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The three vortices of doom

Despite the cheerleading efforts of the legacy media, the economic storm clouds are growing on the horizon.  Oil – the economic “master resource” – passed $80 per barrel yesterday.  Meanwhile, central banks around the world have begun to unwind the stimulus packages used to bail out the economy in the aftermath of the 2008 crash.  And all the while, governments are struggling to balance the need to manage their borrowing while maintaining the value of their currencies.  Add to that the politics of the new nationalism and you have a recipe for turbulent economic times in the very near future.

For the moment, much of the media focus is on the various policies being pursued by different types of government.  In the USA, for example, concerns have been raised about the sustainability of the US Dollar in the face of Trump’s tax giveaway, record high borrowing and the multi-billion dollar unfunded liability of the baby-boomers’ pensions.  In the UK, a similar pension crisis is brewing in the private sector as a decade of near-zero percent interest rates have left private pension funds in deficit.  Meanwhile, the UK government and the Bank of England are desperately attempting to shore up the value of a Pound that has been holed below the water line by the Brexit referendum result and the slow-motion train wreck of the Tory Brexit negotiations.  Across the channel, things appear better on the surface, but only because the peripheral states (excluding Greece) have been allowed to reflate the debt bubbles that almost collapsed the Euro in 2011.  None of the measures implemented in the EU to prevent a new banking crash have fixed the fundamental flaw in the single currency that allows individual states to run their own (deficit) fiscal policies separate from the monetary policy operated by the European Central Bank.  Next time around, it is likely to be whole countries rather than banks that turn out to be too big to save.

Missing from the debate around these – very serious – issues is any analysis of the underlying causes of the current global economic malaise.  In part – as most environmental campaigners understand – this is because economists treats as “externalities” those things – including money creation – that ought to be at the very centre of economics if it is to bear any resemblance to the real world.  It is no accident, of course, that were such things as the cost of pollution added to the cost of doing business, there would not be a single profitable corporation on the planet.

By far the biggest blind spot in economics, however, is its treatment of energy as just another cheap resource to be exploited.  In fact, energy should be treated as a separate category alongside capital, labour and resources in any model that seeks to explain the way the real world works.  This is because energy is the transformative force that allows us to (temporarily) defy the second law of thermodynamics, which says that things move from order to chaos; they break down not up.  As Steve Keen puts it:

“Capital without energy is a statue; labour without energy is a corpse.”

Not all energy sources are equal, of course.  Even in the days before fossil fuels, humans quickly learned that oxen, horses, mules and dogs were more productive than human labour for particular tasks.  But what, exactly, made them more productive?  It was the fact that they required less energy (food) to complete the task.  That is, productivity = the most efficient use of energy.

This fact has been hidden in the course of the past two centuries by the massive amounts of energy locked up in fossil fuels like coal, gas and oil.  For example, the average energy of the 42-gallon barrel of oil about which everyone is complaining over the $80 price tag, is 5.8 million Btu.  To get that amount of energy from an average horse would require that we work the horse for eight hours a day, five days a week, for 50 weeks of a year.  To get the same amount of work out of the average human would at best (using leg muscles) require him (males are generally stronger than females) to work for more than a decade (more than a century if he is using the muscles in his arms).

Another way of understanding this is to see that for a mere $80 dollars we get more than $350,000 worth of work (if we had to pay a human the average wage to do it).  This also explains why relatively small changes in the price of energy (particularly oil because its use is ubiquitous) have such a dramatic impact on the monetary economy.  Just three years ago, for every $40 spent on oil, companies were returning $350,000 worth of productive work.  Today, the same $40 is returning just $175,000 of productive work; something that largely explains the so-called “productivity puzzle,” as well accounting for why ten of last eleven recessions were preceded by a spike in the price of oil.

