Foreword
This article marks a planned change of direction for Surplus Energy Economics, and not just in the provision of downloadable SEEDS data for readers. The case for impending economic contraction has been made, and is being vindicated by events. The need now is for hard analysis and constructive initiative.
As you may know, the global process of inflexion from economic growth into contraction has, in its earlier phases, moved slowly, though it’s now accelerating markedly.
This said, even the early deceleration phase has wrought profound changes in the economy and society.
Throughout this precursor period which has preceded economic contraction, we’ve tried to reinvigorate the material economy with monetary innovation. Though wholly futile, this has resulted in sharp reductions in the real cost of capital, creating a huge escalation in financial liabilities and a correspondingly enormous bubble in asset prices.
This has become a candyfloss (cotton candy) economy, resembling a sweet confection which has vast open spaces within very little material substance. An economy in which the substance of economic output is modest and falling, whilst inflated asset values can’t be sustained, and liabilities cannot conceivably be honoured, is exactly this kind of confection.
Thus far, people who rely on earned incomes have been the main victims of this process, whilst the owners of assets have been its beneficiaries. But the gains enjoyed by the latter exist only in paper form. What lies ahead is a collapse in these paper values, as the financial system fractures under the sheer weight of the liabilities imposed upon it.
We cannot know how much of this is understood by decision-makers.
But my reading of the situation is that sentiment in the corridors of power is changing rapidly, from presentational optimism to a sense of resignation.
There’s only one way in which even a semblance of normality can now be sustained for a little longer, and that’s by driving government debt relentlessly upwards.
They, like we, know where this ends – in a process of debt monetization which leads to the hyperinflationary destruction of the purchasing power of money.
There are, if truth be told, some upsides to this unfolding process. Economic contraction, centred on rapidly falling discretionary consumption, is our best – perhaps our only – hope of preventing environmental catastrophe.
The reversal of prior financial distortions can push back against the socially-destabilizing trend towards ever-widening inequalities. The failure of centralized, top-down institutions can create space for decentralized, bottom-up alternatives operating at a more human scale.
But chaos undoubtedly looms. As old certainties crumble, orthodox classical or neoclassical economics is well on the way to becoming a busted flush. The promise of ‘infinite growth on a finite planet’ is being exposed as fallacious. Monetary and fiscal policies can’t fix material economic deterioration.
We’re now entering a phase of fake it till you break it.
For us, the polemical is no longer enough, and the need for rigorous, hard-data analysis and projection has become imperative.
Above all, we need to develop a clear understanding of economic disequilibrium, a concept which reveals the real dynamics that are shaping the economy. This is discussed towards the end of this article.
For these reasons, the first edition of the SEEDS Databook can now be downloaded at the resources page of this site.
An impossible task
“We will know you sold out when you come back to the UK to take up a newly created position as ‘energy or economic czar’ advising the govt. of the day (and your website disappears)”
This comment was made – presumably very much tongue-in-cheek! – in our discussions around a previous article. As I said at the time, I’m about the last person who would be offered any such job, and I can’t imagine the British (or any other) government admitting its need for such a role.
It wasn’t – and isn’t – my intention to discuss here the first budget presented by new chancellor (finance minister) Rachel Reeves. She has, in fairness, an impossible job. Britain undoubtedly needs massive investment in public services and infrastructure, but taxes, measured as a proportion of GDP, are already at record levels. There are, as Liz Truss and Kwasi Kwarteng found out, limits to markets’ acceptance of excessive government debt issuance.
The brutal reality, of course, is that public services are floundering, and infrastructure is deteriorating, because Britain is getting poorer. The economy has long since inflected from growth into contraction. There’s no quick fix in taxing “the rich”, because the wealth of the most prosperous exists only on paper, and can’t be monetized to any significant extent.
Around the World, some people feel poorer – because they are – whilst others feel wealthier, but only because the paper values of assets haven’t crashed yet.
Not quite yet – but now we know
But there’s one aspect of the British budget which does merit our attention. It’s the assurance that, whilst public debt will rise in the early years of this five-year parliament, it will then start to head back downwards.
We’ve heard this numerous times before, not just from successive British chancellors, but from finance ministers around the World.
It’s the fiscal equivalent of ‘tomorrow never comes’.
The simple mathematics of the equation are that governments can’t, by borrowing now, generate enough growth in the future to pay down the initial debt plus interest. The taking on of self-liquidating debt, though still just about possible in parts of the private sector, is impossible at the macroeconomic level.
What this means is that, globally, public debt is on a relentlessly upwards trajectory, and you don’t need to be a doomster or a gold-bug to know where that leads.
Governments almost certainly now know that public debt expansion has become the only way in which they can sustain the semblance of ‘business as usual’ for a bit longer.
