Gail,
Doesn't your last statement imply we do one thing while the world does another? The best solution would seem to be for the world to do all the above.

I think trade imbalances will be primarily driven by the relative weighting of his last point -- how much bankruptcy versus how much inflation. This is really a critical question for each of us, as it affects where we should put our savings, whether into cash, commodities, or other equities.

I know food and tools, a house, and skills are always good bets, but beyond that it just isn't clear to me.

Anything in the financial sector seems like a very bad bet, in any case.

I could see a lower GDP will make the budget deficit and overall debt look a LOT worse, but wouldn't trade imbalance (for the US) be improved by a focus on tangible wealth generation like manufacturing?

It seems like the lower level of debt will reduce natural gas production. We have already seen cutbacks in planned drilling from natural gas companies, related at least in part to the loss of available credit markets.

It may also interfere with oil production and distribution, because there are many smaller entities (oil and gas service companies, gas stations, various kind of subcontractors) involved in the distribution chain, and they rely heavily on debt financing. Utilities are similarly likely to be affected. They are likely to have a more difficult time buying fuel and trading for electricity over the grid.

All of this is likely to lead to disruptions of many types--loss of electrical power, shortages of gasoline and diesel, and probably some interference with agriculture.

At the same time, we no longer have factories for a lot of basic things we need--repair items for the electric grid; new nuclear reactors; fertilizer; clothing and shoes; items to repair the cars we drive. One can think of a lot more.

With the disruption to fuel supplies and utilities, we will most likely have a lot less that we can manufacture or produce from agriculture. At the same time, our needs for imports will be as high, or higher, then ever before. How do we bridge this gap?

I think he's saying that the Financial sector of the Service economy is way too big, employs way too many people and that may be true of the Service economy itself! What do you do with all these people when they are no longer needed to produce real things, which itself has been exported from the US?

Gail points to some consequences of Herman's ideas. It does seem obvious that there will be less credit but it will take VASTLY less credit and debt to bring the system back toward a steady state. It is the sheer huge size of our combined government, corporate and individual debt about $50+ trillion vs our GDP $13 or $14 trillion) that daunts me.That is a ratio of 3.5 to 1. At the nadir of the Great D that ratio had soared to only 2.5 to 1. Most TOD ers believe that cheap energy has allowed the kind of productivity that has converted that oil drum into a drum of something more valuable but if that cheap drum of oil isn't replaced with another cheap drum of a different energy, then where will the productivity emanate from? If growth slows or stops or becomes negative, that debt will never be repaid unless the currency is expanded, ie inflation. I think we have here not a problem but a "predicament" as JM Greer has pointed out in his latest book,"The Long Descent." Greer points out that problems may have solutions but predicaments do not.We know what expanded debt and credit did to the economy when the expansion was out of phase with real wealth creation and we fear what the consequences of pulling the plug on debt and credit might be, but what other choices are there? The huge majority of the nation opposed the banking bailout by a treasury secretary who was a Goldman Sachs former CEO. The problems were created and advanced by investment banks and bankers such as Paulson and his tribe so here we had the ludicrous spectacle of a banker bailing out himself paid by us using a hurry up offense. He promoted the banking bailout to prevent something worse.But he advanced no evidence to support his assertions that something worse might happen. Something worse may happen anyway but at least his former bank and his former tribal members are sleeping better.The morons and crooks who devised and promoted this debacle are not being punished but most of their employees are, as well as most of the country. The wall street banking industry owned the government and now the positions are reversed. They have the cash and we have the trash. As to How Prof Daly would handle a transition......well how can we transition from a situation of debt and credit created wealth to wealth? We can't. There is no easy way to erase wealth. Most of our wealth was chimera. It was never there anyway. Should we punish the banking axis of evil? Of course. Would it yield much money? of course not but sending a horde of these bankers and buffoons to the guillotine would send a message.This hurried and poorly thought out propping up of a failed financial system just delays the inevitable collapse. The investment banks should have been allowed to fail. There would have been huge financial harm to all manner of people and not just the investment banks who were leveraging and trading their own securities but innocents like the Norwegian Teacher's union and pensioners in Japan and Korea and other banks and insurance and pension funds and even governments worldwide. But they bought those securities. I didn't nor did 99% of my citizens. You choose. You lose. Will the world ever trust the US financial system again? Not in my lifetime, with or without a bailout. Daly points out the obvious that for wealth to be real, it has to be real. Real wealth is created by people doing real work not pushing paper oops! I mean hitting a keyboard to create a CDS to insure against a default which the bogus insurer can't pay anyway. GDP will fall and fall hard. There will be no way to balance a trade deficit that is 70% due to our purchase of imported oil any more than we can have energy independence by drilling off Virginia or California. YOYO folks. You're on your own. Hugh in Jackson Hole.

