#17. Finance, the economy and bomb disposal

Preparedness and the Coming Crunch

To me (and, I imagine, to many readers here), the comparatively imminent detonation of a financial time-bomb seems pretty obvious. Unable to find real growth, the economy is living instead on printed and borrowed money, and the merest whisper that the money-printing, credit-creating sausage-machine might be turned off can be enough to create panic in capital markets.

In a way, this situation is analogous to bomb disposal, except that no-one knows how to defuse this type of bomb, and few have yet acknowledged that the bomb exists at all.

Once upon a time, American comic Bob Newhart mused about how bombs are always dealt with by experts. In the ensuing sketch, a bomb is dealt with by “a team of non-experts”, with particularly hilarious results. A few years earlier, British comedy giant Tony Hancock had found himself in a similar position in an episode in which the Army sends an officer from the Catering Corps to defuse a bomb in his cellar.

In both cases, the bomb explodes.

Minus the humour, that’s where we are now, because there are few if any experts where our kind of bomb is concerned. Worse still, many of those in charge of world economic affairs don’t appear to know a bomb from a broomstick.

In the Hancock episode, Tony suggested wrapping the bomb in Hattie Jacques’ thick treacle pudding. Today, we’re doing much the same as we wrap our economic bomb in the treacle of created money and credit.

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Since most readers will know this bit, I’ll explain the underlying rationale very briefly. Contrary to widespread belief, the economy is an energy system, not a monetary one. The output of the economy is a function of surplus energy, which is the difference between (a) energy extracted or otherwise accessed, and (b) energy consumed in the access process.

Energy, of course, is not just oil, gas or electricity, but nutrition and human labour as well. The first energy surplus was created by agriculture, when the ability of 20 people to live on the labour of 19 enabled the 20th person to do other things, be it government, education, the military or – most importantly – the creation of capital goods such as ploughs, roads, barns and bridges.

The only value that money commands lies in its acceptability as a “claim” on the goods and services produced by the real (energy) economy. In the agrarian era, all transactions involved payment for labour – past labour, if you were buying an existing house or plough; current labour, if you employed someone to plant a field; or future labour, if you commissioned someone to build you a barn. “Labour”, “energy” and “capacity to do work” are interchangeable terms. Anything bought or sold today is the product of energy, but in our modern society that energy is far likelier to be provided by fuel than by human effort.

Just as money is “a claim on goods and services” – put more simply, “a claim on energy” – debt, as “a claim on future money”, is really “a claim on future energy”. That’s fine, so long as we do not create “claims” (in the form of money and debt) that exceed the real goods and services that will be available when the claims fall due. If this happens, all claims cannot be met, so the excess has to be eliminated via one or more forms of “value destruction” (of which the most obvious are default and inflationary devaluation).

The energy surplus has been weakening for some years, because the energy consumed in accessing energy – in the jargon, the “energy cost of energy”, or “ECOE” – is rising as the most efficient energy sources are displaced by costlier and more marginal alternatives.

The equation here is the “energy return on energy invested”, or “EROEI”. Back in 1990, the global EROEI was about 37:1 (38 units were accessed, 1 unit was consumed in the access process, and 36 units remained for us to use). Now, my work suggests that the global average EROEI has fallen to less than 14:1 (15 units are accessed, 1 unit is consumed in the access process, and 14 units remain for us to use).

This means that the energy cost of energy has risen from 2.6% (1/38) to 6.7% (1/15), and could soar to over 9% by 2020.

In short, our economy is becoming less productive. Real growth has stopped, and is going into reverse. Our answer has been to create money (and credit) in ever larger quantities.

Lastly, an economy probably cannot afford capital investment below an EROEI of about 14:1. That’s where we are now, and this, fundamentally, is why real (post-inflation) interest rates are being kept negative by the authorities. Negative real interest rates logically mean that nobody saves. If nobody saves, no net capital is formed, and no net investment in capital assets takes place. Many countries simply cannot afford to invest, since output is barely sufficient to meet current needs.

What happens next is that, in one way or another, money loses its value.

Are you with me so far?

