ENERGY ECONOMICS AND THE FAILURE OF THE CONVENTIONAL
As a year draws to a close, it has long been customary for analysts to make predictions about specific events in the coming twelve months. That can be an interesting exercise, though perhaps one of questionable value.
But it’s a fair assumption that, rather than trying to pinpoint particular occurrences before they happen, many of the 36,000 people who have visited this site in 2017 are more interested in how new, energy-based thinking is making headway against the failing paradigms of the past and present. The aim here is to discuss with readers how this work has reached its present position, what has been learned from it, and where it might go next.
A learning and development curve
To look forward, it can be helpful to start by looking back. The position as head of research at Tullett Prebon was the best job that I had in a long City career. With the full support of management, the brief was to explore new ideas, and – to use a rather hackneyed phrase – to “think the unthinkable”.
This was a steep learning-curve, with an embarrassment of riches in terms of topics to investigate. Forever Blowing Bubbles asked if financial hubris and the abandonment of rationality was somehow intrinsic to our system. The Dick Turpin Generation looked into the transference of value from the young to the old, whilst Project Armageddon suggested that neither austerity nor stimulus might rescue the British economy from a structural trap. (In passing, there has been no reason to retreat from any of the conclusions reached in this research programme).
But it was Perfect Storm that really set out an agenda for the future. The central proposition was that the economy was a function of surplus energy, and that the exponential rise in the availability of energy since the Industrial Revolution had driven two centuries of exponential growth in population numbers, food supplies and economic activity. The contention was that, if the energy “master exponential” went into reverse, the same must happen in all related areas. It was further explained that a “peak” in the absolute availability of energy wasn’t the issue – rather, the real threat lay in the rising cost of energy, expressed as the proportion of accessed energy that is consumed in the access process.
The immediate objective after leaving Tullett Prebon was the publication of a book explaining and amplifying this thesis. This was Life After Growth, published in hardback in late 2013, and reissued in paperback, with a new introduction, in 2016. It should be emphasised that, although it followed much the same thesis, Life After Growth covered a lot of new ground, and was not simply an expanded version of Perfect Storm.
During the writing of Life After Growth, two immediate next steps became apparent. The first was the creation of this blog, as a platform for promoting these ideas and as a forum for discussion. Reader input has been hugely influential in establishing new areas of enquiry. Just one example is the recent venture into what the economics of surplus energy might be able to tell us about climate change and “sustainable development”. This simply would not have happened without input from readers.
The second, vital initiative was the modelling of the surplus energy economy. Life After Growth explained the issues, but couldn’t really quantify them, because the data required to do so did not exist. Setting out a thesis in a report, a book or an article is all very well, but the thesis can only become truly persuasive if it is put into a meaningful statistical format, including forecasting as well as analysis.
Doing this has taken a long time – about four years – but has been well worth it, as the Surplus Energy Economics Data System (“SEEDS”) has become an extremely powerful tool.
What we know
Based on the SEEDS platform, and helped enormously by reader input, we’ve reached a point at which our understanding of issues is very comprehensive, and can be considered leading-edge in providing interpretations unavailable to conventional methodologies. The system has proved itself a very effective predictor – so much so that some very general projections are made later in this discussion.
First, though, it’s well worth reminding ourselves quite how much we now know.
We know that the economy is an energy system, with a parallel financial economy attached to it in a subservient role. Most of us had long suspected that this might be the state of affairs, but we have now gone a long way towards demonstrating it. We can claim that our ability to predict has become superior to that of conventional thinking. The much-vaunted V-shaped recovery after 2008 hasn’t happened, and massive stimulus hasn’t restored robust growth. The surplus energy perspective always suggested that neither of these consensus expectations was likely to be proved right.
We have known for some time that, in the developed economies of the West, prosperity is deteriorating, something about which the consensus view is still in deep denial. Some of the consequences of waning prosperity have already become apparent, most notably in politics, where events such as “Brexit” and the election of Donald Trump were wholly predictable on the basis of adverse trends in prosperity. Some other logical consequences, in business and finance as well as in politics, are eminently predictable, even though they still lie in the future.
Energy-based analysis, and recognition of the proxy nature of the financial system, have enabled us to understand policy, and its failures, over an extended period. We know that real or “organic” growth began to fade after 2000, and, because we understand energy dynamics, we know why this happened.
We can identify two phases in a process of denial-response to this basic reality. The first was the period of credit adventurism, a policy of unfettered and irresponsible debt creation between 2000 and 2008.
