Twenty (Important) Concepts I Wasn’t Taught in Business School – Part I

Twenty (Important) Concepts I Wasn’t Taught in Business School – Part I

by Nate Hagens  September 20, 2013   theoildrum

This article is full of great writing, charts, graphs, and illustrations, and explains quite well why nature and energy are our true sources of wealth.  Here are some excerpts:

Economic ‘laws’ were created during and based on a non-repeatable period of human history

The economic ‘theories’ underpinning our current society developed exclusively during the [last 100 years when the continents of North and South America, Australia, and other vast regions were barely settled by humans], and when increasing amounts of extraordinarily powerful fossil energy were applied to an expanding global economic system.

Our present culture, our institutions, and all of our assumptions about the future were developed during a long ‘upward sloping’ stretch. Since this straight line period has gone on longer than the average human lifetime… it is difficult to imagine that the underlying truth is something else.

Our true wealth originates from energy, natural resources and ecosystem services, developed over geologic time.

The economy is a subset of the environment, not vice versa

Standard economic and financial texts explain that our natural environment is only a subset of a larger human economy. A  more accurate description is that human economies are only a subset of our natural environment. Though this may seem obvious, anything not influencing market prices remains outside of our economic system…despite a] landmark study in NATURE that showed the total value of ‘ecosystem services’ like: clean air, hydrologic cycles, biodiversity, etc. if translated to dollar terms, were between 100-300% of Global GNP. Yet the market takes them for granted and does not ascribe any value to them at all!!!

Cheap energy, not technology, has been the main driver of wealth and productivity

One barrel of oil, priced at just over $100 boasts 5,700,000 BTUs or work potential of 1700kWhs. At an average of .60 kWh per work day, to generate this amount of ‘labor’, an average human would have to work 2833 days, or 11 working years. At the average hourly US wage rate, this is almost $500,000 of labor can be substituted by the latent energy in one barrel of oil that costs us $100.

Energy is almost everything

In nature, everything runs on energy. The suns rays combine with soil and water and CO2 to grow plants. Animals eat the plants. Other animals eat the animals. At each stage there is an energy input, an energy output and waste heat (2nd law of thermodynamics). But at the bottom is always an energy input. Nothing can live without energy. Similarly, man and his systems are part of nature. Our trajectory from using sources like biomass and draft animals, to wind and water power, to fossil fuels and electricity has enabled large increases in per capita output because of increases in the quantity of fuel available to produce non-energy goods.  The bottom of the human trophic pyramid is energy, about 90% of which is currently in the form of fossil carbon. Every single good, service or transaction that contributes to our GDP requires some energy input as a prerequisite. There are no exceptions. No matter how we choose to make a cup, whether from wood, or coconut, or glass or steel or plastic, energy is required in the process. Without primary energy, there would be no technology, or food, or medicine, or microwaves, or air conditioners, or cars, or internet, or anything.

Energy is special, and non-substitutable

Physics informs us that energy is necessary for economic production and, therefore growth. However, economic texts do not even mention energy as a factor that either constrains or enables economic growth. Standard financial theory (Solows exogenous growth model, Cobb Douglas function) posits that capital and labor combine to create economic products, and that energy is just one generic commodity input into the production function – fully substitutable the way that designer jeans, or earrings or sushi are. The truth is that every single transaction that creates something of value in our global economy requires an energy input first. Capital, labor and conversions are ALL dependent on energy.

Energy has costs in energy terms, which can differ significantly from dollar signals: In nature, animals expend energy (muscle calories) in order to access energy (prey). The return on this ‘investment’ is a central evolutionary process bearing on metabolism, mating, strength and survival. Those organisms that have high energy returns in turn have surplus to withstand the various hurdles found in nature. So it is in the human system where the amount of energy that society has ‘to spend’ is that left over after the energy and resources needed to harvest and distribute that energy are accounted for. Finite resources typically follow a ‘best first’ concept of resource extraction. As we moved from surface exploration based on seeps to seismic surveys showing buried anticlines, to deep-water and subsalt reservoir exploration, and finally to hydro-fracturing of tight oil formations , the return per unit of energy input declined from over 100:1 to something under 10:1. To economists and decision makers only the dollar cost and gross production mattered during this period, as after all, more dollars would ‘create’ more energy. Yet, financial texts continue to view economic activity as a function of infinite money creation rather than a function of capped energy stocks and finite energy flows.

Money/financial instruments are just markers for real capital.

In business school and Wall Street we were taught that stocks going up ~10% a year over the long run was something akin to a natural law. The truth turns out to be something quite different. Stocks and bonds are themselves ‘derivatives’ of primary capital – energy and natural resources – which combine with technology to produce secondary capital – tractors, houses, tools, etc. Money and financial instruments are thus tertiary capital, with no intrinsic value – it’s the social system and what if confers that has value and this system is based on natural, built, social and human capital. And, our current system of ‘claims’ (what people think they own) has largely decoupled from underlying ‘real capital’.

Our money is created by commercial banks out of thin air (deposits and loans are created at same time).  Banks do not lend money, they create it. And this is why the focus on government debt is a red herring. All of our financial claims are debt relative to natural resources.

Debt is a non-neutral intertemporal transfer

Of the broad aggregate money in existence in the US of around $60 trillion, only about $1 trillion is physical currency. The rest can be considered, ‘debt’, a claim of some sort (corporate, household, municipal, government, etc.) If cash is a claim on energy and resources, adding debt (from a position of no debt) becomes a claim on future energy and resources. In financial textbooks, debt is an economically neutral concept, neither bad nor good, but just an exchange of time preference between two parties on when they choose to consume.

Energy measured in energy terms is the cost of capital

The cost of finite natural resources measured in energy terms is our real cost of capital. In the short and intermediate run, dollars function as energy, as we can use them to contract and pay for anything we want, including energy and energy production. They SEEM like the limiters. But in the long run, accelerating credit creation obscures the engine of the whole enterprise – the ‘burning of the energy’. Credit cannot create energy, but it does allow continued energy extraction and much (needed) higher prices than were credit unavailable. At some point in the past 40 years we crossed a threshold of ‘not enough money’ in the system to ‘not enough cheap energy’ in the system, which in turn necessitated even more money.


Other articles by or about Nate Hagens

Biegler, P. July 1, 2016. Material world: why we’re wired to consume. Saving the planet means consuming less, but why is it so hard to do?

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