#202. The shape of things to come


As, when and if the coronavirus pandemic recedes into the past, there’s a widespread assumption that we’ll see the welcome return of a ‘normality’ defined to include “growth” in the economy. The big change looking forward will, we’re assured, be the replacement of climate-harming oil, gas and coal with renewable energy sources, primarily solar- and wind-power.

This aside, almost everything else is going to be ‘more of the same’.

In reality, this consensus narrative of the future is based on the big two fallacies of our age. One of these is that the economy is a financial system, such that we’re assured of growth in perpetuity by our control of the human artefact of money.

The other is that there are no limits to the capabilities of technology, potentialities often extrapolated to and beyond the constraints of physics.        

We cannot know quite how much of this is believed by governments, or whether they ‘know, but don’t say’, that most of it is implausible. Businesses and the general public seem to have bought into this narrative.

Energy reality

The facts of the situation, as we understand them here, are that the supply and the ECoE-cost of energy determine material prosperity, and that this equation has been turning against us over an extended period.

ECoEs – the Energy Costs of Energy – have been rising relentlessly, passing (during the late 1990s and early 2000s) levels at which Western prosperity ceases to grow, and then starts to contract. The EM (emerging market) economies have now reached the ECoE thresholds at which their prosperity, too, turns downwards. 

The factor driving ECoEs upwards has been the effects of depletion on the fossil fuels which continue to supply four-fifths of the energy used in the economy. It might or might not be possible to replace fossil fuel energy quantities with dramatically increased supplies of renewables (REs), but it certainly cannot be assumed (and is indeed implausible) that these can reverse, or even stabilize, trends in ECoEs.

Thus stated, the challenge is enormous. Prior growth in Western prosperity per person went into reverse at ECoEs of between 3.5% and 5.0%, with the same seemingly happening to EM countries at ECoEs between 8% and 10%. Prosperity per capita has already turned down in Mexico, South Africa, Argentina, Brazil, Chile, Saudi Arabia and Turkey.

The SEEDS model puts the ECoEs of fossil fuels today at 11.9%, up from just 2.6% as comparatively recently as 1990. The modern economy was built on fossil fuels with ECoEs at or below 2%. The ECoEs of REs, now close to parity with fossil fuels, are continuing to decrease, but may never fall much below 10%.

Financial fiction

The history of the past quarter-century has been one of trying to use financial tools to overcome the non-financial consequences of energy deterioration.

From the mid-1990s, the authorities adopted ‘credit adventurism’. After this failed in 2008-09, they doubled down with ‘monetary adventurism’, which has now reached its culminating point of failure.

Without a doubt, the search is now on for ‘gimmick 3.0’. Beyond a few shrewd guesses, we cannot know what form this latest ‘fix’ is going to take – but we can be sure that it won’t work.

We can’t ‘fix’ an energy economy with financial tools, any more than we can ‘fix’ an ailing house-plant with a spanner.

When setting out scenarios for the future, we start with two unfortunate inevitabilities. The first is that we’re going to get poorer, a trend that is by no means new, but that has been disguised thus far by financial manipulation, which has masked – whilst it hasn’t ‘fixed’ – an economy drawing rapidly towards the end of an era of growth made possible by low-cost fossil fuels.

The second is that, empowered by the hubris of assumed ‘economic expansion in perpetuity’, we have built a financial system wholly predicated on growth. It takes no great leap of the imagination to see that the financial system, as currently configured, cannot survive.

The authorities are now faced with the alternatives of prolonging financial stimulus to the point of the hyperinflationary destruction of the value of money, or reining-in stimulus, such that asset prices crash and defaults cascade through the system.

It’s by no means clear that the authorities even have the power of selection over which of these outcomes transpires. The idea that they can finesse this situation using policies which are neither too loose nor too tight does not merit serious consideration.

The household predicament

Ultimately, what happens to individuals and households is of greater fundamental significance than what happens to other sectors of the economy. After all, governments, whether democratic or not, are answerable to the public, whilst businesses are wholly dependent on the willingness and the ability of consumers to carry on buying their products.

The obvious conclusion is that households will get poorer, a trend that is already firmly established in the West. Thus far, this process has been gradual. As of 2019, the average American was 6.6% poorer than he or she had been back in 2000, whilst British prosperity per person had fallen by 10.6% since 2003.

Unfortunately, comparatively modest rates of deterioration in top-line prosperity have been leveraged by continuing increases in the cost of essentials, such that, at the discretionary (ex-essentials) level, prosperity fell by 31% (rather than 6.6%) in the United States, and by 29% (rather than 10.6%) in Britain. As discretionary prosperity has fallen, discretionary consumption has continued to increase, but only because of the huge amounts of credit poured into economies around the world.           

From these observations, we can infer that discretionary consumption will fall sharply, as soon as the credit-based, growth-predicated financial system falls apart. This is going to be extremely unpopular, and can be expected to shift the basis of political debate towards economic issues and away from all non-economic topics of debate.

At the very least, we should anticipate increasing demands for redistribution, combined with a shrill insistence that governments should “do something” about the rising costs of essentials. The latter may be taken to mean calls either for regulation and subsidy, or for the outright nationalization of a string of industries.

Taking ‘from the rich’ is a panacea of very limited practical value. Apart from anything else, the wealth of ‘the elites’ is largely paper in nature, and is likely to fall rapidly as asset prices correct downwards in response to belated recognition of economic reality.

A particular concern must be that, as Westerners’ discretionary prosperity fades away, people in the world’s poorer and middle-income countries will find it increasingly difficult to afford even basic necessities. An indicator to watch here will be the global cost of commodity foodstuffs including grains and rice, costs which are closely connected to ECoEs through the energy-intensive nature of food production. Tellingly, the UN FAO’s Food Price Index was 39.7% higher in May 2021 than it had been a year earlier. The same energy connection applies to the cost and availability of water.

If conditions worsen in many of the world’s less affluent countries, one consequence is likely to be an increase in migration flows.

The need for knowledge

As remarked earlier, it’s far from clear how far any of this is understood by governments. Thus far, and conditioned in part by the coronavirus crisis, we can only observe an apparently increasing tendency to stifle dissent, and to strengthen governments’ powers of control. 

An optimistic reading would be that governments will come to terms with the reality of a world economy shaped by energy (and shrinking), rather than governed by money (and growing). A big concern here has to be continued reliance on failing methods of economic interpretation, which in turn means that conventional economic models are losing credibility.

An implicit responsibility falls on those of us who understand the economy as an energy system, particularly where, as here, we can use models to quantify developing trends.

To inform debate here, the following tables set out the critical economic and financial parameters for the economies of America, Britain and China. All are drawn from the SEEDS economic model (the Surplus Energy Economics Data System).

Factors common to each include the rise of trend ECoEs, the slowing (and the subsequent deterioration) in aggregate prosperity, and the ongoing decline in prosperity at the per capita level.

In each case – even in China – discretionary prosperity per person is falling, a factor that will be of critical importance once the subsidy of financial manipulation reaches its point of failure.

As of 2019 – that is, before the covid crisis – aggregate debt already stood at 358% of prosperity in America, 349% in Britain and 513% in China. Greater concern should be prompted by even more extended ratios applying to broader commitments represented by financial assets (which, to a very large extent, are the liabilities of the government, corporate and household sectors).

Both sets of parameters show every sign of soaring to levels at which the financial system implodes. Not included in the tables here are levels of public expenditures which are becoming unsustainable, when measured, not against the increasingly misleading metric of credit-inflated GDP, but against prosperity.

Space dictates that these tables, like the interpretations suggested here, can be no more than summaries, but it is surely clear that decision-makers, in particular, need to ditch false perceptions of how the economy actually works, and adopt techniques which quantify the true scale of the challenges now looming.

#201. The Icarus factor


The vicissitudes of the coronavirus crisis have tended to bury an appreciation of longer-term trends under a blanket of concern about the immediate. With each apparent success or setback in the fight against covid-19, economic sentiment has fluctuated, in ways which, whilst wholly understandable, bear no relation to all-important underlying trends.

Almost everything that we hear and read about the current situation is somewhere between the misleading and the outright fallacious. Reportedly modest falls in economic output last year disguise, beneath gargantuan fiscal and monetary interventions, a far harsher reality. Assurances of a brisk “recovery” promise little more than a return to purely statistical, cosmetic “growth”.

The current spike in inflation is no more “transitory” now than QE and ZIRP were “temporary” back in 2008-09.

The public are being treated to three main fictions. The first is that we can spend our way to prosperity.

The second is that we can borrow our way out of a debt problem.

The third is that we can print our way to monetary stability.

It’s quite possible, of course, that decision-makers really believe all of this is feasible, but there’s no necessary conflict between sincerity and fallacy.

The trap has sprung

Debate around the stimulus trap exemplifies the extent of incomprehension. During 2020, huge fiscal deficits were run, mainly in order to sustain incomes during protracted lock-downs. Provisional data for a group of sixteen advanced economies covered by the SEEDS model puts this deficit at 12% of GDP when the latter is defined to include the deficit itself.  

The vast majority of this fiscal support was financed using money created out of the ether by the central banks. Between them, the Fed, the ECB, the Bank of England and the Bank of Japan used close to $8.6tn of newly-created liquidity to fund government fiscal deficits.

There has been extensive additional stimulus in the form of rent and interest ‘holidays’ granted to business and household borrowers and tenants. These have inflicted costs on lender and landlord counterparties that will, in due course, have to be made good. In any case, it seems most unlikely that there will be much contraction in the scale of stimulus during 2021.

At present, we’re being assured that the recent upturn in inflation is “transitory”, traceable in large part to “temporary” interruptions to supply chains. Part of the misunderstanding here is that, by convention, inflation is calibrated only in terms of consumer purchases, and thus excludes rampant escalation in asset prices.

In some countries, notably America and Britain, supporting and further inflating the prices of stocks and property has taken on a bizarre, quasi-religious fervour, seemingly oblivious of the obvious fact that all that’s really accomplished by the much-vaunted “wealth effect” is the encouragement of yet more borrowing

As and when it turns out that price increases are more than a passing phenomenon, the assumption is that central banks can head off inflation before it starts to make serious inroads into the purchasing power of money. Central bankers, it’s said, have tools at their disposal which include stopping, tapering or even (in extremis) reversing asset purchases and, if needs must – though whisper it who dares – raising interest rates.

If any of these tools were to be used, however, the results would include sharp falls in asset prices, a widespread undermining of collateral, and a cascade of defaults amongst businesses and households burdened with record levels of debt.

Defaults at a systemically dangerous scale would make it imperative for the authorities to intervene, in order to preserve the balance sheets of the banking and broader lending sectors. Doing this at the requisite size would be a task far beyond the capabilities of governments, and would therefore force central bankers into monetization on a scale exceeding anything experienced thus far.

What this means is that, whichever door we go through, we end up in the same place.

Feeding the addiction

As well as accepting that monetary tightening is outside the bounds of practicality, we also need to recognize that credit moderation isn’t feasible in economies which have become addicted to continuous infusions of debt.

