The following is an excellent excerpt from the book “CURRENCY WARS: The Making of the Next Global Crisis” by James Rickards from Chapter 10 “Currencies, Capital and Complexity” on page 218 and I quote: “Complexity, Energy and Money – To see the implications of this for macroeconomics and capital markets, begin with the understanding that money is stored energy. The classic definition of money includes the expression “store value,” but exactly what value is being stored? Typically value is the output of labor and capital, both of which are energy intensive. In the simplest case, a baker makes a loaf of bread using ingredients, equipment and her own labor, all of which use energy or are the product of other forms of energy. When the baker sells the loaf for money, the money represents the stored energy that went into making the bread. This energy can be unlocked when the baker purchases some goods or services, such as house painting, by paying the painter. The energy in the money is now released in the form of the time, effort, equipment and materials of the painter. Money works exactly like a battery. A battery takes a charge of energy, stores it for a period of time and rereleases the energy when needed. Money stores energy in the same way.
This translation of energy into money is needed to apply Chaisson’s work to the actual operation of markets and society. Chaisson deals at the highest macro level by estimating the total mass, density and energy flow of human society. At the level of individual economic interactions within society, it is necessary to have a unit to measure Chaisson’s free energy flows. Money is the most convenient and quantifiable unit for this purpose.
The anthropologist Joseph A. Tainter picked up this thread by proposing a related yet subtler input-output flow analysis that also utilizes complexity theory. An understanding of Tainter’s theory is also facilitated by the use of the money-as-energy model.
Tinter’s specialty is the collapse of civilizations. That’s been a favorite theme of historians and students since Herodotus documented the rise and fall of ancient Persia in the fifth century BC. In his most ambitious work, The Collapse of Complex Societies, Tainter analyzes the collapse of twenty-seven separate civilizations over a 4,500-year period, from the little-known Kachin civilization of highland Burma to the widely known cases of the Roman Empire and ancient Egypt. He considers an enormous range of possible factors explaining collapse, including resource depletion, natural disaster, invasions, economic distress, social dysfunction, religion and bureaucratic incompetence. His work is a tour de force of the history, supposed causes and processes of civilizational collapse.
Tainter stakes out some of the same ground as Chaisson and complexity theorists in general demonstrating that civilizations are complex systems. He demonstrates that as the complexity of society increases, the inputs needed to maintain society increase exponentially—exactly what Chaisson would later quantify with regard to complexity in general. By inputs, Tainter refers not specifically to units of energy the way Chaisson does, but to a variety of potentially stored energy values, including labor, irrigation, crops and commodities, all of which can be converted into money and frequently are for transactional purposes. Tainter, however, takes the analysis a step further and shows that not only do inputs increase exponentially with the scale of civilization, but the outputs of civilizations and governments decline per unit of input when measured in terms of public goods and services provided.
Here is a phenomenon familiar to every first-semester microeconnomics student—the law of diminishing returns. In effect, society asks its members to pay progressively more in taxes and they get progressively less in government services. The phenomenon of marginal returns produces an arc that rises nicely at first, then flattens out, and then declines. In this thesis, the familiar arc of marginal returns mirrors the arc of the rise, decline and fall of civilizations.
Tainter’s main point is that the relationship between people and their society in terms of benefits and burdens changes materially over time. Debates about whether government is “good” or “bad” or whether taxes are “high” or “low” are best resolved first by situating society on the return curve. In the beginning of a civilization, returns to investment in complexity, usually in the form of government, are typically extremely high. Relatively small investment of time and effort in an irrigation project can yield huge returns in terms of food output per farmer. Short periods of military service shared across the entire population can yield huge gains in peace and security. A relatively lean bureaucracy to organize irrigation, defense and other efforts of this type can be highly efficient as opposed to ad hoc supervision.
At the beginning of civilization, the research budget for the invention of fire was zero, while the benefits of fire were incalculable. Compare this to the development costs of the next generation of Boeing aircraft relative to the small improvements in air travel. This dynamic has enormous implications for the presumed benefits of increases in government spending beyond some low base.
Over time and with increasing complexity, returns on investment in society begin to level off and turn negative. Once the easy irrigation projects are completed, society begins progressively larger projects covering longer conduits with progressively smaller amounts of water produced. Bureaucracies that started out as efficient organizers turn into inefficient obstacles to improvement more concerned with their own perpetuation than with service to society. Elites who manage the institutions of society slowly become more concerned with their own share of a shrinking pie than with the welfare of society as a whole. The elite echelons of society go from leading to leeching. Elites behave like parasites on the host body of society and engage in what economists call “rent seeking,” or the accumulation of wealth through nonproductive means—postmodern finance being one example.
