Peak Resources: Finance

Showing posts with label Finance. Show all posts

Charles Blomfield's painting of the 1886 eruption of Mount Tarawera based on eyewitness accounts

Are we headed for the next succession of financial destruction? It’s been ten years since the global financial crisis (GFC) of 2008 that almost ruined western industrial civilisation. And while rich people in the west, at least mainstream media, seem to have the impression that we now are “back to business” lots of people around the globe are suffering from the reality of limits to growth that struck at the heart of the global economy in 08. Even if more fortunate people, like Swedes, can go on deluding themselves (for a little while) that there’s no problem with our current perverse growth paradigm there are people who don't have that luxury. Just take a look at most of the countries in the Middle East and you will quickly understand how peak oil, water scarcity, food crises, overpopulation and climate change can trigger endless misery and suffering (read Nafeez Ahmeds excellent book on this).

Contrary to the dominant narrative of “progress” I see major systemic crises converging towards the year 2020, or sooner! Are we reaching a major tipping point or simply another wave of entropy entering the system?

The symptoms of this can be found in the global economy itself with the rate of global growth stagnating (i.e. energy and debt limits) and tensions between countries competing for limited resources increasing. We also see it in the political sphere where maniacs with empathy deficit disorder get into power as a response to people's frustrations and start talking about all kinds of warfare: cultural, economic and military. We already see social unrest, conflict and trade wars but also talk about military wars connected to resources, mainly oil. Most societies are already very vulnerable, lack resilience to withstand further shocks, so a global financial meltdown could escalate fairly rapidly into chaos and destruction. When people lose everything, and they don't know why, they tend to get angry and violent. How will the US act? Will they unwind the empire, all military bases etc., or spend every bit of their last resources to plunder the planet? The place is more like an oligarchy so the über rich might decide they want the last of the oil, not for the people but for themselves. Europe is a basket case and is likely to break down, every nation on their own eventually. If a economic collapse doesn't do it, the flood of climate refugees will.

As for Sweden, we will see our massive housing bubble pop and a deep recession meanwhile people fleeing from the middle east will want to immigrate here. With the nationalist and xenophobic party, the Sweden Democrats, now being the third largest party things could turn out to their advantage as people become poorer and are likely to blame immigration issues. Similar to what we see in the rest of Europe. There is, however, a fairly strong left still in play in Sweden and to my surprise they got 10% of the votes in this year's election. So perhaps there is still some balance left in the political system, but without any major blocs the grownups in the government has yet to come to an agreement about how to rule, so maybe not. While they argue about who get what seat the world is on fire, and so it goes with large bureaucratic structures that become incompetent. And so the likelihood of social unrest increases.

As for the UN climate targets last chance of bending the emissions curve, I'm pretty pessimistic. A global financial meltdown will put all those hopes on hold and even if action did occur its likely too late to stop the climate from going above the 2C target. Moreover, what we need is not “green growth” but actual downsizing which would happen when the economy contracts. If we won't voluntarily give up consumption, mother nature will do it for us. But of course, it won't be what most people hoped for, it likely won't be a civilised and peaceful decent.

Will there be a global financial meltdown soon? Somewhere between 2018-2020? Well, I don’t know, but what's certain is that something has to give since we live on a finite planet where endless growth is impossible. There's no negotiating with nature.

Humans need clean drinking water, food and energy to survive. These things used to be public goods but we decided, somewhere along the road, to make them private goods. This means that an individual have to make, or inherit, money so she/he can purchase these basic necessities. Those who don’t have money get “weeded out”. This is the human created system that has replaced natural selection. Nowadays it doesn't matter if you are clever, healthy, kind or cooperative as long as you have money.

Actually money is the wrong term, what a person needs is capital. There are many types of capital but we humans have decided that financial capital is the most important, compared to e.g. social or ecological capital. Again this is because with financial capital we can get other types of capital that we need for our survival and wellbeing. So we accumulate financial capital, as much as we can get, at the cost of degrading other capital bases. We degrade and destroy ecosystems that generate a stable climate, clean water, food and fuel so that over time these resources start to deplete and the cost rises.

