14 April 2014

Peak Coal

Properties
Comments about coal are usually not complimentary. Despite our dependence on it as a source of heat for electric power generation, environmentalists wish it would go away. On the other hand, advocates like to claim we have more than 110 years of coal left – “at present rates of consumption”. Both sides are overlooking crucial points. Let’s see if we can clarify the future use of coal as a fossil fuel resource.

To begin with, it is important to understand not all coal is of equal quality. When I was in grade school, we lived in a house that had a coal furnace. For those who could get it, the coal of choice of home heating applications was anthracite coal because it was the cleanest burning form of coal and provided – ton for ton – the most heat. Unfortunately, we humans have used up most of the readily available anthracite coal. Future consumption will depend on the other three kinds of coal: bituminous, sub – bituminous and lignite.

Most of the commonly produced (and consumed) coals are of two types:

·       Bituminous coal or black coal is a relatively soft coal that contains a tarlike substance called bitumen. It has a 45% to 86% carbon content. Although primarily used for steam powered electricity generation, high quality bituminous coal can be converted to a coking coal used in the production of steel and iron.

·       Sub-bituminous coal contains 35% to 45% carbon. Like bituminous coal, it is primarily used for the generation of steam powered electricity.

Other applications for bituminous coals include their use as a source of heat for kilns in the manufacture of cement and brick, heat for the smelting of metals, and as a source material for the manufacture of liquid fuels, methanol, fertilizer, shingles, and the coal tar we use for the manufacture of plastics, perfumes, mothballs, medicine, dyes, explosives and flavorings.  There are even a few coal fired steam locomotives in use.

As we use these coals up, what we will have left is a soft brown combustible sedimentary rock of relatively low heat content called lignite. Used as a steam coal to produce electricity, lignite has a low carbon content (25% to 35%). Because it contains relatively high quantities of ash and moisture, lignite is often called the “dirty” coal.

It is the carbon content of coal that supports the combustion process. The higher the carbon content, the greater the heat value per ton. Coals are also graded according to plasticity, and their moisture, volatile, ash, sulfur and chemical content. The values in the following chart are an approximation of ranges.


Generally speaking, power companies want the lowest ash and sulfur content, as well as the highest heat value per ton. That fact tends to favor the consumption of bituminous coal over sub-bituminous coal, and both of these coals over lignite. From 1992 through 2012, the total world heat content per ton of the coal we humans consumed fell by more than 10 percent. This means that as we become more dependent on the consumption of coals of lesser heat value, the rate of actual consumption (in tons) will have to increase in order to provide the same amount of heat energy.

Resources and Reserves
Although these two terms are often used as though they are interchangeable, they have very different meanings when we are discussing fossil fuels. The term “resource” refers to the maximum quantity of coal that exists on our planet, irrespective of density, form or location. Coal resource estimates vary widely (up to 11 trillion tons), and are the source of some confusion since many infer that all of this coal can be produced. Compared with current production, there are many who believe our coal reserves will last “forever”.

Unfortunately, most of these “reserves” are useless. We have the same logistics problem with coal that we have with oil. The resource base is far larger than the quantity that is technically and economically recoverable. Coal is embedded in other material (often multiple seams of other overlay), may exist far below the surface of the earth, and may occur in small quantities, irregular pockets, or thin layers that make production impractical. We expect some of this resource base (how much is unknown) is under the ice and oceans that cover vast areas of our planet. In order to produce coal, we must first find it and exploration is an uncertain undertaking. And finally, even if we find a seam of coal, it may not be technically or economically or politically feasible to go into production.

After the elimination of useless deposits, my guess (WAG) is that we humans have inherited approximately 3.4 trillion tons of coal. Of this, perhaps 1.1 to 1.3 trillion tons will eventually be produced.

 And that brings us to reserves. When we talk about reserves there are possible reserves (it is possible they will be found and produced), probable reserves (we think we know where they are and believe they can be produced) and proved reserves (the location, size and characteristics of the coal deposit are known and have been evaluated).

According to World Energy Council data, we have proved reserves of over 400 billion tons of anthracite and bituminous coal, and over 450 billion tons of sub-bituminous and lignite coal left on our planet. The term “proved reserves” usually refers to those quantities of coal that geological and engineering information indicates with reasonable certainty can be produced in the future from known deposits under existing economic and operating conditions. In the following graph we can see that Europe and Eurasia have the largest proved reserves (35% by tonnage), followed by the Asia Pacific region (31%), and North America (28%). Most of the coal in the Europe Eurasia region can be found in Russia, Germany, Ukraine, and Kazakhstan. If Russia takes over the Ukraine and effectively dominates Kazakhstan, it will control 26 percent of the world’s proven reserves of coal.


Higher prices for coal and evolving technology will increase our calculation of economically proven reserves. If my coal resource “guess” is approximately correct, we have 850 billion tons of proven reserves, 200 billion tons of probable reserves, and 250 tons of possible reserves left to consume on our planet. Fair warning: these are optimistic projections.

Proven reserves are broken down by type of coal in the next graph. Seventy percent of the coal found in Europe and Eurasia, 40 percent of the coal in the Asia Pacific region, and 54 percent of North American coal resource base is of lower quality sub-bituminous and lignite coals.



Consumption
World coal consumption has been increasing, and reached 3730 MTOE (Million Tons Oil Equivalent) in 2012. The largest national consumer is China. There was a slight decline in coal consumption within the United States and Europe from 1992 through 2012. Consumption within the Asia Pacific region, however, increased by 38 percent from 1992 through 2002, and 119 percent from 2002 through 2012. China now consumes more coal (50.6 percent of world consumption) than all other nations put together. That means, of course, China also pollutes the air with more combustion products from the consumption of coal than any other nation. (Note 1) Large coal fired plants are under construction or in proposal stages for many nations including China, India, Germany, Russia, Vietnam, Pakistan, Sri Lanka and on and on. These nations will not stop burning coal because they cannot stop. The consumption of coal is embedded in their economic policies.

