Thermodynamics for Economists
Or, “Economics for Scientists”
Reverse Engineering the Global Economy
I cover a wide range of topics in this essay which I bring together to try to tell a story about a certain period in the history of life on Earth. I do my best to present the best available facts and statistics, which of course are subject to change as time goes by and new information becomes available. Those facts paint a disturbing picture that many will find unpalatable and reject. To make the most of this I ask that you try to suspend many of the beliefs that you may hold to be true and to open yourself to the possibility that many of those beliefs have origins not in fact but in repeated reinforcement from social conditioning.
It’s not quite finished yet; it’s a bit sloppy in places and still needs some cleaning up but hopefully soon it should be done (I’ve been saying that for a while…) As of Feb 2015 I am overhauling it so please be patient with any redundant topics being explained a few times; I try to explain things from different angles to make them as understandable as possible and this might result in a little too much verbage. I will try to streamline when I have all the topics adequately covered.
Latest edit: May 10, 2014 – rewrote section defining money.
Feb 4, 2015 – added summary at end, of why growth is required
Feb 13, 2015 – finished the cheetah profit explanation
Feb 14, 2015 – wrote section explaining Exter’s Pyramid
The field of mainstream economics uses many charts, numbers and theories with nice smooth lines to characterize how our economies and societies (should) behave. Since everything that happens in the universe, including our economies, is driven by energy, the economics charts by necessity imply a lot of things going on in the background. Those underlying goings-on can be quite involved, but they aren’t incorporated into the charts. This is a problem because the charts do not account for energy flow.
The Laws of Thermodynamics
The characteristics of energy flow are described by the laws of thermodynamics. The prospect of these can be a little intimidating but they are actually very simple, and you don’t need to have some complex understanding of what energy is to grasp them. In fact, most people already have a very good intuition about what energy is — it’s the stuff that makes things happen. The issue is understanding how energy behaves, because a lot of people think that we can produce energy, but we can’t. We simply use the laws of thermodynamics to our advantage.
This first part might get a little dry (depending on what you find interesting, of course — I find it very interesting) but in order to understand how our economies work it’s essential to have an understanding of how energy works. And in doing so you may also gain a deeper understanding of many aspects of how the world works too. It might take a while to wrap your head around these concepts but when you do, you will have an “Of course! It’s so simple!” moment.
The first law says that energy cannot be created or destroyed, but only transferred from one form to another, like for example, between electrical, gravitational, nuclear, chemical, heat, or motion energy (actually, Einstein’s famous E=mc2 says that matter and energy are interchangeable, but as far as we are concerned, it’s only an issue in nuclear power plants, so not much to worry about in terms of understanding the first law and how it impacts our economies).
The second law of thermodynamics says that energy always flows “downhill”. If you bounce a ball on the street, every successive bounce will be smaller than the previous one. No energy transfer event is 100% efficient. But, like Sesame Street, the second law says that one of those energy forms is not like the others; it’s special. And that special form of energy we are talking about is of course heat (hence the name, “thermo”dynamics), because there is in fact one energy transfer event that is 100% efficient, and that is conversion into heat (for example, your toaster turns electricity into heat and that’s all it does). Heat is a special type of energy because for every other kind of energy transfer event, the inefficiency ends up as heat. Heat is the lowest common denominator, the “sump” in the world of energy into which everything else flows. But even heat flows “downhill” too, and the way it does this is that it always spontaneously flows from hot to cold.
There, now you have it! Those are the laws of thermodynamics! They only get more complicated when you attach math to them. Here are some typical efficiencies:
- burning coal to produce electricity: 40% (the other 60% ends up as heat)
- burning natural gas to produce electricity: 60%
- burning gasoline to drive your car: 20% (the other 80% ends up as heat)
- transferring electricity long distances through high wires: 90% (the other 10% ends up as heat)
- charging and driving an electric car: 80%
- converting sunshine to electricity with a solar panel: 15%
- blowing a wind turbine: maximum 59.3% (the Betz limit)
- bouncing a ball on the street: about 50% depending on the ball and the surface (the other 50% ends up as heat)
- photosynthesis in plants: 1% if you’re very lucky (the other 99% goes to various places but ultimately ends up as heat). It’s usually more like 0.01%.
Interestingly, all of the usable energy percentages above mostly end up as heat too, eventually, just a little bit later on.
It is useful to visualize that virtually all of the energy we use can be traced back to nuclear reactions at some point. Nuclear fusion of hydrogen in the Sun powers our biofuel (including fossil fuel), wind, solar, and hydro systems. Nuclear fission powers our nuclear reactors (nuclear fusion of elements of mass less than iron releases energy, whereas fission of elements larger than iron releases energy). The uranium used in the reactors comes from leftover heavy elements created in supernova explosions 10 billion years ago, before our solar system was even formed. All the heavy elements in the solar system were flung out to create the planets while the lighter hydrogen formed the Sun.
Geothermal energy systems harness energy from the Earth’s core, which is a result of the accumulation of heat over billions of years from radioactive nuclear decay of certain unstable isotopes. Our final remaining source of energy is tidal. This does not come from nuclear reactions, but rather from the tidal pull of the moon, which is the residual rotational energy from the formation of the planets 5 billion years ago, which I guess you could argue was a nuclear event.
What our energy “production” systems do is harness the energy released through the various mechanisms above, like you harnessing a horse and jumping on its back. You do not power the horse and you do not consume the horse either; all you do is go along for the ride. If this energy was liberated, but not harnessed by us, it would eventually end up as heat and be dispersed to the universe, since energy cannot be destroyed (it can, however, be tied up in potential energy forms like fossil fuels in the ground for millions of years). This energy release and dispersion to the universe still ultimately happens when we harness it for our own uses; we aren’t fundamentally changing where the energy ends up. But what we do is get it to do useful things for us on its way down the ladder.
Imagine you had a tank full of propane. You could open the valve wide and burn it all off to liberate the energy in five minutes, but that isn’t very useful. It’s much wiser to slowly feed it to your barbecue or heater and have it do something useful for you over a much longer time frame, like heat your motorhome. In both cases the same amount of energy is released and it more or less ends up doing the same thing – radiating heat to outer space.
For another example, consider a hydroelectric dam. If we didn’t harness the energy from water running downhill, that energy would have otherwise ended up as heat in the water of the river — yes, a river releases heat as it cascades down — it’s just that the heat capacity of water is so high that we don’t notice the slight temperature increase. When we instead turn some of that energy into electricity by turning turbine generators as the water cascades down, the same amount of heat ultimately gets released, but some of it just gets diverted through our toasters and TV’s first.
Since our planet Earth is continually taking in energy from the Sun, but remains more or less thermally stable, the first law of thermodynamics (you cannot create or destroy energy) dictates that our planet must radiate that energy away back into outer space as heat. So too is virtually all the energy we use in our economies also ultimately radiated to outer space as heat as well (we also release higher energy radiation to outer space via radio waves and light, but this is minor). This same process happens all over the universe, except that there is a lot more higher energy radiation like light and X rays being released as well as infrared heat (look up to the stars or the Sun). But the universe is not getting warmer as a result of all this heat radiation, because it is expanding faster than it is heating up. It has expanded so much that the background temperature in the shadow away from the Sun is minus 270 degrees Celsius, or 3 degrees above absolute zero. This corresponds with the cosmic microwave background which is the original extremely hot radiation released by the early universe, having been expanded and muted for 14 billion years. This is how low the surface temperature of the Earth would drop at night if it didn’t turn on its axis (so that there was always a “Dark Side of the Earth”) and there was no atmosphere. Think about that on the next starry night. It’s cold out there!
An interesting experiment is to put some water in a relatively deep, open styrofoam box and leave it outside overnight in the summertime. On clear nights that water will freeze! The styrofoam insulates the water from heat radiating up from the Earth, and at the same time the water is exposed to the near absolute zero temperature of outer space, and therefore the heat spontaneously flows from warm (the water) to cold (outer space) via infrared radiation all night long. The result is that the temperature of the water continually drops and it freezes. On cloudy nights this doesn’t happen because the infrared radiation (heat) being emitted by the Earth bounces off the clouds back towards the ground, which of course includes the water in the open-topped styrofoam box. This is the principle behind the Earth’s greenhouse effect, and why there is concern about global warming because of increased carbon dioxide concentrations. CO2 is a greenhouse gas, meaning that it absorbs infrared radiation and then radiates that energy away again in random directions, including the direction back towards Earth, thereby trapping heat in the atmosphere for longer than would be the case if it didn’t absorb infrared heat. What’s happened is that over the Earth’s history the atmosphere’s CO2 concentration has been continually decreasing as fossil fuels were deposited in the ground over millennia. At the same time, the Sun’s intensity has been continually increasing, which has tended to counterbalance the Earth’s diminishing greenhouse effect and maintain a somewhat constant temperature throughout the Earth’s history. Now, of course, we are increasing the greenhouse effect again by liberating that stored carbon. It’s a lot more complicated than this though so I won’t go into global warming beyond this. But it is an interesting application of the laws of thermodynamics.
Along with the universal conversion of potential energy into heat whenever anything happens, comes another universal phenomenon. Actually, it’s the same phenomenon, just explained in a different way. Anytime anything happens, from you typing on your keyboard, to water vapour condensing in the clouds, to a car moving down the road, the disorder of that system, or alternatively of the universe (because that by definition encompasses every closed system), increases. This disorder is called “entropy”. Entropy is an esoteric concept and I want to expand on it more in a future essay. For now, just consider entropy to be a measure of how randomly disordered the energy contained within a chunk of stuff is. The lowest form of energy for a system is heat, which represents the average of how fast all the molecules making up that hunk of stuff are vibrating and bouncing against each other. These vibrations can be considered to be random in speed, and therefore “disordered”. This would be in contrast to say chemical energy contained within that stuff, which would be represented by some chemical bonds that all of the molecules contain; it isn’t random. This is the easiest way to envision entropy, although there isn’t really one single “right” way to define entropy because it isn’t a logical concept that our brains can fully comprehend.
Ever since the Big Bang (whatever that was), the universe has been getting more and more disordered. This increase in entropy is like time, or pedals on a bike, in that it only goes one way. It is why energy flow is inefficient and results in the production of heat (disorder) as a byproduct. It implies that every time we trigger an energy transfer event to happen to do useful work for us, the resulting energy states cannot thereafter go through further energy transfer events to produce more useful work than the first time, because every time the energy is transferred, it becomes more disordered; its entropy increases. The more disorderly a system is, the less able it is to do useful work.
That might sound complicated but it’s actually stupidly simple. If you have some propane and oxygen, which you then ignite and burn, you get carbon dioxide, water, pressure and heat as a result. What the second law says is that you can’t take that heat and pressure energy and put it back into the carbon dioxide and water to come up with the original propane and oxygen, without additional energy inputs. It basically says, “You can’t go home again”. “You can’t do the same thing twice”. Obviously! You can blink your eye many times but each time you do it, you are using new energy. Each eye blink is a unique event because energetically, all that’s happened is that you have burned a tiny little amount of new oxygen and propane (or its biological equivalent) in order to blink your eye.
Another way of envisioning the second law is that it says you can’t go back in time and do the same thing over again that you already did! That probably opens up a whole new realm of discovery and deep philosophical musings which I think may be beyond the theme of this discussion…
This is why claims of magical water-powered cars are fairy tales. There’s a reason no one has ever seen one, because they do not exist. To say that you can take water, convert it into hydrogen and oxygen, and then burn these to produce water again, along with liberating additional new energy, is no different than claiming that you can go back in time. In a thermodynamic sense, this is exactly what these water-powered cars are supposedly doing. Maybe some day someone will figure out how to crack time travel, but in the meantime I’m pretty sure that the makers of water-powered cars haven’t come to these discoveries, because I am certain that if they had then they would be moving on to much greater pursuits than spreading rumours about the existence of water-powered cars!
The ability of a system to do useful work is called “exergy”. Exergy has the same units as energy but it measures potential useful energy, not total energy, and therefore for any given system it can actually go to zero. The “energy” of a closed system, on the other hand, can not only not go to zero, but it can’t change at all! For example, consider a pressure tank divided into 2 compartments filled with air, one side at high pressure and one side at low pressure. A valve separates the two sides through a pipe, and that pipe goes through a turbine. That system has the ability to do useful work — it has exergy.
But the total energy contained within that pressure vessel remains the same throughout this whole process, since the first law of thermodynamics says that energy can be neither created nor destroyed, and no energy passed through the well insulated external walls in either direction.
Now, the vessel is useless as an energy conversion device. But is it? What if that vessel was made of wood? If it is in an oxygenated environment you could then burn it and liberate some more energy as well. Would it then have no exergy left? Maybe.
Would all the exergy then be gone? Well … what if the water vapour produced from burning that pressure vessel was contained and condensed, so that its latent heat energy was removed to do something else useful?
It can therefore be seen that the term “exergy” is a relative concept and it all depends on how one defines the boundaries of the system in question. But there is not infinite energy available because every time exergy is squeezed from a system, the less able it is to do further work, until its usefulness becomes so small that its exergy can be considered to be zero for all practical purposes.
So now, answer this question: What defines an “energy conversion device”? What qualities does a hunk of stuff need to have in order to be considered an energy converter? The answer? EVERYTHING is an energy conversion device! You looking at it means it is an energy conversion device. Individual energy conversion devices are extremely simple. There is nothing special about your TV that makes it an inherently different lump of matter than a piece of wood. It just seems magical because it contains many many single energy conversion devices doing things in an organized fashion. But each of those individual energy conversion devices inside your TV is no more complicated than burning a piece of wood.
Another way of looking at the second law of thermodynamics is to flip it around. On one hand you can say that any time a higher potential energy source (water above a dam) is converted to a lower potential energy state (the same water below the dam) in order to do useful work for us on its way down the ladder (turn turbine blades), a portion of that energy transferred (gravitational energy) is inevitably converted into heat (greater entropy) as a byproduct, and therefore the useful work that was produced (electricity generation) can never be 100% of the total original energy. But to look at it from the other perspective, you can also say that any time heat spontaneously flows (as it always does) from a higher temperature source (like a boiler burning natural gas) to a lower temperature sink (like a river situated beside this boiler), you are able to convert some of that heat energy into useful work (turn turbine blades and produce electricity). But the laws say that in practice the most you can ever hope to achieve is around 60-70% efficiency. The greater the difference in temperature between the heat source and the heat sink, the greater the potential efficiency that this conversion into work can be. The picture on the Wikipedia Carnot page may help explain this. The first three efficiencies in my bullet list above are examples of this “thermal efficiency”, while the others are just plain old efficiencies — they aren’t “thermal”. This is the way that most of our electricity is produced, from the Rankine Cycle, which converts into electricity a portion of the heat liberated from burning natural gas or coal, or splitting uranium atoms.
These thermodynamic relationships can be summarized graphically for some everyday events in our lives. The most common example is what happens in an engine through its repeating combustion cycle. Equally common is the refrigeration cycle. Most other things in our lives (eg the biochemical reactions going on inside us on a molecular scale) are too complex to display on such a simplified chart, and the validity of such an analysis at a biomolecular level loses its significance and instead becomes much more interesting, but that is another story (subatomic “particles” can violate the laws of thermodynamics for short periods of time, which has much greater philosophical significance than you might think, because they aren’t really “particles” as you think matter is — they no longer have a defined position and velocity).
These laws of thermodynamics have been found to be the most universal things we can study. Nothing above microscopic atomic “particles” can violate them. They aren’t some abstract theory inapplicable to real life. Rather, they describe with 100% precision the energy aspect of every process that happens. If you want to know which events in the world are governed by the laws of thermodynamics, an easy way to determine this is to go find a very thorough dictionary. Now, start at the beginning and for each noun in that book, pair it up with every single verb in that book that you think could ever conceivably go with it. That there is gives a good indication of how many things are governed by the laws of thermodynamics. They are as valid for frogs in a pond as they are for stock brokers at the NYSE (well, it’s all automatrons at the NYSE now…), as they are for black holes in the farthest reaches of the universe, as Stephen Hawking discovered. It would at first appear that since black holes suck up matter, the entropy of the universe should decrease as a result (since all matter has an entropy value associated with it). Sucking up matter would appear to violate the laws of thermodynamics because the total entropy of the universe would decrease as a result, and the laws say that entropy must always increase. But what also happens along with this is that the ubiquitous instantaneous appearance of equal but opposite matter / antimatter particles (which normally almost instantly cancel each other out and disappear again), when happening near a black hole’s event horizon, results in one particle, due to its slightly different properties, being pulled into the event horizon and removed from the universe, while the other particle remains. This particle radiates out into space, creating a “halo” around black holes, which is called Hawking Radiation. The increase in entropy resulting from this halo is consistent with the reduction in entropy resulting from spaceships flying into the black hole, and therefore the laws of thermodynamics remain satisfied. So even black holes cannot violate the laws of thermodynamics. If you wanted to choose the most unwinnable battle you could ever imagine, try to fight the laws of thermodynamics. You. Will. Lose. Period.
Accepting these laws is a little depressing because they say that there is limited energy available in the universe (actually, to be correct, that there is limited order available since the amount of energy is pretty much set) and that when it snuffs out there is nothing we can do about it. This expected fate of the universe is called the heat death. But that’s a long, long ways off in the future. That’s where your spirituality comes into the picture because there’s more to the universe than just energy flow. But energy flow is something we cannot blissfully ignore or deny. Well, we can actually … at our peril.
There’s Trouble Brewing
Why these laws are the way they are is up to anyone’s belief system to explain – God, Allah, Bodh, material reductionism, etc. So you need not feel threatened by them. But they are what they are and they cannot be disputed. They aren’t up for debate.
And by now you might be wondering … when is he going to get to the point, and what do black holes have to do with economics? Well, when it comes to thermodynamics, a lot actually, because most (all?) mainstream economists have managed to convince themselves of certain principles that violate the laws of thermodynamics. Of course, nothing can do that, not even black holes, at least statistically on a macroscopic scale. Therefore, we must entertain the inevitable conclusion that if we are to continue following these flawed economic principles then we will be encountering some major problems in the near future when the limits of the laws of thermodynamics come knocking. The problem is, just because an economist can write an idea down in a chart on a piece of paper, does not make it genuinely applicable to the real world. This is why the scientific method is important, because it provides you with the obligation to test your hypothetical idea in the real world and challenge its validity. Unfortunately, mainstream economists do not follow the scientific method. Therefore, any of the wonderful “theories” they produce should be received with great suspicion.
Essentially, what mainstream economists are putting forth is a perpetual motion machine (a water powered car). Nowadays, if an inventor proposes a design for something that operates as a perpetual motion machine, no one will take him / her seriously, and his / her reputation will have been seriously tarnished as a result (and of course, the invention won’t work so he / she won’t get rich either, unless investors can be duped into giving money). On the other hand, if a professional economist proposes a theory that violates the laws of thermodynamics, instead we appoint him as our leader, pay him lots of money, and put great faith in his ability to direct our societies competently. Because we all like to hope, and have faith in the future. If someone stands up and confidently throws around lots of complex jargon to make it sound like he understands what he’s talking about, we tend to have faith in such a person. I suggest, however, that while hope and faith may be integral to religion or humanitarian causes, or cancer treatments, they have no rightful place in sound economic management.
Our economic models imply the existence of not only perpetual energy available to power our economies (which violates the second law, if that energy is derived from a non-renewable source), but perpetually increasing energy (which violates the first law, point blank). Our apparent violation of these laws has thus far worked out okay over the history of humankind because we were not of a size approaching the limits of the laws of physics for the processes of the planet that support us — we just learned how to liberate more and more energy in new and innovative ways, and to use it more efficiently. But there are limits, and we are quickly approaching them. The Malthusians simply didn’t have their numbers right, and they mistakenly presumed that population growth would increase exponentially as people improve their standards of living, which is actually the opposite of what typically happens (most liberated women don’t want to spend their whole lives as baby factories).
One of the fundamental problems with mainstream economics can be seen early on in any introductory economics textbook when the Production Possibilities Curve first presents itself. This is a two-dimensional representation of the amounts of goods or services that the labour force of an economy could “produce”, versus producing something else. This curve shows how the total productivity of an economy hypothetically shifts as labour is diverted from one activity to another. A country could manage its forests to produce wood sustainably, or it could cut them all down and turn them into farms. Or it could do a bit of both, but not all of both.
When economic growth happens due to improved technology or population increase, the curve shifts outwards. More goods and services are produced. This is the goal of economists, because everybody wins, right? We all now have more prosperity, more economy of scale, more good stuff to raise our standards of living and make our lives better, more flat screen TV’s from Asia, and most importantly, more opportunities for investment in a growing return so that we can make more money! Because as we all know, money equals happiness!
Well, of course fundamentally, that’s not really what has happened. According to the Production Possibilities Chart, all this wealth was created out of nothing more than labour mining raw materials from the land and turning them into goods … presto! End of story. But as I hope my energy explanation above has suggested, there is actually much more going on here than what the Production Possibilities Chart would suggest. So how does the Production Possibilities Curve incorporate energy? It doesn’t. That’s the concern of some other supply / demand chart to sort out, I guess…
What Kinds of Energy Drive our Economy?
What is the nature of the energy needed to support economic productivity and growth? It is useful to break it down into two informal types, which have no real hard scientific delineation separating them, other than for the implications of how one of those types of energy is “produced”. But for the purpose of economic / ecological analysis, their separation is critical. Firstly, we have what I call “technical” energy, or the energy needed to keep the mechanics of our societies going. This is the electricity to run our computers and factories, natural gas to heat our homes, coal to refine metal ores, and gasoline to drive our cars. This can be thought to be separate from the second of my arbitrary types of energy, or “biological” energy, which is the food we eat that powers our bodies and therefore by extension all human labour which forms the basis of our economies.
These two essential types of energy can be thought to be independent of each other because, although “biological” energy can be easily converted into “technical” energy by burning food as a biofuel (eg, ethanol from corn, or biomass-burning electricity generation power plants), it is very difficult to go the other way and convert “technical” energy into “biological” energy. This is because all “biological” energy comes directly from sunshine, via photosynthesis in plants — like, ALL OF IT (actually, that’s not quite true since on the bottom of the ocean are black smoker volcanic vents spewing out hot water and sulphur chemicals which power entirely different kinds of ecosystems, but these are insignificant as far as human food production is concerned). You just can’t make food out of natural gas or oil, at least not on a significant scale. You can make fertilizers out of natural gas and drive farm equipment around using oil products, but all this does is stimulate plants to sequester more energy from sunshine; the energy in the plants does not come from the fertilizers. The only way to do this would be to build greenhouses and power the lights with electricity made from some other energy source, as an aquarium does. But this is neither cost nor energy effective.
So the “biological” energy we have available to us is much more constrained than “technical” energy, and comes with a whole host of associated environmental issues, by virtue of it all necessarily being “produced” by plants sitting happily out in the sunshine somewhere. No happy plants? No food! The more versatile “technical” energy doesn’t have nearly these limitations since electricity can be produced in many different ways depending on what conditions merit at any given time or place.
