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Economic growth with declining energy?

Discussions about the economic and financial ramifications of PEAK OIL
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Will our economy survive continuous Oil/Energy decline?

Yes
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No
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maybe (see comments)
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I don't know
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Total votes : 258

Postby MonteQuest » Mon 13 Sep 2004, 20:08:34

$this->bbcode_second_pass_quote('Canuck', ' ')I think the Euro may become the key currency, at least temporarily, but it is also a fiat currency and it won't be a better haven if the US dollar collapses. The only answer to the problem is to keep growing the global economy. If peak oil prevents that, the economy crashes and hard.


Perhaps "key" in the sense that it will be the prime currency that the overweight investors in US treasuries move to, but, like you said , it is fiat as well.[smilie=pottytrain5.gif]

$this->bbcode_second_pass_quote('', 'I')'ve made this point before to the most optimistic posters. The challenge will not just be to adjust to less oil by restructuring the infrastructure. We don't just have to replace the annual energy loss with an alternative. We have to replace that loss and add enough energy to grow the economy. If we don't, we are all, financially speaking, ruined. We are bankrupt as individuals, as corporations and as countries.


Canuck, we are two peas in a pod on this. I agree entirely, and as you know I have posted numerous times on this issue. It cannot be overstated. So, do you see a solution of sorts that follows this thread? Can we somehow move towards a monetary policy that will avert a meltdown and some stability, or is this a train wreck steaming ahead with the whistle blowing? [smilie=eusa_wall.gif]

Shifting the mindset away from "constant growth" is hard now; people are going to have to be dragged kicking and screaming into a sustainable, post-peak future as far as monetary policy is concerned. They don't understand the policy now, for heavens sake! [smilie=bduh.gif]
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Postby Canuck » Mon 13 Sep 2004, 21:39:50

$this->bbcode_second_pass_quote('MonteQuest', '
')
$this->bbcode_second_pass_quote('', ' ')Perhaps "key" in the sense that it will be the prime currency that the overweight investors in US treasuries move to, but, like you said , it is fiat as well.[smilie=pottytrain5.gif]


I meant key in the sense the US dollar is the currency of international trade.

$this->bbcode_second_pass_quote('', 'S')o, do you see a solution of sorts that follows this thread? Can we somehow move towards a monetary policy that will avert a meltdown and some stability, or is this a train wreck steaming ahead with the whistle blowing? [smilie=eusa_wall.gif]


To be honest? No. If there was a solution, I think we would have decided to eschew growth a long time ago. We can't stop immigration - no matter how much the public may want it - for exactly the same reason. The economy grows or dies.

My most likely scenario - absent a visit from the energy fairy - has the government taking over essential businesses as they go bankrupt and keeping them going. The standard of living collapses so far that rationing is imposed to keep the poor in line and fed. Force is employed to crush dissent. We end up with an Orwellian system with television convincing us that the chocolate ration is going up and up even if it went down yesterday.
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Postby MonteQuest » Mon 13 Sep 2004, 21:57:49

$this->bbcode_second_pass_quote('Canuck', ' ')
My most likely scenario - absent a visit from the energy fairy - has the government taking over essential businesses as they go bankrupt and keeping them going. The standard of living collapses so far that rationing is imposed to keep the poor in line and fed. Force is employed to crush dissent. We end up with an Orwellian system with television convincing us that the chocolate ration is going up and up even if it went down yesterday.


I am reading some interesting articles right now. Here's a link:

http://www.prudentbear.com/ Click on the Is the dollar at risk? slide presentation.

At the bottom of the Powerpoint pres is some great links. If you don't have PP, let me know and I can send them separately. The most immmediately scenario I see is the collapse of the real estate market and people losing their homes big time! The bottom line is that enormous numbers of people have been induced to trade in the equity value of their houses for lump sums of cash, while the market value of their houses is poised to plummet. We can assume that some of them are already in trouble with credit card debt. Connect the dots.
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Postby nero » Mon 13 Sep 2004, 23:06:06

$this->bbcode_second_pass_quote('MonteQuest', 'S')o, nero, do you see an ability for growth in a declining energy world, and how will it affect the need to grow to facilitate the debt? Back to the thread of discussion.


