#192. The Great Dilemma


Governments in general – and finance ministries in particular – face a tricky dilemma.

Simply stated, the dilemma runs like this. If governments don’t keep pouring liquidity into the economy, activity will slump, numerous businesses will collapse and voters will face extreme hardship.

But if they do carry on with gargantuan financial largesse they risk, not just a surge in inflation but, quite possibly, an associated rise in interest rates.

The only practicable line for finance ministers (and central bankers) to try to walk is a “Goldilocks” one, avoiding the extremes both of an overheating financial system and of an excessive cooling of the economy.

The theory is that, if they can tread this course adroitly, economies will enjoy the benefits of a return to growth, with inflation in due course falling back into a preferred range somewhere between 1% and 2%. If achieved, this would amount to a return to what was, in the 1990s, sometimes called “the great moderation”, describing a combination of solid growth and subdued inflation.

If conventional, ‘money-only’ economic interpretations were valid, it might just about be possible for them to walk this line – in reality more like a tightrope – and find solid ground on the other side of the crevasse opened up by the coronavirus crisis.

But energy-based interpretation reveals that no such solid ground exists. Rather, something not unlike stagflation has long been hard-wired into the system. Whilst global GDP expanded at a trend rate of 3.4% between 1999 and 2019, growth in underlying prosperity trended at only 1.25%, and has now ceased to grow at all. This disparity of itself suggests that broad inflation has long been far higher than reported levels. 

None of this should really come as too much of a surprise. After all, pouring cheap credit and cheaper money into the system has been going on for more than twenty-five years, and energy-referenced analysis, as provided by the SEEDS model, reveals that this has done no more than disguise the reality that relentless rises in ECoEs (the Energy Costs of Energy) have put prior growth in material prosperity into reverse.

The aim here is to start by explaining the fiscal and monetary dilemma as it appears on the surface before moving on to use SEEDS analysis to explain why the problems are in fact both structural and insurmountable. In doing so, we need to refer to market expectations, which makes it appropriate to remind readers that this site does not provide investment advice, and must not be used for this purpose     

Loaded for inflation

We should be clear that the balance right now is heavily tilted towards inflation. Throughout the coronavirus crisis, governments have been able to replace the incomes but not the output of idled workers and businesses.

This amounts to supporting demand at a time of extreme contraction in supply.

This is why we’re already seeing inflation spiking in a number of categories, affecting anything that might be in short supply during a vaccine-driven economic rebound. We can infer that official expectations are that this is a transitional effect, likely to ease as capacity is restored, and demand-side stimulus fades. Be that as it may, significant inflationary pressures are showing up across the board.

This perception may have influenced asset market participants, who have bought in to the “Goldilocks” plan but with a distinct bias towards the inflationary side of the equation.

If investors were to factor higher inflation into their calculations, we would expect them to favour those asset classes (such as equities and property) which could be counted on to – at the least – ride the rising inflationary tide. They would steer clear of cash, and be wary of bonds, because, in an inflationary climate, interest rates might rise enough to drive bond yields upwards (though not by enough to make cash a viable preference). They might look favourably on assets such as cryptocurrencies and precious metals which could be perceived as hedges against inflation.  

This, by and large, is what has been happening. Markets, it seems, are expecting policymakers to ‘talk hard and act soft’, combining hawkish homilies about debt and inflation with a continuation of generous support for households and businesses.

This stance echoes the prayer of St. Augustine, who called on the deity to make him virtuous – “but not yet”.

Furthermore, investors, no less than the authorities, must be aware of the delayed price-tags attached to some of governments’ covid response initiatives. For instance, granting interest and rent “holidays” has inflicted substantial losses on counterparties such as lenders and landlords, and these costs must in due course be made good, unless we’re prepared to accept failures in counterparty sectors.

We should, then, anticipate some virtue-signalling tax rises which, in sum, amount to little more than small down-payments on the enormous costs of combating the pandemic.  Not for nothing has inflation been called “the hard drug of the capitalist system” – it offers a beguiling short-term alternative to painful and unpopular adjustment to economic stresses.

The energy point meets the expectation bubble

Guided by conventional interpretation – whose faith in ‘perpetual growth’ is, as yet, unshaken by events or anomalies – governments and investors alike believe that there exists a ‘promised land’ which, if we can once reach it, combines real growth of at least 3% with inflation of less than 2%.

The fatal error on which this supposed nirvana is based is the belief that economics is nothing more than ‘the study of money’, such that energy and broader resource limits to material prosperity do not exist.

The reality, of course, is that everything (including other natural resources) which constitutes economic output is a product of the use of energy, whilst money is nothing more than a medium for the exchange of energy-enabled economic goods and services. The fly in this ointment isn’t that we might ‘run out of’ any form of primary energy, but that energy supply costs (measured as ECoEs) might undermine the dynamic by which energy is translated into economic value. 

As regular readers know, the undermining of this energy dynamic is exactly what we’ve been experiencing over a protracted period. Global trend ECoE has risen from 2.6% in 1990 to 9.2% now. Along the way, this pushed prior prosperity growth in the advanced economies of the West into reverse from 2006 (at an ECoE of 5.7%), and is now doing the same to less complex, less ECoE-sensitive EM countries. There’s a whole raft of flaws in the thesis that we can transition, seamlessly and painlessly, from increasingly costly (and climate-harming) fossil fuels to renewable sources of energy.   

The weakening energy dynamic is precisely why, globally, we’ve spent two decades borrowing $3 in order to deliver $1 of “growth”, and why the ratio of borrowing to GDP has averaged 9.6% to support “growth” of just over 3%.

We’re at the point now where, if they wish to sustain a simulacrum of ‘growth as usual’, the authorities will find it necessary to pour ever-increasing amounts of liquidity into the system. In so doing, they will be creating financial ‘claims’ on economic output that the economy of the future will be unable to meet at value.

At the point at which the ‘real’ economy of energy can no longer support even the illusory sustainability of the ‘financial’ economy of money and credit, the value supposedly contained in these financial “excess claims” will have to be destroyed. Whilst “hard” defaults cannot be ruled out, the balance of probability favours the “soft” default of rampant inflation.

Optimistic investors might, if they were aware of this, think that ‘real’ assets, like equities and property, can still maintain their real value by rising by at least as rapidly as inflation destroys the purchasing power of money.

This, though, is to ignore the effects of the involuntary de-growth induced by the decay of the energy dynamic. As prosperity recedes, consumers will be forced to choose between sinking into a quagmire of debt or adapting to the rising real cost of necessities by cutting back on discretionary purchases.

Whole sectors will suffer utilization rate erosion as prior gains from economies of scale go into reverse. De-complexification of the system will strip some sectors of critical mass, whilst simplification of products and processes will de-layer entire sub-sectors out of existence. Even the Fed cannot sustain the stock prices of businesses whose profitability has ebbed away

It was once famously said that inflation is “always and everywhere a monetary phenomenon”. In our current situation, inflation is likelier to be a ‘denial phenomenon’, if we insist on trying, financially, to engineer “growth” when the critical energy equation is heading in the opposite direction.     


140 thoughts on “#192. The Great Dilemma

  1. Friston’s Law and Fiat Money and Cryptocurrency
    *The amount of free energy that the hydrocarbon production system can produce is inevitably declining
    *The amount of free energy available is the foundation for any debt system. If future free energy is not available in the quantity required to support the debt, then lenders and investors lose.
    *So long as the lenders and investors control the governments which exercise force on their populations, the borrowers also lose.
    *So, as one example in the US, if there were a revolution in Washington and the Federal Government rescinded the guarantees on student loans, then there would be mass defaults, almost instantly. But since there would have been no forgiveness of the loans, the results would be terrible for both the lenders who thought they were buying safe government backed debt and also the borrowers, the college students.
    *Since the government of the US does not recognize the decline in free energy as a real problem, it has continued to promote ever more debt.
    *Since most people have no idea how to survive in the world by actually taking care of their own needs using their own labor and cooperating with their neighbors, they seek some monetary haven which they hope will be insulated from the chaos resulting from mass defaults (either deflationary or inflationary). Gold and Bitcoin and diversification of debt and equity instruments are all attempts to attenuate the decline. But they do nothing to solve the underlying problem. For many people, it is après moi le deluge.
    *The situation might be chaotic and and most of humanity will die, perhaps in a nuclear holocaust as Putin has recently warned at the Davos conference.
    *The best we can hope for is a re-organization of society with a more sustainable system of cascading the use of the free energy. In the natural world, there are very intricate interspecies mechanisms which harvest just the right amount of free energy from the sun, while also leaving enough of that free energy to avoid snowball Earth.
    *Conceptually, both the nGeni of Louis Arnoux and the CoolLabs of Albert Bates are attempts to use ’nature like’ cascading technologies. (This is not an endorsement of their specific proposals.)
    *Farming systems which use photosynthesis by plants to produce carbon in the soil which powers an incredible diversity in the soil food web which cascades the free energy will be one of the essential ingredients as free energy produced by the hydrocarbon production system declines.
    *The only real security is not fiat assets or wealth signifiers such as gold in any form, but instead comes from a deep understanding of the technologically appropriate ways to use free energy from the sun and whatever remains of the hydrocarbon production system. (With important but peripheral contributions from things like falling water.)
    *Humans are designed to minimize the remaining free energy by using energy for life-affirming purposes.
    *The government programs which support ever more debt prevent people from doing what they do best when they have accurate feedback. Similarly, the advertising industry channels reactions in the wrong directions.
    *Status seeking is always a problem. Many indigenous cultures developed methods for taming status seekers…while we have made status seeking a virtue because it increases debt driven GDP.
    *Humans, being social creatures, also need a supportive tribe.

