#207. Could the dollar crack?


How big is the Chinese economy? On one level, that question is easily answered – last year, China’s GDP was RMB 91 trillion.

For comparative purposes, though, what’s that worth in dollars? Authoritative sources will tell you that China’s dollar GDP in 2020 was $14.7tn. Those same sources will also inform you that it was $24.1tn. That’s a huge difference. On the first basis, the Chinese economy remains 30% smaller than that of the United States ($20.9tn). On the second, it’s already 15% bigger.

The explanation for this very big difference lies, of course, in the two ways in which economic data from countries other than the United States can be converted into dollars. One of these is to apply average market exchange rates for the period in question. For convenience, we can call this market conversion.

The alternative is PPP, meaning “purchasing power parity”. To apply this conversion, statisticians compare the prices of the same products and services in different countries. (One such common product is a hamburger, which is why, in its early days, PPP was sometimes called “the hamburger standard”).

The differences between market and PPP calibrations of GDP are enormous. Last year, world GDP was $85tn on the market convention, but $132tn in PPP terms. At the same time, the use of PPP conversion diminishes America’s share of the global economy. Last year, the United States accounted for 25% of global GDP in market terms, but only 16% on the PPP basis.

Using PPP instead of market conversion doesn’t make the economy ‘bigger’, of course. It just means that a higher dollar value is ascribed to economic activity outside the United States.

There’s no ‘right’ or ‘wrong’ way of converting non-American economic numbers into dollars. To a certain extent, it’s case of selecting the convention best suited to the topic being examined. Market conversion is appropriate for transaction values, such as trade, and cross-border assets and liabilities. PPP provides a better measure of the comparative sizes of economies around the world. (The SEEDS economic model produces parallel output on both conventions, though with a preference for PPP).

For macroeconomic purposes, the PPP convention is arguably more meaningful than market conversion, because it better reflects the economic scale of countries like China and India. Additionally, it leaves both market sentiment and short-term vicissitudes out of the process. PPP conversion has been with us for decades, and is carried out by reputable authorities, such that we can accept it as a valid and consistent alternative basis of currency comparison.

Market rates are determined by many factors other than economic comparison. FX market players have multifarious reasons for liking or disliking various currencies. Their opinions do not constitute economic ‘facts’.

An obvious example here is the reaction to the “Brexit” vote. British citizens obviously didn’t wake up 20% poorer on the morning after the referendum, but that’s what market dollar valuation of the UK economy implied. By the same token, market-rate conversion asks us to believe that the economy of resource-rich Russia is a lot smaller (at $1.4tn) than that of Italy ($1.9tn).

People in Russia, China, India and elsewhere are not poorer because FX markets don’t, relatively speaking, like their currencies. Currency undervaluation against PPP equivalence does make these countries’ imports more expensive, but it also gives their exports a competitive advantage.

Benchmarking the market dollar premium

For present purposes, the importance of having two FX conversion conventions is that it enables us to benchmark the dollar itself. Using world economic data going back over four decades, we can examine the relationship between the PPP and the market valuations of the dollar.

In 2020, for example, the GDP of the world outside the United States (WOUSA) was $63tn on the market basis, but $111tn in PPP terms. From this we can infer, either that market conversion undervalues the WOUSA economy, or that the market dollar trades at a premium to its PPP equivalent.

For convenience, we can call this difference the market dollar premium, and calculate the ratio for 2020 at 1.74:1. Put another way, the market dollar commanded a 74% premium over the PPP dollar last year.

There’s nothing abnormal about the dollar enjoying a valuation premium over other currencies. The dollar’s pre-eminence can be traced back to 1945, when America accounted for half of the global economy, and was the world’s biggest creditor. The dollar, after all, is the world’s reserve currency, and the benchmark against which other currencies are measured. Most oil trade continues to take place in dollars, providing a ‘petro-prop’ for the USD, because anyone wanting to purchase oil must first buy dollars.

This being so, it’s no surprise that PPP comparison reveals a market dollar premium.

What’s interesting, though, is the upwards trend in this premium.

In 1980, it stood at 30%.  It reached 40% in 2001, and 50% during 2005-06. The market dollar premium reached 60% in 2009, and 70% in 2015. Based on consensus projections, the premium is expected to carry on rising, from 74% last year to 79% by 2026. Perhaps most strikingly, the dollar premium is twice as big now (74%) as it was in 1999 (37%).

Does the market’s attachment of a widening premium to the dollar make economic sense? It’s at least arguable that it doesn’t. Quite aside from the rise of economies such as China – and America’s falling share of world GDP – there are reasons to suppose that the economic pre-eminence of the United States is eroding, and that the market dollar premium, far from widening, should be contracting.

The most obvious negatives for the market dollar premium are to be found in the fiscal and monetary spheres. Starting in 2008, the Fed has operated monetization policies on a gargantuan scale, lifting the Fed’s assets from $0.8tn in June 2008 to $8.1tn today. Interest rates have been below any realistic estimate of inflation since the 2008-09 global financial crisis (GFC) and, with inflation now rising, are negative to the tune of at least 4.0%, and probably more. With the administration seemingly addicted to fiscal stimulus, and with the Fed apparently willing to go on monetizing deficits, these trends seem set to continue.

Scaling back or reversing QE – or, for that matter, raising rates to head off inflation – would prompt a greatly-amplified repeat of the 2013 “taper tantrum”, and tightening monetary policy could harm the US economy, would trigger sharp falls in asset prices, and would push up the cost of government borrowing. Neither monetization, large scale money creation or negative real rates can be considered positive for the value of a currency.

There’s a clear danger, then, that the US could push the dollar’s “exorbitant privilege” too far.

Meanwhile, the Fed also has to be mindful of the shadow banking system, sometimes called “non-bank financial intermediation”. This isn’t the place for a detailed consideration of shadow banking, but the system resembles an inverted pyramid, with very large assets (which have been put at $200tn) resting on a narrow base of collateral. Government bonds in general, and American bonds in particular, play a central role in this collateral.

Simply stated, a battle royal is likely to be waged between not-so-“transitory” inflation, on the one hand, and, on the other, pressing reasons for not raising the cost of money. 

This might not matter all that much if the market dollar premium hadn’t risen as far as it has. The use of PPP for benchmarking isn’t common practice, but the calculations required for calibrating the market dollar premium aren’t exactly rocket-science – and the implications of this calculation are stark.        

The conclusion seems to be that the dollar now trades at a more-than-exorbitant premium to other currencies – just as America is getting mired in a tug-of-war between stimulus and inflation.

#206. The paradox of growth


An odd paradox emerges when we consider our economic objectives, and question the priority routinely accorded to “growth”.

