#247: The Surplus Energy Economy, part 2



As we have seen in part one of this series, underlying or ‘clean’ economic output, known here as C-GDP, has correlated remarkably closely with primary energy consumption over a period of more than forty years. This means that we cannot “de-couple” the economy from energy use. This conclusion is wholly logical, given that nothing which has any economic value whatsoever can be supplied without the use of energy.

In part two, our aim is to assess the outlook for the supply and cost of energy, because this will determine the prospects for economic output and prosperity. We conclude that, despite their unquestionable importance, alternative energy sources cannot provide a complete or like-for-like replacement for the energy value hitherto sourced from oil, natural gas and coal.

As is apparent in Fig. 4 – charts in this series are being numbered consecutively – there has been a direct correlation between the exponential increases in, on the one hand, the use of energy and, on the other, population numbers and the economic means of their support. The exponential trends in both series started in the late eighteenth century, which was when the Industrial Revolution began, its symbolic commencement being James Watt’s landmark completion of the first truly efficient heat-engine in 1776.

In short, Fig. 4A provides the clearest possible demonstration of the fact that the economy is an energy system, and that exponential expansion in population numbers and economic output was the direct result of discovering how to harness fossil fuel energy.

A second turning-point can be seen in the years after the Second World War. For much of the period since then, energy use (measured in billions of tonnes of oil-equivalent) has expanded even more rapidly than the population has increased.

This has meant that consumption of energy per capita has risen markedly, as shown in Fig. 4C. But the likelihood now is that the availability of energy will decline, both in aggregate (Fig. 4D) and in per capita terms. If this is what is happening, it means that both economic output and material prosperity have started to contract.

Fig. 4

Cost – the critical role of ECoE

The second of the three ‘first principles’ set out in part one is that energy is never ‘free’. 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, or ECoE.

Trend ECoEs are on a relentlessly rising trajectory, and this is the primary cause of a process of deterioration which has seen growth in economic prosperity decline, stagnate and – now – go into reverse. Overall ECoEs (from all sources of energy) have risen from 2% in 1980 to 4% in 2000, and 10% now. The high-maintenance industrial economy cannot cope with double-digit ECoEs – and there’s worse to come.

If ECoEs had stayed at 2%, the economy would still be growing robustly on the basis of abundant low-cost energy, and we wouldn’t have stretched the financial system to breaking-point by piling on vast quantities of debt and other liabilities in pursuit of the chimera of credit-fuelled “growth”.

If they had stuck at, say, 5%, growth would have been over in the West, but would be continuing in less complex EM (emerging market) countries. As it is, ECoEs have reached levels at which global economic contraction has become inescapable.

It’s vital, then, that we understand ECoE, the factor which, whilst it is ignored by orthodox economics, goes further than any other to explain why prior economic growth has gone into reverse. How do ECoEs evolve, and what effects do they have?

Coal, oil and natural gas are the sources of energy on which the modern economy has been constructed, and they continue to account for more than four-fifths of primary energy supply. This is where our consideration of ECoE needs to start.

Although data for earlier periods is not available, it’s clear that the ECoEs of fossil fuels declined during most of the industrial era, probably reaching their nadir in the quarter-century after 1945.

Our use of fossil fuels began with small deposits, largely discovered on a happenstance basis, which were extracted, processed and delivered using rudimentary technologies.

Three processes contributed to a subsequent long decline in ECoEs.

First, as the energy industries expanded, they reaped continuing economies of scale. The relationship between fixed and variable costs dictates that a large oil, gas or coal field is less expensive to develop and operate in unit terms than a smaller one, and this applies to processing and distribution systems as well.

At the same time, the global search for lowest-cost energy supplies reduced ECoEs through the process of geographic reach. A notable milestone in this progression was the discovery and development of the vast petroleum resources of the Middle East. Despite the hopes that have been vested in various basins in more recent times, the industry has never found anything on a scale which compares with the enormous oil wealth of the Middle East. Whilst we cannot rule out the possibility that reserves of comparable size might yet be found elsewhere, we do know that any such discoveries would be remote, and technically challenging, meaning costly to access.

The third factor which has driven fossil fuel ECoEs downwards over time has been technical progress, at every stage of the chain from extraction to processing and distribution. This process has been gradual and, in an era in which excessive faith is often vested in technology, we need to remind ourselves that the capabilities of technology are limited by the laws of physics.

The ‘shale revolution’ is a case in point. The technological advances in fracturing made the extraction of shale energy more cost-effective than the extraction of those same resources would have been at an earlier time. But it did not – and could not – turn American oil and gas resources into the equivalent of Saudi Arabia, an outcome precluded by the differing characteristics of the resources in question. This is why shale has not been hugely profitable, despite many expectations to the contrary.

Technology accelerated the downwards trend in ECoEs, and can mitigate the upwards trajectory driven by depletion, but is limited by the physical characteristics of resources.

Once the benefits of scale and reach had been exhausted, a new factor became the driver of ECoEs. This factor is depletion, a term which describes the natural process whereby lowest-cost resources are used first, leaving costlier alternatives for later. Unlike reach and scale, depletion pushes trend ECoEs upwards rather than downwards.

We need to be clear that we are not going to ‘run out of’ oil, or, for that matter, gas or coal. Rather, what we are experiencing is a relentless increase in costs, as older (and generally larger and simpler) deposits are exhausted, and are replaced by resources which are higher-cost, and are often smaller, more remote and more technically challenging than previous sources.

The broad ECoE situation is illustrated in Fig. 5. It must be emphasised that the left-hand diagram (Fig.  5A) is a stylized, explanatory representation of the “ECoE parabola”, illustrating how ECoEs, initially driven downwards by scale and reach, then turn upwards as a result of depletion, with technology moving from an accelerating to a mitigating role.

Fig. 5

The central chart (Fig. 5B) shows the projection that, with the ECoEs of fossil fuels on a sharply rising trajectory, neither renewables, nor increased contributions from nuclear and hydroelectric power, are likely to do more than moderate the rising trend in overall ECoEs.

In SEEDS analysis, ECoE defines the difference between economic output and material prosperity. As energy supply becomes more challenging, whilst ECoEs continue to increase, prosperity is in the process of declining more rapidly than output measured as C-GDP (Fig. 5C). These are issues to which we shall return.

Matters at issue

At a later stage in this series, we’ll look at the evolution of prosperity in detail, but it’s helpful at this point to remind ourselves of what is at stake. The charts in Fig. 6 are designed to put this into context. For comparison, each is indexed, with 2021 set at 100.

Conventional data informs us that GDP, generally – though mistakenly – assumed to measure economic output and prosperity, was 101% higher in real terms in 2021 than it had been back in 2001 (Fig. 6A). Population numbers increased over that period but, nevertheless, GDP per capita rose by 62% between those years (Fig. 6B). Both of these positive trends are, we are told, capable of continuing indefinitely.

Energy-based interpretation, conducted using the SEEDS economic model, presents a completely different picture. Growth in aggregate prosperity did occur between 2001 and 2021, but SEEDS puts this at only 32% (Fig. 6C), meaning that the world’s average person was only 6%, rather than 62%, more prosperous in 2021 than he or she had been back in 2001 (Fig. 6D).

Fig. 6

Needless to say, this average person’s share of the world’s aggregate debts has increased dramatically, real debt per capita having expanded by 125% between those years – and even this doesn’t cover the broader liabilities embodied in the financial system.

More important still, SEEDS projects that aggregate prosperity is close to its point of inflexion, whilst prosperity per person has already turned down.

Here, then, is the point of contention. In stark contrast to the perpetual growth promised by orthodox economics, energy-based analysis informs us that prosperity can only expand, or even be maintained at current levels, if two conditions can be satisfied.

If aggregate prosperity is to be maintained, aggregate energy supply must not decrease, and we must find a way to stop further increases in trend ECoEs. Unless both conditions can be met, the economy gets smaller, with consequences that will be examined later in this series.

The outlook for supply

The ECoEs of fossil fuels are rising relentlessly, and will continue to do so. This means that volumetric supply of fossil energy is destined to contract.

This can be explained in terms of pricing which, for any energy source, has to meet two tests. First, it must cover suppliers’ costs. Second, it must be affordable for the consumer.

This can be said of any product or service, but the difference with energy is that the affordability of the consumer is determined by the energy to which he or she has access. This isn’t, then, the same kind of supply and demand equation that we might apply to non-energy products and services.

A person might or might not buy a cup of coffee or a refrigerator at its current price, but being unable or unwilling to make these purchases doesn’t reduce his or her income. This is where energy is profoundly different – a reduction in the supply of energy makes the economy poorer.

When ECoEs rise, not only do suppliers’ costs increase, but there is a simultaneous decrease in the prosperity (and hence in the affordability) of the consumer.

When costs are low, price-arbitraging the needs of producers and consumers is straightforward, because the available value margin is wide enough to satisfy both.

As costs rise, though, a point is reached at which volumes contract, because the costs of producers rise at the same time as the affordability of consumers declines. Far from being driven upwards by scarcity, fossil fuel prices might well decline in accordance with the decreasing prosperity (and hence affordability) of the user. This means that energy markets cannot be relied upon to give us advance warning about economic deterioration.

The SEEDS model uses a set of projections which sees the aggregate of fossil fuel supply falling by 18% between 2021 and 2040. Unless offset by increases from non-fossil sources, this would reduce total primary energy supply by 15% over that period.

It’s certainly possible that the supply of nuclear power will increase, but this is expensive, and would require a major resource investment commitment from an economy which, from now on, isn’t growing. The big problem here is scaling. As of 2021, the nuclear sector supplied only 4.5% of the world’s primary energy and, taking not just resource needs but construction times as well into account, it’s extremely unlikely that we can double, treble or quadruple nuclear generation in a comparatively short period of time. Nuclear fusion is plausible in theory, but has remained twenty-five years in the future throughout the lifetime of anyone reading this article.

Scenario assessment

What this means is that practical hopes for replacing dwindling fossil fuel energy are vested in renewables, with wind and solar power the renewable energy (RE) categories deemed to be capable of rapid expansion. In Fig. 7, we look at the demands that REs will be required to meet under four different scenarios.

In each instance, the focus is on the combined supply of energy from wind and solar power, which is shown in orange. For simplicity, it is assumed in all scenarios that fossil fuel supply declines by 18% between 2021 and 2040, and that there are modest increases in the availability of energy from nuclear and hydroelectric power.

In the first scenario (Fig. 7A), there is no increase in wind and solar from the 675 mm toe (tonnes of oil-equivalent) supplied in 2021. On this basis, and despite incremental contributions from nuclear and hydro, total primary energy availability is 12% lower in 2040 than it was in 2021.

In the second scenario, the aim is to see what needs to happen to keep the total supply of energy unchanged throughout the forecast period (Fig. 7B). For this to happen, and with all other parameters unchanged, supply from wind and solar has to be 250% higher in 2040 than it was in 2021. This might be feasible – we’ll look at the challenges shortly – but energy supply per capita would fall markedly, and the economic situation would be worsened by continuing increases in overall ECoEs.

If prosperity is to stand any chance of being maintained at current levels – taking into account rising ECoEs – aggregate energy supply needs to grow by at least 1.5% annually (Fig. 7C). For this to happen, we would need a 900% increase in the supply of energy from wind and solar power. This is roughly the set of projections which corresponds to the lower end of consensus expectations, and we’re not jumping too far ahead if we state here and now that this is extremely improbable.

The final scenario (Fig. 7D) is the one actually used in SEEDS analysis. By 2040, fossil fuel supplies are 18% lower than they were in 2021. Wind and solar power, taken together, have increased by 90%. There has been a 21% rise in the combined contribution of nuclear and hydroelectricity, and a modest increase from renewable sources other than wind and solar.

In this scenario, the aggregate supply of primary energy falls by 8%, and energy availability per capita is 20% lower in 2040 than it was in 2021.

Fig. 7

The limits to transition

Simply stated, the consensus view is that the supply of energy from wind and solar power will increase so dramatically in the coming decades that we can reduce or even eliminate the use of climate-damaging fossil fuels without experiencing any contraction in the economy. There can be no question about the importance of the environmental imperative contained in this view.

But the orthodox line doesn’t just postulate the attainment of environmental sustainability through like-for-like transition to renewables, let alone suggest that we can attain sustainability by making some economic sacrifices, which might be a reasonable point of view.

Rather, it holds out the bold promise of “sustainable growth”.

We’re told, for instance, that most of the world’s vehicles – totalling close to 2 billion, and including 1.1 billion cars – can be replaced with electric vehicles (EVs). The aggregate of global prosperity will carry on growing indefinitely, perhaps by between 3% and 3.5% annually, meaning that the economy will be somewhere between 75% and 90% bigger, in real terms, in 2040 than it was in 2021. Needless to say, there won’t have to be significant sacrifices made by the public, who will carry on driving, flying and consuming at ever-increasing rates.

All of this depends absolutely on dramatic expansion in the energy supplied by renewables, which really means by wind and solar power, as these are the two categories which are capable, at least according to the orthodox narrative, of major increases in scale. The ability of these sources of supply to increase is not a matter of dispute. The question is whether they expand by enough to take over from fossil fuels.

It has to be said that the consensus scenario of seamless transition owes almost everything to assumption, and virtually nothing to a realistic appraisal of what is achievable within available resources and the parameters set by the laws of physics. The latter is a good place to start an investigation of what might be possible for energy transition.

There are, broadly speaking, two ways in which the supply of any material product can be increased. One of these is to increase the technical efficiency of the supply process, and the other is to expand production capacity. If a manufacturer wants to double his output of widgets, he can either find machinery which is twice as efficient as what he is using now, or double the size of his factory.

Where efficiency is concerned, the harnessing of energy is subject to the laws of physics, which set limits to what is possible. This is certainly true of renewables. The potential efficiency of wind power is determined by Betz’ Law, which states that a maximum of 60% of the kinetic energy of wind can be captured by a turbine. The equivalent for solar is the Shockley-Queisser Limit, which is 34%.

For practical purposes, two observations need to be made here. First, we cannot expect to lift conversion efficiency all the way to the Betz and Shockley-Queisser maxima, because no technology can attain perfect theoretical efficiency.

Second, and more importantly, current best practice is already close to theoretical maxima. The conversion ratios of solar panels (where the limit is 34%) already exceeds 26%. The efficiency of wind energy conversion, where the maximum is 60%, is already above 40%.

In short, and whilst technical progress is likely to continue, there can be no quantum leap in conversion efficiencies, a conclusion well stated here.

If we are to attain very large increases in the supply of wind and solar power, the heavy lifting will have to be done by capacity expansion.

The cost of transition to renewables has been calculated, and is known to be enormous, well in excess of USD 100 trillion. What matters, though, isn’t the financial cost, but what that cost means in terms of the material inputs to be purchased with it.

Rapid expansion (and maintenance) of wind and solar generating capacity and distribution will require vast amounts of concrete, steel, copper, plastics, lithium, cobalt, nickel, graphite, rare earths and numerous other raw materials. It is by no means clear that these materials even exist in the requisite quantities – and the environmental and ecological effects of accessing them are likely to be severely adverse.

On one point there is no scope for dispute – making these raw materials available on a huge scale will require the use of correspondingly vast amounts of energy.

Two further considerations exacerbate the input problem. The first is the intermittency of wind and solar power, and the second is the intrinsic difficulty of storing electricity when compared with the storage of fossil fuels. In the absence of fossil fuel back-up, intermittency requires both surplus capacity (for use when the sun is shining and the wind is blowing) and large and efficient methods of storage.

Both of these considerations leverage the necessary quantities of material inputs. Battery weight is about 60X higher than the weight required for the storage of an energy-equivalent quantity of fossil fuels, and between 50 and 100 tonnes of raw materials are needed for each tonne of batteries produced. In some applications, hydrogen might be a viable alternative storage technology, but hydrogen does not exist in its natural state, and its manufacture is energy-intensive.

This is why systemic capacity for the storage of electricity remains very small indeed. Inventories of petroleum are customarily recorded in days, weeks or months, but electricity reserves are calculated in minutes. In the report cited above, it was stated that “[t]he annual output of Tesla’s Gigafactory, the world’s largest battery factory, could store three minutes’ worth of annual U.S. electricity demand. It would require 1,000 years of production to make enough batteries for two days’ worth of U.S. electricity demand”.

It needs to be noted, too, that capacity expansion targets need to take account of the ageing and replacement, not just of batteries, but of wind turbines and solar panels as well.

The second compounding factor is the shape of planned application. It is, for example, one thing to use renewable electricity to power trams or electric railways, but quite another to supply huge numbers of EVs.

What we are trying to do is to transition vehicles – and numerous other systems created on the basis of fossil fuels – to a completely different source of energy. This isn’t how energy-using technologies develop. The Wright Brothers didn’t invent the aeroplane and then sit around waiting for someone to discover petroleum.

Rather, technologies need to be developed in accordance with the energy available. But there is no preparedness to accept that trains and trams might make more sense than cars in a transport system powered by electricity rather than by petroleum. Even the humble bitumen used in road surfaces is sourced from oil.

Serious though these problems are, we have yet to come to the clincher on seamless transition. Even if we assume that all necessary materials for renewable transition exist in the required quantities, they still need to be extracted, processed, manufactured and delivered, and this requires massive quantities of energy that can only come from the legacy energy of fossil fuels. This, in turn, ties the ECoEs of renewables to those of oil, gas and coal.

Even if supplies of fossil fuel energy could be relied upon to continue at current levels, nobody has yet postulated the current uses of this energy that will be relinquished to free up energy for the purposes of transition. Are we prepared to drive less, fly less or consume less, in order to make energy available for the extraction and processing of steel, copper, lithium and cobalt?

A rocky road ahead

The situation, in summary, is that (a) fossil fuel supplies can be expected to decrease more rapidly than alternatives can be expanded, and (b) that the material connection between renewables and fossil fuels makes it implausible that the relentless rise in ECoEs can be stemmed, still less reversed, by renewables expansion. As we have seen, decreasing energy availability reduces economic output, whilst rising ECoEs leverage the adverse consequences for prosperity.

