In the autumn of 2008, as the full seriousness of the global financial crisis (GFC) became apparent to investors, markets fell with dizzying speed.
Something very similar happened in the first quarter of 2020, when it became clear that the coronavirus pandemic had severe implications for the economy.
Perhaps the single most striking aspect of the current situation is that markets haven’t – yet, anyway – gone into a tail-spin.
This might seem surprising, given the take-off in inflation, pressures on the supply of energy and other commodities, and a pretty general recognition that the interest rate cycle has turned.
There are, to be sure, what we might call ‘pockets of concern’, of which the obvious examples are the “tech” sector in America, and the value of GBP. These exceptions aside, though, market responses to the current crisis have been restrained, whilst property price bubbles haven’t burst.
As you may know, this site does not provide investment advice, and must not be used for this purpose.
But we’re entitled to look at the general behaviour of markets as a barometer of sentiment ‘at the sharp-end’ of opinion. Thus far, it’s fair to say that markets have behaved like the dog that didn’t bark “in the night-time” in the famous Sherlock Holmes story about stolen racehorse Silver Blaze.
As you may also know, the view here is that surging inflation signifies a fundamental tipping-point, a moment at which the reversal of prior growth in material prosperity moves from unconventional theory to inescapable fact.
If that is indeed the case, the outlook for the financial system is grim, because the entirety of the system is predicated on the presumption of ‘perpetual growth’.
“Won’t get fooled again”?
Why, then, are markets exhibiting comparative insouciance in the face of seemingly-grave economic trends?
There are, in essence, two main explanations for this relative calm. One of these can be labelled “won’t get fooled again”. The other is a belief that all of the bad news is already priced in to the markets.
The “won’t get fooled again” explanation is that investors lost huge amounts of money in the third quarter of 2008, and again in the first quarter of 2020, only to find out that the World hadn’t, after all, come to an end.
Investors seem determined not to fall for this ‘end of the World’ stuff for a third time.
Given that we should never underestimate the role of psychology in the markets, this is a persuasive argument.
The “already priced-in” explanation is slightly more complicated. For starters, falls in the NASDAQ and in GBP can be portrayed as isolated cases.
The prices of American “tech” stocks had, the argument runs, been inflated to absurd extremes, so what we’re seeing now is nothing more than a long overdue correction towards reality. There’s a precedent here, of course, making a ‘dotcom2’ bust a plausible thesis.
An equally persuasive case can be made that Sterling, like “tech”, is a special case. It’s hard to deny that the British economy has very glaring weaknesses, and the market judgement seems to be that these weaknesses are not replicated, to anything like the same extent, in other Western countries.
This isn’t the place for an assessment of the British economy, but the broad view taken here is that, whilst the UK situation, as measured by SEEDS, is indeed pretty dire, other economies have broadly equivalent problems of their own.
The real question-mark is whether the UK has what it takes to navigate the coming storm.
More generally, the market view seems to be that inflation, whilst clearly not the “transitory” phenomenon claimed until recently by the Fed, can nevertheless be prevented from running wild.
With the coronavirus crisis behind us, it is argued, ruptured supply-chains can now return to normality, and the monetary largesse poured into the economy to counteract “lock-downs” is draining from the system.
Where the war in Ukraine is concerned, there are two ways in which a calm market response can be explained. The first is that, after a period of adjustment, energy and other commodities previously sourced from Russia and Ukraine can be obtained from elsewhere.
A second, more cynical view is that we can already see the outline shape of a conclusion to the conflict. As war cools towards stalemate and settlement – and as the approach of winter demand peaks starts to concentrate minds – the trade freeze might begin to thaw, with Western policy turning out to be no more resolute over Russia than it was in Afghanistan.
Arguing along these lines, whilst rates might indeed rise to perhaps 3% or even 4%, we’re not heading into a re-run of the double-digit rates experienced in the late 1970s and the early 1980s.
A darker perspective
If you’ve been visiting this site for any length of time, you’ll know that the interpretation of the economy set out here differs starkly from the orthodox view which continues to inform decision-making in government, business and finance. The surplus energy interpretation is summarised briefly here, and in greater detail here.
Once we understand that the economy is an energy system, and not a financial one, it readily becomes apparent that material prosperity is a function of the supply, value and cost of energy.
Within this matrix, the most important determinant is cost, referenced here as the Energy Cost of Energy.
ECoE refers to that proportion of accessed energy which is consumed in the access process, and is not, therefore, available for any other economic purpose.
Largely because of depletion, the ECoEs of oil, natural gas and coal have been rising relentlessly, pushing overall trend ECoE to ever higher levels.
This has pushed prior growth in prosperity into reverse, because prosperity is a function of the surplus (ex-ECoE) energy available to the economy.
As ECoEs rise, surplus energy shrinks, and prosperity contracts.
Important though they undoubtedly are, renewable energy sources (REs), such as wind and solar power, can’t push overall ECoEs back down to levels at which growth is possible. The average person in the West has been getting less prosperous over an extended period and, latterly, the same thing has started to happen in EM economies which, by virtue of their lesser complexity, have higher thresholds of ECoE-tolerance.
Energy transition, though undoubtedly imperative on economic as well as on environmental grounds, cannot stem – still less reverse – this prosperity-sapping trend.
The connections between ECoE and prosperity per capita in America, Britain and China are illustrated in fig. 1. Prosperity per capita turned down in the United States from 2000 and in Britain from 2004, and China is now decelerating rapidly towards its own inflexion-point.
Fig. 1
Meanwhile, the real costs of essentials are rising, primarily because the supply of so many necessities is highly energy-intensive. Examples include food, water, housing, infrastructure, the transport of people and products and, of course, energy used in businesses and in the home.
Accordingly, the scope for the consumption of discretionary (non-essential) goods and services is being squeezed. The SEEDS metric PXE – prosperity excluding essentials – is in decline even in countries (such as China) where top-line prosperity has yet to inflect (fig. 2).
Fig. 2
Depending on how we define “essential”, upwards of 50% of Western economies ranks as discretionary, a proportion reflected in activity, employment and profitability.
One implication of falling PXE is a decline in the value of those discretionary sectors which account for more than half of all the businesses whose shares are traded on the markets.
Another implication is that, as the gap between prosperity and essentials narrows, the affordability of mortgages (and of rents) declines, with adverse implications for property.
These negative tendencies in stocks and property can only be exacerbated by rises in nominal interest rates, even if real rates remain negative because inflation is rising more rapidly than nominal rates.
Denial nears denouement
None of this is accepted by an orthodox school of thought which depicts the economy entirely in monetary terms, thereby dismissing the possibility of material constraints, and assuring us of the possibility of ‘infinite growth on a finite planet’.
Accordingly, policymakers have tried to counter energy downside with financial stimulus.
As you can see in fig. 3, this has seen liabilities – such as debts and other financial commitments – rise much more rapidly than prosperity. (It should be noted that the financial “assets” shown in fig. 3 are the systemic counterparts of the liabilities of the government, household and corporate sectors).