In the twenty years before the pandemic – from 1999 to 2019 – reported “growth” of $71 trillion (110%) in world economic output was accompanied by an increase of $206tn (198%) in aggregate debt. Annual average growth of 3.5% in global GDP was made possible by annual borrowing which averaged 10.0% of GDP.  Each dollar of “growth” was bought with close to $3 of net new debt.

Even these calculations exclude dramatic surges in non-debt financial obligations, some of which are reflected in the escalating assets of the financial system, whilst others (such as the emergence of a pension provision “timebomb”) are informal and assumed, but are none the less important for that.   

Addressing the credit effect, SEEDS – the Surplus Energy Economics Data System – calculates that, of the $71tn of “growth” recorded between 1999 and 2019, fully 64% ($45tn) was the cosmetic effect of injecting gargantuan amounts of debt into the system.

Stripped of this effect, the trend rate of growth falls to 1.7% from the reported 3.5%. The compounding effects of this divergence means that underlying or ‘clean’ economic output (calibrated by the SEEDS model as C-GDP) is nowhere near levels of output claimed as GDP.

In other words, assurances of “growth” really promise no more than a return to a state of affairs that was only ever cosmetic in the first place. If liquidity is injected into the system, the spending of this money is counted as “activity” for the purposes of calibrating GDP, irrespective of where this money came from. Alternative calibrations, based on incomes and supposed creation of value, really do no more than confirm this convenient fiction.

No cold turkey

To understand how events will unfold from here, we need to understand how we got into this predicament. This requires recognition that the economy is an energy system, and that money, in its role as a medium of exchange, has no intrinsic worth, but commands value only as a ‘claim’ on the economy of goods and services.

During the last decade of the twentieth century, trend ECoE (the Energy Cost of Energy) rose from 2.6% in 1990 to 4.1% in 2000. This necessarily undermined the scope for growth in prosperity, which, in Western economies, goes into reverse between ECoEs of 3.5% and 5.0%. Beyond these levels, it becomes impossible to combine ongoing energy supply, and the maintenance requirements of complex systems, with further increases in material prosperity.

The deceleration which started to occur in the mid-1990s was recognized, and was even given a label (“secular stagnation”), but its causation wasn’t – and couldn’t be – understood within an orthodoxy which treats the economy as a wholly monetary phenomenon. This bafflement, combined with a contemporary penchant for “de-regulation”, resulted in an effort to “fix” a non-financial problem with financial tools.

This began with ‘credit adventurism’, which made borrowing easier (as well as cheaper) than it had ever been before, and also weakened the necessary connection between risk and return.

After the ensuing (and wholly predictable) global financial crisis (GFC) of 2008-09, the authorities doubled down on fallacy by adopting ‘monetary adventurism’, slashing rates to sub-zero real levels, and failing even to implement some obvious safeguards which might have headed off an unsustainable inflation of asset prices.

Markets could no longer fulfil the necessary functions of price discovery and the pricing of risk. The imperative process of creative destruction was halted, and moral hazard was adopted as a feature rather than treated as a fault. Perhaps worst of all, the capitalist imperative of real returns on capital was suspended, and a huge wedge was driven between asset prices and all forms of income (including profits, dividends and interest, as well as wages).      

The Icarus factor

Where this leaves us is with a financial system that’s “running on empty”, and has long since ceased to act as a meaningful proxy for the ‘real’ economy of labour, energy, goods and services. There’s no way off a treadmill which requires continuous and increasing credit and liquidity injections to retain a waning semblance of viability.

Once the ‘financial’ economy of money and credit has departed this far from the ‘real’ economy of goods and services – and once imbalances between asset prices and all forms of income are this far out of kilter – the trend back towards equilibrium builds unstoppable gravitational force.

In short, money, in all of its forms – whether as debt and other obligations, as asset prices and as other claimed ‘stores of value’ – has taken wing, soaring far above any underlying grounding based in economic reality.

As the situation heats up, the wax securing the wings starts to melt.

From here, a fall back to economic Earth can neither be much delayed, or rendered painless.

#200. Other roads, part one


The release of a new policy document from the International Energy Agency marks a decisive stage in the evolution of the consensus around energy, the environment and the economy. Apart from anything else, Net Zero By 2050: A Roadmap for the Global Energy Sector reinforces the growing sense of commitment to a rapid transition away from reliance on climate-harming fossil fuels.

This policy paper confirms how closely the IEA is aligned with the broad thrust of policy intent in the United States, Britain and the European Union. Emerging economies like China and India might be harder to convince.

It would be easy to critique this document, applauding its ambition whilst questioning some of its methodologies and policy conclusions.

What matters much more, though, is the broad question of how we understand the interconnection between energy, the economy and the environment.

Granted that environmental risk is a function of our use of energy, are energy needs themselves a function of an economy that ‘grows’ according to its own, self-propelled, essentially financial and internal dynamic?

Or should the relationship be reversed, identifying economic prosperity as a subsidiary property of the use of energy?

From which direction?

It was pointed out to me recently that, whilst articles here make frequent reference to SEEDS, the meaning of this acronym is seldom explained. This is an omission based in familiarity and brevity, not reticence.

The short answer is that SEEDS – the Surplus Energy Economics Data System – is an economic model based on recognition that the economy is an energy dynamic. This means that it’s radically different from conventional models, which treat the economy as a wholly financial system.

This difference of approach may sound theoretical, but its practical implications could hardly be more far-reaching.

To illustrate, imagine that you’re trying to predict the future demand for some product or service. Conventionally, you’d do this by starting with GDP, and applying a forward rate of growth to calculate the size of the economy at some date in the future. With this as ‘a given’, you have the parameters or context for estimating the potential size of your market. What matters now is the potential expansion or contraction of demand for your product as a share of that broad context.

Your aim, of course, is practical rather than theoretical – you want to predict the scale and shape of the market for your product or service. You’re unlikely to be interested in the theory of economics itself, and are, in all probability, content to work within consensus methods, and arrive at consensus results. Even if your organization is big enough to employ its own economists, the probability is that this makes no real difference at all to the methodologies used, and very little difference to the resulting forecast.

Governments work in much the same way – they start by projecting, along conventional lines, the probable size of the national economy of the future, and only then assess the implications for the many aspects of policy.    

The same approach is used for the forecasting of future energy requirements. All such conventional projections start with an assumption about the future size of the economy, and only then calculate what that is going to mean for energy needs. The near-unanimity of conventional forecasting right now is that the economy, meaning GDP, will grow at a trend rate of 3%.

Travelling to Net Zero

Hitherto, the resulting informed consensus around energy has been that, whilst renewable energy sources (REs) will capture an ever-increasing share of the energy market, the quantities of fossil fuels used will continue to increase. In contesting this, the IEA report applies a significantly new impetus to the direction of travel in the forecasting of future energy needs.

To be sure, there are differences between proposals and forecasts. Even so, the IEA’s Net Zero is an almost breathtakingly bold break from the prior consensus. It argues that rapid commitment to energy transition can, by 2050, deliver a world with zero net emissions of CO2.

In addition to massively increased investment in renewable sources of energy (REs), the IEA calls for the immediate cessation of all new oil and gas development projects. This amounts to an accelerated run-down of supplies of legacy energy from fossil fuel sources.

The pay-off, says the IEA, isn’t just the prevention of catastrophic degradation of the environment, but includes millions of new jobs and a big – and this time a more globally-inclusive – spurt of economic expansion.

You won’t be expecting me to agree that all of this is feasible, and I don’t. Let’s be clear, though, that the IEA, and others, are absolutely right to stress the need for transition away from climate-harming fossil fuels to REs.

Indeed, SEEDS analysis takes this imperative even further.

Environmentalists – whose ranks now include most Western governments, as well as organisations like the IEA – assert that continued reliance on fossil fuels risks inflicting irreparable harm to the environment.

Where SEEDS goes further is in arguing that, whilst continued fossil fuel dependency would probably wreck the environment, it would certainly destroy the economy.

The explanation for this is simple – it is that the cost of fossil fuel energy is rising, such that its net (post-cost) value is decreasing.

What this means is that the established sources of energy value that have powered the Industrial Age are fading away.

Thinking – forwards or backwards?

This brings us back to the critical issue of method. Instead of assuming a future economy of a given size, and then working backwards to the energy that this economy will require, SEEDS starts with energy projections, and only then asks what size of economy can be supported by the forward outlook for energy.

Put another way, SEEDS dismisses any notion of commencing with an assumed rate of growth in economic output. At the same time, the model also dismisses the idea that GDP is, or can be, a meaningful metric for economic prosperity.

Consensus forward “growth” assumptions, typically 3%, are based on a supposedly cautious continuation of what are accepted as recent trends. These depict the economy, measured as GDP, as something capable of expanding at annual rates of between 3.25% and 3.75%.

That seems to check with stats showing that, between 1999 and 2019 – that is, in the twenty years before the coronavirus shock – annual increments to reported GDP averaged 3.6%.

What this ignores is that, over that same period, annual net borrowing averaged 10.4% of GDP. Unless you believe that the spending of newly-created purchasing power has no effect on the activity measured as GDP, then changes in GDP itself are linked to the rate at which credit expands.

Moreover, debt is by no means the only form of forward obligation whose expansion is linked to economic activity. Whilst each $1 of reported “growth” between 1999 and 2019 was accompanied by an increase of nearly $3 of debt, adding in the expansion of broader financial obligations lifts this ratio to well over $6 of new commitments for each dollar of “growth”.

As so often, the acid test for such varying interpretations is observation. If conventional data is right, global GDP increased by 110% between 1999 and 2019, whilst population numbers expanded by 26%. Even after a surprisingly modest fall (of -3.3%) in world GDP during crisis-hit 2020, output was still higher by 103% over a period (1999-2020) in which population growth was 27%.

This ought, surely, to mean that the economy is in far better shape now than it was back in 1999. Sharply higher prices for assets such as stocks and property seem to reinforce this optimistic reading.

But the economy as we observe it today doesn’t conform to this description.

Most obviously, we’re caught in a stimulus trap. If we carry on pouring gargantuan amounts of liquidity into the system, we face a very real risk of the hyperinflationary destruction of the value of money. But if we stop – or even scale back on – stimulus, asset prices would crash, and a cascade of defaults would ensue.

Can we square this observation of ‘fragility edging into crisis’ with the assurance that economic output has almost effortlessly out-grown population numbers over a very extended period?

The answer, of course, is that we can’t.

After all, if the economy had been performing as strongly as prior growth rates imply, why would we still be locked into a supposedly “temporary” and “emergency” reliance on negative real interest rates that began back in 2008-09?

We can’t, to any significant extent, put the blame for this on covid-19, not least because the official data itself puts the scale of the hit to the economy in 2020 at only -3.3%. At worst, then, we’ve lost a single year of the growth supposedly enjoyed during each of the twenty years preceding the pandemic.

The bottom line is that GDP stats are telling us one thing, and what we can see unfolding right in front of our eyes is the diametric opposite. On the one hand we have an economy that’s growing robustly – on the other, an economy dependent on the life-support of financial gimmickry, and trapped in a cul-de-sac from which there is no obvious route of escape.