The Surplus Energy Economics project concentrates on the analytical rather than the prescriptive, and the foregoing should not be taken as disputing the imperative of transition to renewables.

On the contrary, renewables offer our best chance of mitigating economic decline. If we decided to stick with fossil fuel energy and back-pedal on renewables, the economy would contract under the combined pressures of decreasing energy supply and relentlessly rising ECoEs.

There is not, as is so often assumed, any necessary contradiction between our economic and our environmental best interests, which means that transition is imperative for economic as well as environmental reasons. If we tried to carry on with reliance on fossil fuels, we might wreck the environment but would definitely wreck the economy, as supplies of fossil energy decline, and their ECoEs soar.

But there really is no justification for techno-optimism around transition, and claims that “sustainable growth” is assured are starkly at odds with reality. The fact of the matter is that fossil fuels offer energy density, flexibility and portability that no other source of primary energy can match.

We cannot circumvent the laws of physics, nor sever the necessary connection between energy use and economic output. Neither can we reverse the rise in ECoEs by switching to lower-density sources of energy supply.

With this understood, we can move on to assess the outlook, first for economic prosperity, and then for the financial system.

#246: The Surplus Energy Economy, part 1



We have reached a turning-point at which economics and the economy have parted company. Orthodox economics continues to promise growth in perpetuity, but the economy itself is going in the opposite direction.

The explanation for this is simple. Conventional economics assumes that the economy is driven by money, which is entirely under our control. But the economy is, in reality, not a financial system, but a physical one, which uses energy to convert raw materials into the products and services which constitute prosperity. The modern economy has been built on abundant, low-cost energy from fossil fuels, but this dynamic is winding down and, as we shall see in a future instalment, we have no complete (or timely) alternative with which to replace it.

The aim with The Surplus Energy Economy is to set out a comprehensive assessment of the condition and prospects of the world economy and financial system, seen from the perspective that the economy is shaped by energy, not money. This series of articles will be as specific as possible, using data from the SEEDS economic model.

The conclusions reached here necessarily contradict the orthodox line, which is that the supposed ‘normality’ of growth will soon return, and that seamless transition to renewable energy sources will deliver economic expansion in perpetuity.

The economy is analysed here as a material system which has started to contract after reaching physical constraints imposed by the availability and cost of energy. Similar limits apply to environmental tolerance for energy-based economic activity.

Findings will come later in this series, but we are completely unprepared for the reversal of prior growth in the economy. The ending of growth has not arrived without warning, and we can identify a precursor zone, starting in the 1990s, which was characterised by deceleration, followed by stagnation.

Rendered myopic by denial, and misled by a mistaken economic orthodoxy, we have been attempting the impossible task of fixing material economic problems with monetary tools. As we shall see, this has placed global finance at systemic risk.

An economy on the turn

The consensus view of current global economic problems is that they are temporary, and largely traceable to pandemic lockdowns and the war in Eastern Europe, though some observers do concede that excessive use of QE might have been a factor in the recent resurgence of inflation.

These, though, are explanations rooted in orthodox economics, which makes many fallacious assumptions. One is that the economy is entirely a financial system, not constrained by energy, resource or environmental limitations. Another is that the economy can grow in perpetuity, notwithstanding the limited physical characteristics of the Earth.

The concept of ‘infinite growth on a finite planet’ isn’t a logical proposition, but it’s been a mightily persuasive one.

Evidence is accumulating in support of an alternative view, which is that the economy is a material system, subject to physical constraints, and that economic prosperity is determined by energy, not money. Surplus Energy Economics interprets the economy in this way, and models it on this basis using SEEDS (the Surplus Energy Economics Data System).

Energy interpretation of the economy isn’t going to be accepted by the mainstream any time soon, and not just because it demonstrates the fallacies of orthodox economics. Energy-based analysis tells us that economic growth, far from continuing indefinitely, has already decelerated via stagnation into contraction.

This has never been a remotely acceptable conclusion where the ‘powers that be’ – or, for that matter, the general public – are concerned. Over a very long period, we have been using monetary gimmickry in futile efforts to reinvigorate a floundering economy. But trying to fix a material economic problem with financial tools can be compared to trying to cure an ailing house-plant with a spanner.

These efforts have led, via the global financial crisis (GFC) of 2008-09 and a subsequent era of monetary recklessness, to a point of systemic risk in global finance. We have a ludicrously-inflated “everything bubble” in asset prices and, even more seriously, an enormous complex of inter-connected liabilities which the system cannot possibly honour ‘for value’.

Why, though, are economics and the economy going in different directions?

Origins – ‘the class of ‘76’

When the year 1776 is mentioned, it probably reminds people chiefly of the Declaration of Independence, from which date the history of the United States begins. But two other events of profound importance also happened in that year, and both of them took place in Scotland. James Watt completed the first truly efficient steam engine in 1776, whilst Adam Smith published An Inquiry into the Nature and Causes of the Wealth of Nations in the same year.

The importance of these breakthroughs is scarcely capable of exaggeration. Watt gave the world the ability to convert heat into work, which enabled us to harness the vast energy resources contained in coal, oil and natural gas. Smith’s book, generally referred to as The Wealth of Nations, was the founding treatise of classical economics.

A significant distinction needs to be noted from the outset. James Watt was an engineer and inventor, and his practical work laid the foundations for a vast expansion in the material economy of products and services. Adam Smith was primarily a philosopher – he considered The Theory of Moral Sentiments (1759) his finest work – and can be described as a theoretician, setting out his explanation of the economy in terms of the working of money.

It’s worth remembering, too, that Smith was describing an agrarian economy, and could not have anticipated the coming of the Industrial Revolution. No-one should doubt the importance of Smith’s ground-breaking work, but we are entitled to wonder why, more than two centuries into the Industrial Age, his successors continue to adhere to the precepts of an economy shaped by money alone, not subject to material constraints, and capable of defying logic by delivering “infinite growth on a finite planet”.

The activities which began with ‘the class of ‘76’ have continued in parallel ever since. The heirs to Watt created the huge and complex economy of modern times, accomplished on the basis of energy from fossil fuels. Classical economists, who are the heirs to Smith, have purported to explain this dramatic expansion in terms, not of material energy, but of money, which is an immaterial human artefact used primarily for the exchange – not the creation – of the products and services made available by the harnessing of energy.

So long as the economy continued to expand, there was no necessary conflict, other than at the intellectual level, between these two schools of thought. The beneficiaries of economic growth could thank Watt for their improving prosperity, or hand the credit to Smith, with most people probably giving scant thought to either.

Now, though, we have reached a parting of the ways between economics and the economy. It’s becoming increasingly apparent that economic growth, having decelerated since at least the 1990s (and arguably for a lot longer than that), has gone into reverse.

Classical economics says that this can’t happen. As we shall see, observation makes it increasingly clear that it has.

This presents us with a choice of two interpretations. One, favoured here, is that prior growth in prosperity has reversed because the fossil fuel dynamic has been winding down. The other is that we can restore the economy to perpetual expansion if we work along the monetary lines specified by classical economics.

The existence of ample intellectual and observational evidence makes it imperative that we take note of economic deterioration, and then seek explanations for why it has been happening. In the modern parlance, there is a range of “narratives” which purport to tell us why the economy is struggling. We looked at these rival explanations in a previous article, so need not distract ourselves by revisiting them now.

The line of inquiry followed here is based on reasoning from first principles within a framework of evidence. Our conclusions are simply stated.

Prior growth in the industrial economy has gone into reverse, because the dynamic built on fossil fuel energy has decelerated, over a lengthy period of time, to a point of trend reversal which we might, if we so choose, call “inflexion”. There exists no plausible alternative that offers a complete and timely replacement for the economic value hitherto sourced from oil, gas and coal.

This means that, in material terms, the world is getting poorer. We can see this happening, if we choose to look. At the same time, energy-intensive necessities are becoming more expensive. The ensuing contraction in discretionary prosperity is one of the main economic problems created by this process.

The other is the unravelling of the vast financial system predicated entirely on the assumption that the underlying economy of products and services could never cease to grow, let alone start to contract.

Foundation principles

The Surplus Energy Economics interpretation of the economy reasons from first principles, of which there are three.

First, the economy is an energy system, because literally nothing that has any economic value at all can be supplied without the use of energy. Other raw materials, including food and water as well as minerals and plastics, are functions of the energy required to make them available. Energy is ‘the master resource’, and is the obvious connection between our economic and environmental challenges.

To be slightly more specific, the modern economy is a dissipative landfill system. Energy is used to convert raw materials into products whose ultimate destination is disposal. This is dissipative because, in thermodynamic terms, this process involves the conversion of concentrated, dense energy into the diffuse format of waste heat. The use of fossil fuels as the concentrated input to this process means that the resulting waste heat contains climate-harming gases.

The second principle is that energy is never ‘free’. Whenever energy is accessed for our use, some of that energy is always consumed in the access process. Energy is used at every stage in the creation, maintenance, operation and replacement of the systems which supply us with energy. This ‘consumed in access’ component is a cost deduction, because it is energy which cannot be used for any other economic purpose. It can be thought of as a rent levied upon economic activity by the material character of energy resources.

It is known here as the Energy Cost of Energy, giving us the principle of ECoE.

This means that material prosperity is a product of the supply, value and cost of energy. Prosperity, therefore, is, first and foremost, a material concept, not a financial one.

Money has no intrinsic worth, but commands value only as a man-made ‘claim’ on the material output of the energy economy. It is worthless unless there is something material for which it can be exchanged.

Our third and final principle is that of money as claim.

‘Two economies’

As well as being self-evident, these principles lead us to an obvious conclusion. This is that we need to think conceptually in terms of ‘two economies’. One of these is the ‘real’ or material economy of products and services made available by the use of energy. The other is the ‘financial’ or parallel economy of money and credit.

From this, it follows that the financial economy is a representational counterpart or proxy of the real economy. If these ‘two economies’ are in a reasonably close relationship, we are in a situation of equilibrium where the claims that constitute the financial system can be honoured by the material economy.

As we shall see, the situation now is one of extreme disequilibrium, meaning that we have created an enormous quantity of excess claims which cannot be ‘honoured for value’. This is why major downsizing of the financial system has become inescapable, and will look like ‘value destruction’.

The reality – though it’s of scant comfort – is that much of the ‘value’ that will be destroyed never really existed in the first place, and consisted of monetary claims that the real economy of the future was never going to be able to honour. We are, in fact, in two bubbles – the “everything bubble” in asset prices, which is destined to burst, and the ‘delusion bubble’ of gigantic financial commitments that must be relinquished because they cannot possibly be honoured.

A brief history of now

The central proposition which emerges from first principles is that prosperity is a function of surplus energy, meaning total energy less the ECoE cost of making that energy available for use.

In pre-industrial times, almost all energy was sourced from human and animal labour. The dynamic here was that human energy was obtained from nutrition, and expended in hunting or finding that nutritional energy. The same equation exists in nature, where an animal or a bird survives only if the energy sourced from consuming food exceeds the energy expended in obtaining it.

Agriculture made this process more efficient without, of course, changing the fundamental dynamic. If, say, twenty people could now be fed by the labour of nineteen, an energy surplus existed which enabled the release of the twentieth person for non-subsistence activities. These activities were varied, and included capital investment in buildings, tools and infrastructure, all of which increase productivity in the future by sacrificing consumption in the present. But a surplus of 1/20 is very small, which explains why pre-industrial systems of investment, craft manufacture, education, law and government were rudimentary by later standards.

Accessing fossil fuels was completely transformative. In today’s developed economies, very few people work in agriculture, and their labour is supplemented enormously by inputs and services made available by fossil fuel energy. Modern agriculture, no less than industry, is a system built on oil, gas and coal.

Classical economics, which traces its origins to the pre-industrial era, is prone to ignoring the energy dynamic to the point of absurdity. For example, the statistic that only about 6% of world GDP is attributable to agriculture leads to the absurd proposition that the remaining 94% of the economy could carry on unaffected if we lost the ability to produce food. In many economies, activities like tourism and financial services are statistically larger proportions of GDP than agriculture or the supply of energy, and are thus deemed to be ‘more important’, and worthier of more investment and policy attention, than these basics.

Classical economics side-steps issues of scarcity by promising infinite substitutability, a claim which, where energy is concerned, is now being disproved, with brutal economic consequences.

Conventional economics has been described as “the dismal science” and, whilst it might indeed be dismal, it certainly isn’t a science. What classical economics is pleased to call the “laws” of economics are merely observations about the behaviour of the human artefact of money, and are in no way analogous to the laws of science.

It hardly needs be said that energy cannot be lent into existence by commercial banks, or created out of the ether by central bankers. We can’t overcome environmental problems by sending a cheque to the universe, and neither, for that matter, can we make energy transition to renewables possible by using QE – any such exercise would be self-defeating, because it would simply push up the prices of every raw material input required for the expansion and maintenance of renewables.

Output and prosperity

Two terms used frequently here are output and prosperity, and we need to be clear about the difference between them. The understanding of prosperity, defined in material terms, ought to be the primary objective of economics, and the calculation of prosperity is at the centre of the SEEDS economic model.

The difference between output and prosperity is cost, much as necessary expenses are the difference between individuals’ total and disposable incomes. At the macroeconomic level, output is the value created by the use of energy, and prosperity is what remains after ECoE has been deducted from output thus defined.

The principal metric in orthodox macroeconomics is gross domestic product, which is often, – though quite mistakenly – assumed to be a measure of output or prosperity. In fact, GDP is a quantification of financial transactional activity, and it’s perfectly possible, indeed commonplace, for transactions to take place without any economic value being created.

One technical point needs to be made here before we examine economic output. There are two ways in which other currencies can be converted into dollars for purposes of comparison and global aggregation. One of these is to use market exchange rates, and the other is known as purchasing power parity (PPP). PPP is the convention used in measuring global growth, and it is the one used here, except where otherwise stated. Monetary amounts need to be expressed at constant (‘real’) values, so the nomenclature is ‘$PPP 2021’. SEEDS analysis of national economies is undertaken in local currencies, again at constant 2021 values.

When it comes to internationally-comparable conventional economic statistics, the International Monetary Fund can be regarded as authoritative. In its most recent set of data, published in October, the IMF stated that world gross domestic product fell by 3.0% in 2020, during pandemic lockdowns, grew by 6.0% in 2021, and was likely to have increased by 3.2% during 2022.

From the same source, world GDP was $146 trillion (PPP) in 2021. Adjusted for broad inflation (using the GDP deflator), the equivalent number for 2001 was $73tn, meaning that reported real GDP doubled (+101%) between those years.

Over the same period, though, global debt increased by 180% in real terms, in a relationship illustrated in Fig. 1. Over a period in which reported GDP grew by $73tn, total public and private debt expanded by $232tn (Fig. 1A), meaning that each dollar of reported growth was accompanied by $3.15 of net new borrowing. Another way to look at this is that borrowing averaged 10.8% of GDP during a period in which reported growth in GDP averaged 3.4% (Fig. 1B).

For the United States, growth in GDP of USD 7.3tn (46%) was accompanied by a USD 34tn (115%) increase in aggregate debt. On this basis, USD 4.66 of net new debt was added for each dollar of reported growth, whilst borrowing averaged 8.9% of GDP during a period when GDP itself grew at an annual average rate of 1.9%.

Fig. 1

Given that GDP is a measure of transactions, a direct connection exists between borrowing and changes in GDP. A simple example illustrates this point. If a government were to use borrowed money to employ 10,000 people to dig holes in roads, and another 10,000 to fill them in again, the wages paid to both groups would be added to GDP, even though no economic value has been added. The spending of these wages would contribute to GDP measured as expenditures and, most absurdly, the work would count as ‘value added’ for computational purposes, even though no such value has in fact been created.

The cost of employing these workers would be added to government debt, where it would be disregarded by anyone choosing not to make the connection between the two. The technical terms for these are flow (in this instance, of GDP) and stock (of debt).

What this amounts to is that you can report just about as much “growth” as you like, depending upon how much you are willing and able to borrow. Historic data illustrates this connection. Between 2001 and 2021, average growth in the United States was 1.9%, and annual borrowing averaged 8.9% of GDP, as we have seen. China reported far more growth than America over this period (averaging 7.8%), but also borrowed very much more (an average of 24.7% of GDP).

A reflection on absurdities

This relationship between stock and flow cautions us, not just against an unquestioning acceptance of GDP as a measure of output, but also against relying on the ratio of debt to GDP, because these are not discrete data series.

We are sometimes told that debt “doesn’t matter”, which, of course, is absurd. We are also informed that borrowing now can create growth which, in due course, ‘pays off’ the debt taken on to create it. Individual enterprises can indeed do this, but a borrowing-to-growth ratio of 3:1 (and often higher) makes this a mathematical absurdity at the macroeconomic level.

Whilst we’re pondering absurdities, few are more readily accepted than aggregate ‘valuations’ of assets. We are routinely told that market movements have ‘added’ or ‘wiped out’ billions, or even trillions, in investor value. Statisticians – who really should know better – frequently tot up the supposed value of property and other assets and then deduct liabilities to produce a ‘national balance sheet’. The results usually echo Harold MacMillan when he told the British public (in 1957) that they’d “never had it so good”.

The reality, of course, is that the only potential buyers for the entirety of a nation’s housing stock are the same people to whom it already belongs. Foreign buyers don’t affect this other than at the margin and, in any case, their investment merely shifts property demand between countries.

The same applies to any asset class, including stocks and bonds. Aggregates are arrived at by multiplying average prices by the number of units of the asset in question. This implies that the entire asset class could be sold for that sum, which is completely impossible. The error involved here is the application of marginal transaction prices to the aggregate of stock.

