Financing the End of Modernity
Western neoliberal economies are on the brink of a steep economic decline. Barring an energy / productivity miracle a prolonged and deep recession is clearly on the horizon. While mainstream pundits keep “informing” the public how GDP was actually growing in the past decades (except for a few brief moments), and how the G7 is still the top economic power block, the real economy of goods and services tells a completely different story. Growth — in the sense of real economic output — has stopped 18 years ago in the West, and conditions are now ripe for a rapid contraction. A sobering assessment of the real economy — in which your humble blogger is still actively involved — has become due. Buckle up.
As long time readers might already know by heart: money is not the economy, energy is. Money is but a claim on energy and resources. Everything we mine, grow, manufacture and consume takes energy to produce. No energy, no production, no services. The more we produce / consume the more energy is used up. And while it may seem like that rich countries have somehow decoupled their economies from energy use (ie managed to grow GDP much faster than energy consumption), in fact the opposite is true. All they did was send their high energy intensity manufacturing and mining abroad, then imported all they needed using their overvalued currencies, thus becoming more independent on foreign trade than ever.
The public, together with it’s ruling elite, was led down the primrose path with GDP, and now a reckoning is in short order.
It must be stated loud and clear: Gross Domestic Product (GDP) is an entirely artificial and misleading metric. Contrary to common wisdom it is not a measure of real economic activity, only the amount of financial transactions taking place. There is a world of difference between the two. Sure enough, with the inclusion of finance, insurance and real estate (the so-called FIRE sector, all inflated by ballooning debt levels) there is an ever increasing amount of money changing hands these days… Too bad, though, that these entirely fictional activities do not add a scintilla of value to the economy. Quite to the contrary.
What the recent fixation of our elites on GDP really shows is how we have switched from a real economy based on value added work to an entirely fictional financial economy based on rent seeking. Did you know, for example, that penalties on late credit card payments count as GDP? Well, it’s euphemistically called ‘providing financial services’. Or how about the entirely fictional increase in the rental value of the home you actually occupy? If you had rented it out, you would’ve received an ever growing sum, right? Oh, you didn’t get a penny for living in your own house? That’s your problem, we will still count it as GDP growth. Or how about systematically under-reporting inflation? So any additional money you spend (above official inflation levels) on the same product or a service you used to by much cheaper yesteryear now counts as GDP growth. Clever, huh?
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In order to maintain this simulacrum of growth new money must be conjured into existence — time after time. Partly, to avoid running out of cash while paying ever more for the same products and services month after month, and partly to keep a debt based system alive. Contrary to common wisdom, money is not credited to anyone by banks from deposits, but created out of thin air, and destroyed as soon as that loan is repayed. The problem is, that new money has to be loaned into existence repeatedly, time after time in order to pay back the principal plus the interest on other (prior) loans. This is because when one gets a loan, only the principal is created (and gets transferred to one’s bank account), the interest has to be financed by someone else — by taking out another loan. Simply put there is never enough money in the system to service all existing debts at any given time. Should there be a global ban on all new loans, existing ones would immediately become unserviceable and the money system — together with the economy — would freeze to death.
This financial-economic situation we are in today is nothing new: all this has happened many times over the last five thousand years. Debt has always kept increasing exponentially thanks to interest, while productive assets (land) kept hitting limits in production or rather, diminishing returns. Energy is (and always was) the economy, from food calories stored in grains to fossil fuels powering this entire modern world. So just as every ancient civilization went broke soon after they failed to feed (and thus “power”) their population and economic growth further, so will our uber-complex economy hit the slide as soon as it fails to grow its energy use.
Remember: no net growth in energy means no net growth in the economy. And when the economy simply cannot grow further and contraction begins, then the galactic amount of financial obligations will be impossible to meet. Suddenly an exponentially growing amount of money will chase a shrinking amount of goods. Thus as soon as net energy production switches from stagnation to fall, the financial system will either default — wiping out the assets of the rich — or will switch to hyperinflation — destroying all the excess purchasing power left in the pockets of average folks. All what we have seen since 2008 was a teetering on the edge. What follows is impossible to describe in today’s terms. A panic like the one in 1929, following a similar peak and plateau of energy production, is all but guaranteed.
