How Relocalization Worked

One of the points that I’ve tried to make repeatedly in these essays is the place of history as a guide to what works. It’s a point that deserves repetition. A good many worldsaving plans now in circulation, however new the rhetoric that surrounds them, simply rehash proposals that were tried in the past and failed repeatedly; trying them yet again may thus not be the best use of our limited resources and time.

Of course there’s another side to history that’s more hopeful: something that worked well in the past can be a useful guide to what might work well in the future. I’d like to spend a little time discussing one example of this, partly because it ties into the theme of the current series of posts – the abject failure of current economic notions, and the options for replacing them with ideas that actually make sense – and partly because it addresses one of the more popular topics in the ongoing peak oil discussion, the need for economic relocalization as the age of cheap abundant energy comes to an end.

That relocalization needs to happen, and will happen, is clear. Among other things, it’s clear from history; when complex societies overshoot their resource bases and decline, one of the things that consistently happens is that centralized economic arrangements fall apart, long distance trade declines sharply, and the vast majority of what we now call consumer goods get made at home, or very close to home. Now of course that violates some of the conventional wisdom that governs economic decisions these days; centralized economic arrangements are thought to yield economies of scale that make them more profitable by definition than decentralized local arrangements.

When history conflicts with theory, though, it’s not history that’s wrong, so a second look at the conventional wisdom is in order. The economies of scale and resulting profits of centralized economic arrangements don’t happen by themselves. They depend, among other things, on transportation infrastructure. This doesn’t happen by itself, either; it happens because governments pay for it, for purposes of their own. The Roman roads that made the tightly integrated Roman economy possible, for example, and the interstate highway system that does the same thing for America, were not produced by entrepreneurs; they were created by central governments for military purposes. (The legislation that launched the interstate system in the US, for example, was pushed by the Department of Defense, which wrestled with transportation bottlenecks all through the Second World War.)

Government programs of this kind subsidize economic centralization. The same thing is true of other requirements for centralization – for example, the maintenance of public order, so that shipments of consumer goods can get from one side of the country to the other without being looted. Governments don’t establish police forces and defend their borders for the purpose of allowing businesses to ship goods safely over long distances, but businesses profit mightily from these indirect subsidies nonetheless.

When civilizations come unglued, in turn, all these indirect subsidies for economic centralization go away. Roads are no longer maintained, harbors silt up, bandits infest the countryside, migrant nations invade and carve out chunks of territory for their own, and so on. Centralization stops being profitable, because the indirect subsidies that make it profitable aren’t there any more.

Ugo Bardi has written a very readable summary of how this process unfolded in one of the best documented cases, the fall of the Roman Empire. The end of Rome was a process of radical relocalization, and the result was the Middle Ages. The Roman Empire handled defense by putting huge linear fortifications along its frontiers; the Middle Ages replaced this with fortifications around every city and baronial hall. The Roman Empire was a political unity where decisions affecting every person within its borders were made by bureaucrats in Rome. Medieval Europe was the antithesis of this, a patchwork of independent feudal kingdoms the size of a Roman province, which were internally divided into self-governing fiefs, those into still smaller fiefs, and so on, to the point that a single village with a fortified manor house could be an autonomous political unit with its own laws and the recognized right to wage war on its neighbors.

The same process of radical decentralization affected the economy as well. The Roman economy was just as centralized as the Roman polity; in major industries such as pottery, mass production at huge regional factories was the order of the day, and the products were shipped out via sea and land for anything up to a thousand miles to the end user. That came to a screeching halt when the roads weren’t repaired any more, the Mediterranean became pirate heaven, and too many of the end users were getting dispossessed, and often dismembered as well, by invading Visigoths. The economic system that evolved to fill the void left by Rome’s implosion was thus every bit as relocalized as a feudal barony, and for exactly the same reasons.

Here’s how it worked. Each city – and “city” in this context means anything down to a town of a few thousand people – was an independent economic center; it might have a few industries of more than local fame, but most of its business consisted of manufacturing and selling things to its own citizens and the surrounding countryside. The manufacturing and selling was managed by guilds, which were cooperatives of master craftsmen. To get into a guild-run profession, you had to serve an apprenticeship, usually seven years, during which you got room and board in exchange for learning the craft and working for your master; you then became a journeyman, and worked for a master for wages, until you could produce your masterpiece – yes, that’s where the word came from – which was an example of craftwork fine enough to convince the other masters to accept you as an equal. Then you became a master, with voting rights in the guild.

The guild had the legal responsibility under feudal municipal laws to establish minimum standards for the quality of goods, to regulate working hours and conditions, and to control prices. The economic theory of the time held that there was a “just price” for any good or service, usually the price that had been customary in the region since time out of mind, and the municipal authorities could be counted on to crack down on attempts to push prices above the just price unless there was some very pressing reason for it. Most forms of competition between masters were off limits; if you made your apprentices and journeymen work evenings and weekends to outproduce your competitors, for example, or sold goods below the just price, you’d get in trouble with the guild, and could be barred from doing business in the town. The only form of competition that was encouraged was to make and sell a superior product.

This was the secret weapon of the guild economy, and it helped drive an age of technical innovation. As Jean Gimpel showed conclusively in The Medieval Machine, the stereotype of the Middle Ages as a period of technological stagnation is completely off the mark. Medieval craftsmen invented the clock, the cannon, and the movable-type printing press, perfected the magnetic compass and the water wheel, and made massive improvements in everything from shipbuilding and steelmaking to architecture and windmills, just for starters. The competition between masters and guilds for market share in a legal setting that made quality and innovation the only fields of combat wasn’t the only force behind these transformations, to be sure – the medieval monastic system, which put a good fraction of intellectuals of both genders in settings where they could use their leisure for just about any purpose that could be chalked up to the greater glory of God, was also a potent factor – but it certainly played a massive role.

The guild system has nonetheless been a whipping boy for mainstream economists for a long time now. The person who started that fashion was none other than Adam Smith, whose The Wealth of Nations castigates the guilds of his time for what we’d now call antitrust violations. From within his own perspective, Smith had a point. The guilds were structured in a way that limited the total number of people who could work in any given business in any given town, and of course the just price principle kept prices from fluctuating along with supply and demand. Thus the prices paid for the goods or services produced by that business were higher, all things considered, than they would have been under the free market regime Smith advocated.

The problem with Smith’s analysis is that there are crucial issues involved that he didn’t address. He lived at a time when transportation was rapidly expanding, public order was more or less guaranteed, and the conditions for economic centralization were coming back into play. Thus the very different realities of limited, localized markets did not enter into his calculations. In the context of localized economics, a laissez-faire free market approach doesn’t produce improved access to better and cheaper goods and services, as Smith argued it should; instead, it makes it impossible to produce many kinds of goods and services at all.

Let’s take a specific example for the sake of clarity. A master blacksmith in a medieval town of 5000 people, say, was in no position to specialize in only one kind of ironwork. He might be better at fancy ironmongery than anyone else in town, for example, but most of the business that kept his shop open, his apprentices fed and clothed, and his journeymen paid was humbler stuff: nails, hinges, buckles, and the like. Most of this could be done by people with much less skill than our blacksmith; that’s why he had his apprentices make nails while he sat upstairs at the table with the local abbot and discussed the ironwork for a dizzyingly complex new cutting-edge technology, just introduced from overseas, called a clock.

The fact that most of his business could be done by relatively unskilled labor, though, left our blacksmith vulnerable to competition. His shop, with its specialized tools and its staff of apprentices and journeymen, was expensive to maintain. If somebody else who could only make nails, hinges, and buckles could open a smithy next door, and offer goods at a lower price, our blacksmith could be driven out of business, since the specialized work that only he could do wouldn’t be enough to pay his bills. The cut-rate blacksmith then becomes the only game in town – at least, until someone who limited his work to even cheaper products made at even lower costs cut into his profits. The resulting race to the bottom, in a small enough market, might end with nobody able to make a living as a blacksmith at all.

Thus in a restricted market where specialization is limited, a free market in which prices are set by supply and demand, and there are no barriers to entry, can make it impossible for many useful specialties to be economically viable at all. This is the problem that the guild system evolved to counter. By restricting the number of people who could enter any given trade, the guilds made sure that the income earned by master craftsmen was high enough to allow them to produce specialty products that were not needed in large enough quantities to provide a full time income. Since most of the money earned by a master craftsman was spent in the town and surrounding region – our blacksmith and his family would have needed bread from the baker, groceries from the grocer, meat from the butcher, and so on – the higher prices evened out; since nearly everyone in town was charging guild prices and earning guild incomes, no one was unfairly penalized.

