#320: “Don’t mention the war”

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SOME REALITIES BEHIND THE ONGOING CONFLICT

Foreword

We may not yet know how and when the war in Iran will end, but we can already perceive how it will be spun in retrospect.

Following the pandemic lockdowns of 2020 and the invasion of Ukraine in 2022, the conflict in the Gulf will be the third great excuse for the absence of meaningful growth in the global economy.

In the small things of life, we have a tendency to see excuses for what they are. We don’t make a habit of believing that “the dog ate my homework”, “the payment’s in the post”, or “I can’t buy a round of drinks because a spaceman from Mars stole my wallet”.

In matters of greater moment, however, excuses have a tendency to be swallowed more easily, primarily because of a collective desire to submit to “the willing suspension of disbelief”.

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The two great realities of our predicament are that the economy is inflecting from growth into contraction, and that nobody in any position of authority or influence can afford to admit it. “Life after growth” has, as we have previously reflected, turned into life after truth.

The current conflict is a case in point. The facts of the situation are that asymmetric warfare makes it far easier to close the Straits of Hormuz than to keep this critical waterway open. Bottled up beyond the Straits are about a fifth of the world’s supply of oil and natural gas, and larger proportions still of international trade in these products.

Moreover, the Straits constitute a nitrogen trap, blocking access to sizeable proportions of fertilizer supply at a time when the planting season won’t wait while we sort out “a little local difficulty” in the region.

The global population numbered just over 3.0bn in 1960, by which point virtually all land capable of cultivation was already under the plough, and it’s a reasonable calculation that, in the absence of fertilizers, global carrying capacity might be about 4 billion, or less than half the current total.

As well as these inputs, of course, intensive agriculture also depends on the abundant availability of low-cost energy, a condition that is unlikely to prevail as fossil fuel supply declines, proportionate material costs rise, and “renewables” continue to fall far short of replacing the surplus (ex-ECoE) energy currently sourced from oil, natural gas and coal.

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We should not, from these observations, stray into the territory of doom-mongering, but neither should we be deluded by claims based on GDP.

One of these claims is that agriculture and fisheries account for “only” about six per cent of global economic activity, implying that the remaining 94% of the economy could continue merrily on its way even if the entire ability to supply food were to be lost.

Likewise, we can calculate that energy in its entirety is an even “less important” input than food, and that the proportion of GDP which transits the Straits is, when measured by value, barely a rounding error in the overall total.

GDP is, then, an excellent measure, except when we want to calculate anything that actually matters.

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The single biggest snag with GDP is that it measures, not the supply of material value to the economy, but the aggregate of transactional activity in the system. Accordingly, much of the “growth” reported in recent years has been nothing more than the spending of vast amounts of borrowed money.

This is why SEEDS strips out this ‘credit effect’ to calculate underlying or “clean” economic output, known here as “C-GDP”, from which the deduction of the first-call on resources made by the Energy Cost of Energy enables us to calibrate material economic prosperity.

The C-GDP metric also enables us to compare output with energy use, thus calculating the rate at which non-energy resources are converted, using energy, into the products, artefacts and infrastructures which constitute the “real” or material economy.

Whilst this conversion ratio has been trending gradually downwards in response to the depletion of minerals, non-metallic mining products, biomass and water, ECoEs have been rising relentlessly along an exponential trajectory.

Fig. 1

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The lessons to be learned – rather, to be re-learned – from this war are the parallel vulnerabilities in our economic and financial systems.

On the one hand, the material economy depends on the flawless functioning of an interconnected series of critical supply chains. A preference for profit over prudence dictates that we rely on a JIT (‘just in time’) system which militates alike against the creation of backup capacity and the holding of sizeable inventories.

On the other, the financial system has become not only bloated but lethally cross-dependent. We can gain some insight into this from data published annually by the Financial Stability Board.

At issue here are “financial assets” which, in SEE terminology, are the aggregate of financial claims on the “real” or material economy. Put another way, the “assets” of the financial system are claims on – and liabilities of – the material or non-financial economy, since nobody else can honour them.

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The submission of data to the FSB is voluntary, meaning that available information is neither complete nor timely.

We may know that, at the most recent reporting date, the assets of the financial system of the Cayman Islands totalled $17.5 trillion, or 295,000% of the Islands’ $5.9 billion GDP, but most other offshore financial centres (OFCs) – of which there are about forty – do not file returns with the FSB.

What this means is that, although jurisdictions equivalent to almost 80% of GDP do report to the FSB, we can’t simply gross up from their exposure (510% of GDP) to a global aggregate.

SEEDS estimates – and they can never be more than that – are that global financial assets totalled not less than $665tn at the end of 2024, equating to about 600% of reported GDP.

The latter ratio is far higher than the 475% of GDP estimated for the end of 2007, when the economy was on the brink of the global financial crisis.

Far from being learned, the lessons of 2008-09 have been disregarded in a headlong rush to ever greater risk exposure.

Adjusted for inflation since 2007, these SEEDS estimates indicate that aggregate financial assets have increased by about $315tn in a period in which reported real GDP increased by only $37tn.

The idea that we have added about $8.50 in new financial claims for each dollar of reported “growth” is by no means outlandish, given the preference for ultra-cheap capital in the intervening years.

Asset price gains might only exist on paper, but such gains are an addictive drug in the corridors and offices where decisions are taken. This is one reason why 2008-era promises that reckless monetary expansion would be “temporary”, and would last only for the duration of the “emergency”, were never likely to be honoured.

Moreover, within the estimated $315tn real-terms increase in financial assets since 2007, less than 23% has been sourced from the regulated banking sector, and almost 68% from NBFIs. These non-bank financial intermediaries are known colloquially as the “shadow banking sector”, an opaque and hyper-complex system of cross-collateralised claims.

In essence, then, the financial system has been subject to increasing risk in two distinct ways.

First, there is the scale risk associated with creating upwards of $8 in net new claims for each incremental dollar in transactional activity.

Second, there’s ever-increasing complexity risk driven by the migration of the centre of gravity of risk itself from the comparatively conservative centre of the system to its unregulated and opaque periphery.

Fig. 2

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Thus far, at any rate, the public has not been well served by mainstream coverage of the war. We’ve been deluged with political and military ‘analysis’ which leaves us none the wiser about when and how the conflict might conclude.

But it’s in the economic field that reporting has been at its most shallow. We’re told that the costs of fuel, food and – as if it mattered, in the grand scheme of things – air fares might rise. We’ve also been informed that conflict-induced inflation might keep interest rates ‘higher for longer’.

The citizen, it seems, might have to pay more for his or her fuel, food and travel, and might find mortgages somewhat harder to find, and costlier to service.

These are, in essence, modest and manageable increments to the long-established “cost of living crisis”. Governments might, in addition, have to raise a bit more in taxes, and try to make some modest cuts in public expenditure.

This will hurt, then – and we might, as a result, not feel too happy about some of the protagonists in the conflict – but it needn’t cause us to question anything fundamental, let alone call into doubt promises of infinite economic growth made possible by monetary innovation, technological genius and the wisdom of the PCE (the post-capitalist expediency).

There’s certainly been no suggestion that the JIT-driving prioritizing of profit over prudence might have failed us; that financial claims expansion has gone far beyond crazy; that discretionary (non-essential) affordability might be on a relentlessly downwards trend; or that extreme inequalities are just ‘the price we have to pay’ for “growth”.

Neither should it even be suggested that a point might have arrived when top-heavy, over-centralised private and public institutions might, in the pursuit of resilience, need to be replaced by more localised, bottom-up alternatives.

Fig. 3

#319: The end of growth

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A SYNOPSIS

Foreword

For some time now I’ve been minded to post something about “the end of growth” at LinkedIn.

Obviously this had to state the issues in ways that make sense to anyone not hitherto familiar with the Surplus Energy Economics thesis.

Because of character limits, this had to be brief, and split into two posts. Perhaps because of my lack of prior experience posting there, I wasn’t able to import my formatting to those articles.

So here, as a formatted single article, is the original text. I hope it provides a usefully compact synopsis of our predicament.

Part Two of our ongoing series – The Surplus Energy Economy – will appear here in due course.

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There are times when the most important facts, though straightforward in principle, are simply too big, or too unpalatable, for general recognition

This is one of those times. The Big Fact informing all of the sub-narratives of our age is that the global economy has stopped growing, and is starting to shrink.

We should swiftly dismiss all official or orthodox statistical claims to the contrary. GDP isn’t a measure of material value created in the economy, but of the transactional exchange of money in the system. Money routinely changes hands without value being added, and never more so than when most of the money in question has been conjured out of thin air as credit.

In reality, no form of money has any intrinsic worth. Obviously enough, we can’t eat fiat currencies, power our cars with cryptos, or sow our fields with precious metals. Rather, money is token, not substance – it commands value only as an exercisable claim on those physical products and services for which it can be exchanged.

This principle of money as claim leads directly to a conceptual necessity, which is that we need to think in terms of two economies, not one. The first is the “real” or physical economy of material products and services. The second is the parallel and proxy “financial” economy of money, transactions and credit.

Once this is understood, we are spared the futility of comparing money only with itself.

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There are two things that we need to know about the underlying “real” economy.

The first is that it operates by using energy to convert other raw materials into products, and into those artefacts and infrastructures without which no worthwhile service can be provided. Since some of these products are consumed, whilst others wear out and need to be replaced, this is a continuous process of creation, consumption, abandonment and replacement.

Second, energy is never “free”, but can only be put to use with an energy supply infrastructure. This infrastructure, which might be wells and refineries or wind turbines and grid systems, is material, meaning that it cannot be created, operated, maintained or replaced without the use of energy.

Colloquially, then, we have to “use” energy to “get” energy. Stated more formally, “whenever energy is accessed for our use, some of that energy is always consumed in the access process, and is unavailable for any other economic purpose”.

This proportionate Energy Cost of Energy is a matter, not of money, but of physics. ECoEs from all sources of primary energy have risen from 2.0% in 1980 to more than 11% today. Accompanied by a gradual degradation of the non-energy resource base, this has impaired annual rates of material expansion to a point at which the underlying physical economy inflects from growth into contraction.

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The authors of The Limits to Growth, published back in 1972, used the then-new technique of system dynamics to see this coming, and even gave us a pretty good steer on its probable timing.

None of this is palatable, of course, to a world so obsessed with “growth” that it disregards the obvious truth of Kenneth Boulding’s observation that only “a madman or an economist” could believe in the promise of infinite, exponential economic growth on a finite planet.

Over the past twenty years, material economic prosperity has increased by 25%, but huge rises in the stock of monetary claims have enabled statisticians to assert that the flow of economic activity measured as “real GDP” has more or less doubled (+96%, 2004-2024).

Our resistance to the very concept of an ending and reversal of growth has been vested in two false presumptions. One is that the material economy can be reinvigorated using monetary tools, which would be true only if the banking system could lend energy and raw materials into existence, or if central bankers could conjure them, ex nihilo, out of the ether.

The other is the supposedly “limitless” potential of human ingenuity, enacted as technology. In reality, the potential of technology, far from being limitless, is bounded by an envelope of possibility whose parameters are set by the characteristics of materials and the laws of thermodynamics.

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Since the real costs of energy-intensive necessities are rising, just as top-line prosperity inflects into contraction, the supposed “cost of living crisis” isn’t a temporary “crisis” but the emergence of a wholly predictable trend. This goes a long way towards an explanation of worsening internal political and social instability.

Washington, meanwhile, has awakened, belatedly, to the reality and consequences of material resource finality, an understanding that, we can reasonably infer, has long been grasped in Beijing and Moscow.

The breakdown of international trade – and its balkanisation into trading blocs and exclusion zones – becomes readily explicable if we once recognise the ultimate finality of the material, the impotence of the monetary and the technological, and the resultant intensification of competition for scarce and dwindling resources.

