Tuesday, January 8, 2013

The Wealth of Nations, revisited

I have not been riding on my trusty horse Blog for reasons obvious to anyone who lives here in this beautiful valley in NW Wyoming. There are a lot more enjoyable ways to spend what little time we have than sitting in front of a computer screen. The long string of subzero days and nights has unfortunately driven me back to my mancave and I have been mulling over a fundamental concept. What is wealth? From what does it derive? Is wealth money? Is money wealth?
     This little digression started with a comment by my son some time ago when he noted a pundit commenting that so many $Trillions had “vanished” in the latest downturn. This puzzled him, so he asked me “Where did those $Trillions go?” It was an intelligent question and I tried to explain the disappearance as part of a general “deleveraging” of wealth assets going on over the world. Money isn’t” wealth”, I told him. Money is a symbolic representation of wealth. I knew I wasn’t getting through to him when he insisted that if it was money, it had to go somewhere! His perception was that money and wealth were equivalent, which would be true if our money was a denarius or a Morgan silver dollar, or a $20 gold piece. Unless money was in a cask on a Spanish Galleon going down in a hurricane off Hispaniola ending up with the scallops, when one person lost money, another probably received it, a zero sum transaction, voluntary or not.
       This conversation became a loop in my head leaping down axons to dendrites as I mulled over the concept of wealth from a myriad of standpoints. It’s impossible to escape money, the economy, and economic statistics on the state of the economy flooding us non-stop from a media obsessed with economic news.
      I fled as a participant in the Sickcare industry some years back and I have been spending a good part of my time catching up with my education that was interrupted by too many years learning the medical trade.  I particularly wanted to study the dynamics of civilizations, their rise and fall, and how our civilization has changed our world and how our changing world has altered our societies. I began at the beginning with the Big Bang and ambled cosmologically taking side trips into physics, astronomy, and geology, hop scotching  forward and backward and into side alleys that looked interesting. As I examined the whole span of human history, what stood out to me was the period after about 1750, which happened to be the the nascent industrial revolution as  the premier innovation of the past 350 years. Within this revolution have been other important innovations starting positive feedback loops helping to sustain and accelerate the changes which began the Industrial Revolution.
But what has this got to do with wealth and money?? Coinage had been in existence long before 1750 to facilitate trade and commerce and economic growth. Why is there so much more wealth in the world now than in 1750 and will  wealth continue to grow exponentially in the same way  going forward?
     There were prominent thinkers at the time taking note of the changes, among them Adam Smith who published “The Wealth of Nations”, widely regarded at the bible of modern classical economics. Smith was by no means the first to think about economics. There are a scattering of economic writings as far back as Aristotle  but Smith’s achievement was  in laying out terms like capital and labor and land and how they intersect to influence an economy. It is no coincidence that the term capitalism came into being as the system that most adapted to the industrial revolution in the West. Capitalism of course existed well before 1750 to facilitate trade and grow a nation’s wealth and influence and in  it’s ancestral form was termed Mercantilism which followed the feudalism period of the middle ages. But let’s get back to wealth. There certainly was a lot of wealth before 1750. Wealthy civilizations existed in the Mesopotamian and Harappan and Aztec and Mayan  Civilizations. The Romans, the first big Empire possessed enormous wealth. How did they accrue it? In the case of the Romans, they largely took it from their neighbors. . There was wealth, then as now, concentrated into few hands. Keep in mind that by the time Christ was born, there were probably only 300 million people in the world. By 1750 it had about doubled. By 1900 the number had more than doubled to 1.6 billion and the doubling time up to the present has been getting shorter and shorter. Why did it take so long to double the first time, 1700+ years, and why has the doubling interval grown ever shorter? Could the industrial revolution have had something to do with the exponential population boom? Up until the industrial revolution population growth was largely linear but after the industrial revolution the curve leapt up resembling a hockey stick, the classic yardstick of exponential growth. About 1750 a lot of things beside population also started growing exponentially, in this case Industrial Capital, industrial machines, energy production,food production, and, wealth production.  An intelligent observer should always be wary of the classic trap that association is not necessarily causation. I found early on in my quest that I had to ruthlessly simplify, in much the same way that Occam’s Razor is used as a technique of understanding a complex system. The Razor states that all things being equal, the simplest explanation is often the best. This notion did not start with Occam and in fact goes far back to Aristotle and Ptolemy. So I put the origin of wealth creation into the simplest form: You need a resource. You need people to harvest that resource and accumulate that resource. If the harvest involves picking up or digging the resource, all able bodied people are equal and the harder you work, the more resource you accumulate. It takes energy to harvest a resource, in this case human energy. The next logical step was to find ways to speed up the harvest. Get more people into the act but don’t let them keep the resource. Time to invent Slavery. Animals were used as well because they possessed a lot more energy than people. Thus we now have energy from labor combined with a resource. Let’s say that this resource is copper and perhaps other easily accessible metals. Early on, people discovered some nifty uses for soft malleable copper. It made a nice plate, and decent tools. Someone discovered that if you combined a soft metal like copper with another like tin or zinc, and melted them together, you could get a much harder and stronger tool by taking the energy of fire, the energy of a tool maker and producing something with value added above the value of the resource  itself. Thus was born the Bronze Age. The clever tool and plate makers found ways to make their tools better and faster and trading them for items the toolmakers needed, maybe livestock or firewood or perhaps pretty stones for the toolmakers wife. It didn’t take long for early prospectors to find other metals that were beautiful as well as durable and portable, like gold and silver. The toolmaker could trade for these and accumulate a pile of nuggets. Let’s call this capital. Whatever the resource, if a person could take his ingenuity and his energy or that of a slave to add value to a resource, he could then sell it for capital. Some of these