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Part I
By my analysis, we are not yet on the final path to recovery, and there are one or more financial 'breaks' coming in the future. Underlying structural weaknesses have not been resolved, and the kick-the-can-down-the-road plan is going to encounter a hard wall in the not-too-distant future. When the next moment of discontinuity finally arrives, events will unfold much more rapidly than most people expect.
My work centers on figuring out which macro trends are in play and then helping people to adjust accordingly. Based on trends in fiscal and monetary policy, I began advising accumulation of gold and silver in 2003 and 2004. I shorted homebuilder stocks beginning in 2006 and ending in 2008. These were not ‘great' calls; they were simply spotting trends in play, one beginning and one certain to end, and then taking appropriate actions based on those trends.
We happen to live in a non-linear world; a core concept of the Crash Course. But far too many people expect events to unfold in a more or less orderly manner, with plenty of time to adjust along the way. In other words, linearly. The world does not always cooperate, and my concern rests on the observation that we still face the convergence of multiple trends, each of which alone has the power to permanently transform our economic landscape and standards of living.
Three such trends (out of the many I track) that will shape our immediate future are:
- Peak Oil
- Sovereign insolvency
- Currency debasement
Individually, these worry me quite a bit; collectively, they have my full attention.
History suggests that instead of a nice smooth line heading either up or down, markets have a pronounced habit of jolting rather suddenly into a new orbit, either higher or lower. Social moods are steady for long periods, and then they shift. This is what we should train ourselves to expect.
No smooth lines between points A and B; instead, long periods of quiet, followed by short bursts of reformation and volatility. Periods of market equilibrium, followed by Minsky moments. In the language of the evolutionary biologist Stephen Jay Gould, we live in a system governed by the rules of "punctuated equilibrium."
Complex Systems
Our economy is a complex system. The key feature of such systems is that they are inherently unpredictable with respect to the timing and severity of specific events. For the uninitiated, they can look enormously fragile and prone to flying apart at any minute; for the seasoned observer, there is an appreciation that the immense inertia of the economic system will almost always delay and dampen the eventual adjustments.
Like everybody else, I have no idea exactly what’s going to happen, or precisely when. Anybody who says they do know should be greeted with a furrowed brow and a frown of suspicion. As my long-time readers know, I prefer to assess the risks and then take steps to mitigate those risks based on likelihood and impact.
Which means that although we cannot predict the size (exactly how much) or the timing (precisely when) of economic shifts or world-changing events, we can certainly understand the risks and the dimensions of what might happen. Just as we cannot predict when an avalanche will release from steep slope, or even where or how big it will be, we can readily predict that constant snowfall coupled with the right temperature conditions will lead to an avalanche sooner or later, and more likely in this gully than that one. Given certain conditions, we might expect one that is larger or smaller than normal. Although we don't know exactly when or how much, we do know that when snow accumulates, so do the risks of more frequent and/or larger avalanches.
Such is the nature of complex systems. While inherently unpredictable, they can still be described. The most important description of any complex system is that it owes its order and complexity to the constant flow of energy through it. Complex systems require inputs. This is one way in which we can understand them.
Given this view, one easy "prediction" is that an economy without increasing energy flows running through it will stagnate. To take this further, an economy that is being starved of energy becomes simpler in the process -- meaning fewer jobs, less items produced, and a reduced capacity to support extraneous functions.
Accepting "What Is"
The most important part of this story is getting our minds to accept reality without our passionate beliefs interfering. By ‘beliefs’ I mean statements like these:
- “Things always get better and are never as bad as they seem.”
- “If Peak Oil were ‘real,’ I would be hearing about it from my trusted sources.”
- “Dwelling on the negative is self-fulfilling.”
While each of these things might be true, they also might be false and therefore misleading, especially during periods of transition. Our job is to remain as dispassionate and logical as possible.
Let's now examine more closely the three main events that are converging -- Peak Oil, sovereign insolvency, and currency debasement -- using as much logic as we can muster.
