree. There will be no alternative so the population will just go along with it as long as they are fed and watered.
It’s going to be interesting to see what will happen and it’s not far off right now.
For a gloomy forecast here’s Dmitry;
As Dmitry points out, it is governments that fail. He talks about the former USSA, like the former USSR. Failing governments are the reason printing money indefinitely likely won’t work.
Obviously, these companies have convinced their accountants that if everything works out according to their models, they will eventually come out favorably financially. (Some of the same folks developing these models may have been at work at developing models underlying derivatives.) I agree with you though, that it is really hard to believe this story, given the cash flow results of the last several years.
There is a lot of indirect debt, besides the direct debt of the oil companies–for example, the mortgages of the workers. They are not going to be repaid either, if the workers lose their jobs, and there aren’t new workers coming in to buy the houses. So you may very well be right about the trillion$ debt that is not going to be repaid. Not to mention the derivative problems associated with all of this.
Thanks for the link! I have been reading his papers on economics so it was good to see him in this series. He also wrote a piece for the UK version of “The Conversation” a few weeks ago.
Central Banks lend on the basis of collateral pledged to them, but this does not account for the fact that the assets may in fact be losing value.
So, for instance say a Spanish Bank holds $1B in Mortgage Backed Securities and pledges this as collateral to the ECB, who in return hands them $1B in freshly printed Euros.
Unfortunately, the people living in the condos on the Costa del Sur cannot pay their mortgages and so the MBS start to lose value. The Spanish Bank can’t repo them and sell for par, they have to take a loss. It now cannot pay back its loan from the ECB based on this collateral. So the Spanish Bank is insolvent first, then the ECB is insolvent, because of the loss of value of the asset the loans were based on.
The fact is that just about all industrial investments are losing value, because they need cheap energy to function. Cars, McMansions, Chinese Toy factories, every asset class based on cheap energy availability is losing value, thus the whole debt pyramid becomes insolvent, starting with the smaller retail lenders, working up to the TBTF Banks and finally parking on the balance sheet of the Central Banks.
They are all insolvent, but the system doesn’t recognize that yet. You don’t have to repudiate the debt here, because it can’t be repaid, the capital it was based on has been burned up and cannot be repoed.
What we are observing on the political level is the very gradual recognition that the system as a whole is insolvent. The players with the most power attempt to insulate themselves, which comes at the expense of the weaker players. War ensues as various countries are triaged off the credit bandwagon. It’s very straightforward really.
On other fronts, NEW RANT on the Greek Souvlaki Kabuki Rollercoaster now UP!
Also, we are doing our 3rd Anniversary Vidcast this weekend, and hopefully Gail will be able to join the crew to discuss the latest in Doom Newz. 🙂
Just about all lending is done through Banks.
If a Goobermint issues Bonds, say USTs its the Primary and Indirect Buyers who purchase the debt first, aka the TBTF Banks. They borrow the money from Da Fed to buy those Bonds, then they resell them on the secondary market to Pension Funds, etc.
Same thing with Corporate Paper. If Apple issues out Bonds, the TBTF banks buy those bonds with money they borrow from Da Fed also.
Most retail loans such as mortgages, car loans and student loans also are made by banks, then often bundled into securities, but again the lending is done by Banks.
The problem you have here is debt saturation and the fact there really aren’t any credit worthy borrowers. As the demand has dropped for debt outside of Goobermints, they have picked up the slack, but the realization is coming that Goobermints themselves are not credit worthy.
Most debt currently being issued to large corporations is not making its way out to the real economy, it’s being used for stock buybacks and speculation in various markets looking for yield. So the end result is the customers are starved of credit (which in good times makes it down to them in the form of wages), so they cannot buy what the industries produce, so those industries cannot retire their loans, and they go BK. See Radio Shack, Sears, etc.
Without the debt circulating, the economy deflates regardless how much debt gets issued out Velocity of money drops to zero over time in this paradigm, that’s what has occurred in Greece.
You are right, big banks play a role in the initial sales of the bonds, and in getting mortgages, student loans, and car loans into the hands of the buyers, even if a government agency covers the debt, or if bonds are sold by a big company. The bank collects a fee, I believe, or at least it gets a commission on selling these in the secondary market.
That is a good point about money being used to buy stock back not helping the velocity of money. At most, the owners of the shares of stock will purchase some other shares of stock.
