#203. Surplus Energy Economics


In recent discussions here, it’s been suggested that we need a brief explanation of Surplus Energy Economics (SEE). This is an interpretation which states that the economy is an energy system, not a financial one. This is the understanding which informs the SEEDS economic model.

The timing is certainly appropriate, as established economic conventions are being confounded by adverse trends which financial tools are proving wholly unable to counter. In this context, it’s not at all surprising that interest in SEE and SEEDS continues to increase.

Energy-based analysis reveals that, where the West is concerned, the scope for further economic expansion disappeared between 1997 and 2007, and that the same thing is now happening in the EM (emerging market) economies.

The principle SEEDS metric for economic well-being is prosperity, which the model calibrates both in aggregate and in per capita form. On the latter basis, the average American was (as of 2019) 6.6% poorer than he or she had been back in 2000, British prosperity had declined by 10.6% since 2004, and Canadians had become 8.6% poorer since 2007.

These findings are, of course, quite different from the conventional line, mainly because governments and central banks have resorted, perhaps in all good faith, to credit and monetary policies which have sustained a simulacrum of “growth” even though prosperity is now deteriorating.     

The economic narrative of modern times is that, ever since “secular stagnation” was first noted (but not traced to its energy causation) back in the 1990s, the authorities have tried successive financial ‘fixes’ which have succeeded only in confirming that the economy, being an energy system, cannot be revitalized by monetary ‘innovation’.

‘Credit adventurism’, which led directly to the 2008-09 global financial crisis (GFC), has since been compounded by ‘monetary adventurism’, which has put the monetary system itself at great and increasing risk. We can be certain that the search is on for ‘gimmick 3.0’ – and equally certain that this, too, will fail.

The greatest single error made by conventional economics is the assumption that, if we understand money, we also understand the economy. This fallacy has driven an ever-widening gap between a financial system that has been growing exponentially, and an economy that has ceased expanding, and has started to contract.

In the interests of brevity, some of the implications of SEEDS analysis can only be noted here in outline. First, as prosperity per capita declines, so will the scope for funding public spending without recourse to ever-increasing government debt.

Second, just as prosperity has deteriorated, the cost of essentials has continued to increase, leveraging relatively gradual declines in top-line prosperity into far steeper falls in discretionary prosperity. This in turn means that a large and growing proportion of discretionary consumption has become dependent on continuing increases in debt.

Third, the calibration of prosperity reveals that levels of financial risk are far more severe than they appear on conventional metrics which use credit-inflated, ECoE-ignoring GDP as the denominator.

Each of these factors makes it seem unlikely that the energy basis of the economy will gain official recognition any time soon. Properly understood, the last real opportunity for a “reset” came – and went – back in 2008-09, when we opted to side-step the market implications of dangerously excessive credit.

The only practical alternative now is to try to buy a bit more time before ultra-loose monetary policies trigger a hyperinflationary slump in the value of money, and/or attempts to head off surging inflation trigger asset price collapses and a cascade of defaults.  

Fundamentally, the aim now must be to minimize the economic consequences of a seemingly inescapable failure of the financial system.    

Two interpretations, one reality

Essentially, there are two ways in which the working of the economy can be explained. One of these is the conventional or orthodox explanation, which states that the economy can be understood wholly in terms of money. The alternative, summarised here, is that the economy is an energy system.

If it were true, the monetary explanation would mean that there need be no end to economic growth, because money is a human artefact which is wholly under our control. Some proponents of traditional, money-based economics have been explicit about the absence of physical or resource limits to economic expansion.

It might be contended that the economy has indeed expanded enormously since the publication, in 1776, of Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations, the founding treatise of Classical Economics.

The alternative explanation is that it wasn’t Smith’s magnum opus, but the completion of James Watt’s radically more efficient steam engine – also in 1776, and also in Scotland – that really triggered two centuries of rapid economic growth, because it gave us access to the vast quantities of energy contained in coal, oil and natural gas.