The second, beginning in 2008-09 and still ongoing, is monetary adventurism, and comprises the addition of the recklessness of ‘cheap money’ to the debt recklessness of the earlier chapter.
Just as credit adventurism led to the 2008 banking crash, monetary adventurism is highly likely to create a second and an even more serious (and potentially existential) financial crisis, this time extending far beyond banking, and into the fiat currency system. We know that this must have political and social as well as economic and financial consequences, and we know that the destruction of pension viability – a direct consequence of the crushing of returns on capital – will play a big part as this unfolds. Just as importantly, the conventional thinking which didn’t see 2008 coming is now in blissful ignorance about what is likely to happen next. This ignorance isn’t simply hubris or blinkered thinking. It reflects the breakdown of established paradigms.
Finally – for now – we know that the case for “sustainable development”, as it is generally understood, lacks demonstrated viability, and is a matter of assumption rather than analysis. In short, it is wishful thinking. We know this because energy-based economics, with its distinction between the real and the purely financial, requires us to understand the dynamics of credit, money and “growth”. This process strips away the claims made for growth upon which, in turn, are predicated assumptions about climate change.
From this body of understanding, backed up by statistics, we are able to make some projections with high levels confidence about predictive accuracy. This article isn’t the place for detailed predictions, but there are a number of broad outlines which are worth noting.
Critically, prosperity in the developed economies will continue to deteriorate. This trend appears irreversible and, in some countries, is being exacerbated by mistaken policies. ‘Prosperity’, in this context, means average discretionary incomes – that is, the spending power of individuals and households, after the cost of essentials has been deducted from their resources.
We also know that this waning prosperity will be accompanied by further balance sheet deterioration, meaning that debt will continue to increase faster than economic output, and that provision for the future (most obviously, pensions) will continue to be undermined. The “global pension time-bomb”, for example, cannot be defused without the adoption of policies which would have crippling near-term effects. It seems highly likely that the public will, sooner rather than later, come to understand that their chances of enjoying a comfortable retirement are being destroyed. This recognition is likely to become a political factor of immense importance.
In a political climate characterised by deteriorating prosperity, worsening insecurity and growing resentment over perceived unfairness, the centre-right can expect to get the blame, and it can only make its defeat all the more comprehensive if it argues for more, rather than less, of failed policies like privatisation and deregulation. “Popular” or “populist” politicians can expect to make further gains, though this does not mean that their policies will always be implemented. Donald Trump’s budget, and the growing likelihood of “BINO” – meaning “Brexit In Name Only” – illustrate the determination of the elites to frustrate popular demands. These are promising conditions for the political Left, once it has purged its ranks of the “new” or “centrist” wings perceived by activists to have “sold out” to “liberal” economics in the recent past.
All of this has profound implications for business and finance. The established model, which remains built around the promotion of volume expansion despite deteriorating consumer circumstances, is going to come under increasing pressure. Any business whose strategy is founded on low wages, reduced security of employment, globalisation or the deregulation of consumer and employee protections is in urgent need of a “plan B”. Meanwhile, the near-certainty of a second financial crisis requires a rethink from financial institutions, whose assumptions about another taxpayer bail-out are, very probably, dangerously complacent.
Finally, public tolerance of wealth and income inequalities seems certain to deteriorate still further. Sooner rather than later, either Left or “populist” leaders are going to start asking quite how much money any individual actually needs. The ultra-wealthy might need to dust-off those plans for flight, though it seems increasingly likely that they can forget about New Zealand as a bolt-hole.
What do WE do next?
All of this poses a big challenge, but also a big opportunity, to those of us who understand the energy-basis of the economy. Knowledge may not be power, but it is certainly competitive advantage. It has to be admitted that the “road to SEEDS” began without a master-plan, not least because, at the start, there could be no certainty that codifying the logic of the surplus energy economy would actually be possible. This said, a plan is now necessary, and reader suggestions will be welcomed warmly.
What we’re witnessing, with the failure of established paradigms, is a period of enormous change in how the economy is understood – and with this go corresponding changes in interpretations of politics and society. From a thematic perspective, historians of the future are likely to regard the most important feature of the current period as the discrediting of economic “liberalism”, much as the late 1980s were characterised by the failure of socialism.
