Equating money with wealth is among the most dangerous delusions currently afflicting humanity.
This is, perhaps, understandable given that so few people now have access to money in the quantities needed to improve their lives.
Government, meanwhile, effectively lies when it points to the various pots of money that it has allocated to this or that infrastructure, entitlement or service. This is mendacious because money from central government is allocated as a block grant to local government and other public bodies. In total, these public bodies lack the income to fund their legal responsibilities. As a result, money that was theoretically allocated to provide for such things as mental health beds, fixing potholes and a host of other discretionary activities is actually deployed in firefighting the collapse of mandatory services like child welfare or social care for the elderly.
The solution to this for many in the political sphere is to loosen the purse strings. Quite correctly, they identify the central flaw in the pronouncements of duplicitous politicians like Theresa May and Phillip Hammond; who tell us that “there isn’t a magic money tree.” Because… well… actually, yes there is. It’s called the Bank of England. And were politicians to instruct it to do so, it can spirit into existence as much new currency as it likes.
The conventional way in which central banks spirit money into existence is via the issuance of government debt. Government issues a bond (called a Gilt-Edged Security in the UK) which is auctioned to a closed group of banks and financial institutions. The central bank then spirits new money into existence and uses it to buy these bonds back. That new money then enters the economy via the financial sector.
This, of course, is no more than tradition. There is nothing to prevent the central bank from conjuring new money out of thin air and then distributing it directly into the bank accounts of every citizen. Indeed, this is one of the points made by those who favour some form of Universal Basic Income as an alternative to the UK’s overly bureaucratic and increasingly ineffective social security system. The reason that money is not created in this way is simply that channelling it through the banking and financial system favours the wealthy and powerful at the expense of the wider population.
Midway between the current practice of handing new money to the already wealthy – who get to enjoy it before inflation devalues it – and channelling it directly to the people, is the proposed creation of a national investment bank. Whereas feeding new money to the already wealthy serves only to inflate asset bubbles in unproductive areas like property, fine art and collectibles, an investment bank could provide funding for national infrastructure development. This, in turn, would provide new jobs as well as enhancing the productivity of the economy as a whole.
The only requirement of any of these forms of currency creation is that the government removes sufficient money from the economy through taxation to prevent inflation running out of control. Herein, however, is the problem that has vexed governments down the ages. Exactly how much money does the government need to remove from the economy to prevent inflation?
The current practice of giving new money to the already wealthy requires very little government action. The central bank practice of raising interest rates is considered sufficient. This is because, like taxes, debt repayment is a means of removing currency from the economy. Just as banks create new currency when they make loans, so currency is destroyed when loans are repaid. When the interest rate rises, an additional proportion of the currency in circulation has to be destroyed in order to pay the higher charge.
Once governments start moving new currency directly into the economy – either through investment banks or direct transfers to people’s bank accounts – taxation has to be adjusted accordingly in order to prevent the money supply growing too high and causing inflation.
The problem is that just as central banks cause financial crises by raising interest rates beyond the point where creditors begin to default; governments have a habit of causing crises by allowing too much new currency to be created. It is all too easy for politicians – who need to get re-elected – to promise new investments in popular services – without thinking about the impact of that new spending on the broader economy. In the 1970s, the impact of this kind of currency creation was so great that governments around the world handed control of their money supply to the banking sector; and passed legislation and entered into treaties (like Maastricht) that forbid direct government money printing (states are permitted to bail out banks, but not businesses or citizens).
The inflation of the 1970s is explained in economics textbooks as being the result of profligate governments playing fast and loose with their national economies. The difficulty with that explanation, however, is that exactly the same money creation policies kick-started the greatest economic expansion the world has ever seen. The post-war Marshall Aid programme which printed new dollars into existence in order to rebuild the shattered economies of Western Europe and Japan, together with the spending programme of Britain’s Labour government (which didn’t receive Marshall Aid), paved the way for the twenty-year boom 1953-73. With western growth rates similar to those claimed by modern China, states using newly created currency to invest in and grow the economy became the economic orthodoxy for three decades.
If the supposed relationship between money printing and economic growth and crisis is beginning to sound like a false correlation to you, it is because it is. It is what I refer to as “the Keynesian paradox.”
