Inflation - A Misnomer

How you get poorer and poorer in an economy "doing great"

No, this is not how your purchasing power has disappeared. Photo by rc.xyz NFT gallery on Unsplash

“Misnomers often arise because something was named long before its correct nature was known, or because an earlier form of something has been replaced by a later form to which the name no longer suitably applies.”

One could not find a better example to a misnomer nowadays than what most economists call “inflation”. Contrary to what the term implies (that is, an increase in prices), it is in effect a reduction in purchasing power. This means that the same money buys less bread, cheese or gasoline etc. than last year. Chances are that, as a result, you had to make some tough choices, postponing the buying of a new car, or even presents for Christmas. Some people were even forced to decide between heating and eating. Losing purchasing power is a very serious matter — no wonder that it is not widely used in government communiques.

Another important fact about “inflation” is how under-reported it is. Items can be added and removed, and their weight in the consumer basket adjusted at will to show an artificially lower number than what people experience. This not only serves to calm the public and investors by sending the message that things are not nearly as bad as they seem, but to show an increase in consumption and thus in GDP growth. Take groceries, for example. If your shopping bill goes up by 30% but only 10% is reported as inflation, then the remaining 20% increase in money spent on food can be attributed to growth. Should overall consumption (in real terms) fall as a result of this extraordinary price hike by say 10%, the government could still see an “economic” growth of 10%, despite all metrics indicating that the contrary is true. This is how the economy could be growing while average folks just get poorer and poorer. Is it any wonder that nobody talks about falling purchasing power, only economic growth?

Now, what is the usual answer from central banks to this issue misnamed “inflation”? Raising interest rates, resulting in a rise in the cost of credit. After paying mortgage and credit card fees, though, this leaves one with even less money in their pocket; directly resulting in a further reduction of the amount of goods and services one can buy. The same goes for companies investing in new production lines, solar panels or anything substantial requiring a loan. Now, all these purchases have to be postponed or cancelled in order to finance existing operations.

Seen in this light one can easily spot the logical fallacy here: central banks are fighting the reduction of purchasing power by further reducing the purchasing power of companies and average folks alike. Makes no sense? Well, according to our wise betters and elders, we must all reduce the consumption of goods and services — and thereby lower demand — so that suppliers finally lose their appetite for further price increases. Lower consumption begets lower economic output though — and lower investments all across the board — resulting in an economic slump. In a nutshell central banks are busy engineering a mini-recession to push “inflation” back under a certain limit.

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This reasoning, however, is not only mischievous it is also deeply ignorant. It is rooted in the false belief — or rather: tenet — of supply and demand, and completely ignores planetary boundaries. And this is where we arrive at the recent bout in “inflation”, or rather: the recent fall in purchasing power. Although there were quite a lot of price gauging from large corporations, the brunt of the recent price hikes came directly from increased energy costs and rising food prices. Needless to say, these two are deeply intertwined. A recent study found that food systems currently account for at least 15 percent of global fossil fuel use annually. Quote:

“Food and energy intersect through energy consumption in food production (e.g., fertilizer and pesticide manufacturing, plastic packaging manufacturing, food processing, and transport), and energy production through food and agriculture (e.g., biofuels, bioenergy from livestock and food waste, and on-farm solar and hydropower). Energy intensity in food systems is also growing due to increased mechanization, growing use of fossil-based inputs, globalized supply chains, growing demand for meat, dairy, and ultra-processed foods, and, to some extent, new food trends such as alternative proteins that require 1.5 to 6 times more energy than some meats and whole foods. Business-as-usual food production and processing means that fossil fuel use will also increase unless we drastically transform food systems to break the link between industrial food production and consumption and fossil fuels.”

Good luck with that. So when the price of said fuels go up, so do food prices, along with many other products made by using up copious amounts of coal, oil and gas. The list includes: plastics, glass, cement, iron, steel, aluminum, copper, rare earth elements, and so on. Is it any wonder then, that the skyrocketing price of these commodities have caused major financial troubles to the “renewables” industry? Something, which the above cited report overlooks completely… Along with many politicians and pundits who fail to understand the technical importance of fossil fuels in manufacturing, delivering and maintaining these new energy sources.

When fossil fuel production failed to return to previous levels after the massive 2020 supply chain interruption, we have seen a rapid rise in the cost of these essential inputs to the economy, taking affect already in 2021. The energy crisis precipitating from the war in Europe just made things even worse in 2022. Now, even after a year later, prices still did not return to levels seen in the 2010’s. In fact natural gas (an essential input to making fertilizers, glass manufacturing and smelting metals) is still 2–3 times higher in the EU than before, and 4 times higher than in the US. (This is despite the fact that consumption in the old continent has permanently decreased by 15% already.)

“Inflation” is always and everywhere a selective phenomenon, raising the cost of some goods brutally while leaving the price of others relatively intact. In this case it was driven by disruptions in the availability of fossil fuels, a trend which will surely intensify further down the road. Something, that a universal measure, like hiking interest rates cannot hope to tackle. If “inflation” were brought about — as the name suggest — a universal price increase caused by an overall increase in money supply, then raising interest rates, and thereby slowing down the issuance of credit (the main source of money) would have solved the issue already. 

Since, however, it was the essentials (food and household energy) which were driving “inflation”, the money-printing induced price increase story fell flat on its face. Can anyone reasonably expect that people will start to buy twice as much food and electricity if they were given ‘free money’? Hardly. This massive fall in purchasing power — as “inflation” ought to be called — was caused by global energy being struck by two major crises in 2020 and then in 2022, leading to a massive increase in the price of essentials.

