AT THE LIMITS OF SELF-DECEPTION
Imagine – it couldn’t happen, but imagine – that Congress agreed that it wouldn’t impose a future debt ceiling if the administration promised henceforth to balance the budget. To do this, somewhere between USD 1.6 trillion and USD 2.0 trillion, depending how we calculate it, would have to be pulled out of the budget – taxes would have to rise, public expenditures would have to fall, or a combination of both.
Likewise, and equally impossibly, the Fed committed itself to maintaining interest rates, in perpetuity, at positive real (ex-inflation) levels.
Under these imaginary conditions, capitalism would, at least in part, be restored, because one of the two essential predicates of market capitalism is that investors earn a real return on their capital. (The other is that markets are allowed the unfettered capacity for price discovery, meaning they can put a price on risk). It’s likely that these processes would help tame inflation, thereby defending the value – meaning the purchasing power – of the dollar.
The point of this fictional scenario is that, if it happened, American real GDP would contract, and would carry on doing so for as long as balanced budgets and positive real rates prevailed. Put another way, there would be no growth at all – rather, there would be negative growth – if government was prevented from piling up yet more debt through deficit budgeting, whilst households and businesses could no longer finance expenditures by borrowing at sub-inflation rates.
Then turn to China. Roughly a quarter of the Chinese economy is accounted for by real estate. Much of the real estate sector has been exposed as a scam, a Ponzi scheme, or both. There’s no other way to describe a sector that takes people’s money for homes that haven’t yet been built, and that might never be completed, as part of a broader, gigantic debt binge that has brought much of the sector to the brink of collapse.
The point of this is that, behind the veils of financial camouflage, the global economy has started to shrink. “Growth” has become a story we tell ourselves to keep the economic nightmares at bay. Orthodox economics it itself a fairy-tale, in which the protagonists, instead of “living happily ever after”, enjoy ‘infinite economic growth on a finite planet’.
Looking down the barrel
The reality is staring us in the face – “growth”, whether in America, China or anywhere else – has become sleight-of-hand. If you look for real growth – growth, that is, not manufactured using super-rapid debt and quasi-debt expansion, itself enabled by sub-inflation interest rates – you won’t find it anywhere. Behind various schemes in which the speed of the hand deceives the eye, the global economy has inflected from growth into contraction.
Let’s remind ourselves about the two ways in which money is created. First, it can be conjured out of the ether by central banks. Second, most of it is loaned into existence by the banking system. Regulation is one check on the latter, and the need for collateral is the other. Lenders won’t hand you $1m on your word alone, but will if you can show them an asset which guarantees your ability to honour at least part of your new obligation.
But this is circular, because asset prices, which provide this collateral, are an inverse function of the cost and availability of capital. Accordingly, a credit mountain must create a super-bubble in asset prices, and vice versa.
The medium of control, if indeed there really is one, is interest rates. If these are set at levels below inflation, borrowing becomes profitable. This incentive drives both credit and asset values upwards, with the latter appearing to provide a collateral guarantee for the former. We can, supposedly, be comfortable about adding $X trillion to our debt pile if we’ve also added $X trillion to the collateral value of assets.
But these aggregate asset valuations are no more than notional. At the national level, the aggregate ‘value’ of a country’s housing stock is meaningless, because the only people to whom the entirety of that stock could ever be sold are the same people to whom it already belongs. Globally, the same principle applies to stocks, bonds and other asset classes. This principle is that we deceive ourselves when we apply marginal transaction prices to the aggregates of existing assets.
There are, in fact, two main ways in which assets can be valued. One is the price which the owner could realise by selling the asset to somebody else. The other is utility value – on this basis, a property has value in that it provides the owner with somewhere to live, saving him or her from having to pay rent. The utility value of a stock is the value that will come to the owner in the future, through dividends but, ultimately, through profits.
There is no way that current stock or property values could be justified on a utility basis, even if the economy was still capable of growth. In short, what we have is a confection – you might liken it to a soufflé – in which an excessive credit burden is backed up by inflated asset values which are themselves a function of over-extended credit.
