Money as Energy
* Article: The supply of money in an energy-scarce world. Posted on August 4, 2011 by Richard Douthwaite.
An excerpt from the FEASTA book, 'Fleeing Vesuvius'.
"Money has no value unless it can be exchanged for goods and services but these cannot be supplied without the use of some form of energy. Consequently, if less energy is available in future, the existing stock of money can either lose its value gradually through inflation or, if inflation is resisted, be drastically reduced by the collapse of the banking system that created it. Many over-indebted countries face this choice at present — they cannot preserve both their banking systems and their currency’s value. To prevent this conflict in future, money needs to be issued in new, non-debt ways.
The crux of our present economic problems is that the relationship between energy and money has broken down. In the past, supplies of money and energy were closely linked. For example, I believe that a gold currency was essentially an energy currency because the amount of gold produced in a year was determined by the cost of the energy it took to extract it. If energy (perhaps in the form of slaves or horses rather than fossil fuel) was cheap and abundant, gold mining would prove profitable and, coined or not, more gold would go into circulation enabling more trading to be done. If the increased level of activity then drove the price of slaves or steam coal up, the flow of gold would decline, slowing the rate at which the economy grew. It was a neat, natural balancing mechanism between the money supply and the amount of trading which worked rather well.
In fact, the only time it broke down seriously was when the Spanish conquistadors got gold for very little energy — by stealing it from the Aztecs and the Incas. That damaged the Spanish economy for many years because it meant that wealthy Spaniards could afford to buy from abroad rather than using the skills of their own people, which consequently did not develop. It was an early example of “the curse of oil” or the “paradox of plenty,” the paradox being that that countries with an abundance of non-renewable resources tend to develop less than countries with fewer natural resources. Britain suffered from this curse when North Sea oil began to come ashore, distorting the exchange rate and putting many previously sound firms out of business.
19th-century gold rushes were all about the conversion of human energy into money as the thousands of ordinary 21st-century people now mining alluvial deposits in the Amazon basin show. Obviously, if supplies of food, clothing and shelter were precarious, a society would never devote its energies to finding something that its members could neither eat, nor live in, and which would not keep them warm. In other words, gold supplies swelled in the past whenever a culture had the energy to produce a surplus. Once there was more gold available, its use as money made more trading possible, enabling a society’s resources to be converted more easily into buildings, clothes and other needs.
Other ways of converting human energy into money have been used besides mining gold and silver. For example, the inhabitants of Yap, a cluster of ten small islands in the Pacific Ocean, converted theirs into carved stones to use as money. They quarried the stones on Palau, some 260 miles away and ferried them back on rafts pulled by canoes, but once on Yap, the heavy stones were rarely moved, just as no gold has apparently left Fort Knox for many years. According to Glyn Davies’ mammoth study, The History of Money, the Yap used their stone money until the 1960s.
Wampum, the belts made from black and white shells by several Native American tribes on the New England coast, is a 17th-century example of human-energy money. Originally, the supply of belts was limited by the enormous amount of time required to collect the shells and assemble them, particularly as holes had to be made in the shells with Stone Age technology – drills tipped with quartz. The currency was devalued when steel drill bits enabled less time to be used and the last workshop drilling the shells and putting them on strings for use as money closed in 1860.
The last fixed, formal link between money and gold was broken on August 15, 1971, when President Nixon ordered the US Treasury to abandon the gold exchange standard and stop delivering one ounce of gold for every $35 that other countries paid in return. This link between the dollar and energy was replaced by an agreement that the US then made with OPEC through the US-Saudi Arabian Joint Commission on Economic Cooperation that “backed” the dollar with oil.  OPEC agreed to quote the global oil price in dollars and, in return, the US promised to protect the oil-rich kingdoms in the Persian Gulf against threat of invasion or domestic coups. This arrangement is currently breaking down.
The most important link between energy and money today is the consumer price index. The central banks of every country in the world keep a close eye on how much their currency is worth in terms of the prices of the things the users of that currency purchase. Energy bills, interest payments and labour costs are key components of those prices. If a currency shows signs of losing its purchasing power, the central bank responsible for managing it will reduce the amount in circulation by restricting the lending the commercial banks are able to do. This means that, if energy prices are going up because energy is getting scarcer, the amount of money in circulation needs to become scarcer too if it is to maintain its energy-purchasing power.
A scarcer money supply is a serious matter because the money we use was created by someone somewhere going into debt, and if there is less money about, interest payments make those debts harder to repay. Money and debt are co-created in the following way. If a bank approves a loan to buy a car, the moment the purchaser’s cheque is deposited in the car dealer’s account, more money — the price of the car — comes into existence, an amount balanced by the extra debt in the purchaser’s bank account. Consequently, in the current monetary system, the amount of money and the amount of debt are almost equal and opposite. I say “almost” as borrowers have more debt imposed on them every year because of the interest they have to pay. If any of that interest is not spent back into the economy by the banks but is retained by them to boost their capital reserves, there will be more debt than money.
