Recession Ahead: An Overview of Our Predicament

Many people have the impression that recessions come from financial missteps, such as the US subprime loan fiasco. If energy is involved at all, the problem comes from high oil prices as supply becomes inadequate to meet demand.

The real situation is different. We already seem to be on the road toward a new crisis; this crisis is likely to be much worse than the Great Recession of 2008-2009. This time, a major problem is likely to be energy prices that are too low for producers. Last time, a major problem was oil prices that were too high for consumers. The problem is different, but it is in some ways symmetric.

Last time, the United States seemed to be the epicenter; this time, my analysis indicates China is likely to be the epicenter. Last time, the world economy was coming off a high growth period; this time, the world economy is already somewhat depressed, even before hitting headwinds. These differences, plus the strange physics-based way that the world economy is organized, explain why the outcome seems likely to be worse this time than in 2008-2009.

I recently explained what I see as happening in a presentation for actuaries: Recession Likely: Expect a Bend in Trend Lines. This post is based on this presentation, omitting the strictly insurance-related portions.

The big thing that the vast majority of people do not understand is how important energy is to the economy. Because of this issue, I started my presentation with this slide:

Slide 3

After an opportunity for discussion, I offered the explanation that the role of food for humans is very much parallel to the need for energy of various types for the world economy. Food provides people with the energy required if they are to have the ability to think, move and speak. Energy products of many kinds enable the activities that we associate with GDP. For example, energy consumption enables machinery to operate and goods to be transported.

Slide 4 – Larger image at this link.

Using data from Smil, as well as more recent BP data, we can estimate how fast energy consumption has been growing over a very long period–nearly 200 years. We can see that the highest energy consumption growth occurred in the 1961 to 1970 period; the second highest growth occurred in the 1951 to 1960 period. These are periods we associate with rapid GDP growth and prosperity.

On the next slide, I show the same data displayed in a different way.

Slide 5 – Larger image at this link.

On this slide, I make two changes in the way the data are displayed:

  1. The increases in energy consumption are split into two components: (a) energy used to support population growth and (b) all other, which I describe as energy used to support improvement in “living standards.”
  2. A different graphing approach is used.

Note that when population growth corresponds to the full amount of energy consumption growth (in other words, at times when there is no red area above the blue area), energy consumption per capita is flat. High growth in energy consumption per capita seems to correspond to rising living standards, as occurred in the 1950s and 1960s.

While I label the “all other” category as if it is simply changes in living standards, there are other components, as well. One breakdown might be the following:

  1. True improvement in living standards.
  2. Additional energy investments required to offset diminishing returns.
  3. Increasing use of energy for overhead items that don’t get back to individuals, such as energy used to fight pollution or to allow globalization.
  4. Efficiency improvements allowing available energy to be more productive.

Efficiency improvements (Item 4) will allow more energy to be available for improvement in living standards, while Items 2 and 3 in the above list act in the opposite direction. We do not know to what extent these items really offset each other. Thus, “All other” = “Improvement in Living Standards” is only a rough approximation.

Slide 6 – Larger image at this link.

We can see from Slide 6 that whenever there is no red area above the blue area (flat living standards or flat energy per capita), adverse events seem to happen.

For example, the US Civil War (1861-1865) came at a time of low energy consumption growth. The Great Depression of the 1930s came during another period of low energy consumption per capita growth. World War I came at the beginning of this period, and World War II came at the end. The collapse of the central government of the Soviet Union in 1991 ushered in a decade of low world energy consumption growth, in part because of the loss of the central currency of the Soviet Union.

The “China Coal” note at the end pertains to the way that China and its coal supply has helped pull the world economy forward since 2001. This benefit seems to be already declining.

Slide 7 – Larger image at this link.

Slide 7 shows China’s energy production by fuel. Coal production (in red) soared after China was added to the World Trade Organization in December 2001. Beginning about 2012, China’s coal production began to plateau. Depleting mines and low prices for coal have kept production flat. Imports can be used as substitutes, to some extent, but it is difficult to keep costs low enough and provide adequate total supply.

With the loss of growth in China’s coal production, its economy has had to cut back. Each year, we read about coal mine closures and miners needing to find new jobs. We know that China discontinued its paper and plastic recycling business as of January 1, 2018. China has also been cutting back on solar subsidies, leading to fewer jobs installing solar panels. All of these types of changes reduce the number of people who can afford to buy high-priced goods, such as new homes, vehicles and smart phones.

Slide 8 – Larger image at this link.

It is becoming increasingly clear that China is being forced to cut back on heavy industrialization because of its coal difficulties. Slide 8 shows automobile purchases for six large economies. China is by far the largest of these economies in terms of auto sales. China’s auto sales began to slide in 2018 and are sliding further in 2019 (about -11%).

If we look back at the time of the 2008-2009 recession, we see that auto sales of the US dropped precipitously. The United States was the country that led the world into recession. The inability of US citizens to buy cars was a sign that something was seriously wrong. Now we are seeing a similar pattern in China.

China has reported that its GDP growth rate has been slightly lower during 2019, but we really don’t know how much lower. The amounts it publishes are too “smooth” to be believed. The actual GDP growth rate is believed to be lower than the recently reported 6.0%, but no one knows by precisely how much.

Figure 8b – CNBC Chart of changes in auto sales by country, based on data through October 2019. (Not part of original presentation.) Source

Figure 8b gives a little more information about recent car sales by country. We can see from this chart that based on data through October 2019, world automobile sales are expected to fall by about the same percentage (3%) in 2019 as during the recession year of 2008. I find this disturbing.

