Beyond Economic Depression

January 25, 2009

The purpose of this high level analysis goes beyond an attempt to explain why an economic depression is virtually inevitable. It seeks also to identify a possible pathway out of the economic quagmire.

It is the view of this analyst that many of our political decision makers and/or their advisers do not clearly understand the overarching macro problem. The relevance of this observation is best illustrated by the following quote from an article entitled "Downturn Accelerates As It Circles The Globe", which appeared in the Washington Post on January 24th 2009:

"The depth of the troubles, analysts say, indicates that nations may need to spend more than the billions of dollars already planned on stimulus packages to jump-start their economies, and that a global recovery could take longer, perhaps pushing into 2010."

Perhaps the best way to understand why the above quote misses the mark is to think of a vintage Model T Ford and to imagine that a trailer with a five ton load is hitched to the back of it. Imagine that the car and its load had been travelling comfortably downhill and had reached the bottom. The car had then continued for a while along the road which had flattened but it is now beyond the foot of the next hill and is starting to labour on the incline. The driver has changed down to low gear but the engine is starting to overheat and the car is struggling to continue up the hill. What are the driver's options? If he steps on the gas, one of two things will happen. Either the engine will become flooded and stall, or the wheels will lose traction and start to spin. The "problem", in this case, is that the vintage car has insufficient power to pull the load up the hill.

Now think of the economy. Money supply and government spending are the fuel. The "engine" of the world economy is the set of technologies which was spawned by fossil fuel energies. The "problem" is that this engine is no longer capable of pulling the economic load. We have passed Peak Oil. Coal has spawned "dirty" technologies which the entire world is now arguing will generate CO2 (amongst other things) that will lead to excessive global warming. There is insufficient Natural Gas to enable it to fully replace Oil. Finally, Nuclear Fission, by its very nature, precludes downstream technologies from being developed by Private Enterprise.

With due respect to the monetary theorists, they just don't get it. So let's see if we can explain in simplistic terms why many of their plans and/or proposals are fundamentally flawed:

In monetary terms, Gross Domestic Product (GDP) can be thought of as the stock of money multiplied by the number of times in a year that this money stock turns over ("velocity" of money). What the monetarists are arguing is that if the velocity of money slows, the way to keep GDP bubbling along is to increase the stock of money. Whilst the theoretical mathematics of this argument may be dead right, the argument itself takes no cognizance of what happens in the real world - in the world where goods and services are exchanged for the money that the monetarists are throwing around like confetti.

Let's look at the supply side for a minute, and let's keep it simple.

From a supply side view, GDP can also be expressed this way:

Volume of the stock of goods and services X (multiplied by) the number of times a year that the stock of goods and services turns over (stock-turn) X price per unit of volume of that stock.

Let's look at an example:

Imagine that "oil" was the only product sold in our economy and that the stock of oil was 1 million barrels. If the stock was kept constant; and it turned over ten times a year; and the price of oil was $40 a barrel. Under these circumstances, "GDP" would be:

1,000,000 X 10 X $40 = $400,000,000.

Now imagine that the stock-turn slows because consumers (for whatever reason) buy less oil. Let's say that the stock turn slows to 8 X a year.

GDP would fall to 1,000,000 X 8 X $40 = $320,000,000

Okay, now let's understand that a slowing velocity of money is really the flip-side manifestation of people buying a lower volume of goods and services or, alternatively, the same volume of goods and services less often.

If the authorities' response to this slow-down in activity is to print more money, then - from a supply side perspective - the GDP would appear to remain constant because price inflation would be a consequence of monetary inflation. Let's assume that the oil price rises to $50 a barrel as a result of monetary inflation. Under this scenario, GDP would be calculated as to:

1,000,000 X 8 X $50 = $400,000,000.

Of course, if Peak Oil has passed, then it's also likely that the 1,000,000 barrels in stock may shrink to (say) 800,000 barrels.

If both stock levels and stock turn contract then, if the oil price remained at $40 a barrel, GDP would be:

800,000 X 8 X $40 = $256,000,000.

And if the monetary theorists printed money to address these circumstances, then the price of oil would have to rise to $62.50 a barrel to keep GDP "seeming" to remain constant. Of course, it only remains constant in monetary terms. In real terms (provided the authorities don't publish nonsensical and misleading statistics to mask this fact) the economic activity will have shrunk from 10 million barrels of oil sold a year to 6.4 million barrels of oil a year.

The "theory" of the monetarists is that if you flood the market with money then people will continue to buy the same quantity of oil. The "reality" is that if there is less stock available (for whatever reason) and/or if there is a reduction of the rate at which people are replacing what they bought before, then an inflation of the money supply causes an inflation of prices.

