#150: The management of hardship

GOVERNMENT AND POLITICS IN AN AGE OF DETERIORATING PROSPERITY

Though just over a month has passed since the previous article (for which apologies), work here hasn’t slackened. Rather, I’ve been concentrating on three issues, all of them important, and all of them topics where a recognition of the energy basis of the economy can supply unique insights.

The first of these is the insanity which says that no amount of financial recklessness is ever going to drive us over a cliff, because creating new money out of thin air is our “get out of gaol free card” in all circumstances.

This isn’t the place for the lengthy explanation of why this won’t work, but the short version is that we’re now trying to do for money what we so nearly did to the banks in 2008.

The second subject is the very real threat posed by environmental degradation, where politicians are busy assuring the public that the problem can be fixed without subjecting voters to any meaningful inconvenience – and, after all, anyone who can persuade the public that electric vehicles are “zero emissions” could probably sell sand to the Saudis.

And this takes us to the third issue, the tragicomedy that it is contemporary politics – indeed, it might reasonably be said that, between them, the Élysée and Westminster, in particular, offer combinations of tragedy, comedy and farce that even the most daring of theatre directors would blush to present.

From a surplus energy perspective, the political situation is simply stated.

SEEDS analysis of prosperity reveals that the average person in almost every Western country has been getting poorer for at least a decade.

Governments, which continue to adhere to outdated paradigms based on a purely financial interpretation of the economy, remain blind to the voters’ plight – and, all too often, this blindness looks a lot like indifference. Much of the tragedy of politics, and much of its comedy, too, can be traced to this fundamental contradiction between what policymakers think is happening, and what the public knows actually is.

Nowhere is the gap in comprehension, and the consequent gulf between governing and governed, more extreme than in France – so that’s as good a place as any to begin our analysis.

The French dis-connection

Let’s start with the numbers, all of which are stated in euros at constant 2018 values, with the most important figures set out in the table below.

Between 2008 and 2018, French GDP increased by 9.4%, equivalent to an improvement of 5.0% at the per capita level, after adjustment for a 4.2% rise in population numbers. This probably leads the authorities to believe that the average person has been getting at least gradually better off so, on material grounds at least, he or she hasn’t got too much to grumble about.

Here’s how different these numbers look when examined using SEEDS. For starters, growth of 9.4% since 2008 has increased recorded GDP by €201bn, but this has been accompanied by a huge €2 trillion (40%) rise in debt over the same decade. Put another way, each €1 of “growth” has come at a cost of €9.90 in net new debt, which is a ruinously unsustainable ratio. SEEDS analysis indicates that most of that “growth” – in fact, more than 90% of it – has been nothing more substantial than the simple spending of borrowed money.

#150 France SEEDS summary

This is important, for at least three main reasons.

First, and most obviously, a reported increase of €1,720 in GDP per capita has been accompanied by a rise of almost €27,500 in each person’s share of aggregate household, business and government debt.

Second, if France ever stopped adding to its stock of debt, underlying growth would fall, SEEDS calculates, to barely 0.2%, a rate which is lower than the pace at which population numbers are growing (about 0.5% annually).

Third, much of the “growth” recorded in recent years would unwind if France ever tried to deleverage its balance sheet.

Then there’s the trend energy cost of energy (ECoE), a critical component of economic performance, and which, in France, has risen from 5.9% in 2008 to 8.0% last year. Adjustment for ECoE reduces prosperity per person in 2018 to €27,200, a far cry from reported per capita GDP of €36,290. Moreover, personal prosperity is lower now than it was back in 2008 (€28,710 per capita).

Thus far, these numbers are not markedly out of line with the rate at which prosperity has been falling in comparable economies over the same period. The particular twist, where France is concerned, is that taxation per person has increased, by €2,140 (12%) since 2008. This has had the effect of leveraging a 5.3% (€1,510) decline in overall personal prosperity into a slump of 32% (€3,650) at the level of discretionary, ‘left in your pocket’ prosperity.

At this level of measurement, the average French person’s discretionary prosperity is now only €7,760, compared with €11,410 ten years ago.

And that hurts.

Justified anger

Knowing this, one can hardly be surprised that French voters rejected all established parties at the last presidential election, flirting with the nationalist right and the far left before opting for Mr Macron. Neither can it be any surprise at all that between 72% and 80% of French citizens support he aims of the gilets jaunes (yellow waistcoat) protestors. “Robust” law enforcement, whilst it might just temper the manifestation of this discontent, will have the almost inevitable side-effect of exacerbating the mistrust of the incumbent government.

Because energy-based analysis gives us insights not available to the authorities, we’re in a position to understand the sheer folly of some French government policies, both before and since the start of the protests.

From the outset, there were reasons to suspect that the gloss of Mr Macron’s campaign hid a deep commitment to failed economic nostrums. These nostrums include the bizarre belief that an economy can be energized by undermining the rights and rewards of working people – the snag being, of course, that the circumstances of these same workers determine demand in the economy.

After all, if low wages were a recipe for prosperity, Ghana would be richer than Germany, and Swaziland more prosperous than Switzerland.

Handing out huge tax cuts to a tiny minority of the already very wealthiest, though always likely to be at the forefront of Mr Macron’s agenda, looks idiotically provocative when seen in the context of deteriorating average prosperity. Creating a national dialogue over the protestors’ grievances might have made sense, but choosing a political insider to preside over it, at a reported monthly salary of €14,666, reinforced a widespread suspicion that the Grand Debat is no more than an exercise in distraction undertaken by an administration wholly out of touch with voters’ circumstances.

Whilst Mr Macron has appeared flexible over some fiscal demands, he has ruled out increasing the tax levied on the wealthiest. This intransigence is likely to prove the single biggest blunder of his presidency.

Even the tragic fire at Notre Dame has been mishandled by the government, in ways seemingly calculated to intensify suspicion. Rather than insisting that the restoration of the state-owned Cathedral would be funded by the government, the authorities made the gaffe of welcoming offers of financial support from some of the most conspicuously wealthy people in France.

This prompted some to wonder when corporate logos would start to appear on the famous towers, and others to ask why, if the wealthiest wanted to make a contribution, they couldn’t have been asked to do so by paying more tax. It didn’t help that the authorities rushed to declare the fire an accident, long before the experts could possibly have had evidence sufficient to rule out more malign explanations. After all, in an atmosphere of mistrust, conspiracy theories thrive.

The broader picture

The reason for looking at the French predicament in some detail is that the problems facing the authorities in Paris are different only in degree, and not in direction or nature, from those confronting other Western governments.

The British political impasse over “Brexit”, for instance, can be traced to the same lack of awareness of what is really happening to the prosperity of the voters – whilst “Brexit” itself divides the electorate, there is something far closer to unanimity over a narrative that politicians are as ineffectual as they are self-serving, and are out of touch with real public concerns. Similar factors inform popular discontent in many other European countries, even when this discontent is articulated over issues other than the deterioration in prosperity.

At the most fundamental level, the problem has two components.

The first is that the average person is getting poorer, and is also getting less secure, and deeper into debt.

The second is that governments don’t understand this issue, an incomprehension which, to increasing numbers of voters, looks like indifference.

It has to be said that governments have no excuses for this lack of understanding. The prosperity of the average person in most Western countries began to fall more than a decade ago, and any politician even reasonably conversant with the circumstances and opinions of the typical voter ought to be aware of it, even if he or she lacks the interpretation or the information required to explain it.

Governments whose economic advisers and macroeconomic models are still failing to identify the slump in prosperity need new advisers, and new models.

A disastrous consensus

Though incomprehension (and adherence to failed economic interpretations) is the kernel of the problem, it has been compounded by the mix of philosophies adopted since the 1990s. Following the collapse of the Soviet Union, an informal consensus was created in which the Left accepted the market economics paradigm, and the centre-Right tried to be ‘progressive’ on social issues.

Both moves robbed voters of choices.

Though the social policy dimension lies outside our focus on the economy, the creation of a pro-market ‘centre-Left’ has turned out to have been nothing less than a disaster. Specifically, it has had two, woefully adverse consequences.

