Over the last few weeks, my posts here on The Archdruid Report have tried to sketch out a way of understanding economics that doesn’t contradict the laws of physics or the evidence of history. Perhaps the central concept I’ve been developing along these lines is the sense that there is no such thing as “the” economy in any human society; there are, rather, three economies, each of which follows distinctive rules.
The primary economy, in this way of looking at things, is the natural world itself, which produces something like three-quarters of the goods and services on which human beings rely for survival. The secondary economy, which depends on the primary one, is the collocation of labor, capital plant, and resources extracted from the primary economy that produces the other quarter or so of the goods and services human beings use. The tertiary economy, finally, is the system of social processes by which the products of the first two economies are allocated to people. This can take many different forms, of which the one most familiar to us is money.
The differences between these three economies run deep, and so do the differences in the way they are treated in conventional economic thinking. Unfortunately these two sets of differences do not run in parallel. One way to explore the resulting mismatch is to look at how the three economies, in reality and theory, are affected by the least popular of all the laws of physics: the second law of thermodynamics, more popularly known as the law of entropy.
To call this law unpopular is not to say that it suffers from any lack of recognition by scientists. The comment of Sir Arthur Eddington, one of the twentieth century’s greatest physicists, is typical: “If your theory is found to be against the second law of thermodynamics, there is nothing for it but to collapse in deepest humiliation” – a summing-up so useful that it probably deserves to be called Eddington’s Law. Entropy is the gold standard of physics, the one thing you can count on even when the rest of the cosmos seems to be going haywire. What makes it unpopular, rather, is that it stands in stark conflict with some of the most deeply and passionately held convictions of modern industrial humanity.
For all that, it’s a simple concept to grasp. Pour a cup of hot coffee on a cold morning and you can watch entropy in action. The coffee will gradually get colder and the air around it will get very slightly warmer. All energy everywhere, left to itself, always moves from higher to lower concentrations: that’s the second law of thermodynamics. On the way from higher to lower, the energy can be made to do useful work, and you can even force some energy to a higher concentration by allowing a larger amount of energy to go to a lower one, but one way or another entropy’s price must be paid.
We don’t like thinking in these terms, and for the last three hundred years, most of us in the industrial world haven’t had to. The 18th-century breakthroughs that allowed coal to be turned into steam power, and gave human beings command over amounts of highly concentrated energy never before wielded by our species, convinced most people in the western world that energy was basically free for the taking. In the halcyon days of industrialism, it was all too easy to forget that this vast abundance of energy was a cosmic rarity, a minor and finite backwash in the flow of energies on a scale almost too great for human beings to comprehend.
As far as we know, there are two and only two phenomena in the cosmos that naturally produce high concentrations of energy. The first is gravity. Unlike most physical phenomena, gravity has robust positive feedback: the more mass a body has, the more gravitational attraction it exerts, the more additional mass it can attract, and the more its gravitational attraction increases. This is why what starts as an eddy in an interstellar cloud of hydrogen gas, set in motion perhaps by the shockwave from a distant supernova, can attract steadily more hydrogen to itself until its gravity is strong enough to achieve the fantastic pressures needed for nuclear fusion, and a newborn star flares into life. Even so, entropy still rules; the light and heat that flows out from our Sun over the course of its ten billion year lifespan is still only a fraction of the potential energy of the gravitational collapse that brought it into being and keeps it going.
The second phenomenon that produces concentrated energy is biological life. Life combines positive and negative feedback loops, and so it’s much more fitful and fragile than gravity, but it can still surf the entropy of its neighboring star, tapping a small part of the vast streams of energy that flow entropically from the Sun’s core to the near-absolute-zero cold of interstellar space to concentrate chemical energy for its own use. Over the ages, the resulting concentrations of energy have transformed our planet, pumping oxygen into its atmosphere and burying trillions of tons of carbon underneath the ground in the form of coal, oil, and natural gas. Once that carbon was buried, gravity got to work on it, concentrating it further through heat and pressure. The energy stored in today’s fossil fuel deposits, in turn, is still only a fraction of the energy lost to entropy in the long slow process that brought those deposits into being.