The cost keep rising but the world doesn't pay attention since it’s the most vulnerable that are hit first. It is not until poverty results in death or degradation results in extinction that we start wondering “what is going on?”. We sympathize but feel safe as long as it's happening somewhere else or we have a pile of financial capital to turn to. But what happens if lots of people start deciding that it’s easier to just “move” when rivers dry up, trust breaks down or conflict over remaining resources break out? Syria being a case in point.

Or what happens if the economy takes a beating, perhaps even a sudden crash, that wipes out all your financial capital and/or source of income, what will you do? In some places people can rely on the government, receiving benefits to cover minimum expenses. But what if the crash is so bad that everyone needs benefits at the same time? A healthy government could perhaps manage it. But what if all the government gets in trouble and yours can’t fund the entitlement programs anymore? Now you don’t have a job so you can’t earn money to buy basic goods and the government can’t help you out, you will have to rely on friends and family (community). If that doesn't work perhaps you will move. Greece comes to mind.

The end conclusion is that a growing number of people will have to move as a form of adaptation to rapidly changing socioeconomic or ecological conditions. This, in turn, will create hostility between the “haves” and the “have nots” since there is a limited amount of resources left. The majority are among those who have little since the overall resource pie is shrinking but the minority have more power within the current system since resources are becoming more expensive. This situation will grow worse over time until the majority have had enough. And the a major clash is unavoidable.

At this point, perhaps, the system that we humans created can be replaced. But some of the social and ecological damage can never be reversed. Whatever happens, we have to be prepared for some very turbulent times.

Greek protesters clash with policemen during riots at a May Day rally in Athens May 1, 2010. Credit: Joanna CC-BY-SA 2.0

Debt = theft from future generations

All economic activity requires energy to perform useful work. Without an increasing flow of net energy to society the economy starts to contract. The extraction of finite fossil resources cannot sustain increased growth as depletion and diminishing returns eventually leads to bankruptcy and falling supply.

Shows how the entire Eurozone has been contracting since 2007 as is visible in lower oil consumption.

Monetization based on the assumption that the resource base is endless, which flies in the face of fundamental physics, can only lead to financial collapse. Intermediate stages that we have witnessed since 2008 is the erosion of the middle class, increased wealth inequality and increased numbers of poor people in society. Borrowing of work and resources from the future, through debt fuelled credit expansion, has become completely insane. To the extent that we are eroding the life-support systems that make up the basis for our own long-term survival. It has indebted future generations in ways they can never repay and is a grave intergenerational injustice.

Thermodynamic limitations of the physical world don’t even enter the grammar of most economists or central bankers who are wilfully inept to give advice on anything but how to ruin entire nations. The lack of a systems perspective has made the public unaware of the real dangers of a out of control financial system. Economic growth based on credit fuelled debt, which has exploded since the early 1980s, in form of unlimited issuance of government bonds, credit cards without security, sub-prime mortgages or quantitative easing are all just sophisticated ways of sending the bill to the future.

Its obvious that it's not possible to cure problems that arise from too much of something (debt) by doing more of it (piling on more debt). That's just insanity. If credit costs are larger than income minus other expenses then either the income must increase to balance losses or bankruptcy is the only way out. By now, we know that the pile of debt accumulated is unpayable and so a debt restructuring or debt jubilee is the only way forward. The young generation, especially, need to have their debts forgiven or we will have riots in the streets, political turmoil and an increase in crime rates.