In addition, over 3 billion people living in poor nations are looking for a better life. That means they need more steel (processed using coking coal), and a lot more electricity. One of the criticisms of the recent IPCC report is that it would seem to condemn people who happen to live in a poor nation to irreversible poverty – because the IPCC recommendations would severely limit their access to electricity. Thus while some Western nations may temporarily reduce their consumption of coal, international demand will increase – most notably in the Western Pacific region.



In the following graph, we can see how Chinese coal consumption (72%) dwarfs all other nations in the Asia Pacific region. National governments, particularly in China and India, are committed to economic expansion. China’s consumption of electricity is expected to increase, on average, by five percent per year through 2030. Although it is planning to reduce its reliance on coal for future power generation, China will likely build more than 300 new coal fired plants with a total capacity of 350 – 450 GW over the next 10 to 15 years. Japan is likely to increase its coal fired plant capacity by 30 percent over the next 10 years to replace, and augment, nuclear power generation. About 60% of India's thermal power generation comes from coal-fired power plants and this capacity is scheduled to expand by 500 GW (111 percent).



Production and Price
Thus far, world coal production has kept up with this dramatic increase in demand. Total world coal production increased by 10 percent in the period from 1992 through 2012, and by 60 percent from 2002 through 2012. World production now exceeds 3845 MTOE per year.



As one would suspect, a growing demand for coal has stimulated higher prices. The United States Central Appalachian index has increased 148% from ~ $29 per ton in 1992 to ~ $72 per ton in 2012. The price the Japanese pay for imported steam coal increased 179% from ~ $48 per ton in 1992 to $ 134 per ton in 2012. Note that coal price increases accelerated between 2002 and 2012. World energy prices for all fossil fuels spiked in 2008, causing food riots in several nations. Coal was no exception even though its consumption had little direct effect on food production. Excess production caused a supply/demand imbalance in 2012 and coal prices subsequently declined in 2013. It is probable that the price of coal will again resume its upward trend before 2016.


The price of coal is probably more elastic than the price of oil or natural gas because most of the direct consumers are either corporations or national governments. These entities pass escalating coal prices on to the consumer in the form of higher prices for electricity and mass produced goods. The pain of higher indirect coal prices is spread over a large base of consumers. However, there are limits to indirect price escalation and we should expect consumers in developed nations to become increasingly interested in energy conservation and the purchase of goods that use less electricity.

We should also be aware that long term coal prices tend to be influenced by the price of natural gas and oil. Oil prices are projected to increase substantially as we approach peak oil, and that will increase national interest in the conversion of coal into motor fuel. This will have an upward effect on both the demand for coal and the price of coal per ton.

Peak Coal
In terms of Peak Coal, we actually will have two peaks: one measured by heat content, and one measured by maximum tons produced. Considering the decline of our anthracite resources, and the increasing production of sub-bituminous and lignite coals, there are those who believe we have already passed Peak Coal based on heat (energy) content.

After we take all of these factors into consideration, and make our assumptions about resource availability, production, consumption, price escalation, consumer behavior, government response, and so on....  we can (with some apprehension) calculate the date of Peak Coal. Between 2012 and 2035 annual coal production will increase by ~47 percent. Production begins to stall around 2030, and the curve flattens through the year of peak production - 2035. Thereafter it declines rather quickly because the remaining reserves are more difficult and costly to exploit. Please note there is a lot of production after 2035. But annual average production decreases with each passing year. We will probably be into the next century before the last nugget is pulled from the ground, and that – of course – is what people think they mean when they say... “We have enough coal to last 110 years”. We will have some coal left, but not enough to satisfy demand. Not even close.


 So... just how good is this prediction? It is not a number I pulled from a hat. It is backed by hours of research and a rather large spread sheet. Never-the-less, there are a few analysts who believe I am being too optimistic. On the other hand, most pundits, particularly those associated with the coal industry, will probably assert I am far too pessimistic. (Note 2)

The strength of this prediction depends on several factors which are unknown and unknowable. For example, there is always the hope we humans will find additional seams of coal south of the equator, or in Siberia, or off shore Australia, or in Canada. In situ coal seam gasification would open up additional offshore and under ice resources as well as onshore reserves to production. If we find a way to exploit an additional 200 billion tons of coal, that would delay Peak Coal by perhaps 25 – 35 years, and move the date of Peak Coal to ~ 2065.
  
So, in the final analysis, we just do not know the date of Peak Coal. We can only make our estimates based on current data that is available to the public. Unless we substantially increase our proven reserves, that information definitely indicates Peak Coal will occur before 2050.

But - I could be wrong. You decide.


TCE

MTOE: The tonne of oil equivalent (toe) is a unit of energy: the amount of energy released by burning one tonne of crude oil.
  
Note 1: China now accounts for more than 27% of world carbon dioxide emissions, followed by the United States (17%), India (5.5%), and Russia (5.1%). American CO2 emissions have fallen by more than 9 percent since 2000. By contrast, Chinese carbon dioxide emissions were up by 168 percent during this period.
Note 2: With special thanks to BP, several national coal agencies, the IEA (International Energy Agency), the IMF (International Monetary Fund), the World Coal Association, and several investment research sites (along with a few blogs).
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10 March 2014

Let the Oil Resource Wars Begin: Russia

For the last several years I have been pointing out the obvious: Russia will use its oil, coal and natural gas reserves as a weapon in any confrontation with the West. Eastern Europe needs natural gas to survive winter cold. Western Europe needs natural gas to survive winter cold. Both depend on Russia for some of their supply. Russia is in a position to squeeze the nations of Eastern and Western Europe any time it wants to force its will on them.

