#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Governments, which continue to adhere to outdated paradigms based on a purely financial interpretation of the economy, remain blind to the voters’ plight – and, all too often, this blindness looks a lot like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.

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.

 

 

#143: Fire and ice, part one

TRAUMA FOR THE TAX-MAN

Is 2019 the year when everything starts falling apart?

It certainly feels that way.

The analogy I’m going to use in this and subsequent discussions is ‘fire and ice’.

Ice, in the potent form of glaciers, grinds slowly, but completely, crushing everything in its path. Whole landscapes have been shaped by these icy juggernauts.

Fire, on the other hand, can cause almost instantaneous devastation, most obviously when volcanoes erupt. Back in 1815, the explosion of Mount Tambora in the Dutch East Indies (now Indonesia) poured into the atmosphere quantities of volcanic ash on such a vast scale that, in much of the world, the sun literally ceased to shine. As a result, 1816 became known as “the year without a summer”. As low temperatures and heavy rain destroyed harvests and killed livestock, famine gripped much of Europe, Asia and North America, bringing with it soaring food prices, looting, riots, rebellions, disease and high mortality. Even art and literature seem to have been influenced by the lack of a summer.

The economic themes we’ll be exploring here have characteristics both of fire and of ice. The decline in prosperity is glacial, both in its gradual pace and its ability to grind assumptions, and systems, into the ground. Other events are likelier to behave like wild-fires or volcanoes, given to rapid and devastating outbursts, with little or no prior warning.

Fiscal issues, examined in this first instalment of ‘fire and ice’, have the characteristics of both. The scope for taxing the public is going to be subjected to gradual but crushing force, whilst the hard choices made inevitable by this process are highly likely to provoke extremely heated debate and resistance.

Let’s state the fiscal issue in the starkest terms:

– Massive credit and monetary adventurism have inflated GDP to the point where it bears little or no resemblance to the prosperity experienced by the public.

– But governments continue to set taxation as a percentage of GDP.

– As GDP and prosperity diverge, this results in taxation exacting a relentlessly rising share of prosperity.

– Governments then fail to understand the ensuing popular anger.

France illustrates this process to dramatic effect. Taxation is still at 54% of GDP, roughly where it’s been for many years. This no doubt persuades the authorities that they’ve not increased the burden of taxation. But tax now absorbs 70% of French prosperity, leading to the results that we’ve witnessed on the streets of Paris and other French towns and cities.

Few certainties

It’s been said that the two certainties in life are “death and taxes”, but ‘debt and taxes’ hold the key to fiscal challenges understood improperly – if at all – by most governments. The connection here is that debt (or rather, the process of borrowing) affects recorded GDP in ways which provide false comfort about the affordability of taxation – and therefore, of course, about the affordability of public services.

The subject of taxation, seen in terms of prosperity, leads straight to popular discontent, though that has other causes too. In order to have a clear-eyed understanding of public anger, by the way, we need to stick to what the facts tell us. I’ve never been keen on excuses like “the dog ate my homework” or “a space-man from Mars stole my wallet” – likewise, we should ignore any narrative which portrays voter dissatisfaction as wholly the product of “populism”, or of “fake news”, or even of machinations in Moscow or Beijing. All of these things might exist – but they don’t explain what’s happening to public attitudes.

The harsh reality is that, because prosperity has deteriorated right across the advanced economies of the West, we’re facing an upswell of popular resentment, at the same time as having to grapple with huge debt and monetary risk.

If you wanted to go anywhere encouraging, you wouldn’t start from here.

The public certainly has reasons enough for discontent. In the Western world, prosperity has been deteriorating for a long time, a process exacerbated by higher taxation. The economic system has been brought into disrepute, mutating from something at least resembling ‘the market economy’ into something seemingly serving only the richest. As debt has risen, working conditions, and other forms of security, have been eroded. We can count ourselves fortunate that the public doesn’t know – yet – that the pensions system has been sacrificed as a financial ‘human shield’ to prop up the debt edifice.