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So, the challenge for us now is to prepare ourselves. This depends on where (both geographically and organisationally) we are now. If you’re reading this in Riyadh or Oslo, don’t worry about it – scarcity is going to drive up the value of your energy resources (though don’t put too much faith in any investments that you may have that are denominated in other people’s currencies).

For the rest of us, our societies have to adapt. To clear the decks, let’s rid ourselves of what might be called the “juvenilia” of transition. For the most part, biofuels are idiotic. Out of each three or so units of energy accessed, one unit is used up in the access process – and we have 7 billion mouths to feed with finite amounts of land (and increasingly expensive inputs). Electric vehicles are another form of idiocy – the process of converting other fuel forms into electricity loses roughly two-thirds of the initial energy content. The same applies to hydrogen.

Renewables are the future. Historically, they have had lower EROEIs (and higher ECOE energy costs) than fossil fuels, though this differential is now disappearing. Converting waste into heat is imperative. Systems need to be redesigned, with shorter supply lines (stop shipping food half way around the world and grow it locally instead), and we need far greater energy efficiencies (scrap the SUV and get on the bus).

In most of countries – other than the net energy producers – we’re getting poorer. That’s not necessarily the disaster that you might suppose, since the idea of a linear equation linking happiness directly to the material ability to consume is nonsense (and if you doubt that, please re-read Affluenza).

The distribution of income and wealth is going to become even more critical (and controversial) than it’s ever been before. We need to reward initiative and effort, but we will be unable to afford what I might call “fossilised wealth structures”.

We need to be flexible, and the society of the future will not be able to afford the collective indulgence of ideology. There are some things that private enterprise does far better than the dead hand of the state, but there are some services which are better provided collectively.

Our societies will need to be open-minded, pragmatic, efficient, non-ideological, fairer and – if I may put it this way – more modern.

Now, can your society change, or is the weight of tradition, consumerism, vested interests, ideology and irrationality simply too great? Are family and community values strong enough to let adaptation happen without too much social or political disorder? If your society can adapt, that’s good. If adaptation requires persuasion, involvement and effort, do it. If the prospects seem really bad – and depending, of course, on your own circumstances – you might need to move to somewhere else.

Don’t put too much faith in money, as the value of money will be trashed if we keep on creating it to sustain the illusion of normality. Farm-land is good, but only if input requirements are low-intensity. There should be no lack of opportunities, since solar and wind developments are imperative, as is waste conversion to heat. 

Forgive me for finishing this way, but – please – think things through. Try to be open-minded, and don’t believe everything you’re told. We don’t need a bunker mentality, but we do need flexibility.       

23 thoughts on “#17. Finance, the economy and bomb disposal

  1. Tim, I find your analysis interesting but incomplete in that it omits the economic role of location – or 3D space – which is a part of ‘land’.

    Perhaps two thirds of money in existence came about through credit created in the form of mortgage loans by credit institutions aka banks. This credit is based upon the use (rental) value over time of location, and the value embedded in that location which in my analysis is a combination of energy in material form and intellectual value (both in the form of IP and the knowledge and knowhow which qualifies labour).

    So we cannot ignore the energy embedded in and passing through location, and in transport across location, and more to the point – the scope for energy savings in the use of location.

    In my view there is colossal scope for energy efficiency and savings and such savings have a value at the retail price (unlike renewables which are typically sold at the wholesale market bid).

    I believe – and am acting upon this belief – that one of the Big Trades of the 21st century will be the exchange of intellectual value (IP, knowledge and knowhow) for the value of carbon fuel saved. It is far more profitable to prospect for and mine carbon fuel savings than it is to prospect for and mine the raw materials.

    Energy savings cover a whole gamut within the built environment. As Kunstler put it, US suburbia is the greatest misallocation of resources in human history. With the right agreements, and the right instruments, I believe it is possible to transition from a moribund $ economy to an energy and knowledge economy.

    • A lot of food for thought here!

      The scope for energy saving is indeed enormous. Current use is incredibly wasteful, but has become habitual.

