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A matter of simple arithmetic

It is 2015.  Tom has a job paying £1000 a month.  He spends £500 on rent, and £75 each on energy, food and transport.  He spends another £25 on assorted occasional items like clothing.  The local council takes £150 in taxes.  He spends another £50 on various subscriptions such as his TV and gym.  Social activities like going to a restaurant or bar account for another £25.  Tom also likes to set £25 aside for a rainy day.  In the post-2008 economy things may not be ideal, but Tom is able to get by.

Unfortunately for Tom – and millions like him – not everyone was content with their circumstances.  Given the opportunity, they voted against the advice of their technocratic elders and betters, in favour of those who promised to take back control and to make their lives great again… except that that isn’t what happened.  Various new restrictions on free trade began a process of unravelling of the supply chains which had kept the cost of living far lower than it would otherwise have been.

Fortunately, the impact of new trade barriers on supply chains was small and gradual between 2016 and 2019, so that businesses and industries were mostly able to adapt to the changing circumstances.  Moreover, the glut of cheap oil from the US fracking industry helped to maintain low prices for consumers.  But then, with no consideration of the economic impacts, the public health technocracy began shutting down entire economies in the face of a virus which was only really a threat to the very old and the very sick.  This seriously accelerated the collapse of global supply chains, resulting in eye-watering spikes in prices… particularly in essentials like energy and food.

Not that the damage ended there.  In response to the Russian invasion of Ukraine, the western technocracy imposed a package of self-harming economic sanctions on Russia in the belief that the Western economies could withstand the damage for longer than the Russian economy could – European leaders, in particular, claiming that the Russian economy would have collapsed by Easter 2022.

It is just a couple of weeks before Easter 2023, and the Russian economy is still growing.  But Tom is struggling to make ends meet.  Tom now has £1500 to spend.  But each of the things he spends on have risen faster.  His landlord upped the rent to £750, because the central bank had jacked up the interest rate on the landlord’s buy-to-let mortgage.  Tom was told he either pay up, or the landlord would have to sell the house.  The energy and transport companies trebled their prices, while the price of food rose even more.  Careful saving on food and energy allowed Tom to keep his outgoings to £150 for energy and £75 for food.  But he has no choice but to pay the £250 for transport, as this is solely to get to work.  To add insult to injury, Tom’s local council has increased taxes to £200.  With careful planning, Tom is still able to pay for his TV and phone subscriptions, but he had to cancel his gym membership.  He doesn’t go to restaurants anymore, and he is no longer going to be able to put money aside for a rainy day.

If only things were to improve after easter 2023, Tom might just about get by.  But it isn’t going to work out that way.  The central bank is still raising interest rates on the basis of entirely flawed economic models which link employment to inflation.  Only when they see mass lay-offs will they begin to lower rates.  And so, Tom’s landlord is once again jacking up the rent because the Landlord is struggling to pay the mortgage.  Food prices continue to rise at rates not seen in half a century, and there are now widespread shortages of certain foods.  Energy prices are not rising quite as fast, but prices are still rising faster than wages.  Meanwhile, rates and transport costs are still rising steeply, as are the various subscriptions that Tom has thus far managed to afford.

Tom would like a pay rise in line with inflation.  But unlike last year, when employers were still worried about post-lockdown labour shortages, this year the management have made clear that further pay rises are out of the question.  Unlike better-paid workers elsewhere in the economy, Tom can’t really afford the loss of pay involved in going on strike.  And so, the only thing Tom can do is to cut back on his own expenditure… and in 2023, this means cutting everything which is not essential.

All of the subscriptions are cancelled.  Socialising has been cut to a minimum.  Tom’s house is no longer heated.  Instead, he warms just one room for a couple of hours and wears outdoor clothing indoors.  His diet has changed from what he might like to eat to just what he really needs.  Even so, Tom is now dipping into his savings just to cover day-to-day expenses.  As with millions of people in similar circumstances, Tom can only hope that things get better before his savings run out.

Real-life Toms appear in the latest citizens panel report from the Bank of England:

“In the early part of 2022, most of the people who took part in our forums were mainly concerned about the impact of rising inflation on those on lower incomes. For the more comfortably off, personal finances were less of a worry. Energy bills were rising following Russia’s invasion of Ukraine and the cost of the weekly shop was going up. But it felt manageable. Especially for those who had been able to build up savings during the pandemic.

