Monday, May 28, 2012

Warren Buffet, on stocks, gold, and land.



            I had the tube set on CNBC a few weeks ago, and as I heard that Mr. Buffet will speak soon, I made sure to stop what I was doing, so I could watch.  It is never a bad thing to listen to someone, who has achieved and lived through so much.

            There are three main themes that Mr. Buffet spoke about.  Stocks, gold and he briefly touched on farmland.  The reason I am writing this article is because I disagree with his views on two out of these three subjects, and the third subject, I do agree on, I feel people need to be much more aware of.  The reason I believe that it is necessary to talk about his views, is because we need to have a perspective offered for the average person, which is something that Mr. Buffet does not offer.  Let us face it, his current views and choices are a reflection of a multi-billionaire, who is in charge of Berkshire Hathaway.  When they invest, they get to often ask for preferred shares, with certain strings attached in their favor.  They also have some of the best analysts out there watching out for their investments.  When they invest in a company, and they announce it, that company instantly improves its chances of doing better, because their investments act as a vote of confidence.  Lastly, Mr. Buffet is elderly and insanely rich.  If his investments turn sour, I doubt he will lose much sleep over it.  The average person does not fit any of these categories, except for maybe the elderly part.  The average person has different choices available to him/her, and we are living in very different circumstances.  No one cares if Joe, Peter, or Zoltan Ban decides to buy shares in a company, and it most certainly does not help improve that company’s reputation.  So let us examine each subject from a mortal’s perspective.

Gold:

            Yes, I do own some and I intend to hold on to it.  So, given that Mr. Buffet is very vocal about talking it down, it is natural that I should disagree with him.  My last purchase of gold was in the fall of 2008, at a price of about $850.  Needless to say that given the price range it is in at $1500-1600 currently, I don’t feel all that bad about having bought into it.  Nor am I feeling all that distressed by its recent volatility.  Price may go up or down 10% or more, but at this point, it would have to retreat much further than it is likely to, before I start losing money. 

            Mr. Buffet objects to holding this asset on the grounds that unlike holding stocks, it is a non-productive asset.  In other words, a stock is backed by production of a good that is in market demand.  Farmland’s obvious value is that it is the asset that makes the production of food possible.  Gold he argues does not create any value added.  It does not produce anything.  He also strengthens his argument by comparing long term progress of gold prices versus stocks, where stocks obviously have an advantage.

            Like I said, I do own some gold.  I started buying in 2007, and I have to say that since then, there is not one major stock index in the western world, which to my knowledge has outperformed gold.  The Dow Jones index for instance has not changed since then, while gold has doubled in price.  There are of course individual stocks that performed much better than gold.  I should point out however that there are few investors out there who regularly outperformed the broader stock market.

            While it is true that I have an interest to talk up the price of gold, it is also true that Mr.  Buffet needs to talk gold down and stocks up.  He is after all heavily invested in stocks, and when money is parked in gold, it is bad for stocks, because there is less money in play to make stocks go higher.  In reality however, investing in gold is no different than holding cash, and many investors have chosen to do that lately.  Some invest in safe heaven and stronger currencies, such as Swiss franks, or Canadian and Australian dollars, others choose to invest in gold, or silver.  The rise in the price of gold from about $300 an ounce over a decade ago, to over $1500 currently is a no confidence vote in the global economy and national currencies.  If there are some new developments that will stabilize the global economy and provide us with a path towards sustainable growth, then perhaps it will be time to sell gold, and put our confidence back in stocks.  That is a far away possibility however, and at this point, I am becoming increasingly skeptical about solving the underlying problems that currently prevent the economy from firing on all cylinders. 

As we get busy talking about the merit of arguments coming from left and right, mainly focused on levels of taxation, government borrowing and spending, we lose sight of the fact that the underlying problem we are not addressing, which is a real dampener on growth is being ignored, due to the fact that the solution to it does not fit either ideological model.  The main drag on growth for the past decade has been resource scarcity, and the only solution is a global mechanism meant to encourage the economy to add far more value to the raw materials we consume.  In other words we have to get more out of less.  There is no chance of such a mechanism being implemented any time soon, so gold will remain a solid investment for the duration it will take for us to get it together and move to tackle the real problem.