Peak Oil
Peak Oil is now a matter of open inquiry and debate at the highest levels of industry and government. Recent reports by Lloyd's of London, the US Department of Defense, the UK industry taskforce on Peak Oil, Honda, and the German military are evidence of this. But when I say “debate,” I am not referring to disagreement over whether or not Peak Oil is real, only when it will finally arrive. The emerging consensus is that oil demand will outstrip supplies “soon,” within the next five years and maybe as soon as two. So the correct questions are no longer, "Is Peak Oil real?" and "Are governments aware?” but instead, "When will demand outstrip supply?" and “What implications does this have for me?”
It doesn't really matter when the actual peak arrives; we can leave that to the ivory-tower types and those with a bent for analytical precision. What matters is when we hit “peak exports.” My expectation is that once it becomes fashionable among nation-states to finally admit that Peak Oil is real and here to stay, one or more exporters will withhold some or all of their product "for future generations" or some other rationale (such as, "get a higher price"), which will rather suddenly create a price spiral the likes of which we have not yet seen.
What matters is an equal mixture of actual oil availability and market perception. As soon as the scarcity meme gets going, things will change very rapidly.
In short, it is time to accept that Peak Oil is real - and plan accordingly.
Sovereign Insolvency
Once we accept the imminent arrival of Peak Oil, then the issue of sovereign insolvency jumps into the limelight. Why? Because the hopes and dreams of the architects of the financial rescue entirely rest upon the assumption that economic growth will resume. Without additional supplies of oil, such growth will not be possible; in fact, we’ll be doing really, really well if we can prevent the economy from backsliding.
Virtually every single OECD country, due to outlandish pension and entitlement programs, has total debt and liability loads that Arnaud Mares (of Morgan Stanley) pointed out have resulted in a negative net worth for the governments of Germany, France, Portugal, the US, the UK, Spain, Ireland, and Greece. And not by just a little bit, but exceptionally so, ranging from more than 450% of GDP in the case of Germany on the 'low' end to well over 1,500% of GDP for Greece.
Such shortfalls cannot possibly be funded out of anything other than a very, very bright economic future. Something on the order of Industrial Age 2.0, fueled by some amazing new source of wealth. Logically, how likely is that? Even if we could magically remove the overhang of debt, what new technologies are on the horizon that could offer the prospect of a brand new economic revival of this magnitude? None that I am aware of.
In the US, the largest capital market and borrower, even the most optimistic budget estimates foresee another decade of crushing deficits that will grow the official deficit by some $9 trillion and the real (i.e., “accrual” or “unofficial”) deficit by perhaps another $20 to $30 trillion, once we account for growth in liabilities. This is, without question, an unsustainable trend.
It’s time to admit the obvious: Debts of these sorts cannot be serviced, now or in the future. Expanding them further with fingers firmly crossed in hopes of an enormous economic boom that will bail out the system is a fool’s game. It is little different than doubling down after receiving a bad hand in poker.
The unpleasant implication of various governments going deeper into debt is that a string of sovereign defaults lies in the future. Due to their interconnected borrowings and lendings, one may topple the next like dominoes.
However, it is when we consider the impact of the widespread realization of Peak Oil on the story of growth that the whole idea of sovereign insolvency really assumes a much higher level of probability. More on that later.
For now we should accept that there's almost no chance of growing out from under these mountains of debts and other obligations. We must move our attention to the shape, timing, and the severity of the aftermath of the economic wreckage that will result from a series of sovereign defaults.
Currency Wars
We could trot out a lot of charts here, examine much of history, and make a very solid case that once a country breaches the 300% debt/liability to GDP ratio, there's no recovery, only a future containing some form of default (printing or outright).
In a recent post to my enrolled members, I wrote:
The currency wars have begun, and the implications to world stability and wealth could not be more profound. Fortunately, all of my long-time enrolled members are prepared for this outcome, which we've been predicting here for some time.
When pressed, the most predictable decision in all of history is to print, print, print. So I can't take credit for a 'prediction' that was just slightly bolder than 'predicting' which way a dropped anvil will travel; down or up?
The only problem is, widespread currency debasements will further destabilize an already rickety global financial system where tens of trillions of fiat dollars flow daily on the currency exchanges.