Fig. 3
Meanwhile, this process has created cosmetic “growth” in metrics such as GDP, because these metrics measure monetary activity rather than material prosperity.
With this understood, it becomes apparent that there has been a relentless widening in the gap between the ‘financial’ or proxy economy of money and credit and the ‘real’ or material economy of goods and services.
This creates an ultimately irresistible force tending towards the restoration of equilibrium between the two economies of money and energy.
Inflation is a logical concomitant of this process, because prices are the point of intersection between the monetary (financial demand) and the material (physical supply). This relationship is illustrated in fig. 4.
Fig. 4
The necessary conclusion of this dynamic is that a large proportion of the monetary claims embedded in the financial system cannot possibly be honoured ‘for value’ by a faltering underlying economy of material prosperity.
The process of excess claims destruction can take place either (a) through an inflationary degradation in the purchasing power of money, or (b) through a process of failure and default driven by a determination to use rate rises to prevent ever-worsening rates of inflation.
In practical terms, what this means is that we face a choice between untamed inflation or a ‘hard default’ slump, both in forward commitments and in asset prices, which are the corollary of the liabilities side of the value equation.
Perhaps the single most disturbing aspect of the present situation is rigid adherence to the fallacy that fiscal and monetary policy can deliver ‘growth in perpetuity’ despite worsening resource (and environmental) limits to expansion.
When governments (and others) assure us that we can “grow out of” current pressures on living standards, and that we can promote policies of “sustainable growth”, they are – perhaps in all good faith – making promises that the material economy simply cannot honour.
The previous article set out what was intended to be a short but comprehensive guide to the economy understood as a surplus energy system. It’s been pointed out that, however comprehensive that report may be, it’s far from being “short”.
Here, then, is “the short version”. The intention is to make both versions available as downloads.
THE PERFECT STORM HAS ARRIVED
With economies stumbling, the cost of living rising at rates not seen in forty years, and world markets gripped by nervousness, there are two ways in which we can try to make sense of current economic turbulence.
We can, if we wish, see all of this as temporary – caused by the lasting effects of the pandemic, latterly compounded by the war in Ukraine – and assure ourselves that the ‘normality’ of continuous economic “growth” will return once these crises are behind us.
The alternative is to face facts.
Ultimately, the economy is an energy system, not a financial one, because literally nothing that has any economic value whatsoever can be supplied without the use of energy.
The vast and complex economy as we know it today was built on energy from coal, oil and natural gas, in a process whose origins can be traced to 1776, when James Watt completed the first really efficient engine for the conversion of heat into work.
Whenever energy is accessed for our use, some of that energy is always consumed in the access process. For much of the time since 1776, this Energy Cost of Energy (ECoE) declined, driven downwards by economies of scale, technological progress and a worldwide search for lowest-cost energy resources.
Latterly, though, the positive impetus of scale and geographic reach has faded out, leaving depletion – the process of using lowest-cost resources first, and leaving costlier alternatives for later – to push fossil fuel ECoEs back upwards.
Technical innovation continues, but it should never be forgotten, even in an age obsessed with technology, that the scope for technological progress is limited by the laws of physics.
This is particularly pertinent to the assumed “transition” to renewable energy sources (REs). Instead of unthinking extrapolation from past reductions in their costs, we need to note that renewables, too, have their technical limitations.
One of these is the Shockley-Queisser limit which determines the maximum potential efficiency of solar panels. Another is Betz’s Law, which does the same for wind turbines. Best practice is already close to these theoretical limits.
Moreover, dramatic expansion in RE capacity will make huge demands on material resources, including steel, concrete, copper, cobalt and lithium. For the foreseeable future, these resources, even if they exist at all in the quantities required, can only be made available through the use of legacy energy from oil, gas and coal.
To be clear about this, we most emphatically shouldmake every effort to transition to renewables, not just on environmental grounds, but for economic reasons as well.
But we cannot assume that the ECoEs of REs will ever fall to levels low enough to replicate the economic value of fossil fuels.
Environmental “sustainability” is a practical, no-brainer objective. But “sustainable growth” is no more than wishful thinking, and the probabilities are heavily stacked against it.
I drew attention to the implications of the energy economy when I was head of research at Tullett Prebon, publishing the Perfect Storm report back in 2013. Since then, I’ve carried on exploring this concept at Surplus Energy Economics, as well as building SEEDS, an economic model which runs on energy rather than financial principles.
What has emerged is that, as trend ECoEs have risen relentlessly, prior economic growth has petered out before going into reverse.
Throughout a quarter-century precursor zone that has preceded the onset of economic contraction, we’ve become adept at deluding ourselves that we can continue to rely on ‘infinite growth on a finite planet’.
Because GDP measures financial activity rather than material prosperity, we’ve been able to create an artificial simulacrum of “growth” by pouring vast quantities of cheap credit – and, latterly, cheap money as well – into the system.
Ultimately, of course, money has no intrinsic worth, but commands value onlyas a ‘claim’ on the goods and services produced by the energy economy. Prolonged financial gimmickry – sorry, “innovation” – has had the effect of driving a wedge between the ‘real’ or material economy of energy and the ‘financial’, ‘claim’ or proxy economy of money and credit.
Because prices are the point at which these two economies intersect, inflation is a logical outcome of this divergence between the material and the monetary.
Whether we carry on letting inflation run hot, or raise interest rates in an effort to tame it, the end result is that we get poorer, either through an economic slump, or through the inflationary destruction of the purchasing power of money.
And there’s a sting in this tail (or tale), too. Most of those products and services that we deem “essential” – including water, food, housing, infrastructure and the transport of people and products – are energy-intensive, meaning that the real costs of necessities will continue to rise, even as overall prosperity erodes.
This means that the affordability of discretionary (non-essential) goods and services – those things that consumers might want, but do not need – will contract, with obvious implications for large swathes of the economy.
Orthodox economics continues to deny all of this, asking us to believe that there is no material shortage that cannot be overcome by using financial “demand” to push prices upwards.
The reality, though, is that no amount of demand, and no increase in price, can produce anything that does not exist in nature. Neither can any amount of technological genius overcome the laws of physics in general, or the laws of thermodynamics in particular.
Recent trends, albeit overshadowed by concerns over covid and Ukraine, are confirming that the “precursor zone” has ended; that economic contraction has begun; and that even the myth of perpetual “growth” can no longer be sustained.
Beyond high inflation, deteriorating prosperity and the erosion of discretionary consumption, this also means that the financial system faces a process of drastic downsizing, a process that can be expected to be disorderly.
The debate – between orthodox ‘perpetual growth’ and material (and environmental) physical constraint – may run for some time yet, but the outcome is now beyond dispute.
The question now devolves into one of preparation and adaptation, which can only start once the reality of economic limits is grasped.
The title of this report makes intentional reference to the Perfect Storm paper published by Tullett Prebon back in 2013, when I was head of research at that organization.