This is why, as I’ve tried to point out in previous posts, those who expect to get some new and even more concentrated energy source to replace our dwindling reserves of fossil fuels are basically smoking their shorts. It took an extraordinarily complex series of processes, more time than the human mind has evolved the ability to grasp, and an equally unimaginable amount of energy lost to entropy, to produce the highly concentrated fossil fuels we’ve wasted so profligately over the last three hundred years. There are plenty of diffuse energy sources left, but raising them to concentrations that will allow them to power our current civilization would require huge amounts of additional energy to be sacrificed to entropy – and once you subtract the entropy costs of concentration from the modest energy supplies available to a deindustrial world, there isn’t much left. Try telling that to most people, though, and you’ll get a blank look, because we’ve lived with abundant concentrated energy for so long that very few people recognize just how rare it is in the broader picture.
Economics, once again, feeds this blindness. Most economic models, interestingly enough, admit entropy into what I’ve called the secondary economy: there’s a clear sense that producing goods and services consumes resources and produces waste, and that energy fed into the process is lost to entropy in one way or another. Most of them, however, explicitly reject the role of entropy in the primary economy, insisting that resources are always available by definition if you only invest enough labor and capital. As for the tertiary economy, most economic theories accept it as given that money is anti-entropic – it produces a steady increase in value over time, which is the theoretical justification for interest.
In the real world, by contrast, the primary economy is just as subject to entropy as the secondary one. Oil that has been pumped out of the ground and burned is no longer available to use as an energy resource, and if enough of it has been pumped out, the oil field runs dry and it stops being a resource too. Natural cycles can keep some resources available at a steady level by surfing the entropy of the Sun, but only if human action doesn’t mess up those cycles – something we are doing a great deal too much of just now. By ignoring the reality of entropy in the primary economy of nature, we are setting ourselves up for a very awkward future.
And the tertiary economy? This is where things get interesting, because the anti-entropic nature of money posited by mainstream economic theories has been accepted even by most critics of those theories. There’s accordingly been a flurry of proposals for changing the way money works so that it loses value over time. This is understandable, but it’s also unnecessary, because money as it exists today has an exquisitely subtle mechanism for losing value over time. The only difficulty is that mainstream economists and the general public alike treat it with the same shudder of dread and indignation their Victorian ancestors directed toward sex.
We’re talking, of course, about inflation.
I’ve come to think of inflation as the primary way that the tertiary economy resolves the distortions caused by the mismatch between the limitless expansion of the tertiary economy and the hard limits ecology and entropy place on the primary and secondary economies. When the amount of paper wealth in the tertiary economy outstrips the production of actual, nonfinancial goods and services in the other two economies, inflation balances the books by making money lose part of its value. I suspect – though it would take a good econometrician to put this to the test – that in the long run, the paper value lost to inflation equals the paper value manufactured by interest on money, once the figures are adjusted for actual increases or decreases in the production of goods and services.
It’s instructive to note what happens when governments attempt to stop the natural balancing process of inflation. In American economic history, there are two good examples – between the Civil War and the First World War, on the one hand, and between 1978 and 2008 on the other. In the first of these periods, the US treasury reacted against the inflation of the Civil War years by imposing a strict gold standard on the currency, and since the pace at which new gold entered the economy was less than the rate at which the production of goods and services expanded. The result was the longest sustained bout of deflation in the history of the country.
Despite the claims of precious-metal advocates today, this did not produce economic stability and prosperity. Quite the contrary, the economic terrain of the second half of the 19th century was a moonscape cratered by disastrous stock market collapses and recurrent depressions. The resulting bank and business failures probably eliminated as much paper value from the economy as inflation would have, but did so in a chaotic and unpredictable way: instead of everybody’s corporate bonds losing 5% of their value due to inflation, for example, some bonds were paid in full while others became worthless when the companies backing them went out of existence. The same calculus has come into play since the beginning of the Volcker era at the Federal Reserve Board, when “fighting inflation” became the mantra of the day; since then we’ve had a succession of crashes as colorful as anything the 19th century produced.
