Tuesday, February 24, 2009

Fractional Reserve Banking and Growth

Very busy week (I guess I can't complain about having more work than I can easily deal with!). As a result, unfortunately, just another quick thought for this week's post (and a day late, at that):

I've just finished reviewing "Crisis of Civilizatoin," a new book by Nafeez Mossadeq Ahmed of the Institute for Policy Research and Development, a London-based think tank. It's an outstanding book, and one that I will review properly on this blog when published and available to the public. In the mean time, however, I want to briefly discuss a comment made by Mr. Ahmed on fractional-reserve banking.

For the past few weeks, I've been hinting that I'm going to return to the causes of our civilization's demand for perpetual growth (formerly discussed in The Problem of Growth). One element, that I hadn't properly considered before reading Mr. Ahmed's book, and that I must now consider more carefully, is the role of fractional-reserve banking.

Put simply, by lending out at interest more "money" than a bank has deposits, the bank creates a situation where significantly more money must be repaid than was borrowed. In order to generate this difference, the community is forced to put the money to growth-oriented tasks, rather than merely borrow money now and save to pay it back. So the firm that borrows money must use it to finance growth--in production, consumption, etc.--in order to generate the money necessary to pay back the principal plus interest. This is fairly straight-forward, of course, but the systemic result of the practice of fractional-reserve banking, when spread throughout society, is that society as a whole must grow in order to have enough incrase in "wealth" to be able to repay its lenders.

Wouldn't simple interest cause this same problem, without considering fractional-reserve banking? The discussion on the rationale behind the prohibition on usury is best left for another day, but the bottom line is that fractional-reserve banking is more than a mere escalation on the catalyst for growth caused by interest alone. Interest is, in theory, equal to the opportunity cost of the lender (as in, the value of what the lender could do with the money) plus the risk of non-payment. So if a lender lends at interest, they are not really creating a catalyst for growth by the act of lending, because it could have used that money for a growth-oriented purpose itself. In actuality, they are only redistributing capital to where it can work more effectivley, and facilitating economic efficiency. Fractional-reserve banking, on the other hand, allows the lender to create far more growth than he himself could have created by putting his own capital to use.

Food for thought for the time being, more on this in the near future...

Tuesday, February 17, 2009

Satellites & Feedback Loops

A bit off topic for today, but unfortunately I don't have time this week to get back to the core topics of growth and hierarchy:

Most newspapers and news broadcasts carried a brief segment on last week's satellite collision. The interesting part of this story, from my perspective, is that the vast majority of the news coverage failed to even mention the existence of a positive feedback loop at work in "space junk."

With last week's collision, there are at least 2,000 new pieces of debris in orbit around the Earth--junk that will remain in orbit for decades, and that was not intentionally placed in safe orbits. The result: each of these 2,000 pieces is far more likely than planned satellites to be involved in another collission.

It's a bit like the classic grade school science film explaining fission: a gymnasium full of mousetraps with ping-pong balls positioned on top. You trip one mousetrap, and the ping-pong ball bounces about, triggering several more--a chain reaction begins as each fo these ping-pong balls, in turn, trigger several more traps, until the entire gymnasium is filled with a cloud of bouncing balls.

Earth is currently surrounded by a very sparse cloud of man-made objects. However, each of these is relatively large--in the event of a collission, each can break down into thousands of smaller objects still capable of destroying another spacecraft. With every collission--like what happened last week--a positive-feedback loop is reinforced. Impacts beget more impacts, until eventually this sparse cloud of large objects is a dense cloud of small objects. The potential result: low and medium-earth orbit satellites are no longer viable systems, and it is increasingly difficult to launch higher orbit satellites because they must still cross through this deadly cloud.

While I think the potential to eliminate every system that relies on satellites is very significant, I think it's more significant that our civilizational discourse is so ignorant of feedback loops that the topic simply isn't being discussed. We can live without satellites. Whether or not we can survive long without a basic and widespread awareness of systems theory remains an open question...

