Banking is the great octane booster of the engines of economy. It can make many people feel rich. Albert deposits $100 in the First National Bank. Bertrand borrows $100 from the First National Bank and deposits the funds in the Second National Bank. Clyde borrows $100 from the Second National Bank ... and so on ad infinitum. Everyone has $100 in their bank accounts at the same time! There is a lot more spendable funds now than if Albert had just kept his $100 under the mattress. A whole lot more. Whee!
This sort of dementia has been going on for a couple hundred years and has reached a fevered pitch in the last ten or so. How could this go on so long without it all crashing down like the house of cards that it is? That is the marvel of economic growth. As long as the economy, and consequently income, keeps growing in the aggregate, there will be plenty of funds to keep all those plates spinning.
When banking goes into reverse though, it is deadly. Sufficient losses on loans cause banks to become unprofitable. Unprofitable banks have to pull the loss out of their equity and shrink lending, because loans cannot exceed a regulated ratio of bank equity. Roughly $10 of lending has to be cut for every $1 of losses. When lending is cut, borrowers have to pay back loans (if they can) instead of rolling them over. When they can't pay the loans back, the banks have further losses, and must restrict lending even more.
It gets worse. When borrowers have to pay back loans they have to cut other spending. If their income is falling, this causes their spending to fall disproportionately. One person's spending is another's income, so income tends to fall. When income falls, debt becomes harder to pay back, and many borrowers default, causing more loan losses for banks, and more restrictions on lending.
Around and around this destruction goes, and where it stops nobody knows. The entire World's economy is wildly indebted. Households, businesses, and governments have never been so in debt as they are now. What goes up, must come down. The bottom could be shockingly low.
Showing posts with label world economy. Show all posts
Showing posts with label world economy. Show all posts
Sunday, December 13, 2009
Wednesday, June 24, 2009
A Depression Trajectory
As a sort of follow-up to yesterday's post, we will muse a bit on how much world GDP decline to expect to this Depression.
One assumption that we are making is that over the next twenty years or so, fossil fuels will become too expensive to use very much as... well, fuel. The world is not going to run out of oil, gas, or high quality coal - but their fuel use will mostly be limited to its highest ends (i.e., not for mass private cars, heat, or electricity). In the post-fuel hydrocarbon era, much of the remaining supply will be used for non-fuel uses such as fertiliser, plastics, and specialty chemicals.
Its a rather uncertain thing modelling collapse, but it is not unreasonable to say that hydrocarbon production may decline 90% or so in the next 20 years. That may seem outrageous, but many people like ourselves who make a study of this matter are arriving at similar conclusions. Consider this recent post at The Oil Drum. It's a bit technical, but Figure 3 is worth a thousand words.
As every schoolchild knows, or at least ought to know, the industrial economy grows or shrinks with the supply of fuel. If fuel production declines 90%, the economy will fall by a similar amount. There will be efficiency, nuclear power, solar power, hydropower, and many other ways to mitigate the loss of energy available to society - hopefully enough to keep things civilised. And once Civilisation has weaned itself off fossil fuel, economic growth just may well resume from a new, low base and at a slower rate.
We believe an energy-intensive economy such as the USA's will experience roughly a 90% decline over the next 20 years. At the end of the Depression, per-capita income is likely to be in the neighborhood of $5,000 a year in current dollars.
We suggest the Reader consider what life might be like for them on such an income, or a bit more or less - depending on their skill level. Also to consider what sort of means they would have to produce any income in a world where most people can afford very little beyond the basics of food and shelter.
It will be very difficult to hope that investment capital will produce much income. Which industries will even survive this depression? Virtually all bonds are sure to default, including government ones - either directly or through inflation. Successful investors will likely be the active, hands-on sort.
To earn income will require being involved with a surviving industry, such as agriculture. Otherwise you will need to become entrepreneurial, and hard-working. Though challenging, the changes ahead are manageable - as long as you keep a positive outlook.
