Commodity Prices Are Cliff-Diving

31 12 2014

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David Stockman

Submitted by David Stockman via Contra Corner blog,

Crude oil is not the only commodity that is crashing. Iron ore is on a similar trajectory and for a common reason. Namely, the two-decade-long economic boom fuelled by the money printing rampage of the world’s central banks is beginning to cool rapidly. What the old-time Austrians called “malinvestment” and what Warren Buffet once referred to as the “naked swimmers” exposed by a receding tide is now becoming all too apparent.

This cooling phase is graphically evident in the cliff-diving movement of most industrial commodities. But it is important to recognize that these are not indicative of some timeless and repetitive cycle—–or an example merely of the old adage that high prices are their own best cure.

Instead, today’s plunging commodity prices represent something new under the sun. That is, they are the product of a fracturing monetary supernova that was a unique and never before experienced aberration caused by the 1990s rise, and then the subsequent lunatic expansion after the 2008 crisis, of a cancerous regime of Keynesian central banking.

Stated differently, the worldwide economic and industrial boom since the early 1990s was not indicative of sublime human progress or the break-out of a newly energetic market capitalism on a global basis. Instead, the approximate $50 trillion gain in the reported global GDP over the past two decades was an unhealthy and unsustainable economic deformation financed by a vast outpouring of fiat credit and false prices in the capital markets.

For that reason, the radical swings in commodity prices during the last two decades mark the path of a central bank generated macro-economic bubble, not merely the unique local supply and demand factors which pertain to crude oil, copper, iron ore, or the rest.  Accordingly, the chart below which shows that iron ore prices have plunged from $150 per ton in early 2013 to about $65 per ton at present only captures the tail end of the cycle.

Iron Ore- Click to enlarge

What really happened is that the central bank instigated global macro-economic bubble ripped commodity pricing cycles out of their historical moorings, resulting in a one time eruption of price levels that had no relationship to sustainable supply and demand factors in the mines and petroleum patch. What materialized, instead, was an unprecedented one-time mismatch of commodity production and use that caused pricing abnormalities of gargantuan proportions.

Thus, the true free market benchmark for iron ore is the pre-1994 price of about $20-25 per ton. This represented the long-time equilibrium between advancing mining technology and diminishing ore grades available to steel mills in the DM economies.

But as shown below, after Mr. Deng institutionalized export mercantilism and printing press prosperity in the form of China’s red capitalism in the early 1990s, iron ore prices broke orbit and soared to $100 per ton in the second half of the decade and then went parabolic from there. After peaking at $140 per ton on the eve of the financial crisis,China’s mad cap “infrastructure” stimulus boom after 2008 drove the price to a peak of $180 per ton in 2011-2012. To wit, iron ore prices peaked at nearly 9X their historic range.

Post 1994 Commodity Bubble - Click to enlarge

The crucial point is that there was nothing normal, sustainable or economic about the $180 per ton peak. It was a pure deformation of central bank credit expansion and the accompanying false pricing of debt and other forms of long-term capital.

Needless to say, the same thing is true of copper. Its historical benchmarks were in the 60 cents to 100 cents per pound range. Yet after 1994, the global bubble—again led by the enormous credit explosion and currency exchange rate suppression in China and its BRIC satellites—carried the price to  $4 per pound in the eve of the financial crisis, and then to nearly $5 during the peak of China’s post-crisis credit explosion.

Indeed, in the case of copper, not only was the cycle driven by unsustainable construction demand; it was also powered by dodgy forms of financial engineering that turned copper inventories into financing collateral that was sometimes re-hypothecated many times over.

The exact same considerations apply most especially to crude oil. China’s GDP grew from $1 trillion to $9 trillion during the 13 years after the turn of the century. Growth of such enormous proportions is not remotely possible in an honest economy based on productivity, savings, investment and sound money. Likewise, China’s call on the global oil supply system—-which soared by 4X from 3 million bbls/day to nearly 12 million—–is also a drastic aberration; it is a product of runaway credit creation that financed false “demand”.

And that was only the beginning of the aberration. The China engine pulled additional false petroleum demand into the world market equation due to the boom among its suppliers—such as Brazil, Canada and Australia for raw materials and South Korea and Taiwan for  components and parts. Output levels and petroleum consumption in Germany and the US were also goosed by China’s voracious demand for German capital goods and Caterpillar’s heavy machinery, for example.