RE, when you stop ranting and start reflecting like in this thread, you demonstrate a lot of intelligence and wisdom. But I still love your rants for my weekly smile.
Back in the day, a rule of thumb was that prudent lending by a banks was limited to the value of the company’s equity. If you think about it, the bank grabs the assets if the company suddenly folds.
Today, it seems that there is not enough equity to go around, or bank financing is so much “cheaper” than equity, and banks are on the hook for ~80% of the capitalisation despite the risks.
Even worse, I hear that in China, machinery manufacturers were lending money to customers to buy their products.
And so the debt continues to expand, hence with negative interest rates there is nothing to stop it. The “we will make up for our lost profits by vastly increased sales” is just another version of a ponzi scheme, inflated by debt.
Thanks! I hadn’t thought about the issue of assets losing value. This would especially be the case in Europe, where now refineries are closing, and auto makers are closing, because citizens cannot afford their products–also oil supply is running low.
You are welcome.
It’s such an incredibly counter-intuitive paradigm that getting hold of what was actually going on here took me quite some time, and I have a pretty good background in mathematics and finance. As John Kenneth Galbraith famously stated, “The process by which money is created is so simple the mind is repelled.”
In addition to the money creation issue, even JKG does not really address what creates value and what holds value, and obviously this impacts on what it is possible or not possible to do through money creation.
On the Central Bank level, what is not being recognized is the loss of real value in the assets, that is being papered over by QE, but the assets are in fact losig value, and quite rapidly these days. You see it everywhere, in fact the largest builder of Container Ships in the WORLD, Hyundai Heavy Industries (HHI) just reported a $3B loss, which is no surprise with the BDI hitting it’s lowest point EVAH. All those container ships have lost just on paper $3B, but in fact it is much more than that, because it ripples though every company that used to buy space on those ships. All these assets are losing value at an incredible pace now.
I agree about the apparent contrariness of money creation and management. I think it was one of the early Rothschilds who said that if people understood money they would rebel against it. It’s taken, and is still taking a lot of reading to get me to an understanding, and I have no links to finance.
Modern Monetary Mechanics is a breakthrough to any understanding today, and although the number of people with understanding increases every day, it’s quite unable to cut through to the consciousness of politicians and journalists.
I take every opportunity to correct falsehoods when ever they appear.
Re your argument about declining asset values, do you have links to a source of that?
There are quite a few assets that haven’t yet been written down, so quite a lot of this is not yet appearing in balance sheets. There are some refineries closing and car factories closing, but there will be more closing, especially in Europe. The shale assets will need to be written down. Some of this is just starting.
Matthew Krajcik says:
How much future production will come from those investments?
Not much. These wells have a 65 to 70% annual decline rate. 50% of their total production comes from wells less than 18 months old.
Presumably, if they didn’t start new projects and just operated within their existing ones, even with rapid declining production, they should get a much lower cost per barrel equivalent than $299.
They are paying interest on that debt at rates from 4 to 11.5%. The Bakken would be generating $21 million per day with $35 at the well head prices after 18 months. After 36 months they would be generating $5.8 million per day. After Opex and taxes they will be pressed to cover the interest in a few years. These wells are funded with 10 to 30 year loans, and bonds. The investors are not going to see much of their money returned.
“After Opex and taxes they will be pressed to cover the interest in a few years. These wells are funded with 10 to 30 year loans, and bonds. The investors are not going to see much of their money returned.”
Wow, that is much worse than I would have thought. Clearly, it seems no one knows what they are doing if they are lending money 30 years out on shale oil. Maybe the plan is to lend $10 million to the shale oil companies, then take out $100 million in CDS insurance on the $10 million and try to make money by losing money.
Matthew Krajcik says:
Wow, that is much worse than I would have thought. Clearly, it seems no one knows what they are doing if they are lending money 30 years out on shale oil. Maybe the plan is to lend $10 million to the shale oil companies, then take out $100 million in CDS insurance on the $10 million and try to make money by losing money.
The plan is similar to that of the sub-prime housing disaster; if the loans go bad the FED will bail out the banks. The FED initiated the ultimate in Moral Hazard by making profit private, and risk public. This is what happens when the financial industry begins to believe that they will not be held responsible for taking undue risks.
