Sunday, November 19, 2006

The invisible hand.

Thursday 15, June 2006


Article from the Oil Drum website:

The Sound of an Invisible Hand Clapping

(This is a guest post by Dmitry Orlov. Feel free to link or to quote reasonably short passages from the following post but please do not republish in its entirety. Best, Matt)

...One exceptional economist is Andrew McKillop. He is regarded as something of an apostate by people in his profession, to their certain detriment, because he was the first to recognize that high energy prices do not stifle economic growth, but instead accelerate it, and that higher energy prices do not reduce demand for energy, but instead increase it. These are key insights, and Andrew should be given credit for pointing them out.


...Many economists say that higher energy prices will decrease demand and increase supply. Instead, demand is going up and the supply is dropping. It turns out that higher energy prices act as an economic stimulus, both directly, because profits from the energy sector are reinvested, and not necessarily within the energy sector, and indirectly, because, to pay for more expensive energy, people are forced to somehow come up with more money, through increased economic activity of all kinds. Because economic activity requires energy, all of this additional activity causes energy demand to increase, not decrease.

...Such real-world complexities do not agree with the mental model favored by the economists, who like to think of supply and demand as two lines on a graph, and to imagine a magical invisible hand, which makes sure that they always cross. Thus, if energy becomes more expensive, people will buy less of it, until they can produce more of it. This is dogma, useless to argue about. Just as the 17th century physicians, so powerfully ridiculed by Molière, were primarily concerned with the smell of the patient's feces, and favored bloodletting as a cure-all, modern-day economists are primarily concerned with prices, and favor interest rate hikes to treat the economic maladies they misdiagnose.

...While waiting us out, economists have some advice to offer to us. They like to tell oil producers how important it is for them to satisfy the market. They warn that failing to do so would destroy demand for their product by causing consumers to "substitute" other sources of energy, such as solar, biomass, wind, tar sands, oil shale, nuclear, clean coal, and, of course, everyone's favorite non-energy source, hydrogen. Apparently, they didn't get the memo: all these new sources of energy, added together, will never amount to more than just a small percentage of current, fossil fuel-based energy consumption.

...But all of this waiting around for the economists to turn out to be right, or dead, in the long run, seems inadvisable. The physics of resource depletion doesn't care a whit about economic theories, and indicates that oil production has either passed its global peak, or is about to. After that, energy availability will dwindle with each passing year. It is one thing to have supply balanced on a knife's edge: minus a couple of hurricanes, plus an unusually warm winter, steady as she goes. It is quite another to have to live with chronic, ever-worsening shortages. A lot of well-laid plans will have to be abandoned, a lot of investments will become worthless, and business as usual will have to be replaced with the "new normal" – emergency management. And this brings us back around to the question I asked about the economists at the beginning: "What is it that you people are good at?" The answer, I think, is that they are good at making us continue to believe in the markets, in the status quo, and the continuation of business as usual, for as long as possible. They have to be good at this, as a matter of survival, because once we stop trusting their theories, their profession will no longer be economics – it will be history.

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As the price of gasoline has fallen a bit lately, people are inclined to think that the "worst" might be over. As this wayward economist says, it's a false positive. People will struggle mightily to preserve their current standard of living until all options are expired - they will juggle their budgets, try to raise more money, sell stuff they don't need, and so on. But this can only last so long. By the time most people realize they should sell their second or third car, there will be no market for them anyway. Combine this with depreciation and you will see a lot of people stuck with cars they can't afford to use, but they still owe thousands of dollars in debt on them, and which they can't sell, either.

The ripples will spread out, of course. I have said in the past that all of these outlying vinyl snout-house subdivision are future slums. That might be an overly optimistic assessment. Those low quality structures aren't very efficient at keeping in heat in the winter or cool in the summer - and since they are not generally located in a convenient area, the cost of home energy combined with the cost of gasoline to get to and from there could eventually rise to the point where people simply abandon those useless properties. And of course, they aren't going to continue to pay mortgage payments on a place where they can't actually live. They'll rent something in town instead, or move in with family members and friends. If even a small to medium percentage of these mortgages end up in default, the banking crisis spawned will be truly awesome.

And I don't mean that in a flattering sort of way.

Most people have this idea that loans from banks and mortgage companies come from savings they have on hand or profits they make from interest. This is not the case. Loans are fiat money - they are created out of the thin blue air by the regional and central banking authority and then "loaned" at interest to your local banks (and their parent corporations, if they're a big company). If the loans default, the central bank isn't going to make the loan vanish into the same thin air from which it was created - no, they will make your local bank try and pay then what is owed. And since selling these useless properties at auction isn't going to be a successful endeavor, seeing as no reasonably intelligent person wants to buy into abandoned low-class neighborhoods of homes made mostly from bubble gum and duct tape, the banks will themselves be in default on these loans.

We could see a return of bank failures that will make the savings and loan crisis look like a picnic in the park.

Oh, that can't happen, you say. There were safeguards put in after the Great Depression to stop that sort of thing from happening again. Yes, there were. But the big financiers have been steadily eroding and eliminating these safeguards since the 1980's or so, and with the complicity of your local congressperson, those safeguards are now either gone or are a joke. There are no real safeguards anymore. This made things easier for the banks.

It will make things harder on you, because you can now be screwed two ways - once when your local bank goes out of business with all your assets, and again when congress decides to bail them out (but not you personally) using tax dollars, which you have paid or will pay.

Isn't that sweet?

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