The Growing Storm

While the preceding sections covering the ‘ideology of economics’ and a basic ‘economic model’ have only been able to provide the briefest of introduction to the ‘evolution of economics’, there has been an underlying suggestion that ‘all is not well in the economic world’. While you may reasonably assume that this ‘malaise’ is simply a result of the recent ‘turbulence’ in the global finance markets. i.e. since the 2008 financial crisis, it may also reflect a far deeper and more worrying trend. Therefore, the next three sections of discussions will outline and review the work of a number of professional researchers who are better qualified to comment of the state-of-play of the global economy, both now and possibly into the future. These discussions are entitled:

The current discussion is based on the 2013 Tullettt Prebon research publication entitled the ‘Perfect Storm headed up by Dr Tim Morgan. The previous link to the report will allow the reader to review the report in full and you are urged to do so, as this outline only attempts to capture some of the key ‘sound-bites’ taken from the 84 page report. The report essentially begins by providing the following summary:

The economy as we know it is facing a lethal confluence of four critical factors: the fall-out from the biggest debt bubble in history; a disastrous experiment with globalisation; the massaging of data to the point where economic trends are obscured; and, most important of all, the approach of an energy-returns cliff-edge.

Later, the report explains how the bias towards short-term thinking, both political and economical, has led to four developments or trends, which have already started to throw more than two centuries of economic expansion into reverse. Like the work embodied within the ‘Limits to Growthand ‘Oxford Martin Commission for Future Generations publications, to be discussed next, the ‘Perfect Storm report may initially appear to be somewhat academic in scope, although there is now mounting evidence that it may be far more reflective of future trends already in motion. For it suggests that the last two centuries of growth may have already started to decline, possibly up to 10 years ago, and lacking any longer-term vision today’s policymakers appear helpless to correct many of the fundamental many issues now facing the global economy. For example:

Why has there been little or no recovery from the post-2008 economic slump?
Why have traditional fiscal and monetary tools ceased to function?
Why have both austerity and stimulus failed us?

Within the wider scope of the ‘evolution of economics’, we may also have to consider the issues of the underlying ‘human condition that often drives our actions and the growing impact of the ‘global population’ .  However, the ‘Perfect Storm’ analysis primarily focuses on four underlying trends, each of which may render many of the lessons of the past as irrelevant:

  • Trend-1: The Madness of Crowds:
    It has long been recognised that a ‘society of individuals’ can often adopt a crowd psychology, which may appear irrational from a distance. One specific form of ‘madness’ is often grounded in ‘human greed’  and the idea of a ‘quick buck’ that may help to explain the apparent madness that has surrounded so many of the historical financial bubbles of the past and present.

  • Trend-2: The Globalisation Disaster
    It was originally assumed that ‘globalisation’ would make everyone richer, while reality might suggest that the out-sourcing of production to emerging economies was a self-inflicted disaster with few parallels in economic history. The big problem with globalisation was that Western countries reduced their production without making corresponding reductions in their consumption.

  •  Trend-3: An Exercise in Self-Delusion
    One explanation forwarded for widespread ignorance of the state of the economy may be linked to economic and fiscal statistics, many of which have been now been ‘massaged’ out of all relation to reality. This is particular true in the case of inflation, which feeds through to economic models that continue to show ‘growth’ even when it is intuitively evident, based on many other benchmarks, that most western economies have, at best, stagnated.

  • Trend-4: The Growth Dynamo Winds Down
    One of the problems with economics is the focus on ‘fait money’, when in practice money is only the language rather than the substance of the real economy. It is then argued that the economy is, and always has been, quantified as a surplus energy equation, governed by the laws of thermodynamics, not those of the financial market in isolation.

So based on the trends outlined above, the analysis detailed in the report suggests that we are nearing the end of a period of more than 250 years in which growth has been assumed to be the ‘normal’ state of affairs, barring periodic setback associated various wars and disasters. As such, we might also want to table the question raised in the report:

Why is this time so different?

In summary, it is suggested that the ‘2008 financial crash ’ resulted from the bursting of the biggest bubble in financial history, which is described as a ‘credit super-cycle’ that spanned more than three decades. So while the 2008 financial crash shared many of the characteristics of previous financial bubbles in a long history of such events, the credit super-cycle differs in 3 fundamental respects:

  • The first big difference was that the scale and scope of the 2008 crash far exceeded anything that had gone before.
  • The second big difference lay in the shortening of the time between ‘boom and bust’ .
  • The third big difference was that this event coincided with a weakening in the fundamental growth dynamics within the global economy.

Based on these assumptions, the analysis of the dynamics of the credit super-cycle proceeds to consider a number of key issues, e.g.

