The Bumpy Road Ahead For The World Economy

Tyler Durden's Photo
by Tyler Durden
Sunday, May 07, 2023 - 12:10 PM

Authored by Gail Tverberg via Our Finite World,

In the post-World War II era, the US has been known for its hegemony–in other words, its leadership role in the world economy. According to one definition, hegemony is the political, economic, and military predominance of one state over other states. I believe that the US is not far from losing its hegemony. The conflict over future hegemony could lead to a major war.

Hegemony is surprisingly closely tied to leadership in energy consumption. A country with a high share of the world’s energy consumption doesn’t have to depend on imported goods and services from around the world. It can manufacture weapons of war, if it chooses, in as large quantities as it chooses, without waiting for outside suppliers.

One part of today’s problem is the fact that the world’s fossil fuel supply, particularly oil, is becoming depleted. Extraction is not rising sufficiently to keep up with population growth. In fact, total fossil fuel extraction may begin to fall in the near future. In some sense, the fossil fuel supply is no longer adequate to go around. To relieve the stress of inadequate supply, some inefficient users of energy need to have their fossil fuel consumption greatly reduced.

My analysis suggests that the US and some of its “Affiliates” tend to be inefficient users of fossil fuels. These countries are at great risk of having their consumption cut back. The result could be war, even nuclear war, as the US loses its hegemony. After such a war, the US could mostly be cut off from trade with Asian nations. In this post, I will elaborate further on these ideas.

[1] Hegemony is closely related to energy consumption because energy is what allows an economy to manufacture goods of all kinds, including armaments needed for war. The energy consumption of the US as a percentage of the world’s has been falling since 1970.

Data on energy consumption by part of the world is readily available only back to 1965, rather than 1945. Based on this data, US energy consumption as a percentage of the world’s total energy consumption has been falling since 1965.

Figure 1. US Energy consumption as a percentage of world energy consumption, based on data from BP’s 2022 Statistical Review of World Energy.

Figure 1 shows that the US’s share of world energy consumption amounted to 33.3% of world’s energy supply in 1965, but only 15.6% in 2021. In other words, in 2021, the US’s share of world energy consumption in 2021 was less than half of its 1965 level.

There are some economies that have much in common with the US. The countries in this category are advanced economies that have democratic governments. I expect these countries would tend to follow the US’s lead, regardless of whether its actions really make sense. The selected economies are the EU, Japan, Canada, the UK, and Australia. For convenience, I call these countries Affiliates.

[2] Affiliates consumed over 35% of the world’s energy supply in the 1965 -1973 period, but this has fallen in recent years.

Figure 2. Energy consumption for selected advanced economies (referred to in this post as Affiliates) as a percentage of world energy consumption, based on data from BP’s 2022 Statistical Review of World Energy. The EU is based on 2021 membership.

Figure 2 shows that Affiliates consumed 35.5% of the world’s energy supply in 1965. By 2021, their consumption fell to 17.6% of the world’s supply. This, too, is less than half of the 1965 percentage.

[3] The energy consumption of US plus Affiliates as compared to the energy consumption of Rest of the World has shifted remarkably since 1965. The consumption of the Rest of the World has been soaring, while that of US plus Affiliates has shrunk.

In Figure 3, I add together the amounts in Figures 1 and 2 and compare them to the indicated energy consumption of what is left, which I call, “Rest of the World.” It is clear that there has been a huge shift in which grouping consumes the majority of the world’s energy supply.

Figure 3. Comparison of total energy consumption as a percentage of world energy consumption for US + Affiliates and Rest of the World. Amounts based on data from BP’s 2022 Statistical Review of World Energy.

We all know that if a political party has the support of almost 70% of voters, it is likely to be dominant. There is a similar issue with energy consumption. Energy consumption is used in every aspect of the economy. It is important for manufacturing goods and transporting them to their destinations. It is also important for creating jobs that pay well.

If world energy supply is growing, it encourages growth of the world economy. Growing energy supply indirectly allows debt to be paid back with interest. In general, the faster the world’s energy supply is growing, the higher the interest rate that can be supported.