#318: The Surplus Energy Economy, part one

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LIFE AFTER TRUTH

Foreword

It might be fair to say that visitors to this site divide into two broad categories –  those who are interested in economic and financial theory itself, and those more concerned with the explanation of current events and the anticipation of outcomes.

It also needs to be borne in mind that, whilst some readers have long been familiar with surplus energy theory, there are others to whom these concepts are new.

If this first article in a planned series has one message, it is that it’s perfectly possible for us to make sense of economics and finance on our own behalf.

We’re not dependent on what anyone – the authorities, orthodox economists, propagandists, wild optimists or prophets of doom – tries to tell us.

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It doesn’t help anyone’s search for clarity, of course, that the world of today is subject to extraordinary levels of messaging, very little of which is truly objective.

On the one hand, we are frequently informed about new technological breakthroughs, perhaps in the field of energy supply, that will liberate us from the constraints of material economic finality.

On the other, we are warned about imminent financial collapse, sometimes resulting from left-field events not recognised in the generality of analysis.

Two realisations can act as beacons to light our way through this fog of mystification.

The first is that meaningful growth has ended, and that the economy is starting to shrink. We’ll look a little later at how this conclusion can be reached.

The second is that nobody, in any position of authority or influence, can possibly afford to admit that this is happening.

This is how Life After Growth becomes Life After Truth.

Put another way, the idea that “when it gets serious, you have to lie” has graduated from the aside of a single individual to the governing leitmotif of an age.

This situation calls for heightened self-reliance, not in the sense of stockpiling canned food and bottled water, but in deciding for ourselves what we do and do not believe about current and future economic conditions.

What we’re going to do here is to start from some basic principles and then apply these to the economy of today and tomorrow.

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The first of these fundamentals is the principle of money as claim.

This principle recognises that money has no intrinsic worth – we can’t eat fiat currencies, power our cars with cryptos, or plant our fields with precious metals.

Rather, money commands value only in terms of those physical things for which it can be exchanged. Anyone having money has, in effect, an exercisable claim on material products and services. This money may be spent in the present (flow), or set aside for use in the future (stock), but in both cases retains the essential characteristic of claim.

That’s exactly why monetary systems tend to be based on credit.

Acceptance of this principle of claim immediately distances us from an economics orthodoxy which asserts that everything can be explained in terms of money alone, and that we need not take account of the material.

On this fallacious basis have been erected the so-called “laws” of economics, but these are in no way analogous to the laws of science.

Rather, they are merely behavioural observations about the human artefact of money.

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The principle of money as claim necessarily leads to our second fundamental, which is the principle of two economies. One of these is the material or “real” economy of physical products and services. The other is the parallel “financial” economy of money, transactions and credit.

This gives us something which orthodox economics does not have – the ability to benchmark the monetary against the material.

We are no longer trapped in the futility of comparing money only with itself.

Statistical information about the “financial” economy is available in abundance, but much less attention is devoted to the “real” economy of the material. This is where our third and fourth principles fit into the picture.

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The third principle is the principle of conversion. The “real” economy operates by using energy to convert raw materials into products, and into the artefacts and infrastructures without which no worthwhile service can be provided.

Some of the products of this process are consumed, and others wear out and need to be replaced. So the conversion economy is a continuous process of creation, consumption, relinquishment and replacement.

This brings us to the last of our four foundation principles. Far from being “free”, energy can only be put to use using a physical supply infrastructure, stretching all the way from wells and refineries to solar panels and grid systems. This system is material, meaning that it cannot be created, operated, maintained or replaced without the use of energy.

Colloquially, then, we have to “use” energy in order to “get” energy. More formally stated, “whenever energy is accessed for our use, some of this energy is always consumed in the access process, and is not available for any other economic purpose”.

Describing this “consumed in access” component as the Energy Cost of Energy gives us our fourth principle, which is the principle of ECoE.

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At this point we can start to anticipate some of our conclusions.

First, there has been a gradual but significant degradation of the planet’s non-energy resource base. We observe this every time ore grades decline, every time agricultural land needs more inputs to sustain yields, and every time water becomes scarce in certain localities.

Environmental deterioration fits into this broad pattern of extraction and degradation, most obviously through its adverse effects on land, crops and water supplies. The only way in which we can make sense of environmental issues is to locate them within a holistic appreciation of the economics of the material.

It will be readily apparent that we can’t resolve environmental problems by sending money to the universe. The environment, that’s to say, can’t be “bought off”. We cannot frame environmental challenges effectively without reference to the “real” economy of the material.

Second, trend ECoEs have been rising relentlessly, climbing from 2.0% in 1980 to more than 11% today. We’ll look a little later in this series at why this has been happening, and at the consequences of its continuing exponential progression.

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Our third conclusion is that, as a society, we are wholly unwilling to accept the reality of material constraints to economic activity. Many wise and well-intentioned people have made the case for the restraint of voluntary de-growth, but their words have tended to fall on deaf ears.

This resolute denial of reality has led us into two self-deceiving fallacies.

One of these is that the material economy can be reinvigorated using monetary tools. But this isn’t how the relationship between the financial and the physical actually works. We can, indeed, create almost limitless amounts of monetary claims, but energy and other resources can’t be lent into existence by the banking system, or conjured out of the ether by central bankers.

Together the principles of two economies and of money as claim make it apparent that there needs to be a state of equilibrium between the monetary economy and its material counterpart. If we allow the monetary to out-grow the material, we set up forces tending towards the restoration of equilibrium.

What this means is that “excess claims” must, in one way or another, be eliminated. Under conditions of comparatively modest disequilibrium, the erosion of claims through inflation can suffice to meet this need for the elimination of excess claims.

Now, though, we are far beyond those limits at which inflation alone can reconcile the forces tending towards equilibrium. Accordingly, we cannot now escape an enforced elimination of claim value, meaning a crash in asset prices and a cascade of credit defaults.

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Our second exercise in self-deception is the faith that we invest in the supposedly “limitless” potential of technology.

The reality, of course, is that the potential for technological progress, far from being limitless, is bounded by the laws of physics, and specifically by the characteristics of resources and the laws of thermodynamics.

It’s worth reflecting, at this point, that the twin delusions of monetary stimulus and limitless technological possibility share the common characteristic of collective hubris.

If our artefact of money, and our technological genius, could indeed triumph over material reality to make possible ‘infinite economic growth on a finite planet’, we would indeed be ‘Lords of Creation’.

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It will not have escaped your notice that the hubristic fallacies of monetary mastery and limitless technological genius are combined in the contemporary craze for artificial intelligence.

AI technology does indeed offer enormous promise, though this is bounded by some significant potential drawbacks, just one of which is the risk of descending into the “slop” of AI endlessly regurgitating its own flawed output.

But the biggest snag with AI is the business model currently favoured for its development. This is the “go big” strategy of progressing AI using enormous data-centres housing huge numbers of very expensive GPUs.

This, financially speaking, is “loss-leading” on a gargantuan scale.

For American tech, “go big” worked wonderfully in the exploitation of the internet. The pre-requisite is access to huge amounts of capital. This enables firms to make large losses over protracted periods of time, thereby driving competitors out of business, and capturing disproportionate market shares, whether of subscribers, of advertisers or of customers for online retail and other services.

The capital thus lost is more than recouped once quasi-monopoly status has been secured.

But “go big” won’t work with AI. Perhaps the most important problem is that this model makes demands for energy, water and other natural resources at scales beyond the possible.

The “go big” version of AI might fail because the required resources do not exist, or because accessing them imposes too much resource deprivation upon other sectors, including households, municipalities and other non-tech businesses.

The other thing that the AI moguls seem to have overlooked is structural change in the economy. For reasons that we have already mentioned – and that will later be explored in greater depth – the downwards trajectory of material prosperity is being compounded by relentless rises in the real costs of energy-intensive necessities.

The result of these processes is the imposition of inescapable downwards pressure on the affordability of discretionary (non-essential) products and services, and AI is, almost overwhelmingly, a discretionary rather than a necessity.

A curious characteristic of Western AI is the failure to align it with the one complementary technology that could make it materially worthwhile (and no, let’s not get into guessing games about what that is).

It wouldn’t even help if – implausible though it is – the “go big” business model for AI were to succeed. The previous craze for globalisation destroyed swathes of blue-collar employment in the West. If AI were to do the same for white-collar employment, the result would be societies so dystopian that their existing social, political and economic arrangements could not survive.

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The intention with this series is the provision of a comprehensive statement of the Surplus Energy Economics thesis, meeting – if all goes to plan – the needs both of those who are interested in economic and financial theory in its own right, and of those who want to know “what happens next, and how can I navigate it?”

In the meantime, few will have failed to notice increasing instability in domestic and international affairs. In part, this reflects belated Western recognition of something long understood in Beijing and Moscow – the unfolding reality of resource finality, and the new competitive conditions created by scarcity.

We will, of course, continue in our misplaced faith that monetary ingenuity and technological genius can combine to rescue us from the unpalatable consequences of material finality.

It takes no great intuition to recognise that the financial system is headed for a crisis that will make the events of 2008-09 look like a stroll in the park, or that the AI bubble will burst, leaving us with very little recoverable value from burned-out and time-expired GPUs, vast, single-purpose buildings “in the middle of nowhere”, and debt collateralised against assets with minimal recoverable value.

Beyond sheer scale, though, the big difference between the previous GFC and the looming “GFC II” sequel is that, this time, it’s not the banking system, but money itself, that will be in the eye of the storm.

Starting in the 1990s, we put banking at hazard in order to pursue the dream of infinite economic expansion on a finite planet. This time, we’ve gambled with the credibility, and hence the viability, of money itself.

#317: The triumph of the material

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FACT, SCARCITY & THE DE-THRONING OF MONEY

Summary

A distinctly acquisitive gleam is evident these days in the eye of American power. Other people’s presidents seem to be fair game for appropriation, as are other people’s ships, other people’s resources and – even – other people’s countries.

We can call this thievery, or we can call it realpolitik.

The label hardly matters.

What lies behind this apparent outbreak of kleptomania, however, is a shocked awakening to a reality probably long understood in Moscow and Beijing.

This reality is that, in the very different economic future now unfolding, the material will be all-important, and the monetary, by contrast, will matter very little.

1

As you may know, there is only one way in which economic processes can be interpreted effectively.

This requires that – far from ignoring the material and concentrating on the monetary – we draw a clear distinction between the “real” economy of the material and the parallel and proxy “financial” economy of the monetary.

The relationship between these two economies is that money, having no intrinsic worth, commands value only as an exercisable “claim” on the material.

To this principle of money as claim must be added two other pieces of foundational knowledge.

The first is that the “real” economy of the material functions by using energy to convert other natural resources into the products, artefacts and infrastructures which are the physical forms taken by prosperity.

The second is that, far from being “free”, energy comes at a proportional cost, manifested as the fraction of accessed energy consumed in the energy access process.

These are the principle of conversion and the principle of ECoE, the latter being an abbreviation of the Energy Cost of Energy.

The economic history of modern times can be expressed in two observations. Materially, trend ECoEs have risen relentlessly, whilst the non-energy resource base has been degraded, more gradually, by depletion.

Sociologically, we have sought to disregard material finality by developing the hubristic myth that we can manage and overturn these natural processes using two forms of magic – the human artefact of money and the human genius of technology.

This magic thinking will fail as the material asserts its primacy.

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The underlying situation is set out in the first set of charts.

Whilst the rate at which natural resources – including minerals, chemicals, biomass and water – are converted into economic output has been on a gradually declining trajectory, the Energy Cost of Energy has been rising relentlessly, from 2.0% back in 1980 to more than 11% today (Fig. 1A).

The decline in the conversion curve might be moderated by a re-prioritizing of resource use, but there is no cure for soaring ECoEs.

