The dot com bubble. The housing bubble. Markets are prone to an endless succession of irrational exuberance that allows commodities to dramatically overshoot their intrinsic value. Greed and avarice blind the masses to the overvaluation until rationality unpredictably takes hold and the bubble collapses. There are always people who recognize a bubble when they see one; the problem is predicting just when it will pop and catastrophically collapse.
Today a number of experts have recognized that we are living in the midst of a century-plus-long period of irrational exuberance. I like to call it the Carbon Bubble.
The carbon bubble, quite simply, is the constantly increasing consumption of fossil fuels that began with coal in the 19th century and then continued with oil and gas in the 20th. I call it the master bubble because it drives the growth of every economic indicator, from gross domestic product, to automobile production to corn harvests. In fact the incredible human population boom is largely an artifact of the carbon bubble. Seven billion people are fed only because we turn oil into food. For some agricultural products it takes 10 calories of oil to produce one calorie of food. The truth is people are made of oil.
Most people don't think of economic and population growth as a bubble. That's because it has continued continuously since the rise of market economies with only minor setbacks. But modern industrial growth has been turbo-charged by fossil fuels. The carbon bubble's life span is greater than the life span of any human, so for people living today it seems like an inevitability. But it may not be. The deflation of the carbon bubble is a real possibility.
Economic growth is predicated on the expectation that oil supplies will remain reliable and cheap. But the recent history of oil supply and demand gives a hint to what even a partial deflation of the carbon bubble can bring. Spiking oil prices have repeatedly caused economies to stumble, putting a ceiling on economic growth. It's been called the "undulating plateau" and works like this: As oil supplies get tight, prices rise, which in turn crimps economic growth. The combination of oil dependence and production constraints set up a self-sabotaging boom and bust cycle.
As economists point out, price spikes encourage entrepreneurs and innovators. In the past they have spurred exploration and the discovery of new cheap oil sources. It might happen again, but new oil sources are found in increasingly costly places like deep water and perhaps the ecologically fragile Arctic. Technological improvements like energy efficiency and the demise of the Hummer have also made us less vulnerable to oil price swings. But there are limits.
A bubble is sustained by expectations and ultimately collapses when the masses lose faith. Unfortunately, it's impossible to predict the exact moment at which this happens. I am especially bad at it. When my wife and I moved to Spain in 2001, I thought the country was in a real estate bubble. It was, but it took about a decade to pop. Right now it's easy to see a carbon bubble, but is it half empty or half full?
Oil is the lubricant of capitalism, but if the masses lose faith in reliable oil supplies you will begin to hear the hissing sound. The scenes of popular revolution in the Middle East are inspirational but they are spooking oil markets. The loss of Libyan production due to unrest has not been catastrophic, but Libya is a bit player. As one analyst put it, "If what happened in Libya happens in Saudi Arabia, it's the end of western civilization." This is the disturbing point. Are the rise of modern western civilization and the carbon bubble synonymous? If not, then let's stop acting like it.