#200. Other roads, part one

REALITY AND THE ROUTE TO NET ZERO

The release of a new policy document from the International Energy Agency marks a decisive stage in the evolution of the consensus around energy, the environment and the economy. Apart from anything else, Net Zero By 2050: A Roadmap for the Global Energy Sector reinforces the growing sense of commitment to a rapid transition away from reliance on climate-harming fossil fuels.

This policy paper confirms how closely the IEA is aligned with the broad thrust of policy intent in the United States, Britain and the European Union. Emerging economies like China and India might be harder to convince.

It would be easy to critique this document, applauding its ambition whilst questioning some of its methodologies and policy conclusions.

What matters much more, though, is the broad question of how we understand the interconnection between energy, the economy and the environment.

Granted that environmental risk is a function of our use of energy, are energy needs themselves a function of an economy that ‘grows’ according to its own, self-propelled, essentially financial and internal dynamic?

Or should the relationship be reversed, identifying economic prosperity as a subsidiary property of the use of energy?

From which direction?

It was pointed out to me recently that, whilst articles here make frequent reference to SEEDS, the meaning of this acronym is seldom explained. This is an omission based in familiarity and brevity, not reticence.

The short answer is that SEEDS – the Surplus Energy Economics Data System – is an economic model based on recognition that the economy is an energy dynamic. This means that it’s radically different from conventional models, which treat the economy as a wholly financial system.

This difference of approach may sound theoretical, but its practical implications could hardly be more far-reaching.

To illustrate, imagine that you’re trying to predict the future demand for some product or service. Conventionally, you’d do this by starting with GDP, and applying a forward rate of growth to calculate the size of the economy at some date in the future. With this as ‘a given’, you have the parameters or context for estimating the potential size of your market. What matters now is the potential expansion or contraction of demand for your product as a share of that broad context.

Your aim, of course, is practical rather than theoretical – you want to predict the scale and shape of the market for your product or service. You’re unlikely to be interested in the theory of economics itself, and are, in all probability, content to work within consensus methods, and arrive at consensus results. Even if your organization is big enough to employ its own economists, the probability is that this makes no real difference at all to the methodologies used, and very little difference to the resulting forecast.

Governments work in much the same way – they start by projecting, along conventional lines, the probable size of the national economy of the future, and only then assess the implications for the many aspects of policy.    

The same approach is used for the forecasting of future energy requirements. All such conventional projections start with an assumption about the future size of the economy, and only then calculate what that is going to mean for energy needs. The near-unanimity of conventional forecasting right now is that the economy, meaning GDP, will grow at a trend rate of 3%.

Travelling to Net Zero

Hitherto, the resulting informed consensus around energy has been that, whilst renewable energy sources (REs) will capture an ever-increasing share of the energy market, the quantities of fossil fuels used will continue to increase. In contesting this, the IEA report applies a significantly new impetus to the direction of travel in the forecasting of future energy needs.

To be sure, there are differences between proposals and forecasts. Even so, the IEA’s Net Zero is an almost breathtakingly bold break from the prior consensus. It argues that rapid commitment to energy transition can, by 2050, deliver a world with zero net emissions of CO2.

In addition to massively increased investment in renewable sources of energy (REs), the IEA calls for the immediate cessation of all new oil and gas development projects. This amounts to an accelerated run-down of supplies of legacy energy from fossil fuel sources.

The pay-off, says the IEA, isn’t just the prevention of catastrophic degradation of the environment, but includes millions of new jobs and a big – and this time a more globally-inclusive – spurt of economic expansion.

You won’t be expecting me to agree that all of this is feasible, and I don’t. Let’s be clear, though, that the IEA, and others, are absolutely right to stress the need for transition away from climate-harming fossil fuels to REs.

Indeed, SEEDS analysis takes this imperative even further.

Environmentalists – whose ranks now include most Western governments, as well as organisations like the IEA – assert that continued reliance on fossil fuels risks inflicting irreparable harm to the environment.

Where SEEDS goes further is in arguing that, whilst continued fossil fuel dependency would probably wreck the environment, it would certainly destroy the economy.

The explanation for this is simple – it is that the cost of fossil fuel energy is rising, such that its net (post-cost) value is decreasing.

What this means is that the established sources of energy value that have powered the Industrial Age are fading away.

Thinking – forwards or backwards?

This brings us back to the critical issue of method. Instead of assuming a future economy of a given size, and then working backwards to the energy that this economy will require, SEEDS starts with energy projections, and only then asks what size of economy can be supported by the forward outlook for energy.

Put another way, SEEDS dismisses any notion of commencing with an assumed rate of growth in economic output. At the same time, the model also dismisses the idea that GDP is, or can be, a meaningful metric for economic prosperity.

Consensus forward “growth” assumptions, typically 3%, are based on a supposedly cautious continuation of what are accepted as recent trends. These depict the economy, measured as GDP, as something capable of expanding at annual rates of between 3.25% and 3.75%.

That seems to check with stats showing that, between 1999 and 2019 – that is, in the twenty years before the coronavirus shock – annual increments to reported GDP averaged 3.6%.