Other roads

This is where alternative approaches are so important. To be clear, economic orthodoxy describes a robust economy that doesn’t exist, whilst policy orthodoxy is based on the continuation of positive trends which, it turns out, don’t exist either.

The SEEDS approach begins with three observations, familiar to regular readers and requiring only the briefest introduction for those for whom this is new.

First, the economy is an energy system, because literally everything which constitutes economic output is a product of the use of energy.

Second, whenever energy is accessed for our use, some of that energy is always consumed in the access process. This second principle establishes the role of the Energy Cost of Energy (ECoE), and divides the stream of energy and its associated economic value into “cost” (ECoE) and “profit” (surplus) components.

The third principle is that money has no intrinsic worth, but commands value only as a ‘claim’ on the products of the energy economy.

An economy stripped of money would have to resort to barter, or would have to create a replacement human artefact as a medium of exchange.

An economy stripped of energy, on the other hand, would, as of that moment, cease to exist.     

These principles identify a dynamic which, though complex in application, is straightforward in principle. We use energy to create economic value. Some of this energy value has to be used in the energy access process itself. What remains powers all economic activity other than the supply of energy itself. ECoE is the factor which differentiates between economic output and material prosperity.

From this perspective – and in an economy which still derives four-fifths of its primary energy supply from oil, gas and coal – a critical trend has been the relentless rise in the ECoEs of fossil fuels.

This increase in ECoEs fits with observable trends, first by explaining the emergence (though not, in general, the accurate interpretation) of “secular stagnation” in the 1990s, and then by tracking the subsequent, crisis-strewn descent into that dependency on the credit and monetary gimmickry that has created the stimulus trap described earlier.

In short, what SEEDS interpretation says should happen as ECoEs rise coincides with what has happened as this trend has developed.  

Feasible directions?

To resolve this issue, and to restore the capability for growth as well as minimising environmental harm, a transition to REs would need to accomplish two things.

First, it would need to provide a volumetric replacement for fossil fuels. This, unfortunately, is about as far as the conventional setting of targets usually goes.

Second, and critically, it would also need to drive overall, all-sources ECoEs back downwards.

For Western countries, successful ‘transition with growth’ would need, at a minimum, to drive overall ECoEs back below 5%, from a current global trend ECoE level of 9% and rising. For advanced economies, whose complexity involves high maintenance requirements in terms of ex-ECoE (surplus) energy, 5% is the upper ECoE parameter beyond which prior growth in prosperity goes into reverse.

Put another way, driving ECoEs down from 9% to 5% might be enough to forestall “de-growth”, but wouldn’t be low enough to reinstate growth itself. To achieve that, we’d need to push ECoEs down a lot further, probably to levels below 3.5%.  

The volumetric side of the transition equation is tricky, and has been costed at between $95 trillion and $110tn. The financial price tag, of course, isn’t the issue, least of all in a world in which money is routinely conjured out of thin air. What matters is the quantity of material inputs which these sums represent.

Let’s assume, for purposes of hypothesis, that the Earth can supply the requisite amounts of raw materials necessary for the provision of inputs ranging from steel and copper to plastics, lithium and concrete.

As we know, accessing these materials and putting them to use is absolutely dependent on the use of energy. Without energy-intensive activity, we can’t even supply water, let alone extract minerals and convert them into components.

In short, the principle of ECoE – which applies, not just to the creation of capacity, but to its operation, maintenance and replacement as well – tells us that getting energy from RE sources at the scale that we require is absolutely dependent on the prior use of energy for these purposes.

Since, at least for the foreseeable future, the supply of these materials depends on legacy energy from fossil fuels, the ECoEs of renewables are linked to those of oil, gas and coal.

Identifying process

So here’s the equation that net zero combined with growth invites us to accept.

On the one hand, energy sourced from fossil fuels declines rapidly. On the other, physical products of energy – the inputs that we’ll need to expand RE supply dramatically – will become available in very large amounts.

Another way to put this is that we’re planning to abandon the sunk energy invested in the carbon infrastructure, and build a replacement infrastructure at global scale, and carry on driving, flying and doing everything else that we do with energy, at the same time as we’re driving down energy supply from legacy sources.

An obvious snag here is that nobody seems prepared to tell us what uses of energy will need to be relinquished in order to free up the resources needed for physical investment at a transformational scale.       

If we free ourselves from the delusion that the economy is some kind of self-perpetuating, wholly-financial, perpetual-motion mechanism operating independently of energy, the only way to square this circle is to rely on indefinite cost reduction through continued progress in technology. This is why faith in the indefinite advance of technology is implicit in so many aspects of the ‘net-zero-without-economic-sacrifice’ narrative.

The problem with this is that it overlooks the reality, which is that the scope of technology is bounded by the physical parameters of the resource. This, of course, is why no amount of technology – or, for that matter, of financial commitment – has been able to use shale resources to turn the United States into “Saudi America”.       

In addition to technological extrapolation to a point beyond the limits of physics, the critical snag with driving the ECoEs of REs downwards far enough is the fallacious assumption that, through some kind of internal financial dynamic, the economy can “grow”, of its own accord, to make all of the necessary transitional steps possible.

If we once accept the proposition that, whilst energy use falls, real economic output can rise, then we’re in danger of endorsing the fantasy that we can “de-couple” the economy from the use of energy. And, since we cannot produce anything of any economic utility at all without using energy, “de-coupling” is a logical impossibility.

From here

None of this is to say that we can’t, or shouldn’t, bend every effort to transition from fossil fuels to renewables. On the contrary, the transition to net zero goes far beyond the desirable, and into the imperative.

Far from contesting the necessity for transition, SEEDS establishes a compelling economic as well as an environmental case for endeavouring to do exactly that. An economy tied in perpetuity to the rising ECoEs of fossil fuels would face inexorable deterioration.

This isn’t a trend that we have to predict, because it’s beyond doubt that this is already happening.

Where SEEDS-based analysis parts company with the ‘new consensus’ is over the belief, amounting to an article of faith, that this process (a) can be accomplished without sacrifice, and (b) can be combined with economic growth.

Any given quantity of energy cannot be used more than once. Legacy energy value from fossil fuels, already a finite quantity, becomes a smaller finite quantity under plans to accelerate the abandonment of oil, gas and coal.

A situation in which this limited quantity of legacy energy is used to expand RE supply, and to build the requisite infrastructure, and to maintain current energy uses such as driving and flying, fails the test of practicality. The associated assumptions – that technology will provide a fix for everything, and that the economy ‘will carry on growing’ thanks to some kind of internal momentum – fail the test of logical interpretation.                      

All of this, of course, carries the obvious, if startling, implication that we’re trying to progress to a desirable destination using a basis of planning that’s demonstrably false.

The pace at which we should abandon the use of fossil fuel energy is a matter for debate.

But the need to abandon those fallacious, money-only methods of interpretation which create the myth of the economy as a perpetual-motion machine, growing ever larger through an internal mechanism disconnected from energy, has become imperative.   

#199. An American nightmare


“Time moves on”, at least in politics, and it should now be possible for us to examine the American economic situation without being drawn into recent controversies.

In any case, our primary interests here are the economy, finance and the environment, understood as functions of energy, and these are issues to which political debate is only indirectly connected. We cannot know whether the economic policies now being followed in the United States would have been different if Mr Biden hadn’t replaced Mr Trump in the Oval Office, and what we ‘cannot know’ is far less important than what we do.

If you’re new to this site, all you really need to know about the techniques used here is that the economy is understood and modelled, not as a financial construct, but as an energy system. Literally everything that constitutes economic output is a function of the use of energy. Whenever energy is accessed for our use, some of that energy is always consumed in the access process, and this Energy Cost of Energy (ECoE) governs the dynamic which converts energy into prosperity.

Money – which, after all, is simply a human artefact – has no intrinsic worth, and commands value only as a ‘claim’ on the output of the real economy governed by the energy dynamic. Energy, moreover, is the interface between economic prosperity and the environment.   

American dysfunction

Even without getting into the energy fundamentals, a string of dysfunctionalities in the American economic situation should be visible to anyone prepared to look. These are best considered, not within the current disturbances created by the coronavirus pandemic, but on the basis of trends that have been in place for a much longer period.

Most obviously, the aggregate of American debt – combining the government, household and private non-financial corporate (PNFC) sectors – increased in real terms by $28 trillion (104%) between 1999 and 2019, a period in which recorded GDP grew by only $7.4tn.

One way to look at this is that each dollar of reported “growth” was accompanied by $3.75 of net new debt. Another is that, over twenty years in which growth averaged 2.0%, annual borrowing averaged 7.5% of GDP.

To be sure, some of these ratios have been even worse in other countries, but schadenfreude has very little value in economics. Moreover, debt is by no means the only (or even the largest) form of forward obligation that has been pushed into the American economy in order to create the simulacrum of “growth”.     

Other metrics back up this interpretation. Within total growth (of $7.4tn) in reported GDP between 1999 and 2019, only $160bn (2.2%) came from manufacturing. A vastly larger (25.3%) contribution to growth came from the FIRE (finance, insurance and real estate) sectors.

These and other services are important but – unlike sectors such as manufacturing, construction and the extractive industries – they are residuals, priced on a local (‘soft’) basis rather than on ‘hard’ international markets.

To over-simplify only slightly, many services act as conduits for the financial ‘activity’ created by the injection of credit and liquidity into the system.

The real picture – of credit and energy

The SEEDS model endeavours to strip out these distorting effects, and indicates that underlying or ‘clean’ economic output (C-GDP) in the United States grew at an average rate of only 0.7% (rather than 2.0%) between 1999 and 2019.

In essence, reported GDP has been inflated artificially by the insertion of a credit wedge which is the corollary of the ‘wedge’ inserted between debt and GDP (see fig. 1).

Fig. 1

This much should be obvious even to those shackled to quaint, ‘conventional’ economic metrics which – bizarre as it may seem – ignore energy, and insist on wholly financial interpretation of the economy. To trace these anomalies to their cause, though, we need to look at the energy dynamic and, in particular, at the ECoE equation which governs the supply, cost and economic value of energy.

Globally, trend ECoEs are rising rapidly, driven by the depletion effect as it affects petroleum, natural gas and coal. The ECoEs of renewables (REs) such as wind and solar power are falling, but it would be foolhardy to assume that this can push overall ECoEs back downwards at all, let alone to the pre-1990s levels at which real growth in prosperity remained possible. Apart from anything else, RE expansion requires vast material inputs which are themselves a cost function of legacy energy from fossil fuels.

ECoEs equate to economic output which, because it has to be expended on energy supply, is not available for any of those other economic uses which constitute prosperity. This is why SEEDS draws a distinction between underlying economic output (C-GDP) and prosperity.

On an average per capita basis, American prosperity topped out back in 2000 (at $49,400 at constant 2020 values), when national trend ECoE was 4.5%. By 2019, with ECoE now at 9.0%, the average American was 6.6% ($3,275) poorer than he or she had been in 2000. Of course, his or her share of aggregate debt increased (by $68,500, or 71%) over that same period (see figs. 2 and 3).

Again, there are other countries where these numbers are worse. Again too, though, what’s happening in other countries is of very little relevance to a person whose indebtedness is rising whilst his or her prosperity is subject to relentless erosion.   

