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08-13-2009, 09:39 AM
Peak Everything: Temporary Recession or the End of Growth?

by Richard Heinberg*
13 AUGUST 2009

While mainstream economists base their diagnosis of the current economic shrinking on the visible part of the iceberg, Richard Heinberg sustains that what we are witnessing are the devastating consequences of oil depletion and the decline in earth’s resources in general. According to him, it is too late to prepare for Peak Oil–a year too late, in fact [1]. We are in an entirely new economic environment, in which old assumptions about the inevitability of perpetual growth, and the usefulness of leveraging investments based on expectations of future growth, are crashing in flames. Now the name of the game is adaptation and it is not too late to begin a managed transition to a post-fossil fuel society, provided we will rise to the challenge.

Everyone agrees: our economy is sick. The inescapable symptoms include declines in consumer spending and consumer confidence, together with a contraction of international trade and available credit. Add a collapse in real estate values and carnage in the automotive and airline industries and the picture looks grim indeed.

But why are both the U.S. economy and the larger global economy ailing? Among the mainstream media, world leaders, and America’s economists-in-chief (Treasury Secretary Geithner and Federal Reserve Chairman Bernanke) there is near-unanimity of opinion: these recent troubles are primarily due to a combination of bad real estate loans and poor regulation of financial derivatives.

This is the Conventional Diagnosis. If it is correct, then the treatment for our economic malady might logically include heavy doses of bailout money for beleaguered financial institutions, mortgage lenders, and car companies; better regulation of derivatives and futures markets; and stimulus programs to jumpstart consumer spending.

But what if this diagnosis is fundamentally flawed? The metaphor needs no belaboring: we all know that tragedy can result from a doctor’s misreading of symptoms, mistaking one disease for another.

Something similar holds for our national and global economic infirmity. If we don’t understand why the world’s industrial and financial metabolism is seizing up, we are unlikely to apply the right medicine and could end up making matters much worse than they would otherwise be.

To be sure: the Conventional Diagnosis is clearly at least partly right. The causal connections between subprime mortgage loans and the crises at Fannie Mae, Freddie Mac, and Lehman Brothers have been thoroughly explored and are well known. Clearly, over the past few years, speculative bubbles in real estate and the financial industry were blown up to colossal dimensions, and their bursting was inevitable. It is hard to disagree with the words of Australian Prime Minister Kevin Rudd, in his July 25 essay in the Sydney Morning Herald: “The roots of the crisis lie in the preceding decade of excess. In it the world enjoyed an extraordinary boom…However, as we later learnt, the global boom was built in large part…on a house of cards. First, in many Western countries the boom was created on a pile of debt held by consumers, corporations and some governments. As the global financier George Soros put it: ‘For 25 years [the West] has been consuming more than we have been producing…living beyond our means.’” [1] .

But is this as far as we need look to get to the root of the continuing global economic meltdown?

A case can be made that dire events having to do with real estate, the derivatives markets, and the auto and airline industries were themselves merely symptoms of an even deeper, systemic dysfunction that spells the end of economic growth as we have known it.

In short, I am suggesting an Alternative Diagnosis. This explanation for the economic crisis is not for the faint of heart because, if correct, it implies that the patient is far sicker than even the most pessimistic economists are telling us. But if it is correct, then by ignoring it we risk even greater peril.

Economic Growth, The Financial Crisis, and Peak Oil

For several years, a swelling subculture of commentators (which includes the present author) has been forecasting a financial crash, basing this prognosis on the assessment that global oil production was about to peak. [2] Our reasoning went like this:

Continual increases in population and consumption cannot continue forever on a finite planet. This is an axiomatic observation with which everyone familiar with the mathematics of compounded arithmetic growth must agree, even if they hedge their agreement with vague references to “substitutability” and “demographic transitions.” [3]

This axiomatic limit to growth means that the rapid expansion in both population and per-capita consumption of resources that has occurred over the past century or two must cease at some particular time. But when is this likely to occur?

The unfairly maligned Limits to Growth studies, published first in 1972 with periodic updates since, have attempted to answer the question with analysis of resource availability and depletion, and multiple scenarios for future population growth and consumption rates. The most pessimistic scenario in 1972 suggested an end of world economic growth around 2015. [4]

But there may be a simpler way of forecasting growth’s demise.

