The Economy Is Like A Circus

The economy is like a circus. It comes to town, and eventually it leaves town. We get paid in tickets to this circus. As long as the circus stays in town, we can use our tickets. Once the circus leaves town, we are pretty much out of luck.

The reason the circus stays in town is because the economy stays in sufficient balance that the economy can go on. This is much like the way many other self-organized systems function. For example, our bodies continue to function as long as there are suitable balances in many different areas (oxygen, food, water, air pressure). Ecosystems continue to function as long as there is sufficient rain, adequate temperatures, and enough sunlight.

There are many different views as to what limits we reach in a finite world. Some people think we will “run out” of oil, or of energy products. Some think that the energy return will fall too low, as measured in some manner. I see the adequacy of the energy return as being very much tied to the financial system. Thus, the forecast by US Atlanta Fed GDPNow indicating that first quarter 2017 US GDP growth will only be 0.5% is likely to be a problem, assuming it is correct.

Our economy operates on economies of scale. Once we get too close to shrinking, or actually start shrinking, we reach a point where the economic circus starts to leave town. At some point, we will discover the circus is gone. The economy we thought we had, will have left us. If some people are survivors, they will need to pick up the pieces and start over with an entirely new system.

What the Economy Needs to Do to Keep Functioning

For our economy to continue functioning, a number of variables are important:

Prices of commodities – Prices cannot be too high for the consumer to afford goods made with them. They also cannot be low for producers. If prices of oil and other commodities are too low for producers (as they are now), producers need to keep raising debt levels to stay in business. There is a risk that production will stop from lack of adequate new investment, or from bankruptcy of producers.

Wages of non-elite workers – These wages need to be high enough so that workers can afford goods made with commodities, such as cars, homes and computers. These big purchases tend to use commodities even after they are made, adding to “demand” for commodities. If commodity prices such as oil are too low (as they are now), it is likely related to inadequate wages of non-elite workers.

Mandatory payments required of non-elite workers, such as taxes, health care, and education – It is not just wages of non-elite workers that are important. So are required payments, such as payments for taxes, healthcare and education. Clearly, the lower these payments are for non-elite workers, the better the economy functions.

Interest rates – Low interest rates are helpful for some parts of the economy, while high interest rates are good for other parts. Low interest rates help create affordable monthly payments for goods such as homes and cars. If interest rates decline, the market prices of assets such as real estate, shares of stock, and bonds tend to rise. These rising values are of great benefit to owners of these assets, since they can sell these assets and use the proceeds to add to current consumption. Conversely, high interest rates are important to pension plans and to others depending on investment income. Banks have a problem if there is not a big enough “spread” between short and long interest rates.

Increase in debt – An increase in debt indirectly makes the economy “look” much better. Increasing debt acts to raise wages, since some of this growing debt adds to funds available for wages. The higher wages tend to increase demand for goods, and thus indirectly raise commodity prices. A virtuous circle starts, pushing up economic growth, provided an adequate quantity of very cheap energy products is available (under $20 barrel oil, for example) that can be used to make goods and services. Increased debt works less and less well, as the price of energy products increases.

Inflation rates – The higher the inflation rate, the easier it is to repay debt with interest, since most debt is not adjusted for inflation. Also, high inflation rates help keep prices of homes and other buildings from falling as they age, making the use of mortgages more feasible. If the price of a commodity, such as oil or coal, is high and then falls, debt based on the prior high value of the commodity is likely to become a problem.

Quantity of energy products affordable by economy – It takes energy products to produce goods and services. If the price of commodities is low, it is possible for buyers to purchase a large quantity of these products, even on a low budget. Current relatively low prices tend to help the economy, even if producers cannot afford to make adequate investment in new production with such low prices. Thus, today’s low energy prices make the economy look good for at a short time. Afterwards, the outlook is less rosy.