The Future Can't Pay Its Bills

SUBHEAD: Grandiose plans to create large of algal biodiesel farms or vast solar arrays won't be financed.  

By John Michael Greer on 14 December 2011 for the Archdruid Report - (http://thearchdruidreport.blogspot.com/2011/12/future-cant-pay-its-bills.html)

 
Image above: Architects rendering of floating algae farms and vertical bio-airships above the South China Sea. From (http://www10.aeccafe.com/blogs/arch-showcase/2011/03/08/hydrogenase-in-shanghai-china-by-vincent-callebaut-architect).

I want to expand here on some of the points raised in last week’s post, because they deal with factors in our situation that operate well below the surface. One of the things that makes the predicament of industrial society so difficult for most people to notice, in fact, is that its effects are woven so deeply into the patterns of everyday life.

Over the last decade, for example, crude oil prices have more than tripled; over the last decade, behind a froth of speculative booms and busts, the world’s industrial economies have lurched deeper into depression.

Peak oil researchers have pointed out for years that the former trend would bring about the latter, but long after events proved them right, the connection still remains unnoticed by most people. To be fair, the way most people and nearly all economists think about economics makes this sort of blindness to the obvious hard to avoid. It’s standard these days to treat the circulation of money—the tertiary economy, to use a term from my book The Wealth of Nature—as though it’s all that matters, and to insist that the cycles of nature and the production of goods and services (the primary and secondary economies) will inevitably do whatever we want them to do, so long as there’s enough money.

This is why, for instance, you’ll hear economists insisting that the soaring price of oil is good for the economy; after all, all the money being spent to buy oil is getting spent in turn on other things, right? What this ignores, of course, is the fact that the price of oil is going up, in large part, because petroleum is getting steadily more difficult to extract as we exhaust the easily accessible sources, and so the cost of oil production is going up while the amount of oil being produced is not.

As a growing fraction of industrial civilization’s capacity to produce goods and services has to be diverted into oil extraction in order to keep the oil flowing, the amount of that capacity that can be used for anything else decreases accordingly. Notice, though, that this diversion isn’t an obvious thing; it happens one transaction at a time, throughout the economy, as laborers, raw materials, capital, and a thousand other things go into oil production instead of some other economic sector.

The place to begin making sense of the shape of the process under way, it seems to me, is the intriguing article by green economist Herman Daly, cited in last week’s post, about the way that the World Bank’s pursuit of global growth via the worship of economic orthodoxies ran headfirst into a shortage of "bankable projects"—in plain English, economic projects that would yield the ten per cent or so per year necessary to pay off the loan and also make a profit.

The World Bank, as Daly recounts, tried to make up for the shortage by lowering its standards, and pouring money into projects that counted as bankable only in the same imaginary world where Pets.com stock and subprime mortgage-backed securities count as good investments. The point I’d like to make here, though, is that a shortage of bankable projects has been a problem for some time now in regions not normally consigned to the Third World.

The Rust Belt town where I live, Cumberland, Maryland, is one example. Until 1974 it was a significant industrial center, with two large breweries, a tire factory, a fabric mill, and several smaller concerns. 1974, though, was the year that the consequences of America’s first brush with peak oil hit home, and Cumberland was one of the targets. A combination of soaring raw material costs, slumping sales, and competition from overseas shuttered every factory in town, and none ever reopened. Cumberland, like the rest of the Rust Belt, suddenly had a shortage of bankable projects.

The shortage wasn’t total—a handful of "big box" stores found construction loans during the retail-empire boom of the 1990s, for example—but rock-bottom real estate prices, favorable tax policies, low labor costs, and two colleges nearby to provide workforce training at state expense couldn’t lure factory jobs back into the region.

That same experience is being repeated now all over America, and for that matter across much of the industrial world. Capital shortage isn’t an issue—with two rounds of quantitative easing and a tacit agreement on the part of bank regulators not to raise awkward questions about the actual value of the paper assets owned by banks, there’s plenty of money available to lend—but loans aren’t being made, and the reason given by bank after bank is that next to nobody who wants to borrow money has a credible plan that will allow them to pay it back.