Having witnessed the austerity, depression and eventual rise of fascism in the aftermath of the First World War, economist John Maynard Keynes argued that the big mistake made in 1919 was for governments to return to the economic orthodoxy of the pre-war years. This had resulted in austerity policies at home and the imposition of reparations on the defeated enemy. What Keynes argued for was close to what the US delivered in 1945, when it realised its best protection against the Soviet Union was a prosperous, interconnected western bloc.
Keynes’ proposition was straightforward enough: if you give newly created money to a wealthy person, they will exchange it for some form of unproductive asset – a house, a piece of art, a vintage car, etc. If, on the other hand, you give the same new money to a poor person, they will spend it all more or less immediately – on necessities like food, rent, fuel and clothing. In this way, new currency distributed to the poor would quickly circulate around the economy; stimulating growth.
Keynes was correct in terms of money flows but wrong about growth. Indeed, there was a period in European history – the years following the colonisation of the Americas – when a sudden influx of new money (in the form of the gold and silver shipped back to Spain) had exactly the opposite effect. Without the influx of precious metals from the Americas, the Hapsburg Empire might have gone on to become the United States of Europe. Instead, it experienced a prolonged and ruinous period of inflation that resulted in internal revolt and division. In effect, the sudden influx of precious metals had the effect of devaluing the gold and silver (and money based upon it) already in circulation; manifesting as rapidly rising prices across the economy.
More recently, excessive money printing (in order to inflate away reparation debt) in Germany resulted in the runaway inflation of 1924 that helped propel Hitler and the Nazis onto the world stage.
This is the Keynesian Paradox. An economic policy (Marshall Aid) that patently kick-started the largest economic boom in history, also created the inflation of the sixteenth century and the stagflation of the 1970s.
Might this suggest that there was some deeper factor common to sixteenth century Europe and the 1970s that was absent or opposite to conditions in the late 1940s? What else happened in the 1970s? The world experienced a major oil shock as US reserves were no longer sufficient to regulate global oil prices. In the aftermath of the Second World War, global oil production grew exponentially; fuelling the boom. That came to an end in 1973:
In the period since 1973, oil production has continued to grow; but growth has been linear. The result is that the rates of growth enjoyed in the west between 1953 and 1973 are never coming back. Indeed, much of the oil we are adding to the mix today is expensive; giving it a much lower value to the economy than the oil being produced in the aftermath of the Second World War.
One of Keynes’ contemporaries – English Nobel Prize-winning chemist Frederick Soddy – understood this far better than Keynes:
“Still one point seemed lacking to account for the phenomenal outburst of activity that followed in the Western world the invention of the steam engine, for it could not be ascribed simply to the substitution of inanimate energy for animal labour. The ancients used the wind in navigation and drew upon water-power in rudimentary ways. The profound change that then occurred seemed to be rather due to the fact that, for the first time in history, men began to tap a large capital store of energy and ceased to be entirely dependent on the revenue of sunshine…
“Then came the odd thought about fuel considered as a capital store, out of the consumption of which our whole civilisation, in so far as it is modern, has been built. You cannot burn it and still have it, and once burnt there is no way, thermodynamically, of extracting perennial interest from it. Such mysteries are among the inexorable laws of economics rather than of physics. With the doctrine of evolution, the real Adam turns out to have been an animal, and with the doctrine of energy the real capitalist proves to be a plant. The flamboyant era through which we have been passing is due not to our own merits, but to our having inherited accumulations of solar energy from the carboniferous era, so that life for once has been able to live beyond its income. Had it but known it, it might have been a merrier age!”
The economic expansion that Soddy correctly attributed to the fossilised sunlight locked up in coal deposits was to be multiplied a hundredfold by the oil-based expansion that followed the Second World War. And indeed, had we known that it was oil rather than one or other version of politics or economics that was responsible for our brief period of prosperity, our age too might have been merrier.
