#126: What’s next for SEEDS?

THOUGHTS ON FUTURE USE

With SEEDS (the Surplus Energy Economics Data System) now fully operational, it seems logical to wonder about the uses to which it can or should be put. If this discussion doesn’t provide answers, it can, at least, set out some thoughts which might be of interest. As ever, readers’ comments will be very welcome.

For starters, SEEDS wasn’t built with any commercial end in view, still less from any wish to influence policy. Rather, the aim of the project was “to see if it could be done” – could the principles of an economy determined by energy (and not, fundamentally, by money) form the basis of a new way of interpreting events, and forecasting outcomes?

Accomplishing this turned out to be even more difficult than had seemed likely at the outset.

I was prepared for the ‘linguistic’ challenge of expressing energy-based concepts in the financial language customarily used in economics.

But what I had not anticipated was the extent to which, even within the purely financial sphere, it would be necessary to reimagine much that is taken for granted within conventional approaches to the economy.

Outcome

Whether SEEDS has succeeded is a matter for others to judge, and the real ‘verdict’ on the effectiveness of the system is likely, in any case, to be delivered by events. But there do seem to be sound reasons for cautious optimism.

If conventional economic interpretation is correct, what we should have been seeing, long before now, ought to have been a combination of steadily improving prosperity and progressively diminishing risk.

The SEEDS interpretation, in stark contrast to this, is that prosperity has plateaued on a global basis – and has gone into reverse in most advanced economies – whilst risk continues to increase.

Moreover, SEEDS differs starkly from the consensus in pointing unmistakeably to a sequel (here called “GFC II”) to the global financial crisis (GFC I) of 2008.

It isn’t going to be all that long before we find out which interpretation is the right one.

Prosperity examined

What can be done, here and now, is to give you a single example of SEEDS interpretation which you can compare with the consensus or conventional view.

The British economy serves as well as any for illustrative purposes.

Comparing 2017 with 2007 – and with all numbers expressed at constant 2017 values – the GDP of the United Kingdom has increased by 11%. Population numbers have also risen over that period (by nearly 8%), but GDP per capita remained modestly (3.3%) higher in 2017 than it had been back in 2007.

If conventional interpretation has any validity at all, this rise in GDP per capita should mean that the average person in Britain must be more prosperous now than he or she was ten years earlier. Average prosperity certainly shouldn’t have deteriorated over a period in which GDP per capita has risen.

The SEEDS interpretation could hardly be more different from this conclusion.

SEEDS starts by noting that, whilst growth of 11% has added £206bn to British GDP since 2007, this has been accompanied by a £1.23 trillion increase in aggregate debt.

One way of expressing this is that each £1 of growth has come at a cost of £5.45 in net new debt. Another is to note that annual borrowing averaged 6.0% of GDP over a period in which annual “growth” was barely 1.4%.

This necessarily prompts a number of questions.

First, has growth since 2007 been ‘genuine’ and organic, or has it really amounted to nothing more than a cosmetic process of ‘spending borrowed money’?

Second, is taking on £5,450 of new debt in return for a £1,000 rise in income a rational choice, favourable to prosperity?

Third, can this can kind of equation ever be sustainable, or does the rise in indebtedness turn, of necessity, into instability?

Before we can answer these questions, we need to take the energy issue into account. According to SEEDS, 9% of the economic output of the UK in 2017 should be allocated to the provision of energy (in its broadest sense, as the foundation of all economic activity). This is a higher number than that for 2007 (4.8%), a change which exerts a further adverse influence on prosperity.

Altogether, according to SEEDS, the average person was 9.2% worse off in 2017 than he or she had been in 2007. SEEDS can put a number on this deterioration in prosperity (£2,230 per person), enabling comparison with the increase in average per capita indebtedness (of £12,400) over the same period.

Finally, shifting from GDP to prosperity enables us to recalibrate risk exposure. In the British instance, debt at the end of 2017 is likely to have been 250% of GDP, but 349% of prosperity. Likewise, total financial assets (which measure the scale of the banking sector) rise from about 1135% of GDP to about 1580% of prosperity. Both of these risk ratios, measured on the basis of prosperity as analysed by SEEDS, are appreciably higher now than they were on the eve of GFC I back in 2007.

Very different interpretations

These numbers – which, it must be emphasised, are replicated, to a greater or lesser extent, across most other Western economies – supply an interpretation of the national or global economy which could hardly be in starker contrast to a consensus line based on “synchronised growth” and controllable risk. It need hardly be added that these very different conclusions about prosperity can be assumed to be of considerable significance, too, in the political arena.

If SEEDS is – or even simply might be – right about this, then this is information that people need. It further implies that conventional interpretation is failing those who rely on it. This, in turn, seems to require at least some consideration of the uses to which SEEDS should be put.

These possible uses seem to fall into three main categories.

First, there seems a lot to be said in favour of continuing to pursue this approach, and making its findings available to those members of the public who are interested in it.

Other possible applications are less straightforward. Logically, SEEDS interpretation ought to be of use to the policy process, but it is highly unlikely that any government is going to ask for it.

I am not in any sense a ‘zealot’, and I’m certainly not set on convincing anybody of anything. So I’m not going to be promoting SEEDS as a tool that government ‘ought to be’ using. I’m not even sure that I would want to co-operate with government, even in the extremely implausible event of being invited to do so.

This leaves us with the potential for commercial use of SEEDS. I’m not opposed to this in principle, but I do have a set of parameters which, I think, can act as useful guidelines.

The first is that any co-operation with business could extend only to output from the system, and would never involve disclosing matters of process. The second is that SEEDS interpretations must remain available to the public, much as they are now.

In practical terms, this means that SEEDS datasets will be placed on the open access resources page of this site whenever they are relevant to a topic under discussion.

On the other hand, anyone wanting more comprehensive data (for instance, the numbers for all 27 countries covered by SEEDS, in their latest form), or requiring any kind of greater detail or tailored output, cannot expect this material to be made freely available. Much the same would apply to any licensed use of SEEDS output, again within the guidelines of (a) no disclosure of process, and (b) continued public access.

