Why raising interest rates to reduce inflation may work out very badly

Are we headed for very high energy prices? Or, are we headed for a financial system that starts falling apart? The whole economic system may change remarkably. For example, what many people thought was money, or a promised pension plan, may not really be there when the time comes to get value from it. Shelves in stores may be empty when it comes time to make a purchase.

Most people do not understand that the world economy is a physics-based system, powered by energy. If the energy is suddenly much less available, there will be a huge problem. The world economy has been powered by a rapidly growing supply of energy for over 200 years.

Figure 1. World energy consumption by fuel based on Vaclav Smil’s estimates from Energy Transitions: History, Requirements and Prospects (Appendix) together with data from BP’s 2011 Statistical Review of World Energy for 1965 and subsequent. Wind and solar are included in Biofuels.

My concern is that the current attempt to bring inflation down will lead to falling energy supply and a world economy that is rapidly changing for the worse.

Figure 2. Energy amounts for 2010 and prior equal to those in Figure 1, with a corresponding amount for 2020. Future energy for 2030, 2040 and 2050 are rough estimates based on the observation that the world is now reaching extraction limits for both coal and oil.

Everything I can see says that world leaders are not able to face the possibility that the world is already running seriously short of oil and coal. Future supplies are likely to be much lower, and much more expensive, if they are available at all. Other energy types (including natural gas, nuclear, hydroelectric, wind and solar) are simply add-ons to a system built using coal and oil.

Current world leaders do not realize that the energy situation is very much like the water level in Lake Mead. Looking at it from the top, there still seems to be water there but, in fact, the required depth is lacking. Water for watering crops will soon be exhausted. The world’s energy supply is not a whole lot different. The supposedly proven reserves do not tell us anything at all. It is the amount of fossil fuels that can be affordably extracted that is important. We have already exceeded the amount that can be affordably extracted. If central banks cut back future energy supplies using higher interest rates, we can expect to encounter major problems going forward.

In this post, I will try to explain some of the issues involved.

[1] The amount of energy the economy requires depends very much on population. The greater the world population, the more oil is needed for food production and transportation. Non-oil energy is a bit more flexible in quantity than oil, but the total quantity of energy per capita needs to keep rising to prevent very adverse outcomes.

Figure 3. World per capita energy consumption by source, with the 1950-1980 period of rapid growth highlighted. Amounts are equal to those used in Figure 1, divided by population estimates by Angus Maddison.

Figure 3 highlights the fact that the period of Rapid Energy Growth between 1950 and 1980 was a period of unprecedented growth in per capita energy consumption. This was a period when many families could afford their own car for the first time. There were enough employment opportunities that, quite often, both spouses could hold down paying jobs outside the home. It was the growing supply of inexpensive fossil fuels that made these jobs available.

If a person looks closely, it is possible to see that the 1920 to 1940 period was a period of very low growth in energy consumption, relative to population. This was also the period of the Great Depression and the period leading up to World War II. Sluggish energy consumption growth at that time was linked to very undesirable socioeconomic outcomes.

Energy is like food for the economy. If energy of the right kinds is cheaply available, it is possible to build new roads, pipelines and electricity transmission lines. World trade grows. If available energy is inadequate, major wars tend to break out and standards of living are likely to fall. We now seem to be approaching a time of too little energy, relative to population.

[2] Recently published data through 2021 indicates that energy consumption growth is not keeping up with population growth, similar to the situation of the 1930s. This says that the economy is doing poorly. Supply lines are broken; most jobs don’t pay well; many goods that normally would be available aren’t available.

Figure 4. World energy consumption per capita, based on information published in BP’s 2022 Statistical Review of World Energy.

Figure 4 shows that the year with the highest per capita energy consumption was 2018. This agrees with other information such as automobile sales.

Figure 5. Auto sales by country, based on data of vda.de

For example, the number of automobiles sold seems to have peaked back in the 2018 period. China and India are both reporting fewer automobile sales recently. The economy was already sliding into recession in 2019. The 2020 shutdowns hid the very poor condition the world economy was already in. If people were forced to remain in their homes, they could not take to the streets to protest their poor wages and pension plans. The shutdowns helped give the impression the world economy was doing better than it really was.