Until recently, if the banks approved more loans and the amount of money in circulation increased, more energy could be produced from fossil-fuel sources to give value to that money. Between 1949 and 1969 — the heyday of the gold exchange standard under which the dollar was linked to gold and other currencies had exchange rates with the dollar — the price of oil was remarkably stable in dollar terms. But when the energy supply was suddenly restricted by OPEC in 1973, two years after the US broke the gold-dollar link, and again in 1979, the price of energy went up. There was just too much money in circulation for it to retain its value in relation to the reduced supply of oil.
The current “credit crunch” came about because of a huge increase in the price of energy. World oil output was almost flat between September 2004 and July 2008 for the simple reason that the output from major oil fields was declining as fast the production from new, smaller fields was growing. Consequently, as more money was lent into circulation, oil’s price went up and up, taking the prices of gas, coal, food and other commodities with it. The rich world’s central bankers were blasé about these price increases because the overall cost of living was stable. In part, this was because lots of cheap manufactured imports were pouring into rich-country economies from China and elsewhere, but the main reason was that a lot of the money being created by the commercial banks’ lending was being spent on assets such as property and shares that did not feature in the consumer price indices they were watching. As a result, they allowed the bank lending to go on and the money supply — and debt — to increase and increase. The only inflation to result was in the price of assets and most people felt good about that as it seemed they were getting richer, on paper at least. The commercial banks liked it too because their lending was being backed by increasingly valuable collateral. What the central banks did not realise, however, was that their failure to rein in their lending meant that they had broken the crucial link between the supply of energy and that of money.
This break damaged the economic system severely. The rapid increase in energy and commodity prices that resulted from the unrestricted money supply meant that more and more money had to leave the consumer-countries to pay for them. The problem with this was that a lot of the money being spent was not returned to the countries that spent it in the form in which it left. It went out as income and came back as capital. I’ll explain. If I buy petrol for my car and part of the price goes to Saudi Arabia, I can only buy petrol again year after year if that money is returned year after year to the economy from which my income comes. This can happen in two ways, one of which is sustainable, the other not. The sustainable way is that the Saudis spend it back by buying goods and services from Ireland, or from countries from which Ireland does not import more than it exports. If they do, the money returns to Ireland as income. The unsustainable way is that the Saudis lend it back, returning it as capital. This enables Ireland to continue buying oil but only by getting deeper and deeper into debt.
The end of debt-based money
Output in today’s economy gets a massive boost from the high level of energy use. If less and less energy is going to be available in future, the average amount each person will be able to produce will decline and real incomes will fall. These shrinking incomes will make debts progressively harder to repay, creating a reluctance both to lend and to borrow. For a few years into the energy decline, the money supply will contract as previous years’ debts are paid off more rapidly than new ones are taken on, destroying the money the old debts created when they were issued. This will make it increasingly difficult for businesses to trade and to pay employees. Firms will also have more problems paying taxes and servicing their debts. Bad debts and bankruptcies will abound and the money economy will break down.
Governments will try to head the breakdown off with the tool they used during the current credit crunch — producing money out of nothing by quantitative easing. So far, the QE money they have released, which could have been distributed debt-free, has been lent to the banks at very low interest rates in the hope that they will resume lending to the real economy. This is not happening on any scale because of the high degree of uncertainty — is there any part of that economy in which people can invest borrowed money and be sure of being able to pay it back?
Some better way of getting non-debt money into the real economy is going to have to be found. In designing such a system, the first question that needs to be asked is “Are governments the right people to create it?” The value of any currency, even those backed by gold or some other commodity, is created by its users. This is because I will only agree to accept money from you if I know that someone else will accept it from me. The more people who will accept that money and the wider range of goods and services they will provide in return, the more useful and acceptable it is. If a government and its agencies accept it, that increases its value a lot.
As the users give a money its value, it follows that it should be issued to them and the money system run on their behalf. The government would be an important user but the currency should not be run entirely in its interest, even though it will naturally claim to be acting on behalf of society, and thus the users, as a whole. Past experience with government-issued currencies is not encouraging because money-creation-and-spend has always seemed politically preferable to tax-and-spend and some spectacular inflations that have undermined a currency’s usefulness have been the result. At the very least, an independent currency authority would need to be set up to determine how much money a government should be allowed to create and spend into circulation from month to month and, in that case, the commission’s terms of reference could easily include a clause to the effect that it had to consider the interests of all the users in taking its decisions.