Welcome to the real world. Welcome to the events and trends that will climax with the chaos of Peak Energy. European response to the Ukraine crisis is nothing but diplomatic whining and puffery. What else can they do? The oil and natural gas pipelines run through Russian territory. Russia can turn off the spigot any time it wants to make a point.  European dependence on Russian energy resources is going to increase. That means Putin’s control over the nations of Europe will escalate with each passing year.

The European nations are incapable of drafting and the executing a comprehensive energy plan. Any such plan would have to acknowledge the availability, cost, and use of coal, oil and natural gas. It would have to lay out how these resources would be allocated to each participating nation. Unfortunately for the Europeans, there is too much political and environmental opposition to having a realistic discussion about the source and use of fossil fuels. So the people will suffer.

Putin is ambitious. Russia’s interest in the Crimea and the Ukraine is partially based on controlling the pipelines that pass through the Ukraine to Europe. Russia backs Iran because between them, these two nations have over 45 percent of the world’s proven natural gas reserves. Putin backs Assad in Syria because (among other reasons) he wants to influence the production and sale of oil from Iran and Iraq. With Iran as an ally, Russia is positioning itself as a threat to international oil shipments from the Middle East. He would like to re-establish a Russian naval base at Tartus on the Mediterranean. Iran is in a position to shut off oil shipments that pass through the Strait of Hormuz from the Persian Gulf.

Vladimir Putin understands the power of his energy weapon, and he plans to use it.


TCE

13 February 2014

Peak Energy

Introduction

The purpose of this study is to examine long term world trends in the availability and consumption of energy, as well as the relationship of these trends to social change, economic growth, and the resulting political risks through 2050. It is not meant to be a comprehensive document. Instead, it highlights several key issues our political systems will be forced to address in the 21st century. Although the forecasts in this report are derived from the best available information, they cannot be considered as absolute fact. The reader should pay attention to the assumptions as well as the associated commentary for each of the graphs presented in the following text.

Part One: Shifting Patterns of Energy Consumption

In any discussion of energy, one must be aware there are two primary categories of energy consumption.

When we talk about mobile applications, we are referencing the use of fuels to power the engines of transportation including cars, trucks, construction vehicles, farm tractors, planes, ships, boats, and trains. Virtually all of these applications depend on the use of an internal combustion engine. Fuel for the engine is carried within the vehicle. Consequently the fuel must be easy to handle, and compact relative to its energy content. Thus far, products derived from oil provide the best combination of function and energy. Our transportation system depends on huge quantities of gasoline, diesel, jet, and bunker fuels. Although coal and nuclear fuels are practical resources for the energy needed to drive large ships, oil is the dominant resource of energy for most mobile applications.

By contrast, in stationary applications fuels are primarily used as a source of heat to cook food, warm buildings, process agricultural products, convert ore into metals, and generate electricity. Consumption occurs in a chamber or machinery that does not move. Coal, natural gas, and nuclear fuels currently provide most of the energy for these applications. Energy can also be derived from the weight of moving water (hydropower), the sun (solar power), air currents (wind power), and the combustion of biomass. Oil is also an energy resource for stationary applications in the form of kerosene, propane, and heating oil.

In the following text, we compare all forms of energy by equating each one to the energy content of oil. Thus the phrase, tonnes of oil equivalent or TOE which may be defined as a unit of energy that equals the amount of energy released by burning one tonne of crude oil. This gives us a way to compare energy consumption by type of fuel or resource. (Note 1)

Oil, coal and natural gas dominated world energy consumption in 2012. Total market share was just over 86 percent of all energy consumption.

Oil is the primary energy resource for vehicle, ship, plane, and train transportation because the products made from oil are easy to transport, and pack enough energy in a small space to provide a practical source of energy for mobile applications. Products for internal combustion engines include gasoline, diesel, jet, and bunker fuels. Oil provides the raw material for stationary heating and cooking applications in the form of kerosene, propane, and heating oil. Oil is also the raw material resource for thousands of manufactured products as well as agricultural soil and crop amendments.
   
Coal is primarily used as a fuel in stationary applications as a source of heat for the generation of electricity, and the processing of ores into metals such as steel, copper and gold. Although coal can be converted into a liquid fuel, such use has not proven to be economically competitive in most consumer applications. In many nations, coal is burned to provide heat for buildings, hot water and cooking.

Natural gas is primarily used as a fuel in stationary applications as a source of heat for the generation of electricity, the heating of buildings, and the cooking of food. Although compressed natural gas is being used as a transportation fuel, this mobile application currently consumes only a small percentage of our world natural gas resources. Natural gas is the feedstock for the manufacture of soil and crop amendments (primarily fertilizer, herbicides and insecticides).

The energy of moving water and nuclear fuels is primarily used in stationary applications to generate electricity. Together, these two resources accounted for just over 11 percent of world energy consumption in 2012.

Biomass in the form of both fuels for stationary applications (as a source of heat), and mobile applications (as a liquid fuel), along with geothermal energy, wind power, and solar power combined to provide the world with less than 2 percent of our energy consumption in 2012.

The following chart shows energy consumption by fuel as a percentage of total world fuel consumption.


