Why the Global Economy Is Such a Good Indicator
Among other systems-related factors, the economy is what all of us actually experience on a daily basis. The very first signs of collapse will be felt there. Long before we watch sea levels rise dramatically, long before even Republican nut cases like James Inhofe admit that the weather patterns are due to human-induced climate change, we will all feel the impacts of collapse through the economic conditions of life. Our jobs, our incomes, even our ability to find food on the grocery store shelves or gasoline at the pump, will all be subject to seismic shifts of unpredictable magnitude and direction. The vectors of change in everyday life will be chaotic at best. So it is probably a good idea to try to grasp the big picture of what is happening in the global economy.
As I was writing this piece a very important report came out of the FEASTA (Foundation for the Economics of Sustainability) group by David Korowicz titled: Trade Off: Financial system supply-chain cross contagion - a study in global systemic collapse. QE commentator Mark N. had posted another link to this work in a comment to the previous blog. If you have a limited amount of time and have to choose between reading my thoughts below versus reading this report, choose the latter! It sums up a lot of what I was planning to say about the economic system (focusing somewhat on the supply chain criticality) and the role of the financial subsystem in keeping this system afloat. He tackles the problems using the systems approach so actually captures everything I might have to say about the situation. Even if you decide to read my ramblings below, take time to read David's very important work.
What we both have to say is kind of simple. If the financial bubble bursts, the economic system comes crashing down and that will result in massive destruction to the globalized, interdependent world. We will leave a lot of oil in the ground, as it turns out, simply because we cannot get over the most driving aspect of economic activity. We won't do anything unless we can see how it produces a profit in the short term. “We” means everybody (well, perhaps except for the most sapient beings who actually can see into the future).
The Financial System is a Key Subsystem within the Global Economy
The reason I first chose to focus on the financial subsystem was that it is pivotal to many other aspects of the global economy. That is, the financial system forms a nexus through which every other aspect of economic activity must pass. It is a king pin for the economy and the bowling ball is headed right for it.
Now I want to step back (or perhaps I should say go to a higher elevation) and take a look at the larger system and see how the financial subsystem affects the other subsystems that constitute the economy. We need to map out (even if roughly) the other major subsystems in the economy as well as consider what we consider the boundary and interfaces of that system with other relevant systems, both human-centered, and with the Ecos as a whole.
First, though, let's consider the current views on the economy and what people believe drive it in being the engine of our wealth and well being.
Growth is Good (Not!)
What do most people mean by a “healthy” economy? Of course they mean a “growing” economy. Growth of national and global gross domestic product (GDP) is the sine quo non of economic health in the vast majority of people's eyes. The principles that apply are self-obvious, after all. In a growing economy there is an expansion of production that leads to job creation. People with jobs receiving living wages are able to buy the stuff they need which reinforces the growth. As long as there is continuing growth in the population, there will need to be growth in the economy to sustain everyone getting jobs and living decent lifestyles. It is obvious.
What everyone agrees on today, both conservatives and liberals, for example, is that the economy is in trouble. It is not growing (or growing rapidly enough) to be healthy and create those jobs. Of course parties from both extreme positions politically have differing views on what is causing this lack of growth, but they at least agree on the symptoms.
It is ironic, though, that the very thing that everyone is just so sure is the cure to the problem, growth, is actually the cause of our predicament in the first place. Economic growth at a time of approaching limits of critical resources is exactly the opposite of a healthy economy. The economy is entering a phase, a permanent phase, of on-going contraction that no one will be able to halt with any conceivable fiscal or monetary policies. In the end they won't even be able to slow the contraction down after it builds momentum.
To be clear about what I mean by growth let's consider the diagram I used in the last Watching blog, reproduced here.

Figure 1. From the blog post What Am I Watching?, this represents an economy that is growing. The relevant particulars are the import of raw materials and energy, work done on the materials to produce assets and the eventual decay/consumption of assets to produce wastes. The Ecos is represented by the open rectangles, which are sources of resource and sinks for material wastes. Energy waste - low temperature heat - is transported to space. Money is the method for communicating the “value” of assets in the economy. In this model the history of growth in assets, especially in the surpluses, creates an expectation of growth continuing in the future that allowed the creation of credit-based borrowing or the creation of money that is not actually backed by real assets. That increase in money, however, acts to speed up the production of assets as long as the inputs of resources can keep up.
