19 September 2008

An excellent summary by George Mobus of just what is wrong with our financial and economic systems. Go to his blog for more details and read the discussions on TheOilDrum. Now if only those imbecilic bankers and economists who advise our politicians and run our financial institutions would pay greater attention to such writings, our world would be a better place.

1) ALL economic activity is work in the physical sense.

2) ALL work requires the flow of energy from a high potential source, through the work process, to a low potential sink.

3) The guidance of energy flow through the work process requires knowledge (of the process and its control model) and information regarding the energy potential available.

4) In the economy money acts as an information token representing the availability of energy to do work at the micro level.

5) Monetary policies have been crafted to disconnect the meaning of money as energy available to do useful work; money is now a commodity a-la Friedman. Money no longer serves as a measure of available energy. Though its flow, counter to actual energy flow, still acts to guide presumptive energy flow.

6) Fractional reserve banking, loaning some portion of an account to a borrower on the idea that the borrower will use that money as if there were energy to do useful work (unconsciously of course) and produce some additional wealth worked as long as net energy (ERoEI) was increasing over time.

7) Until at least the 1970s net energy had been increasing over time, hence the credit system worked because the debt could, in theory, be paid back in a subsequent time period due to the net increase in wealth-production potential.

8) With the advent of production of harder to obtain (lower ERoEI) oil, net energy gain started to decline (creating the top deflection in the peak curve). As net energy gain started to decline it became increasingly difficult to have an increase in wealth-production capacity -- it became harder to repay loans.

9) Since money value had been decoupled from energy available to do work the signal that loans would be harder to pay back was lost.

10) Sometime between the end of the 70' and into the 80's we found it necessary to continue what amounts to a re-financing scheme, chasing more debt to cover previous debt (note: this is also tied to incomes as evidenced in the growing need for two or more wage earners per household and a lot of corporate merger activities, etc.).

11) In order to generate caches of money to appear as if wealth was being created, market manipulations and speculation took on its own life. 'Sophisticated' schemes (slights of hand) have been invented to keep the illusion that wealth is being created -- now defined in monetary terms rather than hard assets with fixed values. But the wealth is just marks on paper (or registers in a computer memory). Real wealth has been in decline, e.g. the infrastructure decay.

12) With the peak of oil production (or plateau) the total net energy available to do work is starting its downward slide. All borrowing against a future when there would be more, not less, energy is futile. There is no PHYSICAL way that those loans can be paid back. All financial schemes that are based on debt being repaid are doomed to failure. The First Law of Thermodynamics is rather clear on this account. You cannot create energy out of nothing.

We humans are a smug bunch. We actually think that money is some social construct that has meaning beyond a physical reality. We've operated on that assumption and now the piper will be paid.

None of the financial geniuses that currently spout their theories are able to explain what is happening. They cannot predict what will come next. They talk about a "bottom" for this or that market. But there is no bottom as long as net energy is in decline. When total energy really starts to decline (post-peak oil) the s**t will really hit the fan.