These are simply thoughts on what might be done with SEEDS, now that the system has been completed, and seems to be delivering useful results. Any comments on these ideas will be most welcome.

 

#125: Quantum of risk, part two

IRAN, OIL & THE CURRENCY DIMENSION

At first sight, it might appear a reasonable inference that the greatest significance of Mr Trump’s decision about the deal with Iran will be felt in oil markets. The reality, though, may be rather different. Oil may not be hugely affected, and the Iran decision might not do all that much to hasten the next supply squeeze.

The line explored here is that the greatest ramifications of President’s decision may show up in two other areas.

One of these is a widening in the nascent schism between Europe and America over what “capitalism” really means. This is a topic that we’ve explored here before, and needn’t revisit now. This said, the Iran situation could prompt Europe (and others) to accelerate their retreat from the “Anglo-American economic model”.

The other consequence, of far greater immediate practical importance, is what this development might mean for fiat currencies.

Three critical issues, #1 – the petro-prop

To put this in context, we need to remind ourselves of three critical points.

The first is that the US dollar relies massively on the “petro-prop”. Because oil (and other commodities, too) are traded in USD, anyone wanting to buy these commodities needs first to purchase dollars. This guarantees buyer support for the USD, and this in turn gives the dollar a big valuation premium.

If you convert other currencies into dollars on the basis of the prices of comparable goods and services, what results is a PPP (purchasing power parity) rate of exchange. If you then compare this with market averages, you can only conclude that the markets price the dollar at a premium to the fundamentals.

And that premium is massive. Through 2017 as a whole, for example, the market priced the dollar at a premium calculated by SEEDS at 78% above its purely economic (PPP) value. This isn’t new, of course, and premia have certainly been the norm since America ended gold convertibility way back in 1971.

But it’s the dollar’s “petro-prop” premium which alone enables the United States to issue massive amounts of debt – and seldom this can have been more significant than it is now, given America’s bizarre budgetary outlook.

It’s also at least arguable that only the “petro-prop” has allowed the Fed to run huge QE programmes, without either (a) risking severe currency depreciation, or (b) having to maintain interest rates at appreciably higher levels.

So, if you think that QE and ZIRP have underpinned the global financial system in a beneficial way since GFC I, then you have the “petro-prop” to thank for this outcome.

If, conversely, you share the view that “monetary adventurism” has been a new exercise in recklessness, then the “petro-prop” should carry much of the blame.

Either way, the “petro-prop” is a critical feature of the monetary landscape.

Any weakening of it could usher in hugely disruptive change. The one thing, above all, that the United States really doesn’t need right now is for countries buying and selling oil to start doing so in currencies other than USD.

Three critical issues, #2 – fiats in the firing-line

The second point we need to note is that, whereas GFC I, as a consequence of “credit adventurism”, put the banking system at risk, GFC II could extend the risk to the world’s fiat currencies, because the folly-of-choice since GFC I has been “monetary adventurism”.

Fissures in the monetary system are already showing up, initially in the plunging values of a string of EM (emerging market) currencies.

The consensus assumption seems to be that this is happening because of a strengthening USD.

This interpretation, however, is probably far, far too simplistic. The reality might be that investors are becoming more risk-averse, prompting a flight of capital out of EM economies.

This sort of risk aversion, albeit concentrated then on banks rather than national economies, happened in 2007, with the “credit crunch”.

If we call that the “banking credit crunch”, and regard it as the precursor to GFC I, then it’s reasonable to view current trends in EM currencies as a “currency credit crunch”, setting the scene for GFC II.

Three critical issues, #3 – an ignorance of risk

The third in our triumvirate of foundation factors is that fiat currencies, and the financial system more generally, already stand at unparalleled levels of risk – but anyone who assesses these issues along conventional lines is not in a position to appreciate this risk.

Essentially, stock numbers (such as debt), and flow data (typified by reported GDP), are insufficiently connected by conventional interpretation. Imagine that a given economy’s debt rises but, at the same time, its GDP increases, too, restraining the expansion in the ratio. This would be a mathematically valid equation if changes in stock don’t impact measured flow – but they do.

The GDPs of advanced economies (in particular) are dominated by household consumption, which typically accounts for between 60% and 70% of activity measured as GDP. But pushing credit into the system boosts this consumption, thereby invalidating much of the apparent debt ratio comfort derived from apparent increases in GDP. In short, a cessation of credit expansion can expose masked debt risk by undercutting debt-financed expenditures.

That such an event looks increasingly likely is underscored by Nomi Prins’ recent observation that the next threat to the system may be bottom-up, not top-down.

Authorities and observers are accustomed to appraising top-down risk, assessing – for example – the scale to which banks’ assets might be vulnerable.

What happens next, though, could very well be bottom-up. What this means is that hard-pressed borrowers might stumble off a treadmill in which debt servicing has become an increasingly onerous burden within the context of flat-lining incomes and rising household expenses.

What are the risks?

The SEEDS answer to the risk issue is to use calibration based, not on credit-inflated GDP, but on prosperity. The aim is to strip out the component of growth which derives from the simple spending of incremental borrowed money. At the same time, SEEDS factors in trends in the energy cost of energy (ECoE).

An ongoing SEEDS study of the Big Four fiat currencies suggests that risk exposures may be very, very much greater than conventional (GDP-based) calibration indicates. Debt, for example, equates to ‘only’ about 250% of GDP in the United States, but rises to 340% when measured against prosperity.

Other Big Four debt ratios, translated to prosperity calibration, rise to 349% (compared with 250% of GDP) for the UK, 305% (rather than about 240%) for the Euro Area, and 456% (versus 360%) for Japan.

The corresponding impacts on financial assets exposure are even more pronounced. Britain’s financial assets rise from about 1140% of GDP to 1578% of prosperity. For the others (with the GDP-based equivalent in brackets), the levels now stand at 768% (rather than 595%) for the Euro Area, 927% (733%) for Japan, and 660% (490%) for the United States.

All of these ratios – both for debt and for financial assets, measured against prosperity – are far higher now than they were ten years ago, on the eve of GFC I – which isn’t what you’d conclude if you settled for measuring both against credit-inflated GDP.

