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As readers of this blog know, I have long regarded the return of economic crisis as an inevitability (because the core energy and no-growth predicament facing the Western world wasn’t solved in 2008-9 but merely kicked further down the road by increasing debt and printing money). It looks like 2012 will be the crunch year, as a series of inter-related crises are rapidly converging: (1) The European sovereign debt crisis; (2) The continuation of the chronic US inability to balance its books, and of instability in the Middle East; (3) The probable onset of serious declines in global oil production, as new oil megaprojects are no longer able to compensate for accelerating decline from existing fields; (4) heightened risks of a war with Iran, as the narrow window opens between the start of US delivery of the next-generation bunker buster MOP (from November 2011) and the culmination of the Iranian nuclear weapons program and its hardening against air strikes (next year or two).

The European debt crisis dominates headlines, with the Anglo-Saxon media crowing about the lazy, shiftless Meds (as opposed to the diligent and careful Germans) and blaming socialism for their problems. This of course has a number of flaws within it. Greeks work the most hours in the EU – 2000 per year, relative to 1300 in Germany. And the only major EU nations without huge debt and fiscal problems are the Scandinavians, who are about as “socialist” as one gets nowadays.

But this is all sidestepping the fact that debt and fiscal crisis afflict the entire Western world, and it is just that – due to the special political weaknesses of the Eurozone – have manifested first and foremost in Greece, Italy, and Spain. However, a look at the actual statistics reveals that even the “serious” countries are in a great deal of trouble. For instance, in 2010 both the US and Britain had bigger primary deficits (cyclically adjusted) than “basketcase” Greece, whereas Italy’s was actually positive! The Meds’ total net government debt is larger, but on the other hand, if even France is beginning to experience perturbations – a country whose fiscal balances are better in every way than Britain’s or America’s – then it surely cannot be long before the crows come home to roost in the Anglo-Saxon world.

The fiscal crisis

Below are two tables that would be very informative for discussions about the crisis, as they overturn many of the lazy myths and tropes populating the discourse.

debt-sustainability

Though the US position looks salvageable because of the positive GDP growth less cost of finance indicator (suggesting that its ability to pay back its debts are growing faster than the debts themselves), I am not convinced of the reliability of that indicator. First, it assumes fast growth – growth that has yet to materialize despite massive fiscal and monetary stimulus since 2008. Second, it assumes that interest rates on Treasuries will remain low – but that assumes a US that is becoming rapidly indebted and making signals it is going to inflate it away remains an investor safe heaven. It shows zero ability to make a credible commitment to eliminating the budget deficit, which is only going to be compounded as the baby boomers start retiring.

pollaro-budgets-debt

This chart from Michael Pollaro shows that in some respects the US position is actually worse than those of the PIGS in aggregate. For every $60 it received in revenue, it spends $100, and it would take almost 6 years for the US to repay its debt if the entire budget was devoted to it. In contrast, the average PIGS figure is $78 in revenue for every $100 in spending, and it would take them only 2 years of their combined budgets to repay their debts.

The position of Britain is very weak. It’s economy, and especially its budget, is highly reliant on the City of London. The tanking of the financial system has resulted in zero growth (GDP is still about 5% below peak 2007 levels) and chronically high budget deficits at around 10% of GDP, and the prospect of a second recession with pull the figures even further into the red. Nor has a weaker pound stimulated an export based recovery. Britain’s big trump card is that its bonds have very high average numbers of years to maturity, so refinancing will be easier even if its rates were to suddenly lurch upwards. Now its still over-extended and will probably go bankrupt within this decade, but probably later than the Meds or even the US.

Germany has a strong position, with only a modest budget deficit and reasonable levels of debt. Overall, it is net global creditor, with a net international investment position of 37% of GDP. But this presents another problem. Quite a lot of that is in the forms of loans to and assets held by its banks in the stricken Med region. A meltdown there would send the value of these assets plummeting, necessitating massive bailouts that could in turn threaten even Germany’s solvency. Hence, a possible reason for the recent poor sales of German government bonds.

Despite chronic budget deficits and an astronomic public debt of 220% of GDP, I actually think that Japan may be the country in the least danger in the medium-term future. 95% of its government debt is domestic, largely to Japanese corporations, which lend to the government for social spending in exchange for the understanding that tax rates will be held low. But those same banks and corporations are flush with cash: Japan’s net international investment position is an impressive 56% of GDP. In a way, it’s just a different method of financing a welfare state. It’s still probably unsustainable – domestic investors too may dry up, especially as the Japanese population continues to age and begins to spend rather than save – but I’d wager less so than the US or most of Europe.

Fiscally secure nations include China, Latin America, Scandinavia, and Russia. China has problems with various non-performing loans and municipal over-indebtedness, granted, but these weaknesses are largely mitigated by its phenomenal growth rate and a net international investment position of 36% of GDP. Latin America and Scandinavia tend to have responsible fiscal management and adequate growth rates.

Russia has globally low levels of government debt, its citizens likewise have low debt levels (a feature more of its underdeveloped credit system, granted), and an international net investment position of 17% of GDP. Though the budget deficit is currently balanced thanks to high oil prices, a significant drop can take them into the red very quickly and deeply; however, this is NOT a problem because it is a near certainty that on average oil prices in the next decade will remain high and rise further. What IS a problem is that Russia is a “high-beta” economy, highly affected by developments elsewhere – in 2008, its recession was deeper than in any major Western economy (though compared to them it also had the strongest recovery). The primary reason was the sharp cut-off in Western credit to Russian banks and corporations, resulting in multiple refinancing crises. Today, this problem is less acute, with the Russian banks and corporations having learnt that such dependence may be a problem – nonetheless, a huge sovereign debt crisis in the West can still give Russia a very sharp knock in the short-term.

The exergy crisis

This brings us to another side of the issue: peak oil. Oil reserves are depleting, and global production – after being on a plateau from 2005 to today – will probably begin to consistently fall from 2012 as oil megaprojects sharply fall off. Furthermore, a war with Iran, and its possible capability to blockade the Strait of Hormuz for some time, may cause an extremely disruptive spike in world oil prices, as 25% of world oil supplies transit through the Persian Gulf. On the other hand, China is right now entering the mass automobile age, with the numbers of cars sold per year overtaking the US in 2010. So we will see a rise in demand from China and other emerging markets.

But this is not all. As discussed on other posts in the blog, e.g. here, here, economic growth in general is crucially dependent on net energy availability and the efficiency with which it is converted into useful work. Both indicators have slowed to a crawl, and quite soon the former may well go into reverse. Furthermore, the reality of open global markets with limited global energy supplies means that countries will be more and more competitively bidding for the high-EROEI energy sources that remain (primarily, oil). The US in particular is highly dependent on oil to power its service-based economy, but it simply cannot afford oil to the same degree as can China (see this excellent Oil Drum post A Brief Economic Explanation of Peak Oil for an explanation). This means that the economic pie is now limited, and growth in one place (above all, China) is now to the detriment of growth in other already high-income places (the US, and the less efficient parts of Europe). For a limited time, this issue can be bypassed by the accumulation of debt in the high-income countries – much of which, it should be noted, is loaned out from China and the oil exporters. But poor countries lending to maintain rich country living standards is bizarre at face value, and it is unsustainable in the long-run.

How to survive the coming storm?

From the investment perspective: Keep assets in US dollars, but only those that can be sold off at relatively short notice.

Though dangerous in the short-term, China, Russia, and some countries in Eastern Europe are very good long-term plays. In particular, buying in at the depths of crisis can pay huge dividends in the future. A good bet right now: property in Bulgaria and Minsk.

Natural resources are another excellent long-term play (including gold – a good bet in a time of instability). However, it is probably not a good time to buy in right now, as there is the risk of a sharp (but short) fall once the economic deterioration gathers critical pace.