If we continue our obsession with growth, we will accelerate the deterioration of the energy-driven economy, worsen our environmental predicament and squander the resources which might otherwise have formed the basis of a sustainable economy. If, further, we continue to see the financial system as an adjunct of our pursuit of “growth”, we invite systemic collapse.

The irony here, of course, is that the pursuit of growth is, in any case, the pursuit of a chimera.

Conversely, if we aim for stability, and redesign our failing financial system accordingly, we might yet succeed in combining prosperity with sustainability.

Context – failure on two fronts

If – just for a moment – we ignore financial issues, and concentrate wholly on material metrics such as resources, the environment, population numbers, food supply and the physical output of goods and services, it soon becomes clear that we are either at, or very near, the end of “growth”, unless indeed we have already passed the point of down-turn. Essentially, the modern industrial economy is the product of the use of abundant, low-cost energy from fossil fuels. These fuels are ceasing to be cheap at the same time that their use is colliding with the limits of environmental tolerance.    

Conversely, if we focus entirely on the financial, it becomes equally clear that a system reliant on QE and other forms of monetary gimmickry is at existential risk. We can trace the origins of this process back to the 1990s, and the recognition (though not the explanation) of “secular stagnation”. The authorities’ chosen ‘fix’ for this perceived problem was to use debt to stimulate demand, on the assumption that cheap and abundant credit would prove to be a magic elixir for the restoration of growth to the economy. From there, it was a dangerously easy step from credit expansion to the back-stopping of debt (and asset markets) with monetization.

What we have, then, is (a) a material, physical or real economy that has reached or passed peak output, and (b) a counterpart financial economy which, barring a drastic change of direction, is heading towards collapse.

We’re not yet at the point where there are “no fixes” for these issues, but the odds seem stacked against the determined and effective efforts that would be required to achieve sustainability in the aftermath of growth. Might we yet be forced, kicking and screaming, into wiser decisions?

These situations are set out in fig. 1, using data sourced from the SEEDS economic model. Aggregate prosperity has continued to increase (but is nearing the point of down-turn), whilst prior growth in prosperity per capita has already gone into reverse. Both debt and the broader and much bigger category of financial assets (in effect, the liabilities of the household, corporate and government sectors) have soared, and seem destined to carry on doing so, unless and until the financial system implodes.  

Fig. 1

Two excellent, must-read recent papers have reached stark conclusions about the ‘real’ and the ‘financial’ economies. Gaya Herrington, in a report which concentrates on physical, non-financial metrics such as population numbers, natural resources and the environment, concludes that, under any BAU (“business as usual”) scenario, we face “a collapse pattern” which can only be softened (into “moderate decline”) by advances in technology far beyond historic rates of innovation and adoption. 

In Quantitative easing: how the world got hooked on magicked-up money, published by Prospect, Ann Pettifor says that “[g]oing cold turkey would finish off a dysfunctional global financial system that’s now hopelessly addicted to emergency infusions”.

Neither paper gives us no hope at all, but both point to the need for radical change. On the financial situation, Ms Pettifor concludes that “[t]he only solution is surgery on the system itself”. Ms Herrington sets out an alternative SW (“sustainable world”) scenario which, whilst it cannot restore growth, does at least offer stability.  Unfortunately, SW does not correlate well with what’s actually happening.

We can put these ‘potential positives’ into a single conclusion. The best, indeed the only way to achieve economic sustainability is to abandon all aspects of BAU that are geared towards the attainment of growth, and to shift our objectives from growth to resilience. The financial system, likewise, needs to transition way from an obsession with expansion, and aim instead for functional effectiveness in a non- or post-growth World.

In short, the precondition both for economic and for financial stability is that we ditch our obsession with “growth”. The same, of course, applies to our environmental best interests. The biggest single threat to environmental sustainability is our worship of “growth”.

Difficult, straightforward, paradoxical

Simply stated, the required transition is from a state of mind which obsesses over growth to a state of mind which prioritizes stability. 

Attaining this transition is at once difficult, straightforward and paradoxical.

It’s difficult, because the desirability of “growth” is deeply entrenched both in institutions and in the collective mind-set. Political leaders routinely promise growth, businesses strive to achieve it, and the financial system is entirely predicated on it. Advocates of voluntary “de-growth” have never managed to make meaningful inroads into this obsession with “growth”.

It’s straightforward, in the sense that growth is already over. The continued pursuit of growth is the pursuit of the unattainable. As the ECoEs (the Energy Costs of Energy) of coal, oil and gas have risen, the economic value that we derive from the use of fossil fuels has started to diminish. Assertions that we can replace all of this value using renewable sources of energy (REs) are based on little more than wishful thinking and mistaken extrapolation. Apart from anything else, RE expansion requires inputs which, at least for the present, can only be provided by the use of energy from fossil fuels.   

To be clear about this, we must make every effort to develop renewable energy supply, but we shouldn’t delude ourselves into the belief that REs can replicate the economic characteristics of fossil fuels. Well-managed, a transition to REs can contribute to stability. What REs cannot do is deliver a return to growth.       

As well as being both difficult and straightforward, the required transition is paradoxical, because the pursuit of growth is the best way to ensure economic decline. If sustainability is set as the primary objective, this aim might be achievable. But the biggest obstacle to the attainment of sustainability is our obsession with growth.

Measuring our predicament

The purpose of the SEEDS economic model is to provide holistic interpretation by putting together the ‘real’ and the ‘financial’ economies. SEEDS does this by calibrating prosperity from energy principles, and delivering results in a monetary format which enables us to benchmark the financial system.

SEEDS demonstrates a clear linkage between ECoEs and prosperity. For much of the industrial age, ECoEs trended downwards. This meant that, for so long as aggregate energy supply at least kept up with increases in population numbers, the material prosperity of the average person improved.

The fundamental change occurred when ECoEs stopped declining, and started to rise. At first, this happened only gradually. However, the upwards trend in the ECoEs of fossil fuels is an exponential one.

During the 1980s, a rise in trend all-sources ECoEs of 0.8% – from 1.8% in 1980 to 2.6% in 1990 – didn’t matter all that much, and was, in any case, well within margins of error that are accepted in economic calibration. In short, this early rise in ECoEs wasn’t large enough to force itself upon our attention.  

What happened during and after the 1990s, however, was far more serious. In the 1990s, ECoEs rose by 1.5%, from 2.6% in 1990 to 4.1% in 2000. Trend ECoEs then increased by 2.2% between 2000 and 2010, and by a further 2.6% between 2010 and 2020. This put ECoEs at 8.9% last year, compared with 1.8% back in 1980.

Since an ECoE of 8.9% still leaves surplus (ex-ECoE) energy at more than 90% of total energy supply, it might at first sight seem surprising that prior growth in per capita prosperity should already have gone into reverse.

