The Breaking Point

by James Dale Davidson

  • Saudi Arabia = 11.4 million barrels of oil per day, 399 wells, 3 million feet

  In other words, we have had to drill eighty-nine times more wells, covering ninety-nine times more feet of pipe, to produce about the same amount of oil as Saudi Arabia. That is evidence of diminishing returns, with a vengeance. It also vividly underscores what I have been telling you: we face ever-tightening biophysical constraints on growth. The slowdown in energy conversion in the economy can be expected to accelerate decline as the accumulated wealth of the past two centuries is dissipated.

  Return to the Organic Economy?

  You see what this means. The economy in this century of crisis is being forced back into the straightjacket of Soddy’s solar energy income, mostly the energy we can scavenge from photosynthesis in plants and animals that ate plants. Of course, this will be augmented in some locales by hydropower and various photovoltaic technologies for converting sunlight directly into electricity. But before alternative energy can amount to much, there will be a transition period of generations during which the industrial base upon which the transition depends will undoubtedly collapse. There will be no seamless reset of the system based on new energy systems.

  This also underscores the pernicious implications of the trumped up anathema on carbon dioxide. If the UN carbon budget is enforced through mandatory limits, it could result in up to 85 percent of known reserves of fossil fuels being barred from use. To the extent that the modern economy is a surplus energy equation, as I argue it is, the result of the war on fossil fuels is likely to be an economic collapse.

  The Breaking Point will tell across the whole spectrum of the modern economy as Jevons and Soddy hinted and Morgan proclaims. Already, the consequences for growth have been devastating. As David Stockman explained in a June 2015 Contra Corner article, since the conventionally measured precrash peak in December 2007, there has been a sharp deceleration in private sector wages and salary growth. According to Stockman, the United States now has a 1 percent growth economy (one-third its historic trend).17 Meanwhile, the debt incurred to finance federal spending, which does not pay its way, has grown at a 10.24 percent compound rate since 2007. It doesn’t take a divine genius to realize the situation is unsustainable when the shadow economy of debt is multiplying more than ten times faster than the real economy grows.

  Indeed, by the time an economy growing at 1 percent, if that, could double, debt ballooning at a 10.24 percent annual rate would have expanded eight times over, without even counting the effect of compounding interest. This would bring the US government’s debt to GDP ratio to a crushing 812 percent—far beyond the threshold of bankruptcy. Even if average interest rates paid on the debt remained frozen at today’s minimal rate of about 2.5 percent, that would imply annual interest payments of $3.6 trillion.

  Such is the doom-laden arithmetic of government finances. The debt that I imagine compounding at a 10.24 percent rate would undoubtedly compound at an accelerating rate going forward as the real economy weakens and the authorities try more desperately to stimulate the dying industrial world back to life. Unfortunately, it can’t be done. The notional wealth that can be created by the promiscuous creation of fiduciary credit, or “fictitious capital,” tends to rapidly vanish as capital markets react to and devalue malinvestment.

  Little Remaining Margin of Income to Plunder

  With US government spending having recently soared above 70 percent of wages and proprietors income 30 percent higher than in World War II, there is little scope to curtail debt by raising taxes.

  The reserve capacity of the system is spent.

  Losing the “Red Queen’s Race”

  With debt and entitlements growing by leaps and bounds, you can readily see why economies lack a reverse gear. They cannot decline as smoothly as they advance, because the status quo has been built to assume exponentially increasing obligations from year to year. We require ever-greater sums to meet servicing obligations on a soaring debt and rapidly expanding welfare payments (because real incomes are falling for nonelite workers).

  Recall Alice’s discovery, courtesy of the Red Queen, in Through the Looking Glass, that the system must go faster and faster to stay in the same place. (“Now here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”)18 In an economy plagued with diminishing returns, the de facto requirement to go faster and faster to avoid losing the “Red Queen’s Race” underscores the high probability of collapse. With the disappearance of cheap to extract energy resources, we are headed for the Breaking Point.

  Energy Shortfall Takes Marginal Players Out of the Game

  Again, the primary manifestation of “peak oil” is not in soaring prices for the oil itself but in the flat-lining of economic growth among the advanced economies whose average consumers have been unable to grow their incomes in the absence of a continuing surge of affordable oil supplies. After Richard Nixon imposed pure fiat money on the world, launching history’s great borrowing binge, GDP growth slowed, and income for average men in the United States began to decline. Those millions of average men could stay in the game only by sending their wives to work and then by borrowing. Because polygamy was out of the question, when their credit ran out, as it did for millions in the first decade of this century, the game stopped in a crisis of defaulted subprime mortgages that almost collapsed the world economy.

  That is what happened in the run-up to the 2007–8 crisis, and something analogous has been happening more recently in Greece. As of May 2015, some sixty Greek businesses were closed and 613 jobs were lost for each business day of the year. According to data from the Hellenic Confederation of Commerce and Entrepreneurship, Greek retail sales had fallen by 70 percent.19

  The “repossession” of the middle class lifestyle from marginal players in “advanced countries” as well as marginal countries has just begun. In that respect, the fall in oil prices that began in 2014 has ominous implications.

  The Downward Ratchet

  You can see the dynamic by which “lack of demand creates over time lack of supply” in the business headlines. The lead story in the July 27, 2015, issue of The Financial Times said it all: “Energy groups postpone $200 BN in projects as oil price slumps again: Wider commodities route hits spending plans; BP, Shell and Chevron among those cutting costs.”20 The story goes on to detail how the “plunge in crude prices since last summer has resulted in the deferral of 46 big oil and gas projects with 20 bn barrels of oil equivalent in reserves—more than Mexico’s entire proven holdings—according to consultancy Wood Mackinsey . . . The upstream industry is winding back its investment in big pre-final investment decision developments as fast as it can.” It added that the number of large upstream projects to be fully approved during 2015 could probably be “counted on one hand.”

  This plunge in exploration and production CapEx clarifies how the store of resources to meet future hydrocarbon demand was being curtailed by insufficient demand at high prices in 2014–15—a development that amplifies a dynamic that has been building ever since the post war surge of energy inputs stalled with the tripling of the oil price in 1973. The “downward ratchet” effect curtailing growth has intensified over time as EROEI fell, resulting in the Great Slowdown of the twenty-first century.

  “US Wages Have Fallen EVERY Quarter of the ‘Recovery’”

  Part of the reason it has intensified, I believe, is that the declining energy intensity of measured GDP growth involves a growing percentage of statistical “fluff” that exaggerates growth in national income accounting. To put it another way, the growing financialization of the economy may add to GDP as currently measured, but it does not propel the same increase in demand associated with GDP growth as previously constituted. Most of the gains from financialization, as amplified by the creation of trillions in “fictitious capital” out of thin air through quantitative easing, accrued to the already wealthy. So while those on the
upper rungs of the income distribution have gained trillions, median household income in the United States fell by 4.6 percent from 2008 to 2014. This contributed to the downward ratchet effect as declining demand increased the constraints on future growth by curtailing capital outlays for developing oil and gas prospects. Sprott Money, one of Canada’s leading investment analyst and precious metals dealers, claims that “US wages have fallen EVERY quarter of the ‘recovery.’”21

  This is common to all “advanced” economies that are being pinched by a decline in cheap-to-extract hydrocarbon energy. Italy has experienced a 36 percent decline in oil consumption over the past decades. Courtesy of Mariana Mazzucato, we learn that “Mario Pianta has shown in his recent book Nove su Dieci (Nine Out of Ten: Why We Are Almost All Worse Off Than 10 Years Ago) the average salary of Italian workers has fallen by .1% every year for two decades.” That type of accounting exercise would show similar declines in almost every “advanced” economy.

  Given the downward ratchet effect on oil exploration and production (E&P) capital outlays, therefore, you can expect a further slowdown in world energy production per capita, which as we have seen, has been closely correlated to real US GDP growth.

  Looming Ahead: Deflationary Collapse

  Oil is merely the most prominent of many crucial commodities whose prices have plunged because they are too expensive to produce and because the Chinese credit bubble stimulated artificial demand on a massive scale—which provoked growth of expensive supply—and then fell away again.

  For example, iron ore plunged from a 2011 peak of $190 per ton to a 2015 low of $44.59. And copper has plunged to multiyear lows. The same is true of aluminum, lead, nickel, and zinc. Prices of all the industrial metals were plunging in the summer of 2015, providing another strong hint that we are not witnessing an accelerating recovery. If the price of oil and other commodities fall far enough, of course, they will again become temporarily affordable. But when the current deflationary spiral began, they were not.

  The process of ricocheting between deflationary slumps in commodity prices and episodes of partial recovery in which tepid economic activity resumes, supported by unprecedented amounts of fictitious capital conjured out of thin air, will probably cycle at greater amplitude as the system evolves toward collapse. Contrary to headline economic reports, the end of economic growth is happening now.

  The Cycle of Retrenchment

  Think about it. The S&L collapse of the early ’90s opened the door for the Bill Clinton presidency late in the term of George H. W. Bush. Then eight years later, after the dot-com bubble burst, George W. Bush spent two terms in the White House, culminating in the mortgage collapse that paved the way for Obama. I rather expect a deep downturn to trigger the Breaking Point in the wake of the Obama presidency.

  To date, the only apparent expedient for recovery from bubbles caused by runaway credit expansion is yet another round of credit expansion that involves shoveling gargantuan quantities of fictitious capital to the already wealthy. Not surprisingly, this has yet to work.

  Now you face the end of another bubble. The signs are there if your eyes are open. Subprime debt has collapsed, as I forecast in 2014. Commodity prices are plunging. Notwithstanding government statistical fiddles to turn GDP positive, the broader, but long neglected, GNP contracted in Q1 2015 by 0.15 percent. The market has been choppy. No matter what the government does, it is not pushing stocks up. It’s only a matter of time until the big fall. Unfortunately, contemporary economists have little to tell us about the declining state beyond what Adam Smith said. If we want to know more about the declining state, other than that it is “melancholy,” we have to think it through ourselves.

  Your homework assignment, if you care to do it, is to map out your personal survival kit. Put on your thinking cap and try to imagine how the declining economy will affect your well-being: your investments, your livelihood, and your family. I trust that this book has given you a good head start on that exercise. You certainly will not get much help from conventional information sources.

  Most of the great and good economists whose names you know from the news are totally in thrall to the status quo. That is why they all failed to anticipate the mortgage crisis, or almost any other development that mattered over the past half century. They are particularly bound in fealty to the notion that creating fiduciary credit, or fiat money conjured out of thin air, is the culmination of human economic ingenuity. The only job of the establishment economists is to rationalize the status quo and help politicians confuse and mollify you.

  Whatever you do, don’t confuse yourself by imagining that you have nothing to worry about because the retrograde economy is not officially acknowledged. Only mavericks are telling you that the boilers are cold and the ship of state is drifting toward the shoals of collapse.

  But the fact that the established economists have shied away from thinking, much less writing, about the retrograde economy does not mean you have nothing to worry about. They did not forewarn you about the mortgage collapse, either. The fact that they were silent offered no protection against the trillions of dollars in losses suffered in 2008 and since.

  It’s about Energy

  The living mainstream economists have been mum about the importance of the collapse of EROEI on prosperity, but not everyone shares their reticence. There may have been nothing in the Journal of Applied Econometrics to help you understand why prosperity was falling away, but22 Mel Gibson was willing to shout it out in a 1995 interview with Playboy: “It’s about energy. It didn’t spare anyone.”23

  Gibson earned his education in economics as a twenty-one-year-old Sydney drama student cast to play the lead role in Mad Max, a low-budget 1979 dystopian film about life after growth in the Australian outback. Mad Max was the brainchild of Sydney physician and movie producer George Miller, abetted by economist and film buff James McCausland.

  McCausland was an early convert to the peak oil hypothesis of M. King Hubbert. In 1956, Hubbert predicted that US conventional oil production would peak in about fifteen years. In 1971, his prediction came true. He further predicted that world oil output would peak early in the twenty-first century, sometime around now.

  Both Miller and McCausland were impressed by the disruptions and strains arising from the 1973 oil crisis. When the price of oil jumped from three dollars per barrel to almost twelve dollars, Australia’s car-centric culture went into shock. The Mad Max creators drew on that experience to imagine how a long-term and deeper depletion of energy might be felt. Instead of an abstract treatise, they produced a high-voltage action film. They used their cinematic imaginations to help people understand the potential impact of the loss of energy inputs on an apparently fragile civilization. They certainly made more money and had more fun that they would have enjoyed preparing an academic study for the Journal of Applied Econometrics.

  Mad Max cost just $350,000 to make, and it grossed $100 million worldwide. (It was for some time considered the most profitable movie ever made.) It was then followed by two somewhat higher-budget sequels: Mad Max II: The Road Warrior and Mad Max Beyond Thunderdome. A much higher-budget sequel, Mad Max: Fury Road, was released in 2015.

  Imagine yourself as a bit player in the collapse to come in a variation on a Mad Max movie. Imagine yourself in any formerly rich, collapsing economy with critical resource shortages. If you have been a tourist in this postapocalyptic landscape, courtesy of your local cinema or via DVD, you will recall how the desperados and marauders manage to secure enough gasoline to indulge their high-octane hobby of road racing. In fact, they use gasoline as money.

  Of course, this is fiction. But there is realism in the presumption that even when critical resource shortages pinch growth enough to throw the economy into a downward spiral of retrenchment—and even after total financial, industrial, commercial, political, and social collapse—there will still be residual supplies to be had from reworking abandoned refineries in Gas Town, enough to keep some people’s V-8 engines revv
ed up for generations of sequels after the Breaking Point. Hence the notion right out of Mad Max that gasoline distribution is likely to evolve into the hands of outlaw motorcycle gangs: in the future, instead of going to Shell or ExxonMobil, you may have to turn to Hell’s Angels for the fuel to operate your car.

  And we learn from Mad Max Beyond Thunderdome that even when the marauders destroy the last oil refinery in the outback, there will still be enough methane gas in Bartertown to power chainsaws for gladiatorial combat. Some tough cookie like Tina Turner’s character, Aunty Entity, will make alternative fuel using slave labor in her Underground pig farm. But unlike the pious hopes of alternative energy shills, brewing methane gas in the Underground won’t necessarily make the world a peaceful place, much less prosperous. Once prosperity collapses due to an unavailability of sufficiently cheap net energy, there is no easy path back.

  The mainstream economists will tell you nothing about the declining/retrograde economy. But George Miller is in a higher pay grade than any mainstream economist. As of this writing, Mad Max Fury Road, in which the depletion theme in a parched world has been widened to include the lack of fresh water, has grossed $373 million worldwide, a sum that will loom even larger after the coming deflationary collapse.

  Miller knows a good story when he sees one about strong, silent men (and women) obliged to battle leather-clad gangs for gasoline (and fresh water) in a postapocalyptic wasteland. All of which leads to a question: Will the coming deflationary collapse be as grim as that depicted in the Mad Max films?

  I doubt it. For one thing, the liquidity deficit won’t be felt only in an uninhabitable desert. Another reason is that part of the premise of the Mad Max series is that the collapse of urban civilization has been accelerated by nuclear war.