That claim has been rejected with some heat by commentators, but I’ve come to suspect that it may be more accurate than not.

That was exactly what happened to Cumberland, after all; in the changed economic environment after 1974, a factory built here wouldn’t have made enough money to pay back the loans that would have been needed to build it, and so the loans weren’t made. Increasingly, that seems to be true of the industrial world as a whole. All this can be described, in the terms I used in The Wealth of Nature, as a widening mismatch between the tertiary economy of money and the secondary economy of goods and services—or, to put the matter even more simply, a rising tide of paper wealth chasing a falling tide of actual value.

Still, I’ve come to think that there’s another way of looking at it—one that unfolds from the perspectives I’ve been discussing here over the last few weeks.

Let’s step away for a moment from the game of arbitrary tokens we call "money," and look at the economy from a thermodynamic perspective, as a system for producing goods and services by applying energy to an assortment of raw materials. Until the coming of the industrial revolution, the vast majority of the energy that went into human economic systems went from sunlight to crops to human and animal muscle, which produced and distributed goods and services. The industrial revolution transformed that equation adding torrents of cheap abundant fossil fuel energy to the annual income from photosynthesis.

Only a small fraction of the labor force and other resources had to be diverted from food production to bring this flood of energy into the economic equation, and only a small fraction of fossil fuels had to be cycled back into the fossil fuel extraction process; the rest of the labor force, other resources, and all that additional energy from fossil fuels could be poured into the rest of the economy, producing goods and services in unparalleled amounts.

Physicist Ilya Prigogine has shown by way of intricate equations that the flow of energy through a system increases the complexity of the system. If any further evidence was needed to back up his claims, the history of the world’s industrial economies provides it.

The three centuries that followed the development of the first functional steam engines saw economic complexity, measured by the creation of new job categories, soar to a level almost unimaginably greater than any previous civilization had achieved.

The bonanza of wealth produced by adding fossil fuel energy to the sun’s annual contribution spread throughout the industrial economies, and the ways and means by which money sprayed outwards from the pockets of coal magnates and oil barons quickly became institutionalized. Governments, businesses, and societies ballooned in complexity, creating niches for entire ecosystems of office fauna to do tasks the presidents and tycoons of the nineteenth century had accomplished with a tiny fraction of the personnel; workloads obeyed Parkinson’s Law—"work expands so as to fill the time available for its completion"—and everyone found that it was easier to add more staff to get a job done than to get the existing staff to do it themselves.

The result, in most industrial societies, is an economy in which only a small fraction of the labor force actually has anything directly to do with the production of goods and services, while the rest are kept busy managing the sprawling social and economic machinery that has come into being to organize, finance, manage, staff, market, advertise, sell, analyze, tax, regulate, review, praise, and denounce the production of goods and services.

What seems to have been lost sight of, though, is that this immense superstructure all rests on the same foundation as any other economy, the use of energy to convert raw materials into goods and services.

More to the point, it depends on a certain level of surplus that can be produced in this way, and that depends in turn on being able to add plenty of fossil fuel energy to the economic system without having to divert too large a fraction of the labor force, resource base, and energy supply into the extraction of fossil fuels.

Some sense of the difference made by fossil fuels can be measured by comparing the economies of the industrial age to those of societies that, by any other standard, were near the upper end of human social complexity—Tokugawa Japan and Renaissance Italy are the ones that come to mind. Urban, literate, and highly cultured, each of these societies had the resources to support extraordinary artistic, literary, and intellectual creativity. Still, they did this with economies vastly simpler than anything you’ll find in a modern industrial society.

The division of the labor force among economic roles makes a good measure of the difference. In both societies, the largest economic sector, employing around fifty per cent of the adult population (nearly all adult women and most elderly people of both sexes), was the household economy; a good half of the total economic value produced in each society came out of the kitchen gardens, spindles, looms, and other economic facilities associated with households.