Accordingly, the crude oil price path shown below reflects the same global monetary supernova. The $20 price in place during the 1990s was no higher in inflation adjusted terms than it had been one century earlier when the mighty Spindletop gusher was discovered in East Texas in 1901. By contrast, the 5X eruption to north of $100 per barrel during this century represents the impact of fiat credit and false capital market prices deforming the entire warp and woof of the global economy.

 

fredgraph

Self-evidently, we are now in the cliff-diving phase, but unlike the bounce after the September 2008 financial crisis, there will be no rebound this time around. That is owing to two reasons.

First, most of the world is at “peak debt”. That is, the ratio of total credit market debt to current national income ranges between 350% and 500% in every major economy; and that is the limit of what can be serviced even at today’s aberrantly low interest rates.

As Milton Friedman famously observed, markets are ultimately not fooled by the money illusion. In this case, the illusion is that today’s sub-economic interest rates will last forever and that debt carrying capacity has been elevated accordingly.

Not true. Short-term interest rates may be temporarily and artificially pegged at the zero bound by central bankers, but at the end of the day debt carrying capacity is tethered by real economics and normalized costs of money and debt.

Accordingly, the central banks are now pushing on a string.  The credit channel of monetary transmission is over and done. The only remaining effect of the residual level of money printing still underway is that ZIRP enables carry trade gamblers to drive financial asset prices ever higher, thereby setting up another thundering collapse of the financial bubbles being generated for the third time this century by the world’s central banks.

The second reason for no commodity price rebound is the monumental overhang of the malinvestments which have been made, especially since the 2008 crisis. That is obviously what is now pummelling the petroleum sector.

The huge expansion of high cost crude oil capacity—–in the shale patch, tar sands and deep off-shore—-was due to the aberrationally high price of oil and the inordinately cheap cost of capital which were generated during the last two decades by the global central banks. The above price chart for the WTI marker price of crude, for example, is what explains the eruption of shale oil production from 1 million bbls/day prior to the financial crisis to more than 4 million at present., not an alleged technological miracle called “fracking”.

However, the iron ore capacity expansion story is no less cogent. On the eve of the financial crisis, the Big Three miners—-Vale, BHP and Rio—had already doubled their mining capacity from 250 million tons annually at the turn of the century, to 195 million tons per quarter or 780 million tons annually.

Q production

But when prices soared to $180/ton in 2012, investment levels were drastically scaled-up even further. Currently, the Big Three have combined capacity of more than 1.1 billion tons annually that is not only in the investment pipeline, but is actually so far advanced that completion makes more sense than abandonment.  Accordingly, not withstanding the massive over-supply already in the market, several hundred million more tons will compound the surplus and drive prices even closer to the out-of-pocket cash cost of production in the years immediately ahead.

Curent n planned capacity

The above depicted capacity expansion is a quintessential reflection of the manner in which false prices in the capital markets drive excessive and wasteful investment, and cause the crash following the credit driven boom to be all the more destructive. So the cliff-diving price action here is not just another commodity cycle, but instead is a proxy for the fracturing global credit bubble, led by China department.

During the course of its mad scramble to become the world’s export factory and then its greatest infrastructure construction site, China’s expansion of domestic credit broke every historical record and has ultimately landed in the zone of pure financial madness. To wit, during the 14 years since the turn of the century China’s total debt outstanding–including its vast, opaque, wild west shadow banking system—soared from $1 trillion to $25 trillion, and from 1X GDP to upwards of 3X.

But these “leverage ratios” are actually far more dangerous and unstable than the pure numbers suggest because the denominator—national income or GDP—-has been erected on an unsustainable frenzy of fixed asset investment. Accordingly, China’s so-called GDP of $9 trillion contains a huge component of one-time spending that will disappear in the years ahead, but which will leave behind enormous economic waste and monumental over-investment that will result in sub-economic returns and write-offs for years to come. Stated differently, China’s true total debt ratio is much higher than 3X currently reported due to the unsustainable bloat in its reported national income.

Nearly every year since 2008, in fact, fixed asset investment in public infrastructure, housing and domestic industry has amounted to nearly 50% of GDP. But that’s not just a case of extreme of growth enthusiasm, as the Wall Street bulls would have you believe. It’s actually indicative of an economy of 1.3 billion people who have gone mad digging, building, borrowing and speculating.