This leads us to two immediate and very sobering conclusions, neither of which should really come as any great surprise. Indeed, both are pretty obvious, properly considered.

First, if a country spends a decade gaming its currency, it masks the attendant risks, just as it is increasing those risks.

Second, any course of action tending towards a weakening of the dollar’s “petro-prop” could have unexpected consequences. Of course, we don’t yet know what Mr Trump’s Iran move really means, and we don’t know how Russia, China and – critically – European countries are going to respond.

One thing, though, seems certain. Whilst it proved impossible for Saddam Hussein’s Iraq to shift oil trade away from dollars,  there is no reason why really big players shouldn’t do exactly this. If major oil importers such as China, India and even the Euro Area develop new bilateral terms of petroleum trade with Iran, there is no reason whatsoever why these deals should be conducted in dollars.

In the proverbial nutshell, when your need for debt capital is being pushed up by budgetary irresponsibility, it makes no sense at all to undermine demand for your currency.

FX risk with tablejpg_Page1

 

#124: Riddle, mystery, enigma

SEEDS AND THE RUSSIAN ECONOMIC RIDDLE

Winston Churchill famously described Russia as “a riddle, wrapped in a mystery, inside an enigma”, but he also suggested that the key to the riddle might be “Russian national interest”.

It is hard to disagree with either of his conclusions.

What follows is an assessment of Russia, and the rouble, from a strictly economic and financial perspective. If nothing else, we can at least hope to reach a balanced appraisal, which shows that the Russian economy is neither a giant nor a pigmy.

In fact, Russia emerges pretty well from the SEEDS process.

We cannot hope to understand Russia if we accept the forex markets’ long-established distaste for the rouble. What FX markets think about a currency isn’t science, of course, but the simple application of market exchange rates to rouble numbers can lead to conclusions which make no sense whatsoever. On this misleading basis, it is sometimes said, for example, that Russia has an economy ‘the size of Holland’, and her defence expenditure isn’t much bigger than that of France or Britain. Neither statement is meaningful.

An intriguing point to emerge from SEEDS analysis is that the rouble deserves a lot more respect than it tends to get. Unlike America, Britain, the Euro Area or Japan, Russia hasn’t spent a decade gaming her currency through “monetary adventurism”. Neither, for that matter, has she ever adopted the Western practice of “credit adventurism”.

Russia’s private and public debt equates to just 91% of aggregate national prosperity, at a time when ratios for the Big Four range between 340% for the US dollar and 456% for the Japanese yen. Russian exposure to the banking system is small, too – total financial assets stand at 192% of prosperity, nowhere near America’s 660%, let alone Britain’s 1580%.

Like other developed economies, Russia has in recent years experienced a deterioration in prosperity per capita, but this decline has been extremely modest, and SEEDS projects little or no ongoing deterioration, which – again – is in stark contrast to America, Britain or the Euro Area.

Russia, in fact, is one of the few countries which can look ahead to the prospect of the next crash (GFC II) with comparative equanimity.

SEEDS analysis puts this equanimity into perspective. Growth in reported GDP since 2007 may have been pretty modest, at 12%, but this growth has been genuine, because Russia hasn’t emulated the Western practice of pouring debt-fuelled consumption into the system. Over the last decade, each RUB 1 of reported growth has been accompanied by only RUB 3.28 of incremental debt, a ratio lower than the United States (4.33:1), Britain (5.45:1) or the Euro Area (5.97:1), let alone Japan (13.9:1).

As you would expect, Russia’s trend ECoE (energy cost of energy) is low, estimated at 4.9% in 2017, versus a world average that is not only far higher (at 7.7%) but is also rising a lot more rapidly – by 2025, when the global ECoE is likely to have reached a growth-throttling 9.6%, Russia should still be at (or just below) 5%.

Also in 2025, the average Russian can expect prosperity to be pretty much the same as it was in 2017, a far cry from the rates of deterioration to be anticipated in Britain (-5%) or the United States (-6%). It’s worth remembering, too, that the average Russian is about 9% more prosperous now than he or she was back in 2007, again in stark contrast to America (-7%) or the United Kingdom (-9%).

On a longer perspective, Russians remain 75% more prosperous now than they were back in the dark days of 2000, and rampant inflation (which reached 72% in 1999) has been confined to the history-books.

In short, it’s easy for critics to ascribe the popularity of Mr Putin to crude nationalism or electoral chicanery – but SEEDS analysis suggests that prosperity, and economic resilience, might have rather a lot to do with it.

 

 

#123: Quantum of risk, part one

SEEDS IS COMPLETE – IN TIME FOR GFC II

More than four years in the making, SEEDS – the Surplus Energy Economics Data Systemis complete.

Though geographical coverage may be extended further (with Indonesia, Iran and Turkey as possible additions), the system itself is complete. This, under the circumstances, is just as well, because evidence is mounting that GFC II, the sequel to the global financial crisis of 2008 (GFC I), is drawing nearer. So we’re likely to need whatever insights SEEDS may provide.

This discussion sets the scene for what SEEDS can tell us about risk. Future articles will investigate national economies in groups, with the Euro Area countries likely to be addressed first. Each of the succeeding articles is likely to include downloadable summaries of the most important data.

SEEDS – capturing the surplus energy dimension

For those unfamiliar with the project, the ambition for SEEDS was to recalibrate economic measurement – and interpretation and forecasting, too – on the understanding that the real economy of goods and services is an energy system, and not, primarily, a financial one.

For practical purposes, achieving this means that we can use prosperity, instead of GDP, as the denominator for calibrating risk.

Aside from purely methodological issues, GDP has two grave handicaps where economic interpretation and prediction are concerned.

First, it fails to discriminate between organic growth, on the one hand, and, on the other, the simple spending of borrowed money. Though a very important recent report, by BIS luminaries Hervé Hannoun and Peter Dittus, highlights precisely this issue in its description of “the debt driven growth model”, conventional economics still fails to connect debt (stock) and GDP (flow) to the point where the effects of artificial, debt-induced activity can be factored in to interpretations.

