#85. Perfect Storm gets nearer

SURPLUS ENERGY ECONOMICS – AN UPDATE

If you have read Life After Growth (2013 and 2016), or before it Perfect Storm (2011), you will be familiar with the thinking on which the theory of surplus energy economics is based. Though the next article here was to have been a rescue plan for the British economy, it seems more important to update you on surplus energy economics.

My perception is that things are starting to stir, and that the climate is becoming much more receptive to ideas which challenge the traditional interpretation of economics.

What’s happening now?

Though less than six years have elapsed since Perfect Storm, a great deal has changed. Back in 2011, many found it disconcerting that the head of research at a major City institution would put his name to a report stating that a tightening of the energy equation might be bringing 200 years of economic growth shuddering to a halt. Though there were exceptions, much of the mainstream response varied between the dismissive and the derisive. Many, I felt, did not want to accept an analysis which would challenge their fundamental assumptions, as well as predicting an end to a relatively satisfactory state of affairs.

Now, though, this is changing – in two main ways. First, if the Perfect Storm thesis had been wrong, we should know by now, because the economy should be growing strongly, indebtedness should be decreasing as we implement the lessons learned so painfully in 2008 and, above all, there should have been a return to normality.

Instead, we have “secular stagnation”, where such growth as does occur reflects nothing more than the spending of borrowed money. Debt continues to escalate, and the extreme abnormality of ZIRP and other forms of monetary manipulation is doing a great deal of harm. (Even if rates creep up a little, by the way, we will remain a very long way from normality).

Second, economists are now starting to question their prior certainties, with some members of the profession prepared to admit that they may have got it wrong. The credibility of economics itself is in the spotlight.

In short, the economy is moving on in ways that refuse to conform to conventional theory, but bear a closer resemblance to the surplus energy interpretation. The thesis that the real economy would stumble, and that we would go on driving an ever-wider and more dangerous wedge between the “real” and “financial” economies, does seem to be happening.

What is Surplus Energy Economics?

Very briefly, SEE says that the economy is an energy system, not a monetary one. Prosperity is determined by surplus energy – that is, the energy available after the deduction of the energy which is always used up whenever we access energy.

Our entire history can be seen in this way. As hunter-gatherers, all the energy that people obtained from food was consumed obtaining that food, so there was no surplus, no economy and no society.

Agriculture was the “first great breakthrough” because it created the first energy surplus. Put simply, the greater efficiency of farming compared with hunter-gathering, plus the use of animal labour, enabled twenty people to be fed by the labour of nineteen, freeing the twentieth to do other things. This first energy surplus was small, and most people continued to undertake subsistence activities. But there was now an economy of sorts, and a society developed in parallel with it. People could now, for the first time, invest, sacrificing current consumption to create capital assets (such as barns, bridges, agricultural implements and rudimentary workshops) which would improve their lot in the future.

A vastly bigger energy surplus was created when we learned to tap fossil fuels, such as coal, oil and natural gas. This triggered two centuries of exponential growth, not just in economic output, but in population numbers and energy consumption as well. So sophisticated have economies become that, most notably in the West, very few people are engaged in producing food.

The end of growth?

For decades, people have speculated about the relationship between exponential growth and a finite planet. This debate rages on, but the balance is tilting, in two very obvious ways.

First, we are discovering the limitations of the earth as an ecosystem and, second, the surplus energy which has driven growth in economic output and population numbers is coming under mounting pressure.

Where fossil fuels – still well over 80% of our energy consumption – are concerned, two factors are in play. Depletion is robbing us of the gigantic, ultra-low-cost sources of energy which hitherto powered economic growth. Technology is endeavouring to offset this, both increasing the efficiency with which we access conventional fuels, and enabling us to tap energy from renewable sources.

Technology will doubtless continue to progress, but we are in danger of complacency over technological solutions. Renewables still account for barely 3% of global energy consumption, and no-one has yet worked out how to power a 747-size jet using renewables, or how to extract 1 tonne of ore from 500 tonnes of rock without using fossil fuels.

We should be optimistic about renewables, but also realistic. Renewables can supply energy more cost-effectively than fossil fuel sources discovered and brought on stream today. But my interpretation of the thermodynamic balance is that renewables are not going to take us back to an age of vast, low-cost, high-surplus energy from giant fields.

Measuring the state-of-play

If the economy is fundamentally an energy system, we need to assess our situation using measures which are energy-based, not financial. One such measure is EROEI (Energy Returns On Energy Invested). Another is ECoE (the Energy Cost of Energy).

I have long postulated an ECoE curve which is trending upwards relentlessly. I want to be quite clear about the lack of available data, which reflects a lack of financial support for research. The trend ECoE curve used here has been developed and refined over several years, and is subdivided by fuel and location. The system I use is called SEEDS (the Surplus Energy Economics Data System). It can only be a “best estimate”, but I derive encouragement from its seemingly good fit with what is happening to the economy.

