<Herman Daly on the Credit Crisis, Financial Assets, and Real Wealth The Oil Drum DrumBeat: October 14, 2008>

163 comments on Revisiting an April 2007 Forecast Regarding The Connection Between Peak Oil and the Collapse of the Monetary System

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Gail the Actuary on October 13, 2008 - 12:37pm Permalink | Subthread | Parent | Comments top

I am not sure if I have a good feel for how the money supply would have to act going forward.

It seems like the supply of goods and services could contract quite quickly and unpredictably going forward--a loss of credit availability could invoke Liebig's Law of the Minimum on some production chains. Loss of some segments of foreign trade could make it impossible for either the former exporter or the former importer to manufacture some goods that one of them might might previously have been able to manufacture. None of the relationships are linear. They all depend on Liebig's Law of the Minimum.

It would seem like a new currency wound need to divide up whatever is available at a point in time. Since the amount of goods and services available is likely to go down over time, it is hard to see how debt financing could used to a significant extent, especially if the downward steps are unpredictable. You talk about risk free interest rates becoming negative. This would certainly have the effect of discouraging lending.

It seems like one would almost need a monetary supply that decreases over time. Perhaps, money could be issued that is only good for one year, and expires. The amount of money issued each month could decline, as resources and expected output decline. People could not really "save" this money, but that is right. In a declining world, money cannot really be a store of value. A person would need to convert the money into some real goods or an investment in something like a factory. Real goods would tend to need maintenance, and thus would tend to have lower value over time. Factories, because they depend on inputs which are becoming less and less available, would tend to have short life spans.

It seems like the net result would be to encourage a very limited technology world, where everyone works, and produce mostly the outputs they themselves need. Perhaps governmental tax and spending plans could provide some investment.

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Beach Boy on October 13, 2008 - 6:41pm Permalink | Subthread | Parent | Comments top

Gail, the ultimate reason why the amount of goods available is likely to go down over time is Hubbert's Peak (for oil and other things). Therefore, even if the money supply was constant over time, as would be the case if gold was used, there would be inflation (same money, less goods). Of course, with today's fractional reserve banking, debt-based system, which requires the money supply to grow, there would be much higher inflation (after the current deleveraging process).

My personal position on the issue of monetary systems is not trying to get too imaginative. Precious metals-based monetary systems have been used for thousand of years. Remember that on the downward side of Hubbert's Peak complexity is a liability for a system. A pm-based monetary system with 100% reserve banking is simple and resilient. And it would satisfy your requirement of not really being a store of value in a declining world, for there would still be inflation as said above.

Besides, even if countries could use various fancy fiat money systems, to have a fair system for international trade, transactions between countries should be conducted using gold or at least a paper currency that could be redeemed for gold by foreign holders (as was the dollar till 1971). Only that kind of system would prevent a country from getting an unfair advantage, something for nothing, a "free lunch".

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Gail the Actuary on October 13, 2008 - 7:06pm Permalink | Subthread | Parent | Comments top

I think you are right about keeping the currency simple. If everyone knows that the currency will lose value over time, that may be good enough.

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ets on October 14, 2008 - 2:52am Permalink | Subthread | Parent | Comments top

I'd be interested in your thoughts about demurrage/carry-tax economic systems?

From a recent comment of mine:

Here is my preferred monetary system: demurrage based, money is created at a rate equal to the demurrage losses such that the money supply is constant on a per capita basis. Newly created money is distributed evenly to every person. Alternatively, some (or all) of the newly created money could be diverted to public funding in lieu of income and sales taxes.

I think there are a great many benefits to such a system. Most notably that it is an inherently stable system (in a mathematical systems analysis sort of way), contrary to our current debt-based, positive compound interest, fractional reserve system. I think the tax-alternative and budget aspects are pretty promising too.

The implementation would be fairly simple and straight-forward; basically banks become tax collectors and pay the government a percentage of all their deposits. (Do you think that might inspire lending?)

To prevent a flight to cash, bill issues would have expiration dates (organized in overlapping issues), and the treasury would sell them at a premium to face value to account for the devaluation incurred up to the expiration date.

To prevent systemic shock, a gradual, well defined transition should take place, consisting of the following actions:

1. The demurrage rate should be gradually increased to its final value.

2. To allow fixed-rate interest bearing instruments to be unwound and re-negotiated gracefully, the money supply will be gradually increased to it's final per capita value. This would be necessarily inflationary (but at least predictably so). Specific actions to this effect:

2a. The treasury will cease to issue debt instruments. The national debt will cease to grow from day 1. All government spending will constitute new money, without any debt encumbrance.