As ECoEs have risen, so the gap between total and ex-ECoE surplus energy has been widening. This process not only pushes producers’ costs upwards, but simultaneously undercuts the prosperity (and hence the affordability) of the energy consumer (Fig. 1B).

Material economic prosperity is now on a declining curve determined by trends in energy supply, ECoEs and resource conversion ratios (Fig. 1C).

Meanwhile, our futile efforts to reinvigorate the material economy with monetary tools have created wholly unsustainable levels of financial commitments (Fig. 1D).

Fig. 1

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The result has been a global economy awash with monetary “claims”, but dangerously short of material resources.

Going forward, the material becomes all-important, and the monetary becomes chaotic noise around the physical economic curve. Central bankers buying gold, and governments grabbing resources, understand this.

Anyone who clings on to the old paradigms of the monetary – or, for that matter, of the technological – has lost the plot.

Statistically, world debt has risen by 167% in real terms – and broader liabilities by not less than 210% – over a twenty-year period in which the financial equivalent of material economic prosperity has grown by only 25%.

There have been two particularly nasty stings in the tail of this progression.

First, the fading rate at which prosperity has been creeping upwards has already fallen below the pace at which population numbers have continued to increase.

Second, the real costs of energy-intensive necessities have been rising, even as top-line prosperity has been decelerating towards contraction.

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This tale has not been a sweet one, and has intentionally been kept short. Some of its consequences are reasonably foreseeable, but others are not.

As the basis of motivation switches from the monetary to the material, global trade will contract, and the excess claims incorporated in our bloated, credit-based monetary system will be eliminated.

Together, declining prosperity and ever-more-costly essentials will put relentless downwards pressure on those discretionary products and services which consumers might want, but do not need. This discretionary compression is illustrated – for America, China, Russia and the global economy – in the second set of charts.

Governments, no less than individuals, will experience a combination of decreasing resources and rising essential costs. These fiscal situations might be examined here in the future on the basis of SEEDS analysis.

If there’s one final takeaway here, it is that decision-makers will need to stop thinking monetarily, and start thinking materially. Energy- and resource-blindness can no longer be afforded.

As we shift from the monetary mind-set to the material, incentive (understood monetarily) will lose out in importance to strategy (conducted, for want of an alternative, by the state).

This mind-set transition might be one that – in comparison with their BRICS+ rivals – western countries are extremely ill-equipped to manage.

Fig. 2

#316: The class of ‘26

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ON THE EDGE OF CHANGE

Foreword

By convention, this is the season when analysts and others make their predictions for the year ahead. The near-ubiquity of this practice is a very good reason for not following suit.

Instead, and in thanking you for your interest and your contributions to our debates during 2025, I’d like to point out that the coming twelve months will mark the 250th anniversary of the most important year in modern history.

In 1776, Adam Smith published The Wealth of Nations, the foundation treatise of classical economics, whilst the United States Declaration of Independence was promulgated. Most important of all, James Watt completed the first truly efficient steam engine.

1

People had long used coal and other fuels to warm their homes and prepare their food. What was transformative about Watt’s discovery was that it enabled us, for the first time, to convert heat into work. The entirety of the industrial age flowed from that breakthrough.

As most of us know, none of the planet’s resources are infinite, and it’s wholly natural that we deplete reserves by using lowest-cost sources first, and leaving costlier alternatives for later.

Our fundamental problem today is resource depletion, which is driving a wedge between preference and possibility. We want growth to continue; it can’t. We seem to favour wide inequalities between social groups; this is becoming unsustainable

This problem is most acute with fossil fuel energy.

In a sense, we’ve been here before, when the economics of coal deteriorated during the inter-war years. Fortunately, oil and natural gas were available to take over from coal, and their superior characteristics gave the global economy its biggest burst of growth in the quarter-century after 1945.

Our predicament now is that we have failed to find a successor to hydrocarbon energy.

Recent reports from Rystad Energy and the IEA have pointed towards a looming decline in the supply of oil and natural gas.

It’s always been true, of course, that the production of natural resources will decline in the absence of sufficient investment in new sources of supply. But two things are different now.

The first is that a large and rising proportion of oil and gas supply comes from unconventional sources, which have particularly rapid rates of natural decline.

The second is that prices are nowhere near high enough to fund investment at levels sufficient to put much of a brake on a rapid fall in production.

2

Orthodox economics would assure us that this problem will be ‘sorted out by the markets’ – supply shortages will drive up prices, deterring consumption whilst incentivising investment in new sources of supply.

This market case seemed proven by the events of the 1970s, when the price spikes triggered by the oil crises prompted exploration and development in new basins – most obviously the North Sea and Alaska – whilst depressing demand, and encouraging rapid advances in fuel efficiencies.

By the mid-1980s, OPEC’s pricing power had been broken, and the world was awash with oil.

Any such assurance, though, is dangerously misplaced, for two main reasons. First, energy is not like any other commodity. A shortage of coffee and a rise in its price do not make us poorer, but energy shortages and higher costs do make us less prosperous.

The economy works by using energy to convert other raw materials into products, artefacts and infrastructures, so a decrease in the amount of ex-cost energy available to the system makes the economy smaller.

Second, there was no material shortage of oil in the 1970s – on the contrary, petroleum was abundant, and the cost of extraction remained very low. Far from being market events, the oil crises were political, caused by a falling out between the biggest users of oil and the most important exporters.

The critical measure of the condition of energy supply is the Energy Cost of Energy, a calibration of how much energy, being consumed in the energy access process, is unavailable for any other economic purpose. Driven by the depletion of fossil fuel resources, global trend ECoEs have risen relentlessly, from 2.0% in 1980 to more than 11% today.

Fig. 1

3

It might be thought that the consequences of surging ECoEs have been modest. Using the above numbers, the proportion of produced energy available to us may have fallen from 98% in 1980 but remains at 88%, which, we might be tempted to think, is surely enough to keep the economy growing.

This, though, ignores critical leverage in the system. Most of the energy available to the economy – perhaps 95% in complex advanced economies, and 90% or so in emerging market countries – is required simply for system maintenance. It has to be devoted, not just to repairing and replacing infrastructures and productive capabilities, but also to the support of the population.

The West has long since passed the ECoE threshold beyond which growth becomes impossible, and the same is now happening in less complex, more ECoE-resilient EM economies.

Renewables cannot take ECoEs back down to growth-capable levels. In addition to their intermittencies and lesser portability, these renewables depend, for their expansion, maintenance and replacement, on legacy energy from fossil fuels.

This is a material explanation for the financial fact that renewables are reliant on subsidies. This is why no hugely-valuable, enormously profitable renewables corporations have taken over from the oil and gas majors.

Seen in material rather than monetary terms, the whole of the economy is ‘subsidised’ by the energy industries. This subsidy is gradually being withdrawn by rising ECoEs, which can usefully be thought of as the economic rent levied on us for the use of the planet’s energy resources.

4

There are plenty of reasons for not panicking about the ending and reversal of economic growth. We retain more than enough economic resources to supply household essentials and necessary services to the World’s population.

A decrease in the over-consumption of energy and other resources might be our best hope of staving off worsening environmental deterioration. Discretionary products and services are, by definition, things that we might want, but don’t actually need.

This, unfortunately, is where politics clouds the picture.

Post-war optimism combined with rapid economic expansion to support a Keynesian consensus in the quarter-century after 1945.

During the 1970s, a neoliberal ascendancy took over from the Keynesian consensus, by persuading the public that the hardship and stagflation of the times were caused, not by the oil shock, but by “over-mighty” organised labour and “left wing” governments.

At the start of the 1990s, the collapse of the collectivist USSR seemed to mark the final victory of market liberalism, not least because it opened up resources in the former Eastern Bloc to Western investment.

But this triumphalism proved misplaced, as “secular stagnation” – in essence, a trend inflexion – set in. The real cause, as we know, was rising ECoEs, for which no ‘fix’ exists.

But the response favoured at the time was “credit adventurism”.

5

We can’t reinvigorate a flagging material economy with monetary tools, any more than we can cure an ailing house-plant with a spanner. The result of super-rapid credit expansion was the global financial crisis of 2008-09, which more or less compelled decision-makers to adopt the “monetary adventurism” of QE, ZIRP and NIRP.

Nothing, however, compelled them to carry on with monetary adventurism long after the immediate “emergency” had passed. What was really happening was that the GFC marked an epic failure for the neoliberal ascendancy.

Accordingly, new forces – known here as the post-capitalist expediency (PCE) – moved into the space vacated by the failure of 1990s triumphalism.

Each new regime adapts some of the precepts of its predecessor to its own uses. The PCE can be expected to continue to favour low taxation of high incomes; a resistance to the taxation of capital gains and inheritance; a fiscal bias favouring investment returns over earned incomes; deregulation; and, where possible, a small state.

But the PCE will differ from the neoliberals in favouring tariff wars and exclusion zones over globalisation, a closer alignment between political interests and economic policy choices, and a preference for nationalism over the cosmopolitan ethos of the globalisation era.

The latter may, in large part, have been no more than a veneer, but its abandonment has changed the tenor of public debate.

6

Lest the prospect of a self-serving, all-powerful PCE should dampen your festive celebrations, let’s be clear that the PCE cannot win.

The forces of resource degradation and rising ECoEs cannot be halted by political diktat.

The use of super-rapid liquidity expansion to sustain a semblance of normality will result in a massive financial crisis, part of which will be a wholesale destruction of super-inflated paper asset wealth.

The financial recklessness required to maintain a simulacrum of ‘business as usual’ has already put wide swathes of the discretionary economy on life-support.

Our best guides to the future are ECoEs, and the resource conversion ratios which determine material prosperity; and the relationship between the “real economy” of material products and services and the parallel and proxy “financial” economy of money, transactions and credit.

There’s nothing new about self-interest and a lack of candour in politics. We can also trace, as our arc of inevitability, the mechanisms that drive economic and financial policy.

This might not be the most uplifting way to end 2025, but knowledge is always to be preferred over even the most palatable versions of ignorance.

Fig. 2

#315: Madmen and economists

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THE ESCALATING DANGERS OF ECONOMIC DENIAL

Foreword

One of the greatest mysteries of our times is why the authorities have not only permitted but actively, through their policy choices, promoted the formation of the biggest bubble in financial history, whilst knowing perfectly well, all along, how this must end.

They cannot have done this simply to further enrich the already wealthy, since they must know perfectly well that asset value aggregates can never be converted in their entirety into spendable money.

The answer is that fears of the consequences of a bursting bubble are out-matched by an even greater fear – that the ending and reversal of economic growth might move from the land of theory into the realm of established fact.

If it ever became known that the economy had stopped growing and started to shrink, no existing set of social, political or commercial arrangements could survive.

The denial of economic inflexion is the sine qua non for the defence of the status quo. Nowhere in the world is worse equipped than the West for surviving the ending and reversal of growth.

There may indeed be people in authority who sincerely believe that monetary stimulus can reinvigorate a faltering material economy.

Many might also have swallowed the parallel tarradiddle, which is that human technological ingenuity can overturn the laws of physics to make possible the alchemist’s dream of ‘infinite economic growth on a finite planet’.

What seems to have happened is that the only lever that decision-makers can pull in a slumping economy is the lever of financial stimulus, the use of which in turn triggers a runaway compounding process of escalating risk.

1

This article must begin with an apology for the hiatus since #314: How wealth dies was published on 2nd November. Whilst the ending and reversal of growth has long been predictable, the sheer pace at which decline has been accelerating has called for considerable reflection.

As you may know, the Surplus Energy Economics interpretation of economics is based on a comparison between the “real” economy of material products and services and the parallel “financial” economy of money, transactions and credit.