The FED is now leveraged 77:1; in essence, it became insolvent in the process of saving the banks. It is also collateral constrained in that there are no more 10 to 30 year treasuries for it to purchase to back up its money printing. The FED may try to save some of the banks that got involved in the shale disaster, but the chances are the rest of the financial industry is on its own. With oil prices now in a long term decline, things will only get worse:
Dear Mr. Hill, Gail, and All
I stated in a comment that the total amount of oil ever produced by a fracking well is around 3 times the initial year’s production. Here is an article by Jeremy Grantham which casts some doubt on my factor of 3. It may be now that a factor of 2 or maybe a little less is appropriate.
Makes the debt levels of the fracking companies very worrisome, indeed…Don Stewart
Up to 65% of all of the available oil is now often delivered in the first year!
That is pretty amazing (and frightening) if 65% of the available oil is delivered in the first year. Where are all of the future profits going to come from, to pay back all the loans? How can they even cover overhead, if they are only getting a couple of percent of initial oil in a later year?
The amount of loans that are created depends on different factors all together–“demand” for loans, and how much people and businesses can “qualify for”. Perhaps the amounts Richard Werner is talking about are maximums, but these don’t really get lent out. An awfully lot of lending is not done through banks, either. That lending doesn’t seem to have a maximum.
I don’t really see that this undermines my reasoning. There are a lot of sources of debt (government bonds, government agency bonds, corporate bonds, loans from one company to another (including guarantees of a loan), bank loans, peer to peer loans, among other things). All of them are very hard to pay back, as the economy moves from growth to contraction. Some of these don’t sink banks, but other ones do. Some of them sink governments instead. A recent Economist article talked about how banks are moving out of corporate debt and focusing more on household debt, because household debt is deemed less risky. It doesn’t take a whole lot of risky assets to sink a bank. Some of these can come from securities bought from other banks, or indirectly come from derivatives. I understand that there is a lot of Greek debt included in bank balances, for example.
I don’t disagree that debt will sink financial capitalism and deficit government. I think that Keen’s distinction deals more with the ‘legitimacy’ of the debt. For example, a lot of banks loaned Greece money, and some of them helped the Greek government conceal the terrible financial shape the country was in. I guess the banks thought that the yields were good and ‘they’ll think of something’ so that they, themselves, would not have to eat the losses. What did happen is that a lot of the bank loans to Greece were absorbed by the other countries in Euroland. The banks were rescued by the taxpayers. Which evolved into the ‘bail-in’ scheme in Cyprus.
Part of the problem with dealing with the evident bankruptcy of Greece comes from the sense that ‘the citizens of Germany and Slovakia agreed to help the citizens of Greece, and now they are defaulting’. What the citizens of Germany and Slovakia actually agreed to do was to rescue a bunch of bad bank loans. In some sense, a bad loan is a bad loan, end of story. But politically, we depend, as someone said here, on trust.
It is obvious that the US government will never be able to pay its legal debts plus the promises it has made. Yet when S&P had the temerity to downgrade US debt, the government promptly sued and S&P settled for more than a billion dollars.
So the basic ‘trust’ issue is at stake.
The secondary issue, which I admit to confusion about, is the notion that debt can accelerate consumption. It is clear that we can only consume what we produce. No magic waving of paper can make a wheat crop appear or a house materialize. The only way that debt can accelerate production is if there is unused potential production which can be mobilized by debt. There has to be ‘unemployed resources’ which would eagerly welcome the opportunity to work. One of the commenters here has been quoting some numbers to the effect that the US GDP could be a third or so higher if we realized the potential.
What I can see is that someone who has accumulated some money from productive enterprise (lets say, building houses), can forgo his own consumption and loan the money to someone else who would like to, let’s say, buy a car. Such a transaction is, as Keen says, entirely different from a bank conjuring money out of thin air to give to the prospective car buyer.
To my conservative mind, the first instance is the way societies ought to work. Conjuring money out of thin air is bound to end badly.
I’m VERY bad at economics and at the art of creating expensive money out of thin air, as many institutions nowadays seem to do effortlessly. Yet I venture a question: Could it be that the current sorry state of affairs is made still worse by squeezing the wages of the lower and middle working classes? This is now done all over the world, seemingly in the name of some neoliberalist principle which shall remain unnamed, but with economically and socially bad consequences. Think of inequality…
Debt can and does increase consumption. The best example is oil.
New oil production today requires a price of about $100 per barrel to be profitable given the geology of what remains. At this price, and without access to credit, consumers could afford to buy much less oil.