Although this energy problem translates across into the monetary economy, its true cause is a somewhat obscure (to economists and journalists) calculation known as “net energy.”  As with any other economic activity, generating useable energy requires us to expend energy.  A human must eat before she can harvest food; a horse must be fed before it can pull a cart, and an oil rig must be constructed and powered before it can drill for oil.  The difference between the energy input and the energy output (Energy Return on Energy Invested or “EROEI”) can be expressed as a ratio:

Net energy cliff

Note that at a ratio of 50:1, 98 percent of the energy is returned to the economy for use in all of the non-energy generating activities that we have come to depend upon for our industrialised way of life.  Note also that if the ratio drops below 10:1, we experience a net energy cliff in which the amount of energy available to the non-energy economy rapidly falls to zero.  This poses two questions:

  • Why might our net energy ratio fall?
  • What is our current net energy ratio?

The answer to the first question is that we pick the low hanging fruit first.  The first coal seams to be exploited in the industrial economy, in Britain’s Severn Valley, were exposed on the nearby hills.  Only as these surface deposits depleted did people dig coal pits and later coal mines; the depletion of which has led us to the modern practice of exploding the tops off mountains to strip mine the coal seams beneath.  Something similar has occurred with oil.  The first US deposits were located less than 70 feet below the surface; and could be accessed by simply hammering a steel tube into the ground.  As these deposits depleted, the industry moved further afield, eventually moving into very expensive Arctic, offshore, and ultra-deep water deposits.  In addition, the quality of the oil deposits being exploited has fallen considerably.  Shale oil and tar sands require additional recovery and production stages to make them useable compared to conventional crude oil.  What this all adds up to is the need to use ever more energy to maintain the energy available to the wider economy.

The answer to the second question is more contentious.  Most net energy calculations were made at the well-head; measuring the number of barrels out against the “barrel of oil equivalent” (BOE) energy in.  However, what we really need to know is the amount of energy available at the point of use.  That is, we need to include the energy cost of transporting the oil to the refinery, the energy cost of processing the oil, and the energy cost of transporting it to the end user on the “energy invested” side of the equation.  This is particularly important when considering the modern renewable electricity technologies that are proposed as an alternative to fossil fuels.  Taken at face value, wind, solar, tidal and wave energy appear to deliver reasonably good net energy; particularly when compared to fracked shale oil or strip mined tar sands:

The problem is that the net energy ratios are calculated, as it were, at the well-head.  They calculate the electricity output at the turbine or the panel against the cost of manufacturing, transporting and deployment.  However, given the variability and intermittency of renewables, as with oil, what we need is the net energy cost at the point of use.  This means that the energy cost of the combined cycle gas turbine power stations and diesel generators that are used to balance the load from renewables must also be included on the “energy invested” side of the equation (until or unless someone can figure out a viable lower-cost means of storing the excess energy generated when the wind is blowing and the sun is shining).

It is not impossible (although highly unlikely) that someone will discover a relatively easily exploitable oil deposit on the scale of Saudi Arabia’s Ghawar field (which remains the largest field ever discovered).  This would rapidly reverse the falling net energy that we have been experiencing since the first oil crisis in the 1970s.  Whether – given the impact on the environment – we would be wise to leave it in the ground is a moot point, since such a discovery would have the potential to generate economic growth on a scale last seen in the magic years 1953 to 1973:

Source: The Oil Drum/COS

It is also possible that someone will figure out how to properly unlock the potential of nuclear power (something that would look very different to the feeble, toxic and dangerous nuclear generation today).  Far less plausibly, someone may figure out how to run a fusion reaction that provides sufficient net energy to make it worthwhile.  However, it is more likely that for the foreseeable future we will continue to experience falling net energy, and should, therefore consider the likely impact on the economy.

Net energy has its counterpart in the monetary economy in the form of discretionary and non-discretionary spending:

discretionary and non-discretionary spending

The connection between the two is obscured to some extend by the ability of governments and banks to create new currency out of thin air.  Nevertheless, money is the means by which energy is moved within the economy.  Charles Eisenstein puts it this way:

“Looking down from Olympian heights, the financiers called themselves ‘masters of the universe,’ channelling the power of the god they served to bring fortune or ruin upon the masses, to literally move mountains, raze forests, change the course of rivers, cause the rise and fall of nations.”