The explanation for this sensitivity lies in the complexity, and the correspondingly high maintenance demands, of the modern economy. The vast bulk of the economic value derived from energy is required for the upkeep and renewal of systems. Even under the best of circumstances, the scope for growth is constrained by the ‘burden of maintenance’.

SEEDS analysis reveals two very strong correlations here. One of these is between ECoE and prosperity, and the other connects complexity with ECoE-sensitivity. In the advanced economies of the West, prior growth in prosperity goes into reverse at ECoEs between 3.5% and 5.0%. Less complex EM economies can carry on increasing their prosperity until ECoEs are between 8% and 10%.

The latter connection helps explain the apparent divergence between the advanced and the emerging economies over the past twenty years. As of 2000, global trend ECoE was, at 4.1%, well within the threshold at which Western prosperity starts to contract. At that level of ECoE, however, EM countries remained capable of growth. This is why, whilst people in countries like America and Britain have been getting poorer since the early 2000s – and using financial gimmickry to delude themselves to the contrary – Chinese, Indian and other EM citizens have continued to get better off.

A failure to recognize the differing effects of ECoEs on differing economies has led to a great deal of mistaken interpretation of the divergence between growth in countries like China and “stagnation” (in reality, de-growth) in the West. Westerners haven’t become uniformly lazy or complacent over the past two or three decades, any more than EM citizens have been uniformly more industrious and productive.

Rather, the greater complexity of the Western economies has resulted in their earlier exposure to the consequences of rising ECoEs. With ECoEs set to exceed 9% this year, we are well into the ‘zone of inflection’ in which EM prosperity, too, starts to decline.

An accommodation with de-growth?

In this sense, then, growth is over, and “de-growth” has begun. But there’s a world of difference between an economy getting gradually poorer and an economy careering towards a cliff-edge. If we continue our frantic pursuit of growth, the likelihood is that our options will diminish, as resources are exhausted, population numbers continue to increase, environmental and ecological deterioration accelerates and a rickety, Heath Robinson financial system reaches the point of self-destruction.

Of course, nobody would expect political leaders to stop promising growth, or businesses to stop pursuing it. No president or prime minister is likely to proclaim, like the fictional Duke of Omnium, that the country is fine how it is, and the job of government is to keep it that way. No business leader is likely to tell shareholders that corporate strategy is to turn away from expansion, and instead to maintain the company as a reliable generator of value for its owners.

But to concentrate on stated intentions is to overlook mechanisms. If the Holy Grail of “transition to renewables” fails to replace the energy value hitherto derived from fossil fuels, then it will be futile to carry on denying the reality of de-growth.

As we’ve seen in previous discussions, prosperity is declining, whilst the real cost of estimated essentials is rising. As you can see in fig. 2, it’s clear that discretionary prosperity is being compressed, and that continued increases in discretionary consumption have been made possible only by continued credit expansion.

Three processes – prosperity deterioration, the rising cost of essentials and the approach of credit exhaustion – are likely to force businesses into the adoption of policies consistent with the Surplus Energy Economics taxonomy of de-growth.

Some companies, for instance, will work out that switching from a ‘high-volume, low-margin’ to a ‘high-margin, low-volume’ model can support revenues and earnings as the discretionary prosperity of the median consumer declines. Producing less, whilst charging more for it, is one way of maintaining profitability whilst also driving down emissions of CO2.

A de-growing economy is also a de-complexifying one, and this trend is likely to encourage, or indeed to compel, businesses to simplify both their product offerings and their production processes, at the same time tightening their supply lines in pursuit of resilience. Of course, the continuing contraction of discretionary prosperity may shrink or eliminate some sectors, whilst others will be de-layered by customer pursuit of simplification.

Governments, too, will not be immune from these processes. As bridging the ‘discretionary prosperity gap’ by taking on yet more debt ceases to be feasible, the public is likely to become increasingly discontented about the increasing slice of their resources being taken by essentials, be these household necessities or the services provided by government. We should anticipate demands for intervention, particularly over the rising cost of energy.

In other words, businesses and governments might not disavow the pursuit of “growth” – it would be remarkable if they did – but trends are likely to push them in this same direction. If we’re looking for some encouragement, scant though it is, we might note that governments, in promising to “build back better”, have not promised to “build back bigger”.     

Fig. 2

#205. “Discretionary retreat, pockets of collapse”


Anyone seeking a view about the probable shape of the economy of the future has a choice between two schools of thought. The version favoured by governments, businesses, the financial sector and orthodox economists can be labelled ‘continuity’, and amounts, essentially, to ‘growth in perpetuity’. The alternative – very much a minority view, though gaining in influence – warns of imminent economic and broader “collapse”.

It probably won’t surprise you that the evidence supports neither point of view. Properly understood, meaningful “growth” ceased a long time ago, starting in the West, and the World’s average person is now getting poorer.

This does mean that discretionary (non-essential) consumption will decrease, as a rising share of resources is required for necessities. But it doesn’t make a proven case for systemic “collapse”. This isn’t to say, of course, that collapse can be staved off indefinitely, if we keep on making the wrong decisions. 

The future scenario set out here differs from both of the ‘continuity’ and ‘collapse’ extremes, primarily because SEEDS – the Surplus Energy Economics Data System – models the economy as an energy system. The outlook projected by SEEDS modelling combines “discretionary deterioration” with “pockets of collapse”. Parts of the economy will contract, and parts of the financial system will implode, but that describes neither continuity nor a general collapse.

If you want this in the proverbial nutshell, “continuity is finished, but collapse needn’t be inevitable”.    

As so often in economic affairs, we need to be wary of extremes. For example, the collapse of the Soviet economy did demonstrate that extreme collectivism doesn’t work, but it didn’t prove that the opposite extreme – a deregulated “liberal” free-for-all – was necessarily the best way to run an economy.

The same caution applies to economic “-isms”. We can leave it to polemicists to decide whether the USSR was, or was not, a ‘communist’ or a ‘socialist’ system, but we do need to be quite clear that what we have now is not, by any stretch of the imagination, either a ‘capitalist’ or a ‘market’ economy.

A ‘capitalist’ system, after all, requires real, risk-weighted returns on capital, whilst a ‘market’ economy presupposes that losers – victims either of folly or of bad luck – are not bailed out by the state.

Extreme collectivism brought down Soviet Russia, but China escaped this fate by opting for the pragmatic course of ‘allowing capitalism to serve China without letting China serve capitalism’.

An equivalent choice needs to be made now, between following the ultra-“liberal” road to localized collapse, or adopting pragmatic alternatives which can, in short-hand, be called ‘the mixed economy’ of optimized private and public provision. This, of course, would require both effective regulation and the acceptance of a new ethic.

