“If the great and the good didn’t spot this crisis coming then perhaps they don’t qualify to be called the great and the good”, writes Hawkeye in the article entitled “Illogical Economics” on the GOLEM XIV website.
Cross-posted with permission from www.golemxiv.co.uk:
There are many paradoxes in economics. To an outsider it is full of contradictions and inconsistencies. Not least of which is its utter failure to predict the current financial crisis. If the great and the good didn’t spot this crisis coming then perhaps they don’t qualify to be called the great and the good. Economics requires an intellectual framework – a model of the world – that accurately reflects reality. Clearly the world can’t be accused of failing to reflect economic models, so economics must be the one on the hook.
When trying to fathom the causes and consequences of this crisis back in 2008, I was openly exploring various avenues of explanation, many of which lay outside mainstream economics. There was the Austrian Economics approach and the Marxist view of Capitalism in crisis, to mention but two. Each of these avenues seemed to contain elements of plausibility, but most of them failed to provide a holistic narrative of the crisis, and why it was happening at this point in time.
That changed when I set aside a few hours one evening in late 2008 and watched Chris Martenson’s “Crash Course” (http://www.peakprosperity.com/crashcourse). As anyone who has watched it will acknowledge, it’s not an academic treatment, but it does provide a framework based on common sense that situates the current crisis as a series of unsustainable trends: the enormous build up of debts as claims on wealth which can’t all be honoured, and our reliance on energy and material resources which are suffering from diminishing returns.
This instantly made sense, as the concepts of limiting factors and dynamical growth patterns are quite common in the natural sciences. So time to revisit the social science of mainstream economics and see what they had to say on these subjects. Firstly, the role of money is assumed away, as merely a veil over barter, so nothing to see here folks. And secondly, we don’t need to worry about energy as this is merely a small fraction of GDP, and besides humans have infinite ingenuity and resourcefulness. There are no limiting factors declares economics, and no awkward dynamics to model. Problem solved, right? Well, only if we are happy to accept a further set of anomalies:
1) Given that we have a society of money worshipping individuals, why do we have an economic framework that omits the role of money?
2) Given such a highly materialistic society, why do we presume a purely psychic basis of wealth?
Oh, and of course that slight issue we mentioned earlier about a theory that can’t predict crises, predominantly because nothing is unsustainable in its eyes!
So what does economics study, then, if not money or material resources? And could the omission of these two vital aspects possibly be related to it’s failure to predict the crisis?
The intellectual edifice of economics stood resolute, confident that its models of the world, without an actual representation of money or material resources, could accurately explain how we had obtained such abundance of money and resources. Nevermind these bothersome paradoxes and anomalies, they declare, their theories alone held the key to future prosperity.
It would take another few months of exploratory background reading until I came across the works of Frederick Soddy. What struck me was that a Nobel chemist writing in the 1920s had also drawn attention to these paradoxes, and had offered accompanying solutions. Here was a more weighty treatment of the subject than Mr Martenson, using logical propositions carefully assembled one upon the other. For me, the veracity of Soddy’s argument was there for all to see, yet his views were considered highly unorthodox at the time, and for the most part still are. But why is that?
Money as debt
The first pillar of Soddy’s argument surrounds the very nature of money. Everyone uses money, yet few people truly understand what it actually represents. The extent of monetary relations back in Soddy’s day is probably a lot less frequent than now, as many transactions and means of subsistence probably lay outside of market transactions. However, Soddy gave a cogent explanation of money:
“We thus come to look upon money – quite irrespective of whether it is specie or paper – as a token certifying that the owner of it is a creditor of the general community and entitled to be repaid in wealth on demand.” Wealth, Virtual Wealth and Debt (1926) p134
Money is more than just a more advanced substitute for barter, declared Soddy. In barter, all transactions cancel each other out, but with money, there must at all times be someone left holding tokens, rather than real goods or services. Money is therefore a form of negative inventory. As negative objects are not physically possible, we must be dealing with a fabricated construct. A holder of money forgoes actual ownership, instead deferring his purchasing power. It will then require a further social arrangement for this token to get converted back into real goods. Up until it is handed over, it is not a real asset at all, but wider society’s liability. As Soddy quipped:
“Money is the nothing you get in return for something, before you can get anything”.
Therefore, it is not a harmless veil over barter. It is a token of indebtedness, and a claim over the real inventory of goods and services in society. Standard economic models on the other hand declare that the money system is completely neutral. In their worldview society’s mutual indebtedness cancels itself out. If that is the case in their economic models, then why can’t the debts be cancelled out in practice? Mainstream economists refuse to contemplate this very obvious logical contradiction. To them, the money system is absolutely essential for a functioning economy (i.e. it must be preserved at all costs) yet at the same time is unneccessary to model!
No standard macroeconomic model takes into account the burgeoning balance sheets of individuals, banks, companies or Governments. They are obsessed with liquidity, for sure, but have no interest in the liquid!
