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The Inescapable Reason Why the Financial System Will Fail

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The Inescapable Reason Why the Financial System Will Fail

Credit cannot expand faster than fundamentals forever 

Modern finance has many complex moving parts, and this complexity masks its inner simplicity.

Let’s break down the core dynamics of the current financial system.

The Core Dynamic of the “Recovery” and Asset Bubbles: Credit

Credit is the foundation of the current financial system, for credit enables consumers to bring consumption forward, that is, buy more stuff today than they could buy with the cash they have on hand, in exchange for promising to pay principal and interest with their future income.

Credit also enables speculators to buy more assets than they otherwise could were they limited to cash on hand.

Buying goods, services and assets with credit appears to be a good thing: consumers get to enjoy more stuff without having to scrimp and save up income, and investors/speculators can reap more income from owning more assets.

But all goods/services and assets are not equal, and all credit is not equal.

There is an opportunity cost to any loan (i.e. credit), as the income that will be devoted to paying principal and interest in the future could have been devoted to some other use or investment.

So borrowing money to purchase a product or an asset now means foregoing some future purchase.

While all products have some sort of payoff, the payoffs are not equal. If I buy five bottles of $100/bottle champagne and throw a party, the payoff is in the heady moments of celebration.  If I buy a table saw for $500, that tool has the potential to help me make additional income for years or even decades to come.

If I’m making money with the table saw, I can pay the debt service out of my new earnings.

…click on the above link to read the rest of the article…

Three Delusions: Paper Wealth, a Booming Economy, and Bitcoin

Three Delusions: Paper Wealth, a Booming Economy, and Bitcoin

Let us not, in the pride of our superior knowledge, turn with contempt from the follies of our predecessors. The study of the errors into which great minds have fallen in the pursuit of truth can never be uninstructive.”

– Charles Mackay
Extraordinary Popular Delusions and the Madness of Crowds

Delusions are often viewed as reflecting some deficiency in reasoning ability. The risk of thinking about delusions in this way is that it encourages the belief that logical, intelligent people are incapable of delusion. An examination of the history of financial markets suggests a different view. Specifically, faced with unusual or extraordinary price advances, there is a natural tendency (particularly in the presence of crowds, feedback loops, and potential rewards) to look for explanations. The problem isn’t that logic or reason has failed, but that the inputs have been distorted, and in the attempt to justify the advance amid the speculative excitement, careful data-gathering is replaced by a tendency to confuse temporary factors for fundamental underpinnings.

While true psychological delusions are different from financial ones, a similar principle is suggested by psychological research. Delusions are best understood not as deficiencies in logic, but rather as explanations that have been logically reached on the basis of distorted inputs. For example, individuals with delusions appear vulnerable to differences in perception that may involve more vivid, intense, or emotionally-charged sensory input. While those differences might be driven by neurological factors, the person experiencing these unusual perceptions looks to develop an explanation. Maher emphasized that despite the skewed input, the delusions themselves are derived by completely normal reasoning processes. Similarly, Garety & Freeman found that delusions appear to reflect not a defect in reasoning itself, but a defect “which is best described as a data-gathering bias, a tendency for people with delusions to gather less evidence” so they tend to jump to conclusions.

…click on the above link to read the rest of the article…

Un-Merry Christmas: The Perverse Incentives to Over-Consume and Over-Spend

Un-Merry Christmas: The Perverse Incentives to Over-Consume and Over-Spend

Isn’t it obvious that if we set out to design the most perverse, toxic and doomed system possible, we’d end up with the Keynesian Cargo Cult’s insane permanent growth/Landfill Economy?

Few topics are off-limits nowadays: the personal and private are now splashed everywhere for all to see.

One topic is still taboo: the holiday’s perverse incentives to over-consume and over-spend,lest our economy implode. This topic is taboo because it strikes at the very heart of our socio-economic system, which is fundamentally based on permanent growth, the faster the better, as if unlimited expansion on a finite planet is not just possible, but desirable.

In the current Mode of Production, the solution to every social and economic ill is to “grow our way out of it.”

The solution to unemployment: jump-start growth by expanding consumption, spending and borrowing.

The solution to stagnant wages: jump-start growth.

The solution to declining profits: jump-start growth.

The solution to government deficit spending: jump-start growth.

And so on.

So what happens when most people have not just the basics of life, but a surplus of stuff? Where is the growth going to come from if people already have everything?

The answer is three-fold:

1. Replace a perfectly good product with a new product and dump the old one in the landfill.

2. Buy duplicates and put the surplus products in the closet or storage facility.

3. Buy gimmicks (Pet Rocks, etc.) that are tossed in the dump shortly after the holiday gift-giving season ends.

But does this Landfill Economy make sense?