Fig. 2

The fading dream

Just as prosperity per person has been deteriorating, the cost of essentials has been rising. To be clear about this, the calibration of “essentials” (defined as the sum of household necessities and public services) within the SEEDS economic model remains at the development stage, but the results can at least be treated as indicative.

As we can see in the left-hand chart in fig. 3, discretionary prosperity has been subjected to relentless compression between deteriorating top-line prosperity per capita and the rising cost of essentials, a cost which, in turn, is significantly linked to upwards trends in ECoE.

Discretionary consumption has continued to increase – thus far, anyway – but only as a function of rising indebtedness in each of the public, household and PNFC (corporate) sectors. Even these numbers are based on per capita averages, so necessarily disguise a worse situation at the median income level.   

Fig. 3

The liability vortex

Back at the macroeconomic level, America is, very clearly, being sucked into a liability vortex.

Even before the coronavirus crisis, debt stood at 360% of prosperity, up sharply over an extended period, whilst the broader and more important category of “financial assets” – essentially the liabilities of the government, household and PNFC sectors – had risen to 725% of prosperity (fig. 4).

Fig. 4

Like anyone else, Americans can derive false comfort by measuring these liability aggregates, not against prosperity but against GDP, if they’re happy to buy the fallacy that GDP isn’t inflated artificially by financial liability expansion.

Another, almost persuasive source of false comfort can be drawn from the inflated “values” of assets such as stocks and property. The realities here, though, are that the only people who could ever buy properties owned by Americans are other Americans, meaning that the supposed aggregate “value” of the national housing stock cannot ever be monetized. The same, albeit within an international rather than a purely national frame of reference, applies to the aggregate “values” of stocks and bonds.  

More important still, asset prices are an inverse function of the cost of money, and would fall sharply if it ever became necessary to raise interest rates.

Debate rages in America, as elsewhere, about whether inflation is rising at all, and whether, if it is rising, this is a purely ‘transitory’ effect of contra-crisis liquidity injection. An additional complication here is that inflationary measurement excludes rises in asset prices and may, even within its consumer price confines, be an understatement of what’s really happening. The SEEDS-based development project RRCI – the Realised Rate of Comprehensive Inflation – puts indicative American inflation at 5.2% in 2020, rising to a projected 6.6% this year.  

Cutting to the chase

This debate over the reality and the rate of inflation, though, risks missing the point, which is that the in-place dynamic between liabilities and economic output makes either inflation, and/or a cascade of asset price slumps and defaults, an inescapable, hard-wired part of America’s economic near future.

Even before Covid-19, each dollar of reported “growth” was being bought with $3.75 of net new borrowing, plus an incremental $3.80 of broader financial obligations. Even these numbers exclude the informal (but very important) issue of the future affordability of pensions.

Crisis responses under the Biden administration – responses which might not have been very different under Mr Trump – are accelerating the approach of the point at which, America either has to submit to hyperinflation or to tighten monetary policy in ways that invite the corrective deflation of plunging asset markets and cascading defaults.   

The baffling thing about this is that you don’t need an understanding of the energy dynamic, or access to SEEDS, to identify unsustainable trends in relationships between liabilities, the quantity of money, the dramatic over-inflation of asset markets and a faltering underlying economy.

Confirmative anomalies are on every hand, none of them more visible than the sheer absurdities of paying people to borrow, and trying to run a capitalist economy without real returns on capital. Meanwhile, slightly less dramatic anomalies – such as the investor appetite for loss-making companies, the “cash burn” metric and the use of debt to destroy shock-absorbing corporate equity – have now become accepted as routine.

Obvious though all of this surely is, denial seems to reign supreme. Mr Trump – and his equation linking the Dow to national well-being – may have gone, but government and the Fed still cling to some very bizarre mantras.

One of these is that stock markets must never fall, and that investors mustn’t ever lose money. Another is that nobody must ever default, and that bankruptcies destroy economic capacity (the reality, of course, is that bankruptcy doesn’t destroy assets, just transfers their ownership from stockholders to creditors).  

Businesses, meanwhile, seem almost wilfully blind to the connection between consumer discretionary spending, escalating credit and the monetization of debt.

On the traditional basis that “when America sneezes, the rest of the world catches a cold”, what we seem to be nearing now is something more closely approximating to pneumonia.   


Here, as requested, are equivalent charts for New Zealand:

#198. The Theseus gambit


According to Greek mythology, Theseus, having killed the Minotaur, found his way back from the heart of the Labyrinth by following a thread given to him by Ariadne.

There are two lessons – in an earlier idiom, morals – to be taken from this story. The obvious one is the wisdom of taking a thread into the maze and using it to find the way back out. The less obvious lesson is that the thread Theseus followed was reliable, a guide which, like real gold, would pass an ‘assay’ of veracity.

Our current economic and broader circumstances merit comparison with the Labyrinth – we’re in a maze which has many complex blind-alleys, routes to nowhere which tempt the unwary. If we’re to fashion a reliable thread that can be followed through it, we need to apply the assays of logic and observation.

The thread followed here starts with the purposes of saving and investment, purposes which pass the assay of logic, but fail the test of observation. This points to dysfunction based on anomaly, the anomaly being that the practice only conforms to the principle in the presence of growth.

Postulating that the economy is an energy system rather than a financial one also passes the assays of logic and observation, and confirms we have a thread that can be followed to meaningful explanations and expectations.

An assay of logic

Capital theory is as a good a place to start as any. This theory is that, in addition to meeting current needs and wants, a sensible person puts aside a part of his or her income for the purposes both of having a reserve (“for a rainy day”) and of accumulating wealth. The flip-side of this process is that saving – as ‘economic output not consumed’ – provides capital for investment. This theory would apply, incidentally, even if some form of barter were substituted for money.

For this to work, the saver or investor must receive a real return on investment that is positive (that is, it exceeds inflation), and this return must be calibrated in proportion to any risk to which his or her investment is exposed. The user of this capital must earn a return on invested capital which exceeds the return paid to the investor. Any business unable to do this must fail, freeing up capital and market share for more efficient competitors.

This thesis rings true when measured on the ‘assay of logic’ – indeed, it describes the only rational set of conditions which can govern productive and sustainable relationships between saving, investment, returns and enterprise.

But it’s equally obvious that this does not describe current financial conditions. Returns to investors are not positive. These returns are not calibrated in proportion to risk. Businesses do not need to earn returns which exceed appropriate returns being paid to investors. Businesses unable to meet this requirement do not fail. 

When logic points so emphatically towards one set of conditions, whilst observation leaves us in no doubt that contrary conditions prevail, we don’t need to venture further into investment theory in order to confirm the definite existence of an anomaly.

To discover the nature of this anomaly, let’s look again at capital theory to discover the predicates shared by all participants.

The investor needs returns which increase the value of his or her capital.

The entrepreneur needs returns which are higher again than those required by the investor.

The shared predicate here is that the sum of money X must be turned into X+.

For the system to function, then, the shared predicate is growth.

Logic therefore tells us two things. The first is that a functioning capital system absolutely depends on growth. The second, inferred-by-logic conclusion is that, if the system has become dysfunctional, the absence of growth is likely to be the cause of the dysfunction.

Observed anomaly is thus defined as a property of dysfunction, whilst dysfunction itself is a property of the absence of growth.

You don’t need a doctorate in philosophy to reach this conclusion. All you need do is follow a logical sequence which (a) defines anomaly as intervening between theory and current practice, and (b) identifies this anomaly as the absence of growth.

We can confirm this finding by hypothesis. If we postulate the return of real, solid, indisputable growth into this situation, we can follow a sequential chain which goes on to eliminate the anomaly and restore the alignment of theory and practice.     

Testing the thread

The deductions that (a) dysfunction exists, and (b) that this is a product of the lack of growth, take us on to familiar territory. If you’re a regular visitor to this site, you’ll know that the basic proposition is that the economy, far from being ‘a function of money, and unlimited’, is in fact a function of energy, and is limited by resource and environmental boundaries.

Using logic and observation, we can similarly apply the ‘assay of rationality’ to the propositions informing the surplus energy interpretation. There are three of these propositions or principles, previously described here as “the trilogy of the blindingly obvious”.

The first principle is that all of the goods and services which constitute economic output are products of the use of energy. If it were false, this proposition would be easy to disprove. All we’d have to do is to (a) name anything of economic utility that can be produced without the use of energy at any stage of the production process, and/or (b) explain how an economy could function in the absence of energy supply.

The second principle, applied here as ECoE (the Energy Cost of Energy), is that whenever energy is accessed for our use, some of that energy is always consumed in the access process. Again, if this proposition were false, its fallacy could be demonstrated, simply by citing any example where energy can be accessed without the use of any energy at any stage in the access process.

The third proposition – that money has no intrinsic worth, and commands value only as a ‘claim’ on the output of the energy economy – ought, if false, to be the easiest one to disprove. We would need to do no more, as a thought-exercise, than cast ourselves adrift in a lifeboat, equipped with very large quantities of any form of money, but with nothing for which this money could be exchanged. If this experiment succeeded, the ‘claim only’ hypothesis would be disproved.

The inability to disprove these propositions means that the theory of the economy as a surplus energy system passes the assay of rationality. Application is a much more complex matter, of course, but the next test is to see how theory fits observation.

The assay of observation

From the mid-1990s, and as the following charts show, global debt started to expand far more rapidly than continuing growth in reported GDP. Available data for twenty-three economies – accounting for three-quarters of GDP – shows a corresponding trend in the broader measure of ‘financial assets’, which are, of course, liabilities of the non-financial economy of governments, households and private non-financial corporations (PNFCs).

There is reliable data showing yet another correspondence, this time between the GDPs and the unfunded pension obligations (“gaps”) of a group of eight economies which include global giants such as the United States, China, Japan and India.

Let’s be clear about where this takes us. We’ve already identified the absence of growth as the source of financial dysfunction. We’ve now seen parallel anomalies in the relationships between GDP and liabilities.

These divergent patterns can be explained – indeed, can really only be explained – in terms of exploding financial commitments distorting reported GDP. Put another way, there are compounding trends whose effect is to ‘juice’ and to mispresent reported economic output.

This observation accords with the logical conclusion, discussed earlier, that the relationships between saving, investment, returns and enterprise have been distorted into a dysfunctional, anomalous condition by the absence of growth. The only complication is that we have to look behind reported “growth” numbers to make this connection.

What, though, explains the absence – in practice, the deceleration, ending and impending reversal – of growth itself? The right-hand chart indicates that what was happening at the start-point of observed economic distortion was a rise in ECoEs.

The assay that we’ve undertaken has shown the validity of the concepts of output as a function of energy, ECoE as a characteristic of the output equation, and money in the role of ‘claim’. This in turn validates the linkage identified here.

Fig. 1

 Once again, let’s apply the test of hypothesis. Assume that a new source of low-cost (low ECoE) energy is discovered. Prosperity would increase, and real growth would return to the system. The observed anomalies in capital relationships would disappear.

This, remember, is purely hypothesis, because the discovery of a new source of low-cost energy is at the far end of the scale of improbability. We can thus conclude that dysfunction and anomaly will continue, to the climacteric at which the monetary system described by capital theory reaches a point of failure.