Now of course the guild system did finally break down; by Adam Smith’s time, the economic conditions that made it the best option were a matter of distant memory, and other arrangements were arguably better suited to the new reality of easy transport and renewed economies of scale. Still, it’s interesting that in recent years, the same race to the bottom in which quality goods become unavailable and local communities suffer has taken place in nearly the same way in most of small-town America.

A torrent of cheap shoddy goods funneled through Wal-Mart and its ilk, in a close parallel to the cheap blacksmiths of the example, have driven local businesses out of existence and made the superior products and services once provided by those businesses effectively unavailable to a great many Americans. In theory, this produces a business environment that is more efficient and innovative; in practice, the efficiencies are by no means clear and the innovation seems mostly to involve the creation of ever more exotic and unstable financial instruments: not necessarily the sort of thing that our society is better off encouraging.

Advocates of relocalization in the age of peak oil may thus find it useful to keep the medieval example and its modern equivalent in mind while planning for the economics of the future. Relocalized communities must be economically viable or they will soon cease to exist, and while viable local communities will be possible in the future – just as they were in the Middle Ages – the steps that will be necessary to make them viable may require some serious rethinking of the habits that now shape our economic lives.

A Gesture from the Invisible Hand

It’s been a long road, but we’ve finally reached the point in these essays at which it’s possible to start talking about some of the consequences of the primary economic fact of our time, the arrival of geological limits to increasing fossil fuel production. That’s as challenging a topic to discuss as it will be to live through, because it cannot be understood effectively from within the presuppositions that structure most of today’s economic thinking.

It’s common, for example, to hear well-intentioned people insist that the market, as a matter of course, will respond to restricted fossil fuel production by channeling investment funds either in more effective means of producing fossil fuels, on the one hand, or new energy sources on the other. The logic seems impeccable at first glance: as the price of oil, for example, goes up, the profit to be made by bringing more oil or oil substitutes onto the market goes up as well; investors eager to maximize their profits will therefore pour money into ventures producing oil and oil substitutes, and production will rise accordingly until the price comes back down.

That’s the logic of the invisible hand, first made famous by Adam Smith in The Wealth of Nations more than two centuries ago, and still central to most mainstream ideas of market economics. That logic owes much of its influence to the fact that in many cases, markets do in fact behave this way. Like any rule governing complex systems, though, it is far from foolproof, and it needs to be balanced by an awareness of the places where it fails to work.

Energy is one of those places: in some ways, the most important of all. Energy is not simply one commodity among others; it is the ur-commodity, the foundation for all economic activity. It follows laws of its own – the laws of thermodynamics, notably – which are not the same as the laws of economics, and when the two sets of laws come into conflict, the laws of thermodynamics win every time.

Consider an agrarian civilization that runs on sunlight, as every human society did until the rise of industrialism some three centuries ago. In energetic terms, part of the annual influx of solar energy is collected via agriculture, stored in the form of grain, and transformed into mechanical energy by feeding the grain to human laborers and draft animals. It's an efficient and resilient system, and under suitable conditions it can deploy astonishing amounts of energy; the Great Pyramid is one of the more obvious pieces of evidence for this fact.

Such civilizations normally develop thriving market economies in which a wide range of goods and services are exchanged. They also normally develop intricate social abstractions that manage the distribution of these goods and services, as well as the primary wealth that comes through agriculture from the sun, among their citizens. Both these, however, depend on the continued energy flow from sun to fields to granaries to human and animal labor forces. If something interrupts this flow -- say, a failure of the harvest -- the only option that allows for collective survival is to have enough solar energy stored in the granaries to take up the slack.

This is necessary because energy doesn't follow the ordinary rules of economic exchange. Most other commodities still exist after they've been exchanged for something else, and this makes exchanges reversible; for example, if you sell gold to buy marble, you can normally turn around and sell marble to buy gold. The invisible hand works here; if marble is in short supply, those who have gold and want marble may have to offer more gold for their choice of building materials, but the marble quarries will be working overtime to balance things out.

Energy is different. Once you turn the energy content of a few million bushels of grain into a pyramid, say, by using the grain to feed workers who cut and haul the stones, that energy is gone, and you cannot turn the pyramid back into grain; all you can do is wait until the next harvest. If that harvest fails, and the stored energy in the granaries has already been turned into pyramids, neither the market economy of goods and services or the abstract system of distributing goods and services can make up for it. Nor, of course, can you send an extra ten thousand workers into the fields if you don't have the grain to keep them alive.

The peoples of agrarian civilizations generally understood this. It's part of the tragedy of the modern world that most people nowadays do not, even though our situation is not all that different from theirs. We're just as dependent on energy inputs from nature, though ours include vast quantities of prehistoric sunlight, in the form of fossil fuels, as well as current solar energy in various forms; we've built atop that foundation our own kind of markets to exchange goods and services; and our abstract system for managing the distribution of goods and services -- money -- is as heavily wrapped in mythology as anything in the archaic civilizations of the past.

The particular form taken by money in the modern world has certain effects, however, not found in ancient systems. In the old agrarian civilizations, wealth consisted primarily of farmland and its products. The amount of farmland in a kingdom might increase slightly through warfare or investment in canal systems, though it might equally decrease if a war went badly or canals got wrecked by sandstorms; everybody hoped when the seed grain went into the fields that the result would be a bumper crop, but no one imagined that the grain stockpiled in the granaries would somehow multiply itself over time. Nowadays, by contrast, it's assumed as a matter of course that money ought automatically to produce more money.

That habit of thought has its roots in the three centuries of explosive economic growth that followed the birth of the industrial age. In an expanding economy, the amount of money in circulation needs to expand fast enough to roughly match the expansion in the range of goods and services for sale; when this fails to occur, the shortfall drives up interest rates (the cost of using money) and can cause economic contractions. This was a serious and recurring problem in the late 19th century, and led the reformers of the Progressive era to reshape industrial economies in ways that permitted the money supply to expand over time to match the expectation of growth. Once again, the invisible hand was at work, with some help from legislators: a demand for more money eventually give rise to a system that produced more money.

It's been pointed out by a number of commentators in the peak oil blogosphere that the most popular method for expanding the money supply -- the transformation of borrowing at interest from an occasional bad habit of the imprudent to the foundation of modern economic life -- has outlived its usefulness once an expanding economy driven by increasing fossil fuel production gives way to a contracting economy limited by decreasing fossil fuel production. This is quite true in an abstract sense, but there's a trap in the way of putting that sensible realization into practice.

The arrival of geological limits to increasing fossil fuel production places a burden on the economy, because the cost in energy, labor, and materials (rather than money) to extract fossil fuels does not depend on market forces. On average, it goes up over time, as easily accessible reserves are depleted and have to be replaced by those more difficult and costly to extract. Improved efficiencies and new technologies can counter that to a limited extent, but both these face the familiar problem of diminishing returns as the laws of thermodynamics, and other physical laws, come into play.

As a society nears the geological limits to production, in other words, a steadily growing fraction of its total supply of energy, resources, and labor have to be devoted to the task of bringing in the energy that keeps the entire economy moving. This percentage may be small at first, but it's effectively a tax in kind on every productive economic activity, and as it grows it makes productive economic activity less profitable. The process by which money produces more money consumes next to no energy, by contrast, and so financial investments don't lose ground due to rising energy costs.

This makes financial investments, on average, relatively more profitable than investing in the kinds of economic activity that use energy to produce nonfinancial goods and services. The higher the burden imposed by energy costs, the more sweeping the disparity becomes; the result, of course, is that individuals trying to maximize their own economic gains move their money out of investments in the productive economy of goods and services, and into the paper economy of finance.

Ironically, this happens just as a perpetually expanding money supply driven by mass borrowing at interest has become an anachronism unsuited to the new economic reality of energy contraction. It also guarantees that any attempt to limit the financial sphere of the economy will face mass opposition, not only from financiers, but from millions of ordinary citizens whose dream of a comfortable retirement depends on the hope that financial investments will outperform the faltering economy of goods and services. Meanwhile, just as the economy most needs massive reinvestment in productive capacity to retool itself for the very different world defined by contracting energy supplies, investment money seeking higher returns flees the productive economy for the realm of abstract paper wealth.