If you have the means to be an independent financial speculator, try out US CDS. The US will probably never formally default – controlling its own currency, at the most, it will do so via inflation – however, the perceived risk of default WILL be reflected in those instruments. Don’t bet the farm on it, as they’re high risk, but do consider setting aside 10% of your investment poll into this or similar instruments, as the returns have the potential to be mindbogglingly high.

The other two BRIC’s, India and Brazil, I am not so certain of because their low human capital precludes very fast growth.

In terms of specific sectors in the long-term, probably the best bets are IT and medicine because the entire world is aging, and when people are unemployed, they will spend their time on Facebook and playing video games.

Perhaps I’ll have another post on the other aspects of how to keep afloat in the coming era of turbulence. Keep an eye out for it.

Reread S/O posts about the return of geopolitics to Europe and my decade forecast and piece on future superpowers, and continue reading this blog as it is ahead of so many issues well before they started becoming conventional wisdom.

(Republished from Sublime Oblivion by permission of author or representative)
 
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This is the first post in a series of three, in which I will analyze the major trends that will define the next ten years and their likely impacts on global regions. To put these forecasts into context, I must first describe the narrative through which I view the history of the post-WW2 era (the Oil Age, the Age of Hubris, or as John M. Greer aptly described it, the “age of abundance industrialism” – now on the verge of meeting its Nemesis, the waning of Pax Americana and the demise of global Western hegemony), which is dominated by the concept of “limits to growth” – the 1972 Club of Rome thesis that finite resources and pollution sinks will ensure that business-as-usual economic growth can never continue indefinitely on planet Earth.

A Short History of Abundance Industrialism

Driven by an electro-mechanical revolution powered by a windfall of cheap oil, the world registered its highest GDP growth rates in the 1950-1973 period. The era was defined by self-confidence and a secular “myth of progress”, which reached its apogee with the 1969 moon landings. But the next decade saw the arrival of major discontinuities. American oil production peaked in 1970, and went into decline. Saudi Arabia settled into its role as the world swing producer, enabling it to inflict a severe “oil shock” on Western economies in 1973 to punish them for their support for Israel, to be followed by another in 1979 coinciding with the Islamic Revolution in Iran. The decade also saw milestones such as the publication of Limits to Growth, the ending of hyperbolic growth of the world system, and a new emphasis on conservation and sustainability (which led to significant improvements in fuel efficiency and pollution control – back then, the fruits were all low-hanging, so impressive results were not hard to achieve). Yet the first tentative steps towards sustainability were not to be followed through, as the newly-elected Reagan took office proclaiming “Morning in America!”, with its implicit promise of a return to a past with no future. It was a false dawn.

Thus began the “age of diminished expectations”. In the US, physical production by volume and real working class wages stalled in the 1970′s, and have since been on a plateau (slightly tilted up according to official statistics, slightly tilted down according to unofficial ones). The age of Mammon saw rising inequality, both within and between nations (the sole major exception being China whose ascent to world power began in the late 1970′s). As the American industrial base entered its long atrophy, its economy shifted towards construction, services, and finance, – symbolized by metastasizing suburbia – and made possible by new drilling by the oil majors in remoter areas like Alaska, the Mexican Gulf, and the North Sea, a political-security rapprochement with Saudi Arabia, the IT revolution, and the rise of multinational corporations exploiting globalizing markets and cybernetic technology in a flattening world. Sustainability went out the window; quite literally, as Carter’s solar panels were removed from the White House roof in 1986. Finally, the US harnessed its new role as the focal point of the emerging global neoliberal system to open up their economies to the world, unleashing China’s “surplus armies of labor” and the former USSR’s energy resources in the service of Pax Americana.

overshoot

[Source: Tracking the ecological overshoot of the human economy, PNAS.]

This new era of international neoliberalism and developed country post-industrialism coincided with the genesis of humanity’s ecological overshoot of the carrying capacity of the Earth. Though the first global pollution alarm in the form of the “ozone hole” led to an impressive response involving a global agreement on the withdrawal of CFC production, the reaction to the growing specter of runaway climate change caused by man-made CO2 emissions – which is ultimately a far more serious issue – has been muted right up until 2009′s Copenhagen fiasco and today. Instead, the party continued in full blast throughout the 1990′s, for the US was too busy basking in the glow of the ostensible end-of-history triumph of “Western liberal democracy as the final form of human government”.

These hubristic visions of imminent utopia, of global drive-in democracy, collided with hard reality in the first decade of what was supposed to be a “new American century”. The United States is in a state of severe economic disequilibrium and has been in rapid decline relative to its competitors – a condition reminiscent of the USSR in the 1980′s. The probable decline and fall of the global order of which it is the locus will constitute the defining trend of the next decade.

Shifting Winds: The End of Pax Americana

What is Pax Americana? It is the liberal, internationalist, post-Cold War order, which has extended its reach throughout the whole world barring a few socialist holdovers like Cuba and North Korea. Globalization, rule of law, human rights, liberal democracy, free markets, economic growth – these are its self-defined values, which it considers to be the apex of humanity’s socio-political evolution. Its critics, from Western leftists to Third World nationalists, decry it as an exploitative, ruinous, imperialist, hypocritical, end-of-history theology, with voluminous references to the inconsistent ways in which these values are practiced by their own sponsors, or wielded as weapons against its ideological and geopolitical competitors.

But these arguments will soon become academic. As demonstrated by Robert Ayres, there is a glaring hole at the center of modern macroeconomic theory – accounts of growth neglect the vital role of “useful work” (a function of exergy and technical efficiency), whose contribution far outweighs that of labor and capital combined. Both factors have been flattening in the US in recent years, making further growth unsustainable. Furthermore, studies in systems dynamics indicate that brittle systems, with poor “shock absorbers”, can be subject to so-called “cascade collapse“, in which failures at one node produce a self-amplifying resonance that causes many other nodes to fail. If this is an accurate description of the global System, then a setback in any one sphere – be it economic, financial, geopolitical, etc – could usher in a vicious spiral into anarchic apolarity on the international stage.

Pax Americana and its neoliberal ideological superstructure rests on three pillars: cheap oil, American dollars, and the US Navy. Like the legs of a tripod, they all survive – or fall – together. And today, they are crumbling. Let us examine the forces that will be undermining these pillars in the next decade:

Peak Oil

Contrary to the “doomer” worldview, it is almost certainly possible to sustain an industrial civilization without a drop of oil (though ceteris paribus it will be a materially poorer one, because of oil’s uniquely high EROEI). The problem is that today’s industrial system, especially in the US, is built in such a way – gas-guzzling SUV’s on asphalt roads slithering across endless vistas of soulless suburbia – that cheap oil is indispensable to making the commutes and credit flows, the jet flights and JIT production systems, function. An even bigger problem is that Hubbert’s predictions of a global oil peak are (roughly) on schedule: though delayed by the 1970′s oil shocks, it is likely that either 2008 or 2010 was the all-time peak, and oil production will now decline at an accelerating rate – even without accounting for possible discontinuities like a global credit implosion, a sudden collapse of Ghawar, the spread of revolution to Saudi Arabia, or Iranian mining of the Straits of Hormuz.

oil-production

[Source: World Oil Production Forecast - Update November 2009, Oil Drum. Click to enlarge.]

The US spent prodigious sums to fight a war to open up Iraq’s oil reserves, but today its oil production is no higher than in 2000 (and hopes of massively increasing it are probably unrealistic). Russia has reconsolidated state control over its hydrocarbon deposits, discounting Western recriminations over its “resource nationalism”, and has successfully pushed back against Washington-backed “color revolutions”. Central Asia never proved to be the black gold lode of American geostrategic fantasy, and in any case it has since been closed off again by Russia. Due to their immense capital costs, environmental impact, and low energy-return-on-energy-invested (EROEI), there can be no salvation in tar sands or shale. Nor have there been any efforts at mitigation of the kind recommended in the Hirsch report. Any energy transition will be a very drawn-out process, considering the sheer scale of the infrastructure that will have to be replaced – and using continuously lower-EROEI energy sources!

