Could Low Energy Growth Lead To A Recession?

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After an opportunity for discussion, I offered the explanation that the role of food for humans is very much parallel to the need for energy of various types for the world economy. Food provides people with the energy required if they are to have the ability to think, move and speak. Energy products of many kinds enable the activities that we associate with GDP. For example, energy consumption enables machinery to operate and goods to be transported.

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It is becoming increasingly clear that China is being forced to cut back on heavy industrialization because of its coal difficulties. Slide 8 shows automobile purchases for six large economies. China is by far the largest of these economies in terms of auto sales. China’s auto sales began to slide in 2018 and are sliding further in 2019 (about -11%).

If we look back at the time of the 2008-2009 recession, we see that auto sales of the US dropped precipitously. The United States was the country that led the world into recession. The inability of US citizens to buy cars was a sign that something was seriously wrong. Now we are seeing a similar pattern in China.

China has reported that its GDP growth rate has been slightly lower during 2019, but we really don’t know how much lower. The amounts it publishes are too “smooth” to be believed. The actual GDP growth rate is believed to be lower than the recently reported 6.0%, but no one knows by precisely how much.

Figure 8b – CNBC Chart of changes in auto sales by country, based on data through October 2019. (Not part of original presentation.) Source

Figure 8b gives a little more information about recent car sales by country. We can see from this chart that based on data through October 2019, world automobile sales are expected to fall by about the same percentage (3%) in 2019 as during the recession year of 2008. I find this disturbing.

We can also see the huge impact that China has had on keeping world private passenger auto sales rising. The world economy looked like it was headed into recession in January, 2016, when world oil prices were very low, but a spike in China’s automobile sales at that time helped keep total world automobile sales rising and allowed world oil prices to rise from their low point.

In the next sections, I provide some background regarding this story.

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Slide 10 shows the way that I visualize the world economy self-organizing and growing. The economy grows by adding new “layers” of businesses, products, consumers and laws. Unneeded products, such as buggy whips, are dropped from the bottom. Unprofitable businesses close. In some sense, the economy is hollow because of these deletions. It cannot easily go backward because, for example, the support services for widespread use of transport using horses are lacking.

Energy is used to operate all aspects of the system. One part of the system is a self-organizing financial system that helps decide, through wage levels, who gets the benefit of the goods and services that are made. This financial system includes self-organizing interest rates and self-organizing commodity prices.

The most important connection within the economy is the one I show at the center as “Consumers = Employees.” Consumers are very dependent on their wages as employees. If the economy is to continue to operate, workers must receive high enough wages to purchase the goods and services the economy produces. Even the lower-paid workers need to be able to afford food, housing and transportation, or the economy will tend to collapse.

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When we look back through the history on Slides 4, 5 and 6, we see that the growth of energy consumption is very important in how economies operate. The theories of Ilya Prigogine explain why this is the case; when adequate flows of energy are available, self-organizing systems are able to grow.

Few economists today include energy consumption in their models, however. Economic theory has grown over time in its own “ivory tower.” Like other academic subjects, it depends on early theories and the process of peer review. The views expressed must also be pleasing to those in power, who would like everyone to believe that politicians, rather than the laws of physics, are in charge.

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There are many types of self-organizing systems that grow. They all, directly or indirectly, require energy. Plants and animals of all types are self-organizing systems that grow. Hurricanes grow using the energy that they get from warm water.

Governments grow from the tax revenue that they are able to collect; they use the revenue to buy energy products such as electricity to operate governmental offices, oil to build roads and operate police cars, and natural gas to heat buildings.

The Internet grows through the revenue collected to provide its services. The Internet uses revenue to buy computers (made with energy products) and electricity to operate those computers.

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Nearly all 0f the energy we use is hidden. For example, modern food production is very much dependent on energy consumption. Agricultural machines are made using energy products. Soil amendments, including organic soil amendments, are transported using fossil fuel energy. Refrigeration is possible through the use of energy. Hybrid seeds are only possible through energy consumption. Planting seeds by digging with a stick would only use human energy, but such a process would be terribly inefficient.

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Most of us can easily recognize today’s goods and services, such as those listed.

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Promises of future goods and services act like promises of future energy supplies. This happens because creating goods and services that people can actually use requires energy supplies of the appropriate type.

When people get cash or a check, they expect to use it to buy goods and services. Creating these goods and services requires energy consumption. If there is no energy of the right type available, the goods and services won’t be available to fulfill the promises.

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Promises of future goods and services tend to grow faster than actual goods and services because it is these promises that, in some sense, “pull the economy along.” For example, if a young person gets a loan, (s)he can often buy a new car. The fact that a new car is being purchased leads to more jobs in the supply line leading up to new car production. Or, if a business takes out a loan or sells shares of stock, it can use the proceeds to hire employees. It is these growing wages that keep the system operating.

As long as the economy is growing rapidly, the mismatch between growing debt and actual output doesn’t become apparent. As the economy slows, some workers find themselves working fewer hours. Some businesses become less profitable and lay off workers to try to restore profitability. The catch is, with fewer workers, the economy slows even more. It usually takes more debt, at lower interest rates, to get out of such an economic slowdown.

