Bernard Lietaer - Money and Diversity by Local Money

Money and Sustainability The MissingLink

Q A REPORT FROM THE CLUB OF ROME - EU CHAPTER to

finance Wotcfi and the World Bus/ness Academy

Kurnurd Lielaer Christian Amspcrger

- Sally

Gocmcr ~ Stefan Biunnhubei

Contents Introduction:Mark Dubrulle, The Club of Rome - EU Chapter

Correspondence & Endorsements Foreword by Dennis Meadows

Pealing with the Eurozone Crisis... Another Way? Executive Summary ChapterI

Whv this Report. Now? Chapter II Making Economic Paradigms Explicit Chapter 111 Monetary' and Banking Instability

Chapter TV

Instabilities EsplainediThe Fhvsics of Complex Flow Networks Chapter V

The Effects of Today's Money System on Sustainability' Chapter V!

The Institutional Framework of Power Chapter

Examples of Private Initiative Solutions Chapter VIII

Examples of Governmental Initiativ es Chapter IX

Bevond the Limits to Growth? Appendices

Acknowledgements About the Authors About the Club of Rome

Bibliography

CtUB 0Vÿ

THE CLUB OF ROME: EU CHAPTER - CoR-EU Honorary President HRH Prince Philip of Belgium

Telling the Truth about Money Introductory remarks to the Report to Finance Watch and the World Business Academy We are not telling the truth about money- Yet money is at the core of the economy. And economy is ruling the world. It dominates human welfare from cradle to grave. It rules the use of the planet’s natural resources and the quality of the environment. Today it is generally admitted that many limits of the Earth’s ecosystem have been overshot. There is evidence that the present course is not sustainable.

Governments, media and most leaders make every possible effort to convince public opinion to stick to mainstream thinking- If society wishes to be or to become successful, they say, we have to keep faith in the current paradigm. The gospel still is that everything has to be expressed in monetary terms. And that there is no salvation outside the dominant financial systems and banking practices, a monopoly and a major power instrument- Closed systems are preferred to open ones. Complexity is avoided. Indeed a shortsighted vision on sustainable solutions..,

There is, though, a lot of thinking and doing out-of-the-box’ around the world- At conferences, in publications and increasingly through the Web, many authoritative voices are denouncing the blind spots of the present paradigm, inviting us to act without waiting any longer. Yet, their messages are not relayed by the mass media. They are ignored by most political leaders. They don’t reach the public at large. At the same time, people are crying out for a radical change, not theleast in the European Union.

The dub of Rome EU Chapter (CoR-EU), located in Brussels, aims to build bridges between the institutions of the European Union, their constituencies and the international dub of Rome,

which has been a leading think-tank at world level for more than 40 years. TheCoR-EU is acting as a catalyst of reflection on sustainable development in Europe. Its strategic aims for the next few years focus on the issues of money and governance. This includes initiating and facilitating cutting-edge research on ground-breaking concepts in these domains. We asked our fellow Board member Bernard lietaer to prepare a Report on money and sustainability7 that could contribute to a societal discourse on the implementation ofEU policies for development in a wider global context, involving key public authorities and private sector decision-makers, the media as wrell as the public at large. With co-authors Christian Arnsperger, Stefan Brunnhuber and Sally Goerner he produced the present Report, which is fully endorsed by the EU Chapter of the Club of Rome.

While the issue is by definition global, the CoR-EU felt the Report should primarily be addressed on its behalf to a recognised, authoritative and independent European body. The most appropriate choice seemed to be finance Warch, a public interest association, recently created on the initiative of members of the European Parliament. It is dedicated to making finance work for the good of society7, strengthening the voice of society7 in financial regulation reforms by conducting citizen advocacy7 and presenting public interest arguments to lawmakers as a counterweight to private interest lobbyingby the financial industry. It made sense also to address thebusiness community7 at large. We are delighted that the World Business Academy, a non-profit think-tank and network of business leaders, agreed to be a second recipient of our Report. Its mission is to inspire and help business assume responsibility7 for the whole of society7, exploring its role in relation to critical moral, environmental and social dilemmas. Its objectives are to change business leadersâ&#x20AC;&#x2122; consciousness from self-service to servant leadership as well as to change the behaviour of the public at large, so it spends its money whereits values are.

These objectives are dose to the Club of Romeâ&#x20AC;&#x2122;s heart. At the time of writing these remarks we witness the dismantling of the state as guarantor of

public good. Almost everything is for sale in most EU countries. Austerity7 is imposed at all levels. Public unrest will continue to grow- unless new governance structures replace the obsolete ones.

There is a great challenge here for the European Union. We dare hope that the publication of Money and Sustainability: The Missing Link will inspire many a decision maker and opinion leader to change course now, choosing new, creative approaches in monetary issues. We urgently need an increased moral consciousness at all levels.

TheCoR-EU is indebted to the World Academy of Art and Science, represented by Ivo Slaus, President, and Garry Jacobs, Chair of the Board and CEO, as well as to Felix Unger, President of the European Academy of Sciences and Arts for supporting this Report by co -signing these brief preliminary remarks. Mark DUBRULLE Member of the Club ofRome President of the CoR-EU Chapter

Felix UNGER President of the European Academy of Sciences and Arts

ivo SLAUS

President of the World Academy ofArt and Science

Message from the Secretary General of die Club of Rome

Is Money the Evil?

Money, so we are told, is the root of all evil; it makes the world go round; but can’t buy us love. The truth is money has become a central feature of our existence. It measures our economic growth, our social status and our consumption habits. Two billion of us on planet Earth have nowhere near enough to live on; yet one per cent of our population has more than it can ever use and flaunts it in a manner that frequently appalls many of us. How could this have come about? How could a simple invention which had, at its heart, such a laudable goal - to help people trade their commodities easily and effectively - go so wrong? Why have we this rift between finance and economy, between financial markets and thereal economy they were meant to serve? The consequences of this rift have been growing for decades. Over the past forty years, the world has been wracked by over 400 financial crises; they have destabilised

economies, impoverished people around the world and wreaked havoc with tiieplanetis natural capital. Money and financial markets havebecome ends in themselves.

Lietaer and his colleagues have embarked on an ambitious yet timely investigation into the role of money and its effects on sustain ability- . He takes us on an incredible journey, which places money in its rightful context as a means to a sustainable future. He analyses the emergence of a speculation society where money floats around our global casino and where only 2% of the $4 trillion a day traded in foreign exchange transactions actually makes it way into the real economy. But now-, imagine the tables were turned, and we could squeeze 98ÿ6 into the real economy. What might this mean for jobs or for reducing poverty? For sustainability"?

Thebook contains powerful arguments that need to be listened to, digested and acted upon. The section on how money affects sustainability" makes the key point that the global crises we face are interconnected. The financial crisis is but one dimension of a multi-dimensional puzzle, However, the book is more than a diagnosis of the ills and travails of our monetary system; it also points to new ways of reforming our financial system, to pioneering ideas and to potential solutions. The call for alternative thinking and innovative strategies is timely and necessary, The Club of Rome congratulates the authors. Their book articulates many of the concerns that the Club of Rome has articulated over the years. Let therebe no doubt that our financial system is in urgent need of major overhaul. We tamper with it at the margin at our own peril, Without a

well functioning financial market we will not see the progress necessary to protect our natural capital base and secure meaningful work for those who need it. We will pay a high price. The authors understand this and have put before us a reasoned and important book. fan JOHNSON Secretary General - The Club ofRome

Before joining the Club ofRome in 201o, /an Johnson spent 56 years at the World JSnnfc, ivhere he became Vice President for Sustainable Development and,forfive years, Chairman of the Consultative Group on International Agricultural Research (CGIAR).

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tflMAtdOCCl

The World Academy of Art and Science

The current economic, political and moral crises cannot be solved, cannot even be reduced, by applying more of the same approaches that generated them in the first place. New ideas, out-of-the-box thinking, and paradigmatic changes are required. Many prevailing concepts currently taken for granted have to be freshly studied and challenged. Money is such a concept. WAAS endorses and strongly supports the initiative of the Club of Rome-EU Chapter and thanks WAAS fellow Bernard Lietaer who initiated this important and original line of research more than a decade ago and has presented it at meetings of the World Academy. Lietaer and his collaborators, Christian Arnsperger, Sally Goerner and Stefan Brunnhuber, have produced a remarkable study, Money & Sustainability: the Missing Link, which merits serious attention

from leaders, policy-makers, theorists and others trying to understand the roots of the current monetary crisis and measures for ad dressing it.

This study complements other endeavours of WAAS stressing the essential value and role of human capital. The Report reminds us that money is a man-made instrument intended to help society optimisehuman welfare. The prevailing monetary system encourages the multiplication of money for destabilising speculative investment rather than for productive investment that creates jobs, raises real incomes and promotes social equity. The Report examines alternative monetary strategies that can help mobilise under -utilised social resources, especially the huge number of unemployed and underemployed young people and adults whosehuman potential is ignored and squandered by the current system, This Report is a call for prompt political and economic action. We wish to express our appreciation to the authors and to the Club of Rome EU-Chapter for this

important initiative,

Ivo SLAUS

Garry JACOBS

President

Chair of theBoard and CEO

r «1WORLD BUSINESSfor ACADEMY Taking responsibility

the whole

"War is too important to be left to generals," as the old adage goes. Likewise, monetary policy is too important to be left to monetary theorists. The brilliance of this Report is that it captures and maps - with crystal clarity - the fundamental connection between climate change, the cydical boom and bust of our current monetary system, the fragility' of the global economy, the political instability of most of the Western democracies, and the unsustainable overhang over it all of vast pools of international capital in the form of gambling receipts which we euphemistically call “derivatives”.

The capacity to report succinctly and in an informative way on the interrelationship of these dynamic pieces is itself a credit to Bernard Lietaer and his associates. Even more important, the Report is so lucid and readable that the average executive can understand the extraordinary issues it presents in away seldom possible with monetary theorists' articles. The Report has illuminated essential questions usually left in the dusty corners of academia's ivory towers and brought them into full focus in thehurly burly of themarket place. The Report conveys what we must do individually and collectively if we choose to havebusiness enterprises grow in healthy and sustainable ways. From thebusiness viewpoint, monetary policy" isn't an academic exercise:

• In normal times, the pro -cydical amplification of the money creation process is extremely expensive for thebusiness world; businesses tend to be always under- or over -staffed, underor over -in vested, at both ends of this amplified cycle, * In times of crisis, when banks misstep they are in fact holdinghostage the entirebusiness world and increasing therisk for all businesses, big or small, from Main Street to Wall Street, • The solutions presented in chapter VII show what businesses can and should do themselves to systematically avoid these problems, • The full Report is an in valuable tool that enables C- Suite executives and their Boards to understand what they need to know and to do to lead their enterprises and maximize stakeholder value.

The World Business Academy has long been committed

advancing cutting-edge business

information among business executives charged with navigating their businesses through the challenging times we live in. The Academy thanks Bernard Lietaer and his associates for presenting this Report to us, and encourages all levels of government and private enterprises to use the Report to begin a serious conversation on the critical issues the Report illuminates while thereis still time.

RinaldoS. BRUTOCO President

Foreword by Dennis Meadows Arsenic was used as a medicine for thousands of years. It is a deadly poison, of course. But its ability to alleviate the short-term symptoms of distress led many sufferers to use it anyway. Only in the past century has it been mainly replaced

by less deadly alternatives. Fiat currency issued by private institutions through the creation of debt has been used by nations for centuries. Its deadly effects are becoming apparent. But its ability to alleviate the symptoms of distress has led to its use anyway. We can only hope that in this century we will begin to use less deadly

alternatives. I have been reading the literature on sustainability for 40 years. I have attended hundreds of conferences on the same theme over that period. However, before I first encountered Bernardâ&#x20AC;&#x2122;s work, Ihad never heard anyone describe the financial system as a cause of our society's headlong rush to collapse. Quite the contrary: there is a widespread effort to identify how minor changes in the financial system could move global society over to a path that leads to sustainability'. A fish will never create fire while immersed in water. We will never create sustainabilityâ&#x20AC;&#x2122; while immersed in the present financial system. There is no tax, or interest rate, or disclosure requirement that can overcome the many ways the current money system blocks sustainabilityâ&#x20AC;&#x2122;. I used not to think this. Indeed, I did not think about the money system at all.I took it for granted as a neutral and inevitable aspect of human society'. But since beginning to read Bernard's analysesIhave a very different view. He is not alone. For example Thomas Greco has written on this topic. But the depth of Bernard's practical experience, theoretical understanding, and historical perspectives on the financial system leave him without peer.

Inow understand, as proven clearly in this text, that the prevailing financial

system is incompatible with sustainability in five ways:

* it causes boom andbust cycles in the economy * it produces short-term thinking * it requires unending growth * it concentrates wealth

it destroys social capital

Any one of these is probably enough to derail the most carefully considered plan for a transition to sustainability. Together they are a prescription for disaster, which is precisely what they are giving us. The instability of the financial system shouldbe enough to cause alarm, as the authors point out:

the IMF between igjo and 2010 tkere were 145 banking crises,208 monetary crashes and 72 sovereign-debt crises-in other words, a siaggering fotai of 425 systemic crises. An average of more than 10 per year! These crises have hit more than three-quarters of the 180 countries that are members of the IMF, many of them being hifsei?eraZ rimes." “According

Informed observers of the 2008 crisis, by far the most serious so far, believe that the causes of instability’ have not been changed. Indeed many of them have grown worse. There will certainly be another global financial disaster. A common English idiom is, ‘Like a fish out of water'. It refers to someone or something in a very' unaccustomed and awkward situation. But unless the fish does move out of water, its experiments will never lead to fire. We are going to have to go through an awkward period, experimenting with new currency’ systems, if we are to have any chance of our efforts leading to sustainability’.

Viable complementary' currency systems are not alone sufficient to halt our headlong drive towards disaster. But we have no chance of avoiding collapse without them. This text is a rich source of information. It has material for four different books: * a devastating critique of traditional economic thinking

* an excellent discussion of the mechanisms through which money is created in modern society a description of the many problems we may expect from climate change and future collapses of the financial system * proposals for nine different pragmatic monetary complements to the current financial system

The book is therefore a useful starting point for people with very different goals. Our earliest ancestors finally did manage to develop a technology based on fire. But they had to emerge from the ocean to do it. Our descendants will no doubt develop a technology based on sustainability. But they will have to emerge from the current financial system to do it. This book gives the motivation and some preliminary directions for doing that. Em. Prof. Dennis Meadows

New Hampshire, February 2012

Dealing with the Eurozone Crisis... Another Way?

As we go to press, the Greek electorate after two years of drastic austerity measures has voted dearly against the cuts, thebailout and the political mainstream. Chaos in the eurozone seems one step closer, So we take this opportunity to outline how just one of the proposals from this book can be applied now, in Greece, Spain or any other country facing this Idnd of crisis, It's a solution that mainstream financiers and media avoid discussing, but it's elegant and simple. It would work, and the necessary (Open Source) software is available now, Current monetary orthodoxy says that 100*6 of the Greek (or any other) economy must be

either :in5 or 'out* of the eurozone. Everybody knows that either option will entail even higher unemployment and yet more misery. But it doesn't have to be that way! The core principle of complementary currendes, as set out here, is that they run alongside the main currency, increasing resilience and flexibility for the entire socio-economic system, Here's our systemic solution in a nutshell: â&#x20AC;˘ Greece continues to use the euro for all international business: tourism, shipping, exports and imports, etc. Taxes are levied in euros on profits made in these activities, and used to service the country's national debt,

* In

addition, any Greek city/ region wanting to participate can issue its own local currency

(generically called 'Civicsâ&#x20AC;&#x2122; in the case study in chapter VIII). Civics are used to pay for important local, social and environmental programmes. In our example, i Civic is issued to anyone who completes i hour of approved service to the community7. Projects for which Civics are paid should be decided democratically and locally. The issuing city./ region requires payment horn each household of, say, 10 Civics /quarter.

- Households that have earned enough Civics can use an online (eBay -style) market buy them with euros - or any other agreed good or service - from those that have earned not

more than they need. * Civics exist only in electronic form, issued by the city/ region, using mobile phones as a payment mechanism fas happens in Indonesia, S. Africa and Kenya now). So Civics are 100& traceable and their use is transparent.

* A new type of non-profit organisation audits the validity of the Civics in circulation. â&#x20AC;&#x2122; There is no fixed Gvic:euro exchange rate. This is determined in the online market. To increase the value of its Civic, a city simply requires more of them from each household. As the local economy recovers, this number can be reduced, and could even drop back to zero

when full employment is reached. This approach allows the Greek economy to retain the benefits of the euro, while the Civic helps each community solve its own social and environmental problems, while mobilising every household (with appropriate exceptions for disability- , etc.) to participate. (A business -to -business currency called C3 - see chapter VII - could also inject working capital into small businesses and accelerate the recovery of mainstream jobs paid in euros. Similar approaches could be used in other European countries struggling with the consequences of current austerity programmes.) Bernard Lietaer, Christian Arnsperger, Sally Goerner, Stefan Brunnhuber May, 2012

Executive Summary People concerned with sustainability in general - with issues like climate change, environmental degradation, food and w'ater shortages, population growth and energy use - tend not to worry about the money system. Nor do they tend to look for solutions that involve monetary innovations. Even those economists who are also concerned about sustainability in principle are seldom aw'are that our money system systematically encourages unsustainable behaviour patterns that may end up threatening human survival on this planet. In fact, this Report shows that the current money system is both a crucial part of the overall sustainability ‘problem’ and a vital part of any solution. It makes clear that awareness of this ‘Missing Link' is an absolute imperative for economists, environmentalists and anyone else trying to address sustainability" at a , national, regional or global level. Aiming for sustainability" without restructuring our money system is a naive approach, doomed to failure. So the money system is bad for social and environmental sustainability". But this Report also proves - perhaps more surprisingly - that the money system is bad for the money system itself. Unless we fundamentally restructure it, we cannot achieve monetary stability". Indeed, this Report also demonstrates that monetary stability" itself is possible if, and only if, we apply systemic biomimicry - that is to say, if we complement the prevailing monetary monopoly with what we call a ‘monetary ecosystem'.

Finally, the good news is that the information and communication revolution which we are living today is already pushing us in precisely the right direction. Let's look at this idea of the money system as the ‘Missing Link' in more detail. Our world is facing the immense challenges of a two-fold sustainability' crisis. On one hand, climate change, rising greenhouse gas emissions and spikes in food and energy prices signal that our ways of producing and

consuming goods and services have become unsustainable. On the other, repeated financial and monetary crises remind us that our money system has its own problems. The efforts to prop up and ‘save’ this money system during the 2007-2008 banking crash, followed by unsuccessful attempts to contain the toxic economic fallout with a ‘Keynesian stimulus’, have given rise to stark increases in government indebtedness. In the w'ake of the sovereign-debt and euro crisis, both the United States and the EU governments are currently being driven to financial extremes. Pensions, unemployment benefits and other social safety nets as well as investment in a post-carbon economy are all in jeopardy at precisely the time when they are most needed. In parallel, many public assets are in the process of being privatised,

Environmentalists often try to address the ecological crisis by thinking up new monetary incentives, creating ‘green’ taxes or encouraging banks to finance sustainable investment. Economists, in turn, tend to believe the financial crisis can be ‘fixed’ and kept from recurring with better regulation and a strict, prolonged reduction in public spending. But, whether they are advocating greener taxes, leaner government budgets, greener euros or dollars or pounds, couldboth camps be barking up the wrong tree? It is our contention that the ‘Missing Link' between finance and the environment, between money and sustainability, lies elsewhere. What this Report demonstrates beyond doubt is a structural monetary’ flaw - a flaw in the very’ manner in which we create money - that is generating our disconcerting problems. The inescapable conclusion? That, in order to face the challenges of the £ist century’, we need to rethink and overhaul our entire monetary’ system,

CHAPTERI- Why this Report, Now?

