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Economics and the Laws of Physics

Cartoon by Gus Leoniski

Kerryn Higgs is a longtime Webdiary columnist. This is the last in a series of three articles (see Is the economy part of the planet – or the planet part of the economy? , and A Brief History of Economic Growth) that Kerryn has written for Webdiary.


Trained in mathematical statistics before he studied economics under eminent US economist Joseph Schumpeter, Nicholas Georgescu-Røegen worked in his native Roumania until 1948, when he fled the Communist regime, stowed away with his wife in a couple of barrels. Though he started out in the neoclassical orthodoxy, Georgescu-Røegen is celebrated for his application of the second law of thermodynamics to the economic process. The second law is the so-called entropy law, developed by German physicist Rudolph Clausius from Carnot’s original observations of engines. In 1850, Clausius formulated the principle that heat always moves in one direction only, from the hotter to the colder body, and will not flow the other way without the application of more energy. Based on this elementary fact, the entropy law holds that, in closed systems, all energy dissipates, becoming useless for further work in the process.

Thermodynamics describes one-way processes of qualitative change, which are subject to the ‘arrow of time’, and Georgescu-Røegen argues that economic activity is just such a process, even if economists have not noticed: Irreversible physical transformations are implicit in production; material resources and available energy are consumed and waste left behind. Any economy will require a source of materials and a sink where the waste can be dumped, and an economy which produces large quantities of material artefacts will require large sources and large sinks. Standard economic formulae include no variables to represent resources or wastes and are thus incapable of reflecting the thermodynamic implications of an expanding economic process.

Georgescu-Røegen saw all natural resources as subject to entropic exhaustion, and human economic production as inevitably hastening that dissipation. Mineral ores, for example, are most useful and most accessible for human use in concentrated form. The world’s most concentrated ores have already been heavily depleted, while more dilute sources are only rendered accessible by the application of new technologies and more and more energy—but, other than solar, energy resources are also subject to depletion. Gold mining in the twenty-first century illustrates the trend. Much of the gold that remains untapped consists of microscopic particles so that, in most mines today, something like 30 tons of rock has to be removed, pulverised and sprayed for years with cyanide drizzle to recover an ounce of gold. Such an undertaking can only be profitable on a huge scale; it requires a lot of energy and leaves literally mountains of waste.

Georgescu-Røegen uses soil degradation as another illustration of the slow march of entropic exhaustion: “Thousands of years of sheep grazing elapsed before the exhaustion of the soil in the steppes of Eurasia led to the Great Migration”1 (The Entropy Law and the Economic Process, p. 19). By contrast, indicative of the scale, pace and intensity of recent economic history, two decades of intensive cashmere goat grazing in northern China has already compromised the fertility of the Alashan Plateau of Inner Mongolia. China’s rapidly expanded herds of cashmere-producing goats might have slashed the price of sweaters, but they have also grazed these Chinese grasslands down to a moonscape, unleashing some of the worst dust storms on record.

In the case of oil, too—the energy on which the past century of explosive growth has been based—depletion has not taken thousands of years, another sign of the exceptional pace of twentieth century change. Even if oil supply continues to meet demand for several more decades, as optimists argue, there is little doubt that depletion will occur fairly soon in any long-run view of the human prospect. In July 2007, the International Energy Agency warned of looming shortfalls in the supply of both oil and natural gas. What also seems imminent in the year 2007 is the limited capacity of the planet to act as a satisfactory sink to absorb the waste which will be released by burning the rest of the fossil fuels.

While coal is widely expected to be available for a few hundred years, oil appears likely to become the first crucial industrial scarcity, the first resource of which cheap and accessible supplies have approached exhaustion. Apart from the low-cost oil fields remaining, primarily in the Middle East, oil recovery is now carried on in ever less hospitable contexts—deep seas, Arctic climates and low-content oil sands and shales. The proportion of energy yield expended in extraction is on the increase.

For Georgescu-Røegen, this energy ‘budget’ is just as relevant as the economic one—a ton of oil from shale is not worth extracting if it takes equivalent energy from gas to do it: whatever the dollar value, it makes little sense to extract energy once it costs more energy than it yields. This is, after all, one of the most severe qualifications on the virtues of corn-based ethanol. Even the most optimistic estimates suggest that, in the US, it takes 7 or 8 litres of petroleum to produce 10 litres of ethanol, while Cornell’s David Pimentel has estimated a significant net energy deficit.

Shell’s plans to extract petroleum from kerogen deposits in Colorado demonstrate the curious relationship between financial profits and energy deficits and suggest that the market is not necessarily affected by considerations of the ‘energy budget’. Shell plans to freeze an underground perimeter around 15 acres and then heat the 15 acres inside it to 650 degrees Fahrenheit for up to four years, thus ‘cooking’ the kerogen into a liquid suitable for refineries currently handling light crude oil. The energy for this project will come from coal-fired electricity. With western coal priced at about US$12 per ton and oil prices already fluctuating up to US$80 a barrel (and with no royalty charge for the kerogen resource), Shell might turn a profit even if they run an energy deficit—though the corporation has not conceded such a deficit.

If there is a deficit, as both Justin Bleizeffer and Colin Campbell suspect, it would suggest that an energy extraction activity can be profitable in the market without yielding an energy surplus. It should be noted, in addition, that any oil that Shell produces from kerogen not only risks a net energy deficit but will yield greatly inflated CO2 emissions, due to the large amount of coal burned in the course of its extraction. The market, however, is not sensitive to such drawbacks.

