MANAGING THE REALITY OF ‘LIFE AFTER ORTHODOXY’
A new ‘heavenly body’ has entered the cosmology of political and corporate decision. This new influence is the emerging reality that the economy is turning out, after all, to be an energy system, and that long-accepted ideas to the contrary are fallacious.
The concept of limits is replacing the paradigm of ‘infinite growth’.
Where decision-making is concerned, this emerging reality isn’t likely to have an immediately transformational effect. Established nostrums can have a tenacity that long out-lasts the demonstration of their falsity.
We’re not, then, about to see sudden, open and actioned acceptance of the fact that the economy is an energy rather than a monetary system.
Rather, we can expect to see energy reality exert an increasing gravitational pull on the tide of decisions and planning, most obviously in government and business. Policy statements may not change, but the thinking that informs planning and strategy undoubtedly will.
This gravitational effect is starting, as of now, to re-shape perceptions of the present, change ensuing “narratives” of the future, and trigger a process of realignment towards the implications of a world with meaningful constraints.
The aim here is to examine the practical consequences of a contest of interpretations which, whilst it has already been decided at the theoretical level, leaves ‘everything to play for’ in political and commercial practice.
And then there was one
There are, essentially, two ways in which we can seek to explain the working of the economy.
One of these is the conventional or orthodox school of thought, which presents economics as a process determined by the behaviour of money, and acknowledges no limits to the potential for growth.
For the best part of nine years, this site has endeavoured to encourage, explore, model and quantify the alternative interpretation, which states that prosperity is a product of the use of energy, and that there are very real resource and environmental limits to economic expansion.
There are two ‘adjudicators’ of this debate. One of these is logic, and the other is experience.
Logic has always favoured the energy interpretation. The concept of material constraints is not remotely a new one. A notable milestone in the exploration of this thesis was The Limits To Growth, which was published back in 1972, and is now looking remarkably prescient. Hitherto, though, LtG and similar theses could be, and have been, dismissed as theoretical rather than practical challenges to the orthodoxy.
What’s different now is that experience is in the process of confirming the verdict of logic.
In fact, the only thing that the orthodox explanation still has going for it is ‘custom and practice’.
Readers will not misunderstand me if I state that, at the purely intellectual level, this contest is ‘all over bar the shouting’ (though there will be plenty of that).
What lies ahead is a process of adjustment – we might call it realignment – to the new reality of an economy in which the scope for expansion is constrained by limits, both to energy value and to environmental tolerance.
Policy-makers and business leaders may have grasped the latter constraint, but have still to discover the reality of the energy limits to prosperity.
So here’s the question. If you were a decision-maker – in government, say, or in business – what would you do if you knew that the consensus “narrative” of our ever-expanding economic and broader future was heading into the blender?
Theory and narrative, #1 – money and myth
In essence, orthodox theory states that the economy can be explained entirely in terms of money.
The “laws” of economics are not, in fact, analogous to the laws of science. Rather, they are observations about the behaviour of money.
The central conclusion of this orthodoxy is that there need be no limits to economic growth, because the driver of expansion is under our control as the creators and managers of money.
Monetary causation enables us to use pricing, incentives and demand to circumvent all material limitations.
A more recent refinement of this theme combines technical innovation with monetary management to assure us that all material limits can be circumvented, through technology and monetary management, such that ‘growth in perpetuity’ is perfectly feasible, and can be used as a reliable forward presumption.
To use the contemporary idiom, what follows from this is a “narrative” of a perpetually-expanding economy.
Where planning and projections are concerned, this narrative is emphatically directional, flowing from assumed growth to everything else that we want to anticipate.
Here’s what this means in forecasting terms.
Planners and forecasters start with – and tend seldom to question – assumptions about the future size of the economy. If, for instance, we accept a trend real annual rate of growth of 3.5%, simple mathematics tells us that the economy will be twice as big in, say, 2040, as it was in 2020. If we assume trend growth of only 3.0%, growth over that period is 80%. At 4.0%, it will be 120%.
With this presupposition in place, only then do they calculate what this is going to mean in practical terms. If we know that the economy will be, say, X% larger in 2040 than it is now, it can be calculated that the need for energy, for instance, will have expanded by Y%.
If it is further assumed that we need to reduce our use of fossil fuels by Z% over that same period, what remains is a non-fossil market of predictable size, requiring to be filled, in varying possible proportions, by nuclear power, hydroelectricity and renewable energy sources (REs).
This ‘start with growth’ process of calculation delivers the narrative of seamless energy transformation, ever-expanding prosperity, and a billion vehicles powered by batteries or hydrogen.
Theory and narrative, #2 – resources and reality
The alternative thesis reasons from entirely different predicates. Instead of assuming that future energy requirements are a function of assumed economic expansion, our understanding is that prosperity is a function of the availability of energy value.
