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How to Fix a Household Crisis

by Rob Dietz

Economics is a field in crisis.  The failure to prevent or even predict the global financial meltdown is a sure sign of this fact.  Over the last few decades, a number of body blows have dented the credibility of mainstream economists.  But the utter failure to foresee the financial fiasco was like a Muhammad Ali knockout punch to the jaw.  The crisis of credibility is due to the disconnect between what’s happening in the real world and what’s offered in the classroom and economics journals.  For confirmation of the disconnect, witness the Dynamite Prize dished out by the Real-World Economics Review to “honor” those economists most responsible for blowing up the global economy.

Not to be outdone, ecology is also a field in crisis.  This crisis, however, is not about credibility.  Instead, ecology’s crisis stems from the seemingly insurmountable nature of the problems faced by its practitioners.  Imagine going to work each day and having to confront mounds of malaise-inducing evidence of ecological decline, from species extinctions to habitat loss to climate destabilization (just to name a few).  It’s a testament to their dedication that they even show up for work.  Many who do show up tend to focus on localized problems or minor information gaps as entire ecological systems crumble around them.  Who can blame them?  It’s daunting and maybe even depressing to walk out on the tracks and try to stop a train that’s bearing down at full speed.  So instead, they work on a small section of track, hoping to keep the train from derailing for a bit longer.

Wordsmiths will recognize that the names of these two crisis-riddled fields share a common root – oikos, the Greek word for household.  So basically, our entire household is in a state of crisis, and it’s threatening the health of the family, the cat, the dog, the yard, and the whole neighborhood.  When there’s a serious problem in your household, the best course of action is to figure out the cause of the problem, make a plan to address that cause, and take concrete steps to implement your plan.

Step 1 – Figure out the cause.

The cause of the crisis in our two “households” is the pursuit of perpetual economic growth.  From the ecological perspective, the household cannot thrive if its support structure is always under pressure to provide increasing resources for a growing economy.  Unsustainable liquidation of natural resources to produce ever more stuff is no way to run a household.  From the economic perspective, the household will fall if it is built on a faulty financial foundation.  In a financial system that requires exponential growth, claims on wealth (money) will inevitably surpass the availability of real wealth (actual goods and services), and a collapse is bound to follow.  Societal commitment to growing a bigger economy, including the commitment to a financial system geared for such growth, is the root cause of the ecological and economic crisis.

Step 2 – Make a plan.

For their part, economists will have to recognize and accept the inevitable limits to growth, and get to work on the institutions and policies needed for a prosperous steady state.  Ecologists will have to get more involved in economic affairs and be prepared to inform policy makers about the best scientific information on resource resilience.  Such shifts within the disciplines of economics and ecology will require professors to teach different material, students to get a broader education, and practitioners to collaborate with one another.  These are huge shifts that call for the two households to break down some walls and unite under one roof.  Fortunately, Herman Daly, Robert Costanza, and plenty of other inspiring thinkers have given us a substantial start on building the combined household of ecological economics. There has been a tendency to think of ecological economics as a sub-discipline or specialty of economics, but that is entirely inadequate for addressing the root cause of the crises.  We need to think of ecological economics as an evolution of the two disciplines – an integrative game-changer.

Step 3 – Take concrete steps.

Organizations that support ecological economics and the steady state are on the rise, but make no mistake – such groups can hardly be considered mainstream.  CASSE is a tiny organization compared to the anachronistic Club for Growth.  The U.S. Society for Ecological Economics doesn’t have the clout of the American Economic Association.  Let’s make CASSE more influential than the Club for Growth.  Let’s make the USSEE more influential that the AEA.

When we increase our members and solidify our base of support, we’ll have the political power to begin turning concepts from ecological economics into policies.  Then we can commence the tough job of repairing our household.  We’ll get the family into counseling.  We’ll take the cat and dog to see the vet.  We’ll tear up the ornamental grass in the yard, restore some habitat and plant a garden.  Pretty soon the neighborhood will feel like a community shared by all who live there.

The Financial Crisis Is the Environmental Crisis

by Eric Zencey

In May of 2009, U.S. federal legislation created the Financial Crisis Inquiry Commission, charged with investigating the causes of the financial crisis that led to the largest economic downturn since the Great Depression. The Commission’s report is due in January. But don’t get your hopes up; they’re more than likely to get it wrong.

