* 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‘, from Richard Douthwaite:
“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.”