More on what I call exponentiality and why understanding its implications is critical to everyone's economic well-being.
The math is good enough for me. Even if it is 75% correct, exponentiality will get ya if you don't understand it and don't make provisions for it. We are on the upward rise of it after a long flat period:
Exponential Money in a Finite World (Part 1) by Chris MartensonSubmitted by Rob Williams on Fri, 08/29/2008 - 11:00am.
The greatest shortcoming of the human race is our inability to understand the exponential function.
-- Dr. Albert Bartlett
Within the next 20 years the most profound changes in all of economic history will sweep the globe. The economic chaos and turbulence we are now experiencing are merely the opening salvos in what will prove to be a long, disruptive period of adjustment. Our choices are to either evolve a new economic model that is compatible with limited physical resources or risk a catastrophic failure of our monetary system – and with it, the basis for civilization as we know it today.
In order to understand why, we must start at the beginning.
While it was operating well, our monetary system was a great system, one that fostered incredible technological innovation and advances in standards of living, two characteristics I fervently wish to continue. But every system has its pros and its cons, and our monetary system has a doozy of a flaw.
It is this: our monetary system must continually expand, forever.
The US/world monetary system was designed and implemented at a time when the earth’s resources seemed limitless, and so few gave much critical thought to the implications that every single dollar in circulation was to be loaned into existence by a bank with interest. In fact most thought it a terribly “modern” concept, and most probably still do.
Anything that is continually expanding by some percentage amount, no matter how minuscule, is said to be growing geometrically, or exponentially. Geometric growth can be seen in this sequence of numbers (1, 2, 4, 8, 16, 32, 64) while an arithmetic growth sequence is (1, 2, 3, 4, 5, 6, 7). In 1798 Thomas Malthus postulated that human population’s geometric growth would, at some point, exceed the arithmetic returns of the earth, principally in the arena of food. To paraphrase, he recognized that the exponential growth of human numbers would meet with the constraints imposed by a finite world.
As seen in the chart below, human population is growing exponentially and is on track to reach 9.5 billion by 2050. To put this in perspective, it was only in 1960 that the world first passed 3 billion in total population, the same amount that is projected to be added over the next 42 years. Each new person places additional demands on food, water, energy and other finite resources.
In parallel with exponential population growth, our monetary system is also exhibiting exponential behavior. Consider this evidence:
1) Money supply growth (see chart above). It took us from 1620 until 1973 to create the first $1 trillion of U.S money stock (measured by adding up every bank account, CD, money market fund, etc). The sum of all the roads, factories, bridges, schools, and houses built, together with every war fought and every other economic transaction that ever took place over those first 350 years, resulted in the creation of $1 trillion in money stock [1]. The most recent $1 trillion? That has been created in only 4.5 months. The dotted line in the chart is an idealized exponential curve, while the solid line is actual monetary data. The fit is nearly perfect (with a correlation of 0.98 for those interested). Data from the Federal Reserve.
2) Household debt has doubled in only seven years, growing from $7 trillion to $14 trillion. It is a stunning turn of events. Have household incomes also doubled in seven years? No, not even close; they have grown less than half as much, calling into question how these loans will be repaid, let alone doubled again. Data from the Federal Reserve.
3) Total credit market debt (that’s all debt) had finally exceeded $5 trillion by 1975, but has recently increased by $5 trillion in just the past two years, and now stands at nearly $50 trillion. In order for the next 20 years to resemble the last 20 years, debt would have to expand by another three to four times, to $150 trillion to $200 trillion. How likely do you think this is? Data from the Federal Reserve.
How do we make sense of money numbers this large and growing this fast? Why is this happening? Could it be that the U.S. economy is so robust that it requires monetary and credit growth to double every six to seven years? Are U.S. households expecting a huge surge in wages to be able to pay off all that debt? If not, then what’s going on?
The key to understanding all three of the money and debt charts above was snuck in a several paragraphs ago: every single dollar in circulation is loaned into existence by a bank, with interest.
That little statement contains the entire mystery. As improbable as it may sound to you that all money is backed by debt, it is precisely correct, and while many of you may struggle with the concept, you’ll be in good company. John Kenneth Galbraith, the world famous Harvard economist said, “The process by which banks create money is so simple that the mind is repelled” [2].
Here’s how money (and debt) creation works. Suppose we wipe the entire system clean and start over so that we can more easily understand the process. Say you enter the first (and only) bank and receive the very first loan for $1,000. At this point the bank has an asset (your loan) on the books, and you have $1,000 in cash and a $1,000 liability owed to the bank. After a month passes and the first interest accrues, we peek into the system and observe that the $1,000 in money still exists but that your debt has grown by the size of the interest (let’s call that $10). Now your total debt to the bank is $1,000 plus the $10 interest – or $1,010 in total.
Since there’s only $1,000 floating around – and that’s all there is – clearly there’s not enough money to settle the whole debt. So where will the required $10 come from? In our system it must be loaned into existence, taking the form of $10 of new money plus $10 of new debt that must also be paid back with interest.
But if our system requires new and larger loans to enable the repayment of old loans, aren’t we actually just compounding the total amount of debt (and resulting money) with every passing year? Yes, that is precisely what is happening and the three charts supplied above all provide confirmation of that dynamic.
In other words, our monetary system, and by extension our entire economy, are textbook examples of exponential systems. Yeast in a vat of sugar water, predator-free lemming populations, and algal blooms are natural examples of exponential growth. Plotted on graph paper the lines tracking these populations start out slowly, begin to rise more quickly and then, suddenly, shoot almost straight up, yielding a shape that resembles a hockey stick.