For reference, and expressed in PPP-converted dollars at constant 2017 values, SEEDS puts world GDP growth since 2007 at $29.8 trillion, but notes that this was accompanied by a $103tn increase in debt, meaning that $3.50 was borrowed for each dollar of “growth”.

In the absence of this simple spending of borrowed money, growth over the decade since 2007 is estimated by SEEDS at just $10.3tn, with the remaining $19.5tn of reported increments to GDP ascribed to the debt effect.

Moreover, the debt-growth sleight of hand did not begin in 2007. Over time, the gap between GDP and prosperity has widened markedly. Last year, according to SEEDS, ‘clean’ GDP was $90.4tn, a long way (29%) below the reported $127tn.

Second, conventional economics ignores the energy basis of all economic activity. The reality is that everything we do requires energy, and energy can never be accessed free of charge – whenever we tap any form of energy, we always consume energy in the process.

In SEEDS, this cost is known as ECoE (the energy cost of energy), which is measured as a trend, and applied as an economic rent. For reasons discussed here, trend ECoE is rising exponentially, and is acting as an increasingly important obstacle to growth.

The British experience – prosperity versus GDP

Here’s a simple worked example of how SEEDS calibrates prosperity. Between 2007 and 2017, the GDP of the United Kingdom increased from £1.83tn to £2.0tn, a rise of 11%, or 3.3% in per capita terms.

But the increase in GDP between those years (of £206bn) was far exceeded by a £1.13tn surge in aggregate debt. Adjustment for this reduces growth to just £30bn, and puts clean GDP for 2017 at £1.6tn.

Over the same period, according to SEEDS, the UK’s overall ECoE increased from 4.8% to 8.6%, a sharp rise which, in part, reflects energy issues specific to Britain.

Aggregate prosperity, therefore, was barely changed in 2017 (£1,462bn) from 2007 (£1,494bn). But the population did increase between those years, by 7.7%.

In per capita terms, then, the average British citizen was 9.2% less prosperous in 2017 (at £22,300) than he or she had been back in 2007 (£24,370). Apparent growth in GDP per capita was much more than cancelled out by higher debt, and by the rising trend cost of energy.

This is why people feel poorer – whatever assurances they are given to the contrary.

Prosperity, policy and risk

This deterioration in prosperity is by no means unique to the United Kingdom, of course – Greece and Italy have fared worse, and prosperity has eroded since 2007 in every major developed economy with the solitary exception of Germany (+1.0%).

There are three main ways in which the divergence between GDP and prosperity is highly relevant to GFC II.

First, measurement of aggregate prosperity can be used to recalibrate ratios around risk categories such as debt, and exposure to financial asset toxicity. Debt may be ‘only’ 218% of world GDP, but it’s 336% of global prosperity, compared with 236% at the start of GFC I.

Second, prosperity analysis identifies dependency on incremental borrowing going forward, an extremely important consideration if there is any likelihood of access to new credit drying up.

Third, trends in individual prosperity have important implications for politics, and the scope for policy.

On this latter point, it’s worth noting what SEEDS can tell us about recent political trends.

When Donald Trump was elected in 2016, the average American was already 7.2% less prosperous than he or she had been ten years earlier. Also in 2016, the “Brexit” vote in Britain might have come as less of a shock to the “experts” if they’d known that voters were, on average, 8% poorer than they had been back in 2007.

The rejection of all established parties in the first round of the French presidential election might not have been unrelated to a peaking of per capita prosperity in France as long ago as 2000.

The high point of prosperity was more recent in Italy (2007) than in France, but the decline since then has been particularly pronounced (-10%), helping to explain the appeal of populism to Italian voters.

Looking ahead, then, one of the criteria SEEDS can help us to measure is the likelihood, or otherwise, of voters acquiescing in any repeat ‘rescue plan’ along the lines of the response to GFC I.

For most Western countries, the conclusion from SEEDS analysis is that any government which tries to repeat the 2008 combination – rescues for the banks, monetary inflation for the owners of assets, and austerity for everyone else – is going to get short shrift from the voters.

And, given the outcome of the post-2008 policy prescription, this might be just as well…………

 

#122: A tale of two ditties

WHY A CRISIS IS GETTING NEARER

In The Arabian Nights, the heroine Scheherazade told one thousand and one tales. We, on the other hand, need only choose between two songs.

The first, cheerfully whistled by the consensus, is that the world economy is enjoying “synchronised growth”. We needn’t worry about debt and other measures of financial exposure, because a financial crash is very unlikely – and, even if it happened, the authorities would know what to do about it.

The alternative refrain is that most of the “growth” claimed by the authorities is cosmetic; that we really should worry about financial stress indicators; that a crash will happen, because it’s hard-wired into the system; and that plans for dealing with it probably won’t work.

Which of these is the true music – and which is off-key?

The aim here is to weigh the evidence, which comes in many shapes and sizes. The first conclusion is that the consensus view is a Pollyanna song (and Pollyanna, you might remember, found “something to be glad about in every situation, no matter how bleak it may be”). The optimistic consensus is every bit as complacent now as it was back in 2007, when growth was to be celebrated – and debt, we were told, didn’t matter.

The second conclusion is that the odds are shortening on a crisis happening a lot sooner than most people think – it could, indeed, happen latter this year.

Third, and from what we can surmise about them, the plans for responding to a crisis probably won’t work.

GDP – eggs in one basket

When you come down to it, the optimistic consensus is based on a single indicator – growth in GDP. This puts a lot of eggs in one basket, but the conventional line is that GDP is the only basket which matters.

If GDP is growing – and is expanding at a rate faster than population numbers, so that per capita GDP is rising, too – then people are becoming more prosperous. (It’s worth remembering that, for an individual or a household, prosperity increases when income grows more rapidly than essential outgoings such as housing, food and the cost of energy and travel – in short, prosperity is that “discretionary” income which you can spend as you choose).

Rising GDP serves to offset fears about expanding debt, because what matters about debt isn’t the quantum amount, but the ability of the borrower to service and repay it.

Put simply, the assumption – and an article of faith in conventional economics – is that growth in per capita GDP makes people better off. This means that productive output is increasing. Rising GDP gives people more money to spend on things that they want, rather than simply need.