Property is an appropriate example, because we are often treated to the proposition that real property prices can never fall because ‘demand is always increasing as population numbers expand’. The mistake made in such glib statements is the conflation of ‘demand’ with ‘want’. You or I might ‘want’ a new sports car, but that ‘want’ only counts as demand to the extent that we have the wherewithal to implement it. Likewise, ‘wanting’ or ‘needing’ a home does not count as ‘demand’ unless prices are within the reach of those who want or need one.

It’s much more meaningful to think of asset prices as the inverse of the cost of capital. What this in turn means is that stock – not just of asset values, but of liability viability as well – is a temporal function of economic flow.

This leads us, as a precursor to measuring prosperity, into a consideration of what really constitutes economic ‘output’.

Underlying output

As we have seen, much of the economic ‘growth’ of recent times has been created by credit expansion. The SEEDS economic model strips out this ‘credit effect’ to calculate underlying or ‘clean’ economic output, known here as C-GDP.

This is illustrated in Fig. 2. On this adjusted basis, underlying annual average growth in the global economy between 2001 and 2021 was only 1.6%, rather than the reported 3.4% (Fig. 2A).

Over this period, the expansion in C-GDP was only $27tn, or 39%, rather than the reported increase of $73tn, or 101% (Fig. 2B). Put another way, within total reported growth in the global economy over those two decades, only 37% ranks as organic expansion, and the remaining 63% was the cosmetic effect of pouring huge amounts of borrowed money into the system, and counting the ensuing transactions as ‘output’.

Fig. 2

We can ‘cut to the chase’ here by looking back at Fig. 1A and asking ourselves whether the pattern illustrated there is sustainable – in other words, can we carry on, indefinitely, adding more than $3 of debt for each $1 of “growth”, or does a point arrive at which it becomes apparent that this debt can never be repaid?

When that point does arrive – which, of course, it must, and perhaps now has – the result is a collapse in confidence, which happens at the moment when enough people realize that debts and other commitments owed to them cannot be honoured ‘for value’. This will trigger defaults, which may be ‘hard’ (reneging on debts), ‘soft’ (allowing inflation to destroy the real value of debt repayment), or a combination of the two. Since one person’s debt is another person’s asset, there is no cost-free way of simply writing off outstanding debts.

One thing is certain – we cannot create material economic value by borrowing, or by producing new money out of the ether.

The energy connection

For most purposes, the SEEDS calculation of C-GDP commences in 2000 – as we scroll back through the 1990s and beyond, necessary data for some economies is not available, and starting more than two decades ago provides a sufficiency of historic information for our purposes.

In a recent exercise, though, the SEEDS clock on global C-GDP was started, not in 2000, but in 1980, and the results of this investigation, when compared with energy use, were startling. As illustrated in Fig. 3, the relationship between underlying economic output (C-GDP) and primary energy consumption was not just linear but strikingly consistent (Fig. 3A).

The ratio of economic output and energy use, shown in Fig. 3B, didn’t vary by more than +/- 4% in any one of the forty-two years between 1980 and 2021. Given the vicissitudes experienced in both the economy and the supply of energy over that very lengthy period, this consistency is remarkable (and was completely unexpected before the calculations were made).

Fig. 3

This finding might seem surprising, because it implies that there has been no improvement, over a very long period, in the efficiency with which energy is converted into economic value.

There are a number of possible explanations, and these might repay investigation in the future. Just one of these may be that advances in efficiency are cancelled out by deterioration in the quality of non-energy raw materials. In minerals, for example, a decline in ore densities could easily offset any progress made in the efficiency of extraction and processing.

Be that as it may, the clear implication is that we cannot “de-couple” the generation of economic value from the quantitative use of energy. As you may know, the European Environmental Bureau dismissed the concept of de-coupling in a 2019 paper entitled Decoupling debunked: Why green growth is not enough. The report remarked that the case that has been made for de-coupling is “a haystack without a needle”.

Energy itself will be addressed later in this series, but the general conclusion is that the availability of primary energy is poised to decrease, mainly because the supply of alternatives, such as renewables, nuclear and hydroelectricity, will not be able to expand at rates sufficient to offset the impending decline in the production of fossil fuels.

From an environmental perspective, this is positive, but we should be in no doubt at all that a decreasing availability of primary energy means that economic output will contract. The economic outlook suggests broad re-prioritization, and this might provide a modest, and probably transitory, improvement in conversion efficiency (see Fig. 3C). But we should be in no doubt that reduced energy use will result in a smaller economy (Fig. 3D).

Starting from first principles, we have seen how economic output is a linear function of the energy available to the system. In the next article, we’ll look at how the cost of energy feeds into these equations, and how we can conclude – whisper it who dares – that prior growth in material prosperity has gone into reverse.

#245: 2023 – Navigating the narratives


At the start of 2023, an impartial observer could easily conclude that ‘the world has gone mad’. This is most evident in what is sometimes called ‘the public discourse’. Where our economic prospects are concerned, what we are witnessing must rank as the most extreme case of collective denial ever experienced.

Few would dispute that the economy went badly awry last year. In concrete terms, there were widespread and severe falls in living standards, whilst the cost of mortgages and credit rose markedly. Asset prices started their descent from absurdly over-inflated levels.

But there’s a lot that didn’t happen in 2022, but may be lying in wait in the year ahead. Air has started to leak out of the “everything bubble” but it hasn’t, thus far, actually burst, as most bubbles do. We’ve yet to see a cascade of defaults on credit commitments, though this could be a logical corollary of asset price slumps (which impair collateral), and of declining household disposable incomes and falling corporate profitability, most obviously in discretionary sectors.

This is for real

This isn’t intended as a forecast, and we cannot rule out a gradual retreat from the excesses fuelled by a combination of economic deterioration, cheap credit and cheaper money.

Rather, the point is that we need to take this very seriously indeed, and that’s the intention here. The world is awash with “narratives”, and this combines with two factors – the rapidity of change, and the highly elevated levels of risk – to require a focus on what we can know, rather than on what we can only speculate about.

Where “narratives” are concerned, the orthodox line remains that, once the pandemic and the war in Eastern Europe are behind us, the global economy will return to perpetual growth, with technology delivering a shiny new world of prosperity powered by limitless amounts of climate-friendly renewable energy.

This, both in detail and in toto, is at the far end of implausible. Growth in material prosperity has gone into reverse, and claims to the contrary are in direct conflict, not just with logical analysis, but with the lived experiences of millions as well.

De-globalization is already underway, and the much more serious process of the de-financialization of the economy comes next.

This situation presents us with choices. We can participate in collective denial, or we can analyse the economic and broader situation from a rational point of view, founded in first principles. The latter approach is preferred here. Effective analysis of the economy is perfectly possible, but its results are unpalatable to what we might term ‘the generality of opinion’.

The facts of the matter are simply stated. The harnessing of abundant, low-cost energy from coal, oil and natural gas triggered two centuries of remarkable economic growth. Now, though, fossil fuel energy has ceased to be low-cost and can be expected, in consequence, to become a lot less abundant as well. With no complete replacement available for the energy value hitherto sourced from fossil fuels, the economy can only contract.

In no particular order of priority, our second problem is the environmental and ecological harm inflicted by historic and continuing use of carbon energy. On the basis of fossil fuels, the economy has evolved into a dissipative landfill system. Energy is used to process raw materials into products whose ultimate (and usually rapid) destination is disposal. This involves the conversion of energy from concentrated into diffuse form. The latter is waste heat which, in a system powered by fossil fuels, contains climate-harming gases.

None of what we are experiencing now has happened without prior warning. The remarkably prescient The Limits to Growth (LtG), published back in 1972, used system dynamics to forecast declines in industrial output and the supply of raw materials, combined with a worsening in what was then termed “pollution”. These warnings were very largely ignored, not because they were wrong, but because they were inconvenient.

At a humbler and less ambitious level, the SEEDS economic model provides a nearer-term, financially-calibrated interpretation which accords with the prognosis of LtG.

SEEDS draws two important distinctions. One of these is the difference between economic output and material prosperity. The other is the distinction between the ‘real’ or material economy of energy and the ‘financial’ or proxy economy of money and credit.

The interpretation and projections produced by SEEDS are unsettling, in that they involve a continuing deterioration in material prosperity and the fracturing of a financial system entirely predicated on the assumption that prior growth in the economy could never go into reverse.

A series of outcomes follows from this. The first is that, whilst prosperity erodes, the real costs of energy-intensive necessities will rise. This process of affordability compression has two principal effects. One is that consumption of discretionary products and services will contract, and the other is that payment streams from households to the corporate and financial sectors will be undermined.

The latter takes us into the financial system, where successive exercises in denial-gimmickry have created an enormous bubble in asset prices, and a gigantic network of interconnected financial commitments that cannot be honoured. Where these liabilities are concerned, we don’t even have complete data, let alone plans for managing a contraction which seems likely to be disorderly. One consequence is that, whilst the onset of ‘de-globalization’ has started to gain some notice, the process of de-financialization has not.

As assumptions degrade, narratives proliferate

During two centuries of rapid economic expansion, various observations have taken on the status of certainties. Quite naturally, people have come to believe that economic expansion is the natural order of things. Few may pay much attention to announcements about rising GDP – the metric which purports to measure prosperity – but it has long been taken for granted that the material circumstances of individuals and families will improve over time, and that children will be better off than their parents were at any given age.

What we have been experiencing in recent years has been the rapid degradation of such certainties. How individuals react to this dislocation necessarily varies. Some take a “Pollyanna” stance, embracing denial, and accepting the line that growth will resume once the sheer bad luck of a pandemic and a war in quick succession is behind us.

Others, translating “Bond villains” from book and screen to real life, seek someone to blame, which could be anyone from Mr Putin to schemers plotting in the shadows. Still others side with Cassandra, predicting imminent collapse and dusting off the old sandwich-boards of “The End is Nigh!”

It seems likely that there’s a large and growing fourth strand of opinion which, whilst uncommitted to any of the above, is mystified and increasingly suspicious. For many, bafflement and mistrust may be just a few short steps from anger.

The approach preferred here is that of rational analysis and informed debate. I believe that the best process for the advancement of understanding is courteous, informed and reasoned discussion, and I am deeply grateful to everyone who has contributed to our conversations over the past twelve months. A notable milestone was passed in 2022 when, for the first time, more than 80,000 different people from around the world – to be exact, from 154 countries – visited this site at least once.

The immediate plan is to set out a comprehensive statement of what we know about the economy and the financial system from the energy-based perspective. This cannot be accomplished in a single article, but it seems important that we codify our understanding.

Finally, it’s worth remarking that the dissipative-landfill model isn’t some kind of eternal verity. It isn’t the only way to manage the provision of goods and services to the public, and it didn’t exist in anything like its current form before the Industrial Revolution.

The pre-industrial economy might be described as sustainable, but there are two big snags with trying to create “sustainable 2.0”. The first of these is that the global population now numbers eight billion, up from about 660 million in 1776, when the first efficient mechanism for converting heat into work was unveiled.

The second is that the immaterial end-product of the dissipative-landfill system is a set of entrenched attitudes, assumptions which are now colliding with the reality of resource and environmental limits.

Life in agrarian times wasn’t a bucolic idyll and, in any case, we can’t go back to it. What we can do is to analyse the unfolding situation objectively, looking for rationally-based visibility on how events are likely to unfold.

Whilst anyone can leap to conclusions and assumptions, knowledge can only be reached through plodding and faltering steps.

#244. In search of illusory value



If you own a portfolio of stocks whose value has risen over time, or a property whose market price has increased, you are at liberty to cash in those gains by selling your investment. This, though, does not apply to investors in the aggregate because, by definition, any sizeable selling activity drives prices down, thus reducing, eliminating or reversing prior capital appreciation.

Put another way, the tidal-wave of cheap money poured into the economy over the past fourteen years, whilst it may have enriched some, has created paper, notional or non-realisable gains for the majority of investors, including those ‘ordinary’, non-wealthy people whose savings are managed by institutions, and whose wealth is often based on inflated property values which, in the aggregate, cannot be turned into cash.

The principle is that, unlike incomes from dividends or rents, aggregate gains in asset prices cannot be monetized.

Though critical, this point is entirely missed by any media reporter who writes about the billions (or trillions) ‘gained’ by investors over a given period of time, and by those statisticians who, by multiplying the price of the average home by the number of properties, purport to put an aggregate ‘value’ on a nation’s housing stock. The multiplication of aggregate quantities – such as the numbers of stocks, bonds or properties – by marginal transaction prices creates valuations which are as meaningless as they are often impressive.

This needs to be borne in mind when we look at the gains supposedly made ‘by investors’ since the authorities adopted policies which, by driving down returns on capital, have created enormous increases in the market values of assets.

The subject of ‘investors’ has become almost toxic since the global financial crisis, when the authorities were accused of ‘rescuing Wall Street by plundering Main Street’. Inequalities of incomes and wealth have undoubtedly widened dramatically, and some governments have actually made this worse by ‘helping’ young people to go deeply into debt in order to shore up property prices to the benefit of their elders. There is nothing here that any reasonable person would try to defend.

Analytically, though, something fundamental has happened to returns on capital. Income returns – in the form of bankable cash – have been crushed, and replaced by non-bankable capital gains which, in the aggregate, can’t be monetized.

We know how this has happened, and we can be pretty sure about where it ends, which is in falls of varying (but generally severe) magnitude across the gamut of asset classes.

But why has the financial system behaved in this way? The view set out here is that an economy characterised by cosmetic “growth” has been forced to resort to replacing bankable investment returns with cosmetic, non-monetizable “returns” on capital.

What follows is not, in any sense ‘sympathetic’ to investors, still less a defence of the paper beneficiaries of the divergence between incomes and asset prices. Rather, the aim is to examine the abandonment of market and capitalist principles in the face of unacknowledged economic contraction.


Time was when investors earned solid (and, for the most part, reliable) returns on their capital, in the form of cash incomes from stock dividends, bond coupons and property rentals. They would, of course, hope that these returns would be augmented by capital appreciation, but saving and investment remained viable so long as, over time, both incomes and asset prices at least matched inflation. The relationship between risk and return could be calibrated in these terms, with growth potential known to be in an inverse relationship with yields.

Latterly, yields – the rates of income earned on capital – have been crushed, making capital appreciation the primary form of return on investment. But there’s a fundamental difference between investment income and capital gains – whilst incomes are bankable, capital appreciation, in the aggregate, is not. As remarked earlier, the individual can sell his or her stocks, bonds or property in order to bank asset price appreciation, but investors collectively cannot do so.

In short, investors, as a class, have been stripped of cash incomes and fobbed off with paper capital appreciation that cannot, in the aggregate, be monetized, and may very well evaporate as markets back away from the frenzied pursuit of purely paper gains.

The mechanism by which this has happened is clear enough, and is traceable to the adoption and continuation of ultra-low interest rates in response to the global financial crisis (GFC) of 2008-09. But the rationale for this process is far from immediately obvious.

Critics allege that the motivation has been a desire to enrich a wealthy minority at the expense of everyone else, but this explanation, for all its apparent appeal, is faulty. This may well have been the intention but, to be effective, it would have to mean that the wealthiest people could turn all or most of their inflated wealth into cash, which is something that they cannot do at any significant scale. They can use their notional wealth as collateral, but this adds new forms of risk to the ever-present possibility that asset price slumps could diminish their wealth.

The real explanation is simpler. It is that the economy can no longer afford to pay significant levels of bankable income to investors. As the economy has deteriorated, policy responses have, knowingly or not, prioritized the support of demand over returns on capital. What this in turn means is that the system of market capitalism has been abandoned, in all but name.

Let’s be quite clear about this. The fundamental, indispensable principle of capitalism is that investors receive real (above inflation) returns on their capital. A market economy, meanwhile, requires that markets are allowed to perform their critical functions – which are price discovery, and the pricing of risk – without undue interference.

An economy cannot be described as ‘capitalist’ once real returns on capital have been driven into negative territory, and markets cannot be said to be functioning properly when they have been subjected to massive intervention in the form of huge quantities of money created out of the ether.

Throughout its existence, capitalism has been opposed by ‘left wing’ thinkers and actors who have aspired to its destruction. The irony now is that market capitalism has been brought down, not by its enemies, but by its friends.

The obvious question is “why?”, and the true (though less-than-obvious) answer is economic deterioration. We are making do with cosmetic, ‘in name only’ capitalism for the same reason that we are deluding ourselves with cosmetic economic “growth”.


In recent weeks, American markets have rallied – and the dollar has weakened – on speculation that the Federal Reserve might be softening its stance on monetary policy. There’s no evidence, in the Fed’s statements or actions, that any such softening is actually taking place or planned but, as the poet Alexander Pope almost put it, ‘hype springs eternal’.

Central banks use a range of inflation measures in the setting of policy rates but, for our purposes, the best yardstick for comparison is the headline rate of inflation in each currency area. On this basis, the Fed policy rate (4.0%) is 3.7% below inflation (7.7%). Real policy rates in Britain and the Euro Area are -8.1% and -8.0%, respectively (which, in a wiser world, might tell us all we need to know about both of those economies).

There’s a recognized connection which links deflation to economic recession, and this means that monetary policies intended to tame inflation risk inducing or exacerbating recessionary pressures. With this in mind, let’s think this situation through, imagining that, whilst the Fed does indeed, as expected, raise rates by a further 100bps, American headline inflation has retreated to, say, 6% by the time that this has been accomplished.

This scenario would leave US real rates at -1% on this basis of comparison. In such circumstances, would the Fed carry on raising rates? This seems implausible, not least because economic deterioration would prompt a chorus of demands for monetary loosening. In short, it’s unlikely that American policy rates will ever rise above inflation.

The situation is even more stark in the Euro Area and the United Kingdom. The only factor that is likely to tame European and British inflation is a severe and protracted recession, something which has already started to unfold. The British economy, in particular, shows many signs of shaking itself to pieces.

If headline inflation rates were to fall because of economic deterioration, would the European Central Bank or the Bank of England carry on raising rates? This is surely almost inconceivable. The British and European economies seem to be condemned to real rates remaining in deeply negative territory in perpetuity.