Nor will this effect be countered, as suggested by the well-intentioned people mentioned toward the beginning of this essay, by a flood of investment money going into energy production and bringing the cost of energy back down. Producing energy takes energy, and thus is just as subject to rising energy costs as any other productive activity; even as the price of oil goes up, the costs of extracting it or making some substitute for it rise in tandem and make investments in oil production or replacement no more lucrative than any other part of the productive economy. Oil that has already been extracted from the ground may be a good investment, and financial paper speculating on the future price of oil will likely be an excellent one, but neither of these help increase the supply of oil, or any oil substitute, flowing into the economy.

One intriguing detail of this scenario is that it has already affected the first major oil producer to reach peak oil -- yes, that would be the United States. It's unlikely to be accidental that in the wake of its own 1972 production peak, the American economy has followed exactly this trajectory of massive disinvestment in the productive economy and massive expansion of the paper economy of finance. Plenty of other factors played a role in that process, no doubt, but I suspect that the unsteady but inexorable rise in energy costs over the last forty years or so may have had much more to do with the gutting of the American economy than most people suspect.

If this is correct, now that petroleum production has encountered the same limits globally that put it into a decline here in the United States, the same pattern of disinvestment in the production of goods and services coupled with metastatic expansion of the financial sector may show up on a much broader scale. There are limits to how far it can go, of course, not least because financiers and retirees alike are fond of consumer goods now and then, but those limits have not been reached yet, not by a long shot. It's all too easy to foresee a future in which industry, agriculture, and every other sector of the economy that produces goods and services suffer from chronic underinvestment, energy costs continue rising, and collapsing infrastructure becomes a dominant factor in daily life, while the Wall Street Journal (printed in Shanghai by then) announces the emergence of the first half dozen quadrillionaires in the derivatives-of-derivatives-of-derivatives market.

Perhaps the most important limit in the way of such a rush toward economic absurdity is the simple fact that not every economy uses the individual decisions of investors pursuing private gain to allocate investment capital. It may not be accidental that quite a few of the world's most successful economies just now, with China well in the lead, make their investment decisions based at least in part on political, military, and strategic grounds, while the nation that preens itself most proudly on its market economy -- yes, that would be the United States again -- is lurching from one economic debacle to another.

It is unfortunately also the case that many of the nations that have extracted their investment decisions from the hands of a self-terminating market system are not exactly noted for their delicate care for human rights. If that proves to be the wave of the future -- and it may be worth noting that Oswald Spengler, among others, predicted that outcome -- then the invisible hand may end up giving us all the finger.

Harnessing Hippogriffs

One of the more interesting aspects of writing these essays is that I can never predict in advance what will get me a flurry of outraged responses each week. It’s a fair bet that something always does; the collective conversation of the modern industrial world has become so overheated in the last decade or so that it’s difficult to say much of anything without getting somebody in a swivet; still, what it is that sets off the swiveteers routinely catches me by surprise.

Last week was no exception. Of all the things in that essay that might plausibly have launched the usual cries of outrage, the one that did so was an offhand reference to the free market fundamentalists of the Austrian school, many of whom insist that the proper solution to every economic problem is to let the market have its way. As it happens, in making that comment I was thinking specifically of Michael Shedlock aka Mish, whose blog is one of the handful I read daily.

Mish is among the most thoughtful and articulate proponents of the Austrian school in today's blogosphere, and he has an excellent eye for the economic news that matters – which is by and large exactly the economic news that the rest of the media avoids covering. Very nearly the only thing on his blog that makes me roll my eyes is his repeated insistence that the market is always right and government regulation is always wrong; no matter how berserk the market gets, its vagaries are for the best, and any problems should be corrected by privatizing even more government functions. Now of course Mish is hardly an official spokesperson for the Austrian school, as if there were such a thing, but he's not exactly alone in his insistence, either.

Enough people in the peak oil scene share similar views that it's probably necessary to say something about the free market and its potential for solving or creating problems during the twilight years of industrialism ahead of us. Any such comments need to be prefaced, though, by a reminder that a spectrum consists of something other than its two endpoints. Just as a great many people on the left have picked up the dubious habit of using labels such as "fascism" for any political system to the right of Hillary Clinton, a great many people on the right seem to have convinced themselves that any form of economic regulation at all is tantamount to some sort of neo-Marxist hobgoblin – a "socialist-communist-ecologist" system, to use a phrase that actually appeared in one of the comments fielded by last week's post.

Now it bears remembering that drowning is not the only alternative to dying of dehydration; there's a middle ground that is noticeably more pleasant than either. The same principle also applies in economics. The experiment of having government own all the means of production in an industrial society, along the lines proposed by Marx, received a thorough test at the hands of the Communist bloc and failed abjectly. At the same time, the experiment of having government keep its hands off the economy altogether in an industrial society, along the lines proposed by a great many free-market proponents these days, received an equally thorough test, and failed just as dismally. The test took place a little earlier; in America, it ran from the end of the Civil War into the first decade of the twentieth century, and the result was a catastrophic sequence of booms and busts, the transfer of most of the nation's wealth to a tiny minority of wealthy people, the bitter impoverishment of nearly everyone else, and a level of social unrest that included two presidential assassinations and so many bomb attacks on the rich and their families that bomb-throwing anarchists became a regular theme of music-hall songs.

Now it's always possible for theorists to contrast a Utopian portrait of a free-market economy against the gritty and unwelcome realities of extreme socialism, just as it's possible for people on the other side of the spectrum to contrast a Utopian portrait of a socialist economy against the equally gritty and unwelcome realities of unfettered capitalism. Both make great rhetorical strategies, since the human mind is easily misled by binary logic: if A is evil, it seems wholly reasonable to claim that the opposite of A must be good. The real world does not work that way, but this is hardly the only case in which rhetoric ignores reality.

The problem with the rhetoric, however, may be stated a bit more precisely: however pleasant they look on paper, free markets do not exist. Strictly speaking, they are as mythical as hippogriffs.

It occurs to me that some of my readers may not be as familiar with hippogriffs as they ought to be. (Tut, tut – what do they teach children these days?) For those who lack so basic an element in their education, a hippogriff is the offspring of a gryphon and a mare; it has the head, body, hind legs, and tail of a horse, and the forelimbs and wings of a giant eagle. Hippogriffs are said to be the strongest and swiftest of all flying creatures, which is why Astolpho rode one to the terrestrial paradise to recover Orlando's lost wits in Orlando Furioso, and why Juss rode one to the summit of Koshtra Pivrarcha to rescue Goldry Bluszco in The Worm Ouroboros. They are splendid creatures, no question; their only disadvantage, really, is the minor point that they don't happen to exist, and drawing up plans to use them as a new, energy-efficient means of air transport in the face of peak oil, for instance, will inevitably come to grief on that annoying little detail.

Free markets are subject to essentially the same little problem. There have been many examples of market economies in history that were not controlled by governments, but there have been no examples of market economies that were not controlled, and if one were to be set up, it would remain a free market for maybe a week at most. Adam Smith explained why in memorable language in The Wealth of Nations: "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or some contrivance to raise prices." When a market is not controlled by government edicts, religious taboos, social customs, or some other outside force, it will quickly be controlled by combinations of individuals whose wealth and strategic position in the market enable them to maximize the economic benefits accruing to them, by squeezing out rivals, manipulating prices, buying up their suppliers, bribing government officials, and the like: that is to say, behaving the way capitalists behave whenever they are left to their own devices. This is what created the profoundly dysfunctional economy of Gilded Age America, and it also played a very large role in setting up the current debacle.

There's a rich irony here, in that the market economy portrayed in textbooks – in which buyers and sellers are numerous and independent enough that free competition regulates their interactions – is exactly the sort of commons that so many free market proponents insist should be eliminated wholesale in favor of private ownership. All commons systems, as Garrett Hardin pointed out in a famous essay a while back, are hideously vulnerable to abuse unless they are managed in ways that prevent individuals from exploiting the commons for their own private benefit. This year's Nobel laureate in economics, Elinor Ostrom, won her award for demonstrating that it's entirely possible to manage a commons so that Hardin's "tragedy of the commons" does not happen, and she's quite right – there have been many examples of successfully managed commons in history. Strip away the management that keeps it from being abused, however, and the free market, like any other commons, rapidly destroys itself.