With hindsight (though some observers said this at the time), it would almost certainly have been better if, during the GFC (global financial crisis) of 2008-09, market forces had been allowed to run to their natural conclusions. If this had happened, we might well have benefited from the kind of “reset” which has now become an impossibility. It would have been better still, of course, if we hadn’t made the colossal mistakes which caused the GFC in the first place.

The ‘chronology of error’ merits more than the passing attention it can be given here. As regular readers will know, the economy is, self-evidently, an energy system, and today’s large and complex economy is a product of our development of the heat-engine, which gave us access to the vast (but not infinite) reserves of energy contained in coal, petroleum and natural gas. For the first time, economic activity escaped from the constraints of a cycle comprising the labour of humans and animals and the nutritional energy which made this labour possible.

Remarkably, this connection seems to have been ‘hidden in plain sight’, enabling generations of economists to contend that growth has been a property, not of energy, but of money. Extreme collectivists might argue that money should be directed by the state, and their equally extreme opponents that it should be directed entirely by markets, but neither side has seriously questioned the illogical belief that money, rather than energy, determines the performance of the economy.

When – because of depletion – the fossil fuel dynamic began to falter, decision-makers leapt to the fallacious conclusion that “secular stagnation” could be ‘fixed’ with monetary tools. Accordingly, they poured abundant credit into the system from the mid-1990s, and expressed genuine surprise when this largesse brought the banking system to the brink of collapse. The ‘fix’ for credit excess, they then decided, was monetary excess, and they will no doubt express equally genuine surprise when it transpires that this can result only in cascading defaults, the hyperinflationary destruction of the value of money, or a combination of the two. 

The outlook, quantified by the SEEDS economic model, is that the average person will become less prosperous over time. When we look behind the financial gimmickry of credit and monetary “adventurism”, this is already an established trend in the complex economies of the West. The average person in many EM (emerging market) economies, too, is already getting poorer, though a small number of Asian economies may not experience this climacteric for another five or so years.

What happens after that – when gimmickry fails, and deteriorating prosperity can no longer be disguised – is that households, and entire economies, will have to concentrate their diminishing resources on the provision of the essentials. These are hard to define, and harder still to quantify, but SEEDS modelling demonstrates that, in the Western world. the scope for discretionary (non-essential) consumption not supported by borrowing has already fallen markedly.

As well as absorbing a larger share of prosperity, “essentials” are very likely to become steadily more expensive in real terms, to the point where we may be forced to re-define what we mean by “essential”. This results from the high energy-intensity of necessities, including the supply of food and water, utilities and the provision of housing, health care and education.

An obvious implication is that energy-intensive discretionaries will be the first sectors to experience contraction, as soon as the ‘credit prop’ ceases to be tenable. The public won’t like this, of course, but will be far more concerned about the rising cost of necessities. The challenges for governments include (a) ensuring that the essentials are available and affordable for everyone, and (b) managing both expectations and the retreat of discretionary sectors.

These trends can be expected to take place within a ‘taxonomy of de-growth’ that we have discussed before. Briefly, the retreat of prosperity can be expected to involve a process of de-complexification, as we start to relinquish some of the economic and social complexity which, in the past, has developed in tandem with the expansion of prosperity.

Astute businesses will opt for simplification, both of product lines and of production processes. Part of this will be forced upon them by utilization effects (where diminishing sales volumes push unit fixed costs upwards), and by loss of critical mass (where necessary inputs cease to be available through loss of supplier viability).   

These, then, are the factors that can be expected to drive “discretionary retreat”. The contraction of discretionary sectors will, of course, involve job losses, but this will be happening in a context in which economic activity becomes more dependent on human labour and skills as the supply of high-value exogenous energy decreases.

What, though, of “pockets of collapse”? This term is used here to describe the financial consequences of an economy that is contracting, and is doing so in a way leveraged against discretionary sectors.

Hitherto, a financial system wholly predicated on growth has continued to become both larger and more complex even as the underlying economy has been moving in the opposite direction. Parts of the financial system will implode as the sectors to which they are linked enter irreversible decline.

But the big challenge for finance will come when we are forced to recognize that we can neither ‘stimulate’ our way to prosperity nor borrow (or print) our way out of a debt problem. Like the economy of goods and services, the financial system will need to be simplified back into alignment with a ‘de-growing’ economy.

The challenge now – for households, governments and businesses – is to unlearn some harmful preconceptions, and to understand, quantify and prepare for what is happening in the ‘real’ economy of energy.

Wishful thinking, petulance, gimmickry, ideological inflexibility and the placing of blind faith in the ability of technology to trump physics form no basis for effective preparation.                     




#204. How it happens


Even those who continue to think of the economy as a financial system must be feeling, at the least, bafflement and concern over a situation characterised by massive stimulus, worsening monetization of debts, negative real returns on capital, and clear signs of surging inflation, certainly in asset markets, and very probably in consumer prices as well.

For those of us who understand the economy as an energy system, none of these symptoms is at all surprising. We know that the energy dynamic that has driven growth and complexity since the start of the Industrial Age is deteriorating, because of relentless rises in the ECoEs (the Energy Costs of Energy) of fossil fuels.

We also know that there’s no ‘fix’ for this situation.

From this perspective, it’s easy to see that the financial economy of money and credit is becoming ever further detached from the underlying, material or ‘real’ economy of goods and services. This divergence is intrinsically unstable, and is – as the old saying puts it – ‘unlikely to end happily’.

Two immediate questions naturally follow. First, when will this instability culminate in some kind of crisis? Second, how will this come about, and what are the processes that are likely to shape it?

Nobody can be sure about timing, but we can, at least, be reasonably clear about process. With or without a surge in inflation – and/or tumbling markets and a cascade of defaults – what’s likely to happen is that the cost of essentials will carry on rising, whilst top-line prosperity continues to erode.

Being slightly more technical about this, we can call this a squeeze on the discretionary (non-essential) sectors of the economy.       

The issue around discretionary prosperity – defined as the difference between top-line prosperity and the cost of essentials – is scoped, using the SEEDS economic model, in fig.1.     

Fig. 1


Less than a century ago, even in the World’s most prosperous countries, most of the incomes of ‘average’ people were spent on necessities. Car ownership was a luxury, and the typical holiday was likely to be spent in a boarding-house at a seaside resort, reached by train. Indeed, domestic appliances now taken for granted only started to reach the status of normality from the 1930s.

Historians of the future might well describe the post-1945 era as ‘the Age of Discretion’, with economic growth channelled into a rapid expansion of discretionary (non-essential) consumption. One of the clearest implications of the onset of deteriorating prosperity is that the scope for discretionary consumption will now contract, a trend as yet almost wholly unanticipated by governments, businesses and households.

