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