I'm one of the people who said maybe on the survey question. I'm still kicking around what I think about the problem. There are currently alot of oportunities to increase energy efficiency faster than the total energy available will initially decrease but they all take massive amounts of money. Or in other terms people's standard of living has to suffer to free up the resources to improve the energy efficiency. People will also suffer because of the recession caused by increasing energy prices. All told I think both of these factors will facilitate the reduction of debt (in a very unpleasant manner ie bankruptcy). If the world economy didn't have other economic factors (eg you perfect storm factors) to deal with I think it might be able to handle the strain of a small anual decrease in energy consumption. As it stands I'm afraid that we are going to be living in interesting times.
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Postby MonteQuest » Mon 13 Sep 2004, 23:15:18

$this->bbcode_second_pass_quote('', 'A')s it stands I'm afraid that we are going to be living in interesting times.


Nero, check out the link in my previous post. Might open your eyes, especially Warrren Buffett's little story about Thriftville and Squanderland..


http://www.prudentbear.com/
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Postby kjel » Tue 14 Sep 2004, 00:12:41

MonteQuest wrote:$this->bbcode_second_pass_quote('', 'W')hen the FED creates $1, it can lend out $9 for every $1 reserve with interest. So, if we start at day one and nine guys each borrow $1 at 10%simple interest from a bank, that means they each owe $1.10. Where does the $.90 come from to pay the interest on the loans? It must be borrowed into existence. Makes anyone's head hurt until he grasps that concept. It creates an ever-expanding debt spiral with the consequences of tranferring all the wealth from the poor to the bankers if they default. Look what happened in 1929.


Like nero I'm not convinced that this thesis is correct. Here's another analysis of the problem from a very useful site Money: What it is, How it works. I've spent nearly 20 years developing systems for the securities industry and while I'm by no means an expert on the financial system or economics, I've found that this site is accurate as to the nitty-gritty detail of those parts of the system that I do know.

$this->bbcode_second_pass_quote('', 'S')ome writers have claimed that interest on bank loans is a time bomb. They argue that money created through bank lending is only sufficient to repay the principal, so additional borrowing is required simply to pay the interest on the loans. That means the debt owed to banks must be growing at the compound interest rate, which will eventually drive the economy into a ditch. A popular name for this thesis is the debt virus.

What the Debt Virus Thesis Implies

Quoting data from the FDIC website, net loans and leases in 1980 by commercial banks totaled 1,006 billion dollars. During the 21 year period to 2001, the average interest rate on bank loans was 9.84%.
According to the debt virus thesis, that means by 2001 the compound interest costs on just the 1980 loans should total 7,221 billion dollars. If the only additional
loans during that 21 year period were those to enable borrowers to cover their interest payments, the total of bank loans outstanding should have risen to 8,227 billion dollars.

What are the Facts

In truth, the total of bank loans and leases in 2001 was only 3,815 billion dollars. During that 21 year period, the average return on assets of banks was about 0.7%, far less than the 9.84% average interest rate charged on loans. Clearly almost all of the increase in bank loans was borrowing in support of the economy, which grew in nominal GDP from 1,240 billion to 10,082 billion dollars.

Obviously there is a major disconnect here for the debt virus thesis. In most cases, banks will not lend to a party whose income or existing wealth is deemed insufficient to service the loan. A bank may lend to a borrower to cover the interest on an existing loan if it is seen as a temporary cash flow problem. But that is far different from the concept behind the debt virus thesis.

Why the Debt Virus Thesis Fails

The debt virus thesis is based on an incomplete model of money flows. Banks return a major fraction of their income to the non-bank public. Banks borrow from the public and pay interest on those deposits. They pay expenses such as employee wages, overhead costs, and write off bad loans. They buy financial assets for investment and as secondary reserves. Out of net earnings, banks pay taxes and shareholder dividends. All of these return funds to the non-bank public. Banks do well when their customers do well, and lose when their customers lose. The aggregate net worth of banks can only grow apace with the general economy, as the record shows.


BTW, this is a side issue to your main thesis about petro dollars with which I mostly in aggreement.
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Postby MonteQuest » Tue 14 Sep 2004, 00:31:09

$this->bbcode_second_pass_quote('', 'T')he debt virus thesis is based on an incomplete model of money flows. Banks return a major fraction of their income to the non-bank public. Banks borrow from the public and pay interest on those deposits. They pay expenses such as employee wages, overhead costs, and write off bad loans. They buy financial assets for investment and as secondary reserves. Out of net earnings, banks pay taxes and shareholder dividends. All of these return funds to the non-bank public.