The sleight-of-hand of ‘output’
Moreover, when we pour credit into the economy, this money is spent, which is what it’s for. This shows up as transactional activity, which is what we measure as GDP.
The direct functional relationship between credit and the transactional activity (recorded as GDP) can be measured.
Over the past twenty years, each $1 of “growth” in reported real GDP has been accompanied by $3.20 of net new borrowing, and even that ratio excludes broader liability increases which include the “shadow banking” (NBFI) sector. Buying $1 of “growth” by borrowing and spending upwards of $3.20 is self-deluding fakery, pure and simple.
Beyond being simply unsustainable, it leads us to the paradoxical condition of being both wealthy and bankrupt. We’d be wealthy because the paper value of our assets would have soared, and simultaneously bankrupt because our debts would be so big that they could never be repaid.
GDP, meanwhile, is inflated artificially by the pouring of ever more credit into the economy. Since money can (and routinely does) change hands without value being added, there is no correlation between transactional GDP and the creation of material economic value. And, if GDP losses its validity as a measure of output, so do all metrics based upon it. This means that the ratio of debt to GDP becomes unreliable, and we can’t effectively measure the velocity of money.
The same fakery at the heart of reported “growth” is all around us. Some jurisdictions are thinking about super-long mortgages, which could spread the cost of house purchase to, and beyond, the average person’s working life. This amounts to a confession that the ratio between property prices and disposable incomes has become dysfunctional. We can’t admit this, though, because doing so would crash property markets, blowing a gigantic hole in the supposed value of collateral.
The business model de jour is the garnering of consumers’ information in order to flog it to advertisers so they can offer the same products to the same people, a model which adds no real economic value at all.
Another gambit is that of reducing costs by casualizing labour through ‘gig’ employment and zero-hours contracts. These workers, at least, aren’t going to be increasing their purchases of advertised products, or ‘signing up’ to those subscriptions which the same business model portrays as a way of generating valuable new streams of income from the household sector.
Corporates use cheap debt to buy back stock in a process that, far from being accretive to value, provides the sugar-rush of a brief rise in stock prices whilst saddling businesses with ever larger burdens of debt, thereby making them increasingly vulnerable to any shift away from sub-inflation interest rates.
The blanket term for all of this, and more, is gimmickry. This has a lengthening and dishonourable history. It began, back in the 1990s, with making debt easier to access than ever before – seldom did a day pass without credit offers padding the mail-box of the Western householder. Then, when this process of “credit adventurism” detonated in 2008-09, we switched to outright “monetary adventurism”, essentially subsidising credit by setting the real cost of capital at negative levels.
Doing this has put the value of money itself at hazard. We have thrown, first, the viability of the banking system and, second, the sustainability of our currencies themselves, under the wheels of an unstoppable juggernaut. The name painted on the side of that juggernaut is ‘inflexion’, meaning that the economic growth of the past is turning into the economic contraction of the present and future.
Where this all ends is predictable, at least in part. The super-fast money creation scheme fails, asset prices plunge, and defaults rip through the system.
Publicly-reported debt, both state and private, is a huge understatement of the true magnitude of liabilities, which include both the credit assets of the “shadow banking” system and the can’t-be-honoured pension promises which governments have made to the public. NBFI lending is a horror-story of its own, with a sizeable part of this credit channelled to households through BNPL and other non-bank forms of credit.
The truth that mustn’t be told
Indeed, BNPL – ‘buy now, pay later’ – is as good a moniker as any for an economy clinging on to unaffordable lifestyles, and reporting cosmetic (meaning ‘fake’) growth, by ramping up financial promises that cannot possibly be honoured.
The inevitable (though not necessarily imminent) destination of all this self-delusion is a collapse of the financial soufflé. Debts and quasi-debts become unpayable out of material economic flow, and the supposed insurance provided by collateral disappears as asset prices collapse.
