#252: Hardest months, strangest years

THE ANATOMY OF AN UNFOLDING CRISIS

Try as I might, I’ve never quite understood why T.S. Eliot picked on April as “the cruellest month”. In the northern hemisphere, winter is receding into memory by the time that April arrives, whilst spring sees nature getting back into its stride, with May and June, perhaps my favourite months, just around the corner.

April might not, then, be the cruellest month but, for me, it’s almost always the busiest. April is when we get a raft of new economic data, including final outcomes for a lot of prior year metrics, and all of this has to be incorporated into the SEEDS system.

From next month, 2022 replaces 2021 as the base year, meaning that constant financial data is expressed at 2022 values. This conversion of past numbers into their current equivalents requires application of the global GDP deflator, a series which, to the best of my knowledge, isn’t actually published anywhere. It should be noted, in passing, that there are two versions of the global deflator, depending on whether we’re converting other currencies into dollars at market or PPP (purchasing power parity) rates of exchange.

With apologies to those who already know this, SEEDS – the Surplus Energy Economics Data System – is a proprietary economic model built on the understanding that the economy is an energy system, and is not, as we are so routinely informed, entirely a matter of money.

With each year’s iteration, I try to improve the model, and the next version – ‘SEEDS 24A’, as it will be known – will incorporate more detail in two areas, which are broad financial liabilities, and the SEEDS-based RRCI (Realised Rate of Comprehensive Inflation) measure of systemic inflation.

Both are of obvious importance right now. The authorities are trying to tackle inflation without, in my opinion, having a system-wide measure of what it actually is, whilst the stability of the financial system going forward depends, not so much on ‘banks’ as such, but on the broader interconnected network of commitments. Expressed in market dollars, the aggregate of debts owed to banks by private (household and business) borrowers is just over US$90 trillion, but SEEDS estimates put global non-government liabilities at close to US$500tn.

For context, even in the wildly implausible event of all of the world’s central bankers getting together and agreeing to double their assets, the new funds thus created would cover less than 10% of broad private sector exposure.

Development of the SEEDS model began almost ten years ago, following the creation of the Surplus Energy Economics site and the publication of Life After Growth. Work on the latter persuaded me that, if the economy is indeed an energy system, there’s not much point in modelling it as though the only thing that matters in economics is money. The aim was to find out whether it was possible to model the economy on the basis of energy principles.

The strangest years

These, as you will know, have been strange years in economic and financial terms, though the period of strangeness stretches back a lot further than 2013. I hope that some reflections on this might assist our discussion of where things are likely to go next.

I like to begin the ‘narrative of the strangest years’ back in the 1990s. This, as many readers will remember, was the time when the USSR had collapsed, and satellite countries were in the process of leaving the Soviet system, variously known as COMECON and the Warsaw Pact.

For Western leaders, and indeed for their citizens, this seemed an era full of promise. The failure of Soviet collectivism appeared, by default, to have vindicated the superior merits of the market capitalist system. Western governments could anticipate a “peace dividend” from the ending of the Cold War. In the early 1990s, economies seemed set to benefit from ‘the great moderation’, a favourable combination of solid growth and low inflation. People were beginning to debate climate issues, but the threat of what was then known as “global warming” was a cloud that seemed, at that time, ‘little bigger than a man’s hand’.

If you recall this era, and concur with the foregoing description of it, you might be minded to wonder ‘where did it all go wrong?’ It’s fair to characterise our current time as one of extreme financial instability and, for millions, of worsening economic hardship. In stark contrast with the quarter-century after the Second World War, we have been witnessing a relentless widening in the gap between the wealth and incomes of the majority and those of an affluent elite.

There are all sorts of explanations for why so little of the promise of 1993 seems to have been realised in 2023, but only one interpretation really fits the facts. This interpretation is that the era of dramatic economic growth created by accessing coal, oil and natural gas has been drawing to a close.

This has happened in a gradual but relentless way, spanning a quarter-century precursor zone that has seen economic deceleration give way to stagnation, and stagnation succeeded by contraction. The SEEDS model indicates that average global prosperity per person turned down after 2019, and that world aggregate prosperity may have peaked in 2022.

