#231. Short and sharp

A SYNOPSIS OF DETERIORATION AND RISK

Might we very soon face a major financial crisis, at a scale exceeding that of 2008-09?

Are we heading for a global economic slump, or can current problems be explained away in terms of ‘non-recurring events’, such as the war in Ukraine?

Do the authorities have the tools and the understanding required to navigate the current economic storm? And what is the outlook for inflation?

These are valid questions, and I’m well aware that, whilst many visitors to this site are interested in economic principles, theory and detail, others prefer succinct statements of situations and prospects.

That’s understandable – these are deeply worrying times.

The aim with what follows is to (a) set out a brief summary of the economic and financial outlook, as seen through the prism of the SEEDS economic model, followed by (b) a succinct commentary on how these conclusions are reached.

Accordingly, what we might infer from these conditions is left for another day. Like me, you will have your own views on the political and other implications of what’s going on and what is to be expected, but the plan with this discussion is to stick to a strictly objective analysis of economic and financial conditions and prospects.

Data used here by way of illustration is a ‘top-line’ summary at the global level. We might, at a later date, look at some of this material in greater detail, and examine the circumstances of some of the 29 national economies modelled by SEEDS.

Where both the theoretical and the ‘succinctly-practical’ are concerned, urgency is being increased by what we can only call the ‘uncertainties and fears’ generated by current conditions.

In economic and financial terms, it’s becoming ever more obvious, not just that ‘things aren’t going according to plan’, but that decision-makers don’t have replacements for the tools and assumptions that have failed.

What’s clear now is that the shortcomings of money-based economic orthodoxy are becoming ever more apparent, evidenced principally by the failure of policies based on this orthodoxy.

The authorities have tried pretty much everything in the conventional play-book – plus quite a few ventures into the dangerously unconventional – and none of it has worked.

To use the contemporary term, this is a “narrative” of failure that starts with “secular stagnation” in the 1990s, and arrives – as of today – at the very real prospect of “stagflation”.

Where failure is concerned, the combination of high inflation and deteriorating prosperity is about as comprehensive – and as damning – as it gets.

Not too many years ago, the concept of the economy as an energy system might have been deemed a pretty radical ‘challenger theory’ to an established orthodoxy which insists that the study of economics is coterminous with the study of money.

Now, though, the case for the energy interpretation is gaining strength as the credibility of the prior orthodoxy is being eroded away by failure, albeit in a World that still refuses to acknowledge the inadequacies of conventional nostrums.

There are, of course, many different versions of the energy-economy interpretation, with differences of method and emphasis leading to differences of conclusions.

The main focus of effort here at Surplus Energy Economics has been on modelling the economy on an energy rather than a financial basis.

Modelling imposes a certain degree of caution, in that our conclusions should not be allowed to out-run what our models can tell us.

Inferences, of course, are a very different matter.

The outlook in brief

What, then, – and on the basis of what we know – should we now expect?

First and foremost, we can anticipate continuing declines in prosperity, with much the same deterioration already evident in the West now extending to those EM (emerging market) countries in which growth has, until quite recently, remained feasible.

This rate of deterioration can be expected to accelerate. The World’s average person is projected to be 6% poorer in 2030, but fully 21% less prosperous by 2040, than he or she was in 2021.

Meanwhile, the real costs of essentials will continue to rise, pointing towards a rapid contraction in the affordability of those discretionary (non-essential) goods and services which consumers ‘may want, but do not need’.

In real terms, discretionary consumption worldwide is likely to be 14% lower in 2030, and 52% lower in 2040, than it was last year.

Inflation has been driven higher by the rising costs of essentials but, looking ahead, is likely to be contained, to some extent, by deflationary trends in discretionary sectors.

The measure preferred here – which is RRCI, or the Realised Rate of Comprehensive Inflation – forecasts systemic inflation rising from 8.1% in 2021 to 8.6% this year, moderating to 5.3% by 2027.

These forecasts are summarised in fig. 1.

Fig. 1

Finally, in this brief list of projections, we can anticipate major financial dislocation, probably far more severe than the global financial crisis (GFC) of 2008-09. No attempt is made here to put a timescale on this, but it seems very unlikely that it can be long delayed.

