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The Great Contraction: How the End of Cheap Money and Energy Will Degrade or Renew Civilisation
Nafeez Ahmed predicted the 2008 financial crash. But it was not resolved and has led to a more profound crisis which will require a major restructuring of the global economy to survive
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The global economy is moving into a deepening crisis – but what’s really driving this remains poorly understood. This is not just another recession, it is the unwinding of a global system that is increasingly out of sync with planetary systems.
The coming global financial and economic crisis is not simply about monetary policy, debt, the impact of the war in Ukraine, or other piecemeal factors – although those are all relevant. It is about unsustainable mountains of debt-based finance, coming up against the ceiling of a fundamentally self-cannibalising fossil fuel energy crisis, which is rapidly breaching planetary boundaries and destroying our life support systems.
A decade ago, I predicted the global financial system was moving inexorably toward a new major crisis, one that would erupt around the 2020s. It would have two intertwined triggers: the end of cheap money and the decline of cheap oil. And it would have two intertwined consequences: inflation, with a risk of hyperinflation; and currency devaluation. Together, these would create the conditions for a far more devastating global economic crisis.
That crisis is unfolding now. But to understand it, we need to understand the structural causes of what happened in 2008.
The 2008 Financial Crash
In his landmark warning at the International Monetary Fund in September 2006, economist Nouriel Roubini pinpointed three interrelated factors behind what he said would be an imminent global recession: global oil price shocks that were driving up inflation; mounting debt based on excessive lending to prop-up consumer spending, especially concentrated in overheated housing markets; and the deeply interconnected nature of financial networks that meant any such shock in the United States would transmit worldwide.
Roubini recognised that oil shock-driven inflation would make a cascade of debt-defaults on mortgages far more likely. What he didn’t address is the system dynamics behind these processes – dynamics which would guarantee a deeper financial crisis about a decade after.
The oil price shocks that punctured the housing bubble, triggering the 2008 financial crash, happened because around 2004 to 2005, something was shifting in the global energy system.
Instead of continually growing, the global production of cheap, conventional oil started to slow, cap off, and then plateau. Oil industry experts say that a resource ‘peaks’ in production at roughly the point when half its reserves are depleted. After that point, the rate of production gradually tapers off.
We now know that it wasn’t all oil production that had peaked – rather, only the cheapest kind of oil had hit a dramatic slow-down, resulting in an undulating plateau. So we weren’t running out of oil. Instead, we began shifting to more difficult-to-extract oil sources that need more energy just to get the oil out. That leaves us with less energy for economic activity and wider society.
From 2005 to 2007, total world oil production declined for the first time in history. Meanwhile, demand for oil continued to boom, driven by huge GDP growth which rose 9.4% from 2004 to 2005, and 10% from 2006 to 2007.
As rocketing demand hit the ceiling of dwindling supply, oil prices doubled between June 2007 and June 2008. This drove-up costs of living to unaffordable levels.
Consumers couldn’t afford to keep spending, including debt-repayments. Then the housing bubble burst.
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Shale to the Rescue?
Many of the major banks and financial institutions at this point were insolvent. If left to the dictates of contagion, the entire global financial system would have evaporated with little prospect of returning.
Governments and financial institutions responded by injecting new money into the system at record levels through quantitative easing (QE). The problem with this form of QE is that it was effectively based on further borrowing from private commercial markets, underpinning the creation of new cheap money.
This massive influx of cheap borrowing rehabilitated the banks, and allowed funds to continue flowing to both investors and consumers, reviving economic activity.
Buoyed by higher prices, oil firms invested in innovative drilling techniques like fracking in the US. Huge unconventional fossil fuel sources previously assumed to be uneconomical opened up in the form of shale oil and gas. This was one of the major sectors where major new investments were financed by QE.
After the 2008 crash, demand plummeted. But shale oil and gas production ramped up to record levels, because the oil industry bases investment and production targets on forecasts of demand, linked to previous expectations of rising economic growth.
The result was a massive glut of oil and gas on global markets. The excess of supply relative to crashing demand due to global recession led market prices of oil and gas to plummet. This created the illusion that we had entered a bold new era of super-cheap fossil fuel abundance. As QE kicked in, the avalanche of cheap money boosted the new shale enterprises.
Conventional ‘peak oil’ forecasts were wrong. We didn’t hit increasing triple digit oil prices in a world of evermore scarce oil. It seemed, on its face, that we had all the ingredients we needed to return to, if not exceed, previous levels of economic growth – cheap energy and cheap money.
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Beneath the Mask
But this convenient marriage of cheap energy and money concealed the fact that crisis had only been forestalled, not resolved.