Thirty years of economic policy dedicated to minimizing inflation have guaranteed a sizable second helping of economic collapse in the years to come – it’s only in the imaginations of politicians and publicists that the recent “dead cat bounce” in the stock market, and various modest decreases in the rate at which economic statistics are getting worse, add up to a recovery of any kind, much less a return to the unsustainable pseudoprosperity of the years just past. Still, in the longer term, I suspect inflation will also play a major role in the unraveling of the current mess. With the end of the age of cheap abundant fossil fuels, the world faces a very substantial decrease in the amount of primary and secondary wealth in the world, and the notional wealth of the tertiary economy will have to lose value even faster to make up for that decline. Just how this will play out is anyone’s guess, but one way or another it’s unlikely to be pretty.
Wednesday, July 29, 2009
Wednesday, July 22, 2009
The Anti-Ecology of Money
Last week’s Archdruid Report post built on one of E.F. Schumacher’s more trenchant insights to propose a controversial way of making sense of modern economics. Schumacher, in Small Is Beautiful, drew a distinction between primary goods produced by natural processes, and secondary goods produced by human labor, and pointed out that secondary goods can’t be produced at all unless you have the necessary primary goods on hand.
This is quite true, though it’s a point often missed by today’s economists. There is at least an equal difference, though, between either of these classes of goods and a third class produced neither by nature nor by labor. These are tertiary or, more descriptively, financial goods; they form the largest single class of goods in the world today, in terms of dollar value, and the markets in which they are bought and sold dominate the economies of the industrial nations. To call this unfortunate is a drastic understatement, because the biases imposed on our societies by the domination of financial goods are among the most potent forces dragging the world to ruin.
A specific example of a tertiary good may be useful here to help clarify the concept. Consider a corporate bond with a face value of $1000. This is a good in the economic sense – that is, it can be bought for money, it can be sold for money, there are people who want to buy it and people who are able to produce and sell it. Compare it to any more tangible item of value, though, and the bond is clearly a very strange sort of good. It consists of nothing more than a promise, on the part of some corporation, to pay $1000 at some future date. That promise may or may not be honored – junk bonds are bought and sold, for example, in full knowledge of the fact that the chances the issuers will pay up are not good – but even then the chance of collecting on it is treated as an object of value.
The differences between a tertiary good and a primary or secondary one reach further than this. Tangible goods produced by natural cycles or human labor are available in amounts limited by the supply. If there’s only so much water in a river, for example, that’s how much water there is; the fact that people want more, if such is the case, does not produce any more water than the hydrologic cycle is already willing to provide. Equally, if a country’s labor force, capital plant, and resource base are fully engaged in making a certain quantity of secondary goods, producing more requires a good deal more than an agreement to do so; the country must increase its labor pool, its capital plant, its access to resources, or some combination of these, in order to increase the supply of goods.
Yet tertiary goods are available in amounts limited only by the demand. How many bonds can a corporation print? For all practical purposes, as many as people are willing to buy. A good number of the colorful bankruptcies that have enlivened the business pages in recent months, for example, took out firms that mistook a temporary bubble for permanent prosperity, issued bonds far beyond their ability to pay, and crashed and burned when all that debt started to come due. On an even more gargantuan scale, the United States government is currently trying to restart its economy by spending money it doesn’t have, selling bonds to cover the difference, and amassing debt on a scale that makes the most extravagant Third World kleptocracies look like a bunch of pikers. It’s hard to imagine any way in which the results of this absurd extravagance will be anything but ugly, and yet buyers around the world are still snapping up US treasury bonds as though there’s a scintilla of hope they will see their money again.
The difference between supply-limited and demand-limited goods, as this suggests, is among other things a difference between kinds of feedback. Think about a thermostat and it’s easy to understand the principle at work. When the temperature in the house goes below a certain threshold, the heat comes on and brings the temperature back up; when the temperature goes above a higher threshold, the heat shuts off and the temperature goes back down. This is called negative feedback.