Since then, my efforts have been concentrated on (a) promoting discussion (at Surplus Energy Economics) about the energy basis of the economy, and on (b) building an economic model (SEEDS) founded on these principles.
Whilst theoretical debate will continue, and models can always be further refined, time has run out for the purely intellectual contest between conventional and energy-based interpretations of the economy.
Accordingly – and with due apology to those to whom much of this is already familiar – what follows is a comprehensive summary of what we know about the economy as an energy system, and what we can reasonably infer about the future based on this understanding.
INTRODUCTION
Faced with rising inflation, worsening pressure on living standards and significant nervousness in the markets, we’re at liberty – if we so choose – to ascribe all of these problems to the combined effects of the coronavirus crisis and the war in Eastern Europe, and to assure ourselves that the ‘normality’ of never-ending economic growth will return once these temporary vicissitudes are behind us.
The alternative is to face facts.
These are that prior growth in material prosperity has gone into reverse, and that a financial system erected on the mistaken presumption of ‘infinite growth on a finite planet’ faces challenges of a magnitude which eclipse all past experience.
Understood as a system supplying the goods and services which constitute material prosperity, the economy is a dynamic propelled by the supply, value and cost of energy.
The critical element in this equation is the Energy Cost of Energy, which determines how much surplus (ex-cost) energy is available to the system. The ECoEs of oil, natural gas and coal have been rising relentlessly, undermining the fossil fuel foundations of the modern economy.
Protracted efforts to overcome energy deterioration with financial innovation have failed, simultaneously driving a wedge of instability between the ‘real’ or material economy of resources, goods and services and the ‘financial’ or proxy economy of money and credit.
Since prices are the point of intersection between these two economies, surging inflation is a logical signifier of the moment at which divergence becomes unsustainable, and the system becomes subject to forces tending towards a restoration of equilibrium between the energy economy and its financial counterpart.
Financially, and as fig. 1 illustrates, the extent of the imbalance between the material and the monetary economies reveals the downside risk in a system of forward commitments which has grown exponentially as monetary expansionism has fought a losing battle against material deterioration.
Meanwhile, whilst top-line prosperity erodes, the scope for discretionary (non-essential) consumption is being compressed by relentless rises in the real costs of essentials, many of which are highly energy-intensive.
Fig. 1
The inability of financial stimulus to reinvigorate the energy economy is the first of at least three popular myths which are poised to fail in the face of reality.
A second is the supposed ability of renewable energy sources (REs) to replace fossil fuel energy without undermining economic prosperity – whilst a “sustainable economy” may indeed be feasible, “sustainable growth” is a pipe-dream.
Neither can we expect the alchemy of technology to triumph over the laws of physics.
From here, and as the financial system draws ever nearer to the trauma of disorderly downsizing, the economy enters an era in which, whilst “collapse” might be avoided, involuntary contraction has become inescapable.
PART ONE: ENERGY AND PROSPERITY
One of the most profound shortcomings in orthodox economics is the mistaken assumption that “prosperity” is coterminous with “money”.
If this were true, it would enable us, through our control of money, to promote perpetual economic expansion, unfettered by any material constraints imposed by the finite nature of the planet in its physical and environmental characteristics.
We have spent twenty-five years discovering, at enormous cost, that such assumptions are fallacious. Conventional economics, once dubbed “the dismal science”, might or might not be “dismal”, but cannot in any way be considered a science.
Those conclusions which orthodox economists are pleased to call “laws” are, in fact, no more than behavioural observations about the human artefact of money, and are not remotely analogous to the laws of science.
If there is ever to be a science of economics, it will be founded, not in finance, but in thermodynamics.
Critically, we should dismiss the orthodox insistence that financial demand always creates material supply, in part by promoting substitution. No amount of financial stimulus, and no rise in price, can produce resources which do not exist in nature. We can lend and print money into existence, but we cannot similarly create the low-cost energy without which the economy cannot function.
The reality is that prosperity is a material concept, understandable only in terms of resources in general, and of the “master resource” of energy in particular.
As a recent reappraisal by Gaya Herrington confirms, the authors of The Limits to Growth (LtG) were right when, back in 1972, they modelled the Earth as an inter-connected system, and found definite material limitations to expansion.
In the narrower fields of economics and finance, it’s becoming ever clearer that we have been living through a quarter-century precursor zone during which the potential for further growth has been exhausted.
What we are experiencing now is the disruption which attends the ending of this transitional phase, and the onset of involuntary economic contraction.
The aim in Part One is to uncover the operative principles of the economy understood in material terms, and to look at how these define the nature and progression of prosperity.
In Part Two, we look at what the application of these principles tells us about the future of the economy and the financial system.
Principles
The Surplus Energy Economics interpretation is based on three principles, each of which is fully in accordance both with logic and with observation.
First, the economy is an energy system, because nothing which has any economic utility at all can be produced without the use of energy. This applies, not just to services and manufactured products, but to other natural resources as well, because the supply of these materials is a function of the energy required to make them available.
The second principle 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 the Energy Cost of Energy, giving us the principle of ECoE.
Because no unit of energy can be used twice, rises in ECoEs reduce the economic value of any given quantity of energy available to the system. Rising ECoEs also undermine the economics of energy supply, and thus act as a constraint on the quantity, as well as the economic value, of energy available to the economy.
This means that material prosperity is a function of the surplus (ex-ECoE) energy available to the system. Prosperity can be – and, through the SEEDS system, is – quantified and modelled on this basis.
The third principle is that, lacking any intrinsic worth, money commands value only as a ‘claim’ on the products of the material economy of energy.
Money is thus ‘a human artefact, validated by exchange’. It is not a ‘store of value’, but at best ‘a store of claims to value’. Since money is a claim on energy, debt, as a ‘claim on future money’, is in reality ‘a claim on future energy’.
We are at liberty to create as many monetary claims as we see fit, but we cannot create the material prosperity required to honour these claims ‘for value’.
Money and money-equivalents created in excess of the deliverability capabilities of the ‘real’ economy of energy are known in SEE as excess claims. Since, by definition, these excess claims cannot be honoured, they must be eliminated, either through repudiation (‘hard’ default) or through an inflationary degradation of the purchasing power of money (‘soft’ default).
To the extent that these claims are regarded by their owners as ‘value’, divergence between aggregate claims and the material economy must result in ‘value destruction’.
What emerges from these principles is the critically important concept of two economies.
One of these is the ‘financial economy’ of monetary claims, and the other is the ‘real economy’ of energy. This conceptual understanding is vital to a meaningful interpretation of economic and financial conditions, trends and prospects.
For so long as we persist with the time-honoured but fallacious notion of a material economy governed entirely by the immaterial artefact of money, we will continue to make costly mistakes, to cherish expectations which the economy cannot deliver, and to build dangerous risk into a financial system which is wholly predicated on the false assumption of ‘growth in perpetuity’.