    Don Stewart

  2. Here’s what BBC Economics Editor Andy Verity has to say about central bank policy. The emphasis is mine:

    “The pandemic has brought weirdness to many of our lives. The same applies to the Bank of England. It continues to insist it doesn’t engage in monetary financing, where the central bank simply creates money from nothing (once upon a time you could say “prints money” but now it’s digital) and “lends” it to the government.

    “However, what’s happening now is not much different. As the Financial Times has noted, of the money being borrowed by the government this financial year by issuing gilts – a sort of IOU note also known as a government bond – 92.7% of it will be owed to the Bank of England.

    “Not only is the government “borrowing” most of its money from another branch of the public sector. If it pays interest on that debt it gets it straight back. Easy money. But the money the BoE creates from nothing is used to buy gilts from big City players like pension funds, hoping they’ll invest the cash in productive industry (the last 12 years by no means supports that hope).

    “What they get in exchange is BoE reserves, which pay interest at the official rate. So if rates rose, the BoE – underwritten by the Treasury – would be one of the biggest losers.”

    I monitor fiscal and central bank numbers, and it’s clear that we’re into full-on debt monetisation, not just in Britain but around the Western world in general. Such trends are inherently inflationary.


    • As money turned into currency, its ability to adjust became upwards only. That is, in quantity.

  3. There is a really excellent overview of the limits on energy and mining minerals over at energyskepticDOTcom under “Walter Youngquist: Geodestinies Population.” Focus on U.S. but with many other summaries of specific countries.

    “Today there are no large unoccupied resource-rich areas to absorb migration. There are no vacant fertile, well-watered lands. The globe filled up. New lands with untouched resources were no more. With no new geographic frontiers in which to expand, today’s nations jostle for position within the well-populated and fully explored world. The competition through migration and perhaps military conflict will increasingly be over access to Earth’s remaining resources of energy, water, fertile soil, and other minerals. Making rational and successful adjustments between population and resources will determine the destiny of the human race. Populations must recognize that this destiny is by geology imposed upon them. There must be a recognition of natural limits (Hardin, 1993; Meadows, et al., 2004). Because resources and population are unevenly distributed, the current trend is for people to move from distressed areas to areas that have more resources, or for wealthier nations to send basic resources to the impoverished regions. Such aid does not solve the basic problem and may only make it worse if it allows more people to survive temporarily on a land already over-populated for its resources. Hardin’s observations are a facet of his “lifeboat ethics” (Hardin, 1974). A ship is sinking, and there is one lifeboat. It is launched and filled to its stated capacity of 50 people, but there are still 100 people in the water. Do you, in the spirit of fairness for everyone, take on the additional 100 from the water and have everyone drown, or do you preserve the one lifeboat and its passengers so they can get to the far shore and survive? Do you convert the entire world to a giant slum by unrestricted immigration and no population control? Or do you restrict immigration and insist that individual nations do something about population, so that at least some of them who are successful survive? At present, a number of nations are trying to export their population problems, which ultimately will, if not checked, become a global disaster. However, it will have the merit of equality. Poverty will be universal. Continued population migration will make this concept of “lifeboat ethics” a serious consideration. Responsible and firm action may be required to prevent “lifeboat nations” from being swamped and sunk.”

    • Thanks, it’s a good, well-balanced and well-explained article.

      When we look at the manias on Wall Street (so ably presented at Wolf Street), we might dismiss this sort of thing as a sort of late-stage, end-of-bull market frenzy.

      But when we look at fundamentals – debt, borrowing, financial asset exposure, over-stated GDP and so on – I think we’re forced to conclude that things are deteriorating very rapidly indeed.

      The authorities have an ugly choice to make – let rates rise, asset prices slump and the over-borrowed default – or give in to demands for more free money, and invite destructive rises in inflation. The vaccine effect, if indeed it happens, could trigger an almighty surge in spending, speculative activity and prices.