In a market economy, all secondary goods are subject to negative feedback. That’s the secret of Adam Smith’s invisible hand: since the supply of any secondary good is limited by the available natural inputs, labor pool, and capital stock, increased demand pushes up the price of the good, forcing some potential buyers out of the market, while decreased demand causes the good to become less expensive and allows more buyers back into the market. Equally, rising prices for a good encourage manufacturers to allocate more resources, labor, and capital plant to producing that good, helping to meet additional demand, while falling prices make other uses of resources, labor and capital plant more lucrative and curb supply.
Negative feedback loops of a very similar kind control the production of primary goods by the Earth’s natural systems. Every primary good from the water levels in a river and the fertility of a given patch of soil, to more specialized examples such as the pollination services provided by bees to agricultural crops, is regulated by delicately balanced processes of negative feedback working through some subset of the planetary biosphere. The parallel is close enough that ecologists have drawn on metaphors from economics to make sense of their field, and it’s quite possible that an ecological economics using natural systems as metaphors for the secondary economy could return the favor and create an economics that makes sense in the real world.
It’s when we get to the tertiary economy of financial goods that things change, because the feedback loops governing tertiary goods are not negative but positive. Imagine a thermostat designed by a sadist. In the summer, whenever the temperature goes up above a certain level, the sadothermostat makes the heat come on and the house gets even hotter; in the winter, when the temperature goes below another threshold, the temperature shuts off and the house gets so cold the pipes freeze. That’s positive feedback, and it’s the way the tertiary economy works when it’s not constrained by limits imposed by the primary or secondary economies.
The late and loudly lamented housing bubble is a case in point. It’s a remarkable case, not least because houses – which are usually part of the secondary economy, being tangible goods created by human labor – were briefly and disastrously converted into tertiary goods, whose value consisted primarily in the implied promise that they could be cashed in for more than their sales price at some future time. (As a tertiary good, their physical structure had no more to do with their value than does the paper used to print a bond.) When the price of a secondary good goes up, demand decreases, but this is not what happened in the housing bubble; instead, the demand increased, since the rising price made further appreciation appear more likely, and the mis-, mal- and nonfeasance of banks and mortgage companies willing to make six- and seven-figure loans to anyone with a pulse removed all limits from the supply.
The limits, rather, were on the demand side, where they always are in a speculative bubble: eventually the supply of buyers runs out because everyone who is willing to plunge into the bubble has already done so. Once this happened, prices began to sink, and once again positive feedback came into play. Since the sole value of these homes to most purchasers consisted, again, of the implied promise that they could be cashed in someday for more than their sales price, each decline in price convinced more people that this would not happen, and drove waves of selling that forced the price down further. This process typically bottoms out around the time that prices are as far below the median as they were above it at the peak, and for a similar reason: as a demand-limited process, a speculative bubble peaks when everyone willing to buy has bought, and bottoms when everyone capable of selling has sold.
It’s important to note that in this case, as in many others, the positive feedback in the tertiary economy disrupted the workings of the secondary economy. Long before the housing boom came to its messy and inevitable end, there was a massive oversupply of housing in many markets – there are, for example, well over 50,000 empty houses in Phoenix, Arizona right now. Absent a speculative bubble, the mismatch between supply and demand would have brought the production of new houses to a gentle halt. Instead, due to the positive feedback of the tertiary economy, supply massively overshot demand, leading to a drastic misallocation of resources in the secondary economy, and thus to an equally massive recession.
It’s long been popular to compare the tertiary economy to gambling, but the role of positive feedback in the tertiary economy introduces an instructive difference. When four poker players sit down at a table and the cards come out, their game has negative feedback. The limiting factor is the ability of the players to make good on their bets; the amount of wealth in play at the start of the game is exactly equal to the amount at the end, though it’s likely to go through quite a bit of redistribution. For every winner, in other words, there is an equal and opposite loser.
The tertiary economy does not work this way. When a market is going up, everyone invested in it gains; when it goes down, everyone invested in it loses. Paper wealth appears out of thin air on the way up, and vanishes into thin air on the way down. The difference between this and the supply-limited negative feedback cycles of the environment could not be more marked. In this sense it’s not unreasonable to call the tertiary economy a kind of anti-ecology, a system in which all the laws that govern ecology are stood on their heads – until, that is, the delusional patterns of behavior generated by the tertiary economy collide with the hard limits of ecological reality.