Nowhere is this more evident than in China’s vastly overbuilt steel industry, where capacity has soared from about 100 million tons in 1995 to upwards of 1.2 billion tons today. Again, this 12X growth in less than two decades is not just red capitalism getting rambunctious; its actually an economically cancerous deformation that will eventually dislocate the entire global economy.  Stated differently, the 1 billion ton growth of China’s steel industry since 1995 represents 2X the entire capacity of the global steel industry at the time; 7X the size of Japan’s then world champion steel industry; and 10X the then size of the US industry.

Already, the evidence of a thundering break-down of China’s steel industry is gathering momentum. Capacity utilization has fallen from 95% in 2001 to 75% last year, and will eventually plunge toward 60%, resulting in upwards of a half billion tons of excess capacity. Likewise, even the manipulated and massaged financial results from China big steel companies have begin to sharply deteriorate. Profits have dropped from $80-100 billion RMB annually to 20 billion in 2013, and are now in the red; and the reported aggregate leverage ratio of the industry has soared to in excess of 70%.

But these are just mild intimations of what is coming. The hidden truth of the matter is that China would be lucky to have even 500 million tons of annual “sell-through” demand for steel to be used in production of cars, appliances, industrial machinery and for normal replacement cycles of long-lived capital assets like office towers, ships, shopping malls, highways, airports and rails.  Stated differently, upwards of 50% of the 800 million tons of steel produced by China in 2013 likely went into one-time demand from the frenzy in infrastructure spending.

Indeed, the deformations are so extreme that on the margin China’s steel industry has been chasing its own tail like some stumbling, fevered dragon. Thus, demand for plate steel to build dry bulk carriers has soared, but the underlying demand for new bulk carrier capacity was, ironically, driven by bloated demand for the iron ore needed to make the steel to build China’s empty apartments and office towers and unused airports, highways and rails.

In short, when the credit and building frenzy stops, China will be drowning in excess steel capacity and will try to export its way out— flooding the world with cheap steel. A trade crisis will soon ensue, and we will shortly have the kind of globalized import quota system that was imposed on Japan in the early 1980s. Needless to say, the latter may stabilize steel prices at levels far below current quotes, but it will also mean a drastic cutback in global steel production and iron ore demand.

And that gets to the core component of the deformation arising from central bank fueled credit expansion and the drastic worldwide repression of interest rates and cost of capital. The 12X expansion of China’s steel industry was accompanied by an even more fantastic expansion of iron ore production, processing, transportation, port and ocean shipping capacity.

On the one hand, capacity could not grow at the breakneck speed of China’s initial ramp in steel production—so prices soared. And again, not just in the range of traditional cyclical amplitudes. As indicated above, prices rose from $20 per ton in the early 1990s to $180 per ton by 2012—meaning that vast windfall rents were earned on the difference between low cash costs on existing or recently constructed iron ore capacity and the soaring prices in spot and contract markets.

The reality of truly obscene current profits and the propaganda about endless growth in the miracle of red capitalism, combined with the cheap debt available in global capital markets, resulted in an explosion of iron ore mining capacity like the world has never before witnessed in any mineral industry.

Stated differently, the Big Three miners would never have expanded their capacity from 250 million tons to 1.1 billion tons in an honest free market. Nor would they have posted such egregious financial trends as have occurred over the past decade. To wit, even as the global iron ore (and also copper) boom gather steam in the run-up to the financial crisis, the three miners spent $55 billion on CapEx during the four years ending in 2007.

By contrast, during the four most recent years they spent 3.2X more or $175 billion. Not surprisingly, the residue on their balance sheets is unmistakable. Their combined debt went from about $12 billion in 2004 to more than $90 billion at present.

But now, prices will be driven down to the lowest marginal cost of supply, meaning that Big Three EBITDA will violently collapse, causing leverage ratios to soar and new CapEx to be drastically downsized. In turn, Caterpillar’s order book will take a giant hit, and so will its supply chain running all the way back to Peoria.

 

So the collapse of the mother of all commodity bubbles is virtually baked into the cake. As one industry CEO recently acknowledged, his company’s truly variable, cash cost of production is about $20 per ton and he will not hesitate to keep producing for positive variable profit. That means iron ore prices will also plunge far below the current $66 per ton quote now extant in the market.

