The Real Reason for the Crash and How to Fix It

When economists talk about the crash, they usually blame subprime mortgages and profligate lending by the banks. However, our financial problems are only a side-effect of the real issue, which is that, last summer, we experienced our first taste of what it is like to butt up against the limits of the earth’s ability to sustain our growth.

Things have changed so much that it is almost impossible to look back to those days and remember what it was like, and yet it’s only a few months ago.

Starting in early 2007 and peaking last summer, commodities prices shot up massively across the board, culminating last August when oil reach $149.00 a barrel, and gasoline prices around the world shot up by as much as two hundred percent in some countries.

At the same time, food prices shot up and shortages of corn and rice caused terrifying breadlines in many countries, and even in the US and Western Europe there were rice shortages.

At the same time, many people in the US had bought houses using mortgages that they could only afford if they were able to refinance in order to avoid cost increases associated with the end of the interest-only period of their mortgages.

However, starting in mid 2007, rising food and fuel costs began sucking cash out of the economy. At first, consumer spending was unaffected as people used credit card debt to finance their lifestyles, then later, to buy necessities.

Staggering fuel cost increases occurred. Between December of 2006 and June of 2008, the average price of a gallon of gas in the United States rose from $2.80 to $4.10. Meanwhile the fuel efficiency of automobiles had remained stagnant for years and years. And price increases in other large countries, with the exception of India, China and a few others that subsidize gas costs, went through the roof.

The combination of exploding food bills and exploding fuel bills sucked cash out of the economy at the same time that consumer credit in the US maxed out and hundreds of thousands of mortgages increased in cost as prinicpal began to be added to interest.

As a result of the lack of cash in the economy, two things happened: house prices began to drop with sales, and less financially able owners were forced to make a choice: eat and go to work or pay for the house. Refinancing wasn’t possible because the value of the house had declined.

Mortgage payments became overdue, and by October the foreclosure rate was beginning to rise alarmingly.

Because mortgages had been turned into fake securities, it ceased to be possible to tell which of these securities were healthy and which were not, which led to banks being unwilling to loan each other money on the basis of these assets. And the rest is, basically, financial history.

But it isn’t the whole story and it isn’t even the most important part of the story. When you hear pundits talking about the credit crunch, the financial crisis, the banking crisis and the stock market collapse, they are talking about side-effects.

The core of the problem is to be found in the most fundamental place their is: humankind’s relationship with its planet, and our management and use of its resources.

What economists don’t say is this: the whole problem started not with the financial system but here: with our relationship to the earth itself. To some degree, the increase in commodity prices was made worse by institutions and hedge funds attempting to trade commodities to raise cash, as their real estate related activities began to turn into losers.

This was not a major factor, however. The major factor was, quite simply, increasing demand and decreasing supply. Because of high oil prices, demand for ethanol increased dramatically in the United States, with a resulting challenge to supply.

Around the world, droughts and floods caused problems with rice production, cattle ranching and many other essential crops. At the same time, people in Asia were beginning to eat more as and use more energy as their economies expanded and they became wealthier. This, along with steady and massive demand in the west, simply broke the back of the planet’s ability to supply the resources demanded.

So it is important to understand: it was the pressure of demand that caused the disaster, not financial manipulation, and the crisis is not going to be solved by financial bailouts and reconstruction of the banking system. As soon as the system is repaired, and it will be, demand will rise again and the same thing is going to happen, only this time it will be worse because global warming is getting worse, not better, with the result that weather extremes are harming more and more crops of all kinds.

So what do we need to do? Beyond fixing our broken financial system, we absolutely must do two things if we are going to survive. First, we must find effective ways to start atmospheric carbon accumulation on a downward path. Right now, we are at 385 parts per million. If we go much higher, the present crisis will develop into the greatest catastrophe we have ever known.

Second, we need to innovate in every area from fuel efficiency to food production. In fact, innovation is at least as important as reducing carbon emissions, and the two are synergistic: innovation in cleaning up our planet counts, too.

Will we succeed or fail? With the present administration’s commitment to the environment, there is more of a chance, but it is going to be a very near thing.

NOTE: This Journal entry, previously published on our old site, will have any links removed.