2b. To further increase money supply, the treasury will begin buying back its debts at a measured pace.

2c. The government will meet its social security and medicare commitments (possibly renegotiated), infrastructure modernization, and hey, how about some energy programs?

3. To compensate for excessive money generation from the policies of #2 (esp 2c!), the bank reserve ratio will be increased, which will exert deflationary pressure.

4. At the end of the transition period, a mandatory balanced budget clause will become in effect. Government budgets must be payed by carry-fees during the same fiscal period. The financial system should now be national debt free, zero inflation, and stable even in zero or negative growth periods. Yay.

The biggest problem I see with this systems, is one of perception. People are used to seeing money as an asset, rather than a tool to facilitate commerce. The two views are contradictory as was the first point of my earlier comment. That and the big banks might not like it much... :-/

Eliminating the personal and corporate income tax might be a sufficient enticement though.

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Beach Boy on October 14, 2008 - 10:53am Permalink | Subthread | Parent | Comments top

"such that the money supply is constant on a per capita basis"

Let's see if we can get the same result using a precious metals-based monetary system with 100% reserve banking:

1. The money supply grows at the same rate than above-ground bullion stocks. Since after Hubbert's Peak the extraction rate of all minerals will decline, the rate of growth of the money supply will be very low, tending to zero.

2. For reasons amply discussed in TOD, population growth will also stop.

Thus, in the Steady-State scenario feasible after PO, a pm-based monetary system with 100% reserve banking would provide for a constant money supply per capita.

See also that deposits in 100% reserve banks not only do not yield interest (as those banks do not lend) but also experience a small demurrage from the fee the banks cover for their service, though that fee might not be proportional to the account balance (e.g. they might charge per transaction).

Now, why do I prefer this system to yours? As I said in other comment, for simplicy and resilience. Frankly, your system (particularly "Newly created money is distributed evenly to every person") is very good indeed, but with human nature as it is, I don't think it stands a chance, particularly for big countries. And sure enough, while your target system could be zero inflation even in negative growth periods, a gold-based system would cause some inflation during those periods (same coins, less goods). A bit of inflation, however, is not seen as bad by Gail and others.

You are also right in that the transition is important, and your steps might be useful also for the transition to a pm-based system.

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ets on October 14, 2008 - 12:58pm Permalink | Subthread | Parent | Comments top

Is your choice of gold because of its history in that role?

I have a huge problem with gold as currency. Not as an asset, but as currency. Gold is far too good to be a currency. Value dense, doesn't degrade, etc. When times got rough, I'd hold on to my gold, since at least it wouldn't disappear. If everyone did that there would be not any commerce, since no money would circulate.

Any currency already has an advantage over real goods and services due to its universality. Add on top, that currency is a good store of value, and ordinary goods should be seen at a big disadvantage in trade, since money in hand is surely more useful and safer than most anything for which you would trade it.

The first and foremost job of a currency is to circulate. I think the properties of a currency should encourage its circulation. A demurrage charge is designed for that very purpose. The longer you hold it, the greater your losses. The currency has now been knocked down a notch; to be more on par with real goods, not superior to them.

Now if you wish to buy gold with your currency, good, it will make a fine asset. But the currency will keep circulating, since the original owner of the gold will now have to find something to do with the currency.

Essentially, the paradigm shift is to stop perceiving money as an asset, and start seeing it as a shared resource. That's my take on it anyway.

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Gail the Actuary on October 14, 2008 - 12:42pm Permalink | Subthread | Parent | Comments top

I haven't really thought this through, but it seems to me that the total amount of money will have to go down from what is implied by all the debt and promises out there now. We are not going to be able to give everyone full social security and Medicare benefits, and keep the system solvent. Perhaps your renegotiation covers this. I am not sure how you would handle all of the derivatives. It seems like somehow the US government will have to pay off all its debt, and not issue new debt. This will be an interesting experience.

The other thing that comes to mind is that we are dealing with an international marketplace. Whatever system is used necessarily has to be simple, and probably pretty similar everywhere. I'm afraid this system would be too complicated to be used in villages in Africa. It would also be next to impossible to get everyone to agree on its details.

Because of these issues, I am not sure it would work in practice, but it does offer some interesting ideas.

