CHARTING THE COMING CRISIS
Jane Austen once wrote in a letter of how much she disliked “pictures of perfection” which, she said, “make me sick and wicked”.
Perfect pictures are, of course, the preserve of the artist, but the latest version of the energy-based SEEDS system does an improved job of picturing the imperfections that are driving us towards both a rapid deterioration in the economy and a severe financial crisis.
Under normal conditions, we might spend at least a little time discussing the improvements and refinements incorporated into the SEEDS 23 iteration of the model.
The harsh reality is that current conditions are very far from normal, so the priority now has to be to concentrate on what the model is telling us rather than at the way in which this is told.
Before looking at the annotated picture gallery which follows, it must first be warned that that a certain stoicism is required. If you’d prefer a happy ending, where prosperity doesn’t fall, asset prices don’t slump, liabilities aren’t repudiated through force majeure and the ‘liberal consensus’ that has ruled the roost for forty years remains intact, this isn’t the place for you.
The reality is that 2022 is the year where old illusions go to die.
Neither the long-established notion of TINA (There Is No Alternative) nor the newly-minted concept of TINAR (There Is No Acceptable Reality) can serve under conditions of rapid and adverse change.
To be clear about this, the energy dynamic which determines material prosperity is deteriorating, as indeed it has been over an extended period. Relentless rises in the ECoEs – the Energy Costs of Energy – of fossil fuels have put Western prosperity onto a declining trajectory since the early 2000s.
The average American, for instance, is now 11% poorer than he or she was back in 2000. Prosperity per capita has fallen by 13% in Britain since 2004, and by 7% in Japan since 1997.
These trends are now being replicated in less complex, more-ECoE resilient EM (emerging market) economies such as China and India. This means that global prosperity has now turned down after a long plateau in which continued (though decelerating) progress in the EM countries offset continuing deterioration in the West.
There can be no ‘fix’ – financial or technological – for these problems. Monetary manipulation has done no more than buy some time (at huge expense) for a failing system.
The capabilities of technology – whisper it who dares – are bounded by the laws of physics. Transition to renewable energy sources (REs), though imperative, cannot replicate the economic characteristics of fossil fuels.
That worsening economic trends have not been evident in conventional data reflects the way in which various forms of adventurism have been used to create a simulacrum of “growth”. Pouring cheap credit and cheaper money into the system has had the effect of creating activity (as measured by GDP) even though the value of economic output has been deteriorating.
Between 1999 and pre-covid 2019, each $1 of reported “growth” was accompanied by increases of $2.70 in new debt plus an estimated $3.75 in broader financial liabilities. Were unfunded pension promises included in this calculation, it would emerge that close to $10 of forward commitments have been adopted for each “growth” dollar.
All of these numbers precede coronavirus crisis interventions, which have made all of these ratios far worse. Historians of the future are likely to characterise these gargantuan interventions as the ‘last hurrah’ of the money-for-nothing form of denial.
In practical terms, what this long era of self-delusion has accomplished is the driving of an ever-widening wedge between the ‘real’ economy of goods and services and the ‘financial’ economy of money and credit.
The operative process now is one that will forcibly restore equilibrium between the two economies of money and energy. Globally, the gap between them can be calculated at 40%, giving an approximate measure of the extent to which the financial system will be forced to contract.
Since money functions as an aggregate of claims on the real economy, this indicative calculation references the liabilities side of the financial equation. Asset markets will fall by more than this, reflecting the extent of leverage in the dynamic which links the pricing of assets to the underlying structure of liabilities.
This is where the need for stoicism comes in. The stark reality of the situation is that the prices of stocks, bonds and property are poised for extremely sharp falls.
The bond market situation is that the permanence of the inescapable rise in interest rates will, once recognized, drive yields sharply higher. Corporate bonds will be undermined further by a relentless deterioration in the financial conditions of the business sector.
Just as prosperity is eroding, the real costs of essentials – many of which are energy-intensive – are rising rapidly. The SEEDS indicator termed PXE – prosperity excluding essentials – is on a sharp downwards trajectory.
As well as impairing the scope for investment in new and replacement productive capacity, this PXE compression will exert relentless downwards pressure on the affordability of discretionary (non-essential) goods and services.
Though there are ameliorating measures – known here collectively as the taxonomy of de-growth – which businesses can and will adopt to manage deterioration, it is clear that discretionary sectors will bear the brunt of a process by which equity markets start to price the future as it is, rather than as we would like it to be. A series of growth-predicated business models will fail, including the popular “streams of income” model which prioritises the signing up of customers over current revenues.
For property, meanwhile, the combination of deteriorating affordability and rising interest rates creates a dynamic which requires no amplification here.
As asset prices tumble and defaults cascade through the system, the last delusion will fail.
This delusion is that, if we engage in enough tantrums, the adults in the room – meaning central bankers – will step in to ‘kiss it better’.
The take-off in inflation – which has long been under-reported when compared with the SEEDS measure of RRCI (the Realised Rate of Comprehensive Inflation) – makes such intervention impossible.
The game-changer of systemic inflation means that the authorities can no longer, as they did in 2008-09, step in to rescue the reckless whilst penalising the prudent.
It would take a very special form of madness to invoke the supposedly “temporary” gimmicks (sorry, the “unconventional innovations”) of the GFC under conditions of rapidly accelerating inflation.
Barring surrender to a hyperinflationary destruction of the purchasing power of money, neither ZIRP nor QE can be re-invoked. The extinguishers used to fight (or at least to damp down) the fires of the global financial crisis now contain, not foam or water, but gasoline.
“Nobody ever feels or acts, suffers or enjoys, as one expects”, wrote Jane Austen in another letter. Put another way, the era of self-delusion is over, and the stoicism involved in facing reality will now be the characteristic most required to adapt to a new era.