A decade ago, I had warned that US shale was less a ‘boom’ than a “ponzi scheme” enabled by excessive borrowing. I argued we would likely see shale oil and gas peak around 2025. In the meantime, the “unsustainable shale bubble” would fuel “a temporary economic recovery that masks deeper structural instabilities”. Eventually, I wrote, the bubble would burst “under the weight of its own debt obligations”.
At the time, warnings such as this were ridiculed by bullish oil industry executives and liberal pundits alike.
Shale gas has indeed ballooned in a way that was unthinkable in the 1990s thanks to the commercialisation of hydraulic fracturing (fracking). The US is now the largest liquid natural gas (LNG) exporter in the world.
But the economics do not add up.
The shift from conventional to unconventional oil and gas did not actually create super-cheap fossil fuels, but the opposite, by increasing the costs of production. Shale needs more energy, not less, to get the energy out. In other words, the energy return on investment (EROI) – the amount of energy we get out relative to what we put in – underwent accelerated decline after the plateau of conventional oil in 2005 (it had already been gradually declining over the preceding decades).
This put shale oil and gas enterprises in a precarious position.
They needed to keep profits up in a higher production cost environment while the market price was low. So they ramped up drilling rates in the most productive areas to maximise output and sales, which in turn accelerated well depletion rates. Many shale enterprises became dependent on cheap money to cover their higher production costs. Hundreds of billions of dollars were loaned to the industry.
It was only a matter of time before this became unsustainable as growing production challenges converged with mounting debt levels and diminishing profitability.
It didn’t take long for the bankruptcies – unforeseen by most industry executives and pundits – to start. From 2015 to 2019, 172 North American shale operators went bankrupt. The rout didn’t stop, but escalated over the ensuing years, peaking in 2020 as Coronavirus pandemic safety measures saw oil demand crash.
By 2021, global oil supplies tightened, and the resulting price rises began to allow shale operators to break even. Then Russia’s invasion of Ukraine sent prices rocketing, creating a lucrative new economic environment.
The oil price hikes of 2022 allowed shale enterprises to pay off outstanding debts and return to profitability. Yet even in this favourable economic environment, shale industries have not wanted to lift production significantly despite the large global gas shortfalls due to the Russia-Ukraine conflict – and despite pressure from the Biden administration and an opportunity to consolidate the US position as a gas exporter.
The End of Cheap Money
A decade of seemingly cheap fossil fuel abundance has fostered the illusion that the global economy can continue growing based on a stable supply of oil and gas. But this illusion is about to be upended by the clear demise of both.
Since the 2008 crash, QE has not gone into productive investments. Instead, it has gone into asset inflation, commodity speculation and consumption, all powered by creating money through borrowing.
One major area for such investments was cryptocurrency. Bitcoin was founded in January 2009 as the economic crisis deepened, providing a new avenue for stupendous profits that quickly led to a wide range of other blockchain innovations while doing almost nothing to improve economic productivity.
In 2007, global debt due to borrowing by governments, businesses and households stood at 195% of global GDP. By 2020, this had grown to 256% at $226 trillion. QE was used to buttress government spending during the global pandemic to cushion its worst impacts, but most of this spending was also unproductive.
By 2022, global debt grew further to 350%, buoyed by government QE spending via borrowing to cushion consumers from the inflationary impact of rocketing energy prices and the cost-of-living crisis.
The problem is that the more money you lend into existence, the harder it becomes to repay that money, and the lower the value of the money you create – and it’s even harder when the money is not being invested in anything that will grow the real economy.
In 2010, in my book A Users Guide to the Crisis of Civilization, I predicted that QE would therefore set-us up for an even bigger financial crisis around a decade later that would see a resurgence of inflation and currency devaluations, processes that have been increasingly visible for some time and are now taking off.
The 2022 collapse of Bitcoin and the wider cryptocurrency bubble has signalled the reality that these digital assets were vastly overvalued, driven by unsustainable levels of debt-money creation that have up hit-up against the real-world economy and energy system.
This is why the unravelling of the crypto-bubble has come in time with the demise of cheap money as rising inflation has forced central banks to hike interest rates in response.
So dangerous is the situation that leading hedge-fund Elliott Management sent a letter to investors in November 2022 warning that central bank interest rate hikes to combat rising inflation could end up contributing to the risk of “hyperinflation” in developing nations – a rate of inflation that is rapid, self-sustaining, and largely uncontrolled, commonly defined as a monthly inflation rate of at least 50%.