What this ignores is that, over that same period, annual net borrowing averaged 10.4% of GDP. Unless you believe that the spending of newly-created purchasing power has no effect on the activity measured as GDP, then changes in GDP itself are linked to the rate at which credit expands.

Moreover, debt is by no means the only form of forward obligation whose expansion is linked to economic activity. Whilst each $1 of reported “growth” between 1999 and 2019 was accompanied by an increase of nearly $3 of debt, adding in the expansion of broader financial obligations lifts this ratio to well over $6 of new commitments for each dollar of “growth”.

As so often, the acid test for such varying interpretations is observation. If conventional data is right, global GDP increased by 110% between 1999 and 2019, whilst population numbers expanded by 26%. Even after a surprisingly modest fall (of -3.3%) in world GDP during crisis-hit 2020, output was still higher by 103% over a period (1999-2020) in which population growth was 27%.

This ought, surely, to mean that the economy is in far better shape now than it was back in 1999. Sharply higher prices for assets such as stocks and property seem to reinforce this optimistic reading.

But the economy as we observe it today doesn’t conform to this description.

Most obviously, we’re caught in a stimulus trap. If we carry on pouring gargantuan amounts of liquidity into the system, we face a very real risk of the hyperinflationary destruction of the value of money. But if we stop – or even scale back on – stimulus, asset prices would crash, and a cascade of defaults would ensue.

Can we square this observation of ‘fragility edging into crisis’ with the assurance that economic output has almost effortlessly out-grown population numbers over a very extended period?

The answer, of course, is that we can’t.

After all, if the economy had been performing as strongly as prior growth rates imply, why would we still be locked into a supposedly “temporary” and “emergency” reliance on negative real interest rates that began back in 2008-09?

We can’t, to any significant extent, put the blame for this on covid-19, not least because the official data itself puts the scale of the hit to the economy in 2020 at only -3.3%. At worst, then, we’ve lost a single year of the growth supposedly enjoyed during each of the twenty years preceding the pandemic.

The bottom line is that GDP stats are telling us one thing, and what we can see unfolding right in front of our eyes is the diametric opposite. On the one hand we have an economy that’s growing robustly – on the other, an economy dependent on the life-support of financial gimmickry, and trapped in a cul-de-sac from which there is no obvious route of escape.

Other roads

This is where alternative approaches are so important. To be clear, economic orthodoxy describes a robust economy that doesn’t exist, whilst policy orthodoxy is based on the continuation of positive trends which, it turns out, don’t exist either.

The SEEDS approach begins with three observations, familiar to regular readers and requiring only the briefest introduction for those for whom this is new.

First, the economy is an energy system, because literally everything which constitutes economic output is a product of the use of energy.

Second, whenever energy is accessed for our use, some of that energy is always consumed in the access process. This second principle establishes the role of the Energy Cost of Energy (ECoE), and divides the stream of energy and its associated economic value into “cost” (ECoE) and “profit” (surplus) components.

The third principle is that money has no intrinsic worth, but commands value only as a ‘claim’ on the products of the energy economy.

An economy stripped of money would have to resort to barter, or would have to create a replacement human artefact as a medium of exchange.

An economy stripped of energy, on the other hand, would, as of that moment, cease to exist.     

These principles identify a dynamic which, though complex in application, is straightforward in principle. We use energy to create economic value. Some of this energy value has to be used in the energy access process itself. What remains powers all economic activity other than the supply of energy itself. ECoE is the factor which differentiates between economic output and material prosperity.

From this perspective – and in an economy which still derives four-fifths of its primary energy supply from oil, gas and coal – a critical trend has been the relentless rise in the ECoEs of fossil fuels.

This increase in ECoEs fits with observable trends, first by explaining the emergence (though not, in general, the accurate interpretation) of “secular stagnation” in the 1990s, and then by tracking the subsequent, crisis-strewn descent into that dependency on the credit and monetary gimmickry that has created the stimulus trap described earlier.

In short, what SEEDS interpretation says should happen as ECoEs rise coincides with what has happened as this trend has developed.  

Feasible directions?

To resolve this issue, and to restore the capability for growth as well as minimising environmental harm, a transition to REs would need to accomplish two things.

First, it would need to provide a volumetric replacement for fossil fuels. This, unfortunately, is about as far as the conventional setting of targets usually goes.

Second, and critically, it would also need to drive overall, all-sources ECoEs back downwards.

For Western countries, successful ‘transition with growth’ would need, at a minimum, to drive overall ECoEs back below 5%, from a current global trend ECoE level of 9% and rising. For advanced economies, whose complexity involves high maintenance requirements in terms of ex-ECoE (surplus) energy, 5% is the upper ECoE parameter beyond which prior growth in prosperity goes into reverse.

Put another way, driving ECoEs down from 9% to 5% might be enough to forestall “de-growth”, but wouldn’t be low enough to reinstate growth itself. To achieve that, we’d need to push ECoEs down a lot further, probably to levels below 3.5%.  

The volumetric side of the transition equation is tricky, and has been costed at between $95 trillion and $110tn. The financial price tag, of course, isn’t the issue, least of all in a world in which money is routinely conjured out of thin air. What matters is the quantity of material inputs which these sums represent.