Protesters in front of the Alþingishús, seat of the Icelandic parliament, on 15 November 2008. Credit: Haukurth (CC BY-SA 3.0)

Difference between purely financial and energy-induced collapse

In the fall of 2008 the financial system in Iceland collapsed leading to a closure of the three main banks and a 50% fall in the value of the Icelandic króna. When the banks collapsed they left huge obligations to lenders and customers without coverage. The Icelandic government issued a guarantee for all Icelandic accounts, releasing comparative demands from a large volume of overseas accounts (a net deficit of €3.2 billion after all assets were sold). The government had no way of covering this demand, causing the collapse of the Central Bank of Iceland and the currency. Iceland went bankrupt and loans in foreign currency became unpayable for state, businesses and private persons. The Icelandic people voted no in referendums to repay foreign debts, elected different people in office and jailed bankers for corruption. They basically had to restart the system. However, the real reason that Iceland has not suffered like Greece, for example, is because they were able to keep increasing their oil consumption (from imports) while relying heavily on domestic hydropower and geothermal for electricity production. This is not the case for the PIIGS countries which all were heavily reliant on oil imports that they could no longer afford.

Data from the National Energy Agency in Iceland

Greece cannot afford to import more oil

Many of the driving factors behind the Icelandic banking crisis and the GFC arose from a fundamental systems crisis in our present world. The economic model based on eternal financial and material growth has started to meet limits, where the human civilisation has outgrown the capacities of the planet to support it. Borrowing from the future to cover up this fundamental problem is a short sighted strategy that will come to an end, sooner rather than later. And it also means that the collapse curve will be even steeper as we have depleted more resources without making a transition to renewable energy resources.

Against such limitations, all talk or negotiations are futile, and pretending the dilemma does not exist has only lead to bigger risks with ever more debt - stealing from future generations. Countries may be able to handle a purely financial crisis, like Iceland, but they won't be able to handle a energy-induced financial crisis, like in the case of Greece. It doesn't matter what financial reforms they make as long as they can't afford the energy needed to operate society they will continue to contract. So while debt forgiveness is necessary it's not sufficient in solving Greece's problems.

"You cannot permanently pit an absurd human convention, such as the spontaneous increment of debt [compound interest], against the natural law of the spontaneous decrement of wealth [entropy]" - F. Soddy (Cartesian Economics, p. 30).

Credit: Brocken Inaglory CC BY-SA 3.0

Currency war and deflation

The Swedish Central bank (Riksbank) have cut the repo rate to -0.35% and bought another 30 billion SEK in government bonds in the belief that this will stave off deflation (i.e. import inflation). Which it won’t, since the global economy has taken a downturn and it looks like most economies now are facing recession or depression due to the deflationary collapse of commodities, capital spending and global trade. Most intelligent people know that GDP growth is over, since we live on a finite planet, and the reason for this latest bubble had to do with private sector borrowing to inflate consumption rather than productivity increases in the real economy. What professor Didier Sornette at ETH Zurich calls “The illusion of the Perpetual Money Machine” (2012).

Original Meadows et al. (1972) modified by Ragnarsdóttir et al. (2015)

Housing bubble ponzi scheme

The Riksbanks policy will not win over deflation (there are no winners in a global currency war), however, it will fuel the already overheated housing market in Sweden, with a risk of popping this bubble. The ultra-loose monetary policy will encourage Swedish households to take on more debt, despite them being overburdened by debt already. Household debt to disposable income is currently at 172% (see diagram). One can compare this to the famously over leveraged American households before 2008 which topped out at 130% of disposable income.

Household debt to income for various countries in 2014. Source: Riksbank (2015)

There should be plenty of people around today that actually remember the devastating property crash of the early 1990s, but it seems like most people have a short memory. In the early 90s the government had to step in and nationalise the banks while increasing public spending to keep the economy alive in the midst of soaring unemployment. It took at least a decade for the economy to recover and the state to restock its finances after that.