By 2011, evidence had accumulated to show the United States was well down the return curve to the point where greater exertions by more people produced less for society while elites captured most of the growth in income and profits. Twenty-five hedge fund managers were reported to have made over $22 billion for themselves in 2010 while forty-four million Americans were on food stamps. CEO pay increased 27 percent in 2010 versus 2009 while over twenty million Americans either were unemployed or had dropped out of the labor force but wanted a job. Of Americans with jobs, more worked for the government than in construction, farming, fishing, forestry, manufacturing, mining and utilities combined.
One of the best measures of the rent seeking relationship between elites and citizens in a stagnant economy is the Gini coefficient, a measure of income inequality; a higher coefficient means greater income inequality. In 2006, shortly before the recent recession began, the coefficient for the United States reached an all-time high of 47, which contrasts sharply with the all-time low of 38.6, recorded in 1968 after two decades of stable gold-backed money. The Gini coefficient trended lower in 2007 but was near the all-time high again by 2009 and trending higher. The Gini coefficient for the United States is now approaching that of Mexico, which is a classic oligarchic society characterized by gross income inequality and concentration of wealth in elite hands.
Another measure of elite rent seeking is the ratio of amounts earned by the top 20 percent of Americans compared to amounts earned by those living below the poverty line. This ratio went from a low of 7.7 to 1 in 1968 to a high of 14.5 to 1 in 2010. These trends in both the Gini coefficient and the wealth-to-poverty income ratio in the United States are consistent with Tainter’s findings on civilizations nearing collapse. When society offers its masses negative returns on inputs, those masses opt out of society, which is ultimately destabilizing for masses and elites.
In this theory of diminishing returns, Tainter finds the explanatory variable for civilizational collapse. More traditional historians have pointed to factors such as earthquakes, droughts or barbarian invasions, but Tainter shows that civilizations that were finally brought down by barbarians had repelled barbarians many times before and civilizations that were destroyed by earthquakes had rebuilt from earthquakes many times before. What matters in the end is not the invasion or the earthquake, but the response. Societies that are not overtaxed or overburdened can respond vigorously to a crisis and rebuild after disaster, while those that are overtaxed and overburdened may simply give up. When the barbarians finally overran the Roman Empire, they did not encounter resistance from the farmers; instead they were met with open arms. The farmers had suffered for centuries from Roman policies of debased currency and heavy taxation with little in return, so to their minds the barbarians could not possibly be worse than Rome. In fact, because the barbarians were operating at a considerably less complex level than the Roman Empire, they were able to offer farmers basic protections at a very low cost.
Tainter makes one additional point that is particularly relevant to twenty-first-century society. There is a difference between civilizational collapse and the collapse of individual societies or nations within a civilization. When Rome fell, it was a civilizational collapse because there was no independent society to take its place. Conversely, European civilization did not collapse again after the sixth-century AD, because for every state that collapsed there was another state ready to fill the void. The decline of Spain or Venice was met by the rise of England or the Netherlands. From the perspective of complexity theory, today’s highly integrated, networked and globalized world more closely resembles the codependent states of the Roman Empire than the autonomous states of medieval and modern Europe. In Tainter’s view, “Collapse, if and when it comes again, will this time be global. No longer can any individual nation collapse. World civilization will disintegrate as a whole.”
In sum, Chaisson shows how highly complex systems such as civilizations require exponentially greater energy inputs to grow, while Tainter shows how those civilizations come to produce negative outputs in exchange for the inputs and eventually collapse. Money serves as an input-output measure applicable to a Chaisson model because it is a form of stored energy. Capital and currency markets are powerful complex systems nested within the larger Tainter model of civilization. As society becomes more complex, it requires exponentially greater amounts of money for support. At some point productivity and taxation can no longer sustain society, and elites attempt to cheat the input process with credit, leverage, debasement and other forms of pseudomoney that facilitate rent seeking over production. These methods work for a brief period before the illusion of debt-fueled pseudogrowth is overtaken by the reality of lost wealth amid growing income inequality.
At that point society has three choices: simplification, conquest, or collapse. Simplification is a voluntary effort to descale society and return the input-output ratio to a more sustainable and productive level. An example of contemporary systemic simplification would be to devolve political power and economic resources from Washington, D.C., to the fifty states under a reinvigorated federal system. Conquest is the effort to take resources from neighbors by force in order to provide new inputs. Currency wars are just an attempt at conquest without violence. Collapse is a sudden, involuntary and chaotic form of simplification.
Is Washington the New Rome? Have Washington and other sovereigns gone so far down the road of higher taxes, more regulation, more bureaucracy and self-interested behavior that social inputs produce negative returns? Are certain business, financial and institutional elites so linked to government that they are aligned in the receipt of outsized tribute for negative social utility? Are so-called markets now so distorted by manipulation, intervention and bailouts that they no longer offer reliable price signals for the allocation of resources? Are the parties most responsible for distorting the price signals also those receiving the misallocated resources? When the barbarians arrive next time, in whatever form, what is the payoff for resistance by average citizens compared to allowing the collapse to proceed and letting the elites fend for themselves?