As such, it can be said with a high degree of certainty that the world will soon experience a severe shortfall in liquid fuels. Because of its high degree of dependence on cheap oil, this will affect the US disproportionately, which will have to make good with demand destruction. The consequences will include major knock-on effects on consumers, who constitute the mainstay of American economic power.

State Insolvency

The geological realities of peak oil (2005-2010), in combination with soaring demand from industrializing Asia, have led to the worst crisis since the Great Depression, with the free-fall only being checked by a dizzying panoply of monetary flooding, fiscal stimulus, and government bailouts. As if this weren’t enough, the US faces rising entitlements costs as the baby boomers start retiring, a bloated military-industrial complex, and increasing commitments to Afghanistan with no timetable in sight (where there are now more US troops than there were at the peak of the Soviet intervention).

us-budget-woes

[The US budget deficit is predicted to permanently remain in the red even under the rosiest assumptions. As of now, it is the more pessimistic scenarios that are being born out - Republican refusals to raise tax rates or cooperate on Medicare; Soviet-like rhetoric about "defense cuts" while real military spending continues rising; etc.]

Now the major reason why the US has been able to afford both guns (the US military) and butter (its double deficits) in the face of deindustrialization was by giving its many foreign investors an atrocious rate of return, which they accepted in return for America’s “alpha” – its reputation as the largest economy, sole superpower, and global financial center, in other words, the “safe haven” par excellence. It also draws immense strength from the US dollar’s role as the global reserve currency, for instance by allowing it to comfortably buy oil at $-denominated prices even when the currency is weak. But with its “imperial overstretch” (see Afghanistan), moribund financial system, and a budget deficit north of 10% of GDP and projected to remain in the red for the foreseeable future – by some measures, US debt and fiscal metrics are worse than those of the PIGS on aggregate – will this American “alpha” survive? Probably not for much longer.

The creeping monetization of US debt will destroy investor confidence that they will ever make a positive return on their US bond investment. The withdrawal of a single major investor, especially if it coincides with a geopolitical shock, could set off a “cascading collapse” as other investors scurry away from US Treasury bonds. This will leave the US incapable of generating the primary surpluses to service its negative net foreign investment position, leading either to a compound debt trap or a classic emerging market-style currency crisis. Ice or fire? Given America’s democratic system and the bipartisan consensus on fiscal profligacy, I would bet on the latter.

Economic Decline

The collapse of what in some respects resembles an informal tributary system, channeling global (i.e. Asian) savings to the American consumer, will sound the death knell for Pax Americana. As Paul Kennedy argued in The Rise and Fall of the Great Powers, military power is ultimately subordinate to the economic base which supports it. The industrial base that won the Second World War and forged the American superpower has been in decline since the 1970′s – though on paper it boasted a high productivity growth rate, it masked a huge decline in the size and complexity of its “industrial ecosystem”. Mundane manufacturing, the automotive industry, and machine building have all experienced rapid decline; the heavily-subsidized aerospace and defense industries constitute the only major exceptions to this trend.

Now as long as globalization, free trade, and stability reigned, this did not portend international decline. Industrial hallowing out simply freed up workers into sectors that were more in demand, like restaurants, construction, services of all kinds, etc; and women gained many more economic opportunities. The US could get its manufactures from abroad, like Spain during its (literal) Golden Age. Furthermore, the transition from manufacturing to consumption and finance is historically not without precedents, being observed in the halcyon days of empires like Holland and Great Britain. After these former empires had established their initial industrial supremacy through mercantile means, they transitioned to free-trade regimes designed to reinforce their economic hegemony – and in so doing “kicked away the ladder” from countries trying to catch up. (The United States itself was one of the world’s most protectionist nations until the Second World War, at the end of which it accounted for half of global industrial output and drastically reduced tariff rates).

However, as pointed out above, the crumbling of two pillars of Pax Americana, cheap oil and the US dollar, makes the survival of today’s comfortable globalization highly unlikely. When the inflows of cheap credit from abroad cease; when oil flows decline due to geological, political, and geopolitical factors – the US will no longer be able to maintain its privileged position as the world’s “market dominant minority“, its overstretched armed forces will no longer have access to the lavish funding of the days of yore, and the neoliberal world order they upheld will come to an end.

Geopolitical Shocks

Facing the twinned specter of peak oil and fiscal insolvency and supported by an atrophied industrial base, Pax Americana could in fairness be described as a “brittle system” under a growing threat of collapse. Though it may yet fade away gradually into the night, to be slowly displaced by the state-centered, neo-Westphalian, mercantile reality of “world without the West“, it is altogether possible that geopolitical shocks will make the transition far more abrupt and chaotic than expected.

Though nothing’s certain, it is possible, likely even, that the biggest shock will emanate from a confrontation between Iran and the US in the Persian Gulf. Since 2005, the hardline IRGC paramilitary / intelligence clan, whose figurehead is Ahmadinejad), has been in the ascendant in Iran. Their power was further reinforced in 2009 when the Supreme Leader Khamenei sided with the IRGC in the aftermath of the abortive “Green Revolution” spearheaded by the waning “moderate” clerical clan (headed by Rafsanjani), in response to Mousavi’s electoral loss. These internal Iranian developments occurred in tandem with the rising tensions with Israel, Saudi Arabia, and the US over Iran’s pursuit of an nuclear bomb, amidst the window of opportunity left open to the Islamic Republic by the US quagmire in Iraq. Iran sees the Bomb as the best guarantor of regime security by allowing it to establish a regional hegemony in the Persian Gulf region.

This is unacceptable to everyone in the region. Israel views an Iranian bomb as an existential threat; Ahmadinejad expresses the opinion of 62% of Iranians when he says the Israel state should be wiped off the map. The Jewish state is now ruled by Benjamin Netanyahu, a man who in 2007 opined: “It’s 1938, and Iran is Germany, and Iran is racing to arm itself with atomic bombs”. Not much room for compromise there. The rulers of Saudi Arabia, beset by Iranian-stoked ferment amongst their Shi’ite population and undermined by the Iran-backed al-Houthi insurrection on their Yemeni border, view the prospect of an Iranian bomb with similar trepidation. Though they will protest in public, they will be quite happy to see an Israeli-American strike on Iran; rumor has it that Saudi officials have given Israel permission to fly over their territory via backdoor diplomatic channels.

The US is hesitant. Striking Iran carries great risks. First, no matter how good and accurate your bombs are – the US has accelerated the development of a bunker-buster capable of penetrating 60m of reinforced concrete – they are only worth their weight if you know precisely where to strike. Iranian nuclear facilities are highly dispersed and concealed, making the extent of US intelligence on them uncertain. Second, Iran can mine the Strait of Hormuz and harass oil tankers with coastal shore batteries, diesel submarines, and merchant raiders. This will put at risk 20% of the global oil supply; even if the blockade proves ineffective, as predicted by most analysts, soaring insurance rates may result in oil prices spiraling into new highs due to unprecedentedly tight supplies. Third, the Islamic Republic has a panoply of retaliatory options at its disposal: a renewed Hezbollah missile barrage against Israel, increased support for Shi’ite insurgencies in the Arabian peninsula, and above all a resurgence of political violence and state instability in Iraq. As mentioned above, hopes have been pinned on Iraq to delay global peak oil by another decade. Yet it has always been a land of unfulfilled potential, its imminent oil production takeoff regularly stymied once per decade – in 1979 with the outbreak of the Iran-Iraq War, in 1991 with the Gulf War, in 2003 with the US invasion. It would not be out of character for its oil production to plummet again in 2012, in the face of renewed internecine warfare, Iranian incursions, and mining of the Strait of Hormuz.

