Commentary
This comment stream has many useful thoughts about the ideas of Professor Daly. They are a useful jumping off point for understanding the issue, and appreciating what it is we are trying to do with TrueValueMetrics. I met Professor Daly at a conference in January 2010 where he gave a keynote speach based more or less on the ideas of the Steady State Economy. My concern is that good ideas will never get traction unless they are paired with a system of metrics so that people are exposed to the key aspects of performance routinely in all aspects of their media expreience.
Peter Burgess

Herman Daly on the Credit Crisis, Financial Assets, and Real Wealth

Herman Daly: The Disconnection Between Financial Assets and Real Asssets (December 25, 2008) CFTC - Futures Position Limits on Energy? (July 8, 2009) From a Failed Growth Economy to a Steady-State Economy (June 6, 2009) Can We Redefine Prosperity? - Herman Daly - Towards a Steady State Economy (December 17, 2009) An Overlooked Detail - Finite Resources Explain the Financial Crisis (November 21, 2008)

152 comments | Comments can no longer be added to this story. [-] elzeard.bouffier on October 7, 2008 - 10:24am Permalink | Subthread | Comments top

A superb piece, thanks. [-] Gail the Actuary on October 7, 2008 - 11:33am Permalink | Subthread | Comments top

I am glad to hear Prof. Daly's remarks on how the credit crisis should be handled. If we get rid of fractional reserving, derivatives, and structured securities, it seems like there will be vastly less credit. Also, the payback of loans plus interest in a slowly growing economy will take a big chunk out of company's (and individual's) cash flow. Unless the loans are used for only the occasional very productive project, they will be a big drain on the economy.

I wonder how Prof. Daly would handle the transition. It seems like there would be a huge drop in GDP at the time this change takes place. The lower GDP will make it even more difficult to balance the trade deficit. [-] Paleocon on October 7, 2008 - 11:41am Permalink | Subthread | Parent | Parent subthread | Comments top

Gail, Doesn't your last statement imply we do one thing while the world does another? The best solution would seem to be for the world to do all the above.

I think trade imbalances will be primarily driven by the relative weighting of his last point -- how much bankruptcy versus how much inflation. This is really a critical question for each of us, as it affects where we should put our savings, whether into cash, commodities, or other equities.

I know food and tools, a house, and skills are always good bets, but beyond that it just isn't clear to me.

Anything in the financial sector seems like a very bad bet, in any case.

I could see a lower GDP will make the budget deficit and overall debt look a LOT worse, but wouldn't trade imbalance (for the US) be improved by a focus on tangible wealth generation like manufacturing?

The Oil Drum Revisiting an April 2007 Forecast Regarding The Connection Between Peak Oil and the Collapse of the Monetary System >

Topic: Economics/Finance

Tags: credit crisis, economics, herman daly, original, reserve requirements [list all tags]

Previously, Herman Daly wrote a guest post on the Steady State Economy, outlining core suggestions on how to overhaul our banking, financial (and value) systems. I encourage everyone to read it (if short on time, please read the conclusion). Professor Daly was Senior Economist at the World Bank before leaving to teach Ecological Economics at University of Maryland's School for Public Policy. He was also the catalyst for me to leave my own financial career and return to school to study the real economy (i.e. what we call the human economy is only a small part of a larger closed system). Below the fold are his thoughts on the current crisis (current being defined as last 30-40 years or so). (For comparison, here are links to what 'mainstream' economic icons George Soros, and Bill Gross are saying.)

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.

What allowed symbolic financial assets to become so disconnected from underlying real assets? First, there is the fact that we have fiat money, not commodity money. For all its disadvantages, commodity money (gold) was at least tethered to reality by a real cost of production. Second, our fractional reserve banking system allows pyramiding of bank money (demand deposits) on top of the fiat government‐issued currency. Third, buying stocks and “derivatives” on margin allows a further pyramiding of financial assets on top the already multiplied money supply. In addition, credit card debt expands the supply of quasi‐money as do other financial “innovations” that were designed to circumvent the public‐interest regulation of commercial banks and the money supply. I would not advocate a return to commodity money, but would certainly advocate 100% reserve requirements for banks (approached gradually), as well as an end to the practice of buying stocks on the margin. All banks should be financial intermediaries that lend depositors’ money, not engines for creating money out of nothing and lending it at interest. If every dollar invested represented a dollar previously saved we would restore the classical economists’ balance between investment and abstinence. Fewer stupid or crooked investments would be tolerated if abstinence had to precede investment. Of course the growth economists will howl that this would slow the growth of GDP. So be it—growth has become uneconomic at the present margin as we currently measure it.

The agglomerating of mortgages of differing quality into opaque and shuffled bundles should be outlawed. One of the basic assumptions of an efficient market with a meaningful price is a homogeneous product. For example, we have the market and corresponding price for number 2 corn—not a market and price for miscellaneous randomly aggregated grains. Only people who have no understanding of markets, or who are consciously perpetrating fraud, could have either sold or bought these negative pigs‐in‐a‐poke. Yet the aggregating mathematical wizards of Wall Street did it, and now seem surprised at their inability to correctly price these idiotic “assets”.

And very important in all this is our balance of trade deficit that has allowed us to consume as if we were really growing instead of accumulating debt. So far our surplus trading partners have been willing to lend the dollars they earned back to us by buying treasury bills—more debt “guaranteed” by liens on yet‐to‐exist wealth. Of course they also buy real assets and their future earning capacity. Our brilliant economic gurus meanwhile continue to preach deregulation of both the financial sector and of international commerce (i.e. 'free trade'). Some of us have for a long time been saying that this behavior was unwise, unsustainable, unpatriotic, and probably criminal. Maybe we were right. The next shoe to drop will be repudiation of unredeemable debt either directly by bankruptcy and confiscation, or indirectly by inflation.