2012: Reaching “Limits to Growth”? (Cont)
Figure 3 shows that even when all kinds of oil substitutes are included, oil supply has not risen enough to keep oil price flat since the 2003-2004 period.
In my view, what has happened since 2003-2004 is very similar to the effect a person might expect from Liebig’s Law of the Minimum, if oil is a necessary component of the economy, and high oil price signals that too little oil is reaching the system. In agricultural science, Liebig’s Law of the Minimum states that the amount of plant growth is governed not by the total resource available, but by the amount of input of the needed resource in least supply (for example, nitrogen, phosphorous, or potassium). In other words, it isn’t possible to substitute one type of fertilizer for another; similarly, it isn’t possible to substitute one energy product for another in the short term. Instead output contracts, if oil is too high-priced. In a way, this contraction might be seen as a dress rehearsal for the ultimate contraction which Limits to Growth models have suggested will eventually arrive.
I am sure that some would say that oil supply would need to actually decline, for there to be a problem. Since the Limits to Growth model does not look at resource prices, it does not consider this detail. It would seem to me that by the time world oil supply actually declines, the world may already be in a major recession, which does not allow prices to rise high enough to keep production up.
Connection with DebtWhat relationship does debt have to the economy?
Economic growth enables debt, because in a growing economy, the greater amount of resources available at a later date make it much easier to repay debt with interest.
But higher oil prices tend to be associated with higher food prices. (See Figure 6, below.) When prices of oil and food rise, consumers (except for those making more money because of higher oil and food prices) tend to cut back on discretionary spending. This cut-back in spending leads to lay-offs and recession in discretionary segments of the economy. Some laid-off workers default on their debts, and businesses scale back their plans for expansion, because of the “bad economy”. As a result, they too need less debt.
So debt works well in a growing economy, but once an economy hits high oil prices and recession, debt works much less well. An economy has positive feed back loops from debt in a growing economy, but once oil limits (in terms of high prices) start to hit, feedback loops work in reverse–consumers and producers see less need for debt, and in fact, may default on past loans. Shrinking debt levels make it increasingly difficult for GDP to grow.
In my post The United States’ 65-Year Debt Bubble, I showed the following figure:
http://gailtheactuary.files.wordpress.com/2011/10/us-non-governmental-debt_gdp.pngw=448&h=270
Figure 5. US Non-Governmental Debt, Divided by GDP, based on US Federal Reserve and US Bureau of Economic Analysis data.
Figure 5 indicates that for the entire period from 1945 to 2007, non-governmental debt was growing more rapidly than GDP, helping to ramp up GDP. The ratio was close to flat for 2007-2008, indicating non-governmental debt grew about a fast as GDP, and has been declining since. Looking at quarterly data, this decline has continued through the second quarter of 2011. This continued deleveraging makes it more difficult for the economy to grow.
If I am right that we are indeed hitting Limits to Growth, I would expect the deleveraging to continue, and would expect it to get worse, as oil supply gets tighter. The reason why oil supply and not some other resource is involved is because oil is the limit (of the many which we might hit) that we hit first. While there is plenty of oil in the ground, most of what is left is expensive-to-extract oil, because we removed the cheap-to-extract oil first.
Our problem now is different from our problem of high oil prices in the 1970s, because then our oil shortage was temporary, and we could add new inexpensive supply (Alaska, North Sea, and Mexico). Now we have few options, except expensive ones, which cause problems for economic growth.
Part of the problem with high oil price seems to be related to the fact that high oil permits low EROEI oil to be produced. In other words, with high price, it makes economic sense to use a high level of resources to extract the oil. These resources include both resources used indirectly, such as for roads and ports and education, as well as direct expenditures. Clearly, it makes no economic sense to extract oil if the amount of energy required for extraction is greater than the amount produced. With high oil price, it appears likely that we are approaching this limit as well.
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