Another thirty per cent or so of the population in each society, including most of the adult men, was engaged full time in farming and other forms of direct food production; maybe ten per cent of the adult population worked in the skilled trades; and the remaining ten per cent or so was divided between religious professionals, military professionals, artists and performers, aristocrats, and merchants who lived by buying and selling goods produced by others. The limited range of categories available in those societies was not the result of inadequate cleverness.

If some Italian despot or Tokugawa shogun had decided he needed a staff of human resource managers, corporate image consultants, strategic marketing specialists, and the rest of the occupational apparatus of modern business life, say, he would have been out of luck, and if he tried anyway, he would have been out of a job—the resources needed to train and employ some equivalent of modern office fauna would have had to be diverted from more immediate necessities such as training and employing an adequate force of condottieri or samurai, which was not exactly a viable strategy in those times.

This is why Italian despots and Tokugawa shoguns got by with relatively small staffs of clerks, scribes, feudal subordinates, and maybe an astrologer; that’s what their economic systems could afford. Equally, an aspiring craftsman or merchant faced real challenges in expanding his business beyond fairly sharp limits.

In a few cases, a combination of luck, technical skill, and adequate transport allowed one region to take on a commanding role in some specific export market, profit considerably from that, and build up an impressive degree of infrastructure; the golden age of Greece was paid for by the profits from Greek wine and olive oil exports, for example, and the woolen trade brought similar benefits to late medieval Flanders.

Far more often, though, local needs had to be supplied by local production, because the surplus energy that would have been needed to power long distance trade on a large scale simply didn’t exist, or couldn’t be spared from more pressing needs.

Thus the institutional arrangements that governed economic life before the industrial age were as closely tailored to a world of relatively scarce energy, in which most people worked in the household or farming sectors of the economy, as today’s institutional arrangements are tailored to a world awash in cheap abundant energy. That last point defines the crisis of our times, however, because we no longer live in a world awash in cheap abundant energy.

We’ve still got a lot more energy than Renaissance Italy or Tokugawa Japan had, to be sure, but the per capita surplus is not what it once was, and a growing fraction of what we’ve got has had to be diverted to cover increases in direct and indirect energy costs of energy production.

Meanwhile, the institutional arrangements are still firmly fixed in place, and they aren’t optional; try starting a business sometime without dealing with banks, real estate companies, licensing boards, tax authorities, et al., and you’ll quickly discover how non-optional these arrangements are.

The mismatch between the economy we’ve got and the economy we can afford has many implications, but one of the largest is precisely the issue I raised earlier in this post: across the industrial world, there are very few bankable projects to be found, even at a time when there are millions of people who need work, and who would happily buy products if they had the chance to earn the money to do so.

Our economy is burdened with an unproductive superstructure it can no longer support. The globalization fad of the 1990s, which arbitraged the difference in wage costs between Third World sweatshops and industrial-world factories, was in effect an attempt to evade the resulting difficulties by throwing the industrial nations’ working classes under the bus, and it only worked for a decade or so; as so often happens in the declining years of a civilization, a short term fix was treated as a long term solution, and a brief remission of symptoms allowed the underlying crisis to worsen steadily.

Over the long run, the mismatch is a problem that will solve itself; once the unraveling of the industrial economy goes far enough, the superstructure will come apart, leaving a great many human resource managers, corporate image consultants, strategic marketing specialists, and the like with about as much chance of finding jobs in their fields as they would have had 17th-century Osaka or 14th-century Milan.

In the short and middle term, though, the mismatch will almost certainly continue to show itself in exactly the same way that it’s been visible over the last few decades: more and more often, business ventures simply won’t be able to make enough money to cover startup costs or to stay in business. Of course there will be exceptions. We are talking about a shift that will appear, as it has appeared so far, as a shifting of statistical averages, and the background of ordinary economic fluctuations will make it more than usually difficult to tease out the signal from the noise.

Even in hard times, some ventures make fortunes; what makes hard times differ from boomtimes is that the fortunes are fewer, and the odds of making one of them come more and more to resemble the odds of walking away from a Vegas casino with a six-figure jackpot. All this has two implications, it seems to me, that are of core importance for the shape of our future. The first is simply that those of my readers whose plans for the future depend on holding down a job may have a very hard row to hoe.