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There is a lot of confusion about prices. “Demand” is what people, through their wages and debt, can afford. As economists tell us, price depends on supply and demand.

In the short term, prices tend to bounce around a lot. The short term buyers of oil are oil refineries. They need to keep their employees busy. If they see a shortage of oil, they may bid up the price of oil to allow their workers to continue to be employed.

Over the longer term, prices of all energy products tend to depend on consumers’ ability to afford finished products, like cars, homes and cell phones. Producing these objects and shipping them takes energy. They also use energy as they operate.

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The various energy prices shown here are simply a few of the many, many energy prices that we see around the world. Strangely enough, prices of all energy products tend to fluctuate together, over the longer term. Prices depend on affordability of end products, such as cars, homes, computers, food and clothing. Our problem since about 2012 has been lack of affordability of end products.

The primary way of raising affordability is by increasing productivity. Increased productivity is made possible by increasingly leveraging human labor with devices that are built with energy and are operated using energy. For example, a worker with a ditch digging machine is much more productive than a ditch digger with only a shovel. An analyst is more productive with a computer and Internet access than with only pencil and paper.

With higher productivity, more goods are produced in total. As long as not too much of this productive output is skimmed off the top (by governments, or by business hierarchy, or to pay for the devices and their fuel), it is possible for each worker to afford more goods and services, raising total demand.

An alternative way of raising affordability is by adding more debt at ever-lower interest rates. This approach tends to make goods such as cars, homes, and factories appear more affordable because their monthly payments are lower. This added-debt approach only works as long as the economy is growing quickly enough. If the economy slows too much, the added debt leads to financial crashes of many types.

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Many people think that they know the amount of oil that can be extracted based on the current technology and the assumption that prices will eventually rise high enough to extract all of the fossil fuels that seem to be available. For example, the International Energy Agency has prepared reports in which it shows expected oil availability if oil prices rise to $300 per barrel.

The catch is that even if oil prices can bounce high, it is not clear that they can stay very high. The current price of oil is only in the $55 to $65 per barrel range. A price of $300 per barrel will allow oil extraction using very advanced technology. We don’t have any evidence that oil prices can stay this high because demand comes primarily from wages. Prices cannot stay high without adequate support from wage levels.

Of course, the issue is not just oil prices staying sufficiently high. Natural gas, coal, uranium and electricity prices all have difficulty rising high enough and staying high enough. Commodity prices such as copper and steel have the same issue.

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There are many people who say, “Of course, oil prices will rise. Oil is a necessity.” They forget that it is really a two way tug of war between producers getting a high enough price to be profitable and consumers getting a low enough price to be affordable. There will be a winner and a loser.

People also forget that most commodity use is hidden. We see the fuel we buy for our personal vehicles, but there are a huge quantity of oil products required for shipping goods, paving roads, growing food, and for many other uses that we are not aware of. While we might be able to pay a little more to fill our gasoline tank, most of us would not be able to simultaneously pay more for food, transported goods of all kinds and road maintenance.

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Economists often assume that if energy prices rise, wages will rise, as well. If we look at the data historically, however, it doesn’t work that way at all. What happens is the opposite: average wages tend to rise as long as oil prices stay low. Once oil prices spike, average wages tend to flatten out.

The amounts shown on Slide 24 are average wages, computed by taking the total inflation-adjusted wages for the population in total and dividing by population. When oil prices spike, recession soon sets in. The reason why average wages fall is partly because more people become unemployed. Other workers find it necessary to accept lower-paying jobs.

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Many people focus on the run-up in oil prices to July 2008. An equally important point is the fact that the world economy has not been able to maintain these high prices since July 2008. The general price trend has been downward. The cuts by OPEC have not had a material impact.

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Citizens of the United States, Europe, and Japan are used to thinking of high energy prices as being a problem because they are from countries that require substantial imported energy to maintain their GDP. For example, Greece will sell fewer trips on its tour boats, if oil prices are high. This will have an adverse impact on employment and the ability to repay debt with interest.

If a country is an oil exporting country, low oil prices are an even worse problem. This happens because oil exporting countries tend to earn a large share of their revenue from taxes on the sale of oil. These taxes can be much higher if oil is selling for, say, $120 per barrel than if it is selling for $60 per barrel. These tax dollars are used to provide subsidies to offset the high cost of imported food. They are also used to build industry and infrastructure to provide employment to the population.

If oil prices are too low, oil exporting countries will tend to cut back on oil production. In fact, this has been happening for OPEC for the entire year of 2019.

Similar problems occur if commodity prices of any kind (coal, natural gas, uranium, steel, copper, etc.) stay too low for an extended period. Producers go bankrupt, or they stop production, or they pay their employees so poorly that the employees go on strike. Sometimes, they may even start rioting. Many of the riots around the world today are related to low commodity prices.

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The world experienced spiking oil prices in the period leading up to mid-2008. These high prices caused a recession and much lower prices followed. The chart on Slide 28 gives a somewhat exaggerated