The productive process which drives the underlying “real” economy works by using energy to convert other raw materials into products, artefacts and infrastructures, as part of a continuous cycle of production, consumption, relinquishment and replacement.

Though depletion has subjected the non-energy resource base – including minerals, non-metallic mining products, biomass and accessible water – to gradual degradation, the primary factor driving the material economy from growth into contraction has been a relentless rise in the proportionate cost of energy.

Measured here as the Energy Cost of Energy, this cost has climbed from 2.0% in 1980, and 4.3% in 2000, to more than 11% today.

Fig. 1

2

A long-standing debate about the economy is whether material constraints will, or won’t, eventually put an end to growth.

Kenneth Boulding famously said that only “a madman or an economist” could believe that exponential economic growth could carry on forever on a finite planet.

His view was reinforced and quantified by the authors of the contemporaneous The Limits to Growth (LtG), who set out the interconnected processes which would put an end to economic expansion.

But “eventual” has always been a key word in this argument. Though no timescales were specified in LtG, the accompanying charts appeared to put this ending of growth somewhere between 2020 and 2030, which was a matter of little immediate concern when the report was published back in 1972.

LtG has been revisited on a number of occasions, and these reviews have tended to vindicate the original thesis. As this has happened, time has moved on, and the moment of inflexion from economic growth into contraction has drawn ever nearer.

SEEDS analysis concurs with the LtG projections, indicating that material economic growth might already have ended, and that the economy will have inflected into contraction by the end of this decade.

This has been a matter of modelled calculation, but there’s an abundance of external evidence to support it.

Living costs are rising in a way that cannot be explained away as some kind of temporary and self-correcting “crisis”.

In domestic affairs, economic hardship and financial insecurity are combining with elevated levels of inequality to undermine social and political cohesion.

International relations have been degenerating into bare-knuckled fights over scarce and dwindling resources.

3

But the single most compelling piece of evidence for the onset of economic contraction is the gigantic bubble that has been inflated across almost all classes of assets in modern times.

Over the past twenty years, aggregate debt has increased by 165% in inflation-adjusted terms, and broader liabilities – incompletely reported as the assets of the financial system – have expanded by not less than 210%. The real-terms value of global equities has increased by about 250% since 2004.

Against this, reported real GDP has grown by 96%, meaning that each dollar of reported growth has been accompanied by net new financial liabilities of at least $8.

Even this calculation drastically understates the severity of the situation, for two main reasons.

First, the aggregate financial liabilities referenced here do not include enormous “gaps” in the under-resourcing of forward pensions promises.

Second, and even more seriously, most of the “growth” reported in recent times has been cosmetic, amounting to nothing more than the transactional spending of vast amounts of borrowed money.

SEEDS analysis puts real growth in prosperity since 2004 at only 25%, reflecting a 37% increase in energy consumption, a dramatic rise in ECoEs, and a gradual decline in the rate at which energy use converts other resources into economic value.

The scale risk of extreme increases in liabilities has been compounded by rising complexity risk as the financial system has morphed into a bafflingly Byzantine structure of inter-dependent cross-collateralisation.

We can estimate that, over the past twenty years, the regulated banking system has accounted for barely a quarter of the increase in financial commitments, with the unregulated NBFI (“shadow banking”) sector contributing about two-thirds.

In essence, qualitative risk has increased as the centre of gravity of credit supply has migrated from the comparatively transparent and conservative centre of the financial system to its opaque and dangerous periphery.

4

Everyone knows how the reckless over-inflation of bubbles always ends, and many are familiar with the truism that “you can’t taper a ponzi”.

“Everyone” in this context necessarily includes the authorities, which raises the question of why decision-makers have acquiesced in the inflation of a bubble which far exceeds, both in scale and in qualitative risk, anything previously experienced.

In fact, the authorities haven’t just acquiesced in the inflation of the “everything bubble”, but have been conspicuously active in its creation.

Starting in the 1990s, they promoted “credit adventurism” by making debt easier to obtain than ever before. After the GFC of 2008-09, they doubled down with the “monetary adventurism” of QE, ZIRP and NIRP.

The monetary tightening introduced during the immediate period of post-pandemic inflation is already being relaxed, and there’s every reason to suppose that a reversion to QE looms in the very near future.

Meanwhile, governments have become primary drivers of credit expansion, with public debt soaring as fiscal deficits now routinely exceed – in some cases, far exceed – reported “growth”.

But why would governments and central banks knowingly court the chaos that must result from the bursting of ‘the bubble to end all bubbles’?

5

Charles Hugh Smith has given us the clue to this seemingly inexplicable behaviour in a particularly perceptive recent article in which he explained that “the entire bubble economy is a hallucination”.

A “hallucination”, of course, is ‘a perception that differs from material reality’, or, in the simplest of terms, a false narrative. The “false narrative” to which we have been subjected is that economic growth not only hasn’t stopped, but won’t.

If it ever had to be admitted that economic growth had ended, you see, all existing social, political and commercial arrangements would be invalidated. The succeeding priority would be the sustenance of the generality.

This is a change of direction that might be survived by Russia or China – albeit not without significant difficulties – but would put an end to the post-capitalist expediency (PCE) now prevalent in the West.

6

This takes us to the two arguments customarily advanced against the idea that material finality might ever put an end to growth.

The first of these is that, since the economy can be explained and managed in terms of money alone, our complete control over the human artefact of money puts our economic destiny entirely in our own hands.

The second is that the continuity of growth will ensured by human ingenuity, enacted as limitless technological advance.

The recurrence of the word “human” in both of these arguments points to their inherent super-hubris. We are, we’re told, Lords of Creation, who can financially innovate, and technologically circumvent, any obstacle to ‘infinite, exponential economic growth on a finite planet’.

7

Neither of these claims survives rational appraisal.

First, the economy is not shaped by money. Within our two economies conception, we know that money has no intrinsic worth, but commands value only in terms of those material things for which it can be exchanged. This, in Surplus Energy Economics, is the principle of money as claim.

We can indeed create money in virtually limitless amounts, but we cannot similarly create those material things without which money has no meaningful value. Unlike money, energy and raw materials can’t be loaned into existence by the banking system, or conjured out of the ether by central banks.

In essence, money is a proxy for material economic prosperity, whilst the basis of this prosperity is the use of energy to convert natural resources into material products and infrastructures.

The second claim is, if possible, even more hubristically fallacious than the first. Far from being limitless, the potential of technology is contained within an envelope of possibility whose boundaries are set by the laws of physics and the characteristics of materials.

This comes down to a vindication of what Kenneth Boulding said more than half a century ago. The claim that ‘exponential growth can go on forever in a finite world’ is made, if not exactly by ‘madmen and economists’, then on the basis of orthodox economics and cornucopian fantasy.

8

Beyond its sheer size, what’s truly fascinating about the mania for all things AI-related is the way in which it fuses together the monetary and technological delusions that support the claim of never-ending economic growth.

Critical to this fusion is a disregard for the constraints of material finality.

Whatever promise the technology itself might offer, the current Western business model for AI makes vast demands for material resources, the most significant of which are energy and water. Even if these resources actually exist at the requisite scale – which is very far from certain – they can only be channelled into AI at the direct expense of households and other businesses.

The AI bubble also differs in other significant ways from previous exercises in irrational exuberance. For a start, whereas most of the money lost in the dotcom bust was equity, most of the value at risk in AI is debt, with significant cross-financing involved.

The assets used as collateral for this debt are likely to have remarkably little residual value – it’s hard to foresee much money being recovered from fire-sales of burned out or obsolete GPUs, or much of a post-crash market for vast single-purpose buildings ‘in the middle of nowhere’.

Whilst also noting the likelihood of AI degradation through the regurgitation of its own slop, it would be unwise to dismiss the transformative potential of artificial intelligence.

Rather, it seems likely that an alternative business model for AI will emerge, one that uses less capital, requires fewer resources, and, perhaps, sets itself less ambitious objectives.

9

What we have been seeing, then, is the use of reckless financial expansion in an effort to either counter, or disguise, the ending and reversal of economic growth.

Before we leap to the conclusion that this has been a deliberately-promoted false narrative, we need to allow for the fact that fiscal and monetary stimulus is an addictive drug, and a particularly alluring one when no other course of action is available.

Either way, we have long known that a financial system entirely predicated on the false presumption of economic expansion in perpetuity couldn’t possibly survive the ending and reversal of growth.

What recent events have been telling us is that, whilst policy-makers seem to be panicking, the moment of economic inflexion is drawing very close indeed. It might, in this context, be of interest that “the astronomical level of insider selling of publicly traded stocks” has now reached levels second only to those of 2007 – and we know what happened after that.

#314: How wealth dies

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THE NOTIONAL VALUE TRAP

Foreword

Just as growth in the “real” economy of material products and services has been decelerating towards contraction, so aggregates of financial wealth have carried on increasing relentlessly.

Since the widening disequilibrium between the monetary and the material must eventually crash the financial system, the probability is that notional wealth will reach its peak at the same moment at which the monetary system collapses.

We can see this unfolding effect in microcosm in the United Kingdom, where the most recent official calculation put national “net worth” at a near-record £12.2 trillion, or 450% of GDP. Yet you don’t need SEEDS analysis to know that the British economy itself is at an advanced stage of disintegration.

Two key factors explain the apparent paradox between soaring wealth and the onset of increasingly chaotic economic decline.

First, every failed effort made to stem material economic decline using monetary tools increases wealth, as it is measured financially.

Second, most of this wealth is purely notional, in the sense that none of its aggregates are capable of conversion into material value. Put another way, very little of the world’s supposedly enormous wealth actually exists in any meaningful sense.

A very possible final scenario is that, after an initial correction caused by a dawning realization of economic crisis, asset markets will rebound to a last peak before entering outright collapse.

To make sense of these issues, we need a clear understanding of the nature of money and wealth in relation to material economic supply.

1

As many readers will know, there’s no great mystery about the ending and reversal of material economic expansion.

Briefly stated, the “real” economy of physical goods and services is only proxied – and with ever-diminishing fidelity – in the published aggregates of financial flow.

Far from being a measure of the supply of material value to the system, gross domestic product is nothing more than a summation of transactional activity taking place in the economy. It’s perfectly possible, indeed commonplace, for money to change hands without any material economic value being added.

The way in which material value is supplied to society is, in principle, comparatively straightforward. In a continuous process of creation, consumption, disposal and replacement, energy is used to convert other natural resources (including minerals, non-metallic mining products, biomass and water) into products, and into those artefacts and infrastructures without which no worthwhile service can be supplied.

This is a dual equation in which, as energy is used for the conversion of raw materials into products, so energy itself is converted from a dense to a diffuse state. This makes energy-to-mass density, and the portability of energy, important considerations in the resource conversion process of economic supply.

Given that energy is used in the creation, operation, maintenance and replacement of energy-supplying infrastructures, we can state that “whenever energy is accessed for our use, some of this energy is always consumed in the access process, and is not available for any other economic purpose”.

This proportionate “consumed in access” component is measured in SEEDS as the Energy Cost of Energy. ECoEs have long been on an exponentially climbing trend, and have risen from 2.0% in 1980 to 11.3% today.

Renewables, and for that matter nuclear power as well, cannot materially slow, let alone reverse, the relentless rise in ECoEs caused by the depletion of oil, natural gas and coal. Neither can technology halt this trend, since the potential of technology, far from being infinite, is bounded by the limits imposed by the laws of physics.

The other determinant of the supply of physical economic value is the rate at which non-energy raw materials are converted into economic value through the use of energy. This conversion ratio is on a gradually declining trajectory, because resource depletion is occurring at a rate slightly more rapid than that at which the broad swathe of conversion methodologies can advance.

On this basis, global material prosperity has grown by 25% since 2004, which is nowhere near claimed “growth” of 96% in real GDP over that period. Moreover, the 25% rise in aggregate prosperity has been matched by the rise in population numbers over those twenty years.