This at least sets an agenda, whether for 2019 or beyond. The current economic paradigm is on borrowed time, whilst public support can be expected to swing behind parties promoting redistribution, economic nationalism and curtailment of migration. Politicians who insist on clinging on to ‘globalised liberalism’ are likely to sink with it. The tax base is shrinking, requiring new priorities in public expenditure.

If you had to tackle this at all, you wouldn’t choose to do it with the “everything bubble” likely to burst, bringing in its wake both debt defaults and currency crises. But this process looks inescapable. With its modest incremental rate rises, so derided by Wall Street and the White House, the Fed may be trying to manage a gradual deflation of bubbles. If so, its intentions are worthy, but its chances of success are poor.

And, when America’s treasury chief asks banks to reassure the markets about liquidity and margin debt, you know (if you didn’t know already) that things are coming to the boil.

Tax – leveraging the pain

If it seems a little odd to start this series with fiscal affairs, please be assured that these are very far from mundane – indeed, they’re likely to shape much of the political and economic agenda going forward. The biggest single reason for upsets is simply stated – where prosperity and the ability to pay tax are concerned, policymakers haven’t a clue about what’s already happening.

Here’s an illustration of what that reality is. Expressed at constant values, personal prosperity in France decreased by €2,060, or 7.5%, between 2001 (€29,315) and 2017 (€27,250).

At first glance, you might be surprised that this has led to such extreme public anger, something not witnessed in countries where prosperity has fallen further. Over the same period, though, taxation per person in France has increased by €2,980. When we look at how much prosperity per person has been left with the individual, to spend as he or she chooses, we find that this “discretionary” prosperity has fallen from €13,210 in 2001 to just €8,230 in 2017.

That’s a huge fall, of €4,980, or 38%. Nobody else in Europe has suffered quite such a sharp slump in discretionary prosperity – and tax rises are responsible for more than half of it.

This chart shows how increases in taxation have leveraged the deterioration in personal prosperity in eight Western economies. The blue bars show the change in overall prosperity per capita between 2001 and 2017. Increases in taxation per person are shown in red.

In the United Kingdom, for example, economic prosperity has deteriorated by 9.8% since 2001, but higher taxation has translated this into a 29.5% slump in discretionary prosperity. Interestingly, economic prosperity in Germany actually increased (by 8.2%) over the period, but higher taxes translated into a fall at the level of discretionary prosperity per person.

Prosperity and tax – Scylla and Charybdis

The next pair of charts, which use the United Kingdom to illustrate a pan-Western issue, show a problem which is already being experienced by the tax authorities, but is not understood by them.

The left-hand chart (expressed in sterling at constant 2017 values) shows a phenomenon familiar to any regular visitor to this site, but not understood within conventional economics. Essentially, GDP (in blue) and prosperity (in red) are diverging.

This is happening for two main reasons. One is the underlying uptrend in the energy cost of energy (ECoE). The second is the use of credit and monetary adventurism to create apparent “growth” in GDP in the face of secular stagnation. This, of course, helps explain why people are feeling poorer despite apparent increases in GDP per capita. Total taxation is shown in black, to illustrate the role of tax within the prosperity picture.

The right-hand chart shows taxation as percentages of GDP (in blue) and prosperity (in red). In Britain, taxation has remained at a relatively stable level in relation to GDP, staying within a 34-35% band ever since 1998, before rising to 36% in 2016 and 37% in 2017.

Measured as a percentage of prosperity, however, the tax burden has risen relentlessly, from 35% in 1998, and 44% in 2008, to 51% in 2017.

Simply put, the authorities seem to be keeping taxation at an approximately constant level against GDP, not realising that this pushes the tax incidence upwards when measured against prosperity. The individual, however, understands this all too well, even if its causes remain obscure.

What this means, in aggregate and at the individual level, are illustrated in the next set of charts. These show the aggregate position in billions, and the per capita equivalent in thousands, of pounds sterling at 2017 values.

As taxation rises roughly in line with GDP – but grows much more rapidly in terms of prosperity – discretionary prosperity, shown here in pink, becomes squeezed between the Scylla of falling prosperity and the Charybdis of rising taxation. The charts which follow are annotated to highlight how this ‘wedge effect’ is undermining discretionary prosperity.

