Peak Oil, Population, and the Permanent Portfolio

[BearBones]

I wanted to provide a forum dedicated specifically to the interaction between increasing energy prices (whether by unrest in the Middle East or the phenomenon of "peak oil"), exponential world population growth at some point reaching the carrying capacity governed by our energy (and hence food) supplies, and the long-term state of world economies (and, hence, the PP). This has been touched on multiple times, most recently here:
http://gyroscopicinvesting.com/forum/ht ... ic.php?t=2

I am not posting this to convince anyone of anything, especially about the reality (or not) of peak oil, so no need to respond if you think that energy resources are virtually unlimited or if you think that nuclear/solar/wind/geothermal and the like will seamlessly fill in the void when inexpensive petroleum becomes scarce. I must also profess that I know very little about economics and have thought this through only superficially, so I am looking more for the wisdom of others rather than for a forum to proselytize.

Questions that could be addressed:
1.  Is energy scarcity, the natural increased demand provided by population growth, and the increased demand provided by the "development" of "emerging markets" ultimately inflationary or deflationary? I provided the simple argument that decreased supply + increased demand = inflation, but MT and Stone have provided good arguments that things are more complicated than that.
2.  Can one have economic contraction and simultaneous inflation in prices of essential goods and services, as I believe we have witnessed over the past several years?
3.  What happens to debt if there is exaggerated recession due to these factors, tax revenues fall, and the preexisting debt/GDP ratio is too high to pay debt interest?
4.  What happens to fiat currencies if this phenomenon gets exaggerated?
5.  And, related to this, what happens to the value of gold, bonds, etc?

To get thing started, I will start with these posts by Stone:

When oil runs out we have a choice, either people stand idle in poverty or they build renewable energy systems to provide all the energy everyone needs...

No doubt that we will build up alternate energy resources. Energy will alway be available,  but "net energy" (energy output - energy input) will steadily decrease as the "easy" petroleum reserves are exhausted, as they were in the US decades ago. And I'd argue that our current economic models are based on the assumption of steady exponential growth afforded by unlimited, inexpensive energy.

Perhaps, oil reserve scarcity doesn't really change things. Even if there was plenty of oil the choice then would be between having people standing idle in poverty or digging more oil wells.

I guess I do not see this as much a choice between people working or standing idle. Rather it is what happens if we all have to work much harder just to feed ourselves.  To see this, I'll introduce the idea of "energy slaves." Over the past half century, most of us on this forum have lived in a world of seemingly unlimited energy supplies. We take it for granted, but most of us are living as kings have in the past with lots of servants and/or slaves. When energy gets tighter due to increasing demand and decreasing inexpensive resources, we have less slaves and we have to work much harder, just as humans have done for millennia and as purely agrarian societies still do. See this article as a quick reference to what I am saying:
http://peakoilhausfrau.blogspot.com/200 ... laves.html

Does this change things?

[stone]

Bear Bones, I guess what I was trying to get at was the fact that most of the 7B people on the planet would be glad of having more opportunity for paid employment. So if the impediment to getting renewable energy is that it takes too much man power to get it, then there is a disconnect in there.

If only a few people have the purse strings, then the lazy option is simply to say that there is only enough resources for say 5% of the population to live well so the rest of you just sit in the corner. If everyone is a valued customer, then it will make financial sense to employ enough manpower to build the renewable energy systems.

Remember even in the 1980s most of the world's population did not have access to oil. That was purely a financial situation. Nothing to do with being a resource constraint. If oil runs out then provision of renewable energy will also just be a financial issue. With current technology we have vast spare reserves of man power. Imagine if renewable energy developers could out bid Goldman Sachs to get all the best science graduates. All the people who built the ghost estates in Ireland and Spain and Nevada could be building renewable energy plants. Not to mention people in Africa etc.

[BearBones]

Bear Bones, I guess what I was trying to get at was the fact that most of the 7B people on the planet would be glad of having more opportunity for paid employment. So if the impediment to getting renewable energy is that it takes too much man power to get it, then there is a disconnect in there.