Farmland:

            Mr. Buffet mentioned very briefly farmland during his interview, basically saying that it is an investment that is likely to prove itself more valuable than gold.  On this one I agree with him, but I feel we need to look at this asset in more detail.  Furthermore, I think it is important for young people to realize the potential opportunity farming can hold for their future.  The western world is now in a centuries old trend of urbanization.  We are now at the point where there is no more urbanization to be had.  There is in fact a great opportunity for young people to take advantage of the fact that the average age of our farmers is now about 60, so there is therefore great potential demand for young people to take over.  Owning a farm is in no way inferior to owning any other small business.  One is basically self-employed.  There are in fact advantages, because there is never a large decline in demand for what farmers have to offer, which is more than we can say for most non-farm related businesses and self employed trades, especially since the recent volatility and lack of global economic expansion.

            Owning this small business is especially attractive now that food prices have advanced by about 150% over the last decade, so in effect the average revenue of a farmer also rose by that much.  It is true that the price of inputs such as oil and fertilizers also rose, but still the net profit, did rise considerably.  There is little chance of food prices declining in the foreseeable future.  The world’s population is growing by about 80 million new mouths every year.  The world’s middle class is growing together with the power of new emerging nations such as India, China and Brazil, as well as a host of smaller nations, which are growing at an impressive rate.  All these people are demanding to eat food items such as meat, which demands a much higher farmland surface to grow, per unit of calorie provided to the consumer.  While demand for what the land has to offer is still growing rapidly, the amount of farmland available is not growing at all.  Where there are still opportunities to add fresh farmland, it is of marginal quality.  Land productivity increases are also showing a trend of moving towards stagnation in the medium term, and probably decline in the long term.  A UN study released in 2011 has found that ¼ of all farmland in the world is now badly degraded.

So, while the business of farming is a lot about sweaty summer days, mud, manure, dust, hard work, lack of urban excitement, there are also benefits that urban living cannot provide.  First of all, it is a healthier lifestyle physically and mentally.  Second of all, it is a business with a future.  Third, it provides much more stability.  The fact that half of all fresh university undergrads are unemployed, or under-employed in the US, should be a real wakeup call for young people about the fact that it is time to seek out new opportunities, different than the path their parents would have chosen.  Reality is that in the current environment, an education is in most cases no longer a way to go up the social ladder.  Aside from the necessary education, one also needs to know the right people, who can give them the necessary sponsorship (nepotism).  We live in a different world, those who realize it, and chose to seize the moment will benefit greatly, while the ones who fail to, will be left holding the bag.  Personally, I believe people in the western world will fail to seize on this opportunity, leaving the door open for others to come and take over this opportunity for a better life.

Stocks:

            Mr. Buffet loves stocks, and he is not afraid to say it.  If I would have purchased into the market in the spring of 2009, perhaps I would love stocks as well.  We ordinary people, not involved in being full time investors do not have the foresight to seek such moments of opportunity.  In fact, many professional investors lost a lot of money as they were fishing for that spring of 2009 bottom, so what chance would an average individual have?  Most people buy into pension funds, mutual funds and other investment vehicles, meant to allow people to invest and forget about it, while “professionals” take care of their portfolio.  A few adventurous individuals decide to pick individual stocks on their own.  Some people do OK, others not so much.  The best we commoners can do in most cases however is do as well as the broader market.  If one looks at recent historical charts however, it becomes clear that those who have been investing for the last five years, or even in the past decade have not done so well.  So while people like Mr. Buffet may have the tools to beat the market ( Berkshire Hathaway did not beat in the past five years), we do not in most cases, and when we do, it may just be blind luck.