You can make a strong case that we would have experienced peak oil in 1990, rather than today, had we decided to live within out means and not try to maintain our standard of living with debt that can never be repaid.
Another way to think of this is that we consume current solar energy (food, hydro/PV/wind electricity), plus old solar energy (wood), plus ancient solar energy (coal, oil, gas), plus future solar energy (debt).
The implication of our decision to burn future energy with debt is that when the crash occurs there will be a rapid and large drop in oil/gas/coal production which means much more chaos and hardship than if we have accepted a gradual reduction in our standard of living.
The only thing I know how to do is reduce my “standard of living,” but I believe I must be missing some bigger point.
Regarding Greece, I saw a statement made by someone from Greece that Greece had helped out Germany, back when it was having problems (between WW1 and WW2??), and then defaulted on its debt. Of course, now its problem is that it doesn’t have any significant amount of industry that can be profitable with a high price of oil. So writing off debt doesn’t work. Somehow, the structural problem, which is caused by diminishing returns, must be fixed. The closest anyone has come to a solution is to let Greece go back to the Lira, and let the currency sink. Then Greece will become more competitive with the rest of the Eurozone, so perhaps the Eurozone won’t do as well–a detail.
Debt is so “baked into the cake” that we don’t recognize it any more. If tomorrow, there were no new auto or house loans, the number of new (and used) autos would drop close to zero (since very few could afford to buy them), and the number of buyers of houses would drop to zero, so no one could move. In such a situation, the demand for oil would go down, because less oil is needed to make and transport parts for cars and for new homes. Also, the number of cars on the road will trend downward, so there will be less demand for oil that way. With less demand for oil, the price would drop.
I also gave the example of oil companies in North Dakota paying their workers, using borrowed funds. From the point of view of the oil company workers, the funds look just like any other funds. They use them for down payments on a car or a house.
I am old enough to have lived in a world virtually without debt. Cars and houses were bought with the cash one saved. My wife’s parents never had a debt in their lives. My parents did have a debt for a few years when they bought a new house, but it was very much less than the average car loan now. It was a ten year loan and was paid off early.
I know young people today who are building their own houses. Some of them are ‘tiny houses’ on wheels.
I think you underestimate the adaptability that a significant number of people have. I am not denying that those who are not adaptable will die…just that those with their heads screwed on the right way have a reasonable chance of survival. The world won’t look like it does now.
Hi Gail, I think you mean Drachma, as Italy was Lira.
Some believe that Greece would bounce back even after default because it would effectively price in reality, money markets could more easily price in the risk.
While Greece may well have a domino effect, I’m not too sure, while I don’t think a default would go smoothly, the CBs would likely do some massive fire-wall breaks.
Thanks for the correction. I am not thinking that the domino effect will come right away, but later, as some of the low oil price effects become greater, cutting North Sea jobs, for example. Also, problems with negative interest rates.
Debt can accelerate the pillaging of the world’s resources. Without debt most resource extraction would not happen
“What I can see is that someone who has accumulated some money from productive enterprise (lets say, building houses), can forgo his own consumption and loan the money to someone else who would like to, let’s say, buy a car. Such a transaction is, as Keen says, entirely different from a bank conjuring money out of thin air to give to the prospective car buyer.”
Don, I think that this gets to the heart of the issue. When banks lend, the currency that they lend is still theoretically available to the person (depositor) who lent it to (deposited it at) the bank. If you deposit $1000 with the bank, they get to lend most of that out, but you can still spend $1000. This is possible for two reasons: 1) The transfer of money-like things, such as checks and electronic transfers of account balances and 2) The idea that only a small percentage of people will demand the physical cash at any one given time. This is also why I really think that Gail needs to go back to reconsider her dismissal of fractional reserve banking as a problem when talking about debt. I’m not going to tell you that debt isn’t possible in other systems, but I will say that growing debt is required in a fractional reserve system. Especially with a currency that is not backed by a limited good. Go back and look at when total debt in the US declined. Not government debt, not private debt, but total debt. You’ll find that, since records on this have been kept that are readily available, it has only declined once, and that was because of Lehman. That led to bailouts and QE. This growth is baked into our financial system. It is a ponzi scheme.
I don’t follow monetary arguments closely. With that disclaimer:
There are recent papers from institutions like the Bank of England saying that the creation of money no longer depends on deposits at all. So we are ‘post fractional reserve banking’.
