A scary story about money
(No. 13) Is there an actual forest-covered mountain behind your mountain of cash?
From the Department of Stacks and Stacks and Stacks of Stacks
I don’t know about you, but I don’t really understand money that well. I decided recently that that wasn’t okay – that I needed to understand the answers to some pretty basic questions.
First off, what is money? Oddly, the answer is not simple. Money is defined in different ways by different folks. One of the most common definitions is that money is a lubricant for value exchange. In this view, money frees us from the friction of direct barter (I have a pig… I’ll trade you for some of your tobacco…) and enables large groups of folks to trade more easily. Another way money is often described is as a store of value. Currency itself, whether paper notes, metal coins, or digital ones and zeros, has little intrinsic value. The value comes from shared faith between trading parties as to an agreed conceptual value. Basically, a paper dollar bill is worth a dollar because we all agree that it is.
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But there is a third way to think about money that until recently I had never heard before and that I found very eye opening: money is also a future claim on energy and other biophysical assets. Think of it this way: if I lend you money to build a house, you can’t build a house with the money itself, obviously. You’ll need to convert that money into the required biophysical resources that make up the component parts of a house and also into the energy necessary to manufacture and assemble those parts. That conversion process generally starts with oil or coal extracted from the earth. By burning that fuel, as well as by applying some human muscle power (supplied by actual food, grown somewhere else on earth), that money becomes a house made of wood and glass and rubber and plastic and many other physical things.
So here is where things start to get a little weird. If we think of money as a future claim on biophysical assets, then the amount of money in the world should be closely tied to the amount of biophysical assets actually available in the world. If you have seen a picture of earth from space then we can agree that the supply of biophysical assets available to us is finite. It shouldn’t be possible to create more money than you have stuff to exchange for it. Following that logic, the power to create money should be closely guarded. Obvi, right? Like you, I’m guessing, I thought it was closely guarded. If you or I get caught printing money in our basement we go to jail, right?
Until very recently, if I had been asked who has the power to create money I would have said the Federal Reserve, which approves the creation of money by the US Treasury, which then delivers it by armored truck to a bank, where it is put in a vault and then into circulation. Right? Wrong. It turns out only 5% of the money in the world is created that way. The rest? It’s created by your local bank via the mechanism of interest bearing debt. The moment you got approved for the loan to build that house, the money in that loan was created on the spot with a few keystrokes by the loan officer. Just like magic.
So what’s the problem with that?
Well, here’s the thing (and you might want to pour yourself a drink and have a good long think about this one) it turns out that the person paying attention to the relationship between the total available biophysical assets on the planet and the total amount of debt in the world is… well its nobody. Nobody has been watching that. So until pretty recently, nobody had noticed that the ratio between total future claims on biophysical assets (total debt) and actual biophysical assets on the planet has ballooned ominously, particularly since the 2008 financial crisis. We began producing money in the form of debt extremely fast in the aftermath of that crisis to stave off financial collapse. And it worked. But that practice continues to this day. So today we see weird things like the fed actually contemplating the creation of a trillion dollar coin to temporarily solve the latest “debt ceiling” crisis. Globally, we are creating money this way so fast that we are doubling the amount of global debt every 8 years. The size of the entire global economy measured in GDP only doubles about every 26 years (which is already a problematically fast pace, but that’s a discussion for another day). Today global debt stands at nearly 356 percent of global GDP, and it continues to rise. And in the US that ratio is also at record highs.
Actually it’s not true that nobody has noticed this. A few folks have been jumping up and down trying to warn us about it. Ecological Economist Josh Farley is one. Professor Nate Hagens is another. Nate’s podcast, The Great Simplification, is well worth a listen. In this episode, Nate interviews Josh about the many misunderstandings most people have about money and how it works. Nate and Josh are both pretty clear that they believe that the current amount of debt in the world is a very big problem and that if economic growth continues as currently planned (3% a year is the generally agreed optimum pace) some kind of reconciliation/default is coming sooner than we’d like. So far, anyway, Nate and Josh and others are mostly being ignored.
So let’s game this out: if Nate and Josh turn out to be right and the debt-to-physical-resources ratio is dangerously unbalanced, that means we may, in fact, be headed for some kind of default. Put another way, if there are more future claims on natural resources than there are actual natural resources, it means that there are a bunch of us who currently possess money that is already worthless. No future pig for you. No future tobacco for me. No future oil or coal for any of us. We can keep the money, but it can’t be used to buy anything real, because the earth doesn’t contain enough natural resources to make all the stuff we’d buy with it. While nobody was looking, we ran out. Or rather, we will run out when we all try to make the exchange we are all expecting to make – our money for “real stuff”. Meanwhile, the magical printing press at your local bank keeps running.
And here’s the thing, nobody in this story is trying to create a problem. This issue has been created by bankers who honestly just don’t understand the relationship between biophysical assets and the money supply because we don’t teach anyone this stuff. The current dominant economic paradigm, neoliberalism, is founded on the phantasmagorical premise of infinite energy and resource abundance, which enables infinite growth, rather than the hard reality that our economy is tethered directly to the biophysical resources of our home planet. Whoops.
So, what happens now? Nobody really knows – the situation is unprecedented. But looking to history as some kind of guide, generally when a loan comes due and the loan can’t be paid, there is a default and the value of the loan goes to zero. Any hard assets are seized by the bank but in this case there are no hard assets to seize. So… what generally happens then is the banks fail, and bring large parts of the economy down with them (the last time this happened in the U.S. was 1929 – we came close again in 2008). But since many banks have become “too big to fail”, the modern solution is that the government steps in and uses taxpayer money to bail the banks out. But without the biophysical assets to back that money up, that money is also worthless. And so the currency itself collapses. After that, we’re off the edge of the map. Time for a second drink, maybe?
If Nate and Josh and others are right about all of this, as this situation becomes more widely understood I would anticipate some unpleasantness. But, hey, hopefully they’re wrong. I don’t really understand money that well. It’s probably going to be fine.