I get that. So, let me exaggerate and see what we get. Energy gets very expensive such that net energy is on par with that provided by a mule. If most people are eventually working on farms, a few providing manual labor in tar sands, and the rest providing manual labor to care for the the horses, mules, and oxen that supplant the modern combustion engine, what happens to the US and UK economies and, by inference, the assets in the Permanent Portfolio? What if most of compensation for such work is through trade, never contributing to the economy as we know it? Sounds far fetched, but that is how most of the world has operated until the past few decades.

[stone]

Bear Bones, I guess if energy was that expensive and yet equally (un)affordable for everyone, then people would do a lot more teleconferencing, a lot more recyling/reusing and live in places where they could walk to work etc. I don't think the economy need grind to a halt at all. People would still want to pay for food, housing and entertainment. In principle a very prosperous very low energy economy is perfectly possible. In Florence or wherever when the amazing art was being done and the Medici were selling indulgences to all of Europe to spend ridiculously lavishly, I guess they actually consumed rather little energy by our standards.

[stone]

I do get the impression that the boom bust cycle may now be being driven by speculators alternately flooding money into stocks and corporate credit and then into commodities. The resulting spike in commodities causing a recession and so a slump in both commodities and stocks that can then be bought up cheap- rinse and repeat. The Fed creating an interest rate hike used to be the way that boom cycles were brought under control but perhaps that is a thing of the past. Basically now unaffordable commodity prices are what causes a demand collapse and that causes prices to become affordable again. Its a stupid system but perhaps its the system we have.

[MediumTex]

1.  Is energy scarcity, the natural increased demand provided by population growth, and the increased demand provided by the "development" of "emerging markets" ultimately inflationary or deflationary? I provided the simple argument that decreased supply + increased demand = inflation, but MT and Stone have provided good arguments that things are more complicated than that.

A credit based money system relies on the expansion of credit to increase the money supply.  The expansion of credit is premised upon the rational expectation of lenders that there will be sufficiently greater resources in the future to liquidate the debt than there are today (if there weren't this expectation much less lending would occur because it would be obvious most of it wouldn't be paid back).

If credit begins contracting in anticipation of a smaller overall economy in the future due to decreasing economic surpluses resulting from tighter natural resource markets, is that inflationary or deflationary?

2.  Can one have economic contraction and simultaneous inflation in prices of essential goods and services, as I believe we have witnessed over the past several years?

At any given moment, there is simultaneous price inflation and price deflation.  In recent years concert tickets have gone up in price, while flat screen TVs have gone down in price, but the average consumer hasn't seen significant wage gains and thus the overall economy's capacity to facilitate sustained inflation is limited.  In response to higher prices people simply run out of money to pay them, and the economy tips back into recession.

If there is a drought one year, the price of corn could easily skyrocket, but in order to pay the higher prices for corn, people will have to buy less of other things, which will put downward pressure on the price of everything else (since people have the same amount of money to spend as they did before the drought).

3.  What happens to debt if there is exaggerated recession due to these factors, tax revenues fall, and the preexisting debt/GDP ratio is too high to pay debt interest?

A portion of existing debt is defaulted on.  The more important effect, IMHO, is that these conditions will make the issuance of new debt much more uncertain, and thus a lot of new lending simply won't occur.

4.  What happens to fiat currencies if this phenomenon gets exaggerated?

Some will weaken and some will get stronger.  In 2008 the Japanese yen and U.S. dollar strengthened while most other world currencies weakened.

5.  And, related to this, what happens to the value of gold, bonds, etc?

Some bonds will rise in value (based on currency strength) and some will fall in value. 

Gold should do well, depending upon real interest rates and the nature of the political response to the economic challenges we are describing.

[stone]

Medium Tex, I guess you mean corporate and household debt defaulting rather than treasury debt?

I don't see in principle why there couldn't be massive economic expansion with less resource consumption. People could all employ each other as Feng Shui consultants or life coaches or whatever and use the proceeds of that to pay off any debts.

[BearBones]

I don't see in principle why there couldn't be massive economic expansion with less resource consumption. People could all employ each other as Feng Shui consultants or life coaches or whatever and use the proceeds of that to pay off any debts.