…click on the above link to read the rest of the article…

Limits to Economic Growth?

Limits to Economic Growth?

These are notes from a short lecture given at Nottingham University on 28th November 2017. Click on the images to enlarge them.

1 Production Increase

adam-smith

During the 17th and 18th centuries the rise of mercantile power, colonialism and a slave economy was associated with the development of the idea that “improvement” meant production growth and was an indicator of a new idea of progress. This was a core idea in Adam Smith’s book The Wealth of Nations. In it Smith described the production increase at the early stages of the industrial revolution as being the result of an increasing division of labour and specialisation – his famous example being the pin factory.

However what really enabled the industrial revolution to take off was not just that production was being broken down into simplified specialised processes in factories but that this specialisation enabled mechanisation. Machines were being applied to production on a greater scale and these machines were powered. Their energy source was fossil fuels – coal fired steam engines began to overtake wind and water mills, sails, wood and the muscles of humans and work animals as the main energy and power sources.

2 Applications of fossil fuels to machinery and technical infrastructures

slide1

Later in the next century coal power was supplemented oil as a fuel source refined into petroleum and diesel. Later still natural gas became a fuel. The technologies of energy delivery evolved too. Gas was created from coal and piped across towns and cities. The fossil fuels, and later uranium 235, were used to generate electricity which could be distributed by power grids. It could be generated too by hydro power dams as well as by wind and solar.

…click on the above link to read the rest of the article…

Pool of Funding the Heart of Economic Growth

Most experts are of the view that massive monetary pumping by the US central bank, the Fed, during the 2008 financial crisis saved the US and the World from another Great Depression.

If increases in money supply is an important catalyst for economic growth then the World poverty should have been eliminated a long time ago! Most countries have central banks that know how to print money – why then the World poverty still exists?

We suggest that at no stage increases in money supply can be an important driving factor of economic growth.

Some experts do not agree with this. Following the logic that monetary spending by one individual becomes an income of another individual and the spending of another individual becomes an income of the first individual, they hold that this raises the economy’s overall income and in turn overall economic growth.

Note that in this way of thinking, money stimulates consumer outlays, which in turn strengthens overall income and overall economic activity i.e. demand creates supply.

In this way of thinking what funds i.e. provides support to economic growth is the increase in money supply.

We suggest that individuals, which are engaged in the various stages of production, in order to support their lives and wellbeing, require an access to final consumer goods and not money as such.

At any point in time, there is a finite pool of final consumer goods. Hence, the early recipients of a newly created money are going to benefit from the increase in money supply at the expense of the late recipients or no recipients at all of the newly created money.

…click on the above link to read the rest of the article…

Human well-being, economic growth and so-called decoupling

Human well-being, economic growth and so-called decoupling

Some people claim that humans—called breatharians—can live on air alone. Others claim we can have economic growth without increasing our resource use, so-called decoupling. Neither claim withstands scrutiny though here I am only going to deal with the second one.

Hidden beneath the claim of decoupling is the assertion that human well-being and economic growth are synonymous. But, human well-being is far from a one-dimensional economic variable linked unalterably to more income and consumption. So, saying that economic growth must at some point come to an end to maintain the habitability of the planet is not the same as saying that human well-being must also stop improving.

On the contrary, a stable society in harmony with the workings of the natural world in a way that maintains the habitability of the biosphere for humans would seem to be an essential characteristic of a society which offers a high degree of well-being to humans. Destroying that habitability through endless economic growth then is contrary to human well-being in the long run.

All of this should seem obvious. But so often the advocates of growth or “sustainable” growth tell us that ending growth would destroy the chance for countless people to attain well-being in our modern industrial world. While that has some truth within the narrow context that measures well-being as a function of economic output, it misses the point above. An uninhabitable world is really, really bad for human well-being.

The answer these advocates say is economic growth decoupled from increased resource use. But as two recent papers suggest, this is an oxymoron.

As “Is Decoupling GDP Growth from Environmental Impact Possible?” explains,while society has been getting gradually more efficient at producing goods and services, we are not anywhere near economic growth without increased resource use. The apparent decoupling in Germany and some other countries is probably due to the following factors:

…click on the above link to read the rest of the article…

The End of Economic Growth

The End of Economic Growth

UK Chancellor of the Exchequer  Phillip Hammond (finance minister) delivered his budget  on Wednesday last week. The tame budget was overshadowed by news that UK productivity and hence economic growth had stalled. In this post I search for the underlying causes of economic malaise and explore the structure of UK GDP; UK Government and private debt levels; demographics, in particular our ageing population; Higher Education policy, in particular over-production of sub-prime graduates and lastly UK Energy Policy that is focussed on high cost inefficient energy systems.