This raises two more design questions. The first is “Should the government benefit from all the seignorage, the gain that comes from putting additional money into circulation, or should it be shared on some basis amongst all the users?” and the second is “Should the new money circulate throughout the whole national territory or would it be better to have a number of regional systems?” I am agnostic about the seignorage gains. My answer depends on the circumstances. If the new money is being issued to run in parallel with an existing currency, giving some of the gains to reward users who have helped to develop the system by increasing their turnover could be an important tool during the set-up process. On the other hand, if the new money was being issued to replace a collapsed debt-based system, giving units to users on the basis of their previous debt-money turnover would just bolster the position of the better off. It would be better to allow the state to have all the new units to spend into use in a more socially targeted way.
A more definite answer can be given to the second question. Different parts of every country are going to fare quite differently as energy use declines. Some will be able to use their local energy resources to maintain a level of prosperity while others will find they have few energy sources of their own and that the cost of buying their energy in from outside leaves them impoverished. If both types of region are harnessed to the same money, the poorer ones will find themselves unable to devalue to improve their exports and lower their imports. Their poverty will persist, just as it has done in Eastern Germany where the problems created by the political decision to scrap the ostmark and deny the East Germans the flexibility they needed to align their economy with the western one has left scars to this day.
If regional currencies had been in operation in Britain in the 1980s when London boomed while the North of England’s economy suffered after the closure of its coal mines and most of its heavy industries, then the North-South gap which developed might have been prevented. The North of England pound could have been allowed to fall in value compared with the London one, saving many of the businesses that were forced to close. Similarly, had Ireland introduced regional currencies during the brief period it had monetary sovereignty, a Connacht punt would have created more business opportunities west of the Shannon if it had had a lower value than its Leinster counterpart.
Non-debt currencies should not therefore be planned on a national basis or, worse, a multinational one like the euro. The EU recognises 271 regions, each with a population of between 800,000 and 3 million, in its 27 member states. If all these had their own currency, the island of Ireland would have three and Britain 36, each of which could have a floating exchange rate with a common European reference currency and thus with each other. If it was thought desirable for the euro to continue so that it could act as a reference currency for all the regional ones, its independent currency authority could be the ECB. In this case, the euro would cease to be the single currency. It would simply be a shared one instead.
The advantages from the regional currencies would be huge:
1. As each currency would be created by its users rather than having to be earned or borrowed in from outside, there should always be sufficient liquidity for a high level of trading to go on within that region. This would dilute the effects of monetary problems elsewhere.
2. Regional trade would be favoured because the money required for it would be easier to obtain. A strong, integrated regional economy would develop, thus building the region’s resilience to shocks from outside.
3. As the amount of regional trade grew, seignorage would provide the regional authority with additional spending power. Ideally, this would be used for capital projects.
4. The debt levels in the region would be lower, giving it a lower cost structure, as much of the money it used would be created debt free.
In addition to the regional currencies, we can also expect user-created currencies to be set up more locally to provide a way for people to exchange their time, human energy, skills and other resources without having to earn their regional currency first. One of the best-known and most successful models is Ithaca Hours, a pioneering money system set up by Paul Glover in Ithaca, New York, in 1991 in response to the recession at that time. Ithaca Hours is mainly a non-debt currency since most of its paper money is given or earned into circulation but some small zero-interest business loans are also made. A committee controls the amount of money going into use. At present, new entrants pay $10 to join and have an advertisement appear in the system’s directory. They are also given two one-Hour notes – each Hour is normally accepted as being equivalent to $10 – and are paid more when they renew their membership each year as a reward for their continued support. The system has about 900 members and about 100,000 Hours in circulation, a far cry from the days when thousands of individuals and over 500 businesses participated. Its decline dates from Glover’s departure for Philadelphia in 2005, a move which cost the system its full-time development worker.
Hours has no mechanism for taking money out of use should the volume of trading fall, nor can it reward its most active members for helping to build the system up. It would have to track all transactions for that to be possible and that would require it to abandon its paper notes and go electronic. The result would be something very similar to the Liquidity Network system that Graham Barnes describes in the next article.
New variants of another type of user-created currency, the Local Exchange and Trading System (LETS) started by Michael Linton in the Comox Valley in British Columbia in the early 1990s, are likely to be launched. Hundreds of LETS were set up around the world because of the recession at that time but unfortunately, most of the start-ups collapsed after about two years. This was because of a defect in their design: they were based on debt but, unlike the present money system, had no mechanism for controlling the amount of debt members took on or for ensuring that debts were repaid within an agreed time. Any new LETS-type systems that emerge are likely to be web based and thus better able to control the debts their members take on. As these debts will be for very short periods, they should not be incompatible with a shrinking national economy.