Soddy, however, was also perceptive enough to understand that the source of most circulating money was through private bank credit creation. He was highly critical of this unearned priviledge, as in his eyes a bank undertook no genuine forfeiture when creating a loan . In reality the debts are simply an accounting entry. But far from harmless, they help to enforce a power relation within society, and Soddy was well aware of this situation citing a 19th barrister and expert on the subject of credit:
“The merchants who trade in debts – namely bankers – are now the rulers and regulators of commerce; they almost control the fortunes of states.” H.D.MacLeod quotation in Wealth ……. p77
Confusion between debt and wealth
Equally importantly, Soddy went on to warn of the dangers of prolifigate debt expansion:
“You cannot permanently pit an absurd human convention, such as the spontaneous increment of debt, against the natural law of the spontaneous decrement of wealth” Cartesian Economics (1922)
To Soddy the problem lay in the misunderstanding between debts and genuine wealth; one can be endlessly accumulated (social arrangements permitting!), the other cannot. Which leads us onto the second pillar of Soddy’s economic treatise; the acknowledgement of a real and practical basis to the concept of wealth:
“The essence of wealth is not power over men, but power over nature” Wealth ….. p100
As was discussed above, money and debts are a reflection of power over others, but this doesn’t automatically make it the same as wealth in an absolute sense. To mainstream economics, the money system is the measurement basis of wealth, so the more money we have circulating (controlling for price level, of course), the more wealthy we are. However, Soddy declared it a highly unsatisfactory measure of wealth, because the relative power over other members of society can change up or down, regardless of the real goods and services in supply. Not only is the measuring stick highly elastic, but we mustn’t confuse the stick with that which is being measured. Soddy uses the following example to highlight the confusion:
“A ham merchant working on what he is pleased to call a 10 per cent basis of profit, may buy ten hams for the same sum as he sells nine. He may be pleased to think he has made a profit of one ham, but he certainly has not made a ham.” Cartesian Economics
Genuine wealth, Soddy argued, is that which provides us with a high standard of living. It is an ability to do real physical work, over and above that which we can achieve with our hands. And the source of this is any form of “embodied useful energy”. It is no coincidence that the rapid increase in living standards that commenced about 250 years ago was accompanied by a plethora of mechanical innovations, the majority of which require energy inputs to function. Economists and lay people alike admire the spark of human invention, but conveniently overlook the actual fuel that powers them.
Soddy was appalled at the overtly supernatural basis of wealth employed by neoclassical economists. This can be traced back to the influence of Jeremy Bentham and his concept of utility. But the notion of utility is a purely subjective phenomenon that occurs in the minds of people, not in the real world. Economists chose to define wealth by wants and desires alone, as measured by the market price. If this were true, then wealth would only be constrained by human willpower, as the mere act of creating desire can generate wealth. This may sound appealing to us, that we humans have enormous internal powers of creation, but Soddy rightly declared this to be logically absurd, counter to experience and in contravention of the laws of physics :
“Real wealth rots and rusts, whilst debts multiply by the laws of compound interest”.
What baffled Soddy most was why, with the advent of scientific progress, debts were actually growing, and wealth was not more widely distributed:
”Has progress provided for the redemption of debts, or the multiplication of it?” Wealth….. p101
This was symptomatic of some very obvious flaws in economics. Soddy rightly argued that the study of economics had been reduced to little more than the subject of trading, hence he frequently described it as Chrematistics (see http://en.wikipedia.org/wiki/Chrematistics), rather than flatter it with the term economics. This was because neoclassical economists had avoided and obfuscated the main responsibilities of economics, which was to explain the origins of absolute wealth, and to debate its fair distribution. Topics which once were the focus of classical economics (or political economy as it was known back then), but which were waylaid, even before his time. Soddy was quick to point out that holders of monetary claims only have purchasing power to acquire real assets as a result of social conventions. Real wealth cannot be stored in the same way that money can, so there is no guarantee of these claims being honoured.
To Soddy, real wealth has to obey the laws of physics whereas money and debts are merely important social constructs. Paradoxically, neoclassical economics seems to inhabit a parallel universe where wealth can be created at will, money is irrelevant, yet debts are a tangible reality!
On both the origins of wealth and the nature of money, his perceptiveness is timeless and still stands as a severe critique of neoclassical economics . I don’t claim that Soddy pioneered all these views, as many of his theories were clearly influenced by early economists such as the Physiocrat movement and the social criticism of John Ruskin (especially “Unto this last”). There are also echoes of American economists Henry George and Thorstein Veblen too. But he did synthesise a lot of critiques into one coherent framework. His impact on the mainstream has been minimal though, with only obscure pockets of heterodox economic schools following his line of thinking. So what went wrong?