The contest between these two schools of thought is reaching a climax now, because two factors are undermining the fossil fuels dynamic. One of these is the recognition that continued reliance on oil, gas and coal threatens to inflict irretrievable damage to the environment.

The other is that depletion – the practice of using highest-value energy resources first, and leaving costlier alternatives for a ‘later’ which has now arrived – is eliminating the ability of fossil fuels, not just to drive further growth, but even to maintain the economy at its current scale and complexity.         

The view set out here is that this contest is already all but over, and that increasingly desperate reliance on financial gimmickry – plus the increasingly blind faith placed in technology – demonstrate the failure of an interpretation which insists that money, rather than energy, determines the size and shape of the economy.

In principle

The energy-based interpretation of the economy is founded on three principles, each of which is validated both by logic and observation.

The first is that the economy is an energy system, because nothing that has any economic utility (value) at all can be supplied without the use of energy.

The second is that, 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 ECoE (the Energy Cost of Energy).

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

Each of these principles seems incapable of refutation. We know, for example, that an economy deprived of energy would grind to a halt within days, and would collapse within months. We know that we can’t drill an oil well, manufacture a wind turbine or a solar panel, or build an electricity grid without using the products of energy. We know that no amount of money will help someone adrift in a lifeboat, lost in a desert, or in any other way cut off from the process of exchange.   

The first set of charts puts these issues into context. The left-hand chart shows how dramatic increases in population numbers (from less than 0.7 billion in 1776 to 7.8 billion now) – and in the economic means of their support – have been driven by an even more dramatic increase in energy use. For most of that period, energy supply has grown more rapidly than population numbers, enabling prosperity to improve.

The situation now, though, is that trend ECoEs are rising rapidly, which has two adverse consequences for prosperity. The first is that rising ECoEs reduce the economic value obtained from each unit of energy consumed.

The second is that growth in energy supply is likely to cease, because producer costs are rising just as the prosperity of consumers is being undermined. This suggests that increased output of renewables and other non-fossil forms of energy will, at best, do no more than offset a decline in supplies of fossil fuels, leaving total energy availability broadly flat.

This means that, for the first time since the start of the Industrial Age, energy use per person will trend downwards. The deterioration is set to be even more marked at the level of surplus (ex-ECoE) energy per capita, which is the real driver of prosperity.     

Fig. 1

Financial consequences – the high price of denial

Perhaps the strongest evidence for the deterioration of the energy-based economy is the sheer extent – indeed, the outright desperation – of the financial gimmickry that has been necessary in order to sustain a simulacrum of “growth” as rising ECoEs have undermined economic prosperity.

As we shall see, prior growth in the prosperity of the advanced Western economies goes into reverse at ECoEs between 3.5% and 5.0%. Globally, these effects started to undermine growth between 1990 (an ECoE of 2.6%) and 2000 (4.1%). This was the period in which observers first identified a deceleration which they labelled “secular stagnation”.

This phenomenon has not, of course, been understood in energy terms. Rather, decision-makers have resorted to increasingly desperate, dangerous and futile financial innovations in an effort to counter it.    

The first recourse was to ‘credit adventurism’, making debt easier to access than it had ever been before. Since 1995, reported “growth” (of 116%, or $71 trillion) in GDP has been far exceeded by a 247% ($235tn) escalation in debt. This means that each dollar of “growth” has been accompanied by $3.30 of net new debt.

Another way of looking at this is that, whilst annual “growth” averaged 3.3% between 2000 and 2020, annual borrowing averaged 10.8% of GDP. What was happening was that output and growth were being inflated artificially by the pouring of increasing amounts of credit into the system.

SEEDS analysis reveals that underlying or ‘clean’ output – known here as C-GDP – increased at an annual rate of only 1.6%, rather than 3.3%, through this period. Even this average number masks a steady deterioration in clean growth.

