Money & Wealth: Part I

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When talking about collapse issues one of the most prominent yet most commonly misunderstood areas comes with our basic understanding of what wealth and money really is. Both are seemingly simple matters yet upon closer inspection we find that are many nuances and subtleties in this story that people often miss. This misconception can even be extended to economists or people in finance that are well versed in money matters.

Indeed it is the complexity of money and all the financial products that derive from it with things such as bonds, stocks or other investment vehicles that can make us easily forget what wealth is really about. In fact it is this distraction through complexity that makes us commonly believe that wealth and money are one of the same things. It is useful to really grasp what wealth is lest we fall into a trap that many people, including the iluminati, who base much of their wealth in abstract financial instruments.

To understand wealth first we must realise that money only acts as a medium of exchange and by itself is not wealth. In addition to being a medium of exchange, money also acts as a means of measuring the relative value between various goods and services. This means of relative valuation while somewhat abstract is essential in any economy as the means of measuring relative values between goods/services becomes too complex without the use of money (for more information on this topic please refer to the Energy-Money Equilibrium series). These issues of valuation only become more prominent in international trade. Despite these obvious advantages all forms of money from fiat to even gold based currencies do not hold any intrinsic value by themselves. In other words we only place value in money because we can exchange items of value for it. In essence the value of money comes largely from the trust and faith that we have placed in it. This is even truer for fiat based currencies that cannot be redeemed for gold. If money cannot be exchanged for goods or services then any notional value money they have will disappear. For example if one was placed with a $1,000,000 and 1000 gold bars in a desert those forms of money would be of little use. You could not eat, drink or keep cool with this money and so without trade money would be utterly worthless perhaps even a burden and liability due to its weight and the danger it would pose against thieves by simply possessing them. From this simple example we can see that money has no value by itself and therefore cannot be counted as actual wealth. While this example may seem a bit silly the mechanics of money becoming worthless through hyperinflation work in the same dynamics.

However as noted money derives its value by the fact it can be exchanged for items of value so what we can say about money is that it is a claim on wealth. If we extend this claim concept a little bit further we can say that since debt is a claim on future income (money) then what debt really is a claim to a claim to wealth. That maybe a bit of convoluted way of expressing debt but if we wish to distil this last expression we can simply say that debt and money are both claims on the underlying wealth of an economy.

This all sounds nice and rather straightforward but it begs the question of what wealth actually is? Wealth can simply be expressed as the actual assets that a person owns for example a house, SUV, iPhone or other tangible items are all forms of wealth. As a side-note wealth is a measure of stock while money or income is measure of flow. This point while seemingly innocuous now will be an important concept to grasp as we progress further in this topic. As you see these tangible items – the items that society values – is the true wealth of an economy and the only role that money plays (which intrinsically has no value by itself) is it allows and facilitates the transfer of wealth between various agents in an economic system.

The other role money does play is it acts as a store of wealth so if we wish to store money then the money should be able to be exchanged at a later date for the same amount of wealth as if traded that day. At least this is what “sound money” should do. As we know due to the effects of inflation this proves not to be the case. However it is this issue of money acting as a store of wealth which leads to the first source of confusion between money and wealth. The means of wealth storage via money results in wealth being measured in monetary terms. The issue of measuring wealth through monetary values then leads to the point of determining how things are valued in the first place.

In modern economics the value or utility of any given item comes from the exchange value it has in a market. In other words the wealth of any item is only determined or realised once it has a value in the market which it can be sold for. While this may not seem like an issue, at least on first glance, this issue of exchange value does pose a problem. This is because there is a difference between exchange value (the value an item gets in the market) and use value (the value an item has to an individual or society). To illustrate the difference and problems posed by these differences of worth it is best to consider the age old concept of the diamond and water paradox. While water is a requirement for life and therefore has a high use value to people its exchange value is very low while a diamond; which is not needed at all for life and therefore has no or little use value has a high exchange value.

This is a curious development that comes from how our economic system places value on items. So what accounts for the difference? The reasons are actually quite easy to explain: water while highly useful has generally been abundant and easy to extract so even though its use value is high its exchange value has been low due to its abundance and easy extraction. Since the opposite is true for diamonds (it is rare and harder to extract) its exchange value has been high even though its actual use value is considerably lower.

The large discrepancy between use and exchange values generally occurs for many vital commodities such as food, air and most significantly energy resources. These differences in values have become more pronounced in recent years due to the abundances of energy in the last 200 years of the industrial revolution that have made not only energy cheap (from an exchange value standpoint) but have also made other resources such as food and water cheap as energy acts as an enabler of all other resources. For this reason energy can be regarded as the master resource. As a result of this phenomena it is likely we have grossly underestimated the wealth we have accumulated or perhaps in other cases (such as in fossil fuel depletion) we have grossly underestimated the wealth we have liquidated by only focussing on the exchange value of items and not their use value.