This is great for anyone supplying these wants, so retailers, restauranteurs and other ‘customer-facing’ businesses are in clover when consumers are getting more prosperous. Growing prosperity also means that demand is expanding, which, if you’re a producer, makes a compelling case for investing in expansion. As well as spending more day-to-day, the prospering consumer is likely to buy more capital items, like cars or domestic appliances. The prospering person may or may not increase how much he or she saves for the future, but is certainly unlikely to need to take on more credit.

All in all, then, growth in prosperity, as betokened by increasing GDP per capita, is a cheerful situation. Consumers are happy, having (and spending) more money. It’s great for producers of anything from cars to chocolate bars, whilst shopkeepers, restauranteurs and others have “never had it so good”. Happy and prospering citizens may not express gratitude towards politicians – and politics is a thankless task – but they’re unlikely to turn rebelliously against the establishment that has presided over all this prosperity.

A true note?

It’s interesting, to put it mildly, that this happy refrain, played on the magic flute of growing GDP, isn’t exactly what we’re seeing in the world around us.

Far from raking in bigger profits, customer-facing businesses like shops and restaurants are going through a firestorm, with even the survivors typically closing sites, laying off workers and renegotiating rents downwards. New York’s Madison Avenue hasn’t had this many vacant storefronts since 2008.

This, by the way, cannot be blamed on rising on-line purchases – the numbers don’t add up, and no one has yet found a way to eat or drink through a laptop or a smartphone. Incidentally, too, sales of smartphones themselves seem to have peaked.

Sales of cars, meanwhile, aren’t expanding – indeed, are shrinking in many markets. Car makers are cutting their production lines and trimming their rosters of distributors. The boom in car purchases fuelled by specialised credit seems to have peaked.

If customer demand is increasing, as growth in GDP says it must be, then commercial space should be rising in cost, but evidence strongly suggests the onset of severe downwards pressure on rents – and this, moreover, is bad news for any investment or debt predicated on future streams of rental incomes.

Meanwhile, business should be in an expansionary mood. In fact, the trend now is towards cost-cutting and “zero-based budgeting”, something particularly evident in advertising expenditure, which is an important lead-indicator.

The growth in prosperity indicated by rising GDP should have financial as well as commercial implications. People should be putting aside more money for the future, yet a ground-breaking report by the WEF (World Economic Forum), studying a group of eight large economies, identifies an unprecedented shortfall in pension provision, a “global pension timebomb” set to expand from $67tn in 2015 to $428tn by 2050. In the United States alone, says the WEF report, the gap is worsening by $3tn annually, which is 17% of 2015 GDP, and roughly five times what the US spends on defence.,

Politically, the West’s happy and prospering voters, far from letting the establishment get on with building a materialist’s nirvana, are kicking that establishment in the teeth whenever they get the chance, be it Mr Trump, “Brexit”, votes in France and Italy, or even in Germany. The establishment, of course, routinely derides its insurgent opponents as “populists” – which, presumably, means acceptance that established politicians and parties have become unpopulist.

Governments, too, are acting in ways consistent with hardship, not prosperity.  Protectionism and trade wars are a hallmark of seeking someone else to blame, whilst geopolitical belligerence is a time-dishonoured way of distracting the domestic electorate from hardship. Both protectionism and belligerence were rife in the depression conditions of the 1930s. Additionally, and as Charles Hugh Smith has explained in an excellent article, protectionism is a wholly logical consequence of “financial repression” as incorporated into the policy responses to the GFC.

A numbers racket

How, then, can we square the evidence around us with the claim that, because of rising GDP, people are prospering? After all, final data for 2017 is likely to confirm that the world economy (measured in PPP dollars at constant values) has grown by 29% since 2008, equivalent to growth of 17% at the per capita level after allowing for the 11% increase in population numbers over that period.

Regular readers, of course, will know the answers, which needn’t be spelled out in detail here. (Anyone wanting a refresher should read Interpreting the post-growth economy, a guide to Surplus Energy Economics which you can download here).

Essentially, we’ve been faking “growth” by pouring ultra-cheap credit into the economy. Each $1 of growth since 2008 has been accompanied by $3.40 of net new debt, and has also been accompanied, according to SEEDS estimates, by $3.40 of erosion of pension provision. We’ve been keeping up the illusion of “growth” by spending borrowed money and raiding our savings.

Anyone who thinks that this is sustainable needs to re-imagine economic reality.

As we’ve seen, hardly any (in America, less than 1%) of this “growth” has shown up in manufacturing, construction, agriculture or the extractive industries put together. We’re moving money around more rapidly, through finance, real estate and insurance activities. Government is spending more, and people increasingly are “taking in each others’ washing” through low-value service activities, which are saleable only at home.

This pattern of activity is wholly consistent with boosting statistical measures of activity using borrowed money. It is not consistent with “growth” in any meaningful sense of that word.

This cheap money, of course, has created huge bubbles in asset markets such as stocks, bonds and property. These are no offset to debt, of course, because they cannot be monetised. The only people to whom a nation’s housing stock can be sold are the same people to whom it already belongs, so you can’t turn the theoretical value of that stock into money. Using marginal transaction prices to put a value on the aggregate stock of assets is pure sleight of hand.

As regular readers will also know, the SEEDS system generates underlying output numbers, and these are diverging ever further from reported GDP. According to SEEDS, the estimated end-2017 measure, which puts world debt at about 218% of GDP, rises to 336% when debt is measured against aggregate prosperity.

When?………..

We can’t really predict the timing of economic or financial shocks, because they wouldn’t be shocks if we could. We may not get advance warning from stock markets, because debt-financed buy-backs, and relaxed investor attitudes towards “cash-burn”, might not change until after the roof has started to cave in.

But the strong likelihood now is that hardship in sectors like retailing and restaurants will broaden out into other customer-facing activities, perhaps including travel bookings, car rentals, hotel occupancy and other areas of “discretionary” spending.

A strong downtrend may already have set in where commercial rents are concerned, and we need to watch for vulnerabilities in commercial as well as consumer debt.