We can also see the huge impact that China has had on keeping world private passenger auto sales rising. The world economy looked like it was headed into recession in January, 2016, when world oil prices were very low, but a spike in China’s automobile sales at that time helped keep total world automobile sales rising and allowed world oil prices to rise from their low point.

In the next sections, I provide some background regarding this story.

Slide 9

Slide 10 – Larger image at this link.

Slide 10 shows the way that I visualize the world economy self-organizing and growing. The economy grows by adding new “layers” of businesses, products, consumers and laws. Unneeded products, such as buggy whips, are dropped from the bottom. Unprofitable businesses close. In some sense, the economy is hollow because of these deletions. It cannot easily go backward because, for example, the support services for widespread use of transport using horses are lacking.

Energy is used to operate all aspects of the system. One part of the system is a self-organizing financial system that helps decide, through wage levels, who gets the benefit of the goods and services that are made. This financial system includes self-organizing interest rates and self-organizing commodity prices.

The most important connection within the economy is the one I show at the center as “Consumers = Employees.” Consumers are very dependent on their wages as employees. If the economy is to continue to operate, workers must receive high enough wages to purchase the goods and services the economy produces. Even the lower-paid workers need to be able to afford food, housing and transportation, or the economy will tend to collapse.

Slide 11

When we look back through the history on Slides 4, 5 and 6, we see that the growth of energy consumption is very important in how economies operate. The theories of Ilya Prigogine explain why this is the case; when adequate flows of energy are available, self-organizing systems are able to grow.

Few economists today include energy consumption in their models, however. Economic theory has grown over time in its own “ivory tower.” Like other academic subjects, it depends on early theories and the process of peer review. The views expressed must also be pleasing to those in power, who would like everyone to believe that politicians, rather than the laws of physics, are in charge.

Slide 12

There are many types of self-organizing systems that grow. They all, directly or indirectly, require energy. Plants and animals of all types are self-organizing systems that grow. Hurricanes grow using the energy that they get from warm water.

Governments grow from the tax revenue that they are able to collect; they use the revenue to buy energy products such as electricity to operate governmental offices, oil to build roads and operate police cars, and natural gas to heat buildings.

The Internet grows through the revenue collected to provide its services. The Internet uses revenue to buy computers (made with energy products) and electricity to operate those computers.

Slice 13

Nearly all 0f the energy we use is hidden. For example, modern food production is very much dependent on energy consumption. Agricultural machines are made using energy products. Soil amendments, including organic soil amendments, are transported using fossil fuel energy. Refrigeration is possible through the use of energy. Hybrid seeds are only possible through energy consumption. Planting seeds by digging with a stick would only use human energy, but such a process would be terribly inefficient.

Slide 14

Slide 15

Most of us can easily recognize today’s goods and services, such as those listed.

Slide 16

Promises of future goods and services act like promises of future energy supplies. This happens because creating goods and services that people can actually use requires energy supplies of the appropriate type.

When people get cash or a check, they expect to use it to buy goods and services. Creating these goods and services requires energy consumption. If there is no energy of the right type available, the goods and services won’t be available to fulfill the promises.

Slide 17 – Larger image at this link.

Promises of future goods and services tend to grow faster than actual goods and services because it is these promises that, in some sense, “pull the economy along.” For example, if a young person gets a loan, (s)he can often buy a new car. The fact that a new car is being purchased leads to more jobs in the supply line leading up to new car production. Or, if a business takes out a loan or sells shares of stock, it can use the proceeds to hire employees. It is these growing wages that keep the system operating.

As long as the economy is growing rapidly, the mismatch between growing debt and actual output doesn’t become apparent. As the economy slows, some workers find themselves working fewer hours. Some businesses become less profitable and lay off workers to try to restore profitability. The catch is, with fewer workers, the economy slows even more. It usually takes more debt, at lower interest rates, to get out of such an economic slowdown.

Slide 18

Slide 19

There is a lot of confusion about prices. “Demand” is what people, through their wages and debt, can afford. As economists tell us, price depends on supply and demand.

In the short term, prices tend to bounce around a lot. The short term buyers of oil are oil refineries. They need to keep their employees busy. If they see a shortage of oil, they may bid up the price of oil to allow their workers to continue to be employed.

Over the longer term, prices of all energy products tend to depend on consumers’ ability to afford finished products, like cars, homes and cell phones. Producing these objects and shipping them takes energy. They also use energy as they operate.

Slide 20 – Larger image at this link.

The various energy prices shown here are simply a few of the many, many energy prices that we see around the world. Strangely enough, prices of all energy products tend to fluctuate together, over the longer term. Prices depend on affordability of end products, such as cars, homes, computers, food and clothing. Our problem since about 2012 has been lack of affordability of end products.

The primary way of raising affordability is by increasing productivity. Increased productivity is made possible by increasingly leveraging human labor with devices that are built with energy and are operated using energy. For example, a worker with a ditch digging machine is much more productive than a ditch digger with only a shovel. An analyst is more productive with a computer and Internet access than with only pencil and paper.

With higher productivity, more goods are produced in total. As long as not too much of this productive output is skimmed off the top (by governments, or by business hierarchy, or to pay for the devices and their fuel), it is possible for each worker to afford more goods and services, raising total demand.

An alternative way of raising affordability is by adding more debt at ever-lower interest rates. This approach tends to make goods such as cars, homes, and factories appear more affordable because their monthly payments are lower. This added-debt approach only works as long as the economy is growing quickly enough. If the economy slows too much, the added debt leads to financial crashes of many types.

Slide 21

Slide 22

Many people think that they know the amount of oil that can be extracted based on the current technology and the assumption that prices will eventually rise high enough to extract all of the fossil fuels that seem to be available. For example, the International Energy Agency has prepared reports in which it shows expected oil availability if oil prices rise to $300 per barrel.