As far as energy is concerned, the earth is not a closed system of course—it receives an immense amount of solar energy every day, making available a generous and indefinite supply of energy, should humans have the means to harness it. Since the solar energy flux will continue, Georgescu-Røegen regarded it as the only rational basis for long term human energy use—a source not subject to entropic exhaustion for another four or five billion years. Industrial capitalism, however, replaced solar-based energy forms such as wind, water and biomass with the energy stored in terrestrial fuels. These are finite and very much affected by the second law, which tells us that energy, once tapped for work and dissipated as heat, cannot be re-concentrated for a second use. In the words of controversial biologist Paul Ehrlich, those who are waiting for a breakthrough which would overturn the second law might as well “wait for the day when the beer refrigerates itself in hot weather and squashed cats on the freeway reassemble themselves and trot away”.

Some neoclassical economists reject the concept of a physical setting for economic processes. Carl Kaysen claimed that “resources are properly measured in economic not physical terms. New land can be created by new investment, as when arid lands are irrigated, swamps drained, forests cleared. Similarly new mineral resources can be created by investment in exploration and discovery. These processes… have been going on steadily throughout human history” (italics mine). While claims of steady growth can be supported by the evidence of the recent past, the long view of history reveals many dead ends and regressions—and rapid change, whether social or technological, was unknown in pre-capitalist societies.

Thus, though it is true that ‘new land’ has been ‘created’ throughout the history of human settlement, for example as the vast boreal forests of Europe were cleared over several millennia and those of North America were subsequently cleared over a few centuries; and whereas land is still being ‘created’ with the current clearing of the tropical forests of South America, southeast Asia and Africa—over much shorter spans—it seems apposite to ask where the next wave of new land is to be ‘created’. As Herman Daly pointed out, the surface of the earth is not expected to grow and, in the absence of such a development, one would have thought that only tectonic activities are likely to ‘create’ new land. For economists like Kaysen, this is not ‘the right way to look at it’.

A related concept in neoclassical economics is the idea of market substitution which holds that any resource will be readily replaced if it runs down. Nobel Laureate Robert Solow considered that capital investment could substitute for actual resources and even embraced the peculiar possibility that “the world can, in effect get along without natural resources… [A]t some finite cost production can be freed of dependence on exhaustible resources altogether.”

Economists like Kaysen and Solow, by downplaying the physical nature of production and the finite nature of the world, stand squarely on a growth platform which recognises no limits whatsoever. Investment is said to conjure any productive resource we may need. These are the dominant economic ideas which influence the insitutions, both national and international, of the modern world.

In the words of Kenneth Boulding’s much-quoted aphorism: Anybody who believes exponential growth can go on forever in a finite world is either a madman or an economist.


1. ‘The Great Migration’ describes the westward movement of the central Asian herders (known popularly as barbarians) into Europe, a migration sometimes argued to have contributed to the fall of the Roman Empire.



Kaysen, Carl (1972), “The Computer that Printed Out W*O*L*F*”, Foreign Affairs, 50 (4), 660-668.

Solow, Robert M. (1974), “The Economics of Resources or the Resources of Economics”, American Economic Review, 64 (2), 1-14.


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To Kerryn

From new Webdiarist Denis Frith:

I believe you provide a very sound view of how economic growth is really constrained by the ecosystem. It is unsustainable. However, I can provide some points that add substance to the arguments you present. These points have been developed in my ‘What went wrong?’ and are summarized in the other posts. They are developed by taking an ecocentric view of what has happened rather than the common anthropogenic view.

I point out in ‘The Immutable Duality’ that the exuberant use of the fossil fuels to energize the industrial revolution has the unintended consequence of causing global warming. I point out in ‘What went wrong?’ that this mistake occurred because it has been common to treat energy as a commodity whereas it is always associated with matter in our operations. Coal combustion in air releases energy we use but it also exhausts waste matter, including the carbon dioxide that is changing the climate. Georgescu-Roegen said ‘matter matters too’ decades ago but few have absorbed that basic lesson.

I point out in ‘The Dependence on Nature Law’ that all the operations of civilization are dependent on irreversibly using natural resources, many of them exhaustible, producing irreconcilable wastes and devastating the environment together with much of its biodiversity. Technology has enabled this use of what is available from nature but cannot recreate what it has destroyed. Technology has often provided substitutes but they have still entailed an irrecoverable eco cost. That is, industrialization is a cancer on the eco system.

I also show in ‘What went wrong?’ that all the structures of civilization are inherently temporary. They have a limited life. This compares with the many natural processes that are cyclic ones driven by insolation, so they are continuing. Consequently we have to continually draw down on natural bounty capital just to operate and maintain these deteriorating structures during their life time  - whilst some bounty remains. This maintenance of the structure of civilization is not, therefore, sustainable.

Denis Frith,Melbourne, Australia


‘What went wrong? The misdirection of civilization.’

‘The Usufruct Delusion’ 

‘The Dependence on Nature Law’ 

‘The Immutable Duality’ 

Are People's Cultures Unnatural?

Hi Denis.I guess by unnatural you mean unsustainable.  This is certainly true of our current civilisation - and, so far as we can tell, all those so far.

My guess is that we could find sustainable alternatives to our current ways of doing things.  We would probably produce less stuff (and out of recyclable material) but there is no reason why we would not be much happier.

In short I'm an optimist.  Industrial civilisation is going but there is no reason not to replace it with a more human and sustainable one.  Whether this will actually happen is of course doubtful.  I see no technical impediments - only human ones. 