While this point may still seem to be of only academic interest it should be noted these very issues do tend to crop up in times of deprivation and economic dislocation when items in high demand are not bought as people do not have the means to pay the exchange or “going” rates. As a result while the use value of items such as food are still high; perhaps even higher in desperate times (people are more malnourished during these times) since people do not have the means to pay for the goods the exchange value will tend to be lower than in normal times. This leads to the paradoxical situation where the farmer produces a “surplus” of food even though there are millions of people malnourished or even starving. As a result of this “surplus” less food is produced (to cut losses from “overproduction”) which only further exacerbates the situation as there is even less food to go around. These issues can be extended to modern day equivalents when many lands in Africa maybe very fertile yet the amount of wealth is not as high as one would first believe as the exchange value or income ultimately determines the value and wealth of the land. It does not matter how much the people want food, the only thing that matters economically is what people are able to pay for the said food. On the other hand due to the flaws of this exchange value mechanism it can observed that an overweight person from a developed country will gain more utility (in a pure economic sense) from this food than a starving person because they can pay the exchange value and so wealth will transfer to this person as it delivers the greatest amount of utility from an economic standpoint even though the use value is obviously less. This issue is clearly not the best outcome from a social or moral standpoint and this example is a chief reminder of the flaws of the value system used in modern economics.

On this topic of land, the other important point can be made about wealth. That is fundamentally all wealth that we see in the planet comes from either the ecosystem of the Earth or the energy from the sun. Normally from a purely economic perspective we consider wealth as items such as factories, cars, roads or other items that have economic value. While such statements are indeed valid and can be correctly deemed as forms of wealth it is important to note that all these sources of wealth ultimately come from the Earth as they all require resource inputs such as oil, metals etc. to be formed. Therefore from this we can say the economic system that we live in today is actually part of the larger ecosystem and all the wealth we accumulate in the economy derives from the underlying ecosystem we live in.

As a result of this we can easily deduce that for the overall wealth of the human economy to grow it must come at the expense of the natural ecosystems wealth. Since all wealth comes from the Earth or the products from the sun’s energy (which is applicable to many forms of agriculture) it is not technically correct to say man creates wealth rather he merely extracts it from existing resources in the ecosystem.

This relationship between resource extraction and wealth extraction is quite obvious to see in the primary economy when resources are extracted directly from the ecosystems to provide goods of economic value but it can seem even with this wealth extraction concept recognised one may still envision the possibility of wealth creation through the transformation of a resource. To offer an example of this possible wealth creation let us consider the information sector which at its base claims to create wealth by using cheap resource inputs from metals and transforms these input into high value products such as computers and smart phones. While this process does appear to create extra wealth – at least on first glance – it should be noted that the process of manufacturing these products is highly energy intensive. First to build a typical computer or smart phone requires the resources that are scattered across the globe and as result requires large energy inputs to make these long supply lines viable as the video below clearly suggests:

Furthermore the energy use in manufacturing the product in the factory is also very energy intensive and requires very precise conditions (such as dust free rooms) to be maintained. In fact on a weight to weight basis computer manufacturing is around 10 times more energy intensive than the manufacturing or a car.[1]This high energy consumption all stems from the second law of thermodynamics (to read more information on this topic please refer to the Energy: Part II article). In addition to these facts another general pattern can be observed; that is the more complex any given technology becomes the larger the amount of supporting infrastructure is required to build and maintain the technology. This support infrastructure does not just come from physical items such as longer supplier chains or more sophisticated factories but also in the form of higher education and training required for the workers to operate in these environments. These embodied energy costs while not directly related to the construction of the item itself are considerable and will pose a larger energy cost to society in general. This will be an even bigger issue in a declining net energy environment which is likely to be the case in the coming decades.

As noted earlier the exchange value of vital resources such as energy do not capture the true use value of this resource. To understand why this is the case for energy we need to consider how much energy is embodied in the various forms of fossil fuel energy. For example the energy extracted from one barrel of oil is equivalent to around 7 years of labour[2]while the burning of one short ton of coal delivers around three times the amount of energy as a barrel of oil all at a lower cost.[3]While the exchange value in these cases is around $108.50 for the barrel and around $64.96 for coal (at the time of writing) the amount of use value in terms economic output far exceeds their exchange value[4][5] It is this arbitrage between exchange and use value that has been main reason for the explosive amount of economic growth we have seen in the last two centuries during the industrial age.

If the true use value of these fossil fuels plus the associated external costs (due to pollution) were accounted for then it is likely the amount of wealth created through this process would be considerably less. Furthermore as noted earlier all this wealth creation comes at the expense of fossil fuel depletion which is really the destruction of stocks of wealth. If we subtract the true losses of wealth from fossil fuel depletion coupled with the smaller addition of wealth created by capturing the true costs then it is likely no wealth has actually been created in this process. It is also important to note that once these resources are burned they are gone so it really a onetime deal and these stocks act like an endowment from nature.