The shift under way in the economy will more than likely squeeze the current model of economic life from both ends—as it becomes harder to find, keep, and earn a decent living at an ordinary job, businesses will continue to fold, debase their products, or both, and so it will also become harder to convert the income from an ordinary job back into goods and services worth having.

One of the core themes I’ve been discussing here for some time now, the need to move at least one family member out of employment into the household economy, is in part a response to that situation; what you produce yourself for your own consumption doesn’t pay a share of the costs of the economic superstructure.

Beyond that, the deterioration of the official economy is accompanied, as pretty much always happens, by the growth of alternative economic networks that allow goods and services to be exchanged outside normal channels; it may be a while before those networks become solid enough to support more than a few people, but taking part in exchanges through these networks even in their early stages may be worthwhile.

The second implication also relates to a core theme of this blog, though it’s on a larger scale. While other economic arrangements are certainly imaginable, the one we have right now is strictly limited in what it can accomplish by what can make a profit: to repeat Daly’s term, it has to be a bankable project, or by and large, it won’t get done. This may just turn out to be a far more dangerous limitation than anybody has yet realized.

There are, after all, any number of plans for grand projects in response to the end of the age of cheap abundant energy; each of them would require the investment of a great deal of capital, labor, raw materials, and other resources; and under present arrangements, none of them can go forward unless someone can count on making a profit from making them happen. Under present arrangements, in turn, it’s likely that none of them will be profitable enough to get a construction loan or to cover their operating costs once they get built.

We’ve already seen a solid prefigure of this in the ethanol bubble of a few years ago, in which firms in corn states rushed to build ethanol plants. Even with government subsidies and a guaranteed market, a great many of those plants are now bankrupt and shuttered. It’s an open secret that many recent solar and wind energy projects make money only because of government subsidies. Grandiose plans to turn large swathes of Nevada into algal biodiesel farms or vast solar arrays are arguably even more likely to be subject to the same rule—and the subsidies in these latter cases would be ruinously expensive.

Earlier posts here have discussed some of the other reasons why such projects will not be built; if the pattern I’ve sketched here is anything to go by, though, the future these projects imagine won’t arrive, because it won’t be able to pay its bills.

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The Thermodynamic Economy

SUBHEAD: Energy follows laws of its own that are distinct from the rules governing economic activities.

By John Michael Greer on 24 June 2009 in The Archdruid Report -
http://thearchdruidreport.blogspot.com/2009/06/thermodynamic-economy.html

  
Image above: The Second Law of Thermodynamics T-Shirt. From http://www.zazzle.com/2nd_law_of_thermodynamics_tshirt-235231998998010313

The last twelve months or so of economic chaos has taught those of us in the peak oil community some useful lessons. Perhaps the most valuable of these lessons is extent to which conventional economic ideas have failed to make sense of the way that the twilight of fossil fuels is working out in practice.

Not too long ago, it bears remembering, most people on all sides of the peak oil debate – believers, skeptics, and everyone in between – assumed that the law of supply and demand would necessarily define the world’s response to the end of cheap oil. As existing reserves depleted, nearly everyone agreed, the intersection of decreasing supply and rising demand would drive prices up.

Common or garden variety cornucopians insisted that this would lead to more drilling, more secondary extraction, and other measures that would produce more oil and bring the price back down.

Techno-cornucopians insisted that this would lead to the discovery of new energy resources, which would produce more energy and bring the price back down; green cornucopians insisted that this would finally make renewable energy cost-effective, and at least keep the price from rising further; and pessimists argued that none of these things would happen, and the price of oil would rise steadily on up into the stratosphere.

None of them were right. Instead, as the world crossed the bumpy plateau surrounding its 2005 production peak, oil prices moved up and down in waves of increasing violence, culminating in a drastic price spike driven in part by speculative greed, and followed by an equally drastic crash driven in part by speculative panic.