Let’s fast forward to 2050 in order to see if we can make a reasonable projection of future world energy consumption. Although coal has declined from 30 percent of world energy in 2012, to 25 percent in 2050, continued use of this energy resource – particularly in the western pacific region – suggests little change in annual consumption: 3730 million tonnes of oil equivalent energy (TOE) in 2012 versus 3817 tonnes of oil equivalent energy (TOE) in 2050. Natural gas, as a percentage of world energy consumption, is little changed, but annual consumption is projected to increase from 2987 TOE in 2012 to 3812 TOE in 2050. Because of factors we will discuss later, oil consumption has declined from 4131 TOE in 2012 to 3247 TOE in 2050. Oil, which provided 33 percent of the world’s energy in 2012, is projected to become only 21 percent of world energy in 2050. The highest growth energy sectors are nuclear energy (560 TOE in 2012 to 1134 TOE in 2050), hydro electric energy (831 to 1398 TOE), and other energy resources (237 to 1791 TOE). The “Other” category includes biomass, solar, wind, and geothermal energy resources.   Consumption of fuel ethanol and biodiesel is included in the oil consumption tables.

Adjusted World Energy Consumption by Fuel is shown in the following graph.


The following graph shows the changing patterns of energy consumption by type: 2012 versus 2050. Total energy consumption has increased from 12,476 TOE in 2012 to 15,198 TOE in 2050.


As we shall see in the following text, however, these numbers mask the high probability that substantial changes will have occurred in the consumption of available energy resources between 2012 and 2050, significantly transforming the world economy, driving social change, and restructuring our political systems.


The complete report will be available in April.

TCE

Note 1: The IEA/OECD organization defines one toe to be equal to 41.868 GJ or 11.63 MWh of energy.


16 January 2014

Does The Price Of Gasoline Affect The CPI?

Media pundits and some government officials like to tell us that the price of gasoline and food are not important indicators of inflation because they are “volatile”. To them I say: Your pronouncement is absurd, preposterous, ridiculous, ludicrous, misguided, illogical, and foolish. The price of gasoline (and diesel) affect our economy by raising (or lowering) the price of everything we buy and thus the Consumer Price Index (CPI).

Proof?  Let’s calculate the month to month change in the price of American gasoline (all grades) versus the month to month change in the Consumer Price Index (CPI-U), from January 2004 through December of 2013.  Although the ratio of gasoline price change (in %) to monthly changes in the CPI are significant, there is a very high correlation.
The left scale of the following chart shows the month to month change in CPI-U as reported by the Department of Labor, Bureau of Labor Statistics (BLS). The right scale shows the month to month percentage change in the price of gasoline as reported by The Department of Energy (DOE).


As shown by the following chart, there is also a strong correlation between the annual change in the CPI-U index and the annual percentage change in American gasoline prices.  

  
This is important stuff. The long term trend for the price of oil (and hence gasoline) is UP.  That means - on a long term basis - the rate of inflation will also increase. As shown by this chart, the price of oil has been (and will continue to be) volatile.  This chart also shows the predominate bias of oil price movements and the CPI are up (above 0%).  Since the price of oil is a very important component of what happens next to the world economy, the development of alternative (lower cost) production options such as fracking assume increasing importance.


TCE


28 May 2013

Capitalism and Socialism

The rise of western capitalism, banking, and a money economy can be traced back to the 1300s. The Protestant ethic of the 1500’s gave a philosophical voice to the subsequent economic and cultural changes. From these trends emerged the desire for national independence, individual opportunity and personal wealth. It took roughly 200 additional years for these ideas to permeate Western Europe. The energy released by this philosophy led to democracy, freedom, liberty, independence, the industrial revolution, fantastic advancements in science, nation states, and rapid population growth. Moral behavior, usually based on Christian theology, was expected. Success was admired.

It was Ok to work hard and become prosperous.

The proletarian idea that prosperity should be shared among the poor has been around since the beginning of time. It found its modern voice in the socialist economic theories of Engels and Marx during the mid-1800s, and since WW 2 there has been a shift in western cultural philosophy from laissez faire capitalism to democratic socialism. Western political establishments have been increasingly willing to accept socialist concepts of income redistribution, and individual dependence on the State has been encouraged through the creation of a welfare class. The values which led to the success of western civilization continue to be ridiculed. Intellectual competitive superiority is frequently discouraged. Immoral behavior and personal failure are expected. Entrepreneurial energy is frequently overwhelmed by obtuse bureaucracy. With the exception of pop culture icons and political insiders, individual economic success is often frowned upon because it fosters “inequality”.  Pop culture liberal theology, at once permissive and punitive, dominates the rules of moral behavior.

Both capitalism and socialism are rooted in the basic instincts of human nature. But they create a conflict of purpose and belief. On the one hand, most of us are competitive by nature because thousands of years of human survival demanded we compete for food, shelter, sex and safety. It was very simple. Losers didn’t survive. On the other hand, most humans are also naturally compassionate. Think of your response to a whimpering baby, or the incredible amounts of money we give to charity. So there is a dichotomy of human belief. We have evolved a drive to get more for ourselves (money, prestige, political power, and so on), as well as a sympathy for those who have less wealth and power. The strength of these instincts, and their influence on our convictions, vary from individual to individual, and from group to group. They have, however, framed our every attempt to create and sustain the institutions of government.

The natural conflict between competitive instincts and human compassion has been a fundamental characteristic of political institutions ever since primitive man first organized communal living. It manifests itself in two – sometimes irreconcilable – attributes:

·       Legal equality – where most of the governed demand equality before the law; and
·       Economic equality – where most of the governed want equal access to wealth.

This natural conflict is frequently contentious. The problem with every social structure is that a certain percentage of the participants will attempt to take more from society than they contribute: i.e. they readily adopt a welfare lifestyle for as long as the social structure will tolerate their indolence. But within any social structure there are also a certain percentage of the participants who want to increase their personal income and are willing to make the effort to do so through individual effort.