These compounding effects mean that reported economic output has now been inflated far above its underlying equivalent. Essentially, the insertion of a ‘wedge’ between debt and GDP has driven a corresponding wedge between reported (GDP) and underlying (C-GDP) economic output.

Fig. 2

Needless to say, ‘credit adventurism’ has exacerbated financial risk. The artificial inflation of reported output has resulted in the understatement of risk calibrations, such as the ratio of debt to GDP, meaning that risk has become more opaque just as it has become more extreme. At the same time, the deregulatory processes involved in credit expansion have combined with ultra-loose monetary policy to weaken the link between risk and return.

This exercise in ‘credit adventurism’ necessarily culminated in the global financial crisis (GFC) of 2008-09. Rather than accept the market consequences of this process, the authorities opted to compound credit with ‘monetary adventurism’, through the adoption of supposedly “temporary” expedients including QE and ZIRP.

It does not require hindsight to recognize that, during the GFC, the last chance of a meaningful “reset” came and went. The adoption of ‘monetary adventurism’ has created a wholly unsustainable situation, in which real (ex-inflation) interest rates have been pushed permanently into negative territory – which means that people and businesses are paid to borrow – whilst saving is deterred. Other consequences of this process have included a dramatic, artificial inflation of asset markets, and the creation of a severe disequilibrium between asset prices and all forms of income.

Fundamentally, this has suspended the operation of a ‘capitalist’ system which, of course, requires positive real returns on capital. The necessary process of ‘creative destruction’ has been halted by a dynamic which keeps non-viable (‘zombie’) businesses afloat.

The effects of these processes extend far beyond debt itself. Since 2002, the broader category of financial assets – essentially, the liabilities of the government, household and corporate sectors – has expanded at a rate of $7.20 for each dollar of “growth” in GDP. Meanwhile, the crushing of returns on invested capital has contributed to the emergence of huge shortfalls (“gaps”) in the adequacy of pension provision.

In overall terms – and well before the onset of the coronavirus crisis – we had reached a point at which each “growth” dollar is being bought with $3.30 of new debt, $3.90 of other incremental financial liabilities and $2.50 of additional shortfalls in pension provision.

It would not be too much of an over-simplification to assert that we are taking on close to $10 of new liabilities in order to manufacture each $1 of “growth”

The irony is that, of the supposed $71tn “growth” recorded since 2000, fully 60% ($40tn) has been purely cosmetic, with real economic expansion totalling only $26tn over that period.        

Fig. 3

The decisive factor – ECoE

From the foregoing, it will be obvious that the critically important dynamic has been the relentless rise in ECoEs, a trend that has put an end to economic expansion, and has already started putting prior growth in prosperity into reverse.

The history of the economy in recent times can best be understood as an attempt to use financial policy in a failed effort to ‘fix’ an economy hamstrung by a factor – rising ECoEs – that conventional economic interpretation wholly fails even to recognize.   

For most of the Industrial Age, ECoEs have trended downwards. We don’t know what ECoEs were back in the 1770s, but we do know that they were high. They declined steadily over time, reflecting three operative processes.

The first of these was geographic reach, exemplified by the way in which the petroleum industry, from its origins in the Pennsylvania of the 1850s, expanded in pursuit of lower-cost supplies around the World.

The second was economies of scale, a facet of the rapid expansion of the coal, oil and natural gas industries.

The third driver was technology, which progressed from the simple extraction, processing and transport methods of the early Industrial Revolution to the far greater sophistication of the modern energy industries.

The ECoEs of the fossil fuel industries probably reached their nadir in the two decades after the Second World War, when ECoEs seem to have been at or below 1%. This drove the particularly rapid economic expansion of that period.

Latterly, however, the benefits of reach and scale have been exhausted, and depletion has started to drive ECoEs back upwards. Fossil fuel ECoEs reached 2% in 1984, 3% in 1993 and 5% in 2003, and are now close to 12%.