The ongoing rate of deceleration is such that aggregate material prosperity is projected to be 17% lower in 2050 than it is now, which is likely to make the “average” person about 31% poorer than he or she is today.

At the same time, the costs of energy-intensive necessities – including food, water, accommodation, domestic energy, essential transport and distribution – are rising markedly. The “cost of living crisis”, far from being the temporary phenomenon that the word “crisis” is intended to imply, is a firmly established trend.

Since all of these process are both knowable and incapable of being “fixed”, why is monetary value continuing to increase?

The answer lies in the fundamental nature of money, and of how the monetary relates to the material.

2

As we know, no amount of money, irrespective of its format, would be of the slightest use to a person stranded on a desert island, or cast adrift in a lifeboat. If this castaway had an extremely large amount of money, his or her only (and very dubious) comfort would be the prospect of ‘dying rich’.

That’s an appropriate analogy for a world destined to experience financial collapse at the moment of record paper wealth. The financial system, like our castaway, is going to ‘die rich’.

There’s an instructive twist that we can add to the narrative of the castaway. At his or her greatest extreme of privation, a package is seen descending on a parachute. Opening this package with avid hopes of food or other life-saving material supply, the castaway finds only very large quantities of banknotes, gold coins and precious stones, all of which are wholly valueless in his or her predicament.

Decision-makers in society have made this exact same mistake, pouring huge amounts of money into a world whose deficiencies are material. They have done this, not out of idiocy or dishonesty, but because, whilst they cannot be seen to be ‘doing nothing’, no other possible policy response exists.

Governments and central banks can create money and wealth in almost limitless quantities, but they cannot similarly conjure energy, or any other material resource, into existence at the touch of a key-stroke.

The essential point, of course, is that, as our castaway swiftly discovers, money has no intrinsic worth. It commands value only in terms of those physical goods and services for which it can be exchanged. Money is thus an “exercisable claim” on the material.

Warren Buffett alluded to this when he said that “[t]he way I see it is that my money represents an enormous number of claim checks on society. It is like I have these little pieces of paper that I can turn into consumption”.

Various conclusions follow from this principle of money as claim. One of the most important, as regular readers will know, is the imperative need to think conceptually in terms of two economies. One of these is the “real” economy of material products and services, and the other is the parallel “financial” economy of money, transactions and credit.

Another is the absolute futility of any attempt to explain the economy by disregarding the material and concentrating entirely on money. This fallacious line of thinking leads inevitably to the deranged proposition of ‘infinite, exponential economic growth on a finite planet’.

3

None of this means, though, that money is “unimportant”, or that a collapse of the financial system would have no adverse consequences for material economic prosperity.

The most effective approach to economics doesn’t involve the disregard of the material or of money.

Rather, what we need to do is to calibrate the physical economy such that we can benchmark the monetary against the material. This enables us to avoid the futility of measuring the monetary only against itself.

It’s true that, at the moment when the monetary system collapses, we will still have the same amounts of the energy and other natural resources which are the basis of material economic prosperity.

But money is a critical enabler in the processes by which we use energy to convert raw materials into products, artefacts and infrastructures.

This is why not even the poorest person can view the impending collapse of the financial system with equanimity. Without money, how can nations trade products and resources, and how can the individual conduct his or her daily affairs?

Since money – unlike energy and raw materials – is a human construct, it’s perfectly possible, at least in theory, for us to create a new (and perhaps more intelligently-designed) form of money to replace the old.

But the chaos that monetary collapse will cause is hardly capable of over-statement.

4

Within our overall understanding of the principle of money as claim, money itself divides into two functional categories, which are the flow of money in the economy and the stock of monetary claims set aside for exercise in the future.

This “stock of claims” further subdivides into two components. One of these is immediate money, which can be spent without having to go through any preliminary enabling process. Most of this “immediate” money exists as fiat currencies, since it’s difficult to buy our groceries or pay our electricity bills using precious metals or cryptocurrencies.

But by far the largest component of the stock of claims is inferred rather than immediate. This “inferred” money exists as stocks, bonds, real estate and numerous other asset classes.

Before this claim value can be spent, it must be monetised – converted, that is, from an inferred to an immediate state. This means, simply stated, that the assets which comprise inferred value must be sold before they can be spent.

5

The aggregates of these inferred forms of wealth are enormous. Global stock markets, for instance, currently stand at about 160% of world GDP, which is far higher than this metric was in 2007, on the eve of the global financial crisis (114%). Total debt is about 240% of global GDP, and broader financial assets, in those countries which report this information, are about 470%.

If, to these, were added other asset classes, including real estate, promised pensions, precious metals, cryptos and derivatives, we could undoubtedly calculate that global wealth is at all-time record highs.

All of this is a very far cry from the oil crisis years of the 1970s. In 1975, stock markets equated to only 27% of world GDP. At its nadir, in January of that year, the S&P averaged just 72.6, from which point the index has advanced almost continuously – with few and brief interruptions – to a level today of about 6850.

Fig. 1

This has, in fact, been a near-uninterrupted, fifty-year progression. This road from “once-in-a-lifetime cheap” to the vastly higher valuations of today certainly merits some reflection.

It transpires that very little of this accession of paper wealth has happened by accident.

Starting in 1975, the initial advance in stock markets did follow processes that can be ascribed to market forces alone. In that year, the astute investor had little to lose, and much to gain, by putting his or her money, itself subject to severe inflation, into stocks.

Together, an economic rebound from the oil-crises-slump of the 1970s, the gradual taming of inflation and the euphoria created by the policies of the new “neoliberal” incumbencies combined to help to drive markets sharply higher during much of the “decade of greed” of the 1980s.

But everything changed in October 1987.

On “Black Monday”, the markets crashed, with the Dow losing 508 points, or 22.6%, in a matter of hours.

What was really significant, though, was that the authorities stepped in to shore up the markets. One of the most important players was the Federal Reserve, which had itself been created in 1913 in response to another such crash, the Knickerbocker crisis of 1907.

6

The authorities might well have been wise to have intervened as they did in 1987, but, in doing so, they conveyed the strong impression that, if ever things once more went badly enough wrong, they could again be counted upon to ride to the rescue like the fabled 7th Cavalry.

This back-stopping – variously known over the years as the “Greenspan put”, the “Bernanke put”, the “Yellen put” or, more generically, the “Fed put” – remained implicit until 2008.

Then, with the swift, no-holds-barred response to the global financial crisis, the authorities made their support for the market explicit.

Some felt at the time that these interventions were necessary and proportionate, others that they “bailed out Wall Street at the expense of Main Street”. Both points of view had their shares of validity.

But the most astute observers fretted instead about what is called moral hazard.

In the normal course of events, as envisaged by free market purists, the authorities do not intervene in the markets. If things go well, the wise (or simply fortunate) investor makes big profits but, if things go badly, the reckless (or unlucky) investor gets wiped out. Thus the antithetical forces of “fear and greed” are kept in balance.

Intervention dangerously upsets this balance. An investor rescued once naturally assumes that, if things go badly enough wrong again, another bail-out is certain to follow. This provides an enormous incentive to risk-taking, and undermines the important restraint exercised, through prudence, by fear.

7

Behind all of this, though – and seldom noticed by observers – lies the fact that all “values” routinely ascribed to wealth aggregates are fundamentally bogus.

At no point can any of the reported aggregates of wealth be monetized. The only people to whom the stock market could ever be sold in its entirety are the same people to whom it already belongs. The same applies to the global or national housing stock, and to every other asset class.

Whenever we’re told that huge amounts of value – in October 1987, for instance, $1.7 trillion – have been “wiped out” by a market fall, we’re being asked to disregard the fact that at no point, either before or after the event, could the whole market have been sold at its supposed value. The same applies to any statement of how much wealth billionaires have “gained” through rises in the market.

The £12.2tn official calculation of British aggregate “net worth” is similarly meaningless, in the absence of anyone who actually has £12.2tn to spend (and is also daft enough to invest it in Britain)

The fatal error made here is that of using marginal transaction prices to put a “value” on aggregate quantities of assets.

We might think that, were all global stock markets to fall to zero, about $180tn of wealth would have been eliminated.

In fact, that supposed “value” was only ever notional, and never existed in any meaningful form in the first place, because at no point was it ever capable of monetization.

8

This inability ever to monetize even a significant proportion of this inferred wealth enables commentators to write lurid, fact-free articles about aggregate wealth being “destroyed” or “boosted”.

But it also enables the authorities to pursue their cherished “wealth effect” without much danger of all of this largesse being converted into immediate monetary value, and then spent in ways that trigger runaway inflation in the economy.

Central banks’ use of QE is a case in point. So long as this liquidity injection was contained within the capital markets, it could not cross the boundary into spendable money and trigger severe inflation. During the pandemic of 2020, though, when QE was channelled not into the markets but directly to households, severe consumer price inflation did indeed follow.

9

What we have been exploring here is a paradox that is no paradox at all. The world will keep setting new wealth records until the financial system collapses.

Investors have lived with supportive intervention from the authorities ever since 1987, which means that very few of them have ever experienced anything else. Throughout this period – and certainly since official support became explicit in 2008 – the “momentum trade” has been the only game in town. It’s been like gambling in a casino where the house stacks the deck in favour of the punter.

So ingrained has this thinking become that there are likely to be many still determined to “buy the dip” even as the financial system goes finally into the blender. This, in short, is why wealth is destined to collapse – swiftly, not gradually – from an all-time peak.

Our necessary insight here is that, since any value contained in money exists only as a “claim” on a material economy that is now contracting, there must come a point of fatal disequilibrium between claim and substance.

The sheer scale and complexity of the aggregates of claim stock are now so extreme that the authorities will be powerless to backstop the next big crash.

It’s scant consolation to know that these enormous aggregates never, in any meaningful sense, actually existed in the first place.

Thus understood, it might not seem to matter all that much if aggregate (and individual) values collapse. Your house, for instance, will still fulfil its essential function of providing somewhere to live, even if its supposed value slumps from $1m to $200k. Even if you’d decided to sell at the highest price, buying a replacement would have been equally costly.

But this comfort only applies if you hadn’t used the property as security for a large mortgage.

And the financial system as a whole has done exactly that. The entirety of the system is enormously cross-collateralized, and this is where the destruction of “meaningless” aggregate asset values becomes enormously meaningful.

The real comfort, if any is to be found, is that anyone who can find a way of preserving value will have the opportunity of buying utility value at pennies on the dollar. The term “utility” is the watch-word here, because essentials will remain essential even as society is picking over the wreckage of discretionary sectors.

Fig. 3

#313: Building the Biggest Bang

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COULD AI MANIA CRASH THE WORLD FINANCIAL SYSTEM?

Foreword

Most people presumably know by now that we’ve been building a gigantic bubble in AI, and that this bubble is destined to burst. The scale of risk involved is large, and some of the characteristics of that risk are extraordinary.

Its denouement – perhaps in conjunction with the bursting of the contemporaneous bubble in cryptocurrencies – might prove very much more value-destructive than the global financial crisis of 2008-09.

But what very few seem to have noticed, however, is the sequential character of these ‘bouts of irrational exuberance’.

As we shall see – and beyond its sheer size – the AI craze has some distinctive features all of its own.

But the dynamic at work here is one of successive attempts to delay and disguise the inflexion of the underlying economy of material products and services from growth into contraction.

The operative myth is that monetary innovation can reinvigorate a flagging material economy.

Illogical though this notion is, it’s proved far more palatable than the reality of post-fossil material economic contraction.

We cannot yet know whether the AI bust – with or without the help of cryptos – will be big enough to crash the global financial system.

But we can be assured that, if the AI and crypto bubbles aren’t big enough to bring down the structures of money and credit, we’ll carry on building ‘bigger and better’ bubbles until we find one big enough to get the job done.