Socialism attempts to resolve this conflict by imposing rules and regulations on the social structure that “level the playing field”. Legal and economic equality are both imposed by the State.  Participants are expected to conform. Economic freedom is discouraged or prohibited. (Think Cuba, the perfect socialist state).

By contrast, the men who framed America’s Constitution (with the support of some wonderfully intelligent women), attempted to resolve this natural conflict between economic and legal equality by:

·       Making legal equality a matter of constitutional law, and
·       Providing all of the governed the opportunity to increase their wealth.

In theory, every American has the same rights under the law. Discrimination is discouraged. We are expected to have a respect for the law because the law (as administered by the State) respects our rights. Every citizen is treated equally. Also in theory, every American has the same opportunity to achieve economic success. Although fate, fortune, and personal limitations may constrain our ability to achieve economic gain, the State imposes no restrictions on our economic pursuits (as long as they do not deprive others of their economic achievements). We the people have the right to pursue economic success. That’s the theory. The outcome is up to us.

Most intellectuals, politicians, and media pundits do not understand, or choose to ignore, two very fundamental economic principles:

·       The redistribution of national wealth works only so long as there is wealth to redistribute.
·       National wealth pays for welfare.

But here is the problem. There are only three ways to increase national wealth:

·       Conquest and plunder, best demonstrated by the growing wealth of the early Roman Empire.
·       Mercantile economics, a characteristic of wealth creation used by several European governments ~ 1450 - 1750.
·       Private enterprise, as exemplified by the robust economic growth of America 1800 - 2000.

In addition, most intellectuals, politicians, and media pundits do not understand, or choose to ignore, four fundamental realities:

·       The wealth of a nation is created by its people.
·       Capitalism and the institutions of democracy encourage personal economic success.
·       Socialism and the institutions of the State discourage personal economic success.
And one other important point....
·       For a majority of nations, the management methodology of socialism inevitably leads to the creation of a police state.

In a democracy the cultural emphasis is on freedom, liberty, self-discipline, and individual responsibility. Personal achievement is admired and usually rewarded. In a socialist state the cultural emphasis must necessarily be on conformance, restriction, social discipline, and suppression of individual initiative. Personal achievement is always subordinate to the bureaucratic nihilism of the state.

Wealth is best created by systems of governance that have the fewest possible layers of management. This insures institutional leaders are never far from the activities and needs of the governed, minimizes the political impediments of institutional bureaucracy, clarifies individual responsibility, and facilitates the flow of communication among employees. Creative initiative is encouraged. Socialist systems of government, by contrast, typically create multiple layers of inefficient and frequently incompetent management, embrace the philosophy the governed are subservient to the demands of government, and evolve into political hell holes of competing bureaucratic fiefdoms that discourage open communication among employees. Creative initiative is often punished.

Let us summarize these points with a single truth:

In order to increase national wealth, the people must be free to do so.

TCE

Note 1: For a discussion of institutions, and to understand why big government socialism will never work;  see  “Commentaries On Cultural Economics: Institutions”,  http://tinyurl.com/aoylyt5

04 April 2013

Will America Ever Pay Off Its Debt?

Assuming no unusual economic event occurs during the last 6 months of the federal fiscal year (ending September 30, 2013), American GDP for that period should be in the range of ~ 16.3 trillion. If so, then the United States will end its fiscal year with a debt to GDP (Gross Domestic Product) ratio of 106%. That means for every $1.00 of GDP, the Federal government owes someone one dollar and six cents. About 78% of this debt to GDP ratio will be in the form of public debt: money that has been borrowed from pension funds, foreign banks, insurance companies, individuals, and so on. Buyers receive notes, bonds and other financial instruments that promise to repay the face value of the paper they purchase plus interest. Interest on this paper is projected to have an average year-end rate of 2.36%. Gross interest costs are estimated to be ~ $293 billion. (Note 1)

Gross Federal Debt also includes interagency (intergovernmental) debt.  For the full fiscal year, another 31% of this debt to GDP ratio was in the form of money that has been borrowed from other federal agencies. These securities, issued by the Treasury, include paper issued to government trust funds, revolving funds, special funds, and the Federal Financing Bank. Social Security is the largest Trust fund and holds over 50% of the Treasury’s interagency paper. Other large creditors that own Federal Government debt include the Civil Service Retirement and Disability Fund, the Medicare Trust Fund, and the Military Retirement Trust Fund. Treasury gives these agencies an electronic IOU that acknowledges the existence of the debt. Booked (but not paid) interest costs for the 2013 fiscal year are estimated to be about $179.3 billion.

Public debt should end fiscal 2013 at ~ $12.4 trillion, interagency (intergovernmental) debt is estimated at ~ $4.9 trillion, and total debt is projected to be ~ $17.3 trillion. The 2013 fiscal year federal budget is $3.8 trillion. For fiscal 2013, total accrued or paid gross interest costs are estimated to be about 12.4% of the federal budget, and about 2.9% of GDP.
With the exception of maturing paper, and demands for funds received by Federal agencies, there is no provision in the 2013 budget to repay any prior debt. The total debt outstanding, including accumulated interest, just keeps growing larger each year.
Despite the common belief that China holds an enormous portion of U.S. debt, two-thirds of the treasury’s bankroll currently comes from the Social Security Trust Fund, pensions for public-sector workers, pensions for military personnel and other retirees, and American investors. China, with less than 8 percent of the U.S. government’s paper, is among several nations that invest in treasury securities. As of March 2013, the Federal Reserve was holding $1.79 trillion in U.S. Treasury securities. On a net basis, it increased its holdings of treasury securities by $58.9 billion in calendar 2012. The Federal Reserve is required to send its net profits to the treasury, and was able to pay $88.9 billion in profits to the treasury in 2012.

