The World’s Fragile Economic Condition – Part 2

The world economy can appear to be operating quite well but can be hiding a major problem that causes it to be fragile. My presentation The World’s Fragile Economic Condition (PDF) explains why we should expect financial problems if energy consumption stops growing sufficiently rapidly. In fact, a global sell off in the equity markets, such as we have started to see recently, is one of the kinds of energy-related impacts we would expect.

This is Part 2 of a two-part write up of the presentation. In Part 1 (The World’s Fragile Economic Condition – Part 1), I explained that a large portion of the story that we usually hear about how the world economy operates and the role energy plays is not really correct. I explained that the world economy is a self-organized system that depends upon energy growth to support its own growth. In fact, there seems to be a dose-response. The faster energy consumption grows, the faster the world economy seems to grow. The period with fastest growth occurred between 1940 and 1980. During this period, interest rates were rising and workers saw their wages increase as fast as, or faster than, inflation. After 1980, the rate of growth in energy consumption fell, and the world needed to tackle its growth problems with a different approach, namely growing debt.

In this post, I explain how debt (and its partner, the sale of shares of stock) help pull the economy forward. With these types of financing, investment in new production becomes almost effortless as long as the return on investment stays high enough to repay debt with interest and to repay shareholders adequately. At some point, however, diminishing returns sets in because the most productive investments are made first.

The way diminishing returns plays out in energy extraction is by raising the cost of producing energy products. In order for the sales prices of energy products to rise to match the rising cost of production, rising demand is needed to give an upward “tug” on sales prices. This rising demand is normally produced by adding increasing amounts of debt at ever-lower interest rates. At some point, the debt bubble created in this manner becomes overstretched. We seem to be reaching that point now, especially in vulnerable parts of the world economy.

Slide 34

Let’s first look at a slide from Part 1, explaining the way in which the economy works like a giant factory.

Slide 20

As long as energy products are very inexpensive, it is possible for the economy to expand very rapidly. When this happens, the Goods and Services produced in Box 4 are able to grow so rapidly that all of the Resource Providers in Box 1 can be well compensated, simply by using a quasi-barter arrangement, facilitated by the use of money. With this approach, Resource Providers can get adequately paid using the Goods and Services produced in close to the same time period. Something of this nature occurred prior to 1970, when inflation-adjusted oil prices were less than $20 per barrel (Part 1, Slide 26).

Slide 35

If the growth of the economy slows, so that not enough Goods and Services are being created by the economy to use this approach, it is possible to work around the problem by adding debt. Adding debt makes it possible to substitute promised future Goods and Services for already produced Goods and Services.

Slide 36

Added debt makes it seem like more goods and services are available to pay resource providers.

Selling shares of stock acts very much like debt, because the funds provided by these shares also provide access to goods and services that others have already produced. In the case of the sale of shares of stock, the promises are for future dividends, capital appreciation, and partial ownership of the company.

Slide 37

Growing debt looks like it can solve all problems! No wonder that Keynesian economists found it so useful. But the return must remain high enough to repay debt with interest.

Slide 38

Borrowing money generally comes with the requirement that the amount borrowed be repaid with interest. If the energy purchased using debt allows the economy to grow fast enough, there is no difficulty in repaying debt with interest. If energy is very inexpensive (equivalent to oil cost less than $20 per barrel in inflation-adjusted price), this payback system generally works because a large amount of energy can be purchased for a small quantity of debt.

If the price of the energy rises, much more debt is required for the same amount of energy produced. For example, if oil is $80 per barrel, the affordability is much lower. It takes four times as much debt to pay for a barrel of oil. Repayment of debt with interest becomes more difficult.

Slide 39

In Part 1, we observed that US long-term interest rates have been falling almost continuously since 1981. This situation of falling interest rates led to falling mortgage payments for a given amount borrowed. Because of the lower monthly payments, homes became more affordable; in other words, there tended to be more potential buyers for homes at a given price level. Indirectly, the increased affordability of home ownership tended to raise the resale value of homes. It also encouraged the building of additional homes.

Building homes indirectly requires the use of many different types of commodities. Metals are used in pipes and in wiring. Wood is used for framing. Concrete is often used for the basement. Oil is needed to haul these goods to the site where the home is to be built. Thus, indirectly, falling interest rates tend to raise commodity prices.