The deeper driver of this, the letter said, is the ultra-loose near-zero interest rate monetary policies which enabled the avalanche of cheap money during the pandemic, and came hot on the heels of a whole decade of record low interest rates. This era of cheap borrowing, the letter concluded, is coming to an abrupt end. This has “made possible a set of outcomes that would be at or beyond the boundaries of the entire post-WWII period”.
As a result, the global economy is currently “on the path to hyperinflation” which could lead to “global societal collapse and civil or international strife”, the investor letter warned.
Numerous countries across the global South are now experiencing the impacts of these inflationary trends combined with haemorrhaging currency valuations, making it impossible for them to repay their debts. This growing debt-crisis is fast approaching a point where it cannot be contained.
The End of Cheap Fossil Fuels
Just as cheap money is evaporating, so too is cheap energy. In line with my 2012 prediction, experts now argue that US shale production is, indeed, reaching an inflexion point.
Last May, the US natural resources investment house Goehring & Rozencwajg found that contrary to what everyone assumes, US shale gas production is about to peak and decline as early as next year.
The problem is that “little analysis is being done by anyone on supply issues, or how long the shale gas revolution has left to run”, concluded the firm’s quarterly investment research newsletter.
Today, over half of US gas is produced from just three fields: the Marcellus and Hayneville fields account for 40%, and gas from Permian oil shale accounts for some 12%.
The newsletter’s conclusions are based on a detailed analysis of production data at these fields. Their findings were stark: the tremendous shale-driven growth in US natural gas supply is about to slow dramatically because both the Marcellus and the Hayneville fields are plateauing and will decline over the next few years.
The Marcellus “will likely stop growing within the next 12 months and given today’s completion activity will likely begin its period of steep decline in 2025” while the Haynesville “will take somewhat longer to plateau but will then begin its steep decline more quickly thereafter”, around late 2024. Even if their analysis was off by 20%, this would only push the decline out by a year. This could lead gas prices to rise as much as four-fold.
Other respected forecasters have offered similar assessments. According to London-based energy consultancy Energy Aspects, US shale oil production is likely to peak in 2024. Oslo-based energy research firm Rystad Energy is now also forecasting a US oil production peak around 2023 to 2024. Dan Eberhart, CEO of the sixth largest oilfield services company in the US says that the “consensus view” in the shale industry is that shale oil “would not grow past 2025 because of inventory degradation”.
Saudi Arabia to the Rescue?
The shale revolution is the primary resource that compensated for supply shortfalls from plateauing global conventional oil.
But there is no alternative source that can address the emerging supply gap from shortfalls in US oil production.
The Middle East is often viewed as the region that could play this role. In particular, Saudi Arabia is believed to be one of the few remaining oil powerhouses that can still help regulate the international oil market by pumping out vast volumes of oil at short notice.
But there are now growing questions about whether Saudi Arabia still has the capacity to do this for a meaningful duration– and that even if it does, whether it would be able to sustain such higher production without accelerating overall decline.
In fact, there is good reason to suspect that Saudi Arabia is already peaking.
An analysis in 2021 by the Paris-based Shift Project commissioned by the French Ministry of the Army concluded that Saudi Arabia’s oil production will peak and decline after 2030. And in July 2022, Saudi Crown Prince Mohammed bin Salman declared that after its oil production reaches a capacity of 13 mbd by 2027, “the kingdom will not have any additional capacity to increase”.
Saudi Arabia is already exhibiting signs that production challenges are happening far more quickly than this.
In 2016, I warned that Saudi Arabia was on the brink of experiencing a peak in its oil production, and that according to some studies this would happen by the late 2020s, followed by a gradual plateauing and decline of production. I also warned that on average, Saudi Arabia would experience a decline in net oil exports over time indicating this looming energy challenge.
Since my forecast, Saudi net crude oil exports have declined consistently over the last six years from 7.4mdb (million barrels of oil) a day in 2016 to 6.2mbd in 2022. While it is still not clear how close the kingdom is to peak oil, its oil production has also declined year-on-year in that period from 12.4 mbd to 10.9 mbd.
It’s possible that the Saudis wish to keep production lower to prolong the life of its reserves and remain in prime position to take market share in coming years as shale enters its twilight. Even so, this would still indicate that fields are expected to enter imminent decline. It’s therefore becoming increasingly clear that Saudi Arabia will not have the capacity to significantly increase production for a considerable period of time, even if some capacity increases are possible.
No More ‘Normal‘
The global economic crisis wrought by these converging processes will be larger and longer than previous crises. The global economy might not be able to return to equilibrium.
We face the prospect of an energy shock erupting exactly as the availability of cheap borrowing dries up. Unlike with the 2008 crash, the capacity for conventional QE to absorb the damage will be extremely limited. With the cheap debt-money bonanza over, Bitcoin and other cryptocurrencies will not be able to return unless they experience radical restructuring.