Without growth in energy supply, an individual economy is forced to become a service economy. It is forced to import almost all of the manufactured goods that it needs, even armaments needed for war. Such an economy is forced to place an emphasis on growing debt and growing complexity. Unfortunately, both of these things are subject to diminishing returns. As growth in energy supply turns to shrinkage in energy supply, we should expect debt bubbles to pop.

A country is likely to stop making advances in the sciences as it shifts to a service economy. This linked chart by Visual Capitalist analyzes patents in 2021 by the country of the individuals listed on the patent applications. On this basis, China’s patent count was more than double that of the US. China is also the major producer of many clean energy technologies because it has both the resources and the technology.

As a service economy, the US has tended to specialize in healthcare, with spending in this sector accounting for 18.3% of GDP. Yet the US’s healthcare results are dismal. US life expectancies have fallen behind those of other advanced countries. The recent covid vaccines, which were strongly advocated by US health authorities, worked far less well than had been hoped. In February 2022, the New York Times published an article, US Has Far Higher Covid Death Rate Than Other Wealthy Countries.

[4] US data shows that its energy consumption was rising rapidly in the 1949 to 1973 period. Such rapid growth in energy consumption would make other countries envious. It would tend to expand America’s hegemony.

Figure 4. US energy consumption for the period 1949 to 2022 based on EIA data with fitted exponential growth indications for periods chosen by author.

Figure 4 shows how quickly US energy consumption was growing, starting in 1949, using EIA data. Energy consumption growth averaged 3.5% per year in the 1949 to 1973 period. This rapid growth is what we would expect of a country that was an energy leader for the rest of the world. Standards of living could rise. Parents could often afford to raise several children.

An article in the Oxford University Press says that the US’s proliferation of major military bases overseas was developed in the 1950s and 1960s to contain communism and to provide global defense of US interests. Such a huge build-out of bases during this period would not have been possible without the rapid ramp-up in US energy consumption.

Between 1960 and 1969, the number of miles of high-voltage long distance electricity transmission lines tripled. This was evidence of the rapid growth in electricity production that the US was achieving; it was a pattern that other countries would want to emulate. It added to the hegemony of the US.

Statista shows that between 1951 and 1973, the number of US automobile sales per year more than doubled, from 5.16 million to 11.42 million. With this increase came a need for more paved roads and more pipelines to carry oil products. With its growing energy consumption, the US was able to accomplish all this growth. Growing energy consumption also allowed the US to manufacture nearly all the vehicles sold in the US in this period.

[5] US hegemony faced a major challenge in 1970 when US oil production hit a peak and started to fall.

Figure 5. Monthly US oil production through February 2023. Chart by EIA, with notes by Gail Tverberg.

US crude oil production rose rapidly until 1970, when it suddenly started falling. Work was quickly begun on oil extraction from the North Slope of Alaska. This oil offset most of the decline in oil production from the lower 48 states through the mid-1980s.

US hegemony depends upon the quantity of energy products US businesses and citizens consume. When oil prices become unaffordable, citizens and businesses buy less. Figure 6 shows that oil prices had been amazingly low prior to 1973, averaging only $16.31 per barrel, even after adjusting for inflation to 2021 price levels.

Figure 6. Average annual Brent spot oil prices, together with average prices for the fitted growth periods shown on Figure 4. Based data from BP’s 2022 Statistical Review of World Energy.

Comparing Figure 6 to Figure 4, we see that once oil jumped up to an average of $73.14 per barrel in the 1973 to 1983 period, US energy consumption flattened out. At this high price, efficiency became more important. Smaller imported cars, often from Japan, became popular. The US and several other parts of the world started building nuclear power plants to replace electricity created by burning oil. Within a few years, oil production was ramped up in other parts of the world, such as the North Sea and Mexico, relieving the tightness in oil supply.

Once oil prices began to rise again in the 2005 to 2008 period, US oil from shale became available in response to higher prices. The catch was that at these higher prices, oil tended to be unaffordable by the American public. Oil was still affordable in most of the Rest of the World, however.

These “Rest of the World” countries tended to use oil much more sparingly in their energy mix. They often had other advantages as well: warmer climate, lower wage levels, recently built factories, and an energy mix that emphasized coal (which tended to be inexpensive). These advantages helped bring down costs of both manufacturing and resource extraction for the Rest of the World. The shift in energy consumption shown on Figure 3 could occur.

