#144: “Brexit” and the wait for Godot


It is perhaps appropriate that Samuel Beckett’s play Waiting for Godot was written in French, and premiered in Paris in January 1953, not appearing in English until its London debut in 1955.

As you’ll know, Godot himself never appears, which some might say is the real point of the narrative. Certainly, his non-arrival has no serious consequences.

This is where drama and reality part company. Like Vladimir and Estragon in Beckett’s play, both sides of the “Brexit” impasse have been waiting for more than two years now, and are waiting still, for the political equivalent of Godot to turn up. This time, it’s going to be very serious indeed if the major character (or characters) fail to put in an appearance.

If you’re a regular visitor to this site, you’ll know that I steer well clear of taking sides over the outcome of the “Brexit” referendum. This said, those of us who understand the surplus energy basis of the economy had solid reasons for expecting the vote to turn out as it did.

Though GDP per person was slightly (4%) higher in 2016 than it had been in 2006, personal prosperity in Britain deteriorated by almost 9% over that decade. When the public went to the polls, the average person was £2,150 worse off than he or she had been ten years previously, and was, moreover, significantly deeper in debt.

These are not conditions in which the governing can expect the enthusiastic backing of the governed. There were other factors in play, of course – including widening inequality, and the lack of a national debate over immigration – but the “leave” vote was founded on popular dissatisfaction with an “establishment” seemingly unconcerned about deteriorating prosperity.

The authorities’ fundamental inability to understand the prosperity issue was by no means unique to the United Kingdom, and neither were its consequences confined to the 2016 referendum. Had the deterioration in prosperity been understood in the corridors of power, it’s highly unlikely, for instance, that premier Theresa May would have called the 2017 general election which robbed her of her Parliamentary majority.

Calling an early election – intended to “guarantee security for the years ahead” – was just one of many mistakes made by the British authorities before, during and after the referendum on withdrawal from the European Union. The vote itself  seems to have been called in the confident assumption that the “remain” side would win comfortably. The governing Conservatives then elected as their leader an opponent of the “Brexit” process. Perhaps worst of all, the British side negotiated as supplicants, accepting, seemingly without question, Brussels’ highly dubious assertion that the EU held all the high cards.

But it would be wrong to pin all (or even most) of the blame for the “Brexit” negotiations fiasco on the British side. Whatever mistakes Mrs May and her colleagues might have made, they at least have a democratic mandate for what they have been trying to do. Beset on one side by hard-line “Brexiteers”, and on the other by those opposed to carrying out what the public actually voted for, Mrs May had problems enough, even before her Brussels counterparts set out to play politics with the process.

Under these conditions, it’s hardly surprising that the British parliament seems to have reached an impasse, where the main alternatives to a flawed deal appear to involve either (a) leaving the EU without any agreement at all, or (b) disregarding the wishes of the voters, and perhaps inviting those voters to have another go, presumably in the hope that the electorate will ‘get it right this time’.

Needed – Godot

In considering what ought to happen next, we need to be absolutely clear that the stance adopted by the bureaucrats in Brussels has all along made it impossible for Mrs May to secure an agreement acceptable either to parliament or the voters.

Put bluntly, the point has long since been reached where the adults – meaning the elected governments of EU member nations, led by France and Ireland – should step in, forcing Brussels to offer terms which are both (a) mutually advantageous, and (b) acceptable to the United Kingdom. This really means that Paris and Dublin need to mount an eleventh-hour rescue, not just (or even mainly) of the British economy, but of the EU economy as well.

From the outset, Brussels has made three dangerously false assumptions.

The first is that, in terms of economics, a mishandled “Brexit” will hurt Britain far more than it would hurt other EU member states.

The second, flowing from this but extending well beyond economics, was that the EU side holds all the high cards – essentially, that Mrs May should expect nothing more than scraps from a bounteous continental table.

Third, Brussels assumed the role of punishing British voters in order to deter Italians (and others) from following a similar path out of the EU.

This third point is the easiest to counter. The role of Brussels, which in many other areas is carried out commendably, is to better the circumstances of EU citizens.

It is not to influence how those citizens cast their votes.

The economic point, though critical, is a bit more complicated, but needs to be outlined to explain why Ireland and France, in particular, ought now to be intervening to break the impasse.

Where Ireland is concerned, the assumption in Brussels that a mishandled “Brexit” would more dangerous for the British than for anyone else is gravely mistaken. Although Britain is a major trading partner for Ireland, the main problem for the Republic is a broader one. Essentially, Ireland is in no condition to withstand any major shock to the system – and a bungled “Brexit” would certainly be exactly that.

We’ve examined the Irish predicament before, so a brief summary should suffice here. Following statistical changes (dubbed “leprechaun economics”) introduced in 2015, reported GDP has become an even less meaningful measure of economic conditions. GDP grew by 49% between 2007 and 2017 (including a one-off 25% hike in 2015), adding €97bn (at constant 2018 values) to recorded output – but this occurred courtesy of a near-doubling in debt, such that each €1 of “growth” was bought with €4.85 of net new borrowing. Meanwhile, the all-important energy cost of energy (ECoE) now exceeds 11% in Ireland, at level at which growth is almost bound to go into reverse.

Fundamentally, reported GDP (of an estimated €309bn last year) grossly overstates real activity (adjusted for borrowed spending, €184bn), let alone prosperity (€164bn, or €33,550 per person).

Critically, over-stated GDP gives dangerously false comfort about financial exposure. Aggregate debt, for instance, might be “only” about 320% of GDP, but equates to well over 600% of prosperity.

Worse still, Ireland’s financial sector is grossly over-large in relation even to GDP, let alone prosperity. The most recent available numbers (for the end of 2016) put financial assets at 1750% of GDP, but this equates now to a frightening 3200% or so of prosperity.

Far from deleveraging after the disaster of 2007-08, both debt and financial assets are a lot bigger now than they were on the eve of the global financial crisis (GFC I) – in inflation-adjusted terms, debt has virtually doubled (+95%) since 2007, and financial assets have expanded by about 60%.

Moreover, the markets might know about the “leprechaun” factor in Irish GDP, but seem not – yet – to have applied the logic of that knowledge to the critical measures of national financial risk. On the assumption that the authorities in Dublin do know quite how dangerous Irish financial exposure really is, they have every incentive to strive for a form of “Brexit” which minimises economic and financial damage.

France has different, but equally compelling, reasons for intervening, and would have a lot more negotiating clout to bring to the table. As we’ve seen, there has been widespread unrest in France, unrest whose causes can be traced to deteriorating prosperity. Though personal prosperity as a whole is only about €1,650 (5.8%) lower now than it was ten years ago, the slump in discretionary (‘left-in-your-pocket’) prosperity has been leveraged to 32% by a near-€2,000 increase in the burden of taxation per person.

This has put Mr Macron’s government in an unenviable position. Neither the fiscal carrots offered by the president, nor the law enforcement sticks planned by his government, can address the fundamental issue, which is that a substantial majority of the population supports the grievances (if not necessarily the methods) of the ‘gilets jaunes’.

This seems to mean that Mr Macron can forget about his cherished labour market “reforms”, and further suggests that, unless something pretty dramatic happens, he can probably forget about re-election as well. The last thing his government needs right now is the economic harm likely to be inflicted on France by a bungled “Brexit”. It would be far, far better for the president to act in a conspicuously statesmanlike way to break the impasse.

In this situation, it’s unrealistic to expect Britain to resolve this issue unaided by Europe. If, as most observers believe, Mrs May’s deal is going to be shot down by parliament, neither of the remaining options looks palatable. Both those who support a “no deal” exit, and those who’d like to ignore (or re-run) the “Brexit” vote, are playing with fire. But neither can we expect the Brussels side of the talks to have a last minute conversion either to humility or to pragmatism.

In short, there are compelling reasons for European governments – led by France and Ireland – to enforce a rationality seemingly absent, on this issue, in Brussels.

#143: Fire and ice, part one


Is 2019 the year when everything starts falling apart?

It certainly feels that way.

The analogy I’m going to use in this and subsequent discussions is ‘fire and ice’.

Ice, in the potent form of glaciers, grinds slowly, but completely, crushing everything in its path. Whole landscapes have been shaped by these icy juggernauts.

Fire, on the other hand, can cause almost instantaneous devastation, most obviously when volcanoes erupt. Back in 1815, the explosion of Mount Tambora in the Dutch East Indies (now Indonesia) poured into the atmosphere quantities of volcanic ash on such a vast scale that, in much of the world, the sun literally ceased to shine. As a result, 1816 became known as “the year without a summer”. As low temperatures and heavy rain destroyed harvests and killed livestock, famine gripped much of Europe, Asia and North America, bringing with it soaring food prices, looting, riots, rebellions, disease and high mortality. Even art and literature seem to have been influenced by the lack of a summer.