And ‘condemned’ is the mot juste. Negative real rates are not just anomalous, but extraordinarily harmful, yet, as the following charts show, they have been the norm since the GFC of 2008-09. Over that same period there has been a dramatic increase in the assets of the main Western central banks, which rose from $2.7 trillion at the start of 2007 to a recent peak of $26tn.

Fig. 1


As everyone presumably knows, rate repression was adopted during the GFC, and methods of implementation fell into two main categories. First, central banks slashed policy rates as part of ZIRP (zero) or negative (NIRP) interest rate policies. Second, they used newly-created money to buy huge quantities of fixed-interest securities, thereby driving prices up and yields down. QE can be regarded as complementary to NIRP and ZIRP, because it drives market rates down to levels consistent with policy rates.

Beyond methods and terminology, the overall effect was, and has remained, to keep nominal interest rates below inflation.

At the time, these innovations were described as “temporary”, to be operated only for the duration of the “emergency”. Adjectives do have a certain amount of elasticity, but negative real rates have now been with us for fourteen years, a period longer than the combined duration of the First and Second World Wars, and it’s too much of a stretch to describe this as “temporary”. The original intention, we might assume, was to restore the normality of positive real rates ‘as and when conditions allow’ – but this has simply never happened, and it’s become progressively less likely that it ever will.

Negative real rates have become ‘the new abnormal’.

As remarked earlier, a climate of negative returns on capital abrogates the fundamental principle of the capitalist system, whilst intervention at the enormous scale experienced since 2008 critically undermines markets’ ability to fulfil their essential functions of price discovery and the pricing of risk.

These might be regarded as purely theoretical objections, but there have been numerous adverse practical consequences of adopting an open-ended acceptance of negative real rates of return on investment, consequences which range beyond the dangers implicit in the creation of the ludicrous “everything bubble”.

Just one of these has been the driving of a wedge between the (generally older) people who already owned assets back in 2008-09 and the (generally younger) people who aspire to acquire them. It’s unlikely that the eventual bursting of the “everything bubble” will do much to assuage the resentment of the latter because, even if asset prices fall to levels they could once have afforded, their financial circumstances are likely to have deteriorated.

Another important consequence has been the stymying of the necessary process of creative destruction, whereby the failure of some enterprises frees up both market space and capital for new, more dynamic businesses.

Creative destruction cannot function when ‘zombie’ companies are kept afloat by ultra-low interest rates. Low rates further create an incentive for lenders to avoid declaring borrowers to be ‘non-performing’, a process which leads to write-offs and capital impairment. With rates at ultra-low levels, it becomes comparatively easy to avoid this, by adding ongoing interest to outstanding capital, especially when it’s recognized that ultimate loan repayment isn’t actually going to happen anyway.


When QE was introduced, traditionalists warned that this was a latter-day version of ‘money printing’, and must result in inflation. Defenders of QE have since pointed to low headline inflation rates to support claims that QE ‘hasn’t caused inflation’. The irony here is that such claims are routinely made within the shadow of the “everything bubble” in all classes of assets.

What makes such claims possible is the convention which confines the measurement of inflation to consumer prices, and disregards rises or falls in the prices of assets.

The latter should, of course, be included in any measure of systemic inflation, for at least two main reasons. First, the scale of asset-related transactions makes it impossible, in practical terms, to disconnect the two – the day-to-day activities of insurers, lenders, agents, brokers and many others are directly connected to the prices of the assets that they insure, buy or sell. Second, asset price inflation has very real consequences, good or bad, most obviously for savers, retirees and young people who wish to purchase homes and acquire assets.

The SEEDS economic model has its own measure of systemic inflation, which is RRCI (the Realised Rate of Comprehensive Inflation). Some examples of RRCI, compared with the broad-basis GDP deflator, are illustrated in the next set of charts.

Fig. 2

Historically, as you can see, systemic RRCI inflation has tended to be higher than the GDP deflator in most years and in most locations. Based on the GDP deflator, compound global inflation between 2001 and 2021 was 1.6%, but this rises to 3.8% on the basis of RRCI. Over that same period, the RRCI rates of inflation were 3.6% (rather than 2.0%) in the United States, 3.4% (rather than 2.2%) in Britain, and 2.4% (rather than 1.6%) in the eight-country Euro Area group covered by the SEEDS model.

You will have noted that, had systemic RRCI been used instead of the GDP deflator in the preparation of economic accounts over the past quarter-century, a large proportion of the “growth” reported over that period would have been eliminated.

But the relevant point in the rate policy context is, of course, that the extent of negativity in real rates becomes even more pronounced when nominal rates are measured against systemic inflation. Though this may have been unintentional, there’s an element of sleight-of-hand in operating negative real rates which inflate asset prices, when this asset price inflation is then excluded from the inflation measure against which the extent of negativity in real rates is calibrated.

In short, the assurance that QE ‘doesn’t cause inflation’ is only valid when inflation is measured in a way which excludes the very kind of inflation that is created by QE. This is comparable to the adoption, during the early 1970s, of “core” inflation measures which excluded energy and food at the very time when the prices of both of these necessities were soaring. No wonder this was described as ‘inflation with the inflation taken out’.

By way of illustrating of the working of QE, let’s imagine that a latter-day Isaak Walton – the author of The Compleat Angler – had been put in charge of monetary policy during the GFC, and had started handing QE largesse, not to the markets, but to fishermen. The prices of rods, reels and all other items of angling paraphernalia would have soared. Rivers, lakes and beaches would have been crammed with zealous – and affluent – people in pursuit of the denizens of the deeps.

This, of course, isn’t what happened, and QE money was directed, not to anglers, but to investors. The same principle of selective inflation applied, but it was the prices of stocks, bonds and property, rather than those of floats, flies and lures, that adopted exponential trajectories.

The point is that QE does cause inflation, but does so at the point at which new money is injected into the system. By a quirk of economic history, rises or falls in the prices of assets are not included in headline measurements of inflation, but are part of the systemic pricing picture nevertheless. The convention of limiting the definition of inflation to consumer prices thus enables commentators to state that QE ‘isn’t inflationary’ at a time of rampant inflation in asset prices.

Between the GFC and 2019, the bulk of the QE enacted by the central banks was poured into the markets, creating huge inflation in asset prices. With the onset of the pandemic, though, this pattern changed. Essentially, governments started running enormous fiscal deficits to support households (and employers) affected by lock-downs, and these deficits were funded by central bankers, who used QE to purchase existing government bonds.

For the first time, to any significant extent, QE was now flowing, not just to investors, but to consumers. This was followed, as surely as night follows day, by surges in consumer prices.

What this demonstrates is that the statement that QE ‘doesn’t cause inflation’ needs, at the very least, to be modified to ‘QE doesn’t cause consumer price inflation, so long as it doesn’t flow to consumers’.


The central contention made in this analysis is that investors have been deprived of adequate income returns – and fobbed off with non-monetizable capital gains instead – because of a fundamental deterioration in what is affordable for the economy. Regular readers will be familiar with the issues involved – and a comprehensive analysis of the economy is planned for forthcoming publication – but a brief synopsis is appropriate here.

Because nothing that has any economic value at all can be supplied without the use of energy, material economic prosperity is a function of the quantity, value and cost of energy available to the system.

Another way to put this is that the economy is a dissipative landfill system, in which energy is used to extract raw materials and convert them into products whose ultimate destination is disposal. The rapid growth in the size and complexity of the modern economy has been made possible by the use of fossil fuels, with the result that climate-harming gases are a sizeable component of the waste heat which is the outcome of the energy dissipation process.

Over time – and as we have seen – there has been remarkable consistency in the rate at which primary energy is converted into economic value. The absence of efficiency gains in the conversion process may be a product of the depletion of non-energy resources. But the end result has been that economic output has increased or decreased in line with the quantities of energy consumed.

Critically, though, output isn’t the same thing as prosperity, in much the same way that total and disposable incomes are not the same thing. The difference between the two is cost and, at the macroeconomic level, the cost involved is the Energy Cost of Energy. The principle of ECoE is that, whenever energy is accessed for our use, some of that energy is always consumed in the access process. This is a deduction from output, because energy value consumed as ECoE cannot be used for any other economic purpose.

Once the cost-reducing processes of geographic reach and economies of scale had been exhausted, depletion became the principal driver of the ECoEs of fossil fuels. These – and the overall ECoE of a system dominated by oil, natural gas and coal – have been rising exponentially, undermining prosperity.

This process first began to make its presence felt during the 1990s, when it created the economic drag which was then labelled “secular stagnation”. This term referenced a non-cyclical deterioration in growth, though orthodox economics has never made the necessary connection between economic deceleration and rising ECoEs.

Because GDP is a measure, not of material value but of transactional activity, we have been able to inject cosmetic “growth” into the system through an expansion in credit, with each $1 of reported increase in GDP being accompanied by more than $3 of net new borrowing over a period stretching back to the 1990s. Economic historians of the future are likely to date these processes from the 1990s, and to identify the GFC of 2008-09 as the first demonstration of the reality that using liability expansion to create synthetic “growth” is not a workable solution. The subsequent sequence has involved supplementing “credit adventurism” with “monetary adventurism”, leading, inevitably, to the second and larger crisis which looms on the near horizon.

The problem, of course, is that a rapid expansion of debt dictates an equally rapid rise in the cost of servicing that debt. This is the equation that forced us into crushing rates – debts had become so big that we could no longer afford to service them as we had in the past.

The charts in Fig. 3 illustrate some central aspects of this process. The use of rapid monetary expansion has driven a wedge between aggregate prosperity and reported GDP (see Fig. 3A), whilst average prosperity per person has trended downwards as ECoEs have risen (3B). At the same time, the real costs of energy-intensive essentials have been rising, imposing a progressively tighter squeeze on living standards (Fig. 3C). Along the way, efforts to create “growth” using exponential expansion in debt and broader liabilities have introduced worsening instability into the financial system (Fig. 3D). Incidentally, the forward projections shown in Fig. 3D assume the continuity of current practice, though it’s very probable that we are now at, or very near, the point of inflexion.

Fig. 3


It’s not entirely true to say that the implications of crushed returns on investment have gone wholly unnoticed. The new context was addressed in an important report on pension prospects published by the World Economic Forum back in 2017.

Looking at the United States, the WEF stated that annual real returns on equity investment were likely to be 3.45% in the future, compared to a historic 8.6%. More tellingly – because of the lesser scope for capital appreciation included within total returns calculations – real returns on bonds were likely to fall to just 0.15% in the future, from 3.6% in the past.

The inference to be drawn from this is that paper capital gains – being, by definition, non-monetizable in the aggregate – cannot be used to pay pensions. This is partly why the WEF report, which looked at eight countries, warned that a pensions “gap”, then measured at $70 trillion, was likely to expand to over $400tn – at 2015 values – by 2050. For reference, global GDP in market dollars was $75tn at that time.

A summary of where our investigation has taken us is that, as the underlying economy has decelerated towards contraction, so cash returns on investment have been replaced by cosmetic capital gains, ‘cosmetic’ in the sense that they cannot, in the aggregate, be turned into cash by investors. This has not, remotely, been coincidental.

This ties in with the “wealth effect”, in that increases in paper wealth have two effects. The first is to make people more relaxed about taking on additional debt. The second is that it disinclines them to ask awkward questions.

The issue now is when belief in the supposed reality of purely notional gains will be replaced by hard-headed assessment – or, perhaps, outright fear – which takes over from the long-standing penchant for irrational hope over solid fact.

Thus far, the effects of dawning reality have largely been confined to the wilder fringes of “tech”, where we’ve been witnessing collapses in the absurd market values once ascribed to cash-burning businesses in a frenzy of IPO and SPAC activity.

But we cannot assume that investors are going to stop asking questions at the point where only the most obvious froth has been blown off the markets. The search for substance isn’t going to end with the discovery that it cannot be found in a bright idea, adept marketing, leased office space and a mailing list.

As we know, there are a number of salient features of the economy that have been ignored during a long period of what we might term ‘the voluntary suspension of disbelief’.

Observers may come to recognize that there are limits to how long we can proclaim “growth” on the basis of the injection of cheap credit and cheaper money into the system. The divergence from economic reality is reflected in the first of the following charts (Fig. 4A), which plots the disequilibrium that has come to characterise the relationship between the ‘real’ economy of material prosperity and the ‘financial’ economy of transactions, of which an ever larger proportion neither creates nor represents material value. If we apply percentage equilibrium downside (calculated here at 40%) to the sheer scale of financial exposure (Fig. 4B), we can identify truly vertiginous levels of financial risk.

Even if this point is not recognized quite yet, market participants must surely be aware by now that standards of living are trending downwards, creating an affordability squeeze which puts at risk, not just discretionary (non-essential) consumption, but also the reliability of financial flows from households to the corporate and financial sectors.

What we can now anticipate is the replacement of starry-eyed gullibility with hard logic, inclining investors to get into a competitive retreat from the unrealistic. Portfolios will be weighted increasingly towards non-discretionary sectors, those with solid material value, and those which do not depend on income streams from increasingly hard-pressed households. Other asset classes, including residential and commercial property, will be part of the decline that sets in as ‘keeping up the payments’ gets ever harder, and as investors start to turn against anything exposed to affordability compression.

And it’s axiomatic that, when investors rush for the exit-doors, those doors get smaller.

Fig. 4

#243. The Great Inflexion



As everyone surely knows by now, the global economy has entered a recession which is likely to be both severe and protracted. For the most part, governments and central bankers are concentrating on the task of trying to tame inflation.

Their critics tend to argue for more expansionary fiscal and monetary policies, contending that stimulus could soften or shorten the recession. They claim, in defiance both of experience and of logic, that expansionary monetary policies needn’t contradict the effort to bring inflation under control.

Where almost everybody is in agreement is that, however long it takes, the recession will end. But there’s a striking absence of explanations for how or why growth is supposed to resume. The fall-back position is no more than an assumption – a recovery will arrive for no better reason than that all previous economic downturns have been followed by rebounds.

The underlying presumption here is cyclicality, a process accepted as routine, not just by policy-makers and central bankers, but by investors, business leaders and the general public alike. It is well understood that the Big Numbers – like economic output, and the aggregate value of the markets – oscillate in sine-wave patterns around central trends.

It’s further assumed that these secular trends are always positive – each recovery exceeds the preceding recession, and each market rebound more than cancels out the latest dip.

This latter assumption has reached the point of invalidation. What economies and markets are now experiencing is trend-inflexion. Cyclicality may indeed continue but, from here on, it will do so around downwards-inflected trends. This process of reversal can only be managed if it is recognized.

The consequences of trend inflexion are readily summarised. On an ex-inflation basis, economic output will deteriorate, whilst the real costs of necessities will carry on rising, even if there are some retreats from the severe spikes experienced in recent times.

The resulting process of affordability compression will drive contraction in discretionary (non-essential) activities. It will also undermine financial flows from households to the corporate and financial sectors. We can anticipate a rolling process of investment contraction, business failures, defaults and rising unemployment.

Asset prices can be expected to fall, though the real risk to the financial system is on the liabilities side of the ledger. None of this is necessarily unmanageable, but its disruptive potential is enormous.

Beyond having to explain why the anticipated recovery has failed to arrive, governments will be under pressure to help out with the cost of living, and can anticipate increasing demands for redistribution. There will be a strident chorus of advocacy of looser monetary policy, risking a breakdown in the resolve to tackle inflation.

Before we get into the processes driving trend inflexion, it’s worth remarking that if, to many people, this recession starts to feel more severe and more unpleasant than any downturn in their previous experience, that’s because it is.


Understanding trend inflexion requires appreciation of how the economy really works, and this, needless to say, cannot be gleaned from orthodox economics, for which infinite growth is an article of faith. This is based on a seemingly unshakeable conviction that the economy can be explained in terms of money alone, a line of argument which dismisses any possibility that there are material limits to economic expansion.

This, of course, isn’t how the economy actually works. There are very real limits, not just to material prosperity but to environmental and ecological tolerance as well.

In a descriptive rather than a pejorative sense, the modern economy is a dissipative landfill system. Energy is used to convert raw materials into products, of which the vast majority are quickly relinquished, generally into landfill. This is a dissipative process because it operates by converting dense or concentrated energy into diffuse forms, essentially waste heat which, in a carbon-based economy, includes climate-harming gases.

The commercial economy has evolved in tandem with this dissipative landfill model. This is why there’s little mileage in supplying consumers with products that will last for decades, and plenty of profit to be made by accelerating the cycle of creation-disposal-replacement.

The dissipative process at the heart of the system is unravelling because access to concentrated energy is in retreat, and has been over a lengthy period. The economic value of concentrated energy is determined by an equation in which the conversion of energy into total worth is offset by the cost of doing so. This cost is known here as the Energy Cost of Energy. ECoE recognizes the fact that, whenever energy is accessed for use, some of this energy is always consumed in the access process.

As the ECoEs of oil, natural gas and coal have risen as a consequence of depletion, underlying growth has deteriorated along a trajectory that leads to contraction in the dissipative landfill system. Though nuclear and hydroelectric power may play an important role in providing alternatives to fossil fuels, the general assumption is that most of the energy of the future will be sourced from renewables, primarily wind and solar power.

Transition to renewables is not just possible, but imperative. The economy, no less than the environment, is at grave and worsening risk unless this happens. Sustainability is a worthy goal, and there’s no reason why it shouldn’t be an attainable one.

Where this logic breaks down is at the point at which transition is spun, not as sustainability, but as “sustainable growth.

This latter claim isn’t feasible, for a very simple reason – renewables cannot match the energy density of oil, gas and coal. As a result, a transition to renewables will truncate the process of diffusion which is central to the dissipative landfill economic system.

The characteristic of lesser density shows up right across the application of renewables. Despite widespread assurances to the contrary, the processes of renewables generation cannot be transformed by technological advances, because the potential of technology is bounded by the laws of physics.