Conclusions:

            Mr. Warren Buffet is certainly a very intelligent, generous, charismatic individual, and no one can take away from his lifetime accomplishments.  At this point however we have to recognize that the wisdom of Mr. Buffet belongs to a bygone era.  The 21’th century will not be similar to the 20’th.  The world had different problems then than now.  It is important for individuals and societies to realize that the adaptations that made people great then, may not be as valuable today.   

Monday, May 21, 2012

The controversy over peak oil, oil prices & technological advances



            Much has been made in the past few years of the triumph over peak oil theorists, courtesy of the higher prices, which made the extraction of a higher proportion of oil in place possible, and also provided incentives for a robust unconventional petroleum industry to develop and flourish.  Canada’s oil sands projects have been going for a while now, but the much trumpeted shale oil industry is new and higher oil prices are credited with its development from a marginal industry in the US to now a significant play.  Many were quick to pronounce that peak oil theory has been disproven, and we never have to worry about this again, at least for our lifetimes.

            What I want to do here is to move beyond the rhetoric and slogans from both sides of the argument, and dig in to the meaning of the recent developments and trends in the oil industry, and try to gain a better understanding of what this all means to us.  I want to focus on conventional petroleum, because it is currently 80% of total liquid fuels supply, so it is therefore the part that is the most relevant.

Basic Facts:

-  According to most studies done, total global conventional original oil in place amounts to somewhere between 5 and 7 trillion barrels.  For our purposes, I chose the middle ground, so I assume that we have 6 trillion barrels of oil in place, that has either already been discovered, or is yet to be discovered.  This number seems to be what the USGS thinks is the most accurate approximation, as a result of its year 2000 study of the world’s oil info available[i].  Since this study, the USGS assumption on new oil discoveries has been proven to be slightly overoptimistic, when compared to actual discoveries over the past decade, so the 6 trillion barrel figure is likely the more realistic figure, rather than the highly optimistic 7 trillion upper bound estimate.

-  Using Current technology and price, we can produce about 40% of total original oil in place.  So out of the total 6 trillion barrels, 2,400 billion barrels are recoverable presently.  About 1,100 billion barrels have already been produced, so about 1,300 billion barrels are yet to be recovered if current prices and technology were to remain static.

-  Technological advances in the past century allowed us to move from only 15-20% of oil in place being recoverable, to the current figure of about 40%.  So, average yearly gain in recoverability rates has been .2%.

-  According to M. King’s Hubbert’s theory of peak oil, which he formulated in the 1950’s, while he worked as a geophysicist for Shell Oil, individual fields as well as regions, or the entire world will experience a maximum peak in production, and an eventual decline around the point where half of the recoverable reserves were produced.  His prediction gained much credibility due to the fact that his calculation for the US peak in crude oil in 1970 was proven to be correct.  US crude oil production is currently less than 2/3 of that peak production year.  World is currently producing about 25-27 billion barrels of conventional oil per year[ii].  Given that fact, we are about four years away from reaching the halfway point of the reserves produced to reserves remaining ratio. It is fair to say that we are close to peak oil territory.  We in fact have been experiencing a plateau in conventional oil production since about 2005, if we go by the EIA statistics on global oil production.


Technology and human ingenuity to the rescue?

            The voices of optimism claim that we need not worry, because aside from unconventional oil supply growth, which currently makes up 20% of total liquids supply, conventional fields will not peak for many decades yet, because the higher price environment, and new technological advances should push the point of peak and decline forward constantly.

            What we should do is quantify the claim, and see exactly what would be needed to stave off this inevitable decline, and also find the estimate of when exactly this decline would become inevitable. 

            A study of the latest methods of enhanced oil recovery, claims that of the conventional oil in place, eventually, 60% will be recovered[iii].  I take this estimate for granted, which I think is reasonable enough.  I don’t think there is much chance of surpassing this 60% figure, because at some point, the efforts needed to push past, will take more energy than we will recover from the field.