It has been frustrating to say the least listening to politicians, their advisors and a host of media commentators proclaim surprise and bewilderment that the UK economy seemed to be broken. Since no one seems to know how it broke, then it is clear no one will know how to fix it, if it can indeed be fixed. In this post I voice opinions on several factors that have combined to create these unwelcome circumstances and in the traditions of this blog, there is an energy theme, which I will leave until last touching on the topics of debt, demographics and sub-prime education en-route.

In very simple terms, the size of the UK economy can be expressed as the number of people times their average economic output. A refined measure would be the number of working-age people (16 to 66) times their average economic output. Economic growth is defined as the percentage change of this aggregate productivity from one year to the next. With the current economic model, growth is vital to the country since it feeds directly through to tax receipts used to deliver public services such as health care, welfare, education and defence. The level of aggregate borrowing (national debt) considered prudent may also be compared to GDP. If GDP growth stalls, so does the ability of the government to borrow prudently to finance public services.

…click on the above link to read the rest of the article…

A Video Game Analogy to Our Energy Predicament

A Video Game Analogy to Our Energy Predicament

The way the world economy is manipulated by world leaders is a little like a giant video game. The object of the game is to keep the world economy growing, without too many adverse consequences to particular members of the world economy. We represent this need for growth of the world economy as being similar to making a jet airplane fly at ever-higher altitudes.

Figure 1. Author’s view of the situation we are facing. World leaders look at their video screens and adjust their controllers to try to make the world economy fly at ever-higher levels.

World leaders look at their video game screens for indications regarding where the world economy is now. They also want to see whether there are specific parts of the economy that are doing badly.

The game controllers that the world leaders have are somewhat limited in the functions they can perform. Typical adjustments they can make include the following:

  • Add or remove government programs aimed at providing jobs for would-be workers
  • Add or remove government sponsored pension plans and payments to those without jobs
  • Add or remove laws regulating efficiencies of new vehicles
  • Change who or what is taxed, and the overall level of taxation
  • Through the above mechanisms, change government debt levels
  • Change interest rates

There are numerous problems with this approach. For one thing, the video game screen doesn’t give a very complete picture of what is happening. For another, the aspects of the economy that can be controlled are rather limited. Furthermore, the situation is very complex–there seem to be several “sides” of the economy that need to “win” at the same time, for the economy to continue to grow: (a) oil importers and oil exporters, (b) businesses and their would-be customers, (c) governments and their would-be taxpayers, and (d) asset holders and the would-be buyers of these assets, such as families needing new homes.

…click on the above link to read the rest of the article…

Monetary Imperialism

Monetary Imperialism

Photo by Nathaniel St. Clair

In theory, the global financial system is supposed to help every country gain. Mainstream teaching of international finance, trade and “foreign aid” (defined simply as any government credit) depicts an almost utopian system uplifting all countries, not stripping their assets and imposing austerity. The reality since World War I is that the United States has taken the lead in shaping the international financial system to promote gains for its own bankers, farm exporters, its oil and gas sector, and buyers of foreign resources – and most of all, to collect on debts owed to it.

Each time this global system has broken down over the past century, the major destabilizing force has been American over-reach and the drive by its bankers and bondholders for short-term gains. The dollar-centered financial system is leaving more industrial as well as Third World countries debt-strapped. Its three institutional pillars – the International Monetary Fund (IMF), World Bank and World Trade Organization – have imposed monetary, fiscal and financial dependency, most recently by the post-Soviet Baltics, Greece and the rest of southern Europe. The resulting strains are now reaching the point where they are breaking apart the arrangements put in place after World War II.

The most destructive fiction of international finance is that all debts can be paid, and indeed should be paid, even when this tears economies apart by forcing them into austerity – to save bondholders, not labor and industry. Yet European countries, and especially Germany, have shied from pressing for a more balanced global economy that would foster growth for all countries and avoid the current economic slowdown and debt deflation.

…click on the above link to read the rest of the article…

Will China Bring an Energy-Debt Crisis?

Will China Bring an Energy-Debt Crisis?

It is easy for those of us in the West to overlook how important China has become to the world economy, and also the limits it is reaching. The two big areas in which China seems to be reaching limits are energy production and debt. Reaching either of these limits could eventually cause a collapse.