With each of these paradigms looking like a busted flush, it seems highly probable that something new will arise to replace them. The discrediting of ultra-“liberal” economics does not invalidate all market-based ideas, any more than the failure of state-controlled socialism invalidated all co-operative systems. There has to be a likelihood that a new ownership model will emerge from a debate stimulated not just by waning prosperity but also by new trends including automation and the “gig” economy. The neoliberal nirvana – of a wealthy elite controlling both automated production and a disempowered, casual workforce – is pretty unlikely to be realised. There is likely to come a point, too, at which delusion over the viability of “sustainable development” gives way to reality.
In this context, the understanding provided by the surplus energy approach to economics becomes ever more important. But how can it be progressed?
Publication of a sequel to Life After Growth may be a good idea, given how very much more is known now than was known then. One idea, under serious consideration now, is the production of targeted reports which readers can forward both to opinion-formers (such as policymakers, specialists, academics and the media) and to like-minded people. Co-operation with government and business is a possibility. So is the creation of a commercial version of SEEDS, though this prospect has not yet progressed beyond the scoping of ideas.
Essentially, it makes no sense to ignore potential for influencing government, business and finance at a time when all three need answers that conventional methods of interpretation are no longer able to supply.
It only remains to wish readers a prosperous New Year. It promises to be an interesting one…….
@Dr. Morgan and All
A few posts ago I said that it seemed to me that the US strategy relative to Russia is to keep on funding the terrorists and let them keep bleeding Russia…counting on the unwillingness of the Russians to start a nuclear war solely due to terrorism. Today, we have this development:
It MIGHT just be a coincidence, but I doubt the Russians think so. And it fits right in with my perception of what the US leadership is up to. The US leadership is willing to gamble the future of the world on maintaining the dollar as the reserve currency.
SEEDS and inflation adjusted numbers
Here is a little essay I wrote for Peak Oil. The subject is ‘deflated’ numbers for use in physical models:
ETP model; inflation adjustment; Shadowstats; Debt
I am reading Dan Arielly and Jeff Kreisler’s book Dollars and Sense. They discuss in detail how the separation of the pain of paying and the pleasure of consumption can profoundly affect human purchasing behavior. Prepayment plans and credit cards are both engineered to separate the pain of paying from the pleasure of consumption, which can greatly increase consumption. Having to pay co-incident with consumption suppresses consumption.
As one example, they cite AOL’s conversion to flat rate billing from usage sensitive billing. AOL’s planners studiously looked at monthly usage and concluded that some people would buy the flat rate plan. Overall network usage would increase by a few percent. What actually happened was that usage doubled. They examine in detail Kreisler’s honeymoon in Antigua, which was purchased as a flat rate, pay for all the champagne you can drink and lobsters you can eat scheme. There is no question that the newlyweds consumed a great deal more due to the flat rate pricing.
How does all this relate to inflation calculations? If the Bureau of Labor statistics is calculating cost per minute used or gallons of champagne drunk or tons of lobsters eaten, then the flat rate is going to seem like a big reduction in price. Thus, the BLS will deflate the money spent purchasing the flat rate honeymoon or the AOL subscription, when, in fact, the customers are paying more money than they were before.
Why is this important? Well, for one thing, the BLS deflator reduces the amount of money the government needs to pay for indexed transfer payments such as Social Security. But in terms of the ETP model, the question is whether BLS deflated GDP is the appropriate measure of economic activity. Or if, instead, something like the Shadowstats numbers or just the actual prices are more appropriate.
A key question is whether using more time on AOL or eating more lobster does anything to increase the earning power of the consumer. In other words, does it enable them to come up with the extra cash they need to pay of the supposedly ‘cheaper’ goods and services. And the answer is almost certainly ‘No’.
Consequently, if consumers want to increase their outgo for the supposedly ‘cheaper’ goods and services, they will need to go into debt.
Exactly what ‘deflated’ numbers might be appropriate is hard to say. But it is pretty clear that ‘hedonically adjusted prices’ are not appropriate.
Now back to SEEDS, and other physical models. It seems to me highly likely that the hedonic adjustments which have been made to the GDP part of the SEEDS model are distorting financial reality. From a financial standpoint, it does no good to double output unless one can charge more, or earn more. An isolated subsistence farmer who figures out how to double production with half the work is obviously a lot better off. But a farmer who is selling his product in order to pay his debts has to be able to get more money for what he sells. Much of the ‘digital dividend’ seems to flow into things which are worth little or nothing. For example, I recently read that digital music has reduced the artists share so that 75 percent of the artists income now is earned by touring. Counting how much music people might be listening to has little or nothing to do with paying the musical performer’s bills.