The clarity of defined anomaly    

For anyone who isn’t a mythical hero, venturing into the Labyrinth, confronting the Minotaur and finding our way out again sounds like a terrifying experience. There are clear analogies to the present, in terms of the uncertainty of the maze, and the fear induced by the unknown. We may not have Ariadne’s thread, but we can fashion a good alternative by opting for rationality, applied through logic and observation.

The results of this process do seem to have the merit of clarity. Comparing capital theory with observed conditions identifies a dysfunction or anomaly that can be defined as the absence of growth. This in turn can be explained in terms of a faltering energy economy. Take away the predicate – growth – and the financial system becomes dysfunctional.

This interpretation helps to clarify the roles of the various players in the situation. Taking the ‘elites’, for example, we know that the defined aim of all elites is to maintain and, wherever possible, to enhance their wealth and influence. We can infer that, if we can identify the dysfunctionality of capital theory and observed conditions, so can they.

Likewise, we know that the defined aim of governments is the maintenance of the status quo, and we can again infer that they, like we, recognize the essential dysfunction as ‘the failure of the predicate’.

To this extent, we can demystify the behaviour of elites and governments. We can also make informed judgements on their probabilities of success. (These probabilities are low, for reasons which lie outside the scope of this discussion).

A similar application of logic and observation tells us that anomaly cannot continue in perpetuity. We can hypothesize the resolution of the energy-ECoE problem, but examination of the factors involved suggests that any such resolution, even if attainable, is unlikely to happen in time to restore equilibrium to the financial system. There are equations which relate the investment of legacy energy (from fossil fuels) into a new energy system (presumably renewables), and these equations give few grounds for optimism where current systems are concerned.

If rationality can take us this far, it surely makes sense to adhere to it. The probabilities are that global prosperity will contract, meaning that systems predicated on growth will cease to function. The logic of the situation seems to be that, when old predicates change, we need to fashion new systems based on their successors. 

#197. “Life After Ideology”?


Two broad sets of ideas have shaped the practice and philosophy of political economy during much of the Industrial Age. One of these is collectivist thinking, which argues for state or communal ownership of “the means of production”. The other is the market philosophy which advocates the primacy of private ownership.

These are ultra-broad-brush categorizations, useful because they correspond to a duality in the human psyche – a duality comprising the desire for collaborative effort and the ambition for self-betterment. These, in their myriad forms, have been the polarities of debate since the onset of industrialization in the 1760s. They have often been labelled “left” and “right”, but these labels are so vague, and their applications have been so varied, that they cannot serve as useful terms in the current context.   

That context is involuntary economic de-growth, caused by a deterioration in the dynamic which has powered economic activity for well over 200 years.

The Industrial Age began when the first efficient heat engines enabled us to access vast reserves of energy contained in coal, petroleum and natural gas. This triggered parallel expansions, exponential in nature, in human population numbers and in the economic means of their support.

It cannot be emphasised too strongly that the economy is an energy system, not a financial one. Anything that has economic utility is a product of energy. The various monetary systems used over time have served primarily as media of exchange for the goods and services made available by the use of energy.

Energy itself has never been “a free lunch”. Whenever energy is accessed for our use, some of that energy is always consumed in the access process. This ‘consumed in access’ component is known here as the Energy Cost of Energy, or ECoE.

ECoEs have been rising relentlessly, and have already passed the thresholds at which, first, advanced Western economies start getting poorer and, latterly, the same thing starts happening to less complex EM countries.

Much of today’s uncertainty and contention can be traced to this process itself, and to our inability, or our unwillingness, to recognize this reality.

The onset of “de-growth”

With these points understood, the long-range interpretation of the economy devolves into a series of equations, comparatively straightforward in principle, though complex in application.

Prosperity is a function of how we convert surplus (net-of-ECoE) energy into economic value. The quantitative variables are the amount of energy available, the proportion of that energy ‘lost’ to the economy as ECoE, the efficiency with which surplus energy is converted into economic value, and the number of people between whom aggregate prosperity is shared.

This energy interpretation indicates that economic prosperity cannot be infinite on a planet with finite resources. Environmental and ecological degradation introduce a new ‘infinity fallacy’, revealing that there are limits to the ability of the ecosphere to tolerate our use of energy, certainly when the vast bulk of that energy is sourced from fossil fuels.    

Problems with this system have been forced upon our attention only in comparatively recent times. As ECoEs have risen, we have begun to encounter (though not to recognize) the limits to material economic growth founded on the use of fossil fuels. At the same time, there has been widening public recognition of the adverse environmental and ecological consequences of the exploitation of fossil energy.

In essence, neither the reserves base nor the environment can support further economic growth based on the use of fossil fuels. Indeed, even the maintenance of current fossil-based prosperity has become impossible.

This presents us with two possible developments. The first is that we find alternative forms of energy which free us from resource and environmental constraints.

The second is that we come to terms with the ending and the reversal of prior growth in material prosperity.

The best available evidence points to an outcome which is at neither of these extremes. We can, and indeed must, develop alternative energy sources, including wind and solar power. But we cannot assume ‘like-for-like’ replacement of the economic value derived from fossil fuels, so we need to plan on the basis that aggregate material prosperity will decrease.

Cognitive dissonance and ideological luxury

The unfolding failure of the established ‘growth engine’ is causing systemic, cognitive, psychological and political disruption.

We’ve done everything we can to deny the reality of involuntary de-growth. Means of denial have included financial gimmickry, the making of exaggerated claims for the potential of renewable energy and for technology more broadly, and even assertions that we can find ways of ‘engineering’ our way out of environmental constraints.

The lengths to which we’ve been prepared to go to deny the physical reality of the faltering economy have been quite remarkable.

Conspiracy theories have flourished in a context of ignorance (about energy reality), suspicion and mistrust.   

Despite the climate of denial, the storm front of de-growth has already thrown systems into chaos. The “market economy” has been abandoned in all but name, transformed into what might best (and most neutrally) be described as the “make it up as you go along” economy. We’ve embraced the fiction that the creation of ever more money can keep the wolf of de-growth from the door.  

It doesn’t help that we’ve spent centuries congratulating ourselves on economic ‘knowledge’ that is fallacious. The conventional basis of economic interpretation – which concentrates on money, puts energy into an ancillary role, and insists on the potential for growth in perpetuity – is in the process of being invalidated.

We have an ingrained sense of ownership of growth, amounting to a feeling of entitlement to a current level of material prosperity that, we believe, can only increase over time. If this isn’t happening, “somebody else” must somehow be at fault. Political economy has long concentrated on the distribution of economic prosperity on the assumption that this prosperity itself must increase in perpetuity. Our financial system is entirely predicated on “growth” in perpetuity.

Most of us cannot even imagine a system in which politicians, opinion-formers, business leaders and financiers stop talking about “growth” and start discussing contraction. There have always been some people who have advocated “de-growth”, but they have tended to promote this as a beneficial choice, not as an involuntary inevitability.    

One definition of “de-growth” might emphasise the loss of luxuries. This applies, not just to the loss of material non-essentials, but to political and ideological luxuries as well. Economic growth has enabled us to indulge in philosophical extremes, including advocacy of wholly-state or wholly-private ownership of “the means of production”. To stand any chance of adapting to involuntary de-growth, we will need to put ideological extremism behind us, and concentrate instead on pragmatism.

From a pragmatic perspective, both the collectivist and the market models have strengths and weaknesses. Pragmatism now decrees that we need to combine the strengths of both, and use each to minimize the weaknesses of the other. The term best describing this pragmatic balance is the “mixed economy” which optimizes a combination of public and private provision. Extreme collectivism failed between the 1960s and the 1990s, and the extreme or “liberal” version of the market alternative has failed now.

Philosophically, the aim now should surely be to seek an optimal combination of systems and ideas which meets the basic needs of everyone, whilst maximising the scope for individual endeavour. One of our greatest assets is our ability to think our way around problems, in the process producing new ideas.

Extremism isn’t wanted, or affordable, on our journey into a post-growth society.

To use a historical rather than a contemporary example, the Puritans of seventeenth-century England believed that theatres, taverns and country dancing were manifestations of evil. The tragedy was that, in addition to exercising their right not to participate in such activities themselves, they also set out to enforce these prohibitions on everyone. Puritan authoritarianism was rooted in religious belief, but there have been, and remain, equivalent schemes of repression founded on secular rather than spiritual persuasion.

Enforced agreement, however it is manifested, would be an even greater handicap in a post-growth than in a growing or a pre-growth society. The finding of solutions to the wholly new challenges of de-growth require the maximised exchange of ideas consistent with respect for the differing ideas of others.          

Pragmatic planning

Without entering into the long-standing debate around utilitarian principles, we can take as a starting-point the objective of seeking “the greatest good of the greatest number”. A worthy aim now would be to ensure the well-being of all as the economy as a whole gets poorer.

In the past, political economy has concentrated on the distribution of economic prosperity within the assumption that the aggregate of this prosperity will continue to grow. For political leaders, ‘sharing out growth’ has seldom been easy.

‘Sharing out hardship’ is going to be very much harder.

Our first priority surely ought to be a combination of research, education and the channelling of expectations. To give just one example, the doctrine of perpetual growth has created the assumption that we can tackle the environmental crisis without having to surrender things such as reliance on cars and frequent overseas travel. Once we recognize the economic as well as the environmental dimension of a faltering fossil fuel dynamic, we’ll become aware that pain-free, seamless transition is a hope rather than an assured reality.

Under these conditions, neither “collectivist” nor “liberal” philosophies can meet our needs. Collectivism tends to espouse subservience to the state, whilst the liberal alternative promotes at least the acceptance of greed, and sometimes its validation, or even its encouragement.

When aggregate prosperity becomes at best ‘a zero-sum gain’, various deep-rooted assumptions fail. One is the idea that one person can prosper without another suffering. Another is that the state can manage the equitable distribution of everything.

Neither should we obsess about “the rich”. Traditionally, the “left” has favoured ‘taking from the rich to give to the poor’, whilst the “right” has validated inequality as a reward for talent and effort. Historically, the widening of the gap between the wealthiest and “the rest” can in reality be connected to growth, both in prosperity and in social and economic complexity. As both prosperity and complexity decrease, this gap can be expected to narrow.

As prosperity per person decreases, the probability is that the cost of essentials will absorb an increasing proportion of prosperity. This is likely to be asymmetric, in that some people will continue to enjoy substantial (though diminishing) discretionary prosperity whilst others will find it ever more difficult to afford the necessities.

In policy terms – and beyond the prerequisites of education, research and the ditching of false notions about the economy and the environment – a primary objective surely needs to be to ensure that the necessities are available and affordable for all. The priorities for would-be leaders have to be (a) to learn about economic and environmental reality, and (b) to plan ahead to preserve and promote both economic well-being and social cohesion in a post-growth society.             


#196. The price of self-delusion


It can’t be emphasised too often that GDP, which is the preferred measure of economic output and “growth”, has become progressively less meaningful over time.

Essentially, GDP mistakes money for prosperity. It counts the spending of money as economic “activity”, drawing no distinctions between how the money is spent, or whether the money itself has been earned, borrowed, airily promised for the future, or simply created out of the ether.

