As last week’s Archdruid Report post argued, prophecies of catastrophe don’t accurately reflect the economic terrain on the downslope of Hubbert’s peak. Mind you, the reassuring fictions of those who insist that business as usual will go on forever won’t fare any better. I’ve suggested that the future we face is an age of economic, social, and technological decline as industrial civilization slides down the long and bumpy slope to the agrarian societies of the deindustrial future. The economic dimension of that decline is crucial, but those who expect it to show up in obvious ways in the markets and crunched numbers of today’s official economics may be missing a central facet of what’s going on.
I have no idea if kids still do this, but in my elementary school days in the late 1960s it was common practice to write IOUs for “a million billion trillion dollars” or some equally precise sum, and use those as the stakes in card games like Old Maid and Go Fish. Some of those IOUs passed from hand to hand dozens of times before being accidentally left in a pocket and meeting their fate in the wash. Kids who were good card players amassed portfolios with a very impressive face value, especially compared to the 25 cents a week that was the standard allowance in my neighborhood just then. If I recall correctly, though, nobody ever tried to convert their IOU holdings into anything more substantial than cookies from a classmate’s lunchbox, and that’s apparently the one thing that kept me and my friends from becoming pioneers of modern finance.
It surprises me how many people still seem to think that the main business of a modern economy is the production and distribution of goods and services. In point of fact, far and away the majority of economic activity today consists of the production and exchange of IOUs. The United States has the world’s largest economy not because it produces more goods and services than anyone else – it doesn’t, not by a long shot – but because it produces more IOUs than anyone else, and sells those IOUs to the rest of the world in exchange for goods and services.
An IOU, after all, is simply a promise to pay a given amount of value at some future time. That describes nearly every instrument of exchange in today’s economy, from bonds and treasury bills through bank deposits and government-issued currency to credit swaps and derivatives. All these share three things in common with the IOUs my schoolmates staked on card games. First, they cost almost nothing to issue. Second, their face value needn’t have any relationship at all to the issuer’s ability to pay up. Third, they can be exchanged for goods and services – like the cookies in my example – but their main role is in exchanges where nothing passes from hand to hand except IOUs.
It’s harsh but not, I think, unfair to call the result an economy of hallucinated wealth. Like the face value of those schoolroom IOUs, most “wealth” nowadays exists only because everyone agrees it does. Outside the social game of the market economy, financial instruments have no value at all, and the game continues only because the players – all of them, from the very rich to the ones with scarcely a million billion trillion dollars to their name – keep playing. They have to keep playing, because access to goods and services, not to mention privilege, perks, and power, depend on participation in the game.
The resulting IOU economy is highly unstable, because hallucinated wealth has value only as long as people believe it does. The history of modern economics is thus a chronicle of booms and busts, as tidal shifts in opinion send various classes of IOUs zooming up in value and then crashing back down to earth. Crashes, far from being signs of breakdown, are a necessary and normal part of the process. They serve the same role as laundry day did in the schoolroom IOU economy, paring down the total number of IOUs when an excess emerges, and thus maintaining the fiction that the ones left still have value.
All this leaves us in a historically unprecedented situation. Economies based purely on hallucinated wealth existed before the 20th century, but only for brief periods in the midst of speculative frenzies – the Dutch tulip mania, the South Sea bubble, and so on. Today’s hallucinated wealth, by contrast, has maintained its place as the mainspring of the global economy for more than half a century. Social critics who point to the housing bubble, the derivatives bubble, or the like, and predict imminent disaster when these bubbles pop, are missing the wider picture: the great majority of the global economy rests on the same foundations of empty air.
Those who have noticed this wider picture, on the other hand, are fond of suggesting that sometime soon, given a suitable shock, the entire structure will come cascading down. Those of you who were reading the alternative press at the time of the 1987 stock market crash will recall predictions of economic collapse in the wake of that vertiginous plunge. Similar predictions have accompanied each of the notable fiscal crises since then – the Japanese stock market debacle of 1990, the Mexican debt crisis of 1995, the Asian currency crash of 1998, the tech-stock crash of 2000, and so on. Similar claims are now being made about the housing bubble, the US trade and credit deficit, and of course about peak oil as well.
