My car was in the shop yesterday for some much needed repairs (new brakes) so my day was confined to working from home. I drive just as little as possible these days and try to take care of multiple errands in one trip but the thought of being without a car or having no fuel for said auto is going to take some adjusting on my part. I do run my business from home so I have a number of days per year where I put on no miles, but currently I could not continue to conduct my business as usual without an auto.

so real growth net of inflation and so is just more energy use and the more productivity we have means just leveraging machinery which of course needs more energy. SO we think out ways to use the energy we found by making bigger, smarter machines so we have growth and productivity. In the end no energy so the machines are useless and the people too.

http://politics.reddit.com/info/2r7od/comments

if you are so inclined...

Fostering economic growth based on the consumption of absolutely exhaustible resources like fossil fuels was (and is) most unwise. And even tragic when such growth brings society into a state of ever greater dependency on those resources for its basic functioning, as is the case with suburban development.

Gail,

Excellent article and great perspective. It is important to understand that our challenges do not exist in isolation, but are interconnected.

I am not an economist, just a casual observer, but it seems that during the first phase of industrial age, our economy grew with an increasing volume of debt creating the capital to finance the growth. Projects have continued to escalate until we now have mammoth mega-projects costing billions of dollars. As a casual observer, I think it is likely that as we slide down the backside, the gamble on continued growth will be less prudent. Costs of expensive projects with increased possibility of non-success (Jack 2?) will see a contraction of available financing. Many think that there will be the oil out there, it is just not at an economic price to recover. While this is true, we may find that although the cost increases, the risk in these projects may also rise and the result is that they will be much harder to fund. If we have a major economic hit, with decreasing liquidity and collapsing dollars, we may reach a point where these projects can no longer be funded at all. At that point we will not have the ability to recover the economic strength to grow back into a position for fund mega projects. This will be the end of the industrial age.

Of course this is just my humble observations and opinions,

ej

At Jay Hanson's Killer_Ape list-serve we were talking about What-is-money?

I was surprised at how many people (including myself) had not taken a deep introspective look into the many meanings of the word "money".

Money is created out of thin air (it is not mined, harvested or other wise extracted from nature) when people make promises to each other (e.g. I promise to return to you in one year from now 5% more money than the amount you give me now --in other words I will manage to create 5% more than exists right now).

The definition of money has changed as we "evolved" from an economy based on tangible assets to one based on intangible ones.

Fine business Gail.

I am imagining our economy as a modern bells and whistles auto. We have a diminishing amount of energy but have been countering this with increased efficiencies. Efficiency attempts to reach 100% and energy attempts to reach 0%. IMO we have less in the way of tech induced efficiencies to look forward to but lots in the way of energy deficiencies (eroei). So, my guess is (and it seems apparent) that we will start to gradually remove from our vehicle all those bells and whistles. There are countries we look on much like those little extras -- power seats, power windows, power power -- that we are discarding as unnecessary energy drains. To keep this a short analogy, as it deserves to be, we end up clinging to a striped down beast consisting of engine drive shaft and wheels. After that is when things get difficult.

In my own attempt to deal with energy more usefully, in a perverse variety of bell and whistle reduction, we have become a multi vehicle family. We have a motorcycle, a van, a small trailer for hauling dung etc. and a tandem bike. With a little bit of planning and by living in a small town this worked quite well and we are spending less on fuel than we did a whole lot of time ago (decades). We would like to get rid of the van and replace it with a small enclosed engine and drive shaft but we can't sell our van which has been referred to, by some young punk kid, as '...that beat up rustbucket old hippie van'. And besides it doesn't want to die so we are stuck there. We could kill it but feel that would result in greater energy losses so are waiting for it to die of natural causes, and then life will be beautiful ... for a while:)

Your take on debt doesn't seem to present a picture that I would be happy with. Debts from the Revolutionary war were huge in comparison to the economy at the time. What about 'not worth a Continental' and the paper printed by Paterson, the initiator of the paper bank note? Debts at the end of the second world war - tens of billions!!! - were supposed to reduce the sons of the victors to eternal penury.