The shockwaves from that spike and crash were not solely responsible for the economic power dive that followed – most of a decade of hopelessly misguided fiscal policy, criminal negligence in the banking and business sectors, and a popular psychology of entitlement extreme even by the standards of past speculative disasters, all had their own parts to play – but even a financial world less shaky than the house of cards that imploded last year would have had a hard time dealing with the body blow inflicted on it by the oil spike and its aftermath.

The rubble from that collapse is still bouncing, even as politicians and pundits insist that the worst is over and a recovery will follow shortly.

This is not exactly comforting; the politicians and pundits of an earlier day said exactly the same thing during the “sucker’s rally” of 1930, when stock markets and other economic indicators regained much of the ground lost in 1929 before plunging catastrophically in the years that followed.

One thing that’s already become clear amid the dust and rubble, though, is that models of the future that assumed a steady upward rise in prices don’t apply to the much more complex reality of spike and crash that is shaping our energy future.

Somewhere in the midwest, perhaps, where a half-completed ethanol plant whose parent company has gone bankrupt is being sold for scrap, and oil leases bought for high prices last June sit unused because the current price of oil won’t justify their development, the dream of a smooth market-driven transition to a different energy system is rolling across a field with the tumbleweeds.

Meanwhile the price of oil is continuing its stubborn refusal to obey the laws of supply and demand.

Demand has dropped, as consumers and businesses caught in the economic downdraft cut costs, and stockpiles are ample, but the price of oil has doubled since its post-spike low, following a slow, ragged, but unmistakable upward trend.

What makes this all the more fascinating is that oil has shown the same habit of standing economic rules on their heads before.

Back in the 1970s, one of the great challenges facing the economics profession was the riddle of stagflation.

According to one of the most widely accepted rules of macroeconomics, inflation and deflation – which can be defined precisely as expansion and contraction, respectively, of the money supply – form two ends of a continuum of economic behavior.

Rising prices, rising wages, and increased economic activity leading to overproduction are all signs of inflation, while flat or declining prices and wages and diminished economic activity leading to recession are all signs of deflation.

In the wake of the Seventies oil shocks, though, the industrial world found itself in the theoretically impossible situation of an inflationary recession: prices were rising, but wages struggled to keep pace, and economic activity declined sharply.

That was stagflation. For more than a decade, economists tried to make sense of the riddle it posed, before finally giving up with a certain amount of relief in the Reagan years, and deciding that it was an anomaly that had gone away and so didn’t matter any more.

To many of the economists who tried to make sense of stagflation, it was clear enough that the oil crises had had something to do with it, but this in itself posed its own awkward questions.

The economics of commodity prices had been studied exhaustively since the time of Adam Smith, but the behavior of the world economy in the face of rising oil prices violated everything economists thought they knew.

Only a few economists at the time, and even fewer since then, realized that these perplexities pointed to weaknesses in the most basic assumptions of economics itself. E.F. Schumacher was one of these. He pointed out that for a modern industrial society, energy resources are not simply one set of commodities among many others.

They are the ur-commodities, the fundamental resources that make economic activity possible at all, and the rules that govern the behavior of other commodities cannot be applied to energy resources in a simplistic fashion. Commented Schumacher in Small is Beautiful:

“I have already alluded to the energy problem in some of the other chapters. It is impossible to get away from it. It is impossible to overemphasize its centrality. [...] As long as there is enough primary energy – at tolerable prices – there is no reason to believe that bottlenecks in any other primary materials cannot be either broken or circumvented.

On the other hand, a shortage of primary energy would mean that the demand for most other primary products would be so curtailed that a question of shortage with regard to them would be unlikely to arise” (p. 123). 

If Schumacher is right – and events certainly seem to be pointing that way – at least one of the basic flaws of contemporary economic thought comes into sight.

The attempt to make sense of energy resources as ordinary commodities misses the crucial point that energy follows laws of its own that are distinct from the rules governing economic activities.

Trying to predict the economics of energy without paying attention to the laws governing energy on its own terms – the laws of thermodynamics – yields high-grade nonsense. Look at the way that rules governing the availability of other resources go haywire when applied to energy.