You can be nearly certain that every single country is seeking a path to a weaker relative currency. The problem is obvious: Everybody cannot simultaneously have a weaker currency. Nor can everybody have a positive trade balance.
If a country or government cannot grow its way out from under its obligations, then printing (a.k.a. currency debasement) takes on additional allure. It is the "easy way out" and has lots of political support in the home country. Besides the fact that it has already started, we should consider a global program of currency debasement to be a guaranteed feature of our economic future.
Conclusion (to Part I)
Three unsustainable trends or events have been identified here. They are not independent, but they are interlocked to a very high degree. At present I can find no support for the idea that the economy can expand like it has in the past without increasing energy flows, especially oil. All of the indications point to Peak Oil, or at least "peak exports," happening within five years.
At that point, it will become widely recognized that most sovereign debts and liabilities will not be able to be serviced by the miracle of economic growth. Pressures to ease the pain of the resulting financial turmoil and economic stagnation will grow, and currency debasement will prove to be the preferred policy tool of choice.
Instead of unfolding in a nice, linear, straightforward manner, these colliding events will happen quite rapidly and chaotically.
By mentally accepting that this proposition is not only possible, but probable, we are free to make different choices and take actions that can preserve and protect our wealth and mitigate our risks.
What changes in our actions and investment stances are prudent if we assume that Peak Oil, sovereign insolvency, and currency debasement are 'locks' for the future?
I explore these questions in greater depth in Part II of this report (enrollment required).
- cmartenson's blog
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Comments
I saw this on Zerohedge; it must be TGIF happy-hour over there because this post got some pretty harsh reactions.
If I haven't thanked the moderators lately: Thank You!
Captain Sheeple
"Such shortfalls cannot possibly be funded out of anything other than a very, very bright economic future. Something on the order of Industrial Age 2.0, fueled by some amazing new source of wealth."
This source of wealth must be the Green Revolution. It seems to me to be the only hope. Without it, the financial system will collapse, and there will not enough available energy for any kind of economy till the population drops dramatically. If it succeeds, then in the long term, even if the paper financial system collapses, then energy will still be available for some kind of economy, even if only in pockets.
Perhaps you mean the 'Green Revolution' can play an important part in transitioning to a reasonable and sustainable alternative energy/economic system. With, or without it the current financial system will collapse. Currently available alternative energy sources simply do not offer high enough EROEI to sustain the current level of complexity (or anywhere near it).
Thanks again Chris,
Due to you constantly pounding the drum and sending your reports and warnings, I am slowly getting prepared. I have no doubt that I will kick myself for not doing more now while it's "easy", but when I look at those around me that think the worst is over, I feel like I'm way ahead of the game. Still, without your constant prodding, I would become complacent and procrastinate. Ooops, gotta go prepare.
Consider the effects of a economic crisis on the global energy complex. Lets supose that in the not too distant future the globe enters a world wide depression with the collapse of the US, Asian and European economies. Factories shutdown, raw material shipments collapse causing mines and other industrial material production to collapse. The oil and gas companies have constant demand to replace parts, and to drill new wells just to keep production in check with demand. Now what happens if Oil and Gas companies can no longer get replacment parts and new materials? This would certainly cause an acceleration of production declines. While perhaps energy companies could manufacture their own replacment parts, it may not be economically viable. The costs of insourcing production of valves metal pipes and other manufactured goods would be expensive without the economy of scale. Since the economy would be weak, its seems unlikely that energy companies could raise prices. So its very likely that an economic collapse would also triggler an collapse in oil and gas production.
That said. My best guess is that the US will be able to maintain its high deficit to GDP gov't expenditures for the next Two years. While the US is bad, there are many other places that are much worse. The analogy that I would like to use is rats fleeing a burning ship and boarding a sinking ship. Investors holding on to sovergn\private debt in collapsing nations such as Greece, Ireland, etc will choose to move their money else where. The US has an advantaged because the US dollar is still the world's reserve currency. We will see more failed sovergn debt, including Spain (Already downgraded this week). France, Italy, and eventually Japan, before the crisis come to US gov't debt. We probably will see some flight from the US Muni bond market, but that would only strengthen the demand for US treasuries as investors dump Munis and buy treasuries. Some investors will move int assets such as PMs, but I think the majority will still with paper assets because they are more easily convertible into other investments.
