The world changed last week, with no headlines to mark the news

At least, in the American media.  Mostly small stories in the back of our newpapers about this significant event, a milestone on the road to Peak Oil.

“King Abdullah stresses the need to keep oil for future generations“, Saudi Press Agency (13 April 2008) — Excerpt:

Custodian of the Two Holy Mosques King Abdullah yesterday emphasised the importance of keeping part of the Kingdom’s natural resources for the welfare of future generations.  “When new discoveries were made, I told them ‘leave them in the ground because our children and grandchildren will need them’,” the Saudi Press Agency quoted the King as saying.

… During the meeting, King Abdullah highlighted the significance of oil revenue and said that as long as there is oil, the Kingdom would not experience economic problems. “I told them once, ‘may God give it long life’… they asked me what is that… I told them petrol. As long as petrol is there, we will remain well. Our country will not have any problems,” he said.

What you probably do not know about China’s food crisis

With the support of modern media and the Internet, we are well-informed about the state of the world. But perhaps not so well-informed as we believe. In The Myth of Grand Strategy I state

It is hubris to believe that any person or small group has sufficient information to develop a plan on a global scale. There are too many complex, unknowable factors. Social factors, such as ethic and religious dynamics. Plus economic, military, and political factors. We lack the understanding to process the data into accurate patterns – a plan. That requires a science of sociology developed to the degree of modern chemistry, so that we could reliably predict results of our actions. Unfortunately sociology is at the stage of chemistry in the Middle Ages, when it was called alchemy. In fact, the yearning for a grand strategy is the equivalent to the search for the Philosopher’s Stone.

Here is a small, brief test. The global food crisis is front-page news. How well-informed are you? Here are a few questions, based on the Bank Credit Analyst report “Is China Running into an agricultural dead end?” (16 April 2008).

1. As China emerges from poverty and famine, their consumption of of food is low compared to the global average. True or False?

Congress shows us how our new government works

History shows that the superficial forms of government remain long after the essentials have changed. For example, the Roman Empire retained the forms of the Republic long after the Republic’s death. Public policy experts, being so close to the object of their study, can be the last to see that a new regime has been born.

So it is with Winslow T. Wheeler. An expert on defense issues after 3 decades working with senators from both political parties and the Government Accountability Office. Author of The Wastrels of Defense, he now directs the Straus Military Reform Project of the Center for Defense Information in Washington.

The US government that he knows has changed, right before his eyes. He sees the new order but does not recognize it. Just like us. His review of the The Petraeus / Crocker Hearings (Counterpunch, 8 April 2008) makes this evident.

It had all the panoply of a modern congressional hearing and what we have come to expect from senators confronting important witnesses. We saw:

The most dangerous form of Peak Oil

Summary: Robert Hirsch describes another form of Peak Oil: political peaking.  Perhaps the Middle Eastern nations can produce more oil to meet the world’s growing thirst — but will they?  Is it in their interest to do so?  Also, the focus of doomsters on shockwaves — instantaneous and large production cuts — ignores the more likely forms of slower political and geological peaking.   Ending on a more optimistic note, history does give us some grounds for optimism.

Robert Hirsch, one of the world’s top energy experts, has an important article in the February issue of Energy Policy magazine, “Mitigation of maximum world oil production: Shortage scenarios.” As usual with his work, it offers a mixture of new insights and careful analysis seldom found in Peak Oil research — on either side of the debate. I strongly recommend reading it. Unfortunately Energy Policy is subscription only. Here is a brief review of his analysis. Here are slides to an earlier presentation on this topic by Hirsch at the ASPO-USA conference in October 2007.

Political Peaking

Hirsch introduces an important concept which he (and many others) has long discussed, but only now is formally described: political peaking, an extreme form of resource nationalism.

Slow steps to nationalizing the US financial sector

Summary:  Consensus opinion has slowly moved from characterizing this as a “subprime mortgage problem” to a “mortgage problem.”  That is progress, but we have far to go before they see the full picture: that US households and businesses have too much debt — and that current trends likely will lead to nationalization of our financial sector.  Links are given to news reports and commentary about our slow match to this new America.