Another problem to which the monetarists seem blind is that wages lag inflation. First price rises and then, in response to increasing difficulties being experienced by consumers to make ends meet whilst continuing to buy the same volume of goods, they hold out their hands for more wages. Employers - who are experiencing their own problems - don't react immediately. Thus, in the short term, consumers have no option but to buy fewer goods and services. It follows that, in an economy where 66% of GDP is accounted for by consumer purchases, any extraordinary inflation of the money supply is virtually guaranteed to exacerbate a slowing velocity of money and a concomitant slowing rate of consumer purchases. At the extreme, if the authorities drop dollars from helicopters, all that they will achieve is that they will hasten the arrival of an Economic Depression. Perhaps the following example will make it crystal clear: Today, in Zimbabwe, a loaf of bread costs somewhere around half a billion dollars and the unemployment rate is around 80%. How many of the 80% unemployed do we think can access half a billion dollars? At the extreme, when you print too much money, the economy tanks.

In summary, dear reader, if you have a robust engine powering a robust vehicle which, in turn, is pulling your 5 ton load then, by depressing the accelerator (increasing the money supply) the car will easily negotiate the next hill. But if the vintage economic vehicle is not sufficiently robust - which is what we are now facing - then you want to be very circumspect about increasing the money supply. This is one of those times when implementing monetary theory will be counterproductive. What will likely happen under these circumstances - as an example - is that the oil price will rise to $150 a barrel. Then, when it collapses again because people can't afford to pay $4 a gallon for gasoline because wages lag inflation, what you will be faced with is a fall in demand and a consumer who has been burned. And we all know that "a burned child dreads the fire". If you offer the consumer a box of matches after he has been burned, he will run a mile in the opposite direction. Printing yet more money in today's environment will not give rise to the desired outcome.

But why am I going on about printing more money? The authorities are not talking about printing more money. They are talking about spending programs. They are talking about "stimulating" the economy.

Well, here are two questions that should stimulate some clarity of thought:

  • How are the authorities going to pay for these stimulation activities? When you cut through all the obfuscatory crap, they will have to print the money to pay for whatever they are planning to do.
  • What do they propose to spend the money on to "stimulate" the economy? Bailouts? (Overhauling the vintage cars)? Buying Toxic Assets at a premium to their real value? What kind of cockamamie logic can defend such irresponsible activity? Re-construction of bridges, power grids and the like? Possibly, but they need to be very careful not to build bridges to nowhere and/or power grids to carry electricity generated by technological dinosaurs such as coal or nuclear power stations.

In fairness, the evidence seems to suggest that President Obama understands the problem. Here is a quote from another article which appeared in the media - also on January 24th:

"In his radio and Internet video address, Obama made a public appeal for the key priorities of the plan, focusing on renewable energy, national security, education, health care and infrastructure."

One problem lies in the Republican response to his plan (from the same article):

"In his party's weekly radio and video address, House Minority Leader John Boehner, an Ohio Republican, said the Democrats' economic package is a "borrow and spend" plan, "chock-full of government programs and projects, most of which won't provide immediate relief."

The core issue now appears to be that the Neanderthal politicians want immediate (!) relief. This testosterone driven attitude is a manifestation of adolescent style posturing if not just plain stupidity. By way of analogy, an 18 month old child cannot be turned into a university graduate overnight. There is a process of development which needs to evolve and the rate of evolution cannot be accelerated beyond reason. The Democrats under Clinton failed to ratify the Kyoto Protocols in 1998. This failure, perpetuated by the Bush Administration until very recently, blocked the march-to-market of new energy paradigm technologies. The bottom line is that the failure of both the Democrats and the Republicans to ratify the Kyoto Protocols cost the world 10 years. The reader should understand that this analyst is an apolitical animal. He has little respect for either party's approach to problem solving. For example, thanks to the Democrat Al Gore, the world is now fixated on Carbon Dioxide. If one applies the basic concept of Specific Heat as taught in Physics 101 then one arrives at the conclusion that CO2 could not possibly have caused the concurrent warming of our atmosphere and our oceans by similar amounts. The attempt to link a cause-and-effect relationship between CO2 and global warming is gobbledygook nonsense! It's hard to be enthusiastic about either party's policies in the face of the self-serving and irresponsible behaviour of the so-called servants of the community.

So how do we extricate ourselves from the bog?

As a starting point, if we are going to bet our meager resources on a particular horse, we need to make damned sure that the horse is the right horse.

Let's think through one example:

If the days of the internal combustion engine are numbered, what will be the most likely replacement technology for personal transport? Consider the question of the electric car.

