PREDICTING THE ECONOMY OF THE FUTURE
In the Western world, at least, there’s an almost palpable sense of public uncertainty, anxiety and discontent which might be attributed to a variety of causes.
Some ascribe it to specific issues, some to the over-reach and incompetence (or worse) of governments, and others to widening inequality between “the elites” and everyone else.
The view taken here is that the deteriorating public mood has a more straightforward explanation, which is that prior growth in economic prosperity has gone into reverse.
The cessation of growth and the onset of involuntary economic contraction are, of course, denied by governments, but this makes popular dissatisfaction worse.
If the economy as a whole is supposed to be growing, but the individual finds that his or her economic circumstances are deteriorating, it’s easy to assume that there must be some kind of bias in the system.
In fact, we don’t need to posit conspiracy theories, or look to ‘the machinations of the mighty’, to explain worsening hardship.
In short, the average person is getting poorer, and feeling less secure. He or she doesn’t like it, and is baffled and suspicious over official assurances that it isn’t happening at all.
Projection – the land of hazard
Forecasting involves entering territory ‘where angels fear to tread’. But the publication of projections has now become imperative, made so (a) by the rapid worsening in the public mood, and (b) by the incomprehension that continues to inform policy decisions.
The projections that interest us come in two main forms. The first category, covering the economic and the financial, is addressed here. The plan is that broader forecasts, which necessarily include the political, will be tackled in a subsequent article.
To ‘cut to the chase’, analysis undertaken using the energy-based SEEDS economic model reaches two principle conclusions.
The first is that the ‘financial economy’ – the monetary counterpart of the ‘real economy’ of material goods and services – will contract by between 35% and 40%, in real terms, and on a global basis.
This is a process to which asset-prices are over-leveraged, so overall falls in the equity, bond and property markets are likely to be a great deal more severe. In parallel with tumbling asset prices, downsizing of financial commitments can be expected to involve both the ‘soft default’ of inflation and the ‘hard default’ of failure.
Second, economic prosperity will continue to deteriorate, whilst the real cost of essentials will carry on rising.
Reflecting this, the scope for the consumption of discretionary (non-essential) goods and services will shrink rapidly, as will the capability for investment in new and replacement productive capacity.
Country-specific analysis suggests that, in comparison with pre-pandemic 2019, discretionary consumption in the United States will have declined by 14% by 2030, and by a further 41% by 2040. In Britain, discretionary consumption is projected to be 57% lower in 2040 than it was in 2019.
Projected trends in discretionary consumption in America, Britain and France are illustrated in the first set of charts, which compare conventional measurement (in black) with SEEDS analyses of underlying trends (blue).
As we shall see, conventional interpretation of past trends has been extremely misleading, conveying the idea that discretionary consumption has continued to grow, from which the inference is that further expansion in discretionary consumption can be expected.
SEEDS modelling shows that the affordability of non-essential goods and services has (at best) plateaued in the United States, and has been trending downwards, over a lengthy period, in most other Western economies.
Two observations are pertinent here.
First, and obviously, the scope for the discretionary consumption of goods and services that people might want, but don’t need, is poised to fall rapidly.
Less obviously, this deterioration is sharply at odds with what might be expected, based on the misleading prior trajectories shown in black.
A critical point to emerge from SEEDS-based analysis is that these prior trajectories have been distorted, such that false interpretations of the past and present have created gravely mistaken expectations for the future.
Principles of analysis
The basis on which prior trends are analysed here, and forward projections are made, has conceptual complications.
In principle, the process of interpretation has to move forwards from the past to evaluate financial risk, but backwards from the present to create the preconditions for effective forecasting.
It’s hoped that this apparent contradiction will be clarified by the description that follows.
Let’s start with GDP. This measure, central to conventional economics, is generally assumed to quantify material prosperity but, in reality, it does no such thing.
Rather, GDP is a measure of activity, which is by no means coterminous with prosperity. If liquidity is injected into the system, the resulting use of that liquidity can create activity that has very little material value.