Ok, so this says the bank returns a major portion of their income(interest) to the non-bank public. So, following this logic, the balance between what the bank returns and what the borrower owes must be borrowed. No, you say they return all of the interest into the economy. Where did the interest money come from that the bank returned? It had to be borrowed as in my example, we only started with a $1, the bank fractionalized it into 9 $1 loans. $ 9 went out, $9.90 must come in. The only person holding any more money than the $9 in circulation is the bank. I'm not an economist, but this is how I see it.
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Postby MonteQuest » Tue 14 Sep 2004, 00:40:25

$this->bbcode_second_pass_quote('', 'T')hat means the debt owed to banks must be growing at the compound interest rate, which will eventually drive the economy into a ditch.


And into a ditch is exactly where we are, and where we will be buried.
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Postby nero » Tue 14 Sep 2004, 01:43:09

So assuming that the shareholders of the bank recieve no profits (to simplify the case not an essential assumption) Monte's example may be described as:

The bank recieves 1 dollar of deposit
The bank lends out 9 dollars at 10% interest for one year
The bank incures liabilities (buys goods and services on credit) over the course of the year equal to $0.82
After one year the loan is repaid plus interest and the bank receives $9.90
The bank at this time then pays $0.90 to pay off it's $0.82 debt (plus interest )
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Postby MonteQuest » Tue 14 Sep 2004, 01:51:20

$this->bbcode_second_pass_quote('nero', 'S')o assuming that the shareholders of the bank recieve no profits (to simplify the case not an essential assumption) Monte's example may be described as:

The bank recieves 1 dollar of deposit
The bank lends out 9 dollars at 10% interest for one year
The bank incures liabilities (buys goods and services on credit) over the course of the year equal to $0.82
After one year the loan is repaid plus interest and the bank receives $9.90
The bank at this time then pays $0.90 to pay off it's $0.82 debt (plus interest )


I don't follow this at all. Where did the money come from to pay the $.90 interest? The 9 guys only had $9 between them.
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Postby nero » Tue 14 Sep 2004, 03:50:33

$this->bbcode_second_pass_quote('', '
')I don't follow this at all. Where did the money come from to pay the $.90 interest? The 9 guys only had $9 between them.


But the bank has a liability for $0.90. Say that liability was spread out amoung our 9 debtors. The debtors could subtract off what the bank owes them when repaying their loan, reducing the amount to be paid back to $9.00
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Postby MonteQuest » Tue 14 Sep 2004, 04:21:29

$this->bbcode_second_pass_quote('nero', '')$this->bbcode_second_pass_quote('', '
')I don't follow this at all. Where did the money come from to pay the $.90 interest? The 9 guys only had $9 between them.


But the bank has a liability for $0.90. Say that liability was spread out amoung our 9 debtors. The debtors could subtract off what the bank owes them when repaying their loan, reducing the amount to be paid back to $9.00


My last post on this. If banks had liabilities equal to all debt owed them, they wouldn't make any money. The only way that exists in the entire world for the interest to be paid on a loan is for it to be borrowed into existence. Money is only created when it is lent, there is no other mechanism. If only the amount of the loan is created say $100,000 dollars at 10%, where does the $10,000 of interest come from to repay the loan?

I can't explain it more clearly, and won't. Don't try. Dead issue.
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Postby jato » Tue 14 Sep 2004, 05:31:40

Okay. Can someone want to sum up the last 5 pages of this thread into one paragraph? :wink:
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Postby MonteQuest » Tue 14 Sep 2004, 12:26:02

$this->bbcode_second_pass_quote('jato', 'O')kay. Can someone want to sum up the last 5 pages of this thread into one paragraph? :wink:



Sure, I will try, although I have already stated it ad naseum. The thread questions was: Will our economy survive continuous Oil/Energy decline?

I maintain that it cannot, for this reason:

The Federal Reserve System, based upon fractional reserves, has a built-in flaw that always keeps total debt ahead of the money supply. The more a nation’s economy expands, the more it automatically goes into debt to the system over and above the money that it borrows. The result is a narrow focus of technology and policy making that concentrates on “money-making” schemes at the expense of the environment, worker’s safety, health concerns, and common sense. This unrepayable debt engine has lead us down a very narrow path; a path whose destination was designed around the endless rape of the planet with almost total disregard to the consequences. It is now time to pay the piper.

Just "how" the money is created becomes a moot point. Our current system demands continous expansion. Peak-oil makes that impossible under the current system, hence my proposal for a new monetary system not based upon continous growth.
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Postby nero » Tue 14 Sep 2004, 12:30:15

$this->bbcode_second_pass_quote('', 'O')kay. Can someone want to sum up the last 5 pages of this thread into one paragraph?