As we all know, plants convert sunshine, carbon dioxide and water (along with nitrogen, phosphorus and a bunch of other “fertilizer” elements) into carbohydrates (sugars) and to a lesser extent other complex organic molecules like proteins and fats. Wood is actually a sugar — that’s why cows eat it. The chemical bonds holding these complex molecules together contain more energy than the bonds in the constituent molecules used to build them do, since the energy of sunshine has been converted into chemical energy via photosynthesis and stored in those complex molecules. This chemical energy forms the basis of the food chain. Animals eat the plants and store the carbohydrates in their tissues. When these complex molecules are metabolized by animals, the chemical equation goes back the opposite direction and they release the energy and allow the animal to live — to move! Along with this, the water and carbon dioxide are released back into the atmosphere, when you exhale (some desert animals never need to drink — their water needs are fully satisfied by metabolism of carbohydrates). There are typically several levels (“trophic” levels) of animals in the food web, with some eating only plants (herbivores), some eating only animals (carnivores), and some eating both (omnivores).
Because the second law of thermodynamics states that anytime energy is transferred (basically, anytime anything happens), the amount of useful energy available to do work (exergy) is diminished (because the entropy, or disorder, has increased), it therefore follows that each successive step up the food chain has less and less carrying capacity for energy, because it takes energy to grow, reproduce, run around, and enjoy living – energy which is not otherwise devoted to accumulating carbohydrates, fats, or protein from the trophic level beneath. The ratio of energy for each successive trophic level is about 1/10, but this varies widely. This results in the trophic pyramid, which shows the amount of biomass at each trophic level decreasing up to the apex predators like cougars or orcas, which are rare. This isn’t actually always the case in every ecosystem, however, since recent studies of pristine unfished coral reefs (yes, there still are some) demonstrate that there is actually more biomass in apex predators like sharks than in smaller herbivorous fishes. This is possible because the sharks are metabolically slower than the little fishies racing all over the place, and the lower energy expenditures of the higher trophic levels can sustain a greater biomass. But soon this will no longer be the case, however, because we are overfishing the oceans to oblivion, mining out all higher trophic levels.
Since the first law of thermodynamics says that energy cannot be destroyed, if each level of the trophic pyramid contains less energy than the one below, then where did the energy go? You know this by now! It was either 1) radiated out to outer space as heat (your body is hot), or 2) deposited in the ground (in reality, very little of the energy is deposited in the ground. Virtually all of it is radiated back out to outer space). Fossil fuels are simply those complex organic molecules up the pyramid, and all the energy they contain, being deposited in a place without oxygen where that energy cannot be liberated until we dig them up and burn them. Flesh turns to goo after a few million years under heat and pressure. To be more scientifically accurate, biomass is composed primarily of carbon, hydrogen, and oxygen; hence the term “carbohydrates”. Fossil fuels are formed when the oxygen atoms are removed from the organic matter as a result of geological process taking millions of years, leaving behind carbon and hydrogen; hence the term, “hydrocarbons”. Hydrocarbons are much more useful than raw biofuels as portable liquid, solid and gaseous fuels due to their more practical chemical properties.
Coal is the remains of ancient swamp forests from the Carboniferous Era; oil is the remains of algae that sank to the bottom of vast shallow seas; oil sand is oil deposits that have been partially broken down by bacteria with much of the lighter volatile fractions having since evaporated; oil shale is solid kerogen deposits (the precursor to oil) that have yet to undergo the cooking process to drive off the oxygen and turn them into conventional oil. Natural gas is the simple companion molecule (methane) that comes along with all of this.
The field of ecological energetics is well summarized in this page. Scroll to the bottom of that link and take note of how much of the planet’s net primary production (the total amount of sunshine energy that is converted into chemical energy and stored by plants) is now sequestered by humanity.
Despite all our modern technology, we have not been able to escape the limits imposed by the trophic pyramid. Our food comes from this triangle, and NOWHERE ELSE. Food cannot be created artificially due to unresolvable stereochemistry mismatches relating to the structure of complex molecules and how they interact with enzymes in our bodies which break them down. All food is produced by plants. Period. (The only exceptions being minerals in vitamin pills, and salt, neither of which provide energy). You can confirm this by walking around the supermarket and reading ingredients labels. Very few of those chemicals with big long names have nutritional value, and those that do were almost all ultimately produced by plants!
It is therefore pretty obvious that there is only so much area (ecological productivity) on the planet that can be devoted to producing food for us and supporting our economies. How much? Let’s go back to the topic of Malthus to answer that.
While Malthus was incorrect in his assertion that human population growth would increase exponentially as standards of living improve, he was correct in a slightly different way because the ecological footprint of people increases significantly with a rising standard of living. In the end, the result is similar. Ecological footprint is a somewhat esoteric number which describes how much ecological productivity (defined as earth-averaged hectares) is needed to support a person in providing them with all the products they buy and in neutralizing all their wastes. It is a fact that this number goes up significantly with an increase in standard of living. Specific numbers aren’t highly useful here because they vary widely depending on the assumptions you make, but if you maintain the same assumptions throughout your analysis, ecological footprint can go up five or ten times, or beyond, as one moves from poverty to prosperity. This is like a five to ten fold increase in population. Combine this with an actual increase in population, and you are talking about phenomenal increases in gross ecological footprint. For a clear example of this, research the population growth of Thailand over the last half century or so, as well as its per capita increase in standard of living. And then go to Google Earth and take a look at how much of the country maintains its original forest cover. Those two observations are related! I’m not making a value judgment about this (not yet), just pointing out the undeniable facts.
Ecological footprint goes up with GDP for a variety of reasons because, obviously, the more money you have, the more biological energy you are going to buy and the more ecological productivity is going to be needed to supply that biological energy! But the most significant and interesting reason is that as people gain economic prosperity, they eat more meat, because they now have a claim on the labour needed to farm it. Since meat is at least one step up the food chain from plants, it is much more photosynthetically intensive, like five to ten times as much on an area basis. It therefore requires much more agricultural output to produce a pound of meat than a pound of wheat (see my other page detailing some numbers for this). This requires more land, more fertilizers, more water, more fossil fuels, and more human labour to establish and work the farm. So what happens is that as human GDP increases, ecological productivity is diverted away from some other wild animal that would have otherwise eaten the plants, and instead sequestered by that person with the growing GDP . This is why bison don’t roam free on the Great Plains anymore – all that grazing land has been diverted to instead supply feedlots to raise beef for our consumption.
You can think of the total ecological potential of the planet as being represented by the area of a pie chart. This area is pretty much set, more or less. We are doing some things to increase it but others to decrease it (although those things that increase it are not sustainable so when you subtract this out, the planet’s total productivity is actually decreasing significantly). So although the Production Possibilities Chart doesn’t state it, what is necessarily implied is that what humanity has been doing over the last few thousand years to shift that curve outwards is increasing the portion of the ecological pie which is devoted to humanity from a tiny sliver hundreds of years ago, to a major wedge now. Economic activity does not make great things out of nothing. Rather, it takes it from the rest of the planet. How much of the global ecological productivity chart do we take for ourselves? Depending on who you talk to and the assumptions you make, anywhere from ½ to 5 times the area of the pie.
Trying to nail down exact numbers for ecological footprint gets a little tricky for a variety of reasons. One is how do you put an acre of ocean into the same equation as an acre of farmland when fish swim across oceans in big schools. And many fish populations naturally cycle through crashes and booms. The productivity of the oceans is inherently more difficult to quantify than farmland. Another complication is how do you separate how much ecological productivity can be sustained indefinitely versus that which is being unsustainably “mined” right now?
These are important concepts, and considering that all our food energy is “produced” by ecosystems, you’d think they should be front and center in economics textbooks. The trophic pyramid and the laws of thermodynamics should be the most fundamental principles taught right from Chapter One. Not just food though, because the vast majority of all the other exergy that drives our economies (my “technical” energy) is also, or rather was also, produced by ecosystems. By far the majority of the energy we use comes from fossil fuels, in the order of 90% or more. We are no different than any other animal population in terms of our energy sources; we are completely dependent on ecological productivity for our existence. What separates us from other animals is that we’ve discovered how to additionally use productivity from ancient ecosystems deposited in the ground hundreds of millions of years ago!
Virtually everything in our economies, at some point along the line, comes from oil or other fossil fuels. The computer you are reading this on is made of plastic and metal. Plastic comes from oil. Metal ore is mined using energy from oil and natural gas. That ore is refined in factories using coal and natural gas. The computer is transported to you using oil. Look around your house — everything you see is dependent on oil! Even oil comes from oil, as described below. Take away oil (without a renewable replacement), and we revert back to the Stone Age — literally! Clearly, substituting fossil fuels from our economies with “something else” as they run out will not be a trivial matter.
And ALL oil comes from ecosystems! I don’t know how more explicitly our dependence on ecosystems could be stated. Far from being airy fairy hippie talk, ecology is actually at the very heart of how our economies operate. You know, “eco – eco”. Ecology sounds a lot like economy. “Ecology” comes from the roots, “the study of the surroundings”. “Economy” comes from the roots, “the management of the surroundings”. You can’t separate one from the other, and you can’t have a healthy economy without a healthy environment. You’d think that in order to be able to effectively “manage the surroundings” you’d have to spend some time “studying the surroundings”, right?
In our quest to sequester ever more low-entropy sources of potential energy, the Energy Returned on Energy Invested number (EROEI) becomes important. This number describes how much energy you have to expend to get an additional amount of new energy “out of the ground”. In our past we had readily available fossil fuels with EROEI’s around 100:1 or even 200:1. Now we have run out of those and conventional oil today is less than 20:1. Non-conventional oil is below 10:1. The inefficiency, effort, and waste necessary to sequester further useful energy from fossil fuels should continue to spiral upwards as the EROEI of our dwindling fossil fuel sources spirals towards 1:1. We of course always choose to harvest the lowest hanging pear fruit first with the highest EROEI, which then leaves us with continually diminishing quality fossil fuel reserves with which to power our economies (and we wonder why there always seems to be an energy shortage…) Once you get below 1:1, well, you don’t have any more energy, at least from that particular source. Because unlike pears on a pear tree, oil doesn’t grow back the next year.
Because of the nature of the EROEI concept (efficiency goes down as the resource becomes scarce, rather than efficiency improving), we can expect the energy crunch to happen increasingly quickly, rather than gradually. This could be contrasted with running out of, say, copper, where its scarcity and increasing price would provide an incentive to use the remaining supplies very carefully and to recycle it from landfills.
But it doesn’t work that way with energy, because we don’t destructively use up copper to mine more copper (of course a small amount of copper is needed for the equipment in copper mines but this isn’t used up and it can be recycled). But this isn’t so with energy. Once we hit the energy crunch there is nothing that can be done to stop it. To try to fight Peak Oil by extracting more and more fossil fuels at faster and faster rates simply makes the problem worse and worse — this amounts to fighting the laws of thermodynamics. The only way to avert disaster in this situation is to get off fossil fuels as an energy source, and quickly! The Hubbert Curve looks like a nice symmetrical bell shape but the ride down is going to be nothing like the ride up. We will not have ample opportunity to prepare and adapt to new constraints.
One of the major problems that needs to be overcome is the belief widely held throughout the realm of economics that an increasing oil price will stimulate increased oil / energy production and in turn this will foster the development of alternative energy sources, and that because of this, market forces will therefore be able to solve Peak Oil by themselves. Harking back to Econ 101, this free market dynamic would seem to be applicable if one uses an analysis of the industrial production of widgets as an example.
It is understandable to believe that this market dynamic should also apply to any other good as well, if one is operating under the assumption that the good in question is produced by people or companies, and if one has faith in the validity of the supply / demand chart. Wikipedia has a webpage, complete with nice smooth charts, dedicated to showing how Supply and Demand are supposed to work together in that Wonderful World of Widgets to restore and maintain balance in the markets.
From Wikipedia: “in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium of price and quantity.”
Hmm… let’s analyze that with respect to a widget. “If supply decreases and demand remains unchanged, then it leads to higher price and lower quantity.” This higher price should stimulate widget producers to take advantage of the imbalance and make a profit by producing more widgets until the price comes down, at which point the market reverts back to equilibrium. “Firms will produce additional output as long as the cost of producing an extra unit of output is less than the price they will receive.” Okay, sounds reasonable, I guess.
What about energy? As explained previously, in order to do anything in the universe, including “producing” a widget, we have to use energy (let’s just say we “consume” and “produce” energy for the sake of humouring the supply / demand chart, even though that isn’t correct). Therefore, when that company producing widgets decides to produce more widgets, what it necessarily also does is increase its energy consumption.
So now let’s leave behind the Wonderful World of Widgets and come back down to Planet Earth to analyze this same chart, but this time let’s say the good in question is no longer widgets, but energy, and specifically the energy that the widget producer needed more of to produce more widgets. Conventional economic theory dictates that (as with widgets) lower supply results in higher prices, which energy companies then take advantage of to produce more energy so that the equilibrium shifts back to its original position.
But wait … how are these energy companies actually “producing” energy to begin with? In order to “produce” energy, they’d also have to “consume” energy first, just like the widget company had to do to make more widgets. So what is it they are actually doing then? Are they consuming energy or are they producing energy? To make any kind of profit they’d have to produce more energy than they consume (unless the form of energy they are selling is more valuable than the form they are buying, but for the overall industry it would indeed have to produce more than it consumed). But that is a perpetual motion machine, and since the first law of thermodynamics says that energy can be neither produced nor consumed, the only resolution to this logical hiccup can come from discarding the misleading concepts of energy “production” and “consumption” and moving on to the concept of EROEI. The miracle of energy “production” happens because the energy companies “invest” less energy than they “liberate”. So now we are right back at square one — EROEI.
The issues with extracting harder and harder oil as Peak Oil progresses are not just economic in nature — they really come down to net energy. While there is a price floor below which extraction of, for example, Alberta oil sand becomes uneconomical, and therefore above this price oil extraction will resume and increase, there comes a point above which it doesn’t matter how high the price goes; the limiting factors shift to become more geological in nature, not economic. If the EROEI is only 1.2 to 1, it doesn’t matter how high oil prices go, because so too will the input costs necessary to suck that oil out also rise along with it. It’s all relative, and scarcity simply shifts the whole economic analysis further up the price axis; they don’t really change the fundamental EROEI problem. At below 1:1, even an infinite oil price will not bring more oil out of the ground (unless other energy sources like natural gas are cheaper but you can bet that gas prices will be following closely in the heels of oil when energy prices really get going). What happens during Peak Oil is that the supply curve generally tends towards a price of infinity, never to return.
Therefore, THE SUPPLY / DEMAND CHART IS NOT VALID FOR ANALYSING ENERGY MARKETS (except for short term dynamics). Some other kind of analysis will be required.
The Future of Fossil Fuels
Claims are often made in the media that we still have centuries of fossil fuels left, with the development of non-conventional oil resources like Alberta’s oil sands and with new technology like fracking (supposedly) unlocking huge reserves of natural gas and shale oil. The official website for Canada’s oil and gas industry, the Canadian Association of Petroleum Producers (let’s put aside for a moment the fact that there does not exist any company in the world that “produces” petroleum) presents the extent of Canada’s known oil reserves at 175 billion barrels, and notes that this is the third largest in the world next to Venezuela and Saudi Arabia — although the extents of those reserves have arguably been overstated so Canada may indeed be #1, for now. The total deposit is about 1.8 trillion barrels, and this is netted down to the fraction that is technically recoverable (with an EROEI greater than something-to-one). Insider sources inform me, however, that the recoverable reserves actually amount to about 350 billion barrels, but the government does not state this so as to not take the stage away from Saudi Arabia, for the time being. If you want to read more about Alberta’s oil sands deposits you can go to the Alberta Energy Resources Conservation Board’s annual report.
If you peruse the CAPP website you will find little discussion of how the size of Canada’s deposits relates to total global reserves and more importantly, to global oil consumption which is currently about 31 billion barrels a year (one cubic mile of oil), of which about a fifth goes to the US. If you dig around you can find the numbers if you know what you are looking for and if you bring along your calculator, but CAPP isn’t going to any great lengths to inform people of these basic concepts. Lots of statistics are thrown around which are generally pretty good; at least the historical statistics. The future projections seem a little ridiculous, but that’s part of their strategy, as I will explain.
CAPP does, however, make a frank admission: “Many of the world’s current producing oilfields are running out of oil.” That’s quite a statement, coming from the oil industry itself! Indeed, global oil extraction rates haven’t increased over the last seven years. The increased consumption from the developing countries, especially in Asia, has been offset by the economic contraction occurring in the western world. Has global demand for oil been dropping because people have decided that they don’t want to buy a new car and improve their standard of living? Not likely. Even during a recession, oil prices remain high. Over those seven years oil price has roughly tripled, albeit erratically, yet global extraction rates barely budged. We are therefore likely at Peak Oil; it would take some miraculous new discovery to be able to increase extraction rates going forward, which of course we haven’t had, as explained by the Do the Math link provided above. Oil discoveries are going down, not up, after having peaked 40 years ago. This is typically the length of time it takes for individual countries to peak in extraction after their peaks in discovery. It is not a leap of logic to apply this same pattern to all countries collectively and presume that on a global scale, extraction should peak 40 years after peak discovery — which indeed it seems to have done. Because of this, the world should soon start its slide down the back side of the Hubbert Curve. But CAPP doesn’t actually call this Peak Oil. The day the oil companies admit to the current reality of Peak Oil will be a historic one.
CAPP’s free admission of the stagnation of global conventional oil extraction might have something to do with the fact that (conveniently) the vast majority of Canada’s oil reserves are not conventional oil… They talk about how energy demand from the world’s growing economy has been and will be increasing over the next few decades, and most importantly, how Canada’s oil sands extraction is going to (conveniently) help meet this demand in the face of stagnating global conventional crude extraction. With current oil sands extraction rates at around 600 million barrels per year the deposit would last centuries! That leaves us with plenty of time to develop alternative renewable energy sources, right?
But you should now be able to see the flaw in CAPP’s logic. They correctly point out how conventional crude extraction has hit a peak globally. Then they argue that Canada’s oil sands are so large that Alberta could plug this gap in supply for the foreseeable future until alternative energy sources are developed (for which they offer nothing more substantial than vague allusions and hand waving). But they will not explicitly quantify either of those two transitions — from conventional crude to synthetic crude, and then from petroleum products to renewables. They will not do this because the numbers don’t add up. They dance around the problem to keep you from thinking about it.
Let’s do a little calculation for a sense of scale to see how long the oil sands deposits would last if they were to hypothetically be needed to power the whole world. 350 divided by 31 is about 11. That is ELEVEN YEARS the oil sands would last if they were to be needed to power the world! Of course, Alberta oil sand isn’t the only petroleum deposit in the world to be developed over the next few decades. But considering that globally there is around a trillion barrels of recoverable oil left, at current consumption rates that works out to about 35 years. Certainly new deposits will be found, but all of the big easy ones already have (rest assured that the planet is being scoured very intensely right now). Future discoveries will be small and / or difficult, with low net energy return — again, that’s what Peak Oil entails. Much fanfare is made of any significant new discoveries but the recent discovery off Norway, as an example, amounts to … are you ready? … ONE MONTH of global oil consumption. Those future discoveries which will undoubtedly be paraded around the media as the solution to our energy woes will constitute the trailing edge at the bottom of the Hubbert Curve.
Another problem not addressed by CAPP concerns the approximate EROEI of 5:1 for oil sands extraction. This means that it takes about 1 unit of external energy to extract, refine, and distribute 5 units of oil sand energy into gasoline ready for your car. This external energy comes primarily in the form of natural gas which is needed to heat the bitumen in the ground to get it to flow, as well as to upgrade it afterwards into something equivalent to what typically squirts out of a conventional oil well (more hydrogen has to be added to the hydrocarbons and the large chains need to be broken down into smaller ones to make up for the volatile fractions that were lost to evaporation long ago).
The Royal Society of Canada recently put out a report addressing the “Environmental and Health Impacts of Canada’s Oil Sands Industry“. On page 47 it states that the natural gas used for in situ steam generation alone “accounts for 20% of the energy contained in the produced bitumen”. When you add in the upgrading processes necessary to turn the bitumen into a salable synthetic crude product, and then to further refine this into gasoline, my overall EROEI estimate of 5:1, or 20%, seems about right, if even an underestimate (the actual EROEI for oil sands seems to be a well guarded secret — numbers previously circulating the internet indicated that it was 3:1, while others have recently pegged it at 8:1. I am fairly comfortable with my 5:1 estimate).
Pages 47 to around 58 discuss why so much natural gas is required and what potential innovations and alternative energy sources could be substituted to reduce demand for gas. Beyond initial efficiency improvements that constitute “good housekeeping”, these alternative energy sources basically mean burning the less valuable heavy fractions of the bitumen as a source of energy, in which case we can say good-bye to our 350 billion barrel deposit and net it down to something closer to 250 billion. The energy has to come from somewhere. It isn’t going to flow out of the ground by itself, not like conventional oil. Of course new techniques will be developed to optimize the efficiency of this extraction and these are and will be touted as evidence of how technology will triumph over scarcity. However, due to the law of diminishing returns, the biggest gains will be at the start, and further gains will drop off sharply after this once we approach thermodynamic limits, which we are probably getting pretty near right now.
It is also noted on page 17 of the National Energy Board’s 2006 Energy Market Assessment that “going forward, as existing projects expand and new projects are initiated, it is likely that operators will be facing declining quality of bitumen reservoirs, with a resultant increase in energy required”. Huh. Even the NEB admits to the inevitable decline in EROEI, even for the oil sands.
Unfortunately, the Royal Society of Canada report doesn’t discuss the supply end of where this natural gas comes from. Is there enough available? According to CAPP itself, “The easier-to-produce sources of natural gas [in Canada] are in decline, so our industry is turning to sources that are more difficult and expensive to develop.” (translation — fracking). Let’s do another little calculation to see how much natural gas would actually be required for the whole oil sands deposit. At 350 billion barrels and a conversion factor of 5800 cubic feet of natural gas per barrel of oil equivalent, divided by an EROEI of 5:1, you get 400 TRILLION cubic feet. How does this compare with natural gas supplies? If we go to the official natural gas website, we find that there is about 6.2 quadrillion cubic feet of known natural gas deposits in THE WHOLE WORLD! This means that it would take a full seven per cent of (known) global supplies of natural gas to extract and refine the oil sands into usable oil! And with North America holding 320 trillion cubic feet of proved reserves it would take a hundred and twenty five percent of North America’s NG supply to process the oil sands! The question must therefore be raised: when Peak Oil really starts to get into full swing, is the world’s demand for natural gas for uses other than for oil sands processing going to be increasing or decreasing? Will the world really be willing to give up this amount of natural gas for such an energy INefficient application?