In this model of the early economy an accumulation of surplus assets (e.g. grains in a granary) could be used as an investment in producing yet more assets. This is the basis of physical growth but also true economic growth. The physical size of the economy, including the biomass assets of our selves, grew proportional to the rest of the Ecos, which has remained essentially fixed in terms of total biomass and materials. The driver for this system is energy flow from the sun through the system, doing constructive work, to deep space as waste heat. We don't see it in this model, but as the size of the system increases, the complexity of the assets also increases with technological and social developments. Thus growth and complexity go hand-in-hand. In fact, increasing complexity seems to be a consequence of solving the problems resulting from growth, e.g. developing more complex farming practices in response to a growing population's demand for more food.
As I suggested in the last blog about financing, initially the borrowing practice, called investment, was from the existing surpluses, from savings. For the majority of the history of banking this has been the case with the exception that fractional reserve banking (as long as it didn't get out of hand) provided a form of borrowing against future, presumed to yet be produced, assets rather than existing assets. This was made possible by the use of money, which became an abstract representation for assets, either real or to be realized. The problem with fractional reserve banking is that it artificially expands the money supply, which in turn can be interpreted as an expansion of the asset base. As I said, as long as this practice was constrained by prudence and there was always an ability to find and utilize a surplus of energy and raw materials this did not seriously hurt anything. Indeed it was probably a catalyst for progress. That was the birth of financing.
Once, a long time ago, growth in the asset base for humanity was good thing. Those assets made it possible for humans to lead increasingly less dangerous lives. They gave humans more time to contemplate both their navels and the Universe. The surplus allowed a few bright individuals to construct more sophisticated ideas about how the world worked. In turn those ideas helped develop better assets and more surplus. Our clever species had transcended a boundary that life had been constrained by since its inception. The reduction of risks by our agriculture and technology meant that we were no longer as subject to the whims of nature as our predecessors and all prior living things had been. Growth in population was also a good thing when we were a rare species. With more people there is more variability in the gene pool and more opportunities for more clever individuals to emerge, which they certainly did. As noted above, with growth in assets comes increase in complexity. And that too was a good thing. Complexity, such as trade relations in neighboring villages, at some level leads to increased flexibility and resiliency. Living cells are the paradigm model of just the right amount of complexity. They are unimaginably complex in some ways (as our biology continues to discover), but not too complex in the sense that they become subject to the costs of complexity. Nor does their complexity increase until they suffer the law of diminishing returns on increased complexity, ala Joseph Tainter's hypothesis regarding human civilization collapse. Cells have evolved a high degree of variation in the exact forms of complexity they possess, but not in the level of complexity.
In the course of evolution of life on Earth, single celled organisms did not grow beyond a biophysical limit, nor did they increase in levels of complexity. Instead they started doing something more interesting. They started to aggregate and cooperate — they auto-organized to form multi-cellular clusters that took on a life cycle of their own. Different kinds of cell clusters would become competitive with each other. That is what gave rise to further evolution right up to the present. But cells, individually, remained at the relatively low level of complexity (and size) leaving the further development of higher complexity to the emergent multi-cellular organization.
The human economy has had a similar emergence of a new level of organization that could accommodate increases in complexity. The “firm” or production organization has acted as an analogue to multi-cellular organisms, allowing new forms of complexity to develop. Civilization has acted as a yet higher level of organization allowing firms to interact in both cooperative and competitive ways. But civilizations were still fragmented and semi-autonomous entities, much like multi-cellular life forms in a larger environment. They also competed and cooperated. But now comes globalization, the advent of a new level of organization for the whole globe. Only now there is no larger environment to occupy. There are no other globalized civilizations with which to compete and cooperate. And, wouldn't you know it, this all comes about just at the time when we have reached a depletion limit on our main source of energy, the source that allowed this growth and development to reach the level it has. We are starting to experience a decline in net energy from fossil fuels. Growth and increasing complexity are no longer options.