Worst of all, GDP ignores the deterioration of the cost-value equation which determines how the economy converts the use of energy into material prosperity. It invites us to believe that the economy exists in complete isolation from physical resources such as energy, minerals, plastics, food and water. If we once let ourselves believe that the economy does indeed exist independently of natural resources, ‘growth forever’ becomes a plausible fantasy.

If we follow the logic of GDP, the complete destruction of the Earth’s ability to produce food wouldn’t be too serious, because it would leave the other 94% of the economy intact. If the economy really is independent of material resources, we could colonise Mars by sending nothing more than some starry-eyed pioneers and a printing-press. A more prosaic – as it were, a more ‘down to Earth’ – example would be that survivors of a ship-wreck could live indefinitely in a lifeboat, just so long as their supply of bank-notes didn’t run out.

You might be familiar with how the economy of money has disguised real trends in the underlying economy of material prosperity. In the twenty years preceding the coronavirus crisis, each $1 of reported “growth” in global GDP was the product of nearly $3 of net new borrowing. Even this understates the extent of our self-deception, because it ignores the creation of huge non-debt liabilities. These include both formal commitments and informal assumptions, the latter typified by enormous gaps in promised (but unfunded) pension expectations.

In America, manufacturing accounted for just 0.2% of all reported economic growth between 2000 and 2020. Even adding construction, agriculture and the extractive industries leaves the growth contribution of globally-marketable, ‘hard’-priced activities at only 5%. The remaining 95% of growth came from services.

These services can be important, and valuable, but they can also act as residuals, sinks for liquidity injected into the system. The FIRE (finance, insurance and real estate) sectors alone accounted for almost 30% of all recorded growth – but how much value do we actually derive from moving money around? – with a further 12% coming from government. Both FIRE activities and government spending are obvious conduits for the injection of borrowed or newly-created money into the system.      

The flip-side of this process is the creation of hugely inflated asset “values”, which are products (a) of the abundance (and hence the cheapness) of money, and (b) of the discounting to the present of forward streams of income which reflect expectations wholly detached from any realistic appraisal of the material economy of the future.

What this in turn means is that most asset “values” are no more than a function of our self-delusion about the true size of the economy of today and tomorrow. Many of them, including the aggregate “values” ascribed to equities and property, are purely notional, in that they can never be monetised. Even defined, committed assets – such as debts owed by others – are only as valuable as debtors’ ultimate ability to pay.

The joys of self-delusion

This situation raises two obvious questions. The first is that, as this is collective self-delusion, does it really matter? After all, we’re not trying to measure ourselves against alternative worlds where economic activity is reported more intelligently.

Second, can those of us who understand this situation – and who can, furthermore, put numbers on it – profit from this knowledge?      

The answer to the second question is that yes, we can.

The answer to the first is that, in economics as in so much else, self-delusion does matter. You wouldn’t expect to win a battle by lying to yourself about how many soldiers or warships your enemy had at his disposal. You wouldn’t expect to drive safely by lying to yourself about how much alcohol you’d consumed.

So why would we expect to become more prosperous by deluding ourselves about the size, shape and direction of the economy?

In economics, self-delusion matters because plans based on false information seldom, if ever, turn out well.

Here’s one example of the dangers implicit in economic self-delusion. Between 1999 and 2019, emissions of climate-harming CO² increased by 48%. If we believe official GDP numbers, economic output grew by 110% over that same period. From this, we can infer that economic output per tonne of CO² increased by 42%. Conversely, we could conclude that each dollar of economic activity now produces 30% less CO² than it did twenty years ago.

If we were to believe this, we could also believe that further such progress could, in due course, tame environmental risk, or even eliminate it altogether, without requiring economic sacrifices.

This sort of calculation helps explain why governments’ seemingly sincere (if belated) commitments to environmental reform aren’t accompanied by measures that, in purely physical terms, might appear necessary. We can, we’re told, overcome environmental risk without having fewer cars, limiting engine sizes, insisting on hybrid-only model slates, or rationing air travel.

Much the same applies to the use of energy. Over twenty years in which GDP increased by 110%, consumption of primary energy expanded by only 54%. Accordingly, the economic value created by the use of a single unit of energy seemingly improved by 36%.

The inference is that, in the future, economic output can grow whilst our use of energy decreases. This where the fantasy of “de-coupling” the economy from energy use comes from, and remains persuasive even though experts at the EEB have described the case for de-coupling as “a haystack without a needle”.

It is, after all, surely obvious that literally nothing of any economic value (utility) whatsoever can be produced without the use of energy – so why would we expect to grow the economy without increasing our consumption of energy?

So any theory which postulates indefinite divergence between energy use and economic prosperity affronts the laws of physics. Suggesting that “technology” can somehow over-rule the constraints of physics simply produces ‘self-delusion squared’.     

Cold reality

When we step away from self-deluding convention (and starry-eyed faith in technology), and look behind the fallacy of GDP, very different conclusions emerge.

For starters, stripped of what we can call ‘the credit effect’, world economic output increased by only 40% (rather than by 110%) between 1999 and 2019.

This means that we delivered 5% less economic value for each tonne of CO² emitted, and 9% less economic output from each unit of energy consumed.

Nor is this all. The Energy Cost of Energy (ECoE) is the critical dynamic determining how much economic value we derive from each unit of energy consumed. Driven primarily by fossil fuel depletion, ECoEs have been (and are) rising relentlessly.

If we include ECoE escalation in our calculation, each unit of emitted CO² yielded 10% less material prosperity in 2019 than in 1999, whilst the relationship between prosperity and energy use worsened by 14% over that same period.

The latter point, in particular, is self-evident – if, from any given quantity of energy supplied, more has to be consumed in the supply process, less remains for any other economic purpose.

These inconvenient observations tell us, amongst other things, that we can’t overcome environmental challenges without changing our behaviour, and that we can’t shrink energy consumption without shrinking the economy.

If we factor ECoE into the equation, two further critical points emerge.

First, CO² emissions are a function of the total energy that we use, whilst material prosperity is linked to surplus (ex-ECoE) energy quantities. As ECoEs rise, they load this equation against us

Therefore, a sizeable – and rising – proportion of CO² emissions is tied, not to the economic value that energy use creates, but to the energy that is used only to make energy supply available. We’re never going to combat climate change and ecological degradation effectively until we take this ‘variable geometry’ into account.

Second, realistic appraisal also tells us that we’re nowhere near a point at which we can use renewable energy sources (REs) as a “fix” for the environmental and economic consequences of rising ECoEs.

Transitioning to technologies such as solar and wind power will require huge investment, which has been costed at between $95 and $110 trillion. The money involved isn’t that important in itself. But it corresponds to vast amounts of steel, copper, plastics, lithium and numerous other resource input requirements. Most of these can only be made available through the use of fossil fuels, meaning that the ECoEs of REs are tied to those of oil, gas and coal.

Western societies’ prior growth in prosperity goes into reverse at or below ECoEs of 5%. Less complex EM countries start getting poorer before their ECoEs reach 10%. The latter level of ECoE might, just, be feasible for REs, but the lower level of ECoEs required to maintain (let alone to grow) Western prosperity is a pipe-dream.

Here, once again, we encounter the chimera of technology. The technological progress of the past has enriched us by increasing the efficiency with which we use both energy itself and those other resources whose availability is energy-dependent.

Critically, though, the scope for technological progress is confined within the envelope of the physical characteristics of the resource itself, and, ultimately, is bounded by the laws of thermodynamics.

Simply put, far too many of our expectations for what technology can deliver in the future are based on a fallacious assumption that we can extrapolate technological progress to the point where it trumps physics.

Anyone who believes that to be possible would be better employed writing science fiction, or running a government department. 

Practical implications

If we once free ourselves from the alluring embraces of financial and technological self-delusion, we’re in a position to recognise fundamental challenges that won’t go away just because we bury our heads in the sand.

Our first observation has to be that prosperity consists of those material things – goods and services – whose provision is a function of energy, not of our ability to pour ever more money into the system.

This linkage to energy is particularly important in the provision of essentials, including food and water, housing, health care, education, necessary transport and, of course, energy itself.

Even the most cursory examination tells us that, as prosperity continues to deteriorate in defiance of our economic self-delusion, so the proportion of our prosperity available for all discretionary (non-essential) purposes will diminish.

If, understanding this, you were in government, your forward planning would surely centre on ensuring the availability and affordability of essentials for everyone. This has already become a critical factor, as ever larger numbers are sucked into poorly-paid, insecure forms of employment, just as the cost of necessities continues to rise.

This is where plans for the universal provision of essentials should be front and centre of the policy process, much as – in some countries – universal provision for health care was the flagship objective for an earlier generation of political leaders. 

If you were in business, and applied this same understanding, you wouldn’t be banking on growth. Rather, you’d be working out how best to insulate yourself from a relentless squeeze on discretionary consumption, and how to safeguard your business from the coming technological disillusionment. 

Many people fear that an economic crisis will be brought about by the inflationary consequences of the endless injection of liquidity on the false premise that ‘money equals prosperity’.

They might very well be right.

It’s equally possible, though, that we might see markets brought down by a sudden, dawning recognition that discretionary consumption is destined to contract (as, excluding debt-funded purchasing, it already is); that perpetual growth in future income streams from consumers is a figment of self-delusion; that property prices must fall back into equilibrium with incomes; and that our fascination with technology has been blinding us to the laws of physics as they apply to prosperity, the economy and the environment.  

#195. The unrelenting squeeze


Henry Ford may have said that “history is bunk”, but a glance backwards can sometimes help us to focus on the future. Though they are not the subject of this discussion, fiat currencies are an example of this.

The world monetary system moved on to a fiat or “command” basis back in 1971. For the following quarter-century, this worked reasonably well, and it seems likely that historians of the future will date the decline of fiat from the second half of the 1990s.

That was when we embarked on the financial excesses which culminated in the global financial crisis (GFC) of 2008-09. The rest – as the saying goes, and with apologies to Mr Ford – “is history”, with the ultimate fate of fiat determined from the moment when the world’s ‘market’ economies decided to turn their backs on market forces, and to ‘make it up as we go along’.

The aim here isn’t to revisit the subjects discussed in the previous article, but it’s worth considering why a monetary system that previously had worked pretty well then turned on to a dangerous path.

What, fundamentally, changed in the 1990s?

The answer, of course, was that ECoEs – the Energy Costs of Energy – reached what was, for Western economies, the climacteric zone that lies between 3.5% and 5.0%. SEEDS dates this ECoE climacteric to the period between 1996 (a global ECoE of 3.4%) and 2005 (5.0%).

From 1997, the prosperity of the average Japanese citizen turned downwards. The same fate overtook Americans in 2000, and the British in 2004, and most other Westerners by 2008.

Well before then, baffled observers had started to wonder about the phenomenon of “secular stagnation”, something which they could identify, but could not explain.

The rest is indeed “history”, because money-based systems of economic interpretation could propose only futile financial solutions for a trend rooted, not in money, but in energy.

