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.

More on the Problem of Interest and Debt

Let us go back to when gold and silver was used to make coins.

These coins could not change in value or number, and the amount mined each year was very small, so if anyone charged interest on a loan then either the borrower ended up with less gold, or they had to take it from some-one else.

Neither of these improved society and it explained why both the Catholic Church and Islam condemned usury - the charging of interest.

The invention ( and public acceptance ) of the concept of paper money and bills partly solved this problem. It meant that the total supply of money in circulation could increase each year in an amount at least equal to the profits made from charging interest.

The Money Supply is the amount of money available for other to access and use. At its most narrow definition it is the money held in bank current deposits - liquid deposits.
The next broadest definition includes other deposits, short term deposits, and non-bank deposits.

It is not the amount of coin or notes in circulation - which is typically only equals 2-3% of the total money supply. The majority of the money supply is accounting notations that state that the depositor has ownership of the stated amount, and these are assumed to be real reserves, and that the owner agrees that these can be lent to others.

A government’s reserve bank or treasury can increase the money supply buy printing more notes and paying government employees and suppliers - this extra cash goes into the banking system and become 10 times that amount in liquid deposits as banks engage in fiat leading ( lending $100 for every $10 held in cash or real reserves ).
Governments can also issue bonds, or modify the definition of tax receipts, so that current deposits appear to increase. Too rapid an expansion of the money supply in this way typically leads to inflation, but in periods of recession, it can stimulate productive activity and improve the circulation of cash through the real economy.

The problem is that interest is charged each agreed time period. So it compounds and grows each year, and even if you gradually pay off your debt and reduce the interest you pay, your payments go back into the banking system, get lent to someone else, and the overall interest over the entire money supply continues to get charged, and paid for from real earnings.

The only way to match this is either inflation, the increase in the prices charged for things, or by making and doing a lot more of whatever generates the real earnings. Some of this might be from wages growth or improved productivity; some might be by the capital growth of the asset you took on debt for ( a future increase in real value to offset the loss due to interest charged now ).  But these are only accounting changes, they don’t alter the underlying dynamic of ongoing interest charged against real earnings.

Throughout history, every economy where interest is charged ends up with debt growing faster than the population’s ability to to pay. It can be masked for a while through apparent increases in property or capital value in currency ($) terms, and it can be eased briefly in periods of economic expansion ( eg; mining or resources booms ) but ultimately everyone becomes more impoverished and the environment more degraded.

Consumer Price Index & Inflation

There are basically two kinds of goods. Those needed by the consumer - food, clothes, leisure, health, etc. and those needed by the producer - factories, companies, brands, patents, buildings and assets... And there is some stuff used by both - semi durable goods used for production, like cars, computers, etc

Most central banks act when they see a rise in the level of Consumer Good prices (CPI), they also generally act against any rise in the general wage level as it may lead to inflation and further increases in the CPI.

But rarely do Central banks act when they see a rise in the general level of producing good prices, and it is clear that all asset prices have risen recently, including housing and stocks.

They also do not act to buffer a general rise in company profit levels, although it usually leads to further increases in producing good prices.

Why are central banks and economists so happy when production good prices rise relative to consuming good prices ? Could it be that the political power resides with big business?

Of course. It also goes some way to explain why the bail out of big business is the "preferred" path is addressing the current financial crisis.

Pity really, as putting money into real wages and investing in broad scale community resources and infrastructure would more rapidly fill the debt bubble with real economic demand and big business would be better off in the long term.

Fixing the Current Financial Problems

The theory runs that you can boost global demand by offering more credit - or increasing debt. And economists argue that the world needs the growth in total demand to absorb the productivity gains in Asia.

So let us look at schemes by which domestic demand can be boosted - offering increasing levels of credit/debt or alternatively - boosting social spending via domestic government programs; direct financing of government deficits by domestic central banks; and increasing the minimum wage and increasing other family incomes.

These last three increase inflation, but inflation is a debt reducing factor and in the current climate may be healthy.

The other side of the coin though is that the debt bubble has been politically encouraged because it boosts investment profits, and the political power assumed by this profit flow has meant that real wages have stagnated, more low and middle class wage earners owe more money to asset holders, and more small asset holders owe more money to big asset holders and their intermediaries.

A real and democratic solution would be to raise real family incomes and real wages, even creating jobs in stressed areas - but that requires an elected government facing off criticism from big business and economic think tanks, who actually know this action will solve the problem but are loath to admit it, preferring to offer the bail out of big business as the only solution.

Its a pity, but the political power lies with those who a) profited by the debt bubble, and b) look like profiting from the "solution"