One assumption that we are making is that over the next twenty years or so, fossil fuels will become too expensive to use very much as... well, fuel. The world is not going to run out of oil, gas, or high quality coal - but their fuel use will mostly be limited to its highest ends (i.e., not for mass private cars, heat, or electricity). In the post-fuel hydrocarbon era, much of the remaining supply will be used for non-fuel uses such as fertiliser, plastics, and specialty chemicals.
Its a rather uncertain thing modelling collapse, but it is not unreasonable to say that hydrocarbon production may decline 90% or so in the next 20 years. That may seem outrageous, but many people like ourselves who make a study of this matter are arriving at similar conclusions. Consider this recent post at The Oil Drum. It's a bit technical, but Figure 3 is worth a thousand words.
As every schoolchild knows, or at least ought to know, the industrial economy grows or shrinks with the supply of fuel. If fuel production declines 90%, the economy will fall by a similar amount. There will be efficiency, nuclear power, solar power, hydropower, and many other ways to mitigate the loss of energy available to society - hopefully enough to keep things civilised. And once Civilisation has weaned itself off fossil fuel, economic growth just may well resume from a new, low base and at a slower rate.
We believe an energy-intensive economy such as the USA's will experience roughly a 90% decline over the next 20 years. At the end of the Depression, per-capita income is likely to be in the neighborhood of $5,000 a year in current dollars.
We suggest the Reader consider what life might be like for them on such an income, or a bit more or less - depending on their skill level. Also to consider what sort of means they would have to produce any income in a world where most people can afford very little beyond the basics of food and shelter.
It will be very difficult to hope that investment capital will produce much income. Which industries will even survive this depression? Virtually all bonds are sure to default, including government ones - either directly or through inflation. Successful investors will likely be the active, hands-on sort.
To earn income will require being involved with a surviving industry, such as agriculture. Otherwise you will need to become entrepreneurial, and hard-working. Though challenging, the changes ahead are manageable - as long as you keep a positive outlook.
Tuesday, June 23, 2009
World Bank Forecasts Contraction
The World Bank has predicted that the world economy will contract by 2.9% this year. Although we suspect the Bank is being overly optimistic, it is good that some institution of repute, such as the World Bank, is talking about the ongoing contraction of the world's economy. People of the world need to get message that times, they are a'changing.
The 2.9%, as we mentioned, is ridiculously low. To back up our assertion, we present an interesting tidbit buried in the Bank's release: the stunning collapse in private capital investment. According to the Bank's press release, private capital has dropped "from $707 billion in 2008 to an anticipated $363 billion in 2009." That is, a drop of over 51%.
Our observation is this: if indeed private investment has dropped by 51% worldwide, we have serious doubts that the world economy is going to drop by only 2.9% this year. In fact, we suspect that the actual drop will be closer to 29% than 2.9%. Although investment drops faster than an economy - as there is legacy capital economies can burn through - the collapse of new capital will make itself felt.
One could argue that world Governments will move to pick up the slack, as it were, but we think not. Governments are not nimble; they cannot react as quickly to economic conditions as can private investors. At the end of the day, more investors will have jumped ship - taking their money with them - than Governments can replace with fresh capital. The end result will be a much greater economic contraction... we expect it will be both shocking and demoralising to many in the world who pinned their hopes on the fabled "green shoots."
The 2.9%, as we mentioned, is ridiculously low. To back up our assertion, we present an interesting tidbit buried in the Bank's release: the stunning collapse in private capital investment. According to the Bank's press release, private capital has dropped "from $707 billion in 2008 to an anticipated $363 billion in 2009." That is, a drop of over 51%.
Our observation is this: if indeed private investment has dropped by 51% worldwide, we have serious doubts that the world economy is going to drop by only 2.9% this year. In fact, we suspect that the actual drop will be closer to 29% than 2.9%. Although investment drops faster than an economy - as there is legacy capital economies can burn through - the collapse of new capital will make itself felt.
One could argue that world Governments will move to pick up the slack, as it were, but we think not. Governments are not nimble; they cannot react as quickly to economic conditions as can private investors. At the end of the day, more investors will have jumped ship - taking their money with them - than Governments can replace with fresh capital. The end result will be a much greater economic contraction... we expect it will be both shocking and demoralising to many in the world who pinned their hopes on the fabled "green shoots."
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