Most of us, for one reason or another, want to know “what comes next”. There are many wrong ways of going about this. We can, for instance, take our expectations for the future ‘on trust’ from others, or we can simply assume (meaning hope) that the future will be what we want it to be.
The only effective way of forming rational expectations, though, is to follow a ‘path of reason’ from “what we know” (about the present) to “what we want to know” (about the future).
The original plan here was to try to encompass this within a single discussion. Practicality, though, suggests that we tackle this in two or three stages.
This first instalment starts with “what we know”.
This turns out to be rather a lot.
We know, for example, that the economy is an energy system. This knowledge identifies an equation which expresses the conversion of energy into material prosperity.
We know, further, that this is a constrained equation. The constraints on our conversion of energy into prosperity are set (a) by the physical characteristics of energy resources, and (b) by the limits of environmental tolerance.
This knowledge enables us to clear the ground by dismissing the fallacy of the infinite. Infinite growth isn’t feasible on a finite planet and within a finite ecosphere.
Far too much of our thinking, and far too many of our economic and broader systems, are based on this ‘infinity fallacy’. We assume, for instance, that economic growth can continue in perpetuity, and that a sustainable financial system can be built on this false assumption. We assume that businesses can offer perpetual expansion to their shareholders, and that governments can promise never-ending “growth” to their electorates.
We’ve reached a point at which the reality of constraint is discrediting the fallacy of the infinite. Environmental constraint is demonstrating itself to us with shocking force. Resource constraint has pushed us into a self-deluding falsification of economic “growth”.
Effective planning for the future requires recognition of the realities of constraint.
At the end of certainty
As well as casting a long shadow over society and the economy, the coronavirus pandemic has created a remarkably extreme ‘dialogue of the deaf’ between competing certainties.
On the one hand, the authorities present vaccines as a ‘magic bullet’, whose efficacy and safety are questioned only by the anti-social and the deranged.
On the other, critics insist, with equal certainty, that the whole ‘covid and vaccine show’ is some kind of nefarious plot by malign agents of ‘the elites’.
Those of us who don’t have specialist knowledge of life sciences cannot determine where reality resides within this shouting-match. Even the experts may not, as yet, have all the requisite information.
But the extremes of the debate about the coronavirus are echoed in similarly extreme views on the economy, finance and government. On the economy, opinions range all the way from ‘assured growth in perpetuity’ to ‘imminent collapse’.
We are entitled to be sceptical, in an impartial way, about certainties.
Excessive certainty, after all, is close kin to extremism, which has seldom served us well. Entrusting everything to the state worked out very badly in the Soviet Union. Handing everything over to ‘the market’ – or, in reality, to unfettered “animal spirits” – is turning out to have been an even bigger mistake.
It’s a reasonable presupposition that ‘all isn’t well’ in the economy, in finance, in government and in the broader categories of trust and social cohesion.
To enquire further than this, it’s necessary to proceed by logical steps from what we know (about the present) to what we want to know (about the immediate and longer-term future).
From what we know
For those who like their conclusions up front, “what we know” can be summarized as follows.
First, the economy is an energy system, whose historic dynamic – fossil fuels – is winding down.
Second, we face severe environmental and ecological threats. These are linked to a significant extent to energy use, which means that our economic and environmental “best interests” are not opposed to each other but, rather, are connected dimensions of a shared predicament rooted in energy.
Third, the world is becoming more confrontational. Wars and revolutions, of course, are recurrent features of history, but a notable feature of modern times is internal antagonism, based in (and further contributing to) suspicions of the motives of others.
Our fourth problem is a widespread lack of understanding of these issues. This might be simple ignorance of the realities around energy, the economy and the environment. It might, alternatively, be some form of denial, in which groups of any size (ranging from ‘elites’ or governments to the public generally) don’t wish to understand, or choose not to accept, the reality of our economic and environmental predicament.
The energy dynamic
In reasoning from “what we know” to “what we want to know”, the place to start is with the economy as an energy system.
As regular visitors to this site will appreciate, the evidence for this interpretation is overwhelming. Apart from anything else, nothing of any economic utility at all can be produced without the use of energy. Interruption to the continuity of energy supply would, and over a pretty short period, result in economic collapse.
Historical evidence affirms both this linkage and its causal direction. The exponential take-off in population numbers (and in their economic means of support) from the late 1700s paralleled a similarly exponential increase in the use of energy, the vast bulk of which, hitherto, has been sourced from fossil fuels.