The first was that the Left’s adoption of its opponents’ economic orthodoxy destroyed the balance of opposing philosophies which, hitherto, had kept in place the ‘mixed economy’, a model which aims to combine the best of the private and the public sector provision. The emergence of Britain’s “New Labour”, and its overseas equivalents, eliminated the checks and balances which, historically, had acted to rein in extremes.

Put another way, the traditional ‘Left versus Right’ debate created constructive tensions which forced both sides to hone their messages, as well as preventing a lurch into extremism which, whilst it might sometimes be good politics, is invariably very bad economics.

The second, of course, was that the new centre-ground – variously dubbed the “Washington consensus”, the “Anglo-American model” and “neoliberalism” – has proved to be an utterly disastrous exercise in economic extremism. One after another, its tenets have failed, creating massive indebtedness, huge financial risk and widening inequality before finally presiding over the wholesale replacement of market principles with the “caveat emptor” free-for-all of what I’ve labelled “junglenomics”.

As well as undermining economic efficiency, these developments have created extremely harmful divisions in society. Whilst Thomas Piketty’s thesis about the divergence of returns on capital and labour is not persuasive, the reality since 2008 has been that asset prices have soared, whilst incomes have stagnated. This process, which has been the direct result of monetary policy, has rewarded those who already owned assets in 2008, and has done nothing for the less fortunate majority.

There is a valid argument, of course, which states that the authorities’ adoption of ultra-cheap money during and after the 2008 global financial crisis (GFC I) was the only course of action available.

But the role of policymakers is to pursue the overall good within whatever the economic and financial context happens to be. So, when central bankers launched programmes clearly destined to create massive inflation in asset prices, governments should have responded with fiscal measures tailored to capture at least some of these gains for the unfavoured majority.

Simply put, the unleashing of ZIRP and QE made a compelling case for the simultaneous introduction of higher taxes on capital gains, complemented by wealth taxes in those countries where these did not already exist.

Failure to do this has hardened incompatible positions. Those whose property values have soared insist, often with absolute sincerity, that their paper enrichment is the product entirely of their own diligence and effort, owes nothing to the luck of being in the right place at the right time, has had nothing whatever to do with the price inflation injected into property markets (in particular) by ultra-cheap monetary policies, and hasn’t happened at the expense of others.

For any younger person, often unable to afford or even find somewhere to live, it is necessarily infuriating to be lectured by fortunate elders on the virtues of saving and hard work.

It’s a bit like a lottery winner criticizing you for buying the wrong ticket.

A workable future

The silver lining to these various clouds is that future policy directions have been simplified, with the paramount objectives being (a) the healing of divisions, and (b) managing the deterioration in prosperity in ways that maximise efficiency and minimise division.

Any government which understands what prosperity is and where it is going will also reach some obvious but important conclusions.

The first is that prosperity issues have risen higher on the political agenda, and will go on doing so, pushing other issues down the scale of importance.

The second conclusion, which carries with it what is probably the single most obvious policy implication, is that redistribution is becoming an ever more important issue. There are two very good reasons for this hardening in sentiment.

For starters, popular tolerance of inequality is linked to trends in prosperity – resentment at “the rich” is muted when most people are themselves getting better off, but this tolerance very soon evaporates when subjected to the solvent of generalised hardship.

Additionally, the popular narrative of the years since 2008 portrays “austerity” as the price paid by the many for the rescue of the few. The main reason why this narrative is so compelling is that, fundamentally, it is true.

The need for redistribution is reinforced by realistic appraisal of the fiscal outlook. Anyone who is aware of deteriorating prosperity has to be aware that this has adverse implications for forward revenues. By definition, only prosperity can be taxed, because taxing incomes below the level of prosperity simply drives people into hardships whose alleviation increases public expenditures.

In France, for example, aggregate national prosperity is no higher now (at €1.76tn) than it was in 2008, but taxation has increased by 17% over that decade. Looking ahead, the continuing erosion of prosperity implies that rates of taxation on the average person will need to fall, unless the authorities wish further to tighten the pressure on the typical taxpayer.

Even the inescapable increase in the taxation of the very wealthiest isn’t going to change a scenario that dictates lower taxes, and correspondingly lower public expenditures, as prosperity erodes.

A new centre of gravity?

The adverse outlook for government revenues is one reason why the political Left cannot expect power to fall into its hands simply as a natural consequence of the crumbling of failed centre-Right incumbencies. Those on the Left keen to refresh their appeal by cleansing their parties of the residues of past compromises have logic on their side, but will depart from logic if they offer agendas based on ever higher levels of public expenditures.

With prosperity – and, with it, the tax base – shrinking, promising anything that looks like “tax and spend” has become a recipe for policy failure and voter disillusionment. This said, so profound has been the failure of the centre-Right ascendancy that opportunities necessarily exist for anyone on the Left who is able to recast his or her agenda on the basis of economic reality.

Tactically, the best way forward for the Left is to shift the debate on equality back to the material, restoring the primacy of the Left’s traditional concentration on the differences and inequities between rich and poor.

On economic as well as fiscal and social issues, we ought to see the start of a “research arms race”, as parties compete to be the first to absorb, and profit from, the recognition of economic realities that are no longer (if they ever truly were) identified by outdated methods of economic interpretation.

Historically, the promotion of ideological extremes has always been a costly luxury, so is likely to fall victim to processes that are making luxuries progressively less affordable. Voters can be expected to turn away from the extremes of pro- public- or private-sector promotion, seeing neither as a solution to their problems.

This, it is to be hoped, can lead to a renaissance in the idea of the mixed economy, which seeks to get the best out of private and public provision, without pandering to the excesses of either. Restoration of this balance, from the position where we are now, means rolling back much of the privatization and outsourcing undertaken, often recklessly, over the last three decades.

Both the private and the public sectors will need to undergo extensive reforms if governments are to craft effective agendas for using the mixed economy to mitigate the worst effects of deteriorating prosperity.

In the private sector, governments could do a lot worse than study Adam Smith, paying particular attention to the explicit priority placed by him on promoting competition and tackling excessive market concentration, and recognizing, too, the importance both of ethics and of effective regulation, both of which are implicit in his recognition that markets will not stay free or fair if left to their own devices.

For the public sector, both generally and at the level of detail, there will need to be a renewed emphasis on the setting of priorities. With resource limitations set not just to continue but to intensify, health systems, for example, will need to become a lot clearer on which services they can, and cannot, afford to fund.

Starting from here

Though this discussion can be no more than a primer for discussion, there are two points on which we can usefully conclude.

First, a useful opening step in the crafting of new politics would be the introduction of “clean hands” principles, designed to prove that government isn’t, as it can so often appear, something conducted “by the rich, for the rich”.

Second, it would be helpful if governments rolled back their inclinations towards macho posturing and intimidation.

A “clean hands” initiative wouldn’t mean that elected representatives would be paid less than currently they are. There is an essential public interest in attracting able and ambitious people into government service, so there’s nothing to be said for hair-shirt commitments to penury. In most European countries, politicians are not overpaid, and it’s arguable that their salaries ought, in some cases at least, to be higher.

There is, though, a real problem, albeit one that is easily remedied. This problem lies in the perception that politics has become a “road to riches”, with policymakers retiring into the wealth bestowed on them by the corporate sponsors of ‘consultancies’ and “the lecture circuit”. This necessarily creates suspicion that rewards are being conferred for services rendered, a suspicion that is corrosive of public trust, even where it isn’t actually true.

The easy fix for this is to cap the earnings of former ministers and administrators at levels which are generous, but are well short of riches. The formula suggested here in a previous discussion would impose an annual income limit at 10x GDP per capita, which is about £315,000 in Britain, with not-dissimilar figures applying in other countries. It seems reasonable to conclude that anyone who thinks that £300,000, or its equivalent, “isn’t enough” is likely to have gone into politics for the wrong reasons.

Where treatment of the “ordinary” person is concerned, there ought, in the future, be no room for the intimidatory practices which have become ever more popular with governments whose real authority has been weakened by failure.