Maybe we aren't reading the same economic history books. Try The Age of Uncertainty by J K Galbraith, or Freedom and Organization by Bertrand Russell. Your take that we have recently invented a new economic wheel based on increased debt isn't convincing. One of the main reasons people came to America was to escape debts or to acquire land without taking on unpayable debts. That didn't last long.

The above mentioned books are not only informative, but both authors have a dry wit and sense of lovable human frailty that I find fulfilling.

I'm also noticing a tendency to blame the US housing bubble for European banking problems, but they have had a bubble too. A huge bubble. I'm not even going to mention China, oops. Wise heads have pronounced concern over the international scale of the situation, which the typically inward looking American financial establishment isn't paying much attention to.

It isn't the debt, it's the debt serviceability. If PO reduces economic flow - which it doesn't have to - then debt serviceablity is a problem. If new debt flows to alternate sources, it isn't. Just because United Buggy Whip was in Chapter 11 didn't mean the end was near in 1907.

Electricity is the major candidate for replacement of oil (and eventually fossil fuels), so an important question is: how is the price of electricity changing?

The EIA table (http://www.eia.doe.gov/cneaf/electricity/epa/epat7p4.html ) shows the price per KWH going from 6.91 in 1994 to 8.14 in 2005, for an 18% increase, and a 1.5% annual increase. This is less than inflation. So, the price of electricity, adjusted for inflation, has dropped over this period.

Now, prices hit a bottom in 1999 at 6.64. Since then they rose at an annual rate of 3.45%, and inflation has been 2.55%, so they've risen at a real rate of .9% per year: that's not a lot.

On the one hand one could argue that measuring from the low point of 1999 is cherry-picking data, OTOH you could reply that we know that conditions have changed since then, with FF inputs rising in price. Finally, I think you have to observe that only oil & gas, at 21% of electricity supply, have actually risen in cost and had limits to supply, while coal and nuclear, at 70% of supply, have not.

So, I think you have to conclude that electricity costs are not rising significantly, and don't show the same problems as oil & gas.

The 12% residual after 1975 is interesting. Could it be speculation in the stock market? Or perhaps printing of excessive amounts of paper money? When was the dollar freed from all backing?

"The Catholic Church forbad debt until 1822."

Debt was never forbidden. Interest was.

And the reason for lifting the prohibition is clear for anyone who understands the evolution of the monetary system. By 1822 fractional reserve banking was allowing M1 to grow faster than M0 (which was physically constrained by the amount of gold and silver mined). In other words, the nature of "money" was changing, becoming less "harder".

It might be useful to repost this contribution I made last year.

A key issue is the nature of the monetary system being used. Unlike in physics, where measurement units are simple and completely defined, in economics/finance, money - one of whose functions is *unit of account*: a measure used to set prices and make economic calculations - has very different properties depending on the monetary system in place.

Below I'll try to show that:
1. The existence of a WIDELY available, RISK-FREE, interest bearing investment requires a "soft" monetary system.
2. For that investment to also yield a REAL positive interest rate, the economic system must be on the way up to Hubbert's Peak.

By "soft" monetary system ("funny money" in gold bugs' jargon) I mean one which is not PURE precious metals-based. By that in turn I mean one in which circulation consists exclusively of bullion or at most of certificates thereof issued by "100% reserve" banks.

So, funny monetary systems comprise:
- the fractional gold standard, which was inherently unstable (because a fractional reserve banking system demands a lender of last resort and the gold standard prevents the existence of one), was suspended during any major upheaval (such as Napoleonic War, American Civil War, WWI) and was definitively abandoned during the Great Depression, and
- the fiat money system, both in its universally adopted fractional reserve banking flavor and in the theoretical-domain 100% reserve banking flavor (Simons 1934 and Fisher 1935).

