SUBHEAD: The notional wealth of the financial economy will have to lose significant value.
By John Michael Greer on 29 July 2009 in The Archdruid Report -
http://thearchdruidreport.blogspot.com/2009/07/economics-of-entropy.html
Over the last few weeks, my posts here on The Archdruid Report have tried to sketch out a way of understanding economics that doesn’t contradict the laws of physics or the evidence of history. Perhaps the central concept I’ve been developing along these lines is the sense that there is no such thing as “the” economy in any human society; there are, rather, three economies, each of which follows distinctive rules.
From http://www.martinlisec.com/illustrations.html
The primary economy, in this way of looking at things, is the natural world itself, which produces something like three-quarters of the goods and services on which human beings rely for survival. The secondary economy, which depends on the primary one, is the collocation of labor, capital plant, and resources extracted from the primary economy that produces the other quarter or so of the goods and services human beings use. The tertiary economy, finally, is the system of social processes by which the products of the first two economies are allocated to people. This can take many different forms, of which the one most familiar to us is money.
The differences between these three economies run deep, and so do the differences in the way they are treated in conventional economic thinking. Unfortunately these two sets of differences do not run in parallel. One way to explore the resulting mismatch is to look at how the three economies, in reality and theory, are affected by the least popular of all the laws of physics: the second law of thermodynamics, more popularly known as the law of entropy.
To call this law unpopular is not to say that it suffers from any lack of recognition by scientists. The comment of Sir Arthur Eddington, one of the twentieth century’s greatest physicists, is typical: “If your theory is found to be against the second law of thermodynamics, there is nothing for it but to collapse in deepest humiliation” – a summing-up so useful that it probably deserves to be called Eddington’s Law. Entropy is the gold standard of physics, the one thing you can count on even when the rest of the cosmos seems to be going haywire. What makes it unpopular, rather, is that it stands in stark conflict with some of the most deeply and passionately held convictions of modern industrial humanity.
For all that, it’s a simple concept to grasp. Pour a cup of hot coffee on a cold morning and you can watch entropy in action. The coffee will gradually get colder and the air around it will get very slightly warmer. All energy everywhere, left to itself, always moves from higher to lower concentrations: that’s the second law of thermodynamics. On the way from higher to lower, the energy can be made to do useful work, and you can even force some energy to a higher concentration by allowing a larger amount of energy to go to a lower one, but one way or another entropy’s price must be paid.
We don’t like thinking in these terms, and for the last three hundred years, most of us in the industrial world haven’t had to. The 18th-century breakthroughs that allowed coal to be turned into steam power, and gave human beings command over amounts of highly concentrated energy never before wielded by our species, convinced most people in the western world that energy was basically free for the taking. In the halcyon days of industrialism, it was all too easy to forget that this vast abundance of energy was a cosmic rarity, a minor and finite backwash in the flow of energies on a scale almost too great for human beings to comprehend.
As far as we know, there are two and only two phenomena in the cosmos that naturally produce high concentrations of energy. The first is gravity. Unlike most physical phenomena, gravity has robust positive feedback: the more mass a body has, the more gravitational attraction it exerts, the more additional mass it can attract, and the more its gravitational attraction increases. This is why what starts as an eddy in an interstellar cloud of hydrogen gas, set in motion perhaps by the shockwave from a distant supernova, can attract steadily more hydrogen to itself until its gravity is strong enough to achieve the fantastic pressures needed for nuclear fusion, and a newborn star flares into life. Even so, entropy still rules; the light and heat that flows out from our Sun over the course of its ten billion year lifespan is still only a fraction of the potential energy of the gravitational collapse that brought it into being and keeps it going.
The second phenomenon that produces concentrated energy is biological life. Life combines positive and negative feedback loops, and so it’s much more fitful and fragile than gravity, but it can still surf the entropy of its neighboring star, tapping a small part of the vast streams of energy that flow entropically from the Sun’s core to the near-absolute-zero cold of interstellar space to concentrate chemical energy for its own use. Over the ages, the resulting concentrations of energy have transformed our planet, pumping oxygen into its atmosphere and burying trillions of tons of carbon underneath the ground in the form of coal, oil, and natural gas. Once that carbon was buried, gravity got to work on it, concentrating it further through heat and pressure. The energy stored in today’s fossil fuel deposits, in turn, is still only a fraction of the energy lost to entropy in the long slow process that brought those deposits into being.