Not a lot of people are going to be paying for consultants and life coaches if the average person is laboring as hard as people did before oil. Hard enough to feed oneself and one's family, let alone to feed a consumer based society. Take 7 billion people, teach them all that we are all entitled to the "American Dream," then throw them back into a pre-1900 environment (when there was energy but largely in the form of coal), and what happens?

[BearBones]

3.  What happens to debt if there is exaggerated recession due to these factors, tax revenues fall, and the preexisting debt/GDP ratio is too high to pay debt interest?

A portion of existing debt is defaulted on.  The more important effect, IMHO, is that these conditions will make the issuance of new debt much more uncertain, and thus a lot of new lending simply won't occur.

4.  What happens to fiat currencies if this phenomenon gets exaggerated?

Some will weaken and some will get stronger.  In 2008 the Japanese yen and U.S. dollar strengthened while most other world currencies weakened.

OK, so does the US default? And does the US dollar strengthen or weaken? And is this inflationary or deflationary? I'm not trying to lead you to my answer. I really don't know.

[stone]

Bear Bones, are you are saying that we will all need to spend all day digging the fields in a post peak oil world? To me that would be not just post fossil fuel but also would entail an entire loss of all knowledge/government as well. I realize some people now spend all day gathering firewood and carrying water for ten miles etc etc but that isn't simply a lack of oil, it is having none of the infrastructure that the ancient Romans had or the Indus valley people had two thousand years before them.

[stone]

Bear Bones, the USD may theoretically end up worthless but USD treasury bonds apparently would never default. Any screw up in the USA would simply make the exchange rate weak such that the debt to be paid would be easy to pay.

[BearBones]

Bear Bones, are you are saying that we will all need to spend all day digging the fields in a post peak oil world? To me that would be not just post fossil fuel but also would entail an entire loss of all knowledge/government as well. I realize some people now spend all day gathering firewood and carrying water for ten miles etc etc but that isn't simply a lack of oil, it is having none of the infrastructure that the ancient Romans had or the Indus valley people had two thousand years before them.

Perhaps not all in the fields, but working a lot harder than we have seen in a century. And remember that many such "great" preindustrial civilizations relied on subverting a large % population (e.g., slaves) to maintain the standard of living. The Roman's "oil" came from the people that they conquered. And when this ended, the civilization collapsed.

[stone]

Bear Bones, is it really true that ancient Rome collapsed because they ran out of slaves or lands to conquer? Slaves need  to eat etc. I don't think slavery really helps much except to flatter the elite with fancy stuff. The medieval cathedrals in europe were built by volunteers. People worked the fields for some of the time and carved gargoyles etc in the time they had spare. I really don't think manual work takes anything like as much time as you seem to fear.

Anyway, what makes you think that we wouldn't be able to power tractors etc? We might not throw away loads of stuff like we do now but I really can't imagine that renewable energy systems would totally fail as you imply. Brazil currently uses ethanol for automobiles and even produces steel using sustainable charcoal growing. Solar power technology etc could provide plenty of electricity. I really think it would only amount to employing currently unemployed people to set it up. I think the only real obstical we face is stupidity/self importance/greed.

[BearBones]

The medieval cathedrals in europe were built by volunteers. People worked the fields for some of the time and carved gargoyles etc in the time they had spare. I really don't think manual work takes anything like as much time as you seem to fear.

...Brazil currently uses ethanol for automobiles and even produces steel using sustainable charcoal growing. Solar power technology etc could provide plenty of electricity. I really think it would only amount to employing currently unemployed people to set it up. I think the only real obstical we face is stupidity/self importance/greed.

Not that it can't be done. I have provided an exaggeration when talking about a purely agrarian society with nothing but mules. Yes, the US, UK and other "industrialized" countries will still be able to do such things as build cathedrals by hand and produce some steel using charcoal, of course. But to get from where we are now to that point would be a very rocky road. For one, our economic systems are built on the assumption of sustained exponential growth. And there would have to be a quantum change in our assumptions about lifestyle.