The catch is that even if oil prices can bounce high, it is not clear that they can stay very high. The current price of oil is only in the $55 to $65 per barrel range. A price of $300 per barrel will allow oil extraction using very advanced technology. We don’t have any evidence that oil prices can stay this high because demand comes primarily from wages. Prices cannot stay high without adequate support from wage levels.

Of course, the issue is not just oil prices staying sufficiently high. Natural gas, coal, uranium and electricity prices all have difficulty rising high enough and staying high enough. Commodity prices such as copper and steel have the same issue.

Slide 23

There are many people who say, “Of course, oil prices will rise. Oil is a necessity.” They forget that it is really a two way tug of war between producers getting a high enough price to be profitable and consumers getting a low enough price to be affordable. There will be a winner and a loser.

People also forget that most commodity use is hidden. We see the fuel we buy for our personal vehicles, but there are a huge quantity of oil products required for shipping goods, paving roads, growing food, and for many other uses that we are not aware of. While we might be able to pay a little more to fill our gasoline tank, most of us would not be able to simultaneously pay more for food, transported goods of all kinds and road maintenance.

Slide 24 – Larger image at this link.

Economists often assume that if energy prices rise, wages will rise, as well. If we look at the data historically, however, it doesn’t work that way at all. What happens is the opposite: average wages tend to rise as long as oil prices stay low. Once oil prices spike, average wages tend to flatten out.

The amounts shown on Slide 24 are average wages, computed by taking the total inflation-adjusted wages for the population in total and dividing by population. When oil prices spike, recession soon sets in. The reason why average wages fall is partly because more people become unemployed. Other workers find it necessary to accept lower-paying jobs.

Slide 25 – Larger image at this link.

Many people focus on the run-up in oil prices to July 2008. An equally important point is the fact that the world economy has not been able to maintain these high prices since July 2008. The general price trend has been downward. The cuts by OPEC have not had a material impact.

Slide 26

Citizens of the United States, Europe, and Japan are used to thinking of high energy prices as being a problem because they are from countries that require substantial imported energy to maintain their GDP. For example, Greece will sell fewer trips on its tour boats, if oil prices are high. This will have an adverse impact on employment and the ability to repay debt with interest.

If a country is an oil exporting country, low oil prices are an even worse problem. This happens because oil exporting countries tend to earn a large share of their revenue from taxes on the sale of oil. These taxes can be much higher if oil is selling for, say, $120 per barrel than if it is selling for $60 per barrel. These tax dollars are used to provide subsidies to offset the high cost of imported food. They are also used to build industry and infrastructure to provide employment to the population.

If oil prices are too low, oil exporting countries will tend to cut back on oil production. In fact, this has been happening for OPEC for the entire year of 2019.

Similar problems occur if commodity prices of any kind (coal, natural gas, uranium, steel, copper, etc.) stay too low for an extended period. Producers go bankrupt, or they stop production, or they pay their employees so poorly that the employees go on strike. Sometimes, they may even start rioting. Many of the riots around the world today are related to low commodity prices.

Slide 27

Slide 28 – Larger image at this link.

The world experienced spiking oil prices in the period leading up to mid-2008. These high prices caused a recession and much lower prices followed. The chart on Slide 28 gives a somewhat exaggerated view of what goes wrong with high oil prices.

If the price of oil suddenly spikes to two or three times its previous price, both the price of food and gasoline are likely to increase. This change tends to lead to a big shift in a family’s budget. Debt payments, such as for a home and car, are pretty much fixed, so the big increase in food and gasoline prices must be taken out of the budget earmarked for everything else. This leads to cutbacks in discretionary spending such as vacations, restaurant meals, and charitable contributions.

In a short time, there are layoffs in discretionary sectors. Those who are laid off are more prone to defaults on loan payments. The problem soon escalates to a recession, with high unemployment and low oil prices.

Slide 29

Strangely enough, central banks push back against high oil prices as well. They know that high oil prices lead to high food prices. Citizens of energy-importing countries will be unhappy with elected officials if oil and food prices rise. Thus, central banks tend to raise short-term interest rates, as soon as they become concerned about high oil and food prices.

The recession that follows will quickly bring food and energy prices back down. If food and energy prices fall, the low prices will be the problem of the energy producers. Oil exporters will find their tax revenue too low, but the high-price problem of oil importers will be gone.

Figure 29b- Slide from a different presentation, showing the trend in interest rates. Larger image at this link.

You will recall that the rapid energy consumption growth periods were 1961 to 1970 and 1951 to 1960. During these periods, the economy was growing almost too quickly. The Federal Reserve was able to keep raising interest rates, as a way of holding down economic growth. It was not until 1981 that the pattern changed from raising interest rates to falling interest rates.

Since 1981, the US Federal Reserve and other central banks have been reducing interest rates. Lowering interest rates and rising debt levels, as mentioned previously, makes goods appear more affordable because of lower monthly payments. The concern now is that interest rates are about as low as they can go. Central banks no longer have room to offset recessionary tendencies (because of slow growth in energy consumption) by lowering short-term interest rates.

Slide 30

Most people never consider the possibility of low energy prices leading to collapse. It looks to me like this is the danger facing us today. Let’s start by looking back at what happened in 1991.

Slide 31 – Larger image at this link.

When the central government of the Soviet Union collapsed in 1991, the individual republics making up the Soviet Union were left on their own to find new currencies and new trading partners. Satellite countries of the Soviet Union were affected as well. Slide 31 shows that the consumption of many types of resources dropped for many years for the whole area. The low point was not reached until 1998.

