What counts as real wealth?

Paul Krugman's opinion piece in yesterday's New York Times reminded me of the consternation I have experienced in years gone by when people tried to educate me about appreciation of personal assets (both physical and paper). According to my savvy friends, appreciated assets represented real wealth. And, they argued, it was worth borrowing money to acquire said assets because they would always be worth more tomorrow than today. It should have been evident to any fool that if the appreciation rate was higher than the interest rate, then it was a sure bet. I must have seemed pretty dense when I looked at them dumbfounded and failed to follow their sage advice.

The entire vision of the dollar value of things like houses and stocks going up continually and forever has always seemed crazy to me. The ups and downs of the stock market, it was pointed out to me, are just noisy blips on a trend line that cannot be denied. Yes I have a mortgage on a house, but not because I view my house as an investment. It is the home I live in. Yes I have some stocks in a TIAA/CREF account, but that is because that is the retirement system — I don't have much choice. I don't really think of it as savings. Rather its a forced play at gambling. If it works out great, if not...

What Krugman pointed out was that the numbers now show that no real wealth was created in the US during the first decade of the twenty-first century! Personal debt far outweighed real savings and now that the appreciated asset bubbles are bursting right and left, the vast majority of people find themselves in deep doo-doo.

This situation can be interpreted in several different ways. One narrative supposes that it was unfettered greed that led to the whole debacle. People wanted to see their assets appreciate at an unrealistic rate, and it made them feel wealthy when the real estate prices on homes in the neighborhood were rising. Bankers were getting greedy for outrageous profits that came from making risky loans and letting them be packaged and chopped up into risk leveled instruments for resale. Greed was the driver.

I accept that greed played a large role in the process of financial mismanagement. But I suspect that what led people to even think they could get away with it was more fundamental. Namely, for all of recent history (last several hundred years or so) the long-run trend has been that wealth has expanded in general, and personal wealth has done so as well. There have been some bumps along the way. We've had a Great Depression and a number of minor depressions as well as some severe recessions (tell me the difference please). But the overall trend in gross national product for the developed nations has been up. Similarly we've seen, through the early part of the twentieth century, an expansion of the middle class. Even poor families can now have TVs and cell phones. So why shouldn't we believe that this is the nature of the world and accept that it's ever upward?

What we didn't recognize is that this growth in wealth, as well as the growth in population, could be not just correlated with, but seen to be caused by the incredible expansion of high grade energy available to do economic work. In other words, 'cheap' energy was readily available to build our roads, our cars, our factories, our general infrastructure, including energy extraction and transformation capital. It was available to run our farms, move our commerce, and provide us with all kinds of wonders of modern technology. And late in the game, energy was generally available to supersize everything. Big box stores. Big Macs. Big houses. And big cars (trucks, SUVs and Hummers).

Then something started to catch up to us. It takes energy to get energy. Just like it takes money to make money, you have to invest some of your energy gained back into extracting and transforming new energy. When energy does work it gets used up and is forever gone. Thus we have to keep reinvesting some portion of our energy to keep the energy flow going. The problem is that the greatest proportion of our energy flow comes from fossil fuels which are a finite resource. Moreover, it is getting harder to find and exploit those fuels. Oil has to come from more exotic places like the deep ocean where it is inherently harder to extract. You need to build sturdier oil platforms, using considerably more energy in the manufacture. You have to use more energy pumping the stuff to get it to the refineries. And, the quality of the oil has been declining as we use up the light-sweet crude and go to the sour stuff, meaning the refining process becomes more energy intensive.

And so it goes with our other fossil fuels. Coal is dirty, produces more CO₂ per BTU than oil or gas, and extracting it is an ecological nightmare. Carbon capture and sequestration is a political favorite and a technological freak show. Forget it. Natural gas may be dwindling faster than oil. In other words we are running out of our primary source of energy and as a consequence our ability to generate real wealth. This is most vivid in the area of alternative energy (wind and solar) capital formation. In order to build the alternative, and hopefully renewable, energy capture and transformation/delivery infrastructure will require a big subsidy from fossil fuels. We have no way to manufacture solar panels from energy obtained from solar panels as yet. Some day in the not-too-distant future we will need an integrated energy production infrastructure that will allow all manufacturing and distribution of energy capital to be done using renewable sources. That also means we will need to be producing significantly more total energy from those sources so that we can power our economy as well as keeping the energy flowing (though I'm pretty sure we are talking about a significantly different kind of economy that won't include NASCAR or the NFL in their current forms).