If we happen to agree that the availability of energy value might indeed conform to the Y% number calculated by growth-predicated forecasts, we might also agree that the economy will be X% bigger by the target date.
The sequence of reasoning, though, is entirely different. It operates in the opposite direction.
In the simplest of terms, conventional forecasting assumes that Y (energy demand) is a function of X (economic growth). The alternative is to restate this as X (economic growth) is a function of Y (energy availability).
The energy approach to economics starts with recognition that the economy is an energy system, because nothing that has any economic utility at all can be provided without the use of energy.
Pausing only to dismiss the quaint notion (the “haystack without a needle”) that the economy can somehow be “de-coupled” from the use of energy, we move on to introduce a second predicate, which is ‘the principle of ECoE’.
This recognizes that, whenever energy is accessed for our use, some of this energy is always consumed in the access process. In Surplus Energy Economics (SEE), this ‘consumed in access’ component is known as the Energy Cost of Energy (ECoE), and is expressed as a percentage.
Importantly, energy cannot be used twice. This means that the proportion of total energy supply absorbed as ECoE cannot also be used for any other economic purpose.
This in turn means that material economic prosperity is a function of the availability of surplus (ex-ECoE) energy.
This makes it vital that any process of interpretation and projection starts with an examination of the trend in ECoEs from the various sources which constitute energy supply.
We know that ECoEs are shaped by geographic reach, economies of scale and the process of depletion. With the potential of reach and scale now exhausted, depletion has become the factor driving the ECoEs of oil, gas and coal.
To be sure, technology acts favourably, accelerating falls in ECoEs when these are declining, and mitigating rises when trend ECoEs are increasing.
Critically, though, it is self-evident that the potential of technology is circumscribed by the limitations of physics, which in this case means the material characteristics of energy resources.
This understanding is critical, because it takes the potential of REs out of the realm of wishful thinking, and requires us to accept two limitations to the potential economic value of renewables.
First, we know that the resources required for the creation and maintenance of RE capacity are products of the legacy energy provided by oil, gas and coal. This means that the trajectory of the ECoEs of renewables is linked to that of fossil fuels.
Second, we also know that REs have their own constraints, most obviously the Shockley-Queisser limit to the theoretical maximum efficiency of solar power generation, and the Betz’ law equivalent for wind power.
We further recognize that ECoEs affect both the delivery costs and the affordability of energy. This means that ECoE trends determine, not just the qualitative nature of available energy, but the quantitative issue of supply.
The last of our three principles – otherwise known as “the trilogy of the blindingly obvious” – is that money has no intrinsic worth, but commands value only as a ‘claim’ on the goods and services made available by the material economy of energy.
Money can be defined as “a human artefact, validated by exchange”.
On this basis, we arrive at the transformative conception that there are two economies. One of these is the proxy or financial economy of money, credit and assets. The other is the material or real economy of goods, services, labour and energy.
With this understood, our ‘control’ over the creation and use of money ceases to endow us with the ability to drive infinite economic growth. It becomes, instead, nothing more than an ability to manage one side (the financial part) of a ‘two economies’ equation determining the relationship between money and material prosperity.
On this basis, the creation of money in its various forms can outgrow the underlying economy, but this process simply creates what are known in SEEDS terminology as “excess claims”.
Much of our recent economic and financial experience can be explained as the creation of ever more abundant excess claims which, by definition, cannot be honoured ‘for value’ by a smaller underlying or ‘real’ economy.
The contemporary financial system is at severe and worsening risk because of the gargantuan scale of the ‘excess claims overhang’ that has been created on the false assumption that the creation of money and credit in their various forms (known to conventional economics as “demand”) can somehow expand the real economy of goods and services.
A future redefined
Applied using the SEEDS economic model, these principles point to a very different future, and, for that matter, present a very different past and present, from those described by orthodox economics.
This, of necessity, results in a very different forward “narrative”.
The following charts provide a snapshot of the interpretation provided by SEEDS (the Surplus Energy Economics Data System).
The left-hand chart shows how, as trend ECoEs have risen relentlessly, average world prosperity per person has plateaued, and has now turned downwards.
At the regional level, prior growth in prosperity has long since inflected in the advanced economies of the West, whilst less complex, less ECoE-sensitive EM (emerging market) countries have continued to enjoy improving prosperity, albeit at a steadily decelerating pace.
Meanwhile, and as the middle chart shows, the real cost of essentials has continued to rise, in large part because so many necessities are energy-intensive.
This process has initiated severe compression of the SEEDS metric of prosperity excluding essentials. PXE is a measure of the affordability, in aggregate, of (a) discretionary (ex-essential) consumption, and (b) capital investment in new and replacement productive capacity.
Finally, where these overview indicators are concerned, an enormous gap has emerged between the financial and the real economies, such that the economy of goods, services and energy is now about 40% smaller than its financial proxy of money, credit and assets.