So long as we have had sufficient net energy to play with, we have needed only to divert a small proportion of our spending to non-discretionary items such as housing, food, clothing, utilities and transport.  However, since the 1970s, as both net energy and energy per capita have fallen, we have been obliged to divert an increasing proportion of our currency to these non-discretionary items.  Those at the bottom of the income distribution understand this only too well as they are obliged to turn to food banks and food stamps to supplement incomes that no longer provide for their needs.  Indeed, as the net energy crisis has grown since 2005, the rate of “in-work poverty” has grown dramatically as labour-intensive businesses struggle to afford to offer a living wage.

Most of those looking at this situation assume that the problem is purely political.  The wicked UK Tories and Blairites and Obama’s incompetent Democrat party simply gave in to pressure from the banking elites and imposed austerity policies that bankrupted the people in order to save the banks.  It would be wrong to rule this out entirely.  There was a perfectly workable alternative to bank bail outs, quantitative easing and near-zero percent interest rates in 2008.  Governments could just as easily have allowed the banks to fail; rapidly nationalised the banking infrastructure (especially the all-important inter-bank computer network) and then used their ability to print money to recapitalise the (now public) banks; compensating investors and account holders on the basis of need.  That they failed to do this is a matter of politics rather than any law of the universe.

This said, while alternative policies might spread the pain of declining net energy more equitably, they cannot remove the problem.  Without a new source of high-EROEI energy, economic growth beyond the temporary inflation of asset bubbles is a thing of the past.  As both consumers and businesses are obliged to spend a greater proportion of their income (i.e. allotted energy) on energy-related items (including food) so our collective ability to sustain discretionary economic activities (like eating out or non-food shopping) will be ever more constrained.

To add to our woes, as Steve Keen explains, a great deal of our discretionary spending since the 1970s has been financed with debt:

Thatchers credit explosion Keen2017The fundamental assumption behind all interest-bearing debt is that the economy will continue to grow exponentially.  Indeed, the word “credit” comes from the Latin “Credo” or “I believe”.  That is, the entire monetary system of the modern global economy is based on the (impossible) belief that our economic activity can grow indefinitely.  Once we admit that (for climate change reasons) we might not be able to grow any more or (for net energy reasons) that further growth may be beyond us, then trust in debt and in currency must also disappear.

We experienced a foretaste of what awaits us in 2008.  However, as it becomes clear that further economic growth (beyond asset bubbles) is no longer possible, faith in currency itself will disappear.  Eisenstein continues:

“What we call recession, an earlier culture might have called ‘God abandoning the world.’ Money is disappearing, and with it another property of spirit: the animating force of the human realm. At this writing, all over the world machines stand idle. Factories have ground to a halt; construction equipment sits derelict in the yard; parks and libraries are closing; and millions go homeless and hungry while housing units stand vacant and food rots in the warehouses. Yet all the human and material inputs to build the houses, distribute the food, and run the factories still exist. It is rather something immaterial, that animating spirit, which has fled. What has fled is money.”

What Eisenstein missed was the surplus net energy that departed back in 2005 when conventional crude oil production peaked.  It was that energy – which currencies were employed to command – that really deserted us.  The result is (for most of us) the ongoing recession that has left most ordinary people worse off than they were a decade ago… not least because debt – and the interest on that debt – are a growing part of our non-discretionary spending.

Energy and debt have become akin to two giant vortices; sucking the monetary and energetic life out of the economy.  There is, though, a third vortex that can only compound these first two.  This is the state vortex.

In addition to its ability to issue new currency, the state has two other powers – to borrow in the currency of other states, and to use taxation to guarantee that borrowing.  In the Modern Monetary Theory that has emerged as an alternative to neoclassical economics, sovereign governments can issue as much new currency as they please in order to invest in growing the economy so long as they increase taxation accordingly in order to avoid inflation.  Unfortunately, this only works where the sovereign nation concerned has a current account (or “balance of payments”) surplus.  A state like the UK, which must convert pounds into dollars to pay for its oil imports, and will soon have to convert pounds into euros to pay for the majority of its non-energy imports, cannot simply print new currency without risking devaluing its exchange rate.  (The USA would face a related problem in the event that China chose not to re-invest in US treasury bonds).