      But here’s a thought – maybe our economic system actually depends on waste? Would food manufacturers’ profits collapse if we consumed every gram of food we purchase, instead of wasting maybe 40% of it? What would happen to car sales if cars lasted for 20 years rather than 10? Or if we all took the rational (?) decision to use public transport instead? What would happen to power industry profits if we all insulated our homes effectively, and installed solar and wind (whilst keeping them off-grid and avoiding the snare of “feed-in”)? Would other industries’ profits suffer if customers became more wise/frugal/responsible?

      Basically, I agree 100% about waste (and 100%, too, about suburbia). But I wonder if there are vested interests where a “throw-away economy” is concerned?

    • This post touches a number of areas for me. I am a developer working in urban locations. Kunstler is right about suburbia, but the challenge of retro-fitting it to something more sustainable is going to be very difficult. Unlike urban locations, where historic uses (public, industrial, distribution) offer up large sites with EOS, suburbia is full of fragmented ownership where site assembly will be a nightmare. New development will be possible in the older inner suburbs where public transport can achieve the population densities required. How do you get the owners of 3000sf detatched homes to give up their way of life? Will it require a seismic market correction, that leads people to abandon their prime asset? Or will there be wholescale expropriation to clear out the sites with best potential for productive reuse? There are huge economic, social and psychological dislocations associated with resetting an expectation. We already have the early signs, such as home ownership in most developed economies reaching(what I believe) is a high water-mark in the mid 2000’s and has declined since. Renting will increasingly become the tenure of economic choice / necessity. Detroit is a fascinating example where swathes of abandoned homes are cleared by the City for safety, and the plots are literally returning to their natural form, prairie.

      Tim’s focus on the ability, or willingness, of a society to adapt is key. The economics of welfare will surely add to the inertia, and any resetting of the “spatial fix” (per Richard Florida) will require an allocation of capital not all economies will be able to afford. Suburbanism was less completely adopted in Europe (vs NAmerica) and that may be a saving grace. I left London a few years ago, and now work in Alberta. My hunch is that resource scarcity will make oil producing regions a priority, and they may have the surplus required to undertake the capital investment required to reset the spatial fix.

      @ Thomas Lunde, there are some sawmill to district energy projects in BC. Look up what Fortis is doing in Kelowna.

      Tom Burr MRICS

  2. Thomas Lunde Canada, BC Interior, Wilderness Area

    Well I’m not your usual theorizer but I do have a thought to add to this article. A bit of background. I am located in an area where three sawmills have shut down over the last 5 years. Each sawmill has left a small mountain of sawdust just sitting there waiting to be used. No one, to my knowledge has thought of a use for this potential thermal resource. The question then is how to turn this resource into a productive endeavor?

    Steam engines! Yes, let’s go back a 100 years to steam. A steam boiler can use sawdust as a heat source. Steam provides power. Power can be heat to be used, say in a greenhouse or as horsepower as in a steam engine or heat as in a hot water heating system.

    In this case the sawdust is free and could be moved if necessary by horse and wagon to the boiler location.

    Now it so happens that my partner and I have access to 100, double pane glass windows, 4 x 4 ft in size. We also have land bounded on three sides by water and a water table of less than 10 ft.

    We are exploring the idea of using this sawdust as a heat source for a steam boiler to have year around greenhouse’s, heat for living quarters and power for electric generation.

    I would be interested in your thoughts on our plans.


    Thomas Lunde

    • This is so far outside my experience that I don’t feel I can comment on your plans – but it sounds like you’ve thought this through really thoroughly and are really excited about it, which is great!

    • EROEIs for these are reasonably well established. This doesn’t mean that the energy they produce is optimal, of course – most obviously, neither produces liquid fuel for transport. But in pure EROEI terms, we’re not all that far from cross-over – EROEIs on remaining fossil fuels are falling rapidly, and will before long be lower than we can get from wind and solar.

    • Fossil fuel EROEIs are falling rapidly, but some FFs still give us attractive surpluses – and yes, we need to use this opportunity to invest in renewables, whilst we can still afford to do so.