The economic themes we’ll be exploring here have characteristics both of fire and of ice. The decline in prosperity is glacial, both in its gradual pace and its ability to grind assumptions, and systems, into the ground. Other events are likelier to behave like wild-fires or volcanoes, given to rapid and devastating outbursts, with little or no prior warning.

Fiscal issues, examined in this first instalment of ‘fire and ice’, have the characteristics of both. The scope for taxing the public is going to be subjected to gradual but crushing force, whilst the hard choices made inevitable by this process are highly likely to provoke extremely heated debate and resistance.

Let’s state the fiscal issue in the starkest terms:

– Massive credit and monetary adventurism have inflated GDP to the point where it bears little or no resemblance to the prosperity experienced by the public.

– But governments continue to set taxation as a percentage of GDP.

– As GDP and prosperity diverge, this results in taxation exacting a relentlessly rising share of prosperity.

– Governments then fail to understand the ensuing popular anger.

France illustrates this process to dramatic effect. Taxation is still at 54% of GDP, roughly where it’s been for many years. This no doubt persuades the authorities that they’ve not increased the burden of taxation. But tax now absorbs 70% of French prosperity, leading to the results that we’ve witnessed on the streets of Paris and other French towns and cities.

Few certainties

It’s been said that the two certainties in life are “death and taxes”, but ‘debt and taxes’ hold the key to fiscal challenges understood improperly – if at all – by most governments. The connection here is that debt (or rather, the process of borrowing) affects recorded GDP in ways which provide false comfort about the affordability of taxation – and therefore, of course, about the affordability of public services.

The subject of taxation, seen in terms of prosperity, leads straight to popular discontent, though that has other causes too. In order to have a clear-eyed understanding of public anger, by the way, we need to stick to what the facts tell us. I’ve never been keen on excuses like “the dog ate my homework” or “a space-man from Mars stole my wallet” – likewise, we should ignore any narrative which portrays voter dissatisfaction as wholly the product of “populism”, or of “fake news”, or even of machinations in Moscow or Beijing. All of these things might exist – but they don’t explain what’s happening to public attitudes.

The harsh reality is that, because prosperity has deteriorated right across the advanced economies of the West, we’re facing an upswell of popular resentment, at the same time as having to grapple with huge debt and monetary risk.

If you wanted to go anywhere encouraging, you wouldn’t start from here.

The public certainly has reasons enough for discontent. In the Western world, prosperity has been deteriorating for a long time, a process exacerbated by higher taxation. The economic system has been brought into disrepute, mutating from something at least resembling ‘the market economy’ into something seemingly serving only the richest. As debt has risen, working conditions, and other forms of security, have been eroded. We can count ourselves fortunate that the public doesn’t know – yet – that the pensions system has been sacrificed as a financial ‘human shield’ to prop up the debt edifice.

This at least sets an agenda, whether for 2019 or beyond. The current economic paradigm is on borrowed time, whilst public support can be expected to swing behind parties promoting redistribution, economic nationalism and curtailment of migration. Politicians who insist on clinging on to ‘globalised liberalism’ are likely to sink with it. The tax base is shrinking, requiring new priorities in public expenditure.

If you had to tackle this at all, you wouldn’t choose to do it with the “everything bubble” likely to burst, bringing in its wake both debt defaults and currency crises. But this process looks inescapable. With its modest incremental rate rises, so derided by Wall Street and the White House, the Fed may be trying to manage a gradual deflation of bubbles. If so, its intentions are worthy, but its chances of success are poor.

And, when America’s treasury chief asks banks to reassure the markets about liquidity and margin debt, you know (if you didn’t know already) that things are coming to the boil.

Tax – leveraging the pain

If it seems a little odd to start this series with fiscal affairs, please be assured that these are very far from mundane – indeed, they’re likely to shape much of the political and economic agenda going forward. The biggest single reason for upsets is simply stated – where prosperity and the ability to pay tax are concerned, policymakers haven’t a clue about what’s already happening.

Here’s an illustration of what that reality is. Expressed at constant values, personal prosperity in France decreased by €2,060, or 7.5%, between 2001 (€29,315) and 2017 (€27,250).

At first glance, you might be surprised that this has led to such extreme public anger, something not witnessed in countries where prosperity has fallen further. Over the same period, though, taxation per person in France has increased by €2,980. When we look at how much prosperity per person has been left with the individual, to spend as he or she chooses, we find that this “discretionary” prosperity has fallen from €13,210 in 2001 to just €8,230 in 2017.

That’s a huge fall, of €4,980, or 38%. Nobody else in Europe has suffered quite such a sharp slump in discretionary prosperity – and tax rises are responsible for more than half of it.

This chart shows how increases in taxation have leveraged the deterioration in personal prosperity in eight Western economies. The blue bars show the change in overall prosperity per capita between 2001 and 2017. Increases in taxation per person are shown in red.

#143 01

In the United Kingdom, for example, economic prosperity has deteriorated by 9.8% since 2001, but higher taxation has translated this into a 29.5% slump in discretionary prosperity. Interestingly, economic prosperity in Germany actually increased (by 8.2%) over the period, but higher taxes translated into a fall at the level of discretionary prosperity per person.

Prosperity and tax – Scylla and Charybdis

The next pair of charts, which use the United Kingdom to illustrate a pan-Western issue, show a problem which is already being experienced by the tax authorities, but is not understood by them.

The left-hand chart (expressed in sterling at constant 2017 values) shows a phenomenon familiar to any regular visitor to this site, but not understood within conventional economics. Essentially, GDP (in blue) and prosperity (in red) are diverging.

This is happening for two main reasons. One is the underlying uptrend in the energy cost of energy (ECoE). The second is the use of credit and monetary adventurism to create apparent “growth” in GDP in the face of secular stagnation. This, of course, helps explain why people are feeling poorer despite apparent increases in GDP per capita. Total taxation is shown in black, to illustrate the role of tax within the prosperity picture.

The right-hand chart shows taxation as percentages of GDP (in blue) and prosperity (in red). In Britain, taxation has remained at a relatively stable level in relation to GDP, staying within a 34-35% band ever since 1998, before rising to 36% in 2016 and 37% in 2017.

Measured as a percentage of prosperity, however, the tax burden has risen relentlessly, from 35% in 1998, and 44% in 2008, to 51% in 2017.

#143 02

Simply put, the authorities seem to be keeping taxation at an approximately constant level against GDP, not realising that this pushes the tax incidence upwards when measured against prosperity. The individual, however, understands this all too well, even if its causes remain obscure.

What this means, in aggregate and at the individual level, are illustrated in the next set of charts. These show the aggregate position in billions, and the per capita equivalent in thousands, of pounds sterling at 2017 values.

#143 03

As taxation rises roughly in line with GDP – but grows much more rapidly in terms of prosperity – discretionary prosperity, shown here in pink, becomes squeezed between the Scylla of falling prosperity and the Charybdis of rising taxation. The charts which follow are annotated to highlight how this ‘wedge effect’ is undermining discretionary prosperity.

#143 04

Finally, where the numbers are concerned, here’s the equivalent situation in France. As far back as 1998, tax was an appreciably larger proportion of GDP in France (51%) than in the United Kingdom (34%). By 2017, tax was absorbing 54% of GDP in France, compared with 37% in Britain.

This means that taxation in France already equates to 70% of prosperity, up from 53% in 1998. Even though the squeeze on overall prosperity (the pink triangle) has been comparatively modest so far (since 2001, a fall of 7.5%), the impact on discretionary prosperity (the blue triangle) has been extremely severe (39%). This is why so many French people are angry – and why their anger has crystallised around taxation.

#143 05

The political fall-out

When you understand taxation in relation to prosperity, you appreciate a challenge which the authorities in Western countries (and beyond) have yet to comprehend. Most of them probably think that, going forward, they can carry on pushing up taxation roughly in line with supposed “growth” in GDP. Presumably, they also assume that the public will accept this fiscal trajectory.

If they do make these assumptions, they’re in for a very rude awakening. The modest tax tinkering implemented in France, for instance, is most unlikely to quell the anger, even though it’s set to widen the deficit appreciably.

Politically, the leveraging effect of rising taxation feeds into a broader agenda which, so far, is either misinterpreted, or just not recognised at all, by the governing establishment.

Here, simply stated, are some of the issues with which governments are confronted:

Prosperity per person is continuing to deteriorate, typically at annual rates of between 0.5% and 1.1%, across the Western economies.

Rising taxation is worsening this trend, leading increasingly to popular resistance.

– The public believes (and not without reason) that immigration is exacerbating the decline in prosperity, both at the total and at the discretionary levels.

– Perceptions are that a small minority of “the rich” are getting wealthier whilst almost everyone else is getting poorer.

Politicians are seen as both heedless of the majority predicament and complicit in the enrichment of a minority.

The popular demands which follow from this are pretty clear.