Seen in this light, raising interest rates are tantamount to suicide. All energy projects (be it fossil fuels, “renewables”, not to mention nuclear) require a massive upfront investment. In such an economic environment only the most profitable projects are executed, where there is sufficient payback to cover the increased payment obligations towards financiers. Without a sufficient pipeline of new energy projects, however, old retiring power plants, ageing solar panels and wind turbines or depleting oil wells simply won’t be replaced, and all we will end up with is a falling energy production. And now we know what that means.
As if on cue, a recent discussion between Nate Hagens and Luke Gromen shed some much needed light on this unhealthy relation between finance and energy. The argument is fairly simple and goes like this: if the break even price of the next new barrel of oil goes up by 8% each year due to depletion and rising costs, then so must the financial returns on treasuries increase at a similar rate. And while interest rates on investment loans can go up as high as they can, the same cannot be told about returns on bonds (where central banks actively interfere with the market to cap interest rates).
Large oil companies (national and private alike) keep their profits in treasury bonds, then use this money a few years down the line to finance their new drilling and exploration activities. It’s easy to see the double whammy here: investment costs just go up and up, while the returns on the oil company’s savings lag further and further behind. (Partly because higher interest rates and cost inflation, but also because ever more material end energy is needed to drill new wells.) So while this year’s profit (let’s say a $100 million) will worth $104 million a year later, the cost of drilling to keep production levels the same will go up to $108 million. The missing $4 million will either have to be loaned into existence (but then one needs ever higher oil prices to pay back that loan), or the amount of oil production has to be reduced. With oil prices stagnating it increasingly looks like that it simply does not worth for oil executives to store their profits in bonds any more. Instead they shower all what they earn on their shareholders, or spend it to buy up each other. The result: oil companies live up their existing petroleum resources, and then pull the plug when those run out.
‘OK’— one might say — ‘good riddance. We will invest in renewables then!’ As I keep explaining on my blog there are two major issues here. One, renewables cannot be made without fossil fuels and two, electric grids require an exponential increase in material investment to accommodate an ever increasing number of wind and solar. The more intermittent electricity generators are on a grid, the more material and energy investment is needed to make more transmission cables, transformers, switchgear etc., then above a certain limit: to build ever bigger batteries. This is a typical self-limiting negative feedback loop, where wind and solar penetration simply stops after hitting diminishing returns — leaving the grid (and all heavy industries, including mining) ever more dependent on fossil fuels. As NERC (North American Electric Reliability Corporation) warns US consumers in its Winter Reliability Assessment report:
As much as two-thirds of the United States could experience blackouts in peak winter weather this and next year. […] The regulator points to the lack of gas transport infrastructure as one of the main challenges for the U.S. grid this winter as it compromises the security of generating fuel supply. The report also notes historical evidence that extreme winter weather can also affect the production of natural gas and, as a result, reinforce the effect of weather on power supply security. […] It is not just natural gas that is problematic, however. The massive buildout of wind and solar capacity has also had an impact on electricity supply reliability and could turn into a problem during the winter.
This is not to say, that all we need is further investments in fossil fuels. That would be a disaster for the climate, ecosystems and our health alike, besides being ever less feasible as easy to drill deposits deplete. It has to be acknowledged, however, that all our energy systems are interlinked and have become completely dependent on one another. Mining and transporting vast quantities of minerals for “renewables” takes diesel, while drilling equipment and pumps require electricity. Take one input away, and the other falters as well.
Now, if you throw material cost inflation and the recent increase in interest rates into the mix, you start to appreciate how a perfect storm is approaching the “renewables” sector. The situation is very similar to the shale oil revolution, except that it’s much worse. When interest rates and costs were low in the 2010’s “renewables” boomed, just like the fracking business. As soon as interest rates started to rise hand in hand with material costs, both the shale and “renewable” energy businesses found it harder and harder to finance further growth and pay back their investors at the same time.