I think Peak Oil production is a problem that is beyond the time frame of the economic crisis. In my opinion, Convention oil production peaked into 2005, and total oil production peaked in 2008. yet oil prices have stabilized between the $65 to $80 price range, because the economy is weak. Further more, Oil shortages would result in the loss of high oil consumption business, such as air travel and air freight that would release 10's of Mbpd if they ceased operation. Civilization would not cease to exist if air travel disappeared. The near term danger to oil and gas production would be loss of manufacturing required to supply replacement and new equipment to maintain current production and infrastructure that prices energy to end users.
Another threat on the horizon is another global war. Most of the eras of war were triggered by an economic crisis. WW2 was triggered by an economic crisis. Europe abandoned democracy in favor of fasicism during the 1930s. The worse the unemployment crisis grew the worse leaders the population elected. The 21st Century is not likely to be any different than the past 70 Centuries on how populations deal with crisises. The proof is that we are in another global economic crisis. We have failed to learn from our past mistakes and are doomed to travel the same path as previous crisises. It should have been obvious 10 years ago to the common man that we were heading for a major crisis unless we began to change. Change didn't happen because the population was unable or unwilling to recognize the crisis we were creating for ourselves.
I can't say when the next global war will begin. I can tell you that it will be near when you see a second era of fascism and totaliarism.
Super read!
Most people think sovereign bonds interest rates must rise soon, but afaics, they fail to understand the nature of the global debt trap we are in:
http://financialsense.com/contributors/shelby-moore/perpetual-deflation-causes-inflation
Dr. Martenson, the most fundamental aspect that causes abrupt change, i.e. Minsky moments, is that centralization of policy prevents optimum annealing.
Or more generally stated, the universe is trending to maximum disorder, and pockets of exponential order along the way, implode back to trend exponentially. Failure to comprehend the exponential quality of nature, i.e. entropy, is the greatest human inability:
http://www.youtube.com/watch?v=F-QA2rkpBSY
A person I often agree with, the monetary PhD scientist Antal Fekete has postulated that the Yuan is strong:
http://financialsense.com/contributors/antal-fekete/the-donkey-in-the-china-shop
But the reason that I disagree with him is very relevant to why tariffs do not work.
The centralization of fitness is always a weakness. Maximum annealing to optimum fitness only occurs with a free market of individual trials. I am sure Dr. Fekete understands why I say, this is why only gold is money.
For the specific weaknesses of China's centralized economic and monetary policy, read my recent article:
http://financialsense.com/contributors/shelby-moore/perpetual-deflation-causes-inflation
Note I recently wrote a scholarly research paper about the theory of annealing fitness and free markets:
http://goldwetrust.up-with.com/knowledge-f9/book-ultimate-truth-chapter-6-math-proves-go-forth-multiply-t159-15.htm#3640
That research derives or fits into a theory of the universe that I have proposed as a way to unify Einstein's General Relativity and Quantum Mechanics (Quantum Information): (note I am planning to study "Q-Orders" as potential self-similarity case of "frequency" in my theory)
http://goldwetrust.up-with.com/technology-f8/theory-of-everthing-t124.htm#3681
As for Peak Oil, we have more Natural Gas in the world that we know what to do with, and cars run just as well with CNG as they do on gasoline or diesel, losing only 10% power if a $1000 conversion kit is employed on a gas engine without compression ratio increase. Honda's CNG Civic is equivalent to gas in performance, except your cost per mile drops significantly due to the fact that CNG is much less expensive per energy unit than gas. And we can make our own CNG in our back yard from human and animal feces, or even from any organic matter:
http://goldwetrust.up-with.com/economics-f4/peak-oil-nonsense-t102-15.htm#3574
Also nuclear and then later nanotech will reduce the cost of energy significantly:
http://goldwetrust.up-with.com/technology-f8/computers-t112-75.htm#3671
Those who like to quote EROEI, forget that energy efficiency is a function of technology, since everything (i.e. my definition of 'matter') that is not infinitely disordered, contains some energy. It is the relative order that allows energy to do useful work.