It’s not all that controversial to describe financial bubbles in this way, though you can safely bet that during any given bubble, a bumper crop of economists and pundits will spring up to insist that the bubble isn’t a bubble and that rising prices for whatever the speculation du jour happens to be are perfectly justified by future prospects. On the other hand, it’s very controversial just now to suggest that the entire tertiary economy is driven by positive feedback. Still, I suggest that this is a fair assessment of the financial economy of the industrial world, and the only reason that it’s controversial is simply that we, our great-grandparents’ great-grandparents, and all the generations in between have lived during the upward arc of the mother of all speculative bubbles.
The vehicle for that bubble has not been stocks, bonds, real estate, derivatives, or what have you, but industrialism itself: the entire project of increasing the production of goods and services to historically unprecedented levels by amplifying human labor with energy drawn from the natural world, first from wind and water, and then from fossil fuels in ever-increasing amounts. Like the real estate at the core of the recent boom and bust, this project had its roots in the secondary economy, but quickly got transformed into a vehicle for the tertiary economy: people invested their money in in industrial projects because of the promise of more money later on.
Like every other speculative bubble, the megabubble of industrialism paid off spectacularly along its upward arc. It’s inaccurate to claim, as some of its cheerleaders have, that everybody benefited from it; one important consequence of the industrial system was a massive distortion of patterns of exchange in favor of the major industrial nations, to the massive detriment of the rest of the planet. (It’s rarely understood just how much of today’s Third World poverty is a modern phenomenon, the mirror image and necessary product of the soaring prosperity of the industrial nations.) Still, for some three hundred years, standards of living across the industrial world soared so high that people of relatively modest means in America or western Europe had access to goods and services not even emperors could command a few centuries before.
In the absence of ecological limits, it’s conceivable that such a process could have continued until demand was exhausted, and then unraveled in the usual way. The joker in the deck, though, was the dependence of the industrial project on the extraction of fossil fuels at an ever-increasing pace. Beneath the giddy surface of industrialism’s bubble, in other words, lay the hard reality of the tertiary economy’s dependence on resources from the primary economy. The positive feedback loop driving the industrial bubble can’t make resources out of thin air – only money can be invented so casually – but it has proven quite successful at preventing industrial economies from responding to the depletion of their fossil fuel supplies fast enough to stave off what promises to be the great-grandmother of all speculative busts.
The results of this failure are beginning to come home to roost in our own time. To understand the economics of the resulting collision, though, it’s necessary to note the relationship between economics and the least popular law of physics – a subject central to next week’s post.
This is quite true, though it’s a point often missed by today’s economists. There is at least an equal difference, though, between either of these classes of goods and a third class produced neither by nature nor by labor. These are tertiary or, more descriptively, financial goods; they form the largest single class of goods in the world today, in terms of dollar value, and the markets in which they are bought and sold dominate the economies of the industrial nations. To call this unfortunate is a drastic understatement, because the biases imposed on our societies by the domination of financial goods are among the most potent forces dragging the world to ruin.
A specific example of a tertiary good may be useful here to help clarify the concept. Consider a corporate bond with a face value of $1000. This is a good in the economic sense – that is, it can be bought for money, it can be sold for money, there are people who want to buy it and people who are able to produce and sell it. Compare it to any more tangible item of value, though, and the bond is clearly a very strange sort of good. It consists of nothing more than a promise, on the part of some corporation, to pay $1000 at some future date. That promise may or may not be honored – junk bonds are bought and sold, for example, in full knowledge of the fact that the chances the issuers will pay up are not good – but even then the chance of collecting on it is treated as an object of value.
The differences between a tertiary good and a primary or secondary one reach further than this. Tangible goods produced by natural cycles or human labor are available in amounts limited by the supply. If there’s only so much water in a river, for example, that’s how much water there is; the fact that people want more, if such is the case, does not produce any more water than the hydrologic cycle is already willing to provide. Equally, if a country’s labor force, capital plant, and resource base are fully engaged in making a certain quantity of secondary goods, producing more requires a good deal more than an agreement to do so; the country must increase its labor pool, its capital plant, its access to resources, or some combination of these, in order to increase the supply of goods.