Of note, the biblical prohibition of interest was issued when the monetary system in effect was pure precious metals-based. And it applies to that system. So it is legitimate to earn interest from the current funny money system.

To demonstrate the first point, let 's assume we have a pure gold system. How can some person or institution make a risk-free promise to anyone to pay them interest on the gold they initially lent (plus the principal at maturity)? By one of two ways:

a. The borrower has the power to exact ever increasing quantities of gold from subject/victim populations, i.e. to forever expand its share of the total bullion stock. Clearly that cannot last long.

b. If we assume the borrower's share of total bullion stocks to remain constant at most, which is plausible, then we need the total stock of monetary gold to grow exponentially at that rate or higher (which implies that the amount of gold mined each year must grow exponentially at the same rate too). Actually, the cumulative gold production did grow exponentially, only the rate was very low, as you can calculate from the data at page
http://www.gold-eagle.com/editorials_00/mbutler031900.html

Thus, the annual rate of growth of above-ground gold stocks was 0.11 % from 1200 BC to 600 BC and again from 300 BC to 500 AD (see the reason for the biblical prohibition of interest?), dropping to 0.05 % during the Middle Ages, to rise to 0.59 % during the XIX century and to 1.7 % on average during the XX century (actually it was 1.8 % 1900-1950, 1.6 % 1950-1975 and 1.5 % 1975-2000). Adding silver to the picture changed the above percentages very little.

As said, the above figures provide the ceiling for the interest that could be offered by a risk-free investment if a pure gold standard had been in place. BTW, 1.5 % leads to k = 1/67. Of course, the correlation of higher rates with higher energy use in the XIX and XX centuries is no coincidence, as modern mining is very energy intensive, which also means that, after Hubbert's Peak (for oil and for precious metals), the annual growth rate is bound to get lower and lower.

In a fiat money system, on the other hand, the monetary stock can (and certainly does!) grow exponentially at any rate that suits the keepers of the printing press, so the government can promise beyond any risk to anybody to return them any nominal interest rate below that.

Now comes the second point: how do you insure that the nominal interest earned (plus the returned principal) allows the lender to buy more REAL goods and services than the principal initially allowed them to, in a fashion of a certain annual real rate? By having the amount of available goods and services grow exponentially at a rate that fulfills:

(1 + yGR) = (1 + RIR) (1+MGR) / (1 + NIR)

where
yGR: real Net National Income Growth Rate (approx real GDP Growth Rate)
RIR: Real Interest Rate
MGR: Monetary stock Growth Rate
NIR: Nominal risk-free Interest Rate

*Since MGR >= NIR as said above (to make the investment yielding NIR risk-free), it follows that the real GDP growth rate must be >= the real interest rate.*

(BTW, the last condition holds for any monetary system, hard or soft, and it comes from the Fisher Equation of the Quantity Theory of Money, M V = P y, assuming constant V. See Appendix.)

The good news, then, is that after Hubbert's Peak, since real GDP Growth rates will become negative for a long time, so will real "risk-free" interest rates, and therefore there will be no financial incentive for clearcutting the forest.

Appendix:

At t=0, let be:
y0 the real Net National Income (can be subsituted by real GDP, since we will deal with its growth rate, which will not differ substantially)
M0 the monetary stock (M1 or M2 depending on country)
P0 the price level = M0 V / y0

Let's call Real Purchasing Power at t=0 what an initial amount A0 can buy:
RPP0 = A0 / P0 = A0 y0 / M0 V

Let that initial monetary amount A0 be invested in a risk-free vehicle that yields a nominal interest rate NIR.

