Tuesday, September 16, 2008

We have not been here before

The present economic crisis has two main causes. One is the downturn of an extreme version of the normal business cycle. The other is that a trend - the increasing inadequacy of the world's supply of oil as a result of resource depletion - revealed itself just as that cycle was reaching its peak and both precipitated and accelerated the decline.

There has never been a coincidence of a cycle and a trend in this way before. We are in completely uncharted waters because the cheap, abundant energy supply which has enabled economies to recover from depressions in the past may not be available this time around.

In a normal economic cycle, the easy availability of cheap credit provides the extra purchasing power required for output to grow. According to David Roche, an investment consultant writing in the Financial Times, $4-$5 of new credit is needed for each $1 of GDP growth.

After a time, however, the economy concerned begins to run out of key resources – skilled workers, perhaps, or factory space – and prices begin to rise, pushing up the Consumer Price Index. This, in turn, triggers a response from the central bank, which raises interest rates or puts restrictions on lending to prevent inflation becoming excessive. Borrowing falls, the rate of demand growth slows, and the down phase of the cycle begins.

The cycle that has just entered its down-phase was rather different, however, because the world's central banks failed to step in to keep it within previous bounds. They failed to act because the price rises it generated were not reflected in the consumer price indices they monitored until very recently because supplies of cheap goods, foodstuffs and skilled labour were available from the poorer parts of the world. The price increases which did develop came in ways which did not directly affect consumer prices. They were in asset values: property and share prices increased, but everyone thought that this was a good thing.

These increased asset values provided security for additional loans, and so the up-cycle continued until one critical resource - oil - began to run short on a global scale. Its price soared, taking money out of the oil-consumer-countries' economies and transferring it to the oil producers just at the time that the asset-based borrowing boom was peaking anyway in the US and several other countries. The boom was peaking because borrowers did not have the incomes to take on more debt despite valiant efforts to enable them to do so, such a giving 100% mortgages to be paid off over 40 years at five times (or even seven) times a couple's joint income.

If the current down-turn was like its predecessors, we could expect a period of readjustment (an innocuous term meaning unemployment, repossessions, a few winners and a lot of losers). After a time, house prices would dip down to a point where buyers come back into the market, credit became more freely available and the economy started to pick up.

This time, however, because a super-boom was allowed to develop, the risk is that the bust will be on a similarly super scale and that the capital write-offs will be huge, endangering the banking and money creation systems. Unemployment may reach record levels. The demand for energy is already dropping. The danger is that oil prices will return to a low level, not only destroying the viability of all the renewable energy projects that are now getting under way but also halting oil field development.

If this happens, since very little new capacity will be built, when economies eventually start to recover, supplies of energy and other resource may quickly become inadequate and prices could rise again very rapidly, This could stifle the recovery and make it very costly to move to a more sustainable economic system.

Energy Scenarios Ireland 2.0 explores the present situation and how it might work out.
In Business As Usual we assume that the economists who think that the down-phase of the economic cycle will be short are correct and that growth will resume in the near future. We also assume that significant supplies of oil and gas will be discovered and we can therefore ignore the possibility of energy shortages for the moment. A further assumption is that fossil energy use is not restricted for climate change reasons.

In Enlightened Transition, we assume that action to replace the world's depleting supplies of oil and gas stimulates a global economic recovery so that, as the economy grows, demand for non-renewable energy falls.

In Fair Shares, the economic recovery is slow as Ireland struggles to make its economy more sustainable but with limited resources to do so. In this scenario, falling global energy prices mask
the decreasing supply trend until the economy starts to recover.

In Enforced Localisation no significant action is taken and the country slides into economic collapse. Recovery is long and slow.