All of this, by the way, is happening at the same time as ‘global warming’ is, according to some, turning into ‘global boiling’. The latter term might, or might not, be somewhat hyperbolic, but our environmental and ecological predicament is dire, and we’re now getting the wildfires, heatwaves and floods to prove it. There’s no net positive in any of this – the possibility of successful viticulture in a warming England comes with creeping salination of a large and increasing proportion of rice-producing low-lying lands.
To say that a re-think is in order would be one of the greatest under-statements of all time. I’ve never believed that this site, and others like it, are going to change the climate of opinion. Collectively, people do what suits them, until they are forced by events into responses that we would never choose of our own volition.
Rather, and beyond the value of knowledge for its own sake, the best that we can hope for is that we ourselves can understand what’s happening before others, including decision-makers in the higher echelons of government and business, arrive at the same conclusions.
Those behaviour-changing events are now starting to happen. The promise of ‘infinite economic growth’ is in the process of being exposed as fictional, and this ought to turn us away from the fairy-tale economics which has always assured us of this impossible outcome. The equally fictitious notion that “growth” will enable us to honour our gargantuan debts and quasi-debts is heading into a reality wall.
Two things could happen to government, and both might happen at the same time. The first is that states take sweeping new powers in an attempt to control events that are getting out of hand. The second is a growth of localism as the public loses faith in any supposed ‘solutions’ coming from the centre.
The core problem facing governments is that they’re being called on their unwise promises. The promise of unending growth is being exposed as fallacious, and the promise of an equitable sharing out of this growth is no longer honoured in anything but name. The old agenda has failed, and the powers-that-be have yet to find a new one to put in its place.
Life after soufflé?
We, if not governments, need to remind ourselves that there’s a core of nutritional substance at the heart of even the most inflated culinary confection. Here, in the economy, is what this core comprises.
For starters, the fundamental purpose of the economy is to supply material products and services to society. The physical or “real” economy does this by using energy to convert raw materials into products.
As this happens, a parallel thermal process involves the conversion of energy from dense to diffuse formats. The latter is waste heat and, when fossil fuels are used as the dense energy inputs to the system, this waste-heat contains climate-harming gases.
This energy-material process is driven by a cycle of creation, disposal and replacement – we acquire something, it wears out, and we need to obtain a new one to take its place. Our current economic system accelerates this disposal process, meaning that the material economy is a dissipative-landfill system.
At the same time, the length of the energy-dissipative process determines the size of the productive process. If we switch to lesser-density energy inputs, the dissipative process is truncated, and the material economy is smaller.
The assertion that we can transition from climate-harming oil, natural gas and coal to “green” wind and solar energy without the economy shrinking is based on the assumption that these renewables are, or can be made, as dense as fossil fuels. The only flies in this ointment are the lesser density of renewables, and the inability of technology to over-rule the laws of physics.
The bad news, then, is that financial soufflé is nearing collapse. The good news, if we choose to see it as such, is that the “financial economy” has reached this point because of comparatively gradual, but relentless, contraction in the underlying “real economy” of energy.
This could be “good news” because it might impose upon us environmentally-responsible behavioural changes which we might never get round to making on a voluntary basis.
Tim Morgan
THE CHIMÆRA OF A ‘NEW ECONOMY’
In the spring of 1940, as the phoney war came to an end, Allied military commanders were wondering quite how they were supposed to stop the German advance into France and the Low Countries. For the more realistic amongst them – those who understood the inability of static defences to halt the new mobility of blitzkrieg – the question became one of where and when, rather than how or if, the Wehrmacht and the Luftwaffe were going to make their decisive breakthrough.
The big question now is which part of the economic and financial Maginot Line is going to fracture first. Will decision-makers reach the inescapable conclusion that phoney growth – our equivalent of the “phoney war” – can’t last much longer? Will the financial system, considered both as over-inflated assets and as liabilities that can’t possibly be honoured, succumb to a sudden attack of vertigo?