Energy is the ultimate enabler of growth (again, this is axiomatic: physics and biology both tell us that without energy nothing happens). Industrial expansion throughout the past two centuries has in every instance been based on increased energy consumption. [5] More specifically, industrialism has been inextricably tied to the availability and consumption of cheap energy from coal and oil (and more recently, natural gas). However, fossil fuels are by their very nature depleting, non-renewable resources. Therefore (according to the Peak Oil thesis), the eventual inability to continue increasing supplies of cheap fossil energy will likely lead to a cessation of economic growth in general, unless alternative energy sources and efficiency of energy use can be deployed rapidly and to a sufficient degree. [6]

Of the three conventional fossil fuels, oil is arguably the most economically vital, since it supplies 95 percent of all transport energy. Further, petroleum is the fuel with which we are likely to encounter supply problems soonest, because global petroleum discoveries have been declining for decades, and most oil producing countries are already seeing production declines. [7]

So, by this logic, the end of economic growth (as conventionally defined) is inevitable, and Peak Oil is the likely trigger.

Why would Peak Oil lead not just to problems for the transport industry, but a more general economic and financial crisis? During the past century growth has become institutionalized in the very sinews of our economic system. Every city and business wants to grow. This is understandable merely in terms of human nature: nearly everyone wants a competitive advantage over someone else, and growth provides the opportunity to achieve it. But there is also a financial survival motive at work: without growth, businesses and governments are unable to service their debt. And debt has become endemic to the industrial system. During the past couple of decades, the financial services industry has grown faster than any other sector of the American economy, even outpacing the rise in health care expenditures, accounting for a third of all growth in the U.S. economy. From 1990 to the present, the ratio of debt-to-GDP expanded from 165 percent to over 350 percent. In essence, the present welfare of the economy rests on debt, and the collateral for that debt consists of a wager that next year’s levels of production and consumption will be higher than this year’s.

Given that growth cannot continue on a finite planet, this wager, and its embodiment in the institutions of finance, can be said to constitute history’s greatest Ponzi scheme. We have justified present borrowing with the irrational belief that perpetual growth is possible, necessary, and inevitable. In effect we have borrowed from future generations so that we could gamble away their capital today.

Until recently, the Peak Oil argument has been framed as a forecast: the inevitable decline in world petroleum production, whenever it occurs, will kill growth. But here is where forecast becomes diagnosis: during the period from 2005 to 2008, energy stopped growing and oil prices rose to record levels. By July of 2008, the price of a barrel of oil was nudging close to $150—half again higher than any previous petroleum price in inflation-adjusted terms—and the global economy was beginning to topple. The auto and airline industries shuddered; ordinary consumers had trouble buying gasoline for their commute to work while still paying their mortgages. Consumer spending began to decline. By September the economic crisis was also a financial crisis, as banks trembled and imploded. [8]

Given how much is at stake, it is important to evaluate the two diagnoses on the basis of facts, not preconceptions.

It is unnecessary to examine evidence supporting or refuting the Conventional Diagnosis, because its validity is not in doubt—as a partial explanation for what is occurring. The question is whether it is a sufficient explanation, and hence an adequate basis for designing a successful response.

What’s the evidence favoring the Alternative? A good place to begin is with a recent paper by economist James Hamilton of the University of California, San Diego, titled “Causes and Consequences of the Oil Shock of 2007-08,” which discusses oil prices and economic impacts with clarity, logic, and numbers, explaining how and why the economic crash is related to the oil price shock of 2008. [9]

Hamilton starts by citing previous studies showing a tight correlation between oil price spikes and recessions. On the basis of this correlation, every attentive economist should have forecast a steep recession for 2008. “Indeed,” writes Hamilton, “the relation could account for the entire downturn of 2007-08…If one could have known in advance what happened to oil prices during 2007-08, and if one had used the historically estimated relation [between price rise and economic impact]…one would have been able to predict the level of real GDP for both of 2008:Q3 and 2008:Q4 quite accurately.”