Property price index in Sweden (1986-2014) adjusted for inflation. Country average (grey), Stockholm (black), Göteborg (red), Malmö (blue). Credit: Rika Tilsammans

Sweden’s present housing boom started right (2000) after the recovery from the crisis in the 1990s. The boom was set off by low interest rates and a massive expansion of the financial sector with increasingly lower standards for issuing credit/loans. This have driven up prices to extreme levels, mainly in Stockholm, Göteborg, and Malmö, effectively forcing more people to borrow to afford housing in the inner cities. Property prices have been rising 8-9% per year on average for almost 20 years. During the last 12 months, prices have risen by 12% (average price per m2 SEK 32,692).

Sankt Eriksområdet, Stockholm. New Urbanism. Credit: 199pema (CC-BY-SA 3.0)

Even after 28 years of queueing it is impossible to get a rental flat in Stockholm. So plenty of people, or rather their parents, take on loans of SEK 1-3 million to buy a flat as small as 20-40 m2. Of course not everyone can afford to do that, so it's mostly the rich kids that stay in the city centre, in Södermalm, where all the other hipsters are. No integration there! Most of these youngster don’t have any savings. The only thing they have is their flat, speculating that asset prices will rise, seeing it as an “investment”. But of course it’s not real wealth, it doesn’t contribute to the real economy in any way, all it does is inflate property prices further.

Now, finally, mainstream media and Swedish authorities have started issue warnings about the housing bubble and a potential crash. Of course it’s too late to avoid it now. I guess everyone just love rising housing prices, no wonder since it's private and household debt that has driven GDP growth over the last decade in Sweden. So much for Anders Borgs famous “Swedish growth miracle”! Borrowing consumer demand from the future through credit creation is not equal to creating real wealth, it just implies we will be poorer (can consume less resources) in the future. After all, we live on a finite planet.

Central bank folly continues

It's been six years since the 08 financial crash that almost wrecked the world economy. Governments claim that the crisis is since long over but central bankers are still pulling on all levers, now governing market behaviour, in trying to reach their inflation targets. But unemployment is still at all time highs in Europe and sanctions aimed at Russia have also hurt many European businesses. Over-indebtedness is the problem but central banks believe that the solution is to borrow more, not less. They have tried this method for several years now, Japan for the last 20 years, and the only thing that has happened is that economic inequality has risen dramatically. Thats what happens when you have a zero sum game i.e. running out of cheap resources to produce a surplus. In this case savers are punished and debtors are rewarded. So people with pensions are the first to lose, and banks/people with massive loans the first to gain.

This week the Swedish central bank (Riksbanken) announced negative interest rates of -0.25%, in the belief that "doing more of the same will yield a different result". This comes after the European Central Bank (ECB) announced its new quantitative easing (QE) program on January 22nd. Since then, only three months ago, we now see a massive formation of bubbles with warning signals showing up in European Equities and Global Fixed Income. At least according to the March report from the Financial Crisis Observatory. 56% of all the European Stoxx Equities Sector Indices gives clear warning signals, a month ago that was 0%. The market is overvalued and turned red almost in an instant. However, it is very difficult to anticipate market movements in these global markets that are guided by central banks' over the top measures. It is not free market capitalism any longer, but rather, central bank folly that governs the market.

The US dollar strengthening is global and warning signals can be seen in many currency pairings, for example FX US dollar/Swedish krona. While the Euro and the Russian Rouble has continued momentum downwards. Energy, softs and metals, show negative (undervalued) bubble signs which probably imply weak global demand. The massive increase in warning signals in European Fixed Income is largely due to the size, purchasing 220% of the total net issuance over 1 year, of the ECBs QE announcement. After a 15% rise in 2 months, 56% of all European sector indices show clear bubble signals. This is important to note, especially since the implied Vol, risk perception index, has dropped instead of risen. In the case of Sweden it has now become even cheaper to borrow money, which will fuel the housing bubble and probably end in tears at some point in the not to distant future. Similarly to what happened in the early 90s.

Cauwels, P. & Sornette, D. (March, 2015)

Photo: Martin Addison, Creative Commons (CC-BY-SA)

What is the future for the welfare state?