This does not mean that the best, or for that matter the only, alternative to the unchecked rule of corporate robber barons is Marxist-style state ownership of the economy; once again, dying from heatstroke is not the only alternative to dying from hypothermia. It means, rather, that something between these two extremes might be worth trying, especially if it can be shown by historical evidence to work tolerably well in practice. Of course this is what history shows; broadly speaking, economies that leave the means of production in private hands, but use appropriate regulation to harness their energies to the public good, consistently produce more prosperity for more people than either unfettered capitalism or extreme socialism.

This being said, the midpoint between these extremes may not lie where today's conventional wisdom tends to place it. Consider an example from the not too distant past: a large industrial nation with a capitalist economy, but remarkably tough regulations restricting the growth of private fortunes and the abuses to which capitalist economies are so often prone. The wealthiest people in that nation paid more than two-thirds of their annual income in tax, and monopolistic practices on the part of corporations faced harsh and frequently applied judicial penalties. The financial sector was particularly tightly leashed: interest rates on savings were fixed by the government, usury laws put very low caps on the upper end of interest rates for loans, and hard legal barriers prevented banks from expanding out of local markets or crossing the firewall between consumer banking and the riskier world of corporate investment. Consumer credit was difficult enough to get, as a result, that most people did without it most of the time, using layaway plans and Christmas Club savings programs to afford large purchases.

According to the standard rhetoric of free market proponents these days, so rigidly controlled an economy ought by definition to be hopelessly stagnant and unproductive. This shows the separation of rhetoric from reality, however, for the nation I have just described was the United States during the presidency of Dwight D. Eisenhower: that is, during one of the most sustained periods of prosperity, innovation, economic development and international influence this nation has ever seen. Now of course there were other factors behind America's 1950s success, just as there were other factors behind the decline since then; still, it's worth noting that as the economic regulations of the 1950s have been dismantled – in every case, under the pretext of boosting American prosperity – the prosperity of most Americans has gone down, not up.

It makes a good measure of how far we have come as a nation – and not in a useful direction – that the economic policies of one of the most successful 20th century Republican administrations would be rejected by most of today's Democrats as too far to the left. A case could be made, in fact, that far and away the most sensible thing the US Congress could do today, in the face of an economy that has very nearly choked to death on its own bubbles, is to reenact the economic legislation in place in the 1950s, line for line. (When you're hiking in the woods, and discover that you've taken a trail that leads someplace you don't want to go, your best bet is normally to turn around and go back to the last place where you were still going in the right direction.)

Yet there's an interesting point that also ought to be made about the economic regulation of the 1950s. Outside of antitrust legislation, not that much of it applied to the economy of goods and services on any level, whether that of Mom and Pop grocery stores or big industrial conglomerates. The bulk of it, and very nearly all the strictest elements of it, focused on the financial industry. More broadly speaking, instead of regulating the production and consumption of goods and services, the economic policies of the Eisenhower era focused on regulating money: on ensuring that too much of it did not end up concentrated unproductively in too few hands, and on controlling its propensity to multiply as enthusiastically as rabbits on Viagra. The relative success of these measures points toward a distinction already made in these posts, and to practical steps that will be explored in next week's post.

Why Markets Fail

It’s a safe bet that any public comment on the politics of peak oil, unless it sticks closely to one of a very few widely accepted opinions, will provide a good demonstration of the laws of thermodynamics by turning plenty of energy into waste heat. Last week’s Archdruid Report post was no exception. Between those who thought I was too hard on Cuba, those who thought I was too soft on Cuba, those who insisted America is already a fascist dictatorship, those who thought America would be better off as a fascist dictatorship, and a variety of less classifiable rants, I was well and truly denounced. My favorite for the week was a bit of online splutter that, having exhausted its author’s apparently limited vocabulary of profanity, wound up with the nastiest term he knew: “...you American!”

Those of my readers with a taste for wry humor may well have found all this as entertaining as I did. Still, this week’s essay will leave such amusements behind, and return to the theme I’ve been developing in recent posts, the reinvention of economics that will be necessary in an age of hard ecological limits and deindustrial decline. Vegetarians and animal rights activists take note: a certain number of sacred cows will have to be slaughtered and dissected in the course of that inquiry, and the process is unlikely to be either painless or clean.

Of the sanctified cattle facing a gruesome fate in the years ahead of us, perhaps the most important is that blue-ribbon heifer of modern economics, the belief in the infallibility of free markets. Back in 1776, Adam Smith’s The Wealth of Nations popularized the idea that free market exchanges offered a more efficient way of managing economic activity than custom or government regulation. The popularity of his arguments has waxed and waned over the years; it may come as no surprise that periods of general prosperity have seen the market’s alleged wisdom proclaimed to the skies, while periods of contraction have had the reverse effect.

The economic orthodoxy that has been welded in place in the western world since the 1950s, neoclassical economics, made a nuanced version of Smith’s theory central to its theories, arguing that aside from certain exceptions much discussed in the technical literature, people making rational decisions to maximize benefits to themselves will simultaneously maximize the benefits to everyone. The neoclassical synthesis has its virtues; you won’t find neoclassical economists claiming, as the free market fundamentalists of the Austrian school so often do, that the market is always right, even when its vagaries cause catastrophic human suffering. The concept of market failure is part of the neoclassical vocabulary, and some useful work has been done under the neoclassical umbrella to explain how it is that markets can fail to respond to crucial human needs, as they routinely do.

Still, the great problem with neoclassical economics is the one has already been discussed in these posts: its models have consistently failed to foresee devastating economic disasters that many people outside the economics profession could readily and accurately predict years in advance. The implosion of the world economy in 2008 is only the most recent case in point. One writer who surveyed the economics field in the aftermath of the crash noted with some asperity that fewer than two dozen economists anywhere in the world warned in advance of the gargantuan bubble of securitized debt that exploded that year.

On the contrary, economists by the score lined up during the bubble years to insist that the giddy financial innovations of the previous decade had banished risk from the market and prosperity was assured into the foreseeable future. They were of course quite wrong, and their failure to see disaster as it loomed up in front of them compares very poorly with the large number of people who used historical parallels to recognize what was happening and make uncomfortably precise forecasts of the results. (Keith Brand, who ran the lively HousingPanic blog straight through the bubble, memorably summarized those predictions: “Dear God, this is going to end so badly.”)

I have discussed in several earlier posts some of the reasons why the entire economics profession has been so prone to miss the obvious in such cases. Here, though, I want to focus on a reason for failure that’s specific to neoclassical economics. Since most of the economists who provide advice to governments come out of the neoclassical mainstream, this is hardly irrelevant to our prospects for the future, especially – as I intend to show – because the same blind spot that left so many pundits dining on a banquet of crow in recent months applies with even greater force to the crucial fact of our time, the arrival of peak oil.

The point I want to make here is a little different from the most common critique of neoclassical economics, though there is a connection. Many social critics have commented on the ease with which the neoclassical synthesis consistently ignores the interface between economic wealth and power. Even when people rationally seek to maximize benefits to themselves, after all, their options for doing so are very often tightly constrained by economic systems that have been manipulated to maximize the benefits going to someone else.

This is a pervasive problem in most human societies, and it’s worth noting that those societies that survive over the long term tend to be the ones that work out ways to keep too much wealth from piling up uselessly in the hands of those with more power than others. This is why hunter-gatherers have customary rules for sharing out the meat from a large kill, why chieftains in so many tribal societies maintain their positions of influence by lavish generosity, and why those nations that got through the last Great Depression intact did so by imposing sensible checks and balances on concentrated wealth – though most of those checks and balances in the United States were scrapped several decades ago, with utterly predictable results.

By neglecting and even arguing against these necessary redistributive processes, neoclassical economics has helped feed economic disparities, and these in turn have played a major role in driving cycles of boom and bust. It’s no accident that the most devastating speculative bubbles happen in places and times when the distribution of wealth is unusually lopsided, as it was in America, for example, in the 1920s and the period from 1990 to 2008. The connection here is simple: when wealth is widely distributed, more of it circulates in the productive economy of wages and consumer purchases; when wealth is concentrated in the hands of a few, more of it moves into the investment economy where the well-to-do keep their wealth, and a buildup of capital in the investment economy is one of the necessary preconditions for a speculative binge.

