For SmartPlanet this week, I offered a macro view exploring the common ground between the Occupy movement and the Tea Party — declining energy leading to declining economic surplus — and contemplated the existential questions of what to do about it.

Read it here: Occupy, Tea Party, and the Politics of Less

Beneath the complex narratives of the Occupy and Tea Party movements, and beneath the unfolding collapse of our complex global financial system, is a simpler narrative about energy. Yet this narrative continues to elude most observers, because they don’t understand the fundamental relationship between energy and the real economy. This week I’ll attempt to tell a simple version of that story, in the plainest possible terms, and explain the Occupy and Tea Party movements in that context.

Let’s begin with some economic history.

For nearly all of U.S. history up through the late 1960s, the production of energy, especially oil, had grown continuously. And economic activity, as measured by GDP, grew right along with it.

At the same time, the U.S. dollar was pinned to gold, first under a gold standard requiring the Federal Reserve to maintain 40 percent of its outstanding paper currency in gold reserves, and then under the Bretton Woods Agreement of 1944, which created the International Monetary Fund (IMF) and set exchange rates for various national currencies in terms of US dollars, which in turn were convertible to gold at the rate of $35 an ounce.

Thus the growth of the U.S. economy was pinned to oil and to gold, both hard assets. It helped to keep inflation and deficit spending under control, but it also checked economic growth.

By 1971, however, the costs of the Vietnam War and the end of the post-war infrastructure building spree had stalled economic growth, and spending began to exceed revenues. Growth was further stymied by U.S. oil production, which had peaked in the previous year and begun to decline.

Source: EIA

This was intolerable, because the U.S. had debt, which is a claim on future productivity. Without growth, debt cannot be repaid, making growth an economic imperative.

President Nixon’s solution was to abandon the virtual gold standard entirely, ending the convertibility of dollars into gold and effectively placing the world’s monetary system on a fiat basis denominated in U.S. dollars. Thus in 1971 we entered a new era, in which organic growth driven by increasing energy supply and actual productivity was replaced by artificial growth fueled by debt.

Source: Reading Nature’s Signals

At the time, the expectation of continued growth justified the departure from the gold peg, and oil supply wasn’t yet recognized as a concern. Crude from the Middle East was cheap and abundant, and the largest oil field in North America had just been discovered in 1968. Analysts of the day would have had little reason to fear that debt would run away from the real economy.

But as we can see, that’s exactly what happened. GDP continued to rise at roughly its historical rate, outpacing the faltering growth of energy supply, but it was at the expense of a burgeoning debt load, as shown in this close-up of the years 1965 to 2007:

Source: Sudden Debt

The obvious result of the debt explosion was a debasement of the dollar, in real terms, and a declining net surplus to society. Average working households experienced this as household debt exceeding real disposable income, starting around 1983. In order to thwart the resulting “stagflation,” we loosened financial regulation and borrowing restrictions, which permitted us to blow more bubbles: first the dot-com bubble, then the housing bubble, and then the debt bubble:

Source: San Francisco Fed, marked up by Dave Cohen

The ultimate result was the blow-off of the debt bubble in 2008 and subsequent economic decline as we began the long process of debt deleveraging.

The same cycle, operating over somewhat different time frames and scales, has been happening to most of the world, led first by the demands of remaining competitive in a globalized economy with a major actor becoming a major debtor and currency debaser, then by the flattening-out of world oil supply, starting in 2005. In the pithy formulation of my colleague Gregor Macdonald, “In the old oil cycle, such sovereign debt problems were merely a function of profligacy. In the new oil cycle, a debt crisis is no longer solvable with growth.”

The end of the growth acid trip

We now find ourselves with a global financial regime that is literally teetering on the brink of the abyss. The debt crisis in Europe is an echo of the banking crisis we had in the U.S. in 2008, with MF Global (leveraged 40 to 1 on European debt to equity) playing the part of Lehman Brothers (leveraged 30 to 1 on toxic mortgage debt), and Greece, Italy and Spain playing the uncreditworthy borrowers, Fannie Mae and Freddie Mac. Except in this go-round, France and Germany (playing the part of the US public) and the ECB (playing the part of the Fed) aren’t going along with the script. Rather than monetizing the European debt to infinity and beyond and socializing the losses, they are thinking about skipping out the backstage exit door for a drink and a smoke, and just letting the rest of the players sort out the rest of Act III for themselves: worst case, a global plunge into a deflationary vortex, wiping out most of the financial “wealth” in the developed world.