The War On Democracy

John Pilger has a new documentary out, it is the first he has done one especially for cinema. Here is some of the things he is said about it on his site http://www.johnpilger.com/page.asp?partid=441

"The War On Democracy examines the false democracy that comes with western corporations and financial institutions and a war waged, materially and as propaganda, against popular democracy. It is the story of the people I first saw 40 years ago; but they are no longer invisible; they are a mighty political movement, reclaiming noble concepts distorted by corporatism and they are defending the most basic human rights in a war being waged against all of us."

GetUp's climate change email

Dear friends,

When the Government saturated us with their Climate Clever advertising campaign, GetUp members rallied to raise an unbelievable quarter of a million dollars plus to successfully air our climate spoof ad during the AFL Grand Final.

But government spending of our taxes to advertise their party policies must stop now. Before another dollar of public money is spent, sign the urgent petition to tell Mr Howard and Mr Rudd that we demand an end to government advertising designed to spruik not inform:


Every day of inaction is literally costing us $1 million in advertising. Some of it is legitimate but this Government has spent more than any other on its own advertising - estimated at almost $2 billion. Our Government is now one of the biggest advertisers in Australia, and one of the highest spending governments in the world. It is all with our money, but without our consultation or consent.

The last federal Labor government did the same, as do current state Labor governments - and while the Greens and Labor are making some positive noises there is nothing effective in Australian law to prevent this unbridled abuse of public trust and purse. Now rumours abound that John Howard even intends to break with time-honoured convention and continue taxpayer-funded propaganda during the election period itself. Sign the petition now - and we'll put your name to the $2 billion invoice we'll send to the government for our monies spent:


Imagine what $2 billion of our taxes could do - close the Indigenous health gap, fill the shortfall in public schools funding, double the Government's spending on climate change. But that money has been largely wasted on political self-interest, and that is simply insulting to Australian taxpayers.

Thanks for being a part of this,
The GetUp team

PS - Malcolm Turnbull MP, Peter Garrett MP and Senator Christine Milne have all posted blogs on the Gunns pulp mill approval at GetUp's new blog pages. Click here to read their messages and join the discussion. 

Economics and collateral damage.

The economy exists “within” the environment. It is human activity, most of it economic, that wrecks river systems and causes excessive greenhouse gas emissions. And while the economy can damage the environment, we’re now seeing the feedback flowing the other way as shortages of water and adverse changes in the weather do damage to the economy.
Similarly, the economic dimension of our lives, our need to earn income from production and spend it on consumption, can’t sensibly be divorced from the social dimension of our lives. Few of us live and work just for the joy of owning stuff. The deeper meaning in our lives comes from our social relationships, with parents and siblings, spouses and children, co-workers, neighbours and friends.
The potential for conflict between the economy and the environment, and the economic and the social, is obvious. Policies aimed at enhancing economic efficiency may directly damage the environment and our social relationships.
To say we should ignore this collateral damage so that, becoming richer, we can more easily afford to fix the problems we’ve made worse, is muddle-headed. It’s saying we must destroy the village to save it.

Economists need to have a good look at their methods. All economic activity takes place in the environment, and without the environment there would be no economy. A value must be put on the environment, and all economic activity that directly or indirectly damages the environment should be added as a tax to the cost to production.  The money raised should be used to repair the environment. A carbon tax would be a good example.

A time for action!

Even with our current level of population and water availability, much of Australia is struggling. Our lower Murray wine industry is facing collapse and Adelaide is our most water-stressed capital. If the water crisis continues into this summer the region faces a full-blown disaster.

Never has the case for sustainability been more evident, or more ignored by our political leaders. Peter Costello is a great population booster, yet we have heard nothing from him about where the water will come from for our increased population. And it's now self-evident that the climate problem requires urgent action. We must remember that the CSIRO projections are not a fait accompli but a call to action.

Tim Flannery, in The Age, calls for immediate action.

 1. Immediate ratification of the Kyoto Protocol.

2. Swift and dramatic reduction of Australia's emissions.

3. Restore the world's tropical rain forests.

4. Reform agriculture to store carbon.

With the election just weeks away let's hope our political leaders are listening.  

Australian Solar Science moved to the US.

While Australia gears up for new coal-fired power stations, the US has taken a dramatic turn - setting its sights on the sun. Two of America's biggest power companies have unveiled plans for a multi-billion dollar expansion of solar power supply. And the man behind it all is an Australian scientist who tried and failed to be heard here.What makes the announcement more significant is that the utilities are confidently predicting that their solar power will soon be providing base-load electricity - that is, day and night - at prices competitive with coal.

JOHN HOWARD, PRIME MINISTER: Solar is a nice, easy soft answer. There's this vague idea in the community that solar doesn't cost anything and it can solve the problem. It can't. It can't replace base load power generation by power stations.

MALCOLM TURNBULL, MINISTER, ENVIRONMENT & WATER RESOURCES : You cannot run a modern economy on wind farms and solar powers. It's a pity that you can't, but you can't.

Australian solar science, backed by US power companies, is about to develop solar power stations which will be capable of supplying base load power. It is a tragic missed opportunity for Australia. If the $17 billion surplus had of been invested into this revolutionary technology, Australia would have been a world leader. Instead, we have moved the technology overseas. We need leaders with vision and courage, not naysayers like Howard and Turnbull.

This sort of statemanship is lacking in Australia.

UK Foreign Secretary David Miliband has told the United Nations.

"Although all countries are affected by climate change, the poorest people within the poorest countries will suffer the most.

He called on the richest countries to take the greatest action to combat climate change.

He made the comments in his first speech to the UN as foreign secretary.

'Dangerous' inequalities

Mr Miliband urged co-operation between nations to improve global equality and therefore stability and prosperity.


"Inequalities are not just morally offensive - they are dangerous.