More broadly, concentrations of wealth can be cashed in for political influence, and political influence can be used to limit the economic choices available to others. Individuals can and do rationally choose to maximize the benefits available to them by exercising influence in this way, but the results can impose destructive inefficiencies on the whole economy. In effect, political manipulation of the economy by the rich for private gain does an end run around normal economic processes by way of the world of politics; what starts in the economic sphere, as a concentration of wealth, and ends there, as a distortion of the economic opportunities available to others, ducks through the political sphere in between.

A similar end run drives speculative bubbles, although here the noneconomic sphere involved is that of crowd psychology rather than politics. Very often, the choices made by participants in a bubble are not rational decisions that weigh costs against benefits; it’s not accidental that the first, and still one of the best, analyses of speculative binges and panics is titled Extraordinary Popular Delusions and the Madness of Crowds. Here again, a speculative bubble starts in the economic sphere, as a buildup of excessive wealth in the hands of investors, which drives the price of some favored class of assets out of its normal relationship with the rest of the economy, and it ends in the economic sphere, with the crater left by the assets in question as their price plunges roughly as far below the mean as it rose above it, dragging the rest of the economy with it. It’s the middle of the trajectory that passes through a particular form of crowd psychology, and since this is outside the economic sphere, neoclassical economics can’t deal with it.

This would be no problem if neoclassical economists by and large recognized these limitations. Unfortunately a great many of them do not, and the result is the classic type of myopia in which theory trumps reality. Since neoclassical theory claims that economic decisions are made by individuals acting freely and rationally to maximize the benefits accruing to them, it’s seemingly all too easy for economists to believe that any economic decision, no matter how harshly constrained by political power or wildly distorted by the delusional psychology of a bubble in full roar, must be a free and rational decision that will allow individuals to maximize their own benefits and benefit society as a whole.

Now of course, as mentioned in an earlier post, those who practice this sort of purblind thinking often find it very lucrative to do so. Economists who urged more free trade on the Third World at a time when “free trade” distorted by inequalities of power between nations was beggaring the Third World, like economists who urged people to buy houses at a time when houses were preposterously overpriced and facing an imminent price collapse, not uncommonly prospered by giving such appallingly bad advice. Still, it seems unreasonable to claim that all economists are motivated by greed, when the potent force of a fundamentally flawed economic paradigm also pushes them in the same direction.

That same pressure, with the same financial incentives to back it up, also drives the equally bad advice so many neoclassical economists are offering governments and businesses about the future of fossil fuels. The geological and thermodynamic limits to energy growth, like political power and the mob psychology of bubbles, lie outside the economic sphere. The interaction of economic processes with energy resources creates another end run: extraction of fossil fuels to run the world’s economies, an economic process, drives the depletion of oil and other fossil fuel reserves, a noneconomic process, and this promises to flow back into the economic sphere in the extended downward spiral of contraction and impoverishment I’ve called the Long Descent.

Here again, neoclassical economics is poorly equipped to deal with the reality of noneconomic constraints on economic processes. It thus comes as no surprise that when an economist enters the peak oil debate, it is almost always to claim that there is nothing to worry about, because the market will solve any shortfall that happens to emerge. As shortfalls emerge, expect to hear the claim – already floated by a few economists – that declining production is simply a sign that the demand for fossil fuel energy has decreased. No doubt when people are starving in the streets, we will hear claims that this is simply because the demand for food has dropped.

There are promising signs that the grip of neoclassical theory on modern economics is beginning to weaken. A recent conference on biophysical economics – a field which embraces the heretical concept that the laws of nature trump the laws of money – attracted many attendees and, in a shift of nearly seismic proportions, managed to get coverage in the New York Times. Other alternative viewpoints in economics are beginning to be heard, as they usually are in times of financial woe. Still, what’s needed now is something even more sweeping: an economics of whole systems, perhaps modeled on ecology, in which the entire world of noneconomic factors that influence economic processes is explicitly included in theories and practical analyses. Until that emerges, the advice governments and businesses receive from their paid economists may well continue to make matters worse rather than better.

Strange Bright Banners

The transformation of money from a pragmatic measure of wealth to a metastatic abstraction that threatens to devour the economy of real wealth that created it – the theme of the last three posts here – has, as my readers have been quick to point out, political implications. The conventional wisdom these days ignores those implications; the consensus among alternative thinkers, which I suppose could be called the unconventional wisdom, deals with them in a stereotyped manner. I find it increasingly hard to accept either viewpoint.

The conventional wisdom, like most great fallacies, begins with a truth and stretches it until it becomes for all practical purposes a falsehood. The truth, one of the great achievements of the last three hundred years of thought, is the recognition that human life comprises a number of separate spheres that overlap solely in the life of the individual. Most of us have learned, for example, that when a religious leader makes statements concerning matters of scientific fact, those statements deserve no more (albeit no less) respect than those of any other interested layperson, and if the religious leader claims divine sanction for his opinions, he has overstepped the proper bounds of religion. (We are still in the process of learning that the reverse is also true, and a scientist who attempts to claim the prestige of science for an attack on religion is equally out of line.) Literature and the arts define another such sphere; so does politics; so does the realm of production and exchange of wealth summed up imperfectly in the word economics.

The separation of these spheres, important as it is, can never be total, because each human being participates in all of them and must balance their claims against one another. For this reason it’s entirely appropriate, say, for religious leaders to raise questions about the moral dimensions of the economy, or for a painter such as Picasso to deliver a devastating critique of a political act with his brush, and in the process create one of the great works of his career. In the same way, the political and economic spheres interpenetrate in significant ways, not least because money (the currency of economics) and power (the currency of politics) can often be traded in for one another. Thus it’s reasonable to discuss the ways that the distribution of wealth in a society intersects with its distribution of power.

This is what the conventional wisdom refuses to do. It’s acceptable nowadays to argue about whether government ought to regulate business, and in what minor ways; it’s very occasionally acceptable to talk about the corruption of government by business, though usually only when some egregious example of this standard practice is selected for pillorying in front of the public. It’s not acceptable anywhere in the American mainstream to talk about the extent to which the entire political process from top to bottom has been skewed by economic interests to the point of absurdity. The current “health care reform” farce is a case in point; most of the plans being discussed in Congress just now deal with the fact that half the American people can’t afford health insurance by forcing them to buy it anyway under penalty of law, funnelling tens of billions of dollars out of the pockets of struggling families – in the midst of a recession, no less – into the coffers of a health insurance industry that is already one of the most overfunded and corrupt institutions in American public life. (If this seems as wrongheaded to you as it does to me, dear reader, a letter to each of your congresspersons might be in order.)

It is to the credit of what I’ve called the unconventional wisdom, the consensus viewpoint of critics of the current system, that they recognize this overlap. What makes the unconventional wisdom problematic, here as elsewhere, is that so much of it redefines such overlaps in terms so extreme that a valid insight is once again falsified. It’s unquestionably true that business interests exert undue influence on the American political system, but this does not justify the wild claims so often made about the extent, centralization, and evil intentions of those interests and their influence.

Take the insistence, so often heard from radicals of the left and right alike, that America is a fascist state. If America were a fascist state, those on both sides of the political spectrum who currently exercise their freedom of speech to call it that would long since have been dragged from their beds in the middle of the night by uniformed thugs, never to be seen again – at least until their bones are pulled from a mass grave and identified by dental records decades from now. That is how things happen in a fascist state, and for today’s smug and pampered American radicals to wrap themselves in the mantle of victims of fascism, while relying on civil rights no fascist system grants its citizens, displays a profound disrespect for those who have actually suffered under totalitarian regimes.

To some extent this habit of flinging around extreme claims is simply the normal rhetorical extravagance of those who know they will not be held accountable for their words. Still, it is far from helpful to insist that because American democracy is troubled, corrupted by economic interests, and increasingly dysfunctional, it ought to be equated with the worst examples in our culture’s political demonology. It is even less helpful when this sort of thinking leads to the assumption that anything that replaces it must be better than the system we have now. That’s a common assumption in troubled times, but it’s also one to which history delivers a devastating reproof.

Imagine along these lines, dear reader, that sometime in the next year or so you start hearing media reports about a rising new figure in American politics. He’s young and charismatic, a military veteran who won the Distinguished Service Cross for bravery under fire, and heads a vigorous new third party that looks as though it might just be able to break the stranglehold of the established parties on the political system. Some of his ideas come straight from the fringes, and he’s been reported to have said very negative things about Arabs and Islam, but he’s nearly the only person in American public life willing to talk frankly about the difficulties Americans are facing in an era of economic collapse, and his party platform embodies many of the most innovative ideas of the left and right. Like him or not, he offers the one convincing alternative to business as usual in an increasingly troubled and corrupt system.

