Saturday, November 29, 2008

The overoptimized society

For former Wall Street hedge fund manager and self-styled student of uncertainty Nassim Nicholas Taleb an important cause of the current financial meltdown is best described by ecological science. The system has become overoptimized. The consolidation of finance into the hands of fewer and fewer large players--banks, insurance companies, investment banks, and giant hedge funds--has made it less vulnerable to frequent crises, but more likely to produce a severe crisis when there is a breakdown in the system.

What used to be country-specific or regional crises, now become worldwide crises. In the past we've had the Mexican crisis, the Asian crisis, the Argentinian meltdown and most recently the utterly devastating hyperinflation in Zimbabwe. But none of these became global crises.

"It's vastly more optimal to have one large bank than 10 small banks. It's more efficient," Taleb told The News Hour with Jim Lehrer recently. "[But,] when one bank, [a] large bank makes a mistake, OK, it's 10 times worse than a small bank making a mistake." The moral of the story: A world with a lot of small banks is far more resilient than one with a few large banks. That's the kind of result one would expect in biological communities, and it turns out to be true, not surprisingly, in human communities as well.

But overoptimization isn't just limited to the banking industry. In fact, it is everywhere, and it makes for vulnerabilities across multiple fronts that quite often interact with one another. We've built a system too complex for any human to understand. Therefore, when something major goes wrong, no one can be sure how to correct it.

Witness the floundering attempts to revive the comatose credit markets. The seemingly incoherent policy shifts exhibited by U. S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke are not so much a result of incompetence as a reaction to the opacity of the global economy and the inability of anyone to grasp its workings or interpret its supposed signals.

As for the vulnerabilities across multiple fronts, one need look no further than the world's ports. The financial crisis has slowed many to a crawl as exporters worry that importers on the other side of the ocean may not be able to pay them. Banks are reluctant to issue letters of credit guaranteeing payments when they can't be sure the bank on the other side of the transaction is sound. This has driven dry cargo rates down 90 percent from their highs this year forcing some shipping companies to simply idle freighters. In addition, several shipping companies are on the verge of bankruptcy. And, that means orders for new ships are plummeting as well driving shipbuilders toward bankruptcy or at least consolidation.

The tight coupling and vast size of the globe's major economic actors, once hailed a triumph for economic efficiency, has now become an Achilles' heal. Only a few months ago the globe's just-in-time delivery system was strained beyond the limit. Now, as demand has fallen off a cliff, it's spewing out so much stuff that the Port of Long Beach doesn't know where to put all the imported cars coming ashore. Feast or famine, the system wasn't designed for surges or sudden drops in demand.

Overoptimization has taken place in agriculture as well. We are now hostage to such potential crises as the so far unstoppable wheat rust which threatens to knock down wheat yields worldwide. Farms that grow and rotate multiple crops with multiple varieties would be less efficient, but far more resilient in the face of such plant diseases.

And, with the huge, but clunky U. S.-Canadian electrical grid, we are subject to large consequences from small disturbances. Overgrown tree limbs in Ohio were said to blame for the 2003 power outage that deprived 50 million people of electricity from Detroit to New York and from the Ohio River to northern Ontario. A distributed power system made up of a large number of individual home and business generators might be less efficient; but it would be much more resilient. A failure of even many parts of such a power system would leave most of the rest functioning.

The effects of the overoptimized society have been seen in price swings as well. Small changes in the supply and demand for oil can send the price soaring or plunging, and we have seen both this year. The same has been true in the grain and base metals markets.

What all this tells us is that the pablum we've been fed about the merits of globalization has masked its dreadful vulnerabilities. We have created a system that nobody understands and nobody can fix when it falters. We were told that the global marketplace could heal itself and correct imbalances. Well, obviously it can't, not without mowing down an awful lot of people who did nothing to cause the current financial meltdown.

That's the problem with a complex, tightly interconnected network. When it spirals out of control, it tends to create a cascade of problems everywhere. Nassim Taleb says he used to get up in the morning and worry about what will happen to our out-of-control financial system. Now, he wakes up in the middle of the night and wonders how bad it could get.

Maybe, just maybe, it's time to redesign our society with resilience in mind. If things keep going in the current direction, we will surely be forced to.

Tuesday, November 25, 2008

The energy optimist's lexicon

My latest column on Scitizen entitled "The Energy Optimist's Lexicon" has now been posted. Here is the teaser:

The world's energy optimists often employ a particular lexicon to make their case for abundance far into the future. Whether the lexicon is used cynically or out of ignorance, the result is the same: false impressions.
.....Read more

Sunday, November 23, 2008

Timing is everything

As I watched a panel of speakers take questions about Michigan's and, by extension, the world's energy future at a recent conference, I was struck by how different their unspoken timetables for change were.