Or will businesses, and those who own and run them, be the first to recognise, and respond to, the reality of irreversible economic contraction?
The latter point is considered here. As tends to happen when the ‘old’ economy is in trouble, we – and businesses – are being offered ‘new economy’ alternatives. One proposition sees us “happy” whilst owning nothing. Another, more mainstream version – which is similar, though differently nuanced – sees us consuming rather than buying. Both variants promise greater efficiency in the use of energy and raw materials. Can either, or any, of these ‘new economy’ models live up to their supposed promise?
The big change
If you’ve been visiting this site for any length of time, you’ll know why the inevitability of fracture has arisen. The initial impetus imparted to the economy by the harnessing of fossil fuel energy has been fading out – gradually, but relentlessly – over a protracted period. With no complete replacement source of energy value available, material prosperity has inflected from growth into contraction, a process exacerbated by rises in the costs of energy-intensive necessities.
Far from coming to terms with this, or even recognising the underlying dynamic, we’ve tried to counter the inflexion process by pouring vast quantities of cheap credit, and even cheaper money, into the system. If the material economy can be likened to a beast of burden, we’ve been piling on ever-larger burdens just as the animal itself has been getting weaker.
In the past, the ‘big call’ required of the investment strategist was the one between ‘cyclicals’ and ‘counter-cyclicals’. The latter, which might also be called staples, are those sectors which don’t gain much in a boom, but hang in solidly through a slump. Cyclicals, by contrast, are those activities which prosper in the good times, but suffer disproportionately in the bad.
Historically, if you thought a recession was coming, you’d load up on energy, utilities, pharmaceuticals, food retailers, and anything else which households were still going to need, however bad things got. If, on the other hand, you expected a boom, you’d switch into hospitality, travel, leisure, construction and those discretionary products on which consumers would spend much of their newly-enhanced prosperity.
Now, though, this big call – based upon assumed cyclicality around a positive economic trend – has been changed by the onset of economic inflexion. The postulated alternative to the inflecting economy is some kind of ‘new economy’ of diminished materiality.
Is this feasibility, or fig-leaf?
Essentially, the strategist has to decide whether or not this reinvented economy can work, and then make a choice between sectors and businesses which are, or are not, signed up to the consensus vision of a ‘new economy’. Investors, for the most part, have made their choice – they’ve decided to back ‘new economy’ players, meaning anything ‘tech’, ‘disruptive’, or linked to the new consumer lifestyles promised by the exponents of the ‘new economy’.
Decisions seldom come much bigger than this.
A new “new economy”?
The promise of a ‘new economy’, or even of ‘a new industrial revolution’, is by no means a novel idea, and has a pretty undistinguished track-record. Beyond the ritual attachment of the label “green” to the contemporary versions of such promises, nothing fundamental has changed since then-premier Harold Wilson’s famous reference, back in 1963, to the “white heat of technology” that was, supposedly, going to revolutionise British industry.
There are three distinguishing features of almost all ‘new economy’ promises. The first is that they place excessive faith in the potential of new technologies, and of new offerings to the consumer.
The first shot at a ‘new economy’ paradigm in modern times ended in the dotcom boom and bust. Can the current boom – in anything new, shiny and technological – end differently, defying past precedent?
The second common factor is that these promises tend to be made at times of economic underperformance. When the term “new economy” came to prominence in America in the 1990s, the United States – along with many other countries – was stuck in a low-growth, flat-productivity trap. Wilson’s promise was made in a period of structural decay in British industry.
Today, we know – or at least we sense – that the economy is floundering, and that’s why we’re trying to reinvent it. The American economy is running on the fumes of deficit. China’s real estate chickens have come home to roost.
If no nation can buck this decelerating trend, can technology ‘fix’ it? Technology is all too often tasked with pulling our economic chestnuts out of the fire.