Why, then, did the ECoE inflexion-point in Western prosperity put “the writing on the wall” for fiat currencies? The answer seems to lie in the flexibility that is at once fiat money’s greatest virtue and its fundamental weakness.

So long as the underlying economy keeps growing, fiat money can expand at a roughly commensurate rate, and that’s its virtue.

Once the economy turns down, however, a divergence begins, because fiat systems are incapable of a corresponding contraction, and that’s the system’s inherent vice.

Unless you understand the economy as an energy system, though, you couldn’t – and still can’t – see what’s happening.

Monetary expansion in a contracting economy can only create excesses of those financial ‘claims’ that, customarily, are called “value”. From that point on, the only real question is whether the instrument of “value destruction” is going to be a series of market crashes and debt defaults, or a hyperinflationary debasement of the value of money.

Here, history again provides a pointer, suggesting that decision-makers will almost always avoid formal or ‘hard’ default if the ‘soft’ alternative of inflationary value destruction is available.

So much for history, and the rise and fall of fiat. Turning to the future, here are some charts that ought to (but, of course, won’t) act as a wake-up call for decision-makers.

Fig. 1

Though extended out to 2040, these charts will be familiar to regular readers. What they show is the SEEDS calibration of prosperity per capita, set against the cost of essentials. The latter, defined as the sum of public services and household necessities, remains a development project, but the bottom line is clear enough.

In essence, the prosperity of the average person in America, in Britain and – now – even in China is deteriorating. The cost of essentials is continuing to rise. Accordingly, the scope for discretionary (non-essential) expenditure, within the parameters of prosperity, is eroding fast.

People will still undertake discretionary spending in excess of this shrinking capability, of course, as indeed they are doing now. But they can only do this by resorting to borrowing for this purpose. Discretionary consumption within the affordability of prosperity is undergoing rapid contraction.

More worryingly still, there seems to be every likelihood that the cost of essentials will, in due course, rise above prosperity per capita. As you can see, this might not happen until some time in the 2030s, but that doesn’t mean that we can ignore it until then.

For one thing, these are average numbers, not medians. For every person whose discretionary prosperity remains comfortably positive, there’s another who’s already near, or at, the point of reliance on credit to pay for the essentials.

Here is where we’re entitled to ask some questions. Are governments aware of this situation, as they continue to plan on the basis of rising revenues, and carry on investing in sectors geared towards discretionary consumption?

Do they, and central bankers, really think we can somehow overcome these fundamental, energy-driven trends by pouring yet more cheap credit and cheaper money into the system? Do businesses selling discretionary goods and services realise that they’re becoming hostages to the fortunes of credit expansion? And do those companies and investors reliant on assumed increases in consumer income streams understand the dynamic that is squeezing consumer discretionary prosperity?

In most cases, the answer, very probably, is “no”.

Have political leaders looked ahead to the very different agendas that will concern voters once the gravy-train of cheap credit either hits the deflationary buffers or crashes off the inflationary rails?

Again, probably not.


#194. Where hyperinflation really threatens


Right now, the outlook for inflation – or, conversely, for deflation – is one of the hottest topics of economic debate. Some observers contend that the sheer scale of financial intervention triggered by the coronavirus crisis has made soaring inflation inevitable. Others argue that, on the contrary, the weakness of the underlying economy makes deflation the greater risk.

The real threat, without a doubt, is inflation. This isn’t, though, going to be a re-run of the world’s last brush with hyperinflation in the 1970s and early 1980s.

Back then, soaring oil prices triggered sharp rises in consumer costs and an associated surge in wages. The problem now is that the financial system has out-grown the underlying economy to a dangerous extent. This means that hyperinflationary risk lies not in consumer prices, or in wages, but in the matrix of assets and liabilities created by an increasingly financialised economy.

What this also means is that conventional measures of inflation aren’t going to provide much, if any, forewarning of inflationary risk. This in turn is going to give policymakers every reason for not courting unpopularity by raising interest rates.

Rates will have to rise, of course, and the real prices of traded assets will fall, but it’s likely to be a case of slamming the policy door after the inflationary horse has bolted.

Two economies, one problem

This is an unusually complex issue, so we need to follow a clear analytical path to reach useful conclusions. The best way to start is by drawing a conceptual distinction between ‘two economies’ – a real economy of goods and services, and a financial economy of money and credit.

These ‘two economies’ have grown dangerously far apart. As we’ll see when we get into the numbers, the economy of goods and services had, even before 2020, been growing at barely 2% annually, whilst the financial aggregates of assets and liabilities had been expanding at rates in excess of 6%.

Prices act as an interface between these ‘two economies’, so it’s likely that inflation will mediate the restoration of equilibrium between the financial system and the underlying economy.   

The fundamental issues are simply stated, and involve three essential principles.

First, nothing of any economic value or utility can be produced without the use of energy. This means that the economy is an energy system, and is not, as is so routinely and so mistakenly assumed, a financial one.  

Second, whenever energy is accessed for our use, some of that energy is always consumed in the access process. This ‘consumed in access’ component is known here as the Energy Cost of Energy (ECoE). Because this fraction of accessed energy is required for energy supply itself, it is not available for any other economic purpose. This means that surplus (ex-ECoE) energy is the basis of economic prosperity.

Third, money has no intrinsic worth. It commands value only as a ‘claim’ on the material or ‘real’ economy of goods and services.

With these principles understood, we can examine the ‘real’ economy (of goods, services and energy) and the ‘financial’ or ‘claims’ economy (of money and credit) independently of each other.

If, through monetary expansion, we create present or future financial claims which exceed what the underlying economy of today or tomorrow can deliver, the result is an overhang of excess claims. Since these excess claims cannot be honoured, they must, by definition, be destroyed.

Of assets and liabilities

Before we can get into the mechanics of where we are now, we need to be clear about the meaning of ‘assets’ and ‘liabilities’.

Let’s start with the ‘real’ economy, comprising governments, households and businesses. From this point of view, assets can be divided into two categories.

Defined or ‘formal’ assets are monetary sums, such as cash holdings, and money owed by others.

Equities, bonds and property are undefined or notional assets. Their aggregate ‘valuations’ are meaningless – these asset classes cannot, in aggregate, be monetised, because the only people to whom they could ever be sold are the same people to whom they already belong.

In fact, the prices of traded assets of stocks, bonds and property are an inverse function of the cost of money, so rises in these prices are a wholly predictable consequence of pricing money at low nominal (and negative real) levels.

Unless the authorities are prepared to countenance the hyperinflationary destruction of the value of money, its price – meaning rates – will have to rise.

This, in turn, must cause asset prices to plunge.

It’s axiomatic, though scant comfort, that the bursting of bubbles doesn’t, of itself, destroy value. Rather, it exposes the destruction of value that has already taken place during the period of malinvestment in which the bubble was created.

Furthermore, if the value of a house slumps, or a company’s share price crashes, the house and the company retain their underlying value or utility. The real problems created by an asset price crash are problems of collateral.

This is why our focus needs to be on liabilities rather than assets.   

The nomenclature here can be a little confusing. Debts and other financial commitments are the liabilities of the government, household and business sectors, but they are the assets of the financial system itself. This is why, during the 2008-09 global financial crisis, non-performing or at-risk debts were known as “toxic assets”.       

The crisis in figures

With these basics clarified, we can analyse trends in the ‘real’ and ‘financial’ economies. For this purpose, we’ll be looking at a group of twenty-three countries for whom comprehensive information is available. Between them, this group of countries accounts for three-quarters of the global economy, so can be considered representative of the overall situation.        

As you can see in fig. 1, energy used in these economies increased by 49% between 2002 and 2019. Over the same period, however, their trend ECoE rose from 4.5% to 8.3%. Accordingly, surplus energy increased by 43%.

This was mirrored in a 39% increase in these countries’ aggregate prosperity. Throughout this period, rising ECoEs steadily undercut the rate of increase in prosperity. Accordingly, annual rates of growth in aggregate prosperity have fallen below the rate at which population numbers have continued to increase. This, as the centre chart shows, has resulted in a cessation of growth in prosperity per capita.

This has happened despite the inclusion in this group of China, India and ten other EM countries. In more complex, more ECoE-sensitive Western economies, prosperity per person turned down a long time ago. The average American has been getting poorer since 2000, the inflexion-point in Britain occurred in 2004, and Japanese prosperity per capita stopped growing back in 1997.   

Critically, though, aggregates of financial claims have grown much more rapidly than the pedestrian expansion in aggregate prosperity. Between 2002 and 2019, when prosperity increased by 39%, debt grew by 136%, and non-debt financial assets by 234%.

The result, as shown in the right-hand chart, has been the insertion of an enormous wedge between financial claims and the underlying economy. If you wanted to find hyperinflationary risk on a map, this chart gives you the co-ordinates.

At constant values, the increase in prosperity during this period was $19 trillion. Debt expanded by $116tn, and total financial assets by $262n. In effect, then, each dollar of incremental prosperity was accompanied by $6 of net new debt and $7.60 of additional other financial assets.

This is a good point at which to remind ourselves that these ballooning financial “assets” are the liabilities of the ‘real’ economy of governments, households and businesses.   

Fig. 1



The following charts amplify the picture by showing rates of change, in the real economy metric of prosperity, and in the debt and assets components of the financial economy. Annual growth in prosperity averaged just under 2% between 2002 and 2019, and has been on a declining trend. Financial assets, on the other hand, expanded at an annual average rate of 6.2%.

Fig. 2


To be sure, we haven’t – yet – seen a replication of the dramatic rates of expansion in financial commitments witnessed during the GFC. Now, though, the response to the coronavirus crisis is likely to have accelerated the pace at which we’re taking on financial obligations at the same time that prosperity has taken a beating.

The financial support provided by governments is only one part of the crisis picture. At the same time that governments have incurred enormous deficits to support the incomes of households and businesses, the granting of interest and rent ‘holidays’ has created enormous deferred financial obligations, which in our terms are ‘excess claims’.

Back in 2002, financial assets equated to 298% of prosperity. By the end of 2019, this ratio had expanded to 598%. Taking together both the pandemic hit to prosperity and the rapid expansion in financial commitments, it would be by no means surprising, pending final data, if this ratio was now in excess of 700%.

Ultimately, what we’ve been witnessing is a dramatic escalation in financial claims on what is now a contracting economy. This, rather than consumer price or wage pressure, is the source of the inflationary pressure that jeopardises the system.

How will we know?

As we’ve seen, then, inflation risk isn’t going to be flagged in advance by conventional measures such as CPI and RPI. These measures are sometimes criticised on the grounds that innovations such as hedonic adjustment, substitution and geometric weighting result in the understatement of changes in the cost of living.  The big problem with these indices, though, is that they exclude both changes in asset prices and the effects of asset price changes.

The conventional broad-basis measure, the GDP deflator, is really no better than these consumer prices indices. In theory, system-wide inflation is meant to be captured by comparing a volumetric with a financial calibration of economic output. Like GDP itself, though, this deflator is subject to the cosmetic inflation of apparent ‘activity’ by the expansion of financial claims.

In an effort to measure comprehensive inflation, a system is under development, based on the SEEDS economic model and known as RRCI.

