Foreword
The central thesis of Surplus Energy Economics is the need to draw a clear analytical distinction between the “real” economy of material products and services and the parallel “financial” economy of money, transactions, and credit.
It should never be forgotten that money commands value only as an exercisable “claim” on the material.
Economic and financial equilibrium depends upon the monetary and the material growing at broadly similar rates.
Modest divergence between the two can be mediated by inflation.
More severe disequilibrium can be resolved only by a reset – whether managed or disorderly – of the monetary system.
Over the past twenty years, we can calculate that global material economic prosperity has grown by 25%. Over that same period, reported GDP has increased by 96% (in constant international dollars), and debt by 165%, whilst we can estimate that the assets of the global financial system have expanded by not less than 210%.
Signs of intolerable stress are everywhere plain to see. Tariff wars are the public face of a conflict over dollar hegemony, which is at once a vital national interest of the United States and an increasingly intolerable burden to others, most obviously the BRICS+ nations. The dollar has already been “weaponised” by the imposition of sanctions on Russia, Iran and others.
Risk has been rising relentlessly within the composition of the stock of financial claims, with the sourcing of credit migrating from the regulated centre of the system towards its opaque and unregulated periphery.
Public debt is rapidly out-growing the economy, even in formerly fiscally conservative countries like Germany. In America, Federal debt is, to all intents and purposes, out of control, because any attempt to rein in the deficit would plunge the economy into a slump.
The increasingly plausible spectre at the global feast is the value-destroying monetisation of government debt.
Seeing this, some investors are favouring gold, whilst cryptocurrencies are increasing both in value and in importance. Some jurisdictions are openly contemplating the adoption of CBDCs (central bank digital currencies), which are state-controlled versions of crypto.
All monetary systems are at risk of political expediency outweighing prudence. This is exactly what has been happening to the fiat system.
For investors, the age-old priority of asset allocation is being overtaken by a need to decide which kind of money offers the best combination of value and resilience.
Figure 1. Click on the image to enlarge.
Section 1: The World of Money
Strange things are happening in what we might call “the world of money”.
The dollar has been “weaponised” through the imposition of sanctions, whilst Mr Trump’s tariff war has rocked global flows of trade and investment. Other countries – most obviously the BRICS+ nations – are openly discontented with the global hegemony of the dollar.
This dollar supremacy ranks amongst the very highest national interests of the United States. If the inflow of capital were to turn into an outflow, US markets would slump, perhaps to between half and one-third of their current levels, and the financing of the deficit, and the refinancing of America’s soaring government debt, would become all but impossible.
In this situation, the authorities would be left with no good options, because either rate rises or a drastic reduction of the deficit would plunge the economy into a slump unprecedented in modern times. The monetization of Federal debt through the re-adoption of QE could not be ruled out under these circumstances.
All of this might seem far-fetched, but it should be remembered, that, in historical terms, global money is a comparatively recent phenomenon. The Bretton Woods arrangements, put in place after the Second World War, were the first formalised attempt to create a global financial system, with other currencies tied to a dollar which was itself tied to gold.
This system was overturned when Richard Nixon ended gold convertibility in 1971. Since then, we have lived with free-floating fiat currencies. The problem with fiat has always been the temptation to pour too much money into the system, most obviously by monetising (“printing”) government debt.
Importantly, Bretton Woods was introduced through multinational agreement at a time when America accounted for about half of the global economy, and was the World’s largest creditor.
The switch to untethered fiat was driven unilaterally by a United States which still had sufficient economic clout to effectively compel adoption by others.
Since then, the American share of the global economy has shrunk to an official 26% which, in practice, is nearer 15%. The US now relies on others both to finance government borrowing and to prop up markets which, on any realistic assessment, have been drastically over-inflated by long years of underpriced capital.
We can reasonably infer that the United States can no longer compel others to follow its lead in global currency reform. At the same time, there are no obvious candidates to replace the dollar as the World’s leading currency.
