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Why we cannot grow our way out of the crisis

While we have some sympathy with the Left’s call for stimulus measures, we do not hold, as they do that global growth will allow us to repay the consequent high debt. Growth, such as we have seen since the Second World War, will never be achievable again at those levles because it was based on abundant, sweet, cheap oil. The Oil Drum Blog is an excellent source of information about fossil fuel resources and the consequences of their diminution. Richard Heinburg spells it all out in his guest well referenced article, quoting recent work by James Hamilton of the University of California, San Diego, titled “Causes and Consequences of the Oil Shock of 2007-08,”

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) Link to full article

Our own David Korowitz provides the physics behind the Heinburg’s economic scenario…

If energy flows into the economy decline, growth cannot continue, this reflects thermodynamic realities and embedded dynamic constraints.

Debt is a call on future wealth. We can borrow because the principle plus interest has a better chance of being paid back in a growing economy. In a contracting economy paying back the principle will take a growing share of the total economy, never mind the interest.

The sovereign, corporate, and personal debt already accumulated, and governments’ attempts to run deficit financing to bring us out of recession are likely to fail as rising energy and food prices choke off growth, and lower discretionary income make servicing debt more and more difficult. Eventually, lenders will realise they are throwing good money after bad, or rather bad after worse.

If countries cannot borrow, they cannot run deficits. If you need to import energy, food, or components for vital infrastructure or services, you will need to export something of similar value. This will mean companies integrated into parts of supply-chains may have to drop out. Investment will become close to impossible, even energy investments will occur in a much more risky environment.

Our debt based fiat money system is effectively primed for deflation. The pool of money in the economy is maintained by new borrowing as old debt is repaid. A drop off in new debt issuance, and a reluctance to spend (a reduction in the velocity of money), will mean reduced economic activity on top of the energy constraints. Some governments will no doubt discover the short-term benefits of printing money, only to further loose confidence in their currency.

Valuing a currency will become fraught with difficulties, the dollar will no doubt crash, but against what? We could say that money becomes opaque. We lose confidence in its valuation in space, that’s trade; and time, that’s investment.

Finally, sticking with our thermodynamic theme, we might remember that entropy and information bare a close relationship, a history going back to Claude Shannon in the 1950’s. The collapse of structures and institutions represents a loss of information about how our world works. The increase in uncertainty will be fundamentally stochastic rather than epistemic.  Link to full presentation

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