So let’s assume the oil sands could hypothetically be counted on to chug along for a few decades to make up for the shortfall in global conventional crude extraction, after which the deposit would be finished. At around that time the world will be running really low on oil. A possible solution would be to use Gas-To-Liquids technology, which takes natural gas (methane) and strings together the molecules to make long chain hydrocarbons — essentially, fully synthetic oil. The overall efficiency of this process is around 50%. Cost-wise, well we know that it can’t be competitive with current oil sands operations, otherwise the natural gas being used by Alberta would instead be going directly into GTL facilities to make synthetic diesel. An EROEI of 0.5 to 1 can’t compete with 5:1.
CAPP reassures us that “North America has over a century of natural gas supply at today’s consumption levels.” But what about when consumption levels increase to offset Peak Oil? How long would total known global reserves (6,200 trillion cubic feet) last if they were to hypothetically be needed to ramp up to supply, oh, let’s say, half of today’s global oil consumption via GTL? 30 billion barrels a year divided by 2 is 15 billion. Multiply by 5800 to get cubic feet of natural gas, then multiply by 2 again for the 50% conversion efficiency, and we get 174 trillion. Add to this the current global use of natural gas of 114 trillion cubic feet and we get 288 trillion. Divide this into 6,200 and we get TWENTY ONE YEARS.
Now, lots more natural gas is going to be found, and therefore this number should be increased by some factor. What that factor is, I don’t know. But this calculation doesn’t even consider the EROEI of extracting that gas, which we know will get lower over time as the lowest hanging pear fruit is always picked first. And just because it is known that 6,200 trillion cubic feet exists underground doesn’t mean it can all be recovered. So there is a lot of wiggle room in these numbers, in both directions, but they give an idea of the general magnitude of the problem.
A suggestion by the energy companies to ameliorate the large amount of natural gas needed to process oil sands is to instead build nuclear reactors to provide this energy. Another suggestion is to use coal. Okay, let’s analyze that. Coal is the only fossil fuel I haven’t yet addressed, so what is its capacity? The World Coal Association states that there is about 900 to 1,000 billion short tons left. (Note: I need to revise these numbers for coal. The coal “reserves” represent only the amount of coal that is identified and ready to be extracted out of the ground. Reserves are being continually replaced as they get used up by bringing in new resources into that category. Therefore, there is likely significantly more coal available than I have described here. It seems that no one really knows, however, how much coal will be ultimately available to us with a reasonable net energy return). Yearly consumption is about 7 billion tons, leaving us with over 100 years worth of coal at current consumption rates. In any event, the methodology for estimating the depletion time for coal deposits suffers from the same problem that the analyses for natural gas and oil sands do as I previously explained — that when conventional oil extraction rates start sliding down the back side of the Hubbert Curve, then other fossil fuel sources will be called upon to take up the slack. Coal can also be converted into liquid fuels via coal-to-liquids technology (interestingly, this was pioneered by the Germans in the second world war because they had little access to oil). But the efficiency of these substitutions won’t be anywhere near what conventional crude used to provide. Therefore, to maintain current fossil fuel consumption rates after Peak Oil will require an increasing consumption of natural gas, oil sand, and coal. This herculean feat would cut the forecast lifetimes for coal deposits substantially. And again, if this process was cheap, easy, and efficient, then it would already be in widespread use. But it’s not, and that tells you something about its economics.
The above 1,000 billion tons of coal reserves are based on current prices. If prices rise then substantially more coal will become available as economically recoverable reserves. However, this requires high prices. So when we run out of oil we may turn to those coal reserves to supply oil. But the problem is that the processes that could do this conversion are slow, and they require high energy prices.
If I may offer an opinion here… I can’t help but notice that when we have reached the situation where previous sources of direct energy (coal and nuclear power plants) are now being proposed to provide secondary energy to simply extract and process additional energy from the ground in order to “produce” something (synthetic crude oil) that only a few decades ago used to squirt directly out of the ground with an EROEI of 100:1 …… well, we just might be approaching the bottom of the barrel. We moved away from coal for transportation a long time ago because better energy sources became available. What does it say when we are forced to return back? Desperate situations call for desperate measures. We are in an energy predicament and these last ditch efforts are really just an outright admission of how close our overall energy supplies are to an EROEI of 1:1. Dave Rutledge has summarized a logistic analysis for estimating the amount of time the world’s coal and oil deposits have left, and comes to the conclusion that the world will have used up 90% of all the coal and oil it ever will by the year 2070.
Despite this critical situation, CAPP still manages to maintain a straight face and make the ridiculous assertion that, “We believe that we can and must advance environmental protection, economic growth and a secure energy supply simultaneously.” (emphasis mine).
I fail to see how exponentially increasing the rates of fossil fuel extraction to maintain current energy use rates in the face of a spiraling EROEI can in any way be consistent with “environmental protection”. When was the last time you heard of environmentally friendly fossil fuel extraction? And what of the tremendous amounts of carbon released into the atmosphere with the inefficient EROEI’s we will soon be facing? There’s a reason that carbon got deposited into the ground in the first place. Should we have faith in Carbon Capture and Storage? Wake me up when that fantasy becomes reality. And how do you “capture and store” emissions from millions of individual tailpipes? Furthermore, CCS has significant energy requirements, yet the whole point of CCS is that it is supposed to sequester carbon from large point sources, not millions of individual tailpipes. So then, by definition, if it is to have any appreciable impact on carbon emissions from oil extraction activities, then it needs to be applied to the most INefficient mines out there, which means its additional energy demands will have the most devastating impact on the already very poor EROEI. CCS may have applications for electricity generation from coal or natural gas, but for the production of liquid transportation fuels from oil sands … it has little usefulness.
As to the assertion of “advancing a secure energy supply”, it would seem to me that using up our remaining supplies of non-renewable fossil fuels as quickly as possible without any serious consideration of the consequences would be the antithesis of securing an energy supply! Wouldn’t the most secure energy supply be the one that’s still in the ground? Or renewable? Decentralized?
And my analysis up until now assumed that current demand for energy would continue going forward. But if we are going to also factor in exponential demand increases from future economic growth (which CAPP explicitly states “must” advance), then the situation becomes even more dire. Isn’t China building something like one new coal fired power plant every week?
Still another problem not addressed by CAPP is that the oil sands are “slow oil”. It takes a huge amount of engineering effort to extract and refine oil sand. Factories need to be built overtop each deposit. The stuff has to be cooked in the ground for months before it can even be extracted. This cannot be ramped up quickly like drilling more oil wells can. Therefore, it’s not really feasible to expect oil sands activities to be able to miraculously ramp up to a rate capable of offering a significant response to Peak Conventional Oil and its imminent steep decline down the Hubbert Curve. And of course, even if it was, then the deposit would only last a few decades.
CAPP does not talk about the rate problem because they don’t want you thinking about the two most important words in the whole world right now — Peak Oil. CAPP wants to paint a picture of a prosperous future, powered by petroleum products of course. A frank discussion of Peak Oil would by definition invalidate such a rosy outlook, because Peak Oil directly implies that not only can the rate of oil pulled out of the ground not be increased, but it will unavoidably decline. CAPP wants you to have faith that the oil extracted from Canada will be able to supply increased global demand for a long long time, so there is no immediate need to drop the fossil fuel energy subsidies, curtail fossil fuel consumption from general use and instead divert the remaining petroleum reserves into building a renewable energy infrastructure. We just need to get that darn pipeline built out to the west coast to supply the world! Then everything will be fine! Such is the modus operandi of perception management.
The Future of Energy (and therefore Humanity)
In the face of these harsh numbers, it would seem to be a somewhat high priority to be aggressively developing renewable sources of energy to offset and prepare for Peak Oil. So what do the alternatives offer? Interestingly, and possibly surprisingly to many people, the alternatives generally offer higher EROEI’s than many fossil fuels do! Solar panels have a lifetime EROEI of about 10:1 or more (depending on where they’re installed, obviously) and wind turbines 20:1. That’s way better than oil sands with an EROEI of 5:1. And there is no shortage of solar energy out there, and to a lesser extent wind, so there is no fundamental reason why the majority of the future’s transportation requirements could not be met with electric vehicles and trains powered by solar and wind (who knows, maybe someone will figure out nuclear fusion, and there’s also thorium breeder reactors as a possibility, but nuclear energy has some serious drawbacks as below and we should not count our chickens before they hatch). There is more “technical” energy available to us than we could ever really need, if we choose to harness it properly, and it is going to continue shining down for hundreds of millions more years. To put this into perspective, the entire global economy (excluding food energy) could be powered by a patch of Arizona desert completely covered with solar panels. How big would that patch need to be? Would you believe 700 km by 700 km? Again, that’s to power the ENTIRE global economy!
There is no energy shortage. But there is, or soon will be, a fossil fuel and liquid fuels shortage. So if we are getting down to such poor quality fossil fuels with such low EROEI’s, and since the alternatives generally offer higher EROEI’s, then why aren’t we all clamoring to crank out solar panels and wind turbines to build our prosperous sustainable future? Shouldn’t the supply / demand chart motivate energy companies to move towards extracting renewable energy with a higher EROEI? Surely it must be cost competitive if it has a higher EROEI. There are a few problems holding this transition back. Firstly, wind and solar power are intermittent sources of energy which limits their penetration into the overall energy mix, without the addition of some kind of storage capacity or peaking power alternative to even out supply with demand. This storage capacity would be anything but straightforward on a continent-wide scale, but there may be solutions. We are nowhere near the scale yet, however, which would limit solar and wind power as contributions to the energy mix.
Secondly, we are still not-so-accidentally addicted to liquid fuels for our transportation infrastructure. 99.99% or so of the cars out there burn gasoline, diesel, or some other similar fuel. The Status Quo does not want to change and they are doing everything they can to sabotage and stall it, because there is a lot of money (power) to be made in keeping everyone addicted to fossil fuels in the face of Peak Oil. We can produce all the electricity we want from solar panels, and this will be good for helping to displace burning coal, but it won’t help us a bit with our cars until a significant proportion of the transportation fleet is converted to electric drive. The other alternative liquid fuel source, corn ethanol, arguably has an EROEI of less than parity so it is dead in the water. Ethanol from Brazilian sugar cane has an EROEI of about 8:1 which is pretty good (because it’s tropical), but there is limited capacity to produce this and I don’t think they will be willing to power North America with it.
The most formidable hurdle with alternatives, however, is time; or rather lack thereof. The energy investment part of the ratio in EROEI is all spent up-front during the initial manufacture and installation of the solar panels or wind turbines. With fossil fuels, however, the energy expenditure is spent more as-you-go. It is immediately factored into the extraction, processing, transportation, and use of that product, and this entire process may only last a year or less, with the poorer quality wells we are tapping more often these days such as in the Bakken oil shale losing the bulk of their production in the first few years. By contrast, it may take decades to liberate enough surplus energy from solar panels to realize their EROEI of 20:1. This creates an energy trap, in which for economic and political reasons, there is an incentive to continue down a path of dependence on poorer and poorer quality fossil fuel energy sources, even though better alternative sustainable options exist with higher EROEI’s. The immediate marginal energy advantage of low EROEI fossil fuels is always greater than the immediate marginal energy expenditure required to fabricate and install new solar panels. To divert a significant portion of our energy generation capacity over to solar panel production would require a major investment using today’s fossil fuel sources. Since we are already short of fossil fuels right now, this would require that energy available for immediate use in the economy today would become more scarce than it otherwise would be if we just continued down the doomed trajectory of fossil fuel addiction. Diverting this energy away would depress economic activity which leads to all sorts of fatal problems with the monetary system and financial markets (stay tuned and read on… the implications of reduced economic activity get so much more complicated than this…)
For this reason, it doesn’t matter whether Peak Oil happened 2 years ago, is happening now, or will happen 5, 10, or 20 years from now. The predicament is the same. If we wait for undeniable proof of Peak Oil as the final motivational kick in the butt to invest heavily in alternative sustainable energy sources, it will (likely) be too late. Because establishing a renewable energy future will require major up-front “consumption” of fossil fuels to manufacture that renewable infrastructure — fossil fuels that we won’t have due to Peak Oil!
The definition of Peak Oil is simply the month / year at which the maximum rate of oil extraction / production occurs, and nothing more. This is most commonly implied on a global scale (it happened in the US way back in the 70’s and nowadays, country after country are passing their own peaks). But the total amount of hydrocarbons still in the ground is in the order of many trillions of barrels of oil equivalent — several times greater than has been extracted so far. So how could it be that if we’ve hit Peak Oil, we still have trillions of barrels left in the ground? The thing about hydrocarbons is that there is a whole range of “quality” of the various substances out there. One can think of it as a continuum running from methane gas on one end, through natural gas liquids, condensates, light sweet crude, heavy sour crude, oil sand, oil shale kerogen (a solid), to coal at the other end.
I said before that geology (and technology) will ultimately limit how much hydrocarbons can ultimately be extracted. And we may not even be halfway there. But Peak Oil is about the rate of extraction, and that is largely determined by economics (of course, in conjunction with geology and technology). We’ve already creamed out the nice reserves in the middle of that continuum. The remaining oil is progressively more expensive, and slower to develop. The price floor below which modern oil can no longer be profitably extracted is continually rising, and is probably around $90 right now. But the world needs oil regardless, so the more difficult and expensive reserves will, one way or another, get developed. And paradoxically, as we move over to these poorer quality reserves, the total size of the world’s economically recoverable “reserves” (defined as the portion of the “resources” that are economically recoverable) increases. This is because, at an oil price of say $50, those “resources” weren’t economically recoverable — they weren’t “reserves” as the definition goes. But an oil price of $100 opens up massive new reserves of oil-equivalent fossil fuels (oil sands and possibly oil shale). There are trillions of barrels in the Albertan and Venezuelan oil sands. Many in the media promote this as proof that we aren’t running out of fossil fuels, because every year the size of our potential fossil fuel “reserves” increases. But to the contrary, this is actually a symptom of running out of oil, because the only reason so many more oil “resources” become classified as economically recoverable “reserves” is because the oil price is so high — because we’ve run out of the cheap easy reserves!
But the problem with these vast new reserves is three-fold. Firstly, they are slow. Secondly, they have a low net energy return. Third, only a small proportion of the resource is ultimately recoverable. What this all means is that even though we have trillions of barrels of resources opening up, they won’t be able to ramp up to a rate of extraction to be able to offset declines from more conventional fields. To increase oil consumption rates (which must equal production rates long-term) beyond this new slower rate would require a significantly higher price. But higher oil price kills demand…
Even if it was technically possible to ramp up oil sands extraction fast enough to meet demand, it wouldn’t be economically possible because then price would drop below what is required to fund new capital projects to increase future oil sands production. The price is set at the marginal barrel. So, while the definition of Peak Oil is that it is the date at which the maximum rate of oil extraction occurs, the cause of Peak Oil is that it corresponds with the date at which the maximum extraction rate can be sustained by the economy.
Going forward we will see a moderating effect on oil demand caused by economic damage from high oil prices. This is a circular dynamic that works to reduce the speed at which energy reserves get depleted once Peak Oil hits, beyond what a simple exponentially increasing EROEI spiral would suggest. After price spikes cause economic hardship and lead to recession, Westerners will downsize their gas guzzling SUV’s and get rid of excesses, as they will have less money to spend during a recession. They will adjust and live more frugal lives. As a result, they would (all else being equal) be able to tolerate higher oil prices. Economic growth then might resume for a while (or at least, contraction might slow) until the demand for increasingly scarce oil restarts the cycle and it spikes again. So what may unfold over the near future is an increasingly volatile oil price. Due to the continually decreasing EROEI, the price floor below which oil extraction activities cease being profitable will be continually rising. But regardless of our economic situation we will always need oil, so both price peaks and troughs will trend upwards together. This would tend to result in a constant grinding of the global economy downwards.
How long could that drag on for? How low can EROEI go? Obviously not below 1:1; that’s physically impossible. How about 2:1? Well, EROEI is a bit of a simplistic term in describing the situation, because it only incorporates the direct energy inputs needed to get more energy out of the ground. It doesn’t include all the machinery that has to be manufactured and all the workers that need to be supported. If an oil producing region is going to have any net surplus energy available to provide to the rest of society, then there must be an excess in EROEI above that which is required to sustain Fort McMurray and Alberta. What is this minimum EROEI? We know it’s above 1:1 and it’s probably below 5:1 which the oil sands are today. Let’s say 3:1? Who knows exactly (I plan to do further analysis to this end soon). But that’s a very tight window, so we are clearly very close right now. And this is why claims that the trillions of barrels of US oil shale will save us are grossly misleading. That resource (kerogen is actually a solid) has such a poor EROEI that it is doubtful that an industrial society could even be supported by it at any price. At that extreme, economics lose their significance and geology takes over. Currently, the natural gas inputs to that process are practically free and they still can’t turn a profit.
As the economy contracts and society devolves due to shrinking energy supplies, there will be greater and greater popular unrest from rising unemployment. One way to provide employment opportunities for people will be to open up the last of our fossil fuel reserves to intense extraction activities. As the EROEI of these poor quality reserves continues to drop, more and more labour will be needed to extract them, thus providing hope and motivation for an increasing number of people desperate for work to scrape around under the last rocks at the farthest corners of the continent, searching for the last bits of ooze to burn. These won’t be “good long term jobs”; they will be equivalent to everyone piling down into the bilge with coffee cups to bail out the sinking ship, rather than enjoying the benefits of a healthy seaworthy ship up on deck.
Given the short term nature of the political and economic forces making decisions for us, is it reasonable to presume that we will choose to avoid the energy trap by enduring short term pain for the sake of long term gain, or will the Status Quo catering solely to short term gain, and to hell with the rest, lead to catastrophic medium term collapse? Will “hope and faith” in the emergence of some miraculous new energy technology provide the political cover for inaction on the tough choices that must be made now for a transition to renewable energy sources? Will a shortage of fossil fuels, and all the economic problems this creates, provide the political justification for ever more frantic efforts to extract our remaining fossil fuel reserves that still have reasonably high EROEI’s, thereby making the Peak Oil situation even worse (but transferred to the plate of some future politician’s set of problems, not yours)? As we become ever more desperate, will we place our faith in those politicians that are the best presenters of optimistic lies? We generally like to vilify politicians as being backhanded liars who will take any opportunity available to extend their power, but there is a reason most politicians are liars — because we elect them. It’s our own fault. What chances do honest politicians have of being elected, those who present the sobering facts of our predicament so that we can make intelligent, informed decisions about moving forward — even today when things are still relatively prosperous? Will this burying-our-heads-in-the-sand increase or decrease when we are desperate for any good news? Will we even have functioning democracies much longer?
Society in the 1980’s abandoned all serious efforts to wean our economies onto renewable energy. This was a recipe for some very challenging times ahead, to put it mildly, and we are showing no signs of changing course today, even in the face of flat oil production over the last seven years signalling that we are at Peak Oil. Will we willingly and knowingly drive straight into a Malthusian Collapse because the accountability of the political system to the people it is supposed to represent just isn’t there (or is it that the accountability of voters to their political system is not there?)
As 9 billion people run out of energy to use to efficiently “produce” and move food and other economic goods around, there will be one final source of energy just sitting out there on the land ready for the taking — biofuels. But the amount of biomass that can be produced by the planet is a fraction of what modern industrial society would require to function similarly to what it does now, especially when biofuel production would compete with food production. And with fossil fuels becoming ever more scarce and expensive, we will no longer be able to rely on such intensive agricultural techniques as we do now, further increasing the demands on the biosphere to produce food for us. Currently, as a result of the “miraculous” advances of the Green Revolution (virtually all of the advances of modern industrial agriculture depend on unsustainable energy and irrigation inputs), to produce and distribute 1 Calorie of food energy in the US requires an astonishing 10 Calories of fossil fuel inputs! How much will per-hectare food production decrease when those fossil fuel inputs are greatly reduced or eliminated? What about depleted fresh water reserves (the Ogallalla aquifer is dropping fast)? How will that shortfall be offset? Are we really going to allow any significant expanses of natural ecosystems to continue to exist in the face of hundreds of millions of starving people?
With the destruction of pretty much every natural ecosystem on Earth we will be following the classic lynx and hare population dynamic, except that we have overshot ourselves waaayy beyond the cliff thanks to the previously cheap and abundant energy provided by fossil fuels. What do you consider to be the Earth’s carrying capacity without subsidies from fossil fuels? 4 billion? 6? 1? Whatever number you come up with, it will surely be less than 7 billion because we aren’t sustainable right now. This number, which I hope to better estimate in the near future, is approximately what the global population will adjust to over the next few decades by the time fossil fuels run out — it’s simple physics! The implications of this are quite disturbing and I will leave it to your imagination to come up with scenarios of how that population reduction will actually come about. This is doom and gloom talk but there still may be a chance that it could be averted if we immediately get our act together to deal with the energy and ecological crises. This analysis is neither pessimistic nor optimistic — it is simply extrapolating different curves into the future, some exponential and some not, and seeing how they interact and what we get. The problem is that the nature of these curves is well understood by modern science so we can’t hide behind the comfortable old argument that “Malthus’ predictions haven’t materialized for centuries”, because Malthus didn’t understand the numbers behind modern science. If and when we get undeniable evidence of a Malthusian Collapse sufficient to convince the naysayers, it will be too late!
What is Money Then?
Now that we’ve developed a fairly good picture of how energy fits into the mechanics of how our economy operates, the next step is to relate this to the more familiar financial instruments we interact with. In our economies we work with dollars, not Joules of biological energy. If we want to move on to understanding how energy and the monetary system interact then we need an understanding of what money is, and how this “biological” and “technical” energy analysis relates to it.
Well, if we go back to caveman days, they operated on a barter system. You’d trade an item for a different item that another person was offering. If Andy has a bronze axe that he made but doesn’t need because he already has lots of them (it’s his profession to make them), and Mark has extra clay bowls he made in the campfire, then they could trade each other a bowl for an axe. That works great if Andy wants a bowl and Mark wants an axe. But what if Mark doesn’t want an axe? That’s where a third party enters the scene: Sheryl makes woolen toques, which is what Mark actually wants. But Sheryl doesn’t want the bowl that Mark has to offer; she actually wants Andy’s axe. So now what do they do? These three people could all meet somewhere in a dark forest around a campfire and come to a mutually agreed-upon barter transaction where Andy gives Sheryl the axe, Sheryl gives Mark the toque, and Mark gives Andy the bowl. They formalize the deal with a sacrifice to the pagan gods, and then everyone is happy.
What’s happened here is that the claims of ownership of those items have shifted. Everyone is in agreement with the transaction and it was formalized in some way, like a handshake. That’s what barter is; it’s simply the act of people shifting claims of ownership of items, services, or rights.
And although this barter transaction between Andy, Mark and Sheryl certainly worked, it was kind of cumbersome. Does a circle of people really need to meet for a handshake every time they want to exchange some goods? This would become ever more cumbersome through the ages as society became more sophisticated and the number of specialized items that we produce and use grew exponentially, and our populations ballooned into the millions. Today, it would be impossible to come to a mutually agreeable barter system for exchanging all the different things we use.