"Inequality fuels extremism, it undermines support for an open, global economy, it corrodes trust and respect and reciprocity between nations," he told the assembly.

The poor will suffer the most, but how many Australian politicians give a damn?

Pass the parcel

Labor's response to Ziggy Switkowski will deserve close scrutiny.

Key Howard minister still doesn't get it.

Defence Minister Brendan Nelson has rejected Federal Police Commissioner Mick Keelty's statement that climate change poses the greatest threat to the future of Australia's national security.

Mr Keelty made the statement during a speech to a criminology conference in Adelaide four days ago.

But Dr Nelson has contradicted him, saying terrorism remains the number one challenge.

At a speech last night for the Australian Strategic Policy Institute, Dr Nelson said he held Mr Keelty in high regard but he disagreed with his statement on climate change.

Howard ministers still don't understand the threat of climate change.

JOHN Howard has declared the water shortage in the nation's food bowl a crisis, with experts fearing widespread losses of permanent crop plantings, increased salinity levels, algal blooms, and massive fish deaths.

The impact of climate change on coral reefs is receiving ongoing national and international media attention. Consequences for Australia’s coral reefs could be severe despite our significant efforts in protection and management, if key issues are not addressed urgently. The Australian Institute of Marine Science (AIMS) maintains the following position on climate change and coral reefs:

A report shows that Australia's fire danger season will increase dramatically because of climate change.

Australia must prepare to take in a new class of environmental refugees from the Pacific if the worst fears of climate change are realised, federal Labor says.

 "In their millions, people could begin to look for new land and they'll cross oceans and borders to do it.

"The existing cultural tensions may be exacerbated as large numbers of people undertake a forced migration.

"The potential security issues are enormous and should not be underestimated."

Nelson thinks that terrorism is our number one challenge. What a joke.

We cannot put the Howard government back for another term: the risks are too great.

GetUp email on climate

GetUp email on climate change:

Dear friends,

Last week the Government launched its latest taxpayer-funded ad blitz with a $23 million climate change ad campaign. It's designed to dupe Aussies into believing Mr Howard is tackling the climate crisis - and the dangerous thing is, it may well work. So we're planning to make history this weekend by going with the big one.

More Australians will be watching the AFL Grand Final than any other TV show this year, and our team has been working day and night to get our own climate ad ready for it. Watch it now and help us raise the urgent resources we need by this Saturday to get our ad on the air:


The situation is serious - polling shows swinging voters can be easily swayed by simplification of the solutions. With no competing message on the airwaves, these ads may falsely convince many that the Government is in fact 'Climate Clever'. If each of us just chips in a little - say $100, $50 or $20, we can deliver our planet-saving message direct to 3 million Aussies - fast.


The AFL Grand Final is our chance to capture the nation's attention as we head towards this all-important election season. The public purse is being used like never before to convince voters of our Government's dubious climate change credentials, but together we can arm them with the truth.

That's the beauty of the GetUp movement -  you don't have to be a professional spin-doctor, have the Prime Minister's ear or Rupert Murdoch's wallet: with tens of thousands of concerned Australians all chipping in a little, we can achieve so much. Rather than tear your hair out when you see your own taxes used to sell us a dud, donate now to help Australians see the real climate message.

Thanks for making it happen,
The GetUp team

Peak everything

It's highly unlikely economic growth can continue any further, accountable technology can and must, for us to continue to evolve responsibly. Our planet, solar system and galaxy are hurtling through space. Our own little spaceship requires certain conditions to allow us to survive during the earth's journey to wherever. The window of combinations required for life on earth is extremely small compared to the range of conditions possible in the universe: create the wrong balance and life as we know it will disappear. Polluting and destructive economic growth without accountability, direction, or control, creates its own end point when the balance of conditions for our comfortable survival is tipped, even slightly. As economic growth continues, the closer the end point gets. The earth has reached that end point already for some species of life; we can see our own ahead by the way we are going. Many people really don't believe it will happen: they expect some sort of miracle will come along and fix it before it gets out of hand, or some where to far of in the future to worry about.

But is it already out of hand in Australia. The areas of Australia which produce more than 80% of our fresh food, grains, sheep and cattle have no water, and unless they get a huge downpour within the next couple of weeks, there will be no production for this or next year. This will be serious stuff for the cities and larger population areas, as most food may have to be imported. Unless the food producing areas get lots of rain very soon, next year may well bring some forced changes upon society. With fossil fuel costs rising continuously, it won't be long before food, housing, mobility, and power will be beyond the reach of many except for the top 15-20%. You also have to remember, not that many retires are comfortable, most survive and if you are on the pension, it would be a big struggle unless you had paid up assets. When I was young, you worked 40 hours and slept or enjoyed the rest. You got a house loan for 10-15 years, now you get them from 30 to life. Add a credit card lifestyle and you’re in debt, enslaved to economic growth for life, working longer hours or more jobs to live. Totally illogical to me; that's why it can't and won't go on. There are too many looming problems about to hit all at once. No one is really addressing them and no one seems prepared for any of them, singularly or accumulatively.

Hi Margo

Yeah, the blogosphere has been discussing this inevitable aspect of exponential growth on a finite resource base for some years now. We had some pretty hot debates, led by Ian McPherson and Michael Ekin Smyth on the old SMH site.

Over at The Oil Drum, there is a lot of discussion about the consequences of increasing domestic consumption by most exporting nations. High oil prices are increasing revenue and domestic economic activity even as export volumes decline.

Importing nations will feel the pinch at a faster rate than simple depletion rates would suggest.