So I get around to the question. What counts as real wealth from now on? Energy flow and wealth production go hand-in-hand. Clearly perceptions of value and markets that cater to inflating values in monetary measures cannot serve to tell us what is really 'of value'. We need some kind of more grounded measure, and one that is more objective in its capacity to assess the true amount of wealth we create. I have advanced the notion of an energy denominated economic system for this reason. Many others have done so as well. I think those of us who grasp the significance of the physical meaning of work and energy flow have an understanding that, in the end, what money is doing is providing an indication of where and how energy is flowing to do useful work. But it is a poor indicator because it has been grossly decoupled from the underlying energy reality.

Various thinkers/researchers have proposed various schemes for coupling money and energy. There have been energy-based costing systems, for example, basing product or service price on the amount of energy used up to make that product or provide that service. This approach is criticized for failing to take into account the 'value' of the object or service to human customers. The price, according to the standard thinking, ought to be based on what customers are willing to pay since that reflects the perceived utility of the object/service. Well, that is true up to a point. But it is that whole belief in rational utility deciders and perceived value that has been part of the problem resulting in the decoupling of energy and money. People cannot judge the value of gadgets, especially complex electronic toys, except for how much entertainment they believe they are going to get out of them (I can't tell you how many video games my boys have just HAD to have that within months of obtaining are now gathering dust on some forgotten shelf).

Pricing based on energetic inputs (not only electricity, etc., but human labor since that comes from food energy and that comes from farm energy plus photosynthesis) would have another benefit that would not appreciated by strict market capitalists. It would allow market regulatory mechanisms to assure no excess profits are charged. The discussion about what is a fair profit is long overdue in this world. The market capitalist attitude that prices SHOULD be whatever the market will bear is simply unsustainable (and we are accumulating no small amount of evidence of that claim as we speak). This could be especially helpful in gauging an appropriate level of savings and reinvestment. I will make no bones about my belief that in the end we are going to find that an economy based on what we typically call non-profit-like organizations will come to prevail. I realize this messes with all thoughts about REWARD and such. Which is why I allow that there be some margin of profit that is allowed for companies and individuals to direct toward savings. But the reward for doing good for society ought to be the recognition of doing that good, not living a lifestyle some 200 times above that lived by the janitorial staff (greed again). Unfortunately, in my research on sapience I've come to suspect that the wisdom of balance in all things will not produce this understanding naturally in most minds. There are other consequences and benefits from energy-based pricing. There are also some inherent difficulties from a microeconomics perspective. I hope to explore these more in future blogs. Especially since I suspect that it won't be long before people are going to be casting about for answers when they finally realize the financial system we have now is simply not working as advertised.

Another way to recouple energy and money is, from a macroeconomic perspective, to set the value of dollars based on a fixed amount of energy that can be readily coupled to work (on average). The energy that is available to do useful work is quite a bit less than the raw energy we extract. Oil has to be refined and delivered. Coal has to be processed and burned, mostly producing steam and driving turbine generators for electricity. The only energy that actually counts, from an economic standpoint, is that final product delivered to the points of use. All energy used up getting that final product to the point of use has to be subtracted from the total raw energy you started with to get the actual net energy value. Then, you sum up all of that ready-to-use energy for manufacturing and such and that is what you have to work with. In other words the monetary policy is to only put into circulation that amount of dollars that represent the total net energy available to do economic work. This kind of policy has many implications and ramifications which go against most of our current conception of, for instance, banking and money supply.

There are far many more aspects to re-coupling money and energy than I can begin to go into here. Someday, if I get time, I will write a book about it I suppose. Or if others would like to spend a little intellectual capital on working the ideas out, I'd be happy to see that happen. In any case I don't expect there will be much demand for these ideas until a major calamity has brought people to recognize why they need to question everything! Of course that calamity may be unfolding right now.

Real wealth is the result of real work, not speculative valuation. There is no such thing as asset appreciation since the Second Law of Thermodynamics (its entropy version) ensures that you have to keep pumping energy into everything of value just to stay ahead of decay. Look at the state of our bridges to see what I mean. Those bridges that are crumbling didn't appreciate. You homes don't appreciate. You have to keep putting effort and new pieces into keeping them in steady-state. Appreciation is a horrible illusion that bankers like the common person to believe in because every transaction will be at a new higher price and their cut will make more profits! Only their profits were illusions too. They have been hoised by their own petards along with the rest of us.