Monday, February 09, 2009

Mechanics of Future Oil Price Volatility (A Flubber Cobweb)

I previously examined the interface between peaking oil supplies and oil price volatility as a predator-prey system. With the rapid drop in oil prices, it’s time to add another wrinkle to that story: widespread acceptance (psychosis?) about the stability of high oil prices acted as a damper on oil price volatility. Now that a collapse in oil prices is more than a mere theory, oil markets are poised for a long-term increase in price volatility.

The fundamental problem facing oil markets at present it this: while present supplies are sufficient to meet present weak demand, these sources of production face rapid decline. The current low oil prices are not sufficient to support the long term investment in future supplies, conservation, and consumption efficiency that will be necessary to mitigate the impact of this decline. Because of the time-lag between a sufficient price signal and oil reaching the market (or demand being reduced), and because of the impact of the recent price collapse on producer psychology, volatility will rapidly incrase as the market's price signal must make increasingly exaggerated moves to bring supply and demand into equillibrium.

Without ongoing investment to support present production levels, production decline rates will accelerate

Figure 1: This graph, from Merril Lynch, shows that reduced capital expenditure will have a sharp impact on field decline rates, but assumes this impact will diminish as our economy recovers and capital expenditure picks back up…

There are two key issues here:

1) The market’s price signals react over much shorter time-spans than new supplies or investments in conservation or efficiency can be brought to market. Depending on the specifics, it can take anywhere from 2 to 10+ years to bring a new oil-field into full production. Therefore, even when oil was at $147/barrel, oil producers couldn’t immediately realize profits from oil that would only cost $100/barrel to produce. The same is true with many efficiency and conservation measures—while the most elastic demand (e.g. Summer driving vacations) can be reduced rapidly, other conservation and efficiency efforts take much longer. Electrified rail takes years to fund and build out, and the gradual upgrade of the fuel efficiency of our vehicle fleet (or the replacement with electric vehicles) requires years of consistently high fuel prices or efficiency regulations that generally don’t take effect until several years in the future.

2) Our recent market experience—a rapid crash in prices—undermines efforts at long-term investments in supplies. At $150/barrel, oil companies were willing to invest billions in new projects that, several years in the future, would bring production on line at a cost of $50, $60, or even $80/barrel. Because of the time-value of money, and because our energy futures markets are incapable of economically hedging entire oil megaprojects a decade or more into the future, oil companies needed to leave a large price cushion. $150/barrel oil did not justify a ten-year lead time to produce oil that would cost $140/barrel, even under the assumption that oil would remain at $150/barrel. This cushion shrank some during the (relatively) steady increase in oil prices from 2001 – 2008, and oil companies’ willingness and ability to finance these projects increased. But now that the price of oil has crashed from $150 to $40/barrel, the prospect of a sudden drop in price is more than a mere possibility.

The result of this will be long-lasting: if oil prices again reach $150/barrel, there will be much greater reluctance to invest in long-range projects to produce oil at even $50 or $60/barrel. Similarly, the cost and availability of financing such projects has been dramatically reduced by the credit crunch. The result is that the more aggressive producers—those with the least cash and greatest incentive to take risks—are the least able to finance such projects. Those with the greatest ability to undertake such projects—select oil majors and many national oil companies—are also the most conservative and least willing to risk embarking on long-term, expensive production projects.

Continually Increasing Price Volatility

The principle results of this time-lag and shift in producer-psychology is that price signals must become increasingly over-exaggerated to create the desired market effect. The level of interest and willingness to invest in oil production that was spurred by 2008’s $100+ oil prices will not be regained if oil again hits $100 or $150—it may be necessary for oil prices to hit $200, $250, or more to provide an adequate incentive for oil companies to invest in oil with a $50+ cost per barrel.

And, even when the price level necessary to spur sufficient investment is reached, the resulting production will not come on line immediately. Instead, it will take several more years to reach the market. During this time-lag period between sufficient price signal and new oil reaching the market (or new demand being destroyed), prices will continue to move and push this market signal. If oil at $100/barrel is sufficient to incentivise investment in oil production to meet then-current demand, the market will continue to push the price signal past $100/barrel, especially as geological depletion continues to grind and the incentives for geopolitical disruption continue to rise.