One illustrative example is the system by which council tax (local taxation) arrears are collected in Britain. At present, the typical homeowner pays £1,671 annually, in ten monthly instalments. If someone misses a payment, however, he or she is then required to pay the entire annual amount almost immediately, compounded by court costs of £84 and bailiff fees of £310. Quite apart from the inappropriateness of involving the courts or employing bailiffs, it’s hard to see how somebody struggling to pay £167 is supposed to find £2,067.

This same kind of intimidation occurs when people are penalized for staying a few minutes over a parking permit, or for exceeding a speed limit by a fractional extent. Here, part of the problem arises from providing financial incentives to those enforcing regulations, a practice that should be abandoned by any government aware of the need to start narrowing the chasm between governing and governed.

We cannot escape the conclusion that the task of government, always a thankless one even when confined to sharing out the benefits of growth, is going to become very difficult indeed as prosperity continues to deteriorate.

There might, though, be positives to be found in a process which ditches ideological extremes, uses the mixed economy as the basis for the equitable mitigation of decline, and seeks to rebuild relationships between discredited governments and frustrated citizens.

#149: The big challenges

HOW THE ECONOMICS OF ENERGY VIEWS THE AGENDA

As regular readers will know, this site is driven by the understanding that the economy is an energy system, and not (as conventional thinking assumes) a financial one. Though we explore a wide range of related issues (such as the conclusion that energy supply is going to need monetary subsidy), it’s important that we never lose sight of the central thesis. So I hope you’ll understand the need for a periodic restatement of the essentials.

If you’re new to Surplus Energy Economics, what this site offers is a coherent interpretation of economic and financial trends from a radically different standpoint. This enables us to understand issues that increasingly baffle conventional explanations.

This perspective is a practical one – nobody conversant with the energy-based interpretation was much surprised, for instance, when Donald Trump was elected to the White House, when British voters opted for “Brexit”, or when a coalition of insurgents (aka “populists”) took power in Rome. The SEE interpretation of prosperity trends also goes a long way towards explaining the gilets jaunes protests in France, protests than can be expected in due course to be replicated in countries such as the Netherlands. We’re also unpersuaded by the exuberant consensus narrative of the Chinese economy. The proprietary SEEDS model has proved a powerful tool for the interpretation of critical trends in economics, finance and government.

The aim here, though, isn’t simply to restate the core interpretation. Rather, there are three trends to be considered, each of which is absolutely critical, and each of which is gathering momentum. The aim here is to explore these trends, and share and discuss the interpretations of them made possible by surplus energy economics.

The first such trend is the growing inevitability of a second financial crisis (GFC II), which will dwarf the 2008 global financial crisis (GFC), whilst differing radically from it in nature.

The second is the progressive undermining of political incumbencies and systems, a process resulting from the widening divergence between policy assumption and economic reality.

The third is the clear danger that the current, gradual deterioration in global prosperity could accelerate into something far more damaging, disruptive and dangerous.

The vital insight

The centrality of the economy is the delivery of goods and services, literally none of which can be supplied without energy. It follows that the economy is an energy system (and not a financial one), with money acting simply as a claim on output which is itself made possible only by the availability of energy. Money has no intrinsic worth, and commands ‘value’ only in relation to the things for which it can be exchanged – and all of those things rely entirely on energy.

Critically, all economic output (other than the supply of energy itself) is the product of surplus energy – whenever energy is accessed, some energy is always consumed in the access process, and surplus energy is what remains after the energy cost of energy (ECoE) has been deducted from the total (or ‘gross’) amount that is accessed.

This makes ECoE a critical determinant of prosperity. The distinguishing feature of the world economy over the last two decades has been the relentless rise in ECoE. This process necessarily undermines prosperity, because it erodes the available quantity of surplus energy. We’re already seeing this happen – Western prosperity growth has gone into reverse, and progress in emerging market (EM) economies is petering out. Global average prosperity has already turned down.

The trend in ECoE is determined by four main factors. Historically, ECoE has been pushed downwards by broadening geographical reach and increasing economies of scale. Where oil, natural gas and coal are concerned, these positive factors have been exhausted, so the dominating driver of ECoE now is depletion, a process which occurs because we have, quite naturally, accessed the most profitable (lowest ECoE) resources first, leaving costlier alternatives for later.

The fourth driver of ECoE is technology, which accelerates downwards tendencies in ECoE, and mitigates upwards movements. Technology, though, operates within the physical properties of the resource envelope, and cannot ‘overrule’ the laws of physics. This needs to be understood as a counter to some of the more glib and misleading extrapolatory assumptions about our energy future.

The nature of the factors driving ECoE indicates that this critical factor should be interpreted as a trend. According to SEEDS – the Surplus Energy Economics Data System – the trend ECoE of fossil fuels has risen exponentially, from 2.6% in 1990 to 4.1% in 2000, 6.7% in 2010 and 9.9% today. Since fossil fuels continue to account for four-fifths of energy supply, the trend in overall world ECoE has followed a similarly exponential path, and has now reached 8.0%, compared with 5.9% in 2010 and 3.9% in 2000.

For fossil fuels alone, trend ECoE is projected to reach 11.8% by 2025, and 13.5% by 2030. SEEDS interpretation demonstrates that an ECoE of 5% has been enough to put prosperity growth into reverse in highly complex Western economies, whilst less complex emerging market (EM) economies hit a similar climacteric at ECoEs of about 10%. A world economy dependent on fossil fuels thus faces deteriorating prosperity and diminishing complexity, both of which pose grave managerial challenges because they lie wholly outside our prior experience.

Mitigation, not salvation

This interpretation – reinforced by climate change considerations – forces us to regard a transition towards renewables as a priority. It should not be assumed, however, that renewables offer an assured escape from the implications of rising ECoEs, still less that they offer a solution that is free either of pain or of a necessity for social adaption.

There are three main cautionary factors around the ECoE capabilities of solar, wind and other renewable sources of energy.

The first cautionary factor is “the fallacy of extrapolation”, the natural – but often mistaken – human tendency to assume that what happens in the future will be an indefinite continuation of the recent past. It’s easy to assume that, because the ECoEs of renewables have been falling over an extended period, they must carry on falling indefinitely, at a broadly similar pace. But the reality is much more likely to be that cost-reducing progress in renewables will slow when it starts to collide with the limits imposed by physics.

Second, projections for cost reduction ignore the derivative nature of renewables. Building, say, a solar panel, a wind turbine or an electrical distribution system requires inputs currently only available courtesy of the use of fossil fuels. In this specialised sense, solar and wind are not so much ‘primary renewables’ as ‘secondary applications of primary fossil input’.

We may reach the point where these technologies become ‘truly renewable’, in that their inputs (such as minerals and plastics) can be supplied without help from oil, gas or coal.

But we are certainly, at present, nowhere near such a breakthrough. Until and unless this point is reached, the danger exists that that the ECoE of renewables may start to rise, pushed back upwards by the rising ECoE of the fossil fuel sources on which so many of their inputs rely.

The third critical consideration is that, even if renewables were able to stabilise ECoE at, say, 8% or so, that would not be anywhere near low enough.

Global prosperity stopped growing before ECoE hit 6%. British prosperity has been in decline ever since ECoE reached 3.6%, and an ECoE of 5.5% has been enough to push Western prosperity growth into reverse. As recently as the 1960s, in what we might call a “golden age” of prosperity growth, ECoE was well below 2%. Even if renewables could stabilise ECoE at, say, 8% – and that’s an assumption which owes much more to hope than calculation – it wouldn’t be low enough to enable prosperity to stabilise, let alone start to grow again.

SEEDS projections are that overall world ECoE will reach 9% by 2025, 9.7% by 2030 and 11% by 2040. These projections are comparatively optimistic, in that progress with renewables is expected to blunt the rate of increase in trend ECoE. But we should labour under no illusion that the downwards tendency in prosperity can be stemmed, less still reversed. Renewables can give us time to prepare and respond, but are not going to take us back to a nirvana of low-cost energy.

This brings us to the three critical issues driven by rising ECoE and diminishing prosperity.

Challenge #1 – financial shock

An understanding of the energy basis of the economy puts us in possession of a coherent narrative of recent and continuing tendencies in economics and finance. Financially, in particular, the implications are disquieting. There is overwhelming evidence pointing towards a repetition of the 2008 global financial crisis (GFC), in a different form and at a very much larger scale.