Comparatively few people doubt that reliance on carbon energy has, at the very least, contributed to our environmental and ecological predicament, but it seems to me that fewer still are aware of the effect that the deteriorating economics of fossil fuels have been having on the economy and the financial system.

The effect of energy deterioration can best be expressed using a metric that is known here as the Energy Cost of Energy. Whenever energy is accessed for our use, some of this energy is always consumed in the access process. Within any given quantity of available energy, a rise in ECoEs reduces the remaining ‘surplus’ energy that’s available for any other economic purpose.

Throughout the fossil fuel era, we have always used lowest-cost resources first, saving costlier alternatives for later. The resulting process of depletion has been pushing up ECoEs, and this trend started to affect economic performance during the 1990s, with global trend ECoE from all sources of energy rising from 2.9% in 1990 to 4.2% in 2000.

What this meant was that growth in the material economy decelerated because of a factor, ECoE, which was and is neither recognized nor accepted by conventional economic theory. Fallacious (monetary) diagnosis has led to a succession of mistaken policy responses, starting in the 1990s with ‘credit adventurism’, when it became easier to access new debt than at any time in modern history. This led to the GFC (global financial crisis) of 2008-09, to which we responded with the ‘monetary adventurism’ of QE, ZIRP and NIRP.

Parallel sequences

This much regular readers will know, but what matters here is the equation of two parallel sequences. On the one hand, growth in material prosperity has decelerated, and then stagnated, before going into reverse. On the other, our ever more fallacious attempts to fix a material problem with monetary innovation has driven a widening wedge between the ‘real’ economy of products and services and the ‘financial’ or proxy economy of money and credit.

Once this is understood, past trends start to take on the character of a logical progression, and the future becomes both clearer and more daunting. The material economy will continue to deteriorate, and the ever-widening gap between the material and the financial will fracture the latter.

To be clear, the material economy cannot be compelled to accord with the monetary one – low-cost energy can’t be loaned into existence by the banking system, or created out of the ether by central bankers. Management of the financial system involves a choice between flexing with the real economy, or holding out rigidly against it to the point of fracture.

The course of events since the GFC illustrates our collective pursuit of the wrong choice. Ultra-cheap money was adopted in extremis, and its effects were, of necessity, inflationary. Advocates of QE have long denied that money creation causes inflation, but this stance is only tenable if we disregard sharp rises in the prices of assets, and we’ve been asked to believe that low inflation is consistent with the creation of an “everything bubble” in asset markets.

Inflation made the transition from assets to consumer purchases when, during the pandemic lockdowns, QE ceased to be channelled to investors alone, but was directed to households as well. The concept of systemic inflation, measured by SEEDS as RRCI, shows that inflation has been far higher than the reported headline numbers throughout the ‘free money’ era – and, of course, if we recalibrate inflation to levels which turn out to have been higher, the extent of negativity in real interest rates becomes still more pronounced.

Central banks have received a lot of criticism for raising rates, and reversing QE into QT, in  an effort to tame inflation. In fact, such criticism would be far better directed at the long period during which rates were kept below inflation. Anyone who favours market capitalism knows that this system cannot co-exist healthily with negative real rates, because capitalism absolutely requires that the investor earns positive returns on his or her capital.

The central bankers now find themselves in a situation which even they must recognise as being contradictory. On the one hand, they are reversing past money creation (QT) in an effort to bring inflation under control. On the other, they face the probability of having to create a great deal of new liquidity (QE) to backstop troubled parts of the banking and broader credit system. As we’ve seen, the assets of the entire global central banking system equate to less than 10% of world non-government financial liabilities.

Laying it on the line

The best way to try to make sense of all this is to ‘cut to the chase’, and here is how I suggest that we do so. Ultimately, the system of interconnected liabilities that we call ‘the financial system’ is viable if, and only if, household and business borrowers can honour their commitments. The banking and broader financial system wouldn’t be in trouble if, around the world, households were enjoying robust and improving prosperity, and businesses were enjoying high and rising profitability. This, of course, is the opposite of what households and businesses are experiencing now.