For the full fiscal year 2013 budget, gross treasury interest costs are projected to be $472 billion. These interest costs are paid in cash, IOUs, and electronic transfers to its creditors. But treasury does not have to raise $472 billion. This amount is offset by funds received from on and off budget funds, as well as other interest and income sources. Projected net debt interest costs, which are included in the federal government’s annual fiscal budget, will be approximately $247.7 billion.
But why, we ask, is all this accumulation of debt so important? To answer this question, let’s go out five years and construct a scenario for 2018. If GDP is $22.1 trillion, and accumulated debt has increased to $24.1 trillion (both reasonable expectations), then America will have a debt to GDP ratio of 109%. About 76% of this debt to GDP ratio will be in the form of public debt. The remaining 33% will be in the form of debt owed to agencies and Trust Funds. Normalized interest costs on America’s federal debt will have increased by 80% to $741.2 billion. If the federal budget is (as proposed) $4.7 trillion, then interest costs will increase to 15.8% of the annual budget. (Note 1)
For those of you who like their data in pictures, I have included a graph of America’s debt from 2000 – 2013. The data comes to us courtesy of the U. S. Bureau of the Public Debt.
It is also useful to visualize the annual gross cost of America’s federal debt for 2013 and 2018.
But there are two problems.
In my opinion, by 2018 Social Security and Medicare (and perhaps some other trust funds) will no longer be net buyers of treasury securities. They are going to want some portion of their money back in order to fund projected retirement benefits.  If so, the treasury interest income statement will look something like this.



According to this scenario, net treasury interest costs will have increased by 124% to $555.8 billion. These increased interest costs will have to be included in the projected federal budget of $4.7 trillion, forcing either a reduction of federal spending or an increase in the budget. America will either have to raise taxes or borrow more money just to pay the interest on the federal debt. Given the conservative estimate of interest costs in our scenario, interest on America’s debt will have almost doubled from 6.5% of the budget in 2013 to 11.8% of the budget in 2018. Without an increase in taxes, that’s $308 B that would have to be cut from federal programs. You should know, however, interest on the public debt could be substantially higher. Here is a graph of the estimates used in our scenario.
This brings us to the second problem. What if we want to pay down the federal debt?  Could we?  What happens if we just try to pay off the debt that will exist at the end of fiscal 2018 over a period of 20 years? Dividing $ 24.1 Trillion by 20 years means we would pay off $ 1.2 T of America’s debt each year.  The federal budget for 2018 would have to be increased by at least 25% to $5.9 trillion, and ~ 30% of the federal budget would be allocated to servicing America’s federal debt. (Note 1)

Could America pay off its debt?  A graph says it all.

It’s not hard to visualize the scope of America’s debt challenge. Unfortunately, the increased debt service, including the payment of principle and interest, would be a politically unacceptable burden on the budget. In addition, all too many people in Washington - for political reasons - do not believe any meaningful debt reduction is necessary. Consider the plausible solutions:

  1. Use austerity measures including a reduction of Social Security, Medicare, Medicaid and other health and retirement benefits to hold the line on further indebtedness.
  2. Use draconian austerity measures, including a wealth tax on bank accounts, to save the financial system.
  3. Increase sales and income taxes.
  4. Shift an increasing share of health care costs to the American worker.
  5. Shift more federal spending to State government budgets.
  6. Increase the rate of inflation by adjusting interest rates.
  7. Print money (also inflationary).
  8. Default on selected blocks of treasury debt
  9. Take a much longer time to pay off the debt
  10. Use trade and/or currency measures to enhance domestic economic growth.
  11. Increase tax revenues by encouraging the growth of the private sector.
  12. All or some of the above.

But most of these solutions are not politically expedient. America has accumulated an excessive load of debt, is stuck with costly interest payments, and has become vulnerable to the availability of capital (including money created by the Federal Reserve). It is also worth noting these debt estimates do not include a massive off balance sheet accumulation of unfunded obligations for which the America people are legally responsible. There is only one rational conclusion: America has been led into a debt trap from which there is no politically expedient escape. Given the size of the debt burden and Washington’s attitude, a full repayment of America’s existing debt obligations is highly unlikely.

America will never “pay off” its load of federal debt.

This raises an interesting question. If there is no attempt to control the amount of debt on America’s balance sheet, at what point does America become a bad credit risk? And what would happen next?

The election of 2016 should be lively. Someone will point out America’s political elite have buried our children in a mountain of unmanageable debt. Someone will point out Washington has demolished the economy. Someone will claim federal policies have made Wall Street rich. Someone will point out our political system isn’t working.

Someone will propose a radical solution.

TCE


Notes:
Note 1: Data gleaned from Federal Reserve, Treasury, GAO and CBO sources. Estimates are based on a risk adjusted analysis of publically available federal data. The objective of this essay is to provide the reader with a simple and concise explanation of America’s budget debt challenges. The debt costs discussed in the essay do NOT include planned (or unplanned) additions to Federal debt obligations, nor do they include unfunded government obligations (health care, Social Security, welfare, pensions, etc.), or State and Local debt. 