The Commission has held hearings with and gathered testimony from quite a few experts, all of them entrenched within the mainstream of neoclassical economic theory. The experts have named the usual suspects: cyclical swings between greed and fear; feedback effects that “disequilibrate” markets; cheap and “poorly documented” mortgage financing; bank accounting that kept some liabilities “off balance sheet;” the international sale of debt that guaranteed that a collapse in one market in one country would ripple out to affect the world; foreign demand for American debt, which created demand-pull for riskier and riskier American investments; and unworkable hedge funds that appeared to transform sure-to-fail loans into sure-to-pay investments.

It’s likely that all of these played a role. Fixes for most of them ought to be undertaken on their own merits. (Who could be in favor of “poorly documented mortgages” or “off-balance-sheet” investments?) But none of the testimony makes this point: the financial crisis is also the environmental crisis. We won’t solve the former until we start solving the latter.

Two facts about this crisis stand out: the world came to the brink of global economic collapse, and the world is and remains on the brink of ecosystem collapse. The economy is humanity’s primary instrument for interacting with its environment; this suggests that these two facts are somehow related. And yet none of the standard diagnoses come anywhere close to acknowledging that there might be a connection, let alone start to illuminate it. In the standard view, the financial crisis beset an economy that consists solely of humans acting within formalized systems of their own creation —systems that have no connection to a larger world.

And that’s why the standard view won’t succeed in fixing the problem. The spasm of debt repudiation with which the crisis began — the collapse of the sub-prime lending market — is what happens when an infinite-growth economy runs into the limits of a finite world.

That insight comes from the reference frame suggested by Frederick Soddy, as elaborated by Nicholas Georgescu-Roegen, Herman Daly, and others. Soddy offered a vision of economics as rooted in physics — the laws of thermodynamics, in particular. An economy is often likened to a machine, though few economists follow the parallel to its logical conclusion: like any machine the economy must draw energy from outside itself. The first and second laws of thermodynamics forbid perpetual motion, schemes in which machines create energy out of nothing or recycle it forever. Soddy criticized the prevailing belief in the economy as a perpetual motion machine, capable of generating infinite wealth. That belief is nowhere more clearly manifest than in how we treat money. Soddy distinguished between wealth, virtual wealth, and debt. Real wealth, even the provision of services, is irreducibly rooted in physical reality. The money we use to represent this wealth isn’t real wealth, but virtual wealth — a symbol representing the bearer’s claim on an economy’s ability to generate real wealth. Debt, for its part, is a claim on the economy’s ability to generate wealth in the future. “The ruling passion of the age,” Soddy said, “is to convert wealth into debt” — to exchange a thing with present day real value (a thing that could be stolen, or broken, or rust or rot before you can manage to use it) for something immutable and unchanging, a claim on wealth that has yet to be made. Money facilitates the exchange; it is, Soddy said, “the nothing you get for something before you can get anything.”

Problems arise when wealth and debt are not kept in proper relation. The amount of wealth that an economy can create is limited by the amount of low-entropy materials and energy that it can sustainably suck from its environment and by the amount of high-entropy effluent that natural systems can sustainably absorb. (We can in practice exceed those sustainable limits, but only temporarily; that is the definition of “unsustainable.”)

There are only two ways that an economy can increase the rate at which it creates wealth: it can process a larger and larger flow of matter and energy, increasing its ecological footprint on both the uptake and the effluent side; or it can achieve efficiencies in its use of a constant flow of matter and energy. Both means of growth have limits. Increasing an economy’s ecological footprint decreases the ability of healthy ecosystems to provide us with a civilization-sustaining flow of ecosystem services (like climate stability, a service currently in critically short supply). Efficiency gains in the use of a constant flow offer large returns today and will probably do so into the future, but those gains will become harder and harder to achieve as we run into diminishing returns. Technological advances and efficiencies will allow us to make more with less, especially in places where we’ve been profligate in our use of low-entropy inputs; but no technical advance will get us around the first law of thermodynamics, which tells us “you can’t make something from nothing, nor can you make nothing from something.” Creation of wealth is irreducibly physical, and all physical phenomena obey the laws of thermodynamics.

Thus, the creation of wealth has physical constraints, set by ecosystem limits, physical law, and the limits of the technology we currently employ. But debt, being imaginary, has no such limit. It can grow infinitely, compounding at any rate we choose to let it.