            In order to keep production from conventional fields from declining from this point on, our only chance is to keep the current proven reserve base from shrinking.  In order to do that, we need reserve replacement rate to be at least same as production.  So we need technology to do its magic and increase recoverability, about .5% per year.  I should note here that I am not including in my calculation the fact that quality of reserves produced and reserves we are adding as replacement is not the same in terms of potential production ratio. 

6000 billion barrels x .005 (.5% yearly increase of recoverable reserves) = 30 billion barrels, which is just slightly more than yearly conventional oil production of about 27 billion barrels per year as reported by the EIA.

            Now the thing that you may have already noticed is that we have an estimate of the percentage that will ultimately be recovered, we have the minimum percentage increase in recovery rates needed, and we have an estimate of current recovery rates.

60% ultimate recovery - 40% current rate of recovery = 20% gains potentially still to be achieved x .5% minimum yearly gain needed to stave off decline = 40 years maximum that we can keep conventional production on the current production plateau.

40 years of smooth sailing?

            Forty more years on a production plateau might sound great; especially since most forecasts now assume that unconventional liquid production can be relied on to continue giving us gains in total liquid production for many decades to come.  So a plateau in conventional production, in conjunction with the above mentioned increase in unconventional liquids might on the surface seem like we should stop worrying.

            There are other details however that we need to consider.  First of all, unconventional liquids on average have a much lower return on energy invested than conventional fields.  Conventional fields have a rate of 20/1, while unconventional liquids are at only 5/1 (this is a rough estimate in both cases).  Conventional fields used to have a rate of 50-100/1 a century ago, but despite all the technological improvements, we still have this spectacular decline in net energy return.  This decline will continue, and it will be exacerbated by the growing ratio of unconventional liquids in relation to conventional.  Currently we use about 4 mb/d of energy equivalent to produce about 88 mb/d in total liquids.  By 2050, which is the maximum we can do in terms of staving off the decline in conventional supplies, we will most likely have a maximum total liquids production of maybe 120 mb/d.  But it will probably require about 24 mbd (at a ratio of 5/1) to produce those supplies.  So, net energy increase available to the end consumer will be a much more flimsy 12 mb/d as opposed to the headline increase in liquid fuels of 32 mb/d.  12 mb/d of extra liquid volume is also a misleading number, because many liquid fuels, such as ethanol only have 2/3 the energy per volume unit as crude oil does.  Same goes for NGL.

            We also have to remember that in my calculations, I made many assumptions that are rather optimistic.  For instance, I assume that unconventional supply of liquids will grow from about 12 mb/d currently as measured by the EIA, to 45 mb/d.  There is no guarantee that this will materialize.  I also assume that we will increase recovery rates from conventional fields at a historically much faster rate than we have done thus far (.5% as opposed to .2% during the past century).  I also assumed that this advance in recovery rates will be constant from year to year, while in reality it will likely come in bursts, making our lives very miserable in between those bursts.  There is in fact nothing out there to guarantee that we will ever reach 60% ultimate recovery rates, while there is little chance that we can go much above, because of the simple fact that energy return to energy invested ratios are deteriorating fast, and at some point, these fields will become net energy sinkholes.  There is also the very real danger that during this period, the global financial economy will deteriorate so much that we will simply lose the ability to pay $100 or more for a barrel of oil.  This is in large part due to the continued drag that price inflation of crucial commodities has on the financial economy.  Remember that technology alone will not suffice at this point.  If prices would drop bellow $50 right now, and stay there indefinitely, we would loose at least 20% of current oil supplies on the global market.

            So on balance there is a lot more downside risk than the likelihood of upside surprises.  Meanwhile demand for oil keeps going up worldwide.  The only dampener on demand at this point is a recession prone economy.  The reality is that the debate over whether peak oil is now, or a decade of five decades from now is not as relevant as most people want to make it out to be for various reasons.  Truth is that the economic world changed as of 2006, which was the year after the EIA, and IEA recorded plateau happened for conventional oil[iv].  We can never go back to doing things the way we did up to then.  We can try, and I do believe that we will try, but we will only find disappointment, pain and frustration.