What if people could instead come to some sort of a symbolic handshake, without actually needing to go see each other in person? What if they could have faith in some kind of intermediate store of trading power, and just accept that item instead, in return for giving up something real like a pot, axe, or a toque? That is what money is.
Money acts as a mutually agreed-upon intermediary between everyone in a society, representing the relative value of the claims of ownership of items that are offered for exchange. It is like a formalized, but anonymous, handshake as in the barter system. Because everyone accepts money as being a valuable thing to receive in return for giving up ownership of something real, you accept what is otherwise a worthless token, from some stranger you’ve never seen before, in exchange for something useful because you know that in the future you will be able to trade it in for some other real item of value that you want. You don’t know exactly what you will want or when you will want it, but you accept money as a representation of the wealth that you could own. So at its core, money is simply a symbolic representation of ownership, a non-specific claim over real world goods, services, or rights that hasn’t been exercised yet; the ownership is hypothetical.
Historically, gold and silver fulfilled this role. Gold has little intrinsic value or usefulness as a commodity, but it has very good qualities for functioning as an intermediary proxy for wealth — it is infinitely divisible, it doesn’t corrode, it is rare, glittery, difficult to “produce”, and cannot be easily counterfeited. It has a couple of bad characteristics though. One is the environmental degradation that extracting it typically causes, with mercury being a critical extraction ingredient in poverty-stricken third world areas depending on unregulated gold mining for income (plug these coordinates into Google Earth and look at how far downstream that mess goes: 13°00’46.08″ S 70°32’32.15″ W). Secondly, it can be melted down and diluted, allowing for some degree of counterfeiting (this isn’t necessarily a bad thing, since small denomination coins could be made using a diluted gold alloy; otherwise they’d be too valuable to use as small change). And gold has the same density as Tungsten, so sometimes gold bars have Tungsten at their core. But with modern analytical technology and official minting of coins and bars, these counterfeiting issues are now minimal.
When some people deride gold as a “barbarous relic”, claiming that it has little inherent utility as a metal or commodity, and therefore doesn’t deserve its high value, that is an invalid argument. Gold doesn’t need to have any inherent usefulness to warrant its value. In fact, money should ideally not have intrinsic usefulness or value beyond what it has from being money. As I said, money is a PROXY for wealth, and nothing more. It is merely an intermediary for transactions of real things that actually do have inherent usefulness and value.
So what actually are those things having inherent usefulness or value that money represents? Where do they come from? Well, if you think of any real-world (i.e. non-financial) asset that one could buy, they broadly boil down to three categories which, in future essays, I’m going to pick apart in greater detail: goods, services, and rights. Goods are pretty self-explanatory — they are all the things we make or harvest using our hands or factories. Services are all of the actions we do using our bodies or machinery. Rights refer to any legal permission you have to do something, like harvest some land or impose a toll somewhere.
What ultimately do these things all represent? Goods were obviously brought forth to the market via human labour toiling away at raw materials obtained from the natural world. Most of those raw materials come from biomass, specifically either biofuels, fossil fuels, or food. Most of the energy to power all this goods-producing activity, as well as the “services” we also like to perform, also comes from the same place — biofuels, fossil fuels and food, since whenever anything is moved or transformed, energy is required. Even those raw materials which do not have biological origins — minerals from the ground — need energy to be processed. And again, that energy mostly comes from burning biomass (dead things that used to be alive).
And as for “rights”, well most of the rights that have real-world usefulness (ie, non-financial) ultimately relate to rights to harvest, graze, or mine the natural world.
Getting back to our specific examples, the bronze axe had to be forged by burning firewood or coal, and its handle was made of wood. The ore to make the bronze had to be mined from the natural world. The bowl was fired using coal or firewood. The clay was harvested from the natural world. The toque was woven with wool harvested from sheep. All sheep get their food from eating plants.
So from the above it becomes clear that all of the claims of wealth that money serves as a proxy for basically just boil down to claims on human labour, and by extension all of the ecological production that went into supporting that labour, since that is where the vast majority of all this stuff and energy come from that enable these goods, services, and rights to be “produced”. So to state it once more: money is a claim on ecological production, and specifically on how that ecological production is turned into useful or enjoyable things or services for us, via our brains, bodies, and machinery.
This money-equals-biological-production (essentially, energy) analysis gets more complicated with price manipulation or when you consider the many environmental “externalities” associated with producing that product, which are not accounted for in the price. For example, if greenhouse gases are released or oil spills occur which diminish the ecological productivity somewhere else at some other time, this is not incorporated into the price of that product. In a free market, the only ecological productivity incorporated into the price is that which directly supports the human labour needed to produce or purchase it. Because of this, despite what many economists would like to tell you, free markets are NOT efficient. This is not a political statement; it is merely a statement of the implications of energy flow and how this relates to the nature of the monetary system. Free markets preferentially promote economic activity which externalizes its true costs (and therefore price and position on the supply / demand curve) onto someone else at some other time and some other place. But if this compromises ecological productivity elsewhere then this affects someone else’s ability to make money, because as has been pointed out above, all money is a claim on biological energy.
For another example, let’s take the East Coast Canadian cod fishery which was destroyed in the 1990’s by overfishing, and has not since recovered. It is obvious that we overfished the cod to oblivion. It was being sold at free market prices (actually, governments subsidize overfishing), it was easy to catch, and other countries had access to the spawning grounds of the cod and caught them all (a classic Tragedy of the Commons). In the face of the free market, you can say, “Goodbye, Fishies!” Now, if we had instead recognized that the cod catch was not sustainable at the prices it was being sold for (actually, scientists knew this all too well but politicians refused to heed their warnings), then one thing we could have done is impose a 100% tax on East Coast cod. The result of this would have been a dramatically lower catch because, who would pay twice as much for a piece of fish that is no different from any other? Not many “rational consumers”. However, it could have been promoted in a niche market as being ecologically responsible and thus fetch a higher price from a small group of environmentally conscious consumers. The resulting lower demand placed on the cod stock would have likely meant that there would be enough adult fish left behind to spawn and perpetuate the species. At the time of imposing this tax, many would have seen it as an inefficient intervention into the free market. But with it, we would likely still have an East Coast cod fishery today and many of those unemployed fishermen wouldn’t be unemployed. It’s a classic case of short term gain leading to much greater long term pain.
One could argue that free markets could have prevented such a collapse if private ownership rights had been granted to fishermen so that they would have an incentive to protect and nurture the stocks for the sake of their own long term economic survival. This approach sounds good on paper and does have merit in certain situations — for example with big game in Africa and the poaching of rhino horns, but for the majority of natural resources taken from the planet, this approach is too simplistic, by itself, to account for the intricacies and variability inherent in our economic systems, and the complex and far-reaching interactions amongst global ecosystems. We do not exist in isolated boxes. Fish migrate! Water flows! Pollution drifts! The privatization strategy only works for those natural resources that are renewable, that have a clearly defined and significant monetary worth, that can be neatly packaged up into a discrete legal unit, and can then be granted to some person or corporation as private property — again, examples of this are big game reserves in Africa, and conventional agriculture.
For the millions of species of life in the Amazon rainforest, however, many of which have unknown and unstudied medical benefits for us, how can their inherent value possibly be effectively incorporated into a successful conservation strategy in private hands and in the face of aggressive short term ranching interests, when the only motivating economic force is utilitarianism (i.e., something’s worth is measured solely by its immediate value as a commodity for people to consume)? In other cases, private ownership of those rights — say, for example, oil deposits — would tend to lead to the opposite effect of conservation. In this case, the incentive for the owner of that scarce resource would be to promote an increase in consumption so as to to deplete the stock quickly so that shrinking supply would drive up the price and therefore profit. Lo and behold, this is indeed what we have seen. No one who owns oil deposits is going to go out and try to decrease demand for that oil!
So it becomes apparent that there is something fundamentally mismatched between current economic principles that motivate our consumption patterns and the ecological processes of the planet which support us and actually produce things for us to consume. The problems are many, but ultimately the conflict between thermodynamics and modern economics is Malthusian in nature and stems from a structural requirement in our economic system for perpetual exponential growth. The mathematical requirement for exponential economic growth relates to our system of “fiat” (legally decreed) money we use, or more to the point — the debt from which it is created.
What specifically is modern money and how does it work? I haven’t even mentioned a dollar yet. Well, getting back to the gold and silver based monetary systems that people used a long time ago, it becomes clear that a gold-based monetary system is an ASSET based system, meaning that everyone has some amount of wealth attached to their name. You could either own a bunch of stuff outright, and/or you could own a stack of gold coins which represent the power to have other people give you items in the future, since everyone accepts gold as money, just like you do.
In the economy with three people, each making their own goods – an axe, a toque, and a bowl, the gold that is used as money represents a claim on actual real things that exist in the real world. They were all produced in the past, present, or immediately in the future. Therefore, asset based monetary systems are based on PAST human labour, and by extension all the raw materials and energy that have already been harvested and put to work into the “production” that turned those resources into tangible items of wealth that we can use and improve our lives with. (I’ll have lots more to say about economic production later on and in another article I’m writing…)
Gold based money worked for thousands of years. But now, let’s say we modernized, we got edumucated, got “treknology”, and we decided that we don’t want to live like cavemen anymore, exchanging pieces of useless metal for real things of value. That’s so barbaric… In fact, let’s say that we don’t want to be weighed down by the “barbarous relic” of any tangible real-world thing representing money; we want it all to be symbolic.
So now, imagine a different kind of monetary system. In this system, you don’t use gold as money, which has its value simply because it is scarce and other people value and accept it as money. In this new monetary system, when you buy something, instead of paying for it by giving up an asset like gold, what you do is you instead promise to pay in the future. You provide a signed IOU to Sheryl, and because you are trustworthy, she gives you the toque. This IOU has value, because you signed it and promised to pay it back. If this IOU has value, then couldn’t Sheryl just use that to buy something from someone else, so that your IOU now shifts to the other person that Sheryl bought something from? So Sheryl accepts this IOU in principle because she uses them too! In fact, in this monetary system, everyone uses IOU’s to buy things. They are printed up on pieces of paper and exchanged everywhere, just like gold coins used to be. And the money you will make to pay off that IOU to Sheryl (or to whomever she used it to buy something from) comes from…. you guessed it… OTHER people’s IOU’s!
But anyone can print up a million pieces of paper; how would they prevent counterfeiting? And where would the purchasing power of these pieces of paper come from? Well, each piece of paper would get its power because it is backed by a signature… a signature made by someone who has promised to pay. The promise Mark gives Sheryl for the toque represents wealth, because that paper has a signed promise by the person that made it, that he/she will work enough in the future to create the equivalent wealth (be it in axes or bowls) to equal the price of the toque that Sheryl gave to Mark.
What is a promise? A promise is a “promise” to do something in the future. You don’t promise you are going to make a bowl yesterday. You either did or you didn’t, and if you didn’t you’d be lying. You, or someone else, have signed a contractual agreement to pay back your IOU in the future. Even though you didn’t actually sign that $10 bill you used to pay for the hamburger you just ate, someone else did. And that $10 entered the market and was circulated until you used its power to buy a hamburger. That is why dollars have purchasing power — because they are backed by lots and lots of people’s promises to pay them back. And you pay them back by going to work and literally, “making” dollars. Therefore, unlike an asset backed system such as a simple gold coin monetary system, a debt-backed currency is a claim on future production because the value of that currency comes from all the future wealth that labour will supposedly be “creating” over the next few years as people work to pay off the dollars that they vowed to pay off.
Of the two systems, one which says, “I promise to do this in the future”, or one which says, “look, I have this real thing here that I made last week”, which do you think is more susceptible to… shall we say, “misrepresentation?” Or, let’s be more blunt… which one is more susceptible to fraud? Which model do you think our current monetary system is based on? How did we get from a gold based, asset backed monetary system based on past production of real items, to the one we have today based entirely on increasingly tenuous promises to provide fictitious items in the future? And why would anyone in their right mind accept a fictitious future promise as payment for real items of value if they could instead demand real gold coins as payment? That’s an interesting and complicated story… and I’ll refer you to the Money As Debt series to provide more detail and historical context about how the current system evolved and how it works. But there’s even more to it than that, which I’ll spend the rest of this essay, and my other essays, trying to explain, relating it to the underlying ecological resources that make it all happen, and the structural requirement for growth. And here’s one more question to ponder, at the risk of getting too far ahead of myself — what do you think would happen to the price of gold if / when people lose confidence in the ability of all those IOU promises in a debt-based monetary system to be honoured?
So our current monetary system is built entirely around debt. A debt requires two parties: the lender and the debtor. Those two parties are married by a legal obligation of the debtor to pay back the lender; they are bonded to each other. This is where the financial term “bond” comes from. A bond is just the flip side of the dollar – it is the asset, the debt that someone has agreed to pay back by slaving away at work to provide value to the dollar that the bond created.
So, believe it or not, our modern and supposedly “advanced” monetary system actually entrenches a Medieval, unequal, and “barbarous” master / slave society of lenders and debtors — it can’t function without it! In this system, no one is equal, despite all the nationalistic propaganda we’re constantly subjected to trying to convince us that we live in a fair society built on equal opportunity for everyone. This simply isn’t true.
And when people say that debt based fiat money has no value, this is also incorrect. It can be very valuable and wield great purchasing power. Our money gets its purchasing power because it is backed by the debt burden of every one of the participants in that monetary system! A hundred million workers slaving their lives away to pay off their debts is a very valuable thing. The entity that controls that money supply will literally have an entire army working for it!
At its core, this is all that the complicated financial system is based on. It can seem bewildering listening to the financial news and analysts (they actually try to bewilder you on purpose because they don’t want the average person understanding and questioning it), but all that financial mumbo jumbo is referring to is just different kinds of promises made by different kinds of people/parties, and owed to other different kinds of people/parties, all trying their best to wring out real monetary wealth from these future promises that are having less and less relevance to the real world as each day goes by. There are of course stocks and commodity markets which in principle aren’t bonds; these are real assets, but they pale in size compared with the bond markets. Furthermore, they too have become financialized to the extent that their representation of the real underlying assets has become so distorted that they can be considered to be speculative in nature. And commodities are traded on futures markets, which by definition speculate on future promises to deliver the goods for a certain price. So most of the financial system these days is just promises — debts.
You may be wondering then – we often hear about this “debt to GDP ratio”, which is supposedly important. We are told that we need to control government spending because if debt-to-GDP gets out of control then we could have serious repercussions to contend with as interest payments for that debt spiral out of control and eat up funds available for real government programs. Generally, the rule of thumb is that when debt-to-GDP reaches 100% it’s at the runaway stage and can’t be reeled back in; some form of default will be required on that government debt. But if the whole financial system is just debt, then what specifically does “debt-to-GDP” represent? Isn’t debt-to-GDP just debt-to-debt? What it refers to is a specific type of debt – namely, government debt. There are lots of kinds of debts, and lots of kinds of dollars in the system, and they are all different in how that debt is created and terminated, and how they impact the economy. The “debt” part of debt-to-GDP is the amount of dollars that the government owes its creditors. GDP is “Gross Domestic Product”, which is basically the total summed value of every monetary transaction in an economy for a whole year (it’s more complicated than this but that is basically what it is). So in other words, if debt-to-GDP reaches 100%, this means that if the government debt is $1 trillion, then that will be equal to the total GDP. If, say hypothetically, government tax revenues amount to 20% of GDP, and total government expenditures amount to 25% of GDP, then a full 5% of GDP is a result of the government deficit. If the interest rate on government debt is 3%, then the government is paying 0.15% of GDP on debt interest, which amounts to about 1% of expenditures. Since that level of debt burden would be added each year, in this totally hypothetical example you can see how it could quickly grow larger and eat up a significant amount of government expenditures.
But it’s not quite that simple because firstly, inflation enters the picture which can devalue that debt. Secondly, the government is involved in creating new money so while the government can’t just blatantly print up money for its expenditures because that would be highly inflationary, it performs money creation in a roundabout way. Most people think that our money is printed by the government via the Mint. Not true! Actually, the base money that is created by the government is created when the government runs a deficit — which is the difference between the 20% of GDP in government taxation revenues and the 25% of GDP in government expenditures, in my hypothetical example above. That 5% difference is the deficit and when the government spends that money which it has created by going into debt (via the central bank), it is injecting further money into the system. This is where money comes from.
But the above describes only base money creation. That is only a small amount of the money out there. Believe it or not, but most money is created by private banks out of thin air. When you get a loan for a car or house, that money was not borrowed from the bank! Rather, it was instantly created out of nothing, at the snap of a finger, by the bank. This is called credit money. Private banks are granted special power to do this (but they do have reserve requirements which can vary). So when I say that our money is based on debt, it literally is based on debt, because most money is created out of nothing, by you the consumer, when you take out a loan! No debt? No money! And when people say that our economies would be just fine if we would all just work really hard and pay off our debts, it doesn’t work that way. There would be no more money in that case! In reality, what would actually happen is that the monetary base would be increased as you work harder and the national debt burden would grow even larger.
What is a dollar then? A dollar is a promise to pay. A promise to pay what? … A promise to pay a dollar! How do you get that dollar? You go out and work for dollars! The banks make the dollar and you make the value backing that dollar.
“But I never signed any dollar bills to make promises to pay them off in the future”, you might respond. Ah, but yes you did. If you are an average person, your signature went on the loan you took out to buy your house or car. That debt was used to make dollars! If you are wealthy enough to avoid having to go into debt, good for you. But the system only works if there are many more people out there who are in debt. Furthermore, even if you aren’t in personal debt yourself, your government, on your behalf, has gone into debt to create dollars. A portion of that debt ultimately rests on your shoulders, as a taxpayer in your country.
In this monetary system build entirely out of debt, it doesn’t mean that people can’t own anything. Many people’s net worth could still be positive, on average, and some people could have very positive net worths. But for every person that holds monetary wealth, there is an opposite debt out there and, taken on a country-wide scale, there must be more debt than money for this system to function, as there is another important difference between an asset based and debt based monetary system that I haven’t mentioned yet…
That difference relates to the question I asked earlier: in a debt based monetary system, why would a vendor accept as payment a promise to pay $10 in the future when they could instead just demand payment with some real tangible thing worth $10 today, like $10 worth of gold for example, and then not have to accept the risk of the promise not being honoured? There are a few answers to that. One is that the central bank doesn’t want you to use gold coins for transactions (because that isn’t debt and then it couldn’t control you) so it limits the denomination size to large coins in order to make it difficult to use them as change, and it no longer offers convenient and convertible pieces of paper that are actually legally attached to a gold bar in a vault somewhere, which is what dollars used to be. Also, the banks manipulate the gold price to introduce volatility which scares people away from holding gold as an asset. And the third reason that people prefer dollars over gold as money nowadays, the main one, is that the debt promises signed on pieces of paper return INTEREST, whereas gold doesn’t. Or, at least not in the same straightforward way (gold actually does return interest, but recently the interest one receives from loaning gold out is actually becoming negative (called “backwardation”, meaning that people value holding in hand the gold today higher than in the future, which is a symptom of worries that the gold may not be available in the future… I touch more on this later.)
So then, debt bonds (and therefore money) return interest payments. This leads to the “interest rate”. The rate of interest is (supposed to) reflect the risk of someone defaulting on their IOU to pay back the dollar. The greater the risk there is of a party not being able to pay their IOU’s off, the greater the rate of interest that should be charged for that bond, which is supposed to offset that risk, kind of like gambling. This makes it more difficult to lend to people or companies with a poor credit rating, which should therefore limit the amount of economic resources allocated to that particular risky economic activity, and instead divert it elsewhere into less risky, more productive endeavours with a lower interest rate. According to theory, this is supposed to behave as a kind-of self-regulating “free market” in which the interest rate determines how capital (dollars) will be allocated into different kinds of debts which return some real world wealth from the person on the receiving end of that debt who is working their ass off over the next few years to pay it back.
Because of interest, there is always more debt than money in the system. For example, if a 10-year debt bond (actually called “Treasury Bond”) that was used to create a dollar has a 3% interest rate, then the amount of debt associated with that dollar is actually a dollar compounded at 3% for 10 years! That is $1.34 in debt for every such Treasury dollar in existence — in other words, 34% more debt than money. No one is going to lend you money to create more money if you do not provide a return on that investment. We currently have entire generations of savers who believe that it is their right to earn new money by simply owning money — by parking it in the bank and earning interest off it. Millions of retirees are fully expecting to fund their golden years this way. This is called “usury” (although the term has now come to refer to excessive interest, as opposed to just plain interest), and it was illegal over much of human history, because the obvious implication is that those who have the most wealth will get wealthier and wealthier and hoard the money — since the more money you have, the more money you make, and the less of a proportion of your income your daily living expenses represent. If the monetary system is made up of a set amount of gold coins, for example, then due to usury, those coins would gradually accumulate in the hands of those who have the most gold coins (unless you bequeath your life savings to your irresponsible teenagers who blow it all, but typically, money stays in “the family” and grows more money). Anyone who has played Monopoly can attest to how virtually impossible it is to catch up to someone who has achieved a point of runaway “wealth” and owns most of the board. To this day, usury is banned in Muslim cultures, for the additional reason that it creates an unequal master / slave relationship between creditor and debtor, rather than a partnership as equal “brothers”.
