The Breaking Point

by James Dale Davidson

  Less to Growth than Meets the Eye

  In short, even without a supercomputer and an advanced degree in economics, if you look carefully at the US GDP data, you can see that there is less to reported economic growth than meets the eye. To itemize the squirrely truth about US GDP accounting:

  • There are nontrivial questions about what should be included and left out. In general, the government answers those questions in ways that inflate growth.

  • Totals are distorted by “hedonic” adjustment of output, particularly of computers. (Today’s computer with twice the processing power of an older model is counted as two computers in national income accounts.)

  • GDP is distorted by nonsense like tallying mere promises to pay pensions in the future as current wages.

  • There is evidence of intentional distortion and dishonesty in reporting economic growth, famously characterized by Lyndon Johnson’s instructions to the Commerce Department to “correct” growth estimates.

  This brings us to another crucial methodological issue. A large and growing percentage of the GDP growth recorded in the official accounts is bogus in another sense: it is based entirely on government spending out of an empty pocket.

  The Evanescence of Decay

  A case could be made that even if increased government spending were financed entirely by drawing down a reserve fund (of which none exists), such spending of past surpluses should not be misconstrued as growth. This would be double counting of past income, as would be obvious if you put it in terms of an individual’s income statement. Say you made $500,000 in one year and saved $100,000. Then, a year later, you earned nothing but spent the $100,000 that you had saved. It would be misleading to say that your total income over the two years was $600,000.

  Equally, if you merely secured a loan for $100,000 in the second year, that would not make your income $600,000. Borrowing money and treating that as growth mistakes the nature of growth and overstates the actual vitality of the economy.

  Houston commodity trader Randy Degner, no econometrician himself, has had some fun analyzing US GDP data. Degner strongly disputes the standard practice for Washington to spend borrowed money and treat that as growth. If you follow Degner’s lead and subtract the annual government deficit from GDP data, you see that much apparent growth is only the statistical trail of revenue shortfalls, borrowing, in Morgan’s terms, against the “energy economy of the future.”

  I took Degner’s suggestion and ran through the numbers. I used third quarter nominal GDP for each year in this century—to avoid getting entangled in the government’s fishy deflator calculations—and subtracted the year-over-year growth of the national debt.

  As fiscal years end with the third quarter and the national debt is measured nominally, all the data were comparable. Degner seems to have made his calculations current through fiscal year 2010. Degner concludes in a 2011 article, “U.S. Economic Growth: GDP Minus the Federal Deficit—Doug Short,” that since 1980, there have been fifteen years with negative GDP growth, and the average GDP growth has been -0.3 percent. His data show that, without deficit spending, the GDP has actually been negative since the Reagan administration.13

  The politicians want to downplay the deficit, so they have perfected a bag of tricks to make a bad situation look better than it is. As I tallied the nominal GDP growth for fiscal year 2009 minus the year-over-year growth of the national debt, it was -15.79 percent (Degner reckoned it to be -12 percent). Fiscal years 2011, 2012, and 2014 were also all negative.

  The only year of the Obama presidency to show even a smidgen of growth in this light is 2013, in which GDP was up by the invisibly meager rate of 0.07 percent. Ironically, that meager measure of growth was attributable to extraordinarily cold weather that spiked industrial production as demand for power soared during the early months of the year. Utility demand is counted as industrial production. More to Morgan’s point, growth so far in the twenty-first century has been decidedly negative, as you would expect from the fact that the national debt has doubled since 2008.

  Economy Contracted in Every Year of Obama’s Rule?

  Another strong exhibit hinting that the US economy has been declining is the Chapwood Index, a twice-annual private survey of the actual prices of 500 broadly consumed products that middle-class people buy. Calculations are compiled under the sponsorship of Chapwood Investments, LLC in the fifty largest US cities.14 For 2014, inflation according to the Chapwood Index was 9.7 percent. As measured by the Ministry of Truth, inflation was only 0.8 percent, implying that the real economy contracted by 4.1 percent. When real GDP growth is calculated and the Chapwood Index is used to adjust for inflation, the economy has been contracting during every year of Obama’s presidency. Revised real GDP is down by 21.4 percent since 2011.

