National governments and multilateral organizations attribute the global economy’s deep wounds to a pile-up accident of financial investment outfits and banks. Misconduct and lost confidence that erupted into an unprecedented imbroglio mid-2008 was the supposed culprit behind the recession that has been declared over despite the troubling new spell of worldwide pauperization and protracted indolence on the investment front.
The dominant narrative remains mum on the strong possibility that the turmoil-provoking explosion in the seedy joint of super-leveraged dirty dancing had its fuse lit at a gas station/grocery store somewhere along the interminable commuting route between a North American city, where the jobs are, and exurbia where the zero-down-payment houses were built and sold on the assumption that the costs of transportation and food would never interfere with the perpetual climb of real estate values.
The notion that for the first time in modern history the world has come face to face with a binding resource constraint (call it “peak oil”) is absent from the radar screen of public consciousness.
How did it happen and what’s going on? The typical answer echoing from the academic-liberal media establishment takes excess liquidity as the point of departure.
From there the thread leads to superabundant credit, the competitive search for profit by the financial estate, and the concomitant, across-the-board relaxation of conditions to obtain loans.
As subprime mortgages accumulate — especially in the U.S. and the U.K. — their “securitization” accelerates. Then the U.S. housing market stalls and the opportunity to avoid the consequences of imprudent mortgage deals closes. Many households go “underwater.” They carry negative equity, i.e., owe more on their houses than they are worth.
A tremor shoots through the global investment and banking community. The risk associated with mortgage-backed securities becomes clear. The idea of pooling debt instruments (believing, or pretending to believe, that they are backed by solid, income-generating assets) and issuing further obligations in order to acquire funds to invest in yet other financial instruments (e.g., derivatives) reveals itself to be a fiasco in the making. The Bank of International Settlements (BIS, “the central bank of central banks”) discloses shocking disproportions between global payment obligations and the World GDP, the rate at which the planet’s inhabitants acquire their ability to pay.
Default on mortgages makes balance sheets appear increasingly dicey. The ironic designation “toxic asset” seeps into daily news. The ensuing crisis of confidence among banks reduces business credit. Stock markets fall. U.S. consumption declines; the global economy slows and goes into recession.
World GDP at constant prices, which grew at an annual rate of 5.2 percent in 2007, according to the IMF, moderated to 3.0 percent in 2008 before shrinking by 1.1 percent in 2009. International trade dropped by an estimated 11.9 percent for the year — a decline not seen in the postwar era.
The 2009 contraction was attributable to the 3.4-percent negative growth in the advanced economies, which represent the bulk of global output. China and India, the two new economic superpowers, continued to expand during the year at a sound clip of 8.5 percent and 5.4 percent, respectively. Their ability to grow despite financial calamities and shrunken trade was hailed as the irrefutable proof that the engine of economic expansion remained intact.
Following U.S. example, governments bailed out banks and “too-big-to-fail” merchants of capital in order to prevent catastrophic meltdown. Comprehensive reforms of regulating and supervising investment banking and securities trade were promised.
Coordinated, stimulative monetary policies and fiscal stimulus programs began to turn things around in the second half of 2009.
Worldwide unemployment, which gradually declined following the recession of 2001-2002, from 6.3 percent in 2003 to 5.7 percent in 2007, may have spilled over 6.0 percent during 2009 (IMF data). But there is good reason for optimism. Job loss is more of a problem in the industrialized counties where social safety nets are strong. In the emerging economies, where social safety nets are weak, growth is already accelerating, a sure sign that the forces of job creation are gaining.
“You see, things were not all that bad — and they are improving!”
Recovery will be on firm footing in 2010, enabling the international community to address social problems and national governments to balance the regulation of financial activities with reduced systemic risks (a genuflection toward the maintained belief that naked greed and the productive capital allocative function of investment banking are inseparable binaries).
By leaving out the most essential factors — hence, ignoring the Big Picture as a snapshot of Big History — all of the above and thousands of similar analyses seen in print and pixel every day add up to a rich crop of Utopia.
To make a comprehensive and realistic appraisal of the new millennium’s first decade, the intrinsic new problem of material constraints to economic expansion and the crisis of postwar financial-monetary arrangements cannot be ignored.
Ecological footprint calculations (the brainchild of Prof. W. Rees, University of British Columbia) show that the world economy has overshot the planet’s carrying capacity.
Officious prattle accompanying marginal and sham efforts notwithstanding, the accelerated depletion of precious nonrenewable resources and the frenzied destruction of the environment continues. Inspired by entrenched convictions, solution to unsustainable growth is expected from a global operating system designed to foster exponential growth.