The critical point, however, is that what is already happening is likely to prove to be enough to discredit the “growth and prosperity” mantra underpinning consensus complacency.

It’s also worth remembering that complacency reached its previous peak in 2007. It may be, in the natural world, “always darkest just before the dawn” but, in the economy, it can often seem “brightest just before the crash”.

……and what (can be done)?

Finally, what might the authorities do if the GDP-based ballad of complacency gives way to the discordant reality of weakening prosperity and escalating debt?

It seems reasonable to surmise that policy rates will be cut, though rates are now so close to zero that cuts of the magnitude of 2008-09 are no longer possible. We can expect a lot more QE, though, like most drugs, its effectiveness diminishes as doses rise. Governments can also be expected to try to underpin the banks, but this is made harder by sharp increases in governments’ own indebtedness since the GFC.

Additionally, this time, we might expect “bail-ins”, which amount to taking money from depositors to plug gaps left by failed borrowers. If implemented, bail-ins would probably have lower limits (to protect the poor), and upper limits (to protect the rich). The authorities might also resort to the blatant monetisation of their debts (and it’s worth remembering that the Japanese central bank has already purchased almost half of all outstanding Japanese government bonds, using money newly created for the purpose).

If these are the plans for coping with a crisis, there are at least two reasons why they won’t work.

First, the assumption is likely to be that the main stresses will be confined largely to banks, as they were in 2008. But the GFC put the pressure on banks because it was a crisis caused by “credit adventurism”.

This time around, though, the main cause of a crisis is likely to be the “monetary adventurism” practised since 2008. The implication is that, in the next crisis, fiat currencies might be in the front line – especially if bail-ins and debt monetisation are invoked.

Second, governments are likely to assume public acquiescence in their rescue plans. But politics has changed fundamentally since 2008 – and any government which thinks it can sell another “rescue of the bankers” to the public is probably practising one of the worst types of complacency imaginable.

 

 

 

 

#121: Interpreting the post-growth economy

THE GUIDE TO SURPLUS ENERGY ECONOMICS

For some time now, it’s been clear that we need a succinct (though sufficient) guide to Surplus Energy Economics (SEE), something that summarises the thinking and is suitable for sharing with others. Such a guide needs to combine readability with comprehensive coverage of relevant points.

This guide is now complete. It is entitled Interpreting the post-growth economy. You can download it in PDF form at the end of this article.

Readers will already be familiar with Part One of this report, which is based on the previous article. Part Two adds an extensive commentary on many of the issues involved in applying the principles of SEE to our current circumstances and outlook.

It is hoped that readers will find this document useful and informative. As ever, comments will be most welcome.

Surplus Energy Economics – Interpreting the post-growth economy

#120: The need for new ideas

PLANNING THE POST-GROWTH SOCIETY

This article explores an issue that is always at or near the centre of where the economy is going. Worldwide, the long years of growing prosperity are over, and this change fundamentally invalidates many things that government, business and the public have always taken for granted.

The reason why growth is over, of course, is that we no longer have access to cheap energy. Where geographical expansion and economies of scale once drove down the cost of accessing energy, the driving factor now is depletion, which is pushing costs upward, and is doing so in an exponential way.

Though no abrupt plunge in global prosperity is on the cards, there is scant comfort in that. Prosperity in most Western developed economies has already passed its peak. Our economic and financial systems are extremely vulnerable, because they are predicated on perpetual growth.

Thus far, and in spite of all the accumulating evidence, we haven’t recognised that growth in prosperity is over. Rather, we’ve tried to delude ourselves, by using cheap and easy debt, and latterly ultra-cheap money as well, to pretend that perpetual growth remains alive and well. In themselves, these expedients are harmful in ways that can be managed. Efficiency is being undermined by keeping sub-viable entities afloat, and a major crash in asset values has become an inevitably. Neither of these problems is existential in itself.

But changes are happening, too, in ways that are fundamental. A system dependent on ever-growing consumption and ever-increasing profitability is becoming invalidated. The very concept of debt is becoming untenable, because the process depends on growth in borrowers’ income, something which is no longer happening.

These effects have profound political and social as well as economic and financial implications. As growth unwinds, so does tolerance of inequality – that’s why “populists” have enjoyed an ascendancy, and why trends are moving strongly in favour of the collectivist Left.

The dangers of complacency

If you’re a regular visitor to this site, you’ll know that world prosperity, as measured by the Surplus Energy Economics Data System (SEEDS), is projected broadly flat out to 2030. To put some numbers on this, global average prosperity per person is estimated at $11,050 in 2016, and is expected to be very little changed in 2030, at $11,360 (in 2016 PPP dollars).

There are a lot of reasons, however, not to be lured into any form of complacency by this flat trajectory. First, our economic system isn’t geared to stable-state, but is predicated on perpetual expansion – and that’s a huge problem, now that the conditions which favoured growth in the past are breaking down. Though we can be pretty sure that the era of meaningful growth in prosperity has ended, we cannot know how much collateral damage will result from the challenge of trying to adapt to that change.

Second, the projected global figure for 2030 disguises a wide regional divergence of experience. China, for example, is on the positive side of the equation. Prosperity may not be growing at anything like the rate depicted by GDP per capita, but Chinese citizens are continuing to become better off. For 2016, prosperity is estimated at 30,800 RMB per person – roughly double the equivalent number for 2003 – and the SEEDS projection for 2030 is 42,225 RMB, an improvement of 37%. Improvement is likely, too, in India.

But prosperity in the developed West, already in decline, is set to deteriorate steadily. Comparing 2030 with 2016, prosperity is likely to be 7% lower in the United States, for example, and 10% lower in Britain. These projected declines are in addition to the deterioration that has already happened – prosperity has already peaked in the US, Canada, Australia and most European countries.

Third, and even in countries where prosperity trends are positive, current economic policies suggest that both debt and deficiencies in pension provision will go on growing a lot more rapidly than prosperity.

Worldwide, we’re subsidising an illusory present by cannibalising an already-uncertain future. We’re doing this by creating debt that we can’t repay, and by making ourselves pension promises that we can’t honour. So acute is this problem that our chances of getting to 2030 without some kind of financial crash are becoming almost vanishingly small.