The potential efficiency of solar energy is determined by the Shockley-Queisser Limit, with Betz’ Law doing the same for wind power, and best practice is already close to these physical maxima. Intermittency is part of the low-density character of renewables, and no advance in technology is going to enable batteries to match the power-to-weight ratio of the humble fuel tank.

In the absence of transformative technologies, the heavy lifting of transition is going to have to be done by volumetric expansion. This requires enormous quantities of concrete, steel, copper and other raw materials, and these can only be extracted, processed and delivered – where they exist at all in the requisite quantities – using legacy energy from fossil fuels.

Since the same unit of energy cannot be used twice, the question becomes one of what other energy uses are going to be relinquished to make this energy available for transition. We could, in theory, drive less, fly less, consume less and consign less to landfill, but there, is as yet, no acceptance of a need to do any of this.

None of the foregoing should be read as scepticism about the transition to renewables. There are compelling environmental and economic imperatives for committing maximum effort to transition, and there is no reason in principle why sustainability should not be accomplished.

An essential first step might be to drop, or at least water down, claims that transition can provide affordable growth, because this isn’t possible where the concentration of energy inputs is decreasing.  


The unfolding process of contraction is going to have a series of identifiable adverse effects, and it’s far better that we model them than resort to either guess-work or denial. Aggregate economic output, which has been decelerating over an extended period, is now very close to its point of inflexion. Prior growth in material prosperity, which is defined here as output minus ECoE, has already gone into reverse. In per capita terms, both output and prosperity have already turned down.

At the same time, the real costs of energy-intensive necessities are rising. The net effect is affordability compression. This, as remarked earlier, has two principal consequences. First, the ability of consumers to afford discretionary products and services is in retreat, and cannot be expected to return to growth.

Second, we should be prepared for contraction in the streams of income which flow from households to the corporate and financial sectors. Put colloquially, people will find it ever harder to ‘keep up the payments’ on everything from mortgages and credit to subscriptions and staged-payment purchases.

Readers who are so minded can decide for themselves what constitutes a discretionary or a stream-of-income sector. A question often asked here – the issue of timing – can now be answered, because trend inflexion has already started. Asset prices must correct as the underlying economy contracts, but we need to be in no doubt at all that the real threat to the financial system exists on the liabilities rather than the assets side of the equation.

Properly understood, money has no intrinsic worth, but commands value only as a ‘claim’ on the output of the ‘real’ or material economy. Monetary expansion can increase these claims, but governments, central bankers and the commercial banking system cannot create low-cost energy – or any other component of the material economy – out of the ether.

Prices, as financial values ascribed to material products and services, are at the interface between the ‘real’ economy of goods and services and the ‘financial’ or proxy economy of money and credit. We cannot expect to understand inflation, let alone manage it, until the reality of this relationship is appreciated.

Money, as a claim on products and services, is in reality, a claim on the energy required to make them available. Likewise, debt, as a ‘claim on future money’, is really a claim on future energy. Accordingly, as the dissipative energy system contracts, an increasing number of forward financial claims will be invalidated. It might be contended that, if we decided to allow inflation to run hot, we may be able to ‘inflate away’ part of our enormous mountain of debt and quasi-debt. But this wouldn’t work unless we could somehow curb the creation of new liabilities, and such curbs are irreconcilable with high inflation. In any case, debt elimination through inflation simply transfers losses from borrowers to lenders.

In the previous article, we looked at the mechanics of economic contraction, and these and other issues can be revisited in the future. For now, the following charts illustrate some of the most pertinent aspects of SEEDS interpretation.

Critically, mistaken interpretation of past trends has fostered unrealistic expectations for the future, illustrated here for overall economic output and for discretionary affordability. This leads to policy-makers, businesses and investors planning for a future that isn’t going to happen.

Systemic inflation has long been understated in orthodox data, leading to assertions that inflation ‘has been low’ despite the creation of the enormous “everything bubble” in asset prices. Although systemic inflation – measured here as RRCI – now exceeds 9%, this can be expected to trend downwards, with continuing increases in the real costs of necessities being offset by deflationary pressures in discretionary sectors and in asset markets. This, of course, assumes that the authorities continue to turn a deaf ear to siren calls for them to relax their concentration on defending the purchasing power of money.  

Fig. 1

#242. The dynamics of global re-pricing



There is a growing acknowledgement that the World economy has entered a new era. We know that the cost of capital is trending upwards, with adverse consequences for asset prices. But there’s been remarkably little inclination to examine the underlying processes that are causing this to happen. Neither is there much in the way of recognition that entire sectors could be crushed, or even eliminated altogether, as re-pricing becomes more selective.

We need to dismiss any idea that this is temporary. There are some linkages connecting the resurgence of inflation with pandemic-era QE, and with the war in Ukraine, but these are little more than symptoms.

The underlying dynamic is that the economic driver of the industrial era – the supply of low-cost energy from oil, natural gas and coal – is winding down, and there is no assured replacement at hand. Transition to renewables is imperative, but there’s no guarantee that an economy based on wind-turbines, solar panels and batteries can be as large as the fossil-based economy of today. The probabilities are that it will be smaller.

Had we been prepared to do so, we could have seen this coming. The chain of causation starts in the 1990s, when the authorities responded to “secular stagnation” with deregulation programmes that made credit easier to obtain. The subsequent financial crisis forced the adoption of QE, initially to prop up the banking system, and latterly as a self-standing form of stimulus. We were assured, quite wrongly, that QE would not be inflationary, but it has created a systemically-dangerous “everything bubble” in assets.

The fundamental issue is that the material costs of energy supply have been rising relentlessly. We cannot “de-couple” the economy from energy use, and this report describes a remarkable linearity between the quantity of energy that is used and the economic output that ensues. Meanwhile, and whilst economic output is poised to contract, material prosperity will be further impaired by rises in the Energy Cost of Energy (ECoE).

The true cause of inflation is the worsening disequilibrium between the ‘real’ economy of products and services and the ‘financial’ economy of money and credit. The only way to tame inflation is to eliminate the anomaly of negative real costs of capital. Combined with deterioration in material prosperity, this points towards a fundamental re-pricing of the economy.

With the real costs of energy-intensive necessities continuing to rise, two parts of the economy are at particularly elevated risk. One of these is the supply of discretionary products and services to consumers. The other is those parts of the corporate and financial system which rely on flows of income from the household sector.


The global economy is heading for re-pricing, which means a fundamental change in the relationship between economic flow (including output, incomes and expenditures) and financial stock (the valuations of assets, collateral and liabilities). This process has already commenced – and is going to be chaotic – but its real causation has yet to gain recognition.

As we shall see, there is no non-inflationary way in which economic flow can be increased. This means that, as dynamics of this relationship change, stock valuation must fall.

The reduction of the global balances of assets and liabilities will be an uneven process, both geographically and between sectors, but the generality of financial stock degradation is likely to be of the order of 40-50%, measured from the start of 2022. Sectors providing necessities to consumers will fare better than those supplying discretionaries, for whom the outlook is grim.

The ‘why?’ of re-pricing is simple to describe, but making sense of it requires a major change in how we think about the economy. We need to move away from the economic orthodoxy which continues to assert that the economy is entirely a financial system, not subject to material limitations.

As well as meaning that there need never be any end to growth, the classical conception also asks us to believe that the flow of economic output can be measured by counting financial transactional activity. But transactional activity can be inflated using monetary policies, and it’s perfectly possible for transactions to take place which add no economic value at all. This makes GDP a particularly poor metric for the measurement of prosperity in the economy.

The prerequisite for effective interpretation is recognition that the economy is a system which supplies material goods and services to consumers. The provision of these products and services is a function of the use of energy.

Once this is understood, we need to draw a distinction between economic output and prosperity. Output is analogous to the income of a household, whilst prosperity corresponds to how much of that income remains after the costs of necessities have been met.

The economic output side of the equation involves the conversion of primary energy into economic value. This energy conversion ratio is remarkably static, hardly varying at all over the past forty years. Globally, economic output rises or falls in accordance with increases or decreases in the availability of energy.

The prosperity dimension of the equation is determined by the Energy Cost of Energy. This has been rising relentlessly over a very long period, and there are no realistic grounds for expecting it not to carry on doing so.

The pricing of assets is a function of a process of the futurity which links current prices with forward value expectations. The consensus forward projection has been, and remains, one of continued economic expansion, albeit with minor setbacks along the way.

But material trends are invalidating the money-only notation of classical economics. As this reality sinks in, the consensus futurity will be degraded, introducing a wholly new dimension into equations linking current pricing and forward expectations.

This is going to induce the equivalent of vertigo, as market participants realise that we’ve been pricing a future that cannot happen. The degradation of futurity will trigger chain reactions right across the interconnected, collateralized World financial system.


How can we know that this is going to happen? The answers lie, not in the ebb and flow of market sentiment or, for that matter, of policy, but in the fundamentals.

The effective interpretation of economic processes requires some straightforward foundation principles.

The first of these is that the economy is an energy system, because nothing that has any economic utility whatsoever can be supplied without the use of energy. This applies, not just to products and services, but to the entirety of the economy. The creation and maintenance of infrastructure and capacity is entirely reliant on the availability of energy. Access to raw materials – ranging from minerals, chemicals and plastics to food, fertilizers and water – is a function of the energy required to supply them.

The second principle is that energy is never ‘free’. 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. This is the principle of ECoE.

Oil isn’t ‘free’ because it exists beneath your land – you still need wells, pipelines, refineries and the rest of the supply system. Solar and wind power aren’t ‘free’ just because the sun shines and the wind blows – we still need solar panels, wind turbines and distribution systems, with the added complication of storage capacity to offset intermittency. None of this infrastructure can be built or maintained without the use of energy.

The third foundation principle is that money has no intrinsic worth. Rather, it commands value only as a ‘claim’ on the output of the material economy. This is the principle of money as claim.

From these principles, two conclusions naturally follow.

First, material prosperity is a function of the surplus energy which remains after ECoE has been deducted from total supply.

Second, the economy, as presented financially, is a representation or proxy of the underlying material economy determined by the supply, value and cost of energy.

This wouldn’t be a problem if conventional financial notation was an accurate representation of the material economy.

Unfortunately, though, it is not. We have to take a brief journey into history to see why.


The widening gap between material fact and financial representation can be traced all the way back to 1776. The huge, complex and energy-intensive economy of today began when James Watt unveiled the first really efficient device for converting heat into work, giving us access to the vast energy resources contained in fossil fuels.

Adam Smith’s The Wealth of Nations, published in that same year, was the foundation treatise for a school of economics which seeks to explain everything in terms, not of energy, but of money alone.

Writing as he was in an agrarian, low-energy economy, Smith cannot be blamed for not anticipating the transformation that would result from work that his fellow Scot was at that moment completing just a few miles away. But his successors can, and should, be criticized for a blind adherence to precepts which, by insisting on the financial, rigorously exclude the material.

With material factors disregarded, it becomes perfectly possible to predict infinite economic growth on a finite planet, a proposition which no sensible person should accept. Perhaps Kenneth Boulding, co-founder of general systems theory, put it best, when he said that “[a]nyone who believes exponential growth can go on forever in a finite world is either a madman or an economist”.

On the flimsy foundation of immaterial, money-only interpretation, classical economics has erected what its adherents are pleased to call the “laws” of economics. These, of course, are simply behavioural observations about the human artefact of money, and are in no way analogous to the laws of science.

One example is the assertion that price is the outcome of the interaction of demand and supply, both of which are, of course, stated financially. The inference is that price movements create an automatic adjustment whereby supply increases in accordance with rises in demand.

If demand increases, this logic runs, prices rise such that producers have sufficient incentive to deliver a corresponding increase in supply. Higher prices also reduce demand, but the assumption remains that rising prices create additional supply. Supply is thus a function of demand, mediated by price.

But this could only work if the possibility of unlimited expansion of monetary demand was matched by a correspondingly infinite potential for material supply.

The reality, of course, is that no increase in demand, and no rise in price, can supply anything which does not exist in nature. The banking system cannot lend low-cost energy into existence, any more than central bankers can conjure it ex nihilo from the ether.

Instead of the outcome of some theoretical equation involving financial supply and financial demand, prices should be defined as the monetary values assigned to material products or services. If the balance between the financial and the material changes, prices change with it.

This should be obvious, even to those who insist that QE ‘doesn’t cause inflation’. To be clear about this, the use of QE during and after the GFC (global financial crisis) of 2008-09 may not have caused consumer price inflation, but it most certainly triggered harmful asset price escalation. When, during the pandemic, QE was aimed directly at households rather than, as hitherto, at asset markets, consumer price inflation necessarily ensued.

The mythology of economic infinity remains tenacious, and is evidenced whenever political leaders offer assurances of economic “growth” to the public. The problem at the heart of the ongoing fiscal fiasco in Britain has been the insistence that growth can be manufactured through a carrot-and-stick blend of incentive and need – if the financial framework is right, the argument runs, the better-off will have the incentive to invest, and everyone else will be compelled to work harder, thereby improving productivity. At no point has it been considered that, with global material conditions as they are, meaningful economic “growth” cannot be delivered at all.

Even the conventional calibration of productivity is misleading – dividing economic output by the quantity of human labour is of little real relevance, given that labour is a truly tiny component of the energy used in the modern economy.


Until comparatively recently, the divergence between the material and the classical-financial hasn’t been readily apparent. The heirs to Watt have carried on growing the economy, and the heirs to Smith have carried on representing this growth as the product of financial rather than thermodynamic processes.

Now, though, the energy dynamic is winding down. The supply costs of oil, natural gas and coal are rising through the effects of depletion. There is no assured, like-for-like replacement for the energy value sourced from fossil fuels. Prior growth in material prosperity has gone into reverse.

This is not reflected in financial calibration of economic flow. This calibration will become mistrusted before a new system of economic interpretation and quantification arrives to replace it.

Simply stated, market participants will suffer a loss of faith in what they’re being told about the economy. This will result in downwards revisions of ‘futurity’, a term describing those perceptions of the future that are priced in to the valuation of financial stock. Rising risk premia will be the first manifestation of a much more fundamental realignment between the financial and the material.

We have a choice between getting ahead of the curve on material recognition, or hewing to the tried-and-failing notions of wholly immaterial – financial – causation and explanation.

Based on the principles outlined earlier, there are three things that we need to know. First, how much energy supply can we expect in the future?

Second, how does the use of energy translate into economic value? Third, to what extent will cost trends cause prosperity to deviate from output thus calibrated?

These are complex issues, made more so by orthodox economic conventions which, as exemplified by GDP, conflate transactional activity with material economic output.

A relatively brief set of answers to these questions requires the use of no less than three sets of charts (Figs. 1, 2 and 3), sourced from SEEDS (the Surplus Energy Economics Data System).

The measurement unit used here for energy is the tonne of oil-equivalent (toe). Financial numbers are stated in international dollars, converted from other currencies, not at market rates, but on the more representative basis of purchasing power parity (PPP), which is the convention used for measuring and forecasting global growth. Unless otherwise stated, financial numbers are expressed at constant 2021 values, so the notation is $PPP 2021.


Historically, we can observe that, whilst global real GDP almost quadrupled (+292%) between 1980 and 2021, World consumption of energy slightly more than doubled (Fig. 1A). The implication is that the efficiency with which energy is converted into economic output improved by 85% between those years (Fig. 1B). This makes it easy to understand the popularity of the mistaken notion that we can somehow “de-couple” the economy from the use of energy.

Accepting this at face value, though, would involve disregarding the rapid build-up of debt. Whilst energy use rose by 112% between 1980 and 2021, and GDP expanded by 292%, debt exploded, increasing by about 925% (Fig. 1C). (Comprehensive data for global debt gets hard to find as we scroll backwards from the 1990s, but the estimates used in Fig. 1C are intended to be consistent with subsequent trends – and, in any case, of the additional debt incurred between 1980 and 2021 [estimated here at $323bn], almost three-quarters [$239bn] has been taken on since 2000).

We may have increased GDP per toe of energy consumption by 85% since 1980, then, but the quantity of debt carried per toe of energy use expanded by 380% over that same period (Fig. 1D).

Fig. 1

The fact of the matter is that GDP and debt are not discrete series, because increasing debt boosts the transactional activity measured as GDP. If we reined in credit growth, GDP would, at best, stop growing and, if we tried to reduce outstanding debt, it would slump.

What we have witnessed in modern times is that reported GDP has been inflated artificially by super-rapid debt expansion.

It’s worth reflecting that, if this were not the case, we could reach a point of complete absurdity – the economy would become both extraordinarily wealthy (in terms of GDP), but also bankrupt (through the sheer weight of liabilities which the system couldn’t possibly honour).

The ratio between borrowing and growth has averaged slightly less than 3:1 since 1980, meaning that almost $3 of debt has been added for each $1 of reported growth in GDP. There has been an upwards tendency in this global trend, and the ratios in many of the advanced economies of the West have been appreciably higher than World averages.

This relationship is pictured in Fig. 2A, which compares GDP growth with debt expansion, the latter expressed as a percentage of GDP. Between 1980 and 2021, real GDP expanded at a compound annual rate of slightly less than 3.4%, but the real rate at which debt increased exceeded 5.8%. Reported “growth” of 3.4% was achieved by borrowing at an average annual rate of 10% of GDP.

The SEEDS economic model strips out this ‘credit effect’ to calibrate underlying or ‘clean’ economic output, known here as C-GDP. The annual rate of growth on this basis was materially lower between 1980 and 2021, at slightly less than 1.9%, rather than 3.4% (Fig. 2B). Accordingly, underlying output increased by only 114% – rather than the reported 292% – over that period (Fig. 2C).

Critically, the calculated expansion in C-GDP (of 114%) tallies almost exactly with the increase in energy consumption (112%) over this forty-year period. Put another way, the relationship between underlying economic output and the use of energy is linear.

This was not an anticipated finding during the financial calibration of C-GDP back to 1980 from its previous start-date in 2000. But it reinforces the view, which has been demonstrated in various financial and non-financial ways, that “de-coupling” the economy from the use of energy cannot happen. The European Environmental Bureau reached this conclusion in 2019, describing the case for de-coupling as “a haystack without a needle”.