Whilst the AI craze is fascinating in itself, our main focus here is on the mechanisms involved in the pursuit of financial disaster.

1

The bubble in almost everything AI-related is undoubtedly very large. Most estimates put the scale of capital at risk at between $1.5 and $2 trillion, though it’s no surprise that some sources have produced even bigger numbers, some as high as $6tn.

Even at the lower end of these estimates, the bursting of this bubble could destroy value at about seventeen times the scale of the dotcom crash of 2000-02, and exceed the losses of the 2008-09 global financial crisis by a multiple of four.

Beyond its sheer size, however, this bubble has a series of characteristics that distinguish it from previous such bouts of recklessness

First, massive investment in AI is concentrated in a small group of giant technology companies which together account for about one-third of the entire value of the American stock market.

Second, the investment interconnections between these big players appear to involve a great deal of circular financing.

The sums thus far committed vastly exceed the free cash flows of the companies involved, and one of the central players – Open AI – seemingly expects its losses to rise from $9bn this year to $47bn by 2028.

There exists, as yet, no demonstrable route even to profitability in AI, let alone to the earning of adequate returns on existing and planned capital investment.

If – or rather, when – the bubble bursts, scope for the recovery of residual value looks remarkably small. Most of the assets against which lending is secured consist of enormously expensive, fast-ageing GPUs and huge, single-purpose buildings ‘in the middle of nowhere’.

There’s every prospect of the bubble ending in fire-sales of out-dated chips and redundant data centres.

Perhaps the strangest characteristic of the lot, though, is that the AI model favoured by American Big Tech demands resources – including energy and water – that simply do not exist in the requisite quantities.

Even if they did exist, these demands could pitch deep-pocketed tech behemoths into one-sided competition with households, municipalities and other businesses for constrained supplies of necessities, including power and water.

Putting all of this together – the scale of investment, the paucity of current cash flows, vendor financing, minimal residual value, the lack of a persuasive business plan and unrealistic resource demands – has led some observers to conclude that the AI craze is a gigantic scam.

There is, though, an alternative hypothesis, one which blends hubris with a determination to follow a strategy which, whilst effective in the past, threatens to end disastrously in its latest iteration.

2

We need to be clear that the bursting of a financial bubble does not necessarily pass a negative verdict on the product, service or technology on which the bubble has been built.

Rail remained a very important means of transport after the collapse of the Victorian railway mania of the 1840s. The internet survived and prospered despite the dotcom fiasco, and real estate retained its utility after the subprime lunacy had ended.

AI, perhaps in some form which is thus far undefined, can remain a worthwhile technological breakthrough after the current bubble has burst.

But, if some form of worthwhile, potentially transformative AI does lie ahead, what’s driving the absurd bubble in the sector?

America’s major technology players developed a winning strategy in the aftermath of dotcom. The essential prerequisite is the accumulation of capital resources big enough to finance the making of large losses over a protracted period of time.

This ‘go big’ strategy of loss-leading is how you create a very large customer base, draw in advertisers and other commercial entities, destroy or acquire your competitors, and gain industry-standard dominance for your product.

The aim – whether in social media, internet search, software or on-line retail – is to leverage huge capital availability into the creation of a quasi-monopoly which leads, in due course, to very high levels of profitability.

There can, though, be no guarantee that this ‘go big’ strategy will work with artificial intelligence. For a start, AI could degenerate into an echo-chamber in which it regurgitates its own output in a process known as “AI slop”.

Competitors – most obviously in China – might out-compete Big Tech by preferring an innovative strategy of going smart to the brute force of ‘going big’.

There are no equivalents to the obvious revenue streams that were waiting to be tapped by social media, search and on-line retail twenty or more years ago.

This could quite simply turn out to be a case of ‘too big to work’, in terms less of invested capital than of energy and other resources.

There can be little reason to doubt the hubristic over-confidence of Big Tech, whose existing businesses may be at risk both from enshittification and from underlying economic changes that its leaders either misunderstand or choose to disregard

Is this a disastrous case of ‘going big’ in a completely unsuitable context?

3

Most people probably realise by now that the enormous bubbles in AI and in cryptos are destined to burst, though suggestions that this might cause “some” economic harm are likely to rank amongst the biggest under-statements of all time.

But few seem to recognise the dynamic that has been driving a sequence of ever-more-reckless financial excesses.

As regular readers will know, we need to start by recognizing that money has no intrinsic worth, but commands value only in terms of those physical things for which it can be exchanged. What this means is that money is nothing more than “an exercisable claim on the material”.

We have an infinite ability to create these monetary “claims”, but we cannot similarly create a corresponding increase in the material supply by which alone money is validated.

This obvious “claim” characteristic of money compels the drawing of a distinction between two economies. One of these is the “real” economy of material products and services, and the other is the parallel “financial” economy of money, transactions and credit.

Growth in the “real” economy has long been decelerating towards contraction. Depletion of low-cost carbon energy is reflected in relentless rises in the proportionate Energy Cost of Energy, and there exists, thus far, no alternative to fossil fuels which can tame, let alone reverse, the upwards march of ECoEs.

Meanwhile, the rate at which energy converts into a flow of material value has been trending downwards. This tells us that the non-energy natural resource base – which includes minerals, non-metallic mining products, biomass and accessible water – has been degrading more rapidly than the efficiency of conversion techniques has been able to advance.

At the same time, the vital resource of environmental tolerance for human economic activity has been deteriorating, latterly at a disturbingly rapid pace.

There are two main reasons why this process of deceleration towards economic inflexion has thus far escaped general recognition, despite the growing abundance of evidence to support it.

First, the economics orthodoxy blithely ignores the material, assuring us that no obstacles exist to the use of money to deliver ‘infinite growth on a finite planet’.

This pseudo-science purports to find “laws” of economics in what are in fact nothing more than behavioural observations about the human artefact of money, observations which are not in any way analogous to laws of physics.

Second, an absolute refusal to accept the reality of physical finality has led to the equally fallacious proposition that a flagging material economy can be reinvigorated using monetary tools.

There is a pronounced tendency for cornucopian fantasies to triumph over material realities.

4

Recent history graphically illustrates these processes at work.

We tried to counter the “secular stagnation” of the 1990s by pouring abundant borrowed liquidity into the system. When this “credit adventurism” led, with due inevitability, to the GFC of 2008-09, we doubled down with the “monetary adventurism” of QE, ZIRP and NIRP.

These exercises in financial gimmickry have had a massively distortionary effect on the relationship between asset values and all forms of income. The resultant increases in inequalities have created levels of social instability which, in the absence of enlightened reform, might end only in revolution, anarchy or authoritarian rule.

But our immediate concern must be with the ever-worsening financial risk which these gambits have created. These hazards fall into the distinct categories of scale and complexity risk.

Over the past twenty years, in which global reported real GDP has increased by $96tn, debt has expanded by $284tn, and broader financial liabilities by not less than $770tn – and even the latter number excludes enormous “gaps” in the adequacy of provisions to meet pensions promises.

Moreover, most reported “growth” has been nothing more substantial than the spending of huge amounts of borrowed money. SEEDS analysis indicates that material economic prosperity has increased by only 25% – rather than the reported 96% – since 2004.

Indeed, it has latterly become routine for reported “growth” in GDP to be significantly less than sums borrowed by governments alone.

The worsening of complexity risk has been even more dramatic than the rapid expansion of aggregate liabilities. The financial system has become a truly Byzantine structure of cross-collateralization, in which nobody really knows which component, perhaps small in itself, could, by failing, bring down the whole house of cards.

This can best be considered as an inverted pyramid, in which a massive and super-complex tophamper of liabilities sits atop a remarkably small foundation of monetized value.

The assets of NBFIs – the non-bank financial intermediaries known colloquially as “shadow banks” – have, in modern times, dramatically out-grown those of the regulated banking system.

It’s a disturbing reflection that the extent of broad liabilities isn’t even known with any certainty, since the reporting of data to the FSB is voluntary, and non-reporting jurisdictions include a string of massively-exposed specialist financial centres.

What this means is that, with the locus of risk migrating from the regulated centre of this system to its opaque and hazardous periphery, ever-increasing complexity risk has been added to the quantitative risk of unsustainably rapid expansion in the aggregates of exposure.

5

The mechanism at work here is one by which the consequences of each bout of financial excess lead on to ever-greater exercises in recklessness.

We can trace a sequence which began in the 1990s with attempts to reinvigorate a flagging economy with the super-rapid creation of credit. When this culminated in the GFC, the authorities were more or less compelled to respond with ultra-loose monetary policies.

These sequential processes have been described here as an arc of inevitability.

At the same time, 2008 was a massive exercise in moral hazard – investors who have once been rescued from the consequences of their follies or misfortunes naturally assume that they will be bailed out from any future excesses, even though a repeat of the rescue of 2008 has long since ceased to be a practical possibility.

Once these processes are understood – as a self-driving dynamic of excess in conflict with material economic contraction – it becomes self-evident that the creation of bubbles in a climate of recklessness cannot end until the global financial system collapses.

The AI craze – together with the bubble in crypto-currencies – might prove big enough to crash the system.

If they are not, we can be assured that we’ll keep building ‘bigger and better bubbles’ until this result has been achieved.

#312: A stroll along Revolution Street

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CAN WEALTH AND ORDER SURVIVE?

Foreword

According to a recent BBC report, some of America’s wealthiest men are, or might be, investing in bunkers, or, as the article’s headline puts it, “doom prepping”. Author Zoe Kleinman goes on to mention just one of the many reasons why bunkers may be an impractical idea:

“I once met a former bodyguard of one billionaire with his own “bunker”, who told me his security team’s first priority, if this really did happen, would be to eliminate said boss and get in the bunker themselves. And he didn’t seem to be joking”.

What’s much more interesting, though, is why anyone might seek the dubious safety of underground self-incarceration. Fears of nuclear conflagration, or of environmental catastrophe, might, perhaps, answer this question. The worry emphasised in Kleinman’s article is the potential advance of artificial general intelligence (AGI) or artificial super intelligence (ASI).

The real motives for “doom-prepping”, though, have nothing to do with conflict, climate or a takeover by autonomous technologies. The wealthiest must know that today’s extremes of wealth are abnormal, and might know, too, that the unfolding ending and reversal of material economic growth further stacks the odds against the continuation of this anomaly.

They might be uncomfortably aware, as well, that there is no form of wealth that can be guaranteed to survive extremes of economic, social and political turbulence.

As the economy contracts and the financial system fractures, any wealth contained in stocks, bonds, real estate or even money itself is at existential risk. The merit of gold is limited to being ‘less bad than’ other forms of wealth storage, whilst the energy-aware will be fully conversant with the frailties of crypto.

1

Even if you studied it at university – which very few of us have – the word “revolution” is likely to evoke passé images of beret-wearing Che posters on students’ walls, re-runs of Citizen Smith or Monty Python’s Life of Brian, and the endless tedium of debates about the minutiae of Marx, Engels, Lenin, Trotsky, Gramsci and Mao.

In short, the very idea of “revolution” has come to seem, not just outdated, but positively outlandish.

But conditions are, in reality, increasingly trending towards the breakdown of the established order. Inequalities of wealth and incomes, already extreme, are being leveraged by economic contraction into matters of growing importance, and the essential, if vague, concepts of “merit” and “fairness” are very much in play.

Contemporary radicals might not be following any old-style Marxist-Leninist play-book, but anger with “the powers that be” is undoubtedly intensifying.

Whilst today’s highest-profile challenges to the status quo are essentially counter-revolutionary – even nostalgic – in character, we cannot expect this situation to continue, as hardship widens, and anger and cynicism deepen.