So, my questions are more about what would happen to fiat currencies, debt, economies, and the PP if we start down the road of escalating energy prices combined with the increased demand necessitated by population growth. If you don't think that this will ever happen, then perhaps leave this at as an improbable abstraction.

[MediumTex]

So, my questions are more about what would happen to fiat currencies, debt, economies, and the PP if we start down the road of escalating energy prices combined with the increased demand necessitated by population growth. If you don't think that this will ever happen, then perhaps leave this at as an improbable abstraction.

If you accept the premise that infinite economic growth using feedstocks of finite natural resources is a very temporary economic condition, it probably means that our current monetary system is also a temporary arrangement.

[stone]

I second what Medium Tex says but I also think that the PP is probably very well place do ride out that rocky road. Also it might not be as rocky as we fear. Japan has basically drifted into a much more equilibrium type system. Perhaps we will drift into having a longer and longer doubling time for our phoney paper wealth exponential growth until it isn't really happening anymore even on paper.

[stone]

I know a lot of opprobrium gets thrown at Alan Greenspan but in a "do what I say not what I do" sense I think he understood and understands these issues very well. He pointed out that all of the "growth" in the West was in the FIRE sector. He also pointed out that a basket of consumer items now weighs much the same or less than it did 50 years ago. An ipod doesn't take more iron ore etc than a transistor radio did.

[BearBones]

So, my questions are more about what would happen to fiat currencies, debt, economies, and the PP if we start down the road of escalating energy prices combined with the increased demand necessitated by population growth. If you don't think that this will ever happen, then perhaps leave this at as an improbable abstraction.

If you accept the premise that infinite economic growth using feedstocks of finite natural resources is a very temporary economic condition, it probably means that our current monetary system is also a temporary arrangement.

So if you saw this coming, in what order would you place bets on the individual assets in the PP? Anyone willing to speculate?

[stone]

I suppose the transition could go any number of ways. The traditional way has been to kick the card table over with a war and lots of massacres and confiscation and then start afresh. Then probably only gold holds out if you're lucky enough to live through it. The other way is to have a hyperinflation melt down, then again probably only gold holds out. But perhaps this time around, we will, despite all of the efforts to stop it, simply follow Japan's example of swamping the system in excess bank reserves. That might best favor a full 4x25 PP with rebalancing as things gyrate around into a new perma-ZIRP world. LTT were what did best in Japan but Japan was a net exporter unlike us.
You never know pigs might fly and we might have a new industrial revolution based around sustainable energy, recycling etc with full employment, prosperity all around and stocks ruling the PP (fingers crossed).
Basically anything could happen and the PP is meant for that lack of foresight.

[BearBones]

I appreciate the thoughts, Stone and MT. I am surprised, in a way, that so few people want to participate in this discussion. It is kind of like posting a discussion about the merits of gold on Bogleheads. Then only comments would be negative: "Gold isn't an investment, and it is way overpriced." Or like trying to convince goldbugs that deflation is possible: "The government is printing money out of thin air; inflation is inevitable."

We all get so locked in our views, and we are so biased by the lens of recent memory (myself included). Yet I see few things as important to long term investing and other life preparations as the issue of world population growth interacting with decreasing high net energy natural resources (especially petroleum). Seems to be the response is invariably that we will effortlessly shift to solar/wind/nuclear and the like with no understanding that 1) all of these sources have low net energy compared to oil, and all of these sources will require significant retooling of industrial infrastructures, particularly around transportation, 2) exponential growth of economies may be constrained by such factors, and 3) our economic models necessitate sustained exponential growth. Add massive debt to this. Yikes! Another response seems to be that this does not have to play out with any severe negative ramifications. Doesn't have to, no, but is it a real possibility. We spend a lot more time discussing and planning for even more remote events than this, IMO, such as when we discuss stockpiling food/guns/ammo, moving assets to other countries, and not counting on FDIC.

I especially appreciate your thoughts on the subject, MT, since you have obviously read about this and been willing to look at this issue squarely. And, when pushed, both you and Stone seem to come back to the wise conclusion that you don't know how this will play out, so you are not willing to place heavy bets on any one asset class in the PP. I am not so wise (yet), and I still tend to be biased by the lens of inflation over deflation. That's one reason why I appreciate people commenting so that we can all look at this honestly and from all angles.

