End of Growth Rattles Our Economic Constructs
First a warning: there is no car-chase scene from this sentence down.
The impact of this topic, though far-reaching, unfolds gradually and is barely perceptible. Again, as with other topics covered in this space, the boiling frog principle applies.
End of Growth – Past Tense
The end of growth should not be thought of as a phenomenon which will show up at our doorstep in some distant future. Instead, it is something which has already taken place. The reason it has been missed by most observers is that its effects have been masked by a huge amount of printed debt.
To illustrate this point, the first chart, courtesy of Econimica, show the US historical growth (as measured by GDP) since 1980. The blue bars paint a picture of varying degrees of growth save for 2009 in the immediate aftermath of the global financial crisis.
The next chart shows the amount of federal debt incurred during these years of GDP increases. It is an approximate on how much growth is created from borrowed money.
And the resulting growth net of the federal deficit, which is pretty much a sea of red since 2008. Note also that other forms of debt – public, private or individual – are not even included here.
Infinite Growth in a Finite World
It is also noteworthy that although the conventional view would have everyone believe that growth is a universal virtue and must be achieved at all costs, there is nothing inherently wrong with a zero-growth world. On the contrary, anyone whose cognitive ability is grounded by reality as well as those who paid attention in high school physics and biology classes would have little difficulty grasping the concept that perpetual growth is as unnatural as one can get in the real world with its physical boundaries and limits.
In nature, growth and the sources of growth, upon which growth depends, provide a constant feedback loop which makes growth self regulating.
A herd of deer, thanks to an abundance of food, grows rapidly until two things happen: (1) too many deer put too much demand on the land. The vegetation gets eaten before it gets a chance to regenerate. Eventually, starvation sets in and the deer population gets severely reduced. At the same time, (2) the population of predators also explodes to take advantage of the abundance of food. Over time, none of the vegetation, deer or predators is allowed to endlessly grow.
The same principle applies when it comes to economic activity. Just as in nature, economic growth is driven by enabling factors or sources which provide the fuels necessary for the economy to grow and which also ultimately place limits upon how growth can or cannot continue.
Driving Forces Terminating Growth
Our economy is an immensely complex system with many inputs and outputs interconnected into numerous feedback loops. The growth experienced by the current generations (the baby boomers and to some extent the Gen Xs) in their adulthood has been predicated upon a set of key driving factors which, instead of providing the tailwinds for such growth, are starting to reverse course and turn into headwinds.
Each driving factor is also itself a complex issue which deserves examination in great detail. For the purpose of this post, we will only provide a brief overview.
The most dominant factor fueling economic growth in the past five decades is undoubtedly demographics, or rather, population growth. From an economic point of view, a human, in its simplest form, represents a single unit of consumption. Not only did the population boom following the end of World War II vastly increase the units of consumption, technological innovations and cheap and abundant energy, namely, crude oil, allow people to possess more, experience more, and build more complex societies, all of which led to still more consumption. From diapers, TV dinners, cell phones and condoms to MacMansions, one saw no end to demand growth.
Fast forward to 2015, the demographics paint a very different picture. The core populations (0 to 64 years old, the population group which drives consumption) in the OCED countries, Russia, China and Brazil have peaked. From 2016 forward, there will be a net decrease in this core population, although the overall population will continue to peak before it too starts to decline.
The amount of debt accumulated at all individual, corporate and government levels had been building steadily since the 1970s. In the wake of the global financial crisis in 2008, the amount of debt literally exploded out of control.
People in the developed world have been living beyond their means for quite some time. When times are good, people spend more and expect wages to continue to rise. When times are tough, people borrow from their credit cards in order to maintain their lifestyles. Apart from mortgage debt, revolving debt (credit cards), auto loans and student loans have each reached one trillion dollars in the US. This comes at a time when job/wage growth is stuck in first gear and the boomers are starring at retirement and a ballooning medical bill within a few short years. You think they have much more capacity to rack up additional debt on yet another bigger widescreen TV?
At the corporate level, a similar debt explosion also happened after the financial crisis in 2008. Faced with little growth prospects, corporations borrowed money to engage in financial engineering – buying out peers in order to eliminate competition and buying back their own shares at ever higher inflated prices in order to keep share prices up. They keep borrowing because they can, as zero interest rate policy refugees also known as investors are still willing to buy whatever minuscule risk adjusted yields such corporate bonds offer for lack of better alternatives. However, the companies’ ability to borrow more is drawing to a close, as the damage to their balance sheets from additional borrowing is threatening their credit ratings.