This means that effective interpretation requires an assessment of discretionary prosperity, meaning the resources left to consumers after the costs of necessities have been deducted from top-line prosperity. The situation on this metric is that, whilst prosperity is deteriorating, the real costs of energy-intensive necessities are rising.

This tells us two things. The first is that the affordability of discretionary products and services is declining, and the second is that the household sector will find it ever harder to ‘keep up the payments’ on everything from secured and unsecured credit to subscriptions and staged-payment purchases.

This analysis tells us that a large and growing swathe of discretionary sector businesses are under worsening pressure, and that the decline in the value of these sectors will be exacerbated by falling prices in other asset classes, most obviously commercial and residential property.

Perhaps the ultimate ‘statement of the blindingly obvious’ is that the financial system can remain viable only if (a) borrowers are able to meet their commitments, and if (b) the values of assets used as collateral for these obligations do not suffer significant impairment. Where this is not the case, the alternative outcomes are default, on the one hand, and, on the other, hyperinflationary destruction of liabilities.

Inflation has been called a “hard drug”, because it’s an easy habit for an economy to get into, and a hard habit to break. Whatever the sincerity of their current commitment to tackling the inflation caused by their earlier recklessness, central bankers are going to find it very hard indeed to say ‘no’ when pressed to create yet more new money to head off yet more crises.

These are issues to which I’m certain we’ll return. You will, I hope, allow me to say that none of these issues can be assessed effectively, let alone tackled successfully, unless we have a logical and quantified system of interpretation and projection.

#251: The Everything Crisis

THE ANATOMY OF A SUPER-BUST

Introduction

Even the most cursory glance at economic and financial history will reveal a litany of bubbles and booms, crashes and crises. We’ve seen numerous instances of speculative manias, real estate bubbles, market collapses and banking crises. Even the dot-com bubble of 1995-2000 wasn’t really ‘a first’, since there’s at least one previous instance – the Railway Mania of the 1840s – of the public being blinded to reality by the glittering allure of the latest vogue in technology.

You’d be wrong, though, if you concluded that “there’s nothing new under the Sun” about what we’re experiencing now. The coming crunch – for which the best shorthand term might be ‘the everything crisis’ – sets new precedents in at least two ways.

First, it’s unusual for all of the various forms of financial crises to happen at the same time. Even the global financial crisis (GFC) of 2008-09 wasn’t an ‘everything crisis’. Now, though, it’s quite possible that we’re experiencing the start of a combined stock, property, banking, financial, economic and technological crisis, with ‘everything happening at once’.

Second, all previous crises have occurred at times when secular (non-cyclical) economic growth remained feasible. This enabled us to ‘grow out of’ these crises, much as youngsters ‘grow out of’ childhood ailments.

No such possibility now exists.

The true story of modern economic and financial history involves, on the one hand, the ending and reversal of centuries of economic expansion and, on the other, an absolute refusal to come to terms with this reality.

What follows is an attempt to tell that story as briefly as possible.

We’ve recently concluded our five-part synopsis of The Surplus Energy Economy, a series which begins here. This means that we don’t need to re-visit now a lot of detailed material that readers can access elsewhere at this site.

It starts here

One of the two core realities of our predicament is that the huge and complex modern economy was built on the abundant, low-cost energy made available by oil, natural gas and coal. Quite naturally, we have accessed lowest-cost energy sources first, leaving costlier alternatives for a ‘later’ which has now arrived. ‘Depletion’ is the term which describes this process, and you would not be far wrong if you concluded that, just as fossil fuel resources have depleted, so has the economy.

Depletion doesn’t mean that we ‘run out of’ the resource in question, but that its supply becomes progressively more expensive. The relevant metric here isn’t financial cost – because we can always create new money – but cost understood as the proportion of energy value which, being consumed in the process of accessing energy, is unavailable for any other economic purpose. This metric is known here as the Energy Cost of Energy, or ECoE.

Global trend ECoE (from all sources of primary energy) has risen from 2.0% in 1980 to almost 10% now, and is likely to reach 13% by 2030, and 17% by 2040. What this means is that, from every 100 units of accessed energy, the ‘available for use’ or surplus component has decreased from 98 units in 1980 to 90 units now, and is likely to have fallen to 83 units by 2040.