Monday, May 14, 2012

Rio + 20 part 4: What if?



            So we are now just over a month away from the big event that most people still don’t know about (the Rio summit on sustainability, which is a follow up to the one we had in 1992, also in Rio).  In my first three articles on this subject, which I pledged to write once a month, until July, I concentrated on explaining the public good aspect of global sustainability.  I used various examples of the folly of the assumption that we can achieve a sustainable path based on collective voluntary goodwill.  We now know that we can never get everyone to voluntarily sign up to a binding commitment to behave responsibly, because the benefits of non-collaboration, especially if some do decide to sign on to being good global citizens are just too tempting.  We also know what happened to the economies of the willing good Samaritans who took it upon themselves to try to save the world.  The examples of the EU and California can tell us all we need to know about the pain involved in being responsible.  As for the benefits, the EU effort, to keep emissions at 1990 levels had the effect of reducing global emissions growth from about 42%, to the actual 40% increase we registered during this period.  Not much of a reward, given the amount of pain it took to achieve what they did.  My March article on the Rio summit provides a more detailed analysis for those who are yet to read it, and are interested.  For those who do not have the time, or the interest, I prepared the graph bellow, which speaks volumes.

Data Source EIA[i].

Note:  The yellow line represents what the world’s emissions would be like if Europe would have done absolutely nothing to mitigate emissions output, but would have done the opposite instead, which is to concentrate solely on economic growth, which would have probably led to their emissions rising by an average of 1% per year.  There are many who would take issue with my graph, and I agree with them, because we should keep in mind the outsourcing effect that EU environmental policies had on dirty industries.  There is indeed a strong argument that can be made that in reality, the yellow line I presented, should not even exist on the graph, because EU policies made in fact no difference to the level of global emissions.

                 Now, if I was a European and I would be looking at this graph, I would be quite angry at the fact that my elites did this on my behalf, especially if I were currently a young person, unable to get my foot through the door and find a job.  If I were a citizen of any country in the “global village”, I’d be worried that my government would do the same on my behalf, while other countries will not, causing my family, friends, and community to suffer extreme hardship, or that due to the hardships, I may not even have a chance to start a family, as is the case with many young people in Europe now.  So how open would I be then to accepting arguments on the need to do something about the environment?

            There have been many explanations given in regards to the current trend of environmental skepticism.  We have anthropologists, social behavior experts all trying to come up with complex analysis of the social resistance to environmentalist views.   There is indeed an effort to misinform.  There are cultural and even religious grounds to oppose the arguments for environmental protection.  In the end, we have to understand that the majority of people have immediate concerns, and let us face it, for those who do not have secure positions, such as academics do, and live from paycheck to paycheck, the last thing they want to hear is that their elites are looking to sacrifice their competitiveness in the global labor market, for the greater good of all.

            In fact I don’t think that they realize it, but the environmental crusaders who may have celebrated as they managed to convince the EU or California to engage in voluntary goodwill and self-sacrifice, in fact caused the war to be lost, even as they won a battle.  They gave environmentalism a bad name, and discredited in the process any attempt to do something of actual consequence.  I know that it is hard to admit to this, but nevertheless it has to be done, because as the upcoming summit will prove to us, there is little voluntary goodwill left.

What if we reject it?

            There is precious little we can do to change the outcome of the summit at this point.  What we could do, but I fear we will not, is recognize its failure, and reject the notion that the approaches that made little impact in the past two decades, will somehow bear fruit in the next two.  Then and only then, we will be ready to look at real alternatives.

            In my book, I provided an alternative, in the form of the sustainability trade tariff.  This is a proposal for standardized tariffs that should be applied globally, based on the ability of each nation to produce goods and services in a sustainable manner.  In other words, if Germany’s total GDP is X amount, and its ecological damage as a result of producing X is Y, then Y/X= tariff level on all goods that Germany exports. 

