Reading The Runes: Spotting Trouble With Money And Energy Before It Bites You
Posted Oct 16, 2008 by Julian Darley
The trouble with uncertainty is that you can't be sure of anything. You can't even measure it by normal economic metrics and actuaries at insurance companies can't assign a probability to it, as many have discovered regarding climate change and property insurance. It may be that all we can do with uncertainty is try to disconnect from the source of it and look for indicators and radar blips that will help us get out of the way of the worst effects, and if we do really well, start to construct a different kind of economy and supply chain.
One of the ingredients of uncertainty that many peak oil analysts have long predicted is volatility. Some others that I have also stressed over the last few years are threshold effects, unexpected linkages and cascades. To put it another way, once money and energy get tight in an over-globalized world, you can expect a pretty wild ride and don't be surprised if a sheep lands on your head. There is a book about this phenomenon called the Black Swan. Maybe it should have been called the Black Sheep.
One very black sheep that has just landed on the heads of many British councils and ordinary citizens is the collapse of the Icelandic banking system. Yes Iceland. As if the British banking system, being partially nationalized as I write, doesn't have enough problems of its own!
The Iceland fall-out hitting the UK now is nothing compared to the financial asteroid that has hit Iceland itself, but it was a problem created in Iceland, albeit now exported far and wide, including to UK local governments who are worried about how to pay staff and mend roads because of a financial problem which they thought had nothing to do with them and probably had never even heard of. But they could have got wind of it in time and got out of the way. We'll get to how, in a minute, and discuss some much wider implications and how to look for hidden indicators and trouble in the wings.
Essentially Iceland's top brass turned a tiny volcanic outpost of 320,000 people, formerly dependent of the hard life of fishing, into a giant hedge fund, using the system of carry trade - borrowing low and lending high - to build up a fabulous economy and way of life that was becoming the envy of the world. Just recently they were ranked number one in the UN Human Development Index survey, in part because of very high per capita income and great longevity.
Ironically one of the only countries that exceeds Iceland in life expectancy is Japan, and it was from Japan in particular that Iceland borrowed so much money. Icelandic banks have borrowed about $120bn, while Iceland has a GDP of around $20bn. That's about $375,000 per inhabitant - people who are already fairly heavily indebted homeowners.
Iceland engaged in a furious round of highly leveraged buyouts in this decade, and was starting to produce tycoons faster than Yeltsin's nouveau capitalism in the ‘nineties.
Was no-one worried? Well, yes, even in 2004 the Icelandic central bank started asking awkward questions like, "what happens if share prices go down?"
This is one of the indicator clues that we should monitor: if we are borrowing a lot now, are we relying on prices going up in order to keep paying it back? If you are a bank and you are lending a lot more money than you have in reserves, what happens if your depositors suddenly want their money in cash? This is what causes a run on the bank or even collapse.
It is awfully easy to dismiss such inexact worries as declining stock prices as whining and old-fashioned, so what about a more specific indicator? In March of this year, Landsbanki and Kaupthing, two of Iceland's top banks were achieving a CDS price similar to that of Bear Stearns just before it collapsed. CDS means credit default swap, and its price essentially tells you how much it will cost you to insure against a bank not paying you back the money you have deposited in its vaults. In other words there was clearly a lot of trouble brewing in the Icelandic banking system if only you knew which indicator to look at and how to read it.
Evidently few in Britain were looking at the CDS price of Kaupthing or Landsbanki and that is understandable, but in hindsight, very painful.
There are evidently some obscure metrics of deep money trouble; are there any powerful indicators of deep energy trouble? The answer is a qualified yes, but unfortunately what the energy runes tell us is not much more cheerful than the March CDS price for Iceland and there is no single number like the CDS price or even a composite like the Human Development Indicator.
Most of us now realize that we are borrowing from the past by burning fossil fuels and giving the interest (the energy waste products) to the future by polluting and poisoning all our precious ecosystems. This is now almost a banal truism, potentially dangerous if it leads to complacency. However it is quite clear that very few realize that modern civilization and the ability to feed seven billion people rests not just on the production of oil, gas and coal, but on the colossal energy profit we get from them in comparison with the relatively small effort we expend in mining or extracting them. This is often known as EROEI or energy returned on energy invested.
Unfortunately there is, as yet, no UN EROEI Index, and the price of energy is extremely misleading in a quantitative sense; qualitatively, its volatility should be sending us loud warning blasts that it is time to disconnect from oil especially.
Charles Hall and colleagues have worked hard on EROEI and produced a chart which gives a rough idea of the energy profit of different energy sources:
Keeping track of the falling energy profit or surplus of each source is nearly impossible, and the other great unknown is what is a reasonable minimum energy surplus required by humanity to keep us in something like civilization. One metric that we can expect to see rising again as energy profit diminishes is the number and percentage of people growing their own food, either because they want to or because they have to.
Being more involved in your vital supply chain, including food production, is a potential silver lining to the cloud of energy depletion, but only if we are ready for it. The energy runes are already telling us that there is a growing global food problem - already leading to starvation for some, and it would be wise if we did not wait for any more catastrophes before getting that message.