Monday, December 9, 2013

Mr. Soddy’s Ecological Economy

Frederick Soddy, born in 1877 in England, was a chemist with Ernest Rutherford when they jointly determined that radioactivity was atom decay and transformation. Back in Scotland, he described and named the concept of an isotope, and determined the changes in atomic number brought about by radioactivity. He received the 1921 Nobel laureate in Chemistry for his work on radioactive decay, and foresaw the energy potential of atomic fission.

He turned to economics, revolted by the mass chemical deaths of World War I, published four books from 1921 to 1934, and campaigned for a radical restructuring of global monetary relationships, but was dismissed as a crank.

He saw economics as a physical machine that must draw energy from outside itself.
The first and second laws of thermodynamics forbid perpetual motion - systems that create energy out of nothing or recycle it forever. He criticized the prevailing belief of the economy capable of generating infinite wealth.

Current economists model the economy as a living system. drawing from its environment valuable (or “low entropy”) matter and energy, ores, the raw materials provided by plants and animals. And like all life, an economy emits a high-entropy wake — it spews degraded matter and energy: waste heat, waste gases, toxic byproducts, apple cores, the molecules of iron lost to rust and abrasion. High entropy emissions include trash and pollution in all their forms, including yesterday’s newspaper, last year’s sneakers, last decade’s rusted automobile.

Matter taken up into the economy can be recycled, using energy; but energy, used once, is forever unavailable to us at that level again. The law of entropy commands a one-way flow downward from more to less useful forms. An animal can’t live perpetually on its own excreta. Neither can you fill the tank of your car by pushing it backwards. Thus, Georgescu-Roegen, paraphrasing the economist Alfred Marshall, said: “Biology, not mechanics, is our Mecca.”

Following Soddy, Georgescu-Roegen and other ecological economists argue that wealth is real and physical. It’s the stock of cars and computers and clothing, of furniture and French fries, that we buy with our dollars.

The dollars aren’t real wealth, but only symbols that represent the bearer’s claim on an economy’s ability to generate wealth.

Debt, for its part, is a claim on the economy’s ability to generate wealth in the future.

Soddy said that the ruling passion of the age, is to convert wealth into debt — to exchange a thing with present-day real value (a thing that could be stolen, or broken, or rust or rot before you can manage to use it) for something immutable and unchanging, a claim on wealth that has yet to be made.

Problems arise when wealth and debt are not kept in proper relation.

The amount of wealth that an economy can create is limited by the amount of low-entropy energy that it can sustainably suck from its environment — and by the amount of high-entropy effluent from an economy that the environment can sustainably absorb. Debt, being imaginary, has no such natural limit. It can grow infinitely, compounding at any rate we decide to accept.
Whenever an economy allows debt to grow faster than wealth can be created, that economy has a need for debt repudiation. Inflation can do the job, decreasing debt gradually by eroding the purchasing power, the claim on future wealth, that each of your saved dollars represents. But when there is no inflation, an economy with overgrown claims on future wealth will experience regular crises of debt repudiation — stock market crashes, bankruptcies and foreclosures, defaults on bonds or loans or pension promises, the disappearance of paper assets.

It’s like musical chairs — in the wake of some shock (say, the run-up of the price of gas to $4 a gallon), holders of abstract debt suddenly want to hold money or real wealth instead.

But not all of them can. One person’s loss causes another’s, and the whole system cascades into crisis. Each and every one of the crises that has beset the American economy in recent years has been, at heart, a crisis of debt repudiation. And we are unlikely to avoid more of them until we stop allowing claims on income to grow faster than income.

The problem isn’t simply greed, or ignorance, or a failure of regulatory diligence, but a systemic flaw in how our economy finances itself.  As long as growth in claims on wealth outstrips the economy’s capacity to increase its wealth, market capitalism creates a niche for entrepreneurs who are willing to invent instruments of debt that will someday need to be repudiated.

Soddy suggested five policy prescriptions - taken at the time as evidence that his theories were unworkable. And yet these four are now conventional practice:
abandon the gold standard,
let international exchange rates float,
use federal surpluses and deficits as macroeconomic policy tools that could counter cyclical trends, and
establish bureaus of economic statistics (including a consumer price index) in order to facilitate this effort.

Soddy’s fifth proposal, was to stop banks from creating money (and debt) out of nothing.

Banks do this by lending out more than they physically hold of their depositors’ money at interest — creating debt ( a claim on real wealth in the future ) and creating apparent debit balances in the borrower’s demand deposit (checking) account, where it can be lent out again to create more debt and demand deposits, and so on, almost ad infinitum.

Herman Daly, an ecological economist, and many others have proposed a gradual, legislated move to 100-percent reserve requirement on demand deposits.

Banks could still support themselves by charging fees for safekeeping, check clearing and all the other legitimate financial services they provide. They could still make loans and still be able to lend at interest, but based on the real money of real depositors.  This would re-establish a one-to-one correspondence between the real wealth of the community and the claims on that real wealth.

The immediate response to this economic theory and its fifth proposal, is horror at the impact it would have on GDP, the share market, and economic activity.

But real debts do exist. These are mainly the real world matter and energy high entropy emissions and environmental impacts. The currently, un-costed, costs of removing CO2 from the atmosphere and oceans; of repairing degraded land and water supplies; of neutralising the toxins and organochlorides; and of redressing social inequity and poverty caused by the debt process.

And the problem is that these real debts have to be paid from current wealth generation.
They are not a claim on future real wealth. And they have physical priority over the interest created and charged from debt creation.

We are at a stage where real debts are increasing eroding our current wealth creation, making us all a little poorer each year, and throwing into doubt our ability to create wealth in the future, and so seriously weakening the claims by debt to that wealth.

This is both creating social and personal dissatisfaction and tension, and bringing forward the likelihood of financial crisis and collapse - debt repudiation.

It is increasingly likely that Soddy’s fifth proposal will also become conventional practice.

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