As a result of the price rise during this time-lag, more production investment decisions will be made, and more demand will be destroyed, than was actually necessary to reach an equilibrium point. The result will be an inevitable overcorrection and price crash, restarting the price cycle. With each successive boom and crash cycle, the market psychology will become increasingly resistant to a given move in the price-signal, and the degree to which the price signal must move to create an equivalent market effect will increase. This will result in continually increasing price volatility as the market swings wildly to reconcile the ever moving targets with production and demand.

A Flubber Cobweb

The time-lag between market and fundamentals is exacerbated by inadequate futures markets and our own psychology. On a general level, this is a common process in economics, described by the cobweb model:

Figure 2: A classical economic “Cobweb Model” of supply and demand

This model shows a supply/demand spiral characteristic of a market searching for equilibrium in a steady-state environment—it is NOT characteristic of oil prices in a post-peak environment. Rather, once oil production has peaked, the spiral will work in the opposite direction with increasingly divergent P and Q brackets.

Under peak oil theory, Q must gerally decline, even if there is significant noise present. From a civilizational-perspective, I think there will be a great deal of information carried by what happens to P as Q approaches zero: If P1 and P3 diverge or generally trend higher as Q approaches zero, this may show a sign of fundamental economic strength in the face of peak oil—perhaps indicating that the realized EROEI of alternative energy supplies is sufficient to maintain a global-industrial economy. However, if P1 and P3 converge or generally trend lower as Q approaches zero, then I see this as the dimming of global-industrial system.

One important note: I don’t think that these values carry meaning when measured simply in absolute dollar values—inflation, deflation, and other currency games introduce too much distortion. Rather, I think a measure of the dollar price of oil as a percentage of median national and global incomes (in dollars) will carry much more meaning when measuring the divergence or convergence of P1 and P3 going forward.

Add in declining supply due to geological and geopolitical peak oil and increasing global population and oil price volatility will rapidly accelerate over the next decade.

Discussion Questions:

1. How will this system interact with the global economy (itself a key driver of demand and cyclic in nature)?

2. Will oil price volatility be primarily characterized by increasing spread between price highs and lows, by a shortening of the period between highs and lows, or by some combination of the two?

3. This article suggests that oil price volatility will continually increase. At the same time, I generally criticize other theories that argue for perpetual increase (in population, GDP, resource consumption, etc.). Clearly, at some point volatility must either (1) slow or decrease, or (2) reach a functional maximum at which point market signals are reduced to meaningless “trading noise” and the market function ceases to provide utility. Which result, and why? In the spirit of Kurzweil (link) or Moore’s Law (link), does this process lead inevitably to the end of markets? Half in jest, what if the causal mechanism of the Maya 2012 hypothesis (or insert your favorite apocalypse meme here) is simply global markets grinding to a halt as prices cease to carry meaning and we can’t find a way to reverse the complexification that caused this?

**In light of these three concluding questions, I hope that it is clear that I am not intending to argue some fundamental “truth” with regard to ever-increasing price volatility, but rather that I’m using that argument to set up the three concluding questions (which I consider much more interesting and important in the long-run).

Sunday, February 08, 2009

Emergence 3: Emergence and Collapse

The Oil Drum ran a post last week discussing complexity and collapse which briefly touched on the notion of emergence.  I think it's illustrative of the failure of theories of social complexity to address emergence, and to distinguish between strong and weak emergence.

