By Gail Tverberg: Debt: The Key Factor Connecting Energy and the Economy

Another insightful essay by Gail Tverberg…

There are many who believe that the use of energy is critical to the growth of the economy. In fact, I am among these people. The thing that is not as apparent is that growth in energy consumption is dependent on the growth of debt. Both energy and debt have characteristics that are close to “magic,” with respect to the growth of the economy. Economic growth can only take place when growing debt (or a very close substitute, such as company stock) is available to enable the use of energy products.

The reason why debt is important is because energy products enable the creation of many kinds of capital goods, and these goods are often bought with debt. Commercial examples would include metal tools, factories, refineries, pipelines, electricity generation plants, electricity transmission lines, schools, hospitals, roads, gold coins, and commercial vehicles. Consumers also benefit because energy products allow the production of houses and apartments, automobiles, busses, and passenger trains. In a sense, the creation of these capital goods is one form of “energy profit” that is obtained from the consumption of energy.

The reason debt is needed is because while energy products can indeed produce a large “energy profit,” this energy profit is spread over many years in the future. In order to actually be able to obtain the benefit of this energy profit in a timeframe where the economy can use it, the financial system needs to “bring forward  some or all of the energy profit to an earlier timeframe. It is only when businesses can do this, that they have money to pay workers. This time shifting also allows businesses to earn a financial profit themselves. Governments indirectly benefit as well, because they can then tax the higher wages of workers and businesses, so that  governmental services can be provided, including paved roads and good schools.

Debt: The Key Factor Connecting Energy and the Economy

Gail argues that growth in energy consumption is dependent on growth in debt.

I agree this is true today, but I think a dependency in the opposite direction existed in the past, namely that growth in debt was dependent on growth in energy consumption.

It seems that when Energy Returned on Energy Invested (EROEI) is high, debt growth depends on energy growth, and when EROEI is low, energy growth depends on debt growth.

Tim Garrett showed that economic growth requires energy growth.

We can therefore restate this as when EROEI is high, debt growth depends on economic growth, and when EROEI is low, economic growth depends on debt growth.

There is a maximum limit to the ratio of debt to income, even at near zero interest rates.

This means we could not have built industrial civilization if the cost to extract fossil energy started out at today’s high level.

It also means that industrial civilization will collapse.

Another way to think of this is to recognize that debt is a claim on future energy. When total debt becomes larger than the available income can service, the debt defaults and becomes worthless. Which means the energy we expected in the future will not exist.