Yet tertiary goods are available in amounts limited only by the demand. How many bonds can a corporation print? For all practical purposes, as many as people are willing to buy. A good number of the colorful bankruptcies that have enlivened the business pages in recent months, for example, took out firms that mistook a temporary bubble for permanent prosperity, issued bonds far beyond their ability to pay, and crashed and burned when all that debt started to come due. On an even more gargantuan scale, the United States government is currently trying to restart its economy by spending money it doesn’t have, selling bonds to cover the difference, and amassing debt on a scale that makes the most extravagant Third World kleptocracies look like a bunch of pikers. It’s hard to imagine any way in which the results of this absurd extravagance will be anything but ugly, and yet buyers around the world are still snapping up US treasury bonds as though there’s a scintilla of hope they will see their money again.
The difference between supply-limited and demand-limited goods, as this suggests, is among other things a difference between kinds of feedback. Think about a thermostat and it’s easy to understand the principle at work. When the temperature in the house goes below a certain threshold, the heat comes on and brings the temperature back up; when the temperature goes above a higher threshold, the heat shuts off and the temperature goes back down. This is called negative feedback.
In a market economy, all secondary goods are subject to negative feedback. That’s the secret of Adam Smith’s invisible hand: since the supply of any secondary good is limited by the available natural inputs, labor pool, and capital stock, increased demand pushes up the price of the good, forcing some potential buyers out of the market, while decreased demand causes the good to become less expensive and allows more buyers back into the market. Equally, rising prices for a good encourage manufacturers to allocate more resources, labor, and capital plant to producing that good, helping to meet additional demand, while falling prices make other uses of resources, labor and capital plant more lucrative and curb supply.
Negative feedback loops of a very similar kind control the production of primary goods by the Earth’s natural systems. Every primary good from the water levels in a river and the fertility of a given patch of soil, to more specialized examples such as the pollination services provided by bees to agricultural crops, is regulated by delicately balanced processes of negative feedback working through some subset of the planetary biosphere. The parallel is close enough that ecologists have drawn on metaphors from economics to make sense of their field, and it’s quite possible that an ecological economics using natural systems as metaphors for the secondary economy could return the favor and create an economics that makes sense in the real world.
It’s when we get to the tertiary economy of financial goods that things change, because the feedback loops governing tertiary goods are not negative but positive. Imagine a thermostat designed by a sadist. In the summer, whenever the temperature goes up above a certain level, the sadothermostat makes the heat come on and the house gets even hotter; in the winter, when the temperature goes below another threshold, the temperature shuts off and the house gets so cold the pipes freeze. That’s positive feedback, and it’s the way the tertiary economy works when it’s not constrained by limits imposed by the primary or secondary economies.
The late and loudly lamented housing bubble is a case in point. It’s a remarkable case, not least because houses – which are usually part of the secondary economy, being tangible goods created by human labor – were briefly and disastrously converted into tertiary goods, whose value consisted primarily in the implied promise that they could be cashed in for more than their sales price at some future time. (As a tertiary good, their physical structure had no more to do with their value than does the paper used to print a bond.) When the price of a secondary good goes up, demand decreases, but this is not what happened in the housing bubble; instead, the demand increased, since the rising price made further appreciation appear more likely, and the mis-, mal- and nonfeasance of banks and mortgage companies willing to make six- and seven-figure loans to anyone with a pulse removed all limits from the supply.
The limits, rather, were on the demand side, where they always are in a speculative bubble: eventually the supply of buyers runs out because everyone who is willing to plunge into the bubble has already done so. Once this happened, prices began to sink, and once again positive feedback came into play. Since the sole value of these homes to most purchasers consisted, again, of the implied promise that they could be cashed in someday for more than their sales price, each decline in price convinced more people that this would not happen, and drove waves of selling that forced the price down further. This process typically bottoms out around the time that prices are as far below the median as they were above it at the peak, and for a similar reason: as a demand-limited process, a speculative bubble peaks when everyone willing to buy has bought, and bottoms when everyone capable of selling has sold.
