End of the World, Part II

Fate has given us a couple of gentle reminders, in the form of a recession and a flu pandemic, that stable societies can be disrupted by unforeseen events.

In this edition of Theopraxis Thinking, I want to look at the credit crunch, and how it might play out, in the light of economic changes that shook society in the latter half of the fourteenth century.

Before we reach for our doublet and hose, it may be worth a quick reminder of how the credit crunch came about.

Money as a means of production

The size of a modern capitalist economy can be measured in terms of a quantity of output (Q) multiplied by the price of that output (P). Logic would suggest that the value of economic output should be equal to the amount of money in the economy, but in fact money can be ‘productive’ and generate output several times its worth. Money is productive because it rotates through the economy, and under something known as the equation of exchange, the size of the economy is equal to the amount of money in circulation (M) multiplied by its rotational ‘velocity’ (V).

Equation of Exchange

This velocity of money is rather a strange concept, but let’s look at a pocket economy: Alf wants a new kitchen, so he borrows some money from the bank. He uses it to pay the fitter, who uses his profit to buy his dinner from the butcher. The butcher pays the money into the bank, and they lend the same money to Fred the factory-owner, who uses some of it to pay the wages of his foreman – Alf.

The money keeps circulating and Adam Smith’s invisible hand keeps making every one richer. At least, that’s what everyone thought.

In the years before the credit crunch there was a massive failure of regulation, not to mention common sense. Some ‘
financially over-optimistic lenders’ (I think we’ll just use the acronym ‘fools’) gave money to people who hadn’t the slightest chance of paying it back. These people quite reasonably converted the money into holidays, food, cars and overpriced houses. Then last year these fools found that the holidays had been taken, the food eaten, and the cars and houses were worth less than the value of the loans. In short, some of the money had dropped out of circulation leading to a small but significant drop in M.

These fools had been buying and selling the loans to each other and had failed to keep track of who owned what. An even bigger set of fools had placed bets based on the loans that everyone had lost track of, thus multiplying the uncertainties and potential losses. Consequently everyone was worried about a large drop in M, particularly in the portion of M that they regarded as their own. And since nobody wanted to lend money to someone who might not be able to pay it back – even the biggest fools recognised that that was what got them into trouble in the first place – they simply stopped lending altogether.

In our pocket economy above, neither Alf or his employer would be able to borrow money. Fred would go broke, Alf would lose his job, and the fitter and butcher would suffer right along with them as the flow of money round the economy dried up. We can therefore see how a small drop in M can lead to a very large drop in V, which must inevitably lead to deflation (reductions in P) and recession (reductions in Q).

We will come back to the credit crunch, and its seductive and dangerous solution, in a little while. Right now, I want us to return to Medieval Europe.

Labour as a means of production

The dominant economic system at the end of the fourteenth century was not capitalism but feudalism. The principal means of production was not money but villeins and serfs, who were tied to the land by a series of interlocking oaths and protections that worked upwards from the lowest serf to the king. This was a very straightforward economic system: the regulator was usually some bloke with a sword, and money, to the extent that it was used at all, was a derivative of manpower.

The size of a feudal economy was determined by how many labourers it had and how productively they could work: the latter was determined by the length of the growing season and the level of agricultural technology.

In the eighth to the thirteenth centuries, a warm period had increased the length of the growing season which, coupled with a series of technological improvements such as the mouldboard plough and crop rotation, had led to a rapid increase in food production, and thus the size of population the economy could support. Some historians think that the population had grown too fast, and in the early fourteenth century, England had a population of something like six million souls, 90% of whom ploughed the fields and scattered.

The feudal economy got a nasty shock in the form of climate change: starting in 1314 the warm period came to a brutal end with several successive cold and wet winters. Food production dropped below levels necessary to support the size of population and a seven-year famine ensued, perhaps reducing the population of Europe by more than ten percent. But the famine passed, and if there had been such a thing as a economist in the mid 1320s, he might have breathed a sigh of relief that everything was finally OK again (just like we are starting to do now…).

The End of the World, Part I

In 1348, sailors arrived in Weymouth carrying a simple bacterial disease that could be overcome by even the most basic antibiotic. Back then, with no medicine and poor living conditions, they saw it differently. In time, they came to call the disease the ‘Black Death’.