Would you vote for him? Millions of Germans did; replace the Distinguished Service Cross with the Iron Cross and Arabs with Jews, and the parallel should be self-explanatory. That parallel is anything but unique, for that matter; swap out a few details and you have the early careers of Mussolini, Salazar, Peron, or any number of other dictators of the same era. One of the problems with the continual use of fascism as a bogeyman by political extremists is that it becomes far too easy to forget how promising fascism looked in the 1920s and 1930s to many good people disgusted with the failings of their democratic governments. It’s not the “cornpone Hitler” James Howard Kunstler has predicted that we have to fear, much less the imaginary conspiracies that occupy so much space in today’s alternative discourse, but a suave, articulate, and charismatic figure who harnesses the widespread assumption that anything must be better than what we have today, and replaces a dysfunctional democracy with an all too functional tyranny.

Such a figure, it bears remembering, could as easily emerge from the left as from the right. One popular DVD that circulated widely in the peak oil scene a few years back was called The Power of Community, a documentary about how Cuba survived its own equivalent of peak oil when Soviet fuel subsidies stopped at the end of the Cold War. It’s a worthwhile case study of how a society can weather an extreme energy shortage, but it finessed one of the key points that enabled the Cuban response, namely, that Cuba is a dictatorship. To impose the draconian restrictions on energy use that got his country through its “Special Period,” Castro did not have to mobilize public opinion, placate powerful special interests, and shepherd legislation through a fractious Congress riven by ideological splits and determined to defend its prerogatives; he simply had to impose them, and those who disagreed were welcome to spend the next few years discussing the matter at length behind bars with their fellow political prisoners.

A great deal of the American left seems to have seen nothing wrong in this curious definition of “community.” This in itself is troubling, as is the enthusiastic reception of David Korten’s The Great Turning, among the most antidemocratic books of recent years, by the same circles. Korten argues that certain people – essentially, those who share his background and values – are at a superior “developmental stage” to others and are therefore better suited to rule, and the only way to survive the spiralling crises of the present and near future is to take power away from the “developmentally inferior” people who now hold it and give it to the gifted few. The idea that these few might need to be subject to checks and balances to keep them from abusing their power, it hardly need be said, finds no place in Korten’s book – a point that has done uncomfortably little to decrease its popularity.

It’s from sources like these that a neofascism of the left could quite readily emerge on American soil. Of course a neofascism of the right is equally possible, and the most dangerous possibility of all – because the most likely to slip past social critics unnoticed – might well be a movement that places itself in the abandoned middle ground of American politics. There is a great deal of empty space where common sense and compromise once bridged the gap between the major parties, and those parties themselves have become increasingly detached from the values and needs of the people they claim to represent. That space could offer an unparalleled opportunity to an astute and ambitious demagogue. It’s not exactly comforting that Nick Griffin, the head of Britain’s neofascist British Nationalist Party, is now using images of Churchill and the Battle of Britain in place of the Nazi regalia his followers once sported; Griffin is no fool, and where he goes, others will likely follow.

The crucial point that has to be recognized, and is too little recognized just now, is that it’s quite possible to replace a bad system with one that is much, much worse. Historians generally agree that the Weimar Republic was a failure, but I know of none who would suggest that the regime that followed it was an improvement. In the same way, those philosophes who criticized the Ancien Regime in its last years were quite correct to point out that the French monarchy and government were dysfunctional, corrupt, and wildly inefficient. Still, their guiding assumption – that what replaced it could only be better – was brutally betrayed by the Terror, the imperial tyranny of Napoleon, and a quarter century of bloody warfare, leading to no better end than the devastation of France and the restoration of an even more feckless monarch than the one they hoped to see overthrown.

The collapse of American democracy, or what is left of it, into one or another form of autocracy may be a foregone conclusion at this point. Certainly Oswald Spengler, whose ideas continue to land solid hits on a future his critics just as consistently miss, considered it that. He argued that the great struggle of the century or two ahead of his time would pit failing democracies corrupted by wealth in a long but ultimately losing struggle against the rising force of what he called Caesarism – the rise of charismatic leaders who would finish destroying crumbling democratic institutions and rule by a combination of force of personality and raw physical violence. The first round in that struggle began during Spengler’s own lifetime, though he did not live to see the first generation of Caesars fall; it seems unwise to dismiss the possibility of an imminent second round out of hand.

Still, the last word in all this probably belongs to an unlikely but eloquent spokesman, whose name I do not know. He was an elderly man, a Navy veteran with grandchildren, waiting for his laundry to finish at a laundromat here in Cumberland when I arrived there this morning on the same errand. Passing the time as the dryers tumbled, we talked about the weather and the misbehavior of politicians downriver in Washington DC. Then he shook his head and said, “I feel sorry for my grandkids. Me, I’ve had a good life, and my sons all did pretty well, but my grandkids and other people’s kids, they’ll never have what we had.”

For more than two centuries, the glue that has held American society together has been the hope – often falsified, but more often fulfilled – that each generation, no matter how difficult its own life might be, could hope for better things for its children. That faith is breaking apart where it has not already shattered. In its wake, strange bright banners are all too likely to be unfurled, and I suspect that a great many people who imagine themselves immune from the temptation of simple answers will end up marching beneath those banners toward some terrible destiny.

The Twilight of Money

I’ve commented before in these essays that one of the least constructive habits of contemporary thought is its insistence on the uniqueness of the modern experience. It’s true, of course, that fossil fuels have allowed the world’s industrial societies to pursue their follies on a more grandiose scale than any past empire has managed, but the follies themselves closely parallel those of previous societies, and tracking the trajectories of these past examples is one of our few useful sources of guidance if we want to know where the current versions are headed.

The metastasis of money through every aspect of life in the modern industrial world is a good example. While no past society, as far as we know, took this process as far as we have, the replacement of wealth with its own abstract representations is no new thing. As Giambattista Vico pointed out back in the 18th century, complex societies move from the concrete to the abstract over their life cycles, and this influences economic life as much as anything else. Just as political power begins with raw violence and evolves toward progressively more subtle means of suasion, economic activity begins with the direct exchange of real wealth and evolves through a similar process of abstraction: first, one prized commodity becomes the standard measure for all other kinds of wealth; then, receipts that can be exchanged for some fixed sum of that commodity become a unit of exchange; finally, promises to pay some amount of these receipts on demand, or at a fixed point in the future, enter into circulation, and these may end up largely replacing the receipts themselves.

This movement toward abstraction has important advantages for complex societies, because abstractions can be deployed with a much smaller investment of resources than it takes to mobilize the concrete realities that back them up. We could have resolved last year’s debate about who should rule the United States the old-fashioned way, by having McCain and Obama call their supporters to arms, march to war, and settle the matter in battle amid a hail of bullets and cannon shot on a fine September day on some Iowa prairie. Still, the cost in lives, money, and collateral damage would have been far in excess of those involved in an election. In much the same way, the complexities involved in paying office workers in kind, or even in cash, make an economy of abstractions much less cumbersome for all concerned.

At the same time, there’s a trap hidden in the convenience of abstractions: the further you get from the concrete realities, the larger the chance becomes that the concrete realities may not actually be there when needed. History is littered with the corpses of regimes that let their power become so abstract that they could no longer counter a challenge on the fundamental level of raw violence; it’s been said of Chinese history, and could be said of any other civilization, that its basic rhythm is the tramp of hobnailed boots going up stairs, followed by the whisper of silk slippers going back down. In the same way, economic abstractions keep functioning only so long as actual goods and services exist to be bought and sold, and it’s only in the pipe dreams of economists that the abstractions guarantee the presence of the goods and services. Vico argued that this trap is a central driving force behind the decline and fall of civilizations; the movement toward abstraction goes so far that the concrete realities are neglected. In the end the realities trickle away unnoticed, until a shock of some kind strikes the tower of abstractions built atop the void the realities once filled, and the whole structure tumbles to the ground.