If let us say, initially 100 countries reject this tariff regime, they should be evaluated collectively, and all exports to the countries that did sign on, should be slapped with the corresponding tariff, giving countries that would score better but did not sign on, a reason to do so, gradually leaving the rest more and more isolated and disadvantaged.  Now this would work, unlike the idealistic, “people power, we can do it unilaterally based on voluntary good will, on a local scale” stuff we rely on currently.

            People power is still needed to get things moving of course.  We need people power to get the message out.  We need people power to get political will to at least get the countries on board that would benefit from no longer being undercut by irresponsible actors.  Then people power can take a back seat, and allow economic power and influence to do its job.  It is amazing what the right incentive mechanism can do to automatically convince people of the right path forward.  I know how unglamorous it may seem to idealists, but this can work, while idealism does not.

What would the new world look like?

            At first, there would be difficulties in adjusting to having to compete in sustainability, in order to improve one’s tariff rating.  A stubborn resistance to this would make things even more difficult, because the world would end up being divided in two camps, facing off in a trade war.  There is no guarantee that we would win.

            The benefits however would be great indeed.  The value added economy would flourish, because producing durable products, of higher value would be the best way to avoid having a higher environmental footprint.  Cars, furniture, shoes, appliances would all become more durable, which many may consider to be a boring situation, because people are now accustomed to changing their consumer items more often.  I think we can all agree to suffer a bit of consumer boredom, in favor of being able to provide consumer needs to a wider global population.  The work week would eventually have to be cut, because in the absence of our race to produce and sell more and more, less time will be spent on doing it.  This is a good thing, because since women entered the workforce, the average family provides more labor than it did a century ago, despite the roughly 10 fold productivity per unit of labor increase we had during this period[ii].  I should note that in my book, I proposed a component of the tariff to be concentrated on basic human rights, which is necessary to make sure that some countries don’t shift from environmental abuse in order to provide a cheap place to do business, to human abuse as a substitute.  This should help towards pushing things towards a better path.  Maybe the gains in technology will finally translate in more leisure time being consumed, instead of more and more disposable goods.

            This could be the first step away from the consumer based economy, which we cannot sustain anymore. Trying to maintain this system can cause a great deal of suffering to an increasing number of the members of the “global village” in the process of trying to prop up a broken economic model.  New, creative ideas would be needed to move forward and transition smoothly.  But it is precisely new ideas that we need, in a world where we stagnated culturally, and in the process our economy is stagnating as well.

What if change will not happen?

            Our economic problems are now far greater than what the set of tools we currently have to deal with these difficulties can handle.  The western world is collapsing, because both austerity and spending to stimulate the economy have been tried, and neither works as a permanent solution.  These measures are all we have, courtesy of current ideologies that dominate society, so we cannot do any better than move back and forth between two directions which already failed us.

            It is quite obvious now what will happen in the absence of significant and smart changes to the way we do things.  The timing is uncertain, but the outcome is not.  The financial economy will collapse, paralyzing us.  This paralysis will have consequences that are far worse than the consequences of our unsustainable.  The unsustainable path is in fact the problem, while we try to cure the symptoms.  The unprecedented global increase in commodity prices such as food, oil and other crucial resources, which we have been witnessing for over a decade now, tells us that we reached the limits of what we can do with the current mode of organizing our lives, and there is only one way to go from here, which is down.

We are like a town, which for the first time realizes that it cannot continue to grow and prosper without being able to build certain infrastructures, such as sidewalks, sewage drainage, or night lights for the dark streets.  Few can be persuaded to voluntarily pay for the infrastructure, so a mechanism is needed to decide what needs to be done, and how to get everyone to contribute.  If the town succeeds in applying the right mechanism, they can move forward, if they fail, so will the town.  It is this simple, yet we are finding it so hard to deal with it.






[ii] I made this rough estimate based on data on US productivity since 1983, which on average grew by about 2% per year.

Monday, May 7, 2012

Austerity versus Stimulus: A prominent but useless and even harmful argument.