Note 2: Other interest rate assumptions would give a range of interest costs from $650 - $900 billion. The Social Security Trust Fund assumes it will get a minimum of 3.5% interest per year on the treasury paper held by the fund. Other agencies have similar expectations. As a reference, here is the theoretical range of interest rates at various debt to GDP ratios.
Note 3: Trust Fund Management Program.
The Secretary of the U.S. Treasury is designated by law as the managing trustee for eighteen of the approximately two hundred thirty Federal Investment Funds. With over $2.5 Trillion in assets, the Treasury-managed Investment Funds are the majority of the largest Trust Funds in the Federal Government. They receive Social Security, Medicare, excise and employment taxes---all collected by Treasury---as well as premiums, fines, penalties and other designated monies collected by the agencies that administer the programs for which these Trust Funds exist. 

The Bureau of the Public Debt is delegated the responsibility for administering these eighteen Funds. For each of these Funds, Public Debt immediately invests all receipts credited to the Fund, and maintains the invested assets in the Trust Fund account until money is needed by the related Federal Program agency to fund program activity, such as Social Security and unemployment benefit payments, as well as highway funding.
When the program agencies determine that monies are needed, Public Debt redeems securities from the Funds' investment balances, and transfers the cash proceeds, including interest earned on the investments, to the program accounts for disbursement by the agency. The Bureau provides monthly and other periodic reporting to each Fund's program agency.


Data for Federal Debt Charts - Fiscal Year 2013 and 2018
 

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10 February 2013

Commentaries On Cultural Economics: Institutions


Permanence
An organization may be thought of as a group of people whose collective activities have an ordered existence that is intended to fulfill a common purpose. People who belong to the group may have been brought together by a common cause, shared beliefs, or employment. The group's collective activities may have a commercial, spiritual, or cultural purpose. Some form of order is imposed by influential members of the group on the activities of all group members. The rules, procedures, rituals and behavioral norms of individual participation may range from easygoing attitudes, to the imposition of strict responsibilities. The organization confers rights, obligations and liabilities on the individual participant. Participation will range from informal (casual) to formal (conferring implied or specific obligations).

Organizations become institutions when they take on an existence of perceived historical permanence that is separate and distinct from the lives of individual members. For the purposes of this discussion, institutions may include churches and other religious organizations, charitable and fraternal associations, unions, political parties, government agencies, corporations, hospitals, universities and so on. Institutions project a presence and authority that is larger than the influence of individual participants. There is a structure that confers power on selected members, demands obedience from all participants, and preserves the existence of the institution. The Catholic Church, for example, is an institution that is separate and distinct from Catholics as a body of parishioners. The Democratic Party is an institution that projects a presence that is usually more important than the existence of individual democrats. The U. S. Department of Labor represents the activities of thousands of (largely) faceless government employees. General Electric and Harvard University are icons that have a more lasting charisma than any of the individuals who participate in their activities.

Successful Organizations
Organizations tend to be limited by the strengths and weaknesses of their management. Successful organizations - corporations, government agencies, universities, religious institutions, charities, and so on - will normally have a strong and effective management team. The organization's leadership has a clear and informed vision of goals and objectives. It will usually be proactive, rather than reactive. These leaders, including individuals at all levels of the organization, are able to combine a comprehension of the organization's place in the real world with the capability to execute an operating plan that permits the organization to succeed. Participants (employees or members) are focused on a strategy that will lead to accomplishing specific goals and objectives. There is a sense of mission, a sense of urgency and a sense of pride to be involved in the organization's mission. Most of the participants (employees or members) have a sense of belonging. The organization or institution provides a frame of reference for their activities. Tasks and work processes assume meaning because they are related to the success of the organization's mission. For each individual, success is measured in terms of results. Human energy is focused on the completion of assigned tasks. It is not wasted on debilitating internal political power struggles. Instead, the naturally competitive spirit of human endeavor is channeled into constructive activity that benefits the institution. In this environment, the organization's leaders are not preoccupied with finding the most politically acceptable response to the inevitable challenges that occur in the course of an organization's activity. Instead, potential conflicts are resolved through preemptive personnel communication and proactive public relations.

Less Than Successful Organizations
Unfortunately organizations that have morphed into recognized institutions have a tendency to fossilize because bureaucratic rules, processes, privileges and restrictions suppress freedom of action. As this process permeates the institution, the organization invariably deteriorates, ceases to exist, or becomes irrelevant.

In general, institutions are opposed to change because change dislocates the participant's frame of reference and perception of personal status, disrupts the political structure of the organization, may force the reformation of the institution's culture, and impacts the rules, procedures, rituals and behavioral norms of individual participation. The larger the institution, the less flexible it becomes, because increased size demands the incremental imposition of formal behavior. The older the institution, the greater the resistance to change. Organizational aging breeds an increasingly rigid culture. There is a fixation of beliefs. Symbolic exercises become pedantic routine. Traditional rituals are retained even though they no longer serve any useful purpose and may actually be antithetical to what the institution’s members actually believe. Truth is standardized and eventually fossilized. Artificial rituals and mindless rules crowd out innovation. The institution's embedded culture will tend to support the continuation of doctrinaire positions that create artificial social, intellectual, spiritual and emotional boundaries. There is a tendency to venerate the past while ignoring present needs and opportunities. Such traditionalism fosters false and exaggerated ideas of sacredness and fails to make contemporary interpretations of values and practices.


Zealots, in a display of very human behavior,
will defend the institution against change
because change is viewed as a heresy
against established beliefs.


Human Nature
Organizations are the invention of the human mind. They consequently display very human characteristics. Some participants will strive to accumulate power and authority. Others prefer to avoid personal responsibility or chose to maintain a low profile in order to keep from being blown out by internal political struggles. Competitive divisions and numerous cliques will inevitably develop. They encourage discrimination, elitism, and “chosen people” attitudes. These inner circles tend to believe that everyone else is an outsider who cannot be trusted. Participation in the clique confers personal status and a sense of comfort because participants are dealing with familiar relationships. An “us” versus “them” psychology inevitably develops.