The redistribution of wealth from a minority to the majority has played little role in the Western political discourse over many decades, but conditions suggest that this contentious topic may soon return to a leading place in the debate.

Revolution – meaning ‘the rapid replacement of one regime with another’ – requires a combination, not just of unstable social and economic conditions, but of revolutionary ideas as well. In the absence of such ideas, revolution, thus defined, may seem unlikely.

But a chaotic collapse of order is all too possible. The guiding ideal of Western economies – an ideal not shared by China or Russia – is the sanctity of private profit. But the logic of profit may be a growth-dependent concept, and wholly unsuited to a post-growth economy.

The best ideas on offer might be those of “reform”, involving a voluntary retreat from extremes of inequality. This would be a retreat motivated, not by altruism, but by “fear of something worse”. Economic contraction will involve the redundancy of the big and centralised, and a revitalisation of the small and local, a context potentially favourable for reform.

The clincher, though, might be the impossibility of maintaining any form of concentrated wealth amidst the financial consequences of involuntary and unpreventable economic contraction.

2

There are, broadly, three courses that the development of society might follow. These can be called “reform”, “revolution” and “autocracy”, though these labels cover a mass of interconnected complexities.

“Reform” references a managed retreat towards lower levels of inequality. “Revolution” might mean the forcible replacement of one regime by another, or it might mean a less formal descent into disorder.

“Autocracy” might be invoked to head off revolution, or it might be imposed after the established order has collapsed into chaos.

3

Rebel forces, landing in the “soldier’s hour” before the dawn, were divided into three task-groups. The first took the presidential palace (and the adjacent guards’ barracks) entirely by surprise. The second seized the treasury with equal ease. Only at the radio station was anything more than purely token resistance encountered. By 9 am, the republic had a new government.

This, of course, is the stuff of a thousand thrillers, and the reference to the radio station places it in the middle years of the twentieth century.

But it does define the three things that any insurgency must seize, and over which any incumbency must retain control. These are executive power (including the security forces), money and information, the latter obviously including technology as well as the conventional media.

It seems unlikely, under current conditions, that any – say – Marxist-Leninist insurgency could seize control over these three critical levers of power.

But this isn’t to say that the incumbency couldn’t lose these critical levers in conditions of generalized disorder.

4

What this means is that we need to draw a clear distinction between “revolution” and chaos. The former seems an unlikely occurrence, but the latter outcome is all too plausible.

Chaos occurs where instability of conditions is abundant, but a nucleus of progressive ideas is absent.

Policing by consent has long been the preferred Western model for the maintenance of order, because policing by coercion is vastly more difficult, and drastically more resource-absorbing.

Likewise, the West has, hitherto, largely managed to combine government by consent with the preservation of wide differentials of wealth and income.

The prevalent logic has been that of merit – those who, gifted with greater abilities and greater energies, have accumulated wealth should be entitled to retain, and to pass on to their successors, the benefits of their own efforts.

The problems now arising include a delegitimization of wealth. In past times, wealth could be credited to the efforts of its possessors, but this connection is ceasing to persuade.

Policies have been adopted which, whether intentionally or not, are perceived to have severed the connection between affluence and merit.

5

What needs to be understood here is that, for reasons connected to energy and resource depletion, economic growth started to decelerate at least as far back as the “secular stagnation” of the 1990s.

The favoured tool for combatting this deceleration was credit expansion. This led, inevitably and in relatively short order, to the global financial crisis of 2008-09.

This was a moment at which a critical choice needed to be made. If the authorities had maintained a commitment to the principles of the free market, the over-extended (and the simply unfortunate) would have been wiped out. Opportunities would have opened up for new (and predominantly younger) economic entrants, with new ideas.

Instead, the decision was taken to prop up the system with the “monetary adventurism” of QE, NIRP and ZIRP, and to continue with these policies long after some form of stability had been restored.

The statistical effect has been to create an enormous bubble across multiple asset classes, but the social effect has been extraordinarily divisive.

Anyone who already owned assets in 2008 – or who worked in one of those sectors, mostly financial, in which incomes are linked directly to asset prices – has profited mightily from these policy choices.

But many others have suffered from rising rents, the insecurities of the casualised (“gig”) workplace, increases in the costs of necessities, and incomes that haven’t kept up with the broad level of systemic inflation.

6

In essence, a wedge has been driven between wealth and the nebulous (but powerful) concept of “fairness”.

It can be argued, in their defence, that decision-makers have been tied to an arc of inevitability – economic deceleration drove a recourse to “credit adventurism”, which led on to the GFC, and hence to the adoption of the “monetary adventurism” of those ultra-loose policies which in turn created a socially-divisive shift in the relationship between asset prices and incomes.

This, though, doesn’t give us much guidance on what happens next. When asset prices start to correct back towards a material economic floor far below current levels, do the authorities try to intervene – yet again – to prop up existing wealth-versus-income differentials?

Do they seriously believe that technological advances and monetary innovation can, together, hold back the tide of post-fossil economic contraction?

Or can a system that has already ceased to be “market capitalist” – and has become instead a post-capitalist expediency (PCE) – try to find new ways of defying the forces of economic and financial gravity?

7

Here’s a question for any historically-minded person reading this article:

Was Nicholas II overthrown in 1917 because Russians had been reading Marx, or because hardship and injustice had reached extremes at which the monarchy was no longer sustainable in the face of widespread popular discontent?

This poses a critical question in revolutionary theory, which is the comparative importance of ideas, and of material economic and social conditions, in the making of a revolution.

Lenin, of course, had clear views on this question. The first was that, whilst the rural oppressed (the “peasantry”) cannot make a successful revolution, the urban discontented (the “proletariat”) most certainly can. The second was that a revolution depends on the guiding hand of a “party”, a condition which presupposes a nucleus of ideas.

What Lenin was describing, though, was “revolution”, defined as the relatively rapid replacement of one regime by another. Though outside interference dragged things out until 1923, the Bolsheviks secured effective control of Russia itself within months of the downfall of the Romanovs.

Events were far more chaotic in France. Order was not restored until Napoleon took power in 1799, fully ten years after the revolution itself. Again, foreign interference played a major role, with counter-revolutionary and counter-imperial wars lasting from 1792 until 1815.

The French Revolution also reinforces Lenin’s emphasis on the “proletariat”. The only spontaneous revolt of the “peasantry” was the counter-revolutionary rebellion in the Vendée. No dominant party had an effective blueprint for a post-monarchical state at the time when the Ancien Regime was overthrown.

8

Though such assertions are all too often dismissed as propaganda, the Chinese authorities do remain wholly committed to Marxist-Leninist precepts, as modified for local conditions by Mao.

The Deng reforms did not, in any meaningful way, convert China to Western ideas. Behind Deng’s “two cats” allegory was a clear determination that, whilst capitalism might be allowed to serve China, China would never serve capitalism.

Beijing’s highest priority is the maintenance of high levels of urban employment, a challenge intensified by mass migration from the countryside to the cities.

Private profit is barely a consideration at all for the Chinese authorities. If losses and subsidies are required for the attainment of important national objectives, so be it.

Something not too dissimilar can be observed in Russia. The rise of the “oligarchs” was a feature of the country’s grim experiences in the 1990s. With those experiences confined to the past, billionaires are not required for the ongoing economic resilience of modern Russia.

The very different attitudes to private profit – largely disregarded in China, almost worshipped in the West – are critical to competition between the two leading economic powers. It’s at least arguable that the pursuit of profit is only possible under conditions of economic expansion.

The West in general – and the United States in particular – may be entering a profoundly different era with exactly the wrong set of ideas.

9

In its determination to maintain the central role of private profit, then, the West may be trying to board a train that has already left the station.

SEEDS analysis indicates that material economic prosperity – for which money is no more than an operating proxy and a symbol – is likely to be about 14% lower in 2050 than it is today. Based on current population trends, this would make the World’s average person about 31% poorer than he or she is now.

This average person’s woes will be greatly exacerbated by continuing rises in the real costs of necessities, and by soaring indebtedness, as and if the authorities continue with futile efforts to stave off material economic contraction using monetary tools.

But this “average” person is something of a statistical fiction, because dividing the numerator of aggregate prosperity by the population denominator takes no account of inequalities of incomes and wealth, inequalities which are extreme in the contemporary West.

At the more meaningful level of the median, huge numbers could be condemned to the desperation of destitution were current levels of inequality to be maintained under conditions of severe economic contraction.

Whilst it cannot necessarily be said that the Western authorities set out to create today’s extremes of inequality, these extremes are, as we have seen, products of long-standing policy choices, and inequality remains an issue that few Western leaders are minded to identify and address.

10

It would be relatively easy to reach depressing conclusions after this brief canter over the social, economic and political turf.

In essence, conditions are becoming conducive to a collapse of the existing order, whilst no intellectual blueprint yet exists for the channelling of discontent into the kind of ordered change-of-the-guard described, by Lenin and others, as “revolution”.

But the possibility of “reform” does exist. The template for this is the Britain of 1832, a society in which fewer than 180 people effectively controlled a country in which barely 4% of the English and the Welsh – and just 0.2% of Scots – were entitled to vote.

Though its passage was only enabled by proximity to “the verge of revolution”, the Reform Act of that year put the United Kingdom on a course which steered the country clear of the revolutionary ferment that plagued much of the rest of Europe during the following hundred years.

Essentially, Britain’s leaders opted for reform when the only alternative seemed to be the guillotines and the Phrygian caps of 1789.

Such an outcome might seem hopelessly optimistic until we recognise that economic forces are pushing towards a choice between chaos and managed change.

Centralised organisations are likely to be succeeded by localist alternatives as the burdens of central overheads become ever more unsustainable.

There is no form of stored wealth that can be relied upon to survive economic contraction.

The myth of a technological “rescue” from economic contraction might not long retain its plausibility.

Perhaps most importantly, a West which retains the ideal of personal profit is already being out-prepared by countries which do not.

#311: Putting it together, part two

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THE FIGHT FOR SHRINKING RESOURCES

Foreword

Having set out the basic principles of the surplus energy economy in the previous article, we turn here to projections for the period between now and 2050. Growth in material economic prosperity has already ended, and contraction lies ahead.

There is nothing that can be done to prevent this from happening. The material economy cannot be reinvigorated with monetary stimulus, and there can be no technological ‘fix’ for the laws of thermodynamics.

Beyond simple unawareness of the material dynamics of economic prosperity, our greatest problem is an absolute refusal to accept this process, and adapt accordingly.

The very idea that the consumerist economic model has run out of time is an anathema, not just to the beneficiaries of this system but also to a general public which still believes that there need never be any end to economic expansion within the confines of a finite planet.

We are already seeing the consequences of inflexion from economic growth into contraction. We are seeing it in the widening immiseration so ably chronicled by Charles Hugh Smith, and in the fiscal and political stresses created by the ending of growth.

These pressures will soon build to a point at which profound social and political changes must occur.

As discussed later, we should expect to be subjected to propaganda assuring us that none of this need happen – that fossil fuel energy isn’t scarce, that renewable energy offers a complete and seamless transition away from oil, natural gas and coal, that environmental degradation is some kind of ‘hoax’, and that there’s no need to make fundamental changes in order to manage the ending of the era of fossil-powered consumerism.

In the real world, however, politics – both domestic and international – is already being reshaped by intensifying competition for scarce and dwindling resources.

1

Between now and 2050, aggregate material economic prosperity – the supply of physical products and services to society – is likely to decline by about 17%. Based on current population trends, this would leave the World’s average person about 31% poorer in 2050 than he or she is today.

Over that same period, this person’s real cost of essentials is likely to rise by rather more than 50%. On this basis, his or her PXE – meaning Prosperity eXcluding Essentials, and loosely analogous to “disposable income” – is set to decrease by nearly 70%.