      But I question whether many of our countries can actually afford to invest in anything anyway. Negative real interest rates suggest that these economies have no capability for saving – we deter, not encourage, saving, and ultimately investment can come only from saving or from borrowing. So organic (self-funded) net investment might already be unaffordable.

      Healthy investment levels funded by saving might require a real interest rate of, say, 3% or better. With inflation at c2% (if you belive official data), that implies that rates of 5% are required for savings-based investment. Could Britain, the US or the Eurozone live with 5% rates? Personally, I doubt it. So this could mean that real economic output (surplus energy) has already fallen far enough to prevent investment.

  3. Excellent article Dr Morgan, I wonder how much of the energy conversions in the Uk economy are derived from human effort as we seem to be mostly service based. Does this mean we are insulated to a degree from high fossil fuel prices ?.

    • Thanks. Please note that the only human energy input that we can calculate is physical labour. My calculation for the UK puts this at less than 0.5% of all energy used in the economy.

      Most of our work is not physical labour, involving energy. Our total energy comes overwhelmingly from inputs (oil, coal etc) (99.5%), and only marginally from human labour (0.5%). But this energy MAKES EVERYTHING ELSE POSSIBLE. Even a rocket scientist needs food, a home, warmth, transport, water and so on, physical things that energy alone can facilitate.

      Energy – in forms such as food and resources, not just power and fuel – is critical.

      So being a service based economy is not a cushion. It just means that others provide our food, travel, warmth, resources and so on. So actually it makes us more vulnerable, not less.

  4. My spouses grandmother born in 1906, saw the invention of the car, electricity, airplanes, telephones, medical miracles, three wars containing Canadians, lived on a farm in the depression, and raised 4 children. She passed at 94 years old but had her capacities right to the end. When we talked about the world unfolding she would shake her head and exclaim we are doomed and then chuckle.
    Once, in the many conversations we had, she said the people in the depression were happier than they are today (1994). I said how can that be, most had lost everything, their jobs, house, savings, cars, etc. She said there was a banding together by people to help others. Interesting to know as we may be for an adjustment of this magnitude.

    In a highly leveraged world that is unfolding that may be what is left- giving a helping hand. sdl

    • Thanks, interesting comments. The point about the great depression is very pertinent – memories from my own family members also suggests that there seems to have been more social cohesion then.

      We need to be a little wary here – Britain’s much-vaunted “Blitz spirit” is a gross simplification – but the general point seems to be that social cohesion and mutual support are very important, something I tried to bring out in the book.

      If there’s a sequel to “Life After Growth”, I’ll try to give still more attention to this point.

    • Thank you very much.

      As I think many readers know, I’m not decided on where to go next with this work. Getting the Surplus Energy Economy thesis into print was a big ambition for me, and that’s what “Life After Growth” accomplished.

      Comments here are very helpful as I consider future work.

  5. Tim – In relation to your future work. The thing which alerted me to your work and thinking, was what you were writing about the UK economy. For example, in November 2011, you wrote “In 2009 (the latest year for which fully detailed data is available), the three principal debt-driven sectors accounted for 40% of total output, and the three biggest state-funded sectors contributed a further 19%. If retailing (11%) is added to the ex-growth group – which it surely must be, with consumer incomes under severe pressure – it becomes apparent that a frightening 70% of the British economy is incapable of growth”.

    Is the current situation any better?

    Maybe you could develop this kind of analysis? It shocked me into an awareness of the real world of which most of my friends were unaware. Why not keep hammering away at the differences between what we are told and the realities of what is going on?

  6. Barry

    Thanks, good thoughts as ever.

    The structure of the UK economy has changed very little, and we’re still unable to expand GDP by £1 without borrowing a lot more than £1 to do it.

    What I’m not sure about would be *where* to develop this kind of analysis – any suggestions most welcome…………..

    • Tim

      What is the underlying aim of the blog? Is it more than “just” analysis?

    • Barry, I’m not even sure I can answer that! But I’ve no problem with “thinking aloud” here about it.

