Bill Totten's Weblog

Tuesday, November 14, 2006

Clusterfuck Nation

Comment on current events

by Jim Kunstler, author of

The Long Emergency (Atlantic Monthly Press 2005)

The Entropy Economy (October 16 2006)

I got an email from a reader in the banking sector who said that he generally likes this blog but I that I was "way off" in last week's observations about the US economy. I called him on the phone to entertain his complaints in more detail. His main complaint was that I failed to appreciate the fantastic resilience of American can-do enterprise, and what it means in the larger economic scheme of things. He said that massive amounts of capital were moving into investments for alternative energy and into new technology associated with the pursuit of These capital flows, he said, would keep the US economy humming as far ahead as anyone can see.

He was a thoughtful and articulate fellow, but I still disagree. I still view the US economy as chronically diseased. It must be in the nature of a stock market melt-up, of the type we've seen the past month, to exert a hypnotic effect on herd expectations - generating any number of rationalizations to make the melt-up seem a healthy and natural occurance when it is actually something like an aggressive cancer feeding on the organs of our society and sucking the life out of them.

There may be money flowing into ventures, but that is no guarantee that these ventures will produce significantly more petroleum or viable substitutes for petroleum - or anything that will permit us to keep running WalMart, Disney World, and the interstate highway system. We could sink a trillion dollars into research and development for perpetual motion machines, too, but the venture would probably end in tears.

It seems to me that as long as our overall goal is to keep a lot of cars running by other means, at all costs, then we are going to be horribly disappointed, and our investments will amount to a Chinese fire drill performed like a game of musical chairs with overtones of Ponzi. Whatever else the future may be about, it is unlikely to be a continuation of mass democratic happy motoring in the service of mass consumption. So an investment campaign to save that mode of human existence is a waste of investment. It is just the financial facet of what may turn out to be an even more comprehensive, and utterly futile, effort to save the entitlements and previous investments connected with American suburbia.

A recognition of this would at least allow us to get on with other things and make better investments in a reality-based future.

Personally, I doubt that the putative investments in and related tech amount to more than a tiny fraction of the total capital surging into the markets these days. The big oil companies are spending more of their considerable profits buying back their own stock and crafting farewell compensation packages for retiring executives than on exploration and discovery. In one place they have put up some E & P money, far eastern Russia, they just got their asses kicked by the host government, so they won't even be sticking around there. Excuse me for saying that Chevron's "Jack" experiment in the deep water Gulf of of Mexico will prove to be a public relations stunt. The money going into biodiesel, ethanol, and shale oil combined is probably less than the capital being directed into the next generation of MP3 players.

To me, the Fall 2006 Euphoria only underscores how divorced the financial sector is from real life. Day by day, thousands of grifters are making huge digital dollar profits on abstract financial plays in a global virtual casino. None of these plays has much to do with anything of real and enduring value. They're just scoring points on consolidations of ailing industries, on turns of the interest and currency differentials wheel-of-fortune, abstruse shorting strategies, and similar non-productive shenanigans. While these thousands of playas party hearty, millions of non-playa middle-American shlubs are underwater with their mortgage payments or real estate taxes, going bankrupt from their child's emergency apendectomy, or desperately seeking parking places where the re-po man won't find their Ford Expedition on which they failed to make payments numbers thirty-eight through forty-four after being laid off by the Uniwanker Corporation.

The sentiment now in the financial press is - like that expressed by my banker correspondent - that the US economy is indestructable. It's like Jason, the protean stalker-slasher of countless Friday the Thirteenth movie reels: an implacable monster on a mysterious mission. Nothing can stop it or kill it. Not the tanking real estate sector, not military misadventures in the Middle East, not a ball-and-chain of unimaginable debt. Like Jason, the US economy is fueled now by sheer entropy - the force that drives everything toward death.

Swan Dive (October 09 2006)

Against the background of everything else happening in the financial markets is the apparent circumstance of peak oil. Even The New York Times joined the chorus in a Sunday editorial, saying:

"Our demand for petroleum products strains the limits of the global capacity to supply them. In past decades, if a pipeline broke in Nigeria, Saudi Arabia might compensate by setting workers to pumping more oil. Now, with little additional capacity, rising prices are necessary to balance out supply and demand."

No more increasing capacity = peak oil.

It's as simple as that. We now have nine and a half months of "rearview mirror" action to look back and see that world oil production has retreated from its all-time high of just over 85 million barrels a day achieved in December 2005 (just as geologist Kenneth Deffeyes of Princeton had predicted). For 2006, production has remained in the 84 barrels a day range every month reported so far, while demand has exceeded that.

Texas oil man Jeffrey Brown, a commentator at, the outstanding oil discussion group on the Internet, makes the point that Saudi Arabia is at the same point statistically (in terms of ultimate recoverable reserves) that Texas was at in 1972 when production there peaked. The world's four greatest oil fields are in depletion (Burgan, Kuwait; Daqing, China; Cantarell, Mexico; and Ghawar, Saudi Arabia) and these have accounted for over fourteen percent of the world's oil production. (Ghawar alone accounts for over sixty percent of Saudi Arabia's production.) The North Sea has peaked and production there is "crashing". Venezuela has peaked and its oil is shitty heavy crude. Indonesia (an OPEC member) has peaked and is now a net oil importer. Nigeria's political chaos is making production increasingly difficult-to-impossible. Production in the Canadian tar sands is not making up for losses elsewhere. The US is down to about a four-year supply of conventional crude and condensates while we import seventy percent of the oil we consume. Discovery of new oil (including Chevron's largely hypothetical deepwater "Jack" finds) is barely covering a fraction of the world's consumption. So it goes ...