It’s important to remember that surplus energy isn’t used just to supply products and services to consumers, but to maintain and replace productive and social infrastructure as well. This means that sensitivity to rising ECoEs is an inverse function of complexity – the more complex an economy is, the greater is the surplus energy required just to sustain the system.

Complexity is highest in the Advanced Economies of the West which has meant, in practice, that prior economic growth in these countries went into reverse first, happening once their ECoEs reached about 5%, a climacteric which was traversed in the early 2000s. EM (emerging market) economies, by virtue of their lesser complexity, have been able to carry on expanding at ECoEs above 5%, but most of these countries have now hit their own inflexion-points, which occur at ECoEs of around 10%.

Accordingly, global prosperity per capita peaked in 2019, and preliminary data indicates that world aggregate prosperity may have peaked in 2022.

‘Affordability compression’ and the leverage of necessities

Any person or family whose economic resources start to decrease faces two main challenges. First, he or she has to devote an ever larger proportion of diminishing income to necessities, spending progressively less on discretionary (non-essential) purchases. Second, it becomes increasingly difficult to keep up the payments on debts and other financial commitments taken on in earlier, more affluent times.

The equivalents of both processes are occurring at the macroeconomic level, but each has a twist. First, a family experiencing a fall in income doesn’t tend to encounter a simultaneous rise in the cost of essentials, but this is happening now in the economy, because so many necessities are energy-intensive. The second twist is that, whilst individuals and households can’t conjure new money out of the ether, those managing the economy itself can do this (though they can’t, of course, create economic value by creating money).

The portmanteau term used here to describe this process is affordability compression. At its most basic, this is very simple to unpack:

• Prosperity is deteriorating because ECoEs are rising.

• The costs of necessities are rising because so many of them are energy-intensive.

• The economy is experiencing relentless downwards pressure on its ability to afford discretionary products and services.

• Prior financial commitments are proving ever harder to honour.

The great folly

None of this is entirely new. Between 1990 and 2000, global trend ECoEs rose from 2.9% to 4.2%, the latter pretty close to the inflexion-point of 5% as it applies to the complex economies of the West. The practical consequence of this trend was growing awareness, during the 1990s, of “secular stagnation”, meaning a non-cyclical decline in the rate of growth.

Intelligent people would have reacted to this phenomenon by enquiring into it, and responding accordingly. The concept of the economy as an energy rather than a financial system had been established well before then, and the remarkably prescient The Limits to Growth (LtG), published back in 1972, had warned us about what to expect.

Needless to say, intelligent investigation and reasoned response wasn’t what happened back in the 1990s, which is when the story of our current problems arguably begins. The proponents of orthodox economics denied that there was anything to worry about because, according to their most cherished precepts, there was no reason why economic growth should ever come to an end. The broader perception was that LtG was wrong, not because its precepts and techniques were mistaken, but because its conclusions were unpalatable.

The fundamental error within conventional economics is the presumption that the economy is entirely a financial system, which is not constrained by material limits and is, therefore, capable of delivering ‘infinite growth on a finite planet’. A sub-set of this folly is the belief that the ‘liberal’ process of de-regulation can boost ‘growth’, a fallacy that was particularly fashionable in the decade or so after the collapse of collectivism as represented by the USSR.

Accordingly, the favoured response to “secular stagnation” was to make it easier to borrow than at any previous time in modern history. This was also required if globalization was to succeed in exporting the process of production to lower-cost countries whilst bolstering consumption in the West, a circle which could only be squared by making it ever easier for Westerners to borrow.

These processes lead directly to the GFC, which was ultimately the result of reckless credit creation and shortcomings in macroprudential oversight.

A new model idiocy

The response to the GFC was a resort to ultra-cheap money. You could have seen this coming if in, say, 2008, you had added up the world’s debts, and then applied a normal interest rate to calculate the aggregate cost of debt service, arriving at a number that was completely unaffordable. This was why the “temporary” expedients of QE, ZIRP and NIRP became permanent fixtures of the system.