I am increasingly of the opinion that the crux of understanding the behavior of social complexity is understanding emergence--both what it is, how it works, and what actions are available re: emergence. My first two posts in this series address the nature of emergence and the difference between weak and strong emergence.  In short, there may be two very distinct types of phenomena labled "emergence":
1. Weak emergence: these are systemic phenomena that are theoretically reducible, but not practically reducible due to complexity. Most complexity theory (e.g. modeling, simulation, system laws, etc.) study this form of emergence without noting the differentiation with:
2. Strong emergence: these are systemic phenomena that are fundamentally not reducible, but that are ontologically distinct and can exert downward causation on the system from which they emerge. A possible example is consciousness (though the theoretical problem with strong emergence is that, until we understand *how* it works, we can't rule out that we just haven't yet learned how it is reducible--e.g. what were once viewed as emergent properties of elements seen in the periodic table now appear to be reducible to quantum mechanics). Complexity studies, for the most part, ignore strong emergence, or fail to differentiate strong vs. weak.
Why is this relevant to the question of complexity in civilization and the question of collapse? I think there is an important interface between emergence and the collapse of complex societies as noted by Joseph Tainter and others.  Viz., that one evolutionary strategy for managing complexity is hierarchy, this is the strategy that has dominated human history because it allows centralized control over the complexity, but it also tends to result in collapse because hierarchies are structurally driven to growth and intensification. In contrast, complexity can be managed by the system via emergence, but this removes control from the center. One function of intensification of [hierarchal] complexity is to deal with information management and coordination. However, if consciousness is a guide, this may also be possible via (strong?) emergence in a decentralized system rather than via hierarchy. Such systems could manage complexity, could optimize functioning over time, but without intensification, therefore removing the driver of collapse. Compare, for example, the information processing and coordination function of hierarchal systems with something analagous to "synchronicity" as a strongly emergent coordinating and information processing phenoemenon. The role--and more importantly potential future role--of strong emergence in human systems has been almost entirely ignored.

Any general law of complexity, and any attempt to apply complexity theory to social systems must address emergence directly, and in my view must specifically address the distinction between weak and strong emergence.  I think that current writing on complexity theory, especially as it applies complexity theory to civilization, almost entirely fails to consider the role and impact of these key features.  My writing going forward with this series will be an attempt to address that gap.  Unfortunately, while I hope to continue some kind of posting for the next three weeks, anything requiring more than about 15 minutes effort is unlikely before March 15th...

Readers may also find my litigation checklist of interest.

Monday, February 02, 2009

Peak oil: a symptom, not a cause

Is peak oil--the inexorable decline in global oil production--a cause of our troubles, or merely a symptom of a deeper cause? I think it's the latter.

What is the ultimate cause of our troubles? In my opinion, it is the hierarchal nature of our society. As I discussed in my essay, The Problem of Growth, a terrain consisting of competing hierarchal structure requires that these structures continually work to grow and intensify; the resulting symptom of a requirement for perpetual growth drives both our increasing consumption of non-renewable resources and our FIRE-bubble economy (Finance, Investment, and Real Estate); peak oil, in turn, is a symptom of our non-sustainable use of resources.

There is a temptation to say that the financial crisis has debunked peak oil theory, that the financial crisis delayed the peaking of oil production (or is somehow masking it), that the financial crisis was caused by peak oil, etc. In my opinion, it's much more accurate and informative to point out that both the financial crisis and peak oil are symptoms of a deeper cause, and that this cause--the fundamental structure of our society--is really what must be addressed. The corollary, of course, is that we can't solve the financial crisis or peak oil because they are symptoms, not causes. Instead, we must search for ways to address our fundamental mode of organization...

It's worth noting that some people disagree with my assertion that our civilization's drive for perpetual growth is caused by our hierarchal mode of organization. I'm not intending to defend this logical leap here (see The Problem of Growth for an initial explanation, but I fully admit the theory needs more work). Even if I'm wrong, that still doesn't make the financial crisis or peak oil causes in and of themselves--they are still the symptom of our civilization's drive for perpetual growth (whatever it's ultimate cause may be), and therefore they are the wrong level at which to attack the problems they cause.

First principles: we need to identify the cause to our problem before we can effectively address it (I'm avoiding "solve" here because that suggests some singular, univerally-agreed objective). Our civilization's drive to growth is, again, only a symptom. What is its cause? This, I think, is the key question confronting humanity at present. I may be right that it is our overemphasis of hierarchal structure--and I'll make that argument in more depth in the coming weeks. However, if I'm wrong, that doesn't change the principle that we must identify the root cause in order to rationally proceed...

Sunday, February 01, 2009

Emergence 2: Weak vs. Strong Emergence

Modern study of emergence tends to separate "emergence" into two broad categories:  weak emergence and strong emergence.  This distinction is made by Mark Bedau, among other commentators.  The differences between the two species of emergence are significant.

Strong emergence:  This is the species of emergent discussed in the first post in this series--an emergence that is ontologically separate from its microstructure, not derivable from that microstructure, and capable of exerting downward causation on the functioning of that microstructure.