In short, if we consume less energy, the economy gets smaller. Likewise, if we use less energy per capita, the average person gets poorer.

This doesn’t necessarily describe individual national economies because, just as primary energy is traded between countries, so are energy-containing products. A country can, for example, consume less energy simply by importing cars and computers – or, for that matter, food – rather than producing these items at home.

Looking ahead, though, such trades are likely to be moderated by arbitrage, to the detriment of economies which rely heavily on the import of energy-intensive commodities and products.

The overall situation is what matters, and this is that reductions in global energy supply lead to a shrinking of the World economy.

Fig. 2


SEEDS projections for World energy use are illustrated in Fig. 3A. Essentially, supply is expected to be 10% lower in 2050 than it was in pre-pandemic 2019.

Within these totals, it’s estimated that fossil fuel production will decline by 26%, a decrease of rather more than 3.0 bn toe. Though rapid, growth in output from renewable energy sources (REs) is likely to make up less than 1.2 bn toe of this shortfall. The combined contributions of nuclear and hydroelectric power are projected to increase by 28%, but these are too small a share of the energy slate to offset the decline driven by the falling availability of energy from oil, gas and coal.

As can be seen in Fig. 3B, there may be a very slight, and probably temporary, improvement in the conversion ratio between energy and economic value expressed as C-GDP. The assumption involved here is that a significant proportion of energy-intensive, non-essential economic activities will contract rapidly through decreases in affordability. But it’s extremely unlikely that there will be material or lasting deviation from the linear relationship between energy use and economic output.

Accordingly, C-GDP is projected to be 8% lower in 2040 than it was in 2021 (the grey line in Fig. 3D), matching the expected decline in primary energy supply over that same period.

As we have seen, though, output isn’t the same thing as prosperity, the difference between the two being the prior claim on resources made by the Energy Cost of Energy.

Fig. 3C shows the projected continuing rate of increase in overall global trend ECoE. The rates of decrease in the ECoEs of renewables are expected to slow, and may then start to rise. There are physical limits to the potential efficiencies of both wind (the Betz Limit) and solar power (the Shockley-Queisser Limit), limits which are well explained here. It’s extraordinarily unlikely that the storage cost-efficiency and flexibility provided by a simple fuel tank are ever going to be replicated by batteries. Moreover, fossil fuels are not subject to the burdens of intermittency.

Critically, the vast material inputs required for RE expansion can only be provided through the use of legacy energy from fossil fuels. This creates a linkage between the ECoEs of fossil fuels and the ECoEs of renewables.

It should never be forgotten – though it almost routinely is – that the potential capabilities of technology are limited by the laws of physics.

These are important points, because it’s all too easy to assume that the economy can transition, seamlessly, from fossil fuels to renewables. This mistaken assumption – and it’s no more than that – informs vast swathes of corporate, financial and government planning.

The application of ECoE to the projected outlook for C-GDP reveals that economic prosperity – shown in blue in Fig. 3D – is set to fall a lot more rapidly than material output itself. By 2040, global prosperity is projected to be 16% lower than it was in 2021. If population numbers continue to rise, albeit at historically low rates, prosperity per capita could decrease by 27% between 2021 and 2040.

At no point since 1776 – not even during the Great Depression between the wars, which caused severe hardship, but was temporary – have we ever had to confront anything even remotely comparable.

None of this, of course, is yet incorporated into the futurity currently priced by the markets. But the unfolding deterioration in underlying economic conditions can be expected to compress the gap between financial expectation and material economic reality.

Fig. 3


The foregoing should have made it clear that two diverging trends have shaped the economy over an extended period. On the one hand, the material economy of products and services, determined by energy, has been decelerating towards involuntary de-growth.

On the other, extraordinary levels of financial commitments have been taken on in an ultimately-futile effort to counteract or deny this tendency. These trends, and some of their future implications, are illustrated in Fig. 4.

Since the late 1990s, the financial economy, measured as GDP, has diverged from the material or ‘real’ economy to the point where the downside between the two has widened to 40% (Fig. 4A). There can be no indefinite prevention of the restoration of equilibrium between the material and the financial, and this has direct read-across implications for the levels of liabilities depicted in Fig. 4B.

Though the global debt mountain is serious, real exposure needs to be referenced to those broader ‘financial assets’ which are the liabilities of the government, household and business sectors of the economy. These broader liabilities include the NBFI (non-bank financial intermediary) sector, sometimes called the “shadow banking system”.

As we saw in a recent article, available data is incomplete, accounting for 85% of the global economy, but quite possibly excluding major asset exposure in specialist financial centres not included in reported numbers. A best estimate is that total financial exposure stands at about 575% of World GDP, but 925% of global prosperity.

Perhaps the single most disturbing aspect of worsening imbalances is the extent of leverage embodied in the economy and the financial system.

As we have seen, a projected decrease of 8% in energy supply between now and 2040 produces a corresponding decrease in real global economic output. But rises in ECoEs leverage this into a 16% fall in aggregate prosperity.

This implies that prosperity per capita will be about 27% lower in 2040 than it was in 2021. But the cost of energy-intensive necessities will carry on rising markedly, in response to increases in ECoE. This is illustrated in Fig. 4C. This implies a near-50% fall in the affordability of discretionary (non-essential) products and services, even though top-line economic output is only projected to fall by 8%.

Fig. 4


This leverage is critical, because the affordability connection ties the sustainability of financial liabilities, not to top-line output, but to PXE, the SEEDS term for “prosperity excluding essentials”. When we consider, for example, the affordability of mortgage payments, it’s clear that this affordability must be related, not to total household incomes, but to household disposable incomes, and much the same applies at macroeconomic level.

This is why, where the business and broader economic outlook is concerned, we have entered an affordability crisis. This has two implications.

First, and most obviously, consumers whose disposable resources are being compressed between falling incomes and the rising costs of necessities experience a leveraged reduction in what they can afford to spend on discretionary purchases.

Second, it becomes ever harder for households to sustain payments on everything from secured and unsecured credit to subscriptions and staged-payment purchases.

In short, not only will sectors supplying discretionary products and services to consumers experience a relentless deterioration in volumes and profitability, but the same thing will happen to those parts of the corporate and financial ecosphere which rely on streams of income from the household sector.

Where segmental projections are concerned, it should be noted that the data in Figs. 4C and 4D is harmonized. This means that, whilst GDP in 2021 is accepted as the baseline – enabling comparison with other sources of forecasts – prior and future trends are restated in accordance with energy-based calculations of output and prosperity. The segmental balance illustrated in Fig. 4D shows that the affordability, not just of discretionary purchases but of capital investment as well faces severe compression.


The final set of charts – Fig. 5 – looks at the broad economic structure, inflation, and the critical divergence between expectations and probable outcomes.

Fig. 5A provides an at-a-glance view of the five core components of the economy. One of these is C-GDP output, which correlates closely with energy availability. The second is ECoE, a deduction which itemises the difference between output and prosperity. Next, in this leveraged equation, comes the estimated cost of essentials. The remaining components are discretionary consumption and capital investment, which are the residuals in this leveraged situation.

RRCI – the Realized Rate of Comprehensive Inflation – is the SEEDS tool for measuring systemic price change. Historically, this has been materially understated by the GDP deflator measure used to calculate ‘real’ economic output and growth (Fig. 5B).

Barring outbreaks of monetary policy derangement, the outlook is for RRCI to trend downwards, though remaining above officially-acknowledged rates of broad inflation. Though the costs of essentials will continue to rise, we should anticipate severe and worsening deflation across the discretionary and ‘stream-of-income’ sectors of the economy.

Comparing probable outcomes with expectations is a critical component of planning and strategy – essentially, good decisions can be made by those who understand why consensus expectations are mistaken.

As shown in Fig. 5C, past misstatement of the financial equivalent of material economic performance leads to over-optimistic expectations for the future of the economy. This applies even more strongly to the affordability of discretionary products and services (Fig. 5D), where past trends provide no effective guidance at all to the impending rapid decline of discretionary consumption.

Fig. 5

#241. Behind the crisis


As you would expect, both the mainstream and the specialist media have been giving us minute-by-minute, blow-by-blow coverage of the financial crisis which began with the British government’s 23rd September “fiscal event”.

Unfortunately, this coverage and analysis is founded on a conventional school of economic thought which insists – rather, simply assumes – that all economic events can be explained in terms of money alone.

This assumption is fallacious. The fact of the matter is that we can immerse ourselves entirely in monetary theories and financial analyses until the proverbial “cows come home” without understanding more than the surface manifestations of the underlying situation.

As a corrective, let’s remind ourselves of something that ought to be self-evident. This is that the economy is a system which delivers those material products and services which together constitute prosperity. Money is simply a proxy for these products and services, a means of exchange and distribution which does not, of itself, determine the availability of this material prosperity.

This ‘money-only’ fallacy delivers false comfort, in at least two ways.

First, it enables us to explain away the current crisis in terms of idiosyncrasies – there’s a surface narrative which assures us that, if we can avoid the kind of bungling in which the new British leadership has become enmeshed, we can similarly avoid the kind of crisis now unfolding in the United Kingdom.

We might, indeed, be persuaded that even Britain can find a way out of this crisis through ‘rationalization’, which, in this case, might mean ‘finding rational people to manage its economic affairs’.

Now that growth has reversed

The second source of false comfort is the mistaken assumption that finding the right blend of fiscal and monetary policies can deliver the nirvana of perpetual growth.

Put another way, the implication is that premier Liz Truss and chancellor (finance minister) Kwasi Kwarteng were right to seek a “growth” elixir, even if they have been wrong about the mechanism for doing so.

This is simply not the case. The economy is an energy system, not a financial one. The entire narrative of the past quarter-century has been one of economic deceleration and deterioration caused by adverse changes in the energy dynamic which determines material prosperity.

Critically, the trend Energy Cost of Energy (ECoE) has been rising relentlessly, a process which, having started by creating “secular stagnation”, has now pushed us into involuntary economic contraction.

Fundamentally, we’re at the end of a long period of rising prosperity built on low-cost energy from coal, petroleum and natural gas. There is, as of now, no like-for-like replacement for the energy value hitherto sourced from fossil fuels.

Whilst we might hope to find a successor to waning (and climate-harming) fossil fuel energy value, three reasonable caveats need be recognized about this hope.

First, it is by no means assured. Second, the resulting economy is likely to be smaller, meaning poorer, than the one we have today. Third, no such transition can happen now, or spare us from the consequences of the fallacious assumption that we can rely on ‘infinite economic growth on a finite planet’.

The fact of the matter is that there are no financial ‘fixes’ for material economic deterioration. Looking for such fiscal and monetary fixes simply piles additional risk onto a global financial system already inflated beyond the point of sustainability.

When the financial dust settles, we will be left with a contracting economy, one in which deterioration in material prosperity is compounded by continuing increases in the real costs of energy-intensive necessities.

Accordingly, what we are witnessing is a process of affordability compression. This has many consequences, of which two are most important. First, the ability of consumers to afford discretionary (non-essential) products and services has entered secular contraction.

Second, the compression of affordability is undermining the ability of the household sector to ‘keep up the payments’ on a gamut of financial commitments ranging from mortgages and consumer credit to staged-purchase schemes and subscriptions.

In short, we can now project a future in which discretionary sectors contract relentlessly – with all that that means for employment, profitability and asset values – whilst the world’s gigantic system of interconnected financial liabilities unravels, with the latter process far likelier to be rapid and chaotic than gradual and managed.

A not-so-simple story

The superficial narrative of the current crisis pins the blame squarely on the new leadership of a single (though sizeable) Western economy.

The conventional story is that Ms Truss and Mr Kwarteng sought to find a way in which Britain could break out of a long period of economic underperformance. They decided to do this by cutting taxes, with the benefits skewed towards the better-off, perhaps in the belief that the much-derided theory of “trickle-down economics” might be valid after all.

These tax cuts, added to the decision to cap energy prices for households and businesses, threatened to create an enormous need to raise money by selling gilts (government bonds) to investors. This problem was compounded, first by the known intention of the Bank of England to unload gilts as part of a QT programme and, second, by the absence of the modelled and reasoned data and projections customarily provided by the Office for Budget Responsibility.

This ill-thought-out package occurred at a time of high inflation, to which it was known that the Bank intended to respond with rate rises and QT.

Markets responded to this ill-considered intervention in two ways, both of which should have been anticipated. First, FX markets sold off sterling, with GBP falling to slightly over $1.03, from levels above $1.22 just a few weeks previously. Second, the gilts market crashed, with yields on the 10Y bond spiking to over 4.5%, from 2% as recently as August.

This produced a toxic combination of expectations. A falling exchange rate would increase the prices of imports, driving inflation higher and, perhaps, forcing the Bank into a programme of accelerated monetary tightening involving rate hikes and QT.

Meanwhile, higher rates would increase borrowing costs, pushing property prices sharply downwards and, in all probability, triggering a wave of defaults on secured, unsecured and business debts.

In the event, nemesis came from a different quarter, with the viability of pension funds put at risk by falls in the value of gilts. It was this consideration which pushed the Bank into panic mode, intervening with a reversion to QE.

Behind the folly

So far, this is – to paraphrase a British radio soap – just “an everyday story of idiot folk”. Britain’s fiscal credibility has been shot to pieces, with one observer referring to the UK as a “submerging economy”. Policy folly has been compounded by a paralyzing sense of utter incompetence, with criticism extended from the executive leadership to the Bank.

Opposition politicians must have struggled to hide their partisan delight behind a façade of grave concern. Conservative MPs seem shell-shocked, worried as much about the prospect of plunging property prices as about marginal constituencies.

As objective observers, we need to look at this in different ways, of which one is specific to Britain, and the other more general. The common factor linking both is the belief in economic “growth”.

The British economy has long been living on borrowed time. The United Kingdom’s economic model is fundamentally flawed. Britain lives beyond its means, covering – but simultaneously exacerbating – its chronic current account deficit through the sale of assets. This is not sustainable, not least because a point is reached at which no saleable assets remain.

An economy thus structured relies on the continuous expansion of private credit. Credit expansion, in turn, requires both lender collateral and borrower confidence, and both have been provided by the inflated prices of assets, principally property.

There is, of course, an inherent contradiction here. On the one hand, the inflation of property (and broader asset) prices requires low and falling borrowing costs. On the other, debt expansion should, all things being equal, drive the cost of borrowing upwards.

Britain had already reached this point, as flagged by inflation, and as recognized by the Bank in its plans to raise rates and undertake QT. Even before 23rd September, the best that Britain could reasonably hope for was a “soft landing”.

QE, of course, is no more than a temporary ‘fix’. QE might not, at least pre-covid, have created retail price inflation – which is the only part of the pricing process that most observers bother to look at – but it has undoubtedly created reckless asset price inflation.

Both in Britain and elsewhere, systemic inflation – modelled by SEEDS as RRCI – has long been a great deal higher than the broad calculation expressed as the GDP deflator.  

The wider issues

There is, though, a second and broader way in which we need to understand what’s really happening. The central mistake made by Liz Truss and Kwasi Kwarteng was the assumption that there must be some combination of fiscal and monetary policies which could deliver the Holy Grail of “growth”.

Methods and policies may differ, but this belief in the possibility of infinite growth is shared by decision-makers – and corporate leaders, investors and the general public – right across the globe. The whole of the financial system worldwide is entirely predicated on the assumption of growth in perpetuity.

Conventional economics, with its fallacious assertion that the economy is entirely a financial system, fosters and endorses this mistaken assumption.

But the harsh reality is that the economy really functions, not financially, but as a system for delivering material prosperity in the form of goods, services, built assets and infrastructure. Self-evidently, all of this depends on the value obtained from the use of energy.

This isn’t simply a matter of the absolute quantity of energy that can be supplied. Rather, 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, or ECoE.

Driven primarily by depletion, the ECoEs of fossil fuel energy have been rising exponentially. Since oil, gas and coal still account for more than four-fifths of total energy consumption, much the same has happened to overall trend ECoE. This has meant that aggregate prosperity has stopped growing, and prosperity per capita has already turned down.

What this means is spelled out in the following charts. Just as top-line prosperity is falling, the real costs of energy-intensive essentials have been rising (first chart).

The inevitable result is that the affordability of discretionary purchases is falling, a trend that cannot be reversed, and can no longer be disguised by using cheap debt to prop up discretionary spending (second chart).

Financially, our wholly futile efforts to ‘fix’ material economic problems with financial expansion have created gigantic commitments which the economy of the future will be wholly unable to honour (third chart).

Lastly, the ‘financial’ economy of money and credit and the ‘real’ economy of energy-determined products and services have diverged, creating downside that the SEEDS economic model calculates at 40% (fourth chart).

This disequilibrium – rather than the ‘mistakes of incomprehension’ made at the national level – is the real explanation for the crisis into which, with utter inevitability, the world has now been pitched.

Fig. 1

#240: Trussed for the block?


New British premier Liz Truss, and her chancellor (finance minister) Kwasi Kwarteng, have embarked on a gigantic economic gamble. If it succeeds, it will surprise, not just “trickle-down”-averse Joe Biden, but everyone who understands the realities of post-abundance economics.

If it fails, it’s likely to induce a “Sterling crisis”, with disastrous consequences for the costs of imports, and of servicing debts denominated in foreign currencies.

The verdict on this gamble will be passed, not by the voters, but by the currency and gilts (government bonds) markets. So far, a few hours after the chancellor’s statement, it’s not looking good, with Sterling down to just above $1.10. Investors are understandably reluctant to buy a pig in a poke, particularly when a detailed price-tag hasn’t been attached to it.

Many things are extraordinary about this gambit. It’s not new, of course, for governments to prioritize the greedy over the needy, but they are seldom quite so brazen about it. The Truss administration seems to be at war with permanent officials, and has already sacked the senior civil servant at the Treasury. For the first time since the Office for Budget responsibility was created back in 2010, the advice of the OBR has not been sought, and its economic and fiscal forecasts have not been published.