This shift in manufacturing and resource extraction away from the US and Affiliates creates problems, however. If the US and Affiliates are increasingly at odds with countries outside this group, it becomes much harder for the US to exert hegemony over these countries. The problem is that the US depends upon the countries it is at odds with for necessities. Even in making munitions for the Ukrainian conflict, the US needs to depend on China and other Asian countries for parts of its supply lines.

[6] The world economy is now headed for a bottleneck. The world economy is similar to a Ponzi Scheme, with growth in the output of goods and services necessary to fund financial promises of many kinds. There are limits to the amounts of fossil fuels available at affordable prices, and the world is hitting those limits now.

Because the world economy follows the laws of physics, the growth in the output of goods and services depends upon the continued growth in the production of energy products.

Figure 7. World Energy Consumption by Source, based on Vaclav Smil estimates from Energy Transitions: History, Requirements and Prospects and together with data from BP’s Statistical Review of World Energy for 1965 and subsequent. Wind and solar are included in “Biofuels.”

We have known for a very long time that fossil fuel output is limited. Back in 1957, Rear Admiral Hyman Rickover of the US Navy gave a speech warning that world-wide fossil fuel energy supplies were expected to become unaffordable between 2000 and 2050. High oil prices seem to have been a major factor underlying the Great Recession of 2008-2009. This especially affected the US, with its large amount of subprime housing debt. The problems experienced since late 2021 with spiking prices of oil and high prices of imported coal and natural gas are also evidence of the limits the world is reaching.

Figure 8 shows my view of where future world energy supply is headed. While this chart was originally prepared in 2020, the forecast still seems to be reasonable, especially if regulators get their way in mandating the reduction of (unaffordable) fossil fuel use.

Figure 8. Amounts for 1820 to 2020 similar to those from Figure 7, above. Amounts after 2020 assume an average reduction of 6.6% per year to 2050.

If energy consumption falls this rapidly, the world economy will have to adapt in many ways. Economies that cannot tolerate high oil and energy prices are likely to be squeezed out. Based on what already has been happening in Figures 1, 2, and 3, the United States and Europe are especially likely to be adversely affected. The countries that are likely to fare better are ones that don’t require as much energy per capita. These countries are likely to be in warm climates and have relatively poor populations, such as those in Southeast Asia.

As energy supplies fall, business failures and debt defaults can be expected to soar. Governments will be tempted to backstop every financial promise, including failed banks and pension plans. If they do this, other countries will be unwilling to trade using their debased currency. With too much money and few imports, the result is likely to be hyperinflation. If the governments simply allow bankruptcies to take place, the result is likely to be deflation as banks and businesses fail.

[7] The US has been having increasing difficulty in its hegemony role. Some countries have come to believe that the US is now acting unfairly.

Back when the US first attained hegemony, oil and other energy supplies were inexpensive and their supply was growing rapidly. The US was experiencing great economic growth, and other countries wanted the same sort of success. The US plus Affiliates were the ones using the majority of energy products, so the interests of almost all energy users were aligned.

Things have “gone downhill” since 1970 when the US oil supply first started to shrink (Figure 5). Suddenly, the US needed help from the financial system to work around the need to import more oil. One change (in August 1971) was making the dollar a fiat currency, rather than tied to a gold standard. This enabled greater use of debt in operating the economy.

Without the gold standard, the US dollar was able to become the world’s reserve currency. Instead of gold reserves, other countries began buying US Treasuries, which they considered to be a safe store of their money. The US dollar could also play a greater role in financing international transactions. A 2021 analysis by the Federal Reserve shows the dominance of the US dollar in many areas of trade.

This dominant role for the US dollar is now being questioned after the US froze the central bank assets of Russia, as part of the sanctions imposed in response to Russia’s invasion of Ukraine. Other countries are beginning to wonder if holding Treasuries is really a good idea, if the US can impose sanctions which make them unavailable. Countries are also figuring out that it is quite possible to arrange sales of commodities and other goods in currencies other than the US dollar.

Also, the US’s ability to win wars is not very clear. The US’s first big loss was the Vietnam War. After 20 years of fighting, that war ended in 1975, with communist forces seizing control of South Vietnam. The Afghanistan War did not go well either. After 20 years, the US abruptly pulled out. While the US claims the mission was accomplished, it is hard to see that the high cost was justified.