This leads directly to the monetization of government debt and the onset of runaway inflation.
To think that we could escape this grim reality by switching from credit-backed fiat to some alternative monetary system is to misunderstand the role of money itself, a topic to which we shall return.
My reading of this situation is that sentiment in the corridors of power is shifting from forced optimism to a sense of resignation which borders on fatalism.
Ministers and officials increasingly realize that they can’t restore meaningful economic growth or, over the medium- and longer-term, maintain the viability of the public finances.
They just have to make the best of things, and put a brave face on it, for as long as they can.
Where America leads
As so often, America is the leader in the trend towards ever-higher public debt.
Last year, government spent 36.3% of GDP whilst collecting only 29.2% in taxes and other revenues. Nobody of influence, as far as I know, has even raised the idea of balancing the books during the presential campaign. Soaring public debt is now America’s ‘new normal’.
US government debt is rising by $1 trillion every three months, and has already breached the end-2024 projection of $35tn. Annual interest on this debt now exceeds $1tn, which is more than America spends on her armed forces and all of her security agencies combined. More than half of all outstanding public debt has to be refinanced over the coming five years.
The global role of the dollar puts the US in a uniquely advantaged position when it comes to financing fiscal deficits.
As seen in Washington, the current plan is a competitive gambit, designed to maximize the benefits of global dollar pre-eminence.
The deficit is being used to finance massive subsidies, whose purposes are to re-shore industries sent abroad during the era of ‘globalization’, and to drive investment, particularly in new technologies and energy transition.
The theory is that this investment will pay off in the kind of growth that can put debt back onto a sustainable (if not a downwards) trajectory.
But history and mathematics alike decree that not even America can pull this off.
Mathematically, American debt has increased by $35tn (96%) in real terms over the past twenty years. Of this, $21tn was borrowed by government and $14tn by households and private enterprises.
But real GDP was only $9.5tn higher in 2023 than it had been back in 2003. This means that each dollar of private and public borrowing yielded only $0.27 in growth. This number falls to $0.16 if, in addition to debt, we also include expansion in those broader financial assets which are the liabilities of government, households and PNFCs (private non-financial corporations).
History, meanwhile, emphatically endorses the view that runaway public debt can only end badly. It also shows that empires face an inflexion-point in their power and influence when debt service costs crowd out spending on the military.
Mathematicians will likewise recognize that the trajectory of US government debt is taking on an exponential (“hockey-stick”) shape. This reflects, in part, the compounding effect of interest.
This kind of exponential curve can’t be stemmed, still less reversed, until we enter a chapter of debt monetization, after which the value of money itself collapses.
Hesitant, but inevitable
Other countries, lacking the exorbitant privilege of the global reserve currency, have been cautious about following America down the road of soaring government debt. But SEEDS analysis demonstrates that no real choice in the matter now exists. Public debt expansion is the only remaining expedient that can allow the semblance of continuity to last for a few more years.
In the EU, former ECB chief Mario Draghi has argued for expanded debt issuance of €800bn annually, in addition to similar quantities of borrowing already undertaken by member countries. Commission president Ursula von der Leyen, and member governments, have ruled out central debt issuance by the EU itself.
But this is a matter of politics, and doesn’t address Mr Draghi’s main point, which is that the EU faces a grim future unless it invests vastly more borrowed money.
As for Britain, we can assume that the near-term borrowing planned by Ms. Reeves won’t be remotely enough, whilst her tax increases will expose still more of the underlying, leveraged contraction taking place in discretionary (non-essential) sectors of the economy. In the short term, leisure and hospitality will bear the brunt of this discretionary compression, with travel and entertainment lined up to follow.
SEEDS analysis reveals the central problem, which is that the average British person has become 11.3% poorer, in real terms, since 2004, whilst the costs of essentials have been rising relentlessly. This is something which no government could admit to, even if it had the requisite data at its disposal.
Furthermore, any British government has to walk a tightrope, knowing that fiscal excess could, by undermining GBP, trigger the kind of rate rises which will crash the real estate bubble on which the economy depends to an extremely dangerous degree.
Even in China, where government seems today to have an instinctive preference for fiscal conservatism, it’s hard to see how faltering growth can be reinvigorated, or the bad debt crisis in the bloated real estate sector can be resolved, without recourse to far higher levels of government borrowing.
Figure 1
Click on the image to enlarge.
Money and myth
At this point, we need to address the idea that fiscal problems might be alleviated, or even resolved entirely, by the abandonment of the credit-based fiat monetary system in favour of something different. An often-proposed alternative is MMT which, according to taste, means either modern monetary theory or magic money tree.
The MMT thesis is that credit-based money is an inefficient system, maintained only because of the benefits which it confers on banks and other intermediaries.
