Anyone who has been following this blog long enough will know that I predicted 2020 was crunch time and that we were heading into the mother of all energy crises. As I write, the UK is in deep turmoil, Germany is making contingency plans for blackouts, Lebanon has turned power off, China’s rationing electricity and India is doing the same. Low rainfall in Scandinavia has resulted in diminished hydroelectric power output (that will probably impact the UK if Norway is unable to send electricity down the new North Sea cable), and this is happening in South America and the West of the USA where speculation of the grid going down this winter is going rife. South Africa is also in trouble….. It’s hard to not feel like it’s all happening…..
So why are all these crises happening all at once…? Read on, this article is from SURPLUS ENERGY ECONOMICS, one of my favourite sites, which explains the predicament the whole world is seemingly in the grips of…..
#213. A moment of truth
THE ARRIVAL OF ECONOMIC CONSTRAINT
Some of us have long understood that the economy is an energy system, and is not – as orthodox economics insists – wholly a financial one.
We’ve identified credit and monetary adventurism as futile efforts to deny this reality, efforts which, whilst not ‘fixing’ low and reversing “growth”, have exacerbated financial risk by driving a wedge between the ‘real’ economy of goods and services and the ‘financial’ economy of money and credit.
We’ve highlighted relentless rises in ECoEs (the Energy Costs of Energy) as the process by which expansion in economic output peters out, and prior growth in prosperity goes into reverse.
Recent sharp rises in the price of energy might look like just one aspect of the current worsening economic predicament, a predicament which is ‘a crisis in all but name’. Other adverse factors can be cited, but all of them, ultimately, are traceable to a fading energy dynamic.
We’ve built a large, complex and increasingly inter-dependent economy on the predicate that money can drive ‘growth in perpetuity’.
We’re now in the process of discovering that this predicate is false.
From here on, prosperity will continue to deteriorate, whilst rises in the real cost of essentials will leverage this decline into a more rapid erosion of discretionary prosperity.
The good news is that these processes can be understood and modelled, projected and managed.
The bad is that, so far at least, this reality is not being grasped.
It has to be said that no ideology is more rooted than ‘neoliberalism’ in the doctrine that the economy is a financial system, with limitless capability for growth.
This is why those economies most wedded to the ultra-liberal ‘super-fallacy’ are being hardest hit by the harsh reality that neither ‘demand’ nor ‘incentive’ can create low-cost resources.
A new model crisis
Despite the most lacklustre of recoveries from the pandemic-induced downturn, the global economy has collided with the reality of energy constraint.
Natural gas, in particular, is in short supply, but the effects of supply shortages are rippling, too, across the markets in electricity, oil and coal. Almost unthinkably, China – widely regarded as the powerhouse of the world economy – is having to ration supplies of energy to its industrial sectors, whilst grappling with the fall-out from exuberant financial expansion.
Consumer energy and fuel prices are surging, a process as adverse for industry as it’s uncomfortable for households. Though the rise in domestic energy costs is the most conspicuous aspect of energy price escalation, deeper consequences will be felt through sharp increases in the costs of supply to businesses.
All inputs, from minerals and chemicals to food and water, are functions of the energy used to extract and process them. If the supply of energy tightens, and its costs rise, the same happens across the entirety of economic activity.
This, in short, looks like the moment when the reality of energy and broader resource constraint makes itself felt, and the conceit of perpetual growth on a finite planet is revealed as fallacy.
We need to be clear that, insofar as this is an “energy crisis”, it has nothing in common with previous such crises. Neither can it be blamed on after-effects of the pandemic crisis, on gamesmanship (by Russia, or anyone else), on ‘little local difficulties’ (like “Brexit”), or even on the distorting effects of gargantuan financial stimulus, harmful though that has been. Least of all can it be ascribed to ‘brisk economic growth’, since the global economy is unlikely to be any larger in 2021 than it was in 2019.
Rather, what we are experiencing is a predictable – though, in general, not a predicted – collision between resource limitations and a desire for never-ending “growth”.
The economy has hitherto experienced two energy crises (or three, if we include the oil price spike experienced in the American Civil War), but what’s happening now is profoundly different.
During the 1973-74 embargo crisis, and the 1978-79 Iranian revolution, there was no physical shortage of oil, or of energy more generally. These were crises of management, and of trade imbalances and international relations, not of supply fundamentals. Fossil fuel ECoEs remained below 2% in the 1970s, but are nearly 10% now. Even if renewable energy sources (REs) can take over fully from fossil fuels in the future (and this is unlikely), they certainly can’t do so now.