It’s a permissible simplification to state that the general level of asset prices is the inverse of the cost of money. The more cheaply and abundantly capital is made available, the further the prices of stocks, bonds, property and other assets will rise.

The snag, of course, is that aggregate asset prices are meaningless, because these aggregate valuations can never be turned into money. Just as asset prices soared, so debt and quasi-debt escalated. Obviously enough, we cannot sell the whole stock market – to whom? – to pay off the debts that have been taken on to inflate it. The application of marginal transaction prices to “value” aggregate units is a fallacy that convinces only those willing to be persuaded.

All of this has left us hoping against hope that ‘something will turn up’ whilst, at the same time, dreading what that ‘something’ might turn out to be. Where sources of hope are concerned, we are really scraping the bottom of the barrel, pinning our faith on replacing dense (fossil) energy with less dense (renewable) alternatives, or backing technology to over-rule the laws of physics. We’re only now starting to discover that creating new money out of the ether is inflationary, a reality that we’ve ignored by persuading ourselves that asset price escalation ‘doesn’t count as inflation’.

The likeliest course of events now is that the bursting of the “everything bubble” brings on an “everything crisis”. Even unsecured debt is, ultimately, backed by the ‘psychological collateral’ of the assumption that the economy will grow by enough to let us honour our collective obligations.

To understand why we can’t ‘grow out of’ the unfolding crisis, we need to appreciate that prior economic expansion has gone into reverse. Understanding this issue isn’t difficult, but coming to terms with its implications most certainly is.

#250: The Surplus Energy Economy, part 5

WHAT HAPPENS NEXT?

Introduction

Right from the outset, it was likely that the multi-article synopsis of The Surplus Energy Economy would extend to a fifth instalment on the subject of ‘what happens next?’

What most of us probably want to know is whether the economy is destined for gradual decline or sudden collapse. The indications on this issue are contradictory. On the one hand, the economy itself is subject to trends which, whilst adverse, are essentially gradual. On the other, the financial system has been managed (meaning mis-managed) in ways which seem to eliminate any possibility of managed decline.

The plan here is to start by examining, in brief, these two, seemingly-contradictory conditions, and then turn to what some of the implications of this asymmetry might be.

1. The material economy

As we know, the economy is a system for the supply of material products and services to the public. The resulting aggregate is calculated by the SEEDS economic model and is known here as prosperity. The deduction of necessities supplies a second SEEDS metric known as PXE (prosperity excluding essentials).

The economy thus described is a product of the use of energy. The vast and complex economy of today can be traced directly to that point in history at which we discovered a means of converting heat into work. The date usually attached to this discovery is 1776, when James Watt completed the first truly efficient steam engine. This discovery enabled us to harness the vast reserves of energy contained in coal, oil and natural gas.

Quite naturally, we have always accessed lowest-cost resources first, leaving costlier alternatives for later. This ‘later’ has now arrived. Over a lengthy period, the fossil fuel energy supplied to the economy has been getting steadily more expensive. The cost referenced here isn’t financial, but energetic – it’s the percentage of accessed energy which, being consumed in the access process, is not available for any other economic purpose.

This ‘consumed in access’ component is known here as the Energy Cost of Energy. All-sources ECoEs are on a long-established and relentless uptrend, having risen from 2% in 1980 to 10% now. You might like to think of this as a five-fold increase in the material cost of energy to the economy. This process is continuing, and ECoEs are likely to reach 13% by 2030, and 17% by 2040.

No economy, as currently conceived, can cope with these levels of ECoE. Complex Western economies have been experiencing (though not admitting to) deteriorating prosperity since the early 2000s, when ECoEs were between 4.2% (in 2000) and 5.7% (in 2008). Less complex EM (emerging market) economies, by virtue of their lower systemic maintenance costs, are better equipped to cope with rising ECoEs, but their prosperity, too, has started to contract now that ECoEs have reached double digits.

It is widely supposed that we can overcome the effects of deteriorating fossil fuel economics – and simultaneously minimise environmental and ecological harm – by switching to renewable energy sources (REs), principally wind and solar power. These, we are told, can not only support current lifestyles, but deliver “sustainable growth” as well.