The global financial system, which collapsed on the “Street” in late 2008 and, after having spent some time in the ER is now allegedly ready to be released from a public hospital, did not just suffer from a touch of “swine flue” and overexertion. It is incurably ill.
The name of the disease is congenital predisposition to secrete and accumulate disequilibrium. Main cause: Using a single nation’s fiat money (i.e., the U.S. dollar) as the world currency. This built-in asymmetry has been shadowing postwar monetary-financial institutions and practices from their inception, assuring their eventual self-destruction.
There have been many ways for the money of one quarter of the global economy to provide the other three quarters with the liquidity it needed to expand. But some of these ways — especially the buildup of a chronic, structural trade imbalance at the expense of U.S. export potential — have guaranteed that America would sink deeper and deeper into debt.
Fast growth presupposes the integration of national economies into a global whole through increased cross-border trade and capital flows. It demands growing quantities of a shared reference currency and medium of exchange. Consequently, the world currency of choice appreciates (and, as a matter of course, its artificially secured appreciation remains tolerated) whenever and wherever more of it is needed, increasing U.S. imports, setting back U.S. exports, creating and maintaining the long-term tendency of current account deficits. Since, under the system of floating exchange rates current account deficits must equal capital account surpluses, U.S. debt has been covered by loans from the rest of the world.
Per force, the growing external imbalance of the U.S. economy has been matched by worsening internal imbalance: households, businesses, states, and the Federal government are in over their heads.
Economic authority botches the diagnosis and prescribes relaxation.
For decades, leading scholars of the economics profession saw in America’s accumulating payment obligations nothing but confidence in the U.S. economy, the dollar, and — not the least — in the ability of Wall Street to create and diversify financial investment opportunities, i.e., churn out a surreal mountain of derivatives and mortgage-backed securities. During the last years of neoliberal-clout-secured speculative exuberance, the aggregate value of promises flirted with the imagination-defying quadrillion dollars mark while the global GDP was around a meager threescore trillion.
The unshakable belief of ecology-less economics in the unqualified goodness of trade went on a rampage. The more trade, the better — we just can’t have enough of it! A shirt imported from a poor Caribbean country costing less than a tip in a New York restaurant, diesel-run freight ships loaded with bottled lemonade passing each other in the Atlantic; a minority of rich households becoming cluttered with miscellaneous manufactures, so useless that they are forgotten as soon as they are put on the shelves — all this in the name of globalization.
Professors of international economics still go on shading triangles on blackboards, proving with simple geometry that trade benefits everyone all the time – “if we could only make governments remove their cold, dead hands from the market place.” Doesn’t it occur to them that the sides of those triangles may have fractal dimensions and that their circumference could be subject to irreversible deformations through unheeded nonlinear dynamic processes?
But this is exactly how propaganda and advertisement works. Link the broader message to a simple, logically irrefutable core and then hype the bubble. You want to sell a wrinkle removal cream to boomers? Tie it to the desire to remain young. You want to sell the absolute goodness of trade to impressionable undergraduates? Tie it to brilliant old Ricardo’s “English cloth/Portuguese wine” example — you will need only the numbers 1, 2, 3, and 4.
Things always pan out until they don’t.
The shock came to GDP-metered progress and international trade when Janus-faced Mephisto (“either expensive oil or out-of-sorts economy”) lingering in the wings for decades, finally cast its menacing silhouette and entered the stage of world history.
Experts suspect that the global output of conventional crude peaked in 2005.
Starting from that year, supply did not respond as expected to increasing demand. Widely available reports that major oil-producing regions had maxed out their potential to satisfy the world’s unrelenting exaction to keep the energy bonanza going sapped the reason to reject the “peak oil hypothesis.” Protests from the kingdom of hydrocarbons (boiling down to repeated assurances “not to worry, we have more, much more”); the angry uproar of run-of-the-mill economics that considers any nonoptimistic projection silly, and generously supported expertise brandishing a trillion more barrels of reserves here and another two trillions there, only added publicity to the “peak oil debate.”
Prices began their record-breaking rise and speculation was blamed for reaching heights supposedly unjustified by the fundamentals (i.e., demand and supply relations). But this analytic forgets that the sheer suspicion of the “peak” rounds out “fundamentals” with a perception of risk to productive activities, to the solvency of businesses and financial establishments and to the realism of payment obligations, in general.
A good part of what had been labeled parasitically speculative trading in oil-related commercial and financial instruments was defensive in nature. Foundations, insurance companies, pension funds, and cornered-in wealth managers acted more out of fear than greed. At the “peak,” price has every reason not to behave as one might expect based on reports from commodity exchanges about the number of barrels demanded and available.