We have seen a few tentative mentions of nationalization as an option, but no discussion of what that might mean for America.  Perhaps it will be, as the Democratic Party proposes for health care, an easy no-cost solution.  But instead nationalizing two large sectors of the American economy will have large and unexpected effects on America.  It will be the largest expansion of government power since the New Deal. 

The exact form nationalization takes matters little. 

• It can de jure or de facto.  Governmental control has long since moved from legislation to agency dictats.  Our representatives in Congress now function more as Tribunes than a legislature.
• It might be an explicit government take-over, or through existing business structures.  The building might say First National Bank, but so tightly controlled so as to be functionally a government agency.

What will America look like – guessing — after a severe recession and nationalization of these two sectors?

What will America look like after this recession?

This series of articles speculations about our future based on history and the almost inevitable re-balancing of global economy (i.e., end of unconstrained borrowing by US).  The elections are only three eight months away, perhaps our last chance to influence these developments.

I.  This is a government failure on two levels, despite many warnings from major institutions that the US could not forever borrow without inevitable and painful consequences.

1. The US government let it happen, failure of the massive government regulatory apparatus.
2. The US government, esp. the Fed staff, did not model this scenario, despite the warnings.  The Fed’s legendary “500 PhD economists” and their supercomputers could have provided valuable analysis of alternative steps to mitigate this financial and soon-to-be economic collapse.  “Surprise is an event that takes place in the mind of a commander” - and represents a personal failure.

The US economy at Defcon 2

This analysis is far from the consensus viewpoint.  Unlike the consensus view, however, this has the advantage of accurately predicting the events of the past year. 

1. The deleveraging of the US economy is putting “torque” on the US financial system.  This is a process which cannot be stopped prior to completion, although the government will try.  The US economy resembles a rock balanced at the top of a cliff.  It was stable hanging on the top; it will be more stable at the bottom.  Hence the need for Defcon 2 — defense condition 2, one level below the maximum. 
2. As a result of #1, our financial fabric is ripping.  Weak links have been breaking one by one over the past year or so.  As each link breaks, there is more stress on the remaining links.  The tear is getting longer and wider due to several positive feedback loops.  In general, everybody’s (households’, businesses’, investors’ and creditors’) tolerance for risk decreases, and the inevitable reactions slow the economy. 
   1. Households and businesses increase their saving and reduce their spending.  This is good for our future, but reduces current economic activity.
   2. The price of credit increases (the premium of the rate at which you borrow above that the Treasury pays).  Investors sell things.  Creditors cancel loans, or do not roll them over at maturity. 

Understatement can be a form of courage — a comment about the US economy

Summary:  a look at what our leaders are saying today, where we are going (with an ominous comparison with the past), what we can expect to hear from them in the future if America’s citizens continue to slide along, and a (not the) solution.

After 12 years of obscure gibberish from Chairman Greenspan and two years of happy-talk by Chairman Bernanke, listen closely and you can hear a faint note of reality from our leaders about the US economy.  This is progress in tiny steps, but a change in direction from a government addicted to lies.

Chairman Ben S. Bernanke’s Semiannual Monetary Policy Report to the Congress  (27 February 2008):

Chairman Frank, Ranking Member Bachus, and other members of the Committee, I am pleased to present the Federal Reserve’s Monetary Policy Report to the Congress.  In my testimony this morning I will briefly review the economic situation and outlook, beginning with developments in real activity and inflation, then turn to monetary policy.  I will conclude with a quick update on the Federal Reserve’s recent actions to help protect consumers in their financial dealings.

The economic situation has become distinctly less favorable since the time of our July report. …

As understatements go, this is far from the record set by Emperor Hirohito of Japan in his first radio broadcast (15 August 1945), with ” the war situation has developed not necessarily to Japan’s advantage.”  But this economic downturn has just begun, and we might yet hear Bernanke or our President say that we have worked hard, that unexpected and undeserved events have occurred, and therefore shocking and extraordinary measures must be taken.