The third and most obvious characteristic of ‘new economy’ promises is their almost invariable failure to deliver. This failure happens for two main reasons. First, technology cannot live up to what we’ve been told to expect of it. Second, nobody looks too closely into how these promised wonders are to be paid for.
The broader context here is the seductiveness of the new and shiny. Back in the 1630s, Dutch investors came to believe that tulips were the new and unstoppable must-have for the affluent classes in Holland. The supposedly new – though in fact valueless – appeal of the South Sea Company in the early eighteenth century was its promised ability to establish a monopoly of British trade in markets wholly controlled by Spain.
The human tendency towards financial gullibility was well explained by Charles McKay in Extraordinary Popular Delusions and the Madness of Crowds, published in 1841. Neither McKay, his successors nor painful experience have ever overcome our fascination with the ability of ‘the new’ to deliver wealth beyond the dreams of avarice.
Now, though, ‘new economy’ thinking goes a long way beyond simple matters of profit. The current version of ‘new economy’ thinking, with its obligatory “green” tag, is based on the same, time-honoured template of technology driving everything from consumer betterment to ever-growing profitability, but it also promises an ability to combine economic growth with responsible stewardship of the environment. It’s a “get out of gaol free” card that will deliver environmental virtue with no need for sacrifice.
This time, moreover, three new factors are in play. First, though in no particular order, we’ve reached the apparent end of a long period of reckless and destructive ‘money printing’. After the banquet comes the banquet of consequences. The banquet has left society more than a little befuddled – so can we believe what we think we see?
Second, and as mentioned earlier, the underlying material economy has been inflecting from growth into contraction.
Third, we are at last – or at least for public consumption – starting to take belated note of environmental degradation. Previously, the concept of harmful climate change resided, almost entirely theoretically, in the prognoses of the experts, which many chose to disregard. Now, though, we have the heatwaves, wildfires and floods to prove the validity of these warnings.
The joys of non-ownership?
A thesis allied to the concept of a ‘new economy’ is the idea that we might “own nothing, and be happy”. The obvious question is that of who will own everything if we – the public – own nothing. Even so, it’s still worth reflecting on how the ‘non-ownership’ economy is supposed to work.
Essentially, the thinking is that there’s no point in owning, say, a lawnmower, if we’re going to use it only a handful of times each year, and it spends the vast majority of its time shut away in a shed. The proposed alternative is that we simply hire a lawnmower on those few occasions when we actually need one. Likewise, why go to the expense and inconvenience of owning a car which we’re going to use for, at the very most, two or three hours in every twenty-four? Wouldn’t most of us be better off hiring a car, or calling a taxi, when we need to go somewhere?
The superficial appeal of this notion is that increased utilization rates might imply that society would need fewer lawnmowers, and fewer cars, and less of anything else that is only used intermittently. If this were true, it would mean that we could dematerialize the economy, by having the same number of completed journeys – and neatly trimmed lawns – whilst using a lesser quantity of material-intensive equipment. The consumer, meanwhile, would be better off by paying for these things only when he or she actually needs them.
There are at least two obvious snags with this superficially-persuasive notion. The first is that a car – or a lawnmower – used in this intensive way would wear out, and require replacement, far more quickly than one which spends most of its time on a driveway or in a shed.
The second is that this far greater rate of depreciation would have to be amortised into rental charges, whilst the insertion of a lending intermediary would eliminate all, and more, of any supposed gains that the consumer might enjoy from this ‘only when needed’ model.
In short, we can only “own nothing” and “be happy” if happiness means paying more for less.
Variation on a theme
The ‘new economy’ variant on this theme also points towards dematerialisation. If we switched to e-books from the traditional “tree-ware” version, we’d use less pulp and paper. Streaming or downloading music or movies would require fewer material inputs than owning CDs, DVDs and the equipment needed to enjoy them. We wouldn’t need to visit a sports stadium to watch a football match, or travel to a cinema to take in the latest Hollywood blockbuster, because we could watch them in the comfort of our homes. More broadly, the consumer of the future will spend less on products, and more on “experiences”, than he or she does today.