Given all these risks and uncertainties, it is not surprising that the US is pursuing a cautious approach, restraining Israel and pushing for “crippling” sanctions on Iran, targeting its gasoline imports. However, the latter will not achieve much, especially since Russia – which has not received the firm recognition of its sphere of influence over the post-Soviet space that it really wants from Washington – will be able to torpedo any sanctions by allowing Iran to import gasoline through its Central Asian surrogates. Israel may grow impatient and eventually jump the gun without US permission. But Iran will likely consider Israeli and US actions to have been coordinated, and will embark on its “Project Mayhem.” The US may be forced to rush in and respond unprepared to contain the fallout as best it could. Now it is true that alarmist predictions that the US Navy will be crippled by Iranian low-tech swarm attacks are largely unsubstantiated, and there is no question that the US will have no trouble in gaining full air superiority over the obsolete Iranian integrated air defense system. However, defeating Iran’s dispersed retaliatory assets in detail may be a difficult and prolonged undertaking, perhaps even requiring the military occupation of strategic Iranian regions such as Khuzestan and Kish Island.

The US finds itself caught in a Catch-22 situation. Let Iran be, and it develops a nuclear deterrent allowing it to make a bid for regional hegemony – if it is not preempted by an Israeli strike. Attack Iran, and needless to say, anything worse than the most optimistic scenarios (in which the Strait of Hormuz only remains blocked for a few days) will constitute a tremendous physical and psychological shock for Pax Americana, a shock in which all its three pillars come under strain in the form of oil supply disruptions, financial turbulence, and prolonged aeronaval operations.

Endgame

In conclusion, given the inherent fragility of the neoliberal world order and the mounting stresses on it in the years ahead, stresses that could be explosively released in a major geopolitical crisis – possible in Iran, though major clashes in other hotspots like the Caucasus or the East China Sea cannot be dismissed – it is unlikely that Pax Americana will survive the decade.

Yet its collapse will not herald a global collapse and a sudden descent into the Olduvai Gorge, for Pax Americana is ultimately just a subsystem of a larger system – that of global industrialism, the System that encompasses virtually the entire world, with the sole exception of hunter-gatherer remnants in the Amazonian fastnesses and a few mystical recluses. The American empire, much like the Soviet one, will retreat from globalist pretensions, while maintaining a continental hegemony. In the meantime, powered by domestic coal and a new kind of resource tributary system – one based on bilateral deals instead of open markets – China will be well on its world-historical “great reconvergence” with the West, making it the preeminent superpower of the age of scarcity industrialism.

The geopolitics of scarcity industrialism are the topic of the next monograph in this series.

(Republished from Sublime Oblivion by permission of author or representative)
 
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The standard view of the American economy is one of exponential growth: even if interrupted by a recession once a decade and a Depression once every two generations (the 1890′s, the 1930′s, the 2010′s?), the engines of industry would always come back roaring again. Output per American could always be expected to increase as it has from 1790 until the present day. There has never been a decade, even during America’s two Depressions, when US GDP was lower at the end than at the beginning.

However, another point of view on the US economy can be developed by drawing on observations of factors such as median income, energy consumption and inequality. Broadly speaking, this picture is one relative stagnation from 1890-1940, and again from 1973-today, punctuated by the truly remarkable “miracle economy” of the post-war boom. Furthermore, the US is now about to transition to a new phase: economic stagnation and anarchic stasis, to be followed by oligarchic Caesarism. This first post will be, for now, just a series of observations that I believe to be inextricably linked, but lack the theoretical foundations to put on a sound footing. Feel free to skip it, as it might be hard to follow and I’m mostly writing it to get greater understanding for myself. More polished version(s) to follow.

1. Median incomes (the ones that matter to ordinary Americans) tell a radically different story from the GDP figures. As shown below, they remained at a virtual plateau from 1914 to 1940. During the WW2 mobilization, spare capacity filled up, as factories began to produce the tanks, ships, planes, jeeps and misc. that played a crucial role in the Allied victory. After the war, what might have been a new plateau from the 1940-50 base accelerated, literally driven by the automative revolution; it is during this time that the US became a suburban, oil-based civilization.

ave-us-income-saez

However, the oil shocks of the 1970′s threw a jackhammer into that arrangement. Since then, the only discernible rise took place in the 1990′s: a period that saw the opening up of the Chinese “reserve army of labor” and the Soviet resource base to global markets. These began creating powerful deflationary effects in the US. But things went into reverse altogether during the past “lost decade“.

The median household income in 2008 was $50,303. The median household income in 1999, expressed in 2008 dollars, was $52,748.

You’ve got to figure 2009 will see another decline in income, in which case Americans will end the decade significantly less well off than when they started it. We’re not just treading water. We’re going backwards. …

Still, the 2000s have been especially barren. Median income rose only in three years—2005, 2006 and 2007, and even at the cyclical peak in 2007 it was below the levels of 1999 and 2000.

2. More on the energy developments during the period. During 1950-70, the US enjoyed very rapid growth both in absolute energy consumption and the energy efficiency of its techno-industrial base. Therefore, the quantity of “useful work” available for exploitation by American labor and capital increased very rapidly.

But this growth moderated since the 1970′s. Given the continuing reduction in the EROEI of oil, the peaking of the net energy flowing into the US economy from coal in 1998, and the turn to costly shale gas to maintain natural gas production volumes observed within the last decade, this trend must have only strengthened in the 2000′s. Graphs are taken from Economic Growth and Cheap Oil (Robert Ayres).

us-exergy-services-supply

The growth in the”technical efficiency” with which exergy is converted to “useful work” by the American economy has been flattening since the 1980′s (probably due to diminishing returns to investments into more efficiency: see Tainter, etc). Though Obama’s drive to increase energy efficiency is laudable, it will be hard to achieve big results given that most of the low-hanging fruit have already been picked.

technical-efficiency-us-exergy-services

If further improvements in technical efficiency are low, then the US will be going into a permanent hyper depression in the years ahead according to Ayres’ calculations. As of today, the observed results match the Low forecast.

ayres-us-gdp-forecasts

There’s little reason for hope. The potential for squeezing more “useful work” – the single biggest factor in GDP growth – out of the current US energy base are very limited. Coal, oil and natural gas are roads to nowhere. While nuclear and renewables are far more sustainable in the long-term (for maintaining an industrial base), they need 1) several decades to be build up and 2) given the same investments in K and L generate less useful work than today’s hydrocarbons because of their low EROEI’s.

3. Another interesting thing is that the period of stagnant US median incomes is linked with rising inequality. (This explains the continued moderate growth in consumption and GDP – its just that since 1973 a very large portion of it has been accruing to the guys at the top of the pecking order).

Now in stagnant systems – e.g. overpopulated agrarian societies – this is explained (Turchin) by the fact that land, food and credit prices have a tendency to go up, benefiting the elites (landowners, financiers, etc) relative to the rest of the population. While similar processes apply to industrial societies (see Marx), its effects can be combated by the powerful redistribution mechanisms available to the modern state (that were lacking in the agrarian states of yore). Hence, despite the fact that since the 1980′s Western Europe has been on much the same vastly lower growth trajectory, inequality in states such as France and Germany has remained low.

On the other hand, the US – having progressively deregulated the financial sector and knocked down marginal tax rates – has experienced a massive increase in inequality that may now be approaching the levels of the Gilded Age.

marginal-tax-rates

4. Fertility rates are linked to economic conditions. One of the many explanations for the post-war baby boom in the US is that soldiers were returning home, social conservatism, etc. But none of them are very convincing as comprehensive explanations.

us-fertility-rate

Instead, one may interpret the above graph as follows:

  • 1900-1940: stagnant median incomes; TFR approaches replacement level rates as the US ceases being an agrarian society.
  • 1940-1970: the baby boom as US middle class living standards expand rapidly. Populations tend to expand rapidly when their resource base expands. Interesting why TFR expansion started dropping in early 1960′s, though: perhaps looking at cohort TFR’s (which adjust for average age of childbearing) would yield a better fit with the economic stats?
  • 1970-2010: roughly replacement level TFR’s, stable median incomes.
  • 2010+: if median incomes begin to fall in the future, due to energy constraints and/or fiscal collapse, we might well see the TFR drop to something like 1.5.
  • A comparison: Russia completed its post-agrarian fertility transition by the mid-1960′s; after that, the TFR remained stable at around 1.9-2.1 until 1990 (as we know this was a time of zastoi / stagnation, esp. in the later part of this period). But in the 1990′s Russia’s TFR fell off a cliff, along with real living standards (not only did average incomes fall, soaring inequality made most people’s income fall even faster). The nadir was reached in 1999 (TFR=1.16) and has since risen up to 2009 (TFR=1.56).
  • Of course, non-material factors also play a big role: e.g., why is German TFR so much lower than France’s? etc…

5. Preliminary speculations. The reason I’m very skeptical on the Keynesian / Krugman vs. Austrian / Tea Party “debate” is that both positions, though ostensibly opposite, are based on the same presumption: that further economic growth is still possible, if only their policy prescriptions were to be followed. (In a recent Oil Drum posting Gregor MacDonald laid out my thoughts very well in Hollow Men of Economics.