At t=n, we have:
yn = y0 (1+yGR)exp(n)
Mn = M0 (1+MGR)exp(n)
Pn = Mn V / yn
An = A0 (1+NIR)exp(n)

where
yGR: real Net National Income Growth Rate (approx real GDP Growth Rate)
MGR: Monetary stock Growth Rate

How much can An buy at t=n?
RPPn = An / Pn = Ao (1+NIR)exp(n) y0 (1+yGR)exp(n) / [M0 (1+MGR)exp(n) V]
RPPn = RPP0 (1+NIR)exp(n) (1+yGR)exp(n) / (1+MGR)exp(n)

Now, you want RPP to grow at a certain annual Real Interest Rate, RIR, so:
RPPn = RPP0 (1+RIR)exp(n)

From the last two equations:
(1+RIR)exp(n) = (1+NIR)exp(n) (1+yGR)exp(n) / (1+MGR)exp(n)

Taking the nth root:

(1+RIR) = (1+yGR) (1+NIR) / (1+MGR)

As said above, for an investment vehicle that yields a nominal interest rate NIR to be risk-free, NIR has to be <= MGR (otherwise it needs to capture an ever greater share of the monetary stock).

That implies RIR <= yGR

Gail:

The world is very different now than it was before the industrial revolution

It's been a surprise to find out how different the world is today than it was 35 years ago: computerized, globalized, more sophisticated, much larger in population. In particular, the economy is very different. The mass media is all-pervasive, whereas local communities have withered. Our food system is very different (for example, when I grew up, we ate out about three times a year).

It's confusing, because on the surface, things don't seem all that different. We still have internal combustion cars, nuclear families, shopping centers. But underneath, as I'm sure Gail knows, things are way different.

I think it's important to look at the pre-1962 past, because I suspect that is more what our society will look like, rather than a rural-dominated pre-industrial past. For better or worse: nationalism, cultural conservativism, thrift, labor unionism, poverty, rich vs poor, more localized economies.

I'm eager to see the forthcoming essays in Gail's series.

Bart

Gail,

Thank you very much for an excellent piece of writing. In several months of reading The Oil Drum, this is the only post I have encountered which takes as its central theme the key problem facing the modern global economy. We have created an economic system which, by structural necessity, is constantly mortgaging the future to pay for increasing production of wealth in the present, blithely trusting that constantly increasing levels of productivity will pay for its constantly increasing debts. The rapid depletion of fossil fuels is only one manifestation of this structural tendency. An agricultural system which is depleting our farm land of topsoil and nutrients, a system of lumber and paper production which is depleting out timber lands of nutrients, the collapse of ocean fisheries, the mining of concentrated ore deposits and their subsequent dispersal into landfills, etc. are other examples of this tendency.

These sorts of behavior are not accidents or oversights. They are the inevitable consequence of an economic system which pursues and worships short term profit with religious fervor. Most of the posts on The Oil Drum which address solutions to peak oil are focused on how we can preserve the current economic system for some decades longer through clever engineering. Such ideas completely miss the central point of the crisis with which we are faced. Our key task should be to create an economic and political system which has as its raison d’etre the creation and preservation of long term wealth. In fact, in the short to intermediate term it is highly desirable that our economic system should perform the exact opposite of its current function; We should be sacrificing the current production of wealth in order to improve and stabilize the long term health of our resource base. Of course bringing about such a change in economic orientation will require radical social changes. Given the current state of delusion and ignorance with respect to economic reality brought about by the propaganda system of our dominant institutions I am very pessimistic about the possibility of bringing about radical political change. However, if we never explicitly acknowledge the nature of the task that we ought to be taking up, then a small chance of intelligent action becomes exactly zero.

Some random comments that occurred to me as I read this article:

The money we use today is debt. Federal Reserve Notes are bills of credit, liabilities of the Federal Reserve Bank. Your checking accounts and saving accounts are debts of your bank. The money system is the source of the huge debt in our economy. These liabilities of the banks were loaned into existence by the banks in a transaction where you signed your note payable to the bank (like when you buy a car on credit) and the bank created by bookkeeping entry a checking account for you (out of thin air). The bank earns interest on the loan to you, but pays little or no interest on their liabilities. The effect of this money issuing monopoly granted to banks is to enslave you, and transfer wealth from you to them. This was the purpose of the Federal Reserve Act of 1913, after which the value of money has depreciated to almost nothing compared to 1913. Before that gold and silver were money and since it could not be created out of thin air, it held its value. So the point is that debt is not a necessary requisite for industrial society, nor is it a sound means for one to acquire assets; rather it is a scam.