This Report has three objectives: * To provide evidence that the financial and monetary' instabilities plaguing Europe and the rest of the worldhave a structural cause that has been largely overlooked. Addressing this structural cause is a necessary- (but not a sufficient) condition for dealing with today’s challenges,

* To place the monetary problem, and solutions to it, in the context of two global issues: climate change and population ageing. Indeed it makes clear that, in order to avoid the worst scenarios of climate change, massive investment is needed now: investment that will require governmental leadership and funding. Concurrently, the retirement of baby boomers reduces government revenues while adding pressure to already severely strained social programmes. Both issues will reach their peak during this decade, and neither is compatible with austerity measures. Continuing to follow the current monetary paradigm will render governments powerless to

address these social and environmental challenges, * To propose pragmatic solutions that can be implemented cost-effectively by citizens, non-profits, businesses or governments: solutions which would resolve at a structural level several critical sustainability issues currently facing many countries. History will probably see the period 2007-2020 as one of financial turmoil and gradual monetary breakdown. History has also shown that systemic changes in the monetary domain happen only after a crash. Therefore, the time to wake up to monetary issues is now. CHAPTER II

— Making Economic Paradigms Explicit

Debates about economic issues rarely reveal the paradigm from which an economist is speaking. We start by making explicit the conceptual framework that underlies our approach, and compare it with other paradigms currently in use. Rather than defining environmental and social issues as ‘externalities', our approach sees economic activities as a subset of the social realm, which, in turn, is a subset of the biosphere. This view provides the basis for the emergence of a new set of pragmatic tools, flexible enough to address many of our economic, social and environmental challenges. We suffer from a three-layered collective “blind spot’ with regard to our money system. The first blind spot relates to the hegemony of the idea of a single, central currency'. It is widely believed that societies have always, and must always, impose, as a monopoly, a single, centrally-issued currency', on

which interest is charged. In fact, several interesting societies, such as Dynastic Egypt and Europe during the Central Middle Ages (from the IOÿ1 to the 13th century), have encouraged multiple parallel currencies. This latter approach has resulted in greater economic stability, equitable prosperity" and an economy in which people naturally" tend to consider the longer term more than we do.

The second layer of our collective ‘blind spot’ is a result of the ideological warfare between capitalism and communism in the 20ÿ century. Although minute differences between these two systems have been studied ad nauseam, what they" have in common has remained less scrutinised: particularly" the fact that both impose a single national currency" monopoly that is created through bank debt. The only significant difference between the two is that, in the Soviet system, the state owned the banks, whereas, in the capitalist system, this occurs only periodically (usually after banks ‘too big to fail’ experience serious difficulties). From the 18ÿ century" onwards, the systemic status quo was institutionalised through the creation of central banks as enforcers of the monetary monopoly.

This institutional framework spins the final layer of the ‘blind spot’. These three layers explain why there is such powerful and enduring resistance to reconsidering the paradigm of a single, monopolistically produced currency'. CHAPTER III

— Monetary and BankingInstability-

Today's foreign exchange and financial derivatives markets dwarf anything else on our planet. In so10, the volume of foreign exchange transactions reached $4 trillion per day. One day’s exports or imports of all goods and services in the world amount to about 2% of that figure. Which means that 98% of transactions on these markets are purely speculative. This foreign exchange figure does not include derivatives, whose notional volume was $600 trillion - or eight times the entire world’s annual GDP in 2010. It was in this colossal market that the 2007 banking crisis broke out. As with

every previous banking crash, governments felt they had no choice but to rescue the banking system, at whatever cost to the taxpayer* While this is clearly the biggest crisis we have experienced since the 1930s? it is not the first one. According to IMF data, 145 countries experienced banking crises. In addition, there were £08 monetary crashes and 72 sovereign debt crises between 1970 and 2010, That brings the grand total of 425 systemic crises, he, an average of more than ten countries in crisis every year!

The consequences in terms of unemployment, lost economic output, societal disruption and widespread human suffering are dramatic. The full financial costs of the 2007-2008 crisis are unprecedented. In the United States for instance, the $700 billion Troubled Asset Relief Program (TARP) is often talked about, although it is only the first slice of the rescue operation. Mention of this programme is usually followed by the comment: “'most of that money has by now been reimbursed". The US case is of interest because it is the only country where both the government and the central bank have been forced by the courts to reveal the total costs of the rescue programmes related to the 2007-8 crisis. In addition to TARP, forty-nine other programmes have been involved in the US rescue at a total cost of $14,4 trillion. In comparison, the total US GDP in 2007 w’as $16 trillion,

The bailouts, followed by a large-scale Keynesian stimulus plan to avoid a deflationary depression, have resulted in enormous budget deficits and additional public debt. In the twenty-three countries most directly affected by the banking crash, government debt jumped by an average of 24% of GDP, Some European countries such as Iceland, Ireland, Latvia, Denmark and Spain fared worse, with increases in national debt between 30% and 80% of GDP,

The timing could not possibly have been worse. The tidal wave of baby boomers retiring over the next decade will make for huge additional pressures on public debt, A 2010 study by the Bank for International Settlements (BIS) estimated that, by 2020, age-related deficits will increase government debt to more than 200% of GDP in the UK and to 150% in France, Ireland, Italy, Greece, Belgium and the United States, This forecast is still optimistic because

it rests on the assumption of low interest rates. By 2040, projected age-related expenses will propel the debt/ GDP ratios for all these countries to somewhere in the range of 300% to 600%.

The solutions recommended by the financial sector are a package of immediate, coercive austerity measures and a call for governments to privatise everything. In countries where the list of targeted government assets is known, this includes all public roads, tunnels, bridges, parking meters, airports, all government-owned office buildings, as well as water and sewerage systems, For the US, where data are available, this amounts to $9,3 trillion of federal, state and city assets. One assessment of the US situation by the financial sector is as follow's: “As soon as the political pain from cutting public services becomes greater than the cost in terms of votes lost due to selling assets, this market will take off. At the grass-roots level, this critical political pain thresholdhas now' been reached,”! Similarly in Europe, the UK has announced a £16 billion privatisation programme; in Italy, 9,000 publicly owned properties were put up for sale by the Berlusconi government; France’s Sarkozy government sold all the country's toll roads for €5 billion; the conditions attached to the Greek rescue package included a €50 billion privatisation; and the list goes on. These pressures will remain pervasive for a long time. But what happens afterwards? Why would governments become more creditworthy once they have to pay rent for their offices, and have to pay tolls for their employees to drive to work on roads that were once publicly owned? Before proceedingblindly on this course, would it not be useful to determine whether, far from the current crisis being merely another case of gross financial mismanagement, there is an underlying systemic cause common to all financial and monetary instabilities?

—

CHAPTER IV Instabilities Explained: The Physics of Complex Flow' Networks Since the 19ÿ century', mainstream economics has classified the economic system as a closed one. Closed systems have relatively little interaction with

other systems or with the outside environment;, while open systems do. An intellectually convenient feature of closed systems is that they reach static

equilibrium when left undisturbed,

This report proposes that we view the economy as an open system consisting of complex flow networks in which money circulates between and among various economic agents. It has recently become possible to measure with a single metric the sustainability of any complex flow network on the basis of its structural diversity1 and its interconnectivity1, A key finding is that any complex flow system is sustainable if, and only if, it maintains a crucial balance between two equally essential but complementary properties: its efficiency and its resilience. When too much emphasis is put on efficiency at the cost of resilience, diver star is sacrificed. This will automatically result in sudden systemic collapses, We have a worldwide monetary monoculture in which the same type of exchange medium is put into circulation in every country: a single national currency created through bank debt. Such a monoculture tends to spawn a brittle and unsustainable system. The structural solution needed to give sustainability a chance, albeit totally unorthodox, is to diversify the available exchange media and the agents that create them. In short, in place of a monetary monoculture, we need a monetary ecosystem, CHAPTER V

â&#x20AC;&#x201D; The Effects of Todayâ&#x20AC;&#x2122;s Money System on

Sustainability'

Monetary' or financial crises can be highly destructive and are obviously not compatible with sustainabilify. What can be more difficult to perceive is how some mechanisms built into our current money system shape individual and collective behaviours, even when it is not in crisis. On the positive side, modern money should be credited with triggering an explosion of entrepreneurial and scientific innovation without historical precedent. However, there are also five other mechanisms that turn out to be directly incompatible with sustainabilify,

They are: * Amplifi cation of boom and bust cycles: Banks provide or withhold funding

to the same sectors or countries at the same time, thus amplifying the

business cycle towards boom or bust. Such amplification is detrimental for everyone, including the banking sector itself. In the worst-case scenario, we end up where we are now': when banks stop trusting each other. * Short-term thinking: â&#x20AC;&#x2DC;Discounted cash flow-â&#x20AC;&#x2122; is standard practice in any investment evaluation. Because bank-debt money carries interest, the discounting of all future costs or incomes inevitably tends to lead to

short-term thinking. * Compulsory growth: The process of compound interest or interest on interest imposes exponential growth on the economy. Yet exponential growth is, by definition, unsustainable in a finite world. * Concentration of wealth: The middle class is disappearing worldwide, with most of the wealth flowing to the top and increasing rates of poverty at the bottom. Such inequalities generate a broad range of social problems and are also detrimental to economic growth. Beyond the economic issue, the very survival of democracy may be at stake. * Deuafuarion of social capital: Social capital which is built on mutual trust and results in collaborative action has always been difficult to measure. Nevertheless, whenever measurements have been made, they reveal a tendency for social capital to be eroded, particularly in industrialised countries. Recent scientific studies show that money tends to promote selfish and non-coilaborative behaviours. These behaviours are not compatible with long-term sustainability. Far from being a behaviourally neutral and passive medium of exchange, as generally assumed, conventional money deeply shapes a range of behaviour patterns, of which the five listed above are incompatible with sustainability. The continual imposition of a monopoly of this type of currency thus directly

affects the future of humanity on our planet. CHAPTER VI

â&#x20AC;&#x201D; The Institutional Framework of Power

The history' of money is intimately entwined with power. Historian Niall Ferguson shows how the modern monetary' framework evolved to finance wars

through the emergence of four key institutions: parliaments;, a professional tax bureaucracy, national debt and centralbanks. This ‘Square of Power’ w as first optimised in 18ÿ century Britain to give birth to industrialisation and to an global empire. These same monetary arrangements spread around the world to become the fundamental structure in place practically everywhere today, It is often assumed that the relationship between the banking system and governments has remained unchanged for centuries, A case study of France shows that this is not necessarily the case. Indeed, since 1973, the French government has been forced to borrow' exclusively from the private sector and therefore pay interest on new debt. Without this change, French government debt would now be at 8,6% of GDP instead of the current 78%, Furthermore, the Maastricht and Lisbon Treaties have generalised this same process to all signatory countries. One radical solution would be for government itself to issue a currency that later collects in the form of tax payments. This solution was known in the it 1930s as the ‘Chicago Plan’. Nationalising the monetary creation process confines banks to the role of mere money brokers. Although the Chicago Plan dramatically reduces the possibility' of future banking crashes and instantly resolves all sovereign debt crises, it merely replaces a private monopoly with a public one. This does not get us any closer to the monetary' ecosystem which is called for.

The ‘official story' is that governments, just like any household, must raise the money needed to pay for their activities. This is done either through income (by taxation) or through debt (by issuing bonds). In this story, banks simply act as intermediaries collecting deposits and lending parts of that money to creditworthy individuals and institutions, including governments. However, since 1971, when fiat currency' - that is, money created out of nothing became universal, this story' has been a complete fiction.

The Fiat Currency' Paradigm provides an alternative interpretation of this story. With fiat currency', the primary' purpose of taxation is to create demand for a currency' that has otherwise no intrinsic value. The obligation of paying taxes only in the chosen currency' is what gives the currency' its value, A

sovereign government can therefore choose what it wants to attribute value to by requiring it in the form of tax payments. Governments can thus determine the kind of efforts its citizens must make to obtain this chosen currency. Although this interpretation has impressive academic backing, it is being ignored in favour of the ‘official story’.

In the ‘official story’, governments are completely powerless in the face of an anonymous and all-powerful ‘financial market’. In the Fiat Currency Paradigm, given the nature of fiat currency, governments could conceivably choose to give value to other currencies in parallel to bank-debt money. We propose that meeting the challenges of the 21st century will require them to do so. CHAPTER VII

— Examples of Private Initiative Solutions

Nine examples of innovative motivation systems are presented in this and the next chapter. They can all work in parallel with conventional bank-debt money, use cost-effective electronic media, and should be as transparent as possible to their users. By making these systems more self-policing, such transparency could go a long way towards reducing potential fraud. The systems are presented in order, starting with the easiest andleast controversial and ending with the most complex and revolutionary. The first five can be started privately, either by NGOs or businesses. They are: * Doraland: a system proposed for Lithuania, with the purpose of creating a

‘Learning Country’. In such a system everybody can volunteer to learn and/or teach, andbe rewarded in Doras, a currency whose purpose is to help people realise their dreams. This wouldbest be implemented bv an

NGO. * Wellness Tokens: an NGO initiative working in cooperation with preventive health care providers to deal with issues even before they arise. Wellness Tokens reward and encourage healthy behaviours and thereby reduce

long-term medical expenses for society. * Natural Savings: a financial savings product that is fully backed by living trees. It wouldbe a savings currency' with inflation protection superior to

that of any national currency, while simultaneously providing an incentive to reforest areas and thereby creating long-term carbon sinks. Another of its qualities: it works well for micro-savings. â&#x20AC;˘ C3: a Business-to-Business (B2B) system that reduces unemployment by providing working capital to small and medium-sizedbusinesses. The network's clearing currency wouldbe fully backed byhigh-quality invoices and convertible into conventional money on demand. The insurance industry and banks both play critical and profitable roles in this system. C3S are working today in Brazil and Uruguay, and the latter country accepts C3S in payment of all taxes. * TRC: the Trade Reference Currency is a global B2B currency proposal that would make it profitable for multinational companies to think long-term, thereby resolving the conflict between short-term financial corporate priorities and long-term social and environmental needs. It wouldbean inflation-proof and crash-proof global currency fully backed by a basket of commodities and services relevant to the global economy. The TRC would be a global currency distinct from any existing national currency, thus reducing the risk of geopolitical tensions around monetaiy zones of influence. CHAPTER VIII

â&#x20AC;&#x201D; Examples of Governmental Initiatives

The next four examples of innovative motivation systems are governmental initiatives started at a city, regional or country level. They are: * Torches: a city-based initiative to encourage volunteering while promoting green behaviour and social cohesion in a poor neighbourhood. It has been running since 2010 in the city of Ghent, Belgium. * Biwa Kippu: a proposal for the Biwa Prefecture in Japan to fund the labour components of the ecological restoration and maintenance of Lake Biwa, the oldest and largest lake in Japan. It couldbe either voluntary' or obligatory' for households in the area. * Civics: a proposal empowering a city or region to fund civic activities without burdening their budgets. These activities could provide the labour

component for social, educational and/or ecological projects. Such a system could also take the form of a compulsory contribution. * ECO$: a national or Europe-wide system making it possible to fund critical components of large-scale ecological projects, such as climate change prevention and adaptation projects. It wouldbe an interest-free currency issued by governments. Governments would require businesses to make a contribution proportional to their total sales, payable only in ECOs. This is the most controversial of the nine proposals, because it would be seen as a new* type of corporate tax on the largest corporations. Such an initiative may require governments to ‘declare w'ar’ on run-away climate change.

Not all nine systems - five private and four public - have to be implemented before the benefits of different monetary ecosystems start to become visible. Each community, city, region or country can pick and choose which kinds of system it implements. Together with a dozen other designs already in operation around the world, each combination of new exchange media would give an appropriate monetary ecosystem a chance to emerge. Some of these systems will fail. However, just like in a forest, the most successful types will spontaneously tend to spread. We still have much to learn, particularly about which governance structures are most appropriate for each type of system. CHAPTER IX — Beyond the Limits to Growth?

Wells claimed: “History is a race between education and catastrophe". The stakes in this particular race have never been as high as they are today. Learning will be needed on everyone's part:

H,G.

For today's elites, particularly the financial elites, perusing the classic works of economic historian Arnold Toynbee or more recently of Jared Diamond*, might be relevant. Toynbee attributed the collapse of twenty-one different civilisations to just two causes: too much concentration of wealth, and an elite unwilling until too late to shift priorities in response to changing circumstances. Diamond focuses on environmental degradation as a proximate cause for civilisation collapses. Currently, we are simultaneously pushing the limits on all three of these causes. History teaches that even elites are not

spared in a collapsing civilisation. For those trained in economics, the necessary mental switch required is to look at the paradigm implicit in the teachings they received, and compare it to the approach used in this report. For the population at large, perhaps the most important learning needed is to understand non-linearity, specifically the difference between linear and exponential growth. We are now dealing with an increasingly non-linear world. Grasping these different dynamics will be useful in understanding what is happening to us, and what to do about it.

In closing, it would be naive to think of complementary currencies as a magic bullet to solve all our current and future problems. However, rethinking our money is a necessary ingredient in any effective solution. We can no longer afford to overlook complementary’ currencies as the ‘Missing Link* that can deliver a money system which promotes sustainability’ rather than undermining it at every’ turn.

Footnotes 1 Euromoney, April 2010, p,S5.

2 Jared Diamond, Collapse; How Societies Choose to Faii or Succeed (2005).

ChapterI Why this Report, Now? â&#x20AC;&#x153;My heart is moved by all1cannot save, So much has been destroyed, Ihave casr my lot with those who, age after age,perversely, with no extraordinary power, reconstitute the worldâ&#x20AC;?

Adrienne Rich-i Humanity - and Western civilisation in particular - are on an untenable course. Climate change and species extinctions, an ageing population, high levels of joblessness and unsustainable energy consumption patterns are all issues needing urgent attention. There is a political consensus from the right to the left that, over the next decade, widespread and rapid changes in behaviour will be required. Governments and businesses have traditionally used monetary incentives as the primary motivational tool to induce non-spontaneous behaviour patterns. However, our monetary system is now itself in serious trouble. Because of the mounting challenges we face, the manner in which money shapes our motivations and actions has become part of the problem rather than part of the solution.-i Our current monetary' system - the specific manner in which money is created, circulated and managed in our society - is taken for granted by just about everyone. This includes not only the general public, the business community and nongovernmental organisations, but also policy' makers and a majority of

academics. Consequently, after the massive 2008 financial crisis - the biggest systemic financial failure in history so far â&#x20AC;&#x201D; the only option considered was to bail out the banking system at whatever cost to taxpayers, in order to return as quickly as possible to business as usual. This scenario has been repeated for every one of the large-scale banking crises and monetary meltdowns of our times.ÂŁ i. Identifying Structural Issues

The first purpose of this Report is to provide evidence that the instability of our monetary and banking system is due to a structural reason. As a result, the regulatory changes and capital requirements being debated and implemented within the existing framework will not succeed in avoiding future crashes, precisely because they all leave the actual structure of the monetary system intact. These structural features include the notion that money should be monopolistically created by a banking system, in exchange for debt,Z We claim that reconsidering this monopoly is essential if sustainability is to have a chance to prevail during the 21st century. This does nor mean that such a change will be sufficient to resolve all these problems automatically. Several other dimensions are clearly also relevant - education and governance, to name but two - but these other dimensions will not be the focus of this Report, Instead, we intend to show that if the monetary structure issue is not dealt with, all the other policies will prove fruitless, A monetary system is a form of operating system for human activities. What is urgently needed, we argue, is an upgrade of our collective operating system to one with greater robustness and flexibilityâ&#x20AC;&#x2122; that will allow us to deal successfully with the numerous large-scale challenges of the 21st century, Changing our assumptions about how money is created and circulated could move us towards a sustainable world, one that includes humanity' as well as the planet's biosphere, for which humanity' has now collectively, and unwittingly, become responsible. Far from being a neutral tool facilitating exchanges, our current monetary system plays a key role in shaping human incentives and decisions at all levels: from small-scale local exchanges, to multi-billion dollar

decisions by global corporations* However, what we are proposing will require a paradigm shift in the monetary domain* Paradigm shifts are controversial because they challenge ideas held as selfevident truths, 'which in this case have prevailed for centuries, But the challenge is worth taking because it leads to a path where economics could become a genuinely emancipating social science, Evan sustainable abundance could become a realistic possibility... 2. Offering Pragmatic

Solutions The second purpose of this report is to provide pragmatic suggestions for what can be done now* We will propose several examples of monetary innovations that increase the policy options available to governments, as well as pragmatic financial strategies for businesses, NGOs and citizens at large* Taken together, the synergies between such innovations would generate a radically different human incentive system for living both collectively and individually on our planet* In practice, the new system we describe provides ordinary people with more freedom to live a life that honours more of their humanity, it gives them choice from a wider spectrum of activities to meet their needsf and increases their chances of expressing their gifts and developing their creative passions* For members of today's wealthy elite, the proposed approach makes it possible to remainfinancially wealthy f and to do so toitftout this being at the expense of

the rest of humanity.