History and complexity theory suggest that these questions are not ideological. Instead they are analytic questions whose relevance is borne out by the experience of scores of civilizations over five millennia and the study of ten billion years of increasing complexity in nature. Science and history have provided a complete framework using energy, money and complexity to understand the risks of a dollar collapse in the midst of a currency war.
What is most important is that the systems of immediate concern—currencies, capital markets and derivatives—are social inventions and therefore can be changed by society. The worst-case dynamics are daunting, but they are not inevitable. It is not too late to step back from the brink of collapse and restore some margin of safety in the global dollar-based monetary system. Unfortunately, the deck is stacked against commonsense solutions by the elites who control the system and feed at the trough of complexity. Diminishing marginal returns are bad for society, but they feel great for those on the receiving end of the inputs—at least until the inputs run dry. Today, the financial resources being extracted from society and directed toward elites take the form of taxes, bailout costs, mortgage frauds, usurious consumer rates and fees, deceptive derivatives and bonuses. As citizens are crushed under the weight of this rent extraction, collapse grows more likely. Finance must be returned to its proper role as the facilitator of commerce rather than a grotesque end in itself. Complexity theory points the way to safety through simplified and smaller-sized institutions. Incredibly, Treasury Secretary Geithner and the White House are actively facilitating a larger-scale and more concentrated banking industry, including a protoglobal central bank housed at the IMF. Any success in this endeavor will simply hasten the dollar’s denouement.”
Pg. 256 – “Conclusion – As applied to capital and currency markets, the correct approach is to break up big banks and limit their activities to deposit taking, consumer and commercial loans, trade finance, payments, letters of credit and a few other useful services. Proprietary trading, underwriting and dealing should be banned from banking and confined to brokers and hedge funds. The idea that large banks are needed to do large deals is nonsense. Syndicates were invented for exactly this purpose and are excellent at spreading risk.
Derivatives should be banned except for standardized exchange-traded futures with daily margin and well-capitalized clearinghouses. Derivatives do not spread risk; they multiply it and concentrate it in a few too-big-to-fail hands. Derivatives do not serve customers; they serve banks and dealers through high fees and poorly understood terms. The models used to manage derivatives risk do not work and never will work because of the focus on net risk rather than gross risk.
A flexible gold standard should be adopted to reduce uncertainty about inflation, interest rates and exchange rates. Once businesses and investors have greater certainty and price stability, they can then take greater risk on new investments. There is enough uncertainty in entrepreneurship without adding inflation, deflation, interest rates and exchange rates to the list of barriers standing in the way of innovation. The U.S. economy as guided by the Fed has seen continual asset bubbles, crashes, panics, booms, and busts in the forty years since the United States left gold. It is time to diminish the role of finance and empower the role of commerce. Gold produces the greatest price stability in prices and asset values and therefore provides the best visibility for investors.”
(LIKE THE AUTHOR SAID IN THIS BOOK ON PAGE 256 “DERIVATIVES SHOULD BE BANNED.” IT’S THE SAME THING HE SAID IN AN ARTICLE ON USNEWS.COM DATED JULY 16, 2012 TITLED “DERIVATIVES SHOULD BE BANNED FROM FINANCIAL MARKETS,” WHICH YOU CAN LOOK UP ON THE WEB. I’VE BEEN LOBBYING AGAINST DERIVATIVES WITH MY WISCONSIN LEGISLATORS FOR OVER 23 YEARS BEFORE THAT I WAS AGAINST JUNK BONDS THAT BROUGHT DOWN THE SAVINGS & LOANS. THESE SUBJECTS INTEREST ME BECAUSE I’M 80-YEARS-OLD AND GOT MY START THROUGH FHA (FARMERS HOME ADMINISTRATION) AS A SUCCESSFUL DAIRY FARMER WITH 10 PERCENT DOWN, WHICH I SAVED WHEN I WAS IN THE U.S. AIR FORCE AT A 5 PERCENT INTEREST RATE, WHICH I THOUGHT WAS FAIR AND GREATLY APPRECIATED THE OPPORTUNITY I WAS GIVEN BUT THIS IS NOT WHAT’S HAPPENING TODAY. I’M ATTEMPTING TO TELL MY STORY ON MY BLOG SITE AND I GREATLY APPRECIATE DEMOCRATIC SENATOR ELIZABETH WARREN OF MASSACHUSETTS, WHO IS ON THE SENATE BANKING COMMITTEE LOBBYING AGAINST DERIVATIVES, AS WELL AS INDEPENDENT SENATOR BERNIE SANDERS FROM VERMONT. MY COMMENT IS “I HOPE WE HAVE A FIGHTING CHANCE.” I HOPE WE NEVER SEE CURRENCY WAR IV.
LaVern Isely, Progressive, Independent, Overtaxed, Middle Class Taxpayer and Public Citizen and AARP Members