It’s important to note that in this case, as in many others, the positive feedback in the tertiary economy disrupted the workings of the secondary economy. Long before the housing boom came to its messy and inevitable end, there was a massive oversupply of housing in many markets – there are, for example, well over 50,000 empty houses in Phoenix, Arizona right now. Absent a speculative bubble, the mismatch between supply and demand would have brought the production of new houses to a gentle halt. Instead, due to the positive feedback of the tertiary economy, supply massively overshot demand, leading to a drastic misallocation of resources in the secondary economy, and thus to an equally massive recession.
It’s long been popular to compare the tertiary economy to gambling, but the role of positive feedback in the tertiary economy introduces an instructive difference. When four poker players sit down at a table and the cards come out, their game has negative feedback. The limiting factor is the ability of the players to make good on their bets; the amount of wealth in play at the start of the game is exactly equal to the amount at the end, though it’s likely to go through quite a bit of redistribution. For every winner, in other words, there is an equal and opposite loser.
The tertiary economy does not work this way. When a market is going up, everyone invested in it gains; when it goes down, everyone invested in it loses. Paper wealth appears out of thin air on the way up, and vanishes into thin air on the way down. The difference between this and the supply-limited negative feedback cycles of the environment could not be more marked. In this sense it’s not unreasonable to call the tertiary economy a kind of anti-ecology, a system in which all the laws that govern ecology are stood on their heads – until, that is, the delusional patterns of behavior generated by the tertiary economy collide with the hard limits of ecological reality.
It’s not all that controversial to describe financial bubbles in this way, though you can safely bet that during any given bubble, a bumper crop of economists and pundits will spring up to insist that the bubble isn’t a bubble and that rising prices for whatever the speculation du jour happens to be are perfectly justified by future prospects. On the other hand, it’s very controversial just now to suggest that the entire tertiary economy is driven by positive feedback. Still, I suggest that this is a fair assessment of the financial economy of the industrial world, and the only reason that it’s controversial is simply that we, our great-grandparents’ great-grandparents, and all the generations in between have lived during the upward arc of the mother of all speculative bubbles.
The vehicle for that bubble has not been stocks, bonds, real estate, derivatives, or what have you, but industrialism itself: the entire project of increasing the production of goods and services to historically unprecedented levels by amplifying human labor with energy drawn from the natural world, first from wind and water, and then from fossil fuels in ever-increasing amounts. Like the real estate at the core of the recent boom and bust, this project had its roots in the secondary economy, but quickly got transformed into a vehicle for the tertiary economy: people invested their money in in industrial projects because of the promise of more money later on.
Like every other speculative bubble, the megabubble of industrialism paid off spectacularly along its upward arc. It’s inaccurate to claim, as some of its cheerleaders have, that everybody benefited from it; one important consequence of the industrial system was a massive distortion of patterns of exchange in favor of the major industrial nations, to the massive detriment of the rest of the planet. (It’s rarely understood just how much of today’s Third World poverty is a modern phenomenon, the mirror image and necessary product of the soaring prosperity of the industrial nations.) Still, for some three hundred years, standards of living across the industrial world soared so high that people of relatively modest means in America or western Europe had access to goods and services not even emperors could command a few centuries before.
In the absence of ecological limits, it’s conceivable that such a process could have continued until demand was exhausted, and then unraveled in the usual way. The joker in the deck, though, was the dependence of the industrial project on the extraction of fossil fuels at an ever-increasing pace. Beneath the giddy surface of industrialism’s bubble, in other words, lay the hard reality of the tertiary economy’s dependence on resources from the primary economy. The positive feedback loop driving the industrial bubble can’t make resources out of thin air – only money can be invented so casually – but it has proven quite successful at preventing industrial economies from responding to the depletion of their fossil fuel supplies fast enough to stave off what promises to be the great-grandmother of all speculative busts.
The results of this failure are beginning to come home to roost in our own time. To understand the economics of the resulting collision, though, it’s necessary to note the relationship between economics and the least popular law of physics – a subject central to next week’s post.
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