Finally, where the numbers are concerned, here’s the equivalent situation in France. As far back as 1998, tax was an appreciably larger proportion of GDP in France (51%) than in the United Kingdom (34%). By 2017, tax was absorbing 54% of GDP in France, compared with 37% in Britain.

This means that taxation in France already equates to 70% of prosperity, up from 53% in 1998. Even though the squeeze on overall prosperity (the pink triangle) has been comparatively modest so far (since 2001, a fall of 7.5%), the impact on discretionary prosperity (the blue triangle) has been extremely severe (39%). This is why so many French people are angry – and why their anger has crystallised around taxation.

The political fall-out

When you understand taxation in relation to prosperity, you appreciate a challenge which the authorities in Western countries (and beyond) have yet to comprehend. Most of them probably think that, going forward, they can carry on pushing up taxation roughly in line with supposed “growth” in GDP. Presumably, they also assume that the public will accept this fiscal trajectory.

If they do make these assumptions, they’re in for a very rude awakening. The modest tax tinkering implemented in France, for instance, is most unlikely to quell the anger, even though it’s set to widen the deficit appreciably.

Politically, the leveraging effect of rising taxation feeds into a broader agenda which, so far, is either misinterpreted, or just not recognised at all, by the governing establishment.

Here, simply stated, are some of the issues with which governments are confronted:

– Prosperity per person is continuing to deteriorate, typically at annual rates of between 0.5% and 1.1%, across the Western economies.

– Rising taxation is worsening this trend, leading increasingly to popular resistance.

– The public believes (and not without reason) that immigration is exacerbating the decline in prosperity, both at the total and at the discretionary levels.

– Perceptions are that a small minority of “the rich” are getting wealthier whilst almost everyone else is getting poorer.

Politicians are seen as both heedless of the majority predicament and complicit in the enrichment of a minority.

The popular demands which follow from this are pretty clear.

Voters are going to be angered by the decline in their prosperity, and will become increasingly resistant to taxation. The greatest resentment will centre around “regressive” taxes, such as sales taxes and flat-rate levies, which hit poorest taxpayers hardest.

They’re going to demand more redistribution, meaning higher taxes on “the rich”, not just where income taxes are concerned, but also extending to taxes on wealth, capital gains and transactions.

Popular opposition to immigration is likely to intensify, as prosperity deteriorates and tax bites harder.

Finally, public anger about former ministers and administrators retiring into very lucrative employment is going to go on mounting.

A challenge – and an opportunity?

In terms of electoral politics, most established parties are singularly ill-equipped to confront these issues. Some on “the Left” do embrace the need for redistribution, but almost invariably think this is going to fund increases in public expenditures, which simply isn’t going to be possible.

Others oppose increasing taxes on the wealthiest, and fail to appreciate that fiscal mathematics, quite apart from public sentiment, are making this process inescapable.

On both sides of the conventional political divide there is, as yet, no awareness that economic trends are going to exert glacier-style downwards pressure on public spending. Nowhere within the political spectrum is there recognition of the consequent need to set new, more stringent priorities. In areas such as health and policing, declining real budgets mean that policymakers face hard choices between which activities can continue to be funded, and those which will have quietly to be dropped.

It seems almost inconceivable that established parties are going to recognise what faces them, and adapt accordingly. The “Left” is likely to cling to dreams of higher public expenditures, whilst the “Right” will try to fend off higher taxation of the wealthiest. Even insurgent (aka “populist”) parties probably have no idea about the tightening squeeze on what they can afford to offer to the voters. It’s likely that very few people in senior positions yet realise that an ultra-lucrative retirement into “consultancies” and “the lecture circuit” is set to become electorally toxic.

Politically, of course, problems for some can be opportunities for others. It wouldn’t be all that hard to craft an agenda which capitalises on these trends, promising, for example, much greater redistribution, ultra-tight limits on immigration, and capping the retirement earnings of the policy elite.

If you did promise these things, you’d probably be elected. Unfortunately, though, that’s the easy bit. The hard part is going to be grappling with the continuing decline in prosperity at the same time as fending off a financial crash.