As we shall see, it’s difficult to draw a hard-and-fast line between the essential and the discretionary, but non-essential – ‘want, but not need’ – goods and services probably account for at least two-thirds of the economic activities of Western countries. The idea that this part of the economy might contract will come as a great surprise, and an extremely unwelcome one.

In fact, though, the continuity of discretionary consumption has already, and over an extended period, become a function of credit expansion. Borrowing, whether by households, businesses or governments, has become the ever more important prop supporting everything from travel and leisure to the purchase of non-essential goods.

The ability of the average Western person to afford discretionary consumption without recourse to borrowing ceased growing, and started to shrink, between fifteen and twenty years ago. 

Anyone trying to understand how involuntary “de-growth” is likely to unfold can best focus on two issues – the contraction of discretionary activity, and the failure of a financial system manipulated to sustain growth in discretionary consumption long after organic growth in prosperity went into reverse.

Context – the onset of “de-growth”

If you’ve been visiting this site for any length of time, you’ll know that there are two, diametrically-opposite ways in which we can endeavour to make sense of the economy.

One of these is the ‘conventional’, ‘orthodox’ or ‘classical’ school of economics, which states that the economy is wholly a monetary system, not constrained by resource limitations, and assured of ‘growth in perpetuity’ through our control of the human artefact of money.

Quite aside from its lack of logic, this interpretation is discredited by the truly extraordinary financial and intellectual gymnastics that have been required in order to try to square this comforting thesis with what we see happening around us. The “temporary” (since 2008) expedient of negative real interest rates is just the most extreme (and arguably the most harmful) of the many exercises in gimmickry that have been necessary to sustain the myth of an ever-expanding economy, shaped entirely by money.

The alternative – advocated here, and modelled using SEEDS – is to interpret the economy as an energy system. From this perspective, growth in economic output since the 1770s has been the product of huge increases in the use of low-cost fossil fuels. Now, though – and quite apart from harming the environment – these fuels are losing the ability to support the complex modern economy as they cease to be ‘low-cost’.

In this context – in which energy is the economy, with money a medium of exchange – the only meaningful definition of ‘cost’ is the proportion of accessed energy that is consumed in the access process, and hence is not available for any of the other economic uses that constitute prosperity. Known here as ECoE – the Energy Cost of Energy – this equation is the primary determinant of economic prosperity.

Driven by depletion – since the earlier benefits of geographic reach and economies of scale have reached their limits – the ECoEs of fossil fuels are rising relentlessly. Assertions that this trend can be reversed using renewable energy sources (REs) such as wind and solar power – let alone that we can somehow “de-couple” the energy economy from the use of energy – are exercises in wishful thinking.

REs are indeed vitally important for the future, but we need to recognize that they are highly unlikely to provide like-for-like – scale and economic value – replacements for oil, gas and coal.

SEEDS modelling indicates that prior growth in the prosperity of complex, high-maintenance advanced economies goes into reverse at ECoEs of between 3.5% and 5.0%, territory that was traversed by global ECoEs between 1997 (3.6%) and 2005 (5.0%). Trend ECoEs have now entered the equivalent range (between 8% and 10%) at which prosperity turns down in less-complex, lower-maintenance EM countries. The lower bound of this range was reached in 2017, and the average person in some EM economies is already getting poorer.    

The following charts, familiar to regular readers, show the correlation between trend ECoEs (in black) and prosperity per person (blue) in America, Britain and Australia. In these versions, though, discretionary prosperity has been superimposed (in purple), revealing the extent to which changes in this critical indicator are leveraged by the relatively invariable (and, in general, rising) cost of essentials.

It should be emphasised that discretionary prosperity, as calculated for these charts, makes two assumptions about essentials. The first is that we do not, going forward, tame the rate at which the cost of essentials is rising, perhaps by redefining what we think of as ‘essential’. The second is that there is no acceleration in the rate of increase in this cost.

Fig. 2

The role of discretion

In order to anticipate the probable chain of events, we need to start by looking at how we use prosperity. A critical distinction needs to be drawn between essentials and discretionaries, the latter perhaps best described as “things that people want, but don’t need”. Even this distinction involves judgement calls, in that everyone needs food, but nobody necessarily needs caviar.  

The first call on economic resources is made by essentials. These are defined here in two parts. One of these is household necessities, and the other is public services provided by the government.

The latter qualify as ’essential’, at least in the sense that the citizen has no choice (‘discretion’) about paying for them. The public service and household categories of essentials overlap, particularly where services like health care and education are provided by the government in some countries, but are purchased privately in others.               

The definition of essentials changes over time, and varies by location. Televisions, for example, were still luxuries in most Western countries in 1950, but were regarded as necessities by the 1970s. Cars made a similar transition from luxury to necessity over a not-dissimilar period.

Something regarded as essential in contemporary America might be regarded as a discretionary purchase in less affluent countries. Another example of geographical variation is state-funded health-care, which is seen as vital in most of Europe, but is still no more than an aspiration (and a matter of debate) in the United States, where Obamacare was and remains controversial, and where implementation of a worthy ambition seems to have been surprisingly ill-judged.     

Variability, both over time and between locations, makes the calculation of ‘essentials’ a complicated issue, and it might not even be possible to arrive at a universally-applicable calibration meeting both sets of requirements.

Calibrating the essential

Where SEEDS modelling is concerned, “essentials” are a development project, and the model applies formulae whose results are to be regarded as indicative, not precise. The aims are (a) to calibrate an approximate and consistent measurement, and (b) to assess changes in the cost of essentials over time.

Public services are the more straightforward of the two components of ‘essentials’. Governments spend money in two main ways. One of these is the transfer of resources between people, in the form of benefits such as welfare and pensions payments. These transfers net out to zero at the aggregate and at the average per capita levels, so are not part of essentials for our purposes.

The other part of government spending, sometimes known as ‘government consumption’ or ‘own account’ spending, is used to provide public services. Whatever the individual’s opinion about the merits of various forms of service provision, these outlays rank as ‘essentials’ for our purposes, because the citizen has no choice about paying for them. This means that they are ‘non-discretionary’ outlays.

Household ‘necessities’ are the second – and the harder-to-define – component of ‘essentials’. It’s obvious that everyone needs food, water, accommodation, health care, education, some forms of transport and, of course, energy for direct consumption. Beyond this, what we regard as ‘necessary’ varies geographically and over time.

Amongst ‘obvious’ necessities like food, water and shelter, most are very energy-intensive, such that household energy use far exceeds amounts purchased directly for heating, cooking and fuel.

