October 13, 2008 Posted by nate hagens on October 13, 2008 - 10:08am
Professor Daly's thoughts on the current (2008) crisis
(current being defined as last 30-40 years or so)
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. The 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
pramiding of financial assets on the the already multip[lied 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 commerncal 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
Professor Daly was Senior Economist at the World Bank before leaving to teach Ecological Economics
at University of Maryland's School for Public Policy.
Nate Hagens also observed that Professsor Daly was the catalyst for him to leave his
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).
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).
The text being discussed is available at
For comparison, here are links to what 'mainstream' economic icons George Soros, and Bill Gross are saying.