Such possibilities may currently sound completely utopian and, as long as we stay caught in the conventional monetary' paradigm, they will remain so* The highest cost we are paying for the maintenance of today's monetary' paradigm is the limitation it imposes on what we believe is possible*

The response of governments to our current monetary' predicaments brings to mind a statement by Winston Churchill about the United States during World War II: "You can always count on the Americans to do the right thing... after they have tried everything else!" Since the great banking meltdown of

2008, policy makers have indeed been trying everything possible to resolve the financial crisis except addressing the structure of the monetary1system itself.

We review recent past events in Europe in order to illustrate this point. As of early 2012, all those countries involved in the 2008 crisis have become massively indebted in the process of saving their banking systems from bankruptcy. The financial system has ‘reciprocated’ by observing that these countries have now become too highly indebted, and by demanding the dismantling of Europe’s social safety nets, whichhave taken centuries to build.

Austerity programmes are being imposed simultaneously everywhere, guaranteeing that the economic downturn will last longer than customary. Violent social unrest and the serial stepping-down of governments, as well as authoritarian and nationalistic reflexes, are highly likely to occur in the near future. Even if the euro collapses, the only alternative being considered is a return to a system of national monopolies, each with one national currency, created through bank debt. In the hope of escaping the constraints of the euro by reverting to a currency it can devalue, each European country would still remain locked into the old straighljacket of trying to solve all its problems via the mechanism of a single currency.

3. The Importance of Timing Perhaps the most important factor of all is timing. 2012 is the year of Rio+20, the twentieth anniversary of the first United Nations Conference on Sustainable Development, for which many organisations are arranging special events.4 It is also the fortieth anniversary' of The Limits to Growtht the first Report for the Club of Rome.S

The coming decade also happens to be an unusually critical one in two even more important respects. First, this decade will see the ‘baby boomers’ retire, triggering massive unresolved financial problems concerning pensions and increased health care costs. The Bank for International Settlements (BIS) forecasts that by 2020, on the basis of these extra age-related expenses alone,

debt/ GDP ratios will rise to more than 300% in Japan, 200% in the United

Kingdom, and more than 150% in Belgium, France, Ireland, Greece, Italy and the United States*ÿ

Second, the consensus in scientific and business circles is that to avoid the worst climate change scenariosÿ, unprecedented investment is necessary within this same period to move to a post-carbon economy* Such a rapid introduction of the necessary technologies will require government leadership

and subsidies en masse, Both these issues are time-bound: we cannot afford to wait to address them until after public finances have improved* Missing this decade’s deadline will have dire consequences: the promises made to a whole generation of people who faithfully contributed for their entire working lives to pension funds and health care insurance may be sacrificed* The potential damage to the planet’s biosphere is even more critical, and its effects are expected to last more than 1,000 years! Indeed, the journal Nature recently published warnings about the implications of even moderate climate change*ÿ Here are some excerpts from that paper: “A basic prediction of climate science is that many parts of the world ufi/l experience Zonger and deeper droughts, thanks ro the spnergisric effects of drying, farming and the melting of snow and ice.

expected to shift, expanding the dry eubfropic*. tVhat precipitation there is will probably come in extreme deluges, resulting in runoff rather than drought aZZeuiarion. Warming causes greater evaporation and, once the ground is dry, the Sun’s energy goes into hating the soiZ, Zeading to a further increase in air temperature. That is why, for instance, so many temperature records were setfor the United States in the 1930s Dust Bowl; and why, in 2011, drought-stricken Texas saw the hottest summer ever recorded for a US state. .FinaZZg, many regions are expected to see earlier snowmelt, so less water will be stored on mountaintops for the summer dry season... pattern* are

The paleoclimate record dating back to the medieval period reveals droughts lasting many decades. .Bur the extreme droughts that loiZZ he faced this century toiZZ he far

hotter than the worst of those: recent decades have been decade of the worst drought in the past 1,200 years...

luarmer

than the driest

Most pressingly, what tuiff happen to global food security if dust-bowl conditions become the norm for both food-importing and faod-ejiporfing countries? £jtfreme, widespread droughts tail! be happening at the same time as sea feoe/ rise and salr-iuater intrusion threaten some 0/ the richest agricuirura/ de/tas in the world, such as those of the Nile and the Ganges. Afeamobile, ocean acidfarafian, unarming and ouerfahing may severely deplete the food available from the sea...

Jfuman adaptation to prolonged, extreme drought is difficult or impossible. Historically, the primary adaptation to dust-boLulÿ/lcarion has been abandonment... Feeding some 9 billion people by mid- century in the face of a rapidly icorsening

climate may loelf be the greatest challenge the human race has ever ,/aced.”

Figure 1*1illustrates the effects of this ‘dust-bowlification’ on a global level in the decade of the 2060s, assuming a scenario of moderate climate change* The figure’s author emphasises that “these predictions are not worst-case scenarios: they assume business-as-usual greenhouse-gas emissions* We can hope that the models are too pessimistic, but some changes, such as the expansion of the subtropics, already seem to be occurring faster than models have projected*”

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Figure 1.1: World map of the PDSI (Palmer Drought Severity Index) expected in the decade of the 2060s under a moderate climate change scenario. By comparison, in the US Great Plains during the Dust Bowl of the 1930s, the PDSI spiked very briefly to -6, but otherwise rarely exceeded -3 for the decade. This was sufficient to provoke abandonment of agricultural land on a large scale. Source: Aiguo Dai, 'Drought under Global Warming: A Reviewâ&#x20AC;&#x2122;, Climate Change, Volumes, Issue 1 (Jan/ Feb 2011), pp.45-65.

This map gives those who believe there is no need to tackle climate change head-on some food for thought* Climate change will affect not only all of Mediterranean Europe, but also much of France, Southern Germany, England and almost all of the USA (except Alaska), Brazil, half of Africa and China, and inhabited Australia* Imagine drought conditions similar to those prevailing in Northern Africa today, worse than the Dust Bowl of the 1930s, as far north as Paris, London, Berlin, Beijing or San Francisco*,. These dust-bowl conditions are projected to worsen for many decades and to be "largely irreversible for 1,000 years after emissions stopped" *3 When these drought conditions are combined with rising sea levels from melting ice in Greenland and the poles, much of Earth's biosphere and many of the places where humans have lived from time immemorial are at stake* Appendix B provides further evidence about climate change and its planetary' consequences,iÂŁ If we remain trapped inside today's monetary paradigm, governmental austerity will need to prevail during the decade ahead, precisely the decade when investment in a post-carbon economy needs to take place* The monetary' system is maintained thanks to a powerful and sophisticated banking lobby which logically prefers the structural status quo, However, does it make sense to keep accumulating financial wealth? What is the point of owning even half of Manhattan, London or Shanghai, if it is three feet under water or in the middle of a vast dustbowl?

Finally, the dollar and the euro, the world's first and second most important currencies, are now both wobbly for different reasons* If and when a euro or a dollar crisis breaks out, we should again expect a new round of bank emergencies. However, as the 2010 sovereign debt crisis demonstrated, the majority' of governments are no longer creditworthy enough to bail out the

financial system once more. What then? Just as we no longer have time to wait for further deterioration of the climate, we do not seem to have time for a newT monetary and banking crash. Five thousand years of monetary history reveals that significant changes in the monetary domain take place only when the previous system has collapsed. The most critical time for rethinking the monetary system will therefore be just after a big turmoil.

In short, we will be forced to consider stepping out into totally unorthodox monetary terrain - a terrain of the kind that this Report explores. When assailed by qualms as to how heterodox some of this sounds, please remember that it is orthodoxy that led us to our current predicaments...

Finally, a clarification about the style of this document. Because this is a report and not a treatise, emphasis has been placed on succinctness and clarity rather than on exhaustive demonstration or academic references. In some cases, specialised appendices are provided to develop an argument or provide more evidence for the claims made. However, we are fully aware that what is proposed in this text cannot provide all the answers. It is rather an invitation to consider a newâ&#x20AC;&#x2122; approach offering options that have not been sufficiently explored until now. That is why we are inviting readers to question and debate the topics we survey here. The website u;u/u;.moneu-sustainabifrfu.nef is part of this Report. It provides some extracts from this text and some updates, as well as all the appendices. It also makes available ways to communicate about these ideas. The extracts and appendices are also available at hif Ju/TRynissinQhnfc.

Footnotes 1 Adrienne Rich, 'Natural Resources1,

The Dream of a Common Language - Poems

(1993), Pâ&#x20AC;&#x2122;&o. 2 Details of 425 systemic crises that have occurred since 1970 are given in Chapter III. 2 A layperson's 'Primer1, which explains this process in simple language, appears in Appendix A (online). The respective roles of central banks, the International Monetary' Fund and other monetary firemen are discussed,

4 www.unasd2Qi 2.ora ~ bitJu/TPlinki 4 (As here, ail references to online sources show first the root url, followed by an easy-to-use direct link to the source. In some browsers, it may be necessary to type www. first.) 5 Donella H. Meadows, Dennis L. Meadows, Jorgen Randers and William W. Behrens III, The Limits to Growth (1972). The validity of many of the forecasts made in that Report has been documented in Donella H. Meadows etai. Limits to Groioffo; the

30-Year Update (2004). 6 Stephen G. Cecchetti, Madhusudan S. Mohanty and Fabiifio Zampolli, The Future of Public Debt: Prospects and Implications', BIS Working Paper #300 (2010). See also Chapter III for a more detailed analysis of the impact of age-related expenses on governmental indebtedness. 2 That humans are causing global warming is the position of the Academies of Science from 19 countries plus many scientific organisations that study climate science. A survey of 3,146 earth scientists asked the question KDo you think human activity is a significant contributing factor in changing mean global temperatures?*. 97.5% of climatologists who actively publish research on climate change responded â&#x20AC;&#x153;yes*.

(Doran, 2009) S Joseph Romm, 'Desertification 1 the Next DustbowT, Nature 476 (27 October, 2011), pp.450-451.

9 Romm (2011) 10 This and the other appendices can be seen online at bit.hj/TPmissinalink

Chapter II Making Economic Paradigms Explicit ‘Your paradigm is so intrinsic to your mentalprocess that you are hardly aware of its existence} until you try to communicate with someone with a

different paradigm/' Donella Meadows

Aparadigm is the conceptual framework from which reality is perceived, 1evaluated, or acted upon.* In economics, such a framework or paradigm often remains unspoken and hidden. This has the disturbing implication that sometimes economics is presented as neutral and objective, an incontrovertible ‘hard science'. Paul Samuelson, who received the Nobel memorial price in economics in 1970, is reported to have saidlate in his life that, “Economics has never been a science. And it is even less now than a few years ago". What often remains unclear is the particular epistemic orientation that economists speak from. “Paradigms are inevitable. Therefore, no economist can speak from anywhere but from inside a paradigm. He can change paradigms, but he can never proceed without any paradigm at all, because that would mean having no structuring theoretical conceptions, no formal toolbox, and no empirically oriented techniques".2 We will focus here on two specific dimensions of economic paradigms: * how a paradigm deals with the natural world, specifically with the environment and the planetary' ecosystem

* how a paradigm deals with the monetary system i. Dealing with the natural world

Conceptual relationships between the field of economics and the natural world can be described in three different ways. The most conventional view is to treat anything that is not dealt with unambiguously within one’s own theoretical framework as an ‘externality1 (see Figure 2.1). This economic view' defines its own field as completely self-contained and excludes any other consideration as irrelevant. For instance, in such a view, the natural world is reduced to a resource, an input that is considered to be cost-free - to the extent that no money is exchanged to acquire it. Similarly, humans are reduced to their productive labour input, and their interactions are relevant only if they qualify as ‘services’. As a consequence, work performed by a stay-at-home carer for an elderly relative or a child are not counted in a nation's GDP, because they do not get paid for it. Therefore even though this represents a valuable contribution to sodefy, it simply doesn't exist in this view. F left! of Economics

Externalities

Figure a.i: The Traditional Economics Paradigm: Complete disconnection between economics

and its

extern slides',

We will use the term ‘Traditional Economics' to describe this particular

approach to economics. It is the dominant economic paradigm currently still being taught at most universities and implicitly used by the media and in many corporate boardrooms. This view is quite reductionist and a movement of professional economists have labelled it as “autistic”.Z Others define it as “a fantasy world”:

“Why doIsay today's economics portrays a fantasy world? Is (hot unnecessarily offensive ro o/i those earnest individuals labouring tvirh a demanding discipline? In a sense, it is, andIivould apologize if it were notfor the fact that these same individuals usually denounce interior-oriented work [such as individual or collective values and psychology] as fantasy; and that, ro say the least, is offensive, too. True enough, the more sophisticated among them do not outright denounce hermeneutic-cultural work. They simply claim it can ultimately be reduced to brain-and-sysfem categories - if not, that tvill j'ustshotv it tvas nor much use as far as science work goes. So we should not be too courteous vis-avis those hard- labouring individuals, because they harbour an intellectually and politically dangerous agenda. They would devise macro- or micro-policies - to be implemented on us - subject to the 'ivorfeing assumption’ that our interiors do not really matter at all.”d

The mainstream paradigm harbours the notion that economic agents themselves do not have the capacity to interpret reality, do not care for cultural or spiritual traditions,5 and have no non-materialistic values or deep-lying psychological structures (such as archetypes or an unconscious mind). Such a view has contributed to what Karl Marx and Karl Polanyi a century later saw as the ‘disembedding’ of the economy from the rest of society and from nature or an autonomisation of narrowly economic matters, linked to production and circulation, with respect to the broader contexts of social and environmental issues.ÿ

To address this problem, the OECD2 proposed, for over a decade, a framework with three partially overlapping fields: the economic, the social and the environmental (see Figure 2.2). It considers the area where the three fields overlap as relevant, but also sees a substantial domain where economics operates independently of the other two. This is an improvement over the previous case, as it acknowledges some interaction between economic

activities, other human endeavours and the rest of the biosphere. However, it still retains the idea that the economy is a domain partly abstracted and autonomous from cultural, social and environmental issues,

In this framework it remains possible, therefore, for mainstream economists to claim that introducing psychological, cultural and/or environmental dimensions detracts from what is ‘really economic’ and to see only economics as the discipline that studies all ‘pure’ phenomena ‘disembedded’ from the two

other spheres,

Economic

Social

Environment

Figure a,a: Overlap between the economics, the social and the environmental (OECD

approach).

The economic paradigm underlying our own view is linked to what is now sometimes called ‘Ecological Economics’ inspired by Nicholas Georgescu-Roegen, Kenneth Boulding, Herman Daly, Rene Passet, and Robert Costanza,£ In this paradigm, the field of economics is fully embedded as a subsystem within the social - and the latter, in turn, is a subsystem of the biosphere (see Figure 2,3),3 This 'nested hierarchy’ of the environment, the social and the economic has been called a growth hierarchy as opposed to an ‘oppression hierarchy’,-ÿ In a growth hierarchy, each successive level includes and transcends its predecessor - the latter, therefore, acts as a condition of possibility for the former to exist, The economy exists only thanks to its social infrastructure and human society

exists only because a sufficiently healthy biosphere sustains it* Thus, while in some cases it may be possible to study economic phenomena such as financial flow's without explicitly modelling all components of the underlying social and environmental contexts, the contexts can never be assumed away. The extent to which an economic event or institution influences social organisation, human motivation and/or the environment must be taken into account in this

paradigm* Otherwise, the economy risks sawing off the tree branches that it rests on*

Economic

Social Biospherical Environmental

Figure 2,3: The economicas a subset of the social and the social, in turn, as asubsetofthe

biosphere.

The clear difference between Figures 2*1 and 2*3 is that the latter contains no “externalities'* What was considered an externality' in Figure 2*1 is the context in which economic activities take place* This context contains overarching rules such as entropy that must be taken into account by economics to avoid getting lost in an ‘autistic’ or ‘fantasy’ world*

The difference between Figures 2*2 and 2*3 is that, in the OECD approach, substitutability' between natural, social and economic capital is assumed* This

conjecture pervades the influential approach of ‘endogenous growth’ in mainstream economics,!! In contrast, there is no substitutability between these three forms of capital in the Ecological Economics approach. Here, natural and social capital can be replaced by economic capital only to a limited extent. This limit is the threshold beyond which the conditions of economic

from social and/or natural networks start being destroyed. This often invisible in the short occurs in the form of social and ecological term but with destructive potential in the longer run,!£ sustenance

This Ecological Economics paradigm, which takes into account human values and well-established laws of nature, is not new to £ist-century economics. From the basic sciences viewpoint, there have been brilliant contributions that explicitly incorporate the constraints of the physical world into economics. However they have not been integrated into the mainstream economic paradigm. The pioneering theoretical work of Nicholas Georgescu-Roegen, which provides a valid framework to address today’s major concerns, is one example,!ÿ For more than half a century now, mainstream economics has been unable to integrate sustainability constraints, even those that are unquestioned in hard’ sciences like physics or thermodynamics. There are, of course, some exceptions, Orio Giarini, for instance, has been dealing explicitly with entropy and uncertainty, as well as monetised and the unmonetised activities with economic value,-U Hazel Henderson used the metaphor of a four-layered cake to make this same point: the private sector economy resting on the goods and services provided by the public sector, which in turn rests on non-monetised social economy, which finally rests on 'Mother Nature’,!5

But the problem is that such bridges between £ist century science and economics remain an exception,

The standard measurement of economic progress thus remains the Gross National Product (GNP) per capita, which captures neither the depletion of natural resources, nor the quality of growth, nor the distribution of its benefits, Furthermore, market prices rarely reveal the real costs of a product or service, Their production and disposal can create damage that remains ignored in the

conventional accounting system.ÿ Sufficient evidence now exists for a fundamental rethinking to take place if sustainability is taken seriously. If humanity’s decisions continue to be made on the basis of the Traditional Economics paradigm (Figure 2.1) or even the OECD paradigm (Figure 2.2), all signs point to a bleak future for our human condition and our planet. Indeed, humanity’s unsustainable behaviour is provoking the sixth great mass extinction of the geological record at a rate of 30,000 species per year or three species per hour. Having a greater awareness of the limitations of the dominant economic paradigms is therefore not merely of academic relevance. But what exactly is meant by sustainability in this context?

Defining Sustainability There are currently over a hundred definitions of sustainability, of which we list only a very small sample. The World Commission on the Environment and Development defined a sustainable society as one which 'satisfies its needs without Jirniring the prospects of future generations' Moreover, 'Susiainat/e development is growth in tve/Z-being without physical growth. It is a process and nor a store, and therefore does nor necessariZy imp/y that the population or the economy are static or stagnant/*

—Brundtland Report: Our Common Future12 "Sustainshi/ity is a raiding cry for hope. It postulates that there can be a future design of society in ivhich environments/ degradation and extremes of social ineguity are avoided on an ongoing basis As an agenda, it imp/ieit/y ea/is for a sense of responsihi/ity and action sincere/p aimed at improving or changing our current ivay of living, and averting tvhar many feel is a looming social ecological and economic crisis.*

—Global Business Network: Report on Sustainability Former World Bank economist Herman DalyiS proposes three conditions for a society to be physically sustainable:

The rates of use of renewable resources do not exceed their rates of regeneration. 2. Its rates of use of non-renewable resources do not exceed the rate at which sustainable renewable substitutes are developed. 3. The rates of pollution emissions do not exceed the assimilative capacity of the environment.

As we see in many of these definitions, the first dimension of sustainability deals with the environmental impact of an economy.

Environmental Sustainability We previously stated that the world is currently undergoing a powerful set of shifting conditions including large-scale biodiversity extinction, climate change in the form of extreme weather conditions (including higher frequency of extreme floods and droughts), deterioration of arable soil through salination, pollutants and organic exhaustion as well as fresh water shortages. If not properly addressed, these shifting conditions will threaten the survival of the biosphere, which business, the economy, and all other human activities depend on. The following figure provides a summary of the most important threats to long-term ecological sustainability’ if we continue along our current economic path.££

Biodiversity

Every hour, three species become extinct. The loss of biodiversity is now 50-100 times higher than under natural conditions, without human

intervention.10 Water

I I billion people have no direct access to drinking water. An additional 2,5 billion live without sanitary facilities, Every year. 2.4 million children die as a

result of diseases transmitted via contaminated water, 1796 of the area that was formerly fertile soil is showing evidence of significant Soil depletion depletion. _ The average surface temperature of the Earth is expected to rise between l,4°C and 5,6°C by the year 21 00, Already, significant changes in weather Climate patterns have occurred worldwide, The melting of polar and Greenland ice is well under way and, if not rever sed, could raise sea levels to flood coastal lands where 1/3 of humanity currently lives. _

Figure a,4: Some unresolved environmental problems on our current economic path.