Being as impartial as possible. :) MonteQuest believes that the problem with our money supply system is that it is based on debts and that we will never have enough money to pay off the interest on the debt. He proposes to have the money supply expand instead by having the government spend new money into the economy that is not associated with any debt. I(nero) attempted to point out that that is essentially what the current system already does since the government debt held by the central bank( the fed) will never have to be repaid. (If a debt doesn't have to be repaid is it really a debt?)

The result: We both got frustrated at the lack of apparent understanding of our own position by the other person and very very politely called each other names :)
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Postby MonteQuest » Tue 14 Sep 2004, 13:28:01

$this->bbcode_second_pass_quote('nero', '')$this->bbcode_second_pass_quote('', 'O')kay. Can someone want to sum up the last 5 pages of this thread into one paragraph?


Being as impartial as possible. :) MonteQuest believes that the problem with our money supply system is that it is based on debts and that we will never have enough money to pay off the interest on the debt. He proposes to have the money supply expand instead by having the government spend new money into the economy that is not associated with any debt. I(nero) attempted to point out that that is essentially what the current system already does since the government debt held by the central bank( the fed) will never have to be repaid. (If a debt doesn't have to be repaid is it really a debt?)

The result: We both got frustrated at the lack of apparent understanding of our own position by the other person and very very politely called each other names :)


Jeesh Louise! Forget the Fed debt, what about all the private debt and foreign debt! This will have to be repaid! We have a word for it in English if you don't. It is called bankruptcy! What planet are you guys on?
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Postby kjel » Tue 14 Sep 2004, 15:10:01

MotneQuest wrote: $this->bbcode_second_pass_quote('', 'J')eesh Louise! Forget the Fed debt, what about all the private debt and foreign debt! This will have to be repaid! We have a word for it in English if you don't. It is called bankruptcy! What planet are you guys on?


Yes, the size of the US debt is a serious gobal financial problem. No doubt about that. On the other hand I think it is worth analysing the 'debt virus' thesis because it implies that there is a structural fault in the money system that requires exponential growth leading to inevitable financial colapse. I don't think this is so.

I think part of the problem is that it is easy to forget that money is just a set of tokens with an agreed-upon value passed from hand-to-hand as a substitute for real goods. The number of tokens in the system over any period of time never equals the value of the goods and services which they represent. In basic economic theory, the money supply (MS) is equal to GDP divided by the number of times the aggregate supply changes hands which is known as veolcity (V). Thus $GPP = MS x V = P x Q, where P is price times Q, total quantity of goods and services produced per unit of time. The money supply is also equal to the propensity to save (known as the Cambridge k) or kPQ.

How does this relate to the problem of paying interest? First, in real terms interest is payed not by money, but by production. If I borrow $1000 at 10% I must eventually pay that back from the results of my productive effort (even if that is quite abstract). Either I consume less in the time period in which I make the payments (interest and/or principal) or I have hopefully produced more than I would otherwise (i.e. I have invested the resources loaned to me). We all in some way or other continue to produce and consume as time passes.

In terms of the financial system and the money supply, the question of the repayment of interest becomes "are there enough tokens in the system to make interest payments". Thus a fundamental task for a government and the banking system is to ensure that the number of tokens in the system to cover savings and payments. This must match the growth in the economy (PQ) and changes in the propensity to save k. If they do so, there should always be enough tokens in play.

As nero has pointed out, the principal means of doing this is by having the FED purchase bonds and bills from the government. Someone has to create the tokens for the money passing game. The tokens created are eventually harvested as taxes, but enought debt must always remain to provide the money supply. If all debt were repaid, all money would be recalled and the game would be over. The money created by the FED is called base money. The FED manages that supply day-to-day by buying and selling government debt in the open market (called open market operations) as well as from the Treasury.

Additional money is created by the credit process (called credit money). This is not magic. All that is happening is that production not consumed by some players (savings) is transfered to others who wish to consume now instead of later, or who will invest the resources. The money supply (tokens) increase but only because some of the tokens are not used in circulation (they are saved).

The reserve ratio which appears to allow a magical expansion of money in fact actually only sets an upper llmit on that expansion and in practise is not really essential.