Playing the man
Unfortunately for Soddy his foray into economic matters appeared to have prompted some vitriolic responses, with his obituary describing him as a crank and a heretic. It was rare for any coherent or plausible critique to be levelled at Soddy’s arguments:
“It was indeed a revelation to the author, accustomed to think of the battle for liberty of thought in scientific matters as having been fought and won centuries ago at the time of Galileo and the Inquisition, to find that in economics, as distinct from physics, it has not yet been won at all… If economics were really a science, it would not need to protect itself from criticism by a conspiracy of silence. A responsible criticism would in any scientific subject be met with instant response, and not by the ostrich policy of burying the head in the sand in the hope that that will thereby choke the ears and throw dust in the eyes of the pursuer also.” Wealth…..p292
Instead he suffered a similar fate to that of Nicholas Georgescu-Roegen, an establishment economist in the 1950s and 1960s who appears to have been excommunicated from the neoclassical priesthood in the 1970s for adopting similar theories of economic production grounded in physical reality. In both cases the response from the establishment was either to be ignored, or subjected to personal insults. But tellingly, never a direct attempt to critique his theory through logic or evidence.
This is a cheats method of debating, known in polite circles as Ad Hominem rhetoric, or in more down to earth language as “playing the man, not the ball”. This was nothing short of intellectual cowardice and downright bullying. Hardly the conduct of a mature scientific profession. It has been almost five years since a much clearer and plausible explanation of this crisis has been opened up to my eyes, yet it still feels like a constant battle to get these ideas accepted in academia, the media and the wider public. When I first saw the Crash Course series, it made a lot of common sense and was logically consistent and coherent. I could understand why the mainstream may not have heard of Chris Martenson, given his relative obscurity. But why was this same message, delivered some 90 years ago by a respected Chemist (the closest Britain has probably had to an Einstein) ignored and ridiculed?
The ultimate heresy
Perhaps Soddy’s ultimate heresy was to challenge the inherent power hierarchy of society. He argued that society should control money, not be controlled by it, and that humans should respect nature’s gifts and not overly exploit or squander them. Those were the absurd paradoxes of economics that Soddy did his utmost to try and correct. He cautioned us about our arrogance and explained that our energy dowry, ultimately from sunshine, was the root of our wealth. Finally he dedicated his later life towards promoting a basis for money that didn’t render people as blindly subservient to it. As Ruskin had warned beforehand, to the effect “Now, as he was sinking, had he the gold? Or had the gold him?”.
Soddy’s message delivers some uncomfortable truths about who we are (we are subservient to nature, not omnipotent), and what we can aspire to (we can’t build an economy on get rich quick schemes, so forget about flipping that house, winning the National Lottery, or trying your luck on TV Talent shows). He had clearly pointed out the absurdity of everyone trying to live off the interest from savings. Certainly one group could achieve this, but it would be foolish to think that a whole society can expand its purchasing power in aggregate by the same method. Perhaps most of us are hardwired to believe in the fairytale of perpetual profit and infinite growth. Not only were Soddy’s views deeply unpalatable to the existing power structure of society, but they probably cut against the grain of human instinct, too.
The cult of economics
Economics purports to be an objective and purely neutral science. Yet it clearly fails on both counts. It certainly is not an inclusive subject (outsiders are regularly shunned), nor is it a true science in that it rarely provides testable hypotheses. Even more disconcertingly it actually operates as a Trojan Horse for justifying morally reprehensible decisions and outcomes (e.g. the privatisation of public assets, austerity policies that disproportionately affect the poor, tolerating rising income inequality, etc.). It is in fact an illogical and deeply immoral cult acting as a propaganda machine for certain (already) wealthy interests. The fact that it preys on our inbuilt desires and weaknesses to sneak these insidious theories past us, suggests an even greater deviance. We have trusted them with managing vitally important aspects of our society, and they have wholeheartedly abused that trust.
As Soddy poetically decried:
”We had kings of nations and captains of industry. The captains and the kings depart, leaving us emperors of debt, rulers and regulators of commerce, controllers of the fortunes of States, for whom the one world is too small, and the whole universe capable of assuaging only for a moment an infinite thirst.” Wealth….. p100
Sadly, the ability of this earth to satisfy that infinite thirst is diminishing. Which leaves us with the final paradox of economics. It could know better; and it should know better. The story of Frederick Soddy’s foray into the realm of economics highlights how the central canon has been repeatedly warned of its flaws. But not by chance or incompetence did it ignore these criticisms. The reason it keeps its head in the sand is because the current dogmatic worldview serves specific individuals’ interests. Economics has a lot of dirty secrets, and one by one they are coming home to roost.
 This topic was taken up in the post Money Makes Our Heads Go Round (http://www.golemxiv.co.uk/2012/11/money-makes-our-heads-go-round-guest-post-by-hawkeye/) which gives a detailed exposition of this stance, and it’s slow but steady acceptance within certain areas of academia and regulatory practice.
 The post Slippery Grip of Growth (http://www.golemxiv.co.uk/2013/03/the-slippery-grip-of-growth-guest-post-by-hawkeye/) provides an extensive overview of why the neoclassical basis of growth is flawed. Limitations are constrained by physical resources, no matter how much human ingenuity we have, if there is nothing that can be exploited at an energetic profit, then we’re not going to continue our recent (200 year) good fortune.
 For more detail on the economic writings of Soddy, there are some very good articles. This NY Times Op-Ed by Eric Zency was one of my first tastes of Soddy’s economics:
This piece by Herman Daly is quite detailed:
And his inaugural lectures on economics, entitled “Cartesian Economics” are transcribed (although with Typos) in this link: