The Great Simplification Ahead

“Until debt tear us apart”

Nov 27, 2023

There is no denying that a major economic downturn is now in the books, and that lacking an energy miracle, the world economy is about to go through a major shift. After discussing the faulty nature of prevailing economic metrics (GDP) in last week’s essay, and understanding how economic growth has turned into stagnation 18 years ago already, let’s turn our eyes towards the future. What might the world economy look like after the onset of the coming crisis? How would world leaders react? Could gold or bitcoin save the day? Let’s dive in.

There is a yawning gap between real economic productivity and debt in the world economy. Despite the fact that GDP seems to be growing, real economic output (best measured by energy consumption) has been stagnating for almost two decades now. As a result Western nations have lost their dominance in the world economy, and now face a steep decline due to an ever worsening energy balance and their colossal import dependence.

You see, this is not a matter of money or the lack thereof. Governments all around the world had the chance to print all the money they wanted in the past two decades. There were two thing they could not conjure up, however: cheap raw materials and energy. Contrary to common wisdom, the green energy transition is not a miracle waiting to happen, only an expensive and utterly unsustainable addition to the existing fossil fuel energy infrastructure. Shale oil, the much heralded “solution” to peak oil, has also run its course and now is close to reaching its all time high… Only to embark on a steep decline afterwards. None of this is a monetary question, only a matter of geology and economics: resource depletion and the resulting cost increase. Printing money does not solve any of these issues, only creates more inflation.

Industrial civilization is in overshoot. In the past two centuries we were living way beyond our means: consuming more mineral and natural resources than what could be regenerated or replaced, while releasing way more pollution (including CO2) than what could be absorbed safely by Nature. We are slowly living up our one-time inheritance, and now the chickens are coming home to roost.

Using credit to mask this underlying predicament has only made matters worse by creating a bubble ripe for bursting anytime soon. The underlying economy can no longer support such high debt-levels, and when global energy production (from all sources) start to fall it will be impossible to pay them back. The only outcome seems to be a combination of a massive default (wiping out the assets of the rich), and hyperinflation (destroying all the excess purchasing power left in the pockets of average folks). Although the onset (let alone the outcome) of such a financial crash is nigh on impossible to predict, it might worth our time to lay out some possible scenarios as to what the near future might hold.

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The Horror (Cascading Collapse)

According to a study on societal tipping points a peak and fall in global oil production would bring down the entire financial and trade system like a house of cards. (If you only have a limited amount of time, just read the Summary on page 2–4, it is really persuasive.) In this scenario, following a collapse of the banking system — due to a large amount of debt becoming physically impossible to repay — all lending would stop overnight. Since global trade is wholly dependent on letters of credit (a contractual commitment by the foreign buyer’s bank to pay once the exporter ships the goods), a severe banking crisis would lead to an immediate halt in global trade.

Such an event, of course, would cause all sorts of shortages from food to clothing. The West, whose hollowed out over-financialized rent seeking economies have become wholly dependent on cheap imports, would be hit especially hard. Citizens of this once most envied part of the world would quickly realize that neither their governments, nor their praised free market economy could take care of even their basic needs, and a social collapse would quickly ensue. Massive chaos combined with a zombie apocalypse is sure to follow.

As someone who has spent his entire carrier in manufacturing, supply chain management and logistics (yes, that includes the 2008/2009 crisis too) I can testify that this is a very real risk. During the great financial crisis we were indeed just inches away from a complete freeze in global shipping, but could it have led to the scenario outlined above? This is where I must insert my quibbles: even during the darkest days of the financial mayhem of 2009 people all around the globe were working overtime to find a solution. Everyone from the factory worker to the big financial moguls were interested in keeping the system alive. Things which seemed impossible just a year ago, were somehow done in a matter of days. I learned back then, when the future of the system is at stake miracles can happen almost instantaneously.

I’m not suggesting that we will suddenly make hydrogen fusion possible or launch LNG cargo ships into space to bring back some cheap methane from Titan. Having used up the best of our mineral and energy resources none of this is now possible (not that it ever were). It worth keep in mind though that we are talking about a potential 5–6% drop in oil production year over year after the economic / energetic peak hits somewhere down the line this decade, not a complete halt in petroleum production. Yes, it’s still going to be brutal, wiping out some rather large businesses, even countries; causing disruption in trade, shortages, eye watering prices and all the rest, but the cascade will eventually stop at a more or less sustainable level. Finance is entirely a work of fiction, and since 95% of the resource flows will be still there ready to be shipped, another entirely fictional story supporting some semblance of global trade will be quickly implemented. It ain’t gonna be pretty, but one should never underestimate human ingenuity when an asset manager’s paycheck is at stake.

To illustrate how resilient the financial system might be in face of peak oil, take the following quote from the study linked above:

“We argue that one of the principal initial drivers of the collapse process will be growing visible action about peak oil. It is expected that investors will attempt to extract themselves from „virtual assets‟ such as bond, equities, and cash and convert them into „real‟ assets before the system collapses. But the nominal value of virtual assets vastly exceeds the real assets likely to be available. Confirmation of the peak oil idea (by official action), fear, and market decline will drive a positive feedback in financial markets.”

Sure enough, a global peak in cheap (conventional) petroleum production in 2005 did kick a commodity price rally into motion, however it did not collapsed the system. If you consider that oil production (including non-conventional sources like shale) has reached it’s all time high in November 2018 already (exactly 5 years ago) you can see that the world economy is indeed a self-adaptive system with still a lot of energy left to fight what’s coming. I’m not saying that then we will solve all issues and can sit back, all I’m pointing out that it’s going to take a whole lot more than a few years of falling oil production to bring down this civilization.

Commodity price charts from Trading Economics, with my markups

Bitcoin to save the day

Now that we have the horror scenario behind us, let’s turn towards more “popular” theories on how the future after a financial meltdown could look like. Let’s take Bitcoin for example. According to its supporters it will give the economy a great deal of financial independence, decentralization and transparency while depriving the government of meddling with the money supply. Since it cannot be printed at will, inflation would become a problem of the past and the dream of a truly free market economy would finally come true.

Bitcoin could also solve the question of trust and thus could easily cut out the middlemen from financial transactions (i.e. banks and their letters of credit). Although I’m not an expert of crypto-currencies I can, for example, imagine that soon after a complete financial meltdown many traders would opt for Bitcoin (or similar currencies) to free up shipments stuck in ports around the world.

And here comes my greatest concern. Namely, that Bitcoin and similar block-chain technologies do not scale easily. Their computation power demand is simply enormous, and if all of a sudden millions (or billions) of new users would opt for using it, first it would crash, then as ever more miners would see it as investment opportunity, it would cause energy and material supply chain issues in an already material and energy deprived economy. Bitcoin is a good idea in a world where resources and energy are infinite and thus almost for free, but in a finite world which is about to experience its biggest shock ever… well, maybe not so.

So while crypto-currencies might help relieving the initial shock of the 202X financial crisis, governments would quickly intervene to stop it from spreading (i.e. by banning or severely limiting its use via digital surveillance and through laws enacted using their emergency powers). If there is one thing I learned from past crises is that our wise elites never let a disaster go unexploited, or miss an opportunity to tighten their grip on the economy and the political system. They will make absolutely sure that the wealthy donor class will suffer only a nominal hit, while the masses below will bear the brunt of the crisis.

The wealth pump, siphoning money and power from the lower classes must not be endangered.

The return to the Gold Standard

Similar to the story of Bitcoin, I see a very little chance for a gold based currency to take hold. All my inexpert quibbles notwithstanding, even if a large trading block would opt for using gold to settle their trade imbalances, they would quickly realize that it won’t solve any of their inflation problems. A growing world naturally required a growing currency supply, a shrinking one would actually need an ever smaller supply of money. And the amount of gold in the world is not about to get smaller. At least not on the short term.

While this might sound contra-intuitive, it was exactly bank credit (and thereby the conjuration of a vast amount of money into existence) which has helped the world economy to grow during the past centuries. If the US, for example, stayed on the gold standard in the 1970’s and beyond, the same amount of gold would’ve chased an exponentially growing supply of goods from TV sets to bushels of grain — leading to a deflationary spiral (causing lower production, lower wages, decreased demand, and still lower prices). Since gold cannot be printed or otherwise conjured into existence (although above a certain price level nuclear scientists would have surely found a way to do so at scale) central banks would have no means of stopping this downward spiral.

Conversely, in a shrinking economy a fixed amount of currency (now tied to the value of gold) would chase an ever smaller amount of goods, leading to a persistent inflation till the amount of goods per year — produced by an economy powered by humans and their oxen alone — settle at a sustainable level, somewhere in the 22nd century. I mean there is nothing wrong with a steady state economy, but it will take a lifetime till we get there.

Ironically the entirely government controlled digital currencies, with their ability to self-immolate (not literally), would fit the bill much nicer. They would not only allow for a perfect control of money supply, thereby giving an ability to financially manage the economic descent, but also enable a totalitarian control over the population. ‘Oh you just wrote an opinion piece criticizing the government. Sorry, but now you cannot spend your money anything other than food for 3 months. Have a nice day!’

Irony of ironies, that even this dystopia could not last long. So while governments will certainly take more control over the economy (and the populace) after the mother of all financial crashes, the relentless and accelerating decline in energy production would simply render even the tightest digital autocracy useless. Why, how would you enforce digital regulations, operate crypto or central bank digital currencies once the electric grid collapsed? No electricity — no internet. “No problem.”

Dissolution

This takes us to our last scenario, or should I say the final stage? After the economic / energetic peak in oil production and the onset of the long descent, there will be ever less fuel to operate mines giving us all the minerals this oh-so modern civilization needs, or transportation moving all these raw materials, food and people between various locations. People tend to think of a financial and economic crises as something utterly devastating, but even a 5–6% fall in economic output year-on-year means that the remaining 95% could still keep rattling along.

Perhaps surprisingly the steeper the decline the sooner it stops. The world economic system is in a very unstable equilibrium, meaning that even a tiny disturbance in energy flows can cause a major disruption. Like, for example, a 5% loss in oil production could easily cause a 10% decline by bankrupting a lot of countries and companies all at the same time. Once the rubble stops bouncing though, there would be slightly more energy available than what is actually needed, and a soft rebound would quickly take hold (only until the next major blow to the economy).

It is worth noting, however, that after a decade or two of such economic stumbling, half of the world economy would be gone, and major food shortages would arise. And this is where complex systems start to act really strange: after losing roughly half of their strength, they tend to crumble abruptly, like a jenga-tower where half of the bricks were pulled out and put on top.

Below a certain level of energy supplies not even autocratic nations with strong militaries could survive, let alone big companies or welfare states. In other words: modern societies will eventually fall apart no matter what. Some will fall sooner, while others might last a couple of decades more, depending how much resources they have left per capita. But none of them will be able to escape the physical reality imposed on them by a finite planet with a finite amount of accessible raw materials and energy. Sorry, it simply cannot happen any other way.

This is going to be a process taking multiple decades to unfold, with an ever increasing ferocity: first in the form of inflation, then a debt crisis, followed by major disruptions in international trade. Wars and revolutions will be a recurring theme these decades, till fossil energy runs so low that it will be impossible to manufacture enough tanks (rockets, artillery, you name it) to continue fighting. People will switch to guerilla tactics then, using pick-up trucks, small arms and improvised explosive devices delivered by drones. As large nation states crumble and fail one after the other, the rule of law would slowly give way to militias and mafia like organizations taking over the role of government, enforcing their own “rules” and collecting “taxes” (i.e. protection money). It’s not going to be all that different to what happened after the fall of the Western Roman Empire, where “barbarians” took up the slack left behind by Roman governors.

Lacking an energy miracle, everything will be much smaller and much-much more local in this energy deprived environment. Local currencies will pop up everywhere, while most of the gold will be left buried in hidden locations, after their owners were tortured and killed before they could tell where their stash is. Whatever precious metals left will be accumulated by chieftains and war lords — the future ruling elite of a depopulated Neo-feudal world — and put on display as a sign of power and wealth.

The future of humanity is not all doom and gloom however. Although the remainder of this century is ripe with all sorts of terrible events, those who manage to find a home relatively unaffected by the pollution left behind by industrial civilization and the massive climate disaster burning all that stuff caused, will have a chance living a decent and peaceful life. A dark age is upon us, but contrary to common wisdom these times are nowhere near as gloomy as depicted by historians. Cultures may flourish, new languages and arts may emerge. Although in much-much smaller numbers than today, humanity will most likely continue to inhabit this planet, and tell stories of an industrial civilization causing its own demise.

Until next time,

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