It will come as little surprise to most readers that the world is near to, or past, peak world oil production. Petroleum is so essential to the economics of transportation that many believe when oil peaks, the global economy must also shrink in terms of the total output of goods, even as the population increases. Most who study peak oil and accept the findings of the Hirsch Report do not expect a lasting economic recovery, likely for decades.

If peak oil were our only problem, we could mobilize our nation on an emergency basis to deal with the problem in a straightforward way. In our real world, there is a complex interaction between oil supply, economics and politics. Our economic system is constantly interacting with the politics that makes the rules that govern our economic system. Politics is anything but an efficient way to achieve rational change. The geology is the easy part, but it is the complexity of the social response that makes peak oil difficult to study. The following link provides my expanded explanation in several essays, along with more documentation. Some of the main points are collected below.  http://theragblog.blogspot.com/2009/12/fixing-economy-like-filling-leaky.html

Energy analyst Tom Whipple recently pointed out that our global economic options seem to be increasingly narrowed to the choice between continuing global economic stagnation versus a short start at recovery followed by a relapse into economic contraction and global stagnation. Assuming this is true, use of stimulus spending or any other political and economic policies can’t get us back onto the previous path of prosperity for very long, no matter how wise and skillful these methods may be. http://www.energybulletin.net/node/50536

With global liquid fuel production probably maxed-out below 90 million barrels a day, and global petroleum reserve capacity thought to be less than 6 million barrels a day, a 5% or more annual average depletion rate implies that the world will use up all our reserve cushion within a year or two. The return of another tight global oil market will be accompanied by the return of the crippling oil price increases we saw in mid-2008, but this time imposed on a weaker economy.

The economic crisis is resulting in a huge gap between the global growth predicted by the banking and finance system versus the disappointing performance of the global economy. This shortfall is strongly reflected as political discontent. Centuries of economic expansion have taught us to regard continuous growth as normal. The economic system seems to be broken when this is not the case, and people expect politicians to fix things. Nobody can predict even the economic outcome very well, because it is so largely based on consumer psychology.

Stagflation?

A large part of the US domestic economy now appears to be in a state of deflationary contraction, with a true US unemployment rate approaching that experienced during the great depression. Bad news feeds on itself and this perpetuates a deflationary downturn during hard times. The velocity of circulation of money also slows down, as everyone tries to hoard cash, worsening the problem. http://blog.atimes.net/?p=1236

I think it makes sense to view the US domestic economy as being comprised of two consumer spending sectors with rather different characteristics. First the discretionary spending sector of consumer spending, and then a second non-discretionary sector, which including necessities like food and energy.

Discretionary spending is shrinking fast as the jobless and the growing numbers of those fearful of income loss limit spending to the purchase of bare necessities. Both apples and oranges categories of spending are averaged together to give a rather misleading consumer price index, which sadly excludes food and energy.

Whereas labor and services costs are determined by the supply and demand within the domestic economy, commodities typically have their prices determined by the global marketplace. Whenever a tight global oil market returns, it means that the rising cost of oil needed to transport almost everything pushes up all other commodity prices. This is termed cost-push inflation.

If the non-discretionary sector of the consumer economy is deflating, due to slack demand and home prices decreasing, it does not mean that the same price trends apply to the non-discretionary sector. These two sectors can thus have very different dynamics. The US domestic economy is stagnating while the global commodity sector is seeing price inflation. Housing and labor prices have been falling, even as global commodities prices are rising, to give a misleading picture of inflation. These trends taken together signify stagflation, which tends to defy easy economic remedy.

As US consumer spending relatively shrinks, there also seems to be a global commodity price bubble attracting speculation and driving up many raw materials prices. Commodity prices in general have risen about 30% since March 2009. The price increases may now be spreading to food. http://www.bloomberg.com/apps/news?pid=20601109&sid=aBYSp0.XfXZs

The Keynesian Remedy

Keynesian stimulus is ideally a governmental policy that borrows economic demand from good times and uses the proceeds to boost demand during times of contraction, to keep recessions from deepening into deflationary depressions. Public spending by the US government on public projects

is meant to restore demand missing due to contraction of the private sector of the economy. If there is enough public spending, a multiplier effect helps stimulate demand and revive consumer optimism.

In terms of the scale of the government money being introduced to stabilize the economy, it is mostly going to bailouts, low prime rate credit, and existing entitlements, with a relatively smaller amount of Keynesian stimulus. The Keynesian stimulus is beneficial insofar as it gets to average consumers, but much of the money is headed elsewhere; perhaps overseas to buy commodities, gold, etc. If there are few obvious opportunities for profitable investment within the US consumer economy, money will be attracted elsewhere.

Meanwhile, even the most skillful application of Keynesian stimulus spending can’t get us back onto our previous path of economic expansion for long without cheap oil.

Money Heads Abroad

With the domestic consumer market so depressed, the easy credit offered to the banks now tends to leak out of the US and head abroad, without creating many domestic jobs in the process. The near zero prime rate money available to the big profit-starved investment banks will probably be used to shore up their troubled bottom line with high-profit loans, lending for things like foreign subsidiaries of US corporations, commodities including gold, oil production, and growing markets in emerging nations. Some prime rate money is being borrowed and then used to buy higher interest paying US treasury bonds, giving guaranteed profits but no jobs.

The scale of existing obligations on the part of US consumers, the many federal obligations and entitlements like health care and social security, and private bank debt taken together is an overwhelming tax burden for an aging unemployed population. Given the peak oil situation, it is unlikely that this aggregate burden of US debt can ever be paid back with dollars that retain their current buying power. This leaves a choice of either US government default, or more likely in the short run, devaluation through inflation that keeps the finance books balanced with shrunken dollars. The historic evidence strongly points to solving our debt problems with inflation, which is a concealed form of taxation. Here political policy takes over.

Why Do We Need Banks?

The Federal Reserve and the US Treasury effectively print money, and we are not seeing the deep reform of the banking system regulation urged by many financial experts. What is the extent of our political commitment to keep the existing banks solvent and functioning as if things were normal? Since banks operating within our capitalist system depend on continuous economic expansion to generate their profit, expecting them to be genuinely profitable without cheap oil is probably impossible. And yet It is part of our political legacy that the largest private investment banks, working through the Federal Reserve, have been put in charge of channeling the economic resources of our society and nation.

What we really need is a new kind of bank, or its functional equivalent, that can channel the wealth of society toward a new economy that can be sustainable and stable without the expectation of continuing growth. The facts seem to argue that we need to phase out rather than prop up the big private banks that got us into trouble, with political help. The fact is also that the US Treasury already acts in some ways like a bank under political control. Taken as a whole, this should focus our concern on the politics of regulation. Let us try to help make it all work out.

Roger Baker is an Austin-Texas-based, transportation-oriented environmental activist, recently with a particular interest in energy-oriented economics. He is a founding member of and an advisor to ASPO-USA, is active in the Green Party, the ACLU, and others. He writes for the Texas-based cyber-journal, “The Rag Blog”.

(Note: Commentaries do not necessarily represent ASPO-USA’s positions; they are personal statements and observations by informed commentators.)