“As the year progressed, the picture began to change. A broader range of people told us how they were feeling the effects of higher inflation and had changed their spending habits. Some were cancelling subscription services, eating out less, or delaying (or even cancelling) big spending decisions. Many switched grocery brands to value ranges or other cheaper alternatives. Almost everyone said they were trying to keep energy costs down by, for example, not turning on the central heating for as long as possible.

“Panel members who were on lower incomes said their already precarious financial situation was made worse by higher inflation.

“People told us they were struggling to afford essentials such as food, energy, fuel, and housing. Those on low or fixed incomes such as Universal Credit or state pensions were particularly badly affected. As were people with healthcare issues, disabilities, and caring responsibilities.”

Unfortunately, the Bank of England economists do not use this kind of data in their modelling, even though these are precisely the kind of red lights which signal a big recession ahead.  The point where they observed that “the picture began to change,” is the point where they should have paused their rate hikes.  Instead, because we have yet to see mass business closures and mass redundancies, they are continuing to raise rates.

At this point though, price increases – and growing shortages – have absolutely nothing to do with the amount and/or velocity of currency in the system.  Rather, we are in the early stages of a kind of whip-sawing between supply and demand, as the economy seeks to adapt to a new reality of permanently higher energy and food costs.  As Gail Tverberg recently pointed out:

“When people forecast ever-rising energy prices, they miss the fact that market fossil fuel prices consider both oil producers and consumers. From the producer’s point of view, the price for oil needs to be high enough that new oil fields can be profitably developed. From the consumer’s point of view, the price of oil needs to be sufficiently low that food and other goods manufactured using oil products are affordable. In practice, oil prices tend to rise and fall, and rise again. On average, they don’t satisfy either the oil producers or the consumers. This dynamic tends to push the economy downward.”

The old adage that, “the answer to high prices is high prices,” works to some extent here.  But the whip-saw effect is the economic dance which plays out between producers and consumers in these circumstances.  Energy is not only essential, but also expensive and long-term.  Britain’s 2010-15 ConDem coalition government, for example, was widely condemned last year when electricity prices skyrocketed, for failing to invest in replacement nuclear power stations “because they wouldn’t come online before 2021.”  Drilling new oil fields and investing in new refining capacity are also multi-billion-pound, long-term projects.  And so, a mere year or so of high oil prices is not enough to persuade investors to develop new capacity – the one, brief and once-and-done, exception being the US fracking bubble.  The problem is compounded by net zero policies which insist that much of the demand for oil be legislated to extinction within just a few years.

Meanwhile, of course, the brief period of high energy prices cause chaos in the wider economy, where demand crashes as people cease spending on discretionary goods and services, causing businesses in those sectors to go bust.  The resulting loss of demand creates an equally temporary over-supply of oil, which causes the price of fuel to fall… although, because global oil production – along with its thermodynamic content – is now declining year-on-year, prices are unable to settle at a rate which allows further economic growth or even a steady state to which the economy can re-adjust.

As in my Tom example and in the Bank of England report, as the prices of essentials like energy and food rise, consumers and businesses adjust their consumption accordingly.  Discretionary spending declines in order to accommodate spending on necessities.  At a macro-level though, this is a catastrophe because the majority of the economy is involved with trading discretionary goods and services.  Moreover, the businesses which provide those goods and services rely on a critical mass of consumers to avoid falling into a death spiral in which rising costs must be met by a shrinking consumer base.

The problem is compounded by the procyclical way in which currency is created both nationally and globally.  In both cases, and contrary to the explanations provided by central banks and economics textbooks, currency is created as debt when banks make loans.  The way this happens, however, is misunderstood by most economists.

In a sense, the connection between the real and the financial economy is as limited as the interface between computer hardware and software.  Just as Logic gates (low-level circuitry) and the CPU (higher abstraction of logic gates) provide the essential link in computers, so the issuance of debt is the point of contact between the real and the financial within the economy.  Despite the claims of central bankers, the reason why debt is – or in today’s case isn’t – issued has almost nothing to do with central bank reserves, quantitative easing or overnight interest rates.  Rather, it is the result of an assessment of counterparty risk.  In plain language, banks make loans according to how likely they believe they will be repaid.  It is as simple as that.  A business owner visits the bank to ask for an investment loan, and the bank – or more likely these days the bank’s algorithms– makes a determination based both on the investment plan and the wider economic circumstances, and then either authorises or declines the loan.  And if authorised, some measure of risk will also be included in the collateral required and the interest rate offered.  Something similar happens when Tom asks for a mortgage or a car or home improvement loan.