[MachineGhost]

I especially appreciate your thoughts on the subject, MT, since you have obviously read about this and been willing to look at this issue squarely. And, when pushed, both you and Stone seem to come back to the wise conclusion that you don't know how this will play out, so you are not willing to place heavy bets on any one asset class in the PP. I am not so wise (yet), and I still tend to be biased by the lens of inflation over deflation. That's one reason why I appreciate people commenting so that we can all look at this honestly and from all angles.

I actually think you have a point, but really don't have much to add to the conversation that I didn't in the other thread.  But I don't think it's no happy accident that capitalism and abundant energy are linked.  The industrial revolution wasn't possible until the invention of the steam engine which used wood or coal.  Before that it was just technological breakthroughs in printing or warfare, nothing that really helped the common man rise out of poverty.

MG

[MediumTex]

I especially appreciate your thoughts on the subject, MT, since you have obviously read about this and been willing to look at this issue squarely. And, when pushed, both you and Stone seem to come back to the wise conclusion that you don't know how this will play out, so you are not willing to place heavy bets on any one asset class in the PP. I am not so wise (yet), and I still tend to be biased by the lens of inflation over deflation. That's one reason why I appreciate people commenting so that we can all look at this honestly and from all angles.

I have been trying to think through these peak oil-related issues for about seven years, and in the beginning you are tempted to pick a SHTF scenario and stick with it.  Over time, though, the S somehow never seems to HTF in the way you were imagining it would, and much SHTF planning turns out to have been misguided.  As with the PP, I think it's best to plan for a range of outcomes and not to get too attached to any one of them.

[stone]

In the 1800s someone made an extrapolation based on increases in horse traffic in London. Before long London would be entirely buried under horse manure. Electric trams were invented and the dung fest never came to pass. I think that that is as much a tale about how important it is that we do get new technology up and running as about how hard it is to predict the future. If we sit on our hands then I'm sure the future will be bleak.

When you say renewable energy has low net energy yield I think it is important to always unpick what exactly is meant by such statements. If it takes a certain amount of solar energy to produce the kit to harvest more solar energy then so what? The solar energy would otherwise just be being radiated back out into space by rocks etc anyway. All that matters in the equation is how much manpower and how much scarce minerals etc get consumed. If the only real input is willing manpower that would otherwise be unemployed (or making a nuisance of its self in the FIRE sector or doing government convolutions or whatever) then it is costless.

[BearBones]

I actually think you have a point, but really don't have much to add to the conversation that I didn't in the other thread.  But I don't think it's no happy accident that capitalism and abundant energy are linked.  The industrial revolution wasn't possible until the invention of the steam engine which used wood or coal.  Before that it was just technological breakthroughs in printing or warfare, nothing that really helped the common man rise out of poverty.

I am assuming that you were referring to this thread:
http://gyroscopicinvesting.com/forum/ht ... 5#msg24315
Just looked it over again. Looks like MT, Doodle, Adam, and I are all agreeing that this is an important issue. No one willing to bet on any specific economic scenario or any one of the assets in the PP, though? How boring. Where's Clive when you need someone to stir things up?!

[AdamA]

I have been trying to think through these peak oil-related issues for about seven years, and in the beginning you are tempted to pick a SHTF scenario and stick with it.  Over time, though, the S somehow never seems to HTF in the way you were imagining it would, and much SHTF planning turns out to have been misguided.  As with the PP, I think it's best to plan for a range of outcomes and not to get too attached to any one of them.

In a sense, the S has been H-ing TF in many parts of the world for many decades.  If you live somewhere that is plagued by drought and famine on a regular basis, you're basically experiencing peak oil without ever having experienced the benefits. 

Fossil fuels have allowed us to populate the planet to such a degree that only some of us get to live the good life.  There's just not enough stuff to go around, and there's only going to be less. 

I don't think this will manifest itself as one dramatic SHTF event, but more likely many such events that seem less dramatic to those not involved, but more dramatic to those who have to deal with them directly.