Energy price increases, however, have much deeper roots than recent events might suggest. Due to a failure to grow energy inputs at the same rate as dictated by economic growth, the recent price hike was already baked in years ago: it was a disaster waiting to happen. Fossil fuel production has already started to taper around 2014–2018, as the shale revolution has started to run out of steam, and as China maxed out its coal production. No wonder, there is no infinite growth, especially when it comes to a finite resource, like fossil fuels. As we can see, carbon based energy has started to peak well before the recent crises.

Source: Our World in Data

Our wee little “problem” is that peak fossil fuels means peak civilization. Period. As fossil fuel production will start to dwindle, so will global energy supply. And since energy is the economy, so will economic output falter, resulting in less goods and services produced year after year. Some economists might argue that as economies develop and get wealthier, they turn towards services and use less and less energy per GDP earned. This is all fine, but I must ask how on Earth will the resulting demand increase in tangible goods (cars, smartphones, houses etc.) be met with supply on a globally falling energy input? How on Earth will we produce twice us much stuff with half the energy…? This level of shortsightedness is beyond me to comprehend. 

Should global fossil fuel production begin to fall later this decade, as it looks it will, there would be simply no way to keep producing as much food, solar panels, electric cars (and all the high tech gadgets we became accustomed to) as today. More shortages and price spikes are all but guaranteed to come.

The fall in fossil fuel production is going to be one highly uneven process, affecting some regions much sooner, than others. So while oil production might be rising in some countries even well into the 2030’s, these gains will be eventually offset by a general decline in the rest of the oil fields of the world. Meanwhile alternative energy technologies — “renewables”, nuclear, hydro, etc. not to mention the electric grid itself — will all continue to remain hopelessly dependent on carbon based fuels for their continued operation, let alone expansion… Whether the coming fall in energy output will be a result of depletion or climate policies thus will not matter.

For the record: I’m fully aware that releasing gigatons of CO2 causes climate change. This was a proven scientific fact in 1896 already, with all its consequences laid bare for the world to see. That doesn’t change the fact, however, that nobody on Earth could so far produce a single solar panel, or electric vehicle without the heat and the range of chemical inputs provided by these highly polluting fuels. Is it any wonder then, that there is literally no energy transition to talk about, just additions to an ever growing heap of carbon emissions?

Source: Our World in Data

And we haven’t talked about the ecological destruction which comes with mining and refining copious amounts of poisonous metals to build those wonder-devices from — only to run out of accessible stocks of these raw materials sooner than the conversion to “renewables” could be finished. Humanity remains in deep denial of the fact that it is technology which drives both ecological destruction and climate change. Replacing one form of pollution — or finite resource — with another thus does not solve anything. At all. It is a tech based civilization which is unsustainable, not carbon emissions.

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The price of essentials (food and energy) will thus just keep increasing and increasing, until they eat up a large enough portion of people’s and many manufacturing companies’ income to stifle energy consumption in other areas. After that happens, the rise in energy prices stops, and reverses abruptly as decreases in demand always tend to overshoot available supply significantly. This is due to the psychology of energy price spikes: everybody wants to continue business as usual — consuming at least the same amount of energy as yesteryear — as long as it’s financially possible. As prices grow out of reach (and companies’ ability to pay for), all of a sudden much more businesses shut down than that would be needed to balance supply with demand. Prices suddenly crash, but never fall below previous levels, keeping those closed businesses from returning to the market. Europe’s recent bout of deindustrialization is a case in point.

A similar story is playing out in China with coal. The world’s biggest manufacturing hub is still powered by the dirtiest of fuels, consuming more than half of the world’s supply of this energy source. Counterbalancing the fall of production in existing mines due to depletion, let alone increasing supply even further would require more and more energy as mine shafts have to go deeper, something which in a world of rising energy costs is nothing short of impossible. Rising energy prices increases the cost of mining, which in turn increases energy prices. Just like in Europe there was a price hike, soon to be followed by demand destruction. So when China talks about peaking CO2 emissions, it is a tacit admission that they can no longer afford (subsidize) coal consumption and that they face their own economic decline. 

Installing solar panels, made with coal, is just a hopeless attempt made at stopping the unstoppable.

Likewise, due to a combination of a relentless rise in the energy cost of drilling for more oil and gas (as cheap to produce wells deplete), high interest rates and volatile but still not high enough oil and gas prices, most fossil fuel companies around the world have given up on any attempt keeping production growing. Think: “voluntary” production cuts from OPEC, and privately owned companies merging or begging for higher subsidies. Should this process continue into the future, and all indications are that it will, it will indeed increasingly look like that the world doesn’t need oil, while in fact people will be literally dying to get more. Since oil is the master resource, moving the world from mining to transportation, as soon its production embarks on a sustained descent, so will the world economy hit the slides. This will put further pressure to the cost of essentials (food and energy) maintaining a steady fall in purchasing power for decades to come.

Peak fossil fuels? Whether the coming fall in energy output will be a result of depletion or climate policies, it will not matter: a fall in fossil fuel production, albeit good news for the environment and the climate, will lead to an unprecedented economic decline. Data source: Our World in Data, annotations and trend lines were my work.

Let’s face it: attaining a comfortable middle class life just by working hard no longer holds true. As the cost of living keeps increasing and the amount of money spent on non-essentials keeps declining it will be harder and harder to hold on to current living standards, let alone increasing them. “Inflation” will continue to remain selective, affecting essentials the most, as demand in these categories cannot simply decrease just because of higher prices. Non-essentials like flat screen TV-s, will get pricier too, but at a much lower rate: reflecting increasing competition and a falling demand. The coming energy squeeze will force mergers and mass firings in these areas as less and less companies will be able to pay their bills and their employees at the same time. Fewer working people would, of course, mean lower incomes and thus even lower consumption. This is the true story behind a continuous fall in purchasing power: a long and bumpy slide towards a precarious, subsistence living on the back of a falling global energy production curve.

Until next time,

B

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