The Russia-Ukraine conflict does not appear to be going well for Ukraine and the allies supporting Ukraine. The US and NATO are having difficulty supplying as many armaments as quickly as President Zelensky would like. Ukraine seems to be using up its conventional weapons very rapidly. Neither the US nor other NATO countries can manufacture weapons very quickly, in part because supply lines from around the world are required. How helpful is the US’s hegemony, if the US can’t even easily win a “proxy war” in Ukraine?

There are sanctions, other than freezing assets, that are of concern to other countries. A recent list from a Chinese source lists the following types of hegemony that it considers to be problematic.

  • Political hegemony – Throwing the US’s weight around

  • Military hegemony – Wanton use of force

  • Economic hegemony – Looting and exploitation

  • Technological hegemony – Monopoly and suppression

  • Cultural hegemony – Spreading false narratives

Quite a few countries in my Rest of the World grouping are clearly getting fed up with America’s hegemony. Increasingly, Middle Eastern countries that were previously at odds with each other are setting aside their differences. They are also becoming much more closely aligned with China. Countries in this group, as well as the BRICS group of countries, are already taking steps toward trading in currencies other than the US dollar.

[8] The path ahead looks very bumpy. The US is likely to be kicked out of its role as global hegemon. Rival countries may choose to attack the US with nuclear weapons, or the US may lash out with nuclear weapons as it sees its hegemony fail.

As I analyze the world economy’s future trajectory, I see the following situations falling into place:

(a) The world economy is being stressed by inadequate energy supplies. When prices rise, it tends to cause inflation. Some countries are experiencing a second kind of stress, as well. Their central banks have raised interest rates. This is a dangerous thing to do because it tends to cause falling asset prices in addition to slowing the economy.

I expect that countries that have recently raised interest rates will have many bank failures. Partly, this will come from the falling value of long-term bonds. In time, it will also come from failing real estate mortgages and other loans, since asset prices will tend to fall with higher interest rates. Governments will be tempted conduct massive bailouts. The countries that have recently raised interest rates include the US, the UK, Eurozone countries, Switzerland, Canada, Australia, and Brazil.

Countries that did not raise interest rates, which seem to include China, India, and Iran, will find their economies less affected by bank failures. Russia temporarily raised interest rates, and then lowered them again, so Russia would also seem to be less affected by bank failures.

Countries that raised rates will be tempted to do bailouts of banks and of “too big to fail businesses.” These bailouts will greatly increase the monetary supply, making countries that didn’t raise interest rates unwilling to trade with them. This dynamic will tend to increase the trend toward two separate trading areas–one including much of Eurasia and one including the US, Canada, Europe and perhaps South America.

(b) If we think about it, cutting back greatly on trans-Atlantic and trans-Pacific shipping would save a great deal of oil if there is not enough oil to go around. This will be another impetus for “Rest of the World” countries, especially those in the Asia-Pacific area, to cut back on shipping across the major oceans.

(c) With failing banks and a cutback in trade between regions, the US dollar will cease to be used as a reserve currency for a large part of the world. The US dollar might still be the reserve currency for some trades, particularly with other countries in the Americas.

(d) I expect that a block of countries will eventually coalesce, centered in Asia, that will mostly trade among themselves. China will probably be the leader of this block.

(e) The US and Europe will mostly be pushed off to the side, to trade among themselves and some geographically close neighbors. These areas may need to set up new financial systems using much less debt. These countries will not be able to produce advanced goods, such as computers, by themselves. They will not be able to build new solar electricity generation or new wind turbines because too much of the supply chain will be out of reach. While these countries have been looking at digital currencies, it is not clear that there will be a stable enough electricity supply to make such currencies possible.

(f) There will probably be war at the time of the division into the two (or perhaps more) trading areas. Nuclear weapons may be involved since there are many countries with nuclear weapons. The supply of conventional weapons available for warfare is depleted, with the ongoing war in Ukraine. According to a study done at Harvard, involving 16 cases in which a major rising power challenged an existing major power over the past 500 years, 12 cases ended in war. This analysis would suggest a 75% likelihood of war.

(g) I don’t know what the timing of all these things will be. Bank failures are just beginning. Let’s keep our fingers crossed that the world economy holds together a while longer.