This overall curve suggests that ECoE has been on a rising trend since the 1960s. Initially, increases were pretty modest, with ECoE increasing from 1.2% in 1970, via 1.9% in 1980 and 2.8% in 1990, to 4.2% in 2000. But, because this is an exponential progression, the rate of increase is rising markedly. My estimate for trend ECoE in 2010 is 6.4%, and this is projected to rise to 9.6% by 2020.

In short, we have now moved into territory where ECoE, once a number so small that we could afford to ignore it, starts to destroy the capacity for growth.

The concept of ECoE is best understood as “economic rent”, a charge levied on the economy by the limitations of the earth’s resource set. It is not the same as financial cost, because cost is a closed-system – money spent by, say, a company developing an oil field or a solar project, is a cost to that company, but an income to others, such as contractors, suppliers and employees.

Rather, ECoE is an economic rent, levied by resource limitations but not accounted for when we measure the economy. It can be thought of as a restriction of choice, forcing us to spend more on energy and, therefore, less on other things. It is in some ways analogous to taxation – tax does not reduce gross income, but it forces the recipient to use some of it in a way that might not be his or her preference, reducing how much can be spent in ways that the person might like.

In case this seems remote and theoretical, ECoE is already, and noticeably, eating into our discretionary incomes. As a direct corollary of rising ECoEs, the cost of household essentials has long been rising much more rapidly than general inflation, undermining how much of our incomes we can spend as we choose. I have explained before how prosperity is not a function of how much money someone has, but of how much choice (“discretion”) that person has after paying for essentials.

Finally, ECoE is only tangentially related to the current price of energy to the end-user. As prices soared between 2000 and 2007, and remained high until 2014, massive investment was poured into energy supply. This created a glut which, as well as driving prices down sharply, resulted in a slump in investment. In due course – and depending, of course, on demand – this dearth of investment could drive energy prices sharply higher. But pricing, ultimately, is a cyclical process acting as “noise” around the trend determined by the interplay of depletion and technology.

What next?

If the surplus energy interpretation of the economy is correct, growth should continue to prove elusive. But our system is so predicated on growth – a topic for another article – that we cannot accept even stagnation, let alone adjust to decline.

So we have been faking growth by borrowing. By 2008, the debt mountain had become so big that we could no longer afford to pay a normal rate of interest on it, so the authorities adopted ZIRP (zero interest rate policy) in order to prevent the economy being engulfed. But ZIRP, and other forms of monetary manipulation, cannot resolve the situation, and have their own costs. At zero- or near-zero rates, the economy cannot function normally, and it certainly cannot provide for the future, which is why huge deficits are now imperilling pension provision.

In theory, we might go on faking growth for many more years yet, and I’m pretty sure the authorities will be mightily tempted to try. But this would result in a further escalation of debt, which would also mean that raising interest rates significantly – let alone restoring them to something resembling normality – would become out of the question (which may already be the case). Comparing 2020 with 2015, and taking inflation out of the equation, the world seems likely to grow its GDP by close to $10tn, but to add at least $50tn to its $151tn non-financial debt mountain.

If (or, rather, when) debt escalation reaches crisis point, some kind of write-off might be tried, unless the authorities decide to unleash high inflation in an attempt to destroy the real value of debt. Inflation, which has been described as the “hard drug” of our economic system, can very rapidly get out of control.

So here we have some pointers to the future – debt escalation, and/or hyper-inflation, both of which would be insane choices, but neither of which are beyond the short-termism of the political class.

Ultimately, and whichever folly is chosen, faith in fiat currencies is likely to collapse, to which I will only add that there are already at least two major currencies that I, for one, would not want to hold. In the normal course of events, inflation strips money of its value, but this tends to be gradual – we have little widespread (though plenty of local) experience of what happens when a fiat currency falls apart.

People cannot be expected to accept any of the post-growth consequences described here with a resigned shrug. They are not doing so now – instead, and naturally, they are beginning to blame, and repudiate, established political leaderships, and this was the most significant trend to emerge in 2016.

If the economy – and, in the first instance, the financial system – does start to implode, governments are highly likely to resort to coercion, spouting precious claptrap about “the national interest” as they try to maintain their hold on power.

Though the financial and real economies are different concepts, it is impossible for finance to collapse without inflicting grave damage on the real economy.  Our economy is essentially fragile, depending on attenuated systems, most obviously for payment and clearing. If you try to envisage running an economy without payment systems, banks, insurance or even trusted money, in a climate in which no one knows who owns or owes what, you will appreciate that the real economy is a hostage to finance.

Meanwhile, I’m continuing to refine the SEEDS system, with a new version now almost ready for roll-out. Clearly, it would help if this system, like the broader interpretation of the economy as an energy equation, reached a mainstream audience. My belief is this will happen – as the scale of our predicament, and the shortcomings of conventional interpretations, become ever more obvious, there will emerge a pressing need for a new understanding.

Governments are unlikely to adopt this, though trans-government organisations might. It seems likeliest that a major financial corporation, seeking commercial advantage from “getting there before the competition”, might be the first big player to act.

How things may unfold, and when, remains conjectural – but I do feel that I now have more than enough material for a sequel to Life After Growth.