The key feature of exponential functions that our species desperately needs to understand is illustrated in this next example. [3]
Suppose I had a magic eyedropper that could dispense a drop of water with a most unusual trait – it will double in size every minute – and I place a drop of water in your hand. At first you’d just have a lonely drop of water sitting in your hand, but after one minute it would double in size, and after six minutes you’d have a blob of water that could fill a thimble. Now follow me to Fenway Park, where I am going to place a drop from my magic eye dropper on the pitcher’s mound at 12 p.m. on January 1st of 2008. To make this more interesting, let’s assume that the park is water tight and that I’ve handcuffed you to the highest row of bleacher seats. Way down there, on the mound, I bend over and plop a magic drop of water so small you could not possibly see it from where you are sitting, and it begins to double. My question to you is, at what date and at what time would the park be completely filled? That is, how long do you have to escape from your handcuffs? Days? Weeks? Months? Years?
The answer is this: you have until 12:49 p.m., on that same day, before the park is completely filled. You have only 49 minutes to escape your handcuffs. And at what time do you suppose that the park is still 97 percent empty space (and how many of you will appreciate the seriousness of your predicament)? The answer is that at 12:45 p.m. the park is still 97 percent unfilled. The first 45 minutes filled just 3 percent of the park, while the last four minutes filled the remaining 97 percent.
All of history to reach three billion humans; only 42 years to add another three billion.
That’s why we need to appreciate exponential functions. For quite a while everything seems just fine, and a few minutes later your park is overflowing. Time runs out in a hurry towards the end of any exponential growth system, forcing hurried decisions and limited options.
The constraint: finite resources
So how does this pertain to our economic problems, and why should you care? The truth is there’s nothing inherently wrong with exponential growth as long as you have unlimited room and resources. However, there are clear signs that several key resources on our planet are in their final minutes, to use our Fenway Park example.
None of these are more important than crude oil. “Peak oil” is the global extension of the observation that individual oil fields, without exception, produce slightly more oil each year up to a point (“the peak”), after which they produce incrementally less and less oil each year until their economics force abandonment. It is a fact that the U.S. hit its peak of oil production in 1970 at approximately 10 million barrels a day and now produces barely more than five million barrels a day. It is now widely recognized that oil is a finite resource – and another cold, hard fact is that global oil discoveries peaked some 45 years ago. Because discoveries precede production (you’ve got to find it before you can pump it) we can be certain that production will peak too. We might disagree over the timing, but not the process.
I’m focusing on oil because energy drives an economy, not the other way around. The engine of any economy is energy; money is merely the lubricating oil. Without energy, no amount of additional money would make the slightest difference in our lives. Economists love to say that higher oil prices will stimulate new oil production, as if demand could magically create supply. (Joke: If you lock three economists in a basement they won’t worry about starving because they know their grumbling bellies will soon cause sandwiches to appear.) But just as there no amount of additional price hikes will cause more cod to come from the depleted oceans, so too are oil fields subject to the laws of depletion.
And here’s where the enormous design flaw comes into the story. As Meadows et al in The Limits to Growth (1972) brilliantly predicted, we humans are now encountering physical, resource-constrained limits to our economic and population growth. On the one hand we have a monetary system that, by its very design, must expand exponentially in order to merely operate, while on the other hand we live on a spherical planet with finite resource limits.
When we started our exponential monetary system, initiated by the Bank of England around 1700 but kicked into high gear in 1971 with the international abandonment of gold settlement, nobody ever thought that the day would come that we’d find our ballpark filled nearly to the brim. Who ever thought that oil production would hit a limit? Who knew that every acre of arable land, and then some, would someday be put into production? How could we possibly fish the seas empty? Yet all of these things have come to pass, and our monetary system demands that even more follow.
This is clearly an unsustainable arrangement. Someday soon it will cease to be.
Repeating an opening sentence, our choices now are to either evolve a new economic model that is compatible with limited physical resources, or risk a catastrophic failure of our monetary system and with it the basis for civilization as we know it today. I wish this collision between a finite planet and an exponential money system was far off in the future. Alas, it is certainly within the lifetime of people alive today, and likely already upon us.
We are leaving a legacy of debt to our children, born and unborn. Just as the direct printing of money favored by Weimar Germany in the 1920s destroyed German’s purchasing power, so too does America’s debt accumulation promise to ruin our economy. Thus the moral argument beneath exponential growth in a finite context is, should one generation consume beyond its means and either expect or hope that the next generations will somehow pick up the tab?
Because our economic model and our entire system of money enforce a doctrine of limitless growth, they have become anachronisms incompatible with the well-being of the planet on which we live and depend. Our global money system might be complicated, and it might be sophisticated, but it is soon to be a vestige of the past.
Your job, your savings, your investments, and your future prospects and standard of living depend on the continuation of an unsustainable system now drawing to a close. You owe it to yourself to get ahead of the immense changes that are coming like water roiling up the steps towards the bleacher seat in which you sit.
Next time (Part 2): We’ll use this understanding of our monetary system to examine where we are, and solutions that you and your community should consider before the system collapses. Remember, the end of one thing is always the beginning of another.
[1]Having trouble picturing a trillion? Think of it this way: if you had a single thousand dollar bill you could have a pretty good night on the town with your friends. If you had a stack of thousand dollar bills that was four inches high you’d be a millionaire. If you had a stack 10 inches high you be worth $10 million. How high would your stack have to be in order for you to be a trillionaire? The answer is, a solid stack of thousand dollar bills 68.9 miles high.
[2] If you need more help on this concept, please visit chapters 7 & 8 of my free, on-line Crash Course at chrismartenson.com
[3] I gained a much deeper appreciation for the power of exponential functions from transcripts of speeches given by the mathematician Dr. Albert Bartlett. The following link goes to an exceptional example of his ability to make this complex subject startlingly clear. globalpublicmedia.com |