Since fossil fuels still dominate energy supply, overall ECoEs have risen relentlessly, from 2.6% in 1990, and 4.1% in 2000, to just above 9% now. As we shall see, complex advanced economies need ECoEs that are below 5%, and EM (emerging market) countries require ECoEs that are no higher than 10%.  

It’s abundantly clear that there can be no financial ‘fix’ for rising ECoEs. Equally, we cannot overcome higher ECoEs by using ever larger gross (pre-ECoE) quantities of energy, because rising ECoEs undermine the economics of energy supply itself. Unless the rise in ECoEs can somehow be halted and reversed, economic prosperity must follow a path of continuing decline. 

Supposed solutions to the ECoE problem fall into three categories, none of which is persuasive.

The least feasible of all is that we can somehow “de-couple” economic activity from the use of energy. This is impossible, of course, because the economy is an energy system. The evidence for “de-coupling” has been described by the European Environmental Bureau as “a haystack without a needle”. Only in the kind of alternative universe described by conventional, ‘money-only’ economics can we live on money, detached from physical (meaning energy-based) goods and services for which money can be exchanged.

The second delusion is that ‘there’s a technological solution to everything’. This is an era in which extravagant (and generally extrapolatory) claims are made for technology. The hard reality, of course, is that the scope of technology is limited by the envelope of physics. This is why, for instance, efforts to use shale resources to turn the United States into “Saudi America” have been such a costly failure.

Third, it’s asserted – and often simply assumed – that transition to renewable sources of energy (REs) can push overall ECoEs back downwards. Whilst there are compelling environmental and economic reasons for promoting RE expansion, the ECoEs of REs are unlikely to fall much below 10%, which is nowhere near low enough to prevent deterioration in an economic system built on ECoEs at or below 2%. Apart from anything ese, transition to REs will require enormous resource inputs, most of which can only be made available through the use of legacy energy from fossil fuels.    

The prosperity connection

The SEEDS economic model enables us to identify the levels of ECoE at which Western prosperity turned down, and to measure and predict the equivalent inflexion-points for EM economies.

In the Advanced Economies, prior growth in prosperity per capita went into reverse at ECoEs between 3.5% and 5.0%. This happened in Japan in 1997 (at an ECoE of 4.4%), in the United States in 2000 (4.5%), in Italy in 2001 (4.8%%), in Britain in 2004 (4.5%) and in Canada in 2007 (4.0%).

Latterly, the same thing has started happening in EM countries, too, including Mexico in 2007 (at an ECoE of 5.1%), South Africa in 2008 (6.1%) and Turkey in 2018 (8.7%).  SEEDS analysis shows that, in general, EM prosperity turns down at ECoEs of between 8% and 10%.

Latest data indicates that Chinese prosperity may not now turn down until 2025-26 – by which time ECoE is likely to be between 9.6% and 9.9% – though intervening increases in prosperity are likely to be very modest. The greater ECoE-resilience of the EM economies reflects a lesser degree of complexity, which means that upkeep of existing systems can be accomplished at lower levels of surplus energy.

There are, of course, local nuances around the connection between different countries’ ECoEs and their prosperity inflexion-points, but the ranges cited here – 3.5% to 5.0% for Western countries, and 8-10% for EM economies – are validated by comprehensive analysis.

For the World as a whole – and as the following charts illustrate – prosperity per person has been on a long plateau, during which continued growth in the EM economies has cancelled out Western deterioration. This helps explain the widespread perception that EM countries have been ‘carrying’ global growth since the GFC.

It would be a mistake, though, to assume that this EM resilience can be a continuing facet of the global economy. Rather, lesser complexity explains why countries like China and India have been able to carry on improving their prosperity pending their arrival at higher (and hence later) inflexion points.

Critically – and with most economies now past their economic climacterics – global prosperity per capita seems now to have turned down decisively from a plateau that has lasted since the early 2000s.