The global economy is about to be wracked by two opposing forces. Evaporation of cheap borrowing amidst rising inflation will act as a downwards pressure on demand. Normally plummeting demand would alleviate high oil prices. But the EU’s Russian oil price cap will further tighten already strained oil markets. Demand from China has also been contained due to strong pandemic restrictions. Once its winter COVID-19 wave is passed, this will contribute to resurgent demand through 2023.
If current inflation is indeed less to do with recent central bank monetary policies and more to do with underlying energy issues and the drying up of post-2008 ‘helicopter money’, this means we are unlikely to see recessionary impacts lead to dampening inflation. By around 2025, the peak and plateau of US shale is likely to create a deeper energy shock that will further drive-up oil and gas prices, which will also dramatically exacerbate inflationary pressures across the economy that worsen the cost-of-living crisis.
While Elliott Management’s potential hyperinflationary scenario in this context does not look unlikely, skyrocketing prices are also likely to exacerbate recessionary impacts that will drive massive demand reductions, alleviating pressures on the energy system. Instead of this leading to rising oil output while demand is dropping – which after 2010 led to a huge oil supply glut – it instead will see both demand and supply dropping simultaneously: a Great Contraction.
How governments and financial institutions choose to respond to these trends will determine the outcome, but the global financial and economic system has run out of options, which is why this is a truly systemic crisis.
If central banks continue to hike interest rates to control inflation, this will destroy businesses, jobs and economic growth while escalating the risk of debt crises across numerous consumer markets including housing. If they reduce interest rates and allow inflation to intensify, this will still destroy businesses, jobs and economic growth, while also escalating the risk of debt crises.
Neoliberalism has run out of road, and we will all pay the price.
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A Way Forward
Right now, there is a prevailing delusion that business-as-usual can stumble onwards. But as the financial and economic crisis intensifies, there will not be a return to normal. Instead, the crisis will create a new awakening that business-as-usual is well and truly finished. This will create an unprecedented space for new approaches to reorganising our financial and economic systems.
The only viable way forward is to reorganise the financial and economic system. We will need to pivot through this Great Contraction by mobilising rapidly to rebuild a new monetary order premised on real sources of rising productivity.
Long-term productivity declines in manufacturing, labour and so on are widely recognised as a major driver of economic stagnation, but few have recognised the mounting evidence that one of the deeper drivers of this process is related to the increasingly self-cannibalistic nature of incumbent energy, transport and food industries.
The key to economic prosperity, then, is ramping up investments in the exponentially-improving technologies in these key sectors – such as solar, wind and batteries; electrification of everything including private and public transport; precision fermentation and cellular agriculture; additive manufacturing, precision biology and nanotechnology; computing power, the Internet of Things, AI and autonomous systems, and ensuring that the productive gains from these investments are not centralised and controlled by a powerful minority, but distributed for the benefit of society.
Step 1: Mobilise fossil fuel wealth
When debt-based ‘helicopter money’ is drying up, the question of how we finance productive investments for the future is an urgent one. One answer is to mobilise the vast concentrations of wealth that already exist for the public good.
Governments will be under pressure to act. Instead of lifting taxes across societies, they should target taxes strategically at the biggest concentrations of wealth. The first priority is a windfall tax on incumbent oil and gas companies. This should be accompanied by new regulations designed to incentivise oil and gas companies to invest in clean energy technologies, thus accelerating their own transformation.
Step 2: Mobilise financial wealth
Targeting the biggest concentrations of wealth means that financial institutions, banks and investment houses which are acquiring increasing profits based on asset and commodity inflation – especially those invested in resources such as oil, gas, minerals, metals, and so on – should face increasing taxes.
Many of these institutions are strategically investing in areas where they expect inflationary dynamics to offer huge price hikes for key commodities that will allow them to reap massive profits. These profits can be taxed.
Step 3: Mobilise offshore hidden wealth
Targeting the biggest concentrations of wealth for tax also means ensuring that the largest tax evaders are made to pay too.
That implies coordinated intergovernmental action to close the loop on offshore tax loopholes so that it becomes impossible for the richest businesses and individuals to conceal their wealth and evade taxes. This should be accompanied by stupendous fines for violators.
While this seems like a remote possibility now, it will be far less unlikely as the impacts of global financial crisis sink in and generate widespread anger and resentment against what will be recognised as entrenched economic failures. In November, African nations have already won a UN resolution to begin talks on such a system.