Slide 40

Many assets are purchased with debt. If interest rates are very low, purchasing these assets becomes more affordable. The sale of shares of stock provides another way of raising capital for a company. In the case of oil-producing companies, the purchasers of shares of stock often think, “If extraction costs are rising, surely oil prices and other energy prices will rise as well.” This belief allows the price of shares of stock to be bid up to a high level.

Slide 41

When asset prices rise, economists sometimes refer to the wealth effect. Homeowners feel richer if their homes are worth more, and they can borrow more against them. Owners of shares of stock feel richer if their shares of stock have higher values. Owners of pension plans are happy when stock prices are high, because it looks as if these shares can be sold, allowing the plans to meet their pension obligations.

If the debt bubble stops growing, then the commodity price bubble cannot continue to grow. In fact, it may abruptly pop. This is what happened in the second half of 2008, when oil prices dropped precipitously, from $147 per barrel to the low $30s.

Slide 42

Government pension plans such as Social Security are not treated as debt because they are not guaranteed, but they act in much the same way as debt.

Slide 43

The gray bars on Slide 43 indicate recessions. These recessions often seem to be intentionally caused. If a person looks closely, it is possible to see that in most cases, increases in US short-term interest rates preceded recessions. In fact, if a person looks at the minutes of the Federal Reserve Open Market Committee, it is sometimes clear that the Open Market Committee raised interest rates to intentionally pop asset bubbles in order to “reduce volatile food and energy prices.”

Slide 44

The huge interest rate spike to 18% in 1981 on Slide 43 corresponds with the big drop in oil prices on Slide 44. Interest rates were so high that buyers could no longer afford new homes or factories. Prices seem to have been brought down by falling demand.

Slide 45

If we look at recent oil prices, we can also see that they also depend very much on interest rates. In my paper, Oil Supply Limits and the Continuing Financial Crisis, I show that the US debt bubble popped precisely when oil prices hit a peak in July 2008. That is when US consumer credit and mortgage debt started falling.

On Slide 45, QE stands for Quantitative Easing. This was a program that allowed lower long-term interest rates in addition to lower short-term interest rates. Thus, it gave the Federal Reserve (and other central banks) the power to reduce interest rates to an even greater extent than was possible by reducing short-term interest rates alone.

Slide 46

The Federal Reserve seems to have been instrumental in causing the Great Recession, as well. Slide 46 shows a larger scale of the same information about oil prices and short-term interest rates shown on Slide 43. There can be several years between the time interest rates are raised and the resulting recession occurs, so most people miss the role that intentionally raising short-term interest rates plays.

Also, high oil prices also tend to have an adverse impact on the economy because energy prices rise, but wages do not rise at the same time (Part 1, Slide 28). Consumers are forced to cut back on discretionary goods when the cost of necessities (such as the cost of commuting and the cost of food) rise.

In fact, it seems to be the combination of rising energy prices and increased interest rates that leads to recessions.

Slide 47

On this chart, I show some of the comments heard about oil prices. In mid-2008, it was clear that high oil prices were becoming a problem, especially for those with subprime mortgages who were living in homes that were distant from their work. By early 2014, we started hearing that oil prices had been too low for oil producers in 2013. Because of the unprofitability of oil production, some oil producers were cutting back on investment in new production. See my post, Beginning of the End? Oil Companies Cut Back on Spending.

Now, it is fairly clear that no oil price will work for both producers and consumers. Today’s Brent oil price of about $80 per barrel is both too low for producers and too high for some consumers. Consumers who are particularly affected are those whose currencies are falling relative to the dollar, such as consumers in Turkey and Argentina. Even countries with more modest decreases, such as China and India, are cutting back on automobile purchases. This change will affect future oil demand.

If, by some chance, oil prices should spike to a high level such as $100 per barrel, the affordability problem pretty much guarantees that oil prices will fall back fairly quickly. This issue, by itself, makes it impossible to believe that oil prices will increase endlessly.

I should mention, too, that we are also at a point where no interest rate works for everyone. Those buying new homes and new cars need low interest rates, in order for these goods to be affordable. Pension plans, on the other hand, need high interest rates, in order to meet their pension promises. There is no one interest rate that works for every purpose.