Voters are going to be angered by the decline in their prosperity, and will become increasingly resistant to taxation. The greatest resentment will centre around “regressive” taxes, such as sales taxes and flat-rate levies, which hit poorest taxpayers hardest.

They’re going to demand more redistribution, meaning higher taxes on “the rich”, not just where income taxes are concerned, but also extending to taxes on wealth, capital gains and transactions.

Popular opposition to immigration is likely to intensify, as prosperity deteriorates and tax bites harder.

Finally, public anger about former ministers and administrators retiring into very lucrative employment is going to go on mounting.

A challenge – and an opportunity?

In terms of electoral politics, most established parties are singularly ill-equipped to confront these issues. Some on “the Left” do embrace the need for redistribution, but almost invariably think this is going to fund increases in public expenditures, which simply isn’t going to be possible.

Others oppose increasing taxes on the wealthiest, and fail to appreciate that fiscal mathematics, quite apart from public sentiment, are making this process inescapable.

On both sides of the conventional political divide there is, as yet, no awareness that economic trends are going to exert glacier-style downwards pressure on public spending. Nowhere within the political spectrum is there recognition of the consequent need to set new, more stringent priorities. In areas such as health and policing, declining real budgets mean that policymakers face hard choices between which activities can continue to be funded, and those which will have quietly to be dropped.

It seems almost inconceivable that established parties are going to recognise what faces them, and adapt accordingly. The “Left” is likely to cling to dreams of higher public expenditures, whilst the “Right” will try to fend off higher taxation of the wealthiest. Even insurgent (aka “populist”) parties probably have no idea about the tightening squeeze on what they can afford to offer to the voters. It’s likely that very few people in senior positions yet realise that an ultra-lucrative retirement into “consultancies” and “the lecture circuit” is set to become electorally toxic.

Politically, of course, problems for some can be opportunities for others. It wouldn’t be all that hard to craft an agenda which capitalises on these trends, promising, for example, much greater redistribution, ultra-tight limits on immigration, and capping the retirement earnings of the policy elite.

If you did promise these things, you’d probably be elected. Unfortunately, though, that’s the easy bit. The hard part is going to be grappling with the continuing decline in prosperity at the same time as fending off a financial crash.

How, having been voted into power, are you going to tell the voters that we’re all getting poorer, and that some public services are ceasing to be affordable within an ever more rigorous setting of priorities? And are they going to believe you when you tell them that the destruction of pensions is entirely the work of your predecessors? Finally, what are you going to do when one of the big endangered economies fails?


#142: Past, present and future


As we near the end of a year that can certainly be called ‘interesting’, I’d like to reflect on what’s happened, what’s happening now, and what we might expect to happen going forward. I can’t be sure that this is the last article for 2018 but, in case it is, I’d like to thank everyone for their interest, their comments and their many invaluable contributions to the themes we discuss here – and, of course, to wish you a very merry Christmas and a happy and successful New Year.

Where Surplus Energy Economics, this site and SEEDS are concerned, this has been a memorable year. SEEDS – the Surplus Energy Economics Data System – was finally completed in early 2018, and, amongst other things, this has freed up time for more thematic analysis. It’s both humbling and gratifying to know that about 44,000 people have visited the site this year, another big increase over the preceding twelve months. Most importantly – though this is for you to judge – I like to think we’ve developed a pretty persuasive narrative of how the economy works, and how things are trending.

We can take less satisfaction in what we see around us. According to SEEDS, most of the Western economies have now been getting poorer for at least a decade – and, ominously, the ability of the emerging market economies to grow enough to offset this deterioration, and keep global prosperity static, seems to have ended. World prosperity per person has been on a remarkably long plateau at around $11,000 (constant values, PPP-converted), but has now started to erode.

Deteriorating prosperity might be ‘a new fact’ in the world as a whole, but it’s an established reality in the West – with the single exception of Germany (rather a special case), no developed economy covered by SEEDS has enjoyed any improvement in prosperity at all since 2007. In most cases, the decline in personal prosperity has been happening for longer than that. But our societies seem to have learned almost nothing about what’s going on – and, until the processes are understood, crafting effective responses is impossible.

Historians of the future are likely to be bemused by our futile efforts to escape from the energy dynamic in the economy. From the turn of the millennium, we started pouring ever larger amounts of debt into the system. This led, with utter inevitability, to the 2008 global financial crisis (GFC I).

Undeterred, we then compounded cheap and abundant debt with ever cheaper money, yet the inevitable consequences of this process will still, no doubt, be declared both ‘a surprise’ and ‘a shock’ when they happen. We surely should know by now that we have an “everything bubble” propped up by ultra-cheap money, and that bubbles always burst. If there’s any sense in which “this time is different”, it is that, since 2008, we’ve taken risks not just with the banking system, but with money itself.

The death of debt?

There’s one theme which, though we’ve touched on it before, really needs to be spelled out. Throughout the era of growth, we’ve come to accept the process of borrowing and lending as a natural component of our economic system. Indeed, this practice long pre-dates the industrial age, when borrowing and lending, which then was more commonly called “usury” (the lending of money for interest), began to be de-criminalised after Christian Europe had been shaken up by the Reformation.

Leaving theological and ethical issues aside, we need to be clear that the process of borrowing and lending is a product of growth, because debt can only ever be repaid (and, indeed, serviced) where the prosperity of the borrower grows over time.

For simplicity, we can divide debt into two categories. If someone borrows money to expand a successful business, it is the growth in the income of the business which alone enables interest to be paid and the capital amount, too, to be reimbursed in due course. This is termed “self-liquidating debt”.

“Non-self-liquidating debt”, on the other hand, is typified by the loans consumers take out to pay for a holiday, buy a car or replace a domestic appliance. Here, the borrower is buying something which he or she cannot afford out of current income, and the only way in which this can be repaid is if the borrower’s prosperity increases over time.

Take away the assumed growth in prosperity, however, and both forms of borrowing cease to be viable. “Self-liquidating” debt assumes that an expanded business can earn greater profits, but it’s hard to count on this when potential customers are getting poorer. As for “non-self-liquidating” debt, the all-important rise in the borrower’s means can no longer be relied upon when people generally are getting poorer.

In short, the very process of borrowing and lending is likely to be stripped of its viability as prosperity declines. This should be an extremely sobering thought in a world which is awash with debt, and where supplying cheap credit is seen as a panacea for economic stagnation.

You might well ponder at least two things about this. First, what happens to the large quantities of debt owed by those Western economies whose prosperity has already moved significantly along the downwards curve? Second, what happens to asset prices in a world where the credit impetus goes into reverse?

Reflecting on the essential linkage between debt and growth, you might also wonder why we’re not already seeing the debt edifice crumbling. There are two main answers to this. The first is that the debt structure has been buttressed by de-prioritising another form of futurity – simply put, we’ve already created huge (and burgeoning) gaps in pension provision as part of the price of preserving the edifice of debt.

The second answer is simpler still – we’ve not seen the debt edifice start to crumble yet……

Feeling the pain

People across the Western world certainly seem to know that their prosperity is eroding, and they’re far from happy about it. We can see the effects both in political choices and in rising popular discontent. If you understand deteriorating prosperity, then you understand political events in America, Britain, Italy, France and far beyond – events which, if you didn’t understand the economic process, must seem both baffling and malign.

Though understandable, anger isn’t a constructive emotion, and what we really need is coolly analytical interpretation, understanding and planning. If it’s true that we’re not getting this from government, then it’s equally true that government reflects the climate of opinion. We can hardly expect governments to understand the economic realities when opinion-formers stick resolutely to conventional interpretation. It’s more surprising that conventional methods still command adherence as outcomes continue to diverge ever further from expectations.

Making glib promises is part and parcel of politics and, in fairness, those who don’t do this can expect to lose out to those who do. What is more disturbing is the continued promotion of economic extremism. Nationalising everything in sight won’t work, and neither will dismantling the state and turning the economy into a deregulated, ‘law of the jungle’ free-for-all.

Over the years, we’ve tried both, and should know by now that the lot of the ‘ordinary person’ isn’t bettered by these extremes. At least, when prosperity was still growing, we could live with the price of ideological purity – now that prosperity (in the West, at least) has turned down, though, these consequences are something that we can no longer afford.

If you think about it, the extremes either of collectivism or of ‘laissez faire’ have always been absurdly simplistic. Have we ever really believed that benign apparatchiks can manage things better than people can do for themselves? Or that unfettered ‘capitalism’, which concentrates wealth and power just as surely as collectivism, can do things better? Perhaps most importantly, why do so many of us persist in the view that possessions, material wealth and nebulous ideas of relative ‘status’ are a definition of happiness?

Logically, deteriorating prosperity means that we concentrate on necessities and dispense with some luxuries. Amongst the luxuries that we can no longer afford are ideological extremes, and an outlook founded wholly or largely on ownership and consumerism.