Figure 4 shows that even with the bounce back in 2021, total energy consumption per capita is still below the 2018 and 2019 values. This contrasts with the situation that occurred after the 2008-2009 Great Recession. By 2010, per capita energy consumption was back above the 2007 and 2008 values.

[3] We can look back and see how rising interest rates were used to slow the world economy in the 2004 to 2006 period, and how different the economic situation was then compared to now. Even with the rapid growth the economy was making at the time of the interest rates increases, the result was still a deep recession in 2008-2009.

Figure 6. Figure similar to Figure 4 showing world energy consumption per capita, except that notation has been added with respect to the timing of increases in US Federal Reserve Target Interest Rates.

It is clear from Figure 4 and Figure 6 that between 2001 and 2007, the quantity of energy consumed per capita was rising rapidly. This was the period shortly after China was added to the World Trade Organization. Manufacturing was rapidly being moved to China. China’s demand for energy products of all kinds was rising rapidly. As a result of this greater demand, oil prices were increasing between 2001 and 2007. To try to reduce inflation, the Federal Reserve raised target interest rates in the 2004 to 2006 period and gradually brought them down, starting in late 2007.

There are two things that are striking about this earlier situation:

  1. The world economy (as shown by rising energy supply) was growing much more rapidly during the 2001 to 2007 period than it is in 2022. All the world economy is trying to do now is get back to where it was before the 2020 shutdowns, in terms of energy consumption per capita.
  2. Eventually, there was a bad reaction to the higher interest rates of 2004 to 2006, but this did not come until 2008-2009. This was a much longer lag than most people would expect.

Now, in 2022, we cannot get energy consumption per capita up to the 2018 and 2019 levels. There are many unfinished automobiles, waiting for missing parts. Appliances of many kinds are not available without a long wait. Fertilizer is often not available. Broken supply lines leave many store shelves empty. It is not that demand is unusually high; it is the supply of the energy products we need to grow food and to transport many finished goods that is not available.

Raising interest rates is a way to reduce the demand for finished goods and services, such as automobiles and appliances, if the world economy is growing very rapidly, as it was back in the 2001 to 2007 period. If the problem is an inadequate supply of finished goods and services (due to broken supply lines and low wages for workers), then raising interest rates is entirely the wrong medicine. It will cause even fewer automobiles and appliances to be made. It will cause many current workers to be laid off. Such an approach, when the world is trying to deal with too few workers, will tend to make the situation worse, rather than better.

[4] The trend in fossil fuel supplies is concerning. Both oil and coal are past peak, on a per capita basis. World coal supply has been lagging population growth since at least 2011. While natural gas production is rising, the price tends to be high and the cost of transport is very high.

Most energy charts are similar to Figure 7, showing energy consumption on a total product supplied basis, without reference to the size of the population using those resources.

Figure 7. Total quantity of oil, coal and natural gas supplied based on information published in BP’s 2022 Statistical Review of World Energy.

Figure 7 indicates that coal supplies are, in some sense, the most troubled of the three types of fossil fuels. In the 2001 to 2007 period, China was able to ramp up its manufacturing using coal, but eventually those supplies ran short. In fact, coal supplies around the world started running short. Instead of telling us about the shortfall in production, we started hearing a story that sounds a lot like The Fox and the Grapes of Aesop’s Fables: Coal is a horribly polluting fuel which we don’t really want anyhow.

To understand how these quantities correspond to the world’s rising population, it is helpful to look at consumption divided by population, shown in Figure 8.

Figure 8. Oil, coal and natural gas energy consumption per capita, based on data in BP’s 2022 Statistical Review of World Energy.

Figure 8 shows that oil consumption per capita was relatively stable up until 2019. Then, it suddenly dropped in 2020, and it has not been able to fully recover from that drop in 2021. In fact, we know that as oil production has tried to increase in 2022, its price has risen further. Of the years shown, 2004 was the year with the highest oil consumption per capita. That was back at the time that “conventional” oil production peaked.

Figure 8 shows that the peak production of coal, relative to world population, was in the year 2011. Now, in 2022, the least expensive coal to extract has been depleted. World coal consumption has fallen far behind population growth. The big drop-off in coal availability means that countries are increasingly looking to natural gas as a flexible source of electricity generation. But natural gas has many other uses, including its use in making fertilizer and as a feedstock for many herbicides, pesticides, and insecticides. The result is that there is more demand for natural gas than can easily be supplied.