The fundamental driver of this dislocation will be a dawning realization that the promises and assumptions incorporated both in asset prices and in forward commitments cannot be met by an economy that is not conforming to the consensus and official narrative of ‘growth in perpetuity’.

Along with this will go an invalidation of excuses and a discrediting of promises.

The public will cease to accept assertions that ‘everything would have been fine if it hadn’t been for’ the latest explanation du jour, which might be “the after-effects of the coronavirus crisis”, or “the war in Ukraine”, or “the dog ate my homework”, or whatever the next excuse might turn out to be.

At the same time, the public might come to realize that we cannot, for example, look forward, as promised, to ever-growing prosperity powered by ‘cheap’ renewables and the magic of technology.

The basis of projection

The foregoing has been intended for those who want a succinct statement of the outlook. You might wish to know how we arrive at forecasts which run directly contrary, both to the ‘official’ and the ‘consensus’ picture of the future.

If you’ve been visiting this site for any length of time, you’ll know the core principles on which the Surplus Energy Economics interpretation is based.

First, and in brief, we know that the economy is an energy system, because nothing that has any economic value whatsoever can be supplied without the use of energy.

We further know that energy is never ‘free’, and that, whenever energy is accessed for our use, a proportion of that energy is always consumed in the access process. This ‘consumed in access’ component is known here as the Energy Cost of Energy (ECoE).

The third core principle is that money, having no intrinsic worth, commands value only as a ‘claim’ on the material prosperity created by the use of energy.

It follows that we need to think conceptually in terms of ‘two economies’ – a ‘real’ or material economy of goods and services, and a ‘financial’, ‘proxy’ or claims economy of money and credit.

By measuring prosperity, the SEEDS model enables us to do two main things.

The first is to compare the real and the financial economies, calibrating the relationship between monetary claims and material substance.

Since, by definition, claims that cannot be honoured by the real economy must be eliminated, this indicates the extent of downside that must come into effect through a dynamic of returning equilibrium.

Second, we can use calibrations of changes in prosperity over time to restate prior trends as the basis for forward projection. Even if – for forecasting purposes – we accept nominal GDP (of $146 trillion) in 2021, as a baseline for projections, we don’t remotely need to accept a narrative that purports to explain, in glowing terms, how this number got to where it is.

It’s clear that a large proportion of prior “growth” has been a cosmetic property of stimulus, remembering that stimulus does increase the transactional (‘claims’) activity recorded as GDP, but doesn’t correspondingly increase the underlying value measured here as prosperity.

By restating past trends on realistic, prosperity-referenced lines – and by applying our knowledge of forward trends in prosperity – we are able to interpret past, present and future in a way that tells us a great deal about the prospects for the three critical segments of the economy.

These are the supply of essentials, the capability for investment in new and replacement productive capacity, and the affordability of discretionary goods and services.  

Three main conclusions emerge from this analytical approach.

First, and as shown in the left-hand chart in fig. 2, there has been a marked divergence between the real and the financial economies, a divergence that can be calculated, globally, at 40%. This gives us, in outline terms, a proportionate measure of the downside in the financial system.

Second, the aggregates of financial claims have increased enormously during a long period in which we’ve been trying – and failing – to use financial stimulus to boost material prosperity.

The application of the proportionate imbalance shown in the left-hand chart to the quantitative exposure shown in the middle chart reveals the truly enormous downside risk embodied in the financial system.

This is risk which we might be able to manage – but not if we continue to think of financial stimulus as a means to unattainable material objectives.  

Third, we can calibrate the relationship between prosperity – expressed in per capita terms in the right-hand chart – and trend ECoE.

Given the extreme improbability of ECoEs reversing their established upwards trend – and the virtual inevitability of continuing increases – further deterioration in prosperity becomes pretty much a certainty.

The rate of economic deterioration can be expected to worsen in accordance with systemic trends, including loss of critical mass (where essential inputs either cease to be available, or become prohibitively expensive), and adverse utilization effects (where unit costs rise as volumes contract).  

Again, deteriorating prosperity is a trend that we might be able to manage. But this will not be possible if, though a combination of wishful-thinking and adherence to orthodox nostrums, we remain in deep denial about its reality.    

Fig. 2