BRICS+ is moving towards internal trade in national currencies, with periodic imbalances perhaps being rebalanced using gold. But the bloc is nowhere near the introduction of a common currency and, on the basis of the experience of the Euro, might feel best advised not to try.
But China and other BRICS+ countries do have strategic advantages which they might well try to leverage. These include sheer economic size, the possession of important energy and minerals resources, and a potential ability to overtake America in the technology of markets.
All of these considerations point towards a chaotic fracturing of the global financial system rather than an agreed, or an imposed, orderly reset of the system.
Section 2: The Real Economy and the Financial Economy
Remarkable as it may seem, Ann Pettifor is undoubtedly right when she says that economists “are not routinely trained in the theory of money and banking”, adding that “[y]ou can get through an economics degree, even an economics career, without pausing to think seriously about either”.
A big part of the problem is a lack of clarity over the character and role of money itself. We may know the theory of money being ‘loaned into existence’ by the banking sector, and interest rates being used as the primary instrument for managing the rate at which money is created, but this does no more than describe the modus operandi of the current system.
It doesn’t put money into a complete economic context.
If the reader takes away just one principle from the Surplus Energy Economics project, it should be that any reference to “the” economy is a misnomer.
There is a conceptual necessity to think in terms of two economies – the “real” economy of material products and services, and the parallel “financial” economy of money, transactions and credit.
Starting with the two economies conception, it will be readily apparent that money has no intrinsic worth – we can’t eat fiat money, heat our homes with precious metals, or power our cars using cryptos.
Likewise, no amount of money – irrespective of its physical format – is of the slightest use to a person isolated from exchange, which is the circumstance of someone stranded on a desert island, or cast adrift in a lifeboat.
In short, money commands value only in terms of those physical things for which it can be exchanged. The relationship between the material (“real”) economy and its monetary (“financial”) counterpart is that of the creation and exercise of claims.
Money, then, is token, not substance.
We can, on the two economies basis, usefully think of the general level of prices at any given moment as the rate of exchange between the monetary and the material. If the monetary economy out-grows its material corollary, this “rate of exchange” shifts in a way that we experience as inflation.
When we introduce the material element into the calculation of the broad deflator, it emerges that pan-economy inflation has been markedly higher than the official data used in the calculation of “real” economic growth.
Section 3: The Material Economy and the Monetary Economy
Clarity about the role and character of money should also enable us to de-mystify the potentialities of money in the economy. We cannot reinvigorate a flagging material economy using monetary tools.
Keynes never said that we could, arguing only for the use (and, when appropriate, the reversal) of stimulus to iron out fluctuations in the “business cycle”. Like Adam Smith, Keynes has been honoured much more in the mis-stated than in the factual.
There are, in principle, no limits to the quantity of monetary tokens (“claims”) that we can create, but there are very real constraints on the material side of the exchange process. The banking system cannot lend energy or any other natural resource into existence, and they cannot be conjured ex nihilo, out of the ether, by central bankers.
These are issues of the finite versus the infinite, and are also matters of linguistics.
When the authors of The Limits to Growth (1972) prophesied an impending end to economic expansion – and when the report’s critics countered that LtG left critical factors (like technological innovation, resource substitution and incentives) out of the equation – both sides were speaking different languages.
LtG referenced the material economy, whilst its critics were talking about its monetary corollary.
We can both hope and presume that the economics of the future will put the material and the monetary into their appropriate places within the whole.
Unless and until that new paradigm arrives, however, our best course of action is always to benchmark the financial against the physical.
Section 4: Material Output Growth and Financial Debt Growth
At one level, the structural issue is relatively straightforward. Globally, as well as nationally, both debts and quasi-debts have been out-growing economic output in ways that have become increasingly unsustainable.
Expressing everything in market-converted dollars at constant 2024 values, as in Fig. 2, reported global GDP has grown by 68%, or US$45 trillion, since 2004.