In this, the sixteenth century Europeans might have had something to tell us; because they also experienced an energy crisis. Given that this was a period when economies ran entirely on renewable energy, there is a corrective here too for those who imagine that returning to some pre-industrial idyll might be our salvation. Sixteenth century Europeans chopped down their forests at a much faster rate than the trees could be regrown. As historian Clive Ponting notes:
“A timber shortage was first noticed in Europe in specialised areas such as shipbuilding… In the 1580s when Philip II of Spain built the armada to sail against England and the Dutch had to import timber from Poland… Local sources of wood and charcoal were becoming exhausted – given the poor state of communications and the costs involved it was impossible to move supplies very far. As early as 1560 the iron foundries of Slovakia were forced to cut back production as charcoal supplies began to dry up. Thirty years later the bakers of Montpellier in the South of France had to cut down bushes to heat their ovens because there was no timber left in their town…”
Creating new currency – in this case the new precious metals from the Americas – into an economy that has outrun its energy supplies could only result in inflation because without sufficient energy there could be no economic growth. Only when new sources of energy – in this case, coal from the Severn Valley – can be brought into production does the economy recover and a new round of economic growth begin.
When western states printed new currency into existence to rebuild their war-torn economies in the years after 1945, they did so while almost all of the planet’s oil deposits were still in the ground. Much of the new currency was invested into economic activities that required oil for manufacture and/or transportation. That, in turn, meant that a proportion of the new currency found its way into the accounts of the big oil companies; who used it to open up the vast oil reserves around the planet. It was this cheap, abundant reserve of oil that allowed for massive currency creation without generating inflation. It was precisely at the point when money creation overshot oil production that the inflation of the 1970s set in.
Fast-forward to the very different world of 2018: World production of “conventional” crude oil peaked in 2005. The resulting inflation – followed by the inevitable interest rate rises – triggered the worst financial collapse in living memory. Oil production is still, just about, increasing; but only at great expense. Low quality and expensive oil from fracking, tar sands and ultra-deep water is keeping the economy going; but only at the cost of obliging us – businesses and households – to devote a greater part of our income to energy (either directly or through the energy embodied in the goods and services we purchase).
Unlike money trees, there is nothing magical about oil (which, a handful of electric cars aside, still powers almost all of our agricultural, industrial and transportation vehicles and machinery). Even now, there is more oil beneath the ground than we have used so far. But most of what is left is going to stay in the ground simply because it is too expensive (i.e. it requires too much energy) to extract.
Alternative energy sources do not really exist, other than by sleight of hand. Most often, this is done simply by conflating electricity with energy. But the crisis we face is primarily a liquid fuel crisis. As such, the electrical energy generated by a wind turbine or a nuclear plant is irrelevant. What has actually happened has nothing to do with ending our use of fossil fuels. Rather, states around the world have turned to alternative fossil fuels – coal and gas – together with renewables and nuclear to free up the remaining extractable oil for use in industry, agriculture and transportation. Oil consumption, however, continues to rise, because without it growth would end and the mountain of debt-based currency would collapse around our ears.
This brings us back to the money question. There is a growing belief that the solution to our problems will come in the form of a switch from austerity economics to an expansionary policy based on distributing newly created currency via investment banks and/or universal basic incomes. This, however, is highly unlikely to succeed until or unless we find a means of massively increasing the energy available (at the point of use) to the economy to counteract the decline in affordable oil that is beginning to emerge (replacing unaffordable oil with unaffordable renewables doesn’t really count).
Politically, the demand for an end to austerity is becoming irresistible. We already see its manifestation in Brexit, the election of Donald Trump and the rise of populist (right and left) parties across Europe. Around the world, the people have put the elites on notice that they will no longer tolerate an economy in which a tiny handful of kleptocrats continue to accumulate wealth via a rigged financial system while everyone else sees their standard of living plummet.
The mistake, however, would be to assume that simply printing currency will solve the problem. Without useable energy to back it up, new currency is worthless. Its only role is to steal a fraction of all of the currency already in circulation. This may have small benefits if channelled to ordinary people, since it will be the accumulated currency of the wealthy that is devalued the most – a kind of hidden tax. But the ensuing price increases are far more likely to be experienced by those at the bottom of the income scale; as their ability to pay for necessities is rapidly eroded.
The crisis of our age, then, is not to pick the fruit of the magic money tree; but to discover the location of the magic energy tree whose fruit has fertilised the money tree for the past 250 years. Sadly, that magic (fossilised sunlight) energy tree has shrivelled with age. We may never see its like again.
As you made it to the end…
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