The Global Debt Crisis: Money, Energy, and Limits to Growth

John Bradford, Ph.D.

What we really need is a change in the destructive social dynamics that brought us to this point. And I wish I knew how to do that. But my problem is obvious: Im an economist, and it seems that we need some kind of sociologist to solve our profession's problems.Paul Krugman (2011)

Presidential AddressEastern Economic Journal (2011) 37, 307312. doi:10.1057/eej.2011.8The Profession and the CrisisPaulKrugman

Overview

FundamentalsExponential Growth, What is Money?

Economic CrisisInequality, Debt and Finance, Banking 101

Energy CrisisPeak Oil, Limits to Growth

Overview

Summary:1. We cannot understand today's global economic crisis without understanding our ecological and energy crises. 2. A monetary and economic system based on the expectation of infinite, exponential growth cannot work in a finite world with limited resources.

I. Fundamental Concepts

Exponential Growth:
Population, Money, Oil

Exponential Growth occurs when the amount that something increases is proportional to its current size (or 'value').

Example: The more people there are, the more people will be born.

The rate or percentage increase may be constant.

Exponential Growth:
Population, Money, Oil

You cam think of Exponential Growth as SPEEDING UP.1. The amount that is added growing larger over each unit of timeOR

2. The time shrinking between each additional unit of amount added

Fundamentals: What is Money?

Money can be defined as a social relationship or as the object used to symbolize a social relationship.

The things we call money (coins, bills, checks, beads, etc.) are secondary in importance to the relationship they express.

Fundamentals: What is Money?

Aristotle: Money (nomisma) by itself is but a mere device. It has value only by law (nomos) and not by nature.Money is whatever people believe or treat as money! Money is an abstract social power; it is an unconditional means of payment defined by law.

What sort of relationship is symbolized by money?

MONEY = A CLAIM ON 'WEALTH' OR HUMAN LABOR. It symbolizes a relation of CREDIT AND OBLIGATION (i.e. DEBT)

Fundamentals: What is Money?

Summary: Money is credit. Credit is one end of a credit-debt relationship. Whoever has money is owed by society some quantity of labor or material wealth.Money is a claim on wealth, not wealth. Money represents the absence of wealth, not wealth itself!

=IOU

Fundamentals: What is Money?

Two Types of Money:1. Public Money = universally redeemable IOU issued by the state.2. Private Credit = IOUs which circulate as means of payment.

II. Economic Crisis

INEQUALITY

Wealth Concentration in the United States

Top 1 percentNext 19 percentBottom 80 percent

198333.8%47.5%18.7%

198937.4%46.2%16.5%

199237.2%46.6%16.2%

199538.5%45.4%16.1%

199838.1%45.3%16.6%

200133.4%51.0%15.6%

200434.3%50.3%15.3%

200734.6%50.5%15.0%

Distribution of net worth and financial wealthSource: Domhoff 2011

Financial Wealth in the United States

Top 1 percentNext 19 percentBottom 80 percent

198342.9%48.4%8.7%

198946.9%46.5%6.6%

199245.6%46.7%7.7%

199547.2%45.9%7.0%

199847.3%43.6%9.1%

200139.7%51.5%8.7%

200442.2%50.3%7.5%

200742.7%50.3%7.0%

Source: Domhoff 2011

Financial Wealth Distribution 2007

Source: Domhoff 2011

Income earned by the top 1%
(1970-2010)

Source: Picketty and Saez

Income earned by the top 1%
(1913-2006)

CEO and Worker Pay

CEOs' pay as a multiple of the average worker's pay, 1960-2007Source: Domhoff 2011

Income Inequality in Select Countries

Gini Coefficient

1. Sweden

23.0

2. Norway

25.0

8. Austria26.0

10. Germany

27.0

17. Denmark

29.0

25. Australia

30.5

34. Italy

32.0

35. Canada

32.1

37. France

32.7

81. China

34.0

82. Russia

41.5

90. Iran42.3

*93. United States44.5

Unemployment

DEBT

Exponential Debt Growth

Taken from Monthly Review 2008: Sources: Flow of Funds Accounts of the United States,

Financial Debt and Profits

Financial Debt and Profits

US Total Debt to GDP

Household Debt to GDP

Financial Debt to GDP

Financial Borrowing

In 1998 the total amount of financial borrowing exceeds the total possible. This is because in that year, the Flow of Funds accounts records that the Federal Government had a surplus of $52.6 Billion. This number is then deducted from the total, which equals $1005.5 Billion, compared to $1026.8 Billion in financial sector borrowing.

France

Germany

Greece

Iceland

Ireland

Portugal

Explaining Debt

Remember: borrowing implies a lender. Financial profits rose faster than average, as did financial debts.

Principle: To grow, banks must make more loans. Banks lend more money in order to make more money. To make more money, they ended up borrowing more money to lend, or lending borrowed money.

LEVERAGE = DEBT: Leverage measures the degree to which assets are funded by borrowed money.

Leverage and Bank Growth

Banks can make more money in three ways:Borrow at lower interest rates;

Charge higher interest rates;

Banks have little control over the first two. Competition between banks for funding enforces some uniformity of interest rates.