From the late 1990s, with ECoEs rising beyond 4%, growth in Western prosperity began to peter out. Though “secular stagnation” was (and remains) the nearest that conventional interpretation has approached to understanding this issue, deceleration was noticed sufficiently to prompt the response known here as “credit adventurism”.

This took the form of making credit not only progressively cheaper to service but also much easier to obtain. This policy was also, in part, aimed at boosting demand undermined by the outsourcing of highly-skilled, well-paid jobs as a by-product of ‘globalization’. “Credit adventurism” was facilitated by economic doctrines which were favourable to deregulation, and which depicted debt as being of little importance.

The results, of course, are now well known. Between 2000 and 2007, each $1 of reported growth in GDP was accompanied by $2.08 of net new borrowing, though ratios were far higher in those Western economies at the forefront of credit adventurism. The deregulatory process also facilitated a dangerous weakening of the relationship between risk and return. These trends led directly to the 2008 global financial crisis.

Responses to the GFC had the effect of hard-wiring a second, far more serious crash into the system. Though public funds were used to rescue banks, monetary policy was the primary instrument. This involved slashing policy rates to sub-inflation levels, and using newly-created money to drive bond prices up, and yields down.

This policy cocktail added “monetary adventurism” to the credit variety already being practiced. Since 2007, each dollar of reported growth has come at a cost of almost $3.30 in new debt. Practices previously confined largely to the West have now spread to most EM economies. For example, over a ten-year period in which growth has averaged 6.5%, China has typically borrowed 23% of GDP annually.

Most of the “growth” supposedly created by monetary adventurism has been statistically cosmetic, consisting of nothing more substantial than the simple spending of borrowed money. According to SEEDS, 66% of all “growth” since 2007 has fallen into this category, meaning that this growth would cease were the credit impulse to slacken, and would reverse if we ever attempted balance sheet retrenchment. As a result, policies said to have been “emergency” and “temporary” in nature have, de facto, become permanent. We can be certain that tentative efforts at restoring monetary normality would be thrown overboard at the first sign of squalls.

Advocates of ultra-loose monetary policy have argued that the creation of new money, and the subsidizing of borrowing, are not inflationary, and point at subdued consumer prices in support of this contention. However, inflation ensuing from the injection of cheap money can be expected to appear at the point at which the new liquidity is injected, which is why the years since 2008 have been characterised by rampant inflation in asset prices. Price and wage inflation have been subdued, meanwhile, by consumer caution – reflected in reduced monetary velocity – and by the deflationary pressures of deteriorating prosperity. The current situation can best be described as a combination of latent (potential) inflation and dangerously over-inflated asset prices.

All of the above points directly to a second financial crisis (GFC II), though this is likely to differ in nature, as well as in scale, from GFC I. Because “credit adventurism” was the prime cause of the 2008 crash, its effects were concentrated in the credit (banking) system. But GFC II, resulting instead from “monetary adventurism”, will this time put the monetary system at risk, hazarding the viability of fiat currencies.

In addition to mass defaults, and collapses in asset prices, we should anticipate that currency crises, accompanied by breakdowns of trust in currencies, will be at the centre of GFC II. The take-off of inflation should be considered likely, not least because no other process exists for the destruction of the real value of gargantuan levels of debt.

Finally on this topic, it should be noted that policies used in response to 2008 will not work in the context of GFC II. Monetary policy can be used to combat debt excesses, but problems of monetary credibility cannot, by definition, be countered by increasing the quantity of money. Estimates based on SEEDS suggest that GFC II will be at least four orders of magnitude larger than GFC I.

Challenge #2 – breakdown of government

Until about 2000, the failure of conventional economics to understand the energy basis of economic activity didn’t matter too much, because ECoE wasn’t large enough to introduce serious distortions into its conclusions. Put another way, the exclusion of ECoE gave results which remained within accepted margins of error.

The subsequent surge in ECoEs, however, has caused the progressive invalidation of all interpretations from which it is excluded.

What applies to conventional economics itself applies equally to organisations, and most obviously to governments, which use it as the basis of their interpretations of policy.

The consequence has been to drive a wedge between policy assumptions made by governments, and underlying reality as experienced by individuals and households. Even at the best of times – which these are not – this sort of ‘perception gap’ between governing and governed has appreciable dangers.

Recent experience in the United Kingdom illustrates this process. Between 2008 and 2018, GDP per capita increased by 4%, implying that the average person had become better off, albeit not by very much. Over the same period, however, most (85%) of the recorded “growth” in the British economy had been the cosmetic effect of credit injection, whilst ECoE had risen markedly. For the average person, then, SEEDS calculates that prosperity has fallen, by £2,220 (9%), to £22,040 last year from £24,260 ten years previously. At the same time, individual indebtedness has risen markedly.

With this understood, neither the outcome of the 2016 “Brexit” referendum nor the result of the 2017 general election was much of a surprise, since voters neither (a) reward governments which preside over deteriorating prosperity, nor (b) appreciate those which are ignorant of their plight. This was why SEEDS analysis saw a strong likelihood both of a “Leave” victory and of a hung Parliament, outcomes dismissed as highly improbable by conventional interpretation.

Simply put, if political leaders had understood the mechanics of prosperity as they are understood here, neither the 2016 referendum nor the 2017 election might have been triggered at all.

Much the same can be said of other political “shocks”. When Mr Trump was elected in 2016, the average American was already $3,450 (7%) poorer than he or she had been back in 2005. The rise to power of insurgent parties in Italy cannot be unrelated to a 7.9% deterioration in personal prosperity since 2000.

As well as reframing interpretations of prosperity, SEEDS analysis also puts taxation in a different context. Between 2008 and 2018, per capita prosperity in France deteriorated by €1,650 which, at 5.8%, isn’t a particularly severe fall by Western standards. Over the same period, however, taxation increased, by almost €2,000 per person. At the level of discretionary, ‘left-in-your-pocket’ prosperity, then, the average French person is €3,640 (32%) worse off now than he or she was back in 2008.

This makes widespread popular support for the gilets jaunes protestors’ aims extremely understandable. Though no other country has quite matched the 32% deterioration in discretionary prosperity experienced in France, the Netherlands (with a fall of 25%) comes closest, which is why SEEDS identifies Holland as one of the likeliest locales for future protests along similar lines. It is far from surprising that insurgent (aka “populist”) parties have now stripped the Dutch governing coalition of its Parliamentary majority. Britain, where discretionary prosperity has fallen by 23% since 2008, isn’t far behind the Netherlands.

These considerations complicate political calculations. To be sure, the ‘centre right’ cadres that have dominated Western governments for more than three decades are heading for oblivion. Quite apart from deteriorating prosperity – something for which incumbencies are likely to get the blame – the popular perception has become one in which “austerity” has been inflicted on “the many” as the price of rescuing a wealthy “few”. It doesn’t help that many ‘conservatives’ continue to adhere to a ‘liberal’ economic philosophy whose abject failure has become obvious to almost everyone else.

This situation ought to favour the collectivist “left”, not least because higher taxation of “the rich” has been made inescapable by deteriorating prosperity. But the “left” continues to advocate higher levels of taxation and public spending, an agenda which is being invalidated by the erosion of the tax base which is a concomitant of deteriorating prosperity.

Moreover, the “left” seems unable to adapt to a shift towards prosperity issues and, in consequence, away from ideologically “liberal” social policy. Immigration, for example, is coming to be seen by the public as a prosperity issue, because of the perceived dilutionary effects of increases in population numbers.

The overall effect is that the political “establishment”, whether of “the right” or of the “the left”, is being left behind by trends to which that establishment is blinded by faulty economic interpretation.

The discrediting of established parties is paralleled by an erosion of trust in institutions and mechanisms, because these systems cannot keep pace with the rate at which popular priorities are changing. To give just one example, politicians who better understood the why of the “Brexit” referendum result would have been better equipped to recognize the dangers implicit in being perceived as trying to thwart or divert it.