In short, when the classical Austrians talked about “malinvestment” the pending disasters in the global steel and iron ore industries (and also mining equipment and other supplier industries) are what they had in mind. Except none of them could have imagined the fevered and irrational magnitudes of the deformations that have resulted from the actions of the mad money printers who now run the world’s central banks.

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Another White Elephant is born……..

15 04 2014

The Federal Government has announced a second airport for Sydney at Badgerys Creek will be built.  This has been met with enthusiasm by airlines and business groups.  But what a stupid idea it is……  Absolutely nothing I have read about this project so far even mentions Peak Oil, or where the fuel for all those extra planes will come from.  Or the money for that matter….

Obviously, the aviation industry hasn’t seen this:

One might even ask, “will QANTAS still exist by the time this airport is finished”, IF it even starts……..?

On CO2 emissions, the impacts from a 5% air traffic growth have been assumed to be lessened by a 2% growth in fuel efficiency.  Leaving a 3% growth in CO2 emissions.  If aviation emissions really grow by that much, the aviation industry should be called “Flight Path to a Stormy Future”.  This is because NASA climatologist James Hansen just published a book “Storms of my Grandchildren” predicting huge storms over the Atlantic in addition to the area of cyclones and hurricanes expanding. That will mean a lot of cancelled flights…… because surely we have reached the stage where Climate Change is starting to become very obvious.

This idea has been contentious for a very long time, but there is no doubt opposition will be real.  And likely stronger than ever before.  I don’t think we’ve seen the end of this in the media…….!

badgerryprotest

UPDATE:
The federal and New South Wales governments will today (16 April 2014) announce they are spending nearly $3.5 billion on roads to support the construction of Sydney’s second airport.  The money will flow over the next decade and the news has been welcomed by some nervous Federal Liberal MPs in Western Sydney, who hope it will dampen community opposition to the Badgerys Creek project.

So there you have it.  No rail or even light rail links…. just more roads that won’t be carrying cars to an airport with no planes.. now that’s what I call vision!





With fossil fuels…… you can do ANYTHING!

14 02 2014

The much heralded Ivanpah Solar Thermal Power station in California is being commissioned as I type.  Mighty impressive too….  Sprawling across almost thirteen square kilometres of land near the California-Nevada border, it looks pretty damn beautiful…….

ivanpah

Take 300,000 computer-controlled mirrors, each 2 metres high and 3 metres wide, control them with computers to focus the Sun’s light to the top of 150 metre high towers where water is heated to steam, to power turbines, and….. Ta dah…: you have the world’s biggest solar power plant, the Ivanpah Solar Electric Generating System.

Long-mired by regulatory issues and legal tangles, the enormous solar plant–jointly-owned by NRG EnergyBrightSource Energy and Google opened for business today…….

From the official news release:

The Ivanpah Solar Electric Generating System is now operational and delivering solar electricity to California customers. At full capacity, the facility’s trio of 450-foot high towers produces a gross total of 392 megawatts (MW) of solar power, enough electricity to provide 140,000 California homes with clean energy and avoid 400,000 metric tons of carbon dioxide per year, equal to removing 72,000 vehicles off the road.

BUT……  check out how much steel and concrete has gone into this beast…  how much embodied energy are we looking at..?  anyone trying to tell you this can’t be done without fossil fuels had better watch this…:

Now I’m not saying this shouldn’t be done, and I agree it is an engineering marvel, but I still ask, how will this sort of construction continue, let alone maintenance and eventual replacement post Peak Oil, Peak Coal, Peak Uranium, and Peak Debt…..  Just asking.

More photos here…

 





Automobile deathwatch

10 12 2013

The media is alight with reports of GMH Holden closing its doors some time in 2014.  And this, so short a time since Ford Australia told the world it was doing the exact same thing earlier this year.

There’s outrage everywhere, not least the blogosphere (like this) where everyone’s blaming the new government (for whom I have no time at all..), as if they were actually in charge….  Except they’re not in charge; larger forces at hand are, and the car is dying.  Cars are going extinct, just like the dinosaurs that they have become.