Thus, we have a combination problem: no interest rate works for everyone, and no set of energy prices works for everyone.

Slide 48

The Federal Reserve is now in the process of raising short-term interest rates (see Slide 43). It is also selling the QE securities that it previously acquired to reduce long-term interest rates. If buying these QE securities lowered long-term interest rates, selling them should raise long-term interest rates. Raising both short- and long-term interest rates sounds like a formula for creating a huge number of debt defaults and lowering prices of shares of stock. It is likely that these actions will also start a major recession.

Slide 49

Slide 50

On Slide 50, “earlier” refers to Slide 16 in Part 1 of this presentation. From Part 1, we remember that the first small peak refers to the California gold rush; the second larger peak about 1910 refers to “Electrification and Early Farm Mechanization.” The third peak about 1970 refers to the “Postwar Boom.” The last small peak refers to the expansion made possible by China’s growth, and the growth of other Asian countries.

Slide 50 shows that the troughs refer to periods that were bubble collapses, or the collapse of the central government of the Soviet Union. Slide 51 (next) gives details with respect to these low periods. These were bad times for economies: depression, debt collapses, and periods with significant wage disparity. They were not periods with high energy prices.

Slide 51

Clearly, none of these low periods was a good period for the economy. While we can see that there was low energy consumption during the periods, the primary reason for this low energy consumption was the collapse of a debt bubble or of a government.

Slide 52

Peak coal occurred in the United Kingdom in 1913, and World War I began shortly thereafter, in 1914. When peak coal occurred, wages for workers were very low, because diminishing returns had made the operation of coal mines increasingly expensive, but those purchasing coal could not afford higher coal prices. Thus, mining companies could not afford to pay workers adequate wages. World War I gave an alternative employment opportunity for coal miners and others with low wages.

Entering World War I was a very successful strategy for the UK. The fact that the UK was on the winning side allowed the UK to retain its role as the holder of the reserve currency. In this position, it was fairly easy for the UK to borrow the funds needed to obtain coal and other energy imports.

Germany seems to have encountered peak coal about the time World War II began. Was this an attempt to cover up Peak Coal? We don’t know for certain, but the timing certainly looks suspicious.

In both of these cases, low energy supply seems to have led to fighting, rather than high prices.

Slide 53

The collapse of the central government of the Soviet Union seems to have been an indirect impact of the long term low oil prices in the 1981-1991 period. The high oil prices of the 1970s had encouraged the Soviet Union to ramp up oil production. Once the US raised interest rates and oil prices fell, there were no longer funds for investing in new oil production. The Soviet Union was dependent on oil exports. It was able to continue for quite a few years with low prices, but eventually its central government collapsed. Over the long term, consumption has continued to be much lower, reflecting the permanent loss of industry.

Slide 55

Slide 55 is a graph of the “peaks” on Slide 50. If we listen to mainstream economists (including Paul Romer and William Nordhaus, who recently received the Nobel Prize in economics), improved technology can allow the world economy to become increasingly efficient, and thus overcome the problem of diminishing returns. Slide 55 shows that over a period of nearly 200 years, this has never happened in the past. The troughs represent collapses of one kind or another. These low periods did not represent sustainable situations.

The problem is that diminishing returns leads to the need for very different techniques to work around new problems. For example, if there are diminishing returns with respect to extracting fresh water from wells, the first alternative is to dig deeper wells. Efficiency gains can somewhat help offset the cost of deeper wells. But once the problem advances to the point where desalination is needed, plus remineralizing the water with the correct minerals after desalination, the cost of fresh water becomes much higher. It becomes impossible for improved technology to work around the very large increase in costs that diminishing returns seems to cause.

We haven’t been able to work around diminishing returns with increased efficiency before; we are likely kidding ourselves if we think we can do so now.

Slide 56

Slide 57

Slide 58

The point that should be emphasized is that the reason why the United States economy now looks fairly good is because we are at the top of a debt bubble. This bubble is partly the result of world’s long running low interest rates, and partly because of the United States’ recent tax cuts. Thus, the situation today is a lot like 1929 before the debt bubble collapsed, or a lot like 2007 before the economy derailed. Things look good, but they won’t necessarily stay favorable for very long.

Slide 59 Conclusions Continued v2

Slide 59

Separate Additional Conclusions for Various Audiences 

At this writing, I have actually given variations on this talk three different times, to different audiences. The first audience (which is the one I mentioned at the beginning of Part 1) was a meeting of about 100 property-casualty actuaries. These actuaries help determine rates and financial statement amounts for lines of insurance such as automobile, homeowners, and medical malpractice. The specialized conclusions I added for that audience were the following:

Slide 61

Slide 62

The second version of my talk was given at the 2018 Bermuda International Life and Annuity Conference, to a group of 300+ insurance executives of various kinds. This talk was called Energy Economics: Is a Discontinuity Ahead? This audience was especially interested in my talk because interest rates are central to the operation of pension plans. If interest rates do not rise, this is a major concern for this group.

The conclusion slides to that presentation were the following:

Conclusions -Slide 1 of 2 – Life/Pension version

Conclusions for Life and Annuity Providers – Slide 2 of 2

The third version of the presentation I gave was to a group of followers of Peak Oil theory. This presentation was somewhat shorter and slightly rearranged. The title of this presentation was How the Energy System Really Works and What Seems to Be Going Wrong.

Its short conclusions’ sheet mentions the following dangers:

Conclusions of Shorter Version

About Gail Tverberg

My name is Gail Tverberg. I am an actuary interested in finite world issues - oil depletion, natural gas depletion, water shortages, and climate change. Oil limits look very different from what most expect, with high prices leading to recession, and low prices leading to financial problems for oil producers and for oil exporting countries. We are really dealing with a physics problem that affects many parts of the economy at once, including wages and the financial system. I try to look at the overall problem.
This entry was posted in Financial Implications and tagged , , , . Bookmark the permalink.

2,106 Responses to The World’s Fragile Economic Condition – Part 2

  1. Fast Eddy says:

    A good mate of mine is visiting from Bali — he’s a prominent architect on the island — he was telling me he was interviewed by a architectural magazine and one of the questions was about green architecture…. specifically bamboo constructions…

    He rattled on about how he could not answer because a well constructed house might last a hundred years… whereas a bamboo house will last a fraction of that… the water that goes into growing more bamboo and all the work rebuilding might actually result in the bamboo house being less green than the steel and wood house…. he could not be sure….

    The magazine cut that part out of the interview 🙂

    • The key thing being “a well built house” — i.e an expensive house. With interest rates the way they are, getting an ROI in 20 years makes the point moot — cheap construction can and does get torn down because “it makes sense” financially. Personally, I find it ultimately wasteful. I rather like the idea of building things that will last 200+ years — like much of Europe. Or put another way: there is no such thing as a free lunch. Modern capitalism doesn’t have the answer alas.

    • I can believe that the magazine cut the part of the interview saying that bamboo houses may not be all that green. It seems to be “renewable,” and that is all that is important to some people.

      • Fast Eddy says:

        Meanwhile … The Green School in Bali … is churning out ‘Green Warriors’ to go forth into the world and berate anyone who uses a plastic bag….

        Big bucks to attend — so what you get are wealthy Californians (mostly) flying back and forth (business class) to check on little Noah’s progress….

        When we took on our two wards from the Peens… we met the GS people to see what it was all about … and the intake guy was proudly telling us how they put no pressure on the students… they can do what they want to do …. and I was thinking — this is a recipe for raising a sure-fire pizza delivery boy…. at some point the kids must leave DelusiSTAN … and then what?

        I’ve heard the kids love the place…. as one parent who pulled his kids out said to me ‘of course they love it – it’s like year round summer camp’

        What a f789ing joke

  2. Fast Eddy says:

    Oh wow!!!

    Al Gore has come out and announced that giggle jaggle is a fraud!!!

    Let’s check the disappointment monitor hooked up to the green groopies:


    Now lets go to the anger monitor:



  3. Baby Doomer says:

    Three Colliding Problems Leading to a New Economic Disaster

  4. Beaker says:

    Gail – very nice presentation. I think the only bit I somewhat disagree with are the contention that coal peaks caused WW-I and WW-II, though I’ve seen the argument made elsewhere (Ugo’s book Extracted I think).

    BTW, I think there is a typo just below slide 40:
    “This belief allows the price of shares to stock to be bid up to a high level”
    Maybe that first “to” should be “of” ?

    • The timing of the coal peaks is an amazing coincidence. And in the UK, it is clear that there was a problem with paying adequate wages to workers. I suspect that was also a problem in Germany.

      Adding a new employer (the military), funded by debt, is a great way to get employment up, at least if your own country doesn’t get destroyed by the war.

      I will fix the typo. Thanks!

      • xabier says:

        War was a good distraction for discontented workers and a way to impose state authority on them: also, Germany in 1914 thought that Britain was weak, on the verge of civil war over Ireland, and would either crumble quickly or have to keep out of the war.

    • Fast Eddy says:

      Beaker? Are you an el der?

  5. Third World person says:

    Mammals cannot evolve fast enough to escape current extinction crisis

    Humans are exterminating animal species so fast that evolution can’t keep up; Unless conservation efforts are improved, so many mammal species will die out during the next 50 years that nature will need 3-5 million years to recover, a new study shows

    • Third World person says:

      i always think which species will rule

      after homo sapiens will gone from this planet

      for me in ocean it will be jellyfish
      in land it will be cockroach

    • It seems like it will take a lot more than 3-5 million years to recover, but what is the rush?

      Prehumans gained control of fire over one million years ago. Humans and their predecessors began wiping out other species not long after they learned to burn down whole forests to get the prey they wanted. This pattern continues to this day.

      • Fast Eddy says:

        Humans are perfect the way they are …. the last thing they want is to ‘evolve’ and breed out their competitive nature … because then they would be extinct immediately.

        Imagine dropping this into the Masai Mara

      • i1 says:

        Ha! Looks like my dog. Yeah, if there’s a worthwhile human endevour left, if there ever was one to begin with, it would be to address the spent fuel pond issue. They’ll continue wreaking havoc long after our extinction. Maybe Musk could launch dry casked waste towards the Sun.

  6. Fast Eddy says:

    It’s time for … Fun & Games!!! With your host … Faaaast…. Ed…dy…..

    So it’s like this …

    I was in HK recently … and walking past the Tesla dealer… and I said to M Fast… I’m gonna go in there and ask them where the electricity comes from to charge one of their cars…. (knowing HK power comes from coal and nuclear)….

    But of course M Fast vetoed that … berating me for wanting to make trouble…

    So I let the dog sleep…. but it’s been in the back of my mind like a nagging itch….

    So…. tonight I get onto skype and I call Tesla HK… M Fast says who are you calling at this hour???? I say — Tesla HK…. she shuffles off upstairs murmuring something about Fast being crazy…..

    Anyway … see M Fast … sweet dreams….. press 2 for English… press 2 for sales….

    Hello … hello

    Yes hello …

    I am thinking of buying a model s but I want to make sure it is green… where does the electricity come from ….

    It comes from the charger….

    Yes of course but how is it produced….

    Oh you’d have to check your supplier…

    I have … and it comes from coal and nuclear….

    Pause…. well you can get other options

    Oh? Like what?


    So I can hook some panels onto my roof and charge the car


    Actually I’d need a football field full of panels and batteries to do that — so you are wrong….


    Question – is a tesla green…


    But it is powered by coal and nuclear – are those green


    Btw – did I mention I am a reporter and that I am doing a story on how Tesla in HK is powered by coal and nuclear

    Pause … I need to get your number and have our charging team call you

    Oh no … I have all I need — I was just looking for a good quote and you are a rep of Tesla have told me I can charge a Tesla with solar panels…. even though HK generates 0% of its power from solar…

    Can I get your name? Thanks for that …. I’ll be sure to quote you in my article about how Tesla is far from green …and of course how I can charge one using solar panels on my apartment rooftop….

    Thanks for helping… this is perfect.

    Goodbye now.

  7. Fast Eddy says:

    Peg a cryptocurrency to the USD…. and each coin is worth a USD — always — Magic!!!

    I cannot take much more of this…..

    I feel the need… to strangle …. a Green Groopie… to watch it’s head turn 50 shades of purple… to see the bubbly spittle (green of course) spew from its mouth…. then toss it in the ditch and let the rats eat it….