Nowadays, of course, receiving interest on your savings is accepted by virtually every Westerner as being one of the most fundamental concepts of money. Everything revolves around interest and return. But what about the wealth concentration problem arising from usury? Isn’t that still of concern? Well, according to our modern economists, we have circumvented that problem by setting up our economies so that we can have our cake and eat it too. Not only can the rich get richer via usury, but ideally so can the little guy who has no money, because he can be participating in the creation of new wealth and realize his prosperity that way! Where does that new wealth come from? From economic growth, that’s where! We can grow our way out of the wealth concentration problem, so that value is created at a rate which allows the little people to get wealthy too! What happens is that the transfer of wealth from the middle class (those who “work for their money”) to the wealthy class (those who “have their money work for them”) is ideally matched by the transfer of wealth from natural resources to the working class. This transfer of wealth from resources through the middle class to those earning usury (or its modern equivalent since it is no longer as simple as just plain interest anymore with such low interest rates; it gets much more complicated — read on) is what keeps unemployment in check — it provides jobs for people, since it requires work to extract and transform natural resources. Overall wealth increases, for everyone, because we’ve made the Monopoly board bigger. Or so the theory goes…
Given that we have a monetary system that is set up to reward saving money (which is a debt) with more money, where does the new money come from to pay the interest on the previously created money? Well, more debt of course. Therefore, overall debt can NEVER be repaid in a debt-based monetary system, because to get the dollars needed to pay off the debt requires the creation of more debt than the dollars! The best that can be hoped for is that debts, overall, be serviced, i.e. rolled over and replaced when they expire; but not fully paid off. And the only way to do that is to introduce new money (debt) at a rate roughly equal to the previous debt obligations expiring. This leads to a fundamental requirement for a perpetually increasing money supply — and concurrent economic output too, if the money is going to retain its purchasing power relative to real things you can buy with it in the real economy. This is the catch of course, because it is theoretically possible that the monetary system could grow at an exponential rate while the real economy underneath it doesn’t. But the problem with that scenario is that inflation would be very high due to all the exponential debt (dollar) creation, and investors who wish to receive interest on their dollars would reject a low rate of interest (return) for their loans since the value of the dollars would be dropping faster than they grow by interest. Instead, those investors would either, 1) dump their dollars and buy real world goods in order to protect their wealth against a falling currency or 2) demand a higher rate of interest and this would result in an even faster growing monetary (debt) system. Those two responses should theoretically go hand in hand, and it is the outcome that central bankers really want to avoid. This is what should happen if people behaved rationally and reacted to real data, but in reality it’s much much more complicated than this and there are a variety of ways that this outcome can be avoided, or at least stalled for a while. The main complications are deflation, whereby a recession occurs and many debtors go bankrupt. Then all those debts (dollars) that disappeared with the bankruptcies get wiped from the system and there are therefore less dollars in the system, and prices drop. But economists dislike deflation even more than high inflation because it comes with some very socially disruptive consequences (basically, everything you’d associate with widespread bankruptcies and unemployment, plus it has profound implications to a very delicately interlinked financial system when any one major participant in that system goes bankrupt). Another complicating factor is that central banks can buy the debts to create the dollars by printing them up electronically out of nothing, in effect cheating the forces of supply and demand that would otherwise reject low interest rates. I’ll explain this below.
One of the most difficult concepts to understand is banking and money creation. It’s right up there with understanding thermodynamic entropy — it takes years to wrap your head around it. This is not simply by accident since it is a very secretive sector of the economy, for good reason. They don’t want everyone understanding how it works or there would likely be revolts! I think the best way to envision banking is that banks act as the go-between between money and debt. They are the entities that turn debt into money and then reissue it to someone else. There are basically two types of banks: central and commercial. Central banks turn the government debt into base currency via Treasury Bonds which are sold primarily to other countries like China, but anyone can buy one. Commercial banks operate in the private markets and are involved in creating credit money by taking the dollars that the Treasury Bonds create (and also the credit money created by other commercial banks), and then making more debt and dollars out of them. This is a consequence of the fractional reserve nature of banking, in which banks are allowed to take the assets they have and multiply them many fold and re-issue back into the economy as debt, to create dollars. Basically, banks match up you, the person who is going to be working for the next 20 years to pay off your debts — you, the creator of wealth — up with the dollars on the other end which will be issued to someone else as debt and will have value and purchasing power because of the labour that you will be performing over the next 20 years. Banks go bankrupt when they don’t do due diligence and lend money to non-credit worthy individuals who can’t really pay back their debts. When those individuals default the banks are then on the hook to someone else for the money (debt) they owe them. Because of the levered nature of this system, due to fractional money creation, the difference between profit and bankruptcy is very thin. Before the 2008 crash banks were levered up to 30:1
This entire system is built on credit, promises, and confidence in future prosperity resulting from future economic growth brought about by you, the worker, going into debt and working to pay it off. Due to the fractional nature of money creation, the monetary system is like a balloon that constantly needs to be inflated. Furthermore, it constantly has to grow. The best way to envision this is via Exter’s Pyramid. This shows the base of the monetary system as gold, which has zero counterparty risk. This means that while its price can fluctuate due to a combination of general sentiment towards inflation / deflation, but primarily due to central bank management of the gold price, gold price can actually never go zero. Gold has been money since eternity and everyone accepts gold as money, whether they admit it or not. It is a hunk of metal and cannot default. It will always have value because it represents an asset based exchange system, not a debt based one.
Although gold isn’t officially at the lower apex of the monetary system anymore, and hasn’t been for several decades since dollar / gold convertibility ended in 1971, you can bet that it still fulfils a role there and that the central banks are very aware of gold’s importance, even though they publicly pooh-pooh it. This is because, above gold in the Pyramid is every other type of dollar. Essentially each level of the pyramid is a multiplication of the level beneath. Each level represents and creates money in the system. But the fundamental difference between each of the upper levels of the Pyramid and gold at the base is that they each have “counterparty risk”, which means that they all derive their value because they are made out of debt and must be repaid by someone else. What happens if that someone else goes bankrupt and can’t pay? Then, basically, you’re out of luck… and the money you thought you owned vanished. The FDIC (CDIC in Canada) is a branch of the government that is supposed to swoop in and protect you from such events in order to maintain stability but in reality it is much too small to bail everyone out. This debt (money) destruction is what deflation is. The opposite of deflation is inflation. Although inflation is generally understood to be rising prices, this isn’t exactly correct. What inflation actually is is an increase in the money supply — growth in the size of Exter’s Pyramid — as more debts are created. This typically results in increasing prices because there are now more dollars chasing roughly the same amount of goods and services out there as before, which results in increasing prices. It is not this simple, however, because money velocity is the other factor determining prices. Prices are a combination of how many dollars there are in the system and how fast those dollars get turned over in exchange. Deflation is the opposite of inflation — debts defaulting and money vanishing, which tends to result in decreasing prices.
You can by now see how this pyramid is very … “edgy”, or “jumpy”, due to the fractional reserve nature of money creation. It is all based on confidence in the future. When confidence and optimism is lost, deflationary spirals occur. And deflationary spirals could be very damaging as they cascade from one level down to the next, causing tremendous political and economic mayhem. Periodically, such deflationary crashes are supposed to happen every few years to clear out bubbles at the top of the pyramid and to destroy the bad investments out there. Then the remaining solvent assets can continue growing again and create more wealth. What happens is that basically the upper levels that were inflated due to bubbles deflate and / or vanish. Then the money supply decreases and bankruptcies continue down to the next level beneath, and continue to go down until the safest levels are reached. Historically the safest levels have always been dollars and Treasury Bonds, which is another reason that dollars gain purchasing power and prices drop during deflationary events, since demand for dollars increases as everyone piles out of the higher levels of the pyramid into safer lower ones. Treasury Bonds have always historically been the solvent safety net, because they basically represent the cohesion of the country. Once government debt defaults and government can no longer operate, the country is lost for a while and must be restructured. At this point, people are typically more concerned about their lives than their investments…
Governments and banks really do not like deflationary crashes and they do what they can to keep them to a minimum and prevent the crash going too far down the pyramid (because, truthfully, the entire Pyramid today is insolvent and this would be revealed should a deflationary crash be allowed to ensue unchecked). They do this by stimulating growth, which makes everyone happy because everyone gets to make more profit. Then everyone can take a big sigh of relief and sleep well at night knowing that their investments will not crash by morning… This is done in two ways: via fiscal policy and monetary policy. Fiscal policy is the government increasing spending and going further into debt, which creates more dollars at the base of the Pyramid and satisfies confidence that “the government will save us from ruin”. It hires more people, more stuff happens and everyone is happy. Monetary policy is when the central banks lower interest rates which then allows more debt and therefore more money to be created. Both of these actions create temporary booms. Inevitably, however, they increase debt in the system, and can only be reconciled through more growth, or subsequent deflationary crashes.
There is actually a third option the banks have to keep deflation at bay. This is what they have been doing since 2008 and it is very concerning when one understands the ramifications of it. What the central banks do is issue new base money to keep the government deficit funded, but with a twist. This currency is not backed by anyone’s debt! There is no one who has signed a contractual obligation to pay back the debt that the Fed has created. This debt resides on the central banks’ balance sheets as a liability rather than as an asset, which is what traditional debt dollars were, and the official story given is that the banks will at some point in the future sell these unbacked dollars into the market to future debt-seeking entities, when growth and economic health resumes. In reality, however, this scheme has been tried many times throughout history, and it is called debt monetization (this latest version is called “Quantitative Easing” and various other misleading acronyms), and it always results in the destruction of the currency via hyperinflation. It is an admission by the central banks that fiscal and monetary policies have reached their end and have failed. Look at the following chart of the monetary base. Basically, all of the money / debt pre-2008 was “legitimate” (meaning, there was a debt associated with each dollar — I disagree that our monetary system was ever truly “legitimate”…) But the vast majority of the money creation afterwards was not! What it essentially means is that the economy can no longer grow to provide value to the Treasury Bonds at the base of the Pyramid and even they too would be obliterated in an uncontrolled deflationary crash! The carnage would go all the way to the bottom, to the level of gold.
But if debt monetization always results in the destruction of the currency, then why do people continue giving the Fed faith and keep piling into financial assets? Shouldn’t they all just reject the higher level financial instruments, as well as the dollar, and buy physical gold in anticipation of the crash? Well, the answer to that is several fold. Firstly, people in the know are buying physical gold. But it may be several years before the system collapses and there are still dollar profits to be made. Investors know the game, and they know that if they position themselves correctly with derivatives (I talk more about these later), there is profit to be made with each round of money printing that inflates the balloon a little bit further. Furthermore, the alternative to getting out of the higher level financial assets and jumping into the dollar or gold to avoid a deflationary crash is the knowledge that the Fed can at any time print more imaginary dollars to inflate the higher level assets even further, which would be an opportunity lost for profit. This is how the game has been extended since 2008. There is currently no alternative to the dollar system for everyone to jump into, since it encompasses the entire world’s financial system, so everyone is taking a “wait and see” approach. The Fed remains very powerful despite its insolvent fundamentals because it has the power to print money — to prevent deflation from occurring. This knowledge by investors that the Fed can and does print money to keep deflation at bay keeps them in the higher level asset classes. And the knowledge that hyperinflations are typically preceded by deflationary events in which the dollars actually increase in value as the Pyramid crumbles keeps people in dollars as well. When the Fed’s money printing can no longer counter deflation, it will lose its power and a new monetary system will be put in place, likely backed by gold in some way. Alternatively, the system could end before this if the rest of the world somehow rejected the western monetary system.
Believe it or not, there is actually a fourth way the Fed can fight deflation (and a fifth as well). The above paragraph describes how the Fed can just magically print up Treasuries near the base of the Pyramid, which then get multiplied up through the whole Pyramid via fractional money creation. But it came to light in 2014 that the Fed is actually buying assets at pretty much ALL o the levels of the Pyramid, not just the base. It buys stocks, mortgages, pretty much everything, simply by printing up dollars, trillions of them since 2008. This explains how and why the markets have seemingly inexplicably levitated for so long, sending deflationists into a tailspin trying to understand how they could be propped up. The Fed has done this because there are only so many Treasuries they can print up — they are limited to the size of the government’s deficit, and if the size of the deflationary crash they are fighting is super big, then the “Antidote” of money printing needed to counteract it will also need to be big.
So what, you may ask? What’s the problem? Well the problem is that this system is not too different from a ponzi scheme. Well, actually it is a ponzi scheme — look at it — it is a pyramid. The only difference is that the growing economy is (supposedly) based on increasing the amounts of valuable real world assets available for purchase, whereas the ponzi scheme feeds on itself based on nothing more than investors’ expectations that more people will join and further inflate the price of shares in the scheme. The underlying value of the ponzi scheme has been multiplied many times above its true real world asset value, so that when investors get scared and at some point trigger a panic, the whole thing comes crashing down. THAT is the problem, in that the system is not held together by the underlying wealth and assets of the economy – those have been greatly exaggerated to keep it going. The system is increasingly no longer held together with debt since the Fed’s balance sheet is increasingly not backed by anyone’s debt. The only thing holding the system together is confidence, and increasingly so. That requires intense amounts of propaganda to keep going and if, for whatever reason, confidence is lost, then in an instant the entire monetary system would collapse. What could cause a loss of confidence? Maybe a major war that threatens the viability of the USA? Maybe the rest of the world finally rejecting the dollar as international reserve currency? Or how about physical gold running out because of all the investors (mostly in Asia) who have been buying it because they know what Quantitative Easing really means?
Another way of thinking of our monetary system is that there are always more slaves than masters in the system. Slaves can be controlled and be forced to go to work, “for their own good”. This is a pretty cynical way of understanding the monetary system, but it is unfortunately essentially how most economists believe that wealth is created and how societies of people should be managed. We aren’t smart enough to manage ourselves in a democracy, so the economists have endeavoured to do it for us via the banking system. If everyone can be “encouraged” to go to work to pay off their debts, which statistically always exceed their assets due to interest, then the increased economic production resulting from this activity will continually improve everyone’s standard of living as the economy grows. Voila! We have prosperity, and it’s all because of debt motivating people to go to work!
This is basically how our modern monetary systems operate, although there’s a lot more twists and turns, and today the system has become extremely strained as this inherently unsustainable economic model reaches its limits.
What’s the Problem with the Monetary System?
I hope that by now you may have a few thoughts leading you to believe that maybe our monetary system built around exponential growth has a few inherent flaws… But to many people there is nothing wrong with this system. In fact, most economists believe that as long as the rate of new technological ideas developed by scientists and engineers keeps up with the rate of new money creation, labour will be able to produce more and more stuff using less and less resources, and this will enable our economies to perpetually grow year after year after year … forever! (I’m not kidding. See the textbook, “Economic Growth” by Barro and Sala-i-Martin — they have the imaginary two dimensional charts to prove it!)
Of course, some of the most important ideas ever developed by scientists — the laws of thermodynamics from a few hundred years ago — specifically forbid this from happening, and clearly demonstrate it to be erroneous. To dig a little deeper into why the idea of perpetual economic growth is erroneous, we need to look at what it is that labour actually does to “produce” things.
One of the first things all economists learn, and then subsequently base their entire disciplines of study on, is the idea that labour has “productivity” (think back to the Production Possibilities Curve). This is false. You know it’s false, because only plants can produce. Humans consume.
Believe it or not, but virtually everything that exists in any economics textbook which is based on the premise that labour “produces” things … is false. Here’s a challenge — name one thing that labour produces. Anything. You can probably think of many things. Now take any one of those things and analyze how labour actually “produced” it to begin with. You will find that in every case, every single case, labour needed more resources to make that product than that end product contains, in terms of energy and raw materials that had to be taken from the natural world. I guarantee it, 100%. There’s that pesky second law of thermodynamics popping up again.
Here are some things that we humans actually produce:
- body heat,
- forces when we move our muscles,
- various noises and substances from different bodily orifices,
- our skin also exudes certain substances as well,
That’s about it for physical things. Do any of those have economic value? The only one which does is forces made by our muscles. Therefore, this is what labour “produces”. We produce services, not goods. The planet is what produces goods. All we do is take and transform those goods (minerals, biomass, and energy, also called “primary wealth”) into something else which we call economic goods (“secondary wealth”), and we do this within the bounds of the laws of thermodynamics. We don’t even really “produce” services either, because we had to eat energy first in order to be able to think and move our muscles. Therefore, from here on out, if I ever say that labour or our economy has “productivity”, I use that term loosely.
What we erroneously call economic “productivity” is actually just the generation of entropy (disorder) as we trigger energy transfer events to happen, from higher potential states to lower potential states, to use up exergy. So much for the popular notion that our industrious activities create “order” out of the natural world; quite the opposite actually. What we are actually doing is desperately running around all over the planet and creating DISorder wherever we can find order. If you remember from chemistry class the chart for an exothermic reaction:
Exothermic reactions liberate net energy but in order to get that energy we first have to expend energy. To get something to burn we need to first make a spark. Essentially, this is what our economies do. We scour the planet for the last sources of these exothermic curves, and devise ever more clever tricks to trigger them.
But rather than have that entropy be immediately lost to outer space as heat, our economies are set up to temporarily harness this entropy generation to do useful things for us first. Overwhelmingly, those “useful things” amount to setting up our economies to trigger further energy transfer events to happen in the future, to generate even more entropy for the universe. That’s why we invest effort in establishing farms — we expect that plants will grow and at some point in the future we will have additional sources of exergy available in the form of food with which we can reap the rewards of generating entropy when we eat and metabolize that energy. Rather than have sunshine immediately generate entropy to the universe when it strikes the surface of the Earth which then reflects or radiates away, or do something else “useless” like, say, maintain a few million species in a tropical rainforest, with farms what we do is we temporarily stall the generation of some of that entropy and instead make those entropy generation events happen inside our bodies. Similarly, this is why we invest so much effort in searching for and developing fossil fuel fields.
Maximizing wealth “creation” involves maximizing not only the amount of resources transferred from the natural world to our economies, but equally as importantly, the efficiency of that transfer and the equitable distribution of that wealth throughout our societies, which is what the endless left vs. right, government intervention vs. free market political debates center around.
Many may argue: “But if I work hard at my business to turn a profit I have produced wealth. That value wasn’t there before I worked really hard at my job. I have indeed produced something.”
But did you really “produce” that wealth? And was it really not there before you worked hard? What is “profit” anyways? Well, here’s what profit is. This is what you actually achieved when you worked to earn money:
Yes, that’s really what you did. Your efforts at work claimed for you a portion of the ecological production supporting our economies, just like the work the lion put in to chase and kill that animal went to claiming for the lion a portion of the underlying ecological production supporting that lion population.
Let’s put some numbers to this example to explain. First, let’s pretend it’s a cheetah instead of a lion because cheetahs hunt alone which simplifies the math. And let’s say that every time the cheetah chases a potential prey animal, it burns 50 Calories. If 9 out of every 10 chases is unsuccessful, then the cheetah must on average expend 500 Calories to capture one prey animal. Let’s also say that the meal the cheetah gets from its kill provides 5000 Calories. So that’s an EROEI of 10:1 (my numbers are just hypothetical best guesses, though probably not too far off reality). That 10:1 EROEI is its “profit” – it gets 10 times more back than it invested. This leaves 4500 Calories of energy surplus. That energy surplus goes towards maintaining the cheetah’s movements and body heat when it’s not hunting, to repairing its body from injuries, and towards raising its young. Ultimately, virtually all of this energy ultimately turns into heat and gets radiated to outer space, unless the very unlikely event happens that the cheetah inadvertently gets stuck in a tar pit and is forever entombed, to be later excavated by curious scientists thousands of years later, or dug up by future oil companies who want to sell its now-gooey flesh to others so they can burn it.
Parallel this with your foraging activities at work. Let’s say you need $10 in food a day to keep you going at work. And you need to spend $10 in gas to get you to and from work, plus $5 parking. Add in another $5 per day to cover your work clothes or what have you, and the total comes to a $30 daily investment you need to make in order to work (let’s not consider tuition fees for any previous education, to simplify things). You make $150 per day in wages, so that is a return of 5:1. That leaves you with $125 per day profit that you can now spend. Ignoring income taxes, this goes towards rent, food and gas for when you’re not working, entertainment, material toys, and of course raising children.
Really not very different from the cheetah’s daily budget, is it? The only real difference is that all of the cheetah’s profit comes in the form of food energy, whereas your profit comes in the form of money which is then used to buy things that ultimately all boil down to energy, of which food is a significant component. The vast majority of all the other stuff you buy is a product of oil, natural gas, coal, and biofuels, which of course are just fossilized dead things, not unlike the cheetah that fell into the tar pit…
Now, some may object that what I have described above is not “profit”, but rather “income” from employment; that these are different concepts. Profit, some will say, comes from allocating capital and financial resources to get more financial resources ($) back than you put in. This can come from running a business or from investing in mutual funds, property, or whatever. There is no way that the cheetah’s 10:1 return I have described here is true profit, when investors today are happy with a 5% return on their investments and would kill for 10:1 which actually amounts to 1000% “profit”.
Is this true? Are profit and income different things? What is the difference between income and profit? Let’s go to Investopedia to answer that. Profit is “a financial benefit that is realized when the amount of revenue gained from a business activity exceeds the expenses, costs and taxes needed to sustain the activity.” Income isn’t defined on that site but I think we all understand what I am talking about — the money you make from your job.
What essentially is the difference then between income and profit? Well, basically, income is made when YOU do the work. Profit is made when your financial assets, allocated correctly, work for YOU! It’s that classic old banker slogan trying to get you to park your money in their bank: “Get your money working for you rather than working for your money!”
So now what’s the difference between you working for your money versus your money working for you? Well, your money working for you really means “someone else is working for you”, because as explained previously, all money is debt and on the other side of every legitimate debt is someone enslaved by a mortgage or similar debt. They have to go to work to earn income to service that debt.
Some may object that if you work in your own small business to create genuine profit, you have done the work; not someone else. So, that profit did not come off the back of someone else in debt. Isn’t that blurring the definition of income versus profit? Well, no, not really, because you are just operating as one of the financial assets of the company when you work for it; it just turns out that the profit the company makes also goes back into your pocket, in addition to your income. If you make traditional profit in your company then all that’s happened is that you have allocated a little bit more of a sliver of the global ecological production pie for yourself.
The reason your income provides such a high 1000% return whereas a good traditional profit return these days is a mere 5% is because your income must support your entire life outside of work. If you can’t pull it together in your life you can’t be a very productive employee. Nowadays, over their lifetimes, most people leave no more behind after they die than what they had when they started. In contrast, traditional profit has a narrower scope, and accrues from increases in value above and beyond the difference between income and life expenses. For example, one could say that they need to work 7 hours a day to make ends meet. If they work 8 hours, then that extra hour provides a “profit” above their income. But in order to work this extra hour a day you are giving up more of your life.
Back to the cheetah example, income would be the antelope-hunting mathematics I went through previously — the energy the cheetah expends to get a meal and the energy it gets back from it to live its life (this would be in the order of a daily and weekly time scale). Profit, on the other hand, would be more like any longer term incremental increase in the amounts of antelope available to that cheetah, due to say increased rainfall that stimulated more vegetation for the antelopes to eat, or if there was a disease that went through and reduced the lion population which left more antelope for cheetahs. This increased antelope availability would then allow that family of cheetahs to enjoy a profit, meaning the balance between income and life expenses would shift and widen in the cheetah’s favour, and it would have an increased cub survival rate and result in an increasing cheetah population over time. Hmm… kind of like what humanity’s done over the last several centuries, isn’t it? Either way, income and profit come from the same place — ecological production, and they both involve getting back more than you put in — essentially, a positive EROEI.
If you work in agriculture, fisheries, or logging, then your work literally harvested a portion of ecological production; that’s direct and easy to see, and impossible to refute. But if you instead work in an office or other location detached from the natural world you still emulated the cheetah, because in your work you convinced others (or tricked them if your “work” is more unscrupulous), through one mechanism or another, to provide you with money in return for your labour. Since all money is a claim on ecological production, you have gained access, through the medium of money, to the ecological productivity that someone else has directly harvested from the environment, in trade for your services which somehow in your own way, are enabling society to continue functioning. In an ecological sense, you do not “make” money as I said before. You actually “take” money.