These exponential take-offs occurred from the 1770s, when ‘what changed’ was the development of the first efficient heat-engines, which enabled us to put coal, oil and natural gas to economic use. So the causal linkage is clear enough – access to fossil fuel energy drove population and economic expansion, not the other way around.
A second, parallel and important observation is that, whenever energy is accessed for our use, some of that energy is always consumed in the access process. This is the principle of ECoE (the Energy Cost of Energy).
We know this to be a factual observation because, at the most basic level, we know that we cannot drill an oil well, lay a gas pipeline, manufacture a solar panel or a wind turbine, or install an electricity distribution grid without using energy. Just as energy has to be used to create energy-accessing assets, further energy has to be consumed in their maintenance, and in their eventual replacement. ECoE, then, comprises both initial investment and subsequent upkeep.
These observations form an equation which, in principle, is comparatively simple.
Economic output is a function of the use of energy. The economic value derived from energy use is a function of the surplus energy which remains after the ECoE proportion has been deducted. The resulting material prosperity is a function of the number of people between whom this surplus energy value is shared.
To understand economic prosperity, therefore, we need to know about trends in (a) total energy supply, (b) the ECoE deduction and the residual surplus energy, and (c) population numbers.
In passing, any economic interpretation or model which excludes any of these three components is founded on a fallacy which renders it worthless.
The realization of constraint
Recent times have seen the emergence of two constraints to continued reliance on fossil fuel energy.
The first of these constraints is the environment. We know that emissions from the burning of fossil fuels threaten to raise atmospheric temperatures, and we also know that “global warming” and “climate change” are short-hand for a much broader set of challenges. Pollution alone would be harmful, even if it wasn’t associated with temperature change. Ecological degradation is a consequence, not just of the use of oil, gas and coal, but of the economic growth made possible by fossil fuels.
We can accept, then, that fossil fuel consumption and broader economic expansion have moved us to a point of environmental and ecological constraint.
The second, less-recognized constraint is that the ECoEs of fossil fuels are rising relentlessly. This alone would, in due course, degrade and then destroy an economy wholly reliant on oil, gas and coal.
This means that the environment isn’t the only constraint on the use of fossil fuels. Anyone minded to oppose transition away from fossil fuels needs to be aware that, even if we were so unwise as to ignore environmental issues, rising fossil fuel ECoEs would, in any case, ultimately destroy the economy.
Put another way, those campaigning for greater environmental responsibility and a reduction in fossil fuel use have a “second string to their bow” in the form of ECoE.
The factors which drive ECoEs are – with one exception – reasonably well understood, and can be depicted as an ECoE parabola (see fig. 2).
In the initial stages of energy resource use, ECoEs are driven downwards by economies of scale and geographic reach. Once these drivers are exhausted, ECoEs are pushed back upwards by depletion, a natural consequence of using low-cost resources first, and leaving costlier alternatives for later.
The limits of technology and the reality of the finite
The exception to general understanding of ECoE is the role of technology. In the energy sphere, positive technological progress involves improvements in the efficiency with which energy is accessed and put to use. This progress accelerated the downwards trend in ECoEs and, latterly, has acted to mitigate the rise in energy costs.
But there are two other things that we need to know about technology.
First, its scope is constrained by the laws of physics. Technology has, for instance, lowered the cost of extracting tight oil and gas in the United States, but it hasn’t transformed American shale reserves into the equivalent of the conventional resources of Saudi Arabia.
That this has been impossible illustrates that technology operates within the confines of the characteristics of the resource itself. We cannot, by ignoring these physical constraints, extrapolate past technological trends indefinitely into the future.
Second, most technology doesn’t help us to use energy more efficiently but, rather, finds more ways to put energy to use. This isn’t ‘bad’ in itself, but it can contribute to a mindset which both (a) exaggerates the potential of technology as a ‘fix’, and (b) disguises the important dimension of energy efficiency within the loose category of ‘technology for the sake of technology’.
This consideration of constraints reminds us of another point which is too often forgotten. Economic growth, properly understood, is a matter of using the Earth’s resources to deliver material economic prosperity. These resources are not infinite.
We can debate the extent of the natural resources that were in place originally, and which remain today. These resources include energy, minerals and environmental tolerance.
What we can’t do with any credibility, though, is to claim that these resources aren’t, ultimately, finite. Any philosophy which ignores this reality, and which claims that economic growth can continue in perpetuity on a finite planet, is based on a fallacy of infinity.