These considerations led Soddy to this incontrovertible truth: whenever an economy allows debt — a claim on wealth — to grow faster than wealth can be created, that economy has a structural need for debt to be repudiated.

Inflation can do the job, decreasing debt gradually by eroding the purchasing power of the monetary units in which debt is denominated. And debt repudiation can be exported — some of the pressure to reconcile wealth and debt is released when other nations in the system inflate their currencies or default on obligations.

But when there is no inflation, and when the economy becomes one integrated global system in which export to outside the system is no longer possible, overgrown claims on future wealth will produce regular crises of debt repudiation — stock market crashes, waves of bankruptcies and foreclosures, defaults on bonds or loans or pension promises, the disappearance of paper assets in any shape or form. As Lawrence Summers noted in a speech last year at the Brookings Institute, “In little more than two decades, we have seen the stock market crash of 1987, the savings and loan scandals, the decline of the real estate market, the Mexican crisis, the Asian crisis, LTCM, Enron and long-term capital. That works out to one big crisis every two and a half years.” He went on to add: “We can and must do better.” Each and every one of the crises he listed was, at bottom, a crisis of debt repudiation. We are unlikely to avoid their recurrence until we stop allowing claims on real wealth to grow faster than real wealth can grow.

The cause of the financial crisis, Soddy would certainly say, isn’t simply opportunistic financiers exploiting the lag between innovation and regulation, isn’t simply ignorance, isn’t a failure of regulatory diligence, isn’t a cascading lack of confidence that could be solved with some new and different version of the F.D.I.C. The problem is a systemic flaw in our treatment of money. Whenever and wherever growth in claims on wealth outstrips growth in wealth, our system creates a niche for entrepreneurs who are all too willing to invent instruments of debt that will someday be repudiated. There will always be a Bernie Madoff or a subprime mortgage repackager or a hedge fund innovator willing to play their part in setting us up for a spasm of debt repudiation. Regulation will always be retrospective.

The best solution is to eliminate that niche. To do that, we must balance claims on future production of wealth with the economy’s power to produce that wealth.

Soddy distilled his vision into five policy prescriptions, each of which was taken at the time as evidence that his theories were unworkable. One: abandon the gold standard. Two: let international exchange rates float against one another. Three: use federal surpluses and deficits as macroeconomic policy tools, countering cyclical trends. Four: establish bureaus of economic analysis to produce statistics (including a consumer price index) that will facilitate this effort. These proposals are now firmly grounded in conventional practice. Only Soddy’s fifth proposal remains outside the bounds of conventional wisdom: stop banks from creating money, and debt, out of nothing.

Soddy’s work helped to inspire the short-lived “100% Money” movement that emerged during the Depression, which offered a diagnosis that went beyond treatment of symptoms (the cascading collapse of confidence that led to bank failures, which was addressed through creation of the F.D.I.C.) to reach the underlying cause: the leveraging of debt through the practice of fractional reserve banking. Irving Fisher at Yale and Frank Knight, the prominent Chicago School economist, also supported the elimination of fractional reserve banking. For a time the movement counted no less an economic eminence than Milton Friedman as a sympathizer. (Perhaps because he saw that the tide of history was against him, Friedman eventually dropped his call for elimination of fractional reserve banking from his policy recommendations.) The 100% money movement finds a contemporary advocate in ecological economist Herman Daly, who has called for the gradual institution of a 100 percent reserve requirement on demand deposits. This would begin to shrink what he has called “the enormous pyramid of debt that is precariously balanced atop the real economy, threatening to crash.”

In such a system, banks would support themselves by charging fees for safekeeping, check clearing, loan intermediation, and all the other legitimate financial services they provide. They would not generate income by lending out, at interest, the money entrusted to them for safekeeping — money that does not belong to them. Banks would still make loans and still be able to lend at interest “the real money of real depositors,” people who forego consumption today in order to take money out of their checking account and put it in time deposits (e.g., CDs, passbook savings, and 401Ks). In return these savers would still receive interest payments — a slightly larger claim on the real wealth of the community in the future.

In a 100% money system, every increase in spending by borrowers would have to be matched by an act of saving — abstinence — on the part of a depositor. This would re-establish a one-to-one correspondence between the real wealth of the community and the claims on that real wealth. To achieve 100% money, the creation of monetarized debt through other mechanisms — repackaged mortgages and securitized derivatives and the like — would also have to be brought under control.