The debt situation for governments does not look any better. Different levels of governments the world over have been racking up enormous amounts of debt hoping to bring back growth. The debt incurred from rounds of credit creation has done little to improve the economy other than driving up prices of financial assets. Worse still, the ability for governments to print money out of thin air indefinitely is increasingly being put in doubt.
Peak Energy/Peak Oil
You are forgiven for thinking that I must have been living under a rock in the past two years, for the mere fact that I bring up the subject of peak oil when the world has witnessed the complete collapse of oil prices and everyone around is talking about an oil glut. The reason is not so much of my thinking being so off-based as to the fact that the fundamentals of crude oil, the most critical energy source of today’s world, is shrouded by a mile thick of misinformation and how oil supply and demand is shaping up is most counter-intuitive based on what is observable and what is below the service. The complexity of the subject deserves a dedicated topic of its own which the reader is advised to check out here. But suffice it to say here that a supply crunch is all but baked into the cake.
How does the claim of oil abundance and energy independence brought on by tight oil in the U.S. measure up against reality? What is the impact of tight oil in the context of global crude oil production and consumption?
Energy of different forms, including foods, biomass, coal, crude oil, nuclear or solar, is the fundamental enabler of hierarchical complexities of our societies. In order to enable the complex societies in which we live today, large amounts of energy are required. Since it takes energy to generate energy, it is imperative that the energy invested in its generation would yield a much larger amount of energy output (a high rate of return). That large amount of energy surplus was afforded by fossil fuels and especially crude oil in the past hundred years. However, that energy surplus has shrunk to an alarming level in the past decade.
For those who bought into the notion that we just need to switch over to renewable energies like solar and wind and continue happy motoring, we have some bad news. Barring any earth shattering discovery of another energy alternative to oil and building out an infrastructure to transition to that new energy source soon enough – each of two if’s requires a miracle for it to occur at this point – we are standing at the precipice staring down at what is known as an energy cliff.
Whereas the twentieth century had witnessed unprecedented growth and prosperity riding on the extraordinary amount of energy surplus from the exploitation of fossil fuels, the steady erosion of said surplus is removing yet another one of the key enablers of growth.
Our society, the complexity of which is built upon a large surplus of net energy, will experience the effects of the energy curve and potentially even the energy cliff as the quality of our energy sources continues to degrade.
Consequences of End of Growth
The end of growth, or the mere recognition thereof, has far reaching consequences to the global economy and societies beyond the most obvious impacts. In its most simplistic of consequences, companies and factories have fewer reasons to expand production or service and, in the process, reducing their needs for additional labor.
When the reality of the end of growth begins to sink in, the impact to the financial assets will be nothing short of profound.
For debt instruments such as bonds, the ability of the issuer to borrow at an acceptable interest rate is dependent on the market environment as a whole and the borrower’s ability to service the debt in particular, which in turn is dependent on the borrower’s growth prospects. Worse still, for already overly indebted borrowers, the ability for them to roll over their existing debt in a no-growth or negative growth environment will be extremely challenging and could lead to a debt death spiral.
For the stock market, the situation would be even more dire. Not only are share prices dependent on the company’s earnings (as reflected in the price earnings ratios), more importantly for non-dividend yielding stocks, their prices depend on the perceived growth prospects of the companies’ underlying businesses. What is a growth stock worth without growth? Well, you shave off the growth multiples.
Perhaps the biggest risk of no growth is what would happen to the mountainous pile of debt accumulated by both the private and public sectors. For decades, governments consistently spent more money than they collect. The standard defenses for the practice are (1) they will turn the deficit into a surplus as the economy improves, except that said deficits seldom, if ever, turn into surpluses even during good times, and (2) we will grow out of the debt problem.
As narrative #2 is increasingly being questioned and the imminent onslaught of entitlements and other liabilities from retiring boomers, the debt reckoning is gradually but surely starting to creep into public awareness, as hard as politicians may try to avoid the topic like the plague.
In essence, the effects of the mega-driving forces of demographics, peak energy and peak debt described above are making themselves felt economically. As the prospects of growth grow dim and renewed prosperity seems to be perpetually ‘just around the corner’, the darkening of the social mood is spreading globally as evidenced by the way citizens all over the developed world voted with the middle finger against any and all entities associated with the establishment and status quo.
End of growth itself is a consequence of such driving forces. Its onset invalidates one of the most basic and fundamental assumptions upon which our contemporary economy is based. As it asserts itself, the reshaping of our economic structure as a result will play a major contributing role in the upcoming monetary reset, another topic which will be closely followed here.