Herman Daly on the Financial Crisis

The Oil Drum has an article by the ecological economist Herman Daly on the Credit Crisis, Financial Assets, and Real Wealth. Daly writes:

The current financial debacle is really not a “liquidity” crisis as it is often euphemistically called. It is a crisis of overgrowth of financial assets relative to growth of real wealth—pretty much the opposite of too little liquidity. Financial assets have grown by a large multiple of the real economy—paper exchanging for paper is now 20 times greater than exchanges of paper for real commodities. It should be no surprise that the relative value of the vastly more abundant financial assets has fallen in terms of real assets. Real wealth is concrete; financial assets are abstractions—existing real wealth carries a lien on it in the amount of future debt. The value of present real wealth is no longer sufficient to serve as a lien to guarantee the exploding debt. Consequently the debt is being devalued in terms of existing wealth. No one any longer is eager to trade real present wealth for debt even at high interest rates. This is because the debt is worth much less, not because there is not enough money or credit, or because “banks are not lending to each other” as commentators often say.

Can the economy grow fast enough in real terms to redeem the massive increase in debt? In a word, no. As Frederick Soddy (1926 Nobel Laureate chemist and underground economist) pointed out long ago, “you cannot permanently pit an absurd human convention, such as the spontaneous increment of debt [compound interest] against the natural law of the spontaneous decrement of wealth [entropy]”. The population of “negative pigs” (debt) can grow without limit since it is merely a number; the population of “positive pigs” (real wealth) faces severe physical constraints. The dawning realization that Soddy’s common sense was right, even though no one publicly admits it, is what underlies the crisis. The problem is not too little liquidity, but too many negative pigs growing too fast relative to the limited number of positive pigs whose growth is constrained by their digestive tracts, their gestation period, and places to put pigpens. Also there are too many two‐legged Wall Street pigs, but that is another matter.

Growth in US real wealth is restrained by increasing scarcity of natural resources, both at the source end (oil depletion), and the sink end (absorptive capacity of the atmosphere for CO2). Further, spatial displacement of old stuff to make room for new stuff is increasingly costly as the world becomes more full, and increasing inequality of distribution of income prevents most people from buying much of the new stuff—except on credit (more debt). Marginal costs of growth now likely exceed marginal benefits, so that real physical growth makes us poorer, not richer (the cost of feeding and caring for the extra pigs is greater than the extra benefit). To keep up the illusion that growth is making us richer we deferred costs by issuing financial assets almost without limit, conveniently forgetting that these so‐called assets are, for society as a whole, debts to be paid back out of future real growth. That future real growth is very doubtful and consequently claims on it are devalued, regardless of liquidity.

7 thoughts on “Herman Daly on the Financial Crisis”

  1. I would argue that some level of perpetual growth is possible without an increase in resource consumption through improvements to productivity. Of course, improvements to productivity require investments in productivity, either public, private, or both. And our willingness to invest at any expected return is constrained by our tolerance for risk. So public policy that is designed to increase risk and reduce productivity (ie: the theocratic police-state feudalism of the modern conservative) has a predictable negative consequence on economic growth.
    Then again, some believe that feudalism is the desired result of free markets, while others believe that the demise of feudalism is the desired result of free markets. I personally believe the latter and am often wrongly accused of being a ‘socialist’ as a result. Keynes is rolling in his grave about now…

  2. @John Comeskey
    The argument about perpetual growth presumes a planet with infinite resources. This is not possible. Factor in that humans are probably worse than 22% efficient at best, relative to the amount of toxic waste we output, and things look even less promising.

  3. @BobR
    There are 2 ways to expand macro output:
    1. Move along the curve by expanding resource consumption (and thus drive up the aggregate price level through market forces)
    2. Shift the entire curve outward by improving productivity (and thus allowing greater output with fewer resource inputs)

    By definition, improvements to productivity mean that we enjoy more output while requiring fewer resource input. (Ie: We can do the same job in less time and with less material.) This not only expands macro output, but does it without exerting pressure on the price level – because the expansion is not based upon increased resource consumption.

    Perpetual growth is theoretically possible through perpetual productivity improvements. That is why Keynes accounted for shifts in the aggregate income function as a function of productivity.

  4. And IF we accept the argument that expanded resource consumption is the only way to grow, then we are allowing ourselves to be hamstrung by the conservative vision for a feudal economy.

    RESIST Theocratic Police-State Feudalism!!

  5. What happens at 100% efficiency? How do we grow more without becoming more efficient or consuming more resources?

  6. 100% efficiency? Seriously? If human beings ever get that far, then we’ll probably have figured out how to use birth control by then too. So I wouldn’t worry about that just yet…

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