Let’s assume, for purposes of hypothesis, that the Earth can supply the requisite amounts of raw materials necessary for the provision of inputs ranging from steel and copper to plastics, lithium and concrete.

As we know, accessing these materials and putting them to use is absolutely dependent on the use of energy. Without energy-intensive activity, we can’t even supply water, let alone extract minerals and convert them into components.

In short, the principle of ECoE – which applies, not just to the creation of capacity, but to its operation, maintenance and replacement as well – tells us that getting energy from RE sources at the scale that we require is absolutely dependent on the prior use of energy for these purposes.

Since, at least for the foreseeable future, the supply of these materials depends on legacy energy from fossil fuels, the ECoEs of renewables are linked to those of oil, gas and coal.

Identifying process

So here’s the equation that net zero combined with growth invites us to accept.

On the one hand, energy sourced from fossil fuels declines rapidly. On the other, physical products of energy – the inputs that we’ll need to expand RE supply dramatically – will become available in very large amounts.

Another way to put this is that we’re planning to abandon the sunk energy invested in the carbon infrastructure, and build a replacement infrastructure at global scale, and carry on driving, flying and doing everything else that we do with energy, at the same time as we’re driving down energy supply from legacy sources.

An obvious snag here is that nobody seems prepared to tell us what uses of energy will need to be relinquished in order to free up the resources needed for physical investment at a transformational scale.       

If we free ourselves from the delusion that the economy is some kind of self-perpetuating, wholly-financial, perpetual-motion mechanism operating independently of energy, the only way to square this circle is to rely on indefinite cost reduction through continued progress in technology. This is why faith in the indefinite advance of technology is implicit in so many aspects of the ‘net-zero-without-economic-sacrifice’ narrative.

The problem with this is that it overlooks the reality, which is that the scope of technology is bounded by the physical parameters of the resource. This, of course, is why no amount of technology – or, for that matter, of financial commitment – has been able to use shale resources to turn the United States into “Saudi America”.       

In addition to technological extrapolation to a point beyond the limits of physics, the critical snag with driving the ECoEs of REs downwards far enough is the fallacious assumption that, through some kind of internal financial dynamic, the economy can “grow”, of its own accord, to make all of the necessary transitional steps possible.

If we once accept the proposition that, whilst energy use falls, real economic output can rise, then we’re in danger of endorsing the fantasy that we can “de-couple” the economy from the use of energy. And, since we cannot produce anything of any economic utility at all without using energy, “de-coupling” is a logical impossibility.

From here

None of this is to say that we can’t, or shouldn’t, bend every effort to transition from fossil fuels to renewables. On the contrary, the transition to net zero goes far beyond the desirable, and into the imperative.

Far from contesting the necessity for transition, SEEDS establishes a compelling economic as well as an environmental case for endeavouring to do exactly that. An economy tied in perpetuity to the rising ECoEs of fossil fuels would face inexorable deterioration.

This isn’t a trend that we have to predict, because it’s beyond doubt that this is already happening.

Where SEEDS-based analysis parts company with the ‘new consensus’ is over the belief, amounting to an article of faith, that this process (a) can be accomplished without sacrifice, and (b) can be combined with economic growth.

Any given quantity of energy cannot be used more than once. Legacy energy value from fossil fuels, already a finite quantity, becomes a smaller finite quantity under plans to accelerate the abandonment of oil, gas and coal.

A situation in which this limited quantity of legacy energy is used to expand RE supply, and to build the requisite infrastructure, and to maintain current energy uses such as driving and flying, fails the test of practicality. The associated assumptions – that technology will provide a fix for everything, and that the economy ‘will carry on growing’ thanks to some kind of internal momentum – fail the test of logical interpretation.                      

All of this, of course, carries the obvious, if startling, implication that we’re trying to progress to a desirable destination using a basis of planning that’s demonstrably false.

The pace at which we should abandon the use of fossil fuel energy is a matter for debate.

But the need to abandon those fallacious, money-only methods of interpretation which create the myth of the economy as a perpetual-motion machine, growing ever larger through an internal mechanism disconnected from energy, has become imperative.   

#199. An American nightmare

ENERGY, “GROWTH” AND THE LIABILITY VORTEX

“Time moves on”, at least in politics, and it should now be possible for us to examine the American economic situation without being drawn into recent controversies.

In any case, our primary interests here are the economy, finance and the environment, understood as functions of energy, and these are issues to which political debate is only indirectly connected. We cannot know whether the economic policies now being followed in the United States would have been different if Mr Biden hadn’t replaced Mr Trump in the Oval Office, and what we ‘cannot know’ is far less important than what we do.

If you’re new to this site, all you really need to know about the techniques used here is that the economy is understood and modelled, not as a financial construct, but as an energy system. Literally everything that constitutes economic output is a function of the use of energy. Whenever energy is accessed for our use, some of that energy is always consumed in the access process, and this Energy Cost of Energy (ECoE) governs the dynamic which converts energy into prosperity.

Money – which, after all, is simply a human artefact – has no intrinsic worth, and commands value only as a ‘claim’ on the output of the real economy governed by the energy dynamic. Energy, moreover, is the interface between economic prosperity and the environment.   