Now, if the economy is not growing, then your profit must come at the expense of the rest of society or of the other species on the planet, because it’s a zero-sum game. That’s not necessarily bad or wrong (within reason), because maybe you deserved it, or maybe otherwise you’d have no incentive to work. I mean, someone has to be successful and perpetuate the species, right? On the other hand, if the economy is growing, then everyone gets more wealth as a result of your work (except, of course, the lions, tigers and bears that got displaced by our consumption). This, ultimately, is one of the main reasons why we must have continual economic growth.
I should diverge here for a little bit since at about this point you may be raising your eyebrows at my mechanical treatment of people and economies. It may sound as if I’m describing humans as merely some soulless energy consumption machines: “There goes the engineer, unable to think outside his linear, deterministic models. There is so much more to human psychology and consciousness than this, and since humans are what makes the economy go round, these linear models are grossly overly simplistic”.
To this I say: “Nope, sorry!” I appreciate your concerns but my reductionist analysis is valid when it comes to analysing energy and goods and how these flow through our economies. While humans do indeed drive our economies, on a more fundamental level, however, energy is what powers us. On the scale of people and our economies, energy is a macroscopic system (with an “a”, not an “i”), meaning that the classical laws of physics apply. They are reductionist by nature and we cannot escape that. The laws of thermodynamics don’t care whether or not you like or accept them; you are bound by them regardless. In terms of understanding how our economies function and how this relates to the natural world which supports that activity, my soulless energy analysis is sufficient and accurate. If you deny that my characterization of energy flow from sunshine –> plants –> food –> humans –> labour –> economy is a valid one, then I encourage you to play scientist for a while and perform an experiment by going without food for two weeks, then analyze the results to see how “productive” you are at work…
But don’t despair, because I am the first to argue, strongly, that a mechanical, material reductionist approach to the world is incomplete. Obviously there is much more to the world than as described by the laws of thermodynamics — but just not when it comes to energy flow at the scale of our economies. Do you think these laws determine your thoughts? Emotions? Inspiration? Humour? Scientific revelation? Consciousness? Evolution? Spirituality? Obviously not. But here’s something else that all these other “things” have in common, which is fundamentally different from energy that powers our economies — they are all influenced at the microscopic scale (with an “i”, not an “a”). So remember way back when I said that subatomic so-called “particles” are able to violate the laws of thermodynamics for short periods of time? Well, at this microscopic scale, it’s no longer a deterministic classical system. The idea of discrete objects “existing” starts to break down. And this is also the scale at which thoughts develop, consciousness becomes an emergent quality, and the genetic code changes to enable evolution. This is where the analysis is no longer linear and your own beliefs come into the picture. Those other lenses of perspective are beyond the scope of this essay so I don’t think I need to explore them further here. The laws of thermodynamics are merely one lens through which to analyze the world, and as long as other perspectives don’t conflict with them, then there’s no reason why they can’t be equally valid.
So here are some of those other less tangible things you could also say we “produce”, or at least have something to do with … many of which have economic value:
- and many more such things as mentioned in the paragraph above.
The most economically important of those is of course “ideas”. And it’s not just basic ideas like how to pick up a shovel and dig a ditch that have economic value. “Ideas” also incorporates all our more sophisticated and institutionalized knowledge like patents. Patents are just ideas relating to tricks or methods that are good at getting our entropy generation activities to do certain useful things for us that were not openly obvious to anyone previously. Usually, these patents have to do with finding new sources of higher potential energy, or finding better or more efficient ways of getting the energy transfer events to do useful things for us. This is why patents have economic value.
From this it can therefore be understood that Japan does not produce cars. What it produces is ideas that we call cars. Those physical things that we call cars were actually “produced” by the planet somewhere else, from the mines which provided the raw materials, and from the fossil fuels that had to be dug up somewhere else, all of which had to be shipped to Japan for further processing, directed by forces from our bodies and ideas from our brains, in order to be transformed into some hunks of stuff we like to call “cars”.
Even in a hypothetical world of infinite resources, “productivity” of labour would be limited by how much a person could physically do in a day. For “developing” countries, economic growth is relatively easy because those people who previously did not work, or did not do very “productive” things (in an economic sense at least; they may be doing wonderful things that cannot be measured by GDP), can get an “education” and instead now go work in a factory and use technology (expired or current patents) to build things, or use mechanized equipment and fertilizers to increase agricultural yields — in other words, to increase their consumption of and addiction to fossil fuels. But for mature economies that already went through this modernization process decades ago, where pretty much everyone already works full time and uses technology to its fullest benefit to “produce” valuable things, how can labour increase its “productivity”? It can’t. The Law of Diminishing Returns sets in, and squeezing more and more “productivity” out of people who are already working with the best that technology can offer isn’t really quite as straightforward as the two dimensional economic charts would imply.
But new money must be created somehow; it is required of the monetary system over the long haul because Principal + Interest is always greater than Principle. In a so-called “healthy” growing economy, the new money is created by everyone taking out new loans to invest in the robust economy so that they can make a return on their investment or buy a house. The new money they create by working their lives away is manifested in all the new things they “produce” by converting more ecological productivity, minerals, and energy over into things that we find useful in our economies. Along with this new funny money created by labour, the central bank would increase the base money supply. In a growing economy, the increasing wages of labour would offset the losses in purchasing power from inflation so that people don’t complain too loudly. Most mainstream economists believe that a continuous small rate of inflation is healthy, in part because the knowledge of inflation forces people to invest their money rather than sitting on it, which then stimulates more “productivity”, or so they believe. Interest rates would (ideally) be higher than inflation. If the economy is growing too quickly then the amount of new money creation can be too high and the central bank may cool things down by raising reserve requirements at banks or raising interest rates, which slows down the rate of new lending and money creation, and thus inflation.
What happens if real world economic growth stops, due to say an ageing population that is no longer growing, or from depletion of natural resources, or from stagnation of technological development due to oil industry manipulation for the purpose of keeping everyone addicted to fossil fuels, or from asset bubbles bursting, or from rising interest rates, or from outsourcing your manufacturing base to cheaper third world countries with lower environmental standards? Well that can lead to a recession, or deflation, where the amount of money shrinks due to cascading loan defaults. Therefore, with less money in the system, prices go down. The flip side of this is that unemployment rises because of all those credit defaults. And governments would either need to run deeper deficits or cut spending because they lose out on tax revenues. This is in part why economists try to avoid recessions. Plus growing economies tend to stimulate innovation because new products can most easily gain market acceptance when people are in the consumption mode. There are much more fundamental reasons why our economies (as they’re currently organized) must continually grow, which is the focus of most of the rest of this essay.
But sometimes the opposite can happen and prices can rise along with unemployment. This is called stagflation and it was the dominant theme of the 1970’s. The stagflation of the 1970’s was partly a result of the oil supply shocks. Since energy was more expensive, prices rose, but so did unemployment. There was more to it that that though because in 1971 the US defaulted on its gold convertibility and became an unbacked banker fiat currency. This marked the end of the Bretton Woods system and the beginning of the fully fiat global currency system we currently use, with the US dollar, and all it entails, as the backing of pretty much all other currencies.
As you can imagine, analysing all this can get very complicated in our modern economies. People can spend lifetimes studying these things and can come to completely different conclusions about how economies work and what the future consequences will be from different policy alternatives. This disagreement is, however, to be expected, because almost all economists lack the tools and knowledge base necessary to understand how economies work — they firmly believe that labour has productivity!!! That’s like a scientist believing that all matter is a balance between earth, air, fire and water! Entire disciplines of study have been developed around this highly destructive false meme — that labour produces things — and they range from the right wing, free market-touting Austrian schools worshipping their imaginary thought experiments, to the more centrally planning Keynesian theorists priding themselves on their complex mathematical models, pretty charts, and unintelligible jargon. If you don’t understand Keynesian theory, however, don’t worry; because beyond the basics relating to monetary theory, there is little of substance to it. The only insight you’ll glean from learning Keynesian theory is a better appreciation for how screwed up our world is, with these principles guiding our economic leaders’ decision making processes. The amazing fact is that in this day and age of supposed intellectual enlightenment, almost all economic theories fail at explaining how economies work (with the exception of thermo-economics, or ecological economics). Our economic leaders are failing miserably and they’re all scratching their heads trying to understand why (or alternatively, loudly thumping on their imaginary charts because they think they know why). If only they understood energy!
Back to that book, “Economic Growth”; it has an extensive index. However, the words “energy”, “oil”, and “fossil fuels” are not included in the index. If anyone has an electronic copy, I’d appreciate if you would do a word search for “energy” in the text and let me know how many times it comes up, if at all, and on what pages.
The Other Reason Perpetual Economic Growth is Required
Labour! As technology has progressed through the ages, the efficiency with which it enables us to make things of value that we like to buy has increased. This means that it now takes less labour to produce the same amount of goods that it did fifty or a hundred years ago. This is the result of years and years of continuous refinement in how we make things, ultimately due to competition in the capitalist market system, in which inefficient producers are forced to either increase their efficiency to reduce costs, or face bankruptcy because their product is too expensive compared to what is offered by someone else who made those efficiency improvements.
One would think that the result of this should be that our standards of living should continually increase, and that we should only have to work three days a week now to enjoy the same standard of living as before when we had to work five. Things would become cheaper because they are easier to produce. But what has actually taken place is largely the opposite.
The above utopia would indeed be the case were it not for several critical real world problems. Firstly, the fundamental goods we need for life (i.e. food and energy) are getting more difficult to “produce” for ecological reasons. Our productive ecosystems are being degraded. There are now many more people with generally rising standards of living competing for limited food resources available on the planet. And with a continually decreasing EROEI it requires ever more effort, and therefore more labour, to liberate an additional Joule of net energy. Certain manufactured items which are easier to make, like laptop computers, are indeed getting cheaper, even in the face of monetary inflation, as efficiency drives automation costs down and chip performance up. Computer CPU performance is not currently limited by energy, whereas food production is. Information technology is cheap.
Secondly, different economies compete with each other internationally in the global so-called “free market” and this can dramatically impact capital flows. An economy emerging from poverty which does not care about environmental externalities can manufacture things much more cheaply than well paid Westerners can who value a clean environment that doesn’t give them cancer, and will therefore suck wealth over by establishing itself as a cheap manufacturing center.
Thirdly, the rich are getting richer and the poor are getting poorer. The middle class is disappearing. The middle class drives an economy; the wealthy do not because the middle class actually does the work! So, increasingly now, the middle class is having to work more and more to support both the poor and the rich and powerful, who are themselves increasingly gaining control of both the corporate and government world, and who are doing everything they can to keep it that way. We are becoming serfs. In socialism, individuals work for the benefit of the collective; what we now have is the polar opposite of socialism, a kleptocracy where the collective increasingly works for the benefit of a few. Of course the political spectrum is more like a circle than a straight line, so when a society goes too far off the end to the right it emerges at the far left.
We are now in the situation where the cost of buying most goods is going up, but real inflation-adjusted wages aren’t. This means that people must still work at least five days a week to make ends meet. The technological utopia has not materialized. But if unemployment levels are not much different now than what they were many years ago, and if the amount of labour needed to produce the things necessary for our lives has shrunk overall (energy hasn’t become THAT scarce yet that we need to all pile into the bilge with coffee cups), then what are workers now devoting their time and efforts to? Well, most of the labour force is now dedicated to making the economy bigger — not better; just bigger! Labour is serving our perpetual growth monetary system.
Ironically, the more efficient labour becomes at “producing” things, the more resources must be taken from the natural world. The better we become at using resources to make products for our economy, the faster our economies MUST grow. How can this be? It seems totally backwards. Isn’t the point of technological efficiency to allow us to maintain existing goods and services, but use fewer resources to do so? Yes, that is a nice idealistic dream, but in the real world, these efficiency improvements cause unemployment to go up, all else being equal. If, due to new technology, the amount of labour required to produce x amount of goods and services decreases by say, 10%, but the economy stays the same as measured by the amount of stuff it produces, then unemployment must also go up by 10%. That efficiency leverage also works the other way so that in order to avoid rising unemployment from these efficiency gains, we would need to have an offsetting increase in economic output (growth) to provide new jobs for those displaced workers in sectors like construction and mining activities, rather than in farming and manufacturing which realized the efficiency gains (otherwise, 40% of the labour force will end up on welfare, and that is communism, and it doesn’t work). Therefore, more natural resources must be taken from the planet in order to maintain the new more efficient (but larger) economy than was required for the old inefficient (but smaller) economy! A totally backwards, counter-intuitive result! And the further this progresses, i.e. the greater the proportion of the workforce that gets diverted into construction activities, the faster the economy must grow and the worse it gets!
This is called the “Jevon’s Paradox“, and my explanation is slightly different than what is typically encountered. The common explanation is that as efficiency improves, costs and prices drop. This promotes more consumption and / or more waste, because the lower price shifts the position on the supply / demand chart. As price drops, demand increases. However, only in highly elastic markets would demand increase at a greater rate than the efficiency improvements. In inelastic markets (for example, gasoline for commuting to work along freeways every day), total demand would obviously drop as efficiency improves. This is because if you commuted every day on clogged freeways, you are not going to voluntarily go out and spend more time driving simply because it becomes cheaper due to efficiency improvements. I think the typical explanation for Jevon’s Paradox places too much emphasis on price signals (and in a world of depleting resources, improving efficiency often does not even result in lower prices — it merely delays the inevitable crunch). What I think these explanations miss is the point that unemployment is a critical factor in Jevon’s Paradox, that increased resource consumption does not simply happen because people decide to buy more things when they are cheaper, but it happens because our economic system requires it to go up, to avoid rising unemployment and to satisfy our monetary requirement for perpetual economic growth.
Our current economic system is a hopelessly futile hamster wheel that prevents the benefits of efficiency improvements and wealth “creation” from being realized by the people who actually do the work to bring about that wealth. One could argue that entrepreneurs and venture capitalists reap rewards from such efficiency and technological innovations, and that this is a way for the “little guy” to get wealthy, and there are a few examples of this to provide hope to the masses, like a lottery ticket, but they only represent a small proportion of the players in an economy, and nowadays, the amount of capital required for a successful new VC project essentially precludes those from participating who are merely trying to make ends meet. And beyond this, when the economy stops growing, the wealth transfer away from the middle class continues due to the low tax rates paid by high earners and the convoluted system of usury pervasive at the upper levels of control and ownership. This is happening right now in the western world. But in an economy that is not growing, this siphoning of wealth away from the middle class is not offset by new wealth being taken from the natural world and transferred THROUGH the middle class. In this case, it is simply IMPOSSIBLE for new entrepreneurs and VC’s to lift the overall prosperity of the middle class, because no additional prosperity is being “created” from the natural world because the economy isn’t growing. (When I refer to “high earners” I am not talking about doctors or other legitimate professionals who make lots of money — they work for their money and overall are not actually very wealthy. I am talking about a small group of very powerful, wealthy, and influential “owners”).
This system can NEVER be satisfied until it collapses in a final catastrophic event at some fateful time after the economy stops growing. This fatal degeneration of an economy is first manifested in an increasingly uncontrollable debt spiral. People often blame inefficient workers and government overspending on social programs for our spiraling debt problems but this is totally unfounded. Due to the amazing efficiency improvements brought about by technology over the last 50 years, we could all be lazy slobs at work, only cranking out things with a fraction of the effort that our grandparents did, and still be able to enjoy the same standard of living that they did. Or alternatively, we could have a government twice the size of what it currently is, employing armies to clean up garbage, rehabilitate damaged ecosystems, or care for the mentally ill that have been kicked out onto the streets. We don’t enjoy these benefits though, because the wealth of the middle class is being stolen in this game of Monopoly that has passed the point of no return.
This is not accidental. (Note: there is one mistake in this. Read on for more details.)
Everyone jumping on the hamster wheel 40 hours a week to make the economy grow bigger, simply for the sake of making it bigger, makes absolutely no sense (in reality, “making the economy bigger” really means “transferring your wealth to the center of the bond market vortex”). This is obvious when you look at it through the lens of an energy analysis. It is beyond absurd, and testament to how effective the economic and media conglomerate has been at brainwashing people into believing that they just aren’t working hard enough; that they are lazy.
Over the last century or so the middle class has been “encouraged” to go to work every day to “produce” things through the imposition of artificial scarcity. That’s why you go to work — you need something (food, energy, a house, toys) and you get paid bank credit when you perform your dance at work. The method of stimulation to get the average person off their butt racing their friends around the track has been the mechanical rabbit. As we all know, the greyhounds never actually catch the rabbit, but it makes for a good show watching the dogs race each other and burn themselves out for nothing.
This perpetual artificial scarcity imposed on the middle class is administered through a system of debt slavery. Debt slavery entails the continual theft of a portion of the middle class’ wealth. Just enough wealth needs to be stolen to keep the middle class stimulated to go to work each day, but not so much that it becomes poor, because poor people aren’t very “productive” and they tend to rebel. This theft is enabled through the design of the debt-based monetary system, in which there is never enough money in the system to pay back all the debts. The beneficiaries of this artificial scarcity, the Owners, don’t actually do anything to “produce” themselves, but they enjoy a comfortable transfer of wealth out of the hands of the people who do actually work.
And as long as the economy is growing, almost everyone within the empire remains more or less happy, or at least satisfied. The parasitic Owners accumulate more and more wealth on the backs of the middle class, and the middle class can be placated by being allowed to keep a portion of the fruits of its own labour. If, at the ends of our lives and careers, we have managed to accumulate enough bank credit to own free and clear a pretty plywood box on a postage stamp (a “house” in a city lot) and a car, then the rabbit has done its job. But then you die. The owners are skillful in managing this system to extract as much wealth as possible. They know that if the host dies, so do the parasites. The healthier the host, the healthier the parasites. “A rising tide lifts all boats”. But a host that is too healthy represents excess resources for the taking, so a balance is struck between parasitic sucking and reverse “generosity”.
Look at this graph of the Civilian Participation Rate in the US economy over the last 50 years. One of the most prosperous times in US history, the 1960’s, had employment levels significantly lower than today. And they were working with antiquated technology; they hadn’t even invented computers yet! Yet the average person was far more wealthy than they are today! Ask yourself — where has that wealth gone? The government isn’t stealing it; it’s broke. And government hasn’t yet become so bloated to the point where it chokes off economic activity, either. Red tape isn’t THAT bad yet, and this is offset by the automation efficiencies that computers offer for administrative duties. Something does not add up… This wealth is going somewhere and it’s not going to the middle class, and it’s not going to the government. Then where? China? So the Chinese own America’s farmland and other productive assets? I don’t think so.
We are by nature industrious creatures and if the media controlled by the bond parasites can successfully convince us that the reason we tend to constantly lose wealth is because we aren’t working hard enough at 40 hours a week, then we can be prodded to go out and work even harder. And when needed they can invoke national pride to frame this as a nation-rebuilding effort. They equate progress with growth. Of course you need to work harder when your wealth is being continually stolen by parasites! Don’t people with tape worms need to eat lots of food?
But don’t forget — this wealth “creation” passing through the middle class into the hands of bond parasites is actually a transfer of wealth from natural resources. And now, due to global resource shortages, technological limitations, as well as demographic factors constraining further growth, what’s happening is that the artificial banker-contrived scarcity is meeting genuine real-world scarcity. The tide is sinking and this strands boats. The system is falling apart. And because of the way it’s structured, you can be sure that it will be the middle class that is stranded first. And if the message from the media is handled correctly, the middle class can be turned upon itself, divided and conquered through contrived left versus right antagonism (Keynesians versus Austrians).
Now, when I explain that the economy is built around a transfer of wealth from the natural world through the middle class, to the ultimate consumers, the elites, it’s not like someone whose net worth is a billion times that of the average schmo is out there personally consuming a billion barrels of oil a year. That’s physically impossible. That’s not how the system works. What’s happened is that the elites have gradually accumulated ownership of the real productive assets supporting the economy (farmland, energy deposits), while the middle class has been spending the last few decades fighting over mortgages for pretty plywood boxes on postage stamp city lots. Those plywood boxes maintain their value as long as the system continues growing; otherwise they’re pretty useless since there are so many of them. We as a society have been relegated once again to serfdom, just like in the Middle Ages. We continue stumbling along under the illusion of freedom and prosperity because the real productive resources, i.e. farmland and energy deposits, only have value to their owners if there is a demand for them by the middle class. No rich person is going to consume a billion barrels of oil a year. If there were only a million people in the world demanding oil, then all those deposits the elites own wouldn’t have much value anymore, would they? The owners don’t want to own a bunch of miserable, desperate, rebellious people. They want to own a vibrant society with people singing and dancing. THAT’s why they want you to continue consuming and spending. Unfortunately, all that singing and dancing, as the economy is currently structured, is not sustainable.
Although our monetary problems seem overwhelming, completely overhauling and reforming the monetary system to a zero growth system would not be a very difficult process. It could be done in a year, with tremendous worldwide upheaval as everyone loses all their money, but it could be done and will be done at some point soon. What that monetary system will look like, who knows. The real problem is the beast that our monetary system has created, sculpted, and reinforced through decades, centuries, of capital investment patterns responding to the structural requirement for perpetual monetary growth. That beast is the global economy.
Our monetary system is the driver of the freight train and the global pattern of real world capital allocation is the freight train. While it would be easy for the driver to jump off and change directions, that won’t stop the freight train. There is tremendous momentum behind economic growth because almost everyone works in jobs in some way contributing to economic growth, all the corporate investments in the world are done so as to create and reap monetary rewards from growth, and our settlement patterns are built to function using cheap liquid energy. That cannot be unraveled and redistributed overnight. What are all the construction workers and design engineers, and everyone else who is currently employed in building new infrastructure, going to do for a job when we no longer need endless rows of new suburbs and freeways? How much of any given country’s workforce do these people represent? What will happen to a national economy when unemployment goes up by that much because it isn’t growing anymore?
And the problem is not just the physical economy, but also our collective beliefs about how it should operate, and our inability to understand what is going on and how we are being robbed. Most people believe that the way to help the economy is to go out and consume stuff, but how can this possibly be true, if we are running out of the resources necessary to drive the economy? Most people believe that labour “produces” things, and that the way to get the economy back on track is for labour to work harder and produce more things, for economic growth to pick up. Most people fail to realize that the supposed “solution” of economic growth actually makes the problems worse. And to suggest to virtually any Westerner that they should no longer be allowed to receive interest on their savings would be met with disbelief and hostility. What they don’t understand is that the current monetary system’s structure which is built around debt and interest is not designed to reward savers with interest; it is designed to steal savers’ wealth by duping them with phony returns from interest rates that are below inflation! Interest is used as a weapon against the middle class! How long will it take to change these popular attitudes, especially when the bond parasites themselves control the media? Will the majority of people even have a clue what is going on when the system collapses? The reaction of most people to these problems is to bury their heads in the sand and hope for the best, or to latch on to ideologically extreme political movements, or worse yet, to lap up the media propaganda dished out by the ruling oligarchy. I suggest that the best approach is to understand what’s going on so you can prepare for it and hold accountable the true perpetrators.
