How might we face economic contraction?

Suppose the peak oil predictions are even a little bit on target. The peak of oil production may have already been reached. We are most assuredly in some kind of world wide production plateau at very least. The issue is really even larger than oil, there will be a peak in all fossil fuel production in the not-too-distant future even while the aspirations of a growing population drive them to seek the same energy-intensive amenities enjoyed in the northern/western societies. But we can look at the peak in oil production as a harbinger of things to come. Oil is, after all, the most useful (say for transportation), dense energy sources ever discovered. Our entire economic infrastructure and most products produced within it, are directly tied to oil in one form or another. As production peaks, and then declines, the energy basis that drives our economy will diminish in quality and quantity, and therefore we will experience a contraction in real wealth production in the future.

Exacerbating this scenario will be the need to increasingly adapt to climate change. We are still trying to understand what climate change means in a warming world. Of late the variation in weather anomalies and extremes in temperature, storms, and the like, have given us reason to believe that much of our infrastructure will be put under tremendous stress as the climate system adjusts, or, conceivably, switches abruptly to a new dynamic attractor regime. Visions of having to relocate millions, possibly billions, of people from costal zones due to rising sea levels are starting to haunt even the most insistent deniers (though, of course they will deny it!) Imagine what it will take to move large portions of New York City, or what it would take to build dikes around it. If these scenarios play out, more and more energy will need to be diverted to accommodation of the climate and in a world of diminishing energy that means taking away even larger amounts of energy previously used for consumption.

It is now easy to picture the world situation in just a few years. Energy available to do useful work will begin to decline (many feel it is already in decline and we are just now begriming to realize it). As this happens we will see one of two possible scenarios play out depending on how we view the role and purpose of money. From my previous blogs on the alternative view of economics, based on the field called ecological economics, where money should be pegged to an energy standard, you might guess that I think there are serious consequences of not realizing this reality as we go forward.

The simple fact will be that as the amount of available energy per unit of time diminishes less real work can be done and the economy will contract. We will reverse our historical trend to grow in pseudo-measures such as the GDP and enter what is effectively a depression, by former definitions. How will we perceive this contraction? What will life be like in a permanent decline of real wealth (at least until we reach a level of population and energy input that can sustain a steady-state economy)?

As an aside, for those of you who still believe that the magic of technology will somehow rescue us from this notion of permanent decline, say by the discovery of some wonderful method of converting solar energy into electricity and fuel, try to remember the lessons learned from ethanol production. Sustainable energy sources will certainly be in the future of humanity, but the level of production of energy available to do useful work will never come close to what we have enjoyed with fossil fuels. I will try to get back to this subject in the future, but for now please try to recognize that the scale of the problem and the concentration difference between the energy in fossil fuels vs. what is available in real-time solar influx make it essentially physically impossible to replace fossil fuels with solar (PV, wind, hydro, etc. are all forms of solar energy). Even if fantastic breakthroughs in technology were to come about, the shear amount of time that it would take to deploy these technologies would mean they would not take effect for several decades. Then, on top of that, note that the manufacturing and bootstrapping of these technologies would most surely be leveraged on fossil fuels. These are just a few of the reasons that believing that technology will rescue us and keep our current lifestyle in play are simply delusional. Sorry.

Now consider scenario 1 — business as usual —, we do not tie money to available energy so that the amount of money in circulation, in all of its various forms (M1, M2,...), is independent of the work that can be accomplished and, by the standard definition of money, there will always be more actual paper and derivative monies than the available energy warrants. Under this scenario we get exactly what we have now, inflation. Since, according to my claim, the underlying value of money is energy, then each unit of money will have less and less value for representing useful work. Thus it will take more units of money to buy the same unit of work. That, by anyone's definition, is inflation.

Simultaneously, as things become more expensive, individuals will not be able to afford stuff they previously bought in the consumer-growth economy. As the aggregate spending of millions of former consumers diminishes, sales will go down. And the inflation affecting consumers will similarly be felt by businesses that are compelled to protect their bottom lines. We all know what happens when sales diminish and costs increase. People lose their jobs. But unlike previous business cycle downturns, this one is caused by reduction in energy for doing work. There is no recovery phase. Businesses close and no new jobs are ever created. Self-sufficiency will come in handy.