In the last census held just five months ago, there were 17.2 million vehicles counted in Australia, including motor cycles, and about half a million were ‘trucks’ of various types.  Which means that, roughly, there are some 16 million cars registered for a population of 23 million, or almost 1.5 cars per 2 people.  Let’s face it, there are two cars for two people in this supposedly green household…

I know when I drive on the freeway to Brisbane at my leisurely 90 km/h, hundreds of cars and many trucks pass me.  Every time I do this (as less often as possible you must understand!) I know we are stuffed.  All I can think about are the tonnes of non renewable fuel consumed to do this, and unbelievable amounts of debt that must be out there to pay for all that travelling.  And yet, it wasn’t like this once…..

Just pretend for a moment that you’re a farmer at the dawn of the 20th century.  You’ve got all the seeds you need for the next growing season, all the ploughs, hoes, and other accessories, too.  You’d be out in the paddocks now, except for one problem: you haven’t got a horse….!  Or a bullock…

That’s a major disaster…. How can you run your farm without a horse to do the heavy lifting….?

Three generations ago, that would have been a real head-scratcher.  Today, however, the answer is obvious: head down to Massey Ferguson and fork out for a tractor.  With debt of course……

From our current perspective, the transition from horses to horsepower appears seamless, but in fact it didn’t happen like that, nor was it accidental.  It was a complex process that leveraged emerging technologies to address rapidly changing needs in the farming sector.  At a time, let’s not forget, oil production was rising fast, and oil was cheaper than chips… Farmers didn’t just switch to tractors because tractors were more efficient than horses, they switched to tractors because farmers had to produce exponentially larger amounts of food for a population that was abandoning rural life for bustling cities, thanks to the Fossil Fuelled Industrial Revolution.  And because the farmers’ big switch worked, vast numbers of people could leave farming altogether, forcing tractors to get bigger and faster, thus  fuelling a vicious circle of dependence.

Something similar is happening to the car as we speak.

A century later, the private car is dying. Older Australians may still appreciate the vehicles parked in their driveways, but as we’ve seen time and time again, young people just don’t care.  In 1991, of NSW kids aged 20-24, 79 per cent had licences. By 2001 it had risen to 80 per cent. Yet by 2008 it had crashed to just 51 per cent and continues to decline. A new study in Victoria by Monash University shows the number of licence holders under 30 is dropping at more than 1 per cent a year.  Neither of our 26 year old twins have a license, though one of them is currently learning to drive just to be able to get work now he’s finished University……

But there’s more to it than that: young people aren’t blase about cars simply because it’s harder to get a license nowadays, or because they can’t afford them (although those are contributing factors). It’s because cars are no longer necessary.

A paper by Curtin University academics Peter Newman and Jeff Kenworthy, Peak Car Use: Understanding the Demise of Automobile Dependence, cites soaring oil prices, traffic congestion, a preference for inner-city living, public transport growth, an ageing population, and more crowded cities for pushing people away from cars. ”Peak car use is a major historical discontinuity that was largely unpredicted by most urban professionals and academics,” write the authors.

So why is everyone surprised, even outraged, that the car companies are closing their doors?  Especially when they build totally inappropriate cars for today’s capacity to fuel them….?

The rationale for building cars in Australia is about as thin as an EH Holden’s paintwork.  In competition with much bigger and cheaper global competitors, Australia’s car industry never stood a chance.  It certainly did its job to help secure an industrial base in a less specialised world, but the world has changed now, it’s one big supply chain and Australia has to sell into it and buy from it.

Mitsubishi is gone (mind you, I know from first hand experience what crap cars they built), Ford is all but gone, Holden is preparing to go and Toyota may not be far behind. There were almost 44 million vehicles manufactured globally in the first six months of 2013: more than 10 million in China, more than five million in the US, Japan close behind, then Germany, South Korea, India, Brazil, Mexico at about two million each. Australia made 94,000 vehicles in that time and ranks 30th out of 39 car-manufacturing nations, alongside Hungary and Austria.  Are we still surprised…?

Fact of the matter is, to continue making cars would need more oil and more money.  And both those commodities are in short supply.  Even the US Government is selling its shares in GM, at a loss of $10.5 billion!





How do you like the Long Emergency so far………..?

5 12 2013

James Howard Kunstler is one of my favourite writers.  No one has such a way with words, incisive, cynical, sarcastic, derisive, humorous, and also well written full of wit and clever imagery……

Here he is doing a TED talk.  Enjoy……..