Sweden, the EU, and other nations are entering a period of enormous change. Population and economic growth are stagnating and will end. Current policies for social welfare are not designed to meet these challenges and there is a significant chance they will fail in achieving their set targets. Many western countries are now at a crossroads. They can either pursue old policies that depend on growth and fail, or decide that the end of growth gives them interesting new possibilities and have a chance to succeed.

The end of growth

1. LTG Business as Usual Scenario (dotted line)
and historical data. Source: Turner (2014)

We have known for a long time that there are physical limits to population and economic growth in terms of what the Biosphere can provide. The Limits to Growth (1972) “business-as-usual” (BAU) scenario produced about forty years ago now aligns well with historical data that has been updated (Figure 1, Turner, 2014). Showing that we are headed in the wrong direction, away from achieving sustainable development. The BAU scenario results in collapse of the global economy and environment, subsequently forcing population down. A collapse in this context simply refers to the fact that standard of living will fall at rates faster than they have historically risen, due to disruption of economic functions. According to the model, a fall in population only occurs after about 2030 but the general onset of collapse first appears at about 2015 when per capita industrial output begins a sharp decline (Turner, 2014). Given the imminent timing, we ought to raise the question whether the current economic difficulties are related to dwindling resources and an end to growth.

Time of great stresses

Most people assume that the major global difficulties will occur after the end to growth. According to Dennis Meadows, one of the original authors of the book limits to growth, this is not correct. Instead, the global population will experience the most stress prior to the peak, as pressures mount high enough to neutralize the enormous political, demographic, and economic forces that now sustains growth. Pressures building up can take many forms, for example, rising energy and resource costs (A), growing debt (B), climate change (C) and growing population dependency ratio (D).

A) Rising resource costs

The history of commodity prices has generally been one of steadily decline for most of the last century. However, the average price fall of some 1.2% a year (inflation adjusted) met it’s low point in 2002. Since 2002 we have seen a remarkable price rise in most commodities (Figure 2). Rising energy and food prices, for example, seems to be the new normal. Unless there is a global economic contraction, prices will likely continue to rise.

2. Commodity indices (1900-2010) - Paradigm shift Source: GMO (2011)

B) Growing Debt

The European Union have/is experiencing a major debt crisis (figure 3 and 4) which have brought about massive unemployment, falling investments, and decreasing confidence in economic recovery. Social safety nets have broken down and a whole generation may be lost. Harsh austerity measures on public expenditures have been taken and vulnerable people are suffering. Such policy decisions can be recognized in neo-liberal economic doctrines, where market confidence is more important than financial politics as a political and economic tool. Almost no reforms have been made to rein in financial excess, e.g. financial transaction tax, since the start of the crisis in 2008. By allowing the financial sector to dictate what is politically feasible the EU has turned it’s back on citizens and discontent is growing, feeding the rise of extremist political parties.

3. Public debt in % of GDP in 2013 (left) 4. Private debt in % of GDP in 2012 (right). Source: Eurostat

C) Climate Change

One effect of climate change is changes in precipitation patterns and increased variability in crop yields. At the moment yields of several crops in Europe are stagnating (e.g. wheat) or decreasing (e.g. grapes in Spain), whereas yields of other crops (e.g. maize in northern Europe) are increasing. Extreme climatic events, including droughts and heat waves, have negatively affected crop productivity during the first decade of the 21st century. Figure 5. shows the projected mean changes in water-limited crop yield 2050, revealing a pattern of decreases in yields along the Mediterranean and large increases in Scandinavia. This will impact food production and food security, and may increase immigration patterns to northern Europe.

5. Changes in water-limited crop yield (2050). Source: European Environmental Agency

D) Growing population dependency ratio

The world is aging at a rapid rate and by 2030 there will be 34 nations where more than 20% of the population is over 65 (figure 6). This has broad implications for economic growth and immigration trends. While Sweden's dependency rate will rise we still have a rise in population both from births and from immigration (SCB, 2014). Given today's immigration policy the potential to meet the growing needs of an aging population is better than other countries such as Japan or Austria.