In some drclesf the word 'sustainability' has become synonymous with constraints, heavy-handed governmental regulations, or even a leftist conspiracy* This perception has been amplified by well-funded disinformation campaigns underwritten by various vested business interests, in particular from the carbon energy industries*ÿ As will be seen in Chapter V, such campaigns are an example of the systematic short-term thinking automatically generated by our monetary system and the manner in which it ‘programs1 our behaviour* Contrary to this view, we see the ‘sustainability sector' as one of the most promising business opportunities of the 21st century* During the first ten years of this century, sustainable economic, social and ecological development has become strategically important for business* Corporations with serious environmental and social governance strategies and integrated policies are

performing better than the average*ÿ

There is greater demand for products and services that impose lower burdens on ecosystems* This not only relates to new products and services such as renewable energy, but also to ‘redefining business’ such as, cradle-to-cradle

or bio-mimicry industries.ÿ! Among the pioneers of such new business models, Interface carpets and Herman Miller office furniture are examples of

long-existing corporations that have transformed themselves into different and more sustainable entities. Many more examples of such transformations exist and their numbers continue to increase rapidly.ÿS Corporations and countries providing these new goods and services will be better prepared than those that only retain industrial-age ideas, processes and markets.

The future relevance of environmental sustainability is voiced by many leaders without any leftist political leanings. Below' are a few' observations from such leading figures: anticipate the inevitable, and it seems to me inevitable, whether ive like it or nor, that ure are moving toivard an economy which must be limited and selective in its growth pattern. The earth has finite limits - a difficult idea for Americans to adjust to." “Ifs good business

—John D. Rockefeller III "Socialism eo/iajwed because ir did not allotv prices to tell the economic truth. Capitalism may collapse because it does notallow prices to tell the ecological truth”

— 0ystein Dahle, former vice-president of Exxon for Norway and theNorth Sea "Human beings and the nafurai world are on a collision course. Human activities infl ict harsh and often irreversible damage an the environment and an crifica/ resources. If not checked, many of our current practices put at serious risk the future that we urish for human society and the plant and animaZ kingdoms, and map so aZfer the living world that it will be unatie to sustain life in the manner that u?e knoiv.

fundamental changes are urgent if we are ivill bring about.

avoid the collision our present course

—Declaration of 1700 leading scientists from 70 countries, including 102 Nobel laureates in the sciences, with endorsements from the science academies of the USA, the UK, Brazil, Canada, China, France, Germany, India, Italy, Japan and Russia (Junes, 2005) "Business is a large vessel; it ivill require great common

effort and planning

of the present destructive course, and fotvards susftiinakfe development..."

overcome the inerria momentum

tt> areate a new

—“Changing Course”, World Business Council for Sustainable Development (Geneva, 1992) "fn our vietv as Philips, sustainability is no longer an option but an imperative. Over the pastel ve years, we hove seen more and more institutional and individual investors equating sustainability tvirh good management and good long-term prospects. And so

they should.”

—Gerard EGeisterlee, CEO of Royal Philips Electronicsÿ "As far as [the Dutch specialised chemical company] DSM is concerned, the need for sustainable development is beyond debate. Sustainable entrepreneurship involves the simultaneous pursuit of prof table economic growth, further development of our employees, good corporate citizenship and sustainable use 0/ natural resources."

—Peter Elverding, CEO of Royal DSM (Triple P Report, £005)

"All our efforts to defeat poverty and pursue sustainable development tvili be in vain if environmental degradation and natural resource depletion continue unabated.”

—Kofi Annan, former UN Secretary-Generals® However, the ecological crisis is only one of the issues threatening sustainability today. The human dimension is just as relevant.

Human Development We define human development as an increase in the capacity for a human being to choose.ss The choices being referred to here involve life choices such as careers, lifestyles or locations to live. On that basis, sustainable development can be defined as augmenting man’s capacity for choice now, while preserving the options available for future generations, In such an interpretation, the 'prospects of future generations’ involve not only the ecological aspects, but also the social, economic, cultural and governance underpinnings necessary for a good quality' of life,

Our Own Framework for Sustainability In this Report, we use the definition of sustainability developed as an outcome of the 1992 Rio Earth Summit as our reference. During this summit, an ‘Earth Charter’ was drafted, headed by Maurice Strong of Canada, Mikhail Gorbachev of Russia and Steven Rockefeller of the United States, Along with various stakeholders, they developed a set of principles necessary to achieve a just and sustainable world. These principles can be found at www.earthcharter.ora and fall into four key categories:

Resp ect and care for the whole community of life 2, Ecological integrity 3, Social and economic justice 4, Democracy, non-violence and peace

The reference material for our analysis in this Report also includes the work known as ‘The Natural Step’, by Karl-Henrik Robert, a physician from Sweden who started by researching the systemic reasons for the escalating cancer rates in his medical practice. The Natural Step offers four system conditions that must be met for a sustainable world:

Eliminate our contribution to the progressive build-up of substances extracted from the Earth’s crust (for example, heavy metals and fossil fuels) 2, Eliminate our contribution to the progressive build-up of chemicals and compounds produced by society (for example, dioxins, PCBs and DDT) 3, Eliminate our contribution to the progressive physical degradation and destruction of nature and natural processes (for example, over-harvesting forests and the paving-over of critical wildlife habitat) 4, Eliminate our contribution to conditions that undermine people’s capacity to meet their basic human needs (for example, unsafe working conditions and insufficient pay to live on)3£

Understanding the community systems that are capable of satisfying a fuller range of human needs is a cornerstone of environmental and human sustainability'. The Earth Charter Commission, working with the World

Resources institute and Global Community Initiatives, developed a comprehensive methodology for communities to evaluate their own sustainability and plan for a more sustainable futures

the Monetary7 System In order to spell out the economic paradigm in which we operate, the monetary dimension of the economy must explicitly be explored. Not all paradigms do this - some, and most notably the dominant Traditional Economics approach, view money as a passive element not affecting the way that individuals and collectives choose to act. The Ecological Economics paradigm, in the way we conceive it here, takes the monetary dimension much more seriously. How so? This is what we intend to explain in the remainder of this chapter. The exploration of this feature is what most sets this study apart from other economic texts and studies on sustainability.3ÂŁ 2. Dealing with

The modern monetary' system has played a positive role in the achievements of the Industrial Age. For better and for worse, it has made a human population explosion possible, from 250 million in 1750 to over seven billion today. The production of goods over time follows a similar curve to that of population growth: between 1800 and the present, GDP per capita in the developed world multiplied by a factor of at least twenty7. China, India and Brazil are in the process of reproducing this process as we write. As a result of industrialisation, many people in Europe, North America and parts of Asia have seen their standard of living soar from subsistence to what our ancestors would have considered extraordinary' affluence. These are immense accomplishments, which, irrespective of their drawbacks, shouldbe recognised andhonoured. But what of the other side of this balance sheet? Based on past evidence, what is the effect of the current architecture of money, banking and financial markets on sustainability7? The focus here is not on the obvious effects of policy' decisions - such as the shaping of Third-World policies by the IMF33 - but rather on the effects that systematically arise from the architecture of the monetary' and financial systems themselves.

The ‘Service Function5 Paradigm: Money as an Innocuous Facilitator According to the dominant view of economics, the monetary and financial system is merely a coordinating mechanism. It is a service function supporting the ‘real’ economy where physical goods and services are produced and exchanged. Money is assumed to play a role analogous to that of an engine lubricant, acting as an auxiliary to smooth the way the motor runs without altering the engine itself. All schools of economic thinking view’ the monopolistic creation and circulation of a single currency as a given. It is no more questioned than the fact of having one moon rotating around the Earth. There is wide assumption that all advanced civilisations have used a monopolistic, centrally issued fiat currency because it is the most efficient arrangement. Therefore, the overwhelming majority of economists whether of classical, neoclassical, Austrian, Keynesian or neoliberal persuasion, whether they are ‘Chartalist' post-Keynesians or complexity-oriented ‘emergentists', do not see the need to question the currently established monetary modus operands This notion even extends to the Marxist paradigm: the Soviet system imposed the same monopoly of a single currency created through bank debt. The only significant difference in the Soviet system is that the government owned the banks, while in capitalist societies bank ownership has traditionally been private. Even adherents of the Ecological Economics paradigm - the one espoused in this Report - are frequently unaware of how central the assumption of a single, all-purpose, bank-debt-driven currency is when it comes to the very problems they seek to address. For a more detailed discussion of how different paradigms are mapped, and some of their consequences, please see Appendix C.

Why do practically all economic paradigms share the belief that the only way to operate a national economy is through a monopoly of a single type of currency?

The Monetary ‘Blind Spot* The human eye possesses a biological blind spot where the optical nerve enters the eye. This is an area without vision. Humanity appears to suffer from a similar blind spot when it comes to the way money enters the economy and the social system. There are at least three layers to this phenomenon which include: * the hegemony of single-currency thinking * the ‘capitalist versus communist’ ideological war * an institutionalised st a tus quo Our objective in studying this ‘blind spot’ is to identify our underlying assumptions; rather than to criticise them. Rather than being ‘natural’ or ‘objective’ descriptions of a given realify, they form part of specific paradt'pms, The sets of assumptions and specific world-views that relate to monopolistic money are deeply ingrained in our thinking and lead to this partial blindness, However, like any paradigmatic option, these assumptions and world-views are not laws of nature: we made them up and we can change them.

The hegemony of single-currency thinking Many societies have imposed a single, monopolistic, hierarchically-issued currency, naturally or artificially kept scarce, and associated with positive interest rates. This w’as true in Sumer and in Babylon, in Ancient Greece and in the Roman Empire, as well as from the Renaissance onwards in all Modern societies. The form of these currencies has varied widely, from standardised commodities, precious metals and natural objects such as shells, to paper or electronic bits. But they have had three crucial properties in common: in all cases, only that specific currency was accepted for the payment of taxes; the currency could be stored and accumulated, i.e. hoarded; and borrowing such currencies implied the payment of interest. So widespread has been this approach that we tend to think that it is the only option, leading to the hegemony of single-currency thinking.

In fact, many societies have use a dual-currency or multi-currency system. In those societies, the monopolistic currency described above was then used for long-distance trading with foreigners or with people whom one didn’t know personally. The second type of currency was used for exchanges within the local community, and was of a very different nature. This second currency w'as usually created locally by its users. It was issued in sufficient amounts and did not bear interest. In the most sophisticated cases, this second currency even carried a demurrage fee - i.e. a negative interest on money - which discouraged its accumulation. In short, this other currency would be used as a pure medium of exchange not as a store of value. This w*as the case with the wheat-backed currencies that lasted for well over a millennium in Dynastic Egypt, and with local and regional currencies in Western Europe, during almost three centuries of the Central Middle Ages (10ÿ-13ÿ centuries). These dual systems provide some of the best explanations for the unusual economic well-being of these ancient societies.ÿ Societies in which such dual-currency or multi-currency systems have prevailed have often been matrifocal ones - not to be confused with matriarchal ones. There is no evidence that genuinely matriarchal societies have ever existed. By contrast, there is widespread evidence that advanced matrifocal societies, loosely defined here as those where feminine values are honoured, have existed in various parts of the world, though less frequently than patriarchal ones.35

The ideological warfare between capitalism and communism The second layer of the blind spot is more recent. During most of the £0ÿ century, an intense ideological war was waged worldwide between communism and capitalism. This affected all social and political sciences, including the science of economics with its different schools of thought and particular views on the corresponding ideology (see Figure £.5). Strenuous debates between the different schools of economic thought have resulted in the publication of thousands of books describing the most minute differences between the multifarious ideologies both within and across ‘camps’.

Marx-Engels

Marxtet-

Clascal

Leninisd

[Smith, Millv,.)

Austrians [Hayek, von Mi&es)

ix ,«« Trotskyists 4-

Maoists

Keynes Keynesians

Neo-liijeraf

(Friedman, Chicago]

Figure a.5: Ideological polarisation between communism and capitalism.

What these ideologies all have in common, however, is almost completely overlooked: they all take for granted the monopoly of a centralised currency. Could the reason for this be that both communism and capitalism emerged during a period where patriarchal ideologies were dominant, sprouting two distinct and rival wap of organising an Industrial Age? Their disagreement was not on whether monopolistic money and material growth are beneficial, but rather on what organisational principles, social mechanisms and political means were best suited to building an efficient industrial growth economy. By bringing the focus of attention onto everything except the common monetary aspect of the two competing ideologies, this ideological split substantially reinforced the monetary ‘blind spot'. An institutionalised status quo At some point during the 18th and 19th centuries, the use of a single currency issued through bank debt was institutionalised. This institutionalisation generates the third layer of the “blind spot'. This role is now still played by central banks in every country and/or monetary union. With the 1930 Copenhagen agreements, the Bank for International Settlements (BIS) was created, and with the Bretton Woods agreements of 1944, the International Monetary Fund (IMF) and the World Bank came into existence. More recently, the Treaty of Amsterdam in 1998 led to the establishment of the European

Central Bank.

While these institutions obviously fulfil important and useful tasks in terms of preserving the integrity of the system, they have also become the guardians of a monetary orthodoxy, which reigns almost universally today. And this orthodoxy shapes academic thinking. For instance, is it a coincidence that none of the 69 Nobel laureates in economics to date have made the mistake of questioning the prevailing money paradigm? While two Nobel laureates ended up suggesting monetary reforms, they only did so after they had received the prize. One of them was Friedrich von Hayek with his proposal for the privatisation of money emission (still within the banking sector, however); the other was Maurice Allais with his scathing criticism of fractional-reserve banking, whichhe likened to counterfeiting.

What is colloquially called the ‘Nobel prize for economics’ has as official title the ‘Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel’ (Swedish: Sveriges rihsbanhs pris i ekonomisk vetenskap till Alfred Nobels minne). This prize happens to be funded by a central bank, actually the oldest central bank in existence, also called today the Bank of Sweden. Does this reinforce some biases within academia? Peter Nobel, the great-great nephew of Alfred Nobel, seems to think so. Unlike the Nobel Prizes for Medicine, Chemistry, Physics, Literature and Peace, which were created by Nobel in his 1896 will and fi rst awarded in 1901, the Economics Prize was conceited by Sweden's cenfro! bank in 1968 to mark its tricentenary and yirsr awarded a year later. There is nothing to indicate that he would fcaoe wanted such a prize.’[says the great great nephew ofAlfred Nobel] 'The Economics Prize has ouer the years been criticised as nor being a ‘real’ Nobel, and a newspaper article Peter Nobel wrote in 2010 refuelled the debate. The Economics Prize has nestled itself in and is awarded as if it were a Nobel Prize But it’s a PR coup by economists to improve their reputation he bristles.”3&

Central banks remain attached to the notion that a monopoly of a single national, bank-debt-based currency' must be enforced in each country' or group of countries. They do so despite the poor track record of repeated banking and monetary' collapses, crowned by the massive collapse of 2008. Even a shock of

this scale originating in the country at the core of power, the United States, has not been sufficient to shake the belief that only a single currency per country is required. We can predict with 100% certainty that additional, even bigger crashes will occur again and it is only a question of when, not of whether. The next chapter explores what such crashes mean in practice today. Footnotes 1 The canonical definition was provided by the philosopher of science Thomas Kuhn in The Structure o/Science EeuoJutions (1965). He defines a scientific paradigm as an epistemological pattern, a mental framework that specifies a series of what’s and

how-to’s: dhotis to be observed and scrutinised, and by implication what is to be overlooked; the kind of questions that are supposed to be asked or ignored; how these questions are to be structured; how the results of scientific investigations should be interpreted. A paradigm, according to Kuhn, adjusts over time to the everyday requirements of what he calls 'normal science’, i.e., the business of tinkering with models and making them fit empirical data as well as possible, for as long as possible. The period of normal science is sometimes ended, more or less abruptly, by a 'scientific revolution’. Christian Arnsperger, Eu//-Specfrum .Economics: Tou-ords on Jnc/usiue and Emancipaforiÿ Socia/ Science (2010a), p.25. In opposition to the Traditional Economic paradigm, a movement that initially called itself ‘Post-Autistic Economics’ (PAE) was born at the Sorbonne in Paris in 2000 and was endorsed by a group of Cambridge PhD students in 2001 with the publication of 'Opening Up Economics: A Proposal by Cambridge Students’, (See The Cambridge 27, July 2001, andPost-Autistic Economics Newsletter, issue 7, article 1.) This declaration w as later signed by 797 other PhDs in economics. For a detailed compendium of the documents that launched the 'Post- Autism’ movement, see Edward Fullbrook (ed.), The Crisis in Economics: The Post-Autistic Economics Movement - The First 600 Days (2003). For a follow-up with more reflective, in-depth contributions, see Edward Fullbrook (ed.), A Guide fo tVfcar’s Wrong PVirh Economics (2004), Arnsperger (2010a) p.q, In fact, they should not, because that might contradict instrumental rationality, such as in the case where respect for a ‘Mother Earth’ tradition leads some people to renounce exploitation of some natural resource. American Indians have been denounced as anti-progressive because they give the sacredness of their land priority over marketable coal, ores or petroleum,

See Karl Polanyi, The Great Transformation: The Political andEconomic Origins of Our Time (1944). 2 Towards Sustainable Development (P&ris: OECD, 2000). £ See e.g. Nicholas Georgescu-Roegen (1971); Rene Fasset (1979); Herman Daly (1996); Robert Costanza (2003) pp.237-246: John Gowdy & Jon D. Erikson (2005). For a general but exhaustive treatment, see e.g. Molly Scott Cato (2009) and Herman Daly & Joshua Farley (2011). Ecological economics should not be confused with 'environmental economics’, which w*as initially part of the Traditional Economics approach and has been a driving force behind the OECD approach shown in Figure

2.2.

9 In this statement, we extend ecological economics into w*hat might be called 'political ecology5, since traditionally ecological economists emphasise more the embeddedness of the economic within the environmental, and less its embeddedness within the social. However, political ecology and ecological economics are very closely linked, and most ecological economists will have no objection to our graph here. See, amongst others, Ken Wilber, Sex, Ecology, Spirituality: The Spirit ofEwlution (1995)il An approach that has led mainstream economists to reason as if, with good enough economic and human capital in the form of extremely high-grade technologies and an extremely well-trained workforce, the whole world's production might be manufactured with virtually no natural capital, e.g,, with just a few* grains of matter... 12 This idea - and especially the notion of 'ecological debt5 - is a major theme in the influential book of Tim Jackson, Prosperity Without Groiorh; Economics For a Finite F/anet (2009). 13 Nicholas Georgescu-Roegen (1906-1994) was born in Romania but did most of his academic w ork at Vanderbilt University in the USA, where he w as acknowledged as Distinguished Fellowÿ of the American Economic Association. He made significant contributions in both conventional economics (utility theory, input- output analysis, production theory) and in paradigm-shifting economics - what along the lines of Thomas Kuhn might be labelled 'revolutionary5 economics. He applied rigorous systemic thinking on how to link economics to the physical laws of sustainability in Ana/yricaJ Economics (1966), Paul Samuelson said in the Preface that he considered Georgescu-Roegen to be a scholar's scholar, and an economist's economist51. He added: fcI defy any informed economist to remain complacent after meditating over this essay 55H Nevertheless, complacency is what has greeted that book and its successor, The Entropy Law and rhe Economic Process, Ecological economist Herman Daly 5

concludes in his ‘Obituary Essay on Georgescu-Roegen': “One does not expect fundamental change to occur overnight. But twenty-five years is a reasonable time over which to hope for progress. What is the matter with our discipline?17 (Daly [199b] p.192 and P.19&). Even Samuelson himself, for all his professed lack of complacency, never updated his bestselling economics textbooks to integrate Georgescu- Roegen 's findings. Even 30 years before Georgescu- Roegen, Frederick Soddy, a Nobel laureate in Chemistry, had drawn the attention of economists to their ignorance of entropy and the unsustainability of compound interest, all without success. 14 Orio Giarini 'Science and Economy: The Case of Uncertainty and Disequilibrium' Cadmus, Vol I, N0.2 (April 2011) pp.25-34. 15 Hazel Henderson: Paradigms in Progress: Life beyond Economics (1991). See also Hazel Henderson: Creating Alternative Futures (1996) p.xii. 16 E. U. von Weizsacker, A. B. Lovins and L. H. Lovins, Factor Four: Doubling Wealth - Halting Resource Use (1997). 12 World Commission on the Environment and Development, Our Common Future (19&9), p.200. 18 Harding Tibbs, 'Sustainability”, The Deeper News, Vol. 3, no.i, Jan. 1999, p.5. 19 Herman £. Daly and John E. Cobb, For the Common Good: Redirecting the Economy Toward Community, the Environment, and a Sustainable Future (19&9). 20 The rate of species extinctions at present is estimated at 100 to 1,000 times background' or average extinction rates in the evolutionary time scale of the Earth. J. H. Lawton and R, M. May, Extinction Rates (1995). H Figures according to: FAQ : CED Secretariat: World Bank; IPCC. 22 For a detailed analysis of these campaigns see, for instance, Naomi Oreskes and Erik M. Conway, Merchants of Doubt: How a Handfulof Scientists Obscured the Truth On Issues From Tobacco Smoke to Global Warming (2010), companies with superior performance and positioning on 'sustainability' (be., 23 environmental and social) issues achieved, on average, superior financial returns'* Matthew J. Kiernan, Investing in a Sustainable World (2009), p.xiii. 2d See, e.g,, Michael Baumgart and William McDonough, Cradle to Cradle: Re-Making the Way We Make Things (2002). 2fi See Peter M. Senge, The Necessary Revolution/ How Individuals and Organizations Are Working Together to Create a Sustainable World (200S), 26 The World Scientists' Warning to Humanity w as spearheaded by the late Henry' Kendall, former chair of the Union of Concerned Scientists' board of directors

bitdu/TFIinki$). At the Captains of Industry’ conference in Singapore

(u?j#-Uj-.uc$usa.oro

on September

27th, 2005.