This model has already made significant inroads into traditional business practice, most notably with on-line shopping displacing traditional (“bricks-and-mortar”) retailing. What is euphemistically called the “sharing” economy has progressed in everything from bicycles and cars to garden-use and accommodation. Already, comparatively few motorists actually “buy” a car, in the sense of handing over the purchase price in full, and taking unencumbered ownership of the vehicle. Hire-purchasing – through leasing products – has become the new normal for access to a private car.
Dating has shifted from meeting potential partners in pubs or clubs to an on-line model. We can even do a virtual tour of the house we’re thinking of buying – or renting – without the hassle of actually having to go there. We can’t – yet – provide a virtual reality-equivalent experience for physically travelling from Birmingham to Barbados, but something along these lines might, eventually, become feasible.
In short, what the ‘non-ownership’ and the ‘new economy’ models have in common is a promise of de-materialization, which is the ultimate economic selling-point of systems where we no longer need to own anything, from a DVD player to a lawnmower, but pay for films, music and domestic appliances only when required.
In macroeconomic terms, this looks like an alchemist’s stone, turning the base metal of material-intensive ownership into the gold of a bigger economy that uses less raw materials and, critically, less energy.
Where this fails
As we’ve seen, the basic snag with the ‘own nothing’ model is the accelerated deterioration (and the consequently higher amortization rates) of “shared” equipment. This problem also includes the energy consumed in taking our humble lawnmower from customer A to customer B, as well as taking it back to a depot if this is required, either logistically or for maintenance.
In short, and with little or no net material gain likely to be realised, the actual appeal of the non-ownership model is to those who will own those things that the consumer no longer owns.
The problems with the ‘new economy’ model, on the other hand, are more nuanced, but the first critique is that the model is tilted emphatically towards the discretionary. We might replace our books, CDs and DVDs with their virtual or streamed equivalents, but none of these products is a necessity. On-line grocery purchasing offers tangible advantages, accounting for its rapid growth in popularity, though the energy requirements of the storage and distribution system need to be deducted from any energy reduction achieved through fewer customer journeys to supermarkets.
There is, then, a net energy balance to be calculated in respect of any proposed ‘non-ownership’ or ‘new economy’ economic system. Technology is more energy-intensive than is widely recognised, and older patterns of consumption aren’t quite as energy-intensive as we’re invited to assume – after all, the music-lover doesn’t buy a new CD player every time he adds a disc to his collection, nor buy a new CD to listen again to the same set of tracks.
Accordingly, and if the energy balance is far from decisive, what we need to know is where the discretionary affordability of the consumer is heading.
If he or she is going to enjoy a rate of growth in prosperity which exceeds any increase in the real costs of necessities, then the latest version of the ‘new economy’ might just succeed, where most of its predecessors have failed. If this were an accurate prognosis, people would indeed be leasing, streaming and subscribing, as well as travelling and ‘experiencing’, like never before.
If, though, the costs of essentials are going to out-grow contracting prosperity, people won’t have to choose between CDs or streamed music, or subscription sports-watching and going to the stadium. Rather, they’ll have to choose between music and sports, on the one hand, and necessities (like food and warmth), on the other.
We have the ability, which we may consider valuable, to order food – groceries or prepared meals – on-line, rather than travelling to a supermarket or a restaurant. But we are never going to be able to use technology to supply an immaterial, virtual equivalent of a hamburger.
Put another way, if the exponents of new economic thinking are right to believe that consumer prosperity in general, and discretionary prosperity in particular, are going to grow in the future, then the associated business model might work.
If, though, prior growth in material prosperity has gone into reverse, and the real costs of essentials are going to carry on rising, then any such model, predicated on mistakenly-positive assumptions about consumer-discretionary prosperity, isn’t going to be transformative after all.
If this is the case – and, as we already know, it is – then businesses need a major rethink about what might work for the enterprises of the future.
Tim Morgan
Surplus Energy Economics 