On the other side of this, to get anything done, actors in the real economy must use the currency generated from debt as a claim on the energy and resources they require.  In common terms, if you don’t have the currency to pay for something then you are not going to be able to buy it.  This was a point illustrated by Charles Eisenstein in the aftermath of the 2008 crash:

“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. That is the only thing missing, so insubstantial (in the form of electrons in computers) that it can hardly be said to exist at all, yet so powerful that without it, human productivity grinds to a halt.”

Mostly overlooked, but crucial to this process, is the state of the real economy itself, since this is a moving feast.  In the years after World War Two, for example, energy and resources were so cheap and abundant, that the only consideration was whether a business could attract the labour and technology to exploit them.  Meanwhile, people like Tom, who had steady jobs and good career prospects found it increasingly easy to get a mortgage or to borrow for such things as a car or a family holiday.  Fast forward to today, and the situation is reversed.  Energy and resources are neither cheap nor abundant.  With prices of essentials spiralling upward, with energy and resource production falling, and with global supply chains breaking down, banks have simply tightened lending standards – to countries, businesses and households – on a scale that has generated a dollar shortage internationally along with domestic currency shortages in countries around the world.

In practical terms, this means that just at the point where all of the players need extra currency to make ends meet, new currency is no longer being created – and would be inflationary even if it was – in sufficient amounts.  Nor does the currency problem end there, because in such circumstances, those businesses and households with the wherewithal to pay off their debts, will do so, taking even more currency out of the economy… a process encouraged by central banks raising the interest payable on new and outstanding debt.

Tom – and millions like him – may not have the time to read contrarian economists in order to better understand how the monetary system works.  And he is highly unlikely to know that even the explanation given by contrarian economists is often mythical because it is energy blind.  What Tom does know is that he needs to lower his costs and increase his income… something which cannot be achieved because his employer, his bank, his local council, and government more generally, are attempting the same trick.  He can’t get a pay rise because his employer is cutting costs and raising prices.  He can’t renegotiate his borrowing because the banks are raising prices (interest rates) and cutting costs (tightening lending standards, closing branches and laying off staff).  He can’t lower his tax burden because local and central government are cutting their costs while attempting to raise their income.

Inevitably then, something has to break because millions of people like Tom, within each national economy, are expected to be the engine of recovery based on spending currency which no longer exists.  The private sector is squeezing them with higher prices, even as the banks are taking more in interest rates and the government is labouring under the illusion that they can take even more in taxes.  But there is simply not enough of Tom left for everyone to have a piece.

The only questions left to be resolved are when the breakdown becomes obvious, and how it will unfold?

The sad answer to the first of these is that the breakdown will never become obvious because the human tendency to denial is too great.  We see this, for example, in the way a small but privileged and vociferous minority within the UK insist on blaming much of the current crisis on Brexit, despite Brexit having almost nothing to do with it.  I suspect that, even when we are reduced to eating rats and nettles, most people will claim that it is all the fault of whichever wing of the neoliberal party happens to be in what remains of the government.

The answer to the second question is, it depends.  Central banks could – but probably won’t – act on the feedback from their citizens’ panels to pre-empt the emerging crisis.  Government could – but probably won’t – abandon the idea of running a surplus during a downturn and might act to prevent the collapse of critical infrastructure and to put a public-funded floor beneath incomes.  Businesses – especially the giant corporations – might – but probably won’t – eat more of the higher costs rather than passing them on to consumers.  And crucially, governments – local and national – might- but probably won’t – seek to cut costs in order to lower tax burdens without undermining the value of the currency.

This is where the simple arithmetic comes in.  Tom – and millions like him – has his £1,500.  But between them, businesses, banks and government expect Tom – and millions like him – to stump up £1,700 to prevent them from having to take the hit.  And so, Tom – and millions like him – are simply not going to pay £200 each.  And the businesses, banks and government departments which have based their plans on those hundreds of millions of pounds are themselves going to have to default.  But it is worse than that, because they will also have to factor in the cost of taking Tom – and millions like him – to court in an attempt to recover the debt or risk a repeat of the AG insurance crisis in 2008, where too many of them seek to recover the loss from insurance, causing insurance companies themselves to roll over.

Might it be, indeed, that the way in which this plays out is that the financial “everything bubble” which was inflated after 2008 on the assumption that Tom – and millions like him – would enjoy a permanently rising income, is about to end in an “everything collapse,” in which individuals, banks, businesses and government all fail together?

As you made it to the end…

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