However, we are likely to see Minsky moments with respect to oil, because of the non-optimum annealing rate due to centralized policy of many genres. This is just the way nature deals with change.
You're probably right. I'd say definately right in the long term.
My hope is that the Revolution can produce enough value (Energy), and involve enough people that it can hold off a final collapse until such a time as those present (and surviving) the collapse can strongly benefit from the energy sources that were produced under the current financial system.
In other words, I don't want modern fiat capitalism to die until we've got a boatload of Energy sources in place.
Fantasy, perhaps.
However, I see the Chinese giving it a try.
They haven't become the number one producer of Solar Modules in the world just to sell them to Europe forever. They're going to use them in China. We expect them to officially release a $700+ Billion over 10 Year Energy Policy, including more Hydro and Nuclear, but also at least $200 Billion for Wind and Solar.
It could be that the financial system will collapse, and the Chinese will just Nationalize all of their production. That would suck for the World, and I don't think that that is their preferred option. It doesn't really benefit them to have the US collapse into chaos. We have nuclear weapons.
I think that they understand some of the realities that Chris Martinson talks about, unlike too many Americans that don't have a clue about what Energy actually does for us.
In China there are concerted efforts to build "Solar Cities," in which are contained entire supply chains for Solar (presumably they're doing the same thing for other types of technology). Here in America I see people responding as individuals to Chris's (and others') message on Energy, but in China they're doing it on a mass scale (which hasn't yet been made clear to the World). This is as efficient as its going to get as far as EROI is concerned.
Bottom line, though, I think there are still going to be Dollars, Euros, and Yuan involved, for a long time, though the Dollar crisis is very likely immanent. The west wants China to strenthen their currency, and I think that they'll be suprised when they get it, and it's not going to be pretty. Feel free to insert a furrowed brow and a frown of suspicion here.
As for EROI, for Solar it's only a few years, and it's decreasing. With scale, the EROI will decrease, and the scale is increasing ridiculously fast. There's talk in China of having 40% of their energy supply from Solar in 40 years or so. They're playing for the long term.
See a write up I did a couple weeks ago on Global Demand. http://americansolareconomy.blogspot.com...
I don't think so. This will take a lot longer than anyone can possibly imagine. The United States will continue to sell paper to fund its deficit successfully for many years. Americans will continue to spend more money than they have as well, for many years.
Think five to ten years before anything significant happens. It's a slow roller, folks..
..
Agreed it will be a slow burn in terms of dollar system death, but abrupt volatility along the way, with abrupt end to the current fiat regime at the end.
The psychological support evidence for the slow burn of the dollar is shown on the ongoing GALLUP poll chart at following link, which shows that rising public awareness of real estate being a poor investment is a linear trend since 2002, and the 2007-9 volatility increase in awareness, returned to the linear trendline as if 2007 - 9 never happened!:
http://goldwetrust.up-with.com/economics-f4/stocks-vs-precious-metals-vs-bonds-vs-real-estate-t11-15.htm#3727
I think those who are disagreeing with my comments on peak oil, are looking at the alleged global peak in production of oil and the rising marginal cost of producing oil. I definitely don't disagree with the latter, and the former will eventually happen someday, if not already.
But that is irrelevant to my point, so I don't know what they are logically disagreeing with?
My point is that energy of the universe is abundant, and it only takes technology to get at it.
But the (millions of trial and error annealing of) technology is impeded when you have a centralized elephant dictating false opportunity costs via centralized interest rate policy, enabled by centralized fiat, i.e. socialism:
http://www.marketoracle.co.uk/Article21650.html
http://www.marketoracle.co.uk/Article20857.html#comment92402
http://goldwetrust.up-with.com/economics-f4/is-capitalism-or-is-socialism-increasing-t18-60.htm#3563