I posted this comment (the parts in italics) on the Oil Drum this morning. Read Gail's post and then scroll down if you want to read the comments, or just read below for mine. Below I try to expand on some of these points for clarification and in light of previous posts in this blog.
ALL economic activity is work in the physical sense.
I have pointed this out before. Even mental work is due to the electrochemical activity in the brain, which consumes energy. Nothing, at all, happens without energy being used up.
ALL work requires the flow of energy from a high potential source, through the work process, to a low potential sink.
The amount of work that can be done in a specific time frame depends on the 'quality' of the energy. The most significant quality parameter is the potential difference between the source and the sink (temperature in heat engines, voltage in electrical systems, etc.) High potential differences drive more work per unit time. Natural gas and oil have the highest quality of energy relative to other forms. In addition, oil and its distillate products are easily portable and can be stored reasonably safely. Coal is sufficiently high quality with respect to stationary heat engines (e.g. generating electricity).
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.
Knowledge is an internal stable structure that represents the pathways through which energy should be routed in a work process. Knowledge includes efficiency dynamics. My whole vision of hierarchical control and its guidance of work has been covered here. Information, in real-time, is used to adjust the flows based on dynamic needs and desired results.
In the economy money acts as an information token representing the availability of energy to do work at the micro level.
Monetary tokens (dollars, yen) originally worked well to represent energy available to do work (this differs from the idea of emergy — embodied energy — which asserts cost in energy for production of assets, which is energy expended vs. energy available). A holder of dollars would exchange them for an asset. This signaled the system to route more energy to the work process (company) to make more of that asset. The work process simply turns around and buys more energy from its sources (e.g. electricity and labor).
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.
The gold standard basis for money was by no means a perfect approach. But it did have the effect of standardizing the measure of monetary value. Exchange was based on an agreed upon standard. Its problem lay with the fact that gold is a totally arbitrary value basis. It has no connection to work and hence actual wealth production. Energy, on the other hand, has the advantage of being directly related to the work process. The relationship between joules required, efficiency of the process, and the work obtained are directly measurable values. An inefficient process that uses more joules per unit of output will result in higher cost products. That, in turn, provides a motive for increasing efficiency. Put another way, in a market economy based on energy costs, there will be an efficient price mechanism to direct energy flow to the more efficient processes. That, at least, is one thing neoclassical economics got right.
After taking money off of the gold standard (Nixon) and following Milton Friedman's policy recommendations, money began to lose its connection with real work. It became possible to create the illusions of wealth production without really producing anything. Much of the service industries that arose during the last third of the 20th century, and the jobs within them, produce nothing more than paper (or obesity!). Energy is being expended but no real assets are being produced.
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.
Belief that tomorrow would find higher production than today is at the heart of borrowing. As long as there was, indeed, more production, because there was more energy, to cover both principle and interest, well and good. And as long as interest was kept low - after all, what does it mean to pay energy for energy(?) - then this system tended to work. Also, as long as real assets were the result of the borrowing, it made sense. But in energy contraction the basic assumptions no longer hold.
- 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.
- 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.
- Since money value had been de coupled from energy available to do work the signal that loans would be harder to pay back was lost.
- 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.).
- 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.
- 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.
Here are some prior blogs where I discuss some of these ideas in greater depth.
- What is wealth?
- What are savings?
- Can a change in perspective on money, wealth, etc. save our world?"
- What is useful work?
- How does hierarchical control theory help us?
- What would life be like in an energy-based economy?
- Does it feel like we're waiting for the hammer to fall?
- How might we face economic contraction?
- Rethinking capitalism and banking