ECoE and prosperity
As we have seen, ECoEs are the decisive arbiter of the material prosperity made available by the economy understood as an energy system.
For most of the time from its inception in the symbolic year of 1776, the industrial economy benefited from steady falls in ECoEs. These falls reflected the operation of three positive factors.
The first of these was an expansion in geographicreach, as pioneers scoured the world in search of lower-cost energy resources. The second was economies of scale, a product of the rapid expansion of the energy industries. The third was a steady improvement in the technology of energy extraction, processing and delivery.
The sparsity of data for earlier periods is such that we cannot know what ECoEs were in 1776, when James Watt completed the first truly efficient steam engine, starting the industrial era by enabling us to convert heat into work.
But we do know that ECoEs at that time were very high indeed. Energy operations were small in scale and limited in geographical range, whilst energy accessing technologies were in their infancy.
A long downwards trend then reduced ECoEs to a nadir at or below 1% during a post-1945 quarter-century remarkable for its rate of expansion in economic prosperity.
Latterly, though, ECoEs have turned upwards, largely because, with the benefits of reach and scale maximised, depletion has taken over as the primary driver of the ECoEs of fossil fuels. Depletion describes the way in which lowest-cost resources are used first, leaving costlier alternatives for a ‘later’ which has now arrived.
The overall development of trend ECoEs can be pictured as a stylised parabola, as illustrated in fig. 10 at the end of this report.
The contemporary situation, as shown in fig. 2, is that relentless rises in trend ECoEs are undermining prosperity through a dynamic that cannot be managed in any way by financial policies. Unlike money, low-cost energy can’t be loaned or printed into existence.
SEEDS analysis reveals that the prosperity of the average American has been declining since 2000, and has since (as of 2021) deteriorated by 8%. The ECoE of the United States at the prosperity inflexion-point in 2000 was 5.1% and, as a general observation, this is the approximate level of ECoEs at which prior growth in the prosperity of the Advanced Economies (AEs) of the West goes into reverse.
Emerging Market (EM) economies – by virtue of their lesser complexity, and their consequently lower maintenance demands – enjoy greater ECoE resilience, and prosperity per capita in China might not turn downwards until about 2027, by which time China’s trend ECoE is projected to have reached 13%.
This said, the rate of improvement in Chinese prosperity per capita has decelerated dramatically, and the anticipated increase between 2021 and 2027 is very small indeed (1.6%). The inflexion point calculated for China by SEEDS has moved successively nearer with each iteration of the model.
In some EM countries – including Mexico, South Africa, Argentina, Brazil, Chile and Indonesia – prosperity per person has already started to decrease.
Fig. 2
Globally, and over an extended period, deterioration in Western prosperity has largely been offset by continuing (though decelerating) progress in EM countries. Now, though, this ‘long plateau’ has ended, such that the prosperity of the world’s average person is heading downwards.
This is an accelerating trend, and the ‘average’ person worldwide is likely to be 7% poorer by 2030, and fully 21% less prosperous in 2040, than he or she was in 2019.
With the economy understood as an energy system, we can recognise that the growth momentum injected into the system by the harnessing of energy from fossil fuels has now faded to a point at which prior growth in material prosperity has gone into reverse.
An almost universal failure (and refusal) to recognise this process poses the greatest single threat to global prosperity, material security and stability, a threat comparable with – and directly linked to – energy-induced deterioration in the environmental and ecological well-being of the planet.
This can NOT be “fixed”
Thus far, very limited (and generally mistaken) acknowledgement of the economy’s energy challenge has met responses founded in wishful thinking and, to be frank about it, outright ignorance.
Current problems have been compared with the energy crises of the 1970s, when sharp rises in the price of oil triggered severe disruption, soaring inflation and a sharp slump in the economy.
In fact, any such comparisons are completely inappropriate. There was no material shortage of petroleum in the 1970s, and price rises were caused entirely by political developments – the Oil Embargo of 1973-74, and the Iranian Revolution of 1978-79 – which fractured the relationship between the major consumers and the major exporters of oil.
The reality is that, back in the 1970s, global all-sources ECoEs were between 1.3% and 1.8%, at which further growth remained eminently feasible, even in the highly complex Advanced Economies of the West.
Now, though, trend ECoEs are close to 10%, a level at which prior growth in prosperity must go into reverse, even in less complex, more ECoE-resilient EM countries.
Of the proposed solutions to energy and associated environmental issues, by far the most absurd is the idea that we can somehow “de-couple” economic prosperity from the use of energy. The case that has been made for “de-coupling” has rightly, and authoritatively, been described as “a haystack without a needle”.
Alternative energy sources offer a more realistic set of solutions, with most hope vested in the development of renewable energy sources (REs) such as wind and solar power. As the ECoEs of fossil fuels continue to rise, there is a compelling economic as well as environmental case for maximising the use of REs.
There is something close to an orthodox “narrative” which depicts REs as the assured driver of a new age of growth. This orthodoxy contends that indefinite continuation of past reductions in the costs of REs will provide a smooth transition to a new era in which ever-cheaper electricity will unite with new technologies to combine environmental sustainability with unlimited economic expansion.
Unfortunately, such expectations are informed by a fundamental fallacy, which is the mistaken assumption that REs can provide a complete quantitative and qualitative replacement for the economic value provided historically by fossil fuels.
This isn’t the case, not least because the material resources required for the expansion and maintenance of REs can only be supplied using the legacy energy from oil, gas and coal.
We do not have, and are most unlikely ever to have, a truly renewable system which obtains its necessary inputs (including steel, concrete, copper, cobalt and lithium) without recourse to fossil fuel energy.
It’s not even clear if these raw materials actually exist in the quantities needed for complete transition. Even if they do exist, the energy required to deploy them does not.
This resource connection necessarily ties the ECoEs of REs to those of fossil fuels. The ECoEs of renewables have fallen, from a high base, but we cannot use the ‘fool’s guideline’ of infinite extrapolation to conclude that energy from REs will become cheaper indefinitely.
Moreover, the technical efficiencies of these energy sources are already close to their theoretical maxima, as set for solar power by the Shockley-Queisser limit, and for wind turbines by Betz’s Law. Even the “green” credentials of renewables are subject to severe qualification.
Over-optimistic expectations for renewables are informed by a contemporary fascination with technology, an attitude which forgets that the potential of technology is bounded by the laws of physics.
In short, the only way in which involuntary contraction in material prosperity could be reversed would be by the discovery (and the rapid deployment) of sources of primary energy whose ECoEs are at or below 5%.
Those of renewables are unlikely ever to be lower than about 12%, and are likely to trend back upwards over time. Conventional nuclear power has an important role to play, as do hydroelectricity and, perhaps, geothermal energy. But none of these is remotely scalable to a point sufficient to replace the low-cost energy hitherto sourced from coal, oil and natural gas.
Even new discoveries (such as practicable nuclear fusion) may not be sufficiently scalable within the necessary time period to prevent a continuing deterioration in prosperity.