6. Aging populations 2015 (left) 2030 (right). Source: CNNMoney

Potential Solutions?

Most common solutions to increased welfare costs depend on growth. For example through encouraging higher birth rates, raising immigration rates, increasing labor productivity, raising the retirement age and increasing taxation. Effective responses, however, are different. Especially if one is serious about creating a more resilient society. There will probably have to be a restructuring of the economy, a reorienting of capital and labor structure of society, from production toward maintenance, to serve an aging population and lower resource consumption. Priority has to shift from GDP per person toward maximizing human welfare directly i.e. using different metrics for national targets. Expenditures have to be reduced by developing non-market methods of social support (e.g. volunteer work, time-banking). The benefit of an aging population is that construction rates goes down, so does the need for police, prisons and military, while the need for health care increases. Shorter work time can give more jobs while allowing more leisure time. Shifting taxes from labor towards heavy industries and resource extraction is another interesting idea.

Summary

Several stresses are converging, creating difficulties for the welfare state. Especially in countries with demographic trends of having to care for a larger number of pensioneers. Dependency ratio will increase at the same time as GNP declines. Resource prices have reverted from their long-term downward trend, to increasing prices, but falling again in times of economic contraction.We have unsustainable levels of debt, especially unproductive debt (consumption and speculation), putting downward pressure on the economy. No government has yet tried to increase taxes a lot on the financial sphere or other efforts to get debt levels down, this is mainly because much of our growth today depends on ever increasing debt. Climate change will have many impacts e.g. increasing yields in the north and lower yields in the south of Europe. Scandinavia is in a better position than southern Europe to handle coming heatwaves and floods since temperatures are lower from the beginning. There is plenty of human capital and much work needed to be done (e.g. elderly care) but misalignment of incentives has led to massive unemployment and a generation of lost youths who can't get a job, even with a university degree. Potential solutions should involve changed goals, redirected investment and initiatives to engage the neglected work force. Sweden is in a better position than most other countries to achieve a more resilient society but radical thinking and a clear vision is needed if we wish to maintain our social welfare.

Oil market in turmoil

There seems to be a lot of confusion regarding the recent behavior of the world oil market. After five years of relatively stable oil prices, a barrel of WTI crude has dropped from around 110 to 81 dollar (see chart below). I have been following a discussion in the opinion-pages of Svenska Dagbladet clearly displaying this confusion. The discussion started with an article from Kjell Aleklett, a physics professor in global energy systems at Uppsala University, arguing that falling oil prices may signal the start of a global economic downturn. After which Magnus Grill, a political representative of the Peoples Liberal Party (Fp) and energy businessman, replied by arguing that Aleklett did not understand economic theory and that we instead more likely will see an economic upswing in the close future. So how come these two prominent people get to totally different conclusions? While this is a very complicated subject, fraught with international politics, there are some key points I would like to make from the natural resource dynamics and economics perspective.

Source: U.S. Energy Information Administration

Geological point of view

First of, Grill makes a fundamental mistake when he writes that the concept of peak oil is about running out of oil resources. Peak oil simply refers to the peak in production of oil, as opposed to demand which is generally assumed to increase. The concept is mainly useful for understanding that there are geological conditions/limits to oil extraction which makes oil increasingly expensive and harder to extract, leading to higher capital expenditures (i.e. diminishing economic returns). Peak conventional oil is according to many system scientists not some fuzzy academic concern but a reality, for the US in 1970 and for the world since about 2005-2008 (e.g. Hall, 2010; Turner 2014). Even the conservative IEA has warned about peak oil. The issue is not really about how much oil there is in the world, since there are surely untapped reservoirs, but rather how much effort we can afford spending trying to get to those oil resources. The harder we have to work for getting more oil (e.g. tar sands, fracking, and deepwater drilling) the less net energy we produce for society. In the 1970s every one barrel of conventional oil in form of energy input yielded about 30 barrels of energy in output (i.e. 30:1). Today that relationship is somewhere around 18:1 (Hall, Lambert and Balogh, 2014). Since oil is still the largest source for global energy use (~33%) this has significant implications for the overall economy.