  • An almost psychological change in thinking has elevated the importance of immediate consumption to maintain growth, while an understanding of both the risks and the longer-term consequences has either been forgotten or swept under the carpet.

  • Institutional weaknesses have also undermined regulatory oversight and allowed the provisioning of excessive credit through the creation of high-risk financial ‘innovations’.

  • Risk has also been understated by a false appreciation of economic prospects and by the distortion of essential financial data.

  •  In essence, there has been a distortion of the capitalist model, such that there is now a widening chasm between ‘capitalism in principle’ and ‘capitalism in practice’ .

However, in order to put the credit super-cycle into context, it is argued that three critical issues have to be appreciated, each of which has been grossly misunderstood or understated:

  • The issue of globalisation, as introduced by Trend-2. It is argued that globalisation has impoverished and weakened the West, while ensuring that few nation-states are immune from the consequences of a downturn in the global economy. As such, both national and global economies have become a hostage to future growth assumptions at a time when the scope for generating real growth is deteriorating, i.e. Trend-4.

  • Another critical issue is the undermining of official economic and fiscal data, i.e. Trend-3, which might be characterised in terms of the adage: lies, damn lies and statistics.

  • There has been a fundamental misunderstanding of the dynamics that are really driving the economy. While often only considered in terms of a monetary construct, the economy is, in the final analysis, an energy system, and the critical supply of surplus energy has been in seemingly-inexorable decline for three decades, at least.

While chapters 1 & 2 outline the scope of problems, which may lead to the ‘perfect storm’, chapter 3 turns its attention to the issue described as the ‘globalisation disaster and summarised as follows:

The Western developed nations are particularly exposed to the adverse trends explored in this report, because globalisation has created a lethal divergence between burgeoning consumption and eroding production with out-of-control debt used to bridge this widening chasm.

The report then re-iterates the trends outlined that have undermined economic development based on the following shortcomings:

  • First, insufficient attention has been given to the behavioural and psychological factors, e.g. greed, that also affect the economy, such that policymakers failed to monitor the creation and subsequent bursting of the biggest bubble in economic history without taking the necessary preventative or subsequent corrective action.

  • Second, policymakers and the general public have been misled by data, i.e. statistics,  which did not, and probably still do not, truly represent what is really happening.

  • Third, there has been a failure to grasp the most critical point of all, which is that the economy is an energy dynamic, not a financial one.

Therefore, in order to both illustrate and highlight some of the trends outlined, the changes in ‘production, consumption and borrowing’ need some sort of comparison. One measure of ‘internal production’ can be defined by dividing economic output between:

  • Output which is globally marketable
  • Services which citizens provide to each other.

Manufactured goods, plus the products of the extractive and agricultural industries, fall into the ‘globally marketable’ category, because if they were not competitively priced, consumers would be likely to purchase imports instead. The same can be said of services which are actually sold on the global market, net of services purchased from abroad, which gives us two output categories.

  • The first is ‘Globally-Marketable Output (GMO)’, which represents output potentially capable of sale at world market values and consists of production activities plus net exports of services.

  • The second is ‘Internally-Consumed Services (ICS)’, which comprises services that citizens provide to each other, a number which can be divided further into private and government provision.

So, by way of general illustration, between 1980 and 2011, the American economy expanded by $8.5 trillion, i.e. 128% in real terms. However, within this expansion only $0.9 trillion was provided by ‘Globally-Marketable Output’ activities, i.e. 10% of the total increase. The remaining $7.6 trillion resulted from increases in the services, which Americans provided to each other, either privately amounting to $6.4 trillion or through government amounting to $1.2 trillion. This represented a massive shift in the centre of gravity of the US economy away from production and towards output which can only be consumed internally. However, the following quote possibly highlights the situation in more stark terms:

“The Western response to diminishing production was to expand service industries, but there has to be significant doubt about how much real value is created by doing each others’ washing, eating more fast food or having more frequent manicure sessions .”

Long before the 2008 financial crisis, the relationships between ‘production, consumption and debt’ had become completely unsustainable throughout most of the Western world. In the US, the total credit market debt had soared to $54 trillion by the end of 2011, up from $29 trillion just 10 years previously. Even on an inflation-adjusted basis, debt was 48% higher in 2011 than it had been in 2001. By contrast, GDP had expanded in a real-terms by $2.2 trillion over a ten-year period, while debt had increased by $17.4 trillion. So, by 2008, it only took rumours of the impossibility of servicing the ‘deficit’, let alone repaying the ‘debt’, to spook the credit markets and expose gaping holes in the balance sheets of many major banks around the world. This then led to paralysis in wholesale debt markets, which then took the entire banking system to the brink of collapse. To summarise by way of a quote from the report:

The economic crisis in the West has been created, above all, by the way in which globalisation has driven a wedge between weakening production and soaring consumption, creating a gap which has been filled by a reckless accumulation of debt.