2& In Larger Freedom; Towards Development, Security and Human Rights for All, 2005 report for the UnitedNations both- anniversary summit.

2ft Jamshid Gharajedaghi, Systems Thinking; Managing Chaos and Complexity (1999), p.xvi. 33 See Sarah James and Tobjorn Lahti, The Natural Step for Commtinities,r How Cities

and Towns Con Change to Sustainable Practices (2004). 31 See Gwendolyn Hallsmith, The Key to Sustainable Cities; Meeting Human Needs, Transforming Community Systems (2004) and The Earth Charter Community Action Tool UJUJII;. earth aar.oro. 32 Indeed, the monetary dimension has not been very much at the centre of many of the most recognised and widely cited contributions to the sustainability debate, such as David Pearce and Edward Earbier’s R/ueprintFor a Sustainable Economy (2000), Daly (1996) or Jackson (2009). (For a critical assessment of Jackson’s book from the monetary' angle, see Christian Arnsperger, rMonnaie, dette et croissa nee sans prosperity Portee et limites du "tournant Jacksonnien11, Etopia, No. 8, December 2010, pp.109-116.) Edward Barbier’s momentous study on A Global Green New Deal; .Rethinking Economic Recotÿrÿ (2010) deals extensively with the crucial issue of rgreen5 investment but does so without questioning the structural properties of the current monetary system. In her influential book Plenitude; The New Economies of True Wealth (2010), Juliet B. Schor at least mentions the problem of how money is created and is circulated - but she does not place structural financial and monetary issues at the centre of her proposal, even though she fully realises that growth as ever-increasing material throughput cannot continue. The veil of monetary denial seems to have been torn very' recently in two sustainability studies destined to have a w*ide readership: Charles Eisenstein’s Sacred Economics; Money, Gift, and Society in the Age of Transition (2011) and Richard Heinberg, The End of Growth: Adapting to Our New Economic Reality (2011) - the former offers a whole chapter on non -monopolistic, non-debt money alternatives, and the latter has a section called 'Post-Growth Money1 where structural reform towards non-monopolistic, non-debt money is explicitly cited and discussed sympathetically. 33 On the so-called 'Washington consensus1 and its deleterious effects, w*hich are well documented, see e.g, Joseph Stiglitz, Globalization and Its Diseonfenrs (2002), 34 See Friedrich Preisigke, Girouresen im Griechiscften Agyptenf entha/fend Korngirof GeldgirOf Girobanknotariat mit Einschlufi des Archivwesens (1910; reprinted 1971);

and Bernard Lietaer, Mystertum GeJd,r Emofioncde iJedeufung imd TVtrfctmÿstifeLse eines Thi>us (2000); Au Coeur de Id JVformuie (2011), 35 Much mure detail on these claims about matrifocal societies is given in Lietaer (2000). See also Bernard Lietaer and Stephen Belgin. New Money for a New World (2011), also available on wwwMewmoneuforanewworld.com. 36 Tfobel Descendant Slams Economics Priae’, 27ie Local, 2& September, 2010 (ujujuj.thefcccd.se bit.lu/TPlinki 6).

Chapter III Monetary and BankingInstability â&#x20AC;&#x153;Of all the many ways of organising banking, the worst is the one we have

today. Change is,Ibelieve, inevitable. The question is only whether we can think our way through to a better outcome before the next generation is damaged by a future and bigger crisis/ Sir Mervyn King, Governor of the Bank of England-* The global monetary system seems to run on automatic pilot. What's more, the current global foreign exchange market dwarfs all other markets in history. By 2010, foreign exchange volumes had routinely reached the equivalent of $4 trillion every working day.i 1. The Emergence

of a â&#x20AC;&#x2DC;Global Casino5 The real economy consists of goods and services being produced and traded. When these exchanges take place internationally, one of the parties must exchange the corresponding currency. For example, if someone buys a car imported from Japan in the UK, someone along the supply chain will have to exchange the corresponding pounds for yen. Out of the $4 trillion of daily foreign exchange transactions only about 2% are associated with the real economy; the other 98% are purely speculative. The sole purpose of a speculative transaction is to buy or sell a foreign currency to make money on the change in value between currencies. Using the proverbial metaphor of the

tail wagging the dog, if a dog were to consist of 98% tail and have just 2% available for the rest of its body, visualise what would happen to the dog when the tail moved. 450U 40(H)

3500 3000

Speculative

Real

2500 2000 1500 1000 500

0 I9?q

1953 1955

1002 1095 1005 2W1 2m 2002 2010

Figure 3.1: Daily volume of foreign exchange transactions as reported by theBank for International Settlements (BIS) in April each year versus foreign exchange transactions based on JreaT economic ex changes (1980-2010), The temporary dip in 2004 was due to the replacement of 12 European currencies with the euro.

Such daily volumes of speculative currency transactions are thousands of times larger than the daily trading volumes of all stock markets worldwide. One day's currency speculation represents more than the annual economic output of Germany or China changing hands.* Even these figures may be an underestimate given that hedge funds can trade directly with each other f and those transactions are not registered in the BIS's survey. Another way to measure the scale of this market is the notional amount of currencyâ&#x20AC;&#x2122; derivatives, which rose from approximately $100 trillion at the end of the year 2000 to more than $700 trillion today. Currencyâ&#x20AC;&#x2122; derivatives by themselves represent therefore almost nine times the entire global annual GDPU In short, a â&#x20AC;&#x2DC;global casino' on an unprecedented scale has established itself in our midst. John Maynard Keynes, one of the most prominent economists of the

20th century, correctly identified tlie implications as follows: “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation, When the capital development of a country becomes the product of the activities of a casino, the job is likely to be illdone,”4

The only effective solution when an asset bubble is bursting, and thereby threatens the financial system, is to create a new bubble in another asset class, This is what has repeatedly happened over the past decades. For instance, after the ‘dot-com’ bubble imploded at the end of the 1990s in the USA, a real-estate bubble was created. When the real-estate bubble collapsed in £007, the quantitative easing programmes that ensued started an emerging market bubble. The implications of such bubble strategies are summarised by Ludwig von Mises, one of the founders of the Austrian school of economics: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the monetary system involved,“5 A Scary Banking Season The consequences of the 2007-2008 crisis will be felt for the next decade and dozens of studies have been published on the ‘causes’ of this banking system meltdown. Among the more thorough analyses is the official probe by the US Financial Crisis Inquiry Commission (FCIC)*£ Also worthy of mention is Andrew Ross Sorkin's Too Big to Fail, the detective story narrating hour-by-hour who talked to whom about what during the critical days in New York when a global banking meltdown was averted in extremis,ÿ Detailed case studies for specific banks or countries include one by Anton Valukas, the court-appointed examiner who produced a 2,200-page analysis of the Lehman bankruptcy' and failures in risk management and governance,ÿ The governor of

Ireland's central bank, Patrick Honohan, mined the depths of Ireland's financial and regulatory' failures,ÿ The University' of Iceland produced a general systems model to explain the political, social and economic feedback

loops leading to the Icelandic banking system meltdown. This last model seems equally applicable to Wall Street or the City of London.!ÿ

These reports all suggest at least one common culprit: the financial innovations that had been welcomed for over a decade as w'ays of spreading risk more efficiently - including the now infamous credit default swaps (CDS) and ‘derivatives’ in general.AI AS transactions became more complex and opaque, these innovations resulted in no-one truly knowing who was exposed to what type and scale of risk. Because of this, big banks stopped trusting each other and the inter-bank market abruptly froze. The same happened again in early 2012, but this time mainlyinvolving European banks. While the above analyses allow us to understand retrospectively what happened, they do not tell us how to avoid them in the future. Policy debates have primarily focused on the ‘excesses’ of this latest financial crisis. The tendency is to treat each crisis as if it were a unique and isolated case. As a consequence, recommendations remain within the framework of the existing monetary structure. What most analysts fail to realise is that to identify structural problems, one must focus on what is common among all financial and monetary crises rather than on their differences. In metaphorical terms, a view of the entire forest is required, rather than a close-up inspection of any individual tree or of a specific fype of tree. For example, excessive public debt is generally considered to be the problem in the ongoing euro crisis. The large-scale use of derivatives during a US real-estate bubble is seen as the proximate cause of the 2008 crash. The inflexible link between the national currency' and the US dollar was determined to be the proximate cause of the 2001 Argentine peso collapse. The 1999 Asian crash, which affected a dozen countries, was blamed on “crony capitalism'. While such proximate factors may indeed act as triggers, they never reveal structural causes. Even when different breakdowns are analysed in conjunction, they are usually regrouped within specific categories: for

example, “banking crises’, “monetary' crises', “sovereign-debt crises', and so on. Each category' is then analysed to understand the common causes associated with it; however, deeper structural issues still tend to be neglected. To use

another metaphor, if one is dealing with a proverbial ‘house of cards’, different triggers can bring about different categories of crashes. What would truly make a difference would be to identify the structural brittleness of the house of

cards itself, What governments have learned from the 1930s is that, if one lets the banking system collapse, the rest of the economy will plunge with it. With the ongoing euro crisis, governments may learn that they can no longer afford to save the banking system. The financial system’s own verdict is already clear: the increased public debt burden triggered by the recent banking crisis has led several governments to abruptly lose their creditworthiness. If one wants to remain firmly within the constraints of the Traditional Economy, the only logical solution is for governments, at all levels, to cut budgets in all domains except debt servicing, and privatise everything. This would include privatisation of infrastructural assets traditionally considered normal for governments to own. Examples of this range from city parking meters and streets, to bridges, tunnels and interstate highways, educational facilities, governmental office buildings and water and sewerage systems. Although the privatisation of some assets can be beneficial for society at large, the sudden and forced ‘fire sale’ of critical infrastructure that has taken decades to build up with taxpayers’ money, is not a likely context for fair prices and beneficial outcomes for society. While this new privatisation process is at different stages in different countries, the overall mechanism can be clearly seen - particularly at the US State and city levels, such as in Florida, Illinois or California. Similar privatisation has also started in Europe and is most visible in the UK, Italy and Greece.

To provide more detailed evidence for this argument, we will look at systemic crises, their frequency, types and geographical spreads. We will then probe the consequences of a financial or monetary crisis. Finally, we will take a critical look at privatisation as the solution within the current - and, in our view, defective - monetary' paradigm, 2,

Systemic Crises: Frequency-, Types and Geographical

Spread We need first

what is meant by banking, sovereign-debt and monetary crises, as well as the phenomena that accompany them, such as â&#x20AC;&#x2DC;contagionâ&#x20AC;&#x2122;, A banking crisis occurs when a group of banks simultaneously go bankrupt in a country, requiring significant intervention by the authorities to nationalise or bail them out at taxpayersâ&#x20AC;&#x2122; expense, A sovereign-debt crisisi3 occurs when financial markets estimate that a country or group of countries may default on their national debt. Under the prevailing European rules, governments need to raise the money they need either through higher taxes or by borrowing more from the banking system. Sovereign debt is ultimately backed only by the belief in the capacity for a government to impose on its citizens the taxes necessary to service that debt, to clarify

100

w 00 JO

Sovereign

Monetary

Banking

////

Figure 3.3; Number of systemic crises, with distinctions between the three types: sovereign debt, monetary and banking crises (1970-20 io)M

A monetary (or currency) crisislS takes place when the currency of a country suddenly suffers a substantial drop in value in relation to other currencies. In order to refer to the three types of crises above using a single word, we will define as a systemic crisis any large-scale disturbance involving either a sovereign-debt crisis, a monetary crisis and/or a banking crisis or any

combination of those three. A contagion effect is defined as “the spread of market disturbances, mostly on the downside, from one country to another, a process observed through co-movements in exchange rates, stock prices, sovereign spreads, and capital flow's”.ÿ In short, it is possible for a crisis in one country to trigger a crisis in an unrelated country, regardless of the differences in economic fundamentals. The ‘Tequila effect’ of the Mexican crisis in the 1980s on the rest of Latin America was the first large-scale example. The Southeast Asian crisis of the 1990s was another spectacular demonstration of crisis contagion across

national borders.

The contagion effect is a clear symptom of the structural nature of these crises. Even countries or institutions doing everything ‘right’ according to monetary orthodoxy can be swept into a maelstrom of trouble without much warning. Another sign of the structural nature of these crises is their repetitiveness, independent of the size of, or degree of development in, the countries involved.

The interconnection between these different types of crisis is further justification for looking at what they have in common systemically, For example, when one is able to go behind the scenes as a ‘country’ is being saved from a financial disaster, one can see that it is another country's banking system that is, in reality", being saved. The emergency package put forward at the EU level for Greece in 2010-2011 was thus less about European solidarity than about the German and French banks, which were the biggest holders of Greek sovereign bonds. German and French banks would have needed a new bailout if the Greek government were to have defaulted on its bonds.-LZ

This is the stark reality behind many historic ‘county bailouts', including Mexico's being ‘saved' in 1981 and again in 1994. In reality', both cases were about avoiding a banking crisis on Wall Street.

Furthermore, the label ‘sovereign debt crisis' can hide the direct consequences of an earlier banking crisis. For instance, the Irish crisis of 2011 is currently referred to as a sovereign-debt crisis. In fact, it is simply the

automatic fallout from Ireland’s bailout of its banking system in 2008.

the IMF data summarised in Figure 3.2, there were 145 banking crises, 208 monetary crashes and 72 sovereign-debt crises between 1970 and 2010, This represents a total of 425 systemic crises, an average of more than 10 countries getting into trouble each year! These crises have hit more than three-quarters of the 180 IMF member countries, many of whom have experienced them several times. However, the decrease in the number of crises since 2000 as shown in Figure 3-3 provides little comfort. This is because the smaller number of countries experiencing a crisis has been counterbalanced by the larger size of the economies involved. The 23 countries involved in the 2007-2008 banking crash - including the USA, the UK and Germany - represent approximately half the world’s demand and output.

According

If a car, a plane or an organisation had such a track record, would there not be a universal outcry to send the designers back to the drawing board? Furthermore, the number of casualties from a defective car, plane or organisation is insignificant when compared with the number of victims of a systemic financial or monetary crisis, which can be counted in the millions, sometimes in the hundreds of millions. Nevertheless, in the case of the monetary system, the organisations in charge (such as banks, central banks or the IMF) not only failed to foresee or to effectively cope with the breakdowns, they have also never considered any alternative to the systemic srarus quo. Their solution is invariably to return as quickly as possible to ‘normal’, without making any significant changes to the system’s structure. While it has been officially stated that changes in the "international financial architecture may be necessary' to reduce these risks”,i£ none of those ‘architectural’ changes has ever been implemented in the real world. This ensures that more crises will occur in the future. For those of us who are not bankers, what is meant on a practical level by one of these crises?

The impact on unemployment There is general awareness of the nefarious impact that these crises have on

employment. Notwithstanding stimulus programmes, the number of unemployed since March 2008 has significantly increased in both the euro area (EA-16) and the EU as a whole (EU-27). By the end of 2011, the number of unemployed people in EA-16 went up by 4.4 million to a total of 16 million or a seasonally adjusted unemployment rate of 9.9%. Over the same period, unemployment in EU-27 rose by 6.9 million to reach 23 051 million (9-6%).A3 In the USA, the unemployment rate roughly doubled between £007 and £010, with 13*3 million people unemployed in December £011. Any downturn in unemployment is being hailed as ‘the end of the crisis’. History’ indicates, however, that the impact of a banking crisis on unemployment rates takes an average of 4.8 years to fully manifest itself and that it can last as long as eleven years. In the case of Europe, the ongoing and simultaneous austerity programs will make this effect last significantly longer than average. Malaysia. )997

Indoneilfc 1997 Japs rt, 1992

Thailand. 1997 Philippines. 1997 Hong Kong. 1997 Hanwjv. 19B7

Korea, 1997

Argentina, 7001

7 percent

Historical Average SvMtuii, 1991

Spain, 1977 Colombia, 1993

Finland, 1991

US. 1929 0

Percent Increase

Figure 3.3: Percentage increase in unemployment for selected crises.ÿS Each banking crisis

episode is identified by the country and by the beginning year of the crisis.

Human and societal costs

The social and environmental consequences of a monetary and/or banking crash are felt far longer than the purely financial ones. A systemic crisis affects not only all aspects of the economy, but also leads to social and political turmoil, creating additional uncertainties for everyone in addition to increasing levels of poverty. In20io, theUS Census Bureau reported 4 million additional Americans in poverty, making a total of 44 million, or one in every seven residents. The rise was steepest for children, with one in five children affected*ÿ Because the crisis started later in Europe than in the USA, the full impact on poverty in Europe has not yet been fully documented. Even countries theoretically immune to the financial side of a crisis end up being hit through unemployment and increases in poverty. For instance, the World Bank estimates that the impact of the 2008 crisis in Poland will result in a 3% increase in the number of people in poverty; in the Philippines and Bangladesh, an additional 3% of the population will be in poverty, and in Mexico an additional 8%.2Z

Output losses The economic impact of a crisis is broadly measured by the GDP "output loss', the difference between the actual GDP of a country’ and the output that had been expected based on the long-term trend before the crisis. It provides an indirect estimate of how non-financial businesses within the country- are affected, and the extent to which external trade for other businesses with that country- suffers. Here are two recent analyses: 'The economic cost of the 200J-B crisis is on average much larger than that of past crises/ both in terms of output losses and increases in public debt. The median output loss (computed as deviations of actual outpurÿfrom its trends is 25 percent of GDP in

recent crises, compared to a historical

median of 20 percent of GDP, while the median

increase in public debt (over the three year period following the start of the crisis) is 24 percent of GDP in recent crises, compared to a hisforicai median of 16 percent of GDP* S3

Tn countries that experienced a banking and a monetary crisis simidfaneoush/. the estimated output loss mas a iso substantial每 greater than when each crisis mas experienced separately. The average cumulative output loss was 14.4% in the 32 simultaneous crises and, for the fi rsr time in bistory, mas greater for industrial than for emerging economies* 2A

Transfer costs Another aspect of a banking crisis is the question of who ultimately ends up paving for it. Historically, taxpayers have invariably ended up paving to bail out failing banking systems* The IMF estimates that the transfer payments in support of deposit guarantees during banking crises topped 10% of GDP in many countries* These figures even exceeded 40% in Argentina, Thailand,

Korea, Indonesia and Malaysia*

The magnitude of comparable transfer payments in monetary crises from taxpayers to foreign creditors, including the repayment of loans provided by official international institutions, has not been quantified* However, we surmise they must have been similarly sizeable in a number of recent crises* Such crises are typically accompanied by sharp depreciations in exchange rates* These devaluations directly increase the burden of debt denominated in foreign currency to domestic borrowers and, therefore, the probability' of default on this debt by governments or local businesses* This, in turn, sets the scene for further rounds of banking problems* Because all IMF data are based on government statistics provided by the countries involved, the comprehensiveness of this data is debatable* One exception is the case study of the 2007-2008 US banking crash*

Evaluating the real costs of the 2007-2008 bailout: The case of the USA In the United States, successful legal manoeuvres and lawsuits have forced the

Federal Reserve and different government agencies to release data that would otherwise remain hidden. Thanks to the unprecedented scale of this ‘forced transparency’, we can more closely study the 2007-2008 bailout. Discussion of the cost of the US bailout usually focuses on the $700 billion Troubled Asset Relief Program (TARP) squeezed through Congress during the final months of the Bush administration. This programme was managed by the US Treasury Department. As banks reimbursed these funds over time, the total amount gradually dropped so that by December 2010, the estimated total cost was assessed at “only $25 billion”.£5 Public attention has been primarily focused on this programme. However, Neil Barofslw, the Special Inspector-General for the TARP, told lawmakers: “Inadequate oversight and insufficient information about what companies are doing with the [TARP] money leaves the program open to fraud, including conflicts of interest facing fund managers, collusionbetween participants.,.".ÿ Bernie Sanders, the independent senator from Vermont, managed to pass an amendment to the Wall Street Reform Act forcing the disclosure by the Federal Reserve of an additional $3.3 trillion in emergency loans and other support to the largest financial institutions. The Center for Media and Democracy identified 34 other programmes besides TARP used to prop up the housing and financial sectors.22 This includes both the Treasury and the Federal Reserve providing direct loans to Wall Street companies and banks, making purchases of toxic assets, and offering guarantees for the mortgage and mortgage-backed securities markets through federal housing agencies. According to the government’s own data for these 35 programmes, the amount disbursed for the bailout is actually $4.7 trillion. This amounts to 30% of the United States' GDP and 130% of the federal budget for the fiscal year 2009.