3. Make more Loans! (aka increase its Leverage)

Banking 101

Two Debates about Central Banks

Whether or not there should be a central, national bank.

Whether or not the central bank should be private or public.

These issues tend to get confused, but are in fact distinct. You should keep them separate in your mind.

Fractional Reserve Banking

Suppose you lend Bob $100, but require Bob has to give you back this money (or part of it) whenever you ask for it. Realizing you probably arent going to ask for more than $10 back, Bob keeps $10 and loans out the rest of the deposit to Jane.

Note: normally a 'loan' implies that the lender gives up the right to use the item being loaned! This is not the case here.

Bob the BankDepositorBorrower

You lend the bank $100.

Bob keeps $10, but lends out the rest of the $90.

Bank Runs

Because the bank only has 10 percent of its total deposits on reserve, it necessarily cannot redeem all deposits at the same time. A mass withdrawal by depositors is called a bank run. When a bank run happens, the demands for cash exceed the bank's ability to pay, and if the bank cannot raise enough money, the bank becomes insolvent.

THE BANK'S POTENTIAL LEGAL OBLIGATIONS TO PAY ALWAYS EXCEED ITS ACTUAL ABILITY TO PAY AT ANY MOMENT. Bank Runs are an inherent risk of fractional reserve banking.

Bob the BankDepositorBorrower

Bank owes you $100, whenever you want it.

Borrower owes bank $90 + 10% interest, in 1 year.Bank runs are so called because prior to the introduction of federal insurance people would literally run to the banks to withdraw their holdings.

Shadow Banking
(aka Securitized Banking)

IOUs from other people become a store of value and are traded as money.

Banks sell (trade) these IOUs; lend these IOUs; and borrow against IOUs, (i.e. use IOUs as collateral).

IOUCurrency=

Securitized Banking
(selling and lending loans)

Think of securities as IOUs that are in turn traded and passed along, as in a game of hot potato.

Securitized Banking
(selling and lending loans)

Debt is sold to larger banks.

These Banks then can either sell these loans again, or they can borrow against them in repurchase agreements

Loan sales increased, but most were retained

The 'Bank Run' of 2007-8

The financial panic of 2007-8 was essentially a bank run in these repo markets

IOUs circulated around as money. Banks that purchased these IOUs (e.g. MBSs) borrowed against them in short-term contracts, using them as collateral to borrow cash.

Like a mortgage, this is securitized lending, because putting up collateral makes it less risky or more secure (contra the Commercial Paper market).

The 'Bank Run' of 2007-8

When the value of these securities dropped, because people stopped making their mortgage payments, this (loan to value ratio) was not met.

Lenders demanded that they be paid back, or else be given more collateral, i.e. more securities.

This is basically a mass withdrawal on the debtors who had to find more securities or sell them to raise more money. The sale in turn caused the prices of these securities to decline even further!

How money is created

"The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. The process by which banks create money is so simple the mind is repelled. With something so important, a deeper mystery seems only decent.John Kenneth Galbraith

(1908 2006)

Where does our Money come from?

In the US, the Federal Reserve prints Federal Reserve notes which function as legal tender or fiat money.

This money essentially represents debt to the Fed, to be explained below

US coins, however, are produced by the US Treasury, and do not represent debt to private banks.

Where does money come from?

Two Steps:The Fed creates all new money as debt, from thin air.

Private banks then take this new money and create 10x this amount through fractional reserve banking. This process is called the money multiplier process.

How new money is created by the Federal Reserve (in US)

US TreasuryThe Fed

IOUs (Bonds)Federal Reserve prints money, from nothing, and pays Treasury.Money as Debt

TreasuryFederal Reserve and other Private Banks

US Treasury sells bonds. (T-Bills)In exchange for money now, Treasury gives IOUs, to pay back this money, plus interest.IOU

CashWhatever bonds the other banks do not purchase, the Federal Reserve purchases. The Federal Reserve can exercise a power that the Treasury cannot: it can simply print the money from nothing! But it creates this money as debt.How new money is created by the Federal Reserve (in US)

Money Creation...

Money Multiplier ProcessThe bank, having received the deposits, now lends the new money it has borrowed. Because the newly circulated money also eventually ends up in a bank, the amount of money created from an initial deposit by the Fed is a multiple of the original amount. This is called the money multiplier process.

Money Creation...

Money Multiplier ProcessThe money multiplier is the inverse of the reserve ratio. If the reserve ratio is 10 percent, for instance, then the money multiplier will be 1/.10=10. This factor will be multiplied by the amount of money initially put into circulation to derive the total amount of money that is eventually generated from this amount. For example, a $10,000 loan from the Fed eventually generates $100,000 of new money.

Money as Private Credit

Today, new money (i.e. credit) is primarily loaned into existence by private banks. This establishes monetized relationships of credit and obligation: we are the debtors, the banks are the creditors.

Principal (original amount owed)New money created=In all major economies, the vast majority of money is created by private banks as debt through the fractional reserve system. In the US, all new money is created by private banks, as debt.

Money as Private Credit

Because of the application of interest, total debt will always exceed the size of the existing money supply.

Interest accumulates exponentially!

TOTAL DEBT(Principal + Interest) Money(amount that can be used to pay off debts)