The panel included peak oil lecturer and author Richard Heinberg who other than James Howard Kunstler is probably the most widely recognized name in peak oil circles. It also included Albert Bates, a polymath of sorts, who has authored several books on sustainability, argued environmental and civil rights cases before the U. S. Supreme Court, helped to organize the Global Ecovillage Network, and works assiduously to teach others about permaculture and natural design. Also included were two Michigan state representatives, a utility representative, an independent wind power expert, and an academic transportation expert.

For those who acknowledged the possibility of an upper limit on and perhaps an ongoing drop in the supply of oil starting in, say, the next few years, the time for drastic action seemed to be more or less "yesterday." Not surprisingly this group included Heinberg, Bates, the transportation expert and the wind power expert. One of the state representatives also fell into this group.

The other state representative and the utility representative cautioned against a headlong rush into renewable energy. Yes, an energy transition is necessary to address global warming and fossil fuel depletion. But 2050 is a better time frame for completing the transition. We were told by the state representative that putting all of our eggs in one basket, namely, renewable energy, risked economic damage and risked betting on technologies that might not survive, work as planned or might be improved upon considerably over time.

Rushing to build an entirely new energy infrastructure may indeed not result in an optimal system and may saddle us with technology that will likely be superseded. Witness the efficiency gains in wind generators and the far greater knowledge we have today about where to deploy them compared to, say, 20 years ago. A gradual energy transition would clearly be much better in many ways.

The key question is whether we have the time for said gradual energy transition. Should the analogy be the computer revolution that took from the end of World War II to the middle of this decade to make ownership of a home computer all but universal in the United States? Or should the analogy be the American entry into World War II which led to a command economy directed by the federal government with the aim of winning the war?

One could certainly argue that the United States did not make optimal use of its resources during World War II. But, it did win. And, private industry directed by the War Production Board managed feats which no one believed possible at the beginning. The effort required the sacrifice of the consumer economy, something which is unthinkable today in the United States even now in time of war. In fact, the primary concern in the current economic downturn is to get consumer spending going again even as two wars grind on.

As long as even those who agree that an energy transition is necessary have wildly differing timetables, the needed changes will limp along at a snail's pace. It seems that only a catalyzing event, something as compelling and clear as America's entry into World War II, can now bring about a rapid energy transformation. It's hard to imagine what would be more compelling than a disastrous and failed war in the Middle East, $150 a barrel oil last summer, and now economic freefall. But the public and the vast majority of policymakers have not made the connection.

If they finally do, the now unfolding economic hardship could become the basis a vast public works program aimed at a rapid and successful energy transition, something at least an order of magnitude larger and far more comprehensive than is currently being contemplated by the incoming Obama administration. But that would mean that America could no longer be about mere consumption, a change that would require a true leap of faith.

Friday, November 14, 2008

Higher lows

(I am posting early this week since I am leaving today for the Conference on Michigan's Future where I will be presenting.)

Back in February in a piece entitled "Do High Commodity Prices Speak for Themselves?" I wrote that the emerging spike in commodity prices would tell us less about resource depletion than prices during the inevitable bust. I observed:

The real price of commodities has been going down for more than a century. This is because the race between technology and resource exhaustion has been been won decisively by technology. Whether that will continue is now in question.

One indicator will be to see not what new highs are achieved in various commodities in the coming years, but whether a new floor is established that is significantly above previous historical real prices. In other words, higher lows will be more indicative of our situation than higher highs which are usually a very temporary phenomenon.

Well, the bust has arrived much sooner than I anticipated. So, now seems like a good time to evaluate. To be sure, commodities--which have already taken one of the worst drubbings ever--may have further to fall. But the glee with which their fall has been greeted may be obscuring what current prices are telling us.

Let's look at crude oil. At its peak this summer oil sold for $147.27 a barrel. As I write, crude for December delivery sits at $56.16. That's a decline of 62 percent. But it's a different story if we compare the current crude price with its previous bear market low. On December 10, 1998 crude oil on the New York Mercantile Exchange closed at $10.72 a barrel. Today, even after a precipitous fall in prices, oil remains 424 percent above the previous bear market low.

How about copper? It reached an all-time high on May 5 of $4.26 per pound. As I write, copper for December delivery sells for $1.65. That's a drop of 61 percent. In late 2001, however, copper prices were hovering around 60 cents per pound. That means that even the latest power dive in the price leaves copper 175 percent above its previous bear market lows.

Foodstuffs don't look all that much different. Sugar, for example, was hovering around 4 cents a pound in early 1999, but vaulted to 19.73 cents by February 2006. As I write, sugar for March delivery sits at 11.61 cents. That's a fall of 41 percent leaving sugar still 190 percent higher than its previous bear market low.