Finally, any ‘business as usual’ scenario suggests that we’re not going to succeed in tackling climate change. This is an issue that we examined recently. Basically, each unit of net energy that we use is requiring access to more gross energy, because the energy consumed in the process of accessing energy (ECoE) is rising. This effect is cancelling out our efforts to use surplus (net-of-cost) energy more frugally.

The exponential nature of the rise in ECoEs is loading the equation ever more strongly against us. This is why “sustainable development” is a myth, founded not on fact but on wishful thinking.

The lure of denial

These considerations present us with a conundrum. With prosperity declining, do we, like Pollyanna, try to ignore it, whistling a happy tune until we collide with harsh reality? Or do we recognise where things are heading, and plan accordingly?

There are some big complications in this conundrum. Most seriously, if we continue with the myth of perpetual growth, we’re not only making things worse, but we may be throwing away our capability to adapt.

You can liken this to an ocean liner, where passengers are beginning to suspect that the ship has sprung a leak. The captain, wishing to avoid panic, might justifiably put on a brave face, reassuring the passengers that everything is fine. But he’d be going too far if he underlined this assurance by burning the lifeboats.

The push for electric vehicles threatens to become a classic instance of burning the lifeboats. Here’s why.

We know that supplies of petroleum are tightening, that the trend in costs is against us, and that burning oil in cars isn’t a good idea in climate terms. Faced with this, the powers-that-be could do one of two things. They could start to wean us off cars, by changing work and habitation patterns, and investing in public transport. Alternatively, they can promise us electric vehicles, conveniently ignoring the fact that we don’t, and won’t, have enough electricity generating capacity to make this plan viable, and that we’d certainly need to burn in power stations at least as much oil as we’d take out of fuel tanks. At the moment, every indication is that they’re going to opt for the easy answer – not the right one.

This is just one example, amongst many, of our tendency to avoid unpalatable issues until they are forced upon us. The classic instance of this, perhaps, is the attitude of the democracies during the 1930s, who must have known that appeasement was worse than a cop-out, because it enabled Germany, Italy and Japan to build up their armed forces, becoming a bigger threat with every passing month. Hitler came to power in 1933, and could probably have been squashed like a bug at any time up to 1936. By 1938, though, German rearmament reduced us to buying ourselves time.

Burying one’s head in the sand is actually a very much older phenomenon than that. The English happily paid Danegeld without, it seems, realising that each such bribe made the invaders stronger. It’s quite possible that the French court could have defused the risk of revolution by granting the masses a better deal well before 1789. The Tsars compounded this mistake when they started a reform process and then slammed it into reverse. History never repeats itself, but human beings do repeat the same mistakes, and then repeat their surprise at how things turn out.

Needed – vision and planning 

The aim here is simple. There is an overwhelming case for preparation.  With this established, readers can then discuss what might constitute a sensible plan, and try to work out how any plan at all is going to be formulated in a context of ignorance, denial and wishful thinking.

Let’s start with a basic premise. For more than a millennium, the population of the earth has increased, a process that has become exponential since we first tapped fossil fuels. The population exponential has been paralleled by trends in food and water supply, and in economic activity and complexity.

The “master exponential” driving all the others has been energy consumption. Basic physics dictates the primacy of energy in this mix. If we hadn’t grown our access to energy, we couldn’t have expanded our foods supplies, our population, our economic activity or the complexity of our societies.

For much of the era since 1760, energy has got cheaper. The petroleum industry, for instance, didn’t limit itself to Pennsylvania, but spread its reach across the globe, most notably finding huge oil resources in the Middle East. The same broadening process benefited coal and natural gas. As the energy industries expanded, they harnessed huge economies of scale. A third positive factor, in addition to reach and scale, was technology.

Since a high-point in the post-1945 decades, however, the trend of energy costs has crossed a climacteric. Reach ceased to help, and economies of scale reached a plateau. The new driver became depletion, an entirely logical consequence of using the most profitable resources first, and leaving less profitable ones for later. The role of technology changed, from boosting gains to mitigating decline. The extent to which technology can mitigate the cost of depletion is limited by the envelope of physics.

Only in science fiction, or in wishful thinking, can we get a quart of energy out of a pint pot.

The cost uptrend (and by ‘cost’, of course, is meant the energy consumed in accessing energy) hasn’t stopped growth in aggregate access to primary energy – yet. So far, we’ve been able to offset worsening cost ratios by using more energy. This said, cost is likely to make it harder to grow total supplies in the future. Fundamentally, as the energy consumed in the energy supply process rises, the amount of value that we get from each unit of energy diminishes, just as we hit limits to our ability to use greater volume to offset reduced value.

In petroleum, at least, we are now scraping the bottom of the barrel. If there were lots of gigantic, technically-easy fields still to be developed, we simply wouldn’t be bothering with shales, or crudes so heavy that they have to be mined rather than pumped. It’s become difficult to find a price that is high enough for producers without being too high for customers. Cost, rather than scarcity of reserves, is the factor that’s going to cause “peak oil”.

Renewable energies, though desirable, don’t offer an instant escape, not least because we have to use legacy fossil fuel energy to build wind turbines, solar panels and the infrastructure that renewables require. We once believed that nuclear energy would be “too cheap to meter”, and would free us from dependency on oil, gas and coal. We’re in danger of repeating that complacency with renewables. We need to assume that energy will get costlier, just as growing the absolute quantities available to us is getting tougher.

Growth – the bar keeps rising

As the cost of energy rises, economic growth gets harder. We’ve come up against this constraint since about 2000, and our response to it, thus far, has been gravely mistaken, almost to the point of childish petulance. We seem incapable of thinking or planning in any terms that aren’t predicated on perpetual growth. We resort to self-delusion instead.

First, we thought that we could create growth by making debt ever cheaper, and ever easier to obtain. Even after 2008, we seem to have learned nothing from this exercise in credit adventurism.

