#135: Still not (wholly) about “Brexit”

BRITAIN, EUROPE AND GFC II

A little less than two months ago, we made an effort here to look past the sound and fury of the “Brexit” debate to assess the real state of prosperity and risk in the United Kingdom.

Now, as the world marks the tenth anniversary of the 2008 global financial crisis (GFC I), it’s being reported that Mark Carney, governor of the Bank of England, has warned government that “a chaotic no-deal Brexit could crash house prices and send another financial shock through the economy”.

Risks identified by Mr Carney apparently include a slump in the value of GBP, sharp rises in interest rates and a 35% fall in property prices. Whilst he is right about these risks – and right, too, to warn about the consequences of a mishandled “Brexit” – we need to reiterate that these risks are likely to eventuate anyway, because British prosperity is continuing to deteriorate, whilst financial risk remains highly elevated.

Some updates

As I’m off travelling for much of next week, what I’d like to do here is to pause, as it were, and posit a few things for thought and comment. “Brexit” risk, and the likelihood of GFC II, have to be high on that list.

First, though, I’d like to thank the first two followers of Surplus Energy Economics who’ve made donations towards the upkeep and development of the project. I’m new to the donation process, so I don’t know what the courtesies are for expressing gratitude – but I really do appreciate your support.

While I’m away, please do carry on posting your comments, but please also note that moderation is going to be intermittent for the next week or so. The best way to get comments posted is to leave out links, as any comment including them is automatically placed in the moderation queue.

On “Brexit”

Throughout the debate about Britain leaving the European Union, no view has been taken here about the merits and demerits of “Brexit” itself. There are, though, a number of points which do need to be made.

First, the debate about “Brexit” was extraordinarily nasty and divisive.

Second, it’s vital that the expressed view of the voters is respected.

Third, surplus energy analysis gave us a strong lead on how the referendum was likely to turn out. According to SEEDS, per capita prosperity in Britain was already 10% lower by 2016 than it had been at its peak in 2003. This has to have been a major factor motivating the anti-establishment component of the vote.

Finally, “Brexit” is best considered as a ‘situation’ rather than an ‘event’. A ‘situation’ is something which creates a multiplicity of possible outcomes. The biggest risk with “Brexit” has always been that the British and EU negotiating teams would agree (or disagree) to choose the worst possible result. As things stand, that outcome is looking ever more ominously likely, thoroughly justifying Mark Carney’s warnings.

The British predicament

It would be a mistake, though, to assume, either that “Brexit” alone has created these risks, or that an alternative decision by the voters would have taken these threats away. Neither should risk on the EU side be downplayed.

Expressed at constant values, British GDP was £386bn larger in 2017 than it had been back in 2003. This translates to a gain of 11% at the per capita level, after adjustment for the increase (also 11%) in population numbers over that period.

But any suggestion that British citizens are 11% better off now than they were fourteen years ago is obviously bogus, an observation surely self-evident in a range of indicators spanning real incomes, the cost of household essentials, spiralling debt, sharp downturns in customer-facing sectors such as retailing and hospitality, maxed-out consumer credit and the worsening and widening hardship of the millions struggling to make ends meet. The national housing stock might be ‘worth’ £10 trillion, but that number is meaningless when the only potential buyers of that stock are the same people to whom it already belongs.

SEEDS analysis shows how we can reconcile claimed “growth” with evident hardship. First, growth of £386bn (23%) between 2003 and 2017 was accompanied by a 62% (£2 trillion) increase in aggregate debt. Put simply, Britain has been pouring credit into the system at a rate of £5.20 for each £1 of “growth”.

In the short term, you can have pretty much any amount of statistical “growth” in GDP if you’re prepared to pour this much credit into the system. The problem comes when you cannot carry on doing this, and this is especially the case when you’ve also been a huge net seller of assets to overseas investors as part of a process of consuming at levels far in excess of economic output.

Compounding this, of course, has been an escalating trend energy cost of energy (ECoE) and this, in Britain, has soared from 3.4% in 2003 to a projected 9.2% this year. The latter number is close to a level at which increasing prosperity becomes impossible.

“Stalling between two fools”

This makes Mr Carney’s risks all too real. According to SEEDS, aggregate prosperity in the UK last year was £1.45tn, a number 29% below recorded GDP of £2.04tn. When measured against prosperity rather than GDP, the British debt ratio rises to 361% (rather than 258%), whilst financial assets now stand at 1577% of prosperity (compared with about 1130% of GDP).

Bearing these exposure ratios in mind – and noting the ongoing deterioration in per capita prosperity – the likelihood of a currency slump, spiralling interest rates and a severe fall in property prices has to be rated very highly indeed.

But “Brexit” is by no means the only possible catalyst for a crash. Perhaps the single most depressing aspect of the British predicament is the paucity of understanding of, and response to, structural economic weaknesses.

This is not to say, of course, that EU negotiators have played this situation well. The assumption that the EU holds all the high cards in “Brexit” talks is absurd, and the extreme risk to Ireland is just one of many reasons for caution. The guiding principle, which seems to be to punish British voters’ temerity as a warning to others, appears not just pompous but, given the spread of support for insurgent (a.k.a. “populist”) parties, extremely short-sighted.

On the horizon – GFC II

For the British and the Europeans, “Brexit” has been a massive distraction from broader financial and economic risk. Though we cannot know when GFC II will eventuate, there can be very little doubt that a crash, of greater-than-2008 proportions, is looming ever closer.

As regular readers will know, there is a clear narrative which points unequivocally to GFC II. This narrative is so important, and so seemingly absent from mainstream interpretation, that little apology seems required for reiterating it in brief.

The narrative can be expressed as three very simple propositions:

1. From the late 1990s, the secular capability for growth began to erode.

2. Instead of accepting (or even recognising) this deceleration, the authorities embarked on credit adventurism, making debt cheaper, and easier to obtain, than at any previous time in modern history. Not surprisingly, this led directly to GFC I, and ensured that it would be a debt-centred event, primarily threatening the banks.

3. Rather than take the hit for reset, the authorities then moved on to monetary adventurism, pouring huge amounts of ultra-cheap liquidity into the system. This must lead to GFC II, and GFC II must be a monetary event.

There are plenty of things to debate about this sequence. First, what caused the secular deceleration which triggered the whole process? The explanation favoured here is the rising trend in the energy cost of energy (ECoE), but there are certainly some candidates for ‘best supporting actor’. These include ideological commitment to reckless deregulation, badly mishandled globalisation, and the impact of climate change.

Second, why didn’t we choose reset in 2008? With hindsight, the choice made was the wrong one, as many experts pointed out at the time. By playing ‘extend and pretend’, the authorities made huge mistakes, which included moral hazard, creating massive asset bubbles, all but halting creative destruction, and destroying returns on investment (to the particular detriment of pension provision).

One of the lesser-known consequences was that the market economy, properly understood, became inoperable – after all, positive returns on capital are something of a prerequisite in any ‘capitalist’ economy.

Likewise, when the relationship between asset prices and income was bent completely out of shape, immense divisions were created between those who already owned assets and those (generally younger) people whose aim is to accumulate them.

Lastly, is there anything we can do now about GFC II? Frankly, prevention now looks impossible, but there might still be quite a lot of mitigation that we can implement (without going to the extremes of stockpiling tinned food, bottled water and ammunition).

We cannot know whether the coming explosion is going to be ‘chemical’ (requiring a catalyst) or ‘nuclear’ (requiring only critical mass). But there’s plenty of combustible material around, a huge array of potential catalysts – and an inexorable progression towards critical mass.

Abroad thoughts from home

I hope that, despite a short hiatus in moderation and response, readers can carry on debating these and other issues, and will forgive this brief restatement – which to me seems necessary on grounds of imminence and importance – of issues around “Brexit” and GFC II.

It is hoped that, after the intermission, we can get back to pushing the boundaries.

 

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#136 prosperity & governmentjpg_Page1

392 thoughts on “#135: Still not (wholly) about “Brexit”

  1. “If I lived anywhere other than the US, ”

    Yes Don, but what do you do when you DO live in the US, when faced with its increasing insane behavior, increasing polarization, international brinksmanship that could lead to nuclear war, and an armed populace with huge chips on their shoulders ready to fly off the handle with the least provocation?

    As a boomer in my early 60s with 3 adult children, I have offered them the opportunity to relocate abroad in a country that seems (because no one can know) to be better positioned for declining prosperity. So far, no takers. It’s very hard, as you mentioned previously, to abandon the benefits that flow now for a harder life – or at least a very different, far less Western life-style life – because of troubles we know are coming. Some are doing it, though. In UY, my wife and I met a young American and French husband and wife who had relocated to Montevideo six years previously and had only recently opened a cafe, because they perceived no real life for children in the US. They emigrated with two large suitcases and a small amount of savings. They now have two children, have their own business, and are very happy with their decision. In Ecuador, we met a young Swiss man who married an Ecuadorian woman, who were operating the hacienda we stayed in because the owner had had a serious car accident, and who were in the early stages of setting up their own hotel with some seed money from the young man’s Swiss parents. He told us that his parents were seriously considering retiring to Ecuador. A UY immigration attorney I spoke with told me that he was receiving many inquiries from Europeans, young and old, interested in leaving Europe both for “social reasons,” as he put it, and because, for young people, there were very few economic opportunities and it was too expensive.

  2. The UK is living on borrowed time.
    Although the Seeds data would predict a gradual decline in Prosperity of about 1% pa, that would suggest that we could go on like this for another 25yrs or more, just constantly declining.
    My view is that some event will precipitate a collapse much sooner than that.
    It may well be Brexit.
    When the GFC-II does strike, then I cannot imagine that the UK will ever recover from it. As Mark Carney said, We are already “living off the generosity of strangers”, and when these strangers realise that they are not getting their money back, then they will very quickly disappear and they will be taking whatever they can with them.
    Economically we can all see where this is going, but what is not being addressed are the inevitable social consequences.
    Just think for a minute what it will actually mean for the UK to live within its means.
    Imagine half of all public sector employees being laid off.
    Imaging no free treatment on the NHS
    Imagine no welfare payments.
    Imagine rationing.

    How long will it take a mob to break into your house and steal all your food, your clothes and your blankets ?
    . . . or maybe they won’t steal anything.
    maybe they will just squat in your house, and throw you out instead ?

    And don’t think calling the Police will help, they have all been taken over by private contractors who will be protecting the 1%.
    So you are on your own.
    Maybe it’s about time that you started to get on with your neighbours ?

    • @Johan

      A somewhat apocalyptic view but, none the less possible.

      When GFC 11 does strike it will of course affect many other countries so the UK will not be startling exception so any immediate sacrifices can be introduced as “we’re all in the same boat”. What i’m saying is that the shock element is there but we are not exceptionally incompetent to be in this position (we may be but that will be the argument).

      Paradoxically Brexit might deliver a shock to the system which will wake people up to the broader issues that are in fact more important; in a sense it might prepare us for a period of change.

      You should also not underestimate the sheer inertia in the social system and reluctance to face up to the situation which will of course be reinforced by the government.

  3. What can we do about it all???

    I have just received and am reading the book The Revolutionary Genius of Plants, by Stefano Mancuso. Mancuso is at the University of Florence.

    I’ll be very brief. You need to read the book. Plants solve problems, while animals run away from problems. Since there are arguably few places to run to anymore, perhaps humans need to study how plants behave.

    Animals are designed as centralized creatures: brains, kidneys, liver, social status, etc. Plants are extremely decentralized. A plant can lose half its biomass and continue to function. That is not true of humans (outside a Monty Python sketch). Yet we can find evidence in humans of ‘plant like organization’. For example, the immune system is composed of ‘mobile minds’ which sense everything in our environment. And our brains operate on the basis of something like quorum sensing in terms of the multiplicity of neurons.

    Condorcet, the French scientist at the time of the Revolution, formulated the law that the more people involved in a decision, the better it was likely to be. Current examples using the internet tend to support Condorcet, as longstanding problems in subjects as arcane as quantum physics have been ‘crowd solved’. Turning everything over to a quasi-dictator leads to extreme decisions which are frequently disastrously wrong.

    Mancuso points to the Greek city states and Renaissance Italy as flowerings of creative cooperation which have not been equalled by top-down organizations. Plants, predominately lateral cooperation, constitute 80 percent of the biomass on Earth. Social insects, also predominately lateral cooperation, account for another huge chunk. The predominately top-down animals are evolutionarily not that successful. Humans are somewhere between the social insects and the top-down animals.

    In order for a new system of human governance to emerge, humans must be ‘free to think and innovate’. But ‘Allowing the concept to correspond to the idea of web giants that accumulate huge profits in the hands of a few would be catastrophic.’

    I will add my two cents. Debt and addiction are two giant obstacles to the notion of a replay of Greek city states or Renaissance Italy. Debt is our promise to keep doing what we are doing, diligently working for the benefit of someone else. Addiction (which gets a good chapter in the book), keeps us from breaking free, and gives us faux rewards for doing unhealthy activities. The web giants are masters of addiction.

    Buy the book!!!

    Don Stewart

    • Well,the Roman Empire was less centralised than any modern industrial state – despite possessing widely-distributed urban centres, some quite substantial – and it had a much less complex supply chain to state the obvious.

      When it fell, piece by piece, the rural economy largely survived,as the new possessors of power based their wealth on land rather than trade, for many centuries,and the mass of people were both warriors and farmers.

      The stubborn endurance of the peasant is to a large degree the secret of the survival of civilisation: the building block of human and animal muscle (cemented by manure 🙂 ).

      The distinctive feature of the civilisation which we have constructed since 1700 is not only immense global trade and a very complex and fragile supply chain, but the extinction of the true – largely decentralised – rural economy, highly variable from region to region.

      It just isn’t there any more, so decentralisation would seem to be impossible.

  4. Dr Tim

    In your post above (https://surplusenergyeconomics.wordpress.com/2018/09/14/135-still-not-wholly-about-brexit/comment-page-2/#comment-9376 ) , you state that there have been in practice few cuts to UK Government funding of public services, and that rising ECOE has been and is a major factor in increasing the cost of service provision.

    Might another major factor in service provision costs be the blind “marketisation” of aspects of service provision (whether or not appropriate or beneficial)? The provision of service aspects by the private sector uses existing staff transferred via TUPE initially, but thereafter other staff resources via sub-contracting, so after the usual “honeymoon period” the relevant Department ends up paying not just for service aspect provision but also for the rising administrative costs of the external prime contractor, which is also acting as a “middle man”?

    The Institute for Government publishes its Whitehall Monitor each year and, amongst other things, it records the number and salary count of civil servants, however it also notes the growing number of Arms Length Bodies (ALBs), whose staff are referred to as “public servants” rather than “civil servants”, and therefore are excluded from civil service staffing and salary figures.

    • I agree – the outsourcing process seems likely to have led to administrative duplication.

      Moreover, it is based on a misreading of Adam Smith by many who claim to be his adherents. At no point does Smith state that the private sector is superior to the public sector, and a strong regulatory role is wholly implicit in the importance he places on keeping markets free and fair. The villains of Smith’s vision are monopolies and oligopolies – and we can say that he would have seen a public monopoly as being just as bad as, but not worse than, a private one.

      The guiding principle in Smith is competition, of which there is scant evidence either in outsourcing or in privatising public services. It is worth remembering that Mrs Thatcher did not privatise public services – rather, she privatised industries, many of which didn’t belong in the public sector in the first place.

      Logically, there is no case for the state running an airline (BA), manufacturing cars (Jaguar, Rover) or exploring for oil (Britoil, Enterprise). But neither is there a case for private enterprise running prisons, for instance.

    • I think many do know but they’re determined to have one last party before selling their assets and making good.

      I think Gold would be a good bet depending on what price you’d get if a new post crash currency.

    • It’s an interesting perspective, especially the idea that the dollar might be the currency that cracks, rather than (or perhaps as well as) EM currencies, GBP, EUR or JPY. My money (in whatever currency that might be…) is still on GBP for the starring role.

      I sense that the next crash is now being talked about quite a lot by the general public. Financial market participants still seem to pin their faith in bail-outs, but I don’t think they really appreciate the scale of what is likely, and how GFC II is likely to be a monetary event, rather than the credit event which was GFC I.

    • Tim

      In the EU I understand that bail ins are the rule now; personally I think it will be bail outs still as if the general public or small businesses get hit then all hell will be let loose. It’s one thing to be caught out if you’re a bond investor; it’s entirely another if you’re just parking money for no return.

    • Hi Tim,

      Its interesting that you mention Peter Schiff. I recently listened to him on a podcast and much of what he said was aligned with your views (in terms of debt, QE, declining Western productivity and prosperity etc). I’m not sure I agree with him on the dollar crisis scenario however. I think that for as long as there is demand for oil then the USD should have a degree of comfort from the Petrodollar. A run on the Euro or GDP seems more likely.

      Schiff might be correct regarding gold, but you have to bear in mind that he also has his own gold company, so its in his interest to publicly promote gold as a potential safe-haven (so I always take his comments with a pinch of salt!).

      Please keep up the great work. I’ve shared many of your articles with my actuarial colleagues and we are all in universal agreement with much of the theory backing SEEDS. It can only be a matter of time before it starts to gain a wider traction, I just hope by then its not too late!

    • Thank you, much appreciated. Though perhaps it’s not for me to say, I do think that the course of events is bearing out the SEEDS approach All I can do is keep working on this, and seeking broader recognition.

  5. Dr. Morgan
    It seem to me that the failure of the US dollar would be catastrophic for world trade. Putin addressed the de-dollarization issue at the recent Vladivostok Economic Forum. He agreed that de-dollarization is desirable, not least because the US chronically uses the dollar for geopolitical gain. However, he cautioned that actually taking all the steps to make more than 150 currencies all convertible into each other in the absence of the dollar is a tall order.

    It also seems to me that if the dollar fails, a lot of other currencies will promptly fail. Russia might survive because its trade in dollars has been reduced by sanctions, and it is apparently following a deliberate policy of import replacement. But Russia might have nobody to sell oil to, especially if China fails.

    In other words, global depression. Perhaps the world better hope that the GBP fails???

    Don Stewart

  6. Especially @Xabier
    but also anyone else worried about starving
    https://organicgrowersschool.org/reflections-on-my-tour-of-sustainable-farms-in-cuba/

    The Organic Growers School in Asheville, NC has been a small farmer resource for about 30 years. One of the primary interests of people from the US who are engaged in small farms is that people exactly like them are seen as a primary resource in Cuba…not as a premium priced luxury. Seeing the excitement of a young female farmer showing off her manure digester which generates natural gas for cooking fuel restores ones sense of perspective.

    All of the Caribbean islands are dependent on imported food. Cuba much less than many others. But I think it is correct to say that without tourism, they would all be a lot poorer. Tropical islands may sound like paradise, but they are not an easy place to live, economically.

    Compare with the relative ease of doing ‘sustainable agriculture’ in China:

    In my opinion, all the ‘advanced’ countries should be doing what these Chinese have done over the last 5 years both to sequester carbon to help with climate change and also to prepare for a future when soil productivity will be more essential than ever.

    Don Stewart

    • I often wonder about this Don. As climate change ramps up, I think famine and mass starvation are inevitable in the Southern Hemisphere, as droughts become more prolonged. Thinking closer to home, these days the vast majority of the Western population have absolutely no idea how to produce food, arable or otherwise. I recently saw a video of some American school children being asked where milk came from, and a large proportion assumed it just came from a carton in the shop – they had no conception of it coming from a milked animal.

      I don’t think it would take much disruption to the food supply for there to be serious consequences in the developed world. For example the UK only produces around 52% of the food consumed by the British population. Although there is scope to scale production up, the lag between a reactive response to supply chain disruption, and producing the additional food required, would be far too long. Mind you, given the endemic levels of obesity, maybe putting the country on rations and a diet would suffice!

  7. Survival Plan
    3 days from now the scientists of the world will tell us what we need to do to avoid climate disaster. The draft includes a peaking and steady decline in CO2 emissions beginning 15 months from now. Eric Holthaus, writing in Grist, says:
    ‘To be clear, hitting that goal would require a radical rethink in almost every aspect of society. But the report finds that not meeting the goal would upend life as we know it, too.’
    So what sorts of current thinking can we point to which provide some guidance for the ‘radical rethink’? Rather than write a book, I will simply point some fingers.

    *Learning to behave more like plants and less like animals. Stefano Mancuso’s book The Revolutionary Genius of Plants
    *Learning to cooperate with symbionts and commensals, rather than give in to delusions of dominance. The Secret Life of Your Microbiome, by Prescott and Logan.
    *Reformulating our personal goals. The Courage to be Disliked, by Kishimi and Koga.
    *Reformulating our personal plan for health. Unpublished work by Ari Whitten. Eat more plants. Physical work about 6 hours per day, with 3300 calories fluxing through the body. More joy. Long health span, with productive old age.
    *Looking at the ‘impossible’….Cuban farmers.
    *Doing our part technically. The biochar example from China. The ‘carbon cascade’ machines from China. The Savory Institute. David Johnson at NMSU.

    As for debt, we simply have to understand that the currently rich people are about to lose their claim on the future. Recognize that they won’t go quietly, and that humans have managed revolutions very badly in the past.

    Don Stewart

    • Thanks. On your final point, in particular, I agree entirely. The next article here is going to look at what happens when raising taxes on the “rich” becomes unavoidable, but increasing government expenditures becomes impossible.

  8. Jim Kunstler describes an almost classic case of ‘complexity collapse’ today. He predicts a currency debacle much like that anticipated by Dr. Morgan.

    One comment which is relevant from my list above. Mancuso points out that plants are modular. Even talking about a plant which multiplies by division as a single plant makes no sense. Plants have mastered the art of making modules which work, but which connect gracefully with other modules. The US government began that way, with a federation of 13 independent states. Over the years, it has morphed into a top down organization of incredible complexity. Now, according to Kunstler, about to collapse as faith in money vanishes.

    Don Stewart

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