To be clear about this, it IS imperative that we maximise the development of renewables – to continue to tie the fortunes of the economy to the deteriorating dynamic of fossil fuels would be to invite, not just irreversible environmental deterioration, but economic ruin.
The mistake all too often made is the fallacious assumption that an RE-based economy somehow “must” be as big as, or bigger than, the fossil-based economy of today.
An understanding of the fallacy of this assumption reveals the distinction between a “sustainable economy”, which may and should be feasible, and the mantra of “sustainable growth”, which is impossible.
The mechanics of self-deception
As we have seen, the mistaken interpretation of the economy as entirely a financial system has fostered the delusion that economic growth can continue in perpetuity, and that “growth” is, in some mystical way, not just an inevitability, but an entitlement.
In reality, rising ECoEs started to undercut the scope for further growth during the 1990s, with trend ECoEs rising from 2.9% in 1990 to 4.2% in 2000. Though economic deceleration was noted – and labelled “secular stagnation” – it was not traced to its cause.
Rather, it was assumed that it must be possible to restore the supposed ‘normality’ of brisk growth by the use of financial policies.
The first of these innovations, known in SEE terminology as “credit adventurism”, was invoked from the mid-1990s, when credit was made easier to access than it had ever been before.
Between 1995 and 2007, whilst reported GDP expanded by 63%, global debt doubled, with each incremental dollar of GDP accompanied by $2.30 of net new debt.
Worse still, almost half of all the recorded “growth” of that period was the purely cosmetic effect of pouring additional liquidity into the system, and then counting the transactional use of that added liquidity as ‘activity’ for the purposes of measuring GDP.
It must be stressed that GDP is a measure, not of material prosperity, but of activity – a very important distinction that is seldom, if ever, made in conventional economic presentation. The ability to create activity without adding value has injected unproductive complexity at every level of the economy.
Divergence between debt and economic output, exacerbated both by asset price inflation and by failures of regulatory oversight, led directly to the crisis of 2008-09.
With grim predictability, the authorities then decided to compound prior mistakes with “monetary adventurism”, undertaken using supposedly “temporary” expedients such as QE and ZIRP.
These had the effect of boosting the expansion of financial claims which included, not just debt, but broader financial system “assets” (which are the liabilities of the government, business and household sectors), and the underfunding of pension commitments.
These responses to the GFC bought some time for the perpetuation of the status quo, but did so at enormous cost. The dangers of ‘moral hazard’ were disregarded, and the necessary linkage between risk and return was broken, whilst the essential process of creative destruction was stymied.
Perhaps worst of all, avowedly “emergency” innovations – which have since become permanent – invited us to operate a ‘capitalist’ economy without the essential pre-requisite of positive real (above inflation) returns on capital.
Quantifying self-delusion
The SEEDS model enables us to put these various processes into a value-referenced framework. Let’s start by analysing what happened between 1999 and 2019, the latter year chosen because it excludes the subsequent distortions created by the coronavirus crisis.
Unless otherwise noted, all global data produced by SEEDS and used here is expressed in international dollars, converted from other currencies using the more meaningful PPP (purchasing power parity) convention, and stated at constant 2021 values.
Between 1999 and 2019, recorded global GDP slightly more than doubled (+110%), increasing by $74 trillion. But debt increased by 180%, rising by $204tn, or $2.75 for each dollar of reported “growth”.
Moreover, we can estimate that this $204tn increase in debt was accompanied by a $275tn rise in other financial liabilities, and a worsening, probably of the order of $150tn, in the shortfall or “gap” in the adequacy of provision for future pensions.
Concentrating on debt alone, SEEDS calculates that “growth” in GDP, mathematically averaging 3.7% between 1999 and 2019, was made possible by borrowing that averaged 10.2% of GDP during that period (see fig. 3).
SEEDS calculates that, stripped of this ‘credit effect’, underlying or ‘clean’ economic output (C-GDP) increased by only $28tn, or 41%, over a period in which reported GDP increased by $74tn, or 110%.
This in turn means that fully 63% of all “growth” recorded between 1999 and 2019 was the cosmetic effect of pushing gargantuan quantities of credit into the system, thereby creating enormous forward excess claims whose elimination, through a process of ‘value destruction’, has now become inescapable.
If we were to include 2020 and 2021 in the calculation – and, as well as debt, to incorporate increases in other financial liabilities (such as those of the shadow banking system), plus worsening shortfalls in pension provision – we would find that each $1 of “growth” since 1999 has been fabricated using close to $10 of incremental forward commitments.
Fig. 3
Measuring prosperity
Underlying economic output, calibrated here as C-GDP, is not the same thing as prosperity, the difference between the two being the first call made on output by the Energy Cost of Energy.
Between 1999 and 2019, trend ECoEs rose from 4.1% to 8.7%. This means that a 41% rise in global aggregate output (C-GDP) translates into an increase of only 34% in aggregate prosperity.
Since world population numbers rose by more than 25% between those years, average prosperity per capita increased by only 6.6%, a far cry from the claimed improvement of 67% in GDP per capita. As of 2021, prosperity per capita was only 5.2% higher than it was back in 1999.
These global numbers disguise extremely divergent geographical experiences. In 2021, prosperity per capita in China was more than double (+276%) what it had been in 1999. But per capita prosperity has declined by 8% in the United States since 2000, and by 10% in Britain since 2004.
The typical pattern revealed by SEEDS modelling of 29 national economies shows that, after prosperity per capita has reached its inflexion-point, initial declines are gradual, but rates of deterioration accelerate thereafter. This worsening in the rate of deterioration reflects compounding processes that will be discussed later.
Prosperity inflexion-points occur later in EM countries than in Advanced Economies, but subsequent declines are more rapid in EM economies.
Essentials and the loss of discretion
To concentrate on top-line prosperity – whether per capita or in aggregate – would be to miss much of the point, because what really matters, where the economy and the circumstances of the individual are concerned, is the relationship between total prosperity and the cost of essentials. Many of these essentials are energy-intensive, meaning that their costs will carry on rising, even as prosperity itself erodes.
The difference between prosperity and the cost of essentials is known in SEE terminology as PXE (prosperity excluding essentials), and this is one of the most important calculations produced by the SEEDS economic model.
PXE is now in decline almost everywhere, even in countries where top-line prosperity has yet to reach its point of inflexion.
The SEEDS model defines “essentials” as the sum of two components. One of these is household necessities, and the other is public services provided by the government.
These services count as “essential” because the citizen has no day-to-day discretion (choice) about paying for them.
It should be noted that government spending falls into two broad categories. One of these is transfers, involving redistributive payments such as welfare benefits and pensions. These are not included in the SEEDS definition of essentials, because they net out to zero at the aggregate and at the average per capita levels.
The other category of government spending, which is incorporated in the “essentials” definition, is the direct provision of services, such as education, health care and defence.