Real wealth isn't a bigger home than you need to live a comfortable life. It isn't a bigger SUV so you have the illusion of safety on the highway (by making sure you kill whoever is in the littler car) or can put it in four-wheel drive every three years when it snows more than two inches. Those forms of wealth are also illusory. They consume resources without providing any real benefit beyond bragging rights. Real wealth is assets that produce more real wealth! Building solar energy and wind farms to convert raw, renewable energy into usable energy is real wealth. Having a rational mode of transportation to get you to work is real wealth since as you do your work you are presumably contributing to the maintenance and/or development (not growth) of society. Putting energy into building just enough plows so that we can maintain our food source is real wealth production. Plows have long lifetimes so once built don't need frequent replacement (unless they break). Building a newer, fancier but no more functional version of the plow just to keep sales expanding is not producing real wealth.

There is going to need to be a huge amount of education of people with respect to what is real and what is illusion in the game of economics. Today, the vast majority of people truly believe that making more money or acquiring stuff, and a growing GDP are the goals of life. Unless people start to realize that this version of the American dream (as opposed to having freedom from political tyranny) is an illusion and they need to open their eyes to reality we are going to crash and burn without appeal.

Comments

[AndrewC]

Dr. Mobus,

I can't agree enough George! I was wondering the other day, if it would make a difference if policy were enacted to use different and abolish the old metrics then perhaps people would start to function along different economic paradigms? http://en.wikipedia.org/wiki/Gross_National_Happiness

I think Memmel's comments a while back at theoildrum,have an interesting perspective on real wealth. I like the furniture analogy. http://anz.theoildrum.com/node/4260#comment-375994

I worry that basing our economy on strictly energetic inputs, could falter in two ways.

1. I'm not sure that pricing based on energy could account for negative externalities such as pollution, overfishing. Also a cost that has to be considered is a risk price mechanism accounting for the marginal risk of degrading a resource, pollution ect, that might cause some sort of calamity. i.e Monocropping may be more efficient and the better idea in energetic terms but the risk of relying on a single strain of crops for food, can have disastrous consequences, i.e irish potato blight. What is to keep us from cutting down every last tree that will lead to a great than 1 energy ratio?

2. Also, the way society and the world is today, it seems we are heading towards the net energy cliff which I suppose in an energy based currency would just be a hyperinflation crash? Perhaps this is a system better based on renewable energy sources, for the people of the future?

I'd love to hear your thoughts George. Keep up the blogging!

Regards,
Andrew

[George Mobus]

Hi Andrew.

I'm not advocating anything 'strict' just yet. Just trying to recapture the relationship between money and energy that provides a more solid basis for judging value.

WRT: externality pricing. One approach would be to consider the amount of energy required to mitigate or compensate for damages. For example we have a pretty good idea what kind of work it would take to filter particulates and chemicals out of effluents. The energy required to accomplish this work can be computed. The main problem with our current system is that we have trouble assigning prices to externalities and then enforcing the charges (my wife does ecological accounting research and has actually seen this problem for refinery operations; the only mechanism that anybody has come up with to date is a punitive fine for failure to comply with the rules). An energy-based cost and an Ecos accounting system -- where we assign accounts to natural ecological services and companies and people are charged for using those services -- might be workable. Instead of a fine, companies would simply pay the Ecos for its service. Perhaps a UN or UN + nations transaction management system would fit the bill. It will take some research and details worked out.

As for #2. I agree. My thoughts here are for how we reorganize civilization after a crash of the current system makes it completely clear that we need a better way to organize and control work.

George

[Neven]

"It would allow market regulatory mechanisms to assure no excess profits are charged."

Thanks for another insight!

[Sudeep Bhaumick]

as always i agree wholeheartedly...

but the thing that struck mi was that there is a sense of calm in this post of yours...

i don't honestly know how much longer we have. i wish for some more time. it would be great to hear your thoughts on how things could be managed better. keep posting.

i would just like to thank you any ways and best of luck...

[George Mobus]

Sudeep,

To be honest, I am not thinking so much about salvation as salvage -- what do we do to reorganize society after the crash and purge of failed ideas (and ideology). My version of hope is that someday there will be a small population of wiser humans that begin to reorganize and learn from our mistakes. I'm just trying to envision what a more sapient set of principles might entail.

If I seem calm, it is because I have essentially accepted the inevitability of nature's way and that evolution is the only real solution to long time scale problems.

As sung by the rock group Kansas: "All we are is dust in the wind."

This attitude need not devolve into existential angst (what is the purpose of life????) It is actually a more holistic view of progress than, say, current concepts of economics!

George

[sanket shrotriya]

what is the meaning of 'wheel of wealth' in an economy?
please give me perfect answer or perfect reference as soon as possible

[George Mobus]

Sanket,

I am afraid I do not know this term. Nor, I'm afraid, are any answers I might give going to be 'perfect'. Sorry.

George

[Nici30mW]

[Edit Note: I have removed this comment. It did not have relevance to the topic and appeared to be a spam advertisement. GM]

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