THE US ECONOMY – A SEEDS APPRAISAL
With SEEDS – the Surplus Energy Economics Data System – nearing public release, this article has two purposes. It assesses the outlook for the American economy, and uses this investigation to demonstrate how SEEDS is applied to economic interpretation.
It concludes that American prosperity is in decline, and has been falling ever since it ‘peaked’ way back in 1999. This doesn’t make America unique – prosperity has long been falling across much of the developed West. But it does mean that the central economic task of President Trump, which is to make the average American more prosperous, simply is not possible.
Two main factors are driving the deterioration in prosperity. First, the underlying economy has been deteriorating, a trend disguised by the spending of borrowed money.
Second, in America as elsewhere, the trend cost of energy continues to increase markedly, even while market prices are trapped in a cyclical low. This cost acts as an “economic rent”, and translates into individual experience primarily through the cost of essentials, which are energy-intensive.
Essentially, two things are happening to the average American. First, his or her income is rising less rapidly than the cost of essentials, squeezing the “discretionary” income which is the real definition of prosperity. Second, increases in income are being far exceeded by increases in debt, and also by growing shortfalls in pension provision. So the citizen feels both less prosperous and less secure.
As SEEDS measures it, per capita prosperity was 10% lower in 2016 than it was back in 2000. Neither is this trend likely to reverse – by 2025, the average American is likely to have seen his or her prosperity decline by a further 8% in comparison with 2016. At the same time, per capita debt has increased by almost $54,000, in real terms, since 2000, a problem now being compounded by a rapidly-growing systemic shortfall in pension provision.
‘Conventional’ economics cannot capture any of this. A perspective which ignores both “borrowed consumption” and the trend cost of energy is baffled by popular discontent, in America and elsewhere. Moreover, ‘conventional’ analysis tends to be misled by the apparently-buoyant values of stocks, bonds and property. These values are misleading, because they cannot be monetized – the only buyers for homes, for example, are the same people to whom they already belong.
For as long as these issues are overlooked, popular anger is likely to go on taking ‘the experts’ by surprise.
Context – the politics of waning prosperity
There were two main factors which combined to put Donald Trump in the Oval Office last year. The first was widespread popular contempt for the political process, something which Mr Trump addressed with his promise to “drain the swamp”. The second was the economic hardship being experienced by millions of Americans in a system which they increasingly perceive as benefiting only a wealthy minority.
On this second point, the challenge for Mr Trump is crystal-clear – to be successful, he must improve the material well-being of the average American. But this analysis concludes that there is no possibility of Mr Trump – or, for that matter, of anyone else – increasing per capita prosperity in the United States.
Mr Trump could, of course, try to offset this by redistribution, but there is no indication whatsoever that he will even contemplate doing this. The danger is that, if he decides against ‘taking from the rich to give to the rest’, voters may opt for somebody else who will.
Economic conditions are only one input to political decisions, of course, but their role can often be decisive. If this analysis is correct in concluding that the decline in the prosperity of ‘Middle America’ cannot be reversed, Mr Trump is going to struggle to be re-elected. Though a challenge might be mounted by the self-same establishment that he defeated in 2016, a likelier scenario might be a leftward tilt in the centre of gravity of American politics.
The economy – an energy dynamic, not a financial one
The basis of the surplus energy approach is recognition that the economy is an energy dynamic, not a monetary one. This much should be obvious, because money has no intrinsic worth – it commands value only to the extent that it can be exchanged for goods and services. Energy is central to the supply of all these goods and services.
The value that the economy generates, therefore, is a function of how much energy we can access. But, whenever we access energy, some of that energy is consumed in the access process. The term ‘surplus energy’ describes the difference between the gross quantity of energy available, and the cost of accessing it. That difference or ‘surplus’ is the foundation of prosperity.
The concept of prosperity needs to be understood clearly. Prosperity is not simply the size of someone’s income. Rather, it is the sum left over after essentials have been paid for. This means that prosperity equates to “discretionary” income, which is the sum that he or she can choose how to spend.
The fundamentally energy-based nature of all output creates a natural distinction between “two economies” – the real economy of goods and services, and the financial economy of money and credit. Used properly, the financial system can deliver many benefits. Equally, though, it can be harmful, if it diverges too far from the real economy.
The potential for harm is simple. Money functions only as a “claim” on goods and services, which really makes it a claim on surplus energy. Likewise, since credit is a claim on future money, it is really a claim on future energy.
Financial “claims” – money and credit – can be manufactured out of thin air, and we can create as many of these claims as we like. But, if we create claims that exceed what the real economy can deliver, the excess cannot be honoured. Therefore, it must be destroyed. Inflation is one way of doing this, though default is another.
Energy in America
The consumption of primary energy in the United States has been in gentle decline for a number of years. In 2016, Americans consumed 2.28 bntoe (billion tonnes of oil-equivalent), 2% less than in 2006. Over that period, the population increased by 8%, so energy consumption per person is in a somewhat steeper decline. This is often assumed to indicate greater efficiency. But the alternative possibility – that it may simply reflect deteriorating prosperity – seems disturbingly consistent with the facts.
The supply of indigenous energy increased by 24% over the decade to 2016, and much of this increase has been supplied by unconventional oil and gas, extracted from shale formations using hydraulic fracturing. Reflecting this, the US imported only 11% of its energy needs in 2016, compared with 30% in 2006.
The dramatic increase in unconventional hydrocarbons production has created much hype, tending to disguise a rather more prosaic reality. Shales are costly to produce, not so much in operating expenses but, rather, in capital costs, which are themselves a function of depletion.
The output from shale wells declines far more quickly than conventional production, creating a constant need to drill new wells simply to sustain output, let alone increase it. This puts operators on a “drilling treadmill”, something evident both in huge capital expenditures, and in the inability of the industry to cover its capital costs from operating cash flow.
Moreover, a peak in shale output now looms, and this peak is assumed here to occur in 2021. If some of the more sanguine claims for shale were true, the United States would be scaling back its ability to ensure safe delivery of petroleum from the Middle East. It is clear that the Pentagon has no such intention, and the US remains as interested as ever in political developments in the oil-rich Persian Gulf.
What really matters, where the economy is concerned, isn’t the aggregate amount of energy available, but the cost of accessing it. This is cost expressed in energy terms, not financially. SEEDS estimates the ECoE – the Energy Cost of Energy – of the American demand mix in 2016 as 7.9%, which rises to 9.2% after adjustment for net energy trade. This latter number has been on a rising trend – it was 7.2% in 2006, and only 4.2% in 1996 – and is projected to reach 13.5% by 2026.
The 2016 number is higher than the global average (8.2%), but better than those of competitors including Britain (10.5%), France (11%), China (14.3%) and Germany (15%). So America does enjoy a significant energy advantage over some of its principal competitors, even if that advantage is not as great as is sometimes claimed.
The financial economy
American GDP in 2016 was $18.6 trillion, a real-terms increase of 33% since 2000. Over that period, however, the population has increased by 15%, so the gain in per capita terms has been rather more modest, at 16%. Theoretically, this should have made most Americans markedly more prosperous, but there is a big snag involved in accepting GDP numbers at face value.
Comparing 2016 with 2000, and using constant 2016 values throughout, American GDP increased by $4.6tn. But, and again at constant values, aggregate debt grew by $21trn over the same period. This means that each dollar of recorded growth was accompanied by $4.60 of new debt.
This issue is often overlooked, by economists and policymakers alike. But its relevance should be obvious because, if America goes on adding $4.60 of debt for every $1 of growth, a point must be reached, eventually, at which further growth becomes impossible, because debt has reached a practical maximum.
Another way to look at this is that a significant proportion of reported growth has really amounted to nothing more than the spending of borrowed money. If the ability to keep “borrowing to spend” was to be curtailed, this borrowed element would fall away, resulting in a sharp fall in GDP.
The scale of this problem is evidenced by the way in which America, like other countries, has effectively been forced into a policy of ultra-cheap money by the sheer impossibility of paying a ‘normal’ rate of interest on debts of this size.
ZIRP – meaning zero interest rate policy – has hefty economic costs. Just one of these is that it stymies the essential process of “creative destruction”, by keeping afloat weak players who, in a ‘normal’ interest rate environment, would have gone under, freeing up capital and market share for new, more innovative competitors. Cheap money also incentivizes speculative over innovative activities, as well as deterring saving, and encouraging borrowing.
Another consequence of cheap money is that it destroys the ability to provide for the future. Saving becomes pointless when interest earned is less than inflation. This has particular relevance for pensions. According to a recent report, the deficiency in American pension provision stood at $27.8tn in 2015, and is growing at a rate of $3tn per year.