  Of course, one could question the validity of tracking an unchanging, non–seasonally adjusted basket of consumer purchases. Eventually, purchasing patterns do change with the array of options in the market. So the academic rationalizations for the various gimmicks the government employs to understate the decline in living standards are not wholly ridiculous. Equally, there are clearly items whose prices have cascaded far beyond recorded CPI increases. Here I think of health care costs, but especially tuitions.

  Declining Energy Intensity Means Declining Economy

  This also points to a correlation to which mainstream economists seem chronically oblivious: how tightly the growth of America’s economy, if any, has been correlated with the use of energy and, therefore, what the pronounced falloff in energy conversion means to you.

  The end of growth in energy inputs entails a declining surplus from which to support the overhead costs of complexity. As we have explored in depth, economic growth in the United States, as in all advanced economies, has dramatically decelerated since the 1970s. In his 2014 article, “The Beginning of the End of the Fossil Fuel Revolution (From Golden Goose to Cooked Goose),” Jeremy Grantham illustrated this as a function of decline in the value of the useful energy surplus available for exploitation. The quintupling in oil prices after 1999 drove a fifty-dollar-per-barrel swath of lower-value uses of oil out of business. This $50 per barrel loss amounts to about $1,000 per person, per year in the United States.15 It’s easy to believe that Americans have experienced at least that much economic loss.

  Recent growth rates are far too low to permit government debt, pensions, and welfare commitments to be met. Equally alarming, Morgan suggests we are closer than most people care to admit to a Mad Max moment when the structure of law, bureaucracy, and antimarket subsidies—those that have proliferated on the back of hydrocarbon energy over the past century and three quarters—collapses.

  In 1840, the Federal Budget Was $29 Million

  When you look back to the early 1840s, when hydrocarbon energy inputs were minimal, you see that government spending was unbelievably tiny by today’s standards. In those long forgotten days, the anthracite coal industry was just beginning in Eastern Pennsylvania. Total production in 1840 was just 2.5 million tons. Coal was mostly used by blacksmiths, brewers, and bakers. A few isolated households used coal for heating when they happened to live near surface outcroppings. The first railroad in the United States, the Baltimore and Ohio, began operation in 1830. But coal-powered locomotives only took hold in 1870. In earlier decades, coal played a bigger role in the production of iron for building locomotives and rails. By 1840, eleven small iron furnaces had begun using “rock coal” as anthracite was originally known to smelt iron. It was all rather basic. In 1840, there was no vast energy surplus for politicians to commandeer in order to buy votes.

  In that year, the federal government spent only $29 million. Think about that. Of course, those “dollars” were worth a big multiple of the dollars in your wallet today. A credible estimate is that each 1840 dollar was worth $3,333 current dollars. On that basis, the federal spending of 1840 would have been worth $96.660 billion today—a small fraction (about 2.46 percent) of today’s federal spending o
f over $3.9 trillion.

  Of course, in 1840 there were no entitlements. No Social Security. No Medicare Part B. No food stamps. And US military spending was not greater than that of all other countries combined.

  Also note that the federal government in 1840 operated with a 17 percent surplus of revenues over spending—with $5 million going toward retiring the national debt. This year’s cash deficit is projected at $564 billion, “only” 16.8 percent of revenues and 14.5 percent of spending. Obviously, there was a vast change in government spending after hydrocarbon inputs in the economy began to surge.