Slide 32 -Larger image at this link.

If we look back to see what had happened previously, the Soviet Union was an oil producer and exporter. When oil prices were high in the 1973 to 1980 period, the Soviet Union prospered. But then low prices came along, at least partly because the US Federal Reserve raised interest rates to almost 20% in the 1980-1981 period. (See Figure 29b.)

The long-term low oil prices, in some sense, indicated that the world economy was producing too much oil; some inefficient area(s) of production needed to leave. The Soviet Union may have been singled out by the self-organizing economy because it used energy products in a less efficient manner than other economies. Its adverse outcome may also have reflected the fact that its cost of production was higher, leaving less of the sale price for reinvestment and taxes.

Slide 33

The Soviet Union is an example of what can happen if oil prices stay too low for several years. The central government of such an economy can collapse.

Slide 34

When commodity prices are too low, the economies of countries exporting those commodities are stressed. This is why we see so many uprisings in commodity-producing countries right now. Iraq with its oil has been having protests. Chile, with its copper and lithium exports, has been seeing protests. South Africa with its exports of coal, precious metals and gems has been having riots. With some escalation, any of these low-price situations could lead to an overturned government.

Slide 35

Slide 36

In Slide 36, I give an example of two different kinds of ingredients in a cake:

  1. Ones that are substitutable: the flavoring, which can be vanilla, almond, or something else
  2. Ones that are not substitutable: the flour, which is the energy product

With too small a quantity of flour, all we can do is make a smaller cake. Perhaps we can substitute a different energy product, but electricity most certainly will not do! Some bacteria eat electricity, but humans do not. Substitutability is limited, even within energy products/carriers.

Economists make models focusing on the special case when a material is not essential for the economy. This gives a misleading impression. If they had looked back at what happened when energy supplies were low relative to population growth, as we saw on Slide 6, they could make much better models.

Slide 37

We seem to be sitting on the edge of some form of collapse for at least parts of the world economy, right now.

Without enough energy consumption growth, top-level organizations, such as the European Union, the United Nations and the World Trade Organization, are especially at risk of collapse.

Slide 38

Slide 39

One of our big problems today is excessive wage disparity. High-wage workers rarely have trouble being able to afford homes, cars, vacations, and air conditioning. It is non-elite workers, the ones who have not been able to find high-paying jobs, who have an affordability problem.

The wage disparity problem is an outgrowth of how the physics of the economy works. If there are not enough goods and services to go around, the physics of the economy effectively “freezes out” some of the workers. Under this arrangement, there will be some survivors even if there is not quite enough for everyone. In some sense, the “best adapted” are able to survive. If the inadequate supply of finished goods and services were spread around evenly, there might be no survivors at all.

Slide 41

The thing that is key is that workers need to be able to afford finished goods and services produced by the economy. If too large a share of wages goes to high paid workers, or to owners of robots, there is not enough left over for the “regular” employees.

Slide 42

Many workers have seen their jobs disappear as their employers moved production to another country where wages were lower. Or, jobs can remain, but the wages will fall from the low-wage competition.

Slide 43

US income disparity seems to be as great as it was in about 1930, at the time of the Great Depression.

Slide 44

Slide 45 -Larger image at this link.

If we look at historical world energy consumption by fuel, we observe that it has been rising the vast majority of the time. The little dip that we see about 2008-2009 occurred at the time of the Great Recession. It doesn’t take much of a cutback in energy consumption to cause a major problem.

Back at Slide 20, I remarked,

The primary way of raising affordability is by increasing productivity. Increased productivity is made possible by increasingly leveraging human labor with devices that are built with energy and are operated using energy.

The world economy requires growing energy supply, of suitable kinds, to operate. If the quantity of energy available is reduced, productivity is likely to nosedive. This is true even if the reduction is intentional and seems to be for a good cause, such as reducing CO2 emissions.

We seem to be heading for a contraction in energy supplies now because of continued low energy prices. Fossil fuels are, in some sense, leaving us, whether we like it or not. World coal production has been flat to falling since 2012. IPCC scenarios assume a very different  pattern: Fossil fuel use, especially coal, will grow indefinitely, presumably because of high prices and improved technology.

Many people are hoping that wind, solar, and hydroelectric will someday replace fossil fuels. I consider this highly unlikely because all three are made using fossil fuels. Furthermore, these “renewables” in total represented only 10% of world energy supply in 2018. The 10% is divided as follows: wind, 2%; solar, 1% and hydroelectric 7%.

Slide 46 – Larger image at this link.

There clearly is a correlation between GDP growth and energy consumption growth. China with its growing coal use was pulling the world economy along, especially in the 2002 to 2012 period. Recently, it has lost much of this ability.

In my opinion, Trump’s tariffs are not the cause of our current trade problems. Tariffs seem to be enacted whenever growth in energy consumption per capita is very low. Tariffs were enacted both immediately before the US Civil War and at the time of the Great Depression. The problem is that jobs that pay well indirectly require significant energy consumption. When growth in energy consumption per capita is low, it becomes impossible to find enough jobs that pay well for everyone. Tariffs are used in an attempt to keep jobs that pay well at home.

Slide 47

We don’t know quite what will happen. The closest analogy is the Great Depression of the 1930s. More financial problems seem likely. In fact, they could escalate quite quickly. More strikes, such as those currently going on in France, seem likely. The situation is likely to play out a little differently in various countries.

The physics of the situation seems to try to keep some parts of the system operating, if at all possible. But, as mentioned at Slide 10, the self-organizing system deletes parts of the economy that are no longer needed. We no longer have an economy that can operate with horse and buggy, for example. We can’t just “go backwards” to an economy of an earlier era.

