The End Of The Road
The point beyond which progress or economic survival cannot continue
Western economies have reached an impasse. An inflection point, beyond which further increases in debt levels are no longer feasible — despite a slowing economy screaming for more investment. The onset of a long, protracted economic decline now seems to be inevitable, even to those who follow official GDP metrics alone. But what will this inflection from eight decades of growth into decline bring about? More inflation? Or perhaps a 1930's style deflationary crisis, bringing about a persistent decline in both price and economic output levels due to a lack of demand?
Next week, on the 18th and 19th of September, I will be speaking at a conference on the future titled Brain Bar — The Next 25 Years. If you are in Budapest drop in, it would be nice to meet you in person. Due to that, and my other obligations, I will most likely lack the time to write a proper post next week — please accept my apologies for that.
Thank you for reading The Honest Sorcerer. If you value this article or any others please share and consider a subscription, or perhaps buying a virtual coffee. At the same time allow me to express my eternal gratitude to those who already support my work — without you this site could not exist.
Last week we discussed the connection between energy prices and domestic (private plus government) debt levels. As a recap: every time the cost of electricity rose, the US economy got deeper and deeper into debt. No wonder: energy is the economy — money is just a claim on energy. Every economic activity from mining to manufacturing, or from services to trade, requires the spending of energy first. Without power or fuels the economy would grind to a standstill and economists would be sitting in the dark counting play money. Debts outstanding are thus a claim on future energy use: we have to burn fuel and use electricity to earn the money with which we can settle our dues.
The electric grid, on the other hand, is a perfect microcosm of the entire material economy. The price of electricity not only builds into almost every product or service we buy, but gives an overall picture of the health of an economy. Since power generation involves burning large amounts of fossil fuels (natural gas and coal), and requires a great deal of material and energy investment in infrastructure expansion and maintenance (copper, aluminum, diesel fuel etc.), the price of electricity incorporates the entire energy and metals sector. Large scale deployment of nuclear, hydro and “renewables” adds further weight to this metric: all of these “low-carbon” sources of electricity require mining ores, smelting metals, manufacturing turbines and other components… Not to mention the pouring of thousands of tons of concrete, erecting towers of steel and much more. If energy is the economy, then the price of electricity is it’s blood pressure.
Despite the huge demand generated by AI data centers (threatening to drain 12% of America’s electricity supply by 2028) the material realities of the 21st century have started to bite. The price of electricity started to rise in response to world oil and gas production failing to respond to increased demand in 2021, and many vital components getting much more expensive as a result of supply chain bottlenecks. And while the doubling of the copper price over the last six years — together with advances in mining and processing — have made it possible to economically extract the red metal from lower-grade ores, it also made grid maintenance and expansion all the more expensive. Recent wind and solar additions also took large amounts of materials and energy for their components to be mined, moved, smelted and made — not to mention the untold amount of metals which went into data centers themselves.
Without a dramatic increase in metals production, it is thus hard to imagine how the necessary grid expansion could take place without generating price spikes in both metals and electricity markets.
Expanding grid capacity further will require adding additional natural gas power plants and reviving old nuclear reactors as well — gas turbine and transformer shortages be damned. Last time I checked, however, traditional power plants — together with mining and smelting operations needed to build “renewables” and to make uranium fuel rods — will still be running on fossil fuels for the foreseeable future. Since coal, oil and natural gas are all finite resources, and their production is already plateauing, the predicament we face is not that of inadequate electric generating capacity, but declining fossil fuel and mineral extraction. By the 2030’s it really won’t matter how much more gas or nuclear we will have finally added to the mix: there won’t be enough fuel to run all of those power plants at full capacity. After their useful life is over, and lacking adequate mining capacity to reproduce them, “renewables” will also prove to be hard to replace, making their continued deployment into the decades ahead rather questionable. (1)
Wind and solar could all too easily turn out to be temporary add-ons to the electric grid, not a permanent substitution for any of the previous energy resources.
These trends, however, can only result in one thing: demand destruction. Since our future fossil fuel supply looks increasingly limited, and since every low-carbon energy source continues to depend on cheap coal, oil and gas, there will come a day when electricity generation will also peak, then decline. Such shortfalls in production are usually managed with price increases, forcing customers to use less or simply go bankrupt. (Oh, the beauty of capitalism and free markets!) There is already a bidding competition between data centers, large corporations and everyone else. As a result small businesses and many households are already at a growing risk of being priced out of the electricity market. For many electric bills are already so high that they will either have to close shop soon or stop paying their dues — so that new data centers can churn out even more AI-generated cat videos.