As the third of the following charts shows, the essence of the situation is that the World’s average person is now getting poorer, a problem compounded by an unfounded, blind faith insistence that no such thing can possibly be happening.                   

Fig. 4

#202. The shape of things to come


As, when and if the coronavirus pandemic recedes into the past, there’s a widespread assumption that we’ll see the welcome return of a ‘normality’ defined to include “growth” in the economy. The big change looking forward will, we’re assured, be the replacement of climate-harming oil, gas and coal with renewable energy sources, primarily solar- and wind-power.

This aside, almost everything else is going to be ‘more of the same’.

In reality, this consensus narrative of the future is based on the big two fallacies of our age. One of these is that the economy is a financial system, such that we’re assured of growth in perpetuity by our control of the human artefact of money.

The other is that there are no limits to the capabilities of technology, potentialities often extrapolated to and beyond the constraints of physics.        

We cannot know quite how much of this is believed by governments, or whether they ‘know, but don’t say’, that most of it is implausible. Businesses and the general public seem to have bought into this narrative.

Energy reality

The facts of the situation, as we understand them here, are that the supply and the ECoE-cost of energy determine material prosperity, and that this equation has been turning against us over an extended period.

ECoEs – the Energy Costs of Energy – have been rising relentlessly, passing (during the late 1990s and early 2000s) levels at which Western prosperity ceases to grow, and then starts to contract. The EM (emerging market) economies have now reached the ECoE thresholds at which their prosperity, too, turns downwards. 

The factor driving ECoEs upwards has been the effects of depletion on the fossil fuels which continue to supply four-fifths of the energy used in the economy. It might or might not be possible to replace fossil fuel energy quantities with dramatically increased supplies of renewables (REs), but it certainly cannot be assumed (and is indeed implausible) that these can reverse, or even stabilize, trends in ECoEs.

Thus stated, the challenge is enormous. Prior growth in Western prosperity per person went into reverse at ECoEs of between 3.5% and 5.0%, with the same seemingly happening to EM countries at ECoEs between 8% and 10%. Prosperity per capita has already turned down in Mexico, South Africa, Argentina, Brazil, Chile, Saudi Arabia and Turkey.

The SEEDS model puts the ECoEs of fossil fuels today at 11.9%, up from just 2.6% as comparatively recently as 1990. The modern economy was built on fossil fuels with ECoEs at or below 2%. The ECoEs of REs, now close to parity with fossil fuels, are continuing to decrease, but may never fall much below 10%.

Financial fiction

The history of the past quarter-century has been one of trying to use financial tools to overcome the non-financial consequences of energy deterioration.

From the mid-1990s, the authorities adopted ‘credit adventurism’. After this failed in 2008-09, they doubled down with ‘monetary adventurism’, which has now reached its culminating point of failure.

Without a doubt, the search is now on for ‘gimmick 3.0’. Beyond a few shrewd guesses, we cannot know what form this latest ‘fix’ is going to take – but we can be sure that it won’t work.

We can’t ‘fix’ an energy economy with financial tools, any more than we can ‘fix’ an ailing house-plant with a spanner.

When setting out scenarios for the future, we start with two unfortunate inevitabilities. The first is that we’re going to get poorer, a trend that is by no means new, but that has been disguised thus far by financial manipulation, which has masked – whilst it hasn’t ‘fixed’ – an economy drawing rapidly towards the end of an era of growth made possible by low-cost fossil fuels.

The second is that, empowered by the hubris of assumed ‘economic expansion in perpetuity’, we have built a financial system wholly predicated on growth. It takes no great leap of the imagination to see that the financial system, as currently configured, cannot survive.

The authorities are now faced with the alternatives of prolonging financial stimulus to the point of the hyperinflationary destruction of the value of money, or reining-in stimulus, such that asset prices crash and defaults cascade through the system.