When North America’s deposits of high-grade iron ore were exhausted, for example, the iron industry switched over to progressively lower grades of ore; these contain less iron per ton than the high-grade ores but are much more abundant, and improved technology for extracting the iron makes up the difference.

In theory, at least, the supply of iron ore can never run out, since industry can simply keep on retooling to use ever more abundant supplies of ever lower-grade ores, right down to iron salts dissolved in the sea.

Try to do the same thing with energy, by contrast, and two awkward facts emerge.

First, the only reason the iron industry can use progressively lower grades of ore is by using increasingly large amounts of energy per ton of iron produced, and the same rule applies across the board; the lower the concentration of the resource in its natural form, the more energy has to be used to extract it and turn it into useful forms.

Second, when you try to apply this principle to energy, you very quickly reach the point at which the energy needed to extract and process the resource is greater than the energy you get out the other end.

Once this point arrives, the resource is no longer useful in energy terms; you might as well try to support yourself by buying $1 bills for $2 each. This difficulty can be generalized: where energy is concerned, concentration counts for much more than quantity.

That’s a function of the second law of thermodynamics: energy in a whole system always moves from high concentrations to low. Within the system, you can get energy moving against the flow of entropy, but only at the cost of reducing a larger amount or higher concentration of energy to waste heat.

That’s how fossil fuels came into existence in the first place; the vast majority of hundreds of millions of years of energy from sunlight falling on prehistoric plants were degraded to waste heat and radiated into outer space, and in the process a very small fraction of that sunlight was concentrated in the form of carbon compounds and buried underground.

The same rule of concentration explains a great many things that current economic ideas miss.

Consider the claims made every few years that we can power the world off some relatively low-grade energy source. Latent heat stored in the waters of the world’s oceans, for example, could theoretically provide enough power for the world’s economy to keep it running for some preposterously long period of time, and any number of inventions have tried to tap that energy.

They’ve all failed, because it takes more energy to concentrate that heat to a useful temperature than you get back from the process.

The same is true a fortiriori of “zero point energy,” the energy potential that according to current physics exists in the fabric of spacetime itself. It doesn’t matter in the least that there’s an infinite amount of it, or something close to that; it’s at the lowest possible level of concentration, and thus utterly useless as a power source for human society.

The same limits apply, if less strictly, to many of today’s renewable energy sources.

Solar energy, for example, is very abundant, but it’s also very diffuse. As with any other energy resource, you can concentrate some of it, but only by letting a larger quantity of it turn into waste heat. It’s quite common to hear the claim that because solar energy’s so abundant, our society can easily power itself by the sun, but this shows a failure to grasp thermodynamic reality.

Today’s industrial societies require very highly concentrated energy sources; our transportation networks, our power grids, and most of the other ways we use energy, all work by degrading very high concentrations of energy all at once into waste heat, and without those highly concentrated resources, those things won’t work at all.

Now of course there are plenty of productive things that can be done with more diffuse energy sources.

Once again, solar energy provides a good example. Passive solar heating for buildings is a mature and highly successful technology; so is solar hot water heating; so are a good many other specialized uses, such as using solar ovens for cooking, water purification, and the like.

All these can contribute mightily to the satisfaction of human needs and wants, but they presuppose very different social and economic arrangements than the centralized energy economy of power plants, refineries, pipelines and power grids we have today.

As concentrated energy from fossil fuels becomes scarce, in other words, and more diffuse energy from the sun and other renewable sources has to take up the slack, many of the ground rules shaping today’s economic decisions will no longer apply. What this implies, in turn, is that economics does not exist in a vacuum.

The ground rules just mentioned took shape, after all, in an age where economic processes were dominated – one might even say “distorted” – by our species’ temporary access to extravagant supplies of cheap and highly concentrated fossil fuel energy. The new ground rules of economics that will take shape in the twilight of the age of cheap energy, in turn, will be shaped by the fact that energy is once again scarce, costly, and diffuse.

More generally, it’s necessary once again to pay attention to the myriad ways that human economic systems are rooted in the wider processes of the natural world – a theme that will be central to next week’s post.
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