American dysfunction

Even without getting into the energy fundamentals, a string of dysfunctionalities in the American economic situation should be visible to anyone prepared to look. These are best considered, not within the current disturbances created by the coronavirus pandemic, but on the basis of trends that have been in place for a much longer period.

Most obviously, the aggregate of American debt – combining the government, household and private non-financial corporate (PNFC) sectors – increased in real terms by $28 trillion (104%) between 1999 and 2019, a period in which recorded GDP grew by only $7.4tn.

One way to look at this is that each dollar of reported “growth” was accompanied by $3.75 of net new debt. Another is that, over twenty years in which growth averaged 2.0%, annual borrowing averaged 7.5% of GDP.

To be sure, some of these ratios have been even worse in other countries, but schadenfreude has very little value in economics. Moreover, debt is by no means the only (or even the largest) form of forward obligation that has been pushed into the American economy in order to create the simulacrum of “growth”.     

Other metrics back up this interpretation. Within total growth (of $7.4tn) in reported GDP between 1999 and 2019, only $160bn (2.2%) came from manufacturing. A vastly larger (25.3%) contribution to growth came from the FIRE (finance, insurance and real estate) sectors.

These and other services are important but – unlike sectors such as manufacturing, construction and the extractive industries – they are residuals, priced on a local (‘soft’) basis rather than on ‘hard’ international markets.

To over-simplify only slightly, many services act as conduits for the financial ‘activity’ created by the injection of credit and liquidity into the system.

The real picture – of credit and energy

The SEEDS model endeavours to strip out these distorting effects, and indicates that underlying or ‘clean’ economic output (C-GDP) in the United States grew at an average rate of only 0.7% (rather than 2.0%) between 1999 and 2019.

In essence, reported GDP has been inflated artificially by the insertion of a credit wedge which is the corollary of the ‘wedge’ inserted between debt and GDP (see fig. 1).

Fig. 1

This much should be obvious even to those shackled to quaint, ‘conventional’ economic metrics which – bizarre as it may seem – ignore energy, and insist on wholly financial interpretation of the economy. To trace these anomalies to their cause, though, we need to look at the energy dynamic and, in particular, at the ECoE equation which governs the supply, cost and economic value of energy.

Globally, trend ECoEs are rising rapidly, driven by the depletion effect as it affects petroleum, natural gas and coal. The ECoEs of renewables (REs) such as wind and solar power are falling, but it would be foolhardy to assume that this can push overall ECoEs back downwards at all, let alone to the pre-1990s levels at which real growth in prosperity remained possible. Apart from anything else, RE expansion requires vast material inputs which are themselves a cost function of legacy energy from fossil fuels.

ECoEs equate to economic output which, because it has to be expended on energy supply, is not available for any of those other economic uses which constitute prosperity. This is why SEEDS draws a distinction between underlying economic output (C-GDP) and prosperity.

On an average per capita basis, American prosperity topped out back in 2000 (at $49,400 at constant 2020 values), when national trend ECoE was 4.5%. By 2019, with ECoE now at 9.0%, the average American was 6.6% ($3,275) poorer than he or she had been in 2000. Of course, his or her share of aggregate debt increased (by $68,500, or 71%) over that same period (see figs. 2 and 3).

Again, there are other countries where these numbers are worse. Again too, though, what’s happening in other countries is of very little relevance to a person whose indebtedness is rising whilst his or her prosperity is subject to relentless erosion.   

Fig. 2

The fading dream

Just as prosperity per person has been deteriorating, the cost of essentials has been rising. To be clear about this, the calibration of “essentials” (defined as the sum of household necessities and public services) within the SEEDS economic model remains at the development stage, but the results can at least be treated as indicative.

As we can see in the left-hand chart in fig. 3, discretionary prosperity has been subjected to relentless compression between deteriorating top-line prosperity per capita and the rising cost of essentials, a cost which, in turn, is significantly linked to upwards trends in ECoE.

Discretionary consumption has continued to increase – thus far, anyway – but only as a function of rising indebtedness in each of the public, household and PNFC (corporate) sectors. Even these numbers are based on per capita averages, so necessarily disguise a worse situation at the median income level.   

Fig. 3

The liability vortex

Back at the macroeconomic level, America is, very clearly, being sucked into a liability vortex.

Even before the coronavirus crisis, debt stood at 360% of prosperity, up sharply over an extended period, whilst the broader and more important category of “financial assets” – essentially the liabilities of the government, household and PNFC sectors – had risen to 725% of prosperity (fig. 4).

Fig. 4

Like anyone else, Americans can derive false comfort by measuring these liability aggregates, not against prosperity but against GDP, if they’re happy to buy the fallacy that GDP isn’t inflated artificially by financial liability expansion.

Another, almost persuasive source of false comfort can be drawn from the inflated “values” of assets such as stocks and property. The realities here, though, are that the only people who could ever buy properties owned by Americans are other Americans, meaning that the supposed aggregate “value” of the national housing stock cannot ever be monetized. The same, albeit within an international rather than a purely national frame of reference, applies to the aggregate “values” of stocks and bonds.  

More important still, asset prices are an inverse function of the cost of money, and would fall sharply if it ever became necessary to raise interest rates.