The final point to be considered under the political and governmental heading is the destruction of pension provision. One of the little-noted side effects of “monetary adventurism” has been a collapse in rates of return on invested capital. According to the World Economic Forum, forward returns on American equities have fallen to 3.45% from a historic 8.6%, whilst returns on bonds have slumped from 3.6% to just 0.15%. It is small wonder, then, that the WEF identifies a gigantic, and rapidly worsening, “global pension timebomb”. As and when this becomes known to the public – and is contrasted by them with the favourable circumstances of a tiny minority of the wealthiest – popular discontent with established politics can be expected to reach new heights.

In short, established political elites are becoming an endangered species – and, far from knowing how to replace them, we have an institutionally-dangerous inability to appreciate the factors which have already made fundamental change inevitable.

Challenge #3 – an accelerating slump?

Everything described so far has been based on an interpretation which demonstrates an essentially gradual deterioration in prosperity. That, in itself, is serious enough – it threatens both a financial system predicated on perpetual growth, and political processes unable to recognise the implications of worsening public material well-being.

For context, SEEDS concludes that the average person in Britain, having become 11.5% less prosperous since 2003, is now getting poorer at rates of between 0.5% and 1.0% each year. EM economies, including both China and India, continue to enjoy growing prosperity, though this growth is now decreasing markedly, and is likely to go into reverse in the not-too-distant future.

Is it safe to assume, though, that prosperity will continue to erode gradually – or might be experience a rapid worsening in the rate of deterioration?

For now, no conclusive answer can be supplied on this point, but risk factors are considerable.

Here are just some of them:

1. The worsening trend in fossil fuel ECoEs is following a track that is exponential, not linear – and, as we have seen, there are likely to be limits to how far this can be countered by a switch to renewables.

2. The high probability of a financial crisis, differing both in magnitude and nature from GFC I, implies risks that there may be cross contamination to the real economy of goods, services, energy and labour.

3. Deteriorating prosperity poses a clear threat to rates of utilization, an important consideration given the extent to which both businesses and public services rely on high levels of capacity usage. Simple examples are a toll bridge or an airline, both of which spread fixed costs over a large number of users. Should utilization rates fall, continued viability would require increasing charges imposed on remaining users, since this is the only way in which fixed costs can be covered – but rising charges can be expected to worsen the rate at which utilization deteriorates.

4. Uncertainty in government, discussed above, may have destabilizing effects on economic activity.

There is a great deal more that could be said about “acceleration risk”, as indeed there is about the financial and governmental challenges posed by deteriorating prosperity.

But it is hoped that this discussion provides useful framing for some of the most important challenges ahead of us.

 

 

#145: Fire and ice, part two

“THE JUGGERNAUT EFFECT”

Although it was something of a detour from the theme of fire and ice, our previous discussion about “Brexit” does have one point of relevance to that theme. Here’s why.

All things considered, there seems to be an utterly compelling case for intervention in the dysfunctional “Brexit” process by the “adults” in European governments. Yet, even at this very late stage, no such intervention has happened. Governments seem to see no alternative to letting London and Brussels – but mostly Brussels – make a complete hash of the whole process. Indeed, only now do the governments of the countries most affected (Ireland and France) seem even to be implementing contingency plans for an adverse outcome.

Of course, you might jump to the conclusion that irrationality reigns in European capitals, and especially in Dublin and Paris. But it’s surely obvious that this is part of a much wider process, one which we can think of as a form of shock-paralysis.

Essentially, the idea explored here is that governments around the world have been paralysed into inaction, not so much by fear alone as by a simple inability to understand what’s happening around them. Nothing, it seems to them, is happening rationally. They don’t really understand why so many amongst the general public are so angry – and they certainly don’t even begin to understand what’s happening to the economy.

I call this shock-paralysis “the juggernaut effect”.

Shock-paralysis

The word “juggernaut” seems to derive from Sanskrit, and refers to an enormous waggon carrying the image of a Hindu god. The figurative meaning is of an irresistible force, flattening anyone foolish enough to stand in its way.

Rationally, you’d think that anybody standing in the path of a “juggernaut” ought to be making every effort to escape. But it’s quite likely that shock, fear and incomprehension will have a paralysing effect, overwhelming rational faculties, leaving him or her rooted to the spot.

That’s a useful way to describe the effects that current economic (and broader) trends are having. It doesn’t just apply to governments, of course, and it’s prevalent amongst the general public, too.

Just as the person standing in front of the “juggernaut” is all too well aware of its lethality, today’s leaders and opinion-formers surely know at least something about the financial, economic, political and social forces converging on them.

But they seem incapable of doing anything about it.

A big part of this paralysis is incomprehension – any problem becomes infinitely harder to tackle if you don’t understand why it’s happening. And there are reasons enough for policy-makers, and ‘ordinary’ people too, to feel completely baffled.

The irrational economy

You don’t need to be a committed Keynesian – indeed, you need only numeracy – to understand the basic principles of economic stimulus.

If economic performance is sluggish, activity can be stimulated by pushing liquidity into the system, either through fiscal or through monetary policy. If too much stimulus is injected, though, there’s a risk that the economy will overheat, with growth exceeding the sustainable trend. Rising inflation is one of the most obvious symptoms of an over-heating economy.

Here, though, is the conundrum, for anyone trying to understand how the economy is performing.

Since the 2008 global financial crisis (GFC I), the authorities have pushed unprecedentedly enormous amounts of stimulus into the system.

We ought, long before now, to have experienced overheating, with growth rising to levels far above trend.

This simply hasn’t happened.

This should have been accompanied by surging inflation, most obviously in commodities like energy, minerals and food, but across the whole gamut of goods and services, too, with wage rates rising rapidly as prices soar.

Again, this simply hasn’t happened.

To be sure, there’s been dramatic inflation in asset prices, and that’s both important and dangerous. But the broader point is that neither super-heated growth, nor a surge in price and wage inflation, have turned up, as logic, experience and basic mathematics all tell us that they should.

Pending final data for 2018, it’s likely that global GDP last year will have been about 34% higher than it was back in 2008. Allowing for the increase in population numbers, GDP per capita is likely to have been about 20% larger in 2018 than it was ten years previously. This isn’t exactly super-heated growth. According to SEEDS, world inflation stands at about 2.5% which, again, is nowhere near the levels associated with an over-heating economy. Far from soaring, the prices of commodities such as oil are in the doldrums.

Price (and other) data is telling us that the economy has stagnated. But the quantity of stimulus injected for more than a decade says that it should be doing precisely the opposite.

There can be no doubt whatsoever about the scale of stimulus. The usual number attached to sums created through QE by central banks is in the range $26-30 trillion, but that’s very much a narrow definition of stimulus. Ultra-loose monetary policy, combined with not inconsiderable fiscal deficits, have been at the heart of an unprecedented wave of stimulus.

Expressed in PPP-converted dollars at constant values (the convention used throughout this analysis), governments have borrowed about $39tn, and the private sector about $71tn, since 2008. On top of that, we’ve wound down pension provision in an alarming way, as part of the broader effects of pricing money at negative real levels, which destroys returns on invested capital.

Even if we confine ourselves to QE and borrowing, however, stimulus since 2008 can be put pretty conservatively at $140tn.

That’s roughly 140% of where world PPP GDP was back in 2008. You might think of it as the injection of 12-14% of GDP each year for a decade.

That’s an unprecedentedly gigantic exercise in stimulus.

And the result? In contrast to at least $140tn of stimulus, world GDP is perhaps $34tn higher now than it was ten years previously. Price and wage inflation is subdued, and the prices of sensitive commodities have sagged. The prices of assets such as stocks, bonds and property have indeed soared – but one or more crashes will take care of that.

By now – indeed, long before now – anyone in government ought to have been asking his or her expert advisers to explain what on earth is going on. Assuming that Keynes wasn’t mistaken (and simple mathematics proves that he wasn’t), the only frank answer those advisers can give is that they just don’t understand what’s been happening.

Questions without answers?

The utter failure of gigantic stimulus to spur the economy into super-heated growth (and surging inflation) is reason enough for baffled paralysis. But there are plenty of other irrationalities to add to the mix.

If you were in government, or for that matter in business or finance, then as well as asking your advisers about the apparent total breakdown in the stimulus mechanism, you might want to put these questions to them, too:

– Why has a capitalist economic system become dependent on negative real returns on capital?