This takes us back to the question of domestic debt: can we borrow our way out of this mess? Well, in a nutshell, no. In greater detail: hell no. As we discussed last week, it is commercial banks who create 80% of the money in circulation by literally lending it into existence. Taking on a debt or paying with a credit card creates money out of thin air, which immediately starts circulating in the economy and chase the same amount of goods and kilowatts. And while paying off these debts in small installments takes months or years (eventually destroying this newly minted money), the total amount of debts outstanding just keeps on growing with every credit card transaction and buy now pay later scheme. (Not to mention the vast sums corporations and governments borrow to finance their ongoing operations and spending.) If we keep on borrowing at this rate (let alone at a higher one) we will just keep increasing the amount of money in circulation and create more inflation, not less.
Lending money to open more mines, factories and other productive assets, as opposed to financing consumption alone, would not solve the issue either. Resource depletion is driven by geology and physics, and while an extra infusion of cash can create a lot of activity, it cannot solve the fundamental predicament of running out of accessible easy-to-get energy and minerals. While such “productive lending” would give us access to hitherto uneconomic to recover minerals, it would also require metal and oil prices to continue to rise, so that the loans could be paid back. As a consequence the price of gasoline, electricity, metals etc. would also need to keep increasing, requiring consumers, corporations and the government to take out even bigger loans to build new homes, buy new cars or carrier battle groups. The result? You bet: even higher inflation.
Debt levels, however, have their own internal limits to growth. The last jump in all domestic debt from 185% of GDP to 254% is a case in point. During the run-up to the 2008/9 crash, households, businesses and the government have managed to amass a debt burden two and a half times the gross domestic product. Yet, oil supply failed to respond, and as China used up more and more raw materials and energy, all this increased lending did was create more inflation. Then came the great financial crisis, which destroyed a lot of illusory wealth but not the debt burden of the economy. In the years following the GFC US domestic debt was back to its previous level, at two and a half times the size of the economy. And while the FED’s zero interest-rate policy (ZIRP) did help to hide that problem, as soon as rates began to climb a little the interest to be paid on debts outstanding started to slow the economy down.
It was the return to a 5% federal funds rate, during 2022/23, which exposed the true size of the Western financial system’s debt predicament, though. In 2024 the US government spent $1.13 trillion on interest payments alone, and 2025 doesn’t look more promising either. The private sector is in the same plight. Households and businesses now owe more than $42 trillion to banks and investors; borrowed at a considerably higher average rate than that of US Treasury Securities. At a 254% debt to GDP ratio at least $2.5–3 trillion is being sucked out of the economy in the form of interest payments every year — that is 8–10% of the US gross domestic product. Piling on more debt could increase that figure to well above 10% of GDP, which makes one wonder how a slowing economy could cope with that.
If it increasingly looks like to you that we have hit diminishing returns from debt, you are not entirely mistaken. As debt levels grow, each additional dollar borrowed yields less economic benefit (productivity), and eventually becomes a drag on the economy. No wonder: since the rate of energy and mineral extraction could not be increased in proportion to rising debt levels (due to those pesky geological limitations), all this money can now do is create more inflation — especially in asset markets. You see, not all of this debt goes into the productive economy. Much of it ends up in fixed and financial assets. Households taking on a loan to buy homes tie up hundreds of thousands of dollars in real estate. Companies borrowing to buy up each other’s — or their own — shares, or banks and asset managers investing in treasuries, stocks and bonds all tie up their money in the hope of greater future returns. Increased lending thus inflates the entire economy, creating bubbles everywhere.
In the meantime, and as a further sign of decreasing (real) economic activity, the velocity of money (2) is plummeting. The number of times a dollar was spent to buy domestically produced goods and services per unit of time has been falling since 2007, and after a dip in 2020 it still failed to recover to 2019 (let alone pre-2007) levels. In practice this chronically low velocity means that consumers and firms are holding on to their cash, instead of spending it on goods and services. Although this behavior slows down inflation, it also suggests that confidence in economic recovery is still very low.
Another such indicator flashing red is the copper to gold ratio — or the price of an ounce of copper divided by that of gold. Since the yellow metal is the most widely recognized safe-haven asset among investors, it generally tends to perform well during times of crises. Copper, on the other hand, is a key industrial metal that is used globally in a wide range of industrial applications from wiring to pipes, or from power transformers to electric vehicles. Yet, despite all the hype around electrification, or the building and powering of data centers, the price of the red metal has repeatedly failed expectations. Despite its recent rise it’s still not high enough to incentivize the opening of new mines tapping into hard-to access deposits, making future supply growth a pie in the sky. Just like with electricity, demand destruction is a far more likely outcome than a miracle flooding the market with new copper. Gold on the other hand has just soared to new record highs, indicating increased economic uncertainty ahead… As a result, the copper to gold ratio continues to plummet, reaching record lows as we speak. Fun fact: based on this indicator current economic sentiment is even lower than it was during the great depression in the 1930’s.
Productive investments in the real economy are drying up everywhere in absence of high-enough returns. Investors, banks and asset managers use their massive income from interest payments and economic rent to buy up just about everything, seeking profits the real economy can no longer provide. Manufacturing companies struggle with overcapacity already — and not just in China, but throughout most of the industrialized world. Western households, businesses and governments are drowning in debt while facing job losses and deindustrialization. Wage earners struggle to pay their bills, suffering under the weight of rising energy and food prices.
