Preparedness and the Coming Crunch

To me (and, I imagine, to many readers here), the comparatively imminent detonation of a financial time-bomb seems pretty obvious. Unable to find real growth, the economy is living instead on printed and borrowed money, and the merest whisper that the money-printing, credit-creating sausage-machine might be turned off can be enough to create panic in capital markets.

In a way, this situation is analogous to bomb disposal, except that no-one knows how to defuse this type of bomb, and few have yet acknowledged that the bomb exists at all.

Once upon a time, American comic Bob Newhart mused about how bombs are always dealt with by experts. In the ensuing sketch, a bomb is dealt with by “a team of non-experts”, with particularly hilarious results. A few years earlier, British comedy giant Tony Hancock had found himself in a similar position in an episode in which the Army sends an officer from the Catering Corps to defuse a bomb in his cellar.

In both cases, the bomb explodes.

Minus the humour, that’s where we are now, because there are few if any experts where our kind of bomb is concerned. Worse still, many of those in charge of world economic affairs don’t appear to know a bomb from a broomstick.

In the Hancock episode, Tony suggested wrapping the bomb in Hattie Jacques’ thick treacle pudding. Today, we’re doing much the same as we wrap our economic bomb in the treacle of created money and credit.

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Since most readers will know this bit, I’ll explain the underlying rationale very briefly. Contrary to widespread belief, the economy is an energy system, not a monetary one. The output of the economy is a function of surplus energy, which is the difference between (a) energy extracted or otherwise accessed, and (b) energy consumed in the access process.

Energy, of course, is not just oil, gas or electricity, but nutrition and human labour as well. The first energy surplus was created by agriculture, when the ability of 20 people to live on the labour of 19 enabled the 20th person to do other things, be it government, education, the military or – most importantly – the creation of capital goods such as ploughs, roads, barns and bridges.

The only value that money commands lies in its acceptability as a “claim” on the goods and services produced by the real (energy) economy. In the agrarian era, all transactions involved payment for labour – past labour, if you were buying an existing house or plough; current labour, if you employed someone to plant a field; or future labour, if you commissioned someone to build you a barn. “Labour”, “energy” and “capacity to do work” are interchangeable terms. Anything bought or sold today is the product of energy, but in our modern society that energy is far likelier to be provided by fuel than by human effort.

Just as money is “a claim on goods and services” – put more simply, “a claim on energy” – debt, as “a claim on future money”, is really “a claim on future energy”. That’s fine, so long as we do not create “claims” (in the form of money and debt) that exceed the real goods and services that will be available when the claims fall due. If this happens, all claims cannot be met, so the excess has to be eliminated via one or more forms of “value destruction” (of which the most obvious are default and inflationary devaluation).

The energy surplus has been weakening for some years, because the energy consumed in accessing energy – in the jargon, the “energy cost of energy”, or “ECOE” – is rising as the most efficient energy sources are displaced by costlier and more marginal alternatives.

The equation here is the “energy return on energy invested”, or “EROEI”. Back in 1990, the global EROEI was about 37:1 (38 units were accessed, 1 unit was consumed in the access process, and 36 units remained for us to use). Now, my work suggests that the global average EROEI has fallen to less than 14:1 (15 units are accessed, 1 unit is consumed in the access process, and 14 units remain for us to use).

This means that the energy cost of energy has risen from 2.6% (1/38) to 6.7% (1/15), and could soar to over 9% by 2020.

In short, our economy is becoming less productive. Real growth has stopped, and is going into reverse. Our answer has been to create money (and credit) in ever larger quantities.

Lastly, an economy probably cannot afford capital investment below an EROEI of about 14:1. That’s where we are now, and this, fundamentally, is why real (post-inflation) interest rates are being kept negative by the authorities. Negative real interest rates logically mean that nobody saves. If nobody saves, no net capital is formed, and no net investment in capital assets takes place. Many countries simply cannot afford to invest, since output is barely sufficient to meet current needs.

What happens next is that, in one way or another, money loses its value.

Are you with me so far?

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So, the challenge for us now is to prepare ourselves. This depends on where (both geographically and organisationally) we are now. If you’re reading this in Riyadh or Oslo, don’t worry about it – scarcity is going to drive up the value of your energy resources (though don’t put too much faith in any investments that you may have that are denominated in other people’s currencies).

For the rest of us, our societies have to adapt. To clear the decks, let’s rid ourselves of what might be called the “juvenilia” of transition. For the most part, biofuels are idiotic. Out of each three or so units of energy accessed, one unit is used up in the access process – and we have 7 billion mouths to feed with finite amounts of land (and increasingly expensive inputs). Electric vehicles are another form of idiocy – the process of converting other fuel forms into electricity loses roughly two-thirds of the initial energy content. The same applies to hydrogen.

Renewables are the future. Historically, they have had lower EROEIs (and higher ECOE energy costs) than fossil fuels, though this differential is now disappearing. Converting waste into heat is imperative. Systems need to be redesigned, with shorter supply lines (stop shipping food half way around the world and grow it locally instead), and we need far greater energy efficiencies (scrap the SUV and get on the bus).

In most of countries – other than the net energy producers – we’re getting poorer. That’s not necessarily the disaster that you might suppose, since the idea of a linear equation linking happiness directly to the material ability to consume is nonsense (and if you doubt that, please re-read Affluenza).

The distribution of income and wealth is going to become even more critical (and controversial) than it’s ever been before. We need to reward initiative and effort, but we will be unable to afford what I might call “fossilised wealth structures”.

We need to be flexible, and the society of the future will not be able to afford the collective indulgence of ideology. There are some things that private enterprise does far better than the dead hand of the state, but there are some services which are better provided collectively.

Our societies will need to be open-minded, pragmatic, efficient, non-ideological, fairer and – if I may put it this way – more modern.

Now, can your society change, or is the weight of tradition, consumerism, vested interests, ideology and irrationality simply too great? Are family and community values strong enough to let adaptation happen without too much social or political disorder? If your society can adapt, that’s good. If adaptation requires persuasion, involvement and effort, do it. If the prospects seem really bad – and depending, of course, on your own circumstances – you might need to move to somewhere else.

Don’t put too much faith in money, as the value of money will be trashed if we keep on creating it to sustain the illusion of normality. Farm-land is good, but only if input requirements are low-intensity. There should be no lack of opportunities, since solar and wind developments are imperative, as is waste conversion to heat.

Forgive me for finishing this way, but – please – think things through. Try to be open-minded, and don’t believe everything you’re told. We don’t need a bunker mentality, but we do need flexibility.