#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.