Debate rages in America, as elsewhere, about whether inflation is rising at all, and whether, if it is rising, this is a purely ‘transitory’ effect of contra-crisis liquidity injection. An additional complication here is that inflationary measurement excludes rises in asset prices and may, even within its consumer price confines, be an understatement of what’s really happening. The SEEDS-based development project RRCI – the Realised Rate of Comprehensive Inflation – puts indicative American inflation at 5.2% in 2020, rising to a projected 6.6% this year.  

Cutting to the chase

This debate over the reality and the rate of inflation, though, risks missing the point, which is that the in-place dynamic between liabilities and economic output makes either inflation, and/or a cascade of asset price slumps and defaults, an inescapable, hard-wired part of America’s economic near future.

Even before Covid-19, each dollar of reported “growth” was being bought with $3.75 of net new borrowing, plus an incremental $3.80 of broader financial obligations. Even these numbers exclude the informal (but very important) issue of the future affordability of pensions.

Crisis responses under the Biden administration – responses which might not have been very different under Mr Trump – are accelerating the approach of the point at which, America either has to submit to hyperinflation or to tighten monetary policy in ways that invite the corrective deflation of plunging asset markets and cascading defaults.   

The baffling thing about this is that you don’t need an understanding of the energy dynamic, or access to SEEDS, to identify unsustainable trends in relationships between liabilities, the quantity of money, the dramatic over-inflation of asset markets and a faltering underlying economy.

Confirmative anomalies are on every hand, none of them more visible than the sheer absurdities of paying people to borrow, and trying to run a capitalist economy without real returns on capital. Meanwhile, slightly less dramatic anomalies – such as the investor appetite for loss-making companies, the “cash burn” metric and the use of debt to destroy shock-absorbing corporate equity – have now become accepted as routine.

Obvious though all of this surely is, denial seems to reign supreme. Mr Trump – and his equation linking the Dow to national well-being – may have gone, but government and the Fed still cling to some very bizarre mantras.

One of these is that stock markets must never fall, and that investors mustn’t ever lose money. Another is that nobody must ever default, and that bankruptcies destroy economic capacity (the reality, of course, is that bankruptcy doesn’t destroy assets, just transfers their ownership from stockholders to creditors).  

Businesses, meanwhile, seem almost wilfully blind to the connection between consumer discretionary spending, escalating credit and the monetization of debt.

On the traditional basis that “when America sneezes, the rest of the world catches a cold”, what we seem to be nearing now is something more closely approximating to pneumonia.   

SUPPLEMENT

Here, as requested, are equivalent charts for New Zealand:

#198. The Theseus gambit

THE THREAD OF RATIONAL INTERPRETATION

According to Greek mythology, Theseus, having killed the Minotaur, found his way back from the heart of the Labyrinth by following a thread given to him by Ariadne.

There are two lessons – in an earlier idiom, morals – to be taken from this story. The obvious one is the wisdom of taking a thread into the maze and using it to find the way back out. The less obvious lesson is that the thread Theseus followed was reliable, a guide which, like real gold, would pass an ‘assay’ of veracity.

Our current economic and broader circumstances merit comparison with the Labyrinth – we’re in a maze which has many complex blind-alleys, routes to nowhere which tempt the unwary. If we’re to fashion a reliable thread that can be followed through it, we need to apply the assays of logic and observation.

The thread followed here starts with the purposes of saving and investment, purposes which pass the assay of logic, but fail the test of observation. This points to dysfunction based on anomaly, the anomaly being that the practice only conforms to the principle in the presence of growth.

Postulating that the economy is an energy system rather than a financial one also passes the assays of logic and observation, and confirms we have a thread that can be followed to meaningful explanations and expectations.

An assay of logic

Capital theory is as a good a place to start as any. This theory is that, in addition to meeting current needs and wants, a sensible person puts aside a part of his or her income for the purposes both of having a reserve (“for a rainy day”) and of accumulating wealth. The flip-side of this process is that saving – as ‘economic output not consumed’ – provides capital for investment. This theory would apply, incidentally, even if some form of barter were substituted for money.

For this to work, the saver or investor must receive a real return on investment that is positive (that is, it exceeds inflation), and this return must be calibrated in proportion to any risk to which his or her investment is exposed. The user of this capital must earn a return on invested capital which exceeds the return paid to the investor. Any business unable to do this must fail, freeing up capital and market share for more efficient competitors.

This thesis rings true when measured on the ‘assay of logic’ – indeed, it describes the only rational set of conditions which can govern productive and sustainable relationships between saving, investment, returns and enterprise.

But it’s equally obvious that this does not describe current financial conditions. Returns to investors are not positive. These returns are not calibrated in proportion to risk. Businesses do not need to earn returns which exceed appropriate returns being paid to investors. Businesses unable to meet this requirement do not fail. 

When logic points so emphatically towards one set of conditions, whilst observation leaves us in no doubt that contrary conditions prevail, we don’t need to venture further into investment theory in order to confirm the definite existence of an anomaly.

To discover the nature of this anomaly, let’s look again at capital theory to discover the predicates shared by all participants.

The investor needs returns which increase the value of his or her capital.

The entrepreneur needs returns which are higher again than those required by the investor.