So, Krugman draws many simplistic graphs showing how growth was bigger during the (Keynesian) 1950′s-1960′s than during the (monetarist) 1980′s-2000′s, ergo, the government should throw more and more money at the economy, the deficits and debts be damned. Then there his ridiculous “invisible” bond vigilantes argument: if the US can sell debt so cheaply, why should we worry about exploding budget deficits? Only a few things wrong with this theory…

  1. It’s a complete strawman! By the time the bond vigilantes take off their invisibility cloak, the costs of servicing debt – much of it now in short-term bonds which have to be frequently rolled over – will begin to spike, leading to an irreversible death spiral.
  2. Makes the questionable assumption that the US will grow at 2-3% in the future, whereas 1) the necessity of deleveraging, 2) the exergy situation and 3) the fragile geopolitical situation makes this highly unlikely.

Of course, the Austrians / WSJ are no less insane. If only the rich could get more tax breaks, if only banksters and oil corporations could be coddled even more than they are already, everything would be fine and dandy and we’ll be growing our way into a Randian paradise of abundance.

Both sides UTTERLY fail to consider the vital factor of useful work to economic growth. Useful work is a function of exergy & technical efficiency. Exergy is likely to peak and go into decline within the decade, given the trends in the energy base; technical efficiency appears to have a trend of flattening out. If investors were to suspect there are no prospects for future growth, the credit system – the economic equivalent of fertilizer in agriculture – as it exists today would collapse (why give out loans if there’s little prospects they will be repaid?), and the consequent drop off in investment will lead to depreciation overtaking and the capital stock beginning to contract. Finally, while the labor force will continue to expand, its quality will not because American IQ has been flat since around the 1980′s because of the cessation of the Flynn effect. (The *only* positive, productivity enhancing trend at work is the continued informatization of the economy, which may gain a boost with the appearance of ubiquitous, specialized and highly effective AI’s by the 2020′s.)

This is not an attractive view to take, because it basically means that whatever the government does or doesn’t do, GDP decline is inevitable. But the alternatives aren’t rosy either:

  • If Krugman “wins” the debate: the economy sputters along for a few years, never getting onto a sustainable growth trajectory. Awning budget deficits and ballooning of the public debt (which is now at 140% of GDP if you also count local/municipal debt and Freddie Mac/Freddie Mae liabilities). The result: an Argentina 2000/Latvia 2009-style collapse, probably sometime around 2012-15 (might be triggered by a “geopolitical shock”). End-result: some kind of American Caesarism.
  • If Austrians “win” the debate: the decline is grinding and gradual, rather than sudden and catastrophic.

Instead, it would perhaps be a better idea to craft policies in such a way as to minimize the harm done for (as I suggested in my abortive “Collapse Party” project) and at the same time make the foundations of the American state stronger.

  • Reintroduce the high marginal tax rates of the 1950′s-60′s to reduce inequality and shift the burden to those able to shoulder it. Might prevent the soaring inequality / corruption / resentment that leads to crony Caesarist outcomes. Problem: ACHTUNG SOCIALISM!
  • Allow the financial system to contract / collapse as needed. Today, it is a rotting dead weight on the US – both economically (there’s no need for such a huge financial sector in the first place) and morally (they are a class apart from normal Americans). Problem: institutional capture means same banksters wield immense influence over both parties of power.
  • Reduce military expenditures. There’s a lot that can be cut. First, the metastasized “war on terror” apparatus. Second, the expeditionary/naval component can be cut. There’s no long-term hope of containing China, but the Western US itself is secure. The Pacific Fleet can be reduced. Get out of Afghanistan. On the other hand, maintaining dominance in the Atlantic (core US interest) and the Middle East (oil) is useful. Third, saved money can be used to 1) continue research into next-generation military technologies, 2) reducing deficit. It’s not really a choice, actually. Military contraction is inevitable in the next decade: the only question is whether it will be uncontrolled (as during 1990′s Russia, when c.70% of Soviet military assets depreciated into junk) or controlled (with the result that core strengths will be preserved). Problem: suggesting reductions in military spending is unpatriotic & goes against the powerful defense & MIC lobby.
  • Obamacare is imperfect, but one of the administration’s best achievements. Leave as is.
  • Use savings from cutting off subsidies to the MIC & financial mafias – and the bigger tax intakes – to launch a coordinated restructuring of the US energy base. To accelerate the transition to sustainability, start planning and building lots of new nuclear power plants, and renewables. Start phasing out coal. First, makes a positive contribution to helping the world avoid catastrophic climate change. Second, this transition is in any case inevitable once the EROEI of hydrocarbons dips to lower levels – but by then, switching will harder because there’ll be many other challenges on the plate (e.g. mitigating the increasing effects of global warming; coping with the dearth of capital). So make a head start now. Problem: requires the kind of forward thinking that institutions are chronically incapable of.
  • How do solve all these problems? Obama needs to take a gamble, revolutionize his leadership, launch an all out political assault against the enemies of progress. Problem: not going to happen.

And that’s the story of it.

If I had to bet on it, I’d say US GDP per capita will be 5-25% lower in 2020 than it is now – even though we’re in recession. (Unlike with the 1930′s Depression, there’s no abundant, very high-EROEI energy subsidy on the horizon waiting to propel the US to another level). Inequality will be no lower than today, because of the power of today’s stakeholders in the system, hence – coupled with lower output and the waning of the credit system – median incomes will be a lot lower; hence, many more people in outright destitution. The center of gravity (economy, population) shifting back to the north and east (above all the Great Lakes region) from the south and west. The Presidency will have transitioned to some kind of Caesarism, served by a clique of politically-connected oligarchs. Any imperialist adventures now confined to the Western hemisphere. The citizenry too atomized, apathetic and preoccupied with quotidian concerns to do much about it.

I appreciate your thoughts and criticisms of this post, but do note that it is not meant to be final or “serious”; more like a strange mix of relatively obscure economic concepts, lazy extrapolations and personal impressions. As I said at the beginning, I hope to refine and connect these ideas into a more rigorous and logical framework in the future.

(Republished from Sublime Oblivion by permission of author or representative)
 
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In most Russian bookstores, there is a bookshelf or two dedicated to so-called “patriotic literature” – reappraisals of Stalin against “liberal revisionism”, overviews of Russia’s secret super-weapons, the exploits of its special forces and Russian theo-philosophy. Much of it is (apparent) nonsense, but the economic crisis has forced me to reconsider one particular “patriotic” thesis – Andrei Parshev’s Why Russia is not America.

His big idea, an elaboration and tying together of earlier work, is that Russia’s economy is structurally uncompetitive on the world stage, and that integrating with the global economy will lead to catastrophe. This is because of his counter-intuitive observation that Russia is overpopulated. Though its population density is low on paper, the cold climate, huge landmass and poor riverine connections means that the carrying capacity of north Eurasia is nowhere near as high as that of the world’s other centers of economic and political power – the US, China, and Europe. Because manufacturing is inherently loss-making on the Eurasian plains, it is much more economically “efficient” to just ship out Russia’s mineral resources to fuel manufacturing in warmer, coastal regions such as the Pearl River Delta or the Great Lakes. No more than 20mn Russians are needed to service the pipelines and grow fat from the proceeds; the other 120mn are free to eke out a subsistence living on Russia’s marginal lands, or die out (as indeed many did during the era of neo-liberal reforms). He recommended a return to sovereignty, autarky and sobornost as the solution to these woes.