– Why, since the shock therapy of the 2008 global financial crisis (GFC I), have we accelerated the pace at which we’re adding to the debt mountain?

– Why, seemingly heedless of all past experience, have we felt it necessary to pour vast amounts of cheap money into the system?

– Why have the prices of assets (including stocks, bonds and property) soared to levels impossible to reconcile with the fundamentals of valuation?

– Why has China, reputedly the world’s primary engine of growth, found it necessary to resort to borrowing on a gargantuan scale?

This last question deserves some amplification. Pending final data, we can estimate that Chinese debt has increased to about RMB 220tn now, from less than RMB 53tn (at 2018 values) at the start of 2008. These numbers exclude what are likely to be very large quantities of debt created in what might most politely be called the country’s “informal” credit system.

So, why does an economy supposedly growing at between 6% and 7% annually need to do much borrowing at all?  Put another way, how meaningful is “growth” in GDP of 6-7%, when you have to borrow about 25% of GDP annually, just to keep it going?

And this prompts several more questions. For starters, why are the Chinese authorities, hitherto esteemed for their financial conservatism, presiding over the transformation of their economy into a debt-ponzi? Second, can ‘the mystique of the east’ explain why the world’s markets are seemingly either ignorant, and/or complacent, about the creation of a financial time-bomb in China?

The juggernaut effect

Even these questions don’t exhaust the almost endless list of disconnects in our increasingly surreal economic plight, but they surely give us more than enough explanations for the paralysing “juggernaut effect” in the corridors of power.

Put yourself, if you will, into the shoes of someone trying to formulate policy. Two things are obvious to you, and either one of them would be a grave worry. Together, they’re enough to overwhelm rational calculation.

First, you know that there are some very, very dangerous trends out there. In the purely financial arena, you’re aware that debt has become excessive, whilst the system seems to have become reliant on a never-ending tide of cheap credit.

If your intellectual leanings are towards market economics, you’ll also have realised that pricing money at rates below inflation amounts to an enormous subsidy. Politically, that subsidy is going to the wrong people. If you came into government with business experience, you’ll also know that we’ve witnessed the destruction of returns on capital, which makes no kind of sense from any business or investment point of view.

You might know, too, that the viability of pension provision has collapsed, creating what the World Economic Forum has called “a global pensions timebomb”. If the public ever finds out about that, the reaction could dwarf whatever political travails you might happen to have at the moment.

Lastly – on your short-list of nightmares – is the strong possibility that some event, as yet unknown, will trigger a wave of defaults and a collapse in the prices of property and other assets.

Your second worry, perhaps even bigger than your list of risks, is that you don’t really understand any of this. Your economic advisers can’t explain why stimulus, though carried to (and far beyond) the point of danger, hasn’t worked as the textbooks (and all prior experience) say it should. If there’s anything worse than a string of serious problems and challenges, it’s a complete lack of understanding.

Without understanding, the policy cupboard is bare. You don’t know what to do next, because anything you do might have results that don’t match expectations, making matters worse rather than better.

It might be better to do nothing.

In short, you feel as though you’re making it up as you go along, in the virtual certainty that something horribly unpleasant is going to hit you, with little or no prior warning.

Welcome to “the juggernaut effect”.

#144: “Brexit” and the wait for Godot

WHY EU NATIONAL LEADERS SHOULD INTERVENE

It is perhaps appropriate that Samuel Beckett’s play Waiting for Godot was written in French, and premiered in Paris in January 1953, not appearing in English until its London debut in 1955.

As you’ll know, Godot himself never appears, which some might say is the real point of the narrative. Certainly, his non-arrival has no serious consequences.

This is where drama and reality part company. Like Vladimir and Estragon in Beckett’s play, both sides of the “Brexit” impasse have been waiting for more than two years now, and are waiting still, for the political equivalent of Godot to turn up. This time, it’s going to be very serious indeed if the major character (or characters) fail to put in an appearance.

If you’re a regular visitor to this site, you’ll know that I steer well clear of taking sides over the outcome of the “Brexit” referendum. This said, those of us who understand the surplus energy basis of the economy had solid reasons for expecting the vote to turn out as it did.

Though GDP per person was slightly (4%) higher in 2016 than it had been in 2006, personal prosperity in Britain deteriorated by almost 9% over that decade. When the public went to the polls, the average person was £2,150 worse off than he or she had been ten years previously, and was, moreover, significantly deeper in debt.

These are not conditions in which the governing can expect the enthusiastic backing of the governed. There were other factors in play, of course – including widening inequality, and the lack of a national debate over immigration – but the “leave” vote was founded on popular dissatisfaction with an “establishment” seemingly unconcerned about deteriorating prosperity.

The authorities’ fundamental inability to understand the prosperity issue was by no means unique to the United Kingdom, and neither were its consequences confined to the 2016 referendum. Had the deterioration in prosperity been understood in the corridors of power, it’s highly unlikely, for instance, that premier Theresa May would have called the 2017 general election which robbed her of her Parliamentary majority.

Calling an early election – intended to “guarantee security for the years ahead” – was just one of many mistakes made by the British authorities before, during and after the referendum on withdrawal from the European Union. The vote itself  seems to have been called in the confident assumption that the “remain” side would win comfortably. The governing Conservatives then elected as their leader an opponent of the “Brexit” process. Perhaps worst of all, the British side negotiated as supplicants, accepting, seemingly without question, Brussels’ highly dubious assertion that the EU held all the high cards.

But it would be wrong to pin all (or even most) of the blame for the “Brexit” negotiations fiasco on the British side. Whatever mistakes Mrs May and her colleagues might have made, they at least have a democratic mandate for what they have been trying to do. Beset on one side by hard-line “Brexiteers”, and on the other by those opposed to carrying out what the public actually voted for, Mrs May had problems enough, even before her Brussels counterparts set out to play politics with the process.

Under these conditions, it’s hardly surprising that the British parliament seems to have reached an impasse, where the main alternatives to a flawed deal appear to involve either (a) leaving the EU without any agreement at all, or (b) disregarding the wishes of the voters, and perhaps inviting those voters to have another go, presumably in the hope that the electorate will ‘get it right this time’.

Needed – Godot

In considering what ought to happen next, we need to be absolutely clear that the stance adopted by the bureaucrats in Brussels has all along made it impossible for Mrs May to secure an agreement acceptable either to parliament or the voters.

Put bluntly, the point has long since been reached where the adults – meaning the elected governments of EU member nations, led by France and Ireland – should step in, forcing Brussels to offer terms which are both (a) mutually advantageous, and (b) acceptable to the United Kingdom. This really means that Paris and Dublin need to mount an eleventh-hour rescue, not just (or even mainly) of the British economy, but of the EU economy as well.

From the outset, Brussels has made three dangerously false assumptions.

The first is that, in terms of economics, a mishandled “Brexit” will hurt Britain far more than it would hurt other EU member states.

The second, flowing from this but extending well beyond economics, was that the EU side holds all the high cards – essentially, that Mrs May should expect nothing more than scraps from a bounteous continental table.

Third, Brussels assumed the role of punishing British voters in order to deter Italians (and others) from following a similar path out of the EU.

This third point is the easiest to counter. The role of Brussels, which in many other areas is carried out commendably, is to better the circumstances of EU citizens.

It is not to influence how those citizens cast their votes.

The economic point, though critical, is a bit more complicated, but needs to be outlined to explain why Ireland and France, in particular, ought now to be intervening to break the impasse.

Where Ireland is concerned, the assumption in Brussels that a mishandled “Brexit” would more dangerous for the British than for anyone else is gravely mistaken. Although Britain is a major trading partner for Ireland, the main problem for the Republic is a broader one. Essentially, Ireland is in no condition to withstand any major shock to the system – and a bungled “Brexit” would certainly be exactly that.