  4. Why Does the Repo Market have Negative Interest Rates

    This is beyond my pay grade, but it sounds logical to this novice.
    Don Stewart

    • It’s interesting to me that I didn’t hear anything about the expiration of the SLR in this (supplemental leverage ratio), which expires in the US this month. This was a temporary COVID emergency change the FED made to allow banks to expand their balance sheet with treasuries. Overall seems to me that markets think rates are going up – which has the self fulfilling effect of rates going up. Lower demand for treasury auctions is what I’d predict, leading to more yield curve control (buying bonds) by the fed. Apparently this isn’t unprecedented – has happened three times since 2018 in a little quick research.

      Interesting that Yellen intends to pay for stimulus directly from TGA cash account rather than funding through bond auctions. Maybe she is concerned the increased YCC would undermine confidence?

  5. Various mavericks’ warning predictions for the impending energy/lifestyle future are aligning now:


    My guess is that the economic domino cascade has actually already started, but for now it invoves small, hardly invisible ones at the edges, like incremental cliff collapses undermining a building’s foundations. Yet once its undeniably underway, the mainstream media and ‘influencers who have the platforms to be widely heard’ will echo their 2008 call of ”nobody could have seen this coming” as if it were just another random natural disaster.

    • My view on this is that we have to draw a distinction between the economic and the financial.

      On the economy itself, it’s clear that growth is over, and that a decline in prosperity has begun. How bad that will be depends, at least in part, on how soon decision-makers start to understand how the economy really works, and stop promising “growth” that has ceased to be possible.

      The financial system, on the other hand, does face existential challenges. The markets are still “pricing-in” both growth and, more broadly, ‘more of the same’.

    • FI,
      It is rare for Gail Tverberg to make so precise a prediction as to the timing of a financial collapse as she does in her latest article. She sees it “starting” in a few months and snow-balling, with numerous short-term bad effects including shortages of food in grocery stores. (!)

      I see a new mutant, more infectious and more deadly Covid strain in our near future requiring another massive lockdown.

      In other news, I saw an article over at Z/H this morning where the author comments that the antibodies triggered by the new covid vaccines also destroy other antibodies in the body that are there for other defenses, thus weakening resistance to other diseases. Has anyone seen any discussions of this, it’s new to me.

    • The fundamental problem (though there are many others) is that the entire financial system is predicated on perpetual growth. If that predicate is invalidated, the system – in its current form- cannot survive.

      Ultimately, money is a ‘claim’ on the goods and services produced by the economy. We’ve created financial claims far in excess of anything that can be delivered by the economy of today or tomorrow. We can see this, not just in debt, but in broader financial exposure, and in the huge “gaps” in pension provision.

      In the short term, we can create “growth” by injecting credit into the system. Globally, that means we create roughly $3 of new debt for each $1 of “growth” that we buy with it.

      The conventional, fundamentally mistaken view is that we can “grow out of” these problems, much as youngsters “grow out of” childhood ailments like mumps and measles. This view completely misses the connections between output, financial claims and energy.

      In this sense, the financial system has long been on a collision course with reality, and the coronavirus crisis has brought the moment of impact nearer.

    • I found ‘this’.
      “So, really, what are we protecting against with a COVID-19 vaccine? As I stated above, the vaccines aren’t even designed to prevent infection, only reduce the severity of symptoms. But, they could potentially make you even sicker once you’re exposed to the actual virus.
      That seems like a lot of risk for a truly questionable benefit.”

  6. Note on Energy Density of Food
    A human can burn about 4000 calories per day doing hard work. That would require 50 pounds of tomatoes to supply the calories. But a pound of olive oil will supply the calories. Therefore, in terms of caloric density, you can see that the oil made from the North Atlantic animals was extremely valuable. Petroleum does not quite equal oil from animal fat in terms of caloric density, but it’s close.

    You can also see the economics of shipping dry goods such as wheat rather than shipping wet goods such as fresh produce. You can also see the advantages of drying in the sun and rehydrating. The water content also speeds spoilage. Dried tomatoes are light weight and easy to ship.
    Don Stewart

  7. Don, when the new degrowth government is finally elected, I want you to be the secretary of agriculture and permaculture!