Step 4: Create public money
Modern Monetary Theory – which despite its detractors has in fact been used successfully by mainstream institutions such as the Bank of England – offers a way for money to be created without escalating debt. Instead of money being created by private banks making loans, MMT proposes that money be created by central banks on behalf of the state.
Because there is no private bank to repay, public money does not accelerate debt to private markets. Instead, the only debt is on the part of the government itself. The government then spends that money on the real economy, into real avenues of productive investment, which then reduces any private-sector debt burden.
This approach allows governments to finance key investments in infrastructure as well as public goods and services without increasing public debt.
Step 5. Accelerate the most productive exponential technologies in the public interest
Governments must take a lead in incentivising and scaling up the most productive emerging technologies that can form the foundation of future economic prosperity. This means phasing out dependence on declining industries and phasing in blossoming clean energy, transport and food industries of the future.
The first priority in facilitating this is to leverage existing markets. That requires removing existing market barriers, and recalibrating markets so that they work fairly to allow emerging industries to compete. One of the biggest barriers is the fact that current energy markets are pegged needlessly to gas prices. This needs to be urgently rectified so that electricity generated from clean energy sources is priced independently from fossil fuels.
Another major barrier is vast government fossil fuel subsidies coupled with regulations designed to protect the interests of centralised utility monopolies. Those subsidies should be completely phased out, except for limited and temporary strategic injections of capital required for emergency purposes in the context of the Ukraine crisis, for instance.
The second priority is to create new free and fair electricity markets. The foundation of this is to create rights for individuals to own and trade electricity, which will facilitate decentralised clean energy ownership and production. This can be supported with incentives and tariff schemes designed to accelerate investment and benefit adopters.
These sorts of rights should be extended to production in the emerging transport, food and information sectors to ensure that opportunities for ownership, innovation and enterprise are distributed as far as possible. As many of these sectors tend to work better in a networked and decentralised way, this will also distribute more economic power locally.
Step 6. Strategically invest in difficult infrastructure challenges
Governments should invest first and foremost in areas that are commercially challenging, such as electrifying residential heating and cooking, including heat pumps and insulation. By bringing down household energy costs, this will provide consumers with greater spending power, allowing them to engage in more economic activity.
Other areas where investments can be ramped-up are in key industrial areas where the most productive innovations are emerging. This includes the electrification of major public services such as public transport, wastewater treatment and other areas. Support can also be provided for the electrification of industrial functions like mining, smelting, manufacturing and so on; as well as for R&D on materials innovations to produce key chemicals using clean electricity rather than petroleum; along with recycling and ‘circular economy’ practices.
Step 7. Mass reskilling programme
Economic dynamics mean that dying industries will be disrupted and replaced by entirely new ones. If societies are not alive to the risks and opportunities of these processes, risks could be amplified, and opportunities missed.
Governments can play a key role in working to phase-in new industries while phasing out increasingly obsolete ones. This can involve either facilitating the transformation of incumbent fossil fuel firms into clean energy companies or winding them down on a science-based timeline, which sees their assets and expertise funnelled into new productive clean enterprises.
Emerging industries in many cases will create far more jobs than previous ones, so integral to this programme will be reskilling and retraining fossil fuel workers and livestock farmers at all levels to move into the emerging industries of the future; while also ensuring that societies are able to benefit from talent and skills that can be found abroad.
Step 8. Big oil nationalisation
In some cases, it may make sense to bring the biggest oil and gas giants into public ownership, at least on a temporary basis, to manage either their transformation or winding down for the benefit of the wider economy.
Step 9. Work with local authorities to strategically invest in local and distributed revival
As the new clean energy, transport, food, information and materials innovations scale-up, they will increasingly distribute and localise economic activity and production. Solar power works better in a decentralised network; precision fermentation can be bootstrapped locally; platform innovations are providing more power to individual creators; and the decentralisation of clean energy, food and information production will create new opportunities for localisation of materials and manufacturing.
Even amidst all the tech centralisation going on, as these decentralising forces are being driven by economic factors, they will be impossible to completely stop, control or reverse. This will spur a great ‘localisation’ of economic power, which will provide huge opportunities to empower and enrich local communities.
Private and public power, capital and labour, individual entrepreneurship and collective ownership will become blurred and overlap, creating new economic models.
Governments can work with local authorities to spur and invest in local businesses, infrastructure and services to enhance and accelerate these processes.
There is a possibility of real positive change. It’s worth fighting for. But we can’t fight for what we can’t see. We need to ensure that as many people as a possible wake up to what this moment really is: a transformation as the incumbent system inevitably declines, and a new one emerges. We need to decide whether that new system will be a regression or an evolution.