How, having been voted into power, are you going to tell the voters that we’re all getting poorer, and that some public services are ceasing to be affordable within an ever more rigorous setting of priorities? And are they going to believe you when you tell them that the destruction of pensions is entirely the work of your predecessors? Finally, what are you going to do when one of the big endangered economies fails?

 

#142: Past, present and future

LOOKING BACK AND LOOKING FORWARD

As we near the end of a year that can certainly be called ‘interesting’, I’d like to reflect on what’s happened, what’s happening now, and what we might expect to happen going forward. I can’t be sure that this is the last article for 2018 but, in case it is, I’d like to thank everyone for their interest, their comments and their many invaluable contributions to the themes we discuss here – and, of course, to wish you a very merry Christmas and a happy and successful New Year.

Where Surplus Energy Economics, this site and SEEDS are concerned, this has been a memorable year. SEEDS – the Surplus Energy Economics Data System – was finally completed in early 2018, and, amongst other things, this has freed up time for more thematic analysis. It’s both humbling and gratifying to know that about 44,000 people have visited the site this year, another big increase over the preceding twelve months. Most importantly – though this is for you to judge – I like to think we’ve developed a pretty persuasive narrative of how the economy works, and how things are trending.

We can take less satisfaction in what we see around us. According to SEEDS, most of the Western economies have now been getting poorer for at least a decade – and, ominously, the ability of the emerging market economies to grow enough to offset this deterioration, and keep global prosperity static, seems to have ended. World prosperity per person has been on a remarkably long plateau at around $11,000 (constant values, PPP-converted), but has now started to erode.

Deteriorating prosperity might be ‘a new fact’ in the world as a whole, but it’s an established reality in the West – with the single exception of Germany (rather a special case), no developed economy covered by SEEDS has enjoyed any improvement in prosperity at all since 2007. In most cases, the decline in personal prosperity has been happening for longer than that. But our societies seem to have learned almost nothing about what’s going on – and, until the processes are understood, crafting effective responses is impossible.

Historians of the future are likely to be bemused by our futile efforts to escape from the energy dynamic in the economy. From the turn of the millennium, we started pouring ever larger amounts of debt into the system. This led, with utter inevitability, to the 2008 global financial crisis (GFC I).

Undeterred, we then compounded cheap and abundant debt with ever cheaper money, yet the inevitable consequences of this process will still, no doubt, be declared both ‘a surprise’ and ‘a shock’ when they happen. We surely should know by now that we have an “everything bubble” propped up by ultra-cheap money, and that bubbles always burst. If there’s any sense in which “this time is different”, it is that, since 2008, we’ve taken risks not just with the banking system, but with money itself.

The death of debt?

There’s one theme which, though we’ve touched on it before, really needs to be spelled out. Throughout the era of growth, we’ve come to accept the process of borrowing and lending as a natural component of our economic system. Indeed, this practice long pre-dates the industrial age, when borrowing and lending, which then was more commonly called “usury” (the lending of money for interest), began to be de-criminalised after Christian Europe had been shaken up by the Reformation.

Leaving theological and ethical issues aside, we need to be clear that the process of borrowing and lending is a product of growth, because debt can only ever be repaid (and, indeed, serviced) where the prosperity of the borrower grows over time.

For simplicity, we can divide debt into two categories. If someone borrows money to expand a successful business, it is the growth in the income of the business which alone enables interest to be paid and the capital amount, too, to be reimbursed in due course. This is termed “self-liquidating debt”.

“Non-self-liquidating debt”, on the other hand, is typified by the loans consumers take out to pay for a holiday, buy a car or replace a domestic appliance. Here, the borrower is buying something which he or she cannot afford out of current income, and the only way in which this can be repaid is if the borrower’s prosperity increases over time.

Take away the assumed growth in prosperity, however, and both forms of borrowing cease to be viable. “Self-liquidating” debt assumes that an expanded business can earn greater profits, but it’s hard to count on this when potential customers are getting poorer. As for “non-self-liquidating” debt, the all-important rise in the borrower’s means can no longer be relied upon when people generally are getting poorer.

In short, the very process of borrowing and lending is likely to be stripped of its viability as prosperity declines. This should be an extremely sobering thought in a world which is awash with debt, and where supplying cheap credit is seen as a panacea for economic stagnation.