The need for ideas

The good news is that we’re not going into this new era wholly lacking in knowledge. The trick is to understand what that knowledge really is. Keynes teaches us how to manage demand – or can teach us this, so long as we don’t turn him into a cheerleader for ever bigger public spending. Likewise – if we can refrain from caricaturing him as a rabid advocate of unregulated and unscrupulous greed – Adam Smith tells us that competition, freely, fairly and transparently conducted, is the great engine of innovation. More humbly, or perhaps less theoretically, but surely more pertinently, experience tells us that the “mixed economy” of optimised private and public provision works far better than any extreme.

Going forward, we should anticipate the collapse of the “everything bubble” in asset prices, and should hope that we don’t, this time, go so far into economic denial as to think we can cure this with a purely financial “fix”. I’m fond of saying that “trying to fix an energy-based economy with financial fixes is like trying to cure an ailing pot-plant with a spanner”. We should understand popular concerns, which seem to point unequivocally towards a mixed economy, extensive redistribution and an economic nationalism that needs to be channelled, not simply vilified.

Another, positive point on which to finish is that a deterioration in prosperity needn’t prevent us – indeed, should compel us – to make better use of the prosperity that we do have. There’s no situation which can’t be made worse by rash decisions, or made better by wise ones. The forces described here – economic trends, and their political and social corollaries – all contain the seeds (no pun intended…) of divisiveness. This being so, cohesion and common purpose have never been so important.

Togetherness, and concern for the welfare of others, are, and certainly should be, part of the fabric of Christmas. Seldom can these characteristics have been more important than they are now.


#141: England’s Glory or ship of fools?


There used to be – and, as far as I know, still is – a brand of matches called England’s Glory, sold in iconic boxes featuring the battleship HMS Devastation. If tasked with updating that artwork, one could hardly do better than a rowing-boat full of squabbling fools.

There is, of course, no situation that can’t be made worse by a politicians’ witches’ brew of ambition and obstinacy. But the shambles now being inflicted on the British public is something new in the realms of idiocy.

I don’t intend, here, to go into the merits or otherwise of the voters’ “Brexit” decision itself, though readers are, of course, welcome to debate it. As for the political machinations at Westminster, it need only be remarked that the current imbroglio is consistent with a process that has been bungled right from the start.

What I think we can do here, though, is set out the purely economic context from the standpoint of surplus energy economics (SEE).

If you understand SEE – an interpretation of the economy summarised here – then you’ll know that prosperity in the United Kingdom has been deteriorating since 2003. Though this deterioration is by no means unique to Britain, it’s been more severe there than in most other countries. Properly understood, eroding prosperity has been as instrumental in the “Brexit” process as it has been in the election of Donald Trump, the handing of power to an insurgent (aka “populist”) coalition in Italy, and the elevation, and subsequent travails, of Emmanuel Macron in France.

And this, really, is the critical point. Policymakers right across the Western world simply don’t understand that prosperity is heading downwards. Because they (and their advisors, and most of the commentariat) remain wedded to conventional economic interpretations, they really believe that people are getting better off. In the British instance, they’re convinced that an increase of £3,220 (11.6%) in GDP per capita since 2003 means that people are prospering.

If you believe this, you can’t even begin understand what people in Britain – or, for that matter, in America, Italy or France – have got to complain about. Blind to the economic causes of discontent, politicians tend to fall back on more arcane explanations, many of which seek to pin the blame on unscrupulous “populist” politicians.

Where Britain is concerned, reported GDP increased by £390bn (24%) between 2003 and 2017. Unfortunately, this was accompanied by a £2 trillion (63%) increase in debt. This means that £5.19 was borrowed for each £1 of incremental GDP. It also means that, whilst GDP has grown by between 1.5% and 2% each year, debt has been added at rates of close to 10% of GDP annually.

Fundamentally, it means that most of the “growth” supposedly achieved since 2003 has been nothing more than the simple spending of borrowed money. If, for any reason, Britain lost the ability to carry on adding to its debt in this way, trend growth would fall to somewhere around 0.3%, a number lower than the rate at which population numbers are growing. If ever it became necessary to deleverage, then most of the “growth” of recent years would go into reverse. Anyone questioning this interpretation need only ask himself or herself one question – ‘what kind of economy needs to price credit at rates lower than inflation?

The reason why financial adventurism has been adopted to create a simulacrum of “growth” is that the energy dynamic has turned negative. According to SEEDS (the Surplus Energy Economics Data System), Britain’s trend energy cost of energy (ECoE) has risen from 3.4% in 2003 to 9.2% now. The latter number is a growth-killer. This has been worse than the global increase (from 4.5% to 8.0%) over the same period, which is one of the main reasons why prosperity has fallen more rapidly in Britain than in most other countries. Part of the differential has been the unlucky timing of the maturing of the UK North Sea oil and gas province. But this has been exacerbated by energy policy, nowhere more obviously than in protracted vacillation over replacement nuclear capacity.

According to SEEDS, personal prosperity in the United Kingdom had, by 2017 (£22,050) fallen by £2,490 (10.2%) since 2003 (at 2017 values, £24,540). Moreover, each person now has 47% more debt than he or she had back in 2003.

The political logic here is that, by the time of the referendum in 2016, prosperity had fallen by more than enough to swing the “Brexit” vote against the perceived preference of “the establishment”. Politicians completely failed to understand this trend, and probably wouldn’t have called the referendum at all if they’d been better informed.

Once this essentially economic dimension is understood, what follows is pure tragi-comedy. The Conservatives chose, in succession to David Cameron, to put in charge of the “Brexit” process a leader who believed that the voters’ decision was the wrong one. Still unaware of the deterioration in prosperity, Mrs May called a general election, seemingly believing (along with the ‘experts’) that this would give her a Commons majority of well over 100, when the outcome was that she lost even the slender majority inherited from Mr Cameron. Meanwhile, the EU side opted to posture on a claim that they held all the high cards, and Mrs May and her officials fell for this line, going to Brussels as a supplicant, and so, necessarily, returning with an agreement so flawed that it had no real chance of Parliamentary acceptance.

What the British electorate are watching now is a culminating shambles. Having lost a referendum they expected to win, and been battered in an election they expected to be a triumph, Conservatives have opted now to challenge a leader who, because of her stance on “Brexit”, they should never have chosen in the first place. This has happened at the worst possible time, between the cup of a botched agreement with the EU and the lip of a departure date at the end of March. Some think that the leadership challenge process can be compressed, and it’s probably fair to say that one might as well make a mess of things in three weeks as in six.

Where this leaves the public is with a political class which doesn’t understand the fundamental issues around prosperity, and really believes that either ‘liberal’ or collectivist economic orthodoxy can restore “growth”. It seems hardly necessary to add that a ship of fools remains foolish, whether or not the captain is thrown overboard.

= = = = = = = = = =

Germany vs EA7

Prosp per capita DE EA7 UK

#140: Are yellow jackets the new fashion?


This weekend, the authorities plan to field 89,000 police officers across France in response to anticipated further mass protests by the ‘gilets jaunes’. In the capital, the Eiffel Tower will be closed and armoured cars deployed, whilst restaurateurs and shopkeepers are being urged to close their businesses at one of the most important times of their trading year.

Though the government has climbed down on the original cause célèbre – the rises in fuel taxes planned for next year – there seems to be no reduction in the worst protests experienced in the country since the 1960s. Reports suggest that as many as 70% of French citizens support the protestors, and that the movement may be spreading to Belgium and the Netherlands.

For the outside observer, the most striking features of the protests in France have been the anger clearly on display, and the rapid broadening of the campaign from fuel prices to a wider range of issues including wages, the cost of living and taxation.

The disturbances in France should be seen in a larger context. In France itself, Emmanuel Macron was elected president only after voters had repudiated all established political parties. Italians have entrusted their government to an insurgent coalition which is on a clear collision-course with the European Union over budgetary matters. The British have voted to leave the EU, and Americans have elected to the White House a man dismissed by ‘experts’ as a “joke candidate” throughout his campaign.

Obviously, something very important is going on – why?

Does economics explain popular anger?

There are, essentially, two different ways in which the events in France and beyond can be interpreted, and how you look at them depends a great deal on how you see the economic situation.

If you subscribe to the conventional and consensus interpretation, economic issues would seem to play only a supporting role in the wave of popular unrest sweeping much of the West. You would concede that the seemingly preferential treatment of a tiny minority of the very rich has angered the majority, and that some economic tendencies – amongst them, diminishing security of employment – have helped fuel popular unrest.

Beyond this, though, you would note that economies are continuing to grow, and this would force you to look for explanations outside the purely economic sphere. From this, you might conclude that ‘agitators’, from the right or left of the political spectrum, might be playing a part analogous to the role of “populist” politicians in fomenting public dissatisfaction with the status quo.

If, on the other hand, you subscribe to the surplus energy interpretation of the economy professed here, your view of the situation would concentrate firmly on economic issues.