Of course, we may just be seeing a pause in the commodity bull market that began way back in late 1998. The average span for such bull markets in the past century has been about 17 years. On the other hand, if we go into a long economic slump, but commodity prices never return to their lows, we may chalk that up as another indication that depletion may be stealing the march on technology.

Of course, we can grow more sugar if we decide to expand our acreage or increase our inputs. (That's assuming that the fossil-fuel inputs will be readily available and that we have adequate water and fertile soil, both of which are being depleted by modern farm practices.) We cannot, however, grow more copper or more oil. We may figure out how to get leaner and leaner ores to yield copper. And, we may be able to get more difficult-to-extract deposits of petroleum to yield their oil. The key question is whether this will take a rising portion of society's total effort to do so. If it does, that may mean depletion has begun to overwhelm our technological prowess. And that could mean that we need to find other ways to meet our needs for minerals and energy.

Of course, we can deploy renewable sources of energy. And, we could fully recycle all key metals. But these steps would require practices and an infrastructure much different from what we currently have. And, the changes would have to be put in place long before we reached critical shortages in order to avoid large disruptions in our economic life.

Sunday, November 09, 2008

The (Not So) Invincible Society

My latest column on Scitizen entitled "The (Not So) Invincible Society" has now been posted. Here is the teaser:

Policymakers and the public think of modern industrial society as being resilient and durable. Are they right?
.....Read more

Governing the ungovernable

Some of my acquaintances have been saying for a long time that President George Bush has been leading the United States toward fascism. I have responded that they should be more concerned about anarchy than authoritarianism. For starters, the anti-authority gene runs deep in American culture. But I'm also in the same camp as peak oil Jeremiah James Howard Kunstler who believes that the "federal government will be lucky if they can answer the phones five years from now, let alone regulate anybody's life." Just recall how effective the federal government was in responding to Hurricane Katrina!

I have been dwelling on this in the celebratory aftermath of Barack Obama's election victory. (Full disclosure: I voted for him.) I think that those who supported Obama have reason to celebrate, especially for the way in which he was able to spread blue all over the electoral map of the country. Of course, there will be the difficulty of getting legislation through Congress even with increased Democratic majorities. But there is the much more serious problem of trying to govern the country in a time not only of financial collapse, but also of resource stringency.

It may not seem as if resource stringency is a problem. After all, oil prices are less than half what they were a few months ago. But the price decline has little to do with increasing supply. It is primarily due to swiftly falling demand, and that has been the result of slowing economic activity due to the financial crisis. So, even as the economy tries to lift off again, it will all too quickly face the headwinds of limited supply, not only of oil, but also of other critical resources including agricultural products and some base and rare earth metals.

In his first news conference, Obama tried to reassure the public about his focus on and understanding of economic issues by having an army of financial heavyweights stand with him on stage. Now, I don't easily discount expertise. We've had too little of it in government in the last eight years. So-called "common sense" isn't enough when it comes to understanding highly complex systems. But, the global economy may now be far too complex for anyone to understand. Nassim Nicholas Taleb, author of "The Black Swan," says he lies awake at night sometimes wondering how bad things could get. (Much of the current turmoil was foreshadowed in his book.)

That policymakers don't really understand the current economic system has been most clearly demonstrated in the many iterations of the plan for using the $700 billion in bailout funds appropriated by the U. S. Congress. Treasury officials went from proposing that it be used to buy toxic assets from banks, to proposing and then using it to inject capital into banks by buying preferred shares, to working on a plan to inject money into insurance companies and now even a plan to inject money into a wide array of nonfinancial companies. The truth is they don't really know where the levers of the economy are anymore, and neither does anyone else. Add to this that most economic policymakers recognize no environmental limits to economic growth, and you have a recipe for perpetually wrongheaded and perhaps disastrous economic thinking.

Environmental education giant David Orr is fond of saying that as our knowledge grows, so does our ignorance. He is merely speaking the truth about any complex system. His response is to suggest that we employ wide margins of safety to take into account those dangers which we cannot see or understand at present.

Of course, such advice was never taken seriously in the trading rooms of Wall Street which used the risk formulas of what Taleb calls pseudo-scientists, namely, the financial economists and physicists turned financial risk modelers. They assumed they could calculate risks precisely and created charts and graphs and equations to make people feel comfortable.