All institutions run the risk of evolving into politically active hell holes where everyone is badmouthing everyone else. There is a nasty adversarial elitist struggle for personal position in the hierarchy. When institutions fall into this trap, they inevitably deteriorate because the accumulation and use of political power becomes more important than achieving the objectives or performing the duties of the institution.  Rather than make rational decisions based on a careful evaluation of facts, decisions within this environment are made on the basis of political power. All too often, creative ideas are destroyed simply because one or more factions within the organization chose to oppose the idea merely to demonstrate their ability to dominate the decision making process. (Sound familiar?)

Bureaucracy and Obsolescence
Institutions are afraid to take risks. Risk requires the implementation of the unknown and the results cannot be guaranteed. Failure is not politically acceptable. The retention of power is based on being right and consequently it is better to do nothing (frequently while appearing to do something), than to take an action which fails. If catering to the press is an important requisite of power retention, then it is inevitable that the selected course of action will conjure simplistic images rather than creative change. This is especially true when considering the decisions of government. Badgered by the press and mindless critics, there is no allowance for error. Creative experimentation is not allowed.

Institutions create bureaucracy. Rules, Procedures and Systems are necessary to maintain order. There is the impersonal application of general rules, both to outsiders and to internal staff. Applied rules are likely to be a repetition of what has worked in the past. They are made on a blanket basis, applying to everyone without regard for sanity or common sense. Rules are often part of an overall system, work process, or procedure. Since change can be disruptive, flexibility is to be avoided.

Bureaucratic procedures are usually proposed or written by people who do not have the capacity to understand their impact. They are made by an authorized person (autocratic) or by a committee (the pseudo democratic autocracy of the proletariat). Bureaucratic committees are usually populated by individuals who are ill equipped to make reasonable rules. Individual member motivation is likely to be political, rather than rational. The larger the committee, the more likely it is most of the members will not be able to make a constructive contribution.

There is an inclination of leaders to become administrative bureaucrats or defenders of the institution rather than managers and communicators. Oppressive authority evolves. Rules and regulations replace creative leadership. Red tape and ingrained attitudes smother creative thinking. Traditionalized, dogmatized, and institutionalized organizations fail to hold the interest of adventurous people who could care less about their existence.  As the institution is trivialized (becomes irrelevant), it becomes the target of scorn or is simply ignored.  Although there is a retained fa├žade of historical purpose, its actual activities invariably deviate from its original mission.

What is the lesson?  The creations of human invention inevitably deteriorate.


All institutions are destined to become obsolete.
It is a natural process.


Survival
The first obligation of any institution is to ensure its survival. No matter how irrelevant it has become, no matter how uncompetitive its products or services, no matter how wide the gap between internal self-perception and external assessment, an institution will continue to pursue the familiar until such actions are no longer possible.

Management invariably defends a dysfunctional institutional culture. But it will do no good. Institutions fail because they are no longer relevant to the community’s Cultural Ecosystem (as has happened to some service organizations), are no longer competitive within their industry (think GM before 2007), or are have ossified into politically ineffective institutions (think U. S. Congress).  These institutions continue to exist until they eventually fade away into historical oblivion, collapse in a spectacular display of chaotic failure, or undergo a substantial reformation.

Competitive and market driven institutions, such as corporations, can be revived by disruptive management because their continued existence depends on a positive transformation. Change is motivated by the stark realities of economic survival. Institutions that tend to be constrained by internal political squabbling, such as universities, are unlikely to experience an institutional reformation until their economic structure becomes unsustainable. Political, religious, and fraternal institutions typically decline because they become irrelevant to the cultural Ecosystem within which they must function. But government institutions - legislatures, administrations, and agencies - have the unfortunate ability to hide behind the protection of political dispensation and the police power of the state. Because institutional reorganization will disrupt their perceived selfish-best-interest, insiders vociferously defend government institutions against reorganization and reformation.  Disruptive management, which could revitalize the functions of government, is not allowed by the conceit of entrenched political power.


Even if they have become corrupt, irrelevant or
dominated by special interest agendas,
even if they are no longer needed
or have strayed from their original mission,
the institutions of government tend to survive.

Until there is a revolution.


Organizational self-preservation is instinctive.  It maintains the political power of those in charge (along with various insider cliques), and provides a reassuring frame of reference for other members. Outsiders are still outsiders. Members can make believe everything is OK, even while the institution continues to rot from within. Government becomes a collection of competing political cliques, favored cronies, and dysfunctional institutions. Unyielding conflict replaces compromise. (Note 1)

Cultural Economics
Why is this discussion of institutions important?

Cultural Economists examine institutional behavior and management in order to understand the past (and future) impact they will have on our economy. The results are likely to reveal valuable information to support the associated economic and cultural analysis. For example: Adolf Hitler ascended to power by exploiting the weaknesses of the German government after WW1; Honda, Datsun, Toyota, and Volkswagen were among the companies that took market share from the flawed institutions of the American auto industry after WW2; and the existing world economic crisis can be traced back to deficiencies within the institutions of government and finance. Most large scale economic failure (or success) can be linked to institutional failure (or success), and most institutional failure (or success) can be linked to the internal cultural characteristics of the relevant institutions, and – finally – the cultural characteristics of every institution are driven by the strength and weaknesses of human nature.


The Cultural Economist


Note 1: Sound familiar?  The American people have given their congress an abysmal performance rating, and the administration’s popularity is largely based on the personal appeal of the President. One of the interesting (and disturbing) things about America’s last election cycle is that both candidates for made very personal promises to the electorate. It was as if Congress did not exist, or was – at least – irrelevant.