In the second scenario let's assume we find a way to peg money to energy. In this scenario as energy diminishes over time, so does the money supply (and there are no Mxs beyond M1). The costs and prices of the market are determined by the actual work accomplished so prices will tend to stay the same except that they may rise to reflect increasing scarcity while demand remains. In this scenario the economy is still impoverished because there is less work that can be done. The main difference is that prices more realistically reflect underlying value and hence individuals will be able to make much better decisions in how they use what cash they have. The markets will be providing much more meaningful information to buyers and sellers allowing them to make decisions on what to purchase and what to produce under the constraints of reality.

Of course in both scenarios people will have less because there is less to have. It takes energy to produce stuff and supply services and that energy will become increasingly costly in the real sense. Under scenario 1 everything price inflates, meaning no one will know what anything is worth. In scenario 2 only the price of energy will inflate precisely because it takes energy to get energy and as extraction becomes more difficult, takes more energy to accomplish, the net energy will reflect that increasing price. The monetary system will be giving good signals about the state of the economy.

Admittedly none of this is particularly promising. The decline in energy availability will hurt no matter which way we go. The main difference is that in scenario 2 we will be guided by true information rather than distorted signals. It would be much easier to make decisions about how best to spend what money you have than to guess what the price of something means. In the latter case we might find ourselves buying cheaper goods only to find that their long-term value is worthless.

But I suspect there is an even greater advantage to having an energy-based monetary system. Each of us will have to make decisions about how we apply our skills and knowledge, essentially what we will do for a living. Making such decisions now is a crap shoot. It is probably safe to say that most jobs in our modern 'service' economy do not actually create more useful energy or operate to make better use of what we have. Most people end up using energy without actually contributing to a net gain (or preventing a net loss) in future useful energy. But jobs like that will become more highly visible if money tells us about energy availability. Value would be placed on jobs that contribute to net energy. Historically discounted jobs like farming and teaching would, I suspect, gain greater caché with the unveiling of how this work actually makes us energy richer. Jobs in retailing consumer goods will almost surely disappear. With exposure to the energy flow economy and the value of increasing net energy (through either production or, more likely, conservation and efficiency) through certain kinds of work, people could have better information about what kinds of jobs would be most valued by society. In a contracting world I suspect the value of a game programmer will not get the support it has today.

I wish I had a more hopeful message to deliver. But the reality is that baring a virtual miracle we are heading into a contracting economy. Our capacity to adapt to conditions of such a contraction (only known in a few local economies historically, but now to be played out on a world-wide scale) depend heavily on an ability to see what is happening. We need accurate and truthful information in order to make rational decisions. Under the current regime of money = ?, how will this need be met? Under the scheme whereby money = energy, recognizing that all work can be better represented thus, we would have the information, even if it is distressing, that we would need to decide our actions. Which would you prefer?

Comments

[Russ]

George, I think this is your best post yet(in the brief time I've been visiting this place), and I'm not just saying that because it so appeals to my eschatological sensibilities. :)

This makes the money-pegged-to-energy concept, previously rather abstract, more clear because it's displayed in concrete examples - its relation to compensation for specific jobs.

I still wonder, though, about supply-demand in this wage system. On the one hand, while I can see how a skilled farmer (at least the "engineers" of farming, whatever one calls them) could be highly compensated, and I can see (and certainly hope) that a game programmer would have to dig for grubs, I'm not sure about teachers having much more value. This is because, at least in my experience, teachers are simply not very high-quality people (I shudder to think of the "education" majors I knew in college), and in this future, harsher world, with so many more people seeking fewer non-manual jobs, I should think the competition for each teaching slot would be ferocious, while the skill level needed is simply not very high.

Of course, I'm still thinking in terms of the rotten educational system we now have. Maybe you were picturing something radically different. (On that subject, I started reading your essay on education you linked to some time ago. I didn't get through much of it yet but have it bookmarked. It starts out promisingly, though.)

[George Mobus]

Thanks Russ.

I do indeed foresee a very different kind of education in the future. I would hope that education starts to mean preparing people to live in a steady-state economy, where their work consists of helping capture more of the raw energy inputs to make them available to society or building tools to increase efficiency, etc.

Not all work will be directly about energy. I still think we need the arts, literature, music and all of those pleasures that rejuvenate our inner selves. In an ideal world the energy workers will create a sufficient excess to support a balanced life for everyone instead of more playthings for the ever increasing population.

But that is yet another story!

George