Fears of flying into the future

Climate change, peak oil, 4GW, social decay, ecological collapse, economic collapse, pandemics of new and old diseases … The doomsters seem to have taken control of our newspapers, as the list goes on and on, raising the question “How can civilization survive until next week?”

Imagine picking up the morning paper, coffee cup in hand. You open it and see nothing but good news. The headline story tells of a cat rescued from a tree. No stories about decaying social systems (social systems, like fruit, begin to decay after creation). No accounts of problems caused by increased wealth — no disruptive social changes, no new pollutants (replacing the old ones, like from burning coal and horses in the streets). No wars.

Would this be a good thing? No. It would mean that you died and are now in heaven. Resource scarcity, climate change, war, social instability … these represent the condition we call “life.” For thousands of generations humanity has confronted these problems as we climbed from scavengers to become the dominant species on this planet.

But what about the pollution of our environment, brought about by industrialization and increasing wealth? This is largely a myth in today’s developed nations, and a passing phase in the emerging nations. Consider life in the capital city of an emerging nation…

The city itself is overwhelmed, engulfed by changes with which it has not learned to cope, and which are scarcely understood. Some were inherent in the trebling of the population, some consequences of industrialization. Particles of grime from the factory smokestacks produce impenetrable smog which reduces visibility to a few feet … Much of the city stinks. The city’s sewage system is at best inadequate and in the poorer of neighborhoods nonexistent. Buildings elsewhere are often constructed over cesspools which, however, have grown so vast that they form ponds, surrounding homes with moats of effluvia. … And the narrow, twisted streets are neither sealed nor asphalted. People lock their windows, even in summer, but they have a lot to keep out: odors, dust…

This is London circa 1880 (a slightly altered quotation from William Manchester’s biography of Churchill, The Last Lion).

A happy ending to the current economic recession

History shows the difficulty of predicting the short-term path of economic or political events.  However, we can often see the medium-term with greater clarity.  In January 1942 none could forecast the events of the next 44 months, but it did not take an expert to see that the US would defeat Japan.  So it is with the current economic down cycle in America.

This series describes (see the list at the end) how we have begun to reduce the massive debts accumulated over the past two generations.  As I said here, there are only four ways to get rid of one’s excess debt (that, debt that cannot be repaid):

1.  Growth:  given time and rapid wage growth, the debt burden becomes manageable.  We pay it off ever more easily as incomes grow.  That was the dream solution to America’s high levels of household debt and large long-term government obligations.  It burst in 2000, and will not return in time to help us.

2.  Inflation, reducing the real weight of our debt.  This requires two things.  First, real growth in wages (no signs of this).  Second, either the cooperation or blindness of bond investors — they must either accept negative real after-tax yields, or remain oblivious to rising inflation.  The consequences are severe if our creditors (domestic and foreign) rebel.

3.  Debt can burn off the hard way as debtors default on their loans.  Both recessions and declining home prices drive defaults (involuntary and voluntary, respectively).  This is equivalent of surgery without anesthesia, resulting in bankruptcies, homelessness, decaying neighborhoods, and bank failures.

4.  Socialization of the debt.  The government can spread the burden of debt, in many different ways (that so many of our creditors are foreigners makes this more attractive).

• They can legislate to change contracts (e.g., mortgages):  reducing interest rates and payment terms, preventing or slowing foreclosures.  This spreads the debt burden from debtors to creditors.
• They can change the rules of the bankruptcy courts, with the same result as above – spreading the debt burden from debtors to creditors.
• They can directly intervene in the markets, extending loans (absorbing the resulting losses) or buying property from debtors or creditors (e.g., as the Resolution Trust Company did after the commercial real estate bust in the early 1990’s.)

Socialization is the seemingly easy path.  Done well, we have reforms like those Solon instituted for Athens — laying the foundation for its future greatness.  Done poorly, we have increased moral hazard leading to another cycle of rising debt and speculation – except that the next crash will imperil a larger part of the society, or even all of it. 

It’s all about choice.  Every downturn gives us the opportunity to determine what America will become.  We weigh our fidelity to our principles, our history, our forefathers — vs. our ability to collectively withstand pain (financial, social, political).  These are collective decisions, because all large-scale economic events have a decisive political component. 

