The Money Valve
May 27th, 2014
in Business, Money and Banking
by Reverse Engineer, Doomstead Diner
Discuss this article at the Economics Table inside the Diner
Over the years here I have written numerous articles examining the nature of money and how it works. A few of the them are listed at the end of this article. Recently, in observing the simultaneous collapse of the monetary system and the Energy extraction bizness, I had a bit of an epiphany in terms of being able to explain in a straightforward fashion why the Central Banking paradigm worked when there was vast and cheap energy available, and why it doesn’t work once the energy becomes more scarce and hard to extract.
Money serves as a Valve which controls the downhill flow of energy, which can do useful work as it flows downhill. This is basic Thermodynamics.
To envision how this looked at the beginning of the Industrial Revolution, you have a large stock of energy that is pent up, and there is a high pressure pipe feeding the Money Supply valve. The Valve Controller who is the Central Bank issuing Debt to access the Energy is at this point in complete control of the velocity of money and the economy. They have two places to issue debt to, Industry which utilizes the Energy to produce Products and Waste, and Consumers who Consume the Products and produce Waste also.
If the CB at this point issues out too much credit to Industry, but not enough to Consumers, the Economy “Overheats”, and you can get a crash resultant from this, which basically was the scenario leading into the Great Depression.
The CB can also issue too much credit to Consumers and not enough to Industry, in which case you get an inflationary spiral.
Neither scenario of course is very good for the folks issuing the Credit, they want to maintain an ideal balance between Credit offered to Industry and Credit offered to Consumers so they can continue to extract the energy, Industry produces the Goods and Waste and Consumers consume the Goods and produce Waste. This is the underlying feature of Waste Based Economics.
As long as the Energy is coming out at high pressure, the Money Valve of the CB is in complete control of the Economy.
Now, what occurs when the Energy stock drops down to the point it is coming out at a lower pressure?
In this case, the Money Valve is much less functional. It still can distribute out Credit to both Industry and Consumers, but the amount it can issue in total is constrained by the Energy supply. In such a reductionary scenario, the CB tries to triage off credit to both sectors in order to maintain a steady, if smaller downhill flow.
The problem with this is that Industry functions at large scale and requires a ton of credit to keep operating. Industry also has first dibs on the credit, because of course the same people who issue out the credit also control the Industry. So in the next figure you see more of what is currently occurring, which is that Industry gets a larger portion of the Credit available, and the Consumer less of it.
The way this plays out in real life is that country after country of Consumers are triaged off the Credit Bandwagon, and lose access to the ability to buy the products of Industry. Read that places like Greece, Ukraine, Vietnam, Thailand and just about anywhere else there is currently ongoing Political Upheaval, Coup d’Etats, or Revolution.
Industry is still producing the goods though, even though more and more people are unable to afford them. This leads to the new effect of “Channel Stuffing”, which is where all the excess products being produced get sent to. This is essentially Waste, even though it is all brand spanking new stuff.
I did not bother to redraw the diagram when the Energy Stock falls below the point at which it can feed the Money Valve. This should be obvious, everything comes to a grinding halt. However, because total consumption gets smaller all the time, you have an asymptotic curve which develops, and it takes quite a while to actually fall completely below the point where no Credit can be issued at all. Before that happens though, the large scale industries dependent on gobs of credit to operate will begin to fail.
In truth, as long as you can grow food and have daily energy input from the Sun, you can continue to run some sort of monetary system that operates this way, but it is way smaller than the one we have been operating with since Fossil Fuel energy was accessed. You always need surplus energy relative to your population size to do this though, even at low levels. If there is not a downhill flow of energy to work with, there is no way to make a monetary system like this work.
This is the reason that although they were not using Fossil Fuels, the Roman Empire’s monetary system eventually crashed. As the Empire expanded, it grew in population size, but produced ever less food per capita throughout the Empire, with ever more Waste involved in running an expanding Military and building ever more roads that needed to be maintained in order to move the food around and move the Military around. For the type of agrarian economy they were running, when the energy costs of maintaining it exceeded the ability of the land to produce the food necessary for everyone involved, the monetary system crashed. Of course this took a good deal longer in those years, because it was run at a lower level of throughput.
Like today, the Romans attempted to slow the decline through a gradual debasement of their money, substituting base metals for gold and silver in their coinage. However, making more Money available to the population did not in any way increase their ability to produce food or move it around, or pay for the Military required to maintain order through such a large system. Money is not a substitute for resource availability, whether done through the issuance of more Credit or through the issuance of more Coins. Maintaining the integrity of their currency with Silver and Gold coinage would not have saved the Romans either, they simply would have had less money in the system to work with and fewer resources at the same time. The military would have collapsed sooner with inability to pay the Legions with less coinage available.
I left out many things on these diagrams in order to simplify them. Not taken into account here is the fact that increasing levels of Waste in an economy generate their own costs. An easy example of that would be something like Fukushima, which now is costing Billions in order to try to clean up the mess, and probably can’t ever really be cleaned up even for Trillions.. Even without a disaster like that, you have decommissioning costs on older reactors.
Also not shown explicitly is the waste that comes in the form of carbon emissions into the atmosphere. This has deleterious effects on the overall climate, resulting in more droughts, more destructive cyclonic storms, more powerful Tornadoes and so forth. All of these are constantly doing damage to the overall infrastructure, power lines come down, homes are destroyed and so forth. This is more waste in the system as you need to keep rebuilding the same things over and over again, constantly using up an ever decreasing and ever more expensive supply of stored energy.
Also not shown is how the interest charges applied to all the created money by the CBs escalate all the time due to the compounding of Interest, or how corruption endemic to the system ends up with huge portions of resource wealth being funnelled of into private hands rather than being equitably distributed, or how Goobermint waste and inefficiency also burn up gobs of energy and money. You can look at all those effects as Friction on the system, waste heat that is exhausted all throughout the processes.
The outcome is pretty clear here, once the available per capita energy falls below a critical mass, this monetary system will fail. It remains hard to determine precisely what that critical mass is, particularly within the countries like the FsoA and Wall Street, the UK and the City of London and Germany and the Bundesbank are concerned. The likelihood is these places continue to provide credit to their own populations while triaging ever more peripheral countries off the Credit Bandwagon. This of course is analogous to the Roman Empire collapsing first at the Periphery, and working its way inward over a couple of centuries to Rome itself. In this case though, the collapse is unlikely to take centuries to play out, decades at best is more likely, and perhaps just a few years or even months. What there is of a monetary system now that functions globally is held together by Duct Tape and Bailing Wire,, or in this case Accounting Fraud and outright Theft, as in the case of John Corzine and MF Global.
Money and Energy are integrally related. Money serves as a means to distribute Surplus Energy, it does not Create Energy, nor can it equitably distribute an overall deficit of Energy per Capita. When this monetary system fails, which it is already well on its way toward doing, there will be no substitute, not Gold, not SDRs, not for a long time until there is a relative surplus again. Interim management will require overall shrinkage, more locally based economies, conservation and a lower standard of living for all.
The Free Lunch we got from the Age of Oil is OVAH. The Fat Lady has sung on that one.
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