How Does a Debt Saturated Economy Stumble Along and How Will It Be Resolved?
Japan is a modern example of what happens when economic growth stagnates and debt builds up. Its population growth has stopped or reversed since everyone lives a busy modern lifestyle and doesn’t have time for kids. Due to nationalist tendencies, immigration is not encouraged to further increase population. Labour productivity in the manufacturing sector has reached its maximum and there is not enough land available to increase agricultural output. In short, Japan’s economy has reached its maximum real world productivity. (Since I wrote this it has experienced further problems after its earthquake and tsunami). New money to fund government expenditures must come from increasing government debt. Its debt to GDP ratio is the highest in the world, around 200%. Because of this stagnation, interest rates have been very low for a long time, and government spending has now had to drop because of mounting concerns over its debt levels (actually, it’s picked since to rebuild after the tsunami). It’s interesting that economists have dubbed the previous decade of low economic growth in Japan the “Lost Decade”. Maybe the real problem is a “Lost Monetary System”.
Other “Western” countries have been encountering similar problems as Japan’s. How can a mature economy maintain real growth in this dilemma of runaway money (debt) creation in an environment of stagnating productivity gains? Well, there aren’t many ways to do this. One way is to further develop a manufacturing sector, which is why Germany is still an economic powerhouse (there are also internal reasons within the Eurozone that have helped foster Germany’s manufacturing base). But China has become the new manufacturing superpower, and given its cheap and expertise labour, that doesn’t seem to be changing anytime soon. Japan is already a manufacturing country. Not everyone can be a manufacturing economy in the face of Peak Resources. Maybe growth could be fueled by further exploiting any remaining natural resources, and this could be facilitated by increasing the population through immigration (this is what Canada is doing). But most Western economies are mature, and with a few exceptions like Australia and Canada that still have relatively abundant natural resources left to plunder, they simply can’t grow anymore. This is a natural and unavoidable outcome of a monetary system that requires perpetual economic growth to function, in a world of finite real productivity opportunities.
There is a way to stimulate economic growth for a while, to cheat, and that comes from increasing liquidity, by lowering interest rates, and / or for the government to engage in major deficit spending for a while, to get people to consume more (to “stimulate” the economy). The idea is that the increases in productivity and the sustainable new money creation from this will more than offset the costs of the stimulation in the first place (ie, the government will get back more in tax revenue than it originally spent on the stimulation, due to the resulting economic growth). And when economic activity gets kickstarted again interest rates can be brought back up. But if the resulting increases in real world productivity don’t exceed the debt burdens incurred by doing so, due to the inability of the economy to grow, then the economy is in no better shape afterwards, except that now it has more debt and less room to maneuver. So the success of this strategy depends entirely on the ability of the physical processes supporting an economy to be able to support a larger economy. Obviously!
However, the short term booms these easy money policies create rarely result in an efficient allocation of “productive” assets. The result of this would tend to create deflationary depressions, where all the monetary excesses of the stimulative past must be reconciled and the resulting poor investment decisions must collapse and purge their way out of the system. This is what happened in the Great Depression; the “Roaring Twenties” were created in large part by easy credit and lower than sustainable interest rates which were imposed to help lift the economy out of a recession in 1921. The great credit boom led to a bubble in the stock market which then crashed and resulted in the Great Depression for the next decade. After this, though, the US economy was able to mostly grow its way out of its debt burdens.
Economic growth makes the relative size of the monetary system’s previous debt obligations smaller in proportion to the collective ability of its citizens to service them (note — I said service them, pay the interest and roll them over, not pay them off). This is what the US has done since the Great Depression. After the Second World War, the US had a debt to GDP ratio similar to what it has now. There were a few reasons it didn’t drown in debt back then: firstly, the US economy has been continually growing as it became the manufacturing and agricultural superpower of the world (everywhere else was destroyed after WWII, opening up lots of opportunities for the US). Secondly, the US economy back then was based much more on “production” than consumption. Thirdly, due to cultural and regulatory advantages, the US was the center for new technological innovations for decades (and in many ways, still is). Fourthly, the world economy was much smaller back then and there was enough energy and resources available to power this growth. Fifth, the US dollar has been the world’s reserve currency which allowed for perpetual budgetary deficits to be printed away to balance trade deficits, which foreign countries could hold as an asset, and this allowed for much more consumption in the US than production.
But economic growth isn’t the only way that debt obligations can be reduced. Another way is through outright default of debt repayment, but this is only an option in times of desperation as a last resort because it is an admission that the system has broken down which makes further future debt issuance more expensive, and it has significant legal and political implications. There is, however, another covert and very successful strategy to lower real debt levels, and that comes from stealth inflation, i.e. by printing more money. If the nominal size of the debt burden is constant, then the actual real-world size of that debt can be reduced by increasing the number of dollars in the system so that the purchasing power of previous dollars decreases (as does the size of previous debts denominated in dollars). In this case, the economy doesn’t actually have to grow in real terms since inflation will overstate real economic activity. All that has to happen is for interest rates to be artificially held below the real inflation rate for a length of time. It amounts to a real and significant transfer of wealth from savers to debtors — which of course includes the government. This is called the “inflation tax” and it is a very successful strategy that has worked well over the last half-century, and works as long as almost all the participants in the monetary system can be fooled by it, which unfortunately they are. It’s why the dollar is now worth pennies compared to what it was a hundred years ago.
John Williams has been keeping track of US economic statistics for several decades using the same methodologies that the government used decades ago. His statistics diverge from the official US Government’s version because the government continually revises its methodologies and introduces new statistical gimmicks to make things seem better than they actually are. This is how they can get away with convincing savers to park their money away in savings accounts for a return that is less than inflation. When looking at the numbers and graphs in the above paper, remember to adjust all inflation numbers using the real inflation rate.
The other edge of the sword of the inflation tax is that the government can collect greater real taxes from capital gains on illusory “profits” from price inflation. For example, if you bought a cottage for $100,000 and then sold it next year for $110,000, you would have to pay tax on $10,000 profit. But if the real inflation rate is actually 10%, but falsely stated by the government to be 2% and left out of any capital gains calculation, then you are paying tax on real-world profits you never actually made!
From this it can be seen that there is an error in Damon Vrabel’s above-linked CSPER series explaining how we are pretty much all owned by elites via the structure of the monetary system. While it’s true that there are a few private owners at the centre of the monetary system, the error comes up when he shows a bond market vortex and argues that wealth accumulates in the centre of that by everyone paying interest on their debt, which then flows inwards. But that is not how the system works, because interest rates are less than inflation. The reality is that if you went into debt to buy something of lasting value, historically, you actually gained net worth over the time it took you to pay off that loan. In comparison, someone else who instead saved that money you spent on down payment by forgoing the purchase, and put it in the bank to “grow”, actually lost wealth, because interest is less than inflation. The elites do not make money from interest on bonds. They make their money by being in complete manipulative control of the markets. They play the insider trading game and know how to position their money in the right place at the right time to take advantage of that. In doing so, they squeeze yet more wealth out of the markets, and then they buy real productive assets with that wealth. This has been going on for so long that there is little wealth to be extracted anymore, since it’s mostly only the elites left playing these markets. I explain a bit more about how this insider trading game works further on down this page.
The strategies of the inflation tax combined with economic growth have for the most part maintained a relatively stable debt-to-GDP ratio for the USA… up until recently. But over the last 40 years or more the nature of the US economy has changed dramatically. It is no longer based on production, but consumption. The gross overconsumption exhibited over the last few decades would have never been tolerated by the international markets if it was any other country behaving this way; only the reserve status of the dollar has allowed this to continue. The US has been able to “fake” its real growth by growing its consumption — consumption of goods that were “produced” overseas. This has led to some highly imbalanced global economic flows.
When free market forces want a deflationary collapse to correct this gross misallocation of labour and capital, the central banks step in. This is done from two ends. Firstly, the Chinese Yuan is artificially pegged low in order to keep Chinese exports competitive. This has had the disastrous effect of sucking over manufacturing industries away from the USA. The Chinese want this because although Chinese workers do not get the benefit of a stronger currency, they benefit from getting a job! Americans (supposedly) like this because they get to maintain their purchasing power and consume lots of toys, without actually having to work for them. It appears to be a win-win situation, except that one economy is being hollowed out, and has become completely dependent on artificial currency exchange rates. In a free market (or should I say, “fair” market?), this degree of currency manipulation would have never been tolerated, the two currencies would have moved towards each other long ago to equalize out the discrepancy, and the US would likely still maintain a real manufacturing sector as a result. Free trade and currency manipulation do not mix — the outcome cannot be good!
The other side of this currency manipulation is that the US dollar is artificially propped up by the Fed. The Fed manipulates the bond markets and everything else as well to keep the machine going. When the markets want to move based on fundamentals that would run counter to the artificial manipulation, the Fed steps in and throws some money around into strategic places to squelch the first signs of dissent amongst the ranks. This behavior is tolerated because the dollar is the world’s reserve currency so normal economic rules don’t apply, and China participates because it believes it to be advantageous in the long run. The Fed is so big that everyone has to play along.
The American empire has been built on this uneven playing field. Since technology advancements displace labour inputs (but don’t significantly reduce natural resource inputs due to the laws of thermodynamics and decreasing EROEI’s), then in order to maintain something reminiscent of full employment, the whole world has had to grow along with the USA. With rising unemployment we’d get deflationary spirals due to reduced tax receipts and decreased GDP, and thus decreasing government expenditures, and so on and so on. Our modern economies just don’t function with high unemployment. Plus, the unemployed aren’t “productive” in an economic sense — they cannot be milked by the bond parasites. This deflationary spiral is what our economic leaders desperately fear. Since the global monetary system is the greatest ponzi scheme in the history of the world, the thing that must be avoided at all cost is the ultimate deflationary collapse of that scheme where the debts come due, and you escape this by continually inflating it further. Bury the previous debt monster under greater and greater GDP.
Essentially, what’s happened is that the rest of the world has put its excess labour force to work producing goods at lower than fair wage rates, for transfer into America. America has put its excess labour force to work consuming those goods at lower than fair prices, and exporting dollars in return. Goods enter America, and dollars leave. Then the dollars that left America get recycled back in through the purchase of further government debt bonds, to allow the system (and debt) to grow even larger.
But how does the dollar maintain its purchasing power then? Shouldn’t it deflate in value to correct the “production” imbalances? The reason for this is linked to the status of the dollar as the world’s reserve currency. It is not merely an debt-backed fiat currency. It is actually informally backed by oil and brute force. Its rule is enforced by the American war machine. If you are an oil exporting nation, you better accept dollars for your oil, and willingly join the Anglo-American bond empire, or you will die (see Libya for a recent example). This is why Saudi Arabia has become so rich — it has cooperated with the US and has allowed its own occupation. It gets paid in dollars and because dollars have maintained their purchasing power the country has become very wealthy. But in the process, they have had to give up their sovereignty to western bond parasites. And there is a lot of internal tension within the country as a result — and an extremely wide gap between rich and poor.
The same goes for any other nation exporting anything to the US — it has to accept dollars. And because all countries know that the US military is ensuring that all other countries must accept dollars as well, then they can be relatively certain that their dollars are going to maintain their purchasing power for as long as America remains the global “policeman”. Overall, most countries are relatively satisfied with this because their unemployment problems due to automation technology displacing labour can be solved by exporting products to the US and receiving dollars in return, which they then fund further US debt with, which enables further US consumption, which then enables these countries to reduce unemployment and develop a manufacturing sector; rinse and repeat.
Back to the consumption side, since the US is a consumer based economy, economic activity can be dramatically impacted by changing monetary and lending policies. Therefore, the changes in its GDP makeup over the decades, from production to consumption, can be hidden by manipulating the monetary system. In the early 1980’s interest rates were around 20% (Volcker shocked the system by raising them this high in order to end the stagflation problems of the 1970’s — he was able to do this because US debt was at a manageable level), and they have since steadily decreased to the current Zero percent Interest Rate Policy (ZIRP) as liquidity has been eased in order to stimulate consumption. But don’t forget that all that economic activity created through easy credit is based on creating further debt. Unless this increased economic activity actually results in the creation of some sustainable real world asset with lasting value, such as investing in education, emerging technology, renewable energy, better farming techniques, ecological rehabilitation, or manufacturing, all that has happened is that the level of debt has increased — like a person throwing a $2000 trip to the Caribbean on their credit card — no lasting value has been created out of that expenditure. And with most of the US economy comprised of consumption nowadays, you can bet that hardly any of this new money will end up increasing sustainable long term assets. Instead, all this new money which is not based on real world things of value needs to park itself somewhere and this inevitably leads to asset bubbles.
We had the internet bubble, then it crashed; then the housing bubble, and it too crashed, but has reached nowhere near its bottom. We are now in the midst of the ultimate bubble — the bond bubble. And this bubble is now at its peak. With ZIRP, bond prices cannot possibly go much higher (based on fundamentals at least) for any lasting duration since they go up in price with a falling interest rate. The fact that 10 year government bonds, for example, will in one way or another default long before the 10 years is up, is (was) irrelevant to their buyers, because they never had any intention of holding them to maturity. Rather, their intention was to hold the bonds long enough to make a profit from future falling interest rates, which they knew the Fed would be implementing, because everyone knows it’s a rigged market, and then they’ll sell the bonds back into the market for the next round. Therefore, the bond auctions have until fairly recently had willing buyers. The long term end game to this scheme? Who cares… that’s someone else’s problem…
Since government bonds are simply the government’s debt, and since the US government is now completely insolvent and cannot even service its debt, and since interest rates cannot go any lower, and since the economy cannot grow any further, then how can bonds retain any real value? They can’t, and they won’t … when the bubble pops. And when this one pops, it will be complete, because it is the “sovereign” debt that will go. It will be popping when the ZIRP policy cannot be maintained any longer due to inflation from the massive amounts of money printing currently going on to offset deflation — to keep liquidity up and to service debt obligations. Interest rates will have to go up in the face of double digit inflation (already inflation is significantly higher than interest — a totally unsustainable situation — so then why do you continue to park your money in savings? You should instead buy thousands of chocolate bars with it since they will hold their value better than savings accounts will. Storage issues? Then how about gold and silver coins?)
But maybe interest rates won’t go up if the Fed just “prints” more money to fund the country’s debt obligations. Currently the Fed is artificially suppressing long term bond yields by doing so to keep the system alive but this cannot continue indefinitely, because it violates the laws of physics. Eventually the rubber band will break, and this would lead to probably the greatest deflationary collapse in history, if circumstances were like they were in the 1930’s. But they aren’t. They are much worse.
What we now have is the mother of all ponzi schemes, the $1.5 quadrillion or so Over-the-Counter derivatives bubble. A derivative is a type of financial instrument that trades as its own entity with its own pricing mechanism, but its price is dependent on other real-world things of value. The derivative itself has no real world manifestation. They enable levered speculation around the value of underlying assets, and the degree to which they can be complicated allows investors to hold virtually any position they can dream of. The simplest derivatives are options, and anyone can buy those.
Derivatives are now so important because the scale and degree of complexity they have achieved has overwhelmed normal market forces of supply and demand. Say, for example, that you invest in options, you make some levered bets about future market trends, and those trends don’t end up moving in your favour, and you lose. With the $5000 you invested and lost, you are not big enough to impact the workings of the market. Life moves on. But let’s say that instead you are a big bank, like a BIG bank, so big that you actually influence the monetary system, print the money and set the economic policies. And you invest in the unregulated over-the-counter derivatives market. You make some levered bets and then manipulate the market so that you can’t lose. If you are just some guy who played an insider trading game and got away with a million dollars, you got lucky. You are not big enough to affect the overall economy and the wealth you stole was easily produced by the greater overall market. But if you are a central bank who makes such levered bets, then where does the wealth come from to honour those bets? You ARE the market! There is no greater pool of resources to transfer that wealth to you. This is the problem with derivatives…
The most important function of derivatives over the last couple decades has been to manipulate markets to keep the American (and by extension, global) economic system alive. Specifically, this means suppressing interest rates. This has been done to enable the US government and economy to build up unprecedented levels of debt, but avoid the inevitable deflationary collapse that would ensue if interest rates were allowed to rise according to genuine supply and demand forces. They have essentially enabled the greatest ponzi scheme in history to inflate, but not burst. Since there are not enough buyers for US Government debt, in order to prevent interest rates from rising, the big Wall Street banks have been buying it stealthily. But where do they get the money from? They are totally insolvent. They get their money from the Fed at virtually zero percent interest, then they lever it over about 20 times at zero-risk, and invest in government bonds at 3% return, thereby making a return of about 40% … from doing NOTHING productive (except funding the government’s debt…) This allows the economy to go further into debt but enjoy artificially low interest rates.
Even if you owe a trillion dollars, if the interest rate is zero, you have no problem. The banks hide their liabilities in the derivatives ponzi scheme. The biggest of these banks, JP Morgan, is a branch of the Fed, doing its dirty work under the cover of a commercial bank. And as long as there is not a bank run, they can get away with it. They extort 300 million Americans because if we don’t let them take their big bonuses and instead do what we should do and shut them down, then no one would be left to suppress interest rates anymore, they would skyrocket, and the whole ponzi scheme monetary system would almost immediately collapse!
But derivatives do more than just suppress interest rates; they are also used to drive inflationary booms and deflationary busts, the most catastrophic of which so far has been the US housing bubble. These derivatives are built around garbage assets like hopelessly underwater mortgages on depreciating houses, which are sliced and diced and then securitized for the purpose of then being resold in a nice new pretty package (“Mortgage Backed Securities”) to unsuspecting fund managers who are duped into believing the AAA credit ratings issued by corrupt puppets at the official ratings agencies who have been paid off by the banks to provide such a sweet rating (plus, by law, fund managers must invest in certain classes of assets, and there are no other alternatives to this junk). The banks make levered bets on the performance of these securities (either up, or down), inflate the system in the desired direction, and receive big short term profits as a result.
These alternating inflationary booms and deflationary busts create loan defaults and foreclosures. This is a direct transfer of wealth out of the hands of citizens and into the hands of banks — well, at least to the CEO’s of those banks because the banks are insolvent. This process has been going on for a long time and explains why so much of our farmland and other productive assets are not owned by individual people or families (or governments), but by large corporations — themselves largely owned by a few very wealthy individuals. They used to be owned by average people! That’s you and me! No more! Is it not absurd that there are millions of foreclosed homes being held off the market by the banks to prevent a price implosion, and at the same time so many millions of Americans are now homeless?
The housing crash was orchestrated by the Fed through its backstopping of all mortgages held by the banks. This means that even in the event of a foreclosure, the banks were assured to be bailed out. This enabled the absurd sub-prime mortgage fiasco to develop. How can you possibly make money by lending money at teaser rates below that which you borrow, in any scenario other than a ponzi scheme? The banks had zero incentive to do due diligence and ensure that the people they were providing mortgages to were credit worthy. But then the banks could use that mortgage as a reserve asset and multiply it many times over in the derivatives scheme. This scam grossly inflated housing valuations, and when it inevitably collapsed, the banks didn’t have to worry about the devastating impacts to their balance sheets, because the Fed backstopped them via Fannie Mae and Freddie Mac! But who ultimately paid for this bailout? American taxpayers!
And this is also another of the main reasons why we must have perpetual economic growth. Derivatives are like a leach. When any asset class in rising in value, the derivatives sucking off that asset go up in value multiple times faster. When a bubble is created by the central bank, on the way up, wealth is being transferred from the rest of society to the holders of the derivatives (i.e. the commercial banks). That’s basic math. A derivative making 1000% is by definition hoarding more wealth than a homeowner making 100% on the doubling price of his house. And when the bubble is inflating, no one notices any problems. People’s homes are rising in value, so everyone feels great, but the derivatives that the banks hold are going up even faster. But then what happens when the bubble pops, and the valuation of the assets (house prices) begins dropping? Obviously, those people who bought houses at the high prices lose their shirts and have underwater mortgages. But, as on the way up, the derivatives amplify those losses many fold, so the banks are then in even more desperate trouble than a home-owner with a 20% underwater mortgage is. The banks could be many times underwater.
So now what happens to the bank? It is beyond insolvent, and it should go bankrupt and cease to exist. A deflationary crash should ensue whereby those debts (dollars) are wiped form the system. Do you now see the asymmetry there with derivatives? On the way up the bubble, everyone remains solvent (both homeowners and banks). On the way down, most homeowners remain more-or-less solvent, but on the bank side, there is counterparty risk and the derivatives debts cannot be honoured, so the bank that’s owed 1000% for its position on the “put” side of the derivative, (i.e. correctly betting that the asset class would go down in price) will simply not receive its 1000% return, because the bank that owes it no longer exists! Basically, on the way up, the banks get rich off the masses. On the way down, the banks get rich off … other banks?? But they are all insolvent, and they’re all part of the same system. If one bank goes down, they all do. Therefore, in order to prevent the overall interlinked banking system from totally imploding on itself, the Too-Big-Too-Fail banks must be protected from bankruptcy. The best way to do this is to continue to foster economic growth so that new bubbles can be created, and new derivatives can made around those new rising assets, so that more wealth becomes available to steal from the masses. But if the economy is so far gone, and natural resources so scarce, that it can’t grow anymore, then what? Well, that’s where the central banks step in and provide stealth life support to the banking sector, to keep it from failing. Basically, it amounts to money printing, i.e. criminal counterfeiting, on the scale of trillions of dollars. When there are simply no more bubbles left to blow, then wealth can be stolen from the masses by printing more money and diluting the money supply and stealing from every single person who saves in dollars or bonds, or lives off a fixed income.
The completely insolvent fundamentals of the banks are hidden in the Credit Default Swap (CDS) ponzi scheme, whereby one bank, who say made a 30:1 leveraged bet using their $100 of assets, seeks to purchase insurance against default from this Vegas night out, and finds it from another bank. But the problem is that this other bank is also leveraged the same way, and is also having a blast in Vegas. They are each completely insolvent, and both insuring each other for coverage neither can afford. It becomes a giant fragile house of cards. This house of cards is juiced by the free flow of interbank lending between all the big banks around the world. The crash of 2008 was brought on by a freeze-up of this interbank lending; the banks lost confidence in lending money to other institutions and therefore they were left standing there naked and vulnerable to their insolvent balance sheets. That’s where the central banks step in, by printing up and “lending” money to the banking sector to get the juice flowing again.
The stock market is artificially inflated by High Frequency Trading, which uses high speed computer algorithms trading over milliseconds to manipulate valuations. The Flash Crash of May 2010 was the true fundamentals of this market showing themselves as the algorithms went off the rails for a bit, but the authorities quickly stepped in to fix the “imbalance”. Any time a problem arises, freshly printed taxpayer money is used to fill the hole, because the banks have been determined to be “too big to fail”, meaning that the economy would completely implode if this ponzi scheme was allowed to crash. I would tend to agree since the US economy has reached such a sad state that the market manipulation by the banks is the last thing providing the illusion of systemic solvency. Any imminent bankruptcy is papered away at taxpayers’ expense, resulting in a continual grind of higher prices as wealth is transferred from the middle class to the Owners. With ZIRP and the concurrent deflation as the economy stagnates, we just aren’t noticing significant inflation yet. This paper game is nothing short of outright criminal theft, on a scale of many trillions of dollars.