Though GDP per capita may be continuing to improve, the same cannot be said of prosperity. According to SEEDS (the Surplus Energy Economics Data System), personal prosperity in France has deteriorated by 7% since 2000, a trend starkly at variance with the growth (of 12%) in reported GDP over the same period.

Not only is the average French person poorer now than he or she was back in 2000, but each person’s share of the aggregate of household, business and government debt has increased by almost 70% since 2000. These findings are summarised in the following table, sourced from SEEDS.

France prosperity snapshot

Two main factors explain the divergence between the conventional and the surplus energy interpretations of the economy. One of these is the pouring of enormous quantities of cheap debt and cheap money into the system, a process which boosts recorded GDP without improving prosperity (for the obvious reason that you can’t become more prosperous just by spending borrowed money). The other is the exponential rise in the energy cost of energy (ECoE), a process which impacts prosperity by reducing the share of output which can be used for all purposes other than the supply of energy itself.

In France, and with all sums expressed in euros at constant 2017 values, GDP grew by 23% between 2000 and 2017. But this growth, whilst adding €433bn to GDP, was accompanied by a €3.07tn increase in aggregate debt. This means that each €1 of reported growth in the French economy has come at a cost of more than €7 in net new debt. Put another way, whilst French GDP is growing at between 1.5% and 2.0%, annual borrowing is running at about 9.5% of GDP.

Cutting to the chase here, SEEDS concludes that very little (about €100bn) of the reported €433bn rise in GDP since 2000 has been sustainable and organic, with the rest being a simple function of the spending of borrowed money. Shorn of this credit effect, underlying or clean GDP per capita is lower now (at €29,550) than it was in 2000 (€30,777).

Meanwhile, trend ECoE in France is put at 7.8%. Though by no means the worst amongst comparable economies, this nevertheless represents a relentless increase, rising from 4.6% back in 2000. At the individual or household level, rising ECoE is experienced primarily in higher costs of household essentials. In the aggregate, ECoE acts as an economic rent deduction from clean GDP.

Between 2000 and 2017, clean GDP itself increased by only 5.7%, and the rise in ECoE left French aggregate prosperity only marginally (2.2%) higher in 2017 than it was back in 2000. Over that same period, population numbers increased by 10%, meaning that prosperity per person is 7.1% lower now than it was at the millennium.

In France, as elsewhere, the use of credit and monetary adventurism in an effort to deliver “growth” has added markedly to the aggregate debt burden, which is €3.1tn (86%) higher now than it was in 2000. The per capita equivalent has climbed by 69%, making the average person €41,800 (69%) more indebted than he or she was back in 2000.

The prosperity powder-keg

To summarise, then, we can state the economic circumstances of the average French citizen as follows.

First, and despite a rise in official GDP per capita, his or her personal prosperity is 7.1% (€2,095) lower now than it was as long ago as 2000.

Second, he or she has per capita debt of €102,200, up from €60,400 back in 2000.

Third, the deterioration in prosperity has been experienced most obviously in costs of household essentials, which have outpaced both wages and headline CPI inflation over an extended period.

This is the context in which we need to place changes in the workplace, and a perceived widening in inequality.

On this latter point, part of the explanation for the anger manifested in France can be grasped from this chart, published by the Institut des Politiques Publiques.

In the current budget, policy changes hurt the disposable incomes of the poorest 10% or so (on the left of the scale), but ought to be welcomed by most of the rest – and perhaps might be, were it not for the huge handouts seemingly being given to the very wealthiest. Moreover, these benefits aren’t being conferred on a large swathe of “the rich”, but accrue only to the wealthiest percentile.

French budget 2

This is part of a pattern visible throughout much of the West. Unfortunately, perceptions of hand-outs to a tiny minority of the super-rich have arisen in tandem with a deteriorating sense of security. Security is a multi-faceted concept, which extends beyond security of employment to embrace prosperity, wages, living costs and public services.

Even in the euphoric period immediately following his election, it seemed surprising that French voters would back as president a man committed to ‘reform’ of French labour laws, a process likely to reduce workers’ security of employment. Add in further deterioration in prosperity, and an apparent favouring of the super-rich, and the ingredients for disaffection become pretty obvious.

Where next?

The interpretation set out here strongly indicates that protests are unlikely to die down just because the government has made some concessions over fuel taxes – the ‘gilet jaunes’ movement might have found its catalyst in diesel prices, but now embraces much wider sources of discontent.

Given the context of deteriorating prosperity, it’s hard to see how the government can respond effectively. Even the imposition of swingeing new taxes on the super-rich – a wildly unlikely initiative in any case – might not suffice to assuage popular anger. It seems likelier that the authorities will ramp up law enforcement efforts in a bid to portray the demonstrators as extremists. The scale of apparent support for the movement – if not for some of its wilder excesses – suggests that such an approach is unlikely to succeed.

Of course, it cannot be stressed too strongly that the French predicament is by no means unique. Deteriorating prosperity, a sense of reduced security and resentment about the perceived favouring of the super-rich are pan-European trends.

In the longer term, trends both in prosperity and in politics suggest that the West’s incumbent elites are fighting a rear-guard action. The credibility of their market economics mantra suffered severe damage in 2008, when market forces were not allowed to run to their logical conclusions, the result being a widespread perception that the authorities responded to the global financial crisis with rescues for “the rich” and “austerity” for everyone else.

This problem is exacerbated by the quirks of the euro system. In times past, a country like Italy would have responded to hardship by devaluation, which would have protected employment at the cost of gradual increases in the cost of living. Denied this option, weaker Euro Area countries – meaning most of them – have been forced into a process of internal devaluation, which in practice means reducing costs (and, principally, wages) in a way popularly labelled “austerity”. The combination of a single monetary policy with a multiplicity of sovereign budget processes was always an exercise in economic illiteracy, and the lack of automatic stabilisers within the euro system is a further grave disadvantage.

Finally, the challenge posed by deteriorating prosperity is made much worse by governments’ lack of understanding of what is really happening to the economy. If you were to believe that rising GDP per capita equates to improving prosperity – and if you further believed that ultra-low rates mean that elevated debt is nothing to worry about – you might really fail to understand what millions of ordinary people are so upset about.

After all, as somebody might once have said, they can always eat brioche.

= = = = = = =Pop per capita #141 5

#139: The surplus energy economy


According to conventional interpretation, the world economy faces no problems more serious than sluggish growth and rising tensions over trade. Though debt is high and asset prices are inflated, these issues are manageable within a monetary context that remains “accommodative” (meaning cheap).

Surplus Energy Economics offers a radically different and far more disturbing interpretation. Fundamentally, it states that global prosperity per person is now declining. This is a game-changer in terms not just of economics and finance but of politics and government, too. Deteriorating prosperity means that current debt levels are wholly unsustainable, and makes an asset market crash inescapable, even if the authorities persist with policies of ultra-cheap money.

This take on the economy could hardly be more starkly at odds with the consensus position. With due apologies to those regular readers for whom much of this is familiar fare, what follows is a synopsis of how the economic system is understood here. In stark contrast to conventional interpretations which portray the economy as a financial system, this article explains how, in reality, all economic activity is a function of energy.

As you will see, this simple observation turns the key in the door to an understanding of  how the economy has evolved in recent times, and where it is likely to go next.

Ever since the millennium, we have been engaged in trying to apply futile financial fixes to a deteriorating secular trend in energy-based prosperity. That’s akin to trying to fix an ailing pot-plant with a spanner. These efforts have bought us some time, but have caused serious economic, political and social harm without in any way changing the economic fundamentals.

Where planning and policy are concerned, we are in a truly peculiar situation. Those of us who understand prosperity know that the ongoing downturn is going to have profound consequences – but, as societies, we cannot even start crafting responses whilst consensus interpretation remains in a state of profound denial.

The energy economy

Surplus Energy Economics is a radically different interpretation which recognises that the economy is driven by energy, not by money. Energy is required for the supply of literally all of the goods and services that constitute the economy. Money, on the other hand, acts simply as an exchangeable claim on the products of the energy-based system.

Unfortunately, long habituation to economic expansion has led us into the false assumption that growth is a perpetual phenomenon on which the physical limitations of our planet have no bearing. The harder reality is that the characteristics of the earth as a resource package are the envelope which imposes boundaries on the scope for growth.

Human activity has always been an energy system, starting with the simple balancing of the inputs of nutritional energy with the outputs of labour energy required to obtain this nutrition. This equation was leveraged in our favour by the greater efficiencies introduced by agriculture, though the vast majority of labour remained dedicated to the supply of food. Only when the heat-engine enabled us to harness the vast energy potential of fossil fuels did we create conditions in which the securing of nutrients and other essentials became a minority activity.

The equation governing the value obtained from exogenous (non-human) forms of energy has two components.

The first is the total or gross quantity of energy to which we have access.

The second is the proportion of that total energy which is consumed in the process of accessing it, and therefore is not available for other purposes. The quantity consumed in the access process is described in Surplus Energy Economics as the Energy Cost of Energy (ECoE).

The difference between the gross energy quantity and ECoE is surplus energy. Because this is the source of all goods and services other than the supply of energy itself, this surplus determines prosperity.

We can, of course, deploy this surplus with greater or lesser efficiency. But we cannot escape from the prosperity parameters imposed by the surplus energy dynamic.

The energy cost equation

The quantity of surplus energy-based prosperity available to us is determined by the relationship between energy resources and the technology we apply to them.

At the gross level, the limits to potential are determined, not by the resources available, but by the quantities which can be accessed in ways where ECoE is less than the total energy value obtained. This means that the concept of “running out of” oil, gas or coal is not meaningful. Rationally, reserves of oil, gas or coal whose ECoE exceeds their gross energy value are not worth accessing, so will remain in the ground.

Where fossil fuels are concerned (though the principle is universal), four factors determine ECoE. Over an extended period, ECoE was driven downwards by geographical reach and economies of scale. Once these processes had been maximised, however, the new governing factor became depletion, a consequence of having accessed lowest-cost resources first, and leaving costlier alternatives for later.

The fourth determinant, technology, operates within the physical envelope of resource characteristics. During the phase where reach and scale dominated, technology accelerated the downwards trend in ECoE. Now that depletion has become the primary factor, technology acts to mitigate the rate at which ECoE is rising.

It must clearly be understood, however, that technology cannot breach the resource envelope determined by physical characteristics. For example, new techniques have made shale oil cheaper to extract now than that same resource would have been at an earlier time. But what technology has not done is to imbue shale reservoirs with the same characteristics as a simple, giant oil field like Saudi Arabia’s Al Ghawar. Technology works within the laws of physics, but it cannot change those laws.

It is mathematically demonstrable that, like any type of linear progression, the ECoE curve is exponential. Population numbers illustrate the exponential function. If a population of 1,000,000 people increases by 5% in any given period, the addition in that period is 50,000. Once the base number rises to 10,000,000, however, the increment is 500,000, even though the rate of change remains 5%. When charted, exponential progressions appear as ‘j-curve’ or ‘hockey-stick’ patterns, their apparent shapes determined only by the scale of the quantity axis.

The ECoE trap

Energy sources such as oil, gas and coal have matured to the point where the maximum benefits of reach and scale have been attained, and depletion has become the dominating driver. Fossil fuel ECoEs reached the low point of their parabola in the two decades after 1945, and have since been rising exponentially.

According to the SEEDS model, the fossil fuel ECoE progression has been as follows:

  • 1980: 1.7%
  • 1990: 2.6%
  • 2000: 4.1%
  • 2010: 6.7%
  • 2020E: 10.5%
  • 2030E: 13.5%

Renewable energy sources remain at an immature stage at which ECoEs are falling. Taken together, the ECoE progression for renewables is stated by SEEDS at:

  • 1980: 16.7%
  • 1990: 14.2%
  • 2000: 13.3%
  • 2010: 12.1%
  • 2020E: 11.1%
  • 2030E: 10.2%

In pure calorific terms, the ECoEs of renewables are likely to become lower than those of fossil fuels at some point within the early 2020s.

This does not, however, mean that transitioning to renewables will enable us to escape from the fossil fuel “ECoE trap”. There are three main factors which make this unlikely.

First, renewables account for just 3.6% of all primary energy consumption, with fossil fuels continuing to contribute 85% (and the remaining 11% coming from nuclear and hydroelectric power).

Second, renewables remain to a large extent derivates of the fossil fuel economy, requiring inputs which can be supplied only with the use of energy from oil, gas or coal. This imposes a linkage between the ECoEs of renewables and those of fossil fuels.

Third, and relatedly, it is unlikely that the ECoEs of renewables can fall far enough to restore the efficiencies enjoyed in the early stages of fossil fuel abundance. The overall ECoE of renewables is projected by SEEDS to fall to 10.2% by 2030, but this remains drastically higher than the ECoE of fossil fuels as recently as 2000 (4.1%), let alone back in 1980 (1.7%).

The world ECoE trend for all form of primary energy is as follows:

  • 1980: 1.7%
  • 1990: 2.6%
  • 2000: 3.9%
  • 2010: 5.9%
  • 2020E: 8.3%
  • 2030E: 9.8%


Economic implications

With the economy understood as a surplus energy equation, the history of economic development fits a logical pattern.

Throughout the period from 1760 to 1965 – roughly speaking, from the start of the Industrial Revolution to the post-1945 low-point of the ECoE parabola – the world economy was characterised by rapid growth in aggregate prosperity. This translated into steady improvement in personal prosperity despite the huge growth in population numbers over that period.

This era was characterised by (i) expansion in the gross amounts of energy consumed, and (ii) reductions in ECoE caused by reach, scale and technology. Surplus energy per person was thus on a strongly rising trajectory, growing at rates faster than the expansion in aggregate energy supply. The world became accustomed to growth, which came to be regarded as a natural phenomenon, even though some economists have conceded that our understanding of what makes growth happen is imperfect.

After about 1965, though the bottom of the cost parabola had been passed, ECoEs remained very low, rising from about 1.0% in the mid-1960s to 1.7% in 1980. This rise was modest enough not to impair the trajectories of growth in energy use, economic output, aggregate prosperity and population numbers.

Latterly, however, as the upwards trend in ECoE has become exponential, the scope for further expansion in prosperity has been undermined. It is probable that the rise in trend ECoE between about 1990 (2.6%) and 2000 (3.9%) marked a significant turning-point after which growth became ever harder to attain.

Because the 1990s had been regarded as a propitious period in economic terms – with expansion robust and inflation low – the onset of deteriorating growth was improperly understood. Indeed, this misunderstanding was inevitable given the absence of the ECoE factor from mainstream economic interpretation.

Responses to secular deceleration were required, for two main reasons. First, the public has long regarded growing prosperity as both a norm and an entitlement. Second, the world financial system is entirely predicated on perpetual expansion in the economy. Debt can only ever be repaid if the prosperity of the borrower increases over time.

With the consensus firmly established that the economy was a financial system, it was inevitable that financial solutions would be sought to address secular deceleration. This process began with making credit ever easier to obtain, a process furthered both by deregulation and by reducing real interest rates.

For some years, this expedient appeared to have been successful, as reported economic output boomed between 2000 and 2007. It transpired, of course, that this was a credit-induced boom, a familiar phenomenon, though one in which, this time, inflation was concentrated in asset markets rather than in consumer prices.

When this process led, inevitably, to the 2008 global financial crisis (GFC), the response once again was a financial one. In fairness to decision-makers, this response was largely forced upon them by the rapid expansion of debt – the only way in which a debt default crash could be prevented was by making debt ultra-cheap, both to service and to roll over.

Accordingly, policy rates were slashed to sub-inflation levels, whilst huge amounts of newly-created QE money were used to force up the prices of bonds, thus driving yields to extremely low levels.

It was always predictable – and is now becoming evident – that the monetary expedients adopted after the GFC would be no more effective than the ones which caused that crisis. Debt has continued to expand, asset prices have continued to inflate, and a series of adverse economic consequences have emerged as side-effects of the process.

In short, just as the process of credit adventurism operative between 2000 and 2007 led directly to the GFC, the subsequent policy of monetary adventurism must lead inevitably to a second financial crisis (“GFC II”).

Because the mechanism leading to GFC II has been different from the mechanism operative before the 2008 crisis, GFC II is likely to differ in important respects from its predecessor, with money, rather than just the banking (credit) system, at the eye of the storm. GFC II is likely, also, to be much larger than GFC I, with SEEDS indicating that exposure now is roughly four times the size of exposure in 2007.

The financial dimension

One of the most important lessons of recent economic history is that it is impossible to alter the course of an energy-determined economy using purely financial tools.

The reason for this mismatch is quite straightforward. Having no intrinsic worth, money commands value only as a claim on the goods and services supplied by a physical economy driven by energy. Though financial claims can be created at will, the creation of additional claims does not expand the quantities of goods and services for which these claims can be exchanged.

Inflation has long been understood as a monetary phenomenon, in which prices are forced upwards where the supply of money (“claims”) expands at rates faster than the pace of growth in economic output. Two significant qualifications are required to this statement. The first is that the velocity of money (the speed at which it changes hands) is as important as the stock of money in circulation. The second is that inflation may occur in a variety of locations, including asset prices as well as consumer prices. With these caveats stated, inflation is indeed “always and everywhere a monetary phenomenon”.

The relationship between two quantities – (i) the output of the physical economy, and (ii) the quantum of claims exercisable against that output – plays a critical role in determining financial conditions.

The economic experience since 2000 has been one in which claims have been created at levels far in excess of the rate of expansion in output. This statement has profound economic and financial implications.

Initially, excess claims were created primarily in the form of debt. Latterly, this process has been compounded by the creation of excessive monetary amounts. Stated in PPP-converted US dollars at constant 2017 values (the convention used throughout this discussion), aggregate debt expanded by $53 trillion between 2000 and 2007, and by $99tn between 2007 and 2017.

The increase in debt since 2007 has been accompanied by a rise of similar magnitude in the deficiency of pension provision, a process driven by the collapse of returns on investment which has itself been a function of ultra-cheap money. According to a study published by the World Economic Forum, real returns on US bond holdings have slumped to just 0.15% from a historic norm of 3.6%, whilst returns on equities have fallen from a historic 8.6% to only 3.45%.

This has more than doubled the rate of savings required to achieve any given level of pension provision at retirement. For the vast majority, levels of saving required to deliver pension adequacy have become unaffordable. The pension gap “timebomb” is likely, in due course, to become a hugely important economic and political issue.

These developments, most obviously the escalation in debt levels, have created huge increases in the prices of assets such as bonds, stocks and property. Put simply, bond prices are the inverse of the market yield requirement established by the cost of money, whilst equity pricing is driven by considerations similarly linked to interest rates. Property prices, too, are largely determined by the equation of inverse interest rates applied as a multiple to the median payment capabilities of purchasers.

That bubble conditions prevail across asset markets seems beyond dispute. But the mere existence of a bubble does not on its own imply an imminent crisis. The scale of risk associated with a bubble depends primarily on two issues, not one.

The first of these is the monetary context going forward (a bubble may be sustainable, and may indeed continue to inflate, so long as credit remains both cheap and easy to access). The second is the prosperity of borrowers. The latter, ultimately, is a function of the energy-based economy.

Another way to look at this is that, if monetary conditions tighten, asset prices are likely to fall, perhaps rapidly. Meanwhile, if the prosperity of borrowers diminishes, so does their ability both to service existing debts and to take on additional indebtedness, even if credit remains cheap. Under these conditions, supportive monetary policy is not guaranteed to prevent asset price falls

What this means is that forecasting the future cost of money is not a sufficient way of anticipating crashes in asset prices. In addition, we have to understand trends in borrower prosperity – but this metric is not provided by conventional econometrics.

Calibrating the energy economy

During the period between 2000 and 2007, aggregate debt expanded by $53tn whilst world GDP rose by $25tn. Between 2007 and 2017, growth in GDP was $29.7tn whereas debt increased by $99tn. In the earlier period, therefore, $2.08 was borrowed for each $1 of recorded growth, whilst the ratio in the latter period was $3.33 of borrowing for each growth dollar.

Over the last decade, credit has expanded at the rate of 9% of GDP, roughly three times the pace at which GDP has increased.

Conventional interpretation of the relationship between debt and GDP omits a critical connection between the two. Within any given amount of money borrowed, a significant proportion necessarily finds its way into economic activity. An economy which takes on substantial additional debt will, therefore, experience apparent “growth” in GDP, created by the spending of that borrowed money.

This credit effect is artificial, in the sense that (i) the apparent rate of growth would not continue in the absence of continued increases in debt, and (ii) growth would be put into reverse if the incremental debt was paid down.

This interpretation is reinforced by observation of the type of “growth” supposedly enjoyed. The experience of the United States in the decade between 2007 and 2017 illustrates this point.

Over that period, reported GDP expanded by $2.5tn, to $19.4tn in 2017 from $16.9tn (at 2017 values) in 2007. The combined output of manufacturing, construction, agriculture and the extractive industries contributed just 1.9% of that growth ($48bn). A further 7% came from increased net exports of services. But the vast majority – 91% – of all growth came from services that Americans can sell only to each other.

We need to be clear about what this means. The products of manufacturing, farming and extraction are traded globally and are priced by world market competition, so these activities can be grouped together as GMO (globally marketable output). But internally consumed services (ICS) are priced locally, so are residuals of consumer spending capability.

In short, what was happening during this decade was that American GMO was stagnant, not even increasing in line with population numbers. But ICS activities – residuals which Americans sell only to each other – increased markedly. This is wholly consistent with the fact that, during this period in which GDP increased by $2.5tn, debt expanded by $10.2tn. Money pushed into the economy by cheap borrowing shows up almost entirely in residual ICS activities.

The credit effect is so important that, in order to measure prosperity, it is necessary to arrive at a ‘clean’ measure of output from which this effect has been excluded. The ultra-loose credit conditions of recent years have created a large and widening gap between ‘clean’ (or financially sustainable) output, and recorded GDP numbers inflated by the credit effect.

For instance, within global growth of $25.3tn between 2000 and 2007, the SEEDS algorithms identify clean growth of $10.3tn and a credit effect of $15tn. The $29.7tn of growth recorded between 2007 and 2017 comprised a credit effect of $19.4tn and clean growth of $10.3tn. Therefore, the credit effect accounted for 59% of all reported growth in the earlier period, and 65% in the latter.

Once clean GDP has been identified by the exclusion of the credit effect, what results is a measure of sustainable output, something which equates to the aggregate of financial resources available for deployment. But the first call on these resources is the cost of energy supply because, if this economic rent is not paid, energy supply dries up, and activity grinds to a halt.

Therefore, prosperity is identified by deducting trend ECoE from clean GDP. This calibration is the primary purpose of SEEDS, the Surplus Energy Economics Data System.

Principal findings

Aggregate prosperity furnishes us with personal prosperity data, and also provides a critical denominator against which all other financial metrics can be measured. Here are some of the most important conclusions emerging from this process.

First, prosperity is already in marked decline in almost all Western economies, typically having peaked between 2000 and 2007. The only significant exception to this pattern is Germany, largely because of the benefits conferred on the Germany economy by the euro system.

Deteriorating prosperity, in conjunction with monetary manipulation adopted in failed efforts to counter it, have built huge risk into the financial system. The Western economies where risk is most acute are Ireland, the United Kingdom and Italy.

Most emerging market (EM) economies are at an earlier stage in the prosperity curve, and continue to enjoy increasing personal prosperity. But progress is now slowing markedly, not least because of the impoverishment of Western trading partners. China has grown its debt at a particularly dramatic pace in order to sustain activity and employment, and must be regarded as extremely risky.

Prosperity deterioration is already having a palpable effect on political sentiment in most Western countries. Popular dissatisfaction is eroding support for the ‘globalist liberal’ elites which have been in government for most of the last thirty years, and insurgent (sometimes called “populist”) movements have been the main beneficiaries of this process. At the same time, the decline in prosperity has started to erode the tax base.

Future domestic policy directions are likely to focus on (i) redistribution and (ii) opposition to immigration. We should assume that voters will turn increasingly to parties committed to these policies. We should also anticipate growing opposition to globalisation.

These, of course, are just some of the more important consequences of the downturn in prosperity. Critically, an understanding of the energy basis of the economy explains issues which necessarily baffle conventional interpretation which remains predicated on purely financial assumptions.


#138: Inflexion point


Whilst much of the world seems to be fixated with the tragi-comedy of “Brexit”, here, at least, we can discuss something of greater, indeed of profound importance. According to SEEDS, world prosperity per person has now turned down.

From here on, we get poorer.

Whilst prosperity has been deteriorating for a long time in almost all of the advanced economies of the West, this has been offset by continuing progress in a string of important emerging market (EM) economies such as China and India. This balance has kept the global average remarkably stable during a very extended ‘prosperity plateau’.

Now, though, latest updates to SEEDS – the Surplus Energy Economics Data System – indicate that the pattern has broken downwards. The EM economies can no longer carry global prosperity in the face of deterioration in their Western trading partners.

The inflexion-point in world prosperity has profound implications, of which three seem most important.

First, the downturn is a complete game-changer for politics and government.

Second, the divergence between dwindling prosperity and a still-expanding burden of financial claims and commitments makes some form of extreme correction inescapable.

Third, we need fundamental changes in how we interpret and manage economic affairs.

For this to happen, those who decide policy and mould opinion need to understand what prosperity actually is.

What is prosperity?

For the individual or household, prosperity is simply defined. A person’s prosperity isn’t his or her income, but what remains of that income after essential or ‘non-discretionary’ expenses have been deducted. An individual’s prosperity, then, is ‘discretionary’ spending power, meaning the resources over which he or she exercises choice.

For the economy as a whole, the rationale is the same, but the definition is different. At the macro level, the over-riding essential is the supply of energy. This is the number one priority outlay, for the simple reason that the economy itself is an energy system.

Conventional interpretation continues in the mistaken belief that the economy is a financial system, within which energy is ‘just another input’. But a moment’s thought is sufficient to debunk this illusion.

Money is a human artefact, which we can create at will. But money has no intrinsic worth, and commands value only to the extent that it can be exchanged for goods and services. The real function of money, therefore, is to act as a claim on the output of the real economy. Creating more of these monetary claims adds nothing whatsoever to the quantity of goods and services for which they can be exchanged.

Everything – literally everything – for which money can be exchanged is a product of energy. In pre-industrial times, the energy basis of the economy was confined to human and animal labour, and the nutritional energy inputs which these outputs required, The harnessing of exogenous forms of energy, starting with fossil fuels, leveraged this equation without changing its fundamental dynamic.

Whenever energy is accessed, some of that energy is always consumed in the access process. The driver of prosperity, then, isn’t the gross amount of energy to which we have access, but the net or surplus quantity which remains. This is why the Energy Cost of Energy, abbreviated here as ECoE, is a critical determinant of economic performance.

For fossil fuels, which continue to account for four-fifths of energy consumption, ECoE has followed a parabolic curve, trending downwards over a very long period before turning upwards in the immediate post-1945 decades.

The factors which drove fossil fuel ECoE downwards were geographic reach and economies of scale. Once these factors had been maximised, what took over was depletion, the simple effect of having accessed the easiest (lowest-cost) resources first, leaving costlier alternatives for later.

Technology has played, and continues to play, an important role, first accelerating the downwards trend in ECoE and latterly mitigating its rise. What technology cannot do, however, is over-rule the physical characteristics of the resource set.

Compared with the upwards trend in the ECoEs of mature fossil fuel resources, renewable forms of energy continue to enjoy the benefits of expanding reach and scale. But, and vital though renewables are, we must not exaggerate their capability to mitigate, let alone to reverse, the upwards trend in overall ECoE – critically, the inputs required for the development of renewables remain derivatives of the fossil fuel legacy, which ultimately links their potential ECoEs to those of oil, gas and coal.

The prosperity narrative

The exponential rise in ECoEs is the key factor explaining the evolution of economic affairs in recent years. According to SEEDS, global trend ECoE rose from a barely-noticeable 1.7% in 1980, and 2.6% in 1990, to 4.0% at the millennium (and it has doubled since then).

This increase, though at first pretty gradual, had, by the late 1990s, reached a point at which the capability for further increases in prosperity began to peter out.

This trend, perceived (if at all) as a seemingly-inexplicable slowing in secular growth, was not acceptable either to a system of governance based on continuously rising prosperity, or to a financial system wholly predicated on perpetual growth. The response was to try to evade this reality using monetary expedients. These are described here as financial adventurism.

Initially, this took the form of credit adventurism, which involved making debt ever easier to acquire. Between 2000 and 2007, debt expanded by much more (+43%) than the underlying aggregate prosperity available to carry it (+13%). This ensured, first, that a financial crash would occur and, second, that this crash, being debt-caused, would have its greatest impact on the banking system.

Latterly, the emphasis was switched from credit to monetary adventurism, characterised by the creation of vast quantities of new money, and the slashing of interest rates to all-but-zero, meaning that real, ex-inflation rates have been zero, or negative, since the 2008 global financial crisis (GFC I). Like its credit predecessor, monetary adventurism makes a financial crash inevitable, but with the difference that this event (GFC II) will not be confined to the banking system, but will threaten fiat currencies as well.

The underlying story

To understand what is really going on, it’s imperative that we look behind the “growth” supposedly created by financial adventurism.

Comparing 2017 with 2000 – and expressing all values in 2017-equivalent PPP dollars – reported GDP expanded by $55 trillion (+76%) whilst debt escalated by $152tn (+125%).

This means that, globally, each $1 of reported “growth” since 2000 has been accompanied by $2.76 of net new debt. During the earlier, credit adventurism phase, which was confined largely to the West, the world ratio of growth-to-borrowing was 2.1:1. Latterly, in the monetary adventurism phase, and with ZIRP in place and EM countries joining in, the ratio has been 3.3:1.

The fundamental point, though, is that most of the recorded “growth” in the years since 2000 has been nothing more than the simple spending of borrowed money. In order to identify what has really been going on, SEEDS strips out this ‘credit effect’ to identify clean GDP, and the rate at which this number has been growing.

Comparing 2017 with 2007, supposed “growth” of $29.7tn equates to an increase of only $7.7tn in clean GDP. The remaining $22tn – accounting for 74% of claimed “growth” over the period – was the effect of pouring almost $100tn of additional debt into the system.

This interpretation necessarily has a transformative effect on the measurement of risk. Put simply, the debt ratio implications of a borrowing binge are damped down by the apparent (though unsustainable) boost given to GDP by the spending of borrowed money. Thus, though world debt stood at a reported 215% of GDP at the start of this year, it equated to 301% of the smaller, credit-adjusted measure of clean GDP. Likewise, the true scale of the world banking system, as measured using aggregate financial assets, is far larger than the ratio calculated using credit-inflated headline GDP.

Prosperity – where now?

Once we’ve arrived at clean GDP, the calculation of prosperity further requires the deduction of trend ECoE from this number. World prosperity, thus calibrated, was $83.5tn last year, an increase of 24% since 2000.

Unfortunately, two other things have happened over that period – debt has more than doubled (+125%), and population numbers have expanded by 22%. The former number means that, worldwide, people have 85% more debt now than they had in 2000. The population increase means that they have become only marginally (+2.4%) more prosperous over the same period.

The plateau in overall world prosperity per person since 2000 has, of course, masked starkly divergent regional trends. Whilst people have become 120% more prosperous in China, and 87% better off in India, the citizens of most Western economies have been getting poorer, typically since the early 2000s.

Prosperity in the United Kingdom, for example, was 10.2% lower last year than it was in 2003, whereas Americans have become 7.3% less prosperous since 2005. The average Italian is 13% poorer now than he or she was back in 2001.

From here on, the big change is that prosperity growth in the EM economies is likely to slow to rates which can no longer cancel out continuing impoverishment in the West. Essentially, what’s happening in the EMs is that, with ECoE continuing to rise, and with their Western trading partners getting poorer, trend growth in countries like China and India will slow. It might, of course, be possible to maintain the semblance of “growth as usual” for a while, but only at the cost of piling on ever larger amounts of debt. That is exactly what’s been happening in China.

And this, of course, leads us to one of the most important consequences of deteriorating prosperity – the inevitability of the world financial crisis known here as GFC II.


Comparing 2017 with 2007 – the year before GFC I – debt has increased by 57%, whilst recorded GDP has expanded by 30%. Where debt ratios are concerned, this apparent “growth” has moderated the effect, such that the 57% rise in the quantity of debt has lifted the debt-to-GDP ratio by only 20%, from 179% in 2007 to 215% now. Conventional interpretation states that, in a climate of ultra-low interest rates, this increase in the debt ratio is manageable.

But this, of course, is misleading, for a series of reasons. First, most of the GDP “growth” recorded since 2007 has been cosmetic, amounting to nothing more than a credit effect which would disappear if the supply of cheap and easy credit dried up.

Second, the debt figure itself disguises other adverse balance sheet effects, most obviously the emergence, courtesy of ultra-low returns, of huge holes in pension provision.

Third, the explosion in the quantum of debt since GFC I has created gigantic bubbles in asset classes such as bonds, stocks and property.

To be sure, there’s a theoretical argument which states that these bubbles needn’t burst so long as money remains ultra-cheap. The drawback with this is that, because we’ve piled monetary adventurism on top of the credit variety, debt and the banking system are no longer the major locus of financial stress – we need now to be aware of the threat posed to the viability of fiat currencies by a decade of monetary extremism.

Beyond the inevitability of GFC II – an event likely to be at least four times the magnitude of its 2008 predecessor – the broader implications of the downturn in global prosperity must be left for further consideration.

We can, though, conclude that, from here on, prosperity becomes at best a zero-sum game, stripping away the logic of ‘mutual benefit’ founded on the Ricardian calculus of comparative advantage.

This “transition to zero-sum” logically marks the start of three new trends -the retreat of ‘globalism’, the rise of more nationalistic politics, and a new and growing emphasis on redistribution. Beyond redistribution, the political emphasis now is likely to swing towards opposition to immigration, based on perceptions that this process dilutes prosperity.

None of these trends is either wholly new or entirely a matter of prediction rather than observation – after all, declining prosperity has been a feature of most Western nations for at least a decade, so we’re already witnessing many of its political symptoms.

Predicting that the era of the ‘liberal globalist’ elites is over is the easy part – the hard part is to work out what replaces it, and how the transition takes place.

Another issue which must be deferred for later consideration is that of how we can best manage the downwards trajectory of prosperity. We have many useful tools, not least the interpretations bequeathed to us by thinkers like Adam Smith and John Maynard Keynes. Forging a practical approach is likely to require, first and foremost, a recognition that, whilst our intellectual inheritance is invaluable, doctrinal extremism is a luxury that we can no longer afford.

#137 global prosperityjpg_Page1