Irony of ironies that interest rate hikes were a response to inflation, something which was driven by ever higher energy costs, itself a result of the global energy system hitting its limits in 2021. Thus the only remaining option left for governments to save the “renewables” sector is to print more and more money in the form of bailouts. If you have a hunch that this will lead to a further increase in electricity prices and thus higher inflation, you are not entirely mistaken. Limits on growth of energy production and diminishing returns are tough to negotiate away.
So we are left with an ever expanding financial system adding debt on debt upon debt while the real economy — requiring a steady growth in energy supply — slowly withers on the vine. All it takes is a quick glance at the energy use of Western nations, to realize that something is seriously amiss, and that now they are at an unsustainable path. Since decades now. Not because of a health crisis. Not because of a war, or now two. These horrific events were just serving the final blows to an anemic economic system already in a serious trouble. It’s no wonder then that panic is growing among Western elites what to do when China takes over the leading economic role. The irony is, that this takeover has already happened. A long-long time ago. The fact that this has happened completely undetected, only proves how faulty mainstream economic models and measurements are.
Meanwhile deindustrialization in Europe is in full swing. The economic block has already lost 10–15% of its gas demand — permanently — due to a significantly higher costs of importing LNG versus pipeline gas. Many chemical and metallurgical production sites were closed, together with fertilizer plants, and real economic output has been significantly reduced. As a result the IEA is now forecasting a drop in diesel demand for Germany by some 40,000 barrels per day (a fall of around 4%) for 2023. Since diesel is mostly used by commercial vehicles (trucks and heavy machinery) this single metric alone indicates a corresponding fall in real economic output.
If you look at GDP figures, of course, none of this can be seen. As deindustrialization marches on (combined with a fall in consumer demand due to inflation), the fall in GDP is kept conveniently “in balance” by a similar uptick in financialization. A process whereby financial markets, financial institutions, and financial elites gained an ever greater influence over economic policy and economic outcomes.
As Michael Hudson writes, “An industrial economy’s decline usually provides a grab bag of opportunities for financial predators and vulture funds.” So it is in Germany. This is showing up in corporate profits in Germany, which reached a record high of 234.15 billion euros in the first quarter of 2023. It’s on display in German budget plans for 2024, which impose deep austerity everywhere except the military.
It’s evident in the growth of Germany’s private equity and venture capital industry, which tripled in size from 2012–2021, and that trend is picking up steam. According to Reuters, International and U.S. law firms continue to invest in Germany, with international mergers and acquisitions, finance and private equity hires driving legal market growth in the country
So while on paper everything looks fine — profits are up and the volume of monetary transactions (a.k.a GDP) stays flat — jobs have become precarious and real wages kept falling hand in hand with the overall economic activity. Nothing to see here, move along.
On the global scene shipping (a strong signal of global economic health) keeps sliding into a prolonged decline, too. No wonder: if you produce less, you ship less. And as the EU economy falters, so does US manufacturing plateau after a post-pandemic rebound. And just like in Europe, diesel demand in the US has started to falter, too.
An even more ominous sign of the end of growth in the West is electricity generation. Even if one holds onto the belief that an economy could be run on electricity alone — which it simply cannot — a stagnation in all across the G7 since 2005 should ring some alarm bells. Meanwhile, China has surpassed the EU27 in 2007, the US in 2010, and the G7 in 2020. So much for the West being the leading economic power on the planet. It is simply and demonstrably not. Financially, perhaps (for now). But in real terms..?
Let’s face it: lacking its own energy resources Europe has already started to circle down the drain. The US is also on a high plateau and will likely follow the EU later this decade. After a peak (followed by a rather sudden decline) in shale oil and gas production, there will be no more bunnies to pull out from the hat. The machinations with GDP, based on an ever more precarious and inherently unsustainable financial system, can only mask this decline, but it can neither slow nor stop it.
Thanks to the interconnected nature of Western debt based economies, the fall of either pillars of the old economic order will most likely lead to the fall of the other. This time, lacking an energy miracle, there will be no recovery though. For better or worse the coming financial crisis is here to stay, and most probably will severely hurt China as well through the loss of its markets and much of its foreign reserves. As usual a financial crash is notoriously hard to predict. One thing seems to be sure, however, a lasting simplification of the global economy is in due order.
Until next time,
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