Critically, the deterioration of the energy equation caused by rising ECoEs makes it probable that the real (ex-inflation) cost of household necessities will continue to rise over time.

Tracking the discretionary squeeze

The group of charts shown earlier (fig. 1) sets estimates of essentials against SEEDS calibrations of prosperity per capita for America, Britain and Australia. The common tendency is for the real cost of essentials to rise, whilst prosperity per person has been declining in America since 2000, and in both Britain and Australia since 2004.

In most cases, these declines in top-line prosperity have, thus far, been fairly modest. In America, the average person was (as of 2019) 6.6% worse off than he or she had been back in 2000. Comparing 2019 with 2004, both British and Australian citizens were poorer by about 10.5%. Spread over lengthy periods – nineteen years in America, fifteen in Australia and Britain – these rates of deterioration have been relatively gradual.

At the same time, though, the estimated cost of essentials has been on an upwards trend in all three countries. This means that, since its highest point in each country, discretionary prosperity has fallen by far more than the top-line equivalents.

In America, discretionary (ex-essentials) prosperity fell by 31% (rather than 6.6%) between 2000 and 2019. Decreases in discretionary prosperity since 2004 have been 30% (rather than 10.6%) in Australia, and 27.5% (rather than 10.5%) in the United Kingdom.  

You’ll notice that, in each of these charts, there comes a point – typically in the late 2030s – when prosperity per capita is projected to fall below the cost of essentials. This is the moment at which, at least in theory, discretionary prosperity ceases to exist at the average level. This makes it imperative that we find ways of managing the cost of essentials if we’re to ensure the well-being of the ‘average’ person.

In practice, the likelihood is that deteriorating economic conditions will change our definitions of what is “essential”, at the levels both of household necessities and of public services. It might be, for instance, that car ownership ceases to be regarded as “essential” well before 2040, and that governments will be pressured into imposing tighter priority criteria on the services that they provide.

There are two particularly disturbing aspects of the trends modelled by SEEDS and set out here.

First, per capita averages are not the same as median numbers, and even the latter might not fully reveal widespread and worsening hardship – better-off citizens may continue to enjoy discretionary prosperity long after even the essentials have ceased to be affordable (other than through ever-deepening indebtedness) for many others.

Second, there is little or no sign that these trends are gaining the necessary recognition – and may not do so until governments and others have been compelled to realize that ‘perpetual growth on a finite planet’ is a fallacy (though, if they were to look at trends now – in debt, monetization and the cost of necessities – they could be disabused of this false perception).                

Indications and warnings’

As we have seen, discretionary prosperity is being squeezed between deteriorating top-line prosperity and the rising real cost of essentials. At the same time, discretionary consumption has continued to increase.

This situation reflects two important linkages. The first is rising ECoEs, which are pushing up the cost of essentials at the same time as driving prosperity downwards.

The second is that the divergence between discretionary prosperity and actual consumption of non-essential goods and services links directly to the economy’s worsening dependency on credit and monetary stimulus. If this stimulus were to contract for any reason, discretionary consumption would fall very sharply indeed.      

Where stimulus is concerned, the authorities presumably realize that a balance has to be struck between full-bore, ad infinitum monetization, with its inescapable inflationary risks, and counter-inflationary monetary tightening, which would be likely to drive markets sharply lower, and trigger cascading defaults.

The point is that, whichever way this goes, discretionary consumption has to fall back towards affordable (discretionary prosperity) levels. If inflation takes off, the cost of necessities will rise more rapidly than the price of discretionaries. If, alternatively, monetary policies are tightened, this would have a leveraged, adverse effect on discretionary purchasing.

This is going to have far-reaching effects. Commercially, entire sub-sectors and large fortunes have been built on discretionary consumption supported by credit.  Financially, both the capital values and the balance sheet viabilities of large swathes of the economy would be undermined by any check to credit-funded discretionary spending by consumers.

Business planning and investment perceptions remain firmly rooted in the false paradigm of ever-growing discretionary consumption, yet SEEDS analysis reveals that this paradigm is founded on the fallacious premise of perpetual growth, a premise whose fallacy has thus far been masked by credit and monetary activism. Politically, the rising real cost of necessities can be expected to cause a switch of focus towards alleviating the hardship caused by the rising prices of essentials.

This, then, is where the denouement occurs – and, if we want to understand how events are going to unfold, we need to keep a keen eye on the nominal and the real cost of essentials, whether purchased by households or funded through taxation.     


#203. Surplus Energy Economics


In recent discussions here, it’s been suggested that we need a brief explanation of Surplus Energy Economics (SEE). This is an interpretation which states that the economy is an energy system, not a financial one. This is the understanding which informs the SEEDS economic model.

The timing is certainly appropriate, as established economic conventions are being confounded by adverse trends which financial tools are proving wholly unable to counter. In this context, it’s not at all surprising that interest in SEE and SEEDS continues to increase.

Energy-based analysis reveals that, where the West is concerned, the scope for further economic expansion disappeared between 1997 and 2007, and that the same thing is now happening in the EM (emerging market) economies.

The principle SEEDS metric for economic well-being is prosperity, which the model calibrates both in aggregate and in per capita form. On the latter basis, the average American was (as of 2019) 6.6% poorer than he or she had been back in 2000, British prosperity had declined by 10.6% since 2004, and Canadians had become 8.6% poorer since 2007.

These findings are, of course, quite different from the conventional line, mainly because governments and central banks have resorted, perhaps in all good faith, to credit and monetary policies which have sustained a simulacrum of “growth” even though prosperity is now deteriorating.     

The economic narrative of modern times is that, ever since “secular stagnation” was first noted (but not traced to its energy causation) back in the 1990s, the authorities have tried successive financial ‘fixes’ which have succeeded only in confirming that the economy, being an energy system, cannot be revitalized by monetary ‘innovation’.

‘Credit adventurism’, which led directly to the 2008-09 global financial crisis (GFC), has since been compounded by ‘monetary adventurism’, which has put the monetary system itself at great and increasing risk. We can be certain that the search is on for ‘gimmick 3.0’ – and equally certain that this, too, will fail.

The greatest single error made by conventional economics is the assumption that, if we understand money, we also understand the economy. This fallacy has driven an ever-widening gap between a financial system that has been growing exponentially, and an economy that has ceased expanding, and has started to contract.

In the interests of brevity, some of the implications of SEEDS analysis can only be noted here in outline. First, as prosperity per capita declines, so will the scope for funding public spending without recourse to ever-increasing government debt.

Second, just as prosperity has deteriorated, the cost of essentials has continued to increase, leveraging relatively gradual declines in top-line prosperity into far steeper falls in discretionary prosperity. This in turn means that a large and growing proportion of discretionary consumption has become dependent on continuing increases in debt.