The shared predicate here is that the sum of money X must be turned into X+.

For the system to function, then, the shared predicate is growth.

Logic therefore tells us two things. The first is that a functioning capital system absolutely depends on growth. The second, inferred-by-logic conclusion is that, if the system has become dysfunctional, the absence of growth is likely to be the cause of the dysfunction.

Observed anomaly is thus defined as a property of dysfunction, whilst dysfunction itself is a property of the absence of growth.

You don’t need a doctorate in philosophy to reach this conclusion. All you need do is follow a logical sequence which (a) defines anomaly as intervening between theory and current practice, and (b) identifies this anomaly as the absence of growth.

We can confirm this finding by hypothesis. If we postulate the return of real, solid, indisputable growth into this situation, we can follow a sequential chain which goes on to eliminate the anomaly and restore the alignment of theory and practice.     

Testing the thread

The deductions that (a) dysfunction exists, and (b) that this is a product of the lack of growth, take us on to familiar territory. If you’re a regular visitor to this site, you’ll know that the basic proposition is that the economy, far from being ‘a function of money, and unlimited’, is in fact a function of energy, and is limited by resource and environmental boundaries.

Using logic and observation, we can similarly apply the ‘assay of rationality’ to the propositions informing the surplus energy interpretation. There are three of these propositions or principles, previously described here as “the trilogy of the blindingly obvious”.

The first principle is that all of the goods and services which constitute economic output are products of the use of energy. If it were false, this proposition would be easy to disprove. All we’d have to do is to (a) name anything of economic utility that can be produced without the use of energy at any stage of the production process, and/or (b) explain how an economy could function in the absence of energy supply.

The second principle, applied here as ECoE (the Energy Cost of Energy), is that whenever energy is accessed for our use, some of that energy is always consumed in the access process. Again, if this proposition were false, its fallacy could be demonstrated, simply by citing any example where energy can be accessed without the use of any energy at any stage in the access process.

The third proposition – that money has no intrinsic worth, and commands value only as a ‘claim’ on the output of the energy economy – ought, if false, to be the easiest one to disprove. We would need to do no more, as a thought-exercise, than cast ourselves adrift in a lifeboat, equipped with very large quantities of any form of money, but with nothing for which this money could be exchanged. If this experiment succeeded, the ‘claim only’ hypothesis would be disproved.

The inability to disprove these propositions means that the theory of the economy as a surplus energy system passes the assay of rationality. Application is a much more complex matter, of course, but the next test is to see how theory fits observation.

The assay of observation

From the mid-1990s, and as the following charts show, global debt started to expand far more rapidly than continuing growth in reported GDP. Available data for twenty-three economies – accounting for three-quarters of GDP – shows a corresponding trend in the broader measure of ‘financial assets’, which are, of course, liabilities of the non-financial economy of governments, households and private non-financial corporations (PNFCs).

There is reliable data showing yet another correspondence, this time between the GDPs and the unfunded pension obligations (“gaps”) of a group of eight economies which include global giants such as the United States, China, Japan and India.

Let’s be clear about where this takes us. We’ve already identified the absence of growth as the source of financial dysfunction. We’ve now seen parallel anomalies in the relationships between GDP and liabilities.

These divergent patterns can be explained – indeed, can really only be explained – in terms of exploding financial commitments distorting reported GDP. Put another way, there are compounding trends whose effect is to ‘juice’ and to mispresent reported economic output.

This observation accords with the logical conclusion, discussed earlier, that the relationships between saving, investment, returns and enterprise have been distorted into a dysfunctional, anomalous condition by the absence of growth. The only complication is that we have to look behind reported “growth” numbers to make this connection.

What, though, explains the absence – in practice, the deceleration, ending and impending reversal – of growth itself? The right-hand chart indicates that what was happening at the start-point of observed economic distortion was a rise in ECoEs.

The assay that we’ve undertaken has shown the validity of the concepts of output as a function of energy, ECoE as a characteristic of the output equation, and money in the role of ‘claim’. This in turn validates the linkage identified here.

Fig. 1

 Once again, let’s apply the test of hypothesis. Assume that a new source of low-cost (low ECoE) energy is discovered. Prosperity would increase, and real growth would return to the system. The observed anomalies in capital relationships would disappear.

This, remember, is purely hypothesis, because the discovery of a new source of low-cost energy is at the far end of the scale of improbability. We can thus conclude that dysfunction and anomaly will continue, to the climacteric at which the monetary system described by capital theory reaches a point of failure.

The clarity of defined anomaly    

For anyone who isn’t a mythical hero, venturing into the Labyrinth, confronting the Minotaur and finding our way out again sounds like a terrifying experience. There are clear analogies to the present, in terms of the uncertainty of the maze, and the fear induced by the unknown. We may not have Ariadne’s thread, but we can fashion a good alternative by opting for rationality, applied through logic and observation.

The results of this process do seem to have the merit of clarity. Comparing capital theory with observed conditions identifies a dysfunction or anomaly that can be defined as the absence of growth. This in turn can be explained in terms of a faltering energy economy. Take away the predicate – growth – and the financial system becomes dysfunctional.