This is exactly what’s been happening over a period stretching back to the 1990s, when governments and their advisers first noticed the phenomenon of “secular stagnation”, wholly failed to understand its causes, and sought in vain to ‘fix’ it with various forms of financial gimmickry.
This started with ‘credit adventurism’ before, in response to the 2008-09 GFC (global financial crisis), ‘monetary adventurism’ was added to the mix.
As well as over-inflating asset prices, this process has created activity without adding value, and has injected unproductive complexity into the economy. It has also led to chronic and cumulative understatement of inflation, properly understood as the rate at which money loses purchasing power.
On this basis, GDP has become increasingly misleading, a confection inflated by the injection of low- or even nil-value activity into the system.
By analysing trends forwards from the past, we can plot the divergence between activity (measured as GDP) and prosperity (calculated using the energy-based SEEDS economic model).
Conversely, though, current GDP is where everyone thinks we’re starting from.
This sets contemporary GDP as the logical point from which forecasts need to begin. This is where analysis needs to reason backwards from the present to reveal the prior trends that will shape future developments.
In other words, we need to think of current GDP both as a polite fiction and as a baseline for forecasts.
Benchmarking the economy
Putting this into practice requires a benchmark, and the reference-point used here is prosperity.
This is calculated, using SEEDS, on the basis of principles familiar to regular readers. The first of these principles is that material prosperity is a function of the use of energy. This is an obvious truism, given that literally nothing that has any economic utility at all can be provided without the use of energy.
The second principle is that, whenever energy is accessed for our use, some of that energy is always consumed in the access process, meaning that it is not available for any other economic purpose. With the ‘consumed in access’ component known here as the Energy Cost of Energy, this is ‘the principle of ECoE’.
In short, prosperity can be calibrated as a function of the supply, value and cost of energy.
On this basis, SEEDS calculates that global prosperity increased by 31% between 2000 and 2020. Allowing for a 25% rise in population numbers between those years, the world’s average person was just 4.8% more prosperous in 2020 than he or she had been back in 2000.
The third principle of surplus energy interpretation is that money has no intrinsic worth, but commands value only as a ‘claim’ on the goods and services provided by the energy economy.
Taken together, these principles point towards the need to draw a conceptual distinction between a ‘real’ economy of goods and services (though ultimately of energy) and a ‘financial’ economy of money and credit.
These ‘two economies’ are perfectly capable of diverging from each other, if we create financial ‘claims’ in excess of the material output of the ‘real’ economy.
This, since the 1990s, is exactly what’s been happening.
Since prices are the point of intersection between the financial and the real economies, inflation ought to reconcile any divergence between the real and the financial economies.
It can only do this, though, if inflation is measured accurately, which hasn’t been the case.
Forward from the past
Stated at constant 2020 values, and calculated in international dollars converted from other currencies using the PPP (purchasing power parity) convention, world GDP grew by 94% between 2000 ($68 trillion) and 2020 ($132tn). The global population increased by 25% over that same period, so the world’s average person became 55% more prosperous between those years.
Bearing in mind that GDP measures activity – and the use of money – rather than prosperity, this claim of rapid improvement in material well-being is easily demolished.
For a start, reported “growth” of +94% ($64tn) between 2000 and 2020 was accompanied by an increase of +190% ($216tn) in debt, meaning that each dollar of “growth” came at a cost of $3.40 in net new borrowing.
Using estimates for broader financial exposure (including the shadow banking system), this ratio rises to $7.20 of incremental commitments for each “growth” dollar. If we further include escalation in the shortfalls (“gaps”) in pension provision, we can arrive at incremental ‘hostages to the future’ of close to $10 for each dollar of reported economic expansion.
In short, since the 1990s, we’ve been inflating GDP artificially by injecting liquidity into the system, and counting the use of that liquidity as ‘activity’ for the purposes of measuring GDP.
The alternative calculation of prosperity is undertaken in two stages. First, the model normalises reported output for the effects of credit expansion.
Second, trend ECoE is deducted from the resulting underlying or ‘clean’ output number (C-GDP), because ECoE, as the first and inescapable call on resources, is the difference between output and prosperity.
The next charts show, for the United States and the global economy, the widening divergence between GDP and prosperity.