The fundamental problem from a theoretical standpoint, as I discussed a few weeks ago in “Economic theory and the Real Great Contraction,” is that economic theorists are, in the words of sociologist John Bradford, “unaware of the essential role that energy played in the creation and maintenance of the [economic] order.” (He has a good argument, and I encourage economics geeks to explore that link.) The apparent decoupling of energy from economic growth in the U.S. has emboldened some optimists to claim that energy intensity has increased, and that economic growth has cast off its shackles to primary energy supply. But that illusion vanishes too, after adjusting for offshoring of manufacturing over the last 30 years, and the drawdown of capital stocks. As Gail Tverberg showed this week, on a global basis, energy intensity has remained flat. Economic growth is essentially and unequivocally inseparable from energy growth.

During periods of plenty, laissez-faire economics mainly functions as a way of calling forth supply (of energy, food, and other essentials), but during periods of less, they mainly ration demand: if you can’t pay, you don’t get any. Periods of energy surplus beget positive feedback loops, in which higher demand calls forth greater supply, more debt, and more peace. But periods of energy deficit beget negative feedback loops, where declining energy return on investment (EROI) leads to declining surplus, debt deflation, less peace, less freedom, and ultimately a decline in production and trade.

Source: “Revisiting the Limits to Growth After Peak Oil,” Hall, Day, American Scientist May-June 2009

In the growing gap between real wealth and hallucinated wealth, those with the most wealth were able to game the system and capture more of the declining surplus available to society via various mechanisms: cuts in taxes on capital gains and dividends (which don’t figure in the incomes of average people), cuts in the marginal tax rates of the top income earners, shifting a greater share of the income to corporate structures, and floating individually to the top of globalized companies that continued to grow even as the center of the domestic economy was being hollowed out.

Source: Alan de Smet

The Politics of Less

This brings us to the heart of the Occupy and Tea Party movements. While I would give neither movement undue credit for having an intellectual grasp on the details of economics or energy that brought us to this point, both movements are essentially a response to the declining net surplus available to society. And this is making the banks very nervous. As a memo from the lobbying firm Clark Lytle Geduldig Cranford to the American Bankers Association, recently exposed by Chris Hayes at MSNBC, said:

“Well-known Wall Street companies stand at the nexus of where OWS protestors and the Tea Party overlap on angered populism. Both the radical left and the radical right are channeling broader frustration about the state of the economy and share a mutual anger over TARP and other perceived bailouts.”

They may not fully understand how it happened, or why, but the average Occupy or Tea Party protestor understands one thing: they are getting poorer. The rest of the debate is about the tactics of what to do about it: redistributing the remaining surplus, or shrinking the slice of that surplus consumed by government. Shall we cut the “entitlement programs” of surplus—Medicare and Social Security—or redistribute the wealth to allow them to continue? To reframe it another way, the Occupy movement is the “Help Me Party,” and the Tea Partiers are the “Help Yourself Party.”

The failure of the so-called Supercommittee to come to any agreement on how to cut a mere $1.2 trillion from the federal budget reflects how difficult it is to come to grips with the declining surplus, or as a hedge fund manager friend of mine (I’ll call him Mr. X) puts it: the Politics of Less.

The historical script for the Politics of Less is clear, as Mr. X reminds me constantly: “The period 1770-1815 was marked by bank runs, currency collapse and sovereign defaults. The politics of less led to revolution. So did the great ‘Victorian’ depression 1873-1905. Humans have had social cohesion, or non-coercion, but not both. And certainly not in times of scarcity. The Old Law will return. Cry havoc and loose the dogs of war.” Heavy-handed crackdowns on protesters, surveillance of subversive elements, mass withdrawals from banks, and sovereign debt defaults are all part of the standard story arc.

The political and economic systems that worked in the age of surplus can no longer produce social cohesion. Measured in hard assets, it becomes a fight to maintain one’s standard of living; measured in currency, it becomes a global race to the bottom (currency devaluation).

On a purely mathematical basis, absent a massive redistribution of wealth and a transition to a renewably-powered economy, we are now on a descent trajectory that will bring us to the point where the resource base times the efficiency of production equals consumption times population. That equation suggests a global population of around 1.5 billion or less by the end of this century, or a loss of about five-sixths of the world’s population from peak (circa 2020) to trough (circa 2100).

This leads us to some very fundamental, even existential, questions. Faced with the Politics of Less, can we stomach coerced wealth redistribution, or will we simply let the system collapse? Do you bet on a global expansion of consciousness such that we recognize we are all One and link arms, singing Kumbaya? Or do you get busy on your hilltop doomstead, equipped with backup energy, food, water, ammunition, and gold? Do you join your brothers and sisters in the streets, or do you withdraw to your tribe and erect a security fence on the perimeter?

There are no quick fixes to this challenge. It has evolved over roughly half a century, through Democratic and Republican regimes alike, and we have roughly half a century to respond to it, starting right now. Any response that doesn’t address the fundamental issue of declining net energy is doomed to fail. I like to think we can respond intelligently, and I would never short human ingenuity and compassion. On the other hand, it’s hard to argue against a reversion to the mean of human history.

What’s your bet?

Photo: Occupy Wall Street (david_shankbone/Flickr)