This interpretation helps to clarify the roles of the various players in the situation. Taking the ‘elites’, for example, we know that the defined aim of all elites is to maintain and, wherever possible, to enhance their wealth and influence. We can infer that, if we can identify the dysfunctionality of capital theory and observed conditions, so can they.

Likewise, we know that the defined aim of governments is the maintenance of the status quo, and we can again infer that they, like we, recognize the essential dysfunction as ‘the failure of the predicate’.

To this extent, we can demystify the behaviour of elites and governments. We can also make informed judgements on their probabilities of success. (These probabilities are low, for reasons which lie outside the scope of this discussion).

A similar application of logic and observation tells us that anomaly cannot continue in perpetuity. We can hypothesize the resolution of the energy-ECoE problem, but examination of the factors involved suggests that any such resolution, even if attainable, is unlikely to happen in time to restore equilibrium to the financial system. There are equations which relate the investment of legacy energy (from fossil fuels) into a new energy system (presumably renewables), and these equations give few grounds for optimism where current systems are concerned.

If rationality can take us this far, it surely makes sense to adhere to it. The probabilities are that global prosperity will contract, meaning that systems predicated on growth will cease to function. The logic of the situation seems to be that, when old predicates change, we need to fashion new systems based on their successors. 

#197. “Life After Ideology”?

THE POLITICAL ECONOMY OF DE-GROWTH

Two broad sets of ideas have shaped the practice and philosophy of political economy during much of the Industrial Age. One of these is collectivist thinking, which argues for state or communal ownership of “the means of production”. The other is the market philosophy which advocates the primacy of private ownership.

These are ultra-broad-brush categorizations, useful because they correspond to a duality in the human psyche – a duality comprising the desire for collaborative effort and the ambition for self-betterment. These, in their myriad forms, have been the polarities of debate since the onset of industrialization in the 1760s. They have often been labelled “left” and “right”, but these labels are so vague, and their applications have been so varied, that they cannot serve as useful terms in the current context.   

That context is involuntary economic de-growth, caused by a deterioration in the dynamic which has powered economic activity for well over 200 years.

The Industrial Age began when the first efficient heat engines enabled us to access vast reserves of energy contained in coal, petroleum and natural gas. This triggered parallel expansions, exponential in nature, in human population numbers and in the economic means of their support.

It cannot be emphasised too strongly that the economy is an energy system, not a financial one. Anything that has economic utility is a product of energy. The various monetary systems used over time have served primarily as media of exchange for the goods and services made available by the use of energy.

Energy itself has never been “a free lunch”. Whenever energy is accessed for our use, some of that energy is always consumed in the access process. This ‘consumed in access’ component is known here as the Energy Cost of Energy, or ECoE.

ECoEs have been rising relentlessly, and have already passed the thresholds at which, first, advanced Western economies start getting poorer and, latterly, the same thing starts happening to less complex EM countries.

Much of today’s uncertainty and contention can be traced to this process itself, and to our inability, or our unwillingness, to recognize this reality.

The onset of “de-growth”

With these points understood, the long-range interpretation of the economy devolves into a series of equations, comparatively straightforward in principle, though complex in application.

Prosperity is a function of how we convert surplus (net-of-ECoE) energy into economic value. The quantitative variables are the amount of energy available, the proportion of that energy ‘lost’ to the economy as ECoE, the efficiency with which surplus energy is converted into economic value, and the number of people between whom aggregate prosperity is shared.

This energy interpretation indicates that economic prosperity cannot be infinite on a planet with finite resources. Environmental and ecological degradation introduce a new ‘infinity fallacy’, revealing that there are limits to the ability of the ecosphere to tolerate our use of energy, certainly when the vast bulk of that energy is sourced from fossil fuels.    

Problems with this system have been forced upon our attention only in comparatively recent times. As ECoEs have risen, we have begun to encounter (though not to recognize) the limits to material economic growth founded on the use of fossil fuels. At the same time, there has been widening public recognition of the adverse environmental and ecological consequences of the exploitation of fossil energy.

In essence, neither the reserves base nor the environment can support further economic growth based on the use of fossil fuels. Indeed, even the maintenance of current fossil-based prosperity has become impossible.

This presents us with two possible developments. The first is that we find alternative forms of energy which free us from resource and environmental constraints.

The second is that we come to terms with the ending and the reversal of prior growth in material prosperity.

The best available evidence points to an outcome which is at neither of these extremes. We can, and indeed must, develop alternative energy sources, including wind and solar power. But we cannot assume ‘like-for-like’ replacement of the economic value derived from fossil fuels, so we need to plan on the basis that aggregate material prosperity will decrease.

Cognitive dissonance and ideological luxury

The unfolding failure of the established ‘growth engine’ is causing systemic, cognitive, psychological and political disruption.

We’ve done everything we can to deny the reality of involuntary de-growth. Means of denial have included financial gimmickry, the making of exaggerated claims for the potential of renewable energy and for technology more broadly, and even assertions that we can find ways of ‘engineering’ our way out of environmental constraints.

The lengths to which we’ve been prepared to go to deny the physical reality of the faltering economy have been quite remarkable.

Conspiracy theories have flourished in a context of ignorance (about energy reality), suspicion and mistrust.   