The Wall Street financial reporting company Bloomberg went to court to extract additional data from the administration. Upon completing their research in March 2009, they claimed: “The U.S. government and the Federal Reserve have spent, lent or committed $12,8 trillion, an amount that approaches the value of everything produced in the country last year. The money works out to $42,105 for every- man, woman and child in the U.S. and

14 times the $899,8 billion of currency in circulation. The nation’s gross domestic product was $14.2 trillion in 2008”.ÿ

The most comprehensive estimate has been made by Nomi Prins, an ex-Wall Street insider. Before becoming a journalist, Prins worked as a managing director at Goldman Sachs and ran the international analytics group at Bear Stearns in London. Her estimate includes all the types of supports and guarantees provided by both the US Treasury and the Federal Reserve. She found a total of fifty programmes, several of which w*ere concealed until then, that amounted to a total of $14.4 trillion - a sum greater than the entire US GDP for 2008.23 Most of us have trouble grasping what a billion dollars represents, not to speak of a trillion (= 1,000 billion). To put things into perspective, let us look at the lowest of these estimates, the $4.6 trillion disbursed according to publicly available data. Even that amount makes it by far the most expensive programme ever to have been funded by a government. It is more than the entire inflation-adjusted costs of World War II borne by the United States that is, $288 billion, which, when adjusted for inflation, would amount to $3.6 trillion today. It is more than the inflation-adjusted costs of the Louisiana Purchase, the New Deal, the Marshall Plan, the Korean and Vietnam Wars, the Savings-and-Loan debacle, and the entire NASA budget (including the race to the moon) combined - namely, a “mere" $3.91 trillion.ÿ And remember that it took two centuries to spend that amount of money on all these programmes, compared to less than two years for the financial bailout.

In countries where there is no independently minded Senator such as Bernie

Sanders to force disclosure of central bank data, and no Bloomberg pushing investigative zeal through the courts, such consolidated data are not available. In the eurozone and in Europe in general, no-one has made the effort to consolidate data from the different programmes created to pay for it all or, as far as we know, drawn up an appraisal of the collateral financial damage. The increase in public debt One ironic problem, in light of what is currently happening, is the effect of the

banking crisis on public finances, “The median debt increase among recent crises is 24% of GDP, Thus, public debt burdens have increased significantly as a consequence of policy measures taken during the crisis,”31 Notice that this impact is completely independent of the quality of any government’s own policies, before or during the crisis. While much has been made of the case of Greece where fraud w'as involved, not much can be blamed on governments or citizens in Iceland, Ireland, Latvia, Denmark or Spain, all hit with sudden increases in their national debt, which reached 35% - 75% of their GDP, The irony is that, as soon as governments borrow these large sums from the financial system to save the system itself from bankruptcy, the financial system concludes that governments are now' too indebted and need to

be ‘disciplined’, Figure 3,4 brings together the various components of the impact of banking crises on government finances. The direct fiscal cost of bailing out the banking system is added to output losses with an automatic drop in tax income, Governments thus have no other option than to increase their indebtedness, This, in turn, results in the downgrading of the creditworthiness of affected countries and makes their debt more expensive. What does all this lead to? Direct Fiscal COST Increase In Public Debt Output Losses Medians {% of GDP)

Old crii« (I970-JD06)

Advanced economics

3,7

36,2

32.9

29,4 11.5 12.7 Emerging markets 19,5 16.3 10.0 AH New crises <2007-2009) 5,9 Advanced economies 24.0 25.1 23.9 4.8 Other economies 4.7 4.9 23.9 24.5 All Note : New crises include Austria, Belgium, Denmark, German/, Iceland, Ireland. Latvia. Luxembourg. Mongolia. Netherlands, Ukraine, United Kingdom and United States.

Figure 3,4: Summary of the costs of banking crisesSfi

3* The Sovereign Debt Squeeze Tlie timing of this sadden increase in government debt is particularly unfortunate. The current decade is one in which the OECD countries and their governments have to deal with unprecedented pressures not amenable to being postponed. As mentioned in Chapter I, two critical and predictable challenges during the next decade will be the transition to a post-carbon economy and the sharp increase in financial requirements for retiring baby boomers,

There is currently wide acceptance that massive investments are needed to avoid the worst-case scenarios of global warming. Similarly, there is agreement that will require strong leadership from governmental bodies for such a shift to occur. Because the private sector has invariably required financial incentives to make the necessary commitments, either subsidies or tax deductions are required. After making an inventory of the breakthrough possibilities in current renewable energy technologies, the MIT’s Technology Review concluded: “None of [these technologies] would have happened without federal support. Although some airernafii-e energy technologies might euenrua/hj acfoieiÿe grid parity, few, if any, can suryiife without subsidies now, as they improve their costand effi ciency. All the

darling energy technologies - essentially all the renewables and all the grid-powered electric vehicles - depend on huge subsidies,’ says David Victor of UC San Diego, *and no one really knows lofcaf a world of fiscal austerity wilt look like for these technologies’ ”33

Postponing the transition to a time when the pressures on government finances are alleviated is not an option: beyond a given level of carbon dioxide in the atmosphere and of higher average temperatures, we truly risk runaway climate change. This would lead to rising sea levels, requiring roughly one third of humanity to move to higher ground. As described in Chapter I, the phenomenon of 'dust-bowlification’ would damage the biosphere to a grave extent. Humanity' is playing Russian roulette with the global climate and with the biosphere, while breakthrough energy solutions are available, albeit only

with massive governmental support. How* will we explain to future generations that this support was not forthcoming because we were not able to think outside the box of our monetary arrangements, a legacy system whose main features are centuries old?

The second pressing issue is the impending retirement of baby boomers. This will generate a substantial increase in government spending for pensions and health care - an issue for all OECD countries. The unprecedented ‘Age Wave’ will transform the economics and politics of the world. One expert’s opinion is that “Global ageing will become not just the transcendent economic issue of the 21st century, but the transcendent political issue as well. It will dominate and haunt the public-policy agendas of the developed countries and force renegotiations of their social contracts.”34 There are no historical precedents to help us deal with the Age Wave, and just like with climate change issues, buying time is not an option: all the people involved are alive today, and pushing back the age of retirement only postpones the day of reckoning by a few years. What effects will these two unprecedented challenges now bearing down on us have on government debt, given that they must be dealt with one way or another between now and 2020? For climate change and the related post-carbon economy issues, no study exists yet about the impact on government finances. In connection with the impact of ageing on public debt, however, the BIS prepared a thorough study entitled The Future ofPublic Debt: Prospects and Implications.35

The BIS’s baseline scenario assumes that total government revenue and non-age-related spending remain a constant percentage of GDP and that real interest rates remain unchanged from the historically low average levels of the 1998-2007 period. Both these hypotheses should be considered optimistic ones. Nevertheless, in this baseline scenario, debt/GDP ratios rise rapidly in the coming decade, exceeding 300% of GDP in Japan, 20096 in the United Kingdom and 15096 in Belgium, France, Ireland, Greece, Italy and the United States. In the longer term, the situation grows even more unmanageable: by 2040 the projected debt/GDP ratios for all these countries range from 30096 to

6oo%\ Similarly, the fraction absorbed by interest payments in each of these countries points to the same conclusion: from around 5% today, these numbers rise continuously to above 10% in all cases and climb as high as 2j% in the

United Kingdom. Some fundamental change will obviously happen before these projections become reality. The BIS study says: "Fiscal problems confronting indiisfrial economies are bigger than suggested by official debt figures that show the implications of the .financial crisis and recession for fiscal balances. As frightening as it is to consider public debt increasing to more than 100% of GDP, an even greater danger arises from a rapidly ageing population. The related unfunded liabilities are large and groining, and should be a central part of today's long-term fiscal planning, ft is essential that governments not be lulled into complacency by the ease with which they have financed their deficits thus far. In the aftermath of the .financial crisis, the path offuture output is likely to be permanently beloic where ice thought it icould be just several gears ago. As a result, government revenues ivifl be loiver and expenditures higher, making consolidation even more difficult. The recent sharp rise in risk premiums on long-term bonds issued by several industrial countries suggests that markets no longer consider sovereign debt low-risk

The BIS's conclusion is that “Our projections of public debt ratios lead us to conclude that the path pursued by fiscal authorities in industrial countries is unsustainable". This means that the increase in sovereign debt due to the 2008 banking crisis plus the inevitable financial consequences of an ageing population are sufficient to push most developed countries into an unprecedented fiscal squeeze. Some authors are unambiguously claiming that we are “all going to be bankrupt within ten years“.32 What solution to these quandaries has the financial system proposed? 4. A Solution; The Privatisation of Everything? In early 2009, merely months after the bailouts for the 2007-2008 banking crisis, a ‘working group’ of eighteen banks, investment funds and lawyers3£ released a report entitled Benefits of Private Investment in Infrastructure This strategy is outlined most clearly for the USA, in an article in Furomonep

by Nick Lord, ‘The Road to Wiping Out the US Deficit’: There is

mechanism [for governments]

raise that money: the monetization of existing assets. These assets are extremely valuable. In 2008 the total lvalue of VS government fi xed assets (at a federal, state and local level) was $g.j trillion. O/tftis $1,9 trillion isoiuned by federal government, while $7.4 trillion is held af the state ietÿel. If one assumes that the federal gotrernmenr will not be selling the naug or the municipalities their schools, there is still an immense amount 0/ assets that can he sold. For instance, the oafue o/ail the highways and roads owned bÿ stares and municipalities is $2.4 trillion. There are $550 billion of sewerage assets at state and local leoels along with a further $400 billion of water assets. And in the real estate a perfect

the federal, state and local governments own assets worth $1.09 trillion. The moment the political pain from cutting services is more than the votes lost in selling assets, this marker will take off. Ar grass- root leuei, that political pain threshold has been reached. 33 sector,

As of early 2012, forty-four out of the fifty US States face bankruptcy. They are under increasing pressure to start ‘Public-Private Partnerships’, called P3S

in the USA and Private Finance Initiatives (PFI) in the UK. What actually occurs in these benign-sounding partnerships is that governments are obliged to sell off existing infrastructure, built and paid for with taxpayers' money, in order to reduce existing debt or pay for current public expenditures. Once the infrastructure is privatised, new owners can charge fees for the use of a once free public utility, or increase existing tolls. Thus taxpayers will end up paying twice for the same infrastructure and the second time could be more expensive than the first, given that many infrastructural assets are natural monopolies. Private investments in public utilities can generate a 'win-win' situation when designed and implemented properly. In several European countries, there is a well-established practice of, for instance, the private sector building new toll-paying highways. When such auctions are well prepared and transparent, the results can be beneficial to all parties. However, the P3S currently being proposed are different from their historical precedents in three ways: 1.

The new P3S have a strong preference for buying up existing assets,

rather than building new ones, because the time required and the risks involved are much higher in new projects. 2. Today’s privatisations are decided under unusually pow erful financial pressures, so that a ‘crisis’ fire sale may well distort the whole deal unfairly against the public interest. 3. Such distortions are more likely to occur now because of the unprecedented concentration in the financial sector, with the overall share of financial assets held by the largest financial institutions increasing sharply. The same institutions are, on the one hand, both the direct or indirect buyers of the infrastructure assets and, on the other, control access to other sources of government funding such as the traditionalbond sales. In other words, the “perfect mechanism” to which Nick Lord refers to in Euromoney may be perfect for the financial sector, but not necessarily for the rest of society. One well-documented example is the sale of the revenue of all 36,000 existing parking meters for a period of 75 years by the city of Chicago for a lump-sum payment of $1.2 billion. This decision was approved on 4 December 2008 by the Chicago city council, by 40 votes to 5. The rates charged by the meters went up immediately by 400 to soo%.4£ A later investigation of this

deal by the Chicago Inspector-General’s Office includes the following findings:

The driving force iwfaind the decision fo /ease the parting mefers uras the Cifp's shorf-ferm budgefarp need. While u?e do not guesfion the seriousness of the City’s budget problem that was presented in Fa// 2008 because of the recession, the hastyf 'crisis’ nature of the decision-making process meant that the shortterm budget problems and the large upfront payment the City toas receiving otfersftadoioed a// other legitimate, long-term, public-interest issues.”4i.

It also demonstrates that the city was underpaid by a factor of three! At a discount rate of 5.5% (equivalent to the cost of the city's borrowing), just holding on to the parking meters the city would have received over time $3.51 billion ($2.35 billion more, or 67% more than the sales price). Even using a discount of 7% would have yielded $2.13 billion ($997 million or 45% more than the amount received).

This report shows that the deficit for the years 2008-2009 w'as only $150 million, and the option of a eo-year lease writh a 50% revenue-sharing (on the same terms as in the 75-year lease) would have provided the City with between $302 million and $444 million for immediate use. However, such an arrangement was not proposed during negotiations.

According to Bloomberg, Chicago drivers will pay Morgan Stanley at least $11.6 billion to park at city meters over the next 75 years: ten times w'hat the system was sold for. The next steps are plans to fit more cars into fewer metered spaces by removing marking lines, raising the number of metered slots and expanding the hours requiring fees. “These deals are rarely done under the bright light of public scrutiny”, said Richard Little, director of the Keston Institute for Public Finance and Infrastructure Policy at the University of Southern California in Los Angeles. “Often the facts come out long after the deal is done.'"

All this happened even though the City of Chicago was not an inexperienced apprentice in such privatisation programmes. In 2005, the City leased its Skyway toll road for ninety-nine years for $1.83 billion; and in 2006, its parking garages for ninety-nine years for $563 million. A plan to privatise Midway Airport collapsed in 2009, because the recession drained investors' interest. Nor is Chicago the only US city engaged in such deals. Dana Levenson of the Royal Bank of Scotland and Chicago's chief financial officer from 2004 to 2007, counts about 50 other deals pending in North America, worth between $35 and $40 billion.43 Why do we focus on these American examples? The first reason is that, according to John Perkins' disturbing book Confessions of an Economic Hit Man, US banks and corporations in Latin America and other developing countries have applied similar policies for many decades.44 The current privatisation process is the “economic hit man' coming home. Furthermore, at least in the USA, consolidated data are available. In Europe, each country is dealing separately with the fallout from the 2007-2008 crisis, without pulling all the pieces of the puzzle together. But there shouldbe no doubt that what is happening in the USA is also taking place in Europe. The same financial

institutions are involved in both the USA and Europe; and they are applying the same strategies in Europe, simply with less fanfare and less visibly than in

the United States. For instance, the Berlusconi government started the process of selling an estimated 9,000 publicly' owned properties in Italy. They' include a former royal palace in Palermo, Sicily', several islands in the Venice lagoon and near Sardinia, former convents, lighthouses and aqueducts, as well as long-term leases on beaches, rivers, lakes and Alpine summits. In Rome, the Etruscan museum at Villa Giulia and the land around the Villa Gregoriana in Tivoli are also being considered. The government expects an income of about €3 billion from these sales, three quarters of which is to be used to reduce the debts of local authorities, and the rest to reduce the national debt. “Critics have attacked the government for selling off assets that have been public property' for centuries, and predicted that local authorities will grant speculators permission to build in previously protected areas. ‘What lies behind this transfer of assets is the biggest building and real-estate operation in the history of the republic', said Angelo Bonelli, chairman of the Green party'. Salvatore Settis, a leading archaeologist and head of the prestigious Scuola Normale Superiore, a university in Pisa, denounced ‘a draining and dismantling of the state just to raise money'. He added: ‘The country hasn't realised yet that we are all having our pockets pieked'.1"45

The UK government of David Cameron has officially announced a £16 billion privatisation programme, which includes the high-speed rail link from St Pancras to the Channel Tunnel, the Royal Mail, and NATS, the air traffic control service.

Such privatisation policies could be exported to some other European countries forcefully, as part of future IMF support conditions, as was done in the sovereigndebt crises in the Third WTorld during the 1980s and 1990s. As part of the €110 billion EU-IMF package to avoid default on the Greek debt in 2010, Greece was forced to commit to selling approximately €50 billion of public property'. A full understanding of what this entails is still unavailable as of this writing. Although two-thirds of the population are strongly opposed to

&ucli an approach, Margaret Thatcher’s famous expression, “There Is No Alternative” (TINA), is widely considered to be applicable. But is there really no other way?

5. Conclusion Surely the monetary system has amply proven its inadequacy in view of the frequency of systemic crises worldwide averaging ten per year over the past forty years? It may be a banking crisis, a monetary crisis and/or a sovereign-debt crisis, or a combination of them* How’ever, the tendency to consider each systemic crisis separately tends to obscure the common drivers behind all these crises*

—

The 2007-2008 banking crash has been the worst on record so far* More catastrophic consequences w'ere avoided through massive government support for the financial sector, followed by large-scale Keynesian stimulus programmes to avoid a deflationary depression* This has resulted in significant budget deficits and additional public debt* If we keep within monetary’ orthodoxy, pressures will continue to mount on governments to reduce their deficits by any means, including the dismantling of government-funded social safety nets* In parallel, the cost of baby boomers retiring and the need for massive support for a post-carbon economy present two unavoidable developments requiring large governmental financial resources* The only solution the financial sector has offered is the privatisation of most significant publicly owned infrastructures* How governments will be better financially positioned to deal with the critical needs of this decade at the end of this process remains unclear* Why would governments be more creditworthy when they have to pay rent for the public offices they once owned, or tolls for the use of highways that were previously free? Budgetary’ pressures and the threat of a major monetary’ crash will continue for many years* The social and political consequences are hard to imagine, but will no doubt include large-scale social unrest in a number of countries, which may favour more nationalistic and extremist political parties* Such movements

are already identifiable both in the USA and in Europe evien though the big financial squeeze is just beginning. History has shown that it is easier to start extremist movements than to stop them, and that such scenarios often end up being ‘resolved’ through conflict,

The next chapters will deal with the following questions: * Beyond the symptoms, is there a systemic mechanism that explains endemic financial and monetary instability? If so, what is it? * Assuming that the monetary system can be stabilised, are our current monetary arrangements appropriate to deal with the challenges of the 21st century? To be precise, is today’s monetary structure compatible or not with the sustainability issues ahead? * Are changes in the monetary structure possible? If so, what should they b e? Footnotes I Source:Speech made in New York 25 October 2010 See:u?tuu?.qdnc nce.com

3 4

£ 2

£ 9

bit.lu/TPlmkn The Global Currency Game is Exploding’, The Wall Street Journal) 26 September 2007, pp.Ci and C3. The CIA Facthook 2012 estimates global GDP at purchasing power parity at US$78.98 trillion. John Maynard Keynes, The General Theory of Employment, Jnreresrand Money (1936), p.159. Ludwig von Mises, Human Action:A Treatise on Economics (1949), The Financial Crisis Inquiry Report: Fina/ Report of the National Commission of the Financial and Economic Crisis in the United Stares (2011), Andrew Ross Sorkin, Too Big to Fail (2010). Anton R. Valukas, Lehman Brothers Inc, Chapter 11 Proceedings Examiner’s Report (2010), dow nloadable from http://lehmanreport.ienner.com bit.lu/TPlinkiS (visited: 8 January 2012). 'Restoring Ireland’s Credit by Reducing Uncertainty’, Remarks by Mr Patrick Honohan, Governor of the Central Bank of Ireland, at the Institute of International bis.org ~ and European Affairs, Dublin, 7 January- 2011, downloadable from feir./y/7F/inlrio (visited: 8 January- 2012),