Meanwhile biofuels do not come cheaply

Meanwhile Michael the Italians are on strike because of the massive hike in the price of pasta. One of the reasons given was the planting by farmers of sunflowers to get into the biofuel market in favour of durum wheat, thus reducing the wheat crop which was the main source of flour for their insatiable appetite for the stringy stuff. But it is also happening in the US: good cropland being taken out of food production for biofuel crops. So it's a two-edged sword.

The other worrrying thing is that we are told we should eat less meat (no problem for this veggie) so that there are fewer animals contributing to the greenhouse gasses. But that means more soya bean production to meet world protein needs, so more felling of rainforests, already at an alarming rate. Then they tell us we should eat more chicken so more forests are felled to grow feedstuffs for billions of chooks in intensive broiler houses.

We are on a gravy train which is going to be very hard, if not impossible, to get off.  With fuel in our area never less than $1.40 a litre, costs of farming anything are increasing to a point where it is just not worth planting, especially when one cannot be sure there is going to be a harvest anyway. So much money was spent on fuel putting in this year's massive crop, and much of it is all but lost already. Waste of fuel, and a waste of money few in the bush could ill afford to lose.  A right royal economic mess.

No Silver Bullets

Hi Jenny. You write: "We are on a gravy train which is going to be very hard, if not impossible, to get off."

There's no doubt in my mind that we will be getting off the petroleum gravy train. The question is, will we bring the train to a gentle stop or will we run it off the rails at speed?

I work for a grower-owned sugar mill in far north Queensland. Most of our operating energy is obtained from burning the waste fibre left over from the milling process. During the crush we produce a surplus of electrical energy for export to the grid. However, we still need to find a way to cultivate, harvest and transport the sugar cane without fossil diesel. We would need to grow at least five thousand hectares of palm oil or coconuts to produce enough biodiesel to cover our essential petrodiesel consumption. This is more than 20% of the area under cane in our district.

Biofuels are not going to sustain the happy-motoring paradigm, IMHO. There isn't any obvious way to manufacture liquid transportation fuels with the net energy we currently squander. Biofuels mine our top-soils. We already have a nitrogen, phosphorus and potassium depletion problem to deal with, and without fossil energy it is very difficult to see how we can maintain current levels of food production. People might get more than grumpy if they see huge tracts of land devoted to keeping internal combustion engines fed while they go hungry.

I don't see how we can escape the need to learn to live with radically less energy.

Peak Oil

Peak oil goes mainstream:
As crude oil prices hit a record high yesterday, an as-yet unreleased Queensland Government report warns of massive social dislocation, rising food prices and infrastructure headaches because of rising oil costs.

The report on the looming 'peak oil' crisis concludes that we will have to re-think the way we live and travel in the next few years as relatively cheap liquid fuels become a thing of the past.

'Peak oil' refers to when global output fails to meet demand, a situation the report estimates will occur in the next few years, although some economists believe we are now on the cusp.

Margo: Hi Michael. It's been known about for a while - I think Webdiary's been reporting peak oil for 3 years? You know, this boom Howard is presiding over is built on closed eyes to climate change and peak oil. Public transport, alternative energy, all that stuff - we're way behind, and thus the shock will be greater. 

Howard/Costello's Debt-laden False Economy.

Excerpts from Lateline:

Australian Broadcasting Corporation

Broadcast: 08/09/2007

Reporter: Leigh Sales

ABC economics correspondent Stephen Long discusses the week in business and finance.


LEIGH SALES: The Reserve Bank left the official cash rate on hold this week but that failed to stop interest rates in the money markets soaring to their highest level in more than 10 years. In response, the Reserve Bank announced unprecedented moves to calm the markets. To explain this, I'm joined by economics correspondent Stephen Long. So, Stephen, what's behind these moves on the money market?

STEPHEN LONG: Well, the short answer, Leigh, is that the credit crunch that began in early August has never gone away. In fact, it's got worse. So banks are fearful of lending money to banks, the market for long term bonds back by mortgages has all but dried up.

So there's a rush for short term cash and this week you saw the key short term money market rates, the 30 day bank bill rate for example, soar above 7 per cent, that's about 40 basis points higher than you would expect it to be with the prevailing interest rate at 6.5 per cent, the cash rate at 6.5. Now, in practice, it's these rates that ultimately determine the cost of finance for business and households, so it's a pretty serious situation.
That's almost the equivalent of two interest rate rises above where the Reserve Bank had set the official cash rate. So what was the Reserve Bank's response? Well, that happened on Wednesday.
Thursday morning, it announced that it was broadening the range of securities it accepted when it injected liquidity into the money markets, including buying mortgage backed securities from banks, so now we have the situation where in Australia and the United States, we have a crisis that's come out of dodgy home lend and central banks are buying securities back by mortgages from banks to inject money into the markets.

Now, I would say this raises serious policy issues and possibly issues of moral hazards when you've got central banks underwriting credit in the market. And it should be the subject of debate, although participants in the market have been glad to see the banks intervene in this way, the debate hasn't happened.

LEIGH SALES: Well, indeed, what would happen if the central banks weren't taking this action?

STEPHEN LONG: Well, I guess there's the rub. I mean, if these lending rates in the money markets kept going at these high levels, ultimately it would feed back into the real economy and you'd have a situation where home loan interest rates, for example, went up pretty much across the board.
And we've have Alan Greenspan, the former chairman of the Federal Reserve, who some would argue is partly responsible for the mess we're in now, but nonetheless, he's saying the situation we're in now is identical in many respects to 1987 before the stock market crash. A serious situation.
End of excerpts.  Emphasis added.
If Alan Greenspan is considered to be responsible for this mess, who is responsible in Australia?  Surely not Kevin Rudd!
Well might the "New Order" claim a "stable and prosperous" economy!