Instead of collecting taxes to pay for public services, MMT proponents argue that governments could fund these directly, issuing sovereign money for this purpose. Taxes would be collected, not to finance government spending, but to drain off excess liquidity which could otherwise create high inflation.
The snag with this idea is that it concentrates on the form of money whilst disregarding the functional role which money plays in the economy.
If we did have MMT rather than credit-based money, governments wouldn’t be driving public debt upwards. They would be cranking up the supply of sovereign money instead.
But the end result would be the same.
The fundamental fact is that any kind of money, irrespective of format, is token, not substance. Money has no intrinsic worth, but commands value only in terms of those material things for which it can be exchanged.
This is the principle of money as claim. Money is an exercisable claim validated only by the process of exchange. It has zero worth if isolated from exchange. This is why no amount of money would be of the slightest use to a person adrift in a lifeboat, or stranded on a desert island.
The exchange-dependent claim value of money is a characteristic of all monetary systems ever invented, and isn’t specific to credit-based fiat currency. This is a fundamental principle which applies equally to precious metals, cryptocurrencies, cowrie-shells, or anything else which we might choose to employ as an exchangeable token.
This brings us to a point with which regular readers will be familiar, but which must, under current circumstances, be emphasised with additional force.
It is that the purpose of the economy is the supply of material products and services to society. This is accomplished by using energy to convert raw materials into products, and into the physical artefacts required for the delivery of services.
This “real” economy of the physical has a parallel in the “financial” economy of money, transactions and credit.
Anyone who doesn’t grasp the critical conceptual distinction between these two economies can’t hope to understand how the economy really works, and is destined to keep chasing the chimæras of monetary causation of material trends.
The key – matters of equilibrium
The economic reality described above is that money acts as a parallel, proxy and operating system for the “real economy” of material products and services.
The relationship between the monetary and the material is mediated by price. At any given time, the general level of prices exists as the rate of exchange between the material economy and its financial corollary.
Inflation and deflation are functions of changes in this relationship, as mediated by the price mechanism. If the financial economy expands more rapidly than its material counterpart, the result is the devaluation of monetary claims through inflation.
Under ideal circumstance, the material and financial economies would grow or contract at pretty much the same rate. This would mean that the relationship between claim and substance would be stable.
In practice, the financial economy has generally grown a little more rapidly than the material economy over time, resulting in comparatively modest rates of inflation. An obvious exception to this pattern occurred in the 1970s, when restrictions to the supply of oil undermined the material economy, whilst the financial economy carried on growing. The inevitable result was painfully high inflation.
In short, what we’re describing here is equilibrium between the material and the monetary, in which the quantum of claims remains in sync with the volume of material products and services available for exchange.
Now, though, we’re in a state of extreme disequilibrium. It’s part of the mythology of orthodox economics that material output can be invigorated by monetary expansion. Time and again, this theory has been disproved by surges in inflation.
Our responses to the material economic deceleration which set in during the 1990s have been monetary – credit expansion, latterly reinforced by monetary expansion.
What has this meant for economic equilibrium?
Between 2003 and 2023, the flow of monetary exchange (real GDP) expanded by 98% whilst the material economy grew by only 29%. We can only estimate the global stock of claims – because some jurisdictions choose not to report on this – but this stock seems to have grown by about 160%, again in real terms, between those same years.
As with the “righting couple” familiar to naval architects, the pressure towards a restoration of economic equilibrium increases in proportion to the extent of disequilibrium in the system.
The global magnitude of this disequilibrium, as measured by SEEDS on a trailing twenty-year basis, has now reached epic proportions, just as quantitative exposure keeps setting new records (see Figs. 2A & 2B).
If you’re not familiar with naval architecture and the “righting couple” (well explained for the lay person by Cyril Benstead as long ago as 1935), you might instead think of this disequilibrium as a pendulum effect – the further the pendulum swings to one side of the vertical, the greater the pressure trying to push it back in the opposite direction.
Our predicament now can be likened – if we mix our metaphors – as a far-out-of-kilter pendulum swinging back towards our fragile candyfloss economy.
At first glance, disequilibrium in the United Kingdom (of 23%) looks less critical than the global equivalent of 35%. But there are two problems with the British economy on this basis of interpretation.
First, material prosperity is heading downwards a lot more rapidly in the UK (Fig. 2C) than in the World as a whole (Fig. 2A).
Second, broad financial exposure is about twice as high in the UK – at 11.6X prosperity (Fig. 2D) – as the SEEDS global estimate of 5.8X (Fig. 2B). Even the latter is unmanageable.
This site is not dismissive of the good intentions of everyone in politics, since the ethic of public service still persists.
But the task of ministers and officials has now become an impossible one – they face economic and financial outcomes that can neither be prevented nor acknowledged.
Figure 2
Click on the image to enlarge.