This favourable outcome is, in fact, extremely implausible, for two main reasons. First, scale expansion of the magnitude required would demand vast quantities of concrete, steel, copper, lithium, cobalt and many other inputs which, even where they do exist in the requisite quantities, could only be accessed and put to use using correspondingly vast amounts of energy. Since this could only come from fossil fuels, there is an ‘umbilical link’ between the ECoEs of renewables and those of fossil fuels.

The second obstacle is even more fundamental. It is that renewable energy is less dense than fossil fuels. The economy operates by using energy to convert raw materials into products, a process whose thermal counterpart is the conversion of energy from dense into diffuse forms, the latter being waste heat. The lesser density of renewables lies at the heart of the practical obstacles to transition – these obstacles include conversion efficiency limitations, intermittency, and the problem of storage.

These considerations mean that, whilst a sustainable economy might be possible, it would be smaller than the economy that we have now. Simply stated, “sustainability” is feasible, but “sustainable growth” is a pipe-dream.

Our problems with adjusting to the practical and psychological challenges of economic contraction are compounded by the problem of material leverage. Essentially, the economic resources made available by the use of energy are deployed in three ways. The first of these is the provision of essentials. The second and third, which are the residuals in this equation, are investment in new and replacement productive capacity, and the provision of discretionary (non-essential) products and services to consumers.

The leverage issue involves the energy-intensive character of essentials. What this means is that, just as prosperity is being driven downwards by rising ECoEs, energy deterioration is driving the real costs of essentials upwards.

These issues are summarised in the charts in Fig. 16, which are harmonised and, like all charts shown here, can be opened in another tab for improved visibility.

The first chart (Fig. 16A) shows how energy deterioration is being experienced, not just in output (shown in grey), but also in the ECoE effect on prosperity (blue). The second chart shows segmental allocations between estimated essentials, capital investment and discretionary consumption.

The third and fourth charts illustrate the compression effect created by the simultaneous decline in prosperity and rise in the cost of essentials. The purpose of the fourth chart, Fig. 16D, is to compare the SEEDS trajectory for PXE (in blue) with what you might anticipate if you relied on orthodox economics and its promise of infinite growth (black).

Fig. 16

2. The financial impasse

As we have seen, then, the economy has already entered a contractionary process, and it’s important to emphasise that visible trends in the material economy, whilst adverse, and even daunting, are essentially gradual.

ECoEs haven’t jumped from 2% to 10% overnight, but over four decades. Energy supply itself is likely to be driven downwards by deteriorating economics, but – except in certain instances, such as American shales – rates of decline in fossil supply are likely, once again, to be comparatively gradual, and the overall decrease in energy availability can be mitigated, though not reversed, by increases in supply from other sources, including wind, solar, nuclear and hydroelectric power.

There are two problems, though, with any possibility of gradual or managed economic decline. One of these is the financial system, and the other is a collective and absolute refusal to accept and plan for any possibility other than the mythical (and utterly illogical) prospect of ‘infinite growth on a finite planet’. These, of course, are flip-sides of the same coin.

We have discussed, in previous articles here, the illogicality of conventional economics, which, by insisting on an entirely monetary interpretation of the economy, dismisses any possibility that there might be material limits to economic activity. What the orthodoxy is pleased to call the “laws” of economics are, in reality, no more than behavioural observations about the human artefact of money, and are in no way analogous to the laws of science.

Despite abundant evidence of economic deceleration, stagnation and contraction, decision-makers still put their faith in an orthodoxy that is being disproved by events. There has, indeed, been a Thirty Years’ War between orthodoxy and experience, and we are entitled to wonder about the sheer tenacity of mistaken theories about the economy. Why, for example, do decision-makers still pay heed to this outdated orthodoxy?

There are two answers to this question. First, any orthodox convention that has established itself in systemic thinking can be extremely difficult to dislodge. Second, decision-makers like the orthodoxy because they like the results that it produces.

In fairness to political leaders, it has to be said that any authoritative acknowledgement of economic contraction would, at the very least, crash the markets. They have good reasons, then, for not talking about economic decline. But they have no excuses whatsoever for failing to plan for it, or for making the situation worse. The latter is what they have been doing, and it’s important that we trace this process through its grim and depressing history.