It’s by no means clear that the authorities even have the power of selection over which of these outcomes transpires. The idea that they can finesse this situation using policies which are neither too loose nor too tight does not merit serious consideration.

The household predicament

Ultimately, what happens to individuals and households is of greater fundamental significance than what happens to other sectors of the economy. After all, governments, whether democratic or not, are answerable to the public, whilst businesses are wholly dependent on the willingness and the ability of consumers to carry on buying their products.

The obvious conclusion is that households will get poorer, a trend that is already firmly established in the West. Thus far, this process has been gradual. As of 2019, the average American was 6.6% poorer than he or she had been back in 2000, whilst British prosperity per person had fallen by 10.6% since 2003.

Unfortunately, comparatively modest rates of deterioration in top-line prosperity have been leveraged by continuing increases in the cost of essentials, such that, at the discretionary (ex-essentials) level, prosperity fell by 31% (rather than 6.6%) in the United States, and by 29% (rather than 10.6%) in Britain. As discretionary prosperity has fallen, discretionary consumption has continued to increase, but only because of the huge amounts of credit poured into economies around the world.           

From these observations, we can infer that discretionary consumption will fall sharply, as soon as the credit-based, growth-predicated financial system falls apart. This is going to be extremely unpopular, and can be expected to shift the basis of political debate towards economic issues and away from all non-economic topics of debate.

At the very least, we should anticipate increasing demands for redistribution, combined with a shrill insistence that governments should “do something” about the rising costs of essentials. The latter may be taken to mean calls either for regulation and subsidy, or for the outright nationalization of a string of industries.

Taking ‘from the rich’ is a panacea of very limited practical value. Apart from anything else, the wealth of ‘the elites’ is largely paper in nature, and is likely to fall rapidly as asset prices correct downwards in response to belated recognition of economic reality.

A particular concern must be that, as Westerners’ discretionary prosperity fades away, people in the world’s poorer and middle-income countries will find it increasingly difficult to afford even basic necessities. An indicator to watch here will be the global cost of commodity foodstuffs including grains and rice, costs which are closely connected to ECoEs through the energy-intensive nature of food production. Tellingly, the UN FAO’s Food Price Index was 39.7% higher in May 2021 than it had been a year earlier. The same energy connection applies to the cost and availability of water.

If conditions worsen in many of the world’s less affluent countries, one consequence is likely to be an increase in migration flows.

The need for knowledge

As remarked earlier, it’s far from clear how far any of this is understood by governments. Thus far, and conditioned in part by the coronavirus crisis, we can only observe an apparently increasing tendency to stifle dissent, and to strengthen governments’ powers of control. 

An optimistic reading would be that governments will come to terms with the reality of a world economy shaped by energy (and shrinking), rather than governed by money (and growing). A big concern here has to be continued reliance on failing methods of economic interpretation, which in turn means that conventional economic models are losing credibility.

An implicit responsibility falls on those of us who understand the economy as an energy system, particularly where, as here, we can use models to quantify developing trends.

To inform debate here, the following tables set out the critical economic and financial parameters for the economies of America, Britain and China. All are drawn from the SEEDS economic model (the Surplus Energy Economics Data System).

Factors common to each include the rise of trend ECoEs, the slowing (and the subsequent deterioration) in aggregate prosperity, and the ongoing decline in prosperity at the per capita level.

In each case – even in China – discretionary prosperity per person is falling, a factor that will be of critical importance once the subsidy of financial manipulation reaches its point of failure.

As of 2019 – that is, before the covid crisis – aggregate debt already stood at 358% of prosperity in America, 349% in Britain and 513% in China. Greater concern should be prompted by even more extended ratios applying to broader commitments represented by financial assets (which, to a very large extent, are the liabilities of the government, corporate and household sectors).

Both sets of parameters show every sign of soaring to levels at which the financial system implodes. Not included in the tables here are levels of public expenditures which are becoming unsustainable, when measured, not against the increasingly misleading metric of credit-inflated GDP, but against prosperity.