Where finance is concerned, the basic implication of peak oil is pretty stark: an end to industrial expansion (that is, "growth"). All the alternatives to oil will not keep the industrial economies expanding - they can only slow down a contraction, and only marginally so. The trouble with this picture is that finance is a system that uses paper markers to represent the hope and expectation for the expansion of wealth. These markers are currencies, stocks, bonds, option contracts, derivatives plays, and other certificates that are traded in open markets. If there is no longer any hope of increased wealth in the world, then all those tradable paper markers become losers. Their value unwinds and imagined piles of wealth evaporate into thin air.

The unwinding process depends on the psychology of the people who own these certificates. If they do not understand the global oil situation and its implications, then they will continue to hope for and expect expanded wealth, and thus continue to regard their paper certificates as credible markers of value. And that is largely the case at the moment, since most of the playas in the financial markets are not paying attention to the peak oil story, or don't believe it is for real.

Two special and transient circumstances are now propping up the financial markets. One is that for practical purposes the world is virtually at peak, meaning this is an extra-special time of strange behavior (like the point in the apogee of a steep sub orbital flight in which passengers become momentarily weightless). Supply and demand for oil are only beginning to go out of whack (that is, demand just barely exceeding supply). Even at this early stage, the oil markets themselves are showing stress, as hoarding behavior sets in and induces wider swings of price volatility. But these swings in oil prices - such as the one we're in right now, where prices have crashed twenty percent since the panic buying (hoarding) of June and July - send false signals to the financial playas. The main false signal is that all is well on the global oil scene ... there's no real supply problem ... and hence no threat to the continuing expansion of industrial production and its associated wealth-generating activities. This signal just tells the playas to buy more paper markers. Thus, the stock market goes up.

The second special and transient circumstance is that so much wealth has already accumulated along the way to peak, that financial markets take on a life of their own - as existing wealth "invests" itself in more paper markers hoping and expecting to "grow" into even more wealth. The problem here is that existing wealth is actually being squandered, since the paper markers will only lose value as the hopes and expectations vested in them dissolve in disappointment. But we haven't quite reached that point yet.

In simply bidding the markets up, the system has spun off even more gobs of presumed wealth. Some of this "liquidity" - say, in the checking accounts of people who work for Goldman Sachs - has found its way into Manhattan condominiums, or Aspen McMansions, and filtered through the system to everyone from the lawyers who write up the pre-nuptial agreements to the guys who sell the furniture to the people who drive the delivery trucks that bring it to the door, to the men laying tiles in the new bathrooms.

The basic insanity of a system that presumes vastly increased wealth where none will occur, has led to further distortions in finance. The most obvious one is the so-called housing bubble. The misplaced extreme expectation in the ever-increasing value of paper wealth, led to the hijacking of mortgages by financial playas who bundled them into odd lots of tradable debt (promises to pay) and used them to leverage abstruse bets (hedges) on the behavior of other kinds of paper markers (currencies, interest rate differentials, commodity prices) - very profitably as long as all playas believed that industrial societies that run all oil would continue to grow, to produce more wealth. The level of abstraction in these rackets - their distance from the reality of productive activity - is self-evident.

But they were so successful that the profligate creation of ever more mortgages became an increasingly reckless and irresponsible enterprise. Contracts were made with house-buyers who had no record of credit worthiness and often no real proof of income. Contracts were made on terms (interest payments) that were deceptive, even ruinously false, for the house-buyers. The reckless reassignment of lending risk into ever more abstract layers of deferred obligation, and the ease of credit that ensued, allowed millions of ordinary people to acquire real property on unrealistic terms, which had the affect of bidding up the price of houses that these owners will eventually have to surrender for nonpayment.

That process is now underway. The reckless creation of mortgages had the further effect of stealing demand for house-building from the future. So many new houses were built and then sold to people who will probably have to surrender them, and then so many more beyond that were built in the expectation and hope that reckless mortgage creation would continue forever, that there is now a massive over-supply of total existing houses while the pool of suckers for new ruinous mortgages has shrunk to zero.

Similar excesses in all the other lending and debt sectors, including "non-performing" credit card obligations and government deficits, will also unwind and thunder through the system.

Meanwhile, the false signal from the oil markets that has been broadcasting for eight weeks will come offline and a new signal will come on as prices go back up. The pause in bidding for future oil induced by the panic over-buying of the summer will end. The heating season is here. It's forty degrees out in upstate New York this morning and the furnace is cranking. The Chinese and the Indians and even the people in France have not stopped using oil, even if Americans have put their Winnebagos up on blocks for the season.

As the price of oil goes back up, the financial markets will get a new signal that running industrial societies has just gotten more expensive again. That will dampen hopes and expectations for increased wealth from these societies. Meanwhile, the air will be coming out of millions of mortgages, and the loss of value will spread among playas holding these bundles of mortgage debt (that is, promises that money spent on houses is being paid back, which it won't be). At the same time the houses themselves will lose value as the pool of potential buyers shrinks to nothing. That is, the inflated value (high price) of these assets will deflate.

As this occurs, there will be far fewer wage-earners putting up additional houses, fewer furniture sales, fewer trips by delivery truck drivers and fewer tile-jobs in the McBathrooms.

This is why I view the fall melt-up of the stock markets as a swan dive. We're at the apogee now, just as the world is at the apogee of its oil production. I confess, I thought the reality of our economic predicament would be recognized by the playas and their markets sooner than it has. It turns out the the chief luxury of the final cheap oil blowout has been the artificial support of unrealistic hopes and expectations.

Bill Totten


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