Time to heed the clues
If economic history is a history of problems, homo sapiens has arrived at the frontiers of an undiscovered land inhabited by puzzling threats.
While eyes remain shortsightedly riveted on quarterly and annual GDP growth rates and “jobs, jobs, jobs,” the diminishing supplies of inexpensive exhaustible resources have given notice that there are limits to the aggregate scale of the global economy.
Given the current level of economically deployable technology, the total stock of nonrenewable resources can be represented by the planet’s hydrocarbon reserves, which, in turn, may be proxied by conventional oil. When this premise is augmented with the world economy’s apparent inability to eliminate the problem inherent in the drastic exhaustion of cheap oil while preserving growth, we must become mindful of the following actuality:
Conventional oil reserves have set the gap between ideal (full-employment-level) and actual world output lower than it appears and, consequently, the exchange value of oil has become an index that shows where the world happens to be in its struggle to overcome an unrecognized, complexly manifest, elusive physical obstacle.
A relatively slow increase in the price of oil correlates with recovery. A fast increase and a relatively high level indicate that the period of expansion is coming to an end. A fast major drop signals recession. (The 38-day moving average of the Brent Oil Spot maxed out during July-August of 2008, declining rapidly during the rest of the year and moving up slowly during 2009. Source: Der Spiegel)
The oil-price engendered downturn was thoroughly interwoven with the collapse of real estate values, the banking mess and asphyxiation on global capital markets.
The U.S. real estate market buckled in mid-2006 against a background of rising oil/gasoline and food prices. The increasing burden on household budgets, of which commuting to work from ever more distant residential developments is a significant component, prompted many mortgage holders to put their homes on the market. Prices declined; bankruptcies and foreclosures multiplied.
Central banks were swept along with these developments. The FED, which pursued easy money policy from 2001 through 2003, embarked on a persistent course of tightening from mid-2004 through mid-2006. Higher interest rates reduced asset values in general and helped tank the real estate market.
Mortgage-backed securities began to look more and more like promoters of insecurity. Then a positive feedback loop obtained. It involved reduced credit, declining asset values, liquidity crisis, growing losses in the banking sector, the spectacular demise of famed multinational mini-empires and lesser duchies. Economies slowed and went into recession.
Seeing the run-up in oil prices and the financial meltdown as two manifestations of the same phenomenon — namely that unrestricted global growth has reached an impasse, at best, or a wall, at worst — is the precondition for developing an enlightened perspective on current events and the future.
Counting on a single nation’s currency to provide the liquidity the world economy demands in order to grow exponentially by drawing down a nonrenewable and highly polluting resource defines a vengefully transitory enterprise. When we pair the dilating asymmetry built into the international financial-monetary order with the simple physical fact that the fossilization of living cells over geological ages bequeathed only a lump sum of once-usable barrels of oil, we have a perfect illustration of what the word “untenable” means.
The two subprocesses, unstoppable oil depletion and caricatural expansion of the part’s liabilities to the whole, are enmeshed in a joint dynamic by construction: Oil trade is denominated in dollars. It is little wonder that econometric work has confirmed that a solid underlying quantitative linkage (“cointegration”) exists between the value of the dollar and oil prices. (See, for example, Coudert, Mignon, Penot, “Oil Price and the Dollar,” Energy Studies Review, Vol. 15:2, 2008.)
As long as scholastic formalism (trapped in a matrix of limited and limiting concepts and reflexively rewarding descent into subatomic details) drives analysis, the relationship between the cohegemonic oil/dollar duo and the rest of the variables used to characterize the state of the world economy remains admittedly indecipherable, tentative, or statically fragmented.
To liberate thinking we must accept that the economy is subordinate to nature (rather than vice versa) and that there is socioeconomic-technological evolution. World history unfolds through distinct changes in its comprehensive physiognomy. Individual behavior and institutions are subject to epoch-determining transformations. When conditions are ripe for a system, it claims validity with overwhelming determination and when conditions become radically different it becomes irrelevant and vanishes into the landfill of outlived time.
Such is the first principle of an economics that does not shut out physics and history.
Looking at the panorama through this lens leads to the acknowledgment that the global reservoir of crude oil can diminish only so much before markets begin to sense that the growing stock of financial instruments is an overblown bubble. Suspicion about “permanently” expanding commitments to pay dollars (and rolling over already existing commitments) awakens when the economy’s pivotal resource is selling at (or is judged likely to rise to) profit-damaging levels.