An added benefit: establishing 100% money would have an enormous and positive effect on the public treasury. Seigniorage, the profit that comes from the creation of money, is currently given away free to banks (which collect it as the payment of interest and the repayment of principle on loans made with money that is not actually theirs). Under a 100% money regime, money would be created — spent into existence — by a public authority. (This is what Friedman advocated.) The capture of seigniorage would have obvious benefits for governmental budgeting: the seigniorage on a modest 3% growth in M1 (one of the chief measures of the money supply) amounts to $40 billion a year. And, when you come right down to it, to whom does seigniorage, by rights, belong? Despite long-standing custom to the contrary, the profit that comes from the issuance of money belongs to the sovereign power that guarantees that money. In the U.S., that’s us: We, the People.

This change in our banking system would eliminate the structural cause of spasms of debt repudiation. It would also eliminate one strong driver of uneconomic growth —growth that costs more in lost ecosystem services and other disamenities than it brings in the form of increased wealth. The change is thus economically and ecologically sound. It is, obviously, politically difficult — so difficult that advocacy for it sounds hopelessly unrealistic. But consider: in the 1920s, the abolition of the gold standard and the implementation of floating exchange rates sounded absurd. If the laws of thermodynamics are sturdy, and if Soddy’s analysis of their relevance to economic life is correct, we’d better expand the realm of what we think is realistic.

Steady State Economics and the New Congress

by Brent Blackwelder

My New Year’s wish is for everyone to see the movie Inside Job. It’s a dynamic overview of the people, forces, and philosophy behind the global financial crisis and the ensuing bailouts of the “too-big-to-fail” banks and investment firms. Inside Job shows how pervasive the corruption of the global financial system has become. The movie singles out various Democrats and Republicans as being part of the problem, but it also contains scenes of some keen Congressional investigators such as Senator Levin of Michigan, Chairman of the Permanent Subcommittee on Investigations, who is shown grilling the heads of the big banks and exposing the kinds of swindles that took place.

Advocates of the steady state economy should be working more closely with the cutting-edge organizations fighting global corruption because the corruption and its attendant bribery of public officials is undermining governance around the world.

The ongoing economic depression is the very time steady state advocates should be pushing for a totally different way of proceeding, a way to avoid the boom and busts of the past. We need to blow right by the typical politicians pushing their pet hackneyed ideas for getting the economy moving.

We don’t want to return to the same spot we were in, only to have a new round of speculators crash the economic system and undermine governance. It is important, therefore, to force decision makers in Congress and the Executive Branch to think about a paradigm shift and what a steady state economy would look like.

One obvious approach is to continue increasing the teach-ins, symposiums, and conferences that feature this deep economic debate. CASSE (the Center for the Advancement of the Steady State Economy) can provide the names of experts to university groups, religious congregations, and public interest organizations who want to host events to educate their members and the public about new economic models.

Rallies and demonstrations can help make a difference in awareness and can stimulate Congress to conduct hearings. For example, Tea Party activists demonstrated repeatedly this past fall at Republican primaries to protest the deficit and the gridlock in Congress and to push for tax cuts. Many were bankrolled by powerful right-wing interests, and they got a lot of press. Advocates of big economic change need to think about doing more demonstrations to raise awareness and force Congressional oversight into new economic models of sustainability.

For example, on the United Nations Anti-Corruption Day, December 9, I organized a demonstration outside the headquarters of the U.S. Chamber of Commerce. The U.S. Chamber has been a large force pushing growth at all costs and is well known for its anti-sustainability positions. But what is not so well known is the Chamber’s opposition to those trying to clean up global corruption and improve governance.

On behalf of the Tax Justice Network with participation by Common Cause, Public Citizen, and Friends of the Earth, we paraded in front of the U.S. Chamber and laid out the charges against it. For example, the Chamber is seeking to weaken the Foreign Corrupt Practices Act and is blocking efforts to abolish offshore tax havens, which contain vast sums of money (about $20 trillion) that go untaxed by any jurisdiction.