Economic point of view

Whether or not you buy in to the fact that non-renewable resources are finite and has a depletion function, or maximum yield curve, there are simple economic factors connected to oil which impacts growth. We also have to think about that oil is subject to supply and demand. So while Saudiarabia may have released some reserves, as they are the price setters, there are other more long-term trends influencing the market. Conventional oil production has been stagnating while the production of unconventional oil, especially shale oil in the US, has compensated for the decline and allowed for a small production increase. However, at the same time, many of the major economies are in recession and reducing their energy demand. For example, Italy has lost 25% of its oil consumption over the last five years (Bardi, 2014). And many other economies are in trouble, now even perhaps Germany. So if there is a increase in supply while demand is falling the market may eventually determine that oil prices should go down. Here, the role of financial operators perceptions play an important role. How low prices will go depends on several factors, but short-term the markets confidence in oil can influence large swings, such as the drastic drop witnessed in 2008-2009. And Saudi oil policy also matters. In the long term, however, oil prices are likely to rise. Secondly, Grill argues that lower oil prices is a good thing that could lead to economic upswing. That depends, if you are an importer or exporter. Sweden is dependent on oil imports, mainly for transportation. So for us it is perhaps beneficial but may also deter our society to shift from oil to other liquid fuels. But, lower oil prices hurts economies dependent on oil exports and non-conventional oil drillers dependent on a high oil price (around 75-90/barrel) to break even (Forbes). If oil prices stay low for any longer period industry will probably produce less oil. Thus, lower oil prices in a resource constrained world does not necessarily imply increases in global growth.

Conclusion

This is in essence what peak oil means. Peaking does not mean running out of oil but rather that producing more oil becomes much harder/expensive than before. It is therefore possible that oil will cost less in the future, but that we won't have the money to pay for it. So the real question is, up to when are we able to afford further production? And the crucial point is that when a society's economy is based upon non-renewable energy resources there are limits to growth. It is just how nature works, the laws of thermodynamics, and there is no point in trying to argue with nature. There is however a point in arguing with Magnus Grill since he doesn't seem to understand the complex relationships between ecological and social factors influencing resource extraction and energy availability.

Understanding the monetary system

We live in world where systemic crisis seems to be ever more present, especially in the areas of ecology and finance. Understanding the instabilities in each system is important of course, but to have creative new ideas about potential solutions one also needs to understand the connections between different sectors. Since “finance rules the world” some basic facts and myths need to be understood by people wishing to see a more sustainable future society. This post will deal with the link between money (finance) and ecology (sustainability).

Source: Footprint Network, 2011

What is money? how is it created? and who governs the money flow?

All economic textbooks defines money by what it does, not by what it is. Money is really just an agreement within a community to use something standardized as a medium of exchange. Most money, around 96%, is created through the checks and balances of banks when a new loan is made. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it typically credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created (Bank of England, 2014). This means that there is corresponding debt to the money in circulation, an important fact that most people seem to not understand of forget. The amount of money created in the economy ultimately depends on the monetary policy of the central bank. Central banks normally control this by setting out interest rates, but lately they also do it directly through purchasing assets (quantitative easing).

Systemic Monetary Instabilities

Since the 1970s, the International Monetary Fund (IMF) have identified 145 banking crashes, 204 monetary collapses and 72 sovereign debt crises (Lietaer, 2012). This clearly points to structural instability in the financial system. Underlying this increased instability, building up over the last 30 years, is a regime change from productivity growth to consumptive growth fuelled by low interest rates, financial profits and explosive debt (Fig. 1). The result has been a succession of bubbles and crashes all leading up to the climax of 2008, which brought our financial system close to collapse (Fig. 2)

Fig. 1 Wages and private consumption as % of GDP for the U.S., the EU and Japan.

debt increase due to lower wages and higher consumption

Fig. 2 The global bubble.