You will appreciate that, because prices are the interface between the real and the financial economies, inflation is a natural consequence of this divergence or, rather, of the pressures that operate towards the restoration of equilibrium between the two economies.
You might, indeed, wonder why – more than thirteen years on from the adoption of supposedly “temporary” expedients such as QE and ZIRP – inflation hasn’t accelerated before now.
Part of the answer lies in the systemic understatement of inflation by conventions which, amongst other quirks, exclude asset price rises from a definition of inflation which concentrates on – and, even then, understates – changes in consumer prices.
The SEEDS calculation of the Realised Rate of Comprehensive Inflation (RRCI) indicates that, over the two decades between 2000 and 2020, systemic inflation averaged 3.5% annually, far higher than the official rate of 1.5% over that period.
“The future’s not what it used to be”
What we have been describing is a process of divergence which has driven a wedge between a ‘real’ economy (shaped by the energy dynamic) and a ‘financial’ economy (whose size is determined by monetary policy).
This explains a great deal that, from an orthodox perspective, seems baffling. It warns us that a major correction looms between the ‘two economies’, a correction that must involve financial ‘value destruction’ as a consequence of the elimination of ‘excess claims’.
As we have seen, the contemporary consensus narrative rests on the false premise that we can start with assumptions about future growth and then predict what can be expected to happen in numerous categories of forward outcomes.
Uncovering the false premise – and the ensuing fallacious direction of reasoning – of the consensus narrative acts in a way that might be likened to taking out the bottom brick of a speculative wall.
For example, once we know that future prosperity is a function of energy trends rather than the other way around, we know that we cannot assume that the supply of renewable energy somehow ‘must’ expand in conformity with what growth assumptions supposedly tell us about the scale of energy supply in the future.
Reasoning in this opposite direction has a liberating effect on thought processes. This realization enables us to place into the equation factors which conventional thinking has been forced to ignore, or to treat as anomalous and inconvenient.
We are now at liberty to recognise that each rise in the price of fossil fuels, whilst it increases the cost of using conventional cars and commercial vehicles, also raises the price of all of those materials (including steel, concrete, copper, lithium and cobalt) that are required for energy transition.
We can place the undoubted environmental downsides of this transition into a broader context. We can take cognisance of the fact that the ECoEs of renewables are linked to those of fossil fuels through renewables’ reliance on resources which can only be made available by the legacy energy provided by oil, gas and coal.
What had previously been nagging reservations – such as the resource and investment demands of renewables, the Shockley-Queisser limit, Betz’ law, doubts about how “green” renewables really are, and so on – can now find their appropriate places in a broader understanding of energy, the economy and the environment.
Accommodating gravitational effect
What we’ve been doing here is following a logical process to a point at which a raft of consensus assumptions about the future turn out to have been the products of mistaken assumptions.
Though the theoretical approach is essential, what matters in practical terms is that this interpretation is being borne out by the trend of events. Its consequence is an invalidation of all of the preconceptions which inform the “consensus narrative” of our economic, financial, political and broader future.
If you’re in government, it tells you that future resources are going to be far less than you might hitherto have assumed, and that the provision of essentials is set to become the critical battleground between competing priorities.
If you’re in business, it tells you that we cannot rely on growth, least of all in discretionary sectors, and that the scope for capital investment is poised to decrease rather than to expand.
It anticipates the wholesale failure of business models based on false predicates, and suggests that the taxonomy of de-growth – with its emphasis on product and process simplification, on delayering, and on managing utilization and critical mass risks – is the appropriate template for decisions.
This discussion is not, in any sense, intended as any kind of primer for the conduct of business or government in a future that’s not going to conform to a mistaken consensus.
But one issue is of immediate relevance to the theme that interests us here – are governments, businesses and other organizations going to start a process of fundamental re-appraisal?
The view taken here is that these institutions are not about to reveal a Damascene conversion to the realities of a material (and constrained) rather than a monetary (and unlimited) conception of the economy.
Nobody is likely to start telling shareholders, voters, workers, consumers, the markets or anybody else that the consensus narrative is mistaken, and that, in the words of Mickey Newbury, “the future’s not what it used to be”.
Rather, “gravitational effect” is the appropriate analogy here. Any large organization is entitled to operate research units looking into “what if?” scenarios, and is under no obligation to share the results of such evaluation with others.
This is likely to be the way in which new thinking about the economy crosses the boundary from theory into practice.
It seems most unlikely that institutions will ignore the various factors, some of them described here, which put ‘the currently-assumed’ into the category of ‘the speculative and the potentially mistaken’.
Research processes are likely to act on planning in much the same way that a piece of iron, placed on the rim of a binnacle, acts on a magnetic compass.
New economic thinking can be expected to work its way into decision-making processes in a way more akin to gradual absorption than to a flood.
For practical purposes, the revolution in economic thinking “will not be televised”, but neither can it continue to be dismissed as nothing more than ‘inconvenient theory’.