Energy, Finance, and Geopolitics

As the EU leaders work with the IMF, various central banks around the world and China to figure out a way to prevent a Euro collapse and treat the causes rather than just the symptoms of the crisis, it’s clear that four years into this economic crisis — which would be akin to another Great Depression if not for the capacity of government to intervene more effectively in the economy — the core problems remain unresolved.

The core issues revolve around a triad of energy, finance/debt and geopolitics.   The solution summed up in one sentence:  We must restructure our energy usage so as not to be dependent on oil, restructure debt and the global financial regime so as to return to sustainability, and restructure the world system to give new prominence to rising powers such as China, India, Russia and Brazil, while the US and the EU take important but diminished roles.

Despite all the hoopla around “drill, baby, drill” and oil finds everywhere from North Dakota to off the western shore of Mexico, nothing yet denies the fact that if we are not now at the peak of production, we still will be.   This isn’t as dangerous as some would have you believe.   The traditionalist peak oil school looks at production like a regular normal curve:

This alarmist example posits a quick drop in oil production, leading to crises ever more serious and devastating

The alarmist approach could be a bit early — the peak may still be ten or fifteen years off.  But right now the data does show flat production, even when prices spiked in 2007-08, so there is evidence to support a claim we are now at peak.   The late Matthew Simmons’ book Twilight in the Desert makes a persuasive yet indefinitive case that Saudi Arabia is already peaking and hiding the fact their real reserves are not as plentiful as claimed.   Still, the normal curve shown above is based on how US reserves were depleted — the US peaked in 1973 and production declined dramatically.   The global peak will probably not play itself out in the same way.

The US peaked in an era of cheap oil; with oil expensive and the global economy as dependent as ever on it, the search for new reserves and thorough extraction from existing wells can stretch out the peak potentially quite a while.  The graph could stay around the peak for ten or twenty years and then decline at a much slower pace.  Still, switching from an oil based economy to one that runs on a diverse set of sources ranging from coal to solar, nuclear, geothermal, wind power and others will be difficult.   Waiting for the market to force change will likely assure a period of twenty years of imbalances where real crises and shortages cause political unrest and could yield dangerous movements akin to fascism of the 1930s.    Proactive efforts to actively promote alternative energies alongside efficient exploitation of remaining reserves could help make a safe transition possible; unfortunately it’s hard to find political will to do that when there is still denial that we’re in crisis.

The second issue is global debt.  Thanks in part to cheap energy and seemingly relentless growth, banks grew comfortable making large loans to governments, corporations and individuals without worrying too much about the ability to pay back the money.   The technology revolution helped rationalize this exuberance, technology means you can get more bang for the buck — more growth with fewer resources.  Governments and the private sector got addicted to a debt that could only be maintained so long as growth was rapid, requiring both cheap energy and technological advances.

All of this debt did two things; first it spurred on investment bubbles as lack of regulation (meaning the insiders could rig the game to their benefit) alongside easy credit led to investment for the sake of making “easy money” rather than investing in companies likely to grow the economy.   This created short term jobs in the bubble sectors, but those were unsustainable.  I’ve called this the ‘something for nothing‘ mentality.

What is alarming about this graph is that except for early in the Great Depression when total debt (government and private debt) hit 300%, the average has been about 150% or lower.   Through 2009 it was reaching 380% an amazing debt burden.   Since the debt to GDP ratio of the US government is about 100%, most of it is private or corporate debt.   Much of this run up was during a boom, a sign of an unsustainable economic run up.    The US is doing worse than most in this regard, but Japan, another of the largest economies, is also burdened with high debt.   One can quibble with the statistics used (at least in interpretation) and argue that the graph exaggerates the burden.   Even then the number comes out at near 300% of GDP instead of 380%, still Great Depression levels.   Clearly there is a debt problem, and it’s not limited to governments.

So here’s the deal: how do you pay down the debt without causing a deeper recession?   The only way to do that is through growth.  Spending can be cut, but realistically the best bet is to slow down spending growth.   Moreover, cutting spending during a recession can be disastrous — it does far more harm than raising taxes.  Then if high energy costs return as demand rises economic recoveries can be stopped in their tracks.

The most dangerous issue is the third, however: geopolitics.  It’s also the most promising.   The emerging markets have a lot of under used resources and human talent, and the expansion of Asian and potentially other developing world economies could lead to a global boom.   That could provide the capital to help the developed world restructure its debt.  The problem is that the first world also have to acknowledge relative decline — the balance of power would shift towards countries like Brazil, Russia, India, China and South Africa, the so-called BRICS.

The trouble is that rising powers tend to get over confident and take risks while declining powers choose to fight to try to hold on to what is slipping away.   The so called “power transition theory” may be less viable now when economics dominates and nuclear war is all but unthinkable, but the careless talk in recent Republican debates about policy towards China suggests that many in the US may not get just how vulnerable we are, and how much damage has been done to the economy over the past decades.   The good news is that the BRICS don’t want the West to collapse, economic interdependence is real.  They want to shift towards investment and a greater say in the world economy and, in exchange for helping bail out western states in various ways, influence on our domestic economies.  China is already gaining that through heavy investment in both the EU and the US.   It’s often not noticed, but it results in a real shift of power.

These aren’t the only issues of course — global climate change is still potentially a game changer, and the Mideast could explode and create an oil crisis unrelated to so-called ‘peak oil.’   High energy costs could still undermine the BRICS and thus the world economy.    Still they keys towards the future remain transitioning to new energy sources in a timely manner, turning around the build up in public and private debt in the West likely by a mix of ‘haircuts’ (simply eliminating debt) and capital support from BRICS and other emerging markets.  In exchange control of global financial institutions shift away from western dominance (though maintaining western influence).   Managed right, there is no need for on going crisis, fear of war, or concern that civilization will collapse.   But can we trust the politicians to handle this with any wisdom?

  1. #1 by Ed Darrell on December 5, 2011 - 08:16

    Wasn’t it Churchill who said we can trust the politicians in the U.S. will do the right thing — after having tried everything else?

  2. #2 by brucetheeconomist on December 5, 2011 - 23:49

    “give new prominence to rising powers such as China, India, Russia and Brazil, while the US and the EU take important but diminished roles.” With the overemphasis on American exceptionalism, I’m not sure a lot of the electorate in the US is ready for this. Pat Caddell said on Fox that the US would “blow-up” rather than go quietly into the night the way Britain did. I’m not quite sure what he mean by that, but it seems to me that our leader would do well to think about and how to build support for a changed role of the US, not just promise they’ll maintian us as: # 1!!!!.

    • #3 by Scott Erb on December 6, 2011 - 04:32

      Well, Britain fought two wars before it finally was forced to ‘go quietly into the night.’ But I agree — Americans tend not to understand that we’re not leaders of the world. The China bashing in the GOP debates is a bit scary. China has a policy of trying not to overtly counter another country’s direct interests, and it has followed that policy pretty well, to it’s benefit. We go in and try to push others around to do what we say. Which country is going to be more effective?

  3. #4 by Alan Scott on December 7, 2011 - 16:31

    You guys forget that China and Russia are not our friends. They continually screw us over in our attempts to restrict Iran and the other bad children of the world from blowing it up . Also restricting US energy production is a really harmful policy. Solar and wind have been disasters.

    • #5 by Holden Smith on December 8, 2011 - 21:18

      You would also think the genius would check what the current known recoverable volumes and extraction rates of gas are in the USA today. Well over a century’s worth. This guy is a joke.

  4. #6 by brucetheeconomist on December 17, 2011 - 17:17

    Scott you have a lot of good information here. You might also find this post interesting, and this blog is pretty good for a balanced view on energy issues.

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