Peak Oil Ass-Backwards: Fractional-Reserve Banking, Meet Peak Oil
Peak oil's supply constraints are said to lead to an increase in prices. But does fractional-reserve banking's tie-in not instead imply decreased prices? [part 1/3]
If the ongoing crash of oil prices over the past year – and now the stock market crashes of last week – have continuously taught me one thing, that would be that I've got very little clue regarding the economic implications of peak oil. To explain this I'll have to take a circuitous, roundabout route here, but if you've been as afflicted as I've been then you might find the following a bit illuminating.
For starters, even though I learned about peak oil in 2005, fractional-reserve banking in 2006, and pretty much instantly proceeded to put two and two together, I still ended up falling for what I might unfairly call the "peak oil orthodoxy." I'm not sure where I first came across this "orthodoxy" I speak of, but an example as good as any – and maybe even better than any – would be that of author and a former Chief Economist at CIBC (one of Canada's Big Five banks), Jeff Rubin.
As Rubin explained it in his first of two peak oil books, because peak oil implies a curtailment on the supply of oil, and since the demand end of a growing economy is by definition increasing, the notion of supply and demand imply that prices will head upwards if supply is limited. Because of this, upon oil's peak its price will eventually rise to such ungodly high levels that it'll become unaffordable by many. Following that, its demand will therefore peter out, and so thanks to the new glut in supply the price will crash to equally ungodly low levels. Once things settle down and the consumer can once again afford the now lower-priced oil, the process will repeat itself since the new (and increasing) demand will once again bump up against the limits imposed by peaking oil supplies. As a result, another crash will occur. On and on the process repeats itself, but with the higher price spikes followed by higher troughs.
For better or worse, that's what I now call the "peak oil orthodoxy," and is why I, for one, was waiting for the Second Coming of high oil prices after the spike of $147 in July of 2008. But after patiently waiting for six years, it never came. (At least those 2012 folk had a set date and could just re-apply for their jobs on the 22nd.) In fact, not only did oil's price spend a few years bouncing around the $100 level after rebounding from its low of $32.40 on Dec. 19, 2008, but beginning in June of 2014 it began to dive-bomb to its current level of about $40 (which has now jumped back up to $50 or so in the few days it's taken me to write this). Although the initial price-dive threw me off at first, a bit of reading near the end of 2014 (and I unfortunately can't remember the exact online sources) enlightened me in regards to the notion of demand destruction.
Although demand destruction made so much sense to me that I wrote my first oil piece on it – Peak Oil and the Fracking Bubble: Could this Mimic the 2004-2008 Housing Bubble? – I apparently hadn't properly comprehended the underlying factors and the ultimate implications of demand destruction as I was still expecting oil to eventually rise again, if not just hang out in some mushy middle-area of $70 or so. Although I knew enough that I could have known better, my background in economics – and especially my predisposition to even think in economic terms – is pretty much zilch, so I suppose I've got somewhat of an excuse for being a complete idiot here. In other words, although I'd at least managed to notice and call out the incongruencies brought about by peak oil in a world of fractional-reserve banking, it took me until just recently to fully clue into the underlying and long-term implications of demand destruction. My apologies if you've already read me explain this a few times, but I'll repeat myself here for posterity's sake.
First off, the majority of "money" sloshing around out there – let's say 95% of it – is not created by governments but by private banks when they make loans. Secondly, the method by which this money is brought into existence, via fractional-reserve banking and double-entry bookkeeping, is upon the creation of new loans. In other words, money is created as debt. Furthermore, it is because banks create the principal and not the interest that there is never enough money in existence to pay off all the debts plus the interest. As a result, the debt bubble must be continually enlarged via ever-expanding credit so that previous loans can be serviced, lest the system implode in on itself. This is the debt treadmill, and is why economic growth must be maintained at all costs, even at the cost of utterly trashing the planet we live within.
So along with being gobsmacked when I learned about how most of our "money" is created, what pretty much instantly hit me was that since economic growth requires an increase in energy supplies to power that growth, and since peak oil implies an eventual maximum level of energy extraction, this limit to energy supplies is going to put us in a bit of a pickle.
In the meantime, seeing how the only friend I had amenable to chatting about these things lived half-way across the world in New Zealand, and seeing how I'd quit the Internet (which actually ended up being a five-year hiatus) and so didn't have an Oil Drum or whatever to bounce these thoughts and ideas off of, it was quite some time before I came across any written material putting the two issues I speak of together (the first time came in the book Fleeing Vesuvius I think).
So seeing how we both lived in Toronto at the time, I figured it might be worth stopping over at one of the talks that Jeff Rubin was giving for the release of his second book (The End of Growth), as here was not only some guy writing about peak oil, but an economist writing about peak oil! When the talk – with David Suzuki!? – was over and both authors got to the book signing part of the night, I slowly made my way to the front of the Rubin cue and asked him the following:
If peak oil means the end of growth, and if fractional-reserve banking requires perpetual growth to keep the system going, doesn't that mean we should be moving away from fractional-reserve banking?
But that's not what I'm talking about.
Well, yeah. But still. Doesn't peak oil imply a serious problem to the way in which our banking and monetary systems currently operate, since they need ever more energy to keep growing?
You're talking about the money-multiplier effect, right?
Uhhh, yeah. [I'd only heard it referred to in this way once before.]
Well that's not what I'm talking about.
He then proceeded to say something which I'd already read in his book (of which didn't address my question at all), and as I'd obviously come upon a brick wall, I didn't bother pressing any further and so made my way home.
My stone-walling with Rubin should have been expected though, for if you take a look at his first book, the summation of his peak oil prognostication is pretty much this: Californian's will be eating less Ontario maple syrup, Ontarians will be eating less California avocadoes, and we'll all be eating more locally grown carrots. In short, it's all about basic market mechanisms of supply and demand, which mean that we don't really need to do anything ourselves, nor change our ways, since markets will tidily work out this oil issue for us. But in the meantime, we should get cracking on creating locally-manufactured television sets (according to his second book)! In other words, if you're looking for a ho hum story of peak oil, look no further than Jeff Rubin.
Nonetheless, even though I'd clued into the banality of nearly everything Rubin had to say about peak oil, I unfortunately fell hook, line and sinker for his notion of escalating oil prices. So although I wasn't economically dogmatic and unwilling to question and factor in the method by which most of our money is created, I'd effectively handcuffed myself from being able to comprehend the economic ramifications of peak oil and fractional-reserve banking any further, even though, as mentioned, I'd already written a piece on demand destruction as being behind oil's recent dip in prices.
Nevertheless, for a while now I've had the hunch – based on nothing but a gut feeling – that oil was going to head on down to $20. I even got all techno-savvy and tweeted it, even before the recent stock market and oil price crashes (which, as already mentioned, have had a more recent upswing):
But then came the biggie. A few days after that I was reading the comments from an article on Resilience when it finally hit me: "Wait a second! Demand destruction doesn't imply a minor and/or temporary dip in prices to some mushy middle. It means the opposite of inflating prices – deflating prices! They're going to keep going downwards!"
In other words, not only have I somewhat been in the deflationary closet for nearly a decade now, but I didn't even realize there was a counter-argument, or even a counter-argument closet!
Having finally clued into all that, the implications that my willingness to put two and two together nearly a decade ago was finally leading somewhere. On top of that, that willingness of mine allowed me to take that further step that I'd been looking for, and so allowed me to put two and two and two together. That next "two" being money as a proxy for energy, as I'll get to in Part 2.
EDIT 06/09/2015: In the last sentence, the words "peak credit" have been changed to "money as a proxy for energy."