I agreed with Parshev’s analysis upon my first reading of his book in 2002, a time when I still thought Putin was no more than a better-dressed, sober gangster in Yeltsin’s mold and the country showed little signs of real recovery. Yet as evidence mounted that Russia really was prospering by the mid-2000′s and I became influenced by Krugman’s criticisms of competitiveness, I increasingly came to reject his ideas (e.g. see this comment). However, since then increasing awareness of the vital role played by protectionism in “catch-up” industrial development, the reality of peak oil and above all the economic crisis forced me into reconsidering Parshev.

Russia’s Geographic Curse

According to the geographic-determinism school of economic development, Russia is afflicted by a panoply of woes experienced by no other country or region to anywhere near the same extent. This is held to explain its special path of development, in which attempts to “catch up” with the West only end up reinforcing a Sisyphean loop of unrealized ambitions and tragic legacies.

1) Russia is too cold.

But aren’t Canada and Finland prosperous liberal democracies, despite their harsh climate? Yes, they are. But most of Canada’s 30mn-strong population is concentrated around the Great Lakes, Vancouver and Newfoundland. The former has great riverine connections with the dynamic US heartlands, while the latter two have maritime climes with excellent deep sea ports. There are a few millions living in the agriculturally productive Canadian Prairies (equivalent to Russia’s Black Earth regions). However, Canada has nowhere near so many people living so far north and so far inland as Russia.

Without central planning and subsidized energy flows, it is highly unlikely that settlements in deepest Siberia or the High Arctic could have developed into substantial population centers. Manitoba-Saskatchewan-Alberta (5.9mn) together have fewer people than the demographically weakest Russian Far East (6.7mn), let alone Siberia (20.1mn), the Urals (12.4mn) and the Volga (31.2mn) which all have similar or worse climatic conditions. Just compare the populations of the following rough climatic equivalents: Moscow (14.8mn) and Calgary (1.1mn); Irkutsk (594k) and Yellowknife (19k); Norilsk (135k) and Churchill (923).

As for Finland, it is climatically and geographically equivalent to St.-Petersburg and the Leningrad Oblast, which are atypical in having relatively mild climes and sea access during the warm seasons. Even so, Finland has an unremarkable GDP per capita compared to other developed nations, despite it having some of the best human capital in the world.

The cold makes growing seasons short and late spring droughts are a recurrent problem. This traditionally made Russian agriculture outside the southern Black Earth regions (where the cold is mitigated by exception soil fertility and access to the seas) unproductive and barely sufficient for population subsistence.

This in turn gave rise to peasant cultural traditions deeply averse to the development of capitalist enterprise, with its emphasis on individual initiative and steady capital accumulation. The classic Kluchevsky quote from the 19th century:

There is one thing of which the Great Russian is sure − that a sunny summer day is valuable, that nature would allow little time convenient for agricultural work and that a short Great Russian summer can be shortened even more by a sudden untimely turn of bad weather. This would force the Great Russian peasant to hurry up and toil in order to achieve as much as possible over a short while and take the crop in good time… In this way the Great Russian would learn to take an extraordinary but short effort, would learn to do rush, hasty work and then take a rest during forced idleness in autumn and winter. No other nation in Europe is capable of such short extraordinary effort; but, on the other hand, such lack of habit to regular, moderate, constant work is unlikely to be found anywhere in Europe.

Though peasants view capitalists with suspicion throughout the world (money relations are a threat to the village social relations that serve to guarantee subsistence to its members), the precariousness of Russian agriculture reinforced the antipathy and encouraged the formation of a strong state capable of accumulating and protecting surpluses in the good times to insure the people from dearth in the bad times. It is probably no accident that the Russian state arose out of Muscovy, one of the remotest and least agriculturally productive regions, which however compensated with overwhelming military and political power.

Of course, the influence of climatic factors is much weaker on industry and services, than on agriculture. They have higher added value and the severe cold is mitigated by Russia’s energy riches, made exploitable by the Industrial Revolution. That said, the infrastructure costs remain significantly higher than in more climatically benign nations.

As you can see from the map above, east of Poland and north of Romania, Crimea and the Caucasus, Eurasia is afflicted by deep permafrost. This necessitates laying thick, heated concrete foundations and makes constructing housing, factories and skyscrapers far more costly than in developed nations, despite Russia’s cheaper labor force.

2) Russia is too big and remote.

Russia is in the paradoxical position of being at once overpopulated and underpopulated. Overpopulated in that it is too cold and harsh to sustain a big population; underpopulated in that the population density is low, which makes transport costs per capita prohibitively high. The challenge posed by its huge size and lack of sea ports was noted as far back as the 18th century by Adam Smith in his Wealth of Nations.

…all that part of Asia which lies any considerable way north of the Euxine and Caspian seas, the ancient Scythia, the modern Tartary and Siberia, seem in all ages of the world to have been in the same barbarous and uncivilised state in which we find them at present. The Sea of Tartary is the frozen ocean which admits of no navigation, and though some of the greatest rivers in the world run through that country, they are at too great a distance from one another to carry commerce and communication through the greater part of it.

This is also a constant theme of Stratfor‘s analysis (e.g. see The Recession in Russia).

Throughout history, Russia has lacked navigable river transportation and access to ocean trading routes. Furthermore, Russia’s population is scattered across its vast territory, its natural resources are mostly found in unpopulated areas and a number of regional challengers constantly threaten its territorial integrity. Russia’s core is essentially the northeastern portion of European Russia…

With vast territory, constant expansion to the buffers and a lack of internal transportation, Russia requires a substantial amount of resources to maintain and defend its borders. It requires top-down management of the economy to focus resources on overcoming geographical impediments to development and security. As such, Russia is not a capital-rich country; it is starved for capital by its infrastructural needs, security costs, chronic low economic productivity, harsh climate and geography. Unlike the United States or the United Kingdom, where industrial and post-industrial economic development can spring forth with little or no direction thanks to favorable geography (intricate river transportation systems in the United States and access to oceanic trade routes for both) and the relative security of oceanic barriers, Russia has had to rely on firm state-driven economic development.

Railways ameliorated Russia’s situation by vastly decreasing transport costs across its barren continental swathes, thus reducing the relative advantages enjoyed by the Rimland nations through virtue of their access to sea traffic. (This development was noted more than a hundred years ago by the geopolitical theorist Mackinder, who was concerned by the strategic threat Russian railways posed to British-ruled India). Meanwhile, the telegraph, telephones, radio, TV and eventually the Internet nullified the effects of distance on information exchange.

Nonetheless, Russia continues to incur great costs on account of its cold, continental nature. Road and railway maintenance are relatively hard and expensive in Russia, which has more limited spare resources in the first place. It also largely misses out on the great productivity gains accruing from the cargo freighter revolution of the late industrial age. Outside the Moscow road rings and the Moscow – St.-Petersburg corridor, highways remain little more than directions.

3) Russia has too many enemies.

Given its origins as a settled, economically-weak civilization surrounded by foreboding plains dominated by Asiatic horsemen to the east and Germanic, Scandinavian and Polish rivals to the west, Russia’s rulers have always felt insecure. This drove them to expand the Empire since the 15th century to occupy natural buffers, as far down the North European Plain as possible, to the Carpathian Mountains to the southwest, the Caucasus and Hindu Kush to the south and the Altai Mountains, Tian Shan and Stanovoy Range in the Far East. As Catherine the Great pithily put it, “I have no way to defend my borders except to extend them”. Below is a map showing how Russia’s geo-strategists view the world:

Poor internal communications and technical deficiencies forced Moscow to main large standing armies on every potential front, incurring a constant drain on scarce resources and the productive labor pool. More resources were required for administering non-Russian lands, maintaining a formidable internal policing apparatus, and funding the development of strategic sectors, above all those tied to military applications. Security vacuums in Russia’s periphery drew in Russian troops and bureaucrats. All this makes imperial overstretch, economic inefficiency and primitive consumer markets constant features (not bugs) of any Eurasian empire.