The definition of a “necessity” varies both geographically and over time. Something which was regarded as a luxury in 1962 or 1992 may be regarded as a necessity in 2022. A product or service considered optional in a poor country may be seen as essential in a wealthier one.
The SEEDS calculation of essentials is thus, necessarily, an estimate, and it’s unlikely that a universal definition of “essential”, applicable irrespective of place and time, could ever be agreed (though the importance of the topic merits intensive examination).
What really matters, though, isn’t the precise definition of a necessity, but the trend in the real cost of the broad category of “essentials”. Many necessities – including water, food, shelter and the transport of people and products – are highly energy-intensive. Accordingly, the costs of essentials have carried on rising even as prosperity itself has gone into decline.
With prosperity eroding and the real costs of essentials rising, SEEDS analysis shows a process of rapid convergence, shown in per capita terms in fig. 4.
Fig. 4
As fig. 4 makes clear, SEEDS projections show an impending point of crossover at which the prosperity of the ‘average’ person falls below his or her cost of essentials.
Two important points should be noted about these projected intersections.
First, we can anticipate re-definition of the term “essential”, with some products and services, now deemed necessities, coming to be seen as discretionary.
This will apply, not just to household necessities, but to public services as well. An example of the former might (and probably will) be a decline in car ownership, and an increased reliance on public transport, within a general reduction in travel. Governments will face the unenviable task of deciding which public services can no longer be afforded.
Second, the projections shown in fig. 4 relate to the ‘average’ person. In practice, some people will retain the scope for discretionary consumption whilst an increasing number of the less fortunate will become unable to afford essentials, at least as these are currently defined.
PART TWO: PROJECTING THE FUTURE
In Part One of this report, we have looked at how the economy functions as an energy system, at the meaning and quantification of material prosperity, and at the shortcomings of an economic orthodoxy predicated on the false premise that the economy can be explained, managed – and propelled to infinite expansion – on the basis of money alone.
Turning to projections, there are two issues on which energy-based modelling can provide forward visibility in a way consistent with these fundamentals.
One of these is calibration of the relationship between the financial economy of money and credit and the real economy of goods, services, labour and energy.
This reveals a process trending towards a restoration of equilibrium between the two economies of money and energy. This points towards an inevitable, and very probably a disorderly, contraction, of the order of 40%, in the financial system understood, as it must be, as an aggregation of monetary claims on the material prosperity of today and tomorrow.
First, though, we look at trends in overall economic prosperity and its components.
In preference to a conventional approach which defines the economy as the government, business and household sectors, the SEE interpretation concentrates on three functional segments, which are the provision of necessities, capital investment in new and replacement productive capacity, and the consumption of discretionary (non-essential) goods and services.
As we shall see, general expectations of continuing expansion are based, not just on the false assumption of infinite growth, but also on extrapolation of a recent past mispresented by distorted presentation of historic trends.
In other words, consensus projections are based on the indefinite continuity of a past that simply didn’t happen in the way that convention says that it did.
We conclude that, just as material prosperity is trending downwards, the cost of essentials will continue to rise. This is creating compression effects to which businesses will respond along lines described in SEE as the taxonomy of de-growth.
A primary challenge for governments, meanwhile, will be management of the deteriorating affordability of public services, many of which form part of the essentials which the economy provides to its citizens.
Clarifying underlying trends
If you want to work out where you’re going, it’s rather important to have reliable information about where you’re starting from, and of how you got there.
In economic terms, this is information that orthodox methods cannot provide.
In search of underlying reality, we’ll look at developments between 1999 and 2021, a period which loosely coincides with the prolonged precursor zone preceding the onset of involuntary economic contraction.
Official data says that global real (constant value) economic output, measured as GDP, increased by 116% between 1999 ($68 trillion PPP) and 2021 ($146tn). If these numbers were accurate, they would mean that the world’s average person was 69% better off in 2021 than he or she had been back in 1999.
On this basis, we’re asked to accept that, since the economy expanded at a compound annual rate of around 3.5% (real) between 1999 and 2021, something similar can be relied upon in the future, once the pandemic, and the crisis in Ukraine, are behind us.
It should come as no surprise at all, then, that the long-range consensus is based on rates of growth of between 3.3% and 3.5%, which confirms the prevalence of extrapolation from misunderstood recent history.
As we’ve seen, this interpretation of past trends ignores the fact that GDP, as a measure of activity rather than value, has been inflated, artificially and dramatically, by rapid expansions in debt and other financial commitments. The average person’s share of GDP may have increased by 69% between 1999 and 2021, but his or her share of total debt far more than doubled – rising by 148% – over that period.
The conventional calculation also takes no account of a dramatic rise in trend ECoEs, from 4.1% in 1999 to a growth-crushing 9.4% in 2021.
On an underlying basis which incorporates these critical issues, the SEEDS model shows that global aggregate prosperity increased by only 35% (rather than 116%) between 1999 and 2021. This means that the world’s average person became better off by just 5.2% (rather than the claimed 69%) between those years.
SEEDS analysis informs us that annual growth in prosperity averaged only 1.3% (rather than 3.5%) during that period.
From a forecasting perspective, this enables us to produce two sets of calculations.
One of these, as mentioned earlier, is a calibration of the relationship between the real economy and the financial system.
The other is the ability to revise past trends onto a basis which provides a realistic rather than an optimistically-distorted historic foundation for forward projection.
RRCI – re-basing to prosperity
It should be understood that revising historic numbers is a routine process in economics.
For instance, global GDP rose from a reported $47tn (PPP) in 1999 to $146tn in 2021.
Everyone knows that this nominal increase (of 210%) is misleading, because it ignores inflation. Accordingly, the GDP deflator is applied, revising the 1999 number to $68tn, enabling ‘real’ growth since then to be calculated at 116%.
Since GDP and its component parts are the generally-accepted basis for forecasts, projections produced by SEEDS need to start with the most recent GDP number, however misleading we know it to be.
This does not, though, mean that we need swallow the mythical growth figures – such as the supposed more-than-doubling of the real size of the world economy between 1999 and 2021 – when we know that the increase in underlying prosperity was only 35%.
Accordingly, we need to restate past nominal numbers on the basis of a more realistic assessment of systemic inflation, replacing the GDP deflator with a more meaningful measure of price changes over time.
This alternative measure is known in SEEDS terminology as the Realised Rate of Comprehensive Inflation (RRCI).
Global systemic inflation between 1999 and 2021, measured as the annual GDP deflator, is reported at 1.7%. Applied to an annual rate of increase of 5.3% in nominal GDP, this produces a reported rate of real “growth” of just under 3.6%, compounding to 116% over the period as a whole.
As we’ve seen, though, we know that the expansion in prosperity between those years was only 35%, an annual compound rate of increase of less than 1.4%.
If we accept – for forecasting purposes – the reported rate of growth in nominal (“money of the day”) activity of 5.3%, recognition that prosperity increased at a compound rate of only 1.36% (rather than 3.6%) reveals that the required compound deflator isn’t 1.7%, but 3.87%.
