OK, I admit, I just formulated some new universal laws just to make this section flow nicely from the previous section on the laws of thermodynamics. But still, these “new” laws of economic exchange are so blatantly obvious that I don’t think their universality can be disputed. Here they are:
- First law of economic exchange: Everything that is consumed had to have been produced first.
- Second law of economic exchange: Wealth, power and influence will naturally tend to flow from regions of high consumption to regions of high production.
Just like the laws of thermodynamics state that energy cannot be conjured out of thin air and will always flow from regions of high concentration to regions of low concentration, the laws of economic exchange state that wealth cannot be conjured out of thin air and will always flow from regions of consumption to regions of production. And just like the laws of thermodynamics, the laws of economic exchange are fixed regardless of the political rhetoric and economic fantasy predictions that implicitly assume they do not exist. Let’s take a closer look:
The first law of economic exchange
Every single product you will ever consume will have to have been created first by the combined efforts of nature and human labor. This is as much a fact of life as the first law of thermodynamics. The funny thing about modern society, however, is that we repeatedly try to break this unbreakable law by conjuring vast amounts of money and other financial instruments out of thin air. Money is not real wealth. Neither is stuff like bonds, notes and derivatives. In fact, these exotic financial instruments are nothing but financial promises and yes, a promise can be broken just as quickly as it is made.
To further illustrate this, just imagine that the American government decides to push a few buttons on some central computer and electronically deposit $1 million into the bank account of every person in the country. Would this make the country wealthier? Naturally, the first instinct is a big “of course!”, but when you stop to think just a moment, you see that this most certainly is not the case. On the very first day after this massive nation-wide deposit, every single store will be emptied out by crazed shoppers. On the second day, people will realize that they still have hundreds of thousands of dollars, but nothing to buy with these dollars. As new goods are imported, people will bid against each other and pay more and more for the imported goods that have now become very scarce indeed and it will not be long before hyperinflation sets in, all investors flee the country and America becomes the next Zimbabwe.
This is a rather extreme example and I don’t think that even the Federal Reserve is crazy enough to actually do something as rash as depositing $1 million into every bank account (although Ben Bernanke has famously stated that he will drop money out of helicopters to keep people spending if he has to). However, this is exactly what most Western nations have been doing during the past decade. Yes, they did not deposit $1 million into every bank account, but they did make credit so cheap that many people could borrow $1 million if they wanted to. And yes, the result is currently playing out in front of our eyes.
In short, highly disruptive speculative bubbles like the 2008 housing bubble arise simply because entire nations strive to break the first law of economic exchange – try to create wealth out of thin air. The result is that people consume much more than they produce for a limited period of time and then, quite naturally, find that they have to restore the balance by producing more than they consume (and do so within a badly distorted economy making production extra difficult). Indeed, the correction following an economic bubble is nothing other than the work of the second law of economic exchange.
The second law of economic exchange
If we have managed one thing over the past few decades it is to quite possibly distort the production/consumption balance both between and within nations as much as is physically possible. The first law of economic exchange will always ensure that nothing can be consumed without being produced first, but we have managed to create a myriad of situations where certain people consume more than they produce for decades while others are forced to consume much less than they produce. And yes, these prolonged production/consumption imbalances are exactly the type of situation that the second law of economic exchange serves to correct.
The most obvious example of this is the current shift of power and influence from West to East. The West has been a net-consumer for many years, gradually exporting its productive industry to the East which, according to the first law of economic exchange, has been a net-producer for all of this time. In 2011, the combined trade deficit of the USA and the EU with China was over half a trillion dollars – enough money to buy every single Chinese person an iPad 2 (every single year).
The second law of economic exchange does not like such gross imbalances. Like the second law of thermodynamics, it strives for equilibrium by transferring wealth, power and influence from consumers to producers so that those who over-produce will gain the means with which to increase their consumption and those who over-consume will be forced to increase their production. The fact that we have managed to delay this fundamentally enforced correction for such a long time really is quite remarkable, but it was never going to last forever and hence we are where we are today.
The mechanism through which this massive imbalance could be maintained for such a long time in conflict with the second law of economic exchange is quite simply the massive (and ever increasing) quantities of public and private debt taken on by the developed world. And yes, this is also the mechanism through which the second law of economic exchange is now seeking to restore balance. The European debt crisis and the dangers posed by the American fiscal cliff are both the result of our exchange economy seeking to restore the production/consumption balance. And yes, the final reckoning, whether it is stretched out over many years through harsh austerity measures or manifested in a sudden collapse of the dollar or the euro, will really cause a big shift in wealth, power and influence from West to East.
In addition to this international dynamic, two similar scenarios are at play within individual developed nations. The first of these is the droves of retirees who have managed to consume their way through life and end up at retirement with virtually no personal savings. These people now completely and utterly depend on the totally unsustainable social security system for their livelihood and are in for a rather painful belated reckoning at the hands of the second law of economic exchange when governments are forced to slash benefits to more sustainable levels (as is already happening in Southern Europe).
The second group is the market speculators or “banksters” as they have aptly become known in recent years. These are the people who facilitated all of these painful financial distortions through reckless manipulation of our wide array of exotic financial instruments of fake wealth (primarily derivatives). Many of these speculators have managed to become fabulously rich without producing anything of value (arguably actually producing negative value). The reckoning for these banksters always seems to be just around the corner, but unfortunately they are repeatedly bailed out by government at the expense of the taxpayer because their institutions are deemed to be too big to fail. As with all other great production/consumption imbalances, however, this one will also eventually be rectified by the second law of economic exchange. The only difference will be that things could become quite messy as more and more people understand just how much damage these banksters have done to society in their perpetual pursuit of unearned wealth.
Interaction with the second law of thermodynamics
A simple corollary of the first law of economic exchange is this: increased consumption can only result from increased production. It is at this junction where the laws of economic exchange meet the laws of thermodynamics.
Humanity has proven over the years that we are only able to produce more goods and services by liberating ever increasing amounts of concentrated energy from fossil fuels. And the problem with this is that, as easy-to-access fossil fuels run out and climate change begins to really show its teeth, the enforced transition to renewable energy and all of the additional environmental resistances will greatly hamper our ability to increase our production of real goods and services. And yes, according to our current totally unsustainable economic model, this will result in a seemingly never-ending recession (the one we may very well already be in this very moment).
Yet, despite these fundamental governing laws of our world, we in the West are still trying to consume ourselves to prosperity, blatantly ignoring both the laws of thermodynamics and the laws of economic exchange. However, ignoring the law of gravity while jumping out of a third story window will not stop you from falling your ass off. The same goes for continuing along the paradigm of perpetual debt-based fossil-fueled economic growth while ignoring the laws of thermodynamics and economic exchange.
The seemingly never-ending financial crisis we find ourselves in today is nothing other than the natural correction of massive production/consumption imbalances through the second law of economic exchange. The West has simply been trying to get something for nothing (in complete violation of the first law of economic exchange) for far too long and the time of reckoning is now upon us. As we will discuss on the next page, this reckoning is absolutely essential to achieving a sustainable economic future. It should therefore be welcomed and managed to the best of our ability. If we continue to resist it, however, things could get very nasty.