"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Sunday, September 19, 2010

The inextricable relationship between Energy and Money

Modern civilization is based on the continued growth of what I call the "Trinity" of money, credit, and energy.  Credit, of course is what drives money.  Money is lent into existence, that is, one man's loan is another man's savings.  The two can not be separated.  Savings cannot be created without someone, somewhere in the system, taking on debt.  This applies to individuals, corporations, and governments.

So what of energy?  Energy is the real world, tangible engine of growth.  Energy feeds us, it transports us, it builds things, in essence, it IS the economy.  Money is what we use to measure our progress, to allocate resources, to "keep score" so to speak.

Without a constant, affordable supply of energy, balance sheets, budgets, asset valuations - all get affected.  If you think of an economy as a system of inputs and outputs, energy is the greatest input that creates wealth.  But energy is not free.  It takes energy to extract energy - i.e. coal, oil, gas, etc...

And just as a monetary system needs to grow to survive, so too does the supply of energy need to grow to allow the monetary system to grow.  And that supply of energy doesn't just have to grow, but it has to grow at best, at a constant cost.  That is, if the cost of extracting energy rises, then that impacts the ability of the money supply to grow.

Think of it this way.  I have an investment.  At first, for every dollar I sink in to that investment it yields me $1.50 - I'm doing pretty well.  But what if, over time, there is a diminishing rate of return?  What if I only receive $1.25 for each dollar of input?  Or less?

That is what is happening to industrial civilization today.  It is taking more energy to produce energy.  The easily accessible oil and natural gas is diminishing, and we are now extracting more difficult sources of energy.  And on top of that, there are billions of more people in the world today that want that industrial lifestyle, and hence, need the same energy usage.

So what does that do to a monetary system based on irredeemable currency, born of credit?  How does that impact future growth?

The US Department of Energy commissioned Scientist Robert Hirsch to produce a report that was published in 2005 titled "Peaking of World Oil Production: Impacts, Mitigation, and Risk Management."  Here is the REPORT.

Robert Hirsch was recently interviewed by Matthieu Auzanneau, Oil Man (blog), Le Monde,  to discuss his upcoming book, and how his  2005 report and conclusions have been handled by various US government officials.

Here's an excerpt:
oil man:  What should we expect, before the world is able to catch up with the ‘peak oil’ issue ?
Hirsch:  From a world standpoint, Growth Domestic Product will decline every year for over a decade, and could easily be down 20 or 30 % over this period of time. That’s what I mean when I say « catastrophic ».
Wherever you live, somebody has to get food to you. And modern farming is run by oil, because the tractors that plow the ground and plant the seeds, and do the harvesting, run on oil. And then you have to transport the food to some kind of processor, and from there to the consumer.
From Part II of the interview:

oil man: - What happened after you published your 2005 report on ‘peak oil’ for the US Department of Energy (DoE) ?
Hirsch: The people that I was dealing with said : « No more work on peak oil, no more talk about it ».
People that were high in the administration hierarchy ?
Hirsch: The people that I was dealing with were high in the laboratory level. They were getting their instructions from people on the political side of the DoE, at high levels.
After the work we did on the 2005 study and the follow-up of 2006, the Department of Energy headquarters completely cut off all support for oil peaking and decline analysis. The people that I was working with at the National Energy Technology Laboratory were good people, they saw the problem, they saw how difficult the consequences would be – you know, the potential for huge damage – yet they were told : « No more work, no more discussion. »
I'm sure there are many people that will say, "but there's plenty of oil out there!"  That is true - but there is an increasing cost to extract that oil.  In my opinion, we are in the midst of a global recession, if not depression.  Why is the price of oil still so high?  What would happen to the price of oil if the global economy started growing at the rate is was pre-crisis?  What would that do to the price of oil? 

But you know what else?  If somehow the world economy did rebound to prior growth rates, and energy costs rose with the increased demand, the economy would fall right back into recession.  It's as if the price of oil becomes a wall that stops or slows the growth rate of the world economy.  That wall rises as the economy grows, and shrinks as the economy shrinks.  Catch 22.


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