Complementary currencies have been used to good effect in times of economic turmoil in the past. Some worked so well in the US in the 1930s that Professor Russell Sprague of Harvard University advised President Roosevelt to close them down because the American monetary system was being “democratized out of [the government's] hands.” The same thing happened to currencies spent into circulation by provincial governments in Argentina in 2001 when the peso got very scarce because a lot of money was being taken out of the country. These monies made up around 20% of the money supply at their peak and prevented a great deal of hardship but they were withdrawn in mid-2003 for two main reasons. One was pressure from the IMF, which felt that Argentina would be unable to control its money supply and hence its exchange rate and rate of inflation if the provinces continued to issue their own monies. The other, more powerful, reason was that the federal government felt that the currencies gave the provinces too much autonomy and might even lead to the break-up of the country.
New ways to borrow and finance
The regional monies mentioned above will not be backed by anything since a promise to pay something specific in exchange for them implies a debt. Moreover, if promises are given, someone has to stand over them and that means that whoever does so not only has to control the currency’s issue but also has to have the resources to make good the promise should that be required. In other words, the promiser would have to play the role that the banks currently perform with debt-based money. Such backed monies would not therefore spread financial power. Instead, they could lead to its concentration.
Even so, some future types of currency will be backed by promises. Some may promise to deliver real things, like kilowatt hours of electricity, just as the pound sterling and the US dollar were once backed by promises to deliver gold. Others may be bonds backed by entitlements to a share an income stream, rather than a share of profits, as Chris Cook describes in his article in this book. Both these types of money will be used for saving rather than buying and selling. People will buy them with their regional currency and either hold them until maturity if they are bonds, or sell them for regional money at whatever the exchange rate happens to be when they need to spend.
These savings currencies could work like this. Suppose a community wanted to set up an energy supply company (ESCo) to install and run a combined heat and power plant supplying hot water for central heating and electricity to its local area. The regional currency required to purchase the equipment could be raised by selling energy “bonds” which promise to pay the bearer the price of a specific number of kWh on the day they mature. For example, someone could buy a bond worth whatever the price of 10,000 kWh was when that bond matured in five years. The money to redeem that bond would come from the payments made by people buying energy from the plant in its fifth year. The ESCo would also offer other bonds with different maturity dates and, as they were gradually redeemed, those buying power from the ESCo would, in fact, be taking ownership of the ESCo themselves.
These energy bonds will probably be issued in large denominations for sale to purchasers both inside and outside the community and will not circulate as money. However, once the ESCo is supplying power, the managing committee could turn it into a bank. It could issue notes for, say, 50 and 100 kWh which locals could use for buying and selling, secure in the knowledge that the note had real value as it could always be used to pay their energy bills. Then, once its notes had gained acceptance, the ESCo could open accounts for people so that the full range of money-moving services was available to those using the energy-backed units. An ESCo would be unlikely to do this, though, if people were happy with the way their regional currency was being run. Only if the regional unit was rapidly losing its value in energy terms would its users migrate to one which was not.
Up to now, those who allocated a society’s money supply by determining who could borrow, for what and how much determined what got done. In the future, that role will pass to those who supply its energy. Only this group will have, quite literally, the power to do anything. Money once bought energy. Now energy, or at least an entitlement to it, will actually be money and energy firms may become the new banks in the way I outlined. This makes it particularly important that communities develop their own energy supplies, and that if banks issuing energy-backed money do develop, they are community owned.
As energy gets scarcer, its cost in terms of the length of time we have to work to buy a kilowatt-hour, or its equivalent, is going to increase. Looked at the other way round, energy is cheaper today than it is ever likely to be again in terms of what we have to give up to get it. We must therefore ensure that, in our communities and elsewhere, the energy-intensive projects required to provide the essentials of life in an energy-scarce world are carried out now. If they are not, their real cost will go up and they may never be done.
Working examples of both backed and unbacked forms of modern regional and community monies are needed urgently. Until there is at least one example of a non-debt currency other than gold working well somewhere in the world, governments will cling to the hope that increasingly unstable national and multinational debt-based currencies will retain their value and their efforts to ensure that they do will blight millions of lives.
Moreover, without equitable, locally and regionally controllable monetary alternatives to provide flexibility, the inevitable transition to a lower-energy economy will be extraordinarily painful for thousands of ordinary communities, and millions of ordinary people. Indeed, their transitions will almost certainly come about as a result of a chaotic collapse rather than a managed descent and the levels of energy use that they are able to sustain afterwards will be greatly reduced. Their output will therefore be low and may be insufficient to allow everyone to survive. A total reconstruction of our money-issuing and financing systems is therefore a sine qua non if we are to escape Vesuvius’ flames." (http://fleeingvesuvius.org/index.php/2011/08/04/the-supply-of-money-in-an-energy-scarce-world/)