While the world’s best brains work furiously to alleviate the current financial crisis by employing all sorts of monetary and fiscal measures — tending to the liquidity nature of the problem — Michael Lardelli, posting on Australia’s ‘Online Opinion’, proposes a refreshingly different problem solution.
Notably he doesn’t blame liquidity or credit for the crisis at all. Rather, he says, it was declining global energy resources that were to blame for all our ails.
Bear with us, his reasoning is pretty convincing. First, consider Lardelli’s following point (our emphasis):
No living or manufactured thing exists on this planet without energy. It enables flowers and people to grow. We need energy to mine minerals, extract oil or cut wood and then to process these into finished goods. Without energy the goods would not exist so we can think of each product as containing “embodied energy”. So the most fundamental definition of money is that it is a mechanism to allow the exchange and allocation of different forms of energy. The economy is energy.
Quid pro quo, if the most important source of energy is hydrocarbon-based, sharp fluctuations in hydrocarbon supplies will always have an effect on the economy.
As Lardelli explains:
Until recently (about 2005) the world economy was growing. The number of people has been increasing which requires increased production of food, clothing and shelter – the basics. On top of this, many of us have been using more energy than previously – to travel farther, eat more food, buy additional clothes and enhance our shelters. Until 2005 we could expand our energy use to meet this demand. This is something we were able to do – with occasional interruptions – for the past 150 years. However, after 2005 we could not expand our energy supply. In other words we could not expand the world economy.
The important point being:
That is not to say that we did not try to expand the world economy after 2005. However, much of the expansion that occurred was an illusion. In many industrialised nations a great deal of “money” was created (by increasing the money supply and other means) but it did not correspond to an increase in energy use. This is illustrated by what happened in the USA, where the rate of money creation increased greatly after 2005:
Now, even though the Fed stopped documenting M3 money supply in 2006, others stepped in to continue the time series. Lardelli uses their data to complete the following chart:
The chart shows the extent to which money creation tried to compensate for falling energy production in terms of supporting global growth. The financial crisis, of course, proves to what extent it failed. What’s more, it proves a global shock via GDP contraction may have been needed to rebalance the world in preparation for scarcer energy resources.
You might ask, in that case, where is the associated spike in energy prices that comes with such a rebalancing?
Well, Lardelli feels that notion typifies the economic rather than the scientific view about the energy crisis. Economists, he says, believe scarcity leads to price rises, which can then encourage and pay for cheaper alternatives to be developed. In that scenario there is no limit to how much energy humanity can use.
That is not the ‘scientific’ opinion, however. As Lardelli explains:
If we view the economy as a thermodynamic system (since “the economy is energy”) we would say that a high energy price leads to the greater allocation of a society’s current energy production into the production of more energy. But there is a problem – the energy investment required for new energy production from mined sources increases with time.
Which means:
No source of energy will be exploited if the energy it yields is less than the energy investment required to exploit it.
This, unfortunately, is the situation that is currently materialising: the price of oil is falling below the break-even rate which makes alternative projects profitable — discouraging investment. Yet, international energy experts warn that a future energy crisis can only be avoided if the world invests in alternatives now. As Lardelli puts it:
The world’s energy production is now declining and the profitability of energy production is declining at the same time. This means that the net energy available to support activities other than energy procurement will decrease much faster than the fall in total energy production. We are approaching a “net energy cliff” that gets very serious when less than five units of energy are produced for each unit of energy invested.
The following chart via the Oil Drum blog shows the ‘energy return on energy invested’ quagmire well:
So how does one fend off a perpetual global contraction fueled by declining global energy production?
Well, Lardelli says nothing short of a wartime-esque programme will do the trick. Huge proportions of the world’s remaining oil energy simply must be diverted into building alternative resources like nuclear power stations and solar arrays as soon as possible.
Unfortunately, he thinks it’s unlikely that the right action will be taken in time:
…it would require large, voluntary reductions in living standards in the midst of a serious and worsening economic crisis. The immediate cries for help now (e.g. unemployment benefits, company bailouts) will outweigh any future possibility of improved living standards. Wartime crash programs can work because a nation’s population literally has a gun pointed to its head – the population fears death at the hand of the enemy. Energy decline can be just as deadly as any human enemy but, like climate change, its effects are slower and most people do not understand enough about energy to fear its loss.
Although, can we risk him being right about this?
Related links:
Energy is everything – Online Opinion
A commodity anchor, or oil as money – FT Alphaville
M3, where art thou? - FT Alphaville