[5] Governments and academic institutions have gone out of their way to avoid telling the world how important energy of the right types and in the right quantities is to the economy.

Politicians cannot admit that the world economy cannot get along without the right quantities of energy that match the needs of today’s infrastructure. At most, a small amount of substitution is possible, if all the necessary transition steps are taken. Each transition step requires energy of various kinds. For example, a small amount of intermittent wind can be added to the fossil-fuel generated electricity supply, if care is taken to ramp up fossil-fuel generated electricity to offset the lack of wind when there is a shortfall in supply. Otherwise, battery or other storage is needed for the wind energy until the wind energy is truly needed by the system.

Thus, most people today are convinced that the economy doesn’t need energy. They believe that the world’s biggest problem is climate change. They tend to cheer when they hear that fossil fuel supplies are being shut down. Of course, without energy of the right kinds, jobs disappear. The total quantity of goods and services produced tends to fall very steeply. In this situation, there is likely not enough food for all the people in the world. War is likely to break out over limited resources.

[6] Once the economy starts heading downward, it is not clear that the economy can ever “catch itself” and start back on an upward path again, even for a short while.

Back in 2001, the World Economy was able to get a “bail out” from China’s rapid growth in coal production, but as we have seen, world coal production is no longer growing as fast as population.

Back in about 2010 and 2011, growth in US crude oil from shale formations was able to temporarily bail out world oil supply, but now this is also failing. Also, even the recent “growth” shown is to a significant extent from the completion of “drilled but uncompleted” wells started earlier. Eventually, there are no more “DUCs” to complete.

Figure 9. EIA chart showing US Field Production of Crude Oil through June 24, 2022.

In fact, despite all of the supposed high reserves of many kinds around the world, there is little evidence that the Middle East, or anywhere else, can actually raise production much higher.

Once the economy starts shrinking, debt defaults are likely to become a big problem. Banks will find their balance sheets impaired. They may be forced to close. Citizens with deposits may find that only part of their balance is available to spend.

Government programs will necessarily be forced to cut back to match the energy supplies that are available. For example, if road paving material is not available, roads cannot be repaved. If fuel cannot be found for school buses, students may need to learn at home.

Governments at all levels have promised pension plans. In fact, many employers have promised pension plans. Without a growing supply to cheap-to-produce energy, these promises are meaningless. Somehow, governments will find it necessary to cut back on their promises. Perhaps, Social Security and Medicare programs will be handed back to US States to fund, to the extent that the states have funds for these programs. Governments around the world can expect to face similar problems.

With less energy supply available, the whole world economy that we know today seems likely to start falling apart. Fewer goods will be available through international trade. It is cheap energy that has allowed today’s economy to function. Once this cheap energy is depleted, the world economy will need to shrink back in many ways, at once.

We don’t really know precisely what lies ahead, and perhaps, this lack of knowledge is for the best. We cannot even imagine a world economy changing rapidly for the worse.

About Gail Tverberg

My name is Gail Tverberg. I am an actuary interested in finite world issues - oil depletion, natural gas depletion, water shortages, and climate change. Oil limits look very different from what most expect, with high prices leading to recession, and low prices leading to financial problems for oil producers and for oil exporting countries. We are really dealing with a physics problem that affects many parts of the economy at once, including wages and the financial system. I try to look at the overall problem.
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3,945 Responses to Why raising interest rates to reduce inflation may work out very badly

  1. Herbie Ficklestein says:

    #davidpakmanshow #foxnews #heatwave

    Fox News Struggles to Cover Historic Heat Wave Without Mentioning Climate Change
    97,549 views · 4 days ago

    https://m.youtube.com/watch?v=_BO-qcfdptQ&t=134s

  2. Michael Le Merchant says:

    Pakistan Curbing Interbank Trade to Contain Dollar Shortage, Sources Say

    (Bloomberg) — Pakistan’s central bank is discouraging interbank trading due to a severe shortage of dollars that has pushed the rupee to post its worst weekly drop since 1998, according to people with knowledge of the matter.