Plausible as these claims are, I suspect they’re missing the core of the situation, as well as the lessons taught by twenty years of violent economic gyrations. It’s a mistake to expect hallucinations to obey the laws of gravity. It’s doubly a mistake when the institutions charged with keeping them in midair – the Federal Reserve Board in the US and its equivalents elsewhere – have proven tolerably adept at manipulating markets, flooding the economy with cheap credit (that is, more IOUs) to minimize the effects of a crash, and inflating some other sector of the economy to take up the slack of a deflating bubble. It’s triply a mistake when the American middle class and, to a lesser extent, its equivalents in other industrial countries display a faith in speculation so invulnerable to mere reality that their response to a crash in one market is invariably to go looking for a new speculative bubble somewhere else.
To say that the economic empire of hallucinated wealth will continue to exist, though, does not imply that it will continue to produce the goods and services and provide the jobs that people need. Arguably, it doesn’t do that very well now. The “jobless recovery” of recent years saw most economic statistics rise well into positive territory, while most people saw their expenses rise and their income shrink when their jobs didn’t simply fold out from under them. Things could go much further in the same direction. It requires no particular suspension of disbelief to imagine a situation where the stock market hits new heights daily and other measures of economic activity remain in positive territory, while most of the population is starving in the streets.
Partly, as Bernard Gross pointed out several decades ago, economic indicators have morphed into “economic vindicators” that promote a political agenda rather than reflecting economic realities. The dubious statistical gamesmanship inflicted on the consumer price index and the official unemployment rate in the US show this with a good deal of clarity. Partly, though, most of the common measures of economic well-being only track hallucinated wealth, and the markets whose antics fill so much of the financial news are IOU markets disconnected from what remains of the real economy, where real people produce and consume real goods and services.
Thus trying to track the economic impact of peak oil, global warming, and other aspects of our predicament by watching markets and financial statistics may well turn out to be as misleading as trying to track the supply of cookies in a schoolroom by watching the exchange of IOUs in card games. As for the theory that a massive market crash triggered by peak oil will bring down the economy, this is, to be frank, naive. Crashes there will certainly be, and some of them may be monumental, since volatility in the energy markets tends to play crack-the-whip with the rest of the economy. Crashes aren’t threats to the system, though; crashes, and the recessions and economic turmoil that follow them, are part of the system.
The economy of markets and statistics has aptly been compared to a circus, and like any other circus, it serves mostly to distract. While interest rates wow the crowd with their high-wire act and clowns pile into and out of various speculative vehicles, the real story of economic decline will be going on elsewhere, in the non-hallucinated economy of goods and services, jobs and personal income, all but invisible behind a veil of massaged numbers and discreetly unmentioned by the mainstream media. There's good reason for that to be tucked out of sight, too, because it won't be pretty at all.
As the boom and bust cycle continues and accelerates, we can expect each recession to push more people down into poverty, and each recovery to lift fewer out of it. As industries dependent on cheap abundant energy fold, we’ll see jobs evaporate, lines form at the doors of soup kitchens, and today's posh suburbs slump into tomorrow’s shantytowns. Rising transport costs and sinking median incomes will squeeze the global trade in consumer goods until it implodes; shortages and ad hoc distribution networks will be the order of the day, and wild gyrations in currency markets could easily make barter and local scrip worth a good deal more than a million billion trillion dollars of hyperinflated IOU-money. Poverty, malnutrition, and desperation will be among the very few things not in short supply.
It’s not a pretty future, no, but there are straightforward ways to cope with it, proven in equivalent economic crises in recent history. I’ll be discussing some of those in next week’s post.