Over that same period, though, aggregate public and private debt has increased by $144tn, or 128%, whilst we can estimate that broader financial assets have expanded by not less than $400tn, or 165%.
On this broader basis, we can reckon that each dollar of reported growth has been accompanied by an increase of at least $9 of net new financial commitments.
Much of this “growth” must itself be subject to doubt, given how much new liquidity has been poured into the system. Since the only reason for borrowing money is to spend it, we are entitled to suspect that a high proportion of the increase in the transactional activity measured as GDP has been nothing more than a cosmetic, statistical consequence of super-rapid credit expansion.
Put another way, debt and GDP are not discrete data series.
Even the foregoing numbers, by the way, don’t include large and growing shortfalls in the funding of pensions commitments, or the additional exposure created in derivatives markets which might not, in any final reckoning, net out to zero.
Energy consumption has been included in Fig. 2B as a “real world” indicator, and suggests that the entire confection of financial flow and stock might have become dangerously disconnected from material reality.
This is a point to which we shall return.
Figure 2. Click on the image to enlarge.
Section 5: Monetary Claims Out-growing the Material Economy
Ultimately, the monetary system is at risk of fracture because both the flow and the stock of monetary claims have out-grown the underlying material economy.
In a process of continuous production, consumption, abandonment and replacement, this “real” economy operates by using energy to convert natural resources into products, and into the artefacts and infrastructure without which no worthwhile service can be provided.
The critical parameters in this equation are: the availability of energy; the supply and characteristics of non-energy raw materials; the rate at which these raw materials are converted into value; and the proportionate Energy Cost of Energy which makes the first call on available energy and economic output.
ECoEs – representing the energy required for the creation, operation, maintenance and replacement of the energy supply infrastructure – have long been on a relentlessly rising trajectory. This reflects the depletion of fossil fuel energy, and the inability of alternatives to replicate the critical characteristics, including the density (the specific energy) and portability, of fossil fuels.
The conversion rate, meanwhile, has been trending gradually downwards, which means that non-energy resources have been degrading at rates that have not been fully offset by advances in conversion technologies.
Even if the supply of energy continues to grow for a few more years, increases in the first call on energy made by ECoE mean that the availability of surplus (ex-ECoE) energy is trending downwards.
This means that, just as growth in top-line economic output (here labelled C-GDP) decelerates towards contraction, all-important material prosperity is already at or very near its peak.
The orthodox stance – based much more on hope than on calculation – is that we can counter these adverse trends using a combination of technological innovation and monetary stimulus.
But the potential scope of technology is subject to limits set by the laws of physics, whilst the nature of the two economies equation dictates that monetary stimulus cannot reinvigorate a material economy subject to its own, non-monetary processes.
The great danger now is that efforts to stimulate the material with monetary tools may already have imposed unsustainable levels of stress on the financial system itself.
Figure 3. Click on the image to enlarge.
Section 6: Purchasing Power Parity and Global Economic Growth
There are, as you may know, two different ways of converting other currencies into dollars for purposes of aggregation and comparison.
One of these is to use average or end-of-period exchange rates, and the other is to apply the PPP (purchasing power parity) convention.
There is no “right” or “wrong” currency convention. A German wishing to buy assets or settle a debt in America must first buy dollars in the market for this purpose.
But the Russian and Chinese economies aren’t, in any meaningful way, “smaller” because the FX markets don’t happen to like roubles or renminbi. A low currency valuation makes a country’s imports costlier, but it also makes that country’s exports more competitive.
Global economic growth, it should be noted, is calculated on the PPP rather than the market basis of conversion.
The existence of two different currency conventions enables us to assess the effects of dollar hegemony on international economic relationships (Fig. 4).
When other currencies are converted into dollars at market rates, the aggregate real GDPs of the BRICS+ countries totalled US$26tn last year, or 24% of the global total. On the PPP convention, this number rises to $64tn, or 33% of a much larger total. On this same basis, the US share of World GDP falls from 26% (market) to 15% (PPP).
