EC The World’s Weird Self-Organizing Economy

Figure 2. The author’s view of the analogy of a speeding upright bicycle and a speeding economy.

A bicycle needs to operate at a fast enough speed (about 7.5 feet per second), or it will fall over. Similarly, the world economy needs to grow fast enough, or it will not be able to meet its obligations, including repayment of debt with interest. If the economy grows too slowly, debt defaults are likely to grow, pulling the economy down.

[7] It looks like it should be possible to work around energy problems with improved technology, but experience suggests that this approach represents only a temporary “fix.”

There are two issues that make improved technology less of a solution than it appears to be. The first is diminishing returns. For example, if a business faces a choice between (a) paying a worker to perform a process and (b) adding a machine to that can perform the same process, the business will tend to make the changes that seem to provide the largest cost savings first. At some point, as more technology is added, capital costs can be expected to become excessive relative to the human labor that might be saved. The issue of the diminishing returns to added complexity (which includes growing technology) was pointed out by Joseph Tainter in The Collapse of Complex Societies.

The second reason why added technology tends to be only a temporary solution is because it tends to lead to wage disparity. Wage disparity has a tendency to grow because of the greater specialization and larger organizations needed to coordinate the ever-larger projects. The reduced purchasing power of those at the bottom of the hierarchy can eventually bring an economy down because it can lead to commodity prices that are below the level needed to maintain the extraction of fossil fuels. Fossil fuels are required to maintain today’s economy.

[8] Renewable energy has been vastly oversold as a solution. What is needed is an ever-increasing quantity of inexpensive energy in forms that match the energy needs of current devices. 

The wind and solar story is far different from the story presented in the press. Essentially, wind and solar are extensions of today’s fossil fuel system. The evidence that they are truly beneficial to the economy is shaky at best. We know that if energy sources are truly transferring significant “net energy” to the system, they generally can afford to pay high taxes. The fact that wind and solar require subsidies raises questions regarding whether standard calculations are providing accurate guidance. The press rarely mentions the high tax revenue that high oil prices make possible, worldwide. Tax revenues largely support many oil exporting countries.

Furthermore, the share of the world’s energy supply that wind and solar provide is very low: 1.9% and 0.7%, respectively. They are shown in the almost invisible blue and orange lines at the very top of Figure 3. Fossil fuels contributed 85% of total energy supply in 2017.

 

Figure 3. World energy consumption divided between fossil fuels and non-fossil fuel energy sources, based on data from BP Statistical Review of World Energy 2018.

[9] The world economy becomes very fragile as energy limits approach.

Energy limits seem to be affordable energy limits. Oil prices need to be high enough for exporting countries to obtain adequate tax revenue. In addition, oil producers need prices that are high enough so that they can make the necessary reinvestment, as fields deplete. At the same time, energy prices need to be low enough for consumers to afford goods and services made with energy products.

Much of the developed world’s infrastructure was built when oil prices were less than $20 per barrel, in inflation-adjusted terms. A rising price of oil will lead to a higher cost of replacing roads and pipelines. If these were built using $20 per barrel oil, even a current price of $40 per barrel would represent a significant cost increase. The world has experienced high oil prices for sufficiently long that we have collectively forgotten how low oil prices were between 1900 and 1970.

Most people know that the earth holds a huge quantity of energy resources. The problem is extracting these resources in a way that is both affordable to consumers and sufficiently high-priced for producers. Falling long-term interest rates between 1981 and 2002 allowed the world economy to tolerate somewhat higher oil and other energy prices than it otherwise could because these falling interest rates permitted ever-lower monthly payments for a given loan amount. For example, if interest rates on a $300,000 mortgage would fall from 5% to 4% on a 25-year mortgage, monthly payments would decrease from $1,753 to $1,584. The lower interest rates would allow more people to buy homes of with a given size of mortgage. Indirectly, the lower mortgage rates would permit additional new homes to be built and would allow more inflation in home prices. These benefits would at least partially offset the adverse impact of high energy prices.

Since the natural decline in long-term interest rates stopped in 2002, the world economy has become increasingly fragile; the Great Recession took place in 2007-2009 when oil prices spiked and long-term interest rates were already low by historical standards. It was only when United States’ program of quantitative easing (QE) was put in place that long-term interest rates could fall to even lower levels, helping the economy hide the problem of high energy prices a little longer.

The artificially low-interest rates made possible by QE have problems of their own. They tend to inflate asset prices, including both real estate prices and stock market prices. Thus, they tend to create bubbles, which are prone to collapse if interest rates rise. Artificially low-interest rates also tend to encourage investment in schemes with very low-profit potential. Artificially low-interest rates also encourage cross-border investments to try to take advantage of interest rate differences. If interest rate relativities change, the money that quickly would enter a county can almost as quickly leave the country, causing major fluctuations in currency relativities.

Regulators do not understand the role that physics plays in making the economy operate as it does. They assume that they, alone, have the power to make the economy behave as does. They do not understand how important falling interest rates are in creating growing demand for goods and services. The economy, since 1981, has spent most of its time with falling interest rates; the most recent part of this decline in long-term interest rates has been made possible by QE. These falling interest rates have played a major role in disguising the world’s long-term problem of rising energy costs. These rising energy costs are taking place primarily because the cheapest-to-extract resources were produced first; the resources that are left are have higher costs associated with them, for a variety of reasons, such as being farther away from the user, deeper, or needing more advanced extraction techniques. These issues have not been sufficiently offset by improved technology to keep extraction costs low.

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Vivian Lewis 6 months ago Contributor's comment

in energy statistics the past is prologue but doesn't determine outcomes. as technology improves developing countries CAN get electricity without carbon, for example in countries with lots of sun. We have a pick in India. And in western countries too even with oil prices falling it is not hard to fine alterrnative energy plays.

Moon Kil Woong 1 year ago Contributor's comment

Actually the world needs a cheap, dense, and hopefully safe electric energy storage system more than anything else. This would solve a lot. For energy production, the big hope is geothermal and/or fusion although modern nuclear power plants are much safer as well. Solar helps as does wind energy, but it won't solve our growing energy needs, especially without a dense efficient way of storing it.

Gary Anderson 1 year ago Contributor's comment

I would not feel comfortable having nuclear power close to earthquake faults. Maybe it is just me. But there are other alternatives, but as the author says they are not necessarily enough to bridge the gap. So, energy affordability and proper pricing is very important to the economy. Americans are buying expensive large vehicles more and more. This could squeeze energy in the future.

Vivian Lewis 1 year ago Contributor's comment

there are circumstances in hot developing countries where solar energy off the grid doesn't require subsidies. Where the background is right the same is true of wind power or tidal energy. In places like Iceland and Kenya geothermal power makes sense. It is wrong to assume that these alternatives to oil and gas won't grow more important. And I happen to think nuclear power also often is a suitable option.

Gary Anderson 1 year ago Contributor's comment

Yes, nuclear may have its place. I just happened to be on the middle of a major earthquake out west and on the edge of another one. I think they should be avoided where the ground won't stay still.

Vivian Lewis 1 year ago Contributor's comment

Moon Kil Woong is right about the need to have a storage system for intermittant power like solar or wind. The sun doesn't shine for 24 hours and the wind doesn't always blow. I have a stock for this but it is a long-shot, a geothermal company from Nevada which also is developing storage systems, Ormat, ORA. It is not a global-investing.com pick because it is a US firm, and moreover its share has been beaten down over the volcanic eruption in Hawaii just down the road from its shut-in geothermal power plant. I take a long view.