Slide 48

We are already seeing changes in this direction. Hong Kong’s protests are in the news practically daily. Germany is experiencing job layoffs. We know that in an interconnected world, a recession that starts in one large country is likely to eventually affect much of the rest of the world.

Now we are in a waiting period, waiting to see what happens next. Major changes seem likely over the next five years, but they could happen much sooner.

This entry was posted in Financial Implications and tagged , , , , , by Gail Tverberg. Bookmark the permalink.

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.

638 thoughts on “Recession Ahead: An Overview of Our Predicament

  1. Fig 29B, Peak interest rates 1981

    Increasing interest rates in the 70s were in response to high inflation rates resulting from high oil prices (1st oil crisis 1973 -OPEC power after peak oil in the US) and (2nd oil crisis 1979 – peak oil in Iran)

    The 1980s drop in interest rates can be explained by the recession caused by the 1970s oil crises.

    Since 2000 interest rates have been strategically manipulated to keep the economy alive despite increasing oil prices. What was helpful was that China became the factory of cheap consumer goods, keeping inflation low.

    It would be interesting to see a FRED graph showing interest rates and inflation.

    And then we have the petro dollar debt mountain, another reason to keep interest rates low. Maybe that could be another FRED graph

    • Saint Paul Volcker has gone to the printing press in the SKY…
      Has died….

      When Volcker ruled the Fed, ‘people thought they’d never buy a home again’
      PUBLISHED MON, DEC 9 201911:35 AM ESTUPDATED MON, DEC 9 2019
      Paul Volcker used super-high interest rates as a controversial way of subduing inflation, and he succeeded after two recessions.
      But interest rates for everything in the 1980s skyrocketed, including home mortgages, which rose into the high teens.
      In that era, it was common for sellers to help buyers pay for their homes by letting them assume their mortgages
      ….“What Volcker did was raise the fed funds rate to levels people never thought they would see. In 1981, the fed funds rate was consistently 20% or higher for roughly half the year, and at least on one day it was 22%,” McCarthy said. “He caused two recessions to get what he wanted. It took massive courage to do that.”

      Volcker was not without his critics in Washington and in the business world.

      “It was controversial. There were farmers and business executives out in front of the Fed picketing and complaining about interest rates,” Rupkey said. “Nobody wanted to see interest rates going higher. The way he got around it was the money supply target. They could say, ‘It was out of our hands … it was the fuel for additional inflation.’”

      “So when money supply grew faster than target, they drained reserves in the system and that effectively pushed up the fed funds rate to extremely high levels,” he said.

      Rupkey said Volcker’s legacy is still apparent after making a mark on the economy and Fed policy.

      “A tall tree has fallen in the forest,” he said. “It’s ironic that he cured the inflation problem and [Fed Chairman Jerome] Powell thinks he has a new problem. The struggle the Fed has now is with too-low inflation.”

      Former Fed Chairman Alan Greenspan on Monday called Volcker “the most effective chairman in the history of the Federal Reserve

      © 2019 CNBC LLC. All Rights Reserved. A Division of NBCUniversal

      Yes, the Federal Reserve are the Egyptian High Priests of Ancient times….along with with
      Lawyers and Bankers

    • Here is a chart comparing short term interest rates and inflation rates.

      We would expect the two to be highly correlated for two reasons:

      1. When a person or organization takes out a loan, the loan will be paid back in “dollars of the day.” The lender needs to be compensated for the loss of value that occurs during this period. So logically, the lender needs to receive an interest rate at least equal to the inflation rate. The interest rate should be somewhat above the inflation rate, to cover the default rise and the loss of the lender’s ability to invest the funds elsewhere.

      2. The reason that there is inflation is closely related to spikes in oil and food prices. Regulators of oil importing countries recognize that voters will be very unhappy if these costs rise enough to cause a recession. So they will raise interest rates, to try to squeeze back demand for construction projects and other big user of oil products.

      This is a chart, similar to the one shown above, showing the percentage change in total wages paid as a green line. This line will reflect additions to the labor force (more women working, for example) as well as increases in wages:

      Note the big increases in wages in the 1980 and prior period. This is when wage growth was being pumped up by true growth in productivity, as energy consumption per capita grew. Note the wide difference between the inflation rate and the growth in wages. Families were able to add cars and homes during this period, even with relatively high interest rates.

      After 1980, the growth in wages was mostly fueled by growth in debt. This might be viewed at least partly as recycled petroleum dollar debt. The gap between wage growth and inflation became smaller. This was true, even though the definition of inflation seems to have gradually changed so that it measured a given inflation rate lower. The inflation was achieved by “feature creep,” whether or not it was affordable by those buying the goods.

      Now, there is not much gap between wage growth and the CPI index. The fact that wage growth is low around the world is part of what holds down “demand” and thus inflation rates (and, of course, inflation rates are closely related to commodity prices, such as oil). Growing wage disparity is another factor holding down commodity prices.

  2. Gail do you think there is a sweet spot for oil prices? High enough that oil producers can locate and develop new sources but not so high that we can avoid collapse ?

    • Her answer will probably be NO. Just look at what happens when oil breaks north of $65, the economy begins to slow down because consumers feel the pinch at the pump. That’s way below what the producers need just to break even.

      And don’t forget the problem is made much worse by the growing HUGE WAGE DISPARITY around the world. That’s why we are beginning to see so much civil unrest around the world.

    • I think the sweet spot for oil prices is long past. We need prices higher than $120 per barrel for the energy exporters to get enough tax revenue.