Space dictates that these tables, like the interpretations suggested here, can be no more than summaries, but it is surely clear that decision-makers, in particular, need to ditch false perceptions of how the economy actually works, and adopt techniques which quantify the true scale of the challenges now looming.

#201. The Icarus factor


The vicissitudes of the coronavirus crisis have tended to bury an appreciation of longer-term trends under a blanket of concern about the immediate. With each apparent success or setback in the fight against covid-19, economic sentiment has fluctuated, in ways which, whilst wholly understandable, bear no relation to all-important underlying trends.

Almost everything that we hear and read about the current situation is somewhere between the misleading and the outright fallacious. Reportedly modest falls in economic output last year disguise, beneath gargantuan fiscal and monetary interventions, a far harsher reality. Assurances of a brisk “recovery” promise little more than a return to purely statistical, cosmetic “growth”.

The current spike in inflation is no more “transitory” now than QE and ZIRP were “temporary” back in 2008-09.

The public are being treated to three main fictions. The first is that we can spend our way to prosperity.

The second is that we can borrow our way out of a debt problem.

The third is that we can print our way to monetary stability.

It’s quite possible, of course, that decision-makers really believe all of this is feasible, but there’s no necessary conflict between sincerity and fallacy.

The trap has sprung

Debate around the stimulus trap exemplifies the extent of incomprehension. During 2020, huge fiscal deficits were run, mainly in order to sustain incomes during protracted lock-downs. Provisional data for a group of sixteen advanced economies covered by the SEEDS model puts this deficit at 12% of GDP when the latter is defined to include the deficit itself.  

The vast majority of this fiscal support was financed using money created out of the ether by the central banks. Between them, the Fed, the ECB, the Bank of England and the Bank of Japan used close to $8.6tn of newly-created liquidity to fund government fiscal deficits.

There has been extensive additional stimulus in the form of rent and interest ‘holidays’ granted to business and household borrowers and tenants. These have inflicted costs on lender and landlord counterparties that will, in due course, have to be made good. In any case, it seems most unlikely that there will be much contraction in the scale of stimulus during 2021.

At present, we’re being assured that the recent upturn in inflation is “transitory”, traceable in large part to “temporary” interruptions to supply chains. Part of the misunderstanding here is that, by convention, inflation is calibrated only in terms of consumer purchases, and thus excludes rampant escalation in asset prices.

In some countries, notably America and Britain, supporting and further inflating the prices of stocks and property has taken on a bizarre, quasi-religious fervour, seemingly oblivious of the obvious fact that all that’s really accomplished by the much-vaunted “wealth effect” is the encouragement of yet more borrowing

As and when it turns out that price increases are more than a passing phenomenon, the assumption is that central banks can head off inflation before it starts to make serious inroads into the purchasing power of money. Central bankers, it’s said, have tools at their disposal which include stopping, tapering or even (in extremis) reversing asset purchases and, if needs must – though whisper it who dares – raising interest rates.

If any of these tools were to be used, however, the results would include sharp falls in asset prices, a widespread undermining of collateral, and a cascade of defaults amongst businesses and households burdened with record levels of debt.

Defaults at a systemically dangerous scale would make it imperative for the authorities to intervene, in order to preserve the balance sheets of the banking and broader lending sectors. Doing this at the requisite size would be a task far beyond the capabilities of governments, and would therefore force central bankers into monetization on a scale exceeding anything experienced thus far.

What this means is that, whichever door we go through, we end up in the same place.

Feeding the addiction

As well as accepting that monetary tightening is outside the bounds of practicality, we also need to recognize that credit moderation isn’t feasible in economies which have become addicted to continuous infusions of debt.