It Is Just A Way Of Looking At Things

Everything that can be invented has been invented.
Charles H. Duell, an official at the US patent office, 1899.


Paul, if the world is a finite system (which it is) and constraints apply to all systems (which they do) then your choices in every area are constrained.

Finite has become the calling of our age. I do not believe we are anywhere near reaching this level. We are only seeing the beginnnings of real growth, and progress.

My argument has less to do with what my generation's expectations are than with what options there will be for my grandchild's generation and beyond.

Every generation predicts doom for the generations to follow. I find it to be a natural human condition.

Our future is beholden to a gambling device, the stockmarket. Here we see wealth being measured by indicators such as PE ratio, the bet that when push comes to shove, the company concerned will actually generate the revenue to back its share price.

There is not a special age where the stockmarket fails to be meaningful. Even if all retirement age people were to cash in their chips, they would still have to spend those chips somewhere. This may see some sectors surpass others; however, a crash with money going nowhere, I do not think so.

That is the worst case scenario. Most likely most people will come to the realisation they will need a place to live, investments to live off, and probably many will like to leave their children something in the will.

If, as you say, my generations expectations have a short history, so does the bourse. What will be the wealth generator in Australia in one hundred years when we have dug most of our resources from the ground?

A bourse in one form or another has existed since the 17th century. I have not heard a valid reason to believe it will not exist for at least a few more centuries.

The Unknown Is Most Exciting

Roger Fedyk

Paul, I think that our personal choices are quite constrained.

Personally I think people are not as constrained as many of them believe.

I am now 61 and am forced to think about things that were of marginal interest when I was a younger man. I grew up in a time where your old-age needs were clearly to be provided by the society to which you contributed over your working life.

This is an interesting point. Historically there is not any basis for it. The generation that you are from was the first one to ever think along those lines. The problem is the "needs" have extrapolated into a better lifestyle in retirement than being enjoyed throughout working life. This is not, and never was a possibility for most people. This has nothing to do with governments being "sneaky" it is and always has been a sensible reality.

There is a tendency for all generations to see their time as somehow life changing. There is also a tendency for generations to see themselves as somehow indispensable. This has never been the case throughout history, and it will not be the case with your generation. The show always goes on.

My biggest argument would be that we are stuck in a last century world with two major economic ways of thinking. It is either Keynes or it is Freidman (basic way of looking at it I grant you). The problems of this century will not be adequately covered, and managed by either one of those ideologies not even a combination of both. The great adventure for my generation (and probably the one after) will be finding another.

Back To The Future

Paul, if the world is a finite system (which it is) and constraints apply to all systems (which they do) then your choices in every area are constrained.

My argument has less to do with what my generation's expectations are than with what options there will be for my grandchild's generation and beyond. Our future is beholden to a gambling device, the stockmarket. Here we see wealth being measured by indicators such as PE ratio, the bet that when push comes to shove, the company concerned will actually generate the revenue to back its share price.

If, as you say, my generations expectations have a short history, so does the bourse. What will be the wealth generator in Australia in one hundred years when we have dug most of our resources from the ground?

Craig Of "Some" Interest

Craig Rowley

Paul Morrella you've had a go today at setting up a platform for making yet another personal attack on other 'diarists, this time saying in Interesting Points Roger:

Actually I found the things that Roger wrote interesting. I also found Scott's post interesting. I made an attempt (until interrupted) to answer both.

What's your "problem" with some other 'posters'?

I do not have a "problem" with any poster.

Paul, it is time for you to come clean: Why do you keep bringing up your complaint about some other 'posters'?

I do not have a complaint with Webdiary. If I had a complaint with Webdiary I would not bother posting or reading. I have read a complaint about me (still laughing).

Craig:  Do you really think I am the person you should be posting to? I am only looking to write about world [general political] economic issues.

Interesting Points Roger

Roger Fedyk

Localisation, economic multi-lateralism, communal living, social responsibility, stewardship perhaps? Sounds like......

Possibly, and I would not have a problem with this. I have never had a problem with this. In fact I buy only organic fruit, and vegetables, and have done so for a period of time. This would be taking away from the multi-corporate as you say. I have never been here to push a certain way of living. My only "push" is that people are given free choice. The majority of people are really against "choice" one way or the other.

I am not, and never have been here to protect the current system. There are many things about it I do not personally like. I will not though go to the lengths of deluding myself about it to suit my own biases. This is the problem I find myself coming across constantly with some other posters.

All these options of living are already open to people. It is only a matter of them making a choice. I am all for choice; and that is why I do not want a return to the top-down Keynesian economic approach. The approach of semi-isolationism, and government intervention. It forces a way of living upon us all. A way of living some of us do not wish for.

It also suggests that governments will enact legislation that will limit how much you can extract in any year, just like stopping a run on the bank.  We have built, with the collusion of successive weak-kneed, lying governments, the ultimate Ponzi scheme with our great-grand children left holding the bag of dust.

This is also very possible. I would though be against government intervention if such a thing were to take place. I believe a system of living should live or die depending on how adaptable it is. If the current system fails we should find another.

I too believe this is something all people should consider carefully when making investment decisions. People should always carefully consider their investment decisions!

The Limits Of Personal Wealth Creation

Paul, I think that our personal choices are quite constrained. We are largely captive to the systems that we have inherited or have had foisted upon us.

I am now 61 and am forced to think about things that were of marginal interest when I was a younger man. I grew up in a time where your old-age needs were clearly to be provided by the society to which you contributed over your working life. However, along the way a dramatic and somewhat sneaky change was implemented. In line with world-wide trends in all developed countries, the financial costs of retirement have been pushed gradually from a "society pays" to a "user pays" basis; from "defined benefit" to "defined contribution".

