Dangerous Exponentials ?  

The Economist's "Buttonwood" blog has a post on a new broker report into the effect of disrupting various growth relationships called "Dangerous Exponentials" - Energy in, energy out.

FROM time to time, one reads analyses that are so gloomy they make your humble blogger seem like Voltaire's Dr Pangloss. Normally, they have the perverse effect of making me feel more cheerful. But having read Dangerous Exponentials, a report by Tim Morgan of the broker Tullett Prebon, I have to accept he has a point.

There are two main elements to the report, two sets of exponential relationships. The first is the growth in government debt, money supply and inflation. There has been a step change in the figures since 1971, when the link to gold was removed; in past posts, I have discussed the monetary ratchet, in which lower interest rates leads to more debt, which leads to asset bubbles, which then pop; when they pop, authorities cut rates again and the whole cycle starts again. This process has reached its logical conclusion with rates at zero. The authorities have responded by resorting to QE, money printing. This has not resulted in high inflation (yet) because the velocity of money has collapsed (if you like, the money has been hoarded). Tullett warns that QE will have to be rapidly withdrawn when velocity picks up and is doubtful that will be the case.

The other exponential relates to population and energy. Tullett describes the views of a commentator called Chris Martenson who argues that

The current population of the earth is sustainable only because of an abundant supply of hydrocarbons, and principally of oil.

Tullett argues that global population growth really started to take off in the 19th century, as man learned to exploit hydrocarbons initially coal. These hydrocarbons were a very effective replacment for human labour, creating a massive productivity boost. They allowed food to be produced with fewer people, the released labour to move into industry and the developed world to escape the Malthusian trap in which a growing population exceeded the food supply, causing famine and disease.

Now you can probably see where this argument is going - peak oil - and will be suitably cynical. We have been hearing predictions about resource constraints since the late 1960s. But the world tends to come up with new supplies of energy and the peak gets postponed.

But Tullett has a more subtle point, and one which seems rather telling. Yes, new energy sources are discovered (tar sands, deepwater oil) but they are much more expensive to produce, both in terms of money and the energy required to extract it.

If you view the wealth of mankind as a function of the equation EROEI, the energy return on energy invested, this is a serious deterioration. The wealth added per unit of energy extracted is declining. But the structure of our societies is built not just on abundant energy but on cheap energy. Think of all those American suburbs without public transport which require people to drive miles to get to work or visit shops.

Whether the result of this deterioration is economic cataclysm, as Tullett hints, is impossible to tell. But I think the broker is right in arguing that the lack of focus on this energy in/energy out equation is

the greatest single black hole in the toolkit that economists use to understand the dynamics of the society in which we live.