    • Jeffrey
      Thanks for your (misplaced) confidence. The post doesn’t make much sense without the previous attempt to post about the Basque’s pioneering the mass slaughter of fat rich animals in the Atlantic in North America. It was a huge industry, at the time of the Spanish Armada…so well before what we think of as the industrial revolution. The European hunters wiped out many of the populations seeking energy density. Some historians have declared that it was animal fat which made Europe rich…not the Aztec gold.
      Don Stewart

  8. @Tagio, indeed, she’s quite pessimistic on the inevitability of a really negative outcome soon, which is understandable given the reliably bad response of our rulers to such adult problems. The conclusion on this site for an example was that limiting mass road vehicles to lower-power ICE capacity would be the least-bad option and better than wholesale electric/battery conversion, yet even after the shale oil debacle, the wrong option is again being pushed with the last of the oil:


    Those with power are either unable to understand complex life-threatening problems, or overwhelmed by their greed into not caring and most of us will just be like the ants trampled in the dust while the elephants fight for supremacy. That’s probably why so many people don’t think about these things, they’re either too scary or demoralising.

    • I’ve argued for a long time that we should limit engine sizes, and I further believe that, in an economy powered by electricity rather than oil, trains and trams would make far more sense than EVs – apart from anything else, battery resources will be needed for handling intermittency, and should be prioritized for that purpose.

      A better policy than promoting EVs right now might be to (a) move towards all-hybrid car sales, limited to 1.5 litre engines, and (b) invest in high quality public transport systems.

    • Unfortunately gasoline is the largest fraction of a barrel of oil. If you decrease petrol consumption but need to keep the same amount of diesel and plastics in the economy, you wind up with waste petrol fractions. It’s not really possible to maintain diesel consumption (or any oil fraction) while reducing others. So switching to public transport would result in wasted petrol (I have no idea how it would be disposed of), not fewer barrels of oil being needed.

      It’s like ordering a cheeseburger when you don’t want the bun. Unfortunately the restaraunt in this illustration cannot hold the bun. Ordering burgers would produce a big stack of buns. In the case of petrol, however, it is toxic and flammable so what to do with it?

    • Mark, I was struck by the sentence: ‘The research shows that [these] investors often have high confidence and claimed knowledge’. Could that be an example of ‘The Google Delusion’, whereby even brief interaction with a search engine leads people to over-estimate their knowledge? It looks and sounds very much like a ‘car-crash’ in the making.

    • @Mark
      From a brief glance at the FCA website I noted the mention of some group called
      ‘Britain Thinks’ being associated with the comments provided by the FCA.
      I found this group title highly amusing since as far as I am aware Britain is one of the last countries in which forward thinking is currently being applied.
      It is deeply embedded in 20th century culture and 18th century institutions.
      Globalisation , decentralisation and their energy deficit are way beyond their vision.

  9. You can’t save people from themselves, professional advice or regulatory intervention notwithstanding! I sense a growing polarisation between those who might think about things in a little more depth and those who just muddle on. I’m referring to what I do; financial planning, for want of a better phrase.

    Two simple examples will suffice. Positively, a key insurance cover that individuals with earnings should have is what we call income protection insurance and the Americans disability coverage. You purchase a policy that will replace a portion (up to 60%-70%) of your income if you were to suffer an illness or condition that lasts a long time, usually expiring at retirement age. The largest cause of claim is mental health, followed by musculo-skeletal problems (bad backs, etc.). The take-up of this essential insurance has been historically low (excepting employer-sponsored plans) but, now, I’m getting more enquiries that actually proceed – are people actually beginning to take more individual responsibility at last? A response to the pandemic? Well, I hope so.

    Negatively, I recently had dealings with a (newly poor) chap who “acted on a hot tip from a friend in the pub” in 2017 and invested all of his private pension in shares in a firm called Conviviality. They went bankrupt in 2018 and he lost a large six-figure fund! He wanted to know if he could claim compensation through regulatory channels because of “bad advice”! I gently explained that nothing could be done as it was entirely his own fault. He will, I fear, face an impoverished retirement through an act of crass stupidity. This time “compensation culture” drew a blank.

    It is this sort of thing that the FCA is warning about – it can’t stop acts of stupidity but can at least reference caveat emptor.

  10. an interesting point worth considering if you’re going to be vaccinated,

    the Danish are revising the vaccine injection protocol and asking that the clinicians aspirate before injecting the vaccine to be sure it is going intramuscular and not intraveneous,

    this is a precaution introduced after some instances of blood clotting have occured after vaccination and accidental intravenous injection is a possible cause,

    I’ve never been an early adopter of anything new, I like to take a good look before leaping,

    at the end of John Campbells report he shows a clip sent by a viewer living in China, a city 300km’s south of Wuhan, the viewer is getting vaccinated with his family and notes that there hasn’t been a recorded infection in that city since April 2020,

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