A moment of truth
From an economic perspective, this is a watershed. What we are witnessing is decisive proof that the economy is indeed an energy system, and is not – as orthodox opinion has so long insisted – wholly a matter of money. Pouring yet more money – in econo-speak, demand – into the system isn’t going to create huge new supplies of oil, gas, coal or any other form of primary energy.
All of the world’s decision-making processes – most obviously in government, business and finance – are predicated on an assumption which is turning out to have been fallacious. The economy isn’t, after all, a ‘perpetual growth machine, powered and shaped by money’.
Rather, it’s an energy system, in which material prosperity is a function of the availability, value and ECoE-cost of energy.
With its emphasis on incentive, and its disdain both for government planning and for non-financial motivation, the ideology sometimes called ‘neoliberalism’ is most exposed to the discovery that the economy cannot, after all, be managed in purely financial terms.
This helps explain why those countries most wedded to the idea of ‘leave it to the market’ – and, with it, of accepting inequality as ‘the price of efficiency’ – face the toughest futures. Britain, most conspicuously, is experiencing the consequences of the liberal ‘super-fallacy’ now, but the United States, in particular, won’t be far behind.
Of course, hype – no less than hope – “springs eternal”. But surges in the direct household costs of energy and fuel are now impacting economies, and indirect, second-order effects (traceable to the rising cost of energy to industry) are already making themselves felt in supply shortages and inflation.
For those countries worst affected by energy supply strains, pious promises to “build back better” and to “level up” won’t remove the need to make tough, unpopular decisions. “Green growth” is going to have to transition into “green resilience”. Decades of denial – enacted through monetary gimmickry, and backed up by excessive faith in the alchemy of technology – threaten severe financial and broader consequences.
A rocky road
As the energy interpretation of the economy moves from left-field theory to demonstrable reality, theories and models based on the contrary assumption are breaking down. The economy is moving in directions not anticipated by orthodox theory, invalidating much, and arguably most, of the projections, methodologies, models and policies hitherto accepted as valid.
Those of us who understand the economy as an energy system can predict some, at least, of the consequences of present trends.
First, material prosperity will deteriorate. Properly understood, this has long been an established trajectory in the West, glossed over – but not changed – by increasingly desperate, illogical and hazardous exercises in credit and monetary adventurism. SEEDS analysis makes it clear that the average person in almost all Western economies has been getting poorer since well before the 2008-09 GFC (global financial crisis), and that an increasing number of EM (emerging market) economies, too, are reaching the climacteric at which rises in ECoEs put prior growth in prosperity into reverse.
The rates of decline in top-line prosperity itself look manageable. But rising ECoEs are set to drive up the real costs of essentials (including household necessities and public services). Together, the combined effects of falling prosperity, and the rising cost of essentials, are exerting a tightening squeeze on the scope for discretionary (non-essential) consumption.
This downwards pressure on discretionary prosperity is going to be unpopular, with consumers and with discretionary suppliers alike, and this may prompt efforts to prop up discretionary consumption with yet more reliance on credit expansion.
Denial, for the moment, remains unchallenged. In Britain, for example, households are likely to face further and even larger rises in the cost of gas and electricity, and the price of anything (which means everything) made using energy is going to rise as well. Discretionary consumption cannot continue unchecked through this process.
To be sure, wages might rise to accommodate these cost increases but this, if it happens, will simply fuel an inflationary cycle. The task of repairing the public finances will become harder with each worsening twist in the cost cycle.
Despite this, few yet anticipate contraction in the scope for everything from travel and leisure to the payment of subscriptions and the purchase of the latest gadget. Fewer still have grasped the read-across from deteriorating prosperity to the pricing of property and other assets.
Around the world, these processes in turn imply, not just that inflation will rise, but that the financial system will come under increasing stress. Together, discretionary sectors, and businesses that rely on the ‘stream of income’ model, are going to be in the eye of the storm.
The ‘basics’ of the situation – deteriorating top-line and discretionary prosperity, rising inflation and worsening financial stress – are simply the first-order effects of the deteriorating energy-prosperity equation. More complex processes can be anticipated, some of them identifiable in a taxonomy which sees businesses simplifying their products and processes, de-layering their supply chains, and trying to work around the challenges of falling utilization rates and the loss of critical mass. Popular priorities can be expected to change, intersecting with a deterioration in the affordable resources of governments.
These are issues on which we can reflect and which, to some extent, we can model and predict.
For now though, the imperative is that the realities of resource (and environmental) constraint are recognized, and that plans and assumptions are re-thought accordingly.
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Damn the Matrix 