Mini Arnarson, Porbjbrn Kristjansson, Atli Bjarnason, Haraid Sverdrup and Kristin Vala Ragnarsdottir, Jeefandic Economic CoMqpse; A Systems Analysis Perspective on Financial Social and World System Links (2011), online at http://skemman.is ~ bit.hi/TPlink2Q (visited: & January 2012). 11 See for instance Adrian Buckley, Financial Crisis; Causes, Confe.vf and Consequences, (2011), PP.74-&&. 12 This is the IMF’s definition, “in a systemic banking crisis, a country’s corporate and financial sectors experience a large number of defaults and financial institutions and corporations face great difficulties repaying contracts on time. As a result, non -performing loans increase sharply and all or most of the aggregate banking system capital is exhausted. This situation may be accompanied by depressed asset prices (such as equity and real estate prices) on the heels of run-ups before the crisis, sharp increases in real interest rates, and a slowdown or reversal in capital flows. In some cases, the crisis is triggered by depositor runs on banks, though in most cases it is a general realisation that systemically important financial institutions are in distress... we exclude banking system distress events that affected isolated banks but were not systemic in nature. As a cross-check on the timing of each crisis, we examine whether the crisis year coincides with deposit runs, the introduction of a deposit freeze or blanket guarantee, or extensive liquidity support or bank interventions. This way we are able to confirm about two-thirds of the crisis dates. Alternatively, we require that it becomes apparent that the banking system has a large proportion of nonperforming loans and that most of its capital has been exhausted." ~ kit.hj/TFlmkgj p.5) 13 This is the IMF’s definition, “We identify and date episodes of sovereign debt default and restructuring by relying on information from Beim and Calomiris (2001), World Bank (2002), Sturzenegger and Zettelmeyer (2006), and IMF Staff reports. The information compiled includes year of sovereign defaults to private lending and year of debt rescheduling, Using this approach, we identify 63 episodes of sovereign debt defaults and restructurings since 1970." (www.imf.org ~ bit.ly/TPlink2i p,6). More details can be found in Federico Sturzenegger and Jeromin Zettelmeyer, Debt Defaults and Lessons from a Decade of Crises (2006), table 1in Chapter 1. 14 Sources: World Bank, IMF, Graph created by Michelle Bishop using IMF definitions and data from Gerard Caprio & Daniela Klingebiel (1996); J. Frankel and A. Rose (1996) : Graziela L. Kaminsky' & Carmen M. Reinhart (1999); and, for the data after 2006, Luc Laevan & Fabian Valencia (2010). 15 The more detailed definition of a currency crisis as used by the IMF is “a nominal depreciation of the currency' of at least 30% that is also at least a 10% increase in the 10

rate of depreciation compared to the year before. In terms of measurement of the exchange rate depredation, we use the percentage change of the end- of-period official nominal bilateral dollar exchange rate from the World Economic Outlook (W£0) database of the IMF. For countries that meet the criteria for several continuous years, we use the first year of each 5 -year window to identify the crisis. This definition yields 2Q& currency crises during the period 1970-2QO 7. It should be noted that this list also includes large devaluations by countries that adopt fixed exchange rate regimes.*

fnjtLJtn.imf.org feir.fLr/TFfinfc?: p.6). 16 Rudiger Dornbusch, Yung Chul Park and Stijn Qaessens, 'Contagion: How It Spreads and How* It Can Be Stopped’, World Bank Research Observer, VbL 15, issue 2 (August 2000), pp.177-197,

n l£

ms/TFfin n George Kaufman, 'Banking and Currency Crises and Systemic Risk: Lessons From tjfi.

Recent Events’, Economic Perspectives; A Review from the Federal Reserve Bank of Chicago, No. 3 (2000), p.i. 13 Source: Eurostat (h ftp;//epp.enrostor.ee t>ir.fy/TFfmfc2'?. updated with h ftp;//epp.eurosfar.ec ~ bit.ly/TPlint&q} 2£ Source: Carmen M. Reinhart and Kenneth S. Rogoff, The Aftermath of Financial Crises’, American Economic Review, Vol. 99 (May 2009), pp.466-472. Only major (systemic) banking crises episodes are included, subject to data limitations. The historical average reported does not include ongoing crises.. 31 The New York Times, 16 September, 2010. 22 Bilal Habib, eta/. (2010): Anthony B, Atkinson & S. Morelli (2010). 23 Laevan & Valencia (2010). 34 Kaufman (2000) p.24. 25 See http;//cbo.oov 1.usa.aov/TPlinksS and ujujLLJ.reLifers.com reur.rs/TFftnkgp 26 See tLJtLJiu.siotarp.aoL> bit.ly/TPlink2?n 27 See luinu-spurceiua tch.or 0 bir.fy/TF/inkÿ 2S See tuiuiu.bloomberg.com bloom.bg /TP\ink2S 23 Nomi Prins, It Takes a Pillage (2009). 30 See www.ritholtz.com bit.ly/TPlink?o 31 Laevan & Valencia (2010) p-432 Source: Laevan & Valencia (2010) p.24 and the present authors’ own calculations. 33 David Rotman, 'Praying for Energy Miracle’, Technology Eeuietu, March/April 2011, P<52.

—

34 Peter G. Petersen, 'Gray Dawn: The Global Aging Crisis', Foreign Affairs (January-February 1999), p.43. 35 Cecchetti efaJ. (2010) 36 Ibid., p.16. 37 This is the title of a book by Jacques Attali, Tons mines dans dix ans? Detfe publique: /a derniire chance (2010). 3& Abertis, Allen & Overy LLP, Barclays Capital, Carlyle Infrastructure Partners, Chadbourne & Parke LLP, Citi Infrastructure Investors (CII), Credit Suisse, Debevoise

St Plimpton, Freshfields Bruckhaus Deringer, Fulbright St Jaworski, Mayer Brown, McKenna Long Sr Aldridge LLP, Merrill Lynch, Morgan Stanley, RBC Capital Markets, Scotia Capital and UBS. 39 Euromoney, April 2010, p.&5. 40 Rates for most city parking meters increased from 25 cents to Si an hour. The most expensive meters increased in parallel to $3.50 an hour, and will be increased to S6.50 by 2013 ( Chicago Tribune, 2 December, 200&). 41 Office of the Inspector- General, City of Chicago, An Analysis of the City’s Parking Meter Lease, September 2009 (h ttp://chicag oinspectora en eral.ora frif.hj/TPftnfcgiL 42, wiuu.\bloombero.com bloom.wba/TPlinkÿsn 43 "The Big Sale’, The Economist, 18 September, 2010, p.51. 44 John Perkins, Con/essions of an Economic Hit Man (2004). 45 John Follain, rHard-Up Italy Sells Islands and Palaces’, Sunday Times, 7 April, 2010,

p.24.

Chapter IV Instabilities Explained: The Physics of Complex Flow Networks “One of the beauties of biology is that itsfacts become our metaphors ”

- Kenny AusubeU

“The needfor regulation is always the sign of a faulty design” - William McDonough, architect The previous chapter discussed how banking and monetary instability have been both recurrent and destructive to society* We will now show that these phenomena are caused not only by imperfect monetary policies, lax regulators or unhealthy banking practices, but rather by a structural instability in the monetary' and banking system itself* The system's brittleness stems from its very' structure, a legacy' dating back centuries to the beginning of the industrial age* This structure lacks the agility' and adaptability' needed to cope with the accelerating changes in the economic and social environment that characterise our post-industrial age*A One trap is attributing the problem to ‘human nature'* For instance, the former governor of the Federal Reserve, Alan Greenspan, admitted, after the

banking collapse of 2008, that “the world will suffer another financial crisis" and blamed "human nature" for this state of affairs** The most complete quantitative study of financial crises, entitled This Time Is Different, similarly

explains the systematic repetition of such crises: “Countries, institutions, and financial instruments may change across time, but human nature does not”,3 By doing this, they appear to follow Isaac Newton, who, after the collapse of the South Sea Bubble, allegedly said: “I can calculate the motions of heavenly bodies but not the madness of men”,4 While human nature may indeed play a role, the limitation of these interpretations is that changing human nature is not a realistic basis for attaining global financial stability anytime soon,..

The interpretation that such crashes are simply part of the process of ‘creative destruction’ is also of limited use. Although this is considered by Schumpeter to be a basic characteristic of capitalism,5 the examples he uses all refer to the rise and fallof specific products or individual business units rather than entire monetary or financial systems. Furthermore, Schumpeter’s notion of destruction is limited to older institutions, unable to compete with the innovations of entrepreneurial newcomers. Unfortunately this does not account for what is currently happening in the financial or monetary domain, After each crash, the banking system is bailed out at government expense, and the old way of doing business is taken up again after fine tuning of the regulatory or managerial environment. The fundamental structure - a monopoly of money created through bank debt - is invariably left intact, Something else must be quite wrong with our monetary system, something that has been wrong for centuries, Charles Kindleberger identifies financial crashes as "hardy perennials” for a good reason,ÿ Similarly, when Carmen Reinhart and Kenneth Rogoff chose the title ‘This Time is Different* for their exhaustive study of financial instabilities, it was meant as a warning of something bad repeating itself. In other words, something has been triggering the same type of problems for centuries. What could it be?

Instability as a Structural Flaw The difficulties we face can be compared to the difference between a driver and a car designer, A bad driver can wreck any car. However, a bad car design can make a car unsafe at any speed, so that even a superb driver would have difficulty' driving it safely. Thus, while monetary' policies, appropriate

regulation and bank management are important;, there exists a flaw in the design of the monetary system which causes it to fail despite appropriate interventions. What we discuss in this chapter is the structural flaw' in our modern monetary" system: a flaw that is centuries old. This structural flaw- -was already present in 1637 when the Dutch Tulip bubble burst, and has played an unacknowledged role in every crash since that time, including the current one, Our evidence for this claim comes from the fundamental laws governing all complex flow' systems, including natural ecosystems, economies and financial systems*

Our thesis will be presented in six steps. First, w’e will show that the Traditional Economics paradigm badly" misclassifies economic systems. In his remarkable book The Origin of Wealth: Evolution} Complexity and the Radical Remaking of Economics (2006), Eric Beinhocker demonstrates how the Traditional Economics paradigm misclassified the economy as a closed system in general equilibrium. This explains the dominant paradigm’s empirical failure to deal with several key issues of today. Rather than continuing to describe them with a simple mechanical metaphor in which linear cause-and-effect mechanisms are at play, we need to see economic systems as open systems, which act like complex flow' systems with multiple

and interrelated causalities.

Second, we will deal with complexity' theory', A new set of mathematical tools allows us to deal with complexity and effectively explain a wide range of processes, including economic processes unexplainable using the Traditional Economics paradigm. The third step will be to examine the theory' of complex flow' networks, a subset of complexity' theory' that integrates several recent breakthroughs in theoretical ecology', thermodynamics, information theory' and network analysis. These breakthroughs allow us for the first time to quantify' with a single metric the sustainability' of any complex flow network. Within this framework, sustainability' is defined as an optimal trade-off between two variables working in opposite directions: efficiency and resilience. The fourth step will consist of testing the “complex flow network’

methodology on real-life natural ecosystems and exposing the structural conditions required for a network to be sustainable. We will demonstrate that these findings are applicable to any complex system possessing a similar structure regardless of what circulates in a given network - biomass in an ecosystem, electrons in an electrical power network or money in an economy. The fifth step will then consist of applying this methodology to monetary systems. We will clarify how the pressures towards greater efficiency in finance, economics and engineering have often occurred at the expense of resilience. This is the cause of the systemic brittleness of the monetary and banking system. This dynamic is also the key to a solution that offers greater monetary sustainability.

The last step focuses on potential solutions. Greater diversity and interconnectivity is the key to rendering complex flow networks adaptable and resilient. Our monetary' system must therefore evolve from being a monopoly of conventional money towards becoming an ‘ecosystem’ of multiple currencies. We will subsequently describe how this evolution towards greater monetary' diversity is already taking place, albeit below the radar screen of officialdom.

The Misclassification of Economics Until the late 19ÿ century, economics was considered a field of applied moral

philosophy rather than a science, and even less a mathematical science. For instance, Adam Smith was a Scottish professor of moral philosophy. Similarly, the school of the French Physiocrats (including people like Francois Quesnay) and Jeremy Bentham in England, saw themselves as philosophers and were considered as such by the wider public. It was not until Leon Walras’s Elements d’economie pure (1874) that mathematics was introduced into economics, thus changing economics into a science.

Walras saw a parallel between the idea of balancing points in economic systems and balancing points in nature. He "saw the balance of supply and demand in a market as metaphorically like the balance of forces in a physical equilibrium system. He conjectured that for each commodity traded in a

market, there was only one price, one equilibrium point, at which traders would be satisfied and the market w'ould clear. Prices in a market would predictably settle to a single equilibrium level, just as a ball would predictably settle into the smooth bottom of a bowl,”2 By importing the mathematics of equilibrium theory from the mathematician Louis Poinsot, Walras provided the foundation for the Traditional Economics paradigm,® This paradigm can be found in all textbooks, most economics journals and implicitly in many corridors of power, Unfortunately, a fundamental misconception occurred during the import from physics into economics and is explained most succinctly by Eric Beinhocker (see box 4.1). Box 4.1

— Eric Beinhocker and the Misclassification of Economics

Eric Beinhocker is a Senior Advisor to McKinsey & Co and author of the book Tke Origin of W'ettfrfc. The magazine Fortune named him “Business Leader of the Next Century w. What follows are highlights of his reasoning. “Without realising it and with the best intentions, the Iate-nineteenth- century economists borrowed from physics a set of ideas that fundamentally misdassifi ed the economy as a closed equilibrium system. Their approach set the framework for the Traditional Economics we see today. Unfortunately, [this] misdassifi cation has acted as a straight] acket, forcing economists to make highly unrealistic assumptions and limiting the fi eld's empirical success. Indeed, W' air as and his contemporaries were unaware of the distinction between dosed and open systems. A dosed system is one in which there areno inputs from, or outputs to, the outside world: all energy originates and remains within the system itself. An open system operates with inputs and outputs. 19ÿ century scientists believed most systems to be dosed. Wfe now know that economies function as open systems, absorbing massive amounts of energy from the outside (e.g., solar, mineral, human and animal inputs). They also produce significant amounts of unwanted by-products (e.g., gases, waste, pollution). Even our planet canbedassified as an open system, sitting in the middie of a river of energy from the sun that promotes life and evolution at all levels. While dosed systems have a predictable end state, open systems do not necessarily. They can remain relatively stable and in relative equilibrium for a period, but also exhibit patterns of exponential growth, radical collapse or cydical oscillations. These patterns all exist in actual economies and are dismissed as ‘anomalies' in the Traditional Economics paradigm.

The second fundaments] error in the Traditional Economics paradigm relates to the state of knowledge of thermodynamics until the late 19ÿ century. At that time, scientists only knew about the First Law of thermodynamics, which "states that energy is neither created nor destroyed and is otherwise known as the Conservation of Energy Principle. This was developed in the early to mid-nineteenth century and was clearly spelled out in the texts that Walras.,, and others read.”A£ However, "the Second Law, which wras missing from the physics Walras and Jevons knew, states that entropy, a measure of disorder or randomness in a system, is always increasing (...) Over time all order, structure, and pattern in the universe breaks down, decays and dissipates. Cars rust, buildings crumble, mountains erode, apples rot and cream poured into cofree dissipates until it is evenly mixed.” AI Entropy is time's arrow'. "Without entropy and the inevitable drift from order to disorder there would be no way to tell what the past, present or future is. Since its discovery, entropy has become a central concept in the way physicists view the world. Unfortunately, for Walras, Jevons and the other builders of Traditional Economics, this supreme law' of nature was missing from their framework.”A2 Among all the laws of physics, this Second Law- is not one that can be overlooked. The famous astrophysicist Sir Arthur EddingtonA3 showed no mercy for those unwilling to accept the implications of the Second Law' of thermo dynamics: "If your theory is found to be against the second law- of thermodynamicsI can give you no hope; there is nothing for it but to collapse in deepest humiliation.”ÿ Some economists have tried to revise economic theory to include entropy but havehad only few' foil ow-ers until recently,AS These two foundational errors in the field of Traditional Economics - mis classifying the economy as a closed instead of open system, and ignoring the Second Law' of thermodynamics - make a long list of unrealistic assumptions necessary for the equations to function. Among them is theneed for humans to be driven only by self-interest and perfect rati on ality, the idea that all economic agents have access to all relevant information from the present and the future, and that they process all this information perfectly in an instant. In reality, we must often make decisions with incomplete and ambiguous information with fi nite calculative and cognitive abilities. Furthermore, the world in which these super -humans operate is assumed to be incredibly simple: it does not include any barriers to buying or selling; it involves no transaction costs; all producers are always perfectly efli dent; participants interact only through price in perfect markets; all relevant information is available to everyone and resources are either infi nite or so abundant that no radical scardty is ever on the horizon. "This combination of assumptions has caused Axel Leijonhufvud, an economist at the University of California, Los Angeles, to assert that Traditional Economics models incredibly smart people in unbelievably simple situations' while thereal world is in fact more accurately

described as believably simplepeople [coping] with incredibly complex situations’.”ÿ Mainstream economics has attempted to deal with some of these limitations. For instance, as early as 1978 the Nobel prize in economics w-as awarded to Herbert Simon, the father of bounded rationality' theory, and the 2007 prize was given to three Americans for their work

in 'mechanism design theory’, a branch of economics examining situations in which markets work imperfectly, such as when competition is not completely free, consumers are not fully informed or people hold back private information. Similarly, the 2009 award went to Elinor Ostrom "for her analysis of economic governance, especially the commons*. However, ecological economists including Nicholas Georges cu-Roegen, Kenneth Boulding and Herman Daly who question the fundamental premise of an economy as a closed system and stress the need to account for entropy have to this day been ignored by the Swedish Academy of Sciences and by the Bank of Sweden.

Neither Beinhocker nor we are attacking economists, nor are we questioning the legitimacy of the aspirations of economics to become a science nor its use of advanced mathematics* Beinhocker simply asserts that traditional economics has not been using the right conceptual and mathematical tools* In his approach to the economy, as in the Ecological Economics paradigm generally, consumer demand, markets, technologies, business plans and stocks of natural resources are all in evolution* The one critical exception he implicitly makes is that money itself remains unchanged and non-evolving* We will discuss in this chapter why this assumption is not valid; and in subsequent chapters what becomes possible when we let go of this assumption* Beinhocker proposes ‘complexity economics' as his solution for the radical remaking of economics* Regrettably, the words ‘complexity theory' and ‘chaos theory' have been used, overused and even abused so that their precise meaning has become unclear* We will now define what is meant by complexity and complexity1 theory-* 2. Complexity'

As a starting point, let us distinguish between systems according to the characteristics of their causality- mechanism* At one end of the spectrum lies simple linear causality * This concept dates back to the classical Greeks* Since Newton's time, effective mathematical tools such as mechanics have been available to study processes involving linear causality* At the other end of the spectrum, one finds systems with a Jack of causality} without interaction

among variables* This latter realm is best explored with the mathematical tools

of statistics. The domain of complexity lies between these two extremes; here, there are several causes interacting and there are multiple interactions between variables. Figure 4,1illustrates this dynamic,

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Figure 4.1: The Realm of Complexity .12 The ability to study the order of intertwined and mutual causality in real-world systems opens up a new scientific realm. This could not be

appropriately done using either of to day's mainstay approaches: mechanics (simple linear causality) or statistics (weakly connected causality) The vast majority of real -life natural, social and economic phenomena belong to the realm of complexity. Indeed, natural systems, whether physical, social or economic, only rarely exhibit simple causality (one single cause) or wealdy connected causality (wealdy connected components).

The middle of the spectrum encompasses the majority of real-life systems, This realm of complexity is characterised by intertwined and mutual causality,i£ and dynamic feedback loops between a system's multiple components. From this form of causality emerges ‘ordered complexity'. The simplest physical example of this can be observed when one brings a liquid,

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Figure 4.a (a-d): From random collisions to selforganisation,每 When one applies heat to water, a predictable sequence occurs in distinct stages, each with its own specific characteristics. Before applying any heat, the w-ater molecules randomly move and collide with one another. When heat is applied, themolecules continue to move in the same fashion at a higher speed (figure a). This continues until bubbles appear in the liquid, the first organisational change or phase change' (figur e b). As the temper ature increases further, self- organising loops emerge (figure c). As even greater energy is applied, the structure of the loops changes to a more complex, tightly interconnected pattern (figure d). These patterns of increasingly intricate orders spontaneously emerge from the very structure of a system. In an apparent paradox, a 10 cal r edu cti on of entr opy (i.e. mor e intricate 10 cal or d er j m akes it p ossibl e for the br 0 ad er system and theuniverse to produce more entropy. The resulting selforganisation pro cess has been described as the driving force behind evolution, including the evolution from atoms to more complex molecules, the origins oflife and the evolution of all the different life forms on Earth,

Each successive phase is characterised by higher complexity, and the self-organising order also produces higher entropy,每 For example, a life form is clearly more organised than its surroundings (he, reduces entropy locally), However, any living being feeds on elements of its surroundings and produces waste (i,e, increases entropy in its surroundings). The life forms that will be

successful are those whose internal capacity to circulate energy is the highest, something that will also tend to increase the total entropy of the universe.