China is reaching energy production limits in a way few would have imagined. As long as coal and oil prices were rising, it made sense to keep drilling. Once fuel prices started dropping in 2014, it made sense to close unprofitable coal mines and oil wells. The thing that is striking is that the drop in prices corresponds to a slowdown in the wage growth of Chinese urban workers. Perhaps rapidly rising Chinese wages have been playing a significant role in maintaining high world “demand” (and thus prices) for energy products. Low Chinese wage growth thus seems to depress energy prices.

(Shown as Figure 5, below). China’s percentage growth in average urban wages. Values for 1999 based on China Statistical Yearbook data regarding the number of urban workers and their total wages. The percentage increase for 2016 was based on a Bloomberg Survey.

The debt situation has arisen because feedback loops in China are quite different from in the US. The economic system is set up in a way that tends to push the economy toward ever more growth in apartment buildings, energy installations, and factories. Feedbacks do indeed come from the centrally planned government, but they are not as immediate as feedbacks in the Western economic system. Thus, there is a tendency for a bubble of over-investment to grow. This bubble could collapse if interest rates rise, or if China reins in growing debt.

China’s Oversized Influence in the World

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The End is Near…Depopulation is Out of Control…So Buy Stocks (Seriously)

The End is Near…Depopulation is Out of Control…So Buy Stocks (Seriously)

The world economy is premised on a ludicrous idea.  That Asia, then India, and then Africa will continue to drive economic growth.  So as not to turn this article into a book, lets consider this idea focusing on East Asia consisting of China, Japan, North and South Korea, Taiwan, and minor others.  This region consists of 1.6 billion persons or about 22% of earths inhabitants.  However, since 2008, it is this region that is responsible for nearly 100% of the global increase in demand for oil (best proxy available for true economic growth) and having primarily driven global economic growth.  My point in this article is that the growth in this region is entirely a credit driven supernova against collapsing populations which will never be able to fill the 100+ million newly added apartments or pay back the debt incurred to achieve the “growth”.  Contrarily, from an investor standpoint, this weakness is the green light to “invest” as aggressively as possible because as long as central banks exist, they have your back.
Consider, since 2000, China’s debt outstanding has risen something like 14x’s to 17x’s or from about $2 trillion to something between $30 to $35 trillion presently.  As for Japan, who knows Japan’s true debt as Japan’s central bank is buying much or most of the debt and essentially throwing it in a black hole, never to be seen again(…monetization with a capital “M”).
Why the massive debt creation and central bank monetization?  Depopulation with a capital “D”.  First off, consider the collapse in fertility rates for these nations (chart below).  To maintain a constant, zero growth population, the childbearing population needs to produce 2.1 children in order to replace themselves (dashed line, below).  However, as the chart below shows, E. Asian nations have seen negative fertility rates for decades (Japan turning negative in ’74, S. Korea in ’83, China in ’92, and N. Korea in ’96).

…click on the above link to read the rest of the article…

China Rising: Global Opportunity or Global Threat? 

China Rising: Global Opportunity or Global Threat? 

The recent tightly scripted 19th Chinese Communist Party National Congress has generally been viewed as evidence and celebration of the rise to great power of Chinese President Xi Jinping. President Xi is in ascendance. But what does that really mean for China and the rest of us.

It’s far more useful for us to focus on facts on the ground, on China’s actions than on attempts to parse the meaning of the makeup of the 7 member Standing Committee (SC) at the pinnacle of Party and Chinese government power whose decisions are driven by completely private discussions behind closed doors.

The facts. China has rapidly emerged in the 21st century as global leader in renewable resource development. China’s leadership and success in helping build a global efficient renewable resource system is absolutely crucial if we are to escape climate change driven global ecological catastrophe. Our collective futures are suddenly, to a considerable extent, in President Xi’s hands given the Trump administration’s opposition to effective action on climate change and support for accelerated coal, oil,and natural gas development.

China is manufacturing and installing solar electric and wind energy systems at an astounding rate. China is responsible for 40% of global renewable energy growth according to the International Energy Agency (IEA). Last year, global solar electric (PV) capacity grew by 50%, over 74 gigawatts, with China responsible for almost half of this. By 2022 the IEA forecasts global PV capacity will expand to 920 gigawatts. China, with India soon to follow, is leading the way.

Global investment in renewables now exceeds that in fossil fuel plants. China is also global market leader in electric vehicles, hydropower and biomass systems. China is, as well, global leader in reforestation.