      Citizens of many countries are having trouble buying cars at current oil prices. The fact that governments are trying to demand ever-more-fuel-efficient cars, or electric cars, makes the situation even worse.

      Part of the problem, too, is feature creep. Originally, manufacturers built cars for transportation. Now, cars are entertainment systems on wheels. The heating system warms up the seat for you before you get in. Long ago, windows changed from the crank type to ones that roll down with the touch of a button long ago. Cars have gradually added better bumpers and many other safety features that the powers that be decided we need. But people, on their modest wages, can’t really afford these fancier cars. These changes are not considered part of inflation. They are part of car makers plan to make more money from selling fewer vehicles.

      This vehicle (auto-rickshaw) is similar to one I rode in India.

      It definitely does not have all of the features of US cars. I held onto the car frame for dear life as the vehicle drove down bumpy roads because there were too many of us in the vehicle, and there were not doors on the vehicle.

      • You are correct and as you mentioned previously, also the emission arrangements apart from added safeties and creature comforts elevated the price. A decade ago the cheapest (not imported) real car started at ~EUR9k that’s impossible today..

        But the picture meant as “a car” is not exactly fitting as this is three wheeler some sort of Italian Vespa or similar scooter clone from the ~1940-50s.. Nevertheless these cheap modes of transport basically divide almost scooter like consumption among several passengers, hence say result in ~1/10th fuel demand of US style ~3ton vehicle per person.

      • Such vehicles are a daily proof of ‘divine intervention’.

        Our experience in the coming decade is likely to be one of hanging on very tight as well….

  3. We either need to find a lot more cheap oil and gas (not likely) or we need to find a new source of cheap energy. It’s the only way to keep capitalism going. I think economic collapse will occur in the summer of 2020. After that, who knows.

  4. Another global recession forecast, although his analysis of course overlooks the energy part of the equation:

    ““We live in a world where we have been hit by waves of social unrest, populism, nationalism, asset bubbles, trade wars, currency wars — we have a chaotic environment,” economist Vikram Mansharamani said, adding that the root causes for all of these include oversupply in the field of technology and energy, and ageing of the world’s largest economies that prompt consumers to spend less.

    “When we put these together we have global deflationary pressures,” he said. “So in a world where there is not enough demand and too much supply, countries compete using currencies to boost exports, resulting in a winner-take-all market, inequality and social unrest.”

    “This is tailed by nationalism and populism, with people being led to assign blame, followed by protectionism and taxes on imports, Mansharamani said…

    ““The global economic uncertainty does not limit to just US-China, but ripple effects extend into US-Europe, Japan-Korea, which are paralysing corporate boardrooms of multinational companies as they are no longer investing the way they were…

    ““So when we put all these pieces together, it shows that in the next 24 months there is a high propensity or high probability that we will face the heat of a recession,” he said, adding that these signs, which usually come 12-18 months before we have a recession, show that the economy is within 36 months of a downturn.”

  5. 1°) Iran can produce much more oil
    2°) oil is also free as wind it is enough to recover it
    so the question would be: how long can we suffer before we die?

    • Both oil and wind may be free, but you can still fight over the land.

      Neither is free to collect.

    • It takes a whole system to recover oil or wind. The cost of this system is amazingly high. It includes obtaining enough taxes for the government, for example. Most people miss this point. They assume that knowing something simple, such as “how much energy it will take to extract the energy” is sufficient to know the cost. This is only one piece of a very complex system. For example, if fresh water is becoming scarce in an oil exporting nation, the cost of desalinating sea water and then putting the correct minerals back in will be one part of the overall cost of keeping they system operating. This will be one component of the very high tax revenue required.

      • our Costco sells Kona coffee beans for $20 US per pound. it has been grown in Kona, Hawaii, shipped to San Francisco where it is roasted and packaged, and then shipped back to Hawaii. i call it 5000 mile coffee. because of the economies of scale and our present-day transport system, the coffee can be sold well under the price of what local coffee producers can provide. high-end coffee grown on Oahu (no shipping necessary) sells for $60 US per pound. it does taste better.

    • “A dairy farmer cannot plan for the future because the price paid for his milk has been held hostage by Brexit; a customs broker is cautiously preparing for a big expansion of business, but fearful if he makes the wrong call; a tech executive in London whose payroll relies on European Union workers wonders how she will fill her job vacancies; and two building cleaners, whose livelihood has been rocked by outsourcing, dread the loss of job protections built on rules from the Continent.”

          • Germany is supposed to be the economic leader of the European Union. Automobiles are Germany’s biggest industry. It cannot withstand a contraction of the automobile industry.

            The author says,

            Germany will try and export its way out of trouble, and because as domestic demand falters, and with massive job cuts in the auto industry and elsewhere, imports are going to shrink as well. The result? An already massive trade surplus, which at more than 8pc of GDP is already one of the biggest ever recorded, is going to get even larger.

            That will provoke an inevitable retaliation from the United States and China, the main countries where German goods will be dumped. President Trump has already threatened to slap tariffs on its exports, and the Chinese may well try and find a way of easing German exporters out of its market as well. In truth, a painful economic decline in Germany may well be the trigger for a collapse in the global trading system.

            I expect that the author may be right. China has been trying to dump goods it cannot sell on the world market; Germany is likely to do the same.

      • The “New World Disorder”. It’s here and it’s spreading around the world. Two reasons for this, growing and massive wage inequalities and people want independence from their governments.

        The problem is that as things continue to get worse with the global economy and governments have to pay for all their obligations, they tend to crack down on dissent. The worse part is that this is all happening without the global economy, collapsing.

    • The only sector that is sort of holding up is the service sector. Of course, an economy cannot run on services alone. People need to eat and have transportation.