This site doesn’t ‘do’ party politics, still less the politics of personality, and our focus is on the economy understood – as it should be – as an energy system. But we’re entitled to comment when the government of a major Western economy takes extraordinary risks in pursuit of objectives that aren’t feasible, using policies that aren’t credible.

The Truss government has nailed its colours to the mast of economic “growth”. There are two main planks to this platform. One is the contention that, by borrowing now, an economy can generate enough growth to pay off, in the future, the additional debt incurred in the present. The second is that hand-outs to the better off will percolate through to benefit the less fortunate.

On the latter, Mr Biden has remarked within the last few days that he is “sick and tired of trickle-down economics. It has never worked”. It’s noteworthy that the term “trickle-down economics” is never used by those who advocate it, for the sufficient reason that it’s utter gobbledygook.

Mention of America, though, should remind us that Ms Truss, like her predecessor Mr Johnson, has no misgivings about antagonising Britain’s allies and trading partners. Mr Biden has already made it clear that a trade deal between Britain and the United States – the trophy promised and sought by so many supporters of “Brexit” – isn’t going to happen. The UK seems quite prepared to antagonize the EU – and, again, the White House – by reneging on a treaty determining trade arrangements affecting Northern Ireland.

Political analysts might observe, in this situation, a transference of weakness from party politics to national economics. Liz Truss’s own political fragility is being parlayed into worsening the economic and financial fragility of the British economy.

Ms Truss was not the preferred candidate of Conservative MPs, whose own choice was Rishi Sunak. Her ministerial changes have sent a large cadre of the disaffected to the back-benches. She owes her elevation to party members, a tiny and unrepresentative sliver (0.2%) of the British public. Many, even of those, might have preferred to reinstate Mr Johnson if his name had been on the ballot.

If there’s a Tory precedent here, it’s Benjamin Disraeli (1804-81). His great triumph, the Reform Act of 1867, was achieved by outflanking Mr Gladstone’s Liberals from the left. This seemingly left voters baffled by the difference, if any, between “Dizzystone and Gladraeli”. He may or may not – but it was in character – have said to a dissenting MP “damn your principles! Stick to your party!”. On his elevation to prime minister in 1868, he was wont to say that he had “reached the top of the greasy pole”, the big challenge now being to stay there.  

From an economic perspective, the problem with the new economic gambit is that it’s impossible – in Britain, or anywhere else – to buy growth with debt to a point at which the expanded economy then pays down the incremental borrowing.

Between 1999 and pre-covid 2019, the UK economy expanded by £0.72 trillion whilst increasing aggregate debt by £2.9tn. An equation in which each £1 of borrowing yields less than £0.25 of growth makes it impossible to a pull a rabbit of solvency out of the top hat of debt.

Analysis undertaken using the SEEDS economic model shows that, between 2001 and 2021, British real GDP increased by £560bn (at constant 2021 values) whilst debt soared by £2.93tn, a borrowing-to-growth ratio of 5.22:1. Within the “growth” reported over that period, fully 69% was the purely cosmetic effect of pouring so much extra credit into the system. Reported growth may have averaged 1.8% annually over that period, but annual borrowing averaged 7.2% of GDP.

Organic growth – calculated here as underlying or ‘clean’ economic output (C-GDP) – averaged only 0.6%, rather than 1.8%, through that period. This rate of underlying growth in economic output was less than the trend increase in population numbers (0.77%) through those same years.

Fig. 1

When we further factor-in rises in the Energy Cost of Energy (ECoE), it emerges that British prosperity per capita topped out in 2004, at £27,900 per person, and had, by 2021, fallen by 10%, to £25,090.

At the same time, the estimated real cost of essentials has been rising, even before the recent surge in energy prices. As you can see in the left-hand chart in fig. 2, the average British person is subject to relentless affordability compression. This is reflected in the second chart, which plots relentless contraction in the affordability of discretionary (non-essential) purchases.

This ‘affordability compression’ can be expected to undermine the ability of households to ‘keep up the payments’ on everything from mortgages and credit to staged payments and subscriptions. This is particularly important in an economy extensively leveraged to the global financial system. Despite some contraction in the aftermath of the global financial crisis, British financial exposure remains enormous. When last reported at the end of 2020, financial assets – the counterparts of the liabilities of the household, business and government sectors – stood at 1262% of GDP, far higher than the United States (588%), the Euro Area (795%) or Japan (871%).

Fig. 2.

We need to be clear that SEEDS analyses of other Western economies display, for the most part, patterns that are not dissimilar to those of the United Kingdom. As a direct result of relentless rises in ECoEs, Western prosperity turned down well before the 2008-09 global financial crisis (GFC). The idea that a deterioration in material prosperity can be countered with financial innovation has been a delusion shared by governments around the world.

Where Britain is different is in the government’s preparedness to gamble, and to insist that political will can triumph over economic reality. Though subjected to much criticism, the Bank of England has been doing its best to persuade the international markets that Sterling remains an investment-grade currency, despite the reckless behaviour of its bosses in Westminster. The Bank knows, as the government seemingly does not, that the economic viability of the United Kingdom rests on the credibility of its currency.

The probability has to be that the Truss administration’s gamble will fail. As well as not putting a price-tag on the full-year cost of its energy support programme and its generally regressive tax cuts, nothing has been said about public spending, particularly on health and defence.

What Mr Kwarteng offered the markets today was an un-costed exercise in bluster. The probable consequences are, at the least, weaker Sterling, costlier imports, rising rates and – irony of ironies, where Conservative supporters’ priorities are concerned – falling property prices.

The full consequences won’t be known until it’s clear how much the government needs to borrow, whether investors are willing to lend to it and, if so, at what price.

#239: Life after liberalism?


There can be no doubt at all that the global economy is in very bad shape. For some, this portends a general “collapse”. This, however, presupposes that we don’t adapt to new conditions, and that we don’t learn from past mistakes. We have a pretty solid history of doing exactly that, even if we only arrive at the right conclusions after trying all of the wrong ones first.

Of course, to adapt to new conditions, and to learn from mistakes, we need to know what these conditions and these mistakes actually are. Conventional interpretations of economics are failing us through an inability to provide the information required for this understanding.

The view set out here is that we do have a greatly enhanced understanding of how the economy works. Orthodox economics may continue to cling to precepts first laid down in the eighteenth century – essentially, that the economy can be understood in terms of money alone – but broader thought has moved on, spurred by energy shortages, by environmental concerns, and by recognition that the ‘perpetual growth’ promised by the orthodoxy simply isn’t happening.

The big challenges now are two-fold. The first is to adapt society to an economy that, having ceased to grow, has now started to contract. The second is to redesign a financial system that is exposed to failure because it has been wholly predicated on the fallacious notion that the economy can expand in perpetuity.

Politics isn’t entirely a matter of economics, but it’s very nearly so. Socialist, social democratic, conservative, ultra-‘liberal’ and all other strands of political thought are all founded on particular conceptions of the economy. As Robert Lowe (1811-92) put it, politics is a contest “between those who have – to keep what they have got; and those who have not – to get it”.

Political parties might be described as ‘combinations of economic thought and self-interest’. In practical terms, what this means is that the invalidation of a party’s economic proposition reduces its platform to one of pure self-interest.

For example, politicians in the USSR might have been sincere believers in Marxist-Leninist economic dogma, but they would also have been cognisant of the privileges of Soviet leaders and officials. Likewise, even purist believers in extreme ‘liberal’ economics are not uninfluenced by the rewards that this ideology can provide, not just to its leaders but to its supporters as well.

Contemporary economic liberalism is founded on the proposition that unfettered markets best serve the public interest. As a principle, this is soundly rooted in Adam Smith. Economic liberalism is not threatened by an invalidation of the principle of competition.

But it is challenged on two other fronts.

One of these is the presumption that the economy can be understood in entirely financial terms, and is, on this basis, capable of delivering growth in perpetuity. The unravelling of classical, ‘money only, growth forever’ economics will thus be detrimental to the “liberal” economic proposition.

The other is the claim that, if “liberalism” isn’t very good at delivering equality, at least it compensates for this deficiency by delivering “growth”. As prior growth ceases and goes into reverse, this plank of the liberal economic platform will fail. The public will be left with ‘the inequality without the growth’.

We don’t yet know what political ideas and systems will emerge as we endeavour to address a contracting economy and a failing financial system. But we can be pretty sure that the future ascendancy won’t endorse economic ‘liberalism’.

In other words, a ‘post-growth’ economy will produce ‘post-liberal’ politics.

The duality of prosperity and money

A critical point about economic interpretation, as it’s understood here, is the conceptual distinction that needs to be drawn between two economies. One of these is the ‘real’ economy of goods and services. The other is the ‘financial’ economy of money and credit.

The principles underpinning this interpretation are simplicity itself. The first is that the economy which provides products and services is a material system, determined by the use of energy.

The second is that money, having no intrinsic worth, commands value only as a ‘claim’ on the output of the material economy.  

With this distinction drawn, a realistic appraisal is that, whilst the material economy of energy has ceased growing, the proxy economy of money has carried on expanding. This implies that, whilst economic deterioration may be manageable, the financial system is no longer fit for purpose, and will need to be re-designed.

Much the same applies to economic and political thinking. Extreme collectivism has been tried, and has failed. Extreme liberalism has now reached its equivalent point of failure.

Both of these failed extremes have been rooted in a particular view of the role of the market. For collectivists, the market doesn’t matter, and the economy can be operated on the basis of central diktat. This set of ideas failed in the Soviet Union and, prior to the Deng reforms, was failing in China.

The other extreme is the assertion that the market is all-important. Theoretical liberalism worships the market in much the same way that theocracies worship a deity – that is to say, extreme liberalism isn’t open to doubt about the principle that the market is all-important.

On the shoulders of giants

The irony here is that economic ideologies are variously rooted in things that great thinkers – such as Smith, Marx and Keynes – didn’t actually say. Marx, at least, knew as much, famously stating that “I am not a Marxist”.

The fallacies based on a misreading of Marx are not our priority here, because the unfolding event now is the failure of a ‘liberal’ economic ideology which claims to be based on the precepts of Adam Smith.

In this narrative, Smith is portrayed as a worshipper of the market, an advocate of uncontrolled market operation and an opponent of ‘the public sector’.

The snag is that this caricature misrepresents what Smith actually said.

Smith’s great understanding is that the market operates as a ‘hidden hand’, advancing the general good through the pursuit of individual aims. The public is provided with bread, for instance, not through the altruism of bakers, but through their striving to make a profit.

That is, the operative process driving economic betterment is competition. This remains a wholly valid conclusion.

From this, though, it follows that competition must be allowed to operate unfettered, a principle that we might summarize as markets that are ‘free and fair’.

For Smith, state intervention wasn’t at the top of the list of potential fetters to the beneficial working of the market. This is hardly surprising, because Smith wrote at a time when the state was very small indeed, and when the term ‘the public sector’ was not yet in use.  

Rather, the potential threats to free and fair competition existed, for Smith, in the realm of manipulation. The same competitive incentive that could promote the effective operation of the economy could also lead to self-serving distortion. Smith’s strongest invective is saved, not for the state, but for those market participants who strive to impose distortions, such as monopolies and oligopolies.

In short, Smith did not believe that markets could be free and fair if they were left to their own devices.

In modern terminology, we can state that Smith was an opponent of excessive market concentration and an advocate of effective regulation. Along the lines of “I am not a Marxist”, Smith might, had he lived long enough, have said that ‘I am not a deregulator’.

Effective markets are orderly, not a caveat emptor free-for-all, and they won’t stay free, fair or effective without supervision. The state is the only plausible provider of this supervision.

The realm of the material

The other thing to note about Adam Smith is that he was writing in a pre-industrial society. His master-work, The Wealth of Nations, was published in the same year (1776) as James Watt’s completion of the first truly efficient steam engine.

At the dawn of the industrial age, it would have been impossible for Smith – or Watt – to conceive the concept of resource limits as these are understood today. Where scarcity was recognized, it was scarcity of land, and of labour. The concept of energy or environmental limits could not be understood until we started to experience both.

Explaining the critical importance of the market under conditions in which the concepts of resource and environmental scarcity did not exist, Smith can be said to have laid the foundations for an economic orthodoxy which portrays the economy as a wholly financial system.

A big part of our problem today is that conventional economics hasn’t moved on from a perception which, after all, was laid down 250 years ago.

In numerous other fields of thought, ideas have moved on from precepts which have been challenged by subsequent events. Life scientists and technologists don’t insist on the observance of statements made in 1776.

But economics hasn’t moved with the times. The presumption remains that the economy can be understood in financial terms alone.

Unlike Adam Smith, we live in an energy-intensive economy. Aside from a few mills driven by water or wind, the dominant source of energy in his times was human and animal labour. This had been the case for millennia, so Smith can hardly be blamed for not knowing that this was about to change.

Today, we know that the supply of products and services is a function of the use of energy. If we didn’t know this before, recognition has been forced upon us by events, not just by the current energy crisis but by the events of the 1970s as well.

Even before the oil embargoes of the seventies, the centrality of energy to economic processes should have been obvious. For example, energy deficiencies drove Imperial Japan to fight a war with the United States, and American resource supremacy ensured the outcome. The aircraft, ships and tanks that helped win the war could not have been supplied without the then resource wealth of the American petroleum industry.

Conclusions about the critical importance of energy were expounded as long ago as 1957, by Admiral Hyman G. Rickover, USN, the “father of the nuclear submarine”. One of his observations should resonate particularly with anyone who understands the economy as a surplus energy system:

“Possession of surplus energy is, of course, a requisite for any kind of civilization, for if man possesses merely the energy of his own muscles, he must expend all his strength – mental and physical – to obtain the bare necessities of life” (my emphasis).

The emergence of constraints

We now know, then – as Smith could not – that the economy is a surplus energy system. We also know about the environmental issues associated with the use of energy. This knowledge should enable us to understand that all other materials – including food, minerals, plastics and even water – are products of the energy used to supply them.

Rather than adopt these realities – and to accept, as Admiral Rickover said, that “the Earth is finite” – orthodox economics has jumped through hoops in its insistence that infinite growth is made possible by the wholly financial character of the economy.

The principal plank of this platform is the assertion that demand creates supply – if sufficient financial incentives are provided, there is nothing that the market cannot deliver. If this is taken as a universal proposition, though, the implication is that financial demand stimulus can supply physical resources, of which the most important – the ‘master resource’ – is energy.

The hard facts of the matter are contrary to this proposition. The reality is that no amount of demand stimulus, and no increase in price, can produce anything that does not exist in nature.

It may be true that consumer demand can promote the supply of artefacts. If consumers want a new generation of smartphones, industry will supply them.

So far, so good. But, in a material economy, consumer demand is rooted in prosperity, whilst the ability of industry to respond to demand is dependent on the availability of resources.

The second line of defence for the ‘demand produces supply’ orthodoxy is substitution, meaning that, if a particular raw material is in short supply, market forces will combine with ingenuity to deliver an alternative.

This proposition is now being subjected to the stiffest possible test. An economy built on coal, oil and natural gas is being undermined by scarcity- and depletion-driven rises in fossil fuel costs, and by the worsening environmental consequences of fossil fuel reliance.

To pass this ‘test of substitution’, we would need to be able to transition from fossil fuels to renewables without economic contraction. We have discussed the implausibility of “sustainable growth” on previous occasions, so all that needs to be said here is that full value transition seems extremely unlikely.

In short, we probably can create a sustainable economy built on renewables, but this sustainable economy is going to be smaller – meaning less prosperous – than the economy that has built on fossil fuels.

Past falls in the costs of renewable energy cannot be extrapolated indefinitely, because physics dictates efficiency limits at the level of the individual wind turbine or solar array. Contrary to widespread supposition, technology operates within the parameters of physics, and cannot overcome those restrictions.

If we can’t overcome these limits to efficiency, what remains is a scale issue. If we can’t make wind turbines, solar panels or batteries that have infinite efficiency potential, then we need to build vast numbers of them to enable transition.

And this is where circularity comes into the equation. To build huge numbers of turbines, panels and batteries, we need correspondingly vast quantities of raw material inputs, including steel, concrete, copper, cobalt and lithium. Where these materials exist at all in the requisite amounts, their delivery is a function of the energy required to supply them.

For the foreseeable future, the availability of these resources depends on the legacy energy of fossil fuels. It’s not inconceivable that, at some future point, we may be able – for example – to extract, process and deliver copper, or steel, using renewable energy alone.

The problem with this isn’t feasibility, but efficiency. Renewables may replace fossil fuels in purely quantitative terms, but they can’t replicate the characteristics of oil, natural gas and coal. Oil, in particular, is energy-dense, storable and portable to an extent that electricity cannot match.

A troubled outlook

In past discussions, the SEEDS economic model has been used to provide projections for the scale and composition of the economy of the future. Rather than revisit these forecasting processes, let’s summarise what the key points are.

First, material prosperity will decline, because of the implausibility of replicating the energy value (and, for that matter, the energy flexibility) hitherto provided by fossil fuels.

Second, the real costs of energy-intensive necessities will continue to increase, as a consequence of this same energy dynamic.

Accordingly, the affordability of discretionary (non-essential) consumption will be subjected to relentless compression, as will the affordability of investment in new and replacement productive capacity and infrastructure.

These are the material or ‘real economy’ consequences of a deteriorating energy dynamic.

But there are financial, social and intellectual implications as well. The financial system is wholly predicated on perpetual economic growth. As this precept turns out to be fallacious, the financial system will need to be redesigned on very different assumptions. It’s hard to see how the existing financial system can give way to a new one without extreme trauma.

Intellectually, we should be prepared for the failure of an economic orthodoxy that has been created over more than two centuries of virtually continuous economic growth. Ideas are, to a considerable extent, products of their times and conditions. It’s no surprise that conventional economics has endeavoured to explain the growth that was visible to all participants in the process.

Hitherto, growth hasn’t stopped because of our inability to explain it effectively. Just as economists have developed financial theories about growth, the energy dynamic has carried on delivering growth itself.