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ets on October 14, 2008 - 6:14pm Permalink | Subthread | Parent | Comments top

Hi Gail, thanks for the reply. I'm not sure what you mean when you say that the money supply would have to decrease due to current debts.

I don't have any doubt that we could provide full retirement benefits, but I rather seriously doubt that we will want to. It is certainly a theoretical possibility that every working person in the United States could devote one half or more of their productive time to the care of our retired citizens. I don't think there are many non-retired persons that would like that idea.

Our current system is certainly more complex than the one I propose. I think the problem is that the concept is strange at first glance. But really, the concept is exceedingly simple: a tax on money. Is income tax more simple? Collecting sales tax at every point of sale? Which taxes incentivize strong commerce? Penalize making money, penalize participating in commerce, or penalize the interruption of commerce by withholding the medium of exchange?

I don't see why it would be any more complex for villagers in Africa to trade pieces of paper (or any other token) that have expiration dates as opposed to pieces of paper without expiration dates.

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steve from Virginia on October 13, 2008 - 9:55pm Permalink | Subthread | Parent | Comments top

We are living in 'The Bad Loan Universe'.

In the good loan universe, loans are repaid and the 'money supply component' of lending disappears as a part of the process of repayment. In a well- managed fiat system there is never more credit issued than is demanded by productivity. Productivity in the good loan universe as measured in a transparent and equitable way. The rate of return or earnings on money lent is productive only as it produces value to the original borrower.

In the Bad Loan Universe, laundered credit is considered capital and the resulting inflation is considered productivity. Here, currency exchange is imbalanced and surpluses are loaned against creating even greater money supply and allowing even more bad loans, since there is always more currency than there are good investment opportunities. The flood of cheap money encourages consumption over investment. Loans eventually fall into arrears, consequently, they never disappear from the creditors' books. The money supply component created with each original loan remains. At the same time, the additional money supply component created to rescue the lenders from bankruptcy or to service the currency imbalances are added to the swelling total of unpayable loans. It's the worst of all possible universes; the money supply expands exponentially while the created credit always remains attached like a leach to the original lenders' balance sheets ... and their foolish successors'.

At the center of The Bad Loan Universe this successor dwells, that bloated, feverish black hole of zombie credit, 'The Federal Reserve Bank'. It swells with bad loans that never disappear, but requiring nevertheless more and more interest from the surrounding productive universes. The more bad loans it swallows, the more bad loans it propagates, since all loans that fall into its ambit become tainted by the ralationship and considered 'bad'. 'Sound' planets and nebulae become insolvent in a matter of days, weeks or ... hours, ss their borrowed collateral is rendered equally suspect as that actually within The Bad Loan Universe.

The story has an unhappy ending, I'm afraid ... so I won't tell it. You have to use your imagination.

A new universe of good loans will soon arise from the radioactive plasma left behind by the vaporization of The Bad Loan Universe. If its inhabitants are clever, it may have several different money supplies, that accurately measure and service the different social functions that will require finance. There should be a 'basis' money that values resources and rewards husbandry. A good loan universe would have a free exchange of different currencies while keeping enough separation between them so that problems with one don't infect the others. In the Niewe Good Loan Universe, currency imbalances are quickly rectified by entities buying and selling reserves and monitoring exchange rates, rather than lending against accumulated foreign currency reserves.

Finally, The Good Loan Universe will understand that money supply is only a tool and its misuse will rapidly cause the good lending environment to morph into another Bad Loan Universe.

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Gail the Actuary on October 13, 2008 - 10:25pm Permalink | Subthread | Parent | Comments top

You have some interesting insights there the Bad Loan Universe:

laundered credit is considered capital and the resulting inflation is considered productivity

'The Federal Reserve Bank'. It swells with bad loans that never disappear, but requiring nevertheless more and more interest from the surrounding productive universes. The more bad loans it swallows, the more bad loans it propagates, since all loans that fall into its ambit become tainted by the ralationship and considered 'bad'.

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steve from Virginia on October 14, 2008 - 2:07am Permalink | Subthread | Parent | Comments top

Unfortunately, I don't currently have any insights on how to get from where we are now to where we need to go ... without tremendous agony.

It doesn't help that the people in charge are living in a dreamworld.

Even a good plan will face tremendous obstacles and will be a race against the ecological time bombs.

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163 comments on Revisiting an April 2007 Forecast Regarding The Connection Between Peak Oil and the Collapse of the Monetary System

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