    • UK economy is living on current account deficit for many years. It means that abroad entities are financing existance of the UK.

      • It’s what Tim Morgan has called ‘ living on the kindness of strangers’. One can’t count on them to remain kind forever. The UK looks like an ever-poorer investment region.

        • “Services” seem to be what we add when we have surplus energy. It is the things that are directly from energy products that are most essential. Having practically a services-only country is not helpful in the long run, I am afraid.

  6. “First it was Japan. Then Europe. Now investors are scanning the world for the next outbreak of stagnant inflation and tumbling yields.

    ““Central banks have no choice but to be supportive of risk assets and asset prices until such time as fiscal expansion is possible,” said Nomura Asset Management’s Richard Hodges.”

    • “Interest rates are ultra-low in part because global investors are starved of “safe” assets that will still payout in the event of a sharp downturn or economic catastrophe. But can governments, in fact, provide that insurance for free if there is a risk that interest rates will rise in the next major systemic crisis?

      “A recent International Monetary Fund study of 55 countries over the last 200 years showed that although economic growth exceeded interest rates on government debt almost half the time, this was not a good predictor of whether the surveyed countries were safe from interest-rate spikes in a crisis.

      “Modern economies have many important uses for debt. But it is never a risk-free option for governments, which is why it should be taken on and managed wisely, even when rock-bottom borrowing costs prevail.”

      • This is a Kenneth Rogoff article. A paper of his with Carmen Reinhart points out that in their study of Eight Centuries of Financial Crises, “It is notable that the non-defaulters, by and large, are all hugely successful growth stories.”

        Having economic growth that exceeds the interest rate close to half the time is clearly not sufficient. Economies need long-term growth not to default.

        • Here is an instructive study issued by the Center on Budget and Policy Priorities showing the key relationship between interest rates and economic growth. The demands imposed by burdensome debt-service in the years ahead does not bode well for any marked improvements in GDP growth. To the contrary, economic performance will continue to lag notwithstanding various attempts to manipulate aggregate demand through the combination of stimulative fiscal and monetary polices. While the prospects for a significant decline in economic growth may be averted in the near-term, prospects of sustaining levels of GDP typical of the post-War period appear increasingly dim notwithstanding incremental benefits flowing from technological gains. While I’m not offering “amen” to Prof. Johnson’s ‘Muddling Toward Frugality,’ I suspect that some adjustment in our standard of living expectations are probably in order.

          Thanks for citing the Rogoff/Reinhart article which offered some valuable context to my own understanding of our current circumstances. These two academics provided a constructive understanding to readers on the relentless influence of unsustainable levels of debt-service on economic growth. For their efforts, they were roundly attacked as “partisan ideologues” aiming to promote a conservative agenda. Alas, no good deed
          shall go unpunished!

    • I suppose Hodges means that if interest rates rise, Central Banks will have to do something to bring the interest rates back down, so that asset prices do not fall too badly. It could also mean bailouts for individual borrowers with problems.

      The article also seems to indicate that Nomura Asset Management made a lot of money in 2019 by betting the interest rates would become more negative.

  7. We have an oversupply of goods but the lack of the energy for everyday life: that is our current situation.

    The recession of the human species just continues.

    • Basically, businesses have needed to grow, so they have found ways to make their products ever-more costly. Some things (such as washing machines) also need to be replaced more frequently, because the new version of the product, while in theory is more efficient, is also more breakable.

      The poor citizen finds his/her wages are not high enough to cover the necessities of life.

  8. There is something i dont understand. We talk about interest rates rising. This is our idea about interest rates. As a “investment” gets riskier interest rates rise to compensate that risk. The idea that markets determine interest rates. The federal reserve determines interest rates. There “tigtening” or “easing” renouncement is focused on by markets. So which is it?

    Technically the fed owns about 2.5 trillion of US debt. THis is just a guess but I think they sponsor much much larger ownership. Because the fed and the fractional; reserve banking system allows financial institutions to create money based on their “assets” i would argue that omost all treasuries are owned through large financial institutions that are defacto extensions of the fed. Looking at the following pie chart my admitted guess that the foreign and domestic investors slices are in largly owned by financial institutions chartered by the fed. Whether here or abroad chartered by the fed. My guess is that the fed would rather have its proxies own USA government debt commonly called investment. My guess is that the fact that they had to step in and take direct ownership of USA debt was a indicator of just how dire things were in 2008.

    Chinas holdings are important in my opinion. Why? a mere 1.2 trillion. IMO because these are bought with “money” created by productivity not fractional reserve banking.

    The other large slice of pie is social security fund held “non negotiable bonds” also known as debt. I wonder if and when social security benefits are reduced or eliminated what happens to those bonds? They are not paid when their term is finished? Social security fund is also going to be depleted in 30 years or so. Who will own that slice of the debt pie then? Ah yes “Foreign” and “domestic” “investors”.

    All of this speculation on my part ignores the large chunks held in various instruments “mutual funds” pensions ecetera. These are not directly held by institutions who can directly create money with the fractional reserve system. They are not under grandmas mattress eithor. My guess is that the amount of bonds held directly by individuals is very very low. I dont know a single individual who owns them and never have. Those that do own them through mutual funds. There are those who have followed the rules given to them by the financial pundits about asset classes and frankly so far they have done quite well by following them. Really one could argue that as the premier financial asset anyone with savings in banks owns US treasury bonds.

    All of this would seem quite insane. Luckily Gail has shared ideas about things that make a bit of sense about it. Debt is energy borrowed from the future. Infinite energy extraction allows borrowing a bit from it. Infinite energy extraction is what makes this just a practice to realize potential borrowed from a energy rich future not insanity.