Source: Sornette and Cauwels, 2012

Money and Sustainability

By now it should be obvious to most observers that there are many problems with our current monetary system, but how does it relate to sustainability? In the Club of Rome report “Money and Sustainability the missing link” (2012) Bernard Lietaer summarizes five elements that make the present monetary system incompatible with sustainability, including:

Global wealth inequality

- Amplifies boom and bust cycles
- Produces short-term thinking
- Requires unending growth
- Concentrates wealth
- Destroys social capital

The report is 200 pages long so I won’t go into all of the points above more than to give some short comments. For example, investment may be the single most important element of promoting a more "green" economy since it embodies the relationship between the present and the future. Today a large part of private investments are simply circling around in the financial system without contributing to any solid physical, social or environmental assets. Another large part of investments made by sovereign wealth funds and pension funds goes into fossil fuels and mineral extractions. But in order to avoid the worst scenarios of climate change massive investments are needed now. The international energy agency (IEA) said this June that the world needs 48 trillion dollar in investments just to meet 2035 energy needs. At the moment University students around the world are campaigning for divestment in fossil fuels and I think many people and small businesses around the world are desperately trying to find alternative financing due to the credit crunch.

Are there any alternatives?

To solve the systemic instabilities there are a couple of suggestions. Researchers at the IMF has suggested some form of the Chicago Plan, whereby money creation is moved from the hands of the banks to the state (Benes and Kumhof, 2012). This solution could perhaps go a long way but would not solve the issue of having a currency monopoly of bank-debt money (i.e. monetary collapses could still occur). Moreover, it seems unlikely that any government would adopt this type of policy since it requires a total restructuring of the financial system. Another suggestion is to promote complementary currencies as this could increase societal resilience to financial crisis and help match unmet needs with unused resources. With modern digital technology this would be perfectly feasible and would not require any major governmental intervention, only approval. The claim goes as follows. Monetary systems are a type of complex flow networks, and as such there needs to be a balance between optimization for efficiency and resilience (Fig. 3). A monopoly is very efficient but increases systemic risk over the long term. By increasing the diversity of currencies one could thus enhance resilience to systemic instabilities originating from bank-debt money creation. This is because complementary currencies behaves counter-cyclically with the mainstream economy.

Fig. 3 Today's monetary system is significantly overshooting the optimal balance for maintaining stability.

Source: Lietaer, 2010

Examples of complementary currencies:

- Time banking: US community services, Japan elderly care, UK unemployment

- WIR bank: business-to-business lending Switzerland

- SoNantes: promotes local business in France

- Torekes: community services in poor neighborhoods in the Netherlands

- Bristol pound: promoting community businesses

- Tradecoin: business-to-business

- Bitcoin: p2p global network

- E-portemonnee: promotes environmentally friendly behavior in Belgium

Conclusion

There are many misconceptions about our current monetary system, for example that modern money is a neutral medium of exchange. And with such an awful track record we should at least start thinking about alternative ways of promoting mediums of exchange that does not only take into consideration maximization of profits, but also promotes societal beneficial activities such as education, elderly care, employment, energy efficiency, carbon reductions etc. With modern information technology, spread and use of complementary currencies is very feasible and to low costs. Complementary currencies could act as support systems, especially in times of crisis, enhancing system resilience. In cases where our current monetary system does not promote certain social behavior that would otherwise be beneficial to our communities, complementary currencies could act as enablers of such behavior.

References:

Benes, J., and Kumhof, M. (2012). The Chicago Plan Revisited. IMF working paper 12/202

Lietear, B (2012). Money and Sustainability - the missing link. Club of Rome report.

Sornette, D. and Cauwels, P (2012). The Illusion of the Perpetual Money Machine. arXiv:1212.2833

The big meltdown - 2020?

The Folly of Financial Worship