A chaotic (nonlinear) macrohistoric mutation has played out during the first decade of the 21st century.
The decline in real estate prices, the bailouts, G-this and G-that meetings to coordinate responses to the economic setback, the IMF-led multilateral shuffling, all the compartmentalized, domestic political dramas that took place in the planet’s 265 nations were only masks like those seen in a Chinese opera. They elicited approval and blame. They whipped up emotions, praise, disapprobation, and odium while the deeper story, the irrevocable end to the world’s unsustainable fossil civilization, began to unfold.
Oil, dollar, and unemployment: Three symptoms that tell us the crisis is far from over.
Signs that the prevalent form of economic organization is incapable of substituting away from conventional oil smoothly (i.e., so as to preserve growth) are becoming stronger with every passing day. The system is like a special magnetic field that recognizes consumption as the true North when electricity is turned on nearby; that is, when growth is strong. Businesses across the entire economic spectrum become oriented toward serving the cause of increased consumption. When electricity is off (recession), the molecules (firms) become disoriented. They deploy a wide variety of strategies to survive. Most of them succeed but the result will not be the creation of a sustainable energy base in our time.
There is no closure in sight for the global currency problem. The dollar may have suffered in its capacity to store value, but there is no substitute for it as the comprehensive international medium of exchange and reference currency (unit of account). During the past four decades, the dollar has become everybody’s currency and everybody’s problem. The international community (as is) cannot live with or without it.
ILO reports worsening distress in global employment and a shocking new wave of impoverishment. The consequent loss in spending and the sluggish investment sentiment the world over mutually reinforce one another. And, because a lag exists between recovery as measured by GDP and growth in employment, the hypothetical, hydrocarbon-price-induced cycle has created a self-perpetuating tight fix. By the time employment begins to recover, another setback in overall growth will be around the corner.
“Sensus communis” versus the academy
“Sensus communis,” a concept of Aristotelian origin, recognizes the importance of what may be suggested by absorbing all available information and the totality of aspects. Since it grasps reality by going beyond strictly recognized scholarship and is nourished by the probable, it has always been in conflict with established science which accepts as proper only precisions that are produced and presented within its leading-cathedra-endorsed framework of stock in trade.
Not surprisingly, the theory that the world is on the brink of a macrohistoric transformation because its expansionism has encountered material constraints has been received by either deafening silence or unsparing criticism.
But time is not on the side of the “School.”
It is becoming superannuated by failing in all its predictions and recommendations. Idealized market conditions have not simplified corporate finance; rational expectations have turned out to be as irrational as characters in a Dostoyevsky novel; ever more aggressive deregulation, privatization, and globalization have not caused the world to drift toward general equilibrium; these programs enforced via insensitive institutional pressure seem to have aggravated rather than alleviated the differentiation in levels of living within and among nations. By increasing the misery at the bottom of the income pyramid, they may have inadvertently and indirectly undermined the world’s precarious, relative political stability.
Neoclassical economic sagacity is old chestnut. It will move into the textbooks on the history of economic thought once the gradually coalescing sureness about the devastating effects of overfilling environmental sinks and mindlessly emptying nonrenewable resource reservoirs (conventional oil, most in our face) are recognized for what they are: a “strange attractor.”
Posterity will reproach the neoclassical doctrine for remaining obstinately averse to broadening economic inquiry with physics, especially with the entropy law, biology (e.g., the principles of evolution), realistic sociology, and historicity beyond déja vu cycles in business expansion and credit.
Under emerging circumstances, fealty to 18th century ideals of socioeconomic arrangements and behavior is becoming counterproductive. It is time for an en gros switch in cerebral circuitry.
After presenting this view to an audience, someone will inevitably raise a hand and ask: “So, what do you suggest we should do?”
The answer may not satisfy everybody:
The tradeoff between understanding and making choices implies a certain “division of labor.”
Awareness of potentiality and requisite determination to choose a specific course of action are irreconcilable opposites within a certain range. That is why philosophers rarely become politicians and lawyers frequently do so. Reflection over universals and a large and diversified information base prevents the mind from committing to a program, which, by representing particular business and political interests, credos or ideologies, must encounter rational contenders in the social process of problem solving.
Nonetheless, the paradoxical opposition between plying Phronesis (sweeping practical wisdom) and worshiping Sophia (its counter pole) — to use the words of ancient Athenians – is valid only to a limited extent. The second field is not subsidiary and, as in all tradeoffs, there is a point of contact. Choice-making is grounded on and is the supreme consummation of understanding and our immediate task is to dispel canons of outdated objectivism.