It’s worth reminding ourselves that, in a twenty-year period in which GDP reportedly rose by 94% worldwide, prosperity increased by only 31% whilst, for context, debt escalated by 190%, and estimated broader commitments (excluding pension provision shortfalls) rose by close to 250%.
These broader global trends are illustrated in the right-hand chart. The gap between GDP as reported, and prosperity as calculated by SEEDS, is shown in solid red, and is far smaller than the enormous ‘wedge’ (shown in outline) that has been inserted between debt, broader liabilities, and either calibration of economic output.
Backwards – and forwards – from the present
As we’ve seen, then, recorded GDP has been inflated artificially by massive credit and liquidity injection. By examining trends over a period going back to the 1990s, we can calculate that 2020 GDP of $132tn drastically overstates underlying prosperity of only $87tn.
The ratio between these numbers provides a measure of the extent to which the financial system, including asset prices and liabilities, will need to contract to restore equilibrium between the financial and the real economies.
Where forecasting forward trends is concerned, however, we are faced with a conundrum. Current GDP may be an extremely misleading number but, for most observers, it’s the point from which forward projections need to commence.
The solution is to use today’s GDP as the basis for forecasts, but to apply our knowledge of underlying dynamics to re-state the way in which that number arrived at where it is.
We can – and, for forecasting purposes, we must – use a base-year (2020) world GDP number of $132tn, but we don’t for one moment have to swallow the fiction that this figure has grown by 94%, in real terms, since, 2000.
In other words, we must use our knowledge to recalibrate the past – not just in total, but in component form as well.
In fact, conventional economics routinely re-states the past for purposes of comparison. When calculating “growth”, economists compare current year GDP, not with its nominal (‘money-of-the-day’) equivalent in previous years, but with those prior numbers restated to a constant, inflation-adjusted basis.
For example, a direct comparison between American GDP in 2020 ($20.9tn) and 2000 ($10.3tn) might suggest growth of 104%, but everyone knows that this number has been distorted by inflation between those years.
The application of the GDP deflator raises the 2000 number to $14.9tn at 2020 values, from which growth over that period is then calculated at a ‘real’ (ex-inflation) 40%.
This is where the SEEDS concept of the Realised Rate of Comprehensive Inflation comes into the equation. What RRCI says is that, whilst the nominal GDP figures for each year might be accepted as an accurate measurement of activity, calculation of ‘real’ change over time has been distorted by a severe underestimation of intervening inflation.
Put another way, the purchasing power of money has declined far more rapidly than official data suggests.
It should, of course, come as no surprise to anyone that inflation has, routinely and to a large extent, been under-reported over time. The conventional measurement of inflation uses a number of questionable assumptions, and very largely excludes changes in the prices of assets.
Globally, and on the PPP currency convention, nominal GDP was $50.3tn in 2000, and $132tn in 2020. Official data converts the earlier number to $68tn at 2020 values, resulting in the assertion that the world economy has grown by 94%. The official rebasing calculation infers that broad inflation averaged 1.5% between 2000 and 2020.
RRCI analysis indicates that systemic inflation actually averaged 3.5% annually, not 1.5%, over that period. Accordingly, GDP in 2000 is restated to 2020 values, not at $68tn, but at $100tn. This in turn indicates that ‘real’ growth between 2000 and 2020 was 31%, not 94%.
This is very far from being a purely theoretical point, because working out how far GDP has really travelled over the past twenty years also reveals trends in its components.
It’s almost inevitable that past trends act as the basis of forward expectations.
Accordingly, misunderstanding of the past leads naturally to mistaken expectations for the future.
These components can be stated as “sectors”, which are government, households, financial businesses (such as banks and insurers), and PNFCs (private non-financial corporations).
For our purposes, though, a more useful analysis is one which divides the economy into three segments, which are capital investment (in new and replacement productive capacity), the provision of essentials, and the supply of discretionary (non-essential) goods and services to the consumer.
Interpretation and projection
Again using the United States as an example, the next charts show three alternative interpretations of the evolution of essentials, capital investment and discretionary consumption, within overall economic output, over time.