Without the net energy to allow for genuine economic growth, sovereign debt becomes as unpayable as consumer and corporate debt.  It can be defaulted or it can be inflated away; but it can never be repaid in real terms.  States, however, are unlikely to concede this point until it is too late. To put it another way, states will use all of the power at their disposal to maintain the exchange rate of their currencies even if this results in economic ruin for their national economies and their citizens.

We can see examples of this playing out in the UK, where eight years of austerity policies have failed to dent the national debt.  Most obviously, the unfolding retail apocalypse has been greatly exacerbated by the UK’s archaic local business tax arrangements.  Rather than pay a proportion of their profits in tax, British businesses (and households) pay an amount based on the hypothetical rental value of their property.  Thus, for example, a loss-making business occupying a large store in a city centre will have a much larger Business Rates bill than a lucrative out-of-town supermarket or Amazon warehouse.  As Jonathan Eley at the Financial Times recently reported:

“The UK government is resisting pressure from retailers to reform business rates, saying that it has already made changes and that reforming international corporate taxation is a higher priority.

“Responding to parliament’s Treasury select committee, chancellor Philip Hammond said that a review of business rates in 2016 found ‘no consensus on an alternative base’.

“’Respondents agreed that property-based taxes were easy to collect, difficult to avoid, relatively stable compared to other taxes and had a clear link with local authority spending’, he said in a letter to Nicky Morgan, who chairs the committee.

“The rebuttal comes after growing calls from the retail industry for reforms that would help redress the disparity in rates between bricks-and-mortar and online shopping.”

Government would rather see businesses bankrupted than replace an easy to enforce tax with one that is more difficult to collect.  Nor does the problem end there.  Those businesses that have avoided being bankrupted by the combination of falling sales and rising Business Rates have often only done so by renegotiating their rents with their landlord.  In some cases this has involved threatening to walk away and leave the landlord with an empty property on which the outstanding Business Rates are still due.  And even where the result is merely a lower rent, the result is that property owners – including many of the UK’s pension funds – are obliged to restructure their own businesses along with any outstanding loans.

Another highly lucrative UK tax – one I believe my American readers can look forward to in the near future – is the duty on fuel.  This duty – £0.58 on each litre of fuel (£2.20 per gallon) – is in the news today because the Chancellor is rumoured to be looking to raise it in the coming Autumn budget.  Coming at a time when fuel prices are rising to pre-2014 levels while Britain’s road infrastructure is falling apart, any actual rise will have a massive knock on impact on British households and businesses:

“Tory MP Robert Halfon said: ‘Any tax hikes on drivers will impact badly on business, the economy and push up prices we all pay in the shops.  Pump prices are already rising rapidly now, being 15p up on last year.  A fuel duty hit will slow growth and cripple many small businesses. We must keep the freeze in this levy for the whole of this Parliament.’”

The government, however, needs the additional income to respond to the growing crisis in public services such as the NHS and Britain’s struggling police forces.  And, as with Business Rates, fuel duty is very hard to avoid.  Nevertheless, the knock-on effect is likely to be a degree of trading-down incomes in order to dispense with transport costs.  This is because outside London and the Southeast, for many workers the cost of commuting for employment is now greater than the loss that would be involved in taking lower-paid work closer to home.  It is only faith in a future recovery that causes large numbers of workers to continue to commute; when that faith is lost, economic collapse will surely follow… but don’t expect the state to forgo its tax income to mitigate this.

These, then are the three vortices which (in the absence of some new high-EROEI energy source) are gradually choking the life out of our global industrial civilisation.  As the net energy remaining to us declines, an ever greater proportion of our currency and useable energy will be sucked into them until such time as our economy consists of nothing else but the growing of food and the generation of energy in the service of an ever more capricious state.  This process will inevitably involve the acceleration of the decline in living standards that those at the bottom of the income ladder have been experiencing since the 1970s.  It will also result in a re-localising of economies as the energy required to maintain global supply chains disappears.  In this respect, the conservative nationalism of Brexit and Trump may simply be the relatively benign early manifestation of the politics of our energy-starved future.

As you made it to the end…

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