Hi Gail,

What I got from Prof. Daley's presentation is that the damage has already occurred. The debts exist. There is no mechanism for their removal nor is there remotely sufficient real wealth to do so even if a globally agreed procedure was already in place.

Not only will the GDP fall, it is already falling and has been for a long time now. The decline was simply hidden by statistics that treated imaginary products as though they were real ones, as if bushels of wheat were somehow equivalent to 'credit default swaps of securitized tranches of tax incremented municipal surety bonds' (i.e. indecipherably absurd financial instruments.) As for the Trade Deficit, the arcane relationship between real and hallucinatory production makes it virtually impossible to even calculate what the deficit IS, much less balance it.

The situation is comparable to Peak Oil in a lot of ways. We might like to go on driving big cars on limitless fuels forever (just like we would like to have endless pay raises), but we're not going to because gone is gone. Another non-negotiable constraint imposed by an utterly non-abstract world.

I personally doubt that any government or combination thereof has the power to stop the chain reaction that is accelerating at such a rate as seen in the past few weeks. It would require what? The simultaneous elimination of fear in many millions of minds? The suspension of hundreds of laws controlling the honoring of debts and contracts? How could such an engendering of faith in the faithless even be transmitted to so many people so quickly? To make matters worse, those who need their heads put back on straight are the same people who created the problem in the first place. If we passed a hat for enough money to really bail out the world economy, does anyone believe Hank Paulson or any of his ilk would chip in their own ill gotten gains?

There might still be a miracle. It will require nothing less.

What we are doing now (in discussions like this on The Oil Drum) is not so much proposing realistic solutions to fix what's broke, as we are hashing out the details of better rules-of-play should we ever have the opportunity to rebuild a civilization from the ashes of this one.

Gail,

I'm a financial newbie, trying to learn fast.

As I understand it, derivatives are unsecured, or undersecured side bets. Credit default swaps are on the books for approximately 50 trillion, and total derivatives represent about 500 trillion.

CDS were often acquired as a hedge against paper such as sub-prime mortgages and a large amount of them have already defaulted. If the majority of derivatives are smoke, why hasn't the derivative casino started to unravel? Is this the 1000 lb rhino in the room that everyone ignores?

As Professor Daly has appropriately suggested, this practice should be ended.

That's all well and good, but if mortgages of various qualities have been bundled into securities and unraveling individual mortgages seems nigh impossible, I don't understand how derivatives could be unwound in any sort of organized fashion. This means that it all has to fall down, and then we start again with a new rule book that has some basis in reality.

As I said, I don't understand how the lie is sustained, but what event would be necessary for derivatives to implode?

This all sound pretty scary to me, so I invite anyone to point out the error of my ways.

Cheers,

It seems like there would be a huge drop in GDP at the time this change takes place.

Gail,
I think the profits in the financial industry are counted as part of GDP. If so, there should really be a huge drop. And if there were not, we wouldn't be fixing the problem. Or am I seriously missing the point? Of course some of the financial industry is legitimate useful work, and should be counted, but mostly it is toxic fluff.