Third, the calibration of prosperity reveals that levels of financial risk are far more severe than they appear on conventional metrics which use credit-inflated, ECoE-ignoring GDP as the denominator.

Each of these factors makes it seem unlikely that the energy basis of the economy will gain official recognition any time soon. Properly understood, the last real opportunity for a “reset” came – and went – back in 2008-09, when we opted to side-step the market implications of dangerously excessive credit.

The only practical alternative now is to try to buy a bit more time before ultra-loose monetary policies trigger a hyperinflationary slump in the value of money, and/or attempts to head off surging inflation trigger asset price collapses and a cascade of defaults.  

Fundamentally, the aim now must be to minimize the economic consequences of a seemingly inescapable failure of the financial system.    

Two interpretations, one reality

Essentially, there are two ways in which the working of the economy can be explained. One of these is the conventional or orthodox explanation, which states that the economy can be understood wholly in terms of money. The alternative, summarised here, is that the economy is an energy system.

If it were true, the monetary explanation would mean that there need be no end to economic growth, because money is a human artefact which is wholly under our control. Some proponents of traditional, money-based economics have been explicit about the absence of physical or resource limits to economic expansion.

It might be contended that the economy has indeed expanded enormously since the publication, in 1776, of Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations, the founding treatise of Classical Economics.

The alternative explanation is that it wasn’t Smith’s magnum opus, but the completion of James Watt’s radically more efficient steam engine – also in 1776, and also in Scotland – that really triggered two centuries of rapid economic growth, because it gave us access to the vast quantities of energy contained in coal, oil and natural gas.

The contest between these two schools of thought is reaching a climax now, because two factors are undermining the fossil fuels dynamic. One of these is the recognition that continued reliance on oil, gas and coal threatens to inflict irretrievable damage to the environment.

The other is that depletion – the practice of using highest-value energy resources first, and leaving costlier alternatives for a ‘later’ which has now arrived – is eliminating the ability of fossil fuels, not just to drive further growth, but even to maintain the economy at its current scale and complexity.         

The view set out here is that this contest is already all but over, and that increasingly desperate reliance on financial gimmickry – plus the increasingly blind faith placed in technology – demonstrate the failure of an interpretation which insists that money, rather than energy, determines the size and shape of the economy.

In principle

The energy-based interpretation of the economy is founded on three principles, each of which is validated both by logic and observation.

The first is that the economy is an energy system, because nothing that has any economic utility (value) at all can be supplied without the use of energy.

The second is that, 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 ECoE (the Energy Cost of Energy).

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

Each of these principles seems incapable of refutation. We know, for example, that an economy deprived of energy would grind to a halt within days, and would collapse within months. We know that we can’t drill an oil well, manufacture a wind turbine or a solar panel, or build an electricity grid without using the products of energy. We know that no amount of money will help someone adrift in a lifeboat, lost in a desert, or in any other way cut off from the process of exchange.   

The first set of charts puts these issues into context. The left-hand chart shows how dramatic increases in population numbers (from less than 0.7 billion in 1776 to 7.8 billion now) – and in the economic means of their support – have been driven by an even more dramatic increase in energy use. For most of that period, energy supply has grown more rapidly than population numbers, enabling prosperity to improve.

The situation now, though, is that trend ECoEs are rising rapidly, which has two adverse consequences for prosperity. The first is that rising ECoEs reduce the economic value obtained from each unit of energy consumed.

The second is that growth in energy supply is likely to cease, because producer costs are rising just as the prosperity of consumers is being undermined. This suggests that increased output of renewables and other non-fossil forms of energy will, at best, do no more than offset a decline in supplies of fossil fuels, leaving total energy availability broadly flat.

This means that, for the first time since the start of the Industrial Age, energy use per person will trend downwards. The deterioration is set to be even more marked at the level of surplus (ex-ECoE) energy per capita, which is the real driver of prosperity.     

Fig. 1

Financial consequences – the high price of denial

Perhaps the strongest evidence for the deterioration of the energy-based economy is the sheer extent – indeed, the outright desperation – of the financial gimmickry that has been necessary in order to sustain a simulacrum of “growth” as rising ECoEs have undermined economic prosperity.

As we shall see, prior growth in the prosperity of the advanced Western economies goes into reverse at ECoEs between 3.5% and 5.0%. Globally, these effects started to undermine growth between 1990 (an ECoE of 2.6%) and 2000 (4.1%). This was the period in which observers first identified a deceleration which they labelled “secular stagnation”.

This phenomenon has not, of course, been understood in energy terms. Rather, decision-makers have resorted to increasingly desperate, dangerous and futile financial innovations in an effort to counter it.    

The first recourse was to ‘credit adventurism’, making debt easier to access than it had ever been before. Since 1995, reported “growth” (of 116%, or $71 trillion) in GDP has been far exceeded by a 247% ($235tn) escalation in debt. This means that each dollar of “growth” has been accompanied by $3.30 of net new debt.

Another way of looking at this is that, whilst annual “growth” averaged 3.3% between 2000 and 2020, annual borrowing averaged 10.8% of GDP. What was happening was that output and growth were being inflated artificially by the pouring of increasing amounts of credit into the system.

SEEDS analysis reveals that underlying or ‘clean’ output – known here as C-GDP – increased at an annual rate of only 1.6%, rather than 3.3%, through this period. Even this average number masks a steady deterioration in clean growth.

These compounding effects mean that reported economic output has now been inflated far above its underlying equivalent. Essentially, the insertion of a ‘wedge’ between debt and GDP has driven a corresponding wedge between reported (GDP) and underlying (C-GDP) economic output.

Fig. 2

Needless to say, ‘credit adventurism’ has exacerbated financial risk. The artificial inflation of reported output has resulted in the understatement of risk calibrations, such as the ratio of debt to GDP, meaning that risk has become more opaque just as it has become more extreme. At the same time, the deregulatory processes involved in credit expansion have combined with ultra-loose monetary policy to weaken the link between risk and return.

This exercise in ‘credit adventurism’ necessarily culminated in the global financial crisis (GFC) of 2008-09. Rather than accept the market consequences of this process, the authorities opted to compound credit with ‘monetary adventurism’, through the adoption of supposedly “temporary” expedients including QE and ZIRP.

It does not require hindsight to recognize that, during the GFC, the last chance of a meaningful “reset” came and went. The adoption of ‘monetary adventurism’ has created a wholly unsustainable situation, in which real (ex-inflation) interest rates have been pushed permanently into negative territory – which means that people and businesses are paid to borrow – whilst saving is deterred. Other consequences of this process have included a dramatic, artificial inflation of asset markets, and the creation of a severe disequilibrium between asset prices and all forms of income.