Since the global financial crisis (GFC), we’ve added monetary adventurism to the mix. In the process, we’ve crushed returns on investment, crippling our ability to provide pensions. We’ve accepted the bizarre idea that we can run a “capitalist” economic system without returns on capital. We’ve also accepted value dilution, increasingly resorting to selling each other services that are priced locally, that add little value, and that, in reality, are residuals of the borrowed money that we’ve been pouring into the economy.

We seem oblivious of the obvious, which is that money, having no intrinsic worth, commands value only as a claim on the output of a real economy driven by energy. When someone hands in his hat and coat at a reception, he receives a receipt which enables him to reclaim them later. But the receipt itself won’t keep him warm and dry. For that, he needs to exchange the receipt for the hat and coat. Money is analogous to that receipt.

The first imperative, then, is recognition that the economy is an energy system, not a financial one, in which money plays a proxy role as a claim on output. In this sense, money is like a map of the territory, whereas energy is the territory itself – and geographical features can’t be changed by altering lines on a map.

It’s fair to assume that the reality of this relationship will gain recognition in due course, the only question being how many mistakes and how much damage has to happen before we get there. No amount of orthodoxy can defy this reality, just as no amount of orthodoxy could turn flat earth theories into the truth.

With the energy dynamic recognised, we’ll need to come to terms with the fact that growth cannot continue indefinitely. Rather, growth has been a chapter, made possible by the bounty of fossil fuels, and that bounty is losing its largesse as the relationship between energy value and the cost of access tilts against us.

In one sense, it’s almost a good thing that this is happening. If we suddenly discovered vast oil reserves on the scale of another Saudi Arabia, we would probably use them to destroy the environment.

Undercutting the rationale – consumption, profit and debt

With growth in prosperity no longer guaranteed, a lot of other assumptions lose their validity. One of the first will be the nexus of consumerism and corporate profit, where we assume that consumption by the public must always increase, and, over time, profits must always grow.

We’ll find ourselves in a situation where consumption doesn’t keep growing, and will decrease in per capita terms at a pace which at least matches the rate at which population numbers are growing. In this situation, expecting suppliers to keep on expanding, and carry on increasing their profits, becomes unreasonable. Businesses which insist on trying to maintain profits growth in this context will probably have to resort to cheating, both exploiting consumers and falsifying information. It may well be that this process has already started.

Meanwhile, the invalidation of the growth assumption will have profound implications for debt, and may indeed make the whole concept unworkable. If borrowing and lending ceased to be a viable activity, the consequences would be profound.

To understand this, we need to recognise that debt only works when prosperity is growing. For A to borrow from B today, and at a future date repay both capital and interest, A’s income must have increased over that period. Without that growth, debt cannot be repaid.

There are two routes to the repayment of capital and the payment of interest, and both depend on growth. First, if A has put borrowed capital to work, the return on that investment both pays the interest, and also, hopefully, leaves A with a profit. Alternatively, if A has spent the borrowed money on consumption, A’s income has to increase by at least enough to for him to repay the debt, and pay interest on it.

In an ex-growth situation, both routes break down. Invested debt isn’t going to yield a sufficient return, because purchases by consumers have ceased to expand. A’s income, on the other hand, won’t have increased, because prosperity has stopped growing.

This scenario – in which repayment of debt becomes impossible – isn’t a future prediction, but a current reality, and a reality that is already in plain sight.

We need to be clear that the slashing of rates to almost zero happened because earning enough on capital to be able to pay real rates of interest has become impossible.

Businesses which aren’t growing cannot – ever – pay off their debts, and neither can individuals whose prosperity is deteriorating.

Critically, prosperity, which drives both profits and incomes, is declining.  This is evident, not just in real wages (which, in many developed economies, haven’t grown since 2008), but also in the adverse relationship between nominal incomes and the cost of essentials.

To reiterate, if borrowers’ incomes don’t grow, they cannot pay off their debts, and are likely to go under because they cannot carry indefinitely the burden of compounding interest.

The politics of inequality

Financial exercises in denial (including escalating debt, ultra-cheap money and the impairment of pension provision) have already created a stark division between “haves” and “have-nots”. Essentially, the “haves” are those who already owned assets before the value of those assets was driven upwards by monetary policy. The “have-nots” are almost everyone else, especially the young.

Critically, the cessation of growing prosperity creates a fundamental change in attitudes towards inequality. Someone whose own prosperity is increasing is likely to be pretty tolerant towards a richer neighbour. Put prosperity into reverse, though, and that tolerance evaporates.

Again, this isn’t forecast, but fact. It’s one of the reasons why “populist” politicians are doing so well, and it also lays the foundations for a return to ascendancy by the collectivist Left. For this to happen, left-of-centre parties need to purge themselves of the centrists whose logic ceased to function when prosperity stopped growing.

The need to do this isn’t exactly rocket-science, and it’s already happening. We know that Hillary Clinton failed to see off Donald Trump, but we can’t know whether Bernie Sanders might have succeeded. We cannot know whether Labour under Jeremy Corbyn can win power in Britain, but we can be pretty sure that a Labour party led by a returning Tony Blair, or by someone else with the same “New” Labour policies, could not.

This stacks up to the return of division. The reason for this is that it’s becoming impossible for parties of opposition to accept big chunks of the incumbency’s economic agenda. As ordinary people become poorer, and as their ability to carry their debt burdens diminishes, the focus on inequality will intensify. The “politics of envy” will become “the politics of indignation”. Questions will start to be asked about how much money any one individual actually needs. The deterioration in the ability of the state to provide public services will intensify the politics of division.

To be clear about this, collectivism won’t solve our fundamental economic problems, and neither will a system which mutates Adam Smith’s free and fair competition into something akin to the law of the jungle. Deregulated capitalism is failing now, just as emphatically as Marxist collectivism failed in the past.

A logical conclusion, then, is that we need a new form of politics, just as much as we need a new understanding of economics, new models for business and a new role for finance. Co-operative systems might succeed where corporatism – both the state-controlled and the privately-owned variants – have failed.

All of these new ideas need to be grounded in reality, not in wishful thinking, denial or ideological myopia. But reality becomes a hard sell when it challenges preconceived notions – and no such notion is more rooted in our psyche than perpetual growth.