In the twenty years before the pandemic – from 1999 to 2019 – reported “growth” of $71 trillion (110%) in world economic output was accompanied by an increase of $206tn (198%) in aggregate debt. Annual average growth of 3.5% in global GDP was made possible by annual borrowing which averaged 10.0% of GDP.  Each dollar of “growth” was bought with close to $3 of net new debt.

Even these calculations exclude dramatic surges in non-debt financial obligations, some of which are reflected in the escalating assets of the financial system, whilst others (such as the emergence of a pension provision “timebomb”) are informal and assumed, but are none the less important for that.   

Addressing the credit effect, SEEDS – the Surplus Energy Economics Data System – calculates that, of the $71tn of “growth” recorded between 1999 and 2019, fully 64% ($45tn) was the cosmetic effect of injecting gargantuan amounts of debt into the system.

Stripped of this effect, the trend rate of growth falls to 1.7% from the reported 3.5%. The compounding effects of this divergence means that underlying or ‘clean’ economic output (calibrated by the SEEDS model as C-GDP) is nowhere near levels of output claimed as GDP.

In other words, assurances of “growth” really promise no more than a return to a state of affairs that was only ever cosmetic in the first place. If liquidity is injected into the system, the spending of this money is counted as “activity” for the purposes of calibrating GDP, irrespective of where this money came from. Alternative calibrations, based on incomes and supposed creation of value, really do no more than confirm this convenient fiction.

No cold turkey

To understand how events will unfold from here, we need to understand how we got into this predicament. This requires recognition that the economy is an energy system, and that money, in its role as a medium of exchange, has no intrinsic worth, but commands value only as a ‘claim’ on the economy of goods and services.

During the last decade of the twentieth century, trend ECoE (the Energy Cost of Energy) rose from 2.6% in 1990 to 4.1% in 2000. This necessarily undermined the scope for growth in prosperity, which, in Western economies, goes into reverse between ECoEs of 3.5% and 5.0%. Beyond these levels, it becomes impossible to combine ongoing energy supply, and the maintenance requirements of complex systems, with further increases in material prosperity.

The deceleration which started to occur in the mid-1990s was recognized, and was even given a label (“secular stagnation”), but its causation wasn’t – and couldn’t be – understood within an orthodoxy which treats the economy as a wholly monetary phenomenon. This bafflement, combined with a contemporary penchant for “de-regulation”, resulted in an effort to “fix” a non-financial problem with financial tools.

This began with ‘credit adventurism’, which made borrowing easier (as well as cheaper) than it had ever been before, and also weakened the necessary connection between risk and return.

After the ensuing (and wholly predictable) global financial crisis (GFC) of 2008-09, the authorities doubled down on fallacy by adopting ‘monetary adventurism’, slashing rates to sub-zero real levels, and failing even to implement some obvious safeguards which might have headed off an unsustainable inflation of asset prices.

Markets could no longer fulfil the necessary functions of price discovery and the pricing of risk. The imperative process of creative destruction was halted, and moral hazard was adopted as a feature rather than treated as a fault. Perhaps worst of all, the capitalist imperative of real returns on capital was suspended, and a huge wedge was driven between asset prices and all forms of income (including profits, dividends and interest, as well as wages).      

The Icarus factor

Where this leaves us is with a financial system that’s “running on empty”, and has long since ceased to act as a meaningful proxy for the ‘real’ economy of labour, energy, goods and services. There’s no way off a treadmill which requires continuous and increasing credit and liquidity injections to retain a waning semblance of viability.

Once the ‘financial’ economy of money and credit has departed this far from the ‘real’ economy of goods and services – and once imbalances between asset prices and all forms of income are this far out of kilter – the trend back towards equilibrium builds unstoppable gravitational force.

In short, money, in all of its forms – whether as debt and other obligations, as asset prices and as other claimed ‘stores of value’ – has taken wing, soaring far above any underlying grounding based in economic reality.

As the situation heats up, the wax securing the wings starts to melt.

From here, a fall back to economic Earth can neither be much delayed, or rendered painless.