early capitalists then made just the accumulation of capital their goal. A faster way to accumulate capital was to steal it, a little risky but a whole lot easier. With more capital one could even hire his wife’s dim witted burly brother to do his stealing. Find more knuckle draggers and maybe some smart officer material and cut them in to a little of the action and you now have an army who can steal on a bigger scale, again a whole lot easier than honest work. This in fact became the basis of the Roman Empire, stealing the wealth of all their neighbors and putting the vanquished to work making and growing things to send back to Rome. This worked real well for a long while as long as there were lands and peoples to conquer but eventually the Roman armies smacked into the law of diminishing returns and long supply chains. There were some pretty tough characters to the north who had little of the wealth that the Romans wanted but who could acquit themselves pretty well on their home terrain like the Teutoburg Forrest on the banks of the Rhine which ended  for good and forever Rome’s push north. Worthy opponents sprung up like Hannibal who used cavalry tactics and elephants to defeat much larger Roman Armies in the Punic Wars. Hannibal by the way, utilized some really unusual tactics besides Elephants like catapulting baskets full of poisonous snakes onto the enemy ships! By the end of the fifth century it was all over and a thousand years later only livestock grazed on Rome’s Palatine Hill overlooking what was left of the Forum.
   Over the next 1300 years as world population increased slowly, forests were cleared, crops were planted and towns were built mostly by hand or with the help of draft animals. Wind and water power was utilized early on for transportation as well as in grain mills. The energy for heat and for iron manufacture came initially from wood and charcoal and gradually migrated to coal, a more concentrated form of energy. The invention of the steam engine was a crucial first step helping to kickstart and then drive early  industrial production. The first primitive models were used to pump water out of the coal mines and then as water pumps generally. Improvements by James Watt and others added efficiency and with modifications to produce rotational torque, steam engines were used to power all manner of manufacturing machinery and as motive power for tractors, ships and locomotives and eventually electrical power generation. Today steam turbines generate the bulk of the world’s electricity. It’s crucial to keep in mind that it isn’t steam that is creating this seemingly limitless energy. It’s concentrated carbon in the form of coal, gas and oil that provides the energy to generate steam and what a vast ocean of energy it has been. It is the existence and consumption of  vast almost FREE energy sources that has powered and empowered the industrialization of the world. Fossil energy is viewed as income to the industrial world, fuel to the industrial machines, a magical powerful force that when channeled into man’s machines has displaced the work of millions by virtue of its concentrated energy. One barrel of oil is equivalent to 25000 hours of human labor, 12.5 years.Each American uses 25 barrels of oil a year, equivalent to 312 hard working laborers. If you include gas and coal, it jumps to 700 laborers, or Energy “slaves.” Early economists saw this energy as vast income to the society, to be treated as income to be spent to enrich and benefit mankind. In a real sense, fossil fuels have been THE source of our wealth both directly and indirectly. The countries that have used the most fossil fuels per capita have historically been the wealthiest at least in terms of GDP. It takes a vast amount of energy to power an industrial society and the countries with the greatest fossil endowments and the capacity to utilize fossil energy, Europe and the US, have up until recently been dominant in the world economy. AS recently as the 1970’s, the US with 4-5% of the world’s population was using 80% of the world’s oil. Even now that 4%  of the population is still consuming 25% of it’s oil. Economists are unanimous that it is energy that is the lifeblood of our industrial economy. It is so obvious as to almost not bear mentioning. Mainstream economists do not view Fossil fuels as capital or as EF Schumacher called them “natural capital.” If it were viewed as capital, it might be seen as something to be conserved and deployed when appropriate for the benefit of man, not as mere income to be spent. I have seen comments by economists that fossil resources are just one of many important natural resources necessary for a functioning industrial economy. Should some fossil energy resources get in short supply, a modern technologically driven economy will substitute other energy fuels to power the economy. I can recall visiting a nuclear reactor in Oak Ridge TN as a child and being told that nuclear power was the future of energy that  would be “too cheap to meter”. I also recall in the 1960’s when nuclear fusion research was in full flower.  Pollution free Fusion power plants would be coming on line in just a few decades just in time to replace our  aging first generation fission plants. Popular Science magazine covers were full of dazzling views of cities of the future and ideas as chimerical as an airplane in every garage. This unbounded faith in future energy technology probably partially explains the collective yawn of ridicule when M King Hubbert, a Shell geophysicist stood up and presented a paper the the annual meeting of the American Petroleum Institute in San Antonio Texas in 1956 and predicted that US oil production would peak in about 1970 and fall thereafter roughly approximating a bell curve distribution. When 1970 came and US oil production plateaued and fell as he predicted, little was made of his 1956 presentation. In 1956 production was still rising but here 56 years later is what the curve of US oil production looks like:

It is not a beautiful Gaussian bell distribution. It resembles the Grand Teton in my backyard with the secondary peak in the 1980’s representing the giant Alaskan North Slope field  That little nipple at the far right is frac oil from the Bakken, the Eagle Ford and other fields. It is a bigger nipple by now.   EF Schumacher along with other some non-mainstream economists has stated that Energy follows rules of its own that may bear little relation to conventional supply and demand and substitution concepts that so dominate classical economics.  I regard Fossil Energy as the sine qua non of our industrial economy, the bedrock source of wealth and that a shortage or depletion of these fuels, primarily oil, will crash the industrial economy. My opinion is a minority one shared by a few resource economists and a scattering of energy and resource bloggers. Labor and capital existed long before free fossil energy. Wealth was accumulated slowly. It took free concentrated fossil energy combined with labor and capital to drive civilization up the hockey stick of exponential growth.It is the consequences of that energy driven exponential growth that I would like to cover in a future post. For now I would like to summarize by saying that energy is the basis for and the root of our industrial wealth.

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