Economic Reality 101
It is hard to believe that universities give people PhDs for learning how to ignore reality. That seems to be the case in economics and political science. These “soft”, social sciences have no use for physics, chemistry, and biology. They have everything important to say about political economy wrapped up in neo-classical economic theories. And those theories require growth to continue no matter what. Indefinitely into the future. Infinite growth and development. After all, we humans have transcended the laws of physics, haven't we?
The economists, the politicians, and the sycophant media are still telling us that a healthy economy is a growing economy. In one perspective that is true. And that perspective is the continuing wanting of more stuff. More stuff (assets, whether useful or not) represents wealth and everybody wants to be more wealthy as time goes on. We want to grow. Ergo, growth must be good.
But rather suddenly, seemingly, we are faced with a reality that imposes on the nice neat picture that neo-classical economics has painted. It turns out we are subject to the laws of physics after all. And one of the laws of physics, the conservation principle, states that when you use something at a rate faster than it can be replenished, you tend to deplete the stock! Who knew? Economists had worked very hard to convince themselves and everyone else that in a market-based economy as a resource became scarce and more expensive, we would simply find substitutes at lower costs and get on with things, business as usual. They had never heard of Leibig's law of the minimum, which says there is some critical resource that is needed in every dynamic system that will regulate that system, especially if the dynamic is growth. That is biophysical reality and remember, economists don't worry about physics (or reality).
Here is a similar graphic to Figure 1 above. It has been modified to show two explicit realities that no one in the powers that be, (PTB) seems able to come to grips with. First the bubble inside the money bin is all of the hot air “money” that doesn't actually exist. Or rather it exists (printing presses and bank accounts go nuts) but doesn't represent anything real, not usable assets or asset surpluses. It represents, strictly, an expectation that something real will be in place some day in the future to fill the same space. This is the collective debt that we have created to make it look like everything would be just fine. Note that it feeds on itself. This is the Wall Street players paying themselves huge bonuses for keeping the smoke and mirrors preventing the rest of us from seeing what is really happening. That is a good trick. But it is just a trick. And unfortunately it is tied into the real investment loop that keeps productive work going.
The problem is that productive work can only be accomplished if you have adequate resources to work with. The advent of peak oil is a wake up call telling us that resources are not infinite. Peak oil by itself is not the central problem, but it is sounding an alert that should get us looking more closely at what the real problem is. And that is that because of diminishing returns on energy extraction (EROI) we are able to put less net energy back into the real economy. We thus can do less real work and produce less real goods and services. Everyone is getting poorer without seeming to really understand why. In a similar vein, some critical material resources are depleting so that it takes increasingly greater amounts of energy to keep up the same extraction flow rates. It takes more work to get the same metal out of less concentrated ores.
And there are no substitutes for high powered energy and low entropy material resources. The alternative energy technologies are just not up to the capability to produce the same substantial power that fossil fuels have provided. They may work OK to run a greatly reduced economy, some day, but they will never be able to provide the energy needed to run the current level of economic activity. So between the decline in net energy from fossil fuels and the low power production from alternatives the economy has nowhere to go but into contraction.

Figure 2. The economy after the on-set of declining resources will necessarily contract. Our current situation is that our expectation of continued growth of asset surpluses will continue into the future. We have created a financial (debt to be paid in the future) bubble in our monetary system that continues to skew decisions about investments and profit potentials.
Social Effects of Economic Contraction
The Great Depression of the 1930s is going to look like a cake walk. It wasn't WWII that brought the US out of depression as is generally believed (by who else but economists). That activity only acted as a trigger to spur the work fueled by more abundantly available fossil fuels. We had energy to waste, so waste it we did. The war put people to work, to be sure, building tanks and bombs (the ultimate in a consumption economy!). And once the energy flow infrastructure was in place in support of the war, then when the war ended there was abundant energy to do whatever else we wanted to do. And what we wanted to do was have fun, at least in the west. The eastern world had slightly different priorities and a different way of doing things (communism as it was practiced there) but they still wanted to go on wasting energy on creature comforts and weapons to dominate world politics.
The point is that the Great Depression came to an end and just about everybody believed it would some day. Remember Franklin D. Roosevelt's famous fear speech? There was never any doubt that good times would return one day. And sure enough after the war, the economy started growing again and there were all kinds of jobs. The recovery was a confluence of wartime inspired technological magic and the sheer volume of fossil fuels that were cheaply available. The economists put in their two cents. The Keynesian economists had been arguing that government stimulus (pump priming) would spur economic growth to the point that any debt incurred by the government would be more than paid back by the growth of the economic engine in the future. It did seem to work, didn't it?