      Before the “Perfect Storm” report, and the book, I felt I’d arrived at some interesting conclusions that people could benefit from. At Tullett, I’d always relished the blog because people’s comments were almost always interesting, and often sparked new ideas. So, after leaving TP, I set up my own blog. Simple as that, really.

      Beyond that, I don’t know. On UK matters, my feeling is that no one in a position to do anything about anything actually listens, and maybe no-one appreciates the scale of coming challenges. On the energy issue, the situation is similar, really. There are good advocates of these issues (Richard Heinberg comes to mind) but nothing much seems to happen.

      So, that leaves me pondering – and no answers have turned up as yet….

  7. Tim

    Your experience, telling things as they really are, and apparently not being heard by those in a position to change things, seems to be the way things are when truths which undermine established ways are seen to threaten the power of those with vested interests.

    My experience, as employee and user of a range of public service sectors since the 1950s, was always that when I strayed outside conventional thinking my views were blocked by vested interests. Not just that “they” disagreed, but they seemed unable to hear what I was saying or writing. As you have said “they just didn’t get it”.

    I used to think the problem was to do with my inability to explain my thinking. I now believe that those with vested interests cannot be expected to change their thinking. It would be a kamikaze act!

    Having accepted that this is the way things are, I am content to develop my own understanding of the way things are and avoid the frustration of trying to convert non-believers to my perception of reality.

    But then I am an old man, and maybe I am beginning to conform with what is expected of me!

    • Barry

      I can relate closely to what you say. To explain, I’ve been an analyst since the 1980s. The job satisfaction, for me, has always been about working things out, and hopefully being more often right than wrong.

      For most of that time I analysed equities – in my case, big oil companies. In doing that, you look through ALL the financial numbers, seeking out anomalies or leads to new interpretations. (Cash flow, not profit, is always my preferred guide to performance). You look at the context (for instance, oil prices and so on). You look at operations (production, refining and so on). You look at management quality, management structures and corporate governance.

      Coming from this background, I apply this to the economy. Not just GDP (“income”) but the balance sheet, off-balance-sheet issues, and the cash flow position (GDP adjusted for borrowing). For “operations”, I look at business segments (in this case, I look at a country a bit like a conglomerate, engaged in many industries – what is the outlook for each, and is the mix of industries a good one?). Does anything signficant lurk behind reported data? How good is the context (the global economic outlook)? How good is the management? What are the risk exposures?

      Let me give an ebxample. Japan is a case in point. The strategy is gravely mistaken, which raises questions about management judgment. The balance sheet is mega-weak. Operations are distorted (energy deficiency, in this case). Risks are high (energy prices, savings ratios, demographics, for instance). Cash flow is weak. Off-balance sheet contingent liabilities are huge (ageing population, future welfare costs). If shares in “Japan Inc” were traded on any stock exchange, I’d be a seller rather than a buyer of the shares.

      There’s one very big difference, though. With most big oil companies, if you think you spot a weakness, a risk or an opportunity, management will listen to you and engage with you. They’ll take your ideas seriously.

      Governments, unlike oil company managements, don’t do that…..

  8. People need to realize that solar, wind and other renewable resources can go only so far. Technologies such as LFTR (liquid fluoride thorium reactor) need to be part of the discussion. Unfortunately, ome people would rather dismiss them out of hand.

    • Chris

      I agree. In my book I explain why, quite apart from anything else, renewables aren’t scaleable to the required size. We’d have to plaster the globe in wind turbines and/or solar panels (and how much energy would have to go into such a project?). As for biofuels, we’re going to struggle to feed 7 billion people anyway, even without feeding vehicles rather than people.

      But the problem with thorium – please correct me if I’m wrong – is that it isn’t demonstrably workable yet. I understand that we’ve yet to reach energy in/energy out break-even, that indeed we’re a long way from that, and that reaching this might take decades, plus vast investment.

      What worries me is that I don’t think we have decades. Fossil fuel reserves remain abundant, but extraction costs are escalating. That’s going to knock on into the cost of virtually everything, most notably food, water and minerals.

      I believe that the global economy is already limping along rather than growing. If I’m right, how are we going to afford vast investment in thorium?

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