This doesn’t just mean that the affordability of “travel, tech, toys and tat” will contract rapidly, eliminating millions of jobs and destroying vast amounts of invested capital.

It also means that the household sector will become wholly unable, long before 2050, to support its grotesquely-inflated burdens of debts and quasi-debts.

Even where liabilities are formally the responsibilities of governments and private corporations, what really matters is the carrying capacity of the citizen, in his or her role as consumer and taxpayer.

2

There is no great mystery about why meaningful economic growth is heading into reverse, and no lack of evidence for the proposition that this process is already under way.

To understand why, we need to know that economic prosperity is, and always has been, determined by the availability and use of energy.

At the symbolic start of the industrial age in 1776 – when James Watt completed the first truly efficient machine for converting heat into work – the global population was barely 700 million people.

That number has since soared past 8 billion yet, for most of the intervening years, economic resources have dramatically out-grown population numbers. We can estimate that energy use per person may have multiplied by a factor of about 350 during the industrial era.

The connection between energy, population numbers and the economic means of their support is illustrated in Fig. 1A. The simultaneous timing of the exponential take-offs in population numbers and energy use was no coincidence at all. The causative factor was the harnessing of vast reserves of fossil fuel energy.

Though enormous, these resources are ultimately finite. For much of the industrial era, the efficiency with which these energy resources are consumed has advanced.

The search for fossil fuel energy has spanned the globe, delivering successively larger and lower-cost pools of resources. The energy industries have reaped the benefits of economies of scale, and there has been a gradual but continuous improvement in energy extracting technologies.

There is, though, an equally continuous process known as depletion, which describes a natural preference for using lowest-cost resources first and leaving costlier alternatives for later.

There comes – and, now, has come – a point at which, with the potential of geographic reach and economies of scale exhausted, depletion becomes the primary driver of the economics of energy.

3

The best way to capture these trends is by reference to ECoE.

Energy is never “free”, because it cannot be put to use without an energy-accessing infrastructure, which might be mines, wells, refineries, pipelines, solar panels, wind turbines, power grids or electricity storage systems.

Since all of these systems are material, none of them can be created, operated, maintained or replaced without the use of energy.

What this means, colloquially, is that we must ‘use’ energy to ‘get’ energy. More formally, “whenever energy is accessed for our use, some of that energy is always consumed in the access process, and is unavailable for any other economic purpose”.

If, as here, we describe this “consumed in access” component as the Energy Cost of Energy, the result is the principle of ECoE.

This concept divides the aggregate supply of energy to the system into cost and surplus energy, the latter defined as the total supply of energy minus ECoE.

The concept of surplus energy describes a process common to life itself – for an animal or a bird to survive, the energy it derives from its food must exceed the energy it expends in obtaining that food.

Though the necessary data does not go back as far as the early 1800s, we can confidently infer that ECoEs trended downwards for much of the history of the industrial age, when widening global reach, increasing economies of scale and gradual advances in energy-accessing technologies pushed costs steadily downwards.

We can also be pretty certain that the nadir of ECoEs occurred in the quarter-century after 1945. Just as oil was taking over from coal, so huge new petroleum resources were being brought on line, most obviously in the Middle East.

This explains why that twenty-five-year period was one in which material economic growth was at levels never previously experienced, and which have since become a distant memory.

Latterly, the Energy Costs of Energy have been rising relentlessly, from 2.0% in 1980 to 11.3% today, and are likely to be closing in on 29% by 2050 (Fig 1C).

We had a first brush with the consequences of energy depletion in the inter-war years, when the economic dynamic of coal was decelerating before oil and natural gas were quite ready to take over.

Had oil not been available, the Great Depression of the 1930s, far from ending, would have continued into the kind of secular contraction that is now unfolding in the twenty-first century.

Fig. 1

4

The stark difference today is that no superior (or even like-for-like) successor to fossil fuels exists.

Renewable energy cannot be developed, operated or replaced without the use of legacy energy from oil, gas and coal, a connection which links its ECoEs to those of fossil fuels.

Renewables are inferior in their characteristics, most obviously in their intermittency, and in their drastically lower portability.

The reported specific energies of renewables – the quantity of energy generated per unit of system mass – may appear higher than those of carbon fuels, but these are lifetime calculations, and do not incorporate the much lower specific energies of distribution and storage systems.

A modern wind turbine might generate about 510,000 Wh per kg of mass over 25 years in service, which is far higher than oil products at about 12,000 Wh-kg. But the bottleneck in the system is the much lower specific energies of power storage systems, which are unlikely ever to exceed about 500 Wh-kg.

This doesn’t just mean that wind and solar power cannot replace the economic value presently obtained from fossil fuels, but also suggests that electricity, however generated, may never be able to take over the ‘heavy lifting’ in the economy from oil, natural gas and coal.

5

These points must be emphasised because, as the material economy inflects from growth into contraction, the public will be subjected to an increasing amount of propaganda rooted in a combination of genuine misconception, denial and self-interest.

Almost nobody wants to acknowledge any inevitability about the ending and reversal of economic growth, not least because this process will invalidate the prevalent consumerist economic model, destroy jobs and invested capital at an epic scale, and render current inequalities of wealth and income untenable.

Accordingly, we’ll be variously informed that fossil fuel energy still exists in enormous abundance; or that the use of carbon fuels isn’t driving an environmental deterioration that might not be happening anyway; or that renewables, and perhaps even nuclear fusion, offer a “climate-friendly” future of never-ending economic expansion.

Beyond denial and self-interest, these fallacious claims are rooted in two misconceptions.

The first is the idea that monetary stimulus can overcome resource constraints to reinvigorate the material economy. Such claims disregard the obvious fact that money, having no intrinsic worth, commands value only in terms of those material products and services for which it can be exchanged.

This principle of money as claim requires us to think in terms of the two economies of the material and the monetary. Since money is a “claim on the material”, it cannot, of itself, drive changes in the direction of the material.

The second convenient misconception is that we can overcome economic inflexion through technological innovation. This disregards the fact that the potential scope of technology, far from being infinite, is bounded by the limits set by the laws of physics in general, and the laws of thermodynamics in particular.

This mistaken presumption accords with a contemporary deification of technology, a set of ideas which is collectively hubristic in its assertion that human ingenuity can exercise complete control over our economic and environmental conditions.

Financially, we have moved on from one bubble to the next as the material economy has decelerated towards contraction. When rising ECoEs began to subject the economy to “secular stagnation” in the 1990s, we started to pour vast amounts of new debt and quasi-debt into the system. When this “credit adventurism” led directly to the GFC of 2008-09, we doubled down with the “monetary adventurism” of QE, ZIRP and NIRP.

6

Evidence for the ending of growth, and for the fallacies of monetary and technological fixes, is everywhere to be seen. Much of Europe is heading into fiscal catastrophe by trying to sustain levels of spending that neither tax revenues nor the material economy can support.

Even in the United States, reported “growth” in GDP is now exceeded by the issuance of government debt. Much of China’s past super-rapid growth has turned out to have been the product of a gigantic credit ponzi in real estate.

Likewise, the “cost of living crisis” isn’t remotely the temporary phenomenon that the word “crisis” implies. Excuses – wars, a pandemic, a politically-motivated disruption of trade – have proliferated, but the ending of a one-off era of growth made possible by fossil fuels is everywhere in evidence.

This, essentially, is why both internal and international politics has been deteriorating into a series of raw-knuckle fights over scarce and dwindling economic resources.

Neither can we contend that we’ve had no prior notice about the ending and reversal of growth. Using then then-new science of system dynamics, the authors of The Limits To Growth gave us a prescient warning of the shape of things to come back in 1972.

More recently, SEEDS analysis indicates that a climacteric was crossed in the early years of this century. Between 1980 and 2007, material economic prosperity expanded more rapidly (+57%) than global population numbers increased (+51%). Since then, though, the population (+20.7%) has out-grown prosperity (+18.7%).

7

Once the fundamentals of material prosperity are understood, forecasting future trends becomes comparatively straightforward. In addition to the principle of money as claim and the principle of ECoE, we also need to know that physical supply is delivered by using energy to convert raw materials into products, and into those artefacts and infrastructures without which no worthwhile service can be provided.

ECoE operates as a ‘first call deduction’ on this material supply, and can be thought of as an economic rent payable on the use of the planet’s energy resources. Money then operates in a subsidiary capacity for the distribution and exchange of the resulting material economic prosperity.

On base-case SEEDS projections, the supply of primary energy may not peak until the early 2040s, at which point non-fossil alternatives become unable to grow rapidly enough to offset an accelerating decline in the availability of fossil fuels (Fig. 2A).

In modern times, the conversion ratio governing the efficiency with which energy use translates into material economic supply has trended gradually downwards.

What this means is that the non-energy resource base – which includes metal ores, non-metallic mining products, biomass and water – has been degrading at rates slightly exceeding those at which the efficiency of the broad swathe of conversion technologies has advanced (Fig. 2B).

The forward trajectory of the conversion ratio is assumed here to be broadly flat, reflecting a shift of emphasis away from discretionary (non-essential) products and services.

On this basis, a projected 6.3% increase in energy supply between now and 2050 translates into a 3.5% rise in top-line economic output, known in SEEDS terminology as C-GDP (Fig. 2C).

But the relentless rise in ECoEs is destined to continue, driving a widening wedge between top-line C-GDP output and ex-ECoE prosperity (Fig. 2D).

Fig. 2

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The foregoing projections indicate that aggregate global prosperity will decline by about 17% between now and 2050. But the negative consequences of this trend are likely to be compounded by two adverse factors – continuing increases in population numbers, and relentless rises in the real costs of essentials.

The annual rate of global population expansion has slowed markedly, from just over 1.8% per annum between 1980 and 1990 to slightly less than 1.2% between 2010 and 2020. Some observers have suggested that population numbers might peak at some point in the latter half of this century.

But the probability remains that the population is likely to increase by about 20% between now and 2050, translating a 17% decrease in aggregate prosperity into a 31% decline in the prosperity of the World’s “average” person.

This “average” person is, of course, something of a statistical fiction, and one of our contributors has suggested that this projected “average” decline might reduce the median person to destitution.

We cannot, though, presuppose that contemporary levels of inequality will continue, because asset prices are destined to slump, with no store of wealth guaranteed to survive the coming turbulence in financial and political systems.

The second compounding factor is the relentless rise in the real cost of essentials. These costs can only ever be estimates, since the definition of “essential” varies both geographically and over time. Things once deemed to be “luxuries” are now regarded as necessities, a process that is likely to reverse as material economic prosperity contracts.

SEEDS calibrates “essentials” by combining an estimated cost of household necessities with sums spent by governments on public services. This does not by any means imply that all public services are “essential”, but recognises that the individual has no discretion (“choice”) about paying for them.

Many necessities – including housing, infrastructure, distribution, domestic energy use and the costs of food and water – are energy-intensive in character, as are many of the services provided by governments.

Whilst fiscal pressures can be expected to result in a re-prioritization of public services, the costs of household necessities per person are likely to grow at real rates of between 2.0% and 2.5% per annum.

Of all of the charts generated by SEEDS, the one shown here as Fig. 3B is perhaps the most disturbing, portraying a relentless narrowing of the gap between prosperity per person and the estimated cost of essentials.

As can be seen in Fig. 3C, this translates, at the aggregate level, into a rapid, leveraged compression of the affordability of discretionary (non-essential) products and services.

The final chart compares discretionary affordability – proxied as PXE, meaning Prosperity eXcluding Essentials – with soaring burdens of debt and quasi-debt.

As governments try (and fail) to counter economic contraction with monetary stimulus – and as individuals increasingly resort to credit to support accustomed ways of life – we can see that the inherent instability in the system will build to a point at which the system topples over, probably through a combination of cascading defaults and an inflationary destruction of the purchasing power of money.

Fig. 3