4) Russia retains a burdensome Soviet legacy.

Though technological developments partly mitigated the negative roles of climate and geography in Russian economic development, the Soviet physical legacy of single-industry towns, “gigantism”, remote settlements, and “structural militarization” acted in the opposite direction.

Towns were built in remote areas, including the High Arctic and the Far East, regardless of costs and explicitly designed to serve a planned economy. Heating in apartment blocks was centralized, meaning that even if half the inhabitants left the rest were still entitled to utilities services. All this constituted a massive diversion of energy flows from more “efficient” purposes. Many of these towns relied on just a few large industrial employers to survive; closing the enterprise down, even if it was high unprofitable, would have resulted in humanitarian catastrophe. Incidentally, this is precisely the reason why the neoliberal reforms of the 1990′s weren’t (and probably couldn’t be) really carried through.

Stalin built up the foundations for a gargantuan military-industrial complex (MIC) centered in the remote, uninviting Urals. After the 1960′s, the MIC metastasized to such an extent as to constitute around 30% of Soviet GDP by the mid-1980′s. Though activity collapsed in the 1990′s, Russia retains a structurally militarized economy. Though currently dormant and atrophied, it can be easily reconstituted. In the mean-time the MIC continues to lock up a great deal of Russia’s human and capital resources, along with the armed forced and its vast array of security agencies.

Why America is not Russia

The US is structurally different in almost all respects. Though it has a huge continental interior, its fertile areas are interconnected by an extensive riverine network that remains ice-free throughout the winter months. It possesses excellent sea ports on both coasts. The Great Lakes region is perhaps the best place anywhere in the world for industrial development.

America’s strategic isolation and massive internal potential allow it to maintain a world class navy and expeditionary forces with ease. The US uses them calculatedly and sparingly to check the emergence of any Eurasian hegemon, the only construct that has any chance of challenging its global preeminence. And it is not afflicted by economic distortions from its deep past because America was, at least internally, a consistently free market nation since the earliest days of its founding. Its small population and abundant resources produced large per capita surpluses, sparing it from the Malthusian crises that periodically stunted older civilizations, and instead spurring on the development of free-wheeling capitalism.

From Stratfor‘s The Geography of Recession:

The most important aspect of the United States is not simply its sheer size, but the size of its usable land. Russia and China may both be similar-sized in absolute terms, but the vast majority of Russian and Chinese land is useless for agriculture, habitation or development. In contrast, courtesy of the Midwest, the United States boasts the world’s largest contiguous mass of arable land — and that mass does not include the hardly inconsequential chunks of usable territory on both the West and East coasts.

Second is the American maritime transport system. The Mississippi River, linked as it is to the Red, Missouri, Ohio and Tennessee rivers, comprises the largest interconnected network of navigable rivers in the world. In the San Francisco Bay, Chesapeake Bay and Long Island Sound/New York Bay, the United States has three of the world’s largest and best natural harbors. The series of barrier islands a few miles off the shores of Texas and the East Coast form a water-based highway — an Intracoastal Waterway — that shields American coastal shipping from all but the worst that the elements can throw at ships and ports.
The real beauty is that the two overlap with near perfect symmetry. The Intracoastal Waterway and most of the bays link up with agricultural regions and their own local river systems (such as the series of rivers that descend from the Appalachians to the East Coast), while the Greater Mississippi river network is the circulatory system of the Midwest. Even without the addition of canals, it is possible for ships to reach nearly any part of the Midwest from nearly any part of the Gulf or East coasts. The result is not just a massive ability to grow a massive amount of crops — and not just the ability to easily and cheaply move the crops to local, regional and global markets — but also the ability to use that same transport network for any other economic purpose without having to worry about food supplies.

The implications of such a confluence are deep and sustained. Where most countries need to scrape together capital to build roads and rail to establish the very foundation of an economy — transport capability — geography granted the United States a near-perfect system at no cost. That frees up U.S. capital for other pursuits and almost condemns the United States to be capital-rich. Any additional infrastructure the United States constructs is icing on the cake. (The cake itself is free — and, incidentally, the United States had so much free capital that it was able to go on to build one of the best road-and-rail networks anyway, resulting in even greater economic advantages over competitors.)

Third, geography has also ensured that the United States has very little local competition. To the north, Canada is both much colder and much more mountainous than the United States. Canada’s only navigable maritime network — the Great Lakes-St. Lawrence Seaway —is shared with the United States, and most of its usable land is hard by the American border. Often this makes it more economically advantageous for Canadian provinces to integrate with their neighbor to the south than with their co-nationals to the east and west.

Similarly, Mexico has only small chunks of land, separated by deserts and mountains, that are useful for much more than subsistence agriculture; most of Mexican territory is either too dry, too tropical or too mountainous. And Mexico completely lacks any meaningful river system for maritime transport…

With geography empowering the United States and hindering Canada and Mexico, the United States does not need to maintain a large standing military force to counter either. The Canadian border is almost completely unguarded, and the Mexican border is no more than a fence in most locations — a far cry from the sort of military standoffs that have marked more adversarial borders in human history. Not only are Canada and Mexico not major threats, but the U.S. transport network allows the United States the luxury of being able to quickly move a smaller force to deal with occasional problems rather than requiring it to station large static forces on its borders.

Like the transport network, this also helps the U.S. focus its resources on other things.

Taken together, the integrated transport network, large tracts of usable land and lack of a need for a standing military have one critical implication: The U.S. government tends to take a hands-off approach to economic management, because geography has not cursed the United States with any endemic problems. This may mean that the United States — and especially its government — comes across as disorganized, but it shifts massive amounts of labor and capital to the private sector, which for the most part allows resources to flow to wherever they will achieve the most efficient and productive results.

Russia’s Return to the Future

As I pointed out earlier here and here, Russia is returning to the future. Its demography is stabilizing after the precipitous collapse of the 1990′s, and social morale and faith in the nation is slowly returning, to the dismay of geopolitical competitors, “Russophobes” and “social progressives” alike. Russia is implementing an industrial policy aimed at manufacturing growth and technology diffusion. The state brought the regions back under its thumb and is again becoming the linchpin of the Russian economy. The party’s over for Russia’s oligarchs:

Because of the financial crisis and government consolidation, the once-powerful oligarchs no longer have a say in their future and are merely along for the ride. Indeed, they no longer constitute a powerful and distinct business “class.” Some oligarchs will survive the shakeout, but not with their independence. To some degree, they all will become part of the Kremlin machine so carefully engineered by Putin. As copper oligarch Iskander Makhmudov said in a rare interview: “The oligarchs now have mixed fortunes, but we will all end up being soldiers of Putin one day.”

Instead of liberalizing, the economic crisis has simply reinforced already latent trends in Russia’s economic development. Russia’s ongoing globalization since the 1970′s is slowly beginning to reverse itself; Russia’s decision to apply to the WTO as part of a customs union with Belarus and Kazakhstan is an early indicator of an accelerating trend. Much of what I predicted in The Importance of Self-Sufficiency half a year ago is already coming to pass:

A wave of consolidation will occur in the Russian banking industry, Russia Inc. will close the oil windfall-foreign intermediary-cheap credit loop that was its prior financing mechanism and the country will emerge with a stronger, self-sufficient financial system. The oligarchs, Moscow and the middle classes bear the brunt of the crisis, while the provinces, agriculture and domestic manufacturing benefit, thereby reinforcing already latent tendencies in national development.