We’ve examined the Irish predicament before, so a brief summary should suffice here. Following statistical changes (dubbed “leprechaun economics”) introduced in 2015, reported GDP has become an even less meaningful measure of economic conditions. GDP grew by 49% between 2007 and 2017 (including a one-off 25% hike in 2015), adding €97bn (at constant 2018 values) to recorded output – but this occurred courtesy of a near-doubling in debt, such that each €1 of “growth” was bought with €4.85 of net new borrowing. Meanwhile, the all-important energy cost of energy (ECoE) now exceeds 11% in Ireland, at level at which growth is almost bound to go into reverse.

Fundamentally, reported GDP (of an estimated €309bn last year) grossly overstates real activity (adjusted for borrowed spending, €184bn), let alone prosperity (€164bn, or €33,550 per person).

Critically, over-stated GDP gives dangerously false comfort about financial exposure. Aggregate debt, for instance, might be “only” about 320% of GDP, but equates to well over 600% of prosperity.

Worse still, Ireland’s financial sector is grossly over-large in relation even to GDP, let alone prosperity. The most recent available numbers (for the end of 2016) put financial assets at 1750% of GDP, but this equates now to a frightening 3200% or so of prosperity.

Far from deleveraging after the disaster of 2007-08, both debt and financial assets are a lot bigger now than they were on the eve of the global financial crisis (GFC I) – in inflation-adjusted terms, debt has virtually doubled (+95%) since 2007, and financial assets have expanded by about 60%.

Moreover, the markets might know about the “leprechaun” factor in Irish GDP, but seem not – yet – to have applied the logic of that knowledge to the critical measures of national financial risk. On the assumption that the authorities in Dublin do know quite how dangerous Irish financial exposure really is, they have every incentive to strive for a form of “Brexit” which minimises economic and financial damage.

France has different, but equally compelling, reasons for intervening, and would have a lot more negotiating clout to bring to the table. As we’ve seen, there has been widespread unrest in France, unrest whose causes can be traced to deteriorating prosperity. Though personal prosperity as a whole is only about €1,650 (5.8%) lower now than it was ten years ago, the slump in discretionary (‘left-in-your-pocket’) prosperity has been leveraged to 32% by a near-€2,000 increase in the burden of taxation per person.

This has put Mr Macron’s government in an unenviable position. Neither the fiscal carrots offered by the president, nor the law enforcement sticks planned by his government, can address the fundamental issue, which is that a substantial majority of the population supports the grievances (if not necessarily the methods) of the ‘gilets jaunes’.

This seems to mean that Mr Macron can forget about his cherished labour market “reforms”, and further suggests that, unless something pretty dramatic happens, he can probably forget about re-election as well. The last thing his government needs right now is the economic harm likely to be inflicted on France by a bungled “Brexit”. It would be far, far better for the president to act in a conspicuously statesmanlike way to break the impasse.

In this situation, it’s unrealistic to expect Britain to resolve this issue unaided by Europe. If, as most observers believe, Mrs May’s deal is going to be shot down by parliament, neither of the remaining options looks palatable. Both those who support a “no deal” exit, and those who’d like to ignore (or re-run) the “Brexit” vote, are playing with fire. But neither can we expect the Brussels side of the talks to have a last minute conversion either to humility or to pragmatism.

In short, there are compelling reasons for European governments – led by France and Ireland – to enforce a rationality seemingly absent, on this issue, in Brussels.

#141: England’s Glory or ship of fools?

MAKING THE WORST OF A BAD THING

There used to be – and, as far as I know, still is – a brand of matches called England’s Glory, sold in iconic boxes featuring the battleship HMS Devastation. If tasked with updating that artwork, one could hardly do better than a rowing-boat full of squabbling fools.

There is, of course, no situation that can’t be made worse by a politicians’ witches’ brew of ambition and obstinacy. But the shambles now being inflicted on the British public is something new in the realms of idiocy.

I don’t intend, here, to go into the merits or otherwise of the voters’ “Brexit” decision itself, though readers are, of course, welcome to debate it. As for the political machinations at Westminster, it need only be remarked that the current imbroglio is consistent with a process that has been bungled right from the start.

What I think we can do here, though, is set out the purely economic context from the standpoint of surplus energy economics (SEE).

If you understand SEE – an interpretation of the economy summarised here – then you’ll know that prosperity in the United Kingdom has been deteriorating since 2003. Though this deterioration is by no means unique to Britain, it’s been more severe there than in most other countries. Properly understood, eroding prosperity has been as instrumental in the “Brexit” process as it has been in the election of Donald Trump, the handing of power to an insurgent (aka “populist”) coalition in Italy, and the elevation, and subsequent travails, of Emmanuel Macron in France.

And this, really, is the critical point. Policymakers right across the Western world simply don’t understand that prosperity is heading downwards. Because they (and their advisors, and most of the commentariat) remain wedded to conventional economic interpretations, they really believe that people are getting better off. In the British instance, they’re convinced that an increase of £3,220 (11.6%) in GDP per capita since 2003 means that people are prospering.

If you believe this, you can’t even begin understand what people in Britain – or, for that matter, in America, Italy or France – have got to complain about. Blind to the economic causes of discontent, politicians tend to fall back on more arcane explanations, many of which seek to pin the blame on unscrupulous “populist” politicians.

Where Britain is concerned, reported GDP increased by £390bn (24%) between 2003 and 2017. Unfortunately, this was accompanied by a £2 trillion (63%) increase in debt. This means that £5.19 was borrowed for each £1 of incremental GDP. It also means that, whilst GDP has grown by between 1.5% and 2% each year, debt has been added at rates of close to 10% of GDP annually.

Fundamentally, it means that most of the “growth” supposedly achieved since 2003 has been nothing more than the simple spending of borrowed money. If, for any reason, Britain lost the ability to carry on adding to its debt in this way, trend growth would fall to somewhere around 0.3%, a number lower than the rate at which population numbers are growing. If ever it became necessary to deleverage, then most of the “growth” of recent years would go into reverse. Anyone questioning this interpretation need only ask himself or herself one question – ‘what kind of economy needs to price credit at rates lower than inflation?

The reason why financial adventurism has been adopted to create a simulacrum of “growth” is that the energy dynamic has turned negative. According to SEEDS (the Surplus Energy Economics Data System), Britain’s trend energy cost of energy (ECoE) has risen from 3.4% in 2003 to 9.2% now. The latter number is a growth-killer. This has been worse than the global increase (from 4.5% to 8.0%) over the same period, which is one of the main reasons why prosperity has fallen more rapidly in Britain than in most other countries. Part of the differential has been the unlucky timing of the maturing of the UK North Sea oil and gas province. But this has been exacerbated by energy policy, nowhere more obviously than in protracted vacillation over replacement nuclear capacity.

According to SEEDS, personal prosperity in the United Kingdom had, by 2017 (£22,050) fallen by £2,490 (10.2%) since 2003 (at 2017 values, £24,540). Moreover, each person now has 47% more debt than he or she had back in 2003.

The political logic here is that, by the time of the referendum in 2016, prosperity had fallen by more than enough to swing the “Brexit” vote against the perceived preference of “the establishment”. Politicians completely failed to understand this trend, and probably wouldn’t have called the referendum at all if they’d been better informed.

Once this essentially economic dimension is understood, what follows is pure tragi-comedy. The Conservatives chose, in succession to David Cameron, to put in charge of the “Brexit” process a leader who believed that the voters’ decision was the wrong one. Still unaware of the deterioration in prosperity, Mrs May called a general election, seemingly believing (along with the ‘experts’) that this would give her a Commons majority of well over 100, when the outcome was that she lost even the slender majority inherited from Mr Cameron. Meanwhile, the EU side opted to posture on a claim that they held all the high cards, and Mrs May and her officials fell for this line, going to Brussels as a supplicant, and so, necessarily, returning with an agreement so flawed that it had no real chance of Parliamentary acceptance.

What the British electorate are watching now is a culminating shambles. Having lost a referendum they expected to win, and been battered in an election they expected to be a triumph, Conservatives have opted now to challenge a leader who, because of her stance on “Brexit”, they should never have chosen in the first place. This has happened at the worst possible time, between the cup of a botched agreement with the EU and the lip of a departure date at the end of March. Some think that the leadership challenge process can be compressed, and it’s probably fair to say that one might as well make a mess of things in three weeks as in six.