Again, this is not to ignore the role of the financial and real estate sectors in the ongoing global economic meltdown. But in the Alternative Diagnosis the collapse of the housing and derivatives markets is seen as amplifying a signal ultimately emanating from a failure to increase the rate of supply of depleting resources. Hamilton again: “At a minimum it is clear that something other than housing deteriorated to turn slow growth into a recession. That something, in my mind, includes the collapse in automobile purchases, slowdown in overall consumption spending, and deteriorating consumer sentiment, in which the oil shock was indisputably a contributing factor.”

Moreover, Hamilton notes that there was “an interaction effect between the oil shock and the problems in housing.” That is, in many metropolitan areas, house prices in 2007 were still rising in the zip codes closest to urban centers but already falling fast in zip codes where commutes were long. [10]

Why Did the Oil Price Spike?

Those who espouse the Conventional Diagnosis for our ongoing economic collapse might agree that there was some element of causal correlation between the oil price spike and the recession, but they would deny that the price spike itself had anything to do with resource limits, because (they say) it was caused mostly by speculation in the oil futures market, and had little to do with fundamentals of supply and demand.

In this, the Conventional Diagnosis once again has some basis in reality. Speculation in oil futures during the period in question almost certainly helped drive oil prices higher than was justified by fundamentals. But why were investors buying oil futures? Was the mania for oil contracts just another bubble, like the dot.com stock frenzy of the late ’90s or the real estate boom of 2003 to 2006?

During the period from 2005 to mid-2008, demand for oil was growing, especially in China (which went from being self-sufficient in oil in 1995 to being the world’s second-foremost importer, after the U.S., by 2006). But the global supply of oil was essentially stagnant: monthly production figures for crude oil bounced around within a fairly narrow band between 72 and 75 million barrels per day. As prices rose, production figures barely budged in response. There was every indication that all oil producers were pumping flat-out: even the Saudis appeared to be rushing to capitalize on the price bonanza.

Thus a good argument can be made that speculation in oil futures was merely magnifying price moves that were inevitable on the basis of the fundamentals of supply and demand. James Hamilton (in his publication previously cited) puts it this way: “With hindsight, it is hard to deny that the price rose too high in July 2008, and that this miscalculation was influenced in part by the flow of investment dollars into commodity futures contracts. It is worth emphasizing, however, that the two key ingredients needed to make such a story coherent—a low price elasticity of demand, and the failure of physical production to increase—are the same key elements of a fundamentals-based explanation of the same phenomenon. I therefore conclude that these two factors, rather than speculation per se, should be construed as the primary cause of the oil shock of 2007-08.”

Aftermath of the Peak

There is also controversy over to what degree troubles in the automobile, trucking, and airline industries should be attributed to the oil price spike or the economic crash. Of course, if the Alternative Diagnosis is correct, the latter two events are causally related in any case. However, it may be helpful to review the situation.

Everyone knows that GM and Chrysler went bankrupt this year because U.S. car sales cratered. The current forecast is for sales of about 10.3 million vehicles in the U.S. for 2009, down from last year’s 13.2 million and 16.1 million in 2007. U.S. car sales have not been this low since the 1970s. Sales of light trucks, the most profitable vehicles, took the biggest hit during 2008, as fuel prices soared and car buyers avoided gas-guzzlers. It was at this point that the auto companies really began feeling the pain.

The airline industry’s ills are summarized in a recent GAO document: “After 2 years of profits, the U.S. passenger airline industry lost $4.3 billion in the first 3 quarters of 2008 [as jet fuel prices climbed]. Collectively, U.S. airlines reduced domestic capacity, as measured by the number of seats flown, by about 9 percent from the fourth quarter of 2007 to the fourth quarter of 2008…To reduce capacity, airlines reduced the overall number of active aircraft in their fleets by 18 percent…Airlines also collectively reduced their workforces by about 28,000, or nearly 7 percent, from the end of 2007 to the end of 2008…The contraction of the U.S. airline industry in 2008 reduced airport revenues, passengers’ access to the national aviation system, and revenues for the Trust Fund.” [11]

For the trucking industry, fuel accounts for nearly 40 percent of total operational costs. In 2007, as diesel prices rose, carriers began losing money and added fuel price surcharges; meanwhile the volume of freight began falling. After July 2008, as oil prices crashed, tonnage continued to decline. Overall, the cumulative decrease in loads for flatbed, tanker, and dry vans ranged between 15 percent and 20 percent just in the period from June to December 2008. [12]

This last set of statistics raises a couple of questions crucial to understanding the Alternative Diagnosis: Why, if global oil production had just peaked, did petroleum prices fall in the last five months of 2008? And, if oil prices were a major factor in the economic crisis, why didn’t the economy begin to turn around after the prices softened?