Preliminary indications are that RRCI averaged 4.1% through the period between 1999 and 2019, markedly exceeding a GDP deflator of just under 2%. This differential (of 220 bps) may not sound huge, but its application to a global economy said to have expanded at 3.4% through this period leaves precious little “growth”. Last year, estimated RRCI inflation worldwide was 5.5%, markedly higher than the GDP deflator (1.2%).

Preliminary data for 2020 indicates that RRCIs moved up dramatically in a small number of countries, such as Britain and Ireland, which also happen to be ultra-high-risk in terms of the relationships between their financial exposure and their underlying economies.

More broadly, RRCI suggests that systemic inflation has been rising markedly, both in the sixteen advanced economies (AE-16) and the fourteen EM countries (EM-14) covered by SEEDS.

Fig. 3



What and how?

Even RRCI, though, isn’t likely to give us a clear warning about the true magnitude of hyperinflationary risk. To get a handle on the scale and possible timing of this risk, we need to think about two issues. One of these is spill-over, and the other is futurity.    

Where spill-over is concerned, the risk is that rises in the prices of traded assets may induce consumers to increase their recourse to credit in order to boost their spending to levels commensurate with their perception of increased wealth.

If someone’s home has increased in theoretical value from, say, $400,000 to $600,000, is there any reason why he or she shouldn’t ‘cash in’ part of that gain’ using secured or unsecured credit, which, in any case, remains cheap?

Likewise, is there any reason why a company whose stock price has soared shouldn’t go on an acquisition spree, preferably buying lower-rated companies to enhance ‘growth’ perceptions, and boost earnings per share?

These spill-over risks are additional to the basic risk of supply and demand imbalances in the market for everything from stocks and houses to classic cars and works of art.

The more fundamental issue, though, is futurity, which for our purposes means our collective or ‘consensus’ picture of the economic future. This is far too big a topic for detailed examination here. What it means, though, is that investors might favour seemingly costly stocks if they anticipate brisk growth in earnings; house-buyers may be prepared to bid up prices if they anticipate perpetual expansion in property markets; and lenders might be relaxed about extending loans to borrowers whose incomes, they assume, are going to grow markedly. 

Despite the coronavirus crisis, faith in a ‘future of more’ seems unshaken, and there are assumed to be ‘fixes’ for all issues. The consensus assumption remains that everything from vehicle numbers and passenger flights to corporate earnings and automation are poised to go on growing indefinitely, and that there are technological solutions even for environmental risk and energy constraint.

Looking ahead, it isn’t difficult to see asset price inflation carrying over, first into consumer prices and then into wage demands. This is the point at which policymakers realise, belatedly, that policies of ultra-cheap money are, by their nature, inflationary.

The real risk, then, isn’t just that reactive (rather than anticipatory) rate rises cause asset prices to slump, but that these blows to confidence simultaneously expose the delusions of false futurity.            


#193. Nothing for money


In the light of recent events, it’s hardly surprising that financial collapse has become an increasingly popular subject of debate.

There seems to be a dawning awareness that the economic crisis caused by the coronavirus pandemic has loaded the system for inflation, because the support given to incomes has boosted demand at a time when the supply of goods and services has slumped. Meanwhile, markets in general – and Wall Street in particular – have taken on some truly bizarre characteristics, suggestive, perhaps, of the frenzied dying days of a bull market.

Those of us who understand the economy as an energy system have long known that an event far larger than the global financial crisis (GFC) is inescapable. Indeed, ‘GFC II’ was hard-wired into the system from the moment when the authorities decided to prevent market forces working through to their logical conclusions.  

If markets had been left to their own devices back in 2008-09, what would – and arguably should – have happened was that those who had taken on excessive risk would have paid the price in widespread defaults, whilst asset prices would have corrected back to levels preceding the debt binge which had started a decade before the GFC.

It’s ironic that we hear so much talk of “re-set” nowadays, even though the only real opportunity for resetting the financial system came – and went – more than ten years ago. Promises of a post-pandemic reset are proof – if proof were needed – that ‘hype springs eternal’.  

Properly understood, all that covid-19 has really done is to accelerate our advance along a pre-determined road to crisis.

There are two big differences between the coming crisis and its predecessor.  First, whilst 2008-09 was caused by reckless credit expansion, the coming crash will be a product of far more dangerous monetary adventurism. Second, a crisis previously confined largely to the banking sector will this time extend to the validity of money itself.

The best way to understand the looming crisis is to recognise that the financial system, and the economy itself, are distinct (though related) entities. The ‘real’ or material economy of goods and services is a product of the use of energy. The financial system acts as a proxy for the energy economy, and consists of monetary ‘claims’ on the economic output of today and tomorrow.

If finance and the economy diverge, so that a gap is created between the two, the restoration of equilibrium must involve the destruction of the ‘value’ represented by ‘excess claims’.

Our current predicament is that there now exists, not so much a gap, as a chasm between the material economy and the financial system. The emergence and scale of this chasm can best be depicted as a series of “wedges” that have been inserted between financial claims and underlying economic prosperity.

The debt wedge

The best place to start is with debt, which customarily – though mistakenly – is measured by reference to GDP.

Between 1999 and 2019, world GDP increased by 95%. Expressed in constant international dollars (converted from other currencies on the PPP – purchasing power parity – convention), this means that GDP grew by $66 trillion.

Over the same period, though, debt expanded by 177%, or $197tn. Put another way, this means that each dollar of reported “growth” was accompanied by $3 of net new borrowing.   

As the first set of charts illustrates, what happened was that a “wedge” was inserted between debt and GDP.

This was a product of deliberate policy. The predominant belief, back in the 1990s, was that economic growth could be furthered by “de-regulation”, which included relaxing rules that, hitherto, had limited the rate at which debt could expand.

At the same time, the process of globalisation created its own pressures for credit expansion. Essentially, the aim was to out-source production to lower-cost EM (emerging market) economies whilst maintaining (and preferably increasing) Western consumption.

This divergence between production and consumption created a gap that could only be bridged by making credit ever easier to obtain.  

An even more important factor then in play was an economic deceleration known as “secular stagnation”. The real reason for this deceleration was a relentless rise in the Energy Cost of Energy (ECoE). But this causation wasn’t understood. Instead, policymakers thought that the hard-to-explain deterioration in economic growth could be ‘fixed’ by making credit easier to obtain.

This in turn meant that monetary stimulus, hitherto used for the perfectly reasonable purpose of smoothing out economic cycles, would now become a permanent feature of economic policy.

It seems to have been assumed that excessive debt was something that the economy could somehow “grow out of”, much as youngsters grow out of childhood ailments.     

Financialization – the second wedge

Debt is only one component of financial commitments. There are many other forms of monetary obligation, even without moving into the realms of assumed (rather than formal) commitments such as pensions expectations.

A broader measure, that of financial assets, gives us a better grasp of the extent to which the economy has been financialized. For the most part, these “assets” are the counterparts of liabilities elsewhere in the system, much as banking sector “assets” correspond to the liabilities of borrowers.

Financial assets data isn’t available for all economies, but the right-hand chart below shows the aggregates for twenty-three countries which, between them, account for three-quarters of the world economy. 

What this illustrates is that the “wedge” inserted between debt and GDP is part of a much bigger wedge that has been driven between the financial system itself and the economy.

Comparing 2019 with 2002 (the earliest year for which the data is available), the financial assets of these 23 countries increased by 158%, or $275tn, whilst their aggregated GDPs grew by only $44tn, or 77%.

On this basis, financial assets increased by $6.20 for each dollar of reported “growth”.

It’s a simplification, but a reasonable one, to say that, for these economies, each dollar of growth between 2002 and 2019 was accompanied, not just by net new debt of $2.70, but by a further $3.50 of additional financial commitments. 

What this really means, in layman’s terms, is that debt escalation has been accompanied by a broader – and faster – financialization of the economy. Essentially, ever more of the activity recorded as economic ‘output’ is really nothing more than moving money around.

This is represented in the aggregates by relentless increases in the scale of interconnected assets and liabilities.

The risk, of course, is that failure in one part of the financialised system triggers a cascade of failures throughout the structure.    

The third wedge – the ‘let’s pretend’ economy

By convention, both debt and broader financial commitments are measured against GDP. This would be reasonable if GDP was an accurate representation of the ability of the economy to carry these burdens.

Unfortunately, it is not.

Over the period between 1999 and 2019, trend GDP “growth” of 3.2% was a function of annual borrowing which averaged 9.6% of GDP. The mechanism is that we pour credit into the economy, count the spending of this money as economic “activity”, and tell ourselves that we can ‘grow out of’ our escalating debt burden.

As well as funding purchases of goods and services which could not have been afforded without it, relentless credit expansion also inflates the prices of assets, and this in turn inflates the apparent ‘value’ of all asset-related activities.

The SEEDS economic model strips out this credit effect, a process which reveals that underlying growth in the world economy averaged just 1.4% – rather than 3.2% – between 1999 and 2019. Accordingly, underlying or ‘clean’ output – which SEEDS calls ‘C-GDP’- is now very far below reported GDP. If net credit expansion were to cease, rates of “growth” would fall to barely 1%, and even that baseline rate is eroding. If we were, for any reason, to try to reduce aggregate debt, GDP would fall back towards the much lower level of C-GDP.

Neither is credit-injection the only major distortion in the story that we tell ourselves about economic output. More important still, ECoE – in its role as a prior call on output – is continuing to rise. Incorporating ECoE into the equation reveals that prosperity has stopped growing, whilst the number of people between whom aggregate prosperity is shared is continuing to increase.

In essence, this means that the world’s average person is getting poorer. This happened in most Western countries well before the GFC, and the EM economies have now reached their equivalent point of deterioration.

What began as “secular stagnation” has now become involuntary de-growth.  

We can’t make this hard reality go away by pouring ever more and ever cheaper liquidity into the system. All that monetary loosening really does is to create financial ‘claims’ that the economy cannot meet.

The combined effects of credit manipulation and rising ECoEs form the third wedge – the one that divides economic reality from comforting self-delusion.    


The fourth wedge – the quantum of instability

With the reality of flat-lining output and deteriorating prosperity understood, all that remains is to use this knowledge to recalibrate the relationship between a faltering economy and an escalating burden of financial obligations.

Even the ‘fourth wedge’, pictured below, excludes assumed (though not guaranteed) commitments, of which by far the largest is the provision of pensions.

The final set of charts compares debt and broader financial commitments with underlying prosperity. These charts reveal the drastic widening of the chasm between prosperity and the forward promises that the prosperity of the future is supposed to be able to meet. In SEEDS parlance, we are confronted by a massive crisis of ‘excess claims’ on the economy.

With these equations laid bare, we are entitled to wonder whether decision-makers are in blissful ignorance of this reality, or whether they have at least an inkling of what’s really happening and are simply nursing Micawber-like hopes that ‘something will turn up’. Based on the 2008-09 precedent, we can be pretty sure that the “soft default’ of inflation will play a starring role in the coming drama.  

The question of ‘how much do they know?’ must be left to readers to decide. The same applies to quite how soon you think this situation is going to unravel, and whether you want to label what’s coming as a ‘crisis’ or a ‘collapse’.