With these CDS’s the terrorists can selectively destroy countries. These are the so-called “financial weapons of mass destruction”. What they first do is dupe (or bribe) the politicians of indebted nations to allow the fraudsters to fund their debts… at low interest rates of course. Then when enough of the debt is owned by the banksters, they engage in a media campaign to sew the fears of default due the insolvent fundamentals of the government (but every government is insolvent). This is easy, of course, because they own the media and they control the interest rates. This translates into higher interest payments on the government’s debt. This makes the government even more insolvent and therefore interest rates must go even higher. It is a vicious circle that cannot end without some kind of default happening. But what the terrorists do is push the country right to the brink of bankruptcy but not over the edge, so as to extract as much wealth from the country as they can before default finally happens.
Now, Greek bonds trade for upwards of 150%. America’s government bonds trade for around 2 or 3%. Which country do you think is more insolvent? They are in the same league overall. As you can see from this disparity, interest rates today have zero correlation with economic fundamentals. But America is home base for the criminal bankers so they obviously do not want to blow up America until the very end. And the banksters control the interest rates so they can selectively choose which nation will be attacked with rising rates.
So what happens is that in order to meet the bond repayments at 150%, what does Greece’s government have to do? It has to implement austerity. It has to slash the budget, to hurt and steal from the people of the country. Taxation revenue goes to interest payments. Additionally, the government sells off publicly owned assets to private buyers at firesale prices to help service the debt. In return for its austerity, Greece is granted some bailout money to keep it from outright defaulting right away, via money printing from the central banks (i.e., all other Eurozone taxpayers). When they are done with Greece, which country will be next? Italy? Spain? France? Those countries are too big to be bailed out by money printing. Their collapse would break up the Euro. When will America get it? Eventually the whole world’s financial system will implode because it’s a gigantic ponzi scheme, artificially propping up consumption by manipulating prices lower and allowing debts to continue at interest rates that are far too low (for Americans). Europe’s rising interest rates are actually more reflective of what their monetary systems should be — insolvent.
From a thermodynamic perspective, what the derivatives bubble is hiding is the true prices of natural resources that we are overconsuming away, and on the flip side, the true worthlessness of paper money. So you know all those eco-freaks that have been hysterically screaming that the sky is falling for the last 20 or 30 years, but few people took them seriously? All you had to do was look at the relatively stable prices and counter-argue that there is no scarcity problem, because it would be manifested in rising prices? Well, now you know where those rising prices have been hiding… ($1.5 quadrillion of rising prices, to be more precise.) The price stability has been manipulated into the system.
The Fed’s dual mandate is price stability and full employment. They maintain employment through fostering economic growth (at all costs) by continually dropping interest rates and by invading the rest of the world to secure oil and expand the bond market’s empire. They achieve price stability via the derivatives bubble. The derivatives bubble is hiding rising prices because it creates artificial demand for dollars by buying the debt to create the dollars; buying debt with freshly printed taxpayer money at near 0% interest. Combine this with the US dollar’s reserve status, and these two factors make dollars much more powerful than they should be. Since the US is the world’s greatest consumer of stuff, and since money is a claim on biological productivity, we are all gaining easy access to natural resources at prices that are too low.
What economists fail to understand is that, in the real world constrained by finite resources that has hit limits due to Peak Oil, those two Fed objectives of price stability and full employment (at 40 hours a week), are mutually exclusive goals! You can’t have them both. Full employment at 40 hours a week implies significant economic growth — as explained before, what else is everyone going to work at all day if not for economic growth? This requires that lots of natural resources must be extracted and transformed to support that economic activity. In the face of Peak Resources, then how can prices for those resources remain low when supply is limited? But rather than addressing the problem, economists do their best to hide it by artificially manipulating prices low. But you can’t sustain artificially low prices for natural resources indefinitely into the future via market manipulation because, despite what most economists seem to believe, you can’t print more natural resources into existence like you can dollars! The artificially low prices stimulate demand from consumers but they also don’t take into account things like the imminent Peak Oil and fisheries depletion. The price signal is not getting through.
I have to scratch my head when I hear the most powerful economists in the world, the heads of the central banks, bragging about how they have maintained price stability for such a long period, as if that’s a good thing. How could distorting the price signals which are essential to keep the economy going round efficiently be a good thing? It makes no sense. If we are facing shortages of resources, then shouldn’t prices be allowed to rise to alert the market to that situation and to motivate industries to move in other directions? And then they wonder why the monetary system is on the brink of collapse?
Deflation Versus Hyperinflation
This manipulated house of cards is totally unsustainable and it will at some point collapse. This colossal deflationary collapse, were it allowed to happen, would lead to major shortages of money everywhere (actually, this has already begun, as of August 2011). No one would buy Treasury debt to make new dollars and there would be no more banks to lend money out. The government would not be able to function since its debt to GDP ratio is so high and it would no longer have tax revenues to service those debt obligations. This would be made worse if interest rates rise, which would have to happen since no one would be buying Treasury debt anymore in a deflationary scenario. Unemployment would skyrocket. People would be screaming about the state of the economy. Prices would drop significantly, but no one would have much money to buy anything with; most would go bankrupt due to their unserviceable debt obligations.
Instead, what will likely happen (and is happening) is that for political purposes, the Fed will preempt this collapse by printing money in order to keep the system alive (“Quantitative Easing”). A deflationary hole will be filled with worthless fiat cash. Right now deflation of credit is being offset by inflation from freshly “printed” money. This is highly inflationary, however, because printed money is high power money. It first gets “printed” to the banks, who are supposed to then lend it out. If it does get lent out then it multiplies itself and greatly increases the amount of money in the system via increasing credit — this is inflation … real inflation. This is why it’s not even mathematically possible for an economic recovery to occur because this would multiply the base money significantly and prices would go through the roof with genuine inflation, therefore stagnating growth. But this recovery isn’t going to get a chance to happen, however, because the banks aren’t lending out the money they are being given by the Fed; instead they are using it to fund more derivatives ponzi schemes and CEO bonuses, and to do some patching up of their balance sheets which have been dented from all the previous failed ponzi schemes and billion dollar CEO bonuses…
In short time, as the inflationary depression intensifies and requires increasingly large amounts of money printing to fund the government’s debt obligations and deficits, investors will realize the extent of this money printing, and when they decide that the central banks have lost control and cannot manipulate the system to their advantage anymore, they will bail. The time element of money lending will shorten as people pull their money out of the system. The big player that could trigger this event overnight is China, and they have incentive to do this because they are fighting the Fed’s exported inflation and the way to deal with that is to dump their Treasuries and allow the Yuan to float, which would instantly significantly devalue the US dollar and reduce Chinese inflation. But on the other hand, a stronger Yuan would hurt Chinese exports and cause unemployment to go up. So now you see China’s see saw dilemma.
Regardless of how this transition happens, no one will want to hold cash for long once it does begin (for any interest rate), and certainly not invest it. At some point soon afterwards when the reality of this sinks in, all remaining bond holders will sell … at the same time. This represents a mammoth shift in capital from the future to the present. All those bond holders will be paid in worthless freshly printed confetti. Everyone trying to get rid of dollars increases the velocity of money which causes even more inflation. In the face of rapidly depreciating purchasing power, people freak out and try to spend their money as fast as possible to get hold of scarce real world goods before they disappear off the shelves or become too expensive. Repeat cycle. This is an unstoppable downward spiral that inevitably ends in the rapid destruction of the currency and a return to a barter system or a black market using another country’s currency. Examples of this in the past were Weimar Germany (the smoldering ashes of this collapse provided an ideal environment for Hitler to rise to power), and more recently Argentina and Zimbabwe. We will soon be adding some more examples to this list: the Yen, Euro, Pound, and US Dollar. All other global fiat currencies will likely be going with them too because the whole “developed” world is part of the same bond (debt) empire.
There seems to be a lot of disagreement out there as to whether we will experience hyperinflation or massive deflation. This debate seems to be a bit of a moot point in my opinion since hyperinflation basically is deflation. You get hyperinflation when deflation happens but the debt obligations are too high to be serviced when revenues drop. Hyperinflation actually has nothing to do with traditional inflation. Hyperinflation is deflation, a shortage of money, with the difference being that the deflationary hole is filled with worthless paper. I think hyperinflation should more appropriately be called “hyperstagflation”.
The deflationists seem to argue that the deflationary collapse will happen too quickly for the central banks to have a chance to fire up the printing presses and distribute it where it’s needed. This may be the case, but the end result must surely be hyperinflation because if we did experience massive deflation then the American war machine would no longer be policing the world and the reserve status of the dollar would soon end. With Americans no longer buying foreign goods, those foreign countries would have an incentive to dump their dollars and redeem for badly needed liquidity. This would quickly end the US dollar’s reign of terror.
One way or another, most of the world’s dollar wealth must be destroyed. Considering that we are quickly running out of the important natural resources (food and oil), I fail to see how deflation (resources getting cheaper) could last for any significant length of time, especially given the amount of dollars recently pumped into the world. With massive deflation, oil prices would drop and then oil extraction would halt. Since we are at Peak Oil right now, extracting difficult and expensive oil, then we would quickly run out of oil. Oil is currently the economy. With no oil, how could its price stay down for long? In this sense, the deflationary collapse would merely be one phase of a journey along the timeline of the collapse of modern industrial society … one phase in the upcoming Malthusian Collapse.
“But if the monetary system collapsed that would be deflation”, many argue. This is partly true but the final collapse will not be like any other historical asset bubble bursting, resulting in deflation. With most asset bubbles the thing being inflated is something physical that has some real world value, but its expected future returns have become greatly exaggerated beyond real world fundamentals due to speculation. In the case of the current bond bubble, there is no specific real-world thing whose future returns have been speculated to the moon. Housing? It crashed, at least in the US. Tech? It crashed long ago. Energy? This seems to be the object of manipulative suppression, not inflation, since the Fed desperately wants to keep prices down, and energy would be one of the most visible signs of that. How could there be a speculative bubble when credit has collapsed (comparatively) and unemployment is so high? Speculative bubbles require credit bubbles, and there isn’t really one at this point, at least for real world things of value.
The speculative bubble is in the bond market, the monetary system itself, in debt credibility. This bubble is a result of central bank manipulation of the bond market to artificially create demand for bonds. Therefore, bonds are in the bubble. What do bonds represent? They represent demand for dollars. When bubbles pop, demand decreases for that thing, and prices for that thing drop significantly. So when the dollar bubble pops, how could demand for dollars increase? That would be a very strange bubble if the thing that was experiencing increased demand as a result of a bubble, saw its demand increase after that demand bubble collapses!
Gold and Silver
The final financial collapse could be triggered sooner than this if the gold and silver markets default — meaning that there is no more physical metal available to buy. For decades the western central banks have been manipulating these market to suppress prices using illegal phony “paper gold” contracts on the commodity exchanges. This has been done for the purpose of hiding the mismanagement of their fiat currencies, and also to introduce volatility to destroy peoples’ confidence in using those metals as a store of value, and instead use fiat currencies for both transactions and for storage of wealth. That way, governments (or more to the point, central banks) can control the money supply and manipulate it for short-term profit and political purposes using Keynesian “theory”.
The problem now is that the cat is out of the bag; everyone knows the prices are suppressed. This has been going on for so long that supply has not increased to meet demand, so that we are now on the verge of a default (silver is consumed industrially). When this default happens it will spike silver price overnight, to be shortly followed by gold, and when this happens confidence in the dollar will be destroyed and then the rest will be history. The whole precious metals suppression scheme is a great conspiracy worthy of the best James Bond movie. It would be merely great entertainment if it wasn’t actually true, but it is; and if it wasn’t the world’s monetary system they were destroying in the process, but it is. But rather than take up yet more of your valuable time and space here I will direct you to a thorough explanation by Chris Powell over at GATA if you’d like to read more.
What gold and silver currently represent is a revealing shift in the mentality of the average person. The response by most people to the suggestion that they should trade their retirement stocks and bonds in for precious metals is invariably the same — disbelief, and warnings that the prices could crash any time, and that gold and silver are just hunks of metal that don’t do anything. I think there are two factors at play here. Firstly, to decide to convert a significant proportion of one’s wealth over to hunks of metal is a symbolic act that most people are not willing to entertain; it amounts to admitting that the system is broken, that the future is not going to continue as the past has unfolded. This require s a fundamental shift in a person’s world view. In this case, it doesn’t matter how much evidence and rational arguments are brought forward to explain what all the different investment options represent; if the person is not willing to accept these ideas then the human mind will find ways to block it out. “Hopium” is a powerful drug.
Secondly, the other reservation people typically have regarding buying precious metals is the perception that they aren’t “productive” (this may be the case for gold, but not for silver, as explained above). By contrast, with dollars you can buy bonds and earn interest, you can buy stocks, and do all sorts of other interesting participatory things in the economy that supposedly promote “productivity” and help all the other fellow workers out there who are trying to do good things with the dollars you inject back into the system. How can stashing some hunks of metal in your closet be participating in the economy?
This argument reveals the fundamental misunderstanding by both economists and average people about what drives the economy — the belief that dollars somehow have more inherent “productivity” than gold or silver, and that dollars return interest while precious metals do not (we have already debunked the interest myth). As explained in great detail earlier, our economies do not have productivity. Only plants have productivity. Therefore, dollars, bonds, and stocks do not have productivity either. Money is merely a claim on productivity. The “productivity” of dollars is an illusion created to make people believe that they are doing good with their money by sending it back into the financial system. But the financial system is a sham — all this does is further inflate the bond market’s empire. The tertiary wealth parasites living in those big ivory towers downtown are actually there to steal productivity, not to foster it. That’s why the average person is becoming poor.
But shifts in public sentiment can happen quickly and on a massive scale when the right evidence is presented. That evidence will come as the destruction of the monetary system, empty store shelves, and 50% unemployment. When the mad scramble for precious metals begins, there will be none available because 99% of the gold and silver out there is paper; those who own physical will not be so foolish to sell for any paper price.
And now to summarize, here are the various and somewhat inter-related reasons why economic growth is required in “our” current economic / financial situation:
- The monetary system is debt-based; money is made from debt. Debt is centred around the interest rate (creditors get paid principle + interest by the debtor). In order to service interest on existing money (debt), additional money (debt) must be created at an exponential rate roughly in line with the interest rate. In order to keep prices from increasing too much from this continual new money creation, the real economy must grow along with it so that additional goods and services are available to provide real value to the new money.
- The above isn’t exactly true, however, because investors can be, and historically have been, duped into accepting negative real interest rates via financial repression, which is when the central bank forces interest rates below that of inflation (for example, if you put your money away for a 2% return but inflation has caused prices to go up by 3%, then you have lost purchasing power). So, in this sense the real economy doesn’t have to grow in order to keep up with money creation; all that needs to happen is that the monetary authorities officially lie about the true inflation rate. The result of this is generally a transfer of wealth from savers to debtors. But if the interest rate is 2% and real inflation is 4%, then a 2% real growth rate will help decrease that rate shortfall beyond what it would be with zero growth.
- So that the vast majority of investors can reap a positive return. If the economy is not growing then it would be a zero-sum game, and any real wealth that investors realize through their investments would necessarily come at the expense of someone else. Since economists would like everyone to experience a positive rate of return in their lives / investments, or at least think they can get a positive return if they allocate their assets correctly (some people “deserve” a greater return than others…), then they do everything they can to keep the economy growing. If the rich want to keep getting richer, then the only way they can do this without impoverishing the middle class (and precipitating social unrest and eventually riots) is to grow the economy larger. Another explanation for this point is that economists don’t know what the hell they’re doing and can only manage growth, not contraction or steady state. They have no idea how to fairly distribute wealth amongst society and instead resort to implicitly admitting that they are clueless and must rely on the “creation” of new wealth, via growth, to keep the masses out of poverty.
- You, the average person with a mortgage, are someone else’s asset. You are owned via debt; you are in effect property. The owner of You The Asset wants a positive return on that investment, and the way to do this is to get you to work harder and to “produce” more wealth – to grow the economy.
- The entire system has become hyper-financialized in the delicate house of cards known as the derivatives ponzi scheme. Ponzi schemes must grow or they implode. Any real growth that the economy can provide is sucked up by the derivatives to inflate the system just a little bit farther. The market signals that this ponzi scheme provide have no correlation to underlying fundamentals. They tell the story that the economy is way larger and growing way faster than it actually is. Therefore, any real wealth creation in the economy is immediately sucked up to feed the monster. I’ve talked about this enough already.
- Technological automation has displaced a lot of workers with robots and this directly results in increased unemployment. The system currently has no mechanism for sharing wealth with those newly unemployed people, beyond just keeping them alive through welfare and food stamps. The only ways to address this growing unemployment problem are to:
- reduce the work week, which would spread out the remaining jobs better, but economists perplexingly seem totally unwilling to even contemplate this as they seem to believe that this will lower the economy’s productivity — because they erroneously believe that labour “produces” wealth, which of course it doesn’t as I have previously explained. Labour simply transforms wealth,
- start giving people free money in wealth redistribution schemes, which has been proven throughout history to not work since it provides no incentive for anyone to work and strive further, or
- grow the economy so that all those displaced workers can instead spend their time building new capital — roads, houses, and infrastructure. Incidentally, all this new infrastructure has value so it also fulfils the objective from #1, #2 and #3 above of creating new value which can yield a positive real return for investments, without necessarily impoverishing someone else, since it is no longer a zero-sum game if the economy is growing.
- It’s in our genes. I haven’t talked much about this, but it’s pretty obvious. Historically, people always had a pretty rough go of it. Infant mortality rates were high and before modern medicine was invented diseases took their toll. It wasn’t enough to simply have 2 kids to keep the population going. It was necessary to have many kids since many more would die before reproduction age than they do today. That transition to increased survival rates has only happened over the last century, if even that. But our genes haven’t changed at all; we still have this primal drive to grow things bigger. While our family size has dropped for various social and economic reasons, we still have the drive to grow. It is the human condition to always want more, and I argue that our current capitalist economic system actually entrenches and reinforces such instincts. “More is better” seems to be the underlying attitude we have. When economists talk about growth, it’s almost as if they are trying to portray our economies like flowers. They are things of beauty that need nurturing and growth. Everyone loves flowers, so what’s wrong with growing more flowers? Well, the problem is that in the real world, all flowers must die and decompose and then be recycled into new growth. In fact, all biological growth must follow this fate. We have a name for biological growth which doesn’t and grows uncontrollably – it’s called cancer. But economists don’t view our economies as being cancerous to our environment despite any rational analysis which would show that they are. Economists prefer the flower analogy… When one steps back and looks at the natural world as a whole, this attitude really is no different than with any other species. If presented with the means, then any species will grow its population to fill that niche. It could almost be seen to be a law of nature.
- Economic growth makes real estate developers in for example, Vancouver, rich at the expense of everyone else. Vancouver has experienced a lot of growth over the last few decades. This is presented to the population here as an opportunity for wealth creation for everyone. People are told that they will become wealthy as a result of growth because then their property values will rise. In addition, all this new construction provides jobs for people and increases demand for business from local companies. In reality, however, wealth has inevitably been taken from Vancouverites because there are now more people demanding fewer available resources, assets, and natural areas. Let me explain. If 10 years ago a house here went for half a million dollars, and today it sells for a million, then the owner of that house has made a real “profit” above and beyond inflation. However, that profit is only realized if that person sells the property and moves somewhere else cheaper. So, no, the actual residents of Vancouver have not realized a real profit as a result of their property values increasing; they only realize this profit if they give up their Vancouver residency. Furthermore, the additional strain on the city’s infrastructure from all these new people requires more maintenance and larger roads, bridges etc. Those must be paid for through taxes, which increases the cost of living here. Furthermore, there are now more people on the roads, more people in the parks, more people everywhere, in addition to increased prices for pretty much everything, so there isn’t really any way that the average person is living a better life here. And for anyone who isn’t lucky enough to have owned property since before the boom began, their income will now buy a much smaller home than it would have 10 years ago. However, for the developer who buys an acre of land that is previously a semi-rural house in the suburbs, and then puts up a 100 unit condo in its place, well the people there sure aren’t living better in a tiny sardine can condo unit than the previous people were living in the rural house on a half acre. But the developer and associated bankers will get rich, since now, 100 people have become mortgage slaves versus the previous owner of the property who probably didn’t even have a mortgage at all.
- To provide a mechanism for absorbing inefficient allocation of capital and market manipulation. For example, if the central authorities decide to blow a bubble in a certain asset class to reap some derivatives profit, then if the economy is not growing overall then an inevitable bust will occur where that asset class subsequently crashes to below where it started. However, if that market can be prevented from crashing at the same time that the overall economy grows, then the greater economy can “grow” its way into the inflated asset class so that a crash isn’t necessary. For example, if the central banks blow a housing bubble which results in too many houses being built beyond what fundamentals can support, but then the population can be increased over the next few years, then all those new people will just fill in the extra un-needed houses, while the bankers then move on to some other sector of the economy to blow different bubbles. This is also essential to how the Federal Reserve, via the Exchange Stabilization Fund, manipulates markets. They do this by printing up trillions of monopoly dollars and injecting them into the derivatives market to paint whatever financial picture they want, regardless of real world fundamentals. All this money creation would otherwise create significant inflation, but this inflation is somewhat hidden behind economic growth which provides real world wealth behind some of that money creation. Another similar angle on this theme is that growth allows many otherwise unfeasible small businesses to survive, which prevents people from losing their jobs and creating political problems. For example, if someone opens up a small retail store but does poor market research ahead of time, or does anything else to not manage it efficiently, then a perpetually increasing population in the vicinity will result in perpetually increasing sales which will bury this inefficient allocation of capital, and therefore failure will succeed. Otherwise, if the economy is not growing, then as many new business startups would fail as would succeed.
It is tempting to write a section on “what needs to be done to change course”. Unfortunately it is far too late for that. Our political and economic systems have become so corrupt, our economies so structurally addicted to growth, our energy systems so dependent on burning dead things that are quickly running out, that the inevitable crunch can now not be avoided. What is most important now is that you prepare yourself and your community for what is coming. Others have written about that much more extensively than I could. I may write another piece that could develop ideas about how to organize our societies and economies differently in the future, for the sake of interest for our long term descendents who may be able to build a new society again after the world’s population has been reduced several fold. But it’s always easier to criticize a failed system than put forth alternatives that work in the real world; it is a fine line between that and just spewing forth irrelevant platitudes.
Copyright 2015 Mark Cunnington. If you think this is useful information and not just the rantings of a lunatic …. you can use it and distribute it but please give credit to me and my sources where it is due.