The first chart shows nominal GDP, not adjusted for inflation, whilst the second translates everything to 2020 values based on official inflation data.
As you can see in the second chart, economic output, and each of the three segments within it, is supposed to have carried on increasing, even in the recent period in which debt and other financial commitments have been accelerating unsustainably.
On this basis, it might seem reasonable to infer, not just that aggregate economic output will continue to expand, but also that the future expansion of capital investment and discretionary consumption is assured.
The right-hand chart, whilst accepting 2020 GDP as a point-of-arrival for analysis and a point-of-departure for forecasting, uses RRCI analysis to recast the way in which that point has been reached.
The clear message to be taken from this analysis is that both capital investment and discretionary consumption have flat-lined, with the latter already starting to turn downwards.
The next charts use SEEDS economic projections to carry the RRCI-referenced interpretation of the American situation forwards, and to do the same for the British and the global economies.
For Britain and America, the implications are that, whilst further rises in ECoEs and deterioration in broader resource supply are going to drive economic output downwards, the real costs of energy-intensive essentials will continue to rise.
This means that, looking ahead, both capital investment and discretionary consumption are set to be compressed in ways that interpretations based on mistaken analysis of past trends are incapable of anticipating.
Where global projections are concerned, we’re still in the process of learning the severity of the effect that Western deterioration is going to have on economic performance in EM (emerging market) economies such as China and India. Current indications are that projections for EM prosperity may need to be revised downwards, showing earlier and more pronounced contraction.
This dynamic can be expressed using the SEEDS metric of prosperity excluding essentials (PXE).
The next charts illustrate this metric, showing top-line prosperity as a thin blue line, and PXE as a thicker one. The gap between these lines represents the real cost of essentials, but it should be remembered that PXE states the scope, not just for discretionary consumption, but for capital investment as well.
What is revealed here, where America and Britain are concerned, is pre-existing stagnation, followed by impending rapid deterioration, in PXE.
Global calibration seems to show that PXE might not – quite – have peaked yet, but this projection is subject to the previously-mentioned variable about Western effects on the performance of the EM economies.
Finally, where charts are concerned, the experience and prospects of the average person can be set out by illustrating prosperity and the cost of essentials on a per capita basis. Because population numbers have continued to increase, the per-capita equivalents of the compression of PXE aggregates are more pronounced than the same metrics expressed as aggregates.
In America and Britain, whilst top-line prosperity per person has been trending downwards over an extended period, the real cost of essentials has been rising inexorably.
You’ll notice that, in each of these charts, projection of the per capita cost of essentials ceases in 2030, before the future point at which the lines cross over, and essentials cease to be affordable at all for the average person.
The reason for this is that, long before 2040 – and probably much sooner than that – we’re going to have to re-define what we mean by “essential”.
Lengthy though this discussion has been, the focus has necessarily been confined to an overview of trends, with selected economies used as illustrative examples.
Our first conclusion, which ought to come as no real surprise at all, is that the ‘financial’ economy of assets and liabilities has become grotesquely over-inflated. This informs us that – because of the dynamic that links the financial and the material – it’s only a matter of time before an inescapable process trending towards equilibrium triggers a correction.
SEEDS analysis cannot, of course, tell us when this will happen, but it can indicate a magnitude, varying between economies but, in overall terms, implying a contraction of 35% to 40% in the financial system as a whole.
The leverage within the equation suggests that the repudiation of liabilities at this scale will translate into markedly more severe falls in asset prices.
It should be remembered that aggregate asset pricing is no more than notional, in the sense that totals thus calculated can never be monetised. If, say, asset values fall by $50 trillion, it doesn’t make the economy “poorer” by that amount. In reality, the aggregate ‘valuation’ of asset classes amounts to nothing more than what we – collectively, and through marginal pricing – choose to tell ourselves that our assets are “worth”.
The second and third conclusions are (a) that both discretionary consumption and capital investment are poised to fall very sharply, and (b) that these contractions aren’t “priced in” to collective expectations for the future, because these expectations are based on severely misleading interpretations of recent trends.