We are uncomfortably close to such a possibility just now, especially in our economic affairs. Over the last century, with the assistance of the economic hypercomplexity made possible by fossil fuels, the world’s industrial nations have taken the process of economic abstraction further than any previous civilization. On top of the usual levels of abstraction – a commodity used to measure value (gold), receipts that could be exchanged for that commodity (paper money), and promises to pay the receipts (checks and other financial paper) – contemporary societies have built an extraordinary pyramid of additional abstractions. Unlike the pyramids of Egypt, furthermore, this one has its narrow end on the ground, in the realm of actual goods and services, and widens as it goes up.

The consequence of all this pyramid building is that there are not enough goods and services on Earth to equal, at current prices, more than a small percentage of the face value of stocks, bonds, derivatives, and other fiscal exotica now in circulation. The vast majority of economic activity in today’s world consists purely of exchanges among these representations of representations of representations of wealth. This is why the real economy of goods and services can go into a freefall like the one now under way, without having more than a modest impact so far on an increasingly hallucinatory economy of fiscal abstractions.

Yet an impact it will have, if the freefall proceeds far enough. This is Vico’s point, and it’s a possibility that has been taken far too lightly both by the political classes of today’s industrial societies and by their critics on either end of the political spectrum. An economy of hallucinated wealth depends utterly on the willingness of all participants to pretend that the hallucinations have real value. When that willingness slackens, the pretense can evaporate in record time. This is how financial bubbles turn into financial panics: the collective fantasy of value that surrounds tulip bulbs, or stocks, or suburban tract housing, or any other speculative vehicle, dissolves into a mad rush for the exits. That rush has been peaceful to date; but it need not always be.

I’ve argued in previous posts here that the industrial age is in some sense the ultimate speculative bubble, a three-century-long binge driven by the fantasy of infinite economic growth on a finite planet with even more finite supplies of cheap abundant energy. Still, I am coming to think that this megabubble has spawned a second bubble on nearly the same scale. The vehicle for this secondary megabubble is money – meaning here the entire contents of what I’ve called the tertiary economy, the profusion of abstract representations of wealth that dominate our economic life and have all but smothered the real economy of goods and services, to say nothing of the primary economy of natural systems that keeps all of us alive.

Speculative bubbles are defined in various ways, but classic examples – the 1929 stock binge, say, or the late housing bubble – have certain standard features in common. First, the value of whatever item is at the center of the bubble shows a sustained rise in price not justified by changes in the wider economy, or in any concrete value the item might have. A speculative bubble in money functions a bit differently than other bubbles, because the speculative vehicle is also the measure of value; instead of one dollar increasing in value until it’s worth two, one dollar becomes two. Where stocks or tract houses go zooming up in price when a bubble focuses on them, then, what climbs in a money bubble is the total amount of paper wealth in circulation. That’s certainly happened in recent decades.

A second standard feature of speculative bubbles is that they absorb most of the fictive value they create, rather than spilling it back into the rest of the economy. In a stock bubble, for example, a majority of the money that comes from stock sales goes right back into the market; without this feedback loop, a bubble can’t sustain itself for long. In a money bubble, this same rule holds good; most of the paper earnings generated by the bubble end up being reinvested in some other form of paper wealth. Here again, this has certainly happened; the only reason we haven’t see thousand-percent inflation as a result of the vast manufacture of paper wealth in recent decades is that most of it has been used solely to buy even more newly manufactured paper wealth.

A third standard feature of speculative bubbles is that the number of people involved in them climbs steadily as the bubble proceeds. In 1929, the stock market was deluged by amateur investors who had never before bought a share of anything; in 2006, hundreds of thousands, perhaps millions, of people who previously thought of houses only as something to live in came to think of them as a ticket to overnight wealth, and sank their net worth in real estate as a result. The metastasis of the money economy discussed in previous posts here is another example of the same process at work.

Finally, of course, bubbles always pop. When that happens, the speculative vehicle du jour comes crashing back to earth, losing the great majority of its assumed value, and the mass of amateur investors, having lost anything they made and usually a great deal more, trickle away from the market. This has not yet happened to the current money bubble. It might be a good idea to start thinking about what might happen if it does so.

The effects of a money panic would be focused uncomfortably close to home, I suspect, because the bulk of the hyperexpansion of money in recent decades has focused on a single currency, the US dollar. That bomb might have been defused if last year’s collapse of the housing bubble had been allowed to run its course, because this would have eliminated no small amount of the dollar-denominated abstractions generated by the excesses of recent years. Unfortunately the US government chose instead to try to reinflate the bubble economy by spending money it doesn’t have through an orgy of borrowing and some very dubious fiscal gimmickry. A great many foreign governments are accordingly becoming reluctant to lend the US more money, and at least one rising power – China – has been quietly cashing in its dollar reserves for commodities and other forms of far less abstract wealth.

Up until now, it has been in the best interests of other industrial nations to prop up the United States with a steady stream of credit, so that it can bankrupt itself filling its self-imposed role as global policeman. It’s been a very comfortable arrangement, since other nations haven’t had to shoulder more than a tiny fraction of the costs of dealing with rogue states, keeping the Middle East divided against itself, or maintaining economic hegemony over an increasingly restive Third World, while receiving the benefits of all these policies. The end of the age of cheap fossil fuel, however, has thrown a wild card into the game. As world petroleum production falters, it must have occurred to the leaders of other nations that if the United States no longer consumed roughly a quarter of the world’s fossil fuel supply, there would be a great deal more for everyone else to share out. The possibility that other nations might decide that this potential gain outweighs the advantages of keeping the United States solvent may make the next decade or so interesting, in the sense of the famous Chinese curse.

Over the longer term, on the other hand, it’s safe to assume that the vast majority of paper assets now in circulation, whatever the currency in which they’re denominated, will lose essentially all their value. This might happen quickly, or it might unfold over decades, but the world’s supply of abstract representations of wealth is so much vaster than its supply of concrete wealth that something has to give sooner or later. Future economic growth won’t make up the difference; the end of the age of cheap fossil fuel makes growth in the real economy of goods and services a thing of the past, outside of rare and self-limiting situations. As the limits to growth tighten, and become first barriers to growth and then drivers of contraction, shrinkage in the real economy will become the rule, heightening the mismatch between money and wealth and increasing the pressure toward depreciation of the real value of paper assets.

Once again, though, all this has happened before. Just as increasing economic abstraction is a common feature of the history of complex societies, the unraveling of that abstraction is a common feature of their decline and fall. The desperate expedients now being pursued to expand the American money supply in a rapidly contracting economy have exact equivalents in, say, the equally desperate measures taken by the Roman Empire in its last years to expand its own money supply by debasing its coinage. The Roman economy achieved very high levels of complexity and an international reach; its moneylenders – we would call them financiers today – were a major economic force, and credit played a sizeable role in everyday economic life. In the decline and fall of the empire, all this went away. The farmers who pastured their sheep in the ruins of Rome’s forum during the Dark Ages lived in an economy of barter and feudal custom, in which coins were rare items more often used as jewelry than as a medium of exchange.

A similar trajectory almost certainly waits in the future of our own economic system, though what use the shepherds who pasture their flocks on the Mall in the ruins of a future Washington DC will find for vast stacks of Treasury bills is not exactly clear. How the trajectory will unfold is anyone’s guess, but the possibility that we may soon see sharp declines in the value of the dollar, and of dollar-denominated paper assets, probably should not be ignored, and cashing in abstract representations of wealth for things of more enduring value might well belong high on the list of sensible preparations for the future.

The Metastasis of Money

The confusion between money and wealth, the theme of last week’s Archdruid Report post, has become almost impossible to avoid these days. Perhaps the most important reason is the extent to which money has metastasized so deeply into our economic life that it’s nearly impossible to do much of anything without it.

The economic textbooks you did your best not to read in school justify that ubiquity by a neat rhetorical trick. If you remember anything at all about the economics textbook you did your level best not to read back in your school days, it’s probably that bit of rhetoric; it can be found in the canned explanation for why we use money, somewhere around page 6. It runs something like this: there’s a plumber and a pig farmer who want to do business with one another, see, but the plumber’s Jewish and the pig farmer has nothing to trade but pork. Add money, and voila! The farmer sells his pork to other people and uses the proceeds to pay the plumber, who uses it to buy gefilte fish and matzoh meal. Everyone’s happy except, presumably, the pigs.