Why the Debt Ceiling is a complete oxymoron

22 10 2013

I’ve been saying this for years now, ever since I watched Chris Martenson’s Crash Course and had “the epiphany”.  This short film clearly spells out why debts will one day have to be cancelled, no ifs, no buts……

The Federal Government today announced a $200 billion increase to the Commonwealth debt ceiling.  A six-month audit into Government spending in the face of a “deteriorating” budget position will also come into effect……

Treasurer Joe Hockey announced “the Coalition government will have to increase the debt limit for Commonwealth Government securities to $500b,” and “we are increasing it to that level because I’ve been advised that on 12 December, the current debt limit of $300b will be hit.”

“We need to put it beyond any doubt and we do not want to have to revisit this issue again,” he said, adding the Government needed to “move quickly” particularly in the wake of the recent US debt limit crisis.  So, as rossleighbrisbane wrote at the AIMN, Hockey’s obviously concerned that Labor will continue to waste money in Opposition.

So, either Hockey is stupid, ignorant, or disingenuous.  I suspect all three.

At the very least, he does not understand the exponential function.  Nor does he know about fractional banking.  Some treasurer…….  why oh why are we ruled by MORONS!!!

wealth transfer





Why I Stopped Worrying And Learned To Love The Currency Collapse

18 10 2013

US.debt.limit

US.debt.limit

http://www.davekimble.org.au/peakoil/charts/US.debt.limit.png

by Christian Gustafson of Deflation Land

For the past 300 years, the historical pattern has been for the era marked by a century to continue into the following century by fourteen or fifteen years.

Let me explain.  Everyone knows that the 19th Century, its uprightness, its optimism and sense of purpose, the halcyon days of British Empire, came to an end with World War I, starting in 1914 and building to a nasty crescendo by 1916.  The 20th Century had arrived, and it had some real horrors in store for us.

But if we return back another hundred years, we notice that the 18th Century ends in 1815 with the final defeat of Napoleon, that final project of the Enlightenment and of the French Revolution.  With the Congress of Vienna in 1814-1815, we have a new Europe along the lines of Metternich’s plan, and the 19th Century at last is here.

In 1713 and 1714, we have the Treaties of Utrecht, Baden, and Rastatt, bringing an end to the era of Spain as a major power, and the rise of the Habsburgs.  Louis XIV dies in 1715, after reigning for 72 years.  The Baroque period is over, and we are now firmly in the 18th Century.

We still live in the 20th Century.  Nothing much significant has changed in our lives in the past twenty years. Symptoms of a deeper rot are appearing here and there, foreshadowing a larger crisis, but the crisis itself has not arrived yet.  We still live in an era of Pax Americana, the old republic very much a strained and tired Empire now, with the U.S. Dollar as the world’s reserve currency.

That is going to change.

The next task for History is to dismantle the untenable structures and institutions put in place by late Modernity, which have been extended now as far as they can go.  Our debt-based monetary system will collapse, our unbacked fiats will be worthless.  The debts and unmeetable obligations will all default.

There are ironies and great contradictions as the former home and hope of Liberty becomes viciously unfree and increasingly despotic.  Our leaders no longer govern, but try instead to rule us — they are less legitimate with each passing day, their laws corrupt or worse.  They are nearly finished, and will be swept away with the tide.

Just as in 1914, the internationalist system will break down, dashing the hopes of the would-be first-world nations.  We will probably have a pretty good war as well, or many local ones worldwide.  These transitions tend to involve war.

Deflation first — it clears the way for the complete loss of faith and hyperinflation that will follow.  The next big wave down in the financial markets is the battering ram.  The U.S. national debt is about faith, so is quantitative easing, and so is the very idea of magical coins that could ever be “worth” a trillion dollars.  When this faith breaks, in concert with loss of faith in perpetual growth and unlimited cheap energy, then things will move very, very quickly.

There is nothing any of us can do at this point, except navigate the rapids as well as possible, and to stay out of the way of a dying empire, which is still very dangerous in its death throes.  We are actually very privileged to be alive and witnessing this next transition, to what we do not know just yet.  But what an honour to live at this time, not in ignorance but with an existential resolve to come out of it alive and much the wiser.