The constrained equation
As we’ve seen, then, there’s an equation which relates energy use to the delivery of material prosperity. We’ve also seen that this is a constrained equation, whose limits are set (a) by resource characteristics (availability and ECoE-cost), and (b) by environmental and ecological boundaries.
Unfortunately, we’ve managed to disguise from ourselves the meaning, and even the existence, of this “constrained equation”. We’ve developed an economic philosophy which presupposes that “growth” can continue in perpetuity. We’ve allowed this infinity fallacy to influence our thinking about the world around us, and we’ve embedded this same fallacy into systems.
It’s important to be aware of the extent to which our economy and society are shaped by the “infinity fallacy”. Our financial system is entirely predicated on growth in perpetuity. Businesses, too, are conducted on the basis of a never-ending pursuit of expansion. Governments are assumed – by themselves and by the public – to have a mandate to deliver, in perpetuity, the ‘benefits of growth’.
Politicians and the public may, and do, argue about how growth should be used, and how it should be distributed between people and groups.
But nowhere – in finance, business, government or amongst the general public – is there any kind of preparation for an alternative to an assumed context of perpetual growth. If you ask a financier, a business leader or a politician about his or her plans if “growth” ceases – let alone if it goes into reverse – you’ll be met by a blank stare of incomprehension.
Everything that government, business and finance endeavours to achieve is informed by the assumption of growth. In response to environmental risk, proposals are almost always expressed in terms such as ‘green growth’, ‘responsible growth’, ‘sustainable growth’ and ‘equitable growth’.
To use a hackneyed term, there’s no “plan B” for an ex-growth economy, let alone for an economy whose prior growth has gone into reverse.
The fallacy of the infinite economy
Proceeding step by step, we’ve learned a great deal that conventional thinking fails (or refuses) to encompass.
To recap, the energy economy provides us with a prosperity equation that is constrained both by resource characteristics and by the limits of environmental tolerance. It is further constrained by the ultimately finite character of the Earth, both as a ‘resource set’ and as an ecosphere.
At no point, in reaching these conclusions, have we needed to considermoney.
Money itself is a human artefact. As such, the creation of money isn’t bounded by the physical finality that limits material economic activity. But the only value of money is as a proxy for material goods and services whose supply is subject to these limits.
We can study the operation of money, and this study yields certain worthwhile insights. But the findings which orthodox economics is pleased to call “laws” are, in fact, simply behavioural observations about money. They are not remotely analogous to the laws of physics. Economics, as conventionally understood, may or may not be “gloomy”, but it certainly isn’t a “science”.
The central fallacy of orthodox economics is that it portrays the economy as a monetary system, when the reality, of course, is that it’s an energy dynamic.
The misconception here is huge. Observation and logic inform us that economic prosperity is the product of a physical dynamic that is subject to constraint. Conventional economics seeks to persuade us, instead, that the economy is an immaterial system shaped by the use of the unlimited human artefact of money.
As well as being a misconception, this is also a conceit. If it were true that economic activity was wholly a product of the use of money, then we, as the creators of money, would be in full control of what might grandiloquently be called our ‘economic destiny’.
Our actual position is a more modest one, in that our degree of control is strictly circumscribed by physical factors that we can’t control.
The human artefact of money is claimed to have three qualities. However, it’s an extremely poor ‘store of value’, and how well it functions as a ‘unit of account’ really depends on what it is that we’re trying to quantify.
The fundamental role of money is as a ‘medium of exchange’. Exchange, of course, is a process that depends upon there being something that people are able and willing to exchange. This is why no amount of money, in any form, would be of the slightest use to somebody lost in a desert, or cast adrift in a lifeboat.
Money, then, is validated by exchange, and the “something” for which it can be exchanged is the material value provided by the energy economy.
What this in turn means is that money has no intrinsic worth, but commands value only as a ‘claim’ on the output of the energy economy.
To be clear about this, our control over the supply of money and credit enables us to create financial ‘claims’ that exceed the current or future delivery capability of the economy itself. When we do this, we create excess claims.
When we assign the concept of ‘value’ to the aggregate of claims, we create a situation in which the excess component of this supposed ‘value’ must be destroyed. This value destruction can take the form of repudiation (otherwise called hard default), or of the inflationary erosion of the value of money itself (soft default).
It has to be one, or both, of the above because, by definition, excess claims cannot be honoured, which means that supposed ‘value’ attached to these excess claims must be eliminated.