Despite the climate of denial, the storm front of de-growth has already thrown systems into chaos. The “market economy” has been abandoned in all but name, transformed into what might best (and most neutrally) be described as the “make it up as you go along” economy. We’ve embraced the fiction that the creation of ever more money can keep the wolf of de-growth from the door.  

It doesn’t help that we’ve spent centuries congratulating ourselves on economic ‘knowledge’ that is fallacious. The conventional basis of economic interpretation – which concentrates on money, puts energy into an ancillary role, and insists on the potential for growth in perpetuity – is in the process of being invalidated.

We have an ingrained sense of ownership of growth, amounting to a feeling of entitlement to a current level of material prosperity that, we believe, can only increase over time. If this isn’t happening, “somebody else” must somehow be at fault. Political economy has long concentrated on the distribution of economic prosperity on the assumption that this prosperity itself must increase in perpetuity. Our financial system is entirely predicated on “growth” in perpetuity.

Most of us cannot even imagine a system in which politicians, opinion-formers, business leaders and financiers stop talking about “growth” and start discussing contraction. There have always been some people who have advocated “de-growth”, but they have tended to promote this as a beneficial choice, not as an involuntary inevitability.    

One definition of “de-growth” might emphasise the loss of luxuries. This applies, not just to the loss of material non-essentials, but to political and ideological luxuries as well. Economic growth has enabled us to indulge in philosophical extremes, including advocacy of wholly-state or wholly-private ownership of “the means of production”. To stand any chance of adapting to involuntary de-growth, we will need to put ideological extremism behind us, and concentrate instead on pragmatism.

From a pragmatic perspective, both the collectivist and the market models have strengths and weaknesses. Pragmatism now decrees that we need to combine the strengths of both, and use each to minimize the weaknesses of the other. The term best describing this pragmatic balance is the “mixed economy” which optimizes a combination of public and private provision. Extreme collectivism failed between the 1960s and the 1990s, and the extreme or “liberal” version of the market alternative has failed now.

Philosophically, the aim now should surely be to seek an optimal combination of systems and ideas which meets the basic needs of everyone, whilst maximising the scope for individual endeavour. One of our greatest assets is our ability to think our way around problems, in the process producing new ideas.

Extremism isn’t wanted, or affordable, on our journey into a post-growth society.

To use a historical rather than a contemporary example, the Puritans of seventeenth-century England believed that theatres, taverns and country dancing were manifestations of evil. The tragedy was that, in addition to exercising their right not to participate in such activities themselves, they also set out to enforce these prohibitions on everyone. Puritan authoritarianism was rooted in religious belief, but there have been, and remain, equivalent schemes of repression founded on secular rather than spiritual persuasion.

Enforced agreement, however it is manifested, would be an even greater handicap in a post-growth than in a growing or a pre-growth society. The finding of solutions to the wholly new challenges of de-growth require the maximised exchange of ideas consistent with respect for the differing ideas of others.          

Pragmatic planning

Without entering into the long-standing debate around utilitarian principles, we can take as a starting-point the objective of seeking “the greatest good of the greatest number”. A worthy aim now would be to ensure the well-being of all as the economy as a whole gets poorer.

In the past, political economy has concentrated on the distribution of economic prosperity within the assumption that the aggregate of this prosperity will continue to grow. For political leaders, ‘sharing out growth’ has seldom been easy.

‘Sharing out hardship’ is going to be very much harder.

Our first priority surely ought to be a combination of research, education and the channelling of expectations. To give just one example, the doctrine of perpetual growth has created the assumption that we can tackle the environmental crisis without having to surrender things such as reliance on cars and frequent overseas travel. Once we recognize the economic as well as the environmental dimension of a faltering fossil fuel dynamic, we’ll become aware that pain-free, seamless transition is a hope rather than an assured reality.

Under these conditions, neither “collectivist” nor “liberal” philosophies can meet our needs. Collectivism tends to espouse subservience to the state, whilst the liberal alternative promotes at least the acceptance of greed, and sometimes its validation, or even its encouragement.

When aggregate prosperity becomes at best ‘a zero-sum gain’, various deep-rooted assumptions fail. One is the idea that one person can prosper without another suffering. Another is that the state can manage the equitable distribution of everything.

Neither should we obsess about “the rich”. Traditionally, the “left” has favoured ‘taking from the rich to give to the poor’, whilst the “right” has validated inequality as a reward for talent and effort. Historically, the widening of the gap between the wealthiest and “the rest” can in reality be connected to growth, both in prosperity and in social and economic complexity. As both prosperity and complexity decrease, this gap can be expected to narrow.

As prosperity per person decreases, the probability is that the cost of essentials will absorb an increasing proportion of prosperity. This is likely to be asymmetric, in that some people will continue to enjoy substantial (though diminishing) discretionary prosperity whilst others will find it ever more difficult to afford the necessities.

In policy terms – and beyond the prerequisites of education, research and the ditching of false notions about the economy and the environment – a primary objective surely needs to be to ensure that the necessities are available and affordable for all. The priorities for would-be leaders have to be (a) to learn about economic and environmental reality, and (b) to plan ahead to preserve and promote both economic well-being and social cohesion in a post-growth society.