You might well ponder at least two things about this. First, what happens to the large quantities of debt owed by those Western economies whose prosperity has already moved significantly along the downwards curve? Second, what happens to asset prices in a world where the credit impetus goes into reverse?

Reflecting on the essential linkage between debt and growth, you might also wonder why we’re not already seeing the debt edifice crumbling. There are two main answers to this. The first is that the debt structure has been buttressed by de-prioritising another form of futurity – simply put, we’ve already created huge (and burgeoning) gaps in pension provision as part of the price of preserving the edifice of debt.

The second answer is simpler still – we’ve not seen the debt edifice start to crumble yet……

Feeling the pain

People across the Western world certainly seem to know that their prosperity is eroding, and they’re far from happy about it. We can see the effects both in political choices and in rising popular discontent. If you understand deteriorating prosperity, then you understand political events in America, Britain, Italy, France and far beyond – events which, if you didn’t understand the economic process, must seem both baffling and malign.

Though understandable, anger isn’t a constructive emotion, and what we really need is coolly analytical interpretation, understanding and planning. If it’s true that we’re not getting this from government, then it’s equally true that government reflects the climate of opinion. We can hardly expect governments to understand the economic realities when opinion-formers stick resolutely to conventional interpretation. It’s more surprising that conventional methods still command adherence as outcomes continue to diverge ever further from expectations.

Making glib promises is part and parcel of politics and, in fairness, those who don’t do this can expect to lose out to those who do. What is more disturbing is the continued promotion of economic extremism. Nationalising everything in sight won’t work, and neither will dismantling the state and turning the economy into a deregulated, ‘law of the jungle’ free-for-all.

Over the years, we’ve tried both, and should know by now that the lot of the ‘ordinary person’ isn’t bettered by these extremes. At least, when prosperity was still growing, we could live with the price of ideological purity – now that prosperity (in the West, at least) has turned down, though, these consequences are something that we can no longer afford.

If you think about it, the extremes either of collectivism or of ‘laissez faire’ have always been absurdly simplistic. Have we ever really believed that benign apparatchiks can manage things better than people can do for themselves? Or that unfettered ‘capitalism’, which concentrates wealth and power just as surely as collectivism, can do things better? Perhaps most importantly, why do so many of us persist in the view that possessions, material wealth and nebulous ideas of relative ‘status’ are a definition of happiness?

Logically, deteriorating prosperity means that we concentrate on necessities and dispense with some luxuries. Amongst the luxuries that we can no longer afford are ideological extremes, and an outlook founded wholly or largely on ownership and consumerism.

The need for ideas

The good news is that we’re not going into this new era wholly lacking in knowledge. The trick is to understand what that knowledge really is. Keynes teaches us how to manage demand – or can teach us this, so long as we don’t turn him into a cheerleader for ever bigger public spending. Likewise – if we can refrain from caricaturing him as a rabid advocate of unregulated and unscrupulous greed – Adam Smith tells us that competition, freely, fairly and transparently conducted, is the great engine of innovation. More humbly, or perhaps less theoretically, but surely more pertinently, experience tells us that the “mixed economy” of optimised private and public provision works far better than any extreme.

Going forward, we should anticipate the collapse of the “everything bubble” in asset prices, and should hope that we don’t, this time, go so far into economic denial as to think we can cure this with a purely financial “fix”. I’m fond of saying that “trying to fix an energy-based economy with financial fixes is like trying to cure an ailing pot-plant with a spanner”. We should understand popular concerns, which seem to point unequivocally towards a mixed economy, extensive redistribution and an economic nationalism that needs to be channelled, not simply vilified.

Another, positive point on which to finish is that a deterioration in prosperity needn’t prevent us – indeed, should compel us – to make better use of the prosperity that we do have. There’s no situation which can’t be made worse by rash decisions, or made better by wise ones. The forces described here – economic trends, and their political and social corollaries – all contain the seeds (no pun intended…) of divisiveness. This being so, cohesion and common purpose have never been so important.

Togetherness, and concern for the welfare of others, are, and certainly should be, part of the fabric of Christmas. Seldom can these characteristics have been more important than they are now.