If the new technology electric car is one which will drive up to a service station and "plug in" to recharge its batteries, what will be the technology that will produce the electricity at source? Coal? Nuclear? Both Coal and Nuclear are "dirty" technologies. Furthermore, unlike coal, Nuclear does not lend itself easily to downstream entrepreneurial activity. For example, coal is a raw material from which other products (chemicals, pharmaceuticals, other) can be derived. These other products facilitate employment generating activity in downstream industries. Because of its very nature, Nuclear has no capacity to provide additional bang for the buck. Economic activity may be likened to throwing a stone into a pond. Ripples of economic activity emanated outwards when the fossil fuel stones were thrown into the economic pond. In principle, Nuclear cannot achieve such an outcome.

The "bottom line" (when one thinks things through) is that the days of centralized power generation are drawing to a close except for some niche applications. Just as the Personal Computer replaced the Mainframe Computer except for niche applications, so centralized power generation will give way to distributed power generation closer to the point of consumption. For a variety of reasons, it's virtually inevitable.

From the same article as quoted above:

"In his address, Obama noted that his proposal would boost the nation's energy independence by doubling the country's renewable energy capacity within three years and adding more than 3,000 miles of electricity transmission lines nationwide."

".. more than 3,000 miles of electricity transmission lines nationwide?" In a future environment which needs to be characterized by distributed electricity?

Oops!

Next: If the electric car is one which will have an on-board motor that will recharge the battery rather than power the vehicle, then what will be the nature of that motor? Will it be an internal combustion engine? If not, what will it be and who will be responsible to provide the infrastructure to support the new energy paradigm motor's technology and the production, storage and distribution of fuel therefore? It stands to reason that the new energy paradigm motor to recharge the batteries cannot be solar powered. What will happen if the batteries need recharging at night or in winter?

Oops!

At face value it is clear that any plans by the Big Three and/or Toyota to produce electric motor vehicles but which do not address these types of questions may very well lead them/us down yet another rat hole and yet more billions of dollars of bailout money being required.

Conclusion

Any "solutions" to our economic problems need to flow from a collaborative effort between our authorities (who will likely assume responsibility for new paradigm infrastructure) and Private Enterprise (who will likely need to leverage off that infrastructure).

But the "infrastructure" cannot be provided in a vacuum. We need to think through the issues before rushing out into the market place with six-guns blazing.

Author's Note

It happens that the author hereof has spent the last 20 odd years thinking through the issues. There appear to be two possible alternative "core" energy paradigms, both of which have serious unanswered questions associated therewith. The two are hydrogen (which, supposedly, is an energy sink and which, as a matter of fact, cannot yet be easily stored) and electromagnetic energy scavenging (which physicists argue is a non starter because the very concept appears to breach two of the three laws of thermodynamics).

Fortunately, the hydrogen problems appear technically soluble. For example, hydrogen can be produced from water by applying solar and/or wind energy. Fortunately, most of the same physicists who are against the concept of electromagnetic energy scavenging from the environment are also attracted to the idea of solar power which, when you think about it, is just another way of scavenging electromagnetic energy from the environment.

At the end of the day, we need to dispense with dogma - with preconceived arguments about why something is or is not true. It was in this spirit that I sat down to write Beyond Neanderthal.

Beyond Neanderthal is a factional novel which, via its fictional storyline and fact based themes, explains how and why we landed up in the quagmire and which also presents a possible course of action that will lead us out of it. It also examines the concept of electromagnetic energy scavenging in some detail - so as to open the door a crack to some serious investigation of this option by better qualified people who should have been doing this years ago if they hadn't been so dogmatic about why it can't possibly work.

Whichever energy paradigm we choose - and we might very well opt for both - will require trillions of dollars of infrastructure. It will be the building of this infrastructure that will create jobs in the short term and that will lay the foundations for entrepreneurial endeavour to drive the economy to future boom conditions down the track.

 

Brian Bloom
www.beyondneanderthal.com

 

Beyond Neanderthal can be ordered via the above website. Of course, the more people who read it and talk about its contents, the more impact it will likely have. It is intended to point a direction to future sensible discussion on matters which might previously have been argued by many to be "outside the box" and not even worthy of consideration. Well, we have now seen where the arguments of those people have led us. The typical Baby Boomer who thought he/she was approaching retirement has lost 33% - 50% of his net worth in the past few months and, at the current rate at which jobs are being lost in the USA, we will likely land up with an unemployment rate of more than 10% in the next few months. Perhaps we should all keep an open mind for the time being.

One ounce of gold is so ductile it can be drawn into a wire 50 miles long