It all seems very logical until you think about it for ten seconds. Notice, to start with, how the explanation assumes that the plumber, the pig farmer, the purchasers of pork, the kosher deli, and everyone else are restricted to the specific kind of economic relationships that exist in, and only in, a money economy. The plumber doesn’t, as most people did as little as a hundred and fifty years ago, benefit from a household economy that provides a great deal of his food, including small livestock in the back garden. The pig farmer doesn’t, as most people did until as little as fifty years ago, do essentially all of his household repairs himself. Both of them are defined by a single function: the pig farmer can only produce pork, the plumber only plumbing.

Nor do the farmer, the plumber, or anyone else have access to any of the immense variety of nonmonetary systems of exchange human beings have used throughout history. !Kung hunter-gatherers sharing out a wildebeest among band members according to traditional rules, Haida chiefs distributing blankets and salmon to all comers at a potlatch, and medieval peasants working a baron’s demesne lands for a set number of days each year to maintain their feudal right to their own cottages and fields, all participated in flexible and effective systems of exchange that had nothing to do with money. Urban societies as complex as ancient Egypt got by entirely without money, and still managed to keep plumbers, pig farmers, and a great many other occupational specialties gainfully employed for millennia.

All that the textbook explanation proves, in other words, is that if you have a money economy, it does probably need some kind of money to make it work. This is not the conclusion the textbooks draw from the plumber and the pig farmer, of course; with very few exceptions, they leap from their canned example to the claim that money must be essential to any economy worth the name, and the rest of the textbook proceeds to focus on theories about the behavior of money under the false impression that those theories deal with the behavior of wealth.

The mistaken metaphysics discussed in last week’s post plays a large role in fostering this misunderstanding, but the sheer pervasiveness of money in today’s industrial economy has an even larger role. For most people in the modern industrial world, the only way to get access to any kind of wealth – that is, any good or service – is to get access to money first, and exchange the money for the wealth. This makes it all too easy to confuse money with wealth, and it also fosters the habit of thought that treats money as the driving force in economic life, and thinks of wealth as a product of money, rather than seeing money as an arbitrary measure of wealth.

The thought experiment of placing a hundred economists on a desert island with $1 million each but no food or water is a good corrective to this delusion. Unfortunately this same experiment is being tried on a much vaster scale by the world’s industrial economies right now. We have seven billion people on a planet with a finite and dwindling supply of the concentrated energy resources that are keeping most of them alive, and governments and businesses alike are acting as though the only possible difficulty in this situation is coming up with enough money to pay for investments in the energy industry.

It should be obvious that no amount of money can overcome the thermodynamic and statistical laws that have placed hard limits on the amount of highly concentrated energy resources that happen to exist on our planet. This is not obvious to most people nowadays, however, because the metastasis of money throughout the economy has trained nearly all of us to think that if you have enough money you can get whatever you want. The fact that the richest people in the world can put their entire fortunes into health care and still get old and die is one of the few persistent reminders that money cannot overcome the laws of nature, or provide access to goods and services that don’t exist.

So how did money get transformed from a convenient yardstick for real wealth to the be-all and end-all of contemporary economic life? At least three factors were involved, two of them common to complex urban societies throughout history, one unique to ours.

First, despite the drastic oversimplifications of the textbook example cited earlier, it reflects a reality: a complex society can gain significant advantages from a medium of exchange that can be traded for any form of wealth. Even in societies where most goods and services are distributed by way of social networks, a social consensus tends to establish certain trade goods – wampum shell strings among the First Nations of eastern North America, for instance – as a common measure for those goods and services that are exchanged in other ways. As a society becomes more complex and the division of labor among different crafts expands, some standard measure of wealth becomes more useful. While money itself was invented around 700 BCE by the ancient Greeks, other ways of measuring wealth for the sake of easy exchange had been in use in Old World urban societies for millennia before then, and it’s not inaccurate to include money or some equivalent system as part of the basic toolkit that makes complex urban societies possible.

Second, whenever common measures of wealth are controlled by institutions, those who manage those institutions become powerful, and can be counted on to maintain and expand their power whenever possible. In ancient Egypt, for example, grain in temple warehouses provided the basic measure of wealth; as a result the priests who controlled the stockpiled grain became a potent political force. In medieval Europe, when land was the basic measure of wealth – there’s a reason we still call it “real estate,” as though all other wealth is unreal – the power of the feudal nobility derived directly from their control of land. Today the governments that claim exclusive power to print and regulate money, and the banks and financial corporations that manage most of society’s money, derive much of their effective power from their control over the medium of economic exchange, and can be counted on to encourage the rest of society to rely ever more completely on the thing that gives them power.

These two factors can be traced in the history of most of the complex urban societies of the past. What makes our civilization something of an extreme case is a third factor – the extreme complexity of an economic system that has temporarily replaced the limited energy resources of other human societies with a torrent of cheap and abundant energy from fossil fuels.

Ilya Prigogine, one of the most innovative physicists of recent years, showed via a series of dizzyingly complex equations that the flow of energy through a system increases the complexity of the system. If there was ever any doubt of the accuracy of his claim, it was settled by the economic history of the western world from 1700 to the present. The societies over which the tsunami of the Industrial Revolution broke in the early 18th century were not unusually complex by the standards of past civilizations; their own contemporaries in the Chinese and Ottoman Empires considered western Europeans, and not without reason, to be grunting, smelly barbarians with few of the arts and graces of civilization.

Fossil fuels may not have done anything about the gracelessness and the smell, but it certainly made up for any shortage in complexity. Until the dawn of the industrial age, as a general rule of thumb, some 90% of the inhabitants of any complex society worked in agriculture, providing the food and raw materials that supported themselves as well as the 10% who could be spared for all other economic roles. By 1900, at the zenith of the age of coal, many nations in the industrial world had dropped the percentage of their work force in agriculture below 50%, and shifted the workers thus freed up into a broad assortment of new economic roles. By 2000, buoyed by the much higher concentration and efficiency of petroleum, many industrial nations had dropped the percentage of their work force in agriculture below 5%, with the other 95% filling newly invented roles in the most complex economies in the history of the planet.

One consequence of this swift and unprecedented surge in complexity was the triumph of money over all other systems of exchange. When the vast majority of workers at every income level labored at tasks so specialized that their efforts only produced value when combined with those of hundreds or thousands of other workers, money provided the only way they could receive a return on their labor. When most of the customers for any given product had money and nothing else to exchange for it, buying products for money became standard. Social networks of exchange – household economies, customary local exchanges, church and fraternal networks– shattered under the strain, and were replaced by purely economic relationships – wage labor, shopping, public assistance – that could be denominated entirely in cash. The last three centuries of social and economic history are largely a chronicle of the results.

If economists took a wider view of the history of their discipline than they generally do, they might have noticed that what most of them consider a fundamental feature of all economies worth studying – the centrality of money – is actually a unique feature of an economic era defined by cheap abundant energy. Since the fossil fuels that made that era possible are being extracted at a pace many times the rate at which new supplies are being discovered, current assumptions about the role of money in society may be in for a series of unexpected revisions.

In an ironic way, this process of revision may be fostered by the antics of the world’s industrial nations as they try to forestall the Great Recession by spending money they don’t have. The economic crisis that gripped the world in 2008 was primarily driven by a drastic mismatch between money and wealth. When the price of a rundown suburban house zoomed from $75,000 to $575,000, for example, the change marked a distortion in the yardstick rather than any actual increase in the wealth being measured. That distortion caused every economic decision based on it – for example, a buyer’s willingness to go over his head into debt to buy the house, or a bank’s willingness to lend money on the basis of imaginary equity – to suffer similar distortions. Now that the yardsticks have snapped back to something like their proper length, the results of the distortion have to be cleared out of the economy if the amount of money in the system is once again to reflect the actual amount of wealth.

Yet this is exactly what governments and businesses are doing their level best to forestall. Governments are scrambling to prop up economic activity at a pace the real wealth of their societies can no longer support; banks and businesses are doing everything in their power to divert attention from the fact that a great many of the financial assets propping up their balance sheets were never worth anything in the first place and now, if possible, are worth even less. Both are doing so by the simple expedient of spending money they don’t have. As government deficits worldwide spin out of control and the total notional value of the world’s derivatives market climbs steadily above one quadrillion dollars, the decoupling of money from wealth is even more extreme than it was at the height of the real estate bubble.

This is another context in which a wider view of history than economists usually allow themselves to take could offer a useful warning. The dominance of money in complex societies has a distinctive trajectory over time, and next week’s post will discuss some of the ways in which that trajectory might unfold in the decades immediately before us.