Why Did Oil Prices Fall?

And Why Didn’t Lower Oil Prices Lead to a Quick Recovery?

The Peak Oil thesis predicts that, as world oil production reaches its maximum level and begins to decline, the price of oil will rise dramatically. But it also forecasts a dramatic increase in the volatility of prices.

The argument goes as follows. As oil becomes scarce, its price will rise until it begins to undermine economic activity in general. Economic contraction will then result in substantially reduced demand for oil, which will in turn cause its price to fall temporarily. Then one of two things will happen: either (a) the economy will begin to recover, stoking renewed oil demand, leading again to high prices which will again undermine economic activity; or (b), if the economy does not quickly recover, petroleum production will gradually fall due to depletion until spare production capacity (created by lower demand) is wiped out, leading again to higher prices and even more economic contraction. In both cases, oil prices remain volatile and the economy contracts.

This scenario corresponds very closely with the reality that is unfolding, though it remains to be seen whether situation (a) or (b) will ensue.

Over the past three years, oil prices rose and fell more dramatically than would have been the case if it had not been for widespread speculation in oil futures. Nevertheless, the general direction of prices—way up, then way down, then part-way back up—is entirely consistent with the Peak Oil thesis and the Alternative Diagnosis.

Why has the economy not quickly recovered, given that oil prices are now only half what they were in July 2008? Again, Peak Oil is not the only cause of the current economic crisis. Enormous bubbles in the real estate and finance sectors constituted accidents waiting to happen, and the implosion of those bubbles has created a serious credit crisis (as well as solvency and looming currency crises) that will likely take several years to resolve even if energy supplies don’t pose a problem.

But now the potential for renewed high oil prices acts as a ceiling for economic recovery. Whenever the economy does appear to show renewed signs of life (as has happened in May-July this year, with stock values rebounding and the general pace of economic contraction slowing somewhat), oil prices will take off again as oil speculators anticipate a recovery of demand. Indeed, oil prices have rebounded from $30 in January to nearly $70 currently, provoking widespread concern that high energy prices could nip recovery in the bud. [13]

A barrel of oil from newly developed sources costs in the neighborhood of $60 to produce, now that all of the cheaper prospects have been exploited: finding new oilfields today usually means drilling under miles of ocean water, or in politically unstable nations where equipment and personnel are at high risk. [14] So as soon as consumers demand more oil, the price will have to stay noticeably above that figure in order to provide the incentive for producers to drill.

Volatile oil prices hurt on the upside, but they also hurt on the downside. The oil price collapse of August-December 2008, plus the worsening credit crisis, caused a dramatic contraction in oil industry investment, leading to the cancellation of about $150 billion worth of new oil production projects—whose potential productive capacity will be required to offset declines in existing oilfields if world oil production is to remain stable. [15] This means that even if demand remains low, production capacity will almost certainly decline to meet those demand levels, causing oil prices to rise again in real terms at some point, perhaps two or three years from now. Volatile petroleum prices also hurt the development of alternative energy, as was shown during the past few months when falling oil prices led to financial troubles for ethanol manufacturers. [16]

One way or another, growth will be highly problematic if not unachievable.

Big Picture Diagnosis: Continuing the Trail of Logic

At this point in the discussion many readers will be wondering why alternative energy sources and efficiency measures cannot be deployed to solve the Peak Oil crisis. After all, as petroleum becomes more expensive, ethanol, biodiesel, and electric cars all start to look more attractive both to producers and consumers. Won’t the magic of the market intervene to render oil shortages irrelevant to future growth?