Of two economies
Given the relationship that exists between the constrained equation of the energy economy and the seemingly unconstrained scope for creating monetary claims, it’s helpful to think in terms of ‘two economies’ – the ‘real’ economy of goods and services, and the proxy or ‘financial’ economy of money and credit.
An understanding of the interface between the energy and the financial economies is critical to effective interpretation of the economy that we see around us.
This interface isn’t addressed by orthodox economic interpretation, because conventional economics is based on the false assumption that money is the economy. The objective of the SEEDS economic model is to understand the economy as an energy system, but to present conclusions in the financial idiom in which, by convention, economic issues are debated.
SEEDS analysis indicates that, in the advanced economies of the West, growth in energy-based economic output slowed during the 1990s, and went into reverse in the first decade of the twenty-first century. Modelling of the constrained equation indicates that prosperity per capita turned down in Japan from 1997, in America from 2000, and in Britain from 2004.
These inflexion-points correlate with the rise of trend ECoEs into a range between 3.5% and 5.0%. By virtue of their lesser complexity and their correspondingly lower system maintenance requirements, the equivalent climacterics for EM (emerging market countries) occur at higher levels of ECoE, levels which SEEDS places between 8% and 10%.
The downturn in prosperity which impacted the West between 1997 and 2007, then, isn’t something from which EM countries are immune. Rather, their inflexion-points happen in the same way, but at a later stage on the ECoE curve.
The relationship between ECoEs and prosperity per capita – in America, China and globally – is illustrated in fig. 3.
In the United States, prosperity per person turned down after 2000, when trend ECoE was 4.5%. The equivalent climacteric in China is projected to occur in 2026, when China’s ECoE is likely to be just below 10%.
For the world as a whole, prosperity has been on a long plateau, reflecting the interaction between Western countries (where people have been getting poorer over a lengthy period) and EM economies (where prosperity has continued to improve).
Perhaps the single most important economic event of our times is the ending of this plateau and the onset of de-growth on a global basis.
Exercises in denial
Recognition of this energy-constrained reality was, and remains, denied to those who believe in the infinity fallacy born of the mistaken assumption that the economy is a wholly monetary system. When deceleration – then labelled “secular stagnation” – started to be noted during the 1990s, the natural (though wholly mistaken) assumption was that there must exist a financial ‘fix’ for this unwelcome trend.
Briefly, the history of the intervening period is that the authorities tried, first, to restore growth by pouring abundant credit into the system, a process known here as credit adventurism. The fallacy here was the assumption that the creation of demand must, by some immaterial process, be met by increased supply, an assumption which is invalid in any situation governed by material constraints.
When, as was always inevitable, this gambit took the credit (banking) system to the brink of collapse, a resort was made to monetary adventurism. This process threatens to do to money what credit adventurism so nearly did to the banking system.
The policy of pricing money at sub-zero real levels has had a string of consequential effects. One of these has been an escalation in debt, and another has been rapid growth in the shadow banking system, known more formally as the ‘non-bank financial intermediation’ sector.
Over the past twenty years, we’ve been using credit and monetary policy to ‘buy’ economic “growth” at an adverse rate of exchange. Each dollar of “growth” reported since 2000 has been accompanied by more than $3 of net new debt, and by getting on for $4 of broader financial liabilities. Even these metrics exclude the emergence of huge “gaps” that have emerged in the adequacy of pension provision.
Using SEEDS, we can quantify the deterioration in prosperity, identify the correlation between rising ECoEs and the inflexion-points in underlying economic activity, and map the relationships between liabilities and the maintenance of a simulacrum of “growth”.
But the central issue here is the widening gap between (a) the real economy (of energy, value and prosperity), and (b) the proxy financial economy and its excess claims against non-existent future economic value.
Any article with the professed aim of preferring reasoned interpretation over received certainties must leave readers to determine how sure we can be about the conclusions that are reached here.
This said, there is very substantial evidence – logical and observational – for the proposition that the economy is a physical dynamic, driven by an energy equation that we can identify, and limited by the constraints both of resource characteristics and of environmental tolerance.
We can observe, too, that there is a general ignorance around this proposition, and an insistence, instead, on perpetual growth, driven by the immaterial processes of money within a context of assumed infinity.
If our interpretation is correct, then there exists a serious disconnect between the economy as it is and the economy as it is mistakenly assumed to be. A misunderstanding as fundamental as this goes quite far enough to explain the insistence on assumed certainties in the context of the emergence of a very different reality.