Fundamentally, this has suspended the operation of a ‘capitalist’ system which, of course, requires positive real returns on capital. The necessary process of ‘creative destruction’ has been halted by a dynamic which keeps non-viable (‘zombie’) businesses afloat.

The effects of these processes extend far beyond debt itself. Since 2002, the broader category of financial assets – essentially, the liabilities of the government, household and corporate sectors – has expanded at a rate of $7.20 for each dollar of “growth” in GDP. Meanwhile, the crushing of returns on invested capital has contributed to the emergence of huge shortfalls (“gaps”) in the adequacy of pension provision.

In overall terms – and well before the onset of the coronavirus crisis – we had reached a point at which each “growth” dollar is being bought with $3.30 of new debt, $3.90 of other incremental financial liabilities and $2.50 of additional shortfalls in pension provision.

It would not be too much of an over-simplification to assert that we are taking on close to $10 of new liabilities in order to manufacture each $1 of “growth”

The irony is that, of the supposed $71tn “growth” recorded since 2000, fully 60% ($40tn) has been purely cosmetic, with real economic expansion totalling only $26tn over that period.        

Fig. 3

The decisive factor – ECoE

From the foregoing, it will be obvious that the critically important dynamic has been the relentless rise in ECoEs, a trend that has put an end to economic expansion, and has already started putting prior growth in prosperity into reverse.

The history of the economy in recent times can best be understood as an attempt to use financial policy in a failed effort to ‘fix’ an economy hamstrung by a factor – rising ECoEs – that conventional economic interpretation wholly fails even to recognize.   

For most of the Industrial Age, ECoEs have trended downwards. We don’t know what ECoEs were back in the 1770s, but we do know that they were high. They declined steadily over time, reflecting three operative processes.

The first of these was geographic reach, exemplified by the way in which the petroleum industry, from its origins in the Pennsylvania of the 1850s, expanded in pursuit of lower-cost supplies around the World.

The second was economies of scale, a facet of the rapid expansion of the coal, oil and natural gas industries.

The third driver was technology, which progressed from the simple extraction, processing and transport methods of the early Industrial Revolution to the far greater sophistication of the modern energy industries.

The ECoEs of the fossil fuel industries probably reached their nadir in the two decades after the Second World War, when ECoEs seem to have been at or below 1%. This drove the particularly rapid economic expansion of that period.

Latterly, however, the benefits of reach and scale have been exhausted, and depletion has started to drive ECoEs back upwards. Fossil fuel ECoEs reached 2% in 1984, 3% in 1993 and 5% in 2003, and are now close to 12%.

Since fossil fuels still dominate energy supply, overall ECoEs have risen relentlessly, from 2.6% in 1990, and 4.1% in 2000, to just above 9% now. As we shall see, complex advanced economies need ECoEs that are below 5%, and EM (emerging market) countries require ECoEs that are no higher than 10%.  

It’s abundantly clear that there can be no financial ‘fix’ for rising ECoEs. Equally, we cannot overcome higher ECoEs by using ever larger gross (pre-ECoE) quantities of energy, because rising ECoEs undermine the economics of energy supply itself. Unless the rise in ECoEs can somehow be halted and reversed, economic prosperity must follow a path of continuing decline. 

Supposed solutions to the ECoE problem fall into three categories, none of which is persuasive.

The least feasible of all is that we can somehow “de-couple” economic activity from the use of energy. This is impossible, of course, because the economy is an energy system. The evidence for “de-coupling” has been described by the European Environmental Bureau as “a haystack without a needle”. Only in the kind of alternative universe described by conventional, ‘money-only’ economics can we live on money, detached from physical (meaning energy-based) goods and services for which money can be exchanged.

The second delusion is that ‘there’s a technological solution to everything’. This is an era in which extravagant (and generally extrapolatory) claims are made for technology. The hard reality, of course, is that the scope of technology is limited by the envelope of physics. This is why, for instance, efforts to use shale resources to turn the United States into “Saudi America” have been such a costly failure.

Third, it’s asserted – and often simply assumed – that transition to renewable sources of energy (REs) can push overall ECoEs back downwards. Whilst there are compelling environmental and economic reasons for promoting RE expansion, the ECoEs of REs are unlikely to fall much below 10%, which is nowhere near low enough to prevent deterioration in an economic system built on ECoEs at or below 2%. Apart from anything ese, transition to REs will require enormous resource inputs, most of which can only be made available through the use of legacy energy from fossil fuels.    

The prosperity connection

The SEEDS economic model enables us to identify the levels of ECoE at which Western prosperity turned down, and to measure and predict the equivalent inflexion-points for EM economies.

In the Advanced Economies, prior growth in prosperity per capita went into reverse at ECoEs between 3.5% and 5.0%. This happened in Japan in 1997 (at an ECoE of 4.4%), in the United States in 2000 (4.5%), in Italy in 2001 (4.8%%), in Britain in 2004 (4.5%) and in Canada in 2007 (4.0%).

Latterly, the same thing has started happening in EM countries, too, including Mexico in 2007 (at an ECoE of 5.1%), South Africa in 2008 (6.1%) and Turkey in 2018 (8.7%).  SEEDS analysis shows that, in general, EM prosperity turns down at ECoEs of between 8% and 10%.

Latest data indicates that Chinese prosperity may not now turn down until 2025-26 – by which time ECoE is likely to be between 9.6% and 9.9% – though intervening increases in prosperity are likely to be very modest. The greater ECoE-resilience of the EM economies reflects a lesser degree of complexity, which means that upkeep of existing systems can be accomplished at lower levels of surplus energy.

There are, of course, local nuances around the connection between different countries’ ECoEs and their prosperity inflexion-points, but the ranges cited here – 3.5% to 5.0% for Western countries, and 8-10% for EM economies – are validated by comprehensive analysis.

For the World as a whole – and as the following charts illustrate – prosperity per person has been on a long plateau, during which continued growth in the EM economies has cancelled out Western deterioration. This helps explain the widespread perception that EM countries have been ‘carrying’ global growth since the GFC.

It would be a mistake, though, to assume that this EM resilience can be a continuing facet of the global economy. Rather, lesser complexity explains why countries like China and India have been able to carry on improving their prosperity pending their arrival at higher (and hence later) inflexion points.

Critically – and with most economies now past their economic climacterics – global prosperity per capita seems now to have turned down decisively from a plateau that has lasted since the early 2000s.

As the third of the following charts shows, the essence of the situation is that the World’s average person is now getting poorer, a problem compounded by an unfounded, blind faith insistence that no such thing can possibly be happening.                   

Fig. 4

#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.