The most common form of the Black Death was bubonic – if you found little pustules in your armpits or groin, you had roughly
one chance in five of surviving the next week. If you caught the less common pneumonic form, you had no chance at all.
The Dance of Death

That little bacillus killed 45-50% of Europe’s population over a four year period. There weren’t enough people to bury the dead, who lay in the streets where they fell.

It’s hard to imagine how it must have been to live through that, but the crisis was economic as well as individual. The pyramidal structure of feudal society was now in trouble, because there were not enough workers to support it and they started to demand wages to work the fields. The landowning classes saw the rise in wage levels as a sign of sin and insubordination, and reacted with coercion: a series of brutally-enforced laws tried to hold down wages, but as we all know the market will win in the end. In England, the start of the end of Feudalism can be marked by the Peasants' Revolt in 1381 which can be directly traced back to the repression of free labour and thus to the Black Death.

The End of the World, Part II

In the early years of the fourteenth century, medieval Europe was living beyond its means of production, with more labour than the land could support. Two external shocks, namely the great famine and the Black Death, caused such an over-correction that it led to the downfall of the dominant economic system.

In the early years of the twenty-first century, the developed world is living beyond its means of production, with more debt than the global economy can support. Any external shocks stand a chance of bringing down our economic system too. If we don’t have any massive external shocks, our economic system might survive it. But I fear for its future, because of our addiction to two things: debt and oil.

Firstly, debt: like our sighing medieval economist, we think we are pretty much out of the woods. We’ve solved the credit crunch by generating large increases in M. The fools call this ‘quantitative easing’ but it’s nothing more than printing money. Since the amount of value in the economy hasn’t magically increased (thanks to deflation and recession) this new money has come from massive increases in government debt.

I want to concentrate on the engine of the western world, namely America. [In case you think I’m America-bashing, all this is true of the UK as well, it’s just that if when our economy tanks, it won’t take the rest of the world with it]. Today, US Government debt is something like $53,000 per citizen, about the same as their GDP. Oh, that excludes about $47,000 debt per citizen, excluding mortgages. [When I first wrote this article, government debt was $38k per citizen and I remember thinking, “oh, surely they’ll get that under control” Seems not, eh?]

The US Government owes about $4.5 trillion to foreign governments, 25% of it to the Chinese. Apart from the political risks (if the debt was called in, the Government doesn’t have anything like enough reserves to repay it), the interest on the debt is flowing out of America and further worsening the balance of payments. America also runs a current account deficit, importing consumer goods from China and India and exporting even more dollars.

Several American economists have pointed out that this is completely unsustainable, and any sudden move away from the dollar would completely wreck their economy, and probably that of the rest of the world as well. And even if that doesn’t happen, mandatory government support for healthcare will exceed tax revenue by about 2030. In other words, all discretionary spending thereafter (defence, law enforcement, education, etc.) will require further borrowing. The US Government’s own auditors, the GAO, describe the American economy as heading for a ‘fiscal trainwreck’.

All that debt is inflating our economic balloon, and here comes the pin: peak oil. We show no signs of realising that we just can’t keep increasing our oil consumption, partly because we are ruining the climate and partly because we are not finding as much of the stuff as we are burning - shale gas helps, but that won’t last forever. The 2005 Hirsch Report for the US Department of Energy predicted that ‘peak oil’ was real and that “as peaking is approached, liquid fuel prices and price volatility will increase dramatically, and, without timely mitigation, the economic, social, and political costs will be unprecedented”. It described the effects as “abrupt and revolutionary”.

Our economic output is dependent on the availability of cheap oil. Going back to the Equation of Exchange, if output drops dramatically this is equivalent to a large drop in Q. The money supply (M) can’t drop because of the huge debt and so we will see lead to hyperinflation (dramatic increases in P), or a complete cessation in lending, or probably both.

We need to trim down the debt and move to sustainable energy sources, but neither of those things looks likely at the moment. We are reducing our ability to cope with shocks to an over-burdened system. The result? Although it may not happen in my lifetime, my grandchild may well see the end of Age of Capitalism.