This is why, as I’ve tried to point out in previous posts, those who expect to get some new and even more concentrated energy source to replace our dwindling reserves of fossil fuels are basically smoking their shorts. It took an extraordinarily complex series of processes, more time than the human mind has evolved the ability to grasp, and an equally unimaginable amount of energy lost to entropy, to produce the highly concentrated fossil fuels we’ve wasted so profligately over the last three hundred years. There are plenty of diffuse energy sources left, but raising them to concentrations that will allow them to power our current civilization would require huge amounts of additional energy to be sacrificed to entropy – and once you subtract the entropy costs of concentration from the modest energy supplies available to a deindustrial world, there isn’t much left. Try telling that to most people, though, and you’ll get a blank look, because we’ve lived with abundant concentrated energy for so long that very few people recognize just how rare it is in the broader picture.
Economics, once again, feeds this blindness. Most economic models, interestingly enough, admit entropy into what I’ve called the secondary economy: there’s a clear sense that producing goods and services consumes resources and produces waste, and that energy fed into the process is lost to entropy in one way or another. Most of them, however, explicitly reject the role of entropy in the primary economy, insisting that resources are always available by definition if you only invest enough labor and capital. As for the tertiary economy, most economic theories accept it as given that money is anti-entropic – it produces a steady increase in value over time, which is the theoretical justification for interest.
In the real world, by contrast, the primary economy is just as subject to entropy as the secondary one. Oil that has been pumped out of the ground and burned is no longer available to use as an energy resource, and if enough of it has been pumped out, the oil field runs dry and it stops being a resource too. Natural cycles can keep some resources available at a steady level by surfing the entropy of the Sun, but only if human action doesn’t mess up those cycles – something we are doing a great deal too much of just now. By ignoring the reality of entropy in the primary economy of nature, we are setting ourselves up for a very awkward future.
And the tertiary economy? This is where things get interesting, because the anti-entropic nature of money posited by mainstream economic theories has been accepted even by most critics of those theories. There’s accordingly been a flurry of proposals for changing the way money works so that it loses value over time. This is understandable, but it’s also unnecessary, because money as it exists today has an exquisitely subtle mechanism for losing value over time. The only difficulty is that mainstream economists and the general public alike treat it with the same shudder of dread and indignation their Victorian ancestors directed toward sex.
We’re talking, of course, about inflation.
I’ve come to think of inflation as the primary way that the tertiary economy resolves the distortions caused by the mismatch between the limitless expansion of the tertiary economy and the hard limits ecology and entropy place on the primary and secondary economies. When the amount of paper wealth in the tertiary economy outstrips the production of actual, nonfinancial goods and services in the other two economies, inflation balances the books by making money lose part of its value. I suspect – though it would take a good econometrician to put this to the test – that in the long run, the paper value lost to inflation equals the paper value manufactured by interest on money, once the figures are adjusted for actual increases or decreases in the production of goods and services.
It’s instructive to note what happens when governments attempt to stop the natural balancing process of inflation. In American economic history, there are two good examples – between the Civil War and the First World War, on the one hand, and between 1978 and 2008 on the other. In the first of these periods, the US treasury reacted against the inflation of the Civil War years by imposing a strict gold standard on the currency, and since the pace at which new gold entered the economy was less than the rate at which the production of goods and services expanded. The result was the longest sustained bout of deflation in the history of the country.
Despite the claims of precious-metal advocates today, this did not produce economic stability and prosperity. Quite the contrary, the economic terrain of the second half of the 19th century was a moonscape cratered by disastrous stock market collapses and recurrent depressions. The resulting bank and business failures probably eliminated as much paper value from the economy as inflation would have, but did so in a chaotic and unpredictable way: instead of everybody’s corporate bonds losing 5% of their value due to inflation, for example, some bonds were paid in full while others became worthless when the companies backing them went out of existence. The same calculus has come into play since the beginning of the Volcker era at the Federal Reserve Board, when “fighting inflation” became the mantra of the day; since then we’ve had a succession of crashes as colorful as anything the 19th century produced.
Thirty years of economic policy dedicated to minimizing inflation have guaranteed a sizable second helping of economic collapse in the years to come – it’s only in the imaginations of politicians and publicists that the recent “dead cat bounce” in the stock market, and various modest decreases in the rate at which economic statistics are getting worse, add up to a recovery of any kind, much less a return to the unsustainable pseudoprosperity of the years just past.
Still, in the longer term, I suspect inflation will also play a major role in the unraveling of the current mess. With the end of the age of cheap abundant fossil fuels, the world faces a very substantial decrease in the amount of primary and secondary wealth in the world, and the notional wealth of the tertiary economy will have to lose value even faster to make up for that decline. Just how this will play out is anyone’s guess, but one way or another it’s unlikely to be pretty.
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