Though the drop in Russia’s output was far greater than I expected, it was far worse in Ukraine and the Baltics. Ukraine’s project of Westernization has failed utterly. According to my quick back of the envelope calculations, its GDP is currently (taking into account the recent collapse) around 30-40% lower than it was in the late USSR! (Russia’s is around 0-10% lower, but it is not faced with a fiscal or political crisis). Thus, though there is a possibility of a humanitarian crisis and a demographic shock in Russia, it is much lower than in Ukraine – where in any case a post-Soviet fertility recovery is much less in evidence in the first place. Damningly, opinion polls indicate that Putin and Medvedev are by far the most popular politicians in Ukraine.

Decline and disillusionment in Ukraine, and the return of isolationist nationalism to Russia. What next? History is a guide. A fundamental feature of autarkies is that to be truly self-sufficient they need to expand their domain, much as the Bolsheviks created the Union of Soviet Socialist Republics, which in turn expanded it to COMECON. It has to expand territorially in order to have access to all the vital building blocks of an industrial economy and to be able to hold its own against other economic blocs, which are more tightly interwoven into the world market. As such, it is very likely that within the next decade Ukraine, Belarus and Kazakhstan will again become integrated with Russia, on a spectrum of possibilities ranging from an EU-like structure to a unitary state-empire.

Reintegration will create a state with 210mn souls and will significantly increase the industrial (including military-industrial) power at Moscow’s disposal by at least 50%. One has to keep in mind that Eurasia’s industrial base was meant to be unified when it was constructed during the Soviet era, and as such the gains accruing from reintegration will be more than just the sum of its parts. One of Russia’s geopolitical priorities is to thwart an independent energy corridor for the proposed Nabucco oil pipeline and to link up with its ally Armenia, so it will no doubt continue pressuring Georgia to return into its orbit. Saakashvili’s days in power are almost certainly numbered. Whether Russia will choose to expand in Central Asia is more questionable. On the one hand, they have respectable energy reserves (especially gas), constitute demographic reservoirs amidst graying Slavdom and are geopolitically important. There are few problems with radical Islam and on the whole they appreciate Russian culture. On the other hand, they will present a development burden and China will likely oppose an overt Russian reassertion in Central Asia.

I do not think these trends are possible, or even desirable, to arrest, even should the Kremlin leadership want to (they will be pulled along by the Russian people). The reasons why they are inevitable, I leave to a later post.

Why they are nothing to lament over can be answered now – because of other key global trends. Russia’s oil production very likely peaked in 2008, along with global production. Conserving what remains for its own use should be a priority; exports should only be allowed on the most favorable terms, in exchange for Western technologies, not US Treasuries, Chinese trinkets or oligarch mansions in London. One consequence is that there will be increasing competition for resources. The industrial core (the US, Europe and China) will probably strike up strategic alliances to control and influence resource-rich nations, either overtly (latter-day gunboat diplomacy) or covertly (influence operations, information wars, etc). In this world, much like in the 1930′s, the strong will beat the weak. As such, Russia’s geopolitical priorities would logically be – and this already seems to be happening – to a) maintain its military strength, including the nuclear deterrent, b) neutralize and co-opt Europe and c) extend influence over the energy-rich Arctic, Central Asia and the Middle East. To pursue these goals effectively, it needs economic sovereignty, morale, and the attributes of an empire (in Russia’s case, these are all inter-linked).

The era of childish enchantment with the West, pursued by Andropov’s successors, is coming to an end, at last dispelled by the deafening crash of globalization.

(Republished from Sublime Oblivion by permission of author or representative)
 
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In an article some months ago I suggested that “perhaps this crisis is simply an unconscious recognition of this inconvenient truth?” – namely, the peaking of oil extraction and all that it implies for the continued survival of a financial system built on assumptions of continuous economic growth. In other words, the fashionable approach of focusing on exotic financial instruments, regulatory failures, etc, if a case of mistaking the forest for the trees.

The Oil Drum had a nice graphical summary. According to the author, Gail the Actuary, the chain of causation runs thus: rising oil prices -> inflated asset values -> booming phantom wealth -> high energy costs undermine real economy -> more and more bubbles pricked -> banking crisis -> credit crisis -> cascaded economic failure -> oil demand destruction -> oil prices plummet -> so do ever costlier long-term investments in oil extraction -> economic recovery at lower level -> rising oil prices. Cycle repeats itself to oblivion.

This explains the extreme severity of the crash – record GDP growth at a time of plateaued oil extraction in the 2005-2008 period was patently unsustainable, so a very big “correction could not have been unexpected.

And it is quite a correction.

As of the September-November average, global industrial production was plummeting at an annualized rate of -13% and merchandise trade by a truly remarkable -43%. And it is obvious the collapse accelerated since then…

Already far worse than during even the worst month of 2000-2001, the last and only global slowdown for which the IMF has data.

Already far worse than during even the worst month of 2000-2001, the last and only global slowdown for which the IMF has data.

But this is not a strictly economic post, or meant to be long / detailed (I’ll post that kind of thing within the next few weeks). So on to the next point about the oil connection…

Another Oil Drum blogger, Phil Hart, wrote about the dramatic rise and fall in oil prices in terms of simple supply and demand curves. I’ve had the same thoughts tumbling about in my head but unfortunately didn’t come to writing about them in such detail…

Oil demand and supply.

Oil demand and supply.

His thesis is that because of the geological limits to oil supply, the marginal cost of providing ever more oil is generally low until it reaches some point – say, 85mn barrels a day – and then veers off into the sky (i.e. becomes very inelastic). Demand is also inelastic, since modern society basically runs on oil. Hence there comes a time when the demand curve reaches a point when its intersection with the supply curve – i.e., the market price – starts rising exponentially.

Exponential rise in oil prices; all exponents in a finite environment will eventually overshoot and collapse.

Exponential rise in oil prices; all exponents in a finite environment will eventually overshoot and collapse.

Supply can no longer be expanded to any significant extent, despite the market signals. All we managed was a precarious plateau, the big rate of natural decline of existing oilfields being compensated for by remoter and lower-EROEI sources. The strain got too big, we slipped up and are now falling to a lower plateau – at an annualized rate of at least negative 13% of global industrial production…

PS. Is it also a coincidence that possible the hardest hit major industry was the automobile sector, with production plummeting by up to 50% in most countries? Particularly when you consider that they are the sector that is most tightly linked to cheap supplies of oil products?

Calculated Risk compiled a graph of the fleet turnover (total vehicles divided by annual sales) to give a historical value for the number of years required to totally refurbish America’s car fleet – from hovering at 13-15 years, it soared to an historically unprecedented 27 years. Projecting this forward, the size of the fleet will decline AND age simultaneously since most vehicles don’t last anywhere near 27 years on the road.

Since most vehicles won’t last this long, unless situation turns around the size of the fleet will decline AND age simultaneously. (But of course it won’t, because of impending energy shortages).

This is a completely rational development from a peakist perspective, of course. Even though generally more fuel efficient on paper, a lot of energy needs to be spent manufacturing them; since these initial energy costs have already been spent in old vehicles, it makes sense to prolong their lifespans instead of trying to increase the turnover of the fleet. So unless oil magically remains cheap and plentiful in the years ahead, or hybrids / battery-powered vehicles become far more successful than they are currently, expect the cars on our roads to gradually get older, creakier and dirtier like in Third World places – albeit with much better, cheaper and more intelligent electronics (due to Moore’s Law and its siblings).

(Republished from Sublime Oblivion by permission of author or representative)
 
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Anatoly Karlin
About Anatoly Karlin

I am a blogger, thinker, and businessman in the SF Bay Area. I’m originally from Russia, spent many years in Britain, and studied at U.C. Berkeley.

One of my tenets is that ideologies tend to suck. As such, I hesitate about attaching labels to myself. That said, if it’s really necessary, I suppose “liberal-conservative neoreactionary” would be close enough.

Though I consider myself part of the Orthodox Church, my philosophy and spiritual views are more influenced by digital physics, Gnosticism, and Russian cosmism than anything specifically Judeo-Christian.