    • “To us, Tether seems like a counterintuitive idea in the sense that it is backed by Fiat, which is the main problem that Bitcoin initially seeked to solve. Forgive us if we are not surprised when the only digital currency that tries to be more like the dollar instead of less like it, winds up being one of the firsts to collapse.”

  8. Greg Machala says:

    “We predict that we could be looking at 12 to 13 million innocent civilians who are at risk of dying from the lack of food.” – While All the news is so focused on lies, distortion and trivia, we have a real unfolding catastrophe in Yemen right now. Could Yemen be the first country to experience collapse?

    • Yemen encountered peak oil a few years ago. It has been amazing to me how the country has hung on as long as it has.

      The EIA has a report written in 2014 saying that Yemen produces a little natural gas as well.

      • Hubbs says:

        So what it appears from this chart and confirming your thesis that indeed, even declining oil production, 150,000 bpd, is still worth fighting over? I am assuming that it is indeed the oil that Saudis, US, and US interests are after.

        • Greg Machala says:

          Perhaps there is more easy oil left in Yemen and the military is needed to protect the global oil corporations so they can extract it and make money. Can’t imagine what else is useful there. Yemen is mostly desert.

          • Fast Eddy says:

            They have a fair bit of

            Red Bull wants access to it for their new drink … the Yemenis want it for themselves

            • khat you see...? says:

              Red Bull wants access to it for their new drink … the Yemenis want it for themselves
              The is the classic
              “Excuse us, but we need this more than you do.”

              dynamic that globalization often presents.

              This is often followed by a statement that sounds like
              “Don’t be a selfish, I mean xenophobic, nationalist, anti-democratic regime that doesn’t know what it’s good for its own people.”

              which is actually a threat that there will be political intervention to obtain desired policies in countries that have policies that are unfavored by globalists.

        • Or maybe Saudi Arabia needs employment for some of its vast population. Fighting a neighbor is as good an excuse for employment as any.

    • Fast Eddy says:

      More fun to read about the Stormy and Donald feud!!!

      Don’t bring me down with this famine stuff …..

  9. jupiviv says:

    Thanks for the new post Gail. This chart is interesting:

    Are you familiar with William Engdahl’s work? Here is an excerpt from a 2007 article on his blog:

    “The Sultan, Abdul Hamid II, on November 27, 1899, awarded Deutsche Bank, headed by Georg von Siemens, a concession for a railway from Konia to Baghdad and to the Persian Gulf. In 1888 and again in 1893, the Sultan had assured the Anatolian Railway Company that it should have priority in the construction of any railway to Baghdad. On the strength of that assurance, the Anatolian Company had conducted expensive surveys of the proposed line. As part of the railway concession, the shrewd negotiators of the Deutsche Bank, led by Karl Helfferich, negotiated subsurface mineral rights twenty kilometers to either side of the proposed Baghdad Railway line.[22] Deutsche Bank and the German government backing them made certain that included the sole rights to any petroleum which might be found. The Germans had scored a strategic coup over the British, or so it seemed. Mesopotamian oil secured through completion of the Berlin-Baghdad Railway was to be Germany’s secure source to enter the emerging era of oil-driven transport.

    The German success was no minor event. The geographical position of the Ottoman Empire, dominating the Balkans, the Dardanelles straits, and territory to Shatt-al-Arab at the Persian Gulf, from Aleppo to Sinai bordering the strategic Suez Canal link to the British Empire India trade, down to Aden at the Strait of Bab el Mandeb. The German-Ottoman agreement assuring construction of the final section of the Berlin-Baghdad Railway meant the shattering of England’s hope of bringing Mesopotamia, with its strategic location and its oil, under her exclusive influence and it meant as well a major defeat for France.”

    Highly recommend everyone read the whole thing:

    The “good wars” were indeed fundamentally driven by energy/oil.

  10. Duncan Idaho says:

    1998 — Pinochet arrested. Next up, Milton Friedman & Henry Kissinger?

    • Greg Machala says:

      Kissinger arrested? LOL…that IS funny. Let me see if I can find a pompous figure laughing out loud to capture the elitist look of amusement at your suggestions:

    • Fast Eddy says:

      Al Gore and Leo … for perpetrating fraud

Comments are closed.