John House, MD – In the first part of this series, I mentioned that economic growth and energy have been intimately connected since the beginning of the Industrial Revolution. The more energy available to society, the more the economy grows. Now that we have entered into an era of decreasing net excess energy, economies are shrinking instead of growing.
Debt, too, plays an integral part in powering economic growth. In fact, the modern economy can’t function without it. In recent years, debt has been substituted for excess net energy as the fuel for economic growth. The results have been less than stellar and are likely creating a situation that guarantees economic collapse.
In the loosest sense of the word, our economy is debt. Today, there is more debt than there has been in the history of humankind. Without excess net energy, that debt couldn’t be repaid.
Debt has been part of the human experience for thousands of years. It has taken, and continues to take, many forms. At its most basic, debt is the promise to pay in the future for some good or service provided now.
Another way to look at debt is as an advance of future earnings. A person takes out a loan from a bank to buy a house or car, promising to repay that loan plus interest using income that will be earned in the future. Even in such a simple scenario, a healthy economy is required for a loan to be repaid; if the borrower loses his job because a factory closes due to economic decline, for example, he can’t repay the loan.
Since debt permeates every part of our economy, growth is required in order for debt to be repaid or, at the very least, serviced. Everything talked about with respect to the economy revolves around growth. If the economy isn’t growing, it’s bad. And debt is the reason.
The banking system the average person interacts with is designed around a concept known as fractional reserve banking. That means banks are only required to have on hand – on reserve – a fraction of the money that has been placed on deposit in their bank. The rest they lend out, thereby creating money “out of thin air” while also creating enormous amounts of debt requiring a constant flow of new money being put into the system, i.e. economic growth. On its face, this is good for the economy as it spurs development, creates jobs, increases wealth, etc. If the amount of debt grows too large, or the economy slows, a serious problem develops as the debt can no longer be serviced.
Today, the debt system has grown incredibly complex with debt instruments that are convoluted and almost impossible for the layperson to understand. Most of this debt has nothing to do with “Main Street” but it, too, requires that our economy grow indefinitely and without interruption or the whole scheme collapses.
Since everything in our economy is dependent on energy, a decline in net excess energy means the economy can’t grow, leading to debt default. If the amount of debt default is large it can be devastating to the system. Since even the slightest hint of widespread default would elicit panic in the stock and financial markets, wiping out trillions of dollars overnight, it’s no wonder government and industry agencies are less than honest about the decline in net energy and the impossibility of ever paying off mountains of debt that have been created trying to stimulate the economy. The whole financial system is the very definition of a house of cards.
The financial crisis of 2008-9 brought the global financial system to the very brink of collapse. If it had not been for Herculean efforts of central banks around the world at that time, collapse would have been inevitable. That crisis was one of too much debt that couldn’t be repaid. Ironically, the central banks saved the system by creating more debt. Enormous amounts of it, in fact.
The amount of conventional debt today is estimated to be $100 trillion globally. When the derivatives market is included, the amount of global debt surges to the absurdly high number of $1.3 quadrillion. Since declining net energy is preventing the economy from having the energy it needs to grow, it seems very likely there will be massive debt defaults in the near future. When there is widespread debt, default commerce shuts down.
When commerce shuts down, there is economic collapse and many, many people suffer. Very similar events are happening right now in Venezuela, Greece, Syria, Puerto Rico, and other countries.
With decline in net energy affecting every person on the planet, and with global debt already at unsustainable levels and climbing higher every day, there is widespread agreement among financial experts that central banks will be unable to save the system next time. When that happens, every country – including the U.S. – will experience economic disaster.
We are facing some frightening challenges over the next decade. Next time I’ll explore the most serious of them all: climate change.