If you don't want to get all tangled up in thinking about what peak oil will do to the economy, just look at the broad picture. Energy input allowed more production, i.e., an expansion of the economic pie; more for everyone, but a much higher percentage of the expansion went to those in charge, be they corporate officers or government officials and friends. Less energy will mean less production, hence on average a smaller pie to be divided. You can bet that the greater burden of the lost production will be borne by those outside of government and those not in charge of corporations. The mechanism by which this will be effected is higher prices, unemployment, higher taxes, or a combination. Loss, not gain will be the hallmark of the post peak era.

The idea that rationing is a reasonable solution to deal with shortages is a fools paradise. Never in history has rationing done anything but caused disruption in life, often resulting in even greater shortages. Price is the only effective means of "rationing" and it does not require a great government expansion to do what free people might not otherwise do. As we can already see by the government stepping in and directing some of the now limited supply of energy into the "ethanol solution" that we have diminished the amount of energy otherwise that would have been available to other purposes.

It would be interesting to consider West Texas's Export Land model in your economic analysis. Plus I've proposed a double export land model that probably of even greater concern.
The US import a lot of finished petroleum products these are exports from other countries with excess refining capacity.

I believe the amount of oil products will decline at a rate higher than the simple oil export model. This double export land problem will come on the moment countries with spare refining capacity have problems procuring oil.

So we can expect the amount of finished oil products to increase rapidly and the absolute supply to decrease rapidly.

My WAG is its on the order of 15%-30% per year once spare oil capacity does not exist which seems to be now. So we can expect that by next Summer the US may be unable to import sufficient gasoline or it will be paying and exorbitant price. By late 2008-2009 the absolute amount of exported finished products will simply not be available at any price.

Thus this semi-political export land and double export land model is I think the key economic impact of peak oil.

Gail:

In the US there was a fundamental shift in real wage growth for all quintiles of household income in 1970. Since then the lower 4 quintiles have been essentially flat in comparison and most of the upper quintile gain has actually occurred because of the upper decile and perhaps even the upper percentile.

I see this occurring for two reasons (granted that they are simplified). First, this was the fisrt emergence of the babyboomers from college that included a substantial increase in women. In addition, the homes were about to become empty nests as the children graduated and moved on to other things. The drag of the Vietnam War also played a part as well.

The second major consideration was the peaking of the US supply and the relatively rapid increase in imports (meaning the US dollars were going somewhere else in the world).

Now, I'm not really surprised where we are today given that, even without the industrial revolution, every major Western power in the last 500 years has followed the same path of being the dominant 'technological' power of it's time has flourished, moved from "producing" to finance and 'real estate,' has overreached, and stumbled. The Republic of Venice, the Republic of Florence, Spain, Holland, the British Empire are all examples of countries that have followed the road that the US is following (just a little further down the road in time).

What is different is the size of the population and the size of the impact. To people that say "we've been through this before" (do they mean the planet or the human experience?), I ask the following simple question: "So, how did the population of more than 6.6 billion people fare the last time this happened?"

Last month I was teaching a group of mostly engineers in Atlanta about the principles of combustion and the utilization of energy. I interjected some of the challenges that we face along the way for "things to think about." A surprising number had little hint about what might lay ahead and the challenges we face. It will be interesting next month to see if I get the same response from the next group attending the course.

Wow! so many things and I can't think of how to address them all...Not that I have any expertise, but here goes:

The Catholic church forbade charging interest; then hired Jews to take care of that for them (that's the rumor I heard).

