Friday, 9 March 2012

Economic Contraction

For a long time I struggled to understand economics. I read many different economists and none of them seemed to quite make sense. Only during the last few years, as part of my studies of Peak Oil, did I come to a more satisfying understanding of money, wealth and the economy.

Money is a symbol for wealth, a unit of exchange, a store of value. And it is certainly useful enough when playing those roles. But more important, in our credit based financial system, money is debt. Banks create money when they loan it out. People take out loans based on the belief that their earning power, their "future productivity" will allow them to pay the loan back and with interest. But this can only happen as long as the economy is growing.

In the past, money has often been based on rare precious metals like gold and silver. In order for the money supply to grow, more precious metals had to be dug out of the ground. Many people look back to that system as the good old days and would like to see a return to it, citing the many problems with our credit based system. But we changed to a credit based system because our economy was growing, the money supply needed to grow with it and basing money on rare metals doesn't allow for this.

Wealth is not the same thing as money. The possession of valuable things is often viewed as wealth: precious metals, land, stock and bonds, etc. But I would say that all of these things are only symbols for wealth. What wealth really consists of is having a claim on future productivity, yours or that of someone who has an obligation to you. It's easy to see how this might be so with money or financial instruments like stocks and bonds, which are obviously symbolic, and clearly consist of a claim on the future productivity of a company or country. But consider gold – it does have some industrial uses based on its high electrical conductivity and its resistance to corrosion. But you can't eat it, wear it or heat your house with it and if food or other essentials of life are in short supply, you may not be able to find anyone who is willing to trade their essentials for your gold. If you are stockpiling gold at the moment, it is probably because you have some doubts about the future state of the economy. But I would say that the economy has already ceased to grow, and is beginning to contract. At some point in the future, then there may not actually be goods available to trade for your gold, definitely not the quantity and variety of goods that we are currently accustomed to. The same with land – they aren't making any more and as long as the population and the economy are growing, the value of land should increase. But only if growth continues. In a shrinking economy even productive farmland is wealth only if you can actually farm it and there is someone to buy what you grow.

But what is this thing we call the economy, anyway?

I gather conventional economists would have you believe that the economy is something the people function inside of. Relations between people are mediated in economic terms – in term of money, in other words. Only the most basic relationship between husband and wife, between parent and child are not monetized. And when we come to alimony and child support, even that is not so. We buy our food, rather than grow it. We rent or buy our dwelling place instead of building it. We buy the fuel to heat it instead instead of gathering it. Even our contact with nature is monetized – we pay to travel to a place where nature has been preserved, pay a guide to show us through it, pay for souvenirs to take home with us.

In this view of things, the environment exists off to one side, a supply of energy and material resources and a convenient place to dump our garbage and pollution. And it is for all practical purposes infinite. Or if something does run out, a substitute can always be found to replace it. The critical resource is human ingenuity, applied through technology, which is without limits.

The picture of the economy that I would draw is quite different. The economy exists entirely within human society and is only one of many ways that people may choose to relate with one another. Human society exists entirely within the environment and is entirely dependent on it. And the environment is finite – we are for practical purposes limited to one small planet. The critical resource that has driven economic growth for the last few generations is energy, derived from fossil fuels, for which there is no workable substitute. If that growth is to continue, we must have an every increasing supply of fossil fuels, but we have already reached the maximum rate at which oil can be pumped out of the ground (Peak Oil) and our economy has stalled and will soon start to contract, if it is not already doing so.

The real problem with this is that no one seems to have any idea of how to run an economy that is contracting. No clue of how best to minimize the amount of pain and grief that it seems must ensue. I certainly don't but I expect there is going to be lots of opportunity to learn the hard way over the next few decades.

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