Weak emergence:  Weak emergence is the set of phenomena that is theoretically reducible to the known laws governing the microstructure, but where the calculations required to predict the resulting phenomena are so complex as to be effectively impossible.  Instead, with weak emergence, these calculations are carried out by means of simulation.

This study of weak emergence, also called more broadly the study of complexity, is seen in the (overlapping) modern disciplines of systems theory, neural networks theory, dynamical systems theory, agent based modeling, complex adaptive systems, etc.  One of my favorite authors, John Holland ("Hidden Order" and "Emergence") discusses this form of emergence.

The study of strong emergence has been less fruitful, so far, in science, perhaps because like weak emergence, it is not practicably reducible, but unlike weak emergence, it is also (so far) not capable of simulation.  Strong emergence--as is pointed out by many of its critics--is primarily either a subject of philosophical discourse or it is narrowly useful as a theory of human consciousness that really hasn't changed much since Roger Sperry's groundbreaking theory of consciousness in 1969.

For this blog, and the theory of Rhizome, are we interested in the effects of weak or strong emergence?  In my mind, the answer is clearly "both."  There is little doubt that human systems, evolving civilization, group dynamics, and economic dynamics exhibit weakly emergent traits.  The study of weak emergence, therefore, will likely give us insight into the operation of these systems, how to shape them, and the viability of alternative structures.  My theory of Rhizome communication, for example, and its information processing and economic coordination capability, can be compared to the capabilities of more hierarchal structures by way of simulation.  The functioning of these various structures are fundamentally reducible to known and understood interaction of their microstructure, but the resulting calculations are simply not feasible, and therefore the study of weak emergence may offer useful insights into their functioning.  I am also, however, interested in the potential strong emergence in human civilization.  Even if strong emergence exists nowhere but human consciousness, that alone is interesting enough to warrant further exploration--at a minimum, there is the question of whether a "weakly emergent" phenomena like human civilization and economics can be meaningfully separated from the strongly emergent consciousness present at each individual human component in the microstructure...

Intuitively, however, I think there is a good chance that strong emergence plays a much more significant role beyond human consciousness--in group dynamics, communication, cultural trends, and economic coordination.  This is where I think emergence has something fundamentally new and valuable to teach us--beyond what we can learn from studying complex human systems through the lens of weak emergence.  What exactly this influence of strong emergence is I do not know--one reason I find this so fascinating is that it is a possibility that is simply not being studied or considered.  The possibilities seem endless.  I do, however, have a theory, specifically pertaining to the influence of strong emergence on coordination and information processing.

My theory is that, just like human consciousness (which I presume to be strongly emergent) offers superior coordination and information processing capabilities when compared to non-strongly emergent coordination and information processing (such as computers), I think that strongly emergent phenomena in economic coordination, dynamic network structuring, and human communication may dramatically increase the efficiency of operation of human systems that foster strong emergence.  Such strong emergence may be present to varying degrees in our current economic and political systems, but my hunch is that structures designed to better foster strong emergence would leverage these effects to a much greater degree.  Specifically, as I hinted at in the first post in this series, decentralized but well connected networks (e.g. Rhizome) that mimic the connectivity of the human brain may, like the human brain, foster strong emergence.  Hierarchy, on the other hand, may actually act to dampen strong emergence--in fact, one of the main evolutionary features of hierarchy in human civilization may be that, by dampening strong emergence, system control is maintained at the top of the hierarchy, rather than ceded to some degree to a strongly emergent and ontologically distinct phenomenon.  These ideas are, of course, still very fuzzy, difficult to articulate, and poorly supported, but the potential here makes them worthy of further investigation in my opinion.

While strong emergence may not be subject to study by simulation, as weak emergence is, I think it may be replicable.  That is, if we accept that strong emergence is derivative of an underlying microstructure, then by replicating that microstructure, or at least the salient features of that microstructure, it may be possible to foster strongly emergent phenomena.  This has always been an influence in the theory of Rhizome--largely unstated until now because I haven't had the tools to explain why this was anything more than intuition and speculation on my part.  While I think Rhizome, as a theory, is valid even if there is nothing more than weak emergence in this world, the potential to leverage strong emergence may make the theory even more robust.

Readers may also find my litigation checklist of interest.