Globally, these RRCI calculations reveal that the purchasing power of money declined, not by the reported 30%, but by 57%, between 1999 and 2021.
This restatement is consistent, not just with what we might call ‘everyday experience’, but also with the known shortcomings of orthodox inflation calculations.
For a start, we know that the preferred measure of headline inflation – the Consumer Prices Index – has, since the 1990s, been affected (and reduced) by innovations such as substitution, hedonic adjustment and geometric weighting. Studies based on the application of earlier techniques consistently reveal sizeable understatements in the contemporary presentation of consumer inflation.
Moreover, and as its name indicates, CPI measures only inflation as it is experienced by the consumer, thus excluding many other important metrics, one of which is the inflation in the prices of assets, including stocks, bonds and property.
Asset price inflation most emphatically IS relevant to the overall situation, and not just because of its importance to the relationship between a (generally older) demographic which already owns assets, and a (generally younger) group which aspires to acquire them.
A gamut of transactions in the financial system is linked directly to the prices of assets.
The GDP deflator is supposed to overcome some of these shortcomings through the use of chain-linked measures of volume.
But a large part of the economy – most obviously, financial activities such as banking and insurance – simply cannot be measured volumetrically. We can’t, for practical purposes, meaningfully measure activity in financial services in volume terms, simply by counting the numbers of bank statements provided and insurance certificates issued.
Trend reality
The application of RRCI re-basing to economic data is illustrated in fig. 5.
As mentioned earlier, instead of the usual practice of dividing the economy into sectors (government, businesses and households), these charts depict the world economy in the form of segments, which are essentials, discretionary (non-essential) consumption, and investment in new and replacement productive capacity.
In fig. 5, world economic output for 2021 is stated in all three charts at $146tn (PPP), the reported number for that year. In nominal terms, this reflected an increase of 210% since 1999, when current (“money of the day”) GDP was $47tn.
Application of the GDP deflator raises the 1999 number to $68tn at 2021 values, implying subsequent real “growth” of 116%.
On an RRCI, prosperity-referenced basis, however, the 1999 figure rises, not to $68tn, but to $109tn, reducing subsequent expansion to 35%.
The left-hand and central charts project the situation out to 2027 when, according to the consensus, real GDP is expected to have increased by about 22%. This – as we have noted, and as the middle chart reveals – amounts to extrapolation along the lines of the supposed “trend” rate of growth in recent times.
In the right-hand chart, SEEDS data is used to extend the forecasting period out to 2040, by which time economic output is projected to be lower (by 9%) than it was in 2021.
These, of course, are aggregate numbers, which take no account of increases in population numbers. These rose from 6.0 billion in 1999 to 7.7bn in 2021, and may reach a figure just short of 8.9bn by 2040. On this basis, prosperity per capita is projected by SEEDS to be 21% lower in 2040 than it was in 2021.
Fig. 5
Scoping the future
In fig. 6, SEEDS analysis is used to compare two versions of economic output for the global, American and British economies. In each case, reported 2021 GDP is accepted as a common start-point, even though we know that this is a ‘financial economy’ data-point which is at variance with the underlying ‘real economy’.
In each case¸ the RRCI-based SEEDS trend-line, shown in blue, starts from higher historical levels than those shown in the official ‘real’ equivalent shown in black. It readily becomes apparent that the consensus¸ framed as a continuation of the supposed past, extrapolates from a history that didn’t actually happen.
If you believe, for example, that the American economy had, prior to 2020, been expanding at an annual trend real rate of 2.1%, there’s a superficial basis for believing that it will carry on growing at much the same supposed rate, such that GDP will be 13% higher in 2027 than it was in 2021.
The underlying situation, though, is that American prosperity actually expanded at only 0.5% annually between 1999 and 2019, and that even this slow rate of increase has been decelerating.
The British situation is even less robust, with reported trend growth (of 1.8%) between 1999 and 2021 falling to just 0.3% on an underlying basis.
In both countries, underlying rates of growth in prosperity have, over a lengthy period, been lower than the trend increase in population, which expanded by 0.8% annually in the United States, and by 0.7% annually in the United Kingdom, between 1999 and 2021.
This leads us to an observational conclusion, which is that, if the average or ‘ordinary’ person in most Western countries thinks that he or she has been getting poorer (as well as more indebted) in recent times – rather than more prosperous, as asserted by the official view – the strong probability is that his or her perception is correct.
Fig. 6
It would be hard to over-state the significance of this interpretation, but it becomes of even greater importance when we recognise two other underlying realities.
The first is that divergence between the ‘real’ and the ‘financial’ economies has now reached a point at which even the myth of continuing growth has become untenable.
Mistaken presentation of past trends contributes to an unjustified confidence in the ability of the economy to carry – and, in due course, to honour – its gargantuan financial commitments.
The taxonomy of contraction
The second is that, whilst trends in prosperity per capita have adopted (or, in some economies, are soon to adopt) a trajectory of decline, the real cost of essentials is continuing to rise.
Using methodologies described earlier, fig. 7 sets out economic projections for America, Britain and South Korea, subdivided into essentials, investment in new and replacement productive capacity, and the affordability of discretionary consumption.
It should be stressed that each chart presents aggregates, and that adverse trends are more pronounced at the per capita level. It should also be emphasised that the projections for other countries follow broadly similar patterns.
In each instance¸ prosperity is trending downwards. Even aggregate prosperity is now at the point of inflexion in the United States, whilst the rate of decline in Britain has become relentless.
Likewise, the real costs of essentials are trending upwards.
Together, these processes are compressing both investment capability and discretionary affordability, which are the residuals in the equation.
Stated at constant 2021 values, PXE – the residual difference between prosperity and essentials – is, by 2030, projected to be 14% lower in South Korea, 22% lower in America and 28% lower in Britain than it was in 2021.
Fig. 7
PXE is an indicator of the scope that exists for discretionary consumption and capital investment over time, and it should be said at once that neither of these segments can continue to be propped artificially by credit and monetary subsidy, as has been the case in the past.
This in turn means that, although the entire economy is exposed to the consequences of involuntary contraction, sectors supplying non-essential goods and services will be in the eye of the storm.
It would not be appropriate to specify activities or sectors here. The operative principle, though, can be likened to a household in which decreasing resources, and the rising costs of essentials, compel a reduction in discretionary purchasing.
Of course, no enterprise – whether it supplies discretionaries or essentials – can be expected simply to sit back and let this happen. Beyond general considerations of rising costs and decreasing revenues, there are two particular issues with which businesses will have to grapple.
One of these is a decline in utilization rates – as sales volumes decrease, fixed costs need to be spread across a diminishing number of customers. Passing on these rises in unit costs is likely to result in price increases which exacerbate the rate at which customers and revenues are lost.
The second is a loss of critical mass. As suppliers fail, or reduce the range of goods and services which they offer, a widening range of necessary inputs will either rise in price, or cease to be available at all.