In other words, the intellectual challenge has shifted, from explaining the presence of growth to explaining its absence.

Politically, the need to reinterpret the economy will undercut the political platforms of parties whose precepts are based on the old consensus of perpetual expansion driven by financial management.

Economically ‘liberal’ political movements are particularly exposed to this unfolding process. Their central assertion is that we need to accept the deficiencies of the market system – with inequality the most obvious such deficiency – because liberal market economics can be relied upon to deliver growth.

If this claim is invalidated – along with every other thesis founded on perpetual growth – any party which relies upon it faces the invalidation of its central principle.

Absolute monarchy, for instance, failed when the public ceased to believe in the divine right of kings, and when monarchs failed to deliver prosperity. This intellectual-material axis was at the heart of the French Revolution, a product both of new ideas and of hardship.

If economic liberalism is going to be seen as delivering inequality without the compensating benefit of material improvement, then its day has passed.

The task now – of finding an intellectual and political replacement for liberalism – is as challenging as the designing of a post-growth financial system.

#238. Money and the end of abundance


Amongst the world’s decision-makers, French president Emmanuel Macron has come closer than anyone to spelling out the reality of the current economic situation, saying that “we are in the process of living through a tipping point or great upheaval”, and referencing “the end of abundance” (my emphasis).

If his words are taken seriously – as they should be – a major crisis looms. The global financial system is entirely predicated on perpetual economic growth.

As important as what Mr Macron has said is what he didn’t say. He didn’t say that abundance is over ‘for a year or two’, or that we’ll have to live through this ‘until better times return’. He didn’t make fatuous promises of ‘sunlit uplands’ or ‘a new golden age’.

Some of us have long known that an age of abundance made possible by low-cost energy was coming to an end. Until now, though, decision-makers have fought shy of this conclusion, taking refuge in the tarradiddle of ‘infinite growth on a finite planet’ proffered by a deeply flawed economic orthodoxy.

What should concern us now isn’t when, or whether, other leaders will arrive at this same conclusion. The trend of events is going to impose that emerging reality upon them.

Rather, we need to be prepared for what happens when market participants arrive at the same conclusion as Mr. Macron.  

The nature of the crisis

Preparedness requires clarity, and we need to be in no doubt that what we’re witnessing now is an unfolding affordability crisis. This means two things – and both of them point towards a major financial slump.

First, the ability of consumers to make discretionary (non-essential) purchases is in structural decline. This spells relentless contraction, not just in obvious discretionary sectors like leisure, travel and entertainment, but in ‘tech’ and consumer durables as well.

Second, households will find it increasingly difficult to ‘keep up the payments’ on everything from mortgages and credit to subscriptions and staged-payment purchases.

All of this has obvious negative implications for stock and property markets. But the real risk to the financial system resides, not in asset prices, but on the liabilities side of the equation.

The problems here are inter-connectedness, scale and opacity. Globally, private sector debt totalled $144 trillion at the start of the year, of which $85tn was owed to banks. But these numbers are dwarfed by broader private sector exposure. Analysis carried out for this report puts this number at $513tn, but this is no more than an informed estimate, because available data is neither complete nor timely. The probabilities are that $513tn understates the real scale of the problem.

Most disturbingly of all, the majority of this credit exposure isn’t subject to reporting and regulatory rules of the sort that apply to deposit-taking banks.

With hindsight, the causes of the global financial crisis (GFC) – sub-prime lending, securitization, imprudent lending and inadequate regulatory oversight – should have been apparent long before 2008.

Likewise, historians of the future can be expected to marvel at the subsequent further break-neck growth of an enormous network of interconnected commitments based on the false premise of infinite economic expansion.

Fig. 1 – whose constituent parts are discussed later – provides an overview of the scale of world financial exposure, comparing, at constant dollar values, the situation today with that of 2007, on the eve of the GFC.

Fig. 1

At the end of abundance

Regular visitors to this site will know why material abundance is ending, and will also know that this turning point hasn’t hit us like a thunderbolt from cloudless skies. In fact, we’re at (or very near) the end of an end-of-growth precursor zone which we can trace right back at least as far as the 1990s.

It is surely self-evident that the economy is an energy system, not a financial one. But material prosperity isn’t a simple function of the quantitative availability of primary energy. Rather, the flow of economic value generated by the use of energy divides into two streams.

One of these is cost, meaning the proportion of accessed energy that, 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. Material prosperity is a function of the surplus energy that remains after ECoE has been deducted from the aggregate (or ‘gross’) amount of energy available.

Rising ECoEs affect the energy-prosperity dynamic in two ways. First, they reduce prosperity by decreasing the quantity of surplus energy available. Second, they make it ever harder to strike prices which meet the needs of both producer and consumer. In this equation, prices are an interface between producers’ costs and consumers’ prosperity. As costs rise and consumer affordability diminishes, aggregate supply starts to contract.

ECoEs have been rising over a very extended period, driven primarily by the effects of depletion on fossil fuels. Quite naturally, we have used lowest-cost resources first, leaving costlier alternatives for a ‘later’ that has now arrived.

This trend is a global one, and not even energy-rich countries like Russia or Saudi Arabia are exempt from it. Those who blame the current energy crisis on “Putin’s war” are victims of self-deception. The conflict in Ukraine has, at most, brought the end of energy abundance forward by a small number of years. Neither Saudi nor anyone else can ‘rescue’ us from the effects of rising ECoEs.

After the hope that trade with Russia will resume, the second consolation offered to the public – offered, perhaps, in full sincerity – is that transition to renewable energy sources will recreate the economic abundance hitherto bestowed by oil, natural gas and coal.

The reality, though, is that this is most unlikely to happen. The expansion of renewables depends upon the use of enormous quantities of materials including steel, concrete, copper, cobalt and lithium. These material requirements can only be made available by the use of legacy energy from fossil fuels.

The case for ‘seamless’ transition to renewables is based on three sources of self-delusion. One of these is mistaken extrapolation from past decreases in cost. The second is a failure to recognize that the capabilities of technology are bounded by the laws of physics. The third is simple wishful-thinking.

Advocates of transition to renewables are right to emphasise the critical importance of wind and solar power. A “sustainable economy” may indeed be possible, though it’s being made harder to achieve by our insistence on modelling the future on an adaptation of the processes of today (which is why we’re promoting electric vehicles, when trams and trains make a lot more sense).

But “sustainable growth” is a myth – there’s no reason to suppose that an economy powered by renewables will be as large as the fossil fuel economy of today, and every reason to expect that it will be smaller.

Understanding affordability compression

Just as prosperity decreases, the real costs of energy-intensive essentials will continue to rise. This is part of a broader pattern best understood by dividing economic resources into three functional segments.

These are the provision of essentials, capital investment in new and replacement productive capacity, and discretionary (non-essential) consumption.

These patterns are illustrated in fig. 2. These charts are designed to facilitate comparisons with other forecasts, so they accept latest-year (2021) GDP as a start-point, but use SEEDS prosperity calculations to restate prior trends, and to project future outcomes. Each is stated in national currencies at constant 2021 values.

As you can see, whilst aggregate prosperity is deteriorating, the costs of essentials are rising. This means that both capital investment capability and discretionary affordability are falling.

Fig. 2 

What this means at the household level is illustrated in fig. 3, where prosperity per capita is compared with trends in the estimated costs of essentials. These charts show average per capita numbers, meaning that the situations of those on below-average incomes are worse than these graphs might suggest.

Fig. 3

Of course, decision-makers have never acted on any assumption other than ‘growth in perpetuity’. When rising ECoEs began to bear down on economic performance in the 1990s, the concept of energy causation was disregarded, and it was assumed that the material deceleration involved in “secular stagnation” could be fixed with financial tools.

Accordingly, access to credit was expanded, causing debt to rise rapidly. At least until 2008, this appeared to be working. In fact, though, what we had been doing was creating cosmetic “growth” with liability escalation.  

The GFC should have laid bare the fallacy that we can create material supply with financial demand. Instead, decision-makers doubled down on this fallacy by supplementing “credit adventurism” with “monetary adventurism”. Negative real interest rates are a dangerous anomaly, incentivising borrowing whilst discouraging investment. The capitalist economy, after all, relies upon positive returns being earned by the owners of capital. It also depends on allowing markets to price risk without undue interference.

This means that, in 2022, we’re discovering what many have known (or at least suspected) all along – that we’ve been sacrificing the stability of the financial system, and the effective working of a market economy, in pursuit of a chimera of “growth”.    

Go figure – the scale of exposure

Let’s start putting some numbers on the magnitude of global financial exposure. This is complicated, and fig. 1 (shown earlier) is intended to set out the broad structure of financial liabilities – at constant values – comparing the current situation with the equivalent position on the eve of the global financial crisis (GFC) in 2007.

Please note that the data set out in fig. 1 is stated in constant (2021) dollars converted from other currencies at market rates, not on the PPP (purchasing power parity) convention generally preferred here.

Conventional debt data is available from the Bank for International Settlements. BIS data shows that, at the end of last year, governments owed $81tn whilst, within private sector debt totalling $144tn, $85tn was owed to commercial banks.

The real issue, though, isn’t debt, but broader financial exposure. These “financial assets” – which are the liabilities of the government, household and private non-financial corporate (PNFC) sectors – are reported by the Financial Stability Board.

Financial assets fall into four broad categories. Three of these – central banks, public financial institutions and commercial banks – are self-explanatory, though it’s noteworthy that the total exposure of commercial banks (estimated here at $224tn) far exceeds the conventional debt owed to them by households and PNFCs ($85tn). The fourth is NBFIs, which means ‘non-bank financial intermediaries’.

We need to be clear that the FSB data is neither timely nor complete. The data covers 29 countries which, between them, account for about 85% of the world economy when measured as GDP. The most recently-available data, published on 16th December 2021, relates to the situation at the end of 2020.

To assess the current global position, then, we need to make informed estimates, brought forward to the present, based on the data that is available.

At this point, it’s vital to note that the FSB is not a regulatory authority. Generally speaking, deposit-taking institutions are regulated, but other credit providers are not. This is a huge gap in the ability of the authorities to maintain, or even to monitor, macroeconomic stability.

This lack of regulation is particularly important when we look at NBFIs. This sector is commonly referred to as the “shadow banking system”. NBFI exposure is enormous, and can be estimated at about $290tn as of the end of 2021. This exceeds the combined total of global government and private debt ($225tn).

The NBFI sector comprises various components, which include pension funds, insurance corporations, financial auxiliaries and OFIs (other financial intermediaries). This latter category includes money market funds, hedge funds and REITs.

In an article published in 2021, Ann Pettifor provided a succinct description of the shadow banking system. She traces the rise of the sector to the privatisation of pension funds, which happened in 30 countries between 1981 and 2014, and which, she says, “generated vast cash pools for institutional investors”.

Shadow banking participants “exchange the savings they hold for collateral”, generally in the form of bonds, usually government bonds. Instead of charging interest, they enter into repurchase (repo) agreements whereby the borrower undertakes to buy back the bonds at a higher price.

She points out that securities “are swapped for cash over alarmingly short periods”, and that “operators in the system have the legal right to re-use a security to leverage additional borrowing. This is akin to raising money by re-mortgaging the same property several times over. Like the banks, they are effectively creating money (or shadow money, if you like), but they are doing so without any obligation to comply with the old rules and regulations that commercial banks have to follow”.

Measuring the shadow

How much risk attaches to this depends, of course, on the scale at which it exists, and this is where we run into difficulties. As remarked earlier, FSB reporting covers only 29 economies, though these do account for about 85% of the global economy.

What we need are informed estimates of global financial exposure. The approach used here is to divide the financial assets universe into three parts.

One of these comprises the 23 (of 29) FSB reporting countries that are also covered by the SEEDS economic model.

The second group comprises specialist financial centres, of which two – Luxembourg and the Cayman Islands – are covered by FSB data.

As of 2020, Luxembourg had financial assets of $19.3tn, and a GDP of $79bn. The equivalent numbers for the Caymans were $8.9tn and $4.9bn. Accordingly, their respective ratios of financial assets to GDP were 23,678% (Luxembourg) and 253,485% (the Caymans).

The third group consists of all countries other than the 23 SEEDS-covered economies and the two specialist financial centres.

Together, these calculations suggest that aggregate financial assets totalled $520tn at the end of 2020, rising to an estimated $589tn last year. The deduction of the central bank and PFI (public financial institution) component puts private sector exposure at an estimated $513tn, most of which is unregulated.  

The composition of available data and estimates is illustrated in fig. 4. (Like the other charts used here, fig. 4 can be expanded by opening it in a new tab).

Fig. 4

Assets and liabilities – “the future is almost gone”

There’s no absolute “right” or “wrong” level of financial exposure. What matters is the relationship between monetary commitments and the underlying economy.

Those of us who understand the economy as an energy system are at a unique advantage when it comes to assessing the level and tendency of financial risk. The concept of “two economies” enables us to recognize the true nature of money – in short, we know that money isn’t ‘the economy’, but exists instead as an aggregate of ‘claims on the economy’, which is a wholly different proposition.

As you may know, money has no intrinsic worth, but commands value only as a ‘claim’ on the products and services supplied by the ‘real’ or material economy of products and services.

Three useful distinctions can be made here. First, current monetary activity is a financial representation of the underlying economy of goods and services. Second, liabilities are a claim on the material economy of the future. Third, asset pricing represents a collective perception of what the material economy of the future will be able to deliver.

As we’ve seen, the representation of the economy has become distorted by the use of monetary expansion to create cosmetic “growth”. Liabilities at their current size, meanwhile, could only be honoured “for value” if the underlying economy were to continue to expand indefinitely which, as we’re beginning to discover, cannot happen. Asset prices have been inflated, not just by ultra-low interest rates, but also on the basis of a collective misconception about the future size and shape of the economy.  

Let’s clarify this a little by recognizing that both asset prices and liabilities are embodiments of collective futurity. By “futurity”, we mean common expectations for the future.

If forward expectations are positive, investors assume growing corporate profitability, whilst lenders assume an ability to service and honour expanding debt and quasi-debt commitments. If the expectations embodied in collective futurity are downgraded, asset prices become vulnerable to sharp corrections and, more importantly, assumptions about borrower viability are called increasingly into question.

The current economic crisis is causing an increasing resort to credit by struggling households and businesses. These ‘borrowers from need’ are a far greater default risk than ‘borrowers from choice’, but this worsening risk profile hasn’t – yet, anyway – been reflected in the availability and cost of credit.

Lenders’ collective insouciance about providing credit to high-risk borrowers may reflect a general assumption that credit providers will be bailed out ‘if the worst comes to the worst’.

We need to be absolutely clear that systemic-scale rescues aren’t possible, which is surely obvious to anyone who compares over $500tn of non-government liabilities with a $96tn economy.

This isn’t 2008, when “toxic assets” were largely confined to securitized sub-prime mortgages and reckless real estate-related lending. What we face now is the culling of large swathes of the discretionary economy, combined with degradation of the income streams which flow from households to the corporate and financial sectors. If the authorities attempted to backstop all of this with newly-created money, the result would be hyperinflation.

So the real problem now is – in the words of Mickey Newbury – that “the future’s not what it used to be”. We might also reference a newly-released song by Monkey House – “the future is almost gone”.

The essentially-positive collective futurity that has shaped both asset prices and the cost and supply of capital is turning out to have been wrong. This has a direct read-across to the expectations and attitudes, not just of investors, but of lenders as well.

If we’re making a list of critical interpretational phrases to help us understand changing conditions, we can add “a futurity reset” to “affordability compression”. Both are compatible with Mr Macron’s “end of abundance”.

A process of implosion

As we’ve seen, the long-established positive collective futurity is being undermined by a dawning recognition of the reality that we cannot rely on perpetual economic growth. We can’t know what the sequence of events is likely to be as this reality sinks in, but we do know some of its critical components.

One of these is a slump in capital markets, led by an investor flight from discretionary sectors. This can be expected to occur as soon as investors realize that affordability compression isn’t temporary but is, rather, an intrinsic component of the ending of abundance.

Another is a sharp fall in property prices, reflecting impaired affordability, compounded both by rate rises and by the prospect of distressed sales. People who can no longer afford to service the mortgages they already have are in no position to take on ever larger commitments. We have no systems in place for coping with collapsing property prices, even though such systems would not be difficult to design.  

Governments can be expected to act, even before the financial system starts to implode, because of the need to address the hardship now being suffered by the public. But this is where the authorities are brought to a recognition of quite how limited their options really are. If they resort to full-on monetary intervention, the effects would be to drive inflation higher – particularly in the categories of necessities – which would make household hardship worse.

We need to be clear, meanwhile, that there is no single “right answer” to the rate policy conundrum. The Fed seems to think that rate rises, and the reversal of QE into QT, will defend the purchasing power of the dollar.

The Bank of England has been much criticized for raising rates, and is likely to face more flak over future rate hikes. In fact, it’s highly unlikely that the Bank is naïve enough to think that it can counter double-digit inflation with 0.5% increases in rates. Rather, the Bank can be presumed to be endeavouring to demonstrate to the markets that it’s not indifferent to defending the value of the pound. The very worst thing that could happen to the British economy would be a “Sterling crisis”, and the independence of the Bank is the single strongest defence against this happening.  

The biggest danger of the lot, though, is an implosion within the credit sector, affecting not just banks but NBFIs as well. Here, market participants may – for some time, at least – hold their nerve, placing their trust in the (actually impossible) assumption that, as in 2008-09, governments and central banks will intervene to backstop the system.

Eventually, though, the network of interconnected liabilities will start to unravel, in a similar (though vastly larger) re-run of the ‘credit crunch’ of 2007. At this point, credit flows dry up, because nobody knows which counter-parties are or are not viable.

“All roads”, it’s said, “lead to Rome”, but all of the discernible trends in the financial system point to financial implosion.

As abundance ends, so, too, must any system that is predicated entirely on its infinite continuance.