    State Bank of Pakistan asked commercial lenders to manage import-payment requests from their own inflows, such as exporter accruals and remittances, the people said, asking not to be identified discussing private deliberations. If the bank still needs to borrow, it must seek permission from the monetary authority, the people added.
    https://www.bnnbloomberg.ca/pakistan-curbing-interbank-trade-to-contain-dollar-shortage-sources-say-1.1796418

    • Pakistan is one of the poor countries that is having trouble paying for high-priced fossil fuels. “Cutting back on interbank trade to contain dollar shortage” may solve the problem of an inadequate supply of dollars, but it will make it impossible to import as much fossil fuels as before. All of these changes will make debt defaults much more likely.

      This is not a way to solve today’s problems. We either need lots more cheap fossil fuels for sale, or the world needs lots more inexpensive to borrow dollars distributed around the world. In other words, it needs QE rather than QT, at a very low interest rate. Such actions would make worldwide inflation even worse than it is today.

  3. fromoasa says:

    Was listening to some nice fossil-fueled lyrics by Rod Stewart.

    “She was tall, thin and tarty
    And she drove a Maserati
    Faster than sound
    I was heaven-bound!

    But I must have looked a creep
    In my army-surplus jeep.

    Well, she claimed she was a killer
    And she owned a flood-lit villa,
    A little aways, from the main highway.”

    Rod is even worsely bad than Fast Beddy. But he’ll get none of that after the oil crash.

    • D. Stevens says:

      The cheap energy carnival is over. I hope you had a good time.

      Say goodbye, my own true lover
      As we sing a lovers’ song
      How it breaks my heart to leave you
      Now the carnival is gone
      High above the dawn is waiting
      And my tears are falling rain
      For the carnival is over
      We may never meet again
      Like a drum, my heart was beating
      And your kiss was sweet as wine
      But the joys of love are fleeting
      For Pierrot and Columbine
      Now the harbour light is calling
      This will be our last goodbye
      Though the carnival is over
      I will love you ’til I die

      • gpdawson2016 says:

        The Party’s Over by Eliza Gylkisen

        The party’s over, we had us a time
        Everybody got loaded, everybody looked fine
        We emptied the coffers of water and wine
        The party’s over
        We had a good time
        We danced on the tables midnight til dawn
        Til all the time was up and the good stuff gone
        The house is a shambles, broken glass in the streets
        Guttering candles, blood on the sheets
        We burned all the kindling, passed the bottle around
        Watched the last coals dwindling
        And the ice melting down
        We danced on the tables…
        The party’s over, we had a blast
        Brought in the lawyers to cover our ass
        Left a note for the children to clean up the mess
        The party’s over
        It was a big success!
        We danced on the tables…

  4. Michael Le Merchant says:

    TORONTO EMERGENCY PHYSICIAN DR. JEFF MATHESON SHARES AN UPDATE ON THE MEDICAL SCENE IN ONTARIO
    https://www.bitchute.com/video/Rh3bGf24giz3/

    • Minority of One says:

      An honest Canadian doctor, not afraid to speak his mind. Why? Because he now lives in Mexico. Seems to be very well informed.

    • Increase in emergency room visits seems to correlate with rise in vaccine immunizations.

  5. Fast Eddy says:

    Anthony Fauci on the AIDS vaccine in 1999:

    “You take it and then a year goes by and everybody is fine. And then you say, okay that’s good, now let’s give it to 500 people, and then a year goes by and everything is fine. Well now let’s give it to thousands of people and then you find out that it takes twelve years for all hell to break loose and then what have you done?”

    https://t.me/robinmg/21762

    • Herbie Ficklestein says:

      Fauci’s retirement pension will pay him more than Biden’s annual salary: report
      Fauci is currently the highest paid federal employee in the United States

      SPONSORED by HGREG.com
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      A salary analysis conducted by Open The Books concluded that Fauci’s first year pension payout will total $414,000 which is more than the $400,000 brought in by the president.

      Fauci recently suggested he will retire at the end of President Biden’s first term at which point he will have turned 85 years old and served as a federal employee for 59 years.

      Open The Books analyzed Fauci’s salary, which is currently $480,654 per year but is expected to shoot to $530,000 by 2024, and factored in “conservative” pay bumps and annuities based on previous years to estimate his pension.

      Fox News…

      There is the big payout…some say he’s getting out before the mob comes at his door

      Hopefully he has a very short retirement

    • Of course, that is the problem we are up against now with the COVID-19 “vaccines.”

  6. Michael Le Merchant says:

Comments are closed.