The reasons for this are many and I am not yet arguing against such a shift taking place, however the options for the "user pays" path are limited to a very small number;

  • wealth creation through speculation on the bourse
  • wealth creation through speculation in real estate
  • wealth creation through the ownership of a suitable business
  • wealth creation through gambling
  • wealth creation through criminal activity

As the population of the developed world is becoming increasingly gentrified, all of these options suffer from terminal problems. The first three finds too many of us chasing too few resources. The current situation in the real estate market is a graphic example of the "fool's gold" that we are clinging too. Everything about what a property is "worth" is notional and relies very much on a climate of low supply. As we now see, eventually this wealth system becomes self-feeding and enters a "runaway" state. The end-point is collapse.

We start on this road with good intentions, such as building a nest-egg, but without careful stewardship and regulatory feedback systems we can be on a one-way trip to a financial train wreck. Capital gains tax provides one mechanism for controlling the balance between the competing needs of society but is continuously under fire when it performs its role well.

But at the core of all this is a very human frailty, greed. We can't control or legislate for it very well it seems.


No limits

Roger Fedyk "I think that our personal choices are quite constrained. We are largely captive to the systems that we have inherited or have had foisted upon us. I grew up in a time where your old-age needs were clearly to be provided by the society to which you contributed over your working life".

I have never believed that I should rely on society to provide for my old age.

I have used the following to ensure that I control my own destiny:

• wealth creation through speculation on the bourse, both here and overseas.
• wealth creation through speculation in real estate,which includes investment properties both here and overseas.
• wealth creation through the ownership of a suitable business,and working very hard in building it up and then selling it, which I have done in the last month.

I run a self-managed super fund which shows annual returns in excess of 11%.I believe anybody can do this,(with the right financial advice) that way it really does not matter which political party is in power- you can retire in comfort.

Well Done, But

Alan, that is very impressive. Now tell me how that translates into a course of action for 6 billion people. (You do care about your fellow don't you?)

6 billion businesses all for sale? Who does the work? Who are the customers?

Uranium Johnny

Robert Menzies gained the nick name Pig Iron Bob, will John Howard now gain the name Uranium Johnny? Exporting uranium to India and Russia would appear to be a huge risk

Interesting Point Paul

Paul Morrella you've had a go today at setting up a platform for making yet another personal attack on other 'diarists, this time saying in Interesting Points Roger:

I will not though go to the lengths of deluding myself about it to suit my own biases. This is the problem I find myself coming across constantly with some other posters.

What is your reason for continuing to make points like that on various threads?  

Why did you make such a comment that when your actions have already resulted in one of the some other 'posters'  being banned? 

What's your "problem" with some other 'posters'?

Is it to suggest that some other 'posters' not be alllowed to exercise the "choice" to rely on the statements by Margo published in About Webdiary, Webdiary Ethics, the Editorial Policy and The Webdiary Story to guide the what they submit to Webdiary for publication and to guide them when they are unsatisfied about the translation of those statements into the decisions made each day by the editors?

Is it to suggest some other 'posters' should also be banned for making the choice to ask questions about the editorial and moderation decisions made by the Webdiary editors?

Paul, it is time for you to come clean: Why do you keep bringing up your complaint about some other 'posters'?

Physics and Economics

There is one possibility to marry economic growth and ecology.

That is the consumption of less resource intensive goods.  Ie. there is no economic reason why the economy shouldn't be funded by people paying lots of money for things like hearing the Dalai Lama speak.

The essentials of life could fairly readily be provided outside of the economy by guaranteed non-monetary provision.

This already happens alot and our economy relies on it.  Most of us (economists excepted perhaps) don't run our friends and families as economies.  Distribution of ebooks and movies over the net show that less resource intensive distribution is possible.

This is a possible direction to advocate and move in.  Already as the  Australia institute has shown (Downshifting) the disenchantment with consumerism is huge. 

Richard:  Evan, are you new to Webdiary?  If so, welcome!


Pretty new, yes.

Thanks for your welcome.

And your special subject tonight is

the bleeding obvious. No disrespect intended to the author. When is someone else going to mention the unsustainable exponential growth of humanity?

Paul Morella, patently an intelligent sort of chap must count no few pixies among his friends and acquaintancies.

Read the arguments set out in the above Paul; examine your position and extrapolate it to it's logical conclusion. What if there are no "economic" magic bullets?

Well I'll be buggered

Patently I'm not as smart as I thought I was.

Roger, as you might be aware I do not involve myself with WD anywhere near as much as I used to but drop in from time to time to see what's going down.

Mate, I'm gobsmacked.

Here was I thinking you were apostate, going on our discourse a couple of years ago which involved Malcolm and Jenny. I thought at the time I was getting into a touchy area and the last thing I want is to put you on the spot. 

 And you're doing this gig.

I was intrigued and attempted to download your stuff but it got into the area of  the "too hard basket". (I'm a lazy bastard and only get motivated by the physical or serious intellectual challenges presented.)

My son sends me his stuff in MP3 format by email which, though fuzzy, (my  peripherals contributing) is still decipherable. On the subject, you could do worse than pay him a visit at the "Espy" on St Kilda beach. It's an eclectic venue with plenty of old farts like us mixed up with middle aged couples and lots of younger folk displaying evidence of body piercing (yuk) and tats. He has a wealth of knowledge and equipment that could help you in your endeavours and I know he would be happy to accommodate you. I will let him know of this so he will not be surprised. Ask any of the performing band members to point out Austin Dunmore; he's not hard to find. I think you'll find a lot in common.