  Why Government Grew

  Do you suppose that the vast difference between the tiny solvent government in 1840 and the gigantic bankrupt government of today can be explained by the emergence of better, more coherent arguments for big government in the decades after 1840? If so, what were those arguments that never occurred to the Founding Fathers? You could parse the history books in vain looking for them. It was much simpler than that. Hydrocarbon energy had more of a say than you did. It made work so much more productive that the Treasury filled up with money the politicians quickly squandered to buy votes.

  Another metric for measuring the relative size of government in 1840 is the percentage of GDP it comprised. Of course, there was no BEA afoot in 1840 to establish an official, if “nearly worthless,” calculation of GDP. Nonetheless, economic historians (with no incentive to “spin” the data) credibly estimate US GDP in 1840 at $1.574 billion. That would have put federal spending in 1840 at just 1.8 percent of GDP.

  This glance in the rearview mirror highlights a problem looming in the future. I cannot imagine any deliberate orderly process by which big government could be shrunk to even 18 percent of GDP—ten times its percentage of 1840—no matter how drastically energy inputs recede. There is a “ratchet effect” as government grows that disables the economy from shifting successfully into reverse. A requirement for more than marginal retrenchment implies such high social stress that it would collapse the system.

  Before hydrocarbon energy inputs surged, the United States was too poor to support a massive government. Spending by any measure you care to make was a bare chemical trace of today’s budget.

  A crucial aspect of the story is that the growth in real per capita income surged alongside energy inputs, and came to a halt when the increase in per capita energy consumption stalled at about 70 million BTUs per head. It has been fluctuating around that plateau since 1972–73 (and has lately slipped even lower). Perhaps not by coincidence, productivity growth has plunged since the early ’70s when the real income of production workers stalled out. Note that energy inputs and consumption per dollar of GDP have been sliding dramatically and are now less than half what they were in the early ’70s.

  As we have explored, economic growth in the United States as in all advanced economies, has dramatically decelerated since the 1970s. As reported by the IMF, the rolling five-year average of economic growth of the OECD countries plunged from 4 percent as recently as 1988 to peter out in just a 1 percent stall after 2009. And as we’ve seen, even that is exaggerated.

  Telltale Arithmetic

  While there’s a danger of approaching too close for comfort to the telltale arithmetic that exposes the nonviability of the system, consider that recent growth rates are far too low to permit government debt, pensions, and welfare commitments to be met. Historically, oil demand has grown at 75 percent of the trend rate of GDP growth. Extrapolating from past GDP trends implies a 23 percent increase in oil consumption from 2004 through 2013.

  It didn’t happen.

  The long-established “normal” growth trend was independent of price. When oil prices rose sharply, with US oil consumption rising at 1.8 percent per year, the US oil consumption trend flipped. From July 2004 through July 2013, it turned negative to -1.5 percent per annum.

  Hydrocarbon inputs in the US economy plunged after July 2004. Thereafter, oil supplies failed to go up in response to massive increases in CapEx outlays by oil companies. By the end of 2005, symptoms of the downward spiral of retrenchment had begun to show themselves. As energy inputs receded, so did economic activity.

  By 2008, we were missing a quantity of oil production equal to the annual output of Saudi Arabia. The economy was oil-supply constrained.

  “This Sucker Could Go Down”

  Of course, you remember what happened in 2008. The bankruptcy of Lehman Brothers triggered a financial crisis that brought the whole world economy to the threshold of collapse. It was then, with his $800 billion bailout package facing resistance in Congress that then president George W. Bush made this telling declaration: “If money isn’t loosened up, this sucker could go down.” In the event, he got the bailout. Then, according to official sources, a recovery began in 2009 and everything has been getting better ever since.

  Or has it?

  “A Reality-Gap of 13 Million Jobs”

  While Barack Obama was crowing about “10 million new jobs,” the government’s own data showed that over the six-and-a-half-year period after 2008, the number of employed Americans had fallen by more than three million, in spite of population growth.