I am reminded of a talk I gave at Michigan State University, a captive hub for industrial agriculture and now biofuels research. I downplayed the likelihood that biofuels will be able to substitute in any substantial way for petroleum-derived fuels for reasons of scale, resource scarcity (i.e. scarcity of petroleum- and natural gas-based products now critical to modern agricultural productivity and scarcity of water) and soil degradation. One student came up after the talk and wanted to reassure me that my concern over removing crop waste (for cellulosic ethanol) was being addressed. He was working on research to determine exactly how much crop waste could be removed for biofuel feedstock without affecting soil fertility. Anyone who understands how complex soil is and how comparatively little we know about its interactions in the environment will be forgiven for wondering whether we can calculate such things to the fourth decimal place.

But it is possible to calculate or at least characterize some of the damage done to the ability of the next president to govern the United States. During this year's presidential campaign I was reminded of the perhaps apocryphal saying attributed to members of the Ba'athist party in Iraq, the party through which Saddam Hussein controlled the country: "If we don't govern Iraq, nobody will." Years of insurgency in the country illustrate the sentiment.

Here in the United States, the McCain campaign along with its surrogates did their best to suggest to the American public that Barack Obama was a Manchurian candidate, as if he had been held captive in the Rev. Jeremiah Wright's church and brainwashed to act on instructions to destroy the country upon becoming president. Or perhaps Obama better fit the description of a fifth columnist. His almost laughably tenuous connection with one William Ayers was somehow supposed to prove that Obama was loyal to a terrorist creed born out of the 1960s, a decade during which Obama reached the ripe old age of eight. Maybe it was Obama's middle name Hussein which was the giveaway, a fact almost endlessly repeated on the FOX News Channel. The McCain campaign and its surrogates could never make up their minds about which paranoid vision would work, so they tried all of them. It is the kind of appeal so aptly described by Richard Hofstadter in his famous essay, "The Paranoid Style in American Politics."

Of course, none of these approaches yielded victory, but they can only help to make the country more ungovernable. If you voted for McCain believing that Obama is a traitor--rather than merely an American politician with whom you strongly disagree--shouldn't you resist his treason and those who supported it with every fiber of your being? It is wildly irresponsible to make claims of disloyalty against a candidate. Kathleen Hall Jamieson, an ardent student of campaign advertising, had this to say about such claims during a recent interview on Bill Moyers' Journal:

The notion that we would impugn the integrity of a person running for president on the other side, question their patriotism, is something that we all ought to step back from and say that is unacceptable. The evidence that one should have to mount to make that kind of case should be so clear and so overwhelming that it would persuade that person's mother. And for practical purposes, those are charges that are out of bounds.

Now some will say that the Obama campaign ran many negative ads against McCain. And, I must agree that it was questionable that a McCain administration would just be a continuation of the Bush administration, a message that was the main thrust of the Obama ads. But I defy anyone to point to an ad put out by the Obama campaign--and not by some crazy on the Internet--which branded John McCain as disloyal to his country.

The paranoid style which we saw exhibited in the McCain campaign comes to the fore in times of extreme social stress such as we are witnessing now. (By the way, I don't actually think McCain believed his own attacks, but merely saw them as a useful tactic. And, we saw that in an exchange he had with a questioner at one of his rallies. But that doesn't excuse him in my view.) The paranoid style makes it exceedingly difficult to have serious discussions about issues since the motives of those discussing the issues are always suspect.

Even though a serious dialogue about our interlocking financial and resource crises has been somewhat undermined by the paranoid style exhibited in the presidential campaign, I still believe that the nation can have such a dialogue. But I believe it will end up being much more fruitful on the local level. If energy stringency means a turn away from expansion of the global economy and toward more regional and local economies, then it's hard to see how the federal government could play a dominant role in such a transition. The federal government by its very nature is designed to centralize activities rather than disperse them.

While there are certainly actions the federal government could undertake to aid in the move to a decentralized economy, it seems unlikely those actions would take the right form. For example, if the Congress were to move to expand support of wind and solar power, would it do so in a manner that would make communities more self-sufficient in energy? Or would it emphasize renewable electricity generation by large utilities rather than individual households? I am fairly certain that federal policy would favor the second approach over the first.

And, this brings me to my final point. The reason I call this piece "Governing the ungovernable" is that I believe the problems we now face will not be solved at the central government level. They might be mitigated or exacerbated, but not truly solved. In essence, the world as currently constructed has become ungovernable. So, along with new ways of living, we must find new ways of governing, and I believe those new ways will emphasize the local and the regional over the national or the international.

This tempers my enthusiasm for the new administration about to take power in Washington, one with whom I already have many disagreements especially in the area of energy policy. To the extent that Barack Obama and the team he assembles inspire and empower people to act in their own communities to address energy stringency, climate change, food self-sufficiency and the repercussions of the financial meltdown, the next administration will succeed. But the real successes will have to be imagined and implemented closer to home.