As a result of this it is actually not appropriate to count the burning of fossil fuels as a form of income because really the burning of fossil fuels is a liquidation of stocks of wealth which is a one time deal. To give an analogy it would be like selling your home and then counting the proceeds as part of your yearly income. Such a thought sounds silly but if we consider how many nations count the burning/selling of this resource as part of their GDP (which is a measure of income) it becomes apparent how flawed our accounting system for measuring income and wealth is.

In any case what we can say with a good degree of confidence is that any wealth generated from this endeavour will come at the expense of a reduction in wealth in the natural ecosystem. For wealth to be created in the economy either resources or energy inputs must be consumed from the ecosystem. Now this is not to say this wealth extraction process is always unsustainable because in many instances, at least theoretically, it can be sustainable. This sustainability can arise because our ecosystem is not a completely closed system as it receives energy from the sun. As a result of this solar energy land can regenerate and create new wealth in the ecosystem. Indeed for much of human history wealth primarily came from the solar energy of the sun and wealth was obtained into the economy on a “pay-as-you-go” basis from wealth created from photosynthesis. It is only in the last 250 years that significant sources of energy came from the drawdown of fossil fuels and it is this drawdown that was responsible for the large amount of economic growth in the industrial age.

While it is possible in some circumstances for the human economy to grow for a time it should be noted that growth is only really sustainable if the resources extracted from the ecosystem do not exceed the capacity of the Earth to regenerate new resources and empty various sinks of pollution. Unfortunately in the world we live in today our current rates of consumption of resources exceed the world’s regenerative capacity and as a result many vital resources such as topsoil, water tables, fish stocks and animals are all experiencing declines.[6][7][8][9]In addition the amount of pollution emitted exceeds the capacity of the Earth’s sinks to absorb these waste products and as result the pH in oceans are altering which has an adverse effect on various ocean fauna.[10]In addition oceans accumulate increasing concentrations of pollutants and the atmosphere grows warmer due to C02 emissions. And this is all occurring at current rates of consumption; if we wish to pursue more economic growth and increase the wealth of the human economy even further then it must come at the cost of further degradation of the environment. If continued then it is likely these set of actions will lead to resource collapse (ecosystem bankruptcy?) and uncontrolled climate change.

Another important aspect to consider in this wealth story is that of profit. The normal definition for profit is that the supplier of a good or service must sell at a higher price than they took to produce the good/service. If we consider this from a wealth prospective then this means the cost of procuring the resource must be less than what the transformed resource will sell at the market. In other words the costs of the good/service should be less than the exchange value that it will sell for. However since we are only dealing with the exchange value and do not account for the use value then it is likely the actual profit from wealth standpoint is less than what we would get from an exchange or monetary standpoint. What’s more if all external costs such as pollution and environmental degradation (environmental costs should include the costs for removal of fossil fuels) are fully accounted for then it is likely that there would be no profit at all in various economic transactions (in certain cases it could be even a negative profit). In fact to obtain a real profit it is likely that a combination of three things must happen. Either the external costs are omitted or resources and/or labour must be exploited. By exploitation the price paid to procure these resources or labour must be below their true use value for wealth to accumulate. It is my personal belief that it is a combination of exploitation and unaccounted costs that allows nearly all economic transactions to produce a profit on paper.

Summary

Wealth and money are two fundamentally different concepts and the confusion between the two terms mainly arises from the fact we use money as a store of wealth. As a result of this all wealth is measured in monetary terms. However as money has no actual intrinsic value by itself then its value only comes from the fact it can be exchanged for items of value. It is this fact that means all items of wealth is only measured by their exchange value and not their use value. As a result of this money cannot capture the true value of wealth as not all values are accounted for.

As a result we cannot accurately account for the loss of wealth due to depletion of various resources and this issue is only compounded by the fact all external costs are rarely accounted for. If all these factors were factored in then it is likely the amount of profit or actual real wealth accumulated through our economy is a lot less than we imagined and could even be negative considering the declining quality of resources that we are now extracting.

Finally it should be noted that since money is only a claim on wealth and is not a source of wealth by itself then it follows that if the money supply increases faster than the underlying wealth in the economy then the result will be inflation (if the opposite occurs then we get deflation). It is this dynamic of changing money supply relative to overall wealth that will be explored in the next part of this money and wealth primer.

Further reading

Energy-Money Equilibrium (RE)
Economics and Moral Philosophy (feasta)

References:

[1] = The monster footprint of digital technology (Low-tech Magazine)
[2] = What is a Human Being Worth (in Terms of Energy)? (The Oil Drum: Europe)
[3] = What is the average heat (Btu) content of U.S. coal? (EIA)
[4] = BBC News Market Data: Commodities (BBC)
[5] = Coal News and Markets (EIA)
[6] = What If the World’s Soil Runs Out? (TIME Magazine)
[7] = Chapter 3: Emerging Water Shortages: Falling Water Tables (Earth Policy Institute)
[8] = World fish stocks declining faster than feared (Financial Times: google title name for link)
[9] = THE EXTINCTION CRISIS (Biological Diversity)
[10] = How will ocean acidification affect marine life? (Ocean Acidification)

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