To put this in context, it is about 5x what America spends on defence. In 2016, the US economy expanded by $0.3tn, a number obviously dwarfed by the deepening pension chasm, as well as by a net increase of $1.4tn in debt. When income is growing by $0.3tn annually, but liabilities are increasing by $4.4tn, something is clearly very wrong indeed.
The underlying economy
Since the “borrowing to spend” issue obviously cannot be ignored, SEEDS uses an algorithm to calculate how much economic output is accounted for by the simple spending of borrowed money. Of the $21tn borrowed since 2000, $4.0tn is deemed to be “borrowing for consumption”. This is only 19% of the total borrowed, so might be a conservative estimate. Even so, it has dramatic implications for underlying (borrowing-free) GDP.
According to SEEDS, American underlying GDP in 2016 was only $14.5tn, a number which is 22% below the reported $18.6tn. This underlying number is an estimate of where GDP would be if Americans ceased “borrowing to spend”. It represents an increase of only 7% (rather than the recorded 33%) since 2000. Moreover, it equates to a fall (of 6%) in underlying output per capita.
This analysis goes some way towards explaining a big political (as well as economic) conundrum – the reason why the average American feels poorer is that he or she really is poorer. This deterioration in underlying income, then, is extremely indicative. It becomes even more so when we consider the role of energy, which plays a critical part in determining prosperity.
The real economy
Thus far, we have looked at two measures of American economic output. One of these is recorded GDP, and the other is a borrowing-adjusted calculation of underlying GDP. The third stage in this process is to factor-in energy costs, described earlier as ECoE. This calculation is critical if we are to identify trends in prosperity, rather than simply in income.
The trend cost of energy is quite different from the market price at any given time. Whilst prices are cyclical, cost is a long-term trend, determined by the interplay between depletion and technology. Moreover, cost needs to be considered, not initially in monetary terms, but as the proportion of accessed energy that is consumed in the access process.
The term “cost” can be misleading, because it is not directly analogous to the costs incurred running a home or a business. Those costs leave the home or business but, globally, the energy economy is a closed system, so the cost of energy does not leave it.
Rather, energy cost is an “economic rent” – it is not a sum deducted from income, but an amount that we are forced to use in a particular way. This means that it reduces the amount that can be spent as we choose, and this “discretionary” income is what determines prosperity.
Where America is concerned, SEEDS estimates the 2016 ECoE of the United States at 9.2%, up from 5.5% back in 2000. The main impact of this energy cost “drag” on prosperity is experienced through escalation in the cost of essentials.
In per capita terms, this trend has paralleled the deterioration in underlying GDP. Stripped of borrowed spending, this underlying measure of income declined by 6% between 2000 and 2016. Adding the ECoE component into the mix indicates that per capita prosperity has declined at roughly the same rate. In the future, though, a continuing rise in ECoE is set to exacerbate the erosion of prosperity.
In America, as elsewhere across much of the Western world, organic growth in economic output petered out around 2000. Since then, and again like many other countries, America has been ‘faking’ economic growth by spending borrowed money.
As a result, debt has grown much more rapidly than GDP. In the years between 2000 and the global financial crisis (GFC) in 2008, each $1 of reported growth was accompanied by a $5.20 rise in debt.
Since then, this ratio has improved, averaging $3.85 of borrowing for each growth dollar between 2008 and 2016. Unfortunately, though, this has been compounded by two other trends. First, the ratio of debt-to-GDP is higher now (251%) than it was at the end of 2008 (234%).
Worse still, the policy of ultra-cheap money has created huge and growing shortfalls in pension provision, a structural shortfall now standing at over $29tn, or 157% of GDP, and increasing by $3tn annually.
When we balance out trends in income with trends in debt and other forms of liability, the picture which emerges is one of steadily deteriorating prosperity. As trend ECoE continues to rise, the squeeze on prosperity will tighten further.
America is by no means unique in experiencing downwards pressure on prosperity – the same is happening in many other countries, often more severely than in the United States.
The problems posed for America are twofold. First, the deterioration in prosperity makes it impossible for the President to improve the material prosperity of the average American – in attempting to do so, he is about as powerless as was King Canute when he tried to turn back the tide.
Second, the use of cheap money to ‘manufacture’ nominal economic growth is already creating an escalating level of forward risk. Just as Americans are getting less prosperous, they are also becoming ever more indebted, and face ever greater insecurity as provision for pensions deteriorates.
The time cannot be too far off, for America as for the world more generally, where the future (represented by the collective balance sheet) overwhelms the present.