            I often voiced my opinion that we do not have an accurate view of the post 2007 world and the causes, then and now, which are at the root of the current economic symptoms.  We in fact are guilty of mistaking the symptoms as the actual cause of the ailment.  In my previous article I pointed out the effect that a 150% rise in the global food price and the 500% rise in oil prices since 2000, had on crowding out the non-commodity economy.  I also pointed out that the financial and monetary carelessness we witnessed in the past decade is in fact the automatic response of market and political forces to the pressures on the economy from the above mentioned commodity related difficulties. 

            Now we still have near record high commodity prices, with a few exceptions, such as natural gas.  We also have the aftermath of the mess that the market and political establishment created in its wrongheaded response to the sustained pressure on the economy, caused by the above mentioned rise in commodity prices, which many do not realize but is unprecedented on a global scale. 

            In the face of the absurdly large deficits that, countries such as the US are running, and continuing financial instability in Europe, the political establishment is now pushing for austerity measures to re-stabilize the western world.  There is also a counter voice, which argues for Keynesian stimulus.  In Greece and Eastern Europe, austerity is already a years old practice.  As a result, Eastern Europe, which has all the ingredients necessary to grow at a similar pace as their developing nation Asian counterparts, is stuck in a stagnated mode.  Greece has been in recession for almost half a decade now.  Austerity in Western Europe is in large part responsible for the double dip recession the Euro zone and Britain are experiencing.  In the US, if the tax hikes and spending cuts will go in effect by the end of this year, or at the beginning of next year, as they are scheduled to do in the absence of legislative intervention, they will also enter a recession.  The tax hikes and the spending cuts amount to about 5% of GDP, while the US economy is only growing at 2%, which means the contraction could be deep.

Will Austerity solve the problem?

            I think by far the best barometer of the effects of austerity is Greece.  The Greek budget has been cut substantially since 2009.  Government expenditure as a percentage of GDP dropped from 54% to 50%.  Yet debt to GDP rose from 120% to 165%.  That is because the economy has been contracting at a rate of 5% per year since about 2009.  This led to the economy contracting from $347 billion to $305 billion from 2009 to present, and their economy is still contracting[i].  So, austerity did not make their debt more manageable.  It did however cause irreparable damage to the state and its future economic prospects.  Even with the effect of the debt write-down (default), and with austerity measures in place, it is estimated that in 2020 Greece will have a debt to GDP ratio of 120%.  In other words, they will be where they were when the austerity measures started.  We should also remember that the 120% ratio takes into account the assumption that the global economic situation will be “business as usual”, which I personally think is wishful thinking.
Despite the example of Greece, and the disastrous side effects of austerity in parts of Eastern Europe, we are still told that the austerity formula will work in current circumstances.  In order for it to truly work however, for the short run and the long run, we would have to see the following:

For the short run, austerity measures would have to have a smaller effect on economic growth, than what we have seen in Europe so far.  In other words, we would have to continue expanding GDP, even as cuts in government spending are implemented.  At the very least, the debt to GDP ratio would have to go in a better direction than it would if we were to do nothing.  In the case of Greece, as well as Eastern Europe, that clearly has not been the case.  In most of these examples, debt to GDP ratios worsened considerably, even as public sector jobs wages and benefits were cut, and pensions, health, education and infrastructure services were scaled back.  In the absence of the ability to shift consumption of one’s output of goods and services to other countries, as is the case now, since the whole world is experiencing difficulties, austerity has the potential to throw the economy in a vicious cycle that may go on until the end result will still end up being default.

In the long run we need to retain certain aspects of our social fabric that is meant to keep us adapted to competing in the modern economy.  We need to continue to provide potential investors with infrastructure, both human and physical.  The human infrastructure comes in the form of a well educated, skilled, healthy and dependable workforce.  The physical infrastructure of course needs to provide for transport, energy, and communications.  A post agrarian, consumer driven economy, which is what we are, needs to have a basic social safety net in place to allow the consumer to have the confidence to consume   If these crucial elements that make up a modern economy are overly neglected as a result of austerity measures, there is no point to doing austerity in the first place, because the end result will be the same as eventual default.

