Money and Energy
Posted by Pete Hague on 09 Feb 2012
Today's blog post is a version of a piece I made for the Pod Delusion back in December. It was a reaction to George Osborne's autumn statement, which was pretty much bleak news all the way. The UK economy was, and still is, grinding to a halt and is under performing previous predictions by quite a large margin.
One of the government's chosen method of getting the economy moving again involves underwriting loans to businesses. Apparently, this "credit easing" was supposed to work where quantitative easing failed and restart the UK economy. I had some concerns about this.
As far as my limited knowledge of economics goes, quantitative easing and credit easing share the same underlying principle - you create new money (either centrally in the case of quantitative easing or via a bank in the case of credit easing) and lend it to businesses. With this money they add value to the economy, which offsets to a lesser or greater extent the inflation you would get if you just had more money chasing the same value. Money creation is a carrot provided to motivate people to add value.
This isn't a new idea at all really; money creation goes on at a certain level all the time and in all western economies - it only here and now becomes a government policy because they want to enhance the effect in order to get our stalled economy moving again.
Rather than look at this from the point of view of economics, I want to look at it from the point of view of physics. Our economy can be modelled as a heat engine. We take an input of raw energy, apply process to it, and get useful stuff out at the end, as well as some waste products and heat. To add value to the economy, we need to increase the amount of stuff we are outputting - either by increasing the level of input, or by increasing the efficiency.
But there is more to economics than physical processes. Many transactions go on without having any significant effect on our economic engine at all, they just move money around. Thankfully, a valid physical analysis is possible without worrying about non-physical transactions, as will become clear shortly.
If a physical process wants to keep pace with the expanding money supply, it has to grow at the same rate. Lets assume the money supply expanding at 5% (see here for an example of some 'real world' numbers) - that means a it doubles in approximately 14 years, as must any process that adds enough value to make such an expansion worthwhile. Our chosen method of economic stimulation demands that our economic output is subject to exponential growth.
This shows why we don't need to worry about the non-physical sector; the sum of two or more exponential growth terms tends, as time passes, to equal the largest of those terms with the others becoming insignificant. So whilst there is a balance to be found between the physical and non-physical, and that balance can even be changed, the two cannot be set on separate, divergent tracks without tending towards a clearly absurd state where the economy is entirely dominated by one or the other. Each must independently track the increasing money supply over the long term, or vanish.
So, what happens if we try to grow our output exponentially? Taking a global view (so I don't have to worry about physical output being located in a different country from where it generates economic value) we are approaching peak oil within the next couple of decades, at the most conservative estimate. A levelling off of new discoveries precedes a price peak, and that is almost certainly underway already given the very marginal fossil fuel sources that are now being seriously considered for exploitation. To expect our energy input to not only not decline, but to double, over the next 14 years is not very realistic. Even if you could take the most optimistic projections, and have global energy consumption double on that timescale - could you seriously make it double again over the following 14 years? Or double a third time? If you think the world could operate at this level of energy growth in the run up to peak oil and with no serious replacement for fossil fuels in the pipeline, please show your working.
We are left with efficiency then. How far can that take us? Considering that, historically, energy input growth has not necessarily tracked money supply growth that well, efficiency increases must have done us pretty well so far. But we require exponential growth. If a process is 1% efficient, you can double that efficiency 6 times before you would not be able to double it again without exceeding 100% efficiency and violating the first law of thermodynamics. You would violate the second law of thermodynamics one or two doublings earlier, but where that happens is dependent on the specifics of the process used, and I don't need to go into that much detail to prove my point.
Even from the very low starting point of 1% efficiency, efficiency gains can only supply 84 years of growth at the rate I have stated. Starting from 10% you only get 3 doublings, or 42 years of growth. These limits are on timescales that we have to worry about, especially as for many aspects of our physical economy, such as transportation, we are not starting at these low levels of efficiency.
We could have, overall, a low enough level of thermal efficiency in our physical economy to have decades of growth still available - or we might not. Growing the economy by creating credit to incentivise people to increase output does not provide any mechanism at all that is sensitive to where we are in the lifetime of our efficiency-enabled growth or our input-enabled growth. At some point, this method has to stop working, and before that it will become less effective as both input and efficiency tend towards their asymptotic values. Technical innovations and new resources can only buy us small amounts of time, and neither are by any means guaranteed.
I don't have that much understanding of economics - but I don't need to. Economic factors can adjust the balance between physical and non-physical elements, they can redistribute value between different nations, companies and individuals, and cause short term variations that go against the overall trend, but that does not alter the fact that this overall trend is towards an inability of our physical systems to respond to economic stimuli.
Note that this does not apply only to any one particular school of economics; any attempt to create growth using monetary incentives is ultimately doomed in the long run because the systems that need to grow are subject to physical limits that abstract economic systems are not. No incentive, no matter how large, can induce an enterprise to violate the laws of thermodynamics.
In the autumn statement, the UK chancellor announced his intention to continue to use money to drive growth. I can't honestly say, based on my fairly simple analysis, if this is going to work or not - but I can say that one day it will not work, that as we approach that day it won't' work as well, and that the more it is used, the faster we approach that day by exhausting our options for physical growth.
As an addendum, since that edition of the Pod Delusion went out, credit easing has apparently failed and the Bank of England has been trying some more quantitative easing - almost as if the people running the country don't listen to (or pay attention to) skeptical podcasts. For shame!
It is also worth mentioning, that if you are interested in this kind of physics-based analysis, this blog by Tom Murphy has some interesting articles on similar matters.