Speculation about the future

Inflation is impractical (for reasons too complex to discuss in this post).  Large-scale defaults would likely lead to a deflationary collapse of our financial system.  The government will not allow that to happen as the consequences would be apocalyptic.  I believe that instead we will socialize the debt, the least-painful and most operationally feasible alternative.

Let us light a candle while we walk, lest we fear what lies ahead

Innovation of new forms of society and technology. It is the key to our progress. It has allowed us to evolve from naked hunter-gatherers to the dominant species on this planet. This process is slow, normally taking hundreds or even thousands of years. But occasionally evolution leaps forward. **

Many people look to the future with fear. We see this fear throughout the web. Right-wing sites describe the imminent end of America: overrun by foreigners, victim of cultural and financial collapse. Left-wing sites describe “die-off” scenarios due to Peak Oil, climate change, and ecological collapse - as the American dream dies from takeover by theocrats and fascists.

Most of this is nonsense, but not the prospect of massive changes in our world. But need we fear the future?

The past should give us confidence when we look ahead. Consider Dodge City in 1877. Bat Masterson is sheriff, maintaining some semblance of law in the Wild West. Life in Dodge is materially only slightly better from that in an English village of a century before. But social and technological evolution has accelerated to a dizzying pace, and Bat cannot imagine what lies ahead.

Geopolitical implications of the current economic downturn

There are several schools of economic thinking about the current down cycle of the US economy.

• The mainstream consensus of neo-Keynesian economics:  this is just another business cycle, to be treated with the usual tools.  To see this analysis, read today’s op-ed in the New York Times by Joseph E. Stiglitz.
• There are a few heretics, even some apostates.  The first question if the standard remedies of fiscal and monetary policy, plus devaluing the currency, will work this time.  The latter question the Keynesian paradigm itself.  Does it adequately consider the effect of rising debt levels?  Might the insights of Hyman Minsky show the limts to the operating boundaries of Keynesian theories?  Perhaps we need a fusion of Keynesian and Austrian economics?
• The members of the small Austrian school of economists, vocal but powerless to affect public policy.

What if the heretics and apostates — perhaps even the Austrians — are right, and this cycle is different?  Let us explore this scenario and see what it says about America’s geopolitical (esp. military) strength…

• The current economic downturn takes us beyond the envelope in which mainstream economic theory works.
• This marks the end of the post-WWII economic regime, during the last 25 years of which American public policy allowed massive growth of debt — to both foreign and domestic creditors — and deterioration of the competitiveness of US goods and services on world markets (i.e., decreased ability to pay our foreign debtors).

The key source of disharmony in the global economy is our foreign borrowing and weakening competitiveness.  Either would be bad; having both is deadly.

A recommendation to read these bulletins from the front!

In the 21st century financial wars, dollars replace bullets as shapers of the geopolitical picture.   Journalists, even analysts, do not yet see this change, hence their reports must be read with care. 

These are important articles:   Overseas Investors Buy Aggressively in U.S. (NY Times)  and China turns risk averse as capital outflows (Financial Times).   They must be read carefully to get the vital aspect of the story.  Brad Setser explains in a post today (read the full post!):

Is America’s decline inevitable? No.

Comment on a thread at the DNI blog:

“IMHO, the United States is so far down this path that - absent some deus ex machina - its political / economic decline seems to be inevitable and irreversible.  Under these circumstances, our efforts should not be to seek to stem or to reverse this process but rather to seek means to carve out islands of civility and/or excellence notwithstanding general political decay.  Eg. the Spain of Philip IV, with its imperial decline, was nevertheless also the Spain of Velasquez.”

These sentiments are widespread already.  As times darken such views will become more so.  They raise two important issues.  First, why be an American if one has no faith in the American people?  How can you believe in democracy without that faith?  The second concerns the gravity of the threats we face. 

Perhaps as a result of the long summer of America, the post-WWII era of prosperity and peace (relatively speaking), many folks see any serious threat as Armageddon.  But consider our problems vs. those of our European ancestors.  Did they surrender?

Framing current events about the global economic and geopolitical system

The daily newspapers display events as string of beads.  Discrete, unrelated.  That masks the key to understanding what is happening:  the systemic drivers at work.  This is in my opinion not a series of isolated events or even a cyclical downturn.  We are experiencing a change in the fundamental structure of the global economic regime.

You might find this series of articles of value to properly “frame” these events, listed from old to recent.  Please share your comments (brief and relevant, please), or email me at (spam-protected spelling) fabmaximus at hotmail dot com.

A brief note on the US Dollar. Is this like August 1914?  — How the current situation is as unstable financially as was Europe geopolitically in early 1914.

The post-WWII geopolitical regime is dying. Chapter One  – Why the current geopolitical order is unstable, describing the policy choices that brought us here.

We have been warned. Death of the post-WWII geopolitical regime, Chapter II – A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).

Power shifts from West to East: the end of the post-WWII regime in the news – We are seeing another western industry ceding dominance to eastern competitors, one more step in a larger process.

Death of the post-WWII geopolitical regime, III — death by debt – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.

A recommendation to read these bulletins from the front! – A brief note on today’s articles in the NY Times and Financial Times, with Brad Setser’s explanation of why they are important.

More good news about Peak Oil, on the demand side

Many in the Peak Oil community have trumpeted the rise of oil prices from their 1990’s average of aprox $20 (measured by West Texas Intermediate, aka WTI). For example, note these posts at The Old Drum:

• The Bet
• Oil Price Touches $100 a Barrel; Signal of Pending Oil Shortages Ignored
• Holding Daniel Yergin and CERA Accountable

Unfortunately much of this analysis not only misleads but also might prove counterproductive.

First, the “typical” Peak Oil explanation is likely wrong, even myopic. For example: “Despite the talking head rationale for today’s $4 rally, the underlying reasons for the 8 year+ climb in crude are geologic in nature.” As I discussed here, oil has risen since the recovery began in late 2002 along with the prices other industrial materials. Expansions often strain the supply of industrial inputs, which is why copper is often called Dr. Copper (due to its accuracy as an economic indicator). Oil has risen with commodities in general over the past year, a symptom of the inflation resulting from the rapid expansion of the global money supply in the past few years — also a typical late-cycle event.

More importantly, the straight-line extrapolations of many Peak Oil enthusiasts — forecasting using only a ruler — occasionally works, but usually proves unreliable over time. Cycles, not lines, dominate the real world. That is why folks earning a living in the risky business of forecasting, like Yergin, cannot be stuck clocks (always giving the same answer, right only twice a day).

So that we too are not stuck clocks, let us consider what cyclical dynamics might flatten or even decrease oil demand during the next few years?

I. A global recession

Good news about Global Oil Production!

Forecasts of oil production are converging as better data and analysis eliminate many possible scenarios — including the apocalyptic ones so beloved by doomsters.   The experts in this group look for an imminent (starting somewhere in the next few years) peak in liquid fuels (petroleum & biofuels) production, followed by either a long plateau or a slow decline.  These five experts cover a broad spectrum.  With three Peak Oil advocates included, this can be considered a conservative forecast.

• Oil industry experts and long-time Peak Oil advocates (Colin Campbell, Jean Laherrere). 
• The highly respected Editor of Petroleum Review, Chris Skrebowski.  He produces the Megaprojects report, listing large oil development projects.
• A talented amateur, Stuart Staniford.  
• Sadad Ibrahim Al Husseini, retired EVP of Saudi Aramco.

These forecasts are comforting but challenging.  The global economy will thrive in this scenario if we can reproduce the increases in efficiency, fuel switching and conservation seen in 1979 - 1993 — a 14 years of  global economic growth with no increase in petroleum consumption.  Esp. if global economic growth slows during the next year or two, perhaps building up a cushion of excess production capacity.

If!  If we heed the advice of the February 2005 “Mitigations” report by Hirsch et al and immediately initiate crash programs to prepare for Peak Oil.  If we successfully develop alternative sources, effective methods to increase efficiency, and encourage conservation.  Then we can, with a little luck, manage a smooth transition to the next Age of Energy. 

The doomsters speak confidently of certain disaster following Peak Oil.  They are probably wrong, unless we make it so.

Forecasts

Death of the post-WWII geopolitical regime, III — death by debt

But this *long run* is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again. By John Maynard Keynes, “A Tract on Monetary Reform” (1923)

To know how to move forward we must first learn how we got here. This takes on even greater urgency in this election year.

The US economy was wracked by a series of booms and busts in the decades after the Civil War. In 1913 Congress broke with this policy of laissez faire to create the Federal Reserve, charged with stabilizing the banking system. Despite this (or perhaps because of this), these busts culminated in the Great Depression of the 1930’s.

A solution was at hand. During the years 1919-1936 John Maynard Keynes developed a new paradigm for economics, both quantitatively clear and operationally simple. Its goal was to stabilize the economy at a low level of unemployment, an optimum equilibrium (this is a gross over-simplification). It ignored the inimical effect of rising debt levels. But then, in the long run we are all debt (Keynes had no children).

The US adopted his policy of aggressive economic management, stabilizing the economy though federal spending, plus manipulation of the money supply and value of the dollar. This worked well for many decades.

Average length of expansions:

• 1854-1929: 25 months (laissez faire)
• 1945-1980: 44 months (Keynesian management)

A warning from Professor Niall Ferguson

The Harvard historian Niall Ferguson recently wrote about one of history’s great events, occurring now. Power — economic and political — shifts from West to East while we contentedly watch TV, play with our electronic toys, and exult in our large homes and granite countertops. The foundation of America’s role in the world slowly crumbles during an American Presidential election in which nobody disturbs the crowd by mentioning so unpleasant a subject.

Opening of An Ottoman warning for indebted America, (Financial Times, 1 January 2008):

Future historians will look back on the current decade as a turning point comparable with that of the Seventies. No, not the 1970s. This is not going to be another piece pointing out the coincidence of an unpopular Republican president, soaring oil prices, a sagging dollar and an unwinnable faraway war. I am talking about the 1870s.

At first sight, the resemblances across 130 years may not seem obvious. The 1870s were a time when conservative leaders such as Benjamin Disraeli, British prime minister, were powerful and popular. It was a time of falling commodity prices, after the financial crash of 1873 and the opening up of the American plains to agriculture. And it was an era of currency stability, as one country after another followed the British lead by pegging to gold.

Yet, on closer inspection, we are indeed living through a global shift in the balance of power very similar to that which occurred in the 1870s. This is the story of how an over-extended empire sought to cope with an external debt crisis by selling off revenue streams to foreign investors. The empire that suffered these setbacks in the 1870s was the Ottoman empire. Today it is the US. …

A time-saving tip when reading the daily news

Reading the classic literature helps in many ways.  Such as saving time when following current events.  The same patterns repeat themselves over and over, facilitating recognition and understanding.  For instance, consider the current financial crisis.  Speculators of all kinds, from banks to hedge funds, have made bad bets and lost money.  Accordingly, we are told, they must be bailed out for the sake of the nation. 

Today’s reading is from “Major Barbara” by George Bernard Shaw (1906), Act III.  The speaker is Andrew Undershaft, co-owner of the vast munitions company Undershaft and Lazarus.

The government of your country!  I am the government of your country; I, and Lazarus.  Do you suppose that you and half a dozen amateurs like you, sitting in a row in that foolish gabble shop, can govern Undershaft and Lazarus? 

No, my friend; you will do what pays us.  You will make war when it suits us, and keep peace when it does not.  You will find out that trade requires certain measures when we have decided on those measures. 

When I want anything to keep my dividends up, you will discover that my want is a national need.  When other people want something to keep my dividends down, you will call out the police and military.

And in return you shall have the support and applause of my newspapers, and the delight of imagining that you are a great statesman.

Government of your country!  Be off with you, my boy, and play with your caucuses and leading articles and historic parties and great leaders and burning questions and the rest of your toys.  I am going back to my counting house to pay the piper and call the tune.

I hope you have found this helpful.  Our regular geo-political analysis will resume this evening, again grappling with Chet Richards’ question:  can the America re-embrace the Constitution?