So the whole notion of a deep recession or even a depression, while painful in the short run, never really bothered economists (it bothered incumbent politicians) because they were so sure that the end would come and that in the long run the economy would produce wondrous results for all of society if we just didn't constrain the markets too much, or from a libertarian point of view, don't encumber the markets at all!
The world is currently suffering a major economic slowdown if not outright recession. It varies in intensity in different parts of the world. China says it's doing OK for now, but word leaking out from civil society there tells a different story. The EU is suffering major problems in some members that threaten the very existence of the Union but more immediately could spell major economic problems as the financial system there is unable to compensate for past excesses in those few members. The US is probably best described by the word malaise. Of course for those long-term unemployed who have essentially given up on working an honest job for a living wage it isn't malaise, it is depression already. The prospects for getting out of these economic doldrums are looking more bleak every day. Even economists are starting to take precaution when predicting future growth. Not a small number of economists as well as the common sense man/woman on the street have started feeling that there is something very fundamentally different about the current situation as compared with prior recessions and the Great Depression. No one sees any way to get out of this.
That is for a very good reason, unfortunately. There is no way out. Declining resources, especially net energy to do economic work, is the controlling factor now. Decline means decline, period. We are all part of biophysical system that requires energy to do anything. If the energy flow declines the work declines. The wealth generation (real asset production) declines. Everyone has access to less and less in terms of material goods and services. This is so stupidly simple that it continues to confound me how supposedly intelligent people in government and academia just can't grasp it.
Of course they will grasp it eventually. Unfortunately it will be too late to do anything constructive about it. Actually I think it is already too late. Contraction, unlike unfettered growth, requires careful planning and execution of logistics for managing that contraction with the least pain possible. And our brilliant leaders (thought and political) have already blown it. Planning takes time and knowledge. They put off opening their eyes so long that we now don't have the necessary time. And, to be blunt, I doubt that they will ever have the kind of knowledge needed to develop plans. Thus, I'm afraid society will react to the acceleration of the contraction that is already underway as most societies in the past have reacted to collapse.
Preparations
The only thing that anyone might do to prepare for the economic collapse is to collect a complete set of tool assets that will allow the production of food, shelter, obtaining water, etc. in the future. Of course I am talking about hand tools, not power tools! The principles of biophysical economics are the same they have been since the very beginning of human commerce (my arrow heads for your corn). Future economics will work the same way. Humans need not give up completely and revert to hunter-gatherers in small extended family tribes. But they will have to adapt to a world without fossil fuels or big high-tech wind turbines.
The big unknown will be what happens in society while the contraction is gaining momentum. The one thing you can say for sure about chaos is that just about anything that can happen will happen. There is no way to predict the details in advance. So the only advice I can offer is to use your intelligence as best you can to put together your survival kit (including any community you want to be part of), situate yourself somewhere you think might be hidden of at least defensible, and keep attuned to local signs and conditions. In the end, almost nothing you can come up with is a guarantee of success. Thus my real recommendation is just be prepared to adapt as the situations change. Or be prepared to depart for another location if adaptation is not possible.
This is an appeal to the laws of statistics! If enough people try enough different approaches a few are bound to work.
Economic Predictions
Of course prediction is a fools game, which is, I suppose, why economists and politicians play it. But let me try my hand at constructing a likely scenario. It's actually not too hard. I started with the financial subsystem because that looks the weakest to me. Many kinds of forces are poised to prick the bubble and bring the house of cards down. But what will happen when that bubble bursts is pretty clear. Our economy is utterly dependent on debt-based financing to keep things going. When it dawns on everyone that those debts of yesterday will never be paid back let alone servicing future ones, financing will simply crumble. And when that happens everything else will follow (see Korowicz's report linked above for a description of the interplay between the financial system and supply chains). One of the most critical victims of this domino effect will be the energy supply industry. It takes a lot of money to discover, drill, pump, and refine oil. It takes a lot of capital to extract coal. And frac'ing ain't free. The extraction industries are super dependent on the financial system to keep them in business and once the financial system crumbles the necessary cash infusions will evaporate. No more energy, no matter what price. I suspect that national governments will, at some point intervene, not by bailing out the multiple times failed financial institutions, but by nationalizing the energy sector. One good argument for doing so is that of national security. It takes a lot of energy to run an army and navy. The US DOD is already investing a lot of research money into alternative sources of energy for operations. When they ultimately discover that the Second Law of Thermodynamics has not yet been repealed they will put pressure on Washington to take over the fossil fuel industry because the profit motive won't be working any more.