It is impossible in the context of this discussion to provide a detailed explanation of why the market probably cannot solve the Peak Oil problem. Such an explanation requires a discussion of energy evaluation criteria, and an analysis of many individual energy alternatives on the basis of those criteria. I have offered brief overviews of this subject previously and a much longer one is in press. [17]

My summary conclusions in this regard are as follows.

About 85 percent of our current energy is derived from three primary sources—oil, natural gas, and coal—that are non-renewable, whose price is likely to trend sharply higher over the next years and decades leading to severe shortages, and whose environmental impacts are unacceptable. While these sources historically have had very high economic value, we cannot rely on them in the future; indeed, the longer the transition to alternative energy sources is delayed, the more difficult that transition will be unless some practical mix of alternative energy systems can be identified that will have superior economic and environmental characteristics.

But identifying such a mix is harder than one might initially think. Each energy source has highly specific characteristics. In fact, it has been the characteristics of our present energy sources (principally oil, coal, and natural gas) that have enabled the building of an urbanized society with high mobility, large population, and high economic growth rates. Surveying the available alternative energy sources for criteria such as energy density, environmental impacts, reliance on depleting raw materials, intermittency versus constancy of supply, and the percentage of energy returned on the energy invested in energy production, none currently appears capable of perpetuating this kind of society.

Moreover, national energy systems are expensive and slow to develop. Energy efficiency likewise requires investment, and further incremental investments in efficiency tend to yield diminishing returns over time, since it is impossible to perform work with zero energy input. Where is there the will or ability to muster sufficient investment capital for deployment of alternative energy sources and efficiency measures on the scale needed?

While there are many successful alternative energy production installations around the world (ranging from small home-scale photovoltaic systems to large “farms” of three-megawatt wind turbines), there are very few modern industrial nations that now get the bulk of their energy from sources other than oil, coal, and natural gas. One example is Sweden, which obtains most of its energy from nuclear and hydropower. Another is Iceland, which benefits from unusually large domestic geothermal resources not found in most other countries. Even for these two nations, the situation is complex: the construction of the infrastructure for their power plants mostly relied on fossil fuels for the mining of the ores and raw materials, for materials processing, for transportation, for the manufacturing of components, for the mining of uranium, for construction energy, and so on. Thus a meaningful energy transition away from fossil fuels is still a matter of theory and wishful thinking, not reality.

My conclusion from a careful survey of energy alternatives, then, is that there is little likelihood that either conventional fossil fuels or alternative energy sources can be counted on to provide the amount and quality of energy that will be needed to sustain economic growth—or even current levels of economic activity—during the remainder of this century. [18]

But the problem extends beyond oil and other fossil fuels: the world’s fresh water resources are strained to the point that billions of people may soon find themselves with only precarious access to water for drinking and irrigation. Biodiversity is declining rapidly. We are losing 24 billion tons of topsoil each year to erosion. And many economically significant minerals—from antimony to zinc—are depleting quickly, requiring the mining of ever lower-grade ores in ever more remote locations. Thus the Peak Oil crisis is really just the leading edge of a broader Peak Everything dilemma.

In essence, humanity faces an entirely predictable peril: our population has been growing dramatically for the past 200 years (expanding from under one billion to nearly seven billion), while our per-capita consumption of resources has also grown. For any species, this is virtually the definition of biological success. And yet all of this has taken place in the context of a finite planet with fixed stores of non-renewable resources (fossil fuels and minerals), a limited ability to regenerate renewable resources (forests, fish, fresh water, and topsoil), and a limited ability to absorb industrial wastes (including carbon dioxide). If we step back and look at the industrial period from a broad historical perspective that is informed by an appreciation of ecological limits, it is hard to avoid the conclusion that we are today living at the end of a relatively brief pulse—a 200-year rapid expansionary phase enabled by a temporary energy subsidy (in the form of cheap fossil fuels) that will inevitably be followed by an even more rapid and dramatic contraction as those fuels deplete.

The winding down of this historic growth-contraction pulse doesn’t necessarily mean the end of the world, but it does mean the end of a certain kind of economy. One way or another, humanity must return to a more normal pattern of existence characterized by reliance on immediate solar income (via crops, wind, or the direct conversion of sunlight to electricity) rather than stored ancient sunlight.

