The following is an extract from a recent article by Dr Tim Morgan, who is global head of research at Tullett Prebon. See the complete article at City AM.

“THE West lies at the confluence of four extremely dangerous long-term developments. Individually or collectively, they have already begun to reverse more than two centuries of economic expansion.

The first is well-known: the creation of the worst financial bubble in history – “the great credit super-cycle”. Since the 1980s, a relentless shift to immediate consumption resulted in the accumulation of debt on an unprecedented scale. The financial crisis was not entirely the result of a short period of malfeasance by a tiny minority. What began in 2008 was the denouement of a broad-based process that lasted for 30 years.

The compounding mistake was a belief that globalisation would make everyone richer. The problem was that the West reduced production without corresponding reductions in consumption. At constant 2011 values, US consumer consumption rose by $6.5 trillion (£4.1 trillion) between 1981 and 2011, while government consumption rose by $1.7 trillion. Talk of Western economies moving into services was waffle – consumers sold each other greater numbers of hair cuts and fast food, while increasingly depending on imported goods. The debts used to buy them also soared. Between 1981 and 2011, US indebtedness rose from $11 trillion to $54 trillion.

The third trend – the massaging of economic statistics – may serve as explanation for why this happened. In the US, the benchmark inflation measure has been modified by “substitution”, “hedonics” and “geometric weighting” to the point that reported numbers seem six percentage points lower than under the calculation used until the 1980s. Distorted inflation also tells earners that they are getting better off, even when this conflicts with their own perceptions.

But a final development is perhaps most concerning. The modern economy began when agriculture created an energy surplus, liberating people to engage in non-subsistence activities. A larger liberation occurred with the invention of the heat engine – energy delivered by labour could be leveraged by coal, oil and natural gas. A single gallon of petrol delivers work equivalent to 360 to 490 hours of human labour.

The critical equation is the difference between energy extracted and energy consumed in extraction – energy return on energy invested (EROEI). Since the Industrial Revolution, EROEI has been high. Oil discovered in the 1930s provided 100 units of energy for every unit consumed. But EROEI has fallen, as discoveries have become smaller and more costly to extract. The killer factor is the non-linear nature of EROEIs. Once returns ratios fall below 15:1, there is a dramatic “cliff-edge” slump in surplus energy, combined with a sharp escalation in cost. And the global average EROEI may fall to 11:1 by 2020. Energy will be 50 per cent more expensive, in real terms, than today. And this will carry through into the cost of almost everything – including food.

We are nearing the end of a period of 250 years in which growth has been the assumed normal. And, without action, this will have stark implications for the economies of the West.”

See the complete article at City AM.

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