  But it gets worse. In 2015, Jeff Nielson of Sprott Money reported that the “10 million new jobs” lie, and the fact that 3 million jobs were lost, results in “a reality-gap of 13 million jobs, or exactly 2 million jobs per year.” Nielson stated that the US economy has been losing roughly half a million jobs every year of the “fantasy-recovery.”

  The American economy, as conventionally mismeasured, was growing by around 3.8 percent in 2004 and total US energy use was about 100 quadrillion (quads) BTU. It has since fallen below ninety-five quads without recovering, while GDP growth, even as reported in the official propaganda, crawled along. Even if real GDP growth in 2004 was grossly overstated in official headline reports, real economic activity seems to have receded from that level.

  Economic growth since the Industrial Revolution has been powered by fossil fuels. Lower energy consumption means a lower level of productivity and a shrinking economy.

  Growing economies use more energy. Declining economies use less energy.

  The Link between Oil Consumption and Income

  US oil consumption per employed person has been decreasing at about 0.5 percent per year, along with the percentage of the population with jobs. Diminishing returns in energy production are equivalent to a fall in productivity. This cuts income for nonelite workers, leaving them with insufficient capacity to buy many end products the economy produces.

  The result is a slowdown in growth that can be only temporarily masked by expanding debt. The conventional view attributes the decline in oil consumption per person employed to greater energy efficiency. Yes, we now have more fuel-efficient cars. Between 1973 and 2010, there was a 47 percent increase in auto mileage per gallon. But a closer look shows that is hardly the whole story of the plunge in gasoline consumption and declining mobility in the United States.

  A Three-Decade Low in Fuel Use

  According to the University of Michigan Transportation Research Institute (UMTRI), average fuel consumption by US drivers in 2013 dropped to the lowest level since UMTRI began measuring it in 1984. According to UMTRI researcher Michael Sivak, “Fuel consumption is lower than a generation ago and is some 14 to 19 percent less than peak levels in 2003–2004.” As reported by Bill Visnic in a March 2015 Forbes article, despite an 8 percent growth in population, the absolute amount of fuel consumed by light-duty vehicles decreased by 11 percent between 2004 through 2013.16

  This is an unvarnished hint of economic decline. Only a small portion, less than 20 percent, of the huge drop in gasoline consumption since 2004 is due to improved mileage efficiency within that time frame. The biggest reason for the plunge in driving is not a cultural shift, but a lack of income to support the cost of operating an automobile. Only about 18 percent of people without a car in the United States have full-time jobs. As the UMTRI reported in Visnic’s article, “The
number of vehicles owned per person and household are at the lowest points since the 1990s. Same goes for miles driven per person, driver, household and vehicle.”

  When you think about it, it is clear why suddenly cheaper gasoline could not abruptly reverse the trend and reliquefy a busted middle class. For one thing, people without cars don’t save money on lower gas prices.

  Dramatically Diminishing Returns

  For more perspective on the sharp deterioration in EROEI, consider the astonishing fact that CapEx productivity in oil production has fallen by a factor of five since 2000. And the fall is even more dramatic if you compare the rising cost of oil exploration and production (E&P CapEx) since 1999. E&P CapEx costs between 1985 and 1999 rose at an annual rate of 0.9 percent. Since 1999, however, E&P CapEx costs have been escalating a magnitude faster at 10.9 percent per annum.

  The EROEI, as measured by barrels of conventional oil production, have fallen sharply. Between 1998 and 2005, total CapEx spending of $1.5 trillion added 8.6 million barrels per day of crude production. Since 2005, $4 trillion bought a one million barrel decline in conventional oil production.

  Going Deep for Lower EROEI

  For a clear look at consequences of rapidly deteriorating EROEI, consider this comparison between the number of wells and their depth between the United States, Russia, and Saudi Arabia, each with similar daily production:

  • USA = 11.7 million barrels of oil per day, 35,669 wells, 297 million feet

  • Russia = 10.9 million barrels of oil per day, 8,688 wells, 83 million feet