On another thread, at the time of the half smart arse Keating's announcement of a national super scheme I recognised straight away its ramifications: the diversion of "money" from the general economy into speculative markets. Another attempt by government to avoid its responsibility for social services by privatisation, thereby jacking up the price of commodities rather than investing in infrastructure to secure the future of our society. Could bang on at length mate but this will do for now. If you're going to have a gig at Ian and Jenny's place (to all Webdiarists), if I'm still here (and that is in the lap of the gods), special rates apply at the Coachmans Rest in Coonabarabran! (Hey just joshing but I'm running a business after all.)

Fiona: I've noted your technical questions and will get back to you asap. Meanwhile, yes, October 2008 looks like an interesting possibility.

When The Old Becomes New Again

In the words of Kenneth Boulding’s much-quoted aphorism: Anybody who believes exponential growth can go on forever in a finite world is either a madman or an economist.

I am not aware of ever reading a quote by any person claiming growth can go on forever. My personal view is that we have only scratched the surface of it. I do not believe I will live forever, however; I did not begin planning my funeral from the moment I was born.

There is in fact palpable world-wide and growing resistance against both globalisation, and economic liberalisation. This has been underway for a period of time, and probably was first witnessed by many of us most dramatically in Seattle. It would be delusional of me, and indeed any other person around the world to think this resistance has not grown in strength. Politicians world-wide would be crazy not to ride this sentiment into office. As the only political objective is winning elections I have no doubt many will indeed do just that.

Economic liberalisation has always been misunderstood. It has also been poorly sold. It is not, and it never will be a cure all for that ails the world. Unfortunately I do not believe this has ever been honestly confronted or explained in any meaningful way. It is now not unusual (as I have personally witnessed) hearing of people earning over six figure sums directly attributing the hardships in their lives to "globalisation". It is human nature to see through the individual lens (real and imagined).

Now for the bad news:

Apart from sentimentality toward Keynesian economics there are no viable alternative answers that exist. Actually Keynesian economic theory is certainly not a viable alternative in the world of today. It will fail in the same way it failed by 1980. Only this time around much more rapidly. I do not believe the realisation of this will exclude an attempt at such a doomed failure from being thrust upon us. Far from it I believe it is a necessary final step for my generation. Failure is a necessary part of the learning process. Hopefully next time around (and there will be a next time) those aided with the hindsight of knowledge will do it a little better.

PS the shift away from globalisation, economic rationalism, competition, economic liberalism etc is totally understandable when seen through the prism of an aging western population. Exactly the same way it was understandable that the aged would wish to stay in East Berlin whilst the young attempted to climb the wall. Again many of the misunderstandings come down to failure on the part of economic liberals to fully explain with candor not only the benefits but also the possible downsides to many of their policies. Equally the same lack of candor will eventually see the end to the neo-Keynesian return.

There comes a time for all generations to take the lead. The time eventually (be it late) will also come for the post-boomer generation, and life will not end. I believe by this time globalisation will be much more readily accepted, and understood. I see the early part of this century as the grooming process.

PSS I do not and never have believed this neo-Keynesian phase has been driven by anything but pure perceived self interest (no different to the way any other economic theories are driven). The ruse of this being somehow for the benefit of the third-world or our environmental future is pure unadulterated intellectual dishonesty. Such false claims for the non-existent, and undeserved moral high-ground should be seen, and will one day be seen for exactly what they are.

Shift To The Next Dimension?

Paul, if there is a shift away from globalisation, economic rationalism, competition, economic liberalism where are we shifting to?

Localisation, economic multi-lateralism, communal living, social responsibility, stewardship perhaps? Sounds like......

I'm growing vegetables and herbs for the wife and I and definitely not for sale. Where do I fit on the scale and what is that doing to my Coles Group shares and my superannuation? Thats a big, big, BIG question for those who think that their old age is going to be secured by an endlessly expanding stockmarket.

For those who think that Robert Kiyosaki says something sensible to say now and then try this on for size. His prediction is that the stockmarket will collapse catastrophically in about 10-20 years as hundreds of billions of dollars are extracted permanently from fund portfolios to pay for the retirement years of the baby boomers. It's got me thinking about where my money should be invested.

It also suggests that governments will enact legislation that will limit how much you can extract in any year, just like stopping a run on the bank.  We have built, with the collusion of successive weak-kneed, lying governments, the ultimate Ponzi scheme with our great-grand children left holding the bag of dust.

Oposition to Howard is "uninformed pig headedness"

Mr Howard says the figures are astonishing and underlines the value of globalisation and continued economic growth.

"They also underline the uninformed pig-headedness of those who demonstrate against APEC in the name of helping the poor and dispossessed and the alienated," he said.

"The truth is that economic growth is the sure path out of poverty."

The figures that really must astonish Mr Howard are today polls

There must be a lot of uniformed pig headed Australians that think continued economic growth might just be the end of the human race.

 Our present methods of consuming resources and pursuing economic growth are not sustainable over the long term. We will run out of fossil fuels and minerals, for example. We will run out of mature timber if we keep consuming at the same or a greater rate. Having less able bodied people to work and fuel this consumption of resources by industry is a natural response by our species to diminishing resources. The solution is not to try and sustain our present way of living. The challenge is to find new ways of living on this planet, new ways to provide for our basic needs and our higher needs (art, music, cultural pursuits
etc) without maintaining our current level of consumption.

We must turn our backs on Howard and look to a future for our kids. If I am uninformed and pig headed, I have a lot of company.

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