This story begins in the 1990s, when the phenomenon of “secular stagnation” – a non-cyclical fall in growth – started to attract attention. We, of course, know that was happening back then was caused by a relentless rise in ECoEs, but no such explanation was countenanced by an orthodoxy which insisted that all economic developments have monetary causes, and can be tackled using monetary tools. By putting together various things that Adam Smith and John Maynard Keynes hadn’t actually said, the chosen ‘fix’ was credit expansion.

This, of course, didn’t work, because it can’t. Whilst GDP increased by 50% between 1997 and 2007, debt expanded by 77% over this same period. Essentially, each dollar of incremental GDP was being bought with $2.40 of net new debt, whilst 54% of reported “growth” was the cosmetic effect of credit expansion. This led directly to the global financial crisis (GFC) of 2008-09, an event caused by a combination of breakneck liability expansion and the proliferation of dangerous financial practices.

A case can be made that, under the shot and shell of the GFC, the authorities were justified in using QE, ZIRP and NIRP to steady the ship. These, though, did not turn out to be the “temporary” expedients claimed at the time of their introduction. Even conventional economics would have counselled that negative real rates, reckless credit expansion and the creation of a gigantic “everything bubble” in asset prices could only end badly.

We may never know why ‘the powers that be’ persisted with these utterly irresponsible practices – perhaps they were enjoying the ride as the financial system careered towards the cliff-edge, and perhaps they believed that people (well, the richest ones) really were getting wealthier as purely paper asset values implied.

The latter, of course, isn’t even true, in any lasting sense, because inflated asset values will crash when the “everything bubble” bursts. It has been reported that the world’s wealthiest 218,000 people lost 10% of their wealth, or $10 trillion, over the past year, and this may be just a foretaste of what will happen when discretionary sectors start to implode, and defaults start to cascade through the world’s ludicrously over-stretched ecosphere of interconnected liabilities.

This time around, the leverage effects have been even worse, with each dollar of “growth” between 2007 and 2021 bought with $3.60 of borrowed money, and reported “growth” has been even more cosmetic, with fully 64% of it ascribable to credit expansion. More worryingly still, broad liability expansion averaged an estimated $7 for each dollar of “growth” between 2007 and 2021. Much of this can be ascribed to the non-bank financial intermediary (NBFI) or “shadow banking” sector, which is very largely unregulated.

The final chart in this five-part series, Fig. 17, endeavours to put this into context by comparing output, debt and estimated broad liability data stated at constant dollar values. Estimated broad liabilities now stand at almost 10X prosperity, and even this doesn’t include enormous “gaps” that have emerged in the adequacy of pension provision.

Fig. 17

3. So what next?

On the basis of what we know, we have strong reasons to fear that the realities of economic contraction will continue to be ignored and that, in consequence, any lingering possibility of managed retreat will be rejected.

At present, central banks are showing a commitment to taming the inflation that their own policies have created. They have, thus far, shown no inclination towards the “pivot” that many are urging upon them. The best near-term expectation is that current monetary and fiscal policies will continue until the reality of fracture becomes undeniable.

We can, in the meantime, attach high levels of probability to two processes. One of these is contraction in discretionary sectors, and the other is cascading defaults, commencing at the outer perimeters of the financial system and then travelling inwards towards the regulated banking sector.

A personal view is that the authorities will find themselves forced into trying to counter these trends by a reversion to expansionary monetary policies. Despite the very real downwards pressures created by economic contraction, it’s likelier that we face an inflationary rather than – or rather, as well as – a hard default resolution to over-inflated capital markets and ludicrously unsupportable levels of liabilities.

These, of course, are purely economic and financial trends, and I’m sure that readers will have their own views on the broader implications between economic decline and financial chaos.

Before handing this over to readers for comment, it’s worth asking ourselves what is the worst thing that can happen, in economic terms, in this kind of nightmare scenario. The answer would seem to be the destruction of the purchasing power of money. We may, then, find ourselves needing to find a new medium of exchange. That could be one of the most difficult tasks that we have ever been compelled to undertake – and we’re likely to find ourselves tackling it under very chaotic conditions.