…click on the above link to read the rest of the article…

Tim Jackson: The High Price Of Growth

Tim Jackson: The High Price Of Growth

A finite planet cannot sustain infinite economic growth

Modern society is addicted to and engineered for perpetual economic growth.

Now, a fourth-grader can tell you that nothing can grow forever, especially if you have finite resources. But that simple realization is eluding today’s central planners, despite multiplying evidence that growth is becoming harder and harder to come by.

This week’s podcast guest is Professor Tim Jackson, sustainability advisor for the UK government, professor of sustainable development at the University of Surrey and Director of CUSP. Tim is also a full member of the Club of Rome.

He explains why the exponential growth rates of today’s economies, and their associated rates of resource extraction/consumption, will not be able to continue for much longer — and why a pursuit of “prosperity” (defined much more broadly than simple consumerism) is a much healthier goal for humanity.

Anyone who thinks that exponential growth can go on forever on a finite planet is either a madman or an economist.

Those very steep lines that rise very sharply as we approach the 21st century and show us that we are exceeding our carrying capacity in all sorts of ways are quite compelling. I think people actually feel this to some extent, that having more and more ‘stuff’ going through the system is somehow unsustainable. And not just in environmental ways, but even in social ways.

It’s the classic challenge of the irresistible force meeting the unmovable object. This pervasive idea of prosperity consisting of exponential growth, while the planet is not getting any bigger, is putting ecosystems under lots of stress. The pressures that human society puts on our environment is increasingly obvious.

…click on the above link to read the rest of the article…

China’s economic boom is about to be cut short by peak oil, warns state-funded study 

A new scientific study led by the China University of Petroleum in Beijing, funded by the Chinese government, concludes that China is about to experience a peak in its total oil production as early as next year.

Without finding an alternative source of “new abundant energy resources”, the study warns, the 2018 peak in China’s combined conventional and unconventional oil will undermine continuing economic growth and “challenge the sustainable development of Chinese society.”

This also has major implications for the prospect of a 2018 oil squeeze — as China scales its domestic oil peak, rising demand will impact world oil markets in a way most forecasters aren’t anticipating, contributing to a potential supply squeeze. That could happen in 2018 proper, or in the early years that follow.

There are various scenarios that follow from here — China could: shift to reducing its massive demand for energy, a tall order in itself given population growth projections and rising consumption; accelerate a renewable energy transition; or militarise the South China Sea for more deepwater oil and gas.

Right now, China appears to be incoherently pursuing all three strategies, with varying rates of success. But one thing is clear — China’s decisions on how it addresses its coming post-peak future will impact regional and global political and energy security for the foreseeable future.

Fossil fuelled-growth

The study was published on 19 September by Springer’s peer-reviewed Petroleum Science journal, which is supported by China’s three major oil corporations, the China National Petroleum Corporation (CNPC), China Petroleum Corporation (Sinopec), and China National Offshore Oil Corporation (CNOOC).

Since 1978, China has experienced an average annual economic growth rate of 9.8%, and is now the world’s second largest economy after the United States.

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Investment as a Commitment. Tim Jackson at the Summer School of the Club of Rome in Florence

Investment as a Commitment. Tim Jackson at the Summer School of the Club of Rome in Florence

Tim Jackson speaks at the 1st Summer School of the Club of Rome in Florence, Sep, 2017 (image courtesy Daniel Reinhardt)
There have been several interesting talks at the Summer School on Sustainability in Florence, but the one by Tim Jackson has been among the most focused and relevant ones. Jackson is the author of the book “Prosperity Without Growth”  (2009) and he goes straight to the core of the problem, which lies in our financial system. We are geared for growth, everything in the system pushes for growth, all the financial structures are rewarding growth. And, as Jay Forrester was perhaps the first to note, economic growth is what’ leading us straight to the Seneca Cliff.
So, we need to re-examine the basics of our economic system and propose ways to defuse the ticking bomb that we ourselves have created. There is much to be discussed about Jackson’s proposals, but one that I noted, in particular, was the concept of “investment as a commitment.” I asked Jackson how this is supposed to be different than the current way of investing, and his answer was that, today, investors tend to see the market as a “gamble” in which they may gain or lose; but their main motivation is for big, short-term gains. Clearly, this is not the way that will take us to a saner and safer world.
The key point of the whole thing, as I see the situation, is in the financial system. If we found a way to divest from fossil fuels and to move financial resources to the transition in the form of renewable energy and the related infrastructure, then there is still hope to avoid the Seneca Cliff, at least in its most brutal form.

…click on the above link to read the rest of the article…

Olduvai II: Exodus
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Olduvai II: Exodus
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Olduvai III: Cataclysm
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