In addition to protests, rallies, and teach-ins, there may be other opportunities to confront the new Congress to get a deeper economic discussion going. Here are a couple of possibilities. Given the stated desire of most of the 97 new Members to cut federal spending, Congress should be challenged to eliminate the subsidies for polluting industries, especially for fossil fuels. The last Congress unfortunately continued the big subsidy for corn ethanol that will cost several hundred billion dollars by the year 2022. The new Congress could reverse this decision, and it could cut the agricultural commodity subsidies that benefit agribusiness and undermine organic food production. The challenge is to make the Congress vote and then we can tabulate the results and expose any hypocrites.

Many advocates of a steady state economy criticize gross domestic product (GDP) for failing to give an honest indication of the well-being of the nation. In 1989 Senator Robert Kasten (R-Wisconsin) added an amendment to the Commerce Department appropriations bill that required the Department to product an index of gross sustainable production in addition to the usual GDP. The provision became law and the Commerce Department started implementation, but in the mid-1990s the fossil fuel lobby forced the removal of this modest requirement. Perhaps as part of truth-telling to the American public, Congress could reinstate this provision.

I have suggested several measures of offense, but in 2011 we may have to work significantly on defense. For example, more bailouts may be proposed without any serious reform conditions. Keep in mind the inability of Congress to resist bailing out too-big-to-fail corporations.

For example, take the bailout of General Motors and Chrysler by the last Congress and the Obama administration. Why wasn’t a provision added to prohibit these companies from suing state or federal governments? GM got bailed out and then sued the State of California over clean car standards.

The Obama administration could have insisted on binding conditions for the production of better mileage vehicles similar to Toyota’s Prius and provided for government fleet purchases of high-mileage vehicles. Dan Akerson, CEO of General Motors, recently told the Economic Club in Washington: “We commonly refer to the geek-mobile as the Prius…I wouldn’t be caught dead in a Prius.”

Let’s make sure that Obama and the new Congress don’t continue rescuing fossilized corporations that stubbornly cling unsustainable policies of the past.

What Is a “Green Economy?”

Herman DalyA green economy is an economy that imitates green plants as far as possible. Plants use scarce terrestrial materials to capture abundant solar energy, and are careful to recycle the materials for reuse. Although humans are not able to photosynthesize, we can imitate the strategy of maximizing use of the sun while economizing on terrestrial minerals, fossil fuels, and ecological services. Ever since the industrial revolution our strategy has been the opposite. Fortunately, as economist Nicholas Georgescu-Roegen noted, we have not yet learned how to mine the sun and use up tomorrow’s solar energy for today’s growth. But we can mine the earth and use up tomorrow’s fossil fuels, minerals, and waste absorption capacities today. We have eagerly done this to grow the economy, but have neglected the fact that the costs of doing so have surpassed the benefits – that is to say, growth has actually become uneconomic.

In spite of the fact that green plants have no brains, they have managed to avoid the error of becoming dependent on the less abundant source of available energy. A green economy must do likewise – seek to maximize use of the abundant flow of solar low entropy and economize on the scarce stock of terrestrial low entropy. Specifically, a green economy would invest scarce terrestrial minerals in things like windmills, photovoltaic cells, and plows (or seed drills) – not squander them on armaments, Cadillacs, and manned space stunts. A green economy can be sufficient, sustainable, and even wealthy, but it cannot be a growth-based economy. A green economy must seek to develop qualitatively without growing quantitatively – to get better without getting bigger.

There is another kind of green economy that seeks to be green after the manner of greenback dollars, rather than green plants. Green dollars, unlike green plants, cannot photosynthesize. But dollars can miraculously be created out of nothing and grow exponentially at compound interest in banks. However, Aristotle noted that this kind of growth is very suspect, because money has no reproductive organs. Unlike green plants, green money seeks to grow forever in the realm of abstract exchange value, even as we encounter limits to growth in the realm of the concrete use values for which money is supposed to be an honest token and symbol.

Recently we have grown, or rather “swollen”, by expanding the symbolic realm of finance. Debt is a mere number (like negative pigs) and can easily grow faster than the real wealth (positive pigs), by which it is expected to be redeemed. Wall Street has bought and sold an astronomical number of negative pigs-in-a-poke – they have “sold bets on debts and called them assets”, as Wendell Berry succinctly put it. We have recently experienced the failure of this fraudulent attempt to force expansion. Yet we have so far been unable to imagine any policy other than restarting the old growth economy for another round. After the next crisis we should try to avoid the Ponzi scheme of growth and build a steady state economy – a green economy that is sustainable, just, and sufficient for a good life.