Together, these two processes can be expected to worsen the rate at which economic prosperity declines. These compounding factors help explain why deterioration in prosperity is an accelerating process.
For businesses, the obvious response is simplification, both of product ranges and of supply processes. This will lead to de-layering, as some stages in the production process are eliminated altogether, or are reduced in scale to the point at which they are rendered uneconomic.
What we’re describing here is a process of de-complexification. As the industrial economy expanded, it also became progressively more complex, introducing wholly new activities, many of them very large, which did not exist in the earlier, smaller and less complex economy.
Together, decreasing utilization rates, loss of critical mass, simplification, de-layering and de-complexification form what is known in SEE terminology as the taxonomy of de-growth, though ‘contraction’ might be a more appropriate term than ‘de-growth’ for the description of trends which are part of an involuntary reduction in the scale and complexity of economic activity.
Financial contraction
With two vital concepts understood – the two economies, and the role of money as claim – it becomes apparent that rapid (and very probably disorderly) contraction is to be anticipated in the financial system.
There are many sectors in which the confidence of investors and lenders could very rapidly ebb away.
Calibration of these trends relies on two calculations. One of these is percentage exposure, meaning the gap that divides the ‘financial economy’ of money from the ‘real’ economy of energy, goods and services.
The widening of this gap has already progressed far enough to trigger a sharp and systemic upturn in inflation, a process which largely precludes any continuation of that reliance on “stimulus” which has characterised economic crisis-management over a remarkably prolonged period.
Whilst raising rates might not tame inflation – and perhaps nothing can – central bank inaction, allowing real rates to go ever deeper into negative territory, might not be tenable either.
It is not the purpose of this report to draw detailed comparisons between economies, but fig. 8 illustrates that percentage exposure is frighteningly larger in China (-54%), and markedly smaller in Italy (-10%), than in the United States (-32%), or in the world economy as a whole (-40%).
Fig. 8
In any case, percentage downside is really meaningful only when applied to the proportionate size of the financial system which – within the principle of ‘money as claim’ – needs to be understood in terms of liabilities.
Globally, and stated at constant 2021 values, debt has soared from $113tn (PPP) in 1999 to a provisional $360tn at the end of 2021. Though the ratio of debt-to-GDP has risen to ‘only’ 240% now (from 166% in 1999), the way in which increases in debt inflate activity reported as GDP means that a linkage between numerator and denominator results in a progressive understatement of this oft-cited ratio.
Referenced to prosperity rather than GDP, the debt ratio today rises to over 400%, compared with a similarly-calibrated 175% back in 1999.
Much the same applies to financial assets, which are the counterpart of liabilities in the government, corporate and household sectors of the economy. On the basis of data available for countries accounting for about three-quarters of the world economy, we can estimate that these liabilities, which include those of the shadow banking system, may now equate to at least 930% of prosperity (and about 550% of GDP), compared with 440% of prosperity in 2002.
Inadequacies (“gaps”) in pension provision are harder to calculate, but available data suggests that these might now have risen to about 3x global prosperity, a sharp increase powered, at least in part, by policy-induced crushing of returns on invested capital.
Within the charts shown in fig. 9, it must be understood that we have only limited data on financial assets globally, and still less on the inadequacy of pension provision. The latter, in any case, tends to be referenced, not to firm commitments, but to general expectations, with global pension provision tending to be financed from government revenues rather than from funded provision.
Even so, we can conclude that, following a prolonged period in which forward claims have been increased exponentially in order to sustain a cosmetic simulacrum of “growth”, systemic risk has become enormous within an economy increasingly dependent on, and addicted to, a continuity of breakneck expansion of financial commitments, commitments which might have become impossible to honour ‘for value’ even if the material prosperity of the global economy hadn’t ceased growing, and started to contract.
Fig. 9
PART THREE: CONCLUSIONS
It’s been well said that people have a strong inclination towards believing what they want to believe.
Even so, the extent of contemporary misunderstanding about our true economic and financial predicament can only be described as staggering.
The consensus view remains that current problems combine the lasting effects of the coronavirus crisis with the more recent stresses created by the war in Ukraine. The assumption, seemingly shared at all levels of opinion, is that, as and when these disruptions recede into history, “growth” will return, inflation will fall back to pre-crisis levels, and there need be no re-run of the financial crisis of 2008-09.
This consensus “narrative” is based on at least three critical misconceptions.
The first of these misconceptions is that “growth” can be maintained indefinitely in the future, as it supposedly has been in the past, through the operation of financial policies.
This view not only exemplifies the fallacious orthodoxy that the economy is entirely a financial system, but further ignores the reality of a recent past in which the simulacrum of “growth” has been manufactured by the relentless creation of forward commitments which cannot possibly be honoured ‘for value’.
The second misconception is that we can make a seamless transition from fossil fuels to renewable sources of energy without impairing the performance of the economy. Whilst imperative in environmental terms, this transition cannot replace the economic value hitherto provided by oil, gas and coal. The material resources to accomplish this transition, where they exist at all, can only be provided courtesy of legacy energy from fossil fuels.
Informing both of these is a third misconception which rests on remarkably over-sanguine expectations for technology. Ultimately, the scope of technology is bounded by the limits of physics in general, and thermodynamics in particular.
When we see past these misconceptions, what emerges is an economy poised for severe contraction because of (a) the depletion of the low-cost fossil fuel energy which has powered the industrial sage, (b) the absence of any plausible replacement for this low-ECoE energy, and (c) the sheer idiocy of the idea that we can somehow “de-couple” economic prosperity from the supply, value and cost of energy.
This gap between reality and misconception poses enormous risks for a financial system which has created gargantuan ‘forward claims’ that cannot possibly be delivered. These excess claims will have to be repudiated, through default, through runaway inflation, or a combination of both. This inevitable process of disorderly downside on the claims side of the equation has obvious implications for asset prices which have been inflated, often to the point of absurdity, through a period of ultimately-futile policy gimmickry.
Based on the same misconceptions which distort collective understanding of the economy and the financial system, it is widely assumed that existing political and social arrangements, and the intellectual dogmas that support them, will evolve only very gradually from where they are today.
We have reasonable grounds for concluding that this consensus view is shared by leadership cadres in government, business and finance. Whilst it is fashionable to question the candour of politicians, we can state with confidence that, if business bosses and investors really did have serious doubts about the validity of the consensus “narrative”, these doubts would already have become apparent, not least in corporate strategies and, most obviously, in the markets.
What we cannot calculate is the moment at which reality displaces all of these fondly-cherished delusions, economic, financial and political. A purely personal view – and an admittedly somewhat subjective one – is that we are now very close indeed to the moment at which the myth of perpetual growth succumbs to the hard facts of an economy heading into contraction; a financial system, built on false predicates, trips into a crisis of disorderly downsizing; and the public demands pragmatic responses to challenges which its leaders, perhaps in all good faith, have hitherto refused even to acknowledge.
Surplus Energy Economics 