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Nobel Prize Winner Opens One Eye

Posted on Sunday, January 2nd, 2011 at 5:40 am by R.J. Ruppenthal

At first glance, last week's New York Times Op-Ed piece by Nobel Prize-winning economist Paul Krugman looked like a slam dunk. His column entitled "The Finite World" seemed to be the latest admission by yet another mover & shaker that peak oil and resource scarcity will control our economic destiny for the foreseeable future. Here was someone whose opinion really counts in policy-making circles, joining the chorus of recent "Houston, we have a problem" realizations from a wide range of sources, including mainstream geologists, Wall Street investors, the US Armed Forces, Lloyd's of London, the International Energy Agency, and anyone else who can read the writing on this wall that we're barreling into. All of them are telling us that our earth's supply for key resources (oil, phosphorus, copper, other metals) can no longer keep up with worldwide demand. So whether you believe that there is a physical peak at hand in terms of oil extraction and production, the supply-and-demand equation will put a damper on worldwide economic activity anyway. (*Note: if you need a primer on this, please read some of my previous blogs.)

But whoa, not so fast. Our Nobel Prize-winning economist failed to fully grasp the implications of this simple supply-and-demand scenario. More likely, he's partly on his way towards realizing the full implications of this catastrophe, but is still partly in denial about what it will mean for humanity and our economics. Krugman's column in last week's Times began really well, but finished quite poorly. Here was somebody standing up at an addiction group meeting, saying "I have a problem" and then adding "but I don't need to do anything about it now" as he walked out the door.

Here is what he wrote. After recognizing that world commodity prices (oil, copper, cotton, wheat, corn) are up 25% in the last six months, he explained that finite supplies (and not price speculators) are the culprit. He cited growth and demand from China and other emerging economies, changing weather patterns from climate change, and flattening oil production (peak oil, anyone?) as major factors in driving up commodity prices. So far, so good. And then his big cop-out: "we’re living in a finite world, one in which resource constraints are becoming increasingly binding. This won’t bring an end to economic growth, let alone a descent into Mad Max-style collapse. It will require that we gradually change the way we live…But that’s for the future. Rising commodity prices… have no bearing, one way or another, on U.S. monetary policy. For this is a global story…it’s not about us."

The implication is that we should forget about this trouble and hope it goes away, even though he just finished explaining why it WAS a fundamental problem. If the peak and supply-demand imbalance in key global resources has "no bearing (on) monetary policy", then fine, tell the Federal Reserve to keep sleeping. But as far as I can tell, the impact on monetary policy wasn't the focus of this article until he mentioned it in that sentence. And when the United States economy, and the entire world, is clearly driving 90 miles per hour towards a cliff (as he's just told us, identifying both the severity and imminent nature of the problem), then the statements "but that (need to adapt) is in the future" and "it's not about us" are tantamount to ongoing denial of this problem that should eclipse all others on every policy-maker's agenda. Coming from someone with Krugman's intelligence and pedigree, this is irresponsible. But I'll give him credit for having one eye open and hopefully he'll join the party soon enough.

I don't have a Nobel, but here's my Econ 101 version: when something gets scarce (supply), it becomes more expensive. When someone badly needs it (demand), it also becomes more expensive. Put these two together and you have big trouble. Oil prices stand at $90/barrel right now, even when the economy is still mired in a deep recession with nearly 20% of the U.S. population either unemployed or severely underemployed. Last time there was a recession, oil prices hovered around $50/barrel, but look how high they are even in this time of supposedly lackluster demand. As Krugman pointed out, conventional oil supplies have not increased in four years and oil from less conventional sources (like oil sands or deepwater wells) are more expensive to produce. Many believe we simply cannot produce any more oil on any given day or in any future year than the world is producing now. But soon enough, this debate will be irrelevant; even if we can produce a little more, demand from developing countries is fast increasing and set to overtake the world's supply capacity. So as the economy begins to improve even a bit, those oil prices will shoot up again, and once oil hits about $120/barrel again (which is much closer now than it was before the Summer 2008 price spike) then it should have the same effect on the world economy as the 2008 price spike did: killing it, sparking this last big recession.

Simply put, our economic system is driven by affordable resources and with oil, copper, phosphorus and other elements of the industrial lifeblood, we have reached that point in history where the world's supplies are beginning to fade (they are "finite" as Krugman indicates) and where global supply is overtaken by global demand anyway. Our economies probably will never be able to grow at the same pace again without hitting the roadblock of insanely high prices that stifle demand. That is, of course, unless we adapt and develop some alternatives really quickly. This problem is here, is now, is ours, and we need to face it squarely. Anyone who suggests otherwise is still in denial, but hopefully those folks will wake up and become part of the solution. We're all in this together and we need to work on some alternatives and transitions in a big hurry. Happy New Year, everyone!!!

Link: http://www.nytimes.com/2010/12/27/opinion/27krugman.html

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