This is not to say that the remainder of the 21st century must consist of a collapse of industrialism, a die-off of most of the human population, and a return by the survivors to a way of life essentially identical to that of 16th century peasants or indigenous hunter-gatherers. It is possible instead to imagine acceptable and even inviting ways in which humanity could adapt to ecological limits while further developing cultural richness, scientific understanding, and quality of life (more of this below).

But however it is negotiated, the transition will spell an end to economic growth in the conventional sense. And that transition appears to have begun.

How Do We Know Which Diagnosis Is Correct?

If the patient is an individual human and the cause of distress is uncertain, more diagnostic tests can be prescribed. But to what sorts of blood tests, x-rays, and CAT scans can we subject the national or global economy?

In a sense, the tests have already been done. During the past few decades thousands of scientific surveys of natural resources, biodiversity, and ecosystems have showed increasing rates of depletion and decline. [19] The continuing increase in human population, pollution, and consumption are likewise well documented. This information formed the basis for the Limits to Growth studies, previously mentioned, which use computer modeling to show how current trends are likely play out—and most resulting scenarios show them leading to an end of economic growth and a collapse of industrial output some time in the early 21st century.

Why are the results of such diagnostic tests not universally accepted as a challenge to expectations of continued growth? Primarily because their conclusion runs counter to the beliefs and proclamations of most economists, who maintain that there are no practical limits to growth. They deny that resource constraints provide an eventual cap on production and consumption. And so their diagnostic efforts tend to ignore environmental factors in favor of easily measured internal features of the human economy such as money supply, consumer confidence, interest rates, and price indices.

Ecologist Charles Hall, among many others, has argued that the discipline of economics, as currently practiced, does not constitute a science, since it proceeds primarily on the basis of correlative logic rather than through the building of knowledge by a continuous, rigorous process of proposing and testing hypotheses. [20] While economics uses complex terminology and mathematics, as science does, its basic assertions about the world—such as the principle of infinite substitutability, which holds that for any resource that becomes scarce, the market will find a substitute—are not subjected to careful experimental examination. (It is worth noting that Hall and others have made the effort to lay the conceptual foundations for a new economics based on scientific principles and methods, which they call “biophysical economics.” [21]

Moreover, mainstream economists failed on the whole to foresee the current crash. There was no consistent or concerted effort on the part of Secretaries of the Treasury, Federal Reserve Chairmen, or “Nobel” prize-winning economists to warn policy makers or the general public that, sometime in the early 21st century, the global economy would begin to come apart at the seams. [22] One might think that this predictive failure—the inability to foresee so historically significant an event as the rapid contraction of nearly the entire global economy, entailing the failure of some of the world’s largest banks and manufacturing companies—would cause mainstream economists to stop and re-examine their fundamental premises. But there is little evidence to suggest that this is occurring.

At the risk of repetition: physical scientists from several disciplines have indeed foreseen an end to economic growth in the early 21st century, and have warned policy makers and the general public on many occasions.

Whom should we believe?

The specifics of the Alternative Diagnosis are falsifiable. If economic activity were to rebound above 2007 levels, or if oil production were to rise above the July 2008 high-water mark, then the attribution of the current economic crisis to resource-tied limits to growth may be considered at least partly disproven. However, even if these things were to occur, the underlying reasoning behind the Alternative Diagnosis might still be correct. If the world oil production peak is delayed until, let us say, 2015 or 2020, and if another—this time bottomless—global economic crash results then, the ultimate outcome will be essentially the same. But if, meanwhile, the Alternative Diagnosis were to be taken seriously and acted upon, the consequences of doing so would be beneficial: a decade would have been spent preparing for the event.

Could the Alternative Diagnosis be altogether wrong? That is, might conventional economists be right in thinking that growth can continue forever? It is often said that anything is possible, but some things are clearly much more possible than others. The perpetual growth of human population and consumption within the confines of a finite planet seems like a very long shot indeed, especially since warning signs are everywhere apparent that ecological limits are already being reached and surpassed. [23]

Temporary Recession or the End of Growth? [Voltaire] (http://www.voltairenet.org/article161580.html)