Where this leaves the public is with a political class which doesn’t understand the fundamental issues around prosperity, and really believes that either ‘liberal’ or collectivist economic orthodoxy can restore “growth”. It seems hardly necessary to add that a ship of fools remains foolish, whether or not the captain is thrown overboard.

= = = = = = = = = =

Germany vs EA7

Prosp per capita DE EA7 UK

#135: Still not (wholly) about “Brexit”

BRITAIN, EUROPE AND GFC II

A little less than two months ago, we made an effort here to look past the sound and fury of the “Brexit” debate to assess the real state of prosperity and risk in the United Kingdom.

Now, as the world marks the tenth anniversary of the 2008 global financial crisis (GFC I), it’s being reported that Mark Carney, governor of the Bank of England, has warned government that “a chaotic no-deal Brexit could crash house prices and send another financial shock through the economy”.

Risks identified by Mr Carney apparently include a slump in the value of GBP, sharp rises in interest rates and a 35% fall in property prices. Whilst he is right about these risks – and right, too, to warn about the consequences of a mishandled “Brexit” – we need to reiterate that these risks are likely to eventuate anyway, because British prosperity is continuing to deteriorate, whilst financial risk remains highly elevated.

Some updates

As I’m off travelling for much of next week, what I’d like to do here is to pause, as it were, and posit a few things for thought and comment. “Brexit” risk, and the likelihood of GFC II, have to be high on that list.

First, though, I’d like to thank the first two followers of Surplus Energy Economics who’ve made donations towards the upkeep and development of the project. I’m new to the donation process, so I don’t know what the courtesies are for expressing gratitude – but I really do appreciate your support.

While I’m away, please do carry on posting your comments, but please also note that moderation is going to be intermittent for the next week or so. The best way to get comments posted is to leave out links, as any comment including them is automatically placed in the moderation queue.

On “Brexit”

Throughout the debate about Britain leaving the European Union, no view has been taken here about the merits and demerits of “Brexit” itself. There are, though, a number of points which do need to be made.

First, the debate about “Brexit” was extraordinarily nasty and divisive.

Second, it’s vital that the expressed view of the voters is respected.

Third, surplus energy analysis gave us a strong lead on how the referendum was likely to turn out. According to SEEDS, per capita prosperity in Britain was already 10% lower by 2016 than it had been at its peak in 2003. This has to have been a major factor motivating the anti-establishment component of the vote.

Finally, “Brexit” is best considered as a ‘situation’ rather than an ‘event’. A ‘situation’ is something which creates a multiplicity of possible outcomes. The biggest risk with “Brexit” has always been that the British and EU negotiating teams would agree (or disagree) to choose the worst possible result. As things stand, that outcome is looking ever more ominously likely, thoroughly justifying Mark Carney’s warnings.

The British predicament

It would be a mistake, though, to assume, either that “Brexit” alone has created these risks, or that an alternative decision by the voters would have taken these threats away. Neither should risk on the EU side be downplayed.

Expressed at constant values, British GDP was £386bn larger in 2017 than it had been back in 2003. This translates to a gain of 11% at the per capita level, after adjustment for the increase (also 11%) in population numbers over that period.

But any suggestion that British citizens are 11% better off now than they were fourteen years ago is obviously bogus, an observation surely self-evident in a range of indicators spanning real incomes, the cost of household essentials, spiralling debt, sharp downturns in customer-facing sectors such as retailing and hospitality, maxed-out consumer credit and the worsening and widening hardship of the millions struggling to make ends meet. The national housing stock might be ‘worth’ £10 trillion, but that number is meaningless when the only potential buyers of that stock are the same people to whom it already belongs.

SEEDS analysis shows how we can reconcile claimed “growth” with evident hardship. First, growth of £386bn (23%) between 2003 and 2017 was accompanied by a 62% (£2 trillion) increase in aggregate debt. Put simply, Britain has been pouring credit into the system at a rate of £5.20 for each £1 of “growth”.

In the short term, you can have pretty much any amount of statistical “growth” in GDP if you’re prepared to pour this much credit into the system. The problem comes when you cannot carry on doing this, and this is especially the case when you’ve also been a huge net seller of assets to overseas investors as part of a process of consuming at levels far in excess of economic output.

Compounding this, of course, has been an escalating trend energy cost of energy (ECoE) and this, in Britain, has soared from 3.4% in 2003 to a projected 9.2% this year. The latter number is close to a level at which increasing prosperity becomes impossible.

“Stalling between two fools”

This makes Mr Carney’s risks all too real. According to SEEDS, aggregate prosperity in the UK last year was £1.45tn, a number 29% below recorded GDP of £2.04tn. When measured against prosperity rather than GDP, the British debt ratio rises to 361% (rather than 258%), whilst financial assets now stand at 1577% of prosperity (compared with about 1130% of GDP).

Bearing these exposure ratios in mind – and noting the ongoing deterioration in per capita prosperity – the likelihood of a currency slump, spiralling interest rates and a severe fall in property prices has to be rated very highly indeed.

But “Brexit” is by no means the only possible catalyst for a crash. Perhaps the single most depressing aspect of the British predicament is the paucity of understanding of, and response to, structural economic weaknesses.

This is not to say, of course, that EU negotiators have played this situation well. The assumption that the EU holds all the high cards in “Brexit” talks is absurd, and the extreme risk to Ireland is just one of many reasons for caution. The guiding principle, which seems to be to punish British voters’ temerity as a warning to others, appears not just pompous but, given the spread of support for insurgent (a.k.a. “populist”) parties, extremely short-sighted.

On the horizon – GFC II

For the British and the Europeans, “Brexit” has been a massive distraction from broader financial and economic risk. Though we cannot know when GFC II will eventuate, there can be very little doubt that a crash, of greater-than-2008 proportions, is looming ever closer.

As regular readers will know, there is a clear narrative which points unequivocally to GFC II. This narrative is so important, and so seemingly absent from mainstream interpretation, that little apology seems required for reiterating it in brief.

The narrative can be expressed as three very simple propositions:

1. From the late 1990s, the secular capability for growth began to erode.

2. Instead of accepting (or even recognising) this deceleration, the authorities embarked on credit adventurism, making debt cheaper, and easier to obtain, than at any previous time in modern history. Not surprisingly, this led directly to GFC I, and ensured that it would be a debt-centred event, primarily threatening the banks.

3. Rather than take the hit for reset, the authorities then moved on to monetary adventurism, pouring huge amounts of ultra-cheap liquidity into the system. This must lead to GFC II, and GFC II must be a monetary event.

There are plenty of things to debate about this sequence. First, what caused the secular deceleration which triggered the whole process? The explanation favoured here is the rising trend in the energy cost of energy (ECoE), but there are certainly some candidates for ‘best supporting actor’. These include ideological commitment to reckless deregulation, badly mishandled globalisation, and the impact of climate change.

Second, why didn’t we choose reset in 2008? With hindsight, the choice made was the wrong one, as many experts pointed out at the time. By playing ‘extend and pretend’, the authorities made huge mistakes, which included moral hazard, creating massive asset bubbles, all but halting creative destruction, and destroying returns on investment (to the particular detriment of pension provision).

One of the lesser-known consequences was that the market economy, properly understood, became inoperable – after all, positive returns on capital are something of a prerequisite in any ‘capitalist’ economy.

Likewise, when the relationship between asset prices and income was bent completely out of shape, immense divisions were created between those who already owned assets and those (generally younger) people whose aim is to accumulate them.

Lastly, is there anything we can do now about GFC II? Frankly, prevention now looks impossible, but there might still be quite a lot of mitigation that we can implement (without going to the extremes of stockpiling tinned food, bottled water and ammunition).

We cannot know whether the coming explosion is going to be ‘chemical’ (requiring a catalyst) or ‘nuclear’ (requiring only critical mass). But there’s plenty of combustible material around, a huge array of potential catalysts – and an inexorable progression towards critical mass.

Abroad thoughts from home

I hope that, despite a short hiatus in moderation and response, readers can carry on debating these and other issues, and will forgive this brief restatement – which to me seems necessary on grounds of imminence and importance – of issues around “Brexit” and GFC II.

It is hoped that, after the intermission, we can get back to pushing the boundaries.

 

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