However, the full implication of globalisation may be better highlighted by considering the longer-term competitiveness of nation-states in a world of finite and dwindling physical resource - to quote:

Since the implicitly competitive character of this situation is an obvious one, no great credit need be accorded to China and others for recognising it and acting upon it, most notably by endeavouring to convert the waning and dubious value of Western currency holdings into physical assets in the form of natural resources. What is truly breathtaking is the way in which Western countries have overlooked the obviously-competitive nature of an ultimately-finite resource set.

Proceeding on to chapter 4, the report starts to address the issue of financial statistics, which it claims to have ‘blind-sided’ many policymakers by distorting the facts. To quote:

The reliable data which policymakers and the public need if effective solutions are to be found is not available. Economic data, including inflation, growth, GDP and unemployment, has been subjected to incremental distortion, whilst information about government spending, deficits and debt is extremely misleading.

This last statement appears to be supported by the earlier discussion of ‘Growing Debt. For example, in the UK, the last government came to power in 2010 on the promise to reduce the ‘deficit’ to zero by 2015, in order to start reducing the overall ‘debt’.

Note: Basically, the ‘deficit’ is the difference between what the government takes in by way of taxes, and other revenues, and the amount of money it spends. In contrast, the ‘total debt’ is the accumulation of the national deficit year-on-year.

While the UK government has often claimed to be reducing its debt, in practice, it has only managed to reduced its deficit by ~30%, which translates into an overall increase in the total debt. However, the UK government rarely mentions the overall increase in debt, preferring to cite the 30% reduction in the deficit and its promise to convert the deficit into a surplus in the next parliament, if we re-elect them. However, most people in the UK do not realise that even if the government meets and maintain its revised target of a budgetary surplus of £20 billion by 2017/18, it will still take +70 years for the UK to pay back its total debt, based on a £20 billion surplus throughout this period. Of course, it is far from clear what this will mean to UK public services, e.g. welfare and health, unless the shortfall can be made up by real economic growth in order to provide a ‘real’ increase in tax revenue. Again, if real growth is now approaching some form of global saturation, see  Limits to Growth discussion for further details, then many western economies will be in trouble or even deeper in debt. Possibly, in the face of such a stark reality, people may have been attempted to manipulate the financial data in order to provide a more optimistic outlook, at least, within the political lifetime of the government in power, if not their own children. Finally, in chapter-5, the issue of the decaying growth dynamic is initially summarised as follows:

The economy is a surplus energy equation, not a monetary one, and growth in output, and in the global population, since the Industrial Revolution has resulted from the harnessing of ever-greater quantities of energy. But the critical relationship between energy production and the energy cost of extraction is now deteriorating so rapidly that the economy as we have known it for more than two centuries is beginning to unravel.

It is clear that report believes the characterization of the global economy in essentially monetary terms to be a big mistake and argues that the state of any economy has to be assessed on tangible components, e.g. labour and natural resources, required to meet its needs. In fact, the report claims that most economic problems will remain insoluble for so long as policymakers concentrate on monetary issues rather than on the ‘real’ economy, which is founded on an energy system. The report illustrates this point in the following charts, which shows the historic growth in the use of fossil fuel and the parallel growth in the US GDP over a similar period. 

The two charts above both display an exponential growth, which is ultimately unsustainable – see opening ‘Limits to Growth’ discussion for more details. Of course, the need for this growth is clearly reflected in the corresponding exponential growth of the human population on planet Earth, which is essentially the finite source of all resources.

So, despite the normal presentation of the state of an economy in monetary terms, it actually reflects the underlying state of physical resources, i.e. energy usage and the demand of a growing population. So, as pointed out in the discussion of ‘fiat money’, the stability and durance of paper money rarely stands the test of time, such that the world economy has had to recovery from the ‘demise’ of an estimated 3,800 different paper currencies.

So what value does money bring to the system?

Possibly, the role of money should be seen only as a convenient means of exchange rather than the final ‘yardstick’ by which to quantify the state of an economy, especially growth. In a sense, it might be argued that of the 3 charts above, only energy, as defined in terms of fuel consumption, and human population have any real meaning, although GDP might be seen as a comparative way of assessing various economies. However, within the context of the ‘evolution of economics’ being discussed, it might be argued that the increase in energy usage was only in response to the growing human population and the sophistication of its needs.  So while the report continues towards its conclusion regarding an economy being quantified in terms of energy, the focus of this discussion will now turn its attention towards the ‘Limits to Growth’ as linked to the human population.