The US FED currently requires a 10% reserve that in theory allows a 10x expansion of money. In actuality, the expansion rate is only about 2.7x. After all, most borrow in order to spend and only a small portion of the conomic activity generated will return to the banking system as standing deposits (savings). The money supply can only expand to its maximum value if all funds borrowed are deposited (saved), not spent. Banks only lend when they believe they have a good chance of making a positive return. Their lending activity is limited by the FED by setting capital requirements: a banks capital ration ( lending dividec by equity) must less than or equal to the FED mandated rate.

Note also that credit money is not the only money in the system. Most of the base money consists of currency in circulation (as well as some in bank vaults). In the year 2000, that was 268 Billion USD. Compare that to the amount of the reserve deposits, 29 Billion. Some of this will eventually be used to make interest payments.

It's possible to construct a detailed model of all the flows that will show exactly how all the tokens circulate and how all payments can be made, but its very tedious to follow so I won't do it here.

The fiat money/fractional reserve system is not the only way to create and manage a money supply. It has its defects, but requiring an infinite expansion of credit is not one of them.
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Postby MonteQuest » Tue 14 Sep 2004, 15:50:34

$this->bbcode_second_pass_quote('', 'H')ow does this relate to the problem of paying interest? First, in real terms interest is payed not by money, but by production. If I borrow $1000 at 10% I must eventually pay that back from the results of my productive effort

But where does the money come from to pay for your production? It is borrowed into existence, it cannot come from money already in circulation because that is debt money also.

$this->bbcode_second_pass_quote('', 'I')f all debt were repaid, all money would be recalled and the game would be over.


I totally understand that. The amount of money in circulation "money supply" that is needed for transactions must remain at a certain level to avoid inflation/deflation. But the fact that "interest" on the created money demands that more money must be created to pay it. And since all money created is debt money, we are chasing our tail!

$this->bbcode_second_pass_quote('', 'T')he money created by the FED is called base money. Note also that credit money is not the only money in the system. Most of the base money consists of currency in circulation (as well as some in bank vaults).


How did the free money get into the system? You cannot tell me that the $7.3 trillion dollars of federal debt is necessary money supply that will not have to be paid back. Even if I am totally wrong, it cannot expand forever, and continued expansion is necessary for that to happen, thus peak-oil and the current monetary system cannot coincide
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Postby MonteQuest » Tue 14 Sep 2004, 15:52:47

$this->bbcode_second_pass_quote('', 'I')f all debt were repaid, all money would be recalled and the game would be over.


You just made my case for me in one sentence. I rest my case.
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Postby kjel » Tue 14 Sep 2004, 17:07:54

MoteQuest wrote: $this->bbcode_second_pass_quote('', 'H')ow did the free money get into the system? You cannot tell me that the $7.3 trillion dollars of federal debt is necessary money supply that will not have to be paid back. Even if I am totally wrong, it cannot expand forever, and continued expansion is necessary for that to happen, thus peak-oil and the current monetary system cannot coincide


Your mixing oranges and apples. Yes, the money supply comes into existence through debt instruments issued by the US Federal Government but only those purchased by the FED create the money supply. In 2000, that was only 266 Billion USD. That will not be repaid, only rolled over. It will increase only as the FED sees fit to increase the money supply to match growth (at least we hope so, anything else is inflationary).

Whether the US can repay the 7.3 trillion USD is a separate matter and a serious one. That has to be paid out of future production and unless Americans forgo consumption (i.e. lower their standard of living) out of future economic growth.

$this->bbcode_second_pass_quote('', 'H')ow did the free money get into the system?


Well, in part from past monetary systems. Gold deposits were replaced with fiat money.

However, if you were starting from scratch, the US Treasury would issue bonds and sell them to the FED creating a credit in the Treasury's account(s). The Treasury would issue cheques in exchanges for wages, goods and services. Those cheques would be deposited in banks. The banks would in turn deposit the cheques with the FED, causing transfers from the Treasure accounts to those of the banks. Some of that will be withdrawn as cash by consumers, reducing banks' balances at the FED. Eventually taxes will be collected and funds will return to the treasury, which will in turn spend the money and the cycle thus continues. If enough funds were disbursed in the first cycle to cover all transactions, there would be no further need for the FED to purchase more Treasury bonds. However, if savings are invested and/or the economy grows (and the FED doesn't prices to deflate) the FED will purchase more Treasury bonds. That is, the Treasury will pay its expenses by creating new money (in exchange for bonds) rather than from income.

Note that when I say "cover all transactions" that means only the net of daily exchanges. Remember, every dollar is spent many times over. Only the residual, a float if you like, must exist as money (bank deposits and currency).
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