Money represents a value of exchange ONLY if there are resources to create value that is desired by someone. As resources become expensive, we will trend toward food as the basis of value, whether we use gold or ammunition as a unit of exchange for it.

Gail: In the long run, the term I refer to is "Net Creativity". We humans have to think of resources as though we are borrowing them, not granted them. Every resource we consume should be used to create usefulness for the future generations. If we cannot find a collective way to do this, we will decline in numbers, either slowly or quickly, depending on which Net Consumptive plan our corrupt Corporatocracy comes up with to fill its parachutes in the short term.

Debt: The use of debt by governments is ALWAYS based upon the promise of future resource availability to repay the debt and create more productivity/consumption than exists at the time of the borrowing. It has worked in the past because there have always been massive resource pools to draw upon. The only massive resource pool left that is growing is the population which has been physically removed from useful manual labor by energy sources and technology. We have spent the last 70 years replacing the value of human beings as workers with oil. In the eyes of the Economy, a human being is worth as much as the cheapest thing they can make with their hands that can't be automatically produced by a machine.

"If you want Change, keep it in your pocket. Your money is your only real vote."

Our current measures of economic effort (DJIA, etc) are based on an increasing supply of fossil fuels. We know this isn't the case and in fact supplies are going to decrease. I'd contend that the Dow being at 13,815 today is pretty much meaningless even in the near term.

What does matter? In a post peak world I'd look at ...

total BTUs available
carbon output associated with the BTUs
total consumable calories

Or energy, ecosystem, and economy if you care for Burgundy's triumvirate of collapse.

This, of course, is a leftist/socialist/communist doomer loony sentiment that will never get any traction in the mainstream media. But the truth of it is plain to see if you inspect the conversation here - from doomer to cornucopian we all implicitly agree these are the important things as our world changes.

Another great article Gail! Thanks.

This model explains the vast majority of US real economic growth between 1900 and 2000, except for a residual of about 12% after 1975.

This is really amazing to me. My intuition said energy supply must be the driving factor behind growth, but I had very little to support it.

Have further papers been able to explain the 12%? Seems to match up well time frame wise with moving high energy industry off shore.

Jon Freise
Analyze Not Fantasize -D. Meadows

I believe that technology has also created an economic system that has atomized knowledge.

Currently, very few economic entities contain within themselves all the knowledge that is necessary to generate their particular product or service.

Knowledge has become distributed and goods and services have become an emergent property of the economy itself.

If the economy falters, there is a danger that the loss of inter-economic co-ordination will cause a severe loss of goods and services.

More fundamentally, a faltering economy could also cause a severe erosion of the human knowledge base itself.

Sustainable society within reach

" According to Orr, a pioneer in ecological design and Paul Sears Distinguished Professor and chair of the environmental studies program at Oberlin College, we already have the technology and know-how to create a world where every individual alive today can live a fulfilling, sustainable life. But only - and here's our kick in the pants - if we act immediately to reduce our consumption of fossil fuels.

He also calls for a federal transportation policy to install a high-speed rail network across the country."

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2007/09/22/HOR9MRFI6.DTL

I often think about negative interest rates as a way to change our monetary system for the better. This would increase the value of long term returns instead of increasing the value of immediate & short term returns. This would discourage the hoarding of money and increase investment in long term, sustainable projects. It would destroy the fictionnal image of money as a storage of value and restore it's image of mean of exchange between two things of value.

There are many ways of creating such a system. It would for exemple reduce the nominal value of all the money in circulation by 10% per year. Banks would offer you saving accounts with -7% interests. (wich does not mean that the banks are stealing you 7% because the money you lend them will be worth 10% less at the end of the year).
Banks will make loans at -5%.

What do you think ?

http://en.wikipedia.org/wiki/Demurrage_(currency)

Small niggle, in britain the IR started up mostly with water powered machinery.