Though reliably calculated and reported, PPP is not perfect, as no such measure ever is.
But these comparisons make a prima facie case for the BRICS+ countries feeling disadvantaged by the hegemony of the dollar in global flows of investment and trade.
Readers can, incidentally, make their own equivalent calculations from readily available sources, remembering that historic exchange rates – whether market or PPP – need to be adjusted for inflation differentials over time.
Figure 4. Click on the image to enlarge.
Section 7: Risk Escalation and the Composition of Liabilities
Further significant risk escalation resides in the changing composition of the liabilities structure itself, an issue illustrated in the next set of charts.
Although data on financial assets is neither complete nor timely, we can estimate that, within total real expansion of not less than US$400tn since 2004, only 27% has been sourced from the regulated banking sector, and 65% from the unregulated NBFI (“shadow banking”) system.
What this means is that the sourcing of credit has been migrating, from the relatively conservative centre of the system to its opaque, unregulated and much riskier periphery.
We have been witnessing, then, a qualitative as well as a quantitative escalation in systemic exposure. With this goes the complexity risk of an increasingly Byzantine system of interconnection and cross-collateralization in which it can be almost impossible to understand which components, perhaps comparatively small in themselves, could, by failing, bring down the whole house of cards.
Figure 5. Click on the image to enlarge.
Section 8: The Relentless Rise in Global Public Debt
One of the more disturbing recent trends has been the relentless rise in public debt. Worsening fiscal stresses are a significant part of the intensifying instability of broader monetary conditions, as governments try to deliver on ambitious promises with the confines of increasingly stretched resources.
In the United States, arguments for the ‘responsible’ taming of the exponential rate of increase in Federal debt always run into a practical obstacle, which is that any such return to prudence would create a severe recession in the economy.
Around the World, governments keep finding reasons for borrowing more, ‘reasons’ which include financing energy or technological change, improving national defences or simply ‘keeping up with others’.
In the United Kingdom, chancellor (finance minister) Rachel Reeves is boxed in between rising demands for public expenditures, a tax incidence already at a post-war high, and a set of fiscal rules aimed at the all-important objective of sustaining market confidence in GBP.
As can be seen in Fig. 6 – sourced from the SEEDS database – World fiscal deficits spiked during the global financial crisis (GFC 01) of 2008-09, and again during the pandemic.
Though these recourses to hugely increased borrowing might or might not have made sense under those specific conditions, the general trend, measured in constant monetary amounts, has long been an upwards one.
Reflecting this, global public debt has been rising markedly, not only in absolute amounts (Fig. 6B), but also in relation to economic output. At the same time, public debt is taking on an exponential shape because of the rising costs of debt service (Fig. 6C).
Although some central banks have started to push prior QE into reverse in an effort to tame inflation, a long-run view (Fig. 6D) shows a disturbing trend towards the monetisation of public debt.
For central bankers, there is almost always political pressure to cut rates, a demand that can only become ever more strident as the rising cost of servicing government debt compresses the ability to spend on public services.
Figure 6. Click on the image to enlarge.
Section 9: Intensifying Competition for Increasingly Scarce Resources
As remarked earlier, there is no such thing as a “natural” global financial order. Bretton Woods worked well until the day when it didn’t. Floating fiats were never actually planned as a system, but succeeded the earlier arrangements as an ad hoc response to the conditions of the time.
The view taken here is that worsening internal and geopolitical instability reflects intensifying competition for increasingly scarce resources. The global financial system is one of the cockpits in which this contest is taking place.
Since each country naturally pursues its perceived national interest, resource constraint is creating a series of irreconcilable objectives, and the architecture of the World financial system is not designed – in so far as it was “designed” at all – to resolve these differences.
It’s often said that the “World order” – the set of arrangements introduced after the Second World War – is crumbling. It would be foolhardy to assume that this chaotic de-structuring will not extend into the monetary system itself.