    • Yes, the US became (or was selected) as the host entity for the global credit-debt recycling system (to simplify taking over UK’s role), the FED’s global system umbrella as known today, which has got its kernel root in 17th century CBs or perhaps older.

      The “problem” is that the US also co-evolved as the largest per capita energy consumer (by a large margin!), hence when the cost of getting and upgrading the access to the energy kept increasing ~40yrs ago, the easiest solution on hand was to offload energy intensive industries abroad, and eventually almost all production did, plus the all spectrum foreign intervention policies.

      However, this also paradoxically elevated “new” regional/local elites which up to a point (of reaching certain development status) had no interest in challenging the status quo of the “FED system”. Or acted/lucked out prematurely (e.g. Libya) would be now under protection shield of other powers.

      These giant tectonic plates of dissimilar aims (global capital class, regional rulers and semi-rich, impoverished middle classes joining precariat, color revolution/meddling/invasion induced migrant waves.. etc.), should all collide at some kaboom intersection point in the future. Some estimate it’s still decades/generations away, others forecast ~2025-35 time frame, or some even expect ~immediate impact.

      • Wrong!

        The west exported the manufacturing industry elsewhere because all substantial growth was already a thing of the past. There is nothing as good for growth as people who work for improving their living standards and buys the product they create in the process.

        The energy shipping pathways of the world does not care where the FF’s are sourced nor where it is consumed. Tankers can reach the US as easily as China.

        The US / China dispute is ultimately an energy issue. Once the Chinese manufacturing industry becomes idle from a devaluation of the Yuan due to increasing energy costs, lack of access to high-tech and no dollars entering the economy, then Xi Jinping and his brothers in crime will be dispatched of.

          • rilygtek is also correct as his concept is just limited historical time capsule (subset) of what I wrote about.. He doesn’t factor the “qualitative” macro change over the long term i.e. former global hegemonic powers being now in very advanced state of hollowed out structure with no inner content (lagging technology, institutions, diplomacy, culture, social interaction, and now even crumbling military capability vs 2nd / 3rd tier powers..) simply fast terminal decay at all levels..

            Nevertheless I could be wrong, and the emerging pack (China-India-Russia-..) and theri networks of influence will soonish disintegrate first (or in some global sync) allowing for yet another miraculous round of re-inventing itself for the West, low probability in my book though for this late inning.

            I’m simply more sequencing and triage aficionado..

    • You ask a lot of questions. Let me refer to what Investopedia has to say. Regarding how the economy adjusts interest rates, this is something that Investopedia writes:

      If a nation’s economy were a human body, then its heart would be the central bank. And just as the heart works to pump life-giving blood throughout the body, the central bank pumps money into the economy to keep it healthy and growing. Sometimes economies need less money, and sometimes they need more.
      . . .

      Central Banks Influence Interest Rates
      In most cases, a central bank cannot directly set interest rates for loans such as mortgages, auto loans, or personal loans. However, the central bank does have certain tools to push interest rates towards desired levels. For example, the central bank holds the key to the policy rate—this is the rate at which commercial banks get to borrow from the central bank (in the United States, this is called the federal discount rate). When banks get to borrow from the central bank at a lower rate, they pass these savings on by reducing the cost of loans to its customers. Lower interest rates tend to increase borrowing, and this means the quantity of money in circulation increases.

      The same article has sections on
      Central Banks Set the Reserve Requirement
      In my opinion, the reserve requirement acts in a similar way to the fractional reserving that you mention in your post. Central banks can keep changing the fraction requirement by changing the percentage of the reserve requirement. It is no longer called “fractional reserving,” even if the effect is pretty much the same.

      Central Banks Engage in Open Market Operations

      When a central bank is looking to increase the quantity of money in circulation, it purchases government securities from commercial banks and institutions. This frees up bank assets—they now have more cash to loan. This is a part of an expansionary or easing monetary policy which brings down the interest rate in the economy. The opposite is done in a case where money needs to taken out from the system. In the United States, the Federal Reserve uses open market operations to reach a targeted federal funds rate.

      Central Banks Introduce a Quantitative Easing Program

      In dire economic times, central banks can take open market operations a step further and institute a program of quantitative easing. Under quantitative easing, central banks create money and use it to buy up assets and securities such as government bonds. This money enters into the banking system as it is received as payment for the assets purchased by the central bank. The bank reserves swell up by that amount, which encourages banks to give out more loans, it further helps to lower long-term interest rates and encourage investment

      The way I would explain the situation is that interest rates are something that are self-organized between lenders and borrowers, depending on the “rules of the game.” What Central Banks have been doing since 1981 is to change the rules in such a way that interest rates have generally been falling. Before Quantitative Easing was implemented in 2008, the only interest rates that were affected were short term interest rates. You can see how 3-month interest rates move up and down on this chart. Whenever they rise, the inevitably lead to recession (gray bar) a while later.

      Recessions occur after the short term interest rates hit the long term interest rates, because banks can’t make money by lending out funds then. The problem is that the difference between what they obtain in interests on loans (which tend to be long-term) and the amounts that they pay on bank account deposits and other funds they have access to tends to be too small. Banks slow down on lending funds when short and long term interest rates meet, and not too long afterward, business activity slows down as well, because banks are unwilling to make loans, since they cannot do it profitably.

      Quantitative easing, started in 2008, also affects longer-term interest rates. The government buys up existing securities with money created out of thin air. This leaves less debt in the market place, and tends to reduce the interest rate needed to fund debt. I think of it as an interest rate subsidy that is being bought with the money created out of thin air.

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