With the price of electricity reaching new heights, inflation on the rise, and interest rate cuts ahead most analysts expect a resurgence of the inflation crisis. Sure, as a result of increased lending and money printing we will see inflation rising — but only on the short run. Borrowing money from banks, issuing treasury bills, or governments spending first and taxing later — as Modern Monetary Theory would suggest (3) — all inject freshly minted money into the economy with a promise to be paid back (or taxed) away later. Private and government debt, however, has already reached a level where interest payments take away 8-10% of the gross domestic product, and where borrowers already struggle to keep paying their dues. The system has become totally unsustainable, unable to take on more debt but, at the same time, unable to live without it either. The economy has entered a doom-loop where rising prices and stagnating wages force households, businesses and the government alike to take on more credit, which in turn creates more money — fueling another round of inflation, followed by another round of debt increase.
It’s hard to tell how close we are to the whole edifice to come crumbling down. When it happens, though, the shock will be profound as a multitude of banks, governments and businesses will have to be bailed out — all at the same time.
In the meantime energy prices now threaten to completely deplete the discretionary budget of everyday households and businesses, forcing them to choose between paying their bills and their mortgage. Since the price of electricity builds into everything we do, this recent spike in its price could all too easily prove to be the straw that will eventually break the camel’s back. Yet, instead of trying to slow down the progression of this crisis — i.e.: by regulating AI data center deployment — governments remain entangled in a web of private interests and industry lobby groups. This happens even as old coal power plants have to be retired due to high operating costs, removing much needed stable baseload capacity from the grid. AI, it seems, has now reached net negative societal returns — besides playing a central role in the still growing stock market bubble. Hmm, what could possibly go wrong?
Whatever will be the proximate cause, this coming banking and debt crisis can — and in my opinion most likely will — trigger a global deflationary crisis. Just like the famous Wall Street crash of 1929 did. Back then, a downward spiral of falling demand, reduced production, wage cuts, increased unemployment, and business failures ultimately lead to an economic depression lasting a decade (4), till the second world war began. In fact, I argue, many symptoms of this coming deflationary crisis are already here: manufacturing overcapacity, falling demand due to a cost of living crisis, lay-offs and increased unemployment… In the meantime both the velocity of money and copper to gold ratios have now fallen to their corresponding historic lows — just like a century ago — indicating a complete lack of confidence in economic recovery.
‘But hey, at least the stock market’s doing fine!’
Deja vu, anyone?
Until next time,
B
Thank you for reading The Honest Sorcerer. If you value this article or any others please share and consider a subscription, or perhaps buying a virtual coffee. At the same time allow me to express my eternal gratitude to those who already support my work — without you this site could not exist.
Notes:
(1) Recycling won’t save the day either. First, at every round of recycling we lose a fraction of the material — no recycling process is 100% efficient. Second, recycled metals consist of various alloys and impurities, which introduces a great deal of variance when it comes to their mechanical and electric characteristics. Only the highest cost raw materials (for example silver) goes through the necessary (and very energy intensive) purification process, the rest gets mixed into virgin materials — but only to a small degree (usually 10–30%). Thus without adequate levels of newly mined and smelted virgin material, our metal supply would plummet rather quickly, no matter the amount of stuff waiting for recycling.
(2) “The velocity of money measures the number of times a dollar is spent to buy domestically produced goods and services per unit of time. It’s calculated as the ratio of nominal GDP to the average of the money stock. Nominal GDP measures the value of all final goods and services bought by consumers, firms, the government, and foreigners in a period of time; so, it’s used as a proxy for the value of all transactions that occur in an economy in that period of time.” Source: FRED Blog
(3) Deficit spending does not necessarily have to be financed from issuing bonds. Technically speaking the treasury can spend just like any commercial bank does: by loaning money into existence... However, no amount of money spent can compensate for the loss of cheap resources and wild ecosystems. Even if governments were pouring free money on the system, all they could achieve is more destruction and yes, even higher inflation. Bonds in this sense are not merely a welfare program for investors, but an outlet valve for surplus money to go (thereby preventing it from causing further inflation). As usual though, solutions create their own problems: see the interest rate conundrum explained above.
(4) Once general price levels began to fall, consumers delayed purchases expecting lower future prices and businesses were forced to cut costs through layoffs, further reducing spending and deepening the crisis. The burden of debt also increased as the real value of money started to grow again, leading to more defaults and bankruptcies.
I feel like we need to ban AI data centers for the good of civilization. Those resources should be used elsewhere. It’s a complete waste
Too many humans are using/depleting too many natural resources and producing too much pollution/environmental damage. We are 3,000 times more numerous and consumptive than were our ancestral migratory ecologically balanced Hunter-Gatherers/pastoralists. What could go wrong? Everything.