It takes energy to pump water. It takes energy to keep homes and buildings warm or cool in temperate climates. OK, you can forego the cooling maybe, except that pesky thing about global warming causing severe heat waves and droughts (already underway, thank you Jim Inhofe et al). It takes energy for everything we do. We can't even sleep without expending energy. So look for severe energy rationing as the military takes charge of the supplies and meters it out stingily to the populace.
The financial system will never recover. It started with savings of surplus grain and that is all that we will have in the future, if we are lucky. Debt financing is over or soon will be. There might be localized surpluses under the protection of a few war lord types ala Jim Kunstler's vision in his novels (World Made By Hand). But there will never be the kind of borrowing against future surpluses because everyone is going to finally get that there will barely be enough productive work done to maintain current assets let alone produce future surpluses (one caveat to this is that if the population undergoes a tremendous downsizing there will be a temporary surplus of lots of stuff, but without the energy to maintain it, it too will decay away - no surpluses last for that long.)
When You Watch the Economy
Unless you know how to sift through tons of economics data, your only real access to a view of the economy, unfortunately, is through the main stream media. And the problem with that is that they simply don't have a clue. The best advise I can give here is that you keep track of a few relevant trends. Your can't always trust the raw data reported, such as the jobless rate, or jobs created rate, etc. But what you can do is track the number of times those numbers advance or decline over time. You can even keep track of the amount of advance or decline and then do a form of weighted averaging over time to smooth out the noise. What you will find is that declines outnumber (and outweigh) advances, in measures where a decline signals bad times such as jobs creation, over time. The opposite for data where advances are a bad thing, such as number of unemployed workers.
Another thing to keep an eye on is the number of times some economist or media type grasps onto the slightest bit of seemingly good news. Two years ago these folks were happy as hell when there was the slightest up tick because they just knew that there had to be an end to the economic woes and so these early signs showed that we would recover soon. Today, not so much. Many more economists are warning that we should approach such up ticks with caution. Who knows maybe they are developing a bit of wisdom after all!
Another major trend I am watching in the economy is the number of fraud events that are taking place in our most venerable, historically strong institutions. Mostly now we are watching this drama in the financial industry but it wasn't that long ago we were aghast at the shenanigans at Enron and the demise of Arthur Anderson Accounting as a result. Many big corporations were cooking the books and there probably are still many more doing the same. Get what you can while the getting is good. As people who have access to more detailed information about profits and such get increasingly panicky you can expect to see much more of this, if they get caught. Governments are increasingly strapped to provide investigation or enforcement so there is probably a lot that is going to go under the radar.
Then, of course, there is the jobs situation. The kinds of jobs that are available are increasingly low paying types. Or some previously higher paying jobs are being downgraded because, lets face it, it is a buyers market (corporations are the buyers!) Sooner or later the governments are going to have to take some action on this and it doesn't matter if the Democrats or Republicans are in charge. Only another Nero would ignore the powder keg conditions when a significant proportion of young people are out of work. Actually the news coming out about Romney's tenure at Bain Capital suggest he might just be another Nero. Great choice the Americans have in November, a well meaning but clueless incumbent or a would-be King Louis XVI (see: French Revolution!) Good luck with that.
Let me depart on a somewhat positive note. I've been noticing the number of news items about neighborhood organic gardens and yard gardens have been increasing. The indication is that more people are doing what I've been doing for a few years, converting more and more ornamental planting areas to food plants. I'm locked into my house for a number of sensitive reasons. But I do what I can. The reason this is positive is that people must be sensing that they will need to take charge of their destiny somehow. And they are practicing for self-reliance which is probably going to be the key to riding the economic roller coaster as it passes that first big peak. I'm trying to make sauerkraut this year! Wish me luck.