Is spending like there is no tomorrow the answer?

            If one listens to the likes of Nobel Prize winner Paul Krugman, and renowned economist Joseph Stieglitz, you would think that all we ever had to do to keep the economy from reaching the sorry state it is in, would have been to keep the foot on the accelerator, and continue with fiscal and monetary stimulus[ii].  Lucky us, that we now have major western economies that tried both the conservative austerity program, and the more left leaning policy of stimulus, since the 2008 recession.

            US budget deficits never dipped under the $1 trillion mark since the financial crisis, and there is a sense that even now that we are expecting measures enacted in the past decade, such as tax cuts and spending programs to expire this year, as well as agreed to cuts to kick in as a result of Washington politics, something will come along to prevent these measures from happening.

            The US economy has been growing at a decent pace in the past three years in comparison with many EU countries that were either forced, or chose to go down the road of austerity measures.  This however is a misleading situation, because while the economy is expanding at a rate of about 2% per year, the deficit is at 8% of GDP.  If they were to cut the deficit to about 5%, surely the US would enter a recession, while a 5% deficit is still rather high by historical standards.  Paradoxically, the rate of deterioration of the debt to GDP ratio might become worse than it is now[iii].

            So, one would think that the answer is in allowing deficit spending to stimulate the economy until the private sector can take over the role of economic leader, and then government can cut back.  Problem is that as we can see, the private sector cannot fulfill its expected role.  If the US has not been able to get back to solid private sector growth, which would allow it to start winding down measures to stimulate the economy, and start cutting the deficit after four years of almost 10% budget gaps, will the situation ever go back to normal?  The other important question is how long the market will tolerate continued heavy borrowing, before it imposes austerity measures?  In Europe it already happened for some countries that the market said enough!  In the US, there is probably about a decade to go before the market would suddenly turn against the continued issue of huge sums of bonds, mainly thanks to the US dollar’s privileged status as the main reserve currency around the world.

            Some argue that we only have to wait for the bad credit to be flushed from the system before we can have a self sustaining, private enterprise driven economy again.  Reality is that high commodity prices, which led to the declining health of the financial economy, still persist.  Mature economies, which cannot grow as fast as emerging economies were in fact more vulnerable.  Even though commodities make up a much smaller percentage of GDP than it does in developing economies, the much slower pace of growth, meant that the effect of commodity prices crowding out demand for manufactured goods and services, would have been much more severe in the absence of market and policymaker reaction to flood the economy with credit.  That helped us along until 2008, but now the party is over, and even though we do not want to face reality, we should, because there is no other way.

Broken and outdated Ideologies:

            When dealing with the current crisis, the main game in town is the much bellowed duel of the two main ideological ideas, of left and right.  The political dynamic shaped the argument into a choice of austerity versus stimulus.  As I mentioned however both ideas are irrelevant to the actual problem we are facing.  Nevertheless, as we saw in the weekend elections in France and Greece, we continue to be offered one of these two ineffective choices as directions forward.  We will see this play out later this year in the US, as well as many other countries in Europe.  How long we will go on being deceived by arguments by either side? I don’t know!  What I do know is that in the absence of us dealing with the actual problems that caused our economic stagnation, we will eventually suffer enough economic damage to cause a complete and irreparable collapse of the western world.

What we really need:

            There is only one cure to the problem of excessive demand on our global resources, and that is the proposal I made for a standardized global trade tariff to be implemented.  We need to get more value out of the commodities we consume, and the only way to achieve that is to have a mechanism in place to promote a return to the durable goods economy.  The market, if left unguided, will not do that for us, and neither will legislation enacted by individual states.  We now live in a global economic environment and we therefore need global scale solutions.  What we get instead is the endless and useless debate whether we should choose austerity or stimulus.