Charles Hugh Smith has a post today in which he, humorously, suggests a stone coin worth a trillion dollars…obtained from the island of Yap in the South Pacific. One of his points is that, if money is going to be created out of thin air, then the Federal Reserve should use their magical powers to do some good. Rather than let the criminal banking system reap the benefits, how about eliminating payroll taxes for social security and just print the money to pay the social security benefits. The elimination of the payroll tax would, first, encourage employers to hire more people, and, second, encourage more people the work. The result would be the encouragement of productive activity….as opposed to speculation in financial paper.
“The elimination of the payroll tax would, first, encourage employers to hire more people, and, second, encourage more people the work.”
The reason for paying taxes is not necessarily to fund government programs, but rather to force demand for dollars. If you did not have to pay taxes in dollars, you would not need to use dollars, you could transact using anything you want. Dollars get their value purely from need and confidence.
Don, look up shadow banking. This gets into part of what people talk about when they talk about loaning out deposits as not the main apparatus for money creation. Then you have to think about what money really is. Not idealized notions, but you really have to look at M0, M1, M2, M3, MZM, etc… Then you have to look at CDOs, MBSs, derivatives, rehypothecation, reverse repos, etc… Does all of the ‘paper’ that goes back in forth in those markets count as money? (Much of it does if you think of ‘money’ as M3 money, which is often quite useless to us plebs.)
As for fractional reserve, banks are still required to hold reserves at the Fed based on their deposits. Granted, the shadow banking system often trumps the deposit taking system, but we still have a bastardized fractional reserve banking system, much in the same way that Rocky Road is still ice cream despite it being a lot more complex than Vanilla.
The point here is that, under this system, debt must grow. The following graph is all debt in the US:
Public, private, etc… Notice how many times it went down, and note how many bailout programs were instituted when it did go down. Lehman Bros was a big deal. Debt MUST grow. If it does not, our system comes to a screeching halt. That’s nearly $60 trillion in debt in an economy with a GDP only slightly more than 1/4 of that. If the debt cannot grow there is not enough M2 money for people to pay the interest on that debt, which means that a lot of investors and banks will not be getting their revenue stream, and they will rapidly become insolvent.
“As for fractional reserve, banks are still required to hold reserves at the Fed based on their deposits.”
This may be true for America, but as far as I can tell, it does not apply to most Commonwealth Countries or many other countries, which have zero reserve requirements.
Also, as far as I understand, the Fed accepts other things besides actual dollars as collateral, such as illiquid or “toxic” assets. So, a bank can lend money based on deposits, then deposit the debt it created as an asset at the Fed in order to be able to lend more money.
The constraints continually erode, to ensure that, at least nominally, debt can continue to increase to keep the system from imploding, but as it does so, it becomes more and more prone to implode.
“Also, as far as I understand, the Fed accepts other things besides actual dollars as collateral, such as illiquid or “toxic” assets. So, a bank can lend money based on deposits, then deposit the debt it created as an asset at the Fed in order to be able to lend more money. ”
What regulations a bank has to adhere to depends on the size of the bank. There are different reserve requirements for different sized banks. A lot of those regulations become stupidly complex.
IMO, the shadow banking system does change how reserve requirements work. If you issue a lot of credit card debt, then bundle it up at a bankruptcy remote master trust, tranche it and sell corporate paper to investors and take the proceeds from that sale, you have effectively lowered what would be a 10% reserve requirement down to some lower reserve requirement, and you have investors backing this lower reserve requirement. But much of this is moot in our post (for now) QE world where US banks have somewhere around $2.5 trillion in excess reserves parked at the Fed just collecting interest, courtesy of QE.
(FYI, under a “properly” working fractional reserve system where banks do try to stay right at the reserve limit, a 10% reserve requirement translates to a 10x increase in the money supply, and a 1% reserve requirement translates to a 100x increase in the money supply. 1 + .9 + .9^2 + .9^3 + .9^4 + … = 10. It’s a simple geometric series.)
That interest on excess reserves is part of why all of the cries of hyperinflation have yet to be correct. (The slew of other central banks debasing the currency is another reason, i.e. there’s no place to run, so people don’t lose faith in the dollar because the Yen is even worse.) If the Fed quit with the IOER and even went to a negative rate on those reserves, you’d see that $2.5 trillion become $25 trillion in a hurry, and you’d see a corresponding increase in debt.