This phenomenon of ordered complexity does not occur in systems ruled by simple linear causality, nor does it arise when the components are only weakly coupled. It is the key attribute of the realm of complexity. A system can therefore be labelled complex if, and only if, it has two characteristics: a high diversity of components and a dense network of interactions between these components. As Beinhocker and othersÿ have shown, this is certainly the case with economic processes. The classical mathematical tools used by economists, typically involving linear regressions and general statistics, assume linear causality and independent variables and therefore cannot capture this type of complexity. Traditional Economics must oversimplify economic realify in order to ‘make the equations work'. One consequence of this over-simplification is the failure of economics to deal with the issue of resilience and sustainability. It is only recently, as more powerful and inexpensive computing power has

become available, that a new set of mathematical tools dealing with ordered complexity has emerged. These new tools developed for complexity theory include agent-based modelling (promoted by the Santa Fe Institute); and those that emerged from network and information theories and thermodynamics (which will be our approach). Complexify theory" has already revolutionised a wide range of fields including geophysics, demography, ethology', biology", medicine, acoustics, electronics and finance.

earlier, almost all real-life natural systems lie in the realm of ordered complexity. Because this is the case, complexify' laws may even be more important to understanding real-world systems than the law of gravity' itself. In particular, recent findings in thermodynamics unite long-standing observations about universal patterns of growth and development into a law of physics with profound implications for our understanding of developmental change and evolution itself, as astrophysicist Fran$ois Roddier claims, along with many others (see Box 4.2). As stated

Box 4.a - Francois Roddier and Dewar's law

Francois Roddier is considered to be one of the most brilliant astrophysicists of our times. He is the inventor of an atomic spectrometer used to study the internal workings of the sun, and he has developed the £ eld of adaptive optics that corrects astronomical observations for atmospheric turbulences. Since his retirement in 2000, he has been focusing on the imp act of recent thermodynamics fi n dings on evolution. What follows are some extracts from his latest work:2£

recently been proven. It is an abstract theorem that was published in 2003 in a top European journal of mathematiccj? phpsics.£3 No mainstream newspaper mentioned this breakthrough. The importance of this discovery is nevertheless equivalent to the law of gravity by Newton or Danvinis theory of evolution. This new la un¬ even conditions the latter two, as will be shoivn. Afanp scientists themselves apparently have not pet realised its relevance. 'Theproof is due to Roderick Dewar, a physicist of Scottish origin who works in the National Institute of Agronomic Research in Bordeaux, France. Why in an agronomic institute? This law ofphysics has fundamental implications for the entirefi eld of biology.It also applies to hiimanfcinii and evolution of humansocieties. u From its very beginning, the universe evolves by creating more and more complex material structures capable of dissipating energy ever more effi cienrlp. The stars, the planets,plants, animals andfi nally mankind are a sequence of such structures. Dewar’s law explains ivhp. A Belgian physicist of Russian origin, Ilya Prigogine.fi rst studied this process of energy dissipation in detail. His toorJt earned him theNobel Prize in physics in 1977. Stars, planets, plants, animals, humans, human societies are all 'dissipative structures1 as defi ned by Prigogine. ...Energy dissipation produces disorder or degradation of energy, called entropy in phpsics. Thar is ivhp the dissipation of energy is also called 'entropy production’. Dewar’s law is abbreviated as MEP (.Maximum Entropy Production): a dissipative structure reduces its infernal entropy - i.e, gets more organised internallp - to maximise total enerpp dissipation.„ “A new law

of physics has

Tor plants and animals, information about the environment is stored in penes. Plants and animals have adapted to a specifi c environment. This adaptation takes place fhrouph natural selection. The plants and animals selected are those capable of most rapidlp and effectively dissipating enerpp. By doing this, a livinp beinp chanpes its environment. As the environment chanpes, its genes are no lonper adapted. This living being needs to evolve apain, To remain in harmony with the environment which if is makinp evolve, a livinp being needs to adapt ivifh preater speed. After atoms and molecules, livinp beinps increase in complexity. Those most adept at dissipating energy are the ones that invariably win.

"Geothermal energy dissipates not gradually but suddenly, in the form of earthquakes. The same is true with life. Plant and animai ecosystems develop quickly and collapse suddenly, to be replaced by more evolved populations that can better dissipate energy. The Australopithecus species disappeared along with aft other humanoid species except for our own, initially because of the domestication offire and the cooking offood. "From theNeolithic onwards, information about the environment previously only stored in genes started to be stored in the human brain. fVom thi'f point on. the human brain controis the evolution of humanity. The English zoologist Richard Dawkins hoe proposed to call 'memesâ&#x20AC;&#x2122; in/brmarion stored in human brains, by analogy to 'penesâ&#x20AC;&#x2122;. For humanity, memes replace genes with notable consequences. Humans start sharing the same memes thereby creating a new type of dissipative structure. Different human societies emerge. The development of economies is nothing more than the elaboration of the dissipation of energies through structures that have become human societies. "I am convinced that Dewar's results will become thepillar of a new economic science once economists become aware of its implications. During the 17Ăż cenfurp, England, as the most advanced mimetic society of the time, was the first to limit the powers of monarchy. France followed suit durinp the eighteenth cenrurp. JSecause absolutist monarchy iimired the development of economies, it was doomed to disappear. During the nineteenth cenrurp, European nations - at that time still different mimetic societies - entered into competition un'rh one another. The consequences of this during the twentieth century included two world wars and a Great Depression. "At the end of the second w-ar. two bip ideologies, capitaiism and communism, remained and entered into conflict. The memes of thefree economy eventually ended up spreading into the USSR. Because the Soviet economy was developing more slowly, it collapsed. Humanity as a whoie now> dissipates 2kWfkg per person. An average Frenchman dissipates 6kWfkg/person, an average American lokW/kgfperson. By dissipating energy in this way, the economy is rtyjidip modifying its environment (exhaustion of oi? reserves, pollution, etc.), andsocial inequalities are being exacerbated. "Physics and bioiopp show us where this leads: the extinction of species and the end of civilisations. .Bioiopp has demonstrated how our penes are conrinuousip forced to evolve. We now realise that the same is true with our memes. Fhep. too, have to evolve. No isoiared individuai can uniiateraiip reduce its energy dissipation without taking the risk of being eiiminafed bp naturai selection. Similarly, no counrrp or isoiared civiiisafion can uniiateraiip iimit its economic development. 'The only hope is a change of consciousness on a global level - the realisation of the need for a new meme: the need to reduce our enerpp consumption on a planetary scale. Such a change is starting to occur because, for the very }irsf time, the degradation of the environment is visibie within the time span of one generation - the sign of a seismic environmental shift on a global level. Hence the urpenf call for sustainable development.

...

White trying to save a planet which could not care less, we may be able to saue humanity. ”

* 106 society brain*

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10J

planet*

stars

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now

I 10

I ID’

-L

101

J-

107

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Figure*ÿ: Growth of dissipated energy as a function of the age and the evolution of the universe (from EricChaissonii).

Figure 4.3 shows the evolution of the efficiency of dissipated energy over time. Energy can be measured in watts. The efficiency of dissipated energy is then measured in watts per kilogram of matter. Everything starts with the ‘Big Bang’ some 13.7 billion years ago. Matter starts condensing almost immediately. Under the force of gravity, galaxies slowly start forming, hydrogen is transformed into helium, and heat dissipates at the rhythm of one tenth of a mW/kg (milliwatt per kilogram of matter). Further condensation creates stars for which the rhythm of dissipation is measured in tens of

mW/kg. As stars age and become super-giants, they form atoms of increasing complexity, and agglomerations form to become planets. Planets absorb the light emitted by the stars and reemit it in the infrared, dissipating energy at the rhythm of one mW/kg. On some planets, under the right conditions, life emerges. Even the most primitive forms of life - cyanobacteria - already' dissipate 10 mW/kg, and over a time span of a few billion years they1 have produced all the oxygen we are currently1 breathing. Plants develop and dissipate about 100 mW/kg. In the Cambrian period, animals appear and dissipate more than one W/kg, Finally', humans appear. A human at rest dissipates a minimum of 3W/kg. During an effort the amount of energy dissipated increases ten-fold. The evolution of human societies and their economies is currently driving humanity'’s capacity' to dissipate energy' at an average rate of £000W/kg - and this in an exponential manner.

Roddier reveals the scale and scope of forces driving evolutionary' change at an exponentially accelerating rhythm. Could the same law by which dinosaurs had to give way to smaller and more agile mammals, by which absolute monarchies became irrelevant, or by which communism collapsed also apply to our money system? Could it be that the prevailing meme of a monoculture of money is strangling human evolution and creativity' at a critical juncture of our collective journey? If Roddier’s claims and Dewar’s law are valid, they force upon us the realisation that we must unlock this monetary' stranglehold or become extinct as a species. The next two sections provide the evidence for such a claim.

3. The Physics of Complex Flow Networks The same approach to thermodynamics that Roddier describes has also been applied to the study of complex flow networks such as living organisms, river systems, ecosystems, urban networks, social systems and business networks.** The result of an integration of a large body of existing work in various fields, this Energy' Network Analysis research on the physics of flow networks is also the natural extension of the results of Nobel Prize-winning chemist Iliya Prigogine and Club of Rome co-founder Erich Jantsch’s work on

self-organising energy-flow systems. In fact, according to ecological economist Kenneth Boulding, many early economists held view's that took energy into account. This changed when those who favoured Newtonian mechanics imposed on economics the Traditional Economics paradigm with its now familiar views on the mechanics of ‘rational actors’ and the reliable self-restraint of general equilibrium theory.

The particular synthesis w'e present here is the contribution of four people: the physicist and quantitative ecologist Robert Ulanowicz,££ the nonlinear dynamist Sally Goerner, the professor of Architecture and Urban Planning Robert G. Dyck, and the professor of Government and Environmental Management Dorothy Lagerroos.£2 This new approach provides a concise explanation of why we need to use new tools to understand monetary and economic dynamics as they are actually manifesting in the real world. In this approach, complex systems such as ecosystems, living organisms and economies are all seen as matter-flow, energy-flow and information-flow systems. For example, the famous ‘food chain' is actually a matter/ energy-flow network built out of complex relationships between organisms. Plants capture the sun's energy with photosynthesis; animals eat the plants; species then eat each other in a chain leading all the way to the top predator, only to have all organisms die and decompose, and their energy'/ matter be recycledby bacteria. One peer-reviewed paperÿ gathered extensive research on real-life ecosystems and generalised these findings to the sustainability of any complex flow network. We will provide here only a summary' of its findings. Readers interested in the complete technical and mathematical proofs should refer to the original published paper.23

Decades of studying natural ecosystems have led to a sophisticated mathematical understanding of how a network structure affects an ecosystem's long-term viability. This depends on a balance between effi ciency and resilience. Efficiency', also called throughput efficiency', measures the ability' of a system to process volumes of the relevant matter-flow, energy-flow and/or information-flow. Resilience measures the ability of a system to recover from a

disturbance;, an attack or a change in the environment. With these definitions in mind, we can now define and precisely quantify a complex flow system’s sustainability using a single metric. In general, a system’s resilience is enhanced by higher diversity and by more pathways (or connections) because there are numerous channels of interaction to fall back on in times of trouble or change. For example, a predator fish may ‘connect’ to - i.e., acquire energy and resources, usuallyby eating from - three or four other species (e.g. turtles and snakes) or it may link to only one (e.g. prawns). A fish depending on a single other species for its food supply will have difficulty adapting when that one species gets into difficulty. Researchers have therefore been able to use the amount of diversity and connectivity to quantify a system’s resilience.

Diversity and connect!vity also play an important role in throughput efficiency, but in the opposite direction: effi ciency increases as diversity and connectivity decreases Furthermore, as a flow system becomes more efficient, it tends to build up a kind of self-fuelling momentum (technically called ‘autocatalysis’) that eliminates diversity as it gradually streamlines the process. In general, increasingly efficient systems tend to become more directed, less diverse and, consequently, more brittle.

The point being made here is profound and has wide-reaching implications for all complex flow systems, including our worldwide economy. Since resilience and efficiency' are both necessary' but pull in opposite directions, nature tends to select those systems whichhave an optimal balance of the two. The exact balance varies depending on the system. Therefore, we propose the working definition of sustainability as the optimal balance between efficiency and resilience. A system is maximally sustainable when that balance attains its optimal mix. In Appendix Di, a concrete example is provided of how this methodology' applies to the three channels of carbon flow leading from freshwater prawns to the American alligator, via three intermediate predators: turtles, large fish and snakes, located in the Cypress wetlands of South Florida. When we want to express sustainability' graphically, three variables are involved: diversity', interconnectivity' and the relative weight put on efficiency'

vs. resilience. We are thus dealing with a four-dimensional object, which is difficult to render in a two-dimensional graph. In Appendix D£, a one-minute animation movie presents all four dimensions. In the same section a sequence of three-dimensional graphs gives an idea of what shape we are dealing with, Sustainability Optimum

100%

<r Resilience (<>) (Diversity + Interconnections)

-> Efficiency (A)

(Streamlined)

Figure 4.4: Sustainability curve mapped between the two polarities of efficiency and resilience. In nature, resilience is given more importance than efficiency and the curve is steeper on that

side of the graph. Notice that this two-dimensional graph is a didactic simplification of a four -dimensional object. More complete explanations and a 3-D graphic analysis are available in Appendix D.

Of perhaps even greater importance, the physics of flow networks also explains why excessively large and efficient organisations may pull the whole system toward collapse. In essence, large, highly efficient organisations in the network 'out compete' the smaller organisations for resources, drawing ever more energy’, information and resources into the big, and away from the smaller participants. This, of course, causes the big organisations to get bigger still, and the smaller ones to die off, just as Schumpeter’s classical 'creative destruction’ theory predicts. Unfortunately, killing off large numbers of smaller organisations reduces resilience, increases instability’ and steadily moves the whole system towards collapse (i,e,, sustainability’ = 0), Common

examples include: large, unrestrained predators killing off all their prey causing an ecosystem to collapse; digging large canals in the New Orleans delta, which drained soil from the wetlands, causing the city to sink and the "wetlands to die; and monopolies of commerce which kill off so many small competitors that a positive feedback cycle of ‘the more you have, the more you get’ locks into a ‘winner takes all’ game. This can lead to an economic ‘bubble’, a shimmering bubble of wealth over a feeble, eviscerated real economy. This law of physics explains why we once introduced anti-trust laws. In conclusion: “Life tends to optimise, rather than maximise. Maximisation is another word for addiction.”3£ Indeed, in the real world, all networks corresponding to natural ecosystems operate around the optimal point, within a specific range called the ‘window of viability, which lies on either side of this optimum, as can be seen in Figure 4.5. Sustainability

Natural

Ecosystems

100*

: Window of Viability

4 Resilience (O} (Diversity + Interconnections}

Efficiency (A) (Streamlined}

Figure 4.3: All natural ecosystems oper ate within a1window of viability’ around the optimal

point.

What can we learn from this exploration of sustainability, combining network and information theory with data from real-life ecosystems?

4•Lessons from Nature The main point is that nature does not select for maximum efficiency but for an optimal balance between the two opposing poles of throughput efficiency and resilience. In other words, sustainability requires just enough, and not too much, of both efficiency and resilience. In most human-designed systems, and certainly in the monetary domain, we have been concerned only with efficiency, andhave therefore tended to unduly sacrifice resilience*

Until recently, total throughput and efficiency were assumed to be the main measures of system health, whether in natural science or in economics* Now, however, we can distinguish whether a particular increase in organisational size and/or efficiency is truly a sign of healthy growth, or the beginnings of a short-termbubble doomed to collapse*

Finally, we can assume that nature has solved many of the developmental problems in ecosystems over time* Otherwise, these ecosystems would no longer exist today* These are the same type of problems with which humanity is still struggling in economic terms* Also of interest is that all ecosystems have their most critical structural parameters such as diversity and interconnectivity within a very specific narrow range or what we have called the window of viability* Sally Goerner points out, “All systems, no matter how complex, fall into one of a few classes* All members of a class share certain common patterns of behaviour*“3£

Similarly, complexity theorist Predrag Cvitanovic states, “The wonderful thing about this universality is that it does not matter much how close our equations are to the ones chosen by nature, as long as the model is in the same universality class as the real system* This means that we can get the right physics out of very' crude models* “33 In other words, insights about the behaviour of a system do not require ever more refined modelling, as is the case with linear models* It is simply a matter of determining the class of model characterising that particular system* The findings from one network are valid *..

for any other network displaying the same structure, whether the components are alligators and fish in an ecosystem, electrons in an electrical circuit, or money in an economy.

For instance, electrical power grids have been optimised for decades for greater technical and economic efficiency. It may come as a surprise to many engineers that it is precisely because these power grids have approached maximum efficiency that large-scale electrical blackouts are occurring in the technologically most advanced countries (e.g. Germany or the USA).

Over-efficient streamlining has caused them to lose their resilience.

Similarly, one can intuitively grasp that a balance between efficiency and resilience is key to economic sustainability. For example, vibrant businesses must maintain resilience by creating and maintaining well-knit systems of production, marketing, delivering, accounting and training that have numerous interconnections. Once these are in place, organisations must stay competitive by honing their processes following efficiency principles, typically through streamlining. Yet to survive changing times, organisations must also be able to adjust their business strategies to respond to changes in markets and in the economic climate. Overemphasis on efficiency through streamlining can become problematic when it reduces the diversity needed for adaptability and for the multiplicity of paths. In a business model, this diversity can be seen as agility and choice among different strategic options for dealing with unexpected problems, failures or opportunities. Since the 1990s, stock options for top management in public corporations have become a widespread practice. This approach was successful in getting CEOs focused on short-term and immediately measurable financial results. Using our sustainability framework, we can observe that such myopic profit-maximising pressures are dangerous because they force managers to

over-emphasise streamlining, rigid control and short-term efficiencies at the expense of long-term adaptability and resilience. Over-emphasising efficiency produces rigidity and brittleness, so that one little break in the chain can lead to an sudden breakdown. We can thus predict that overly streamlined corporations are more likely to experience major crises when encountering

unexpected challenges. Recent events illustrate the implications of sudden disruptions in systems overly optimised for the sake of efficiency. For instance: “The £0io Icelandic volcanic ash disrupted air transport across Europe, and gave the world’s manufacturing supply chain one of its biggest tests since the advent of the low-inventory, just-in-time era. Japan’s quadruple disaster - earthquake, tsunami, nuclear alert and power shortages - has put the supply chain under far greater stress. ...Over the past decade or so the just-in-time concept of having supplies delivered at the last minute, so as to keep inventories dowm, has spread down the global manufacturing chain. Now, say economists at HSBC, this chain may [need to] be fortified with ‘just-in-case’ systems to limit the damage from disruptions."34

Conversely, roo much diversity and connectivity could lead to excessive overhead and insufficient efficiency. In short, poorly connected networks are fragile, brittle and may collapse

when they meet an unexpected challenge; while overly connected networks tend to become stagnant. The key to a successful sustainability strategy is therefore the appropriate balancef in all complex flow systems, be they corporations, ecosystems, or economies.

5. Application to Monetary Systems Our global monetary system is a network of monopolistic national currencies, one for each country. The technical justification for enforcing a monopoly of national currencies is to optimise the efficiency- of price formation and exchanges in national markets. In a seminal paper written in 1953, Milton

Friedman similarly justified the introduction of floating exchange rates to improve global efficiency- by letting free markets determine the prices of each national currency.35 This idea was actually implemented by President Nixon in 1971 when he took the dollar off the gold standard. Since that time, an extraordinarily sophisticated and efficient global communications infrastructure has been built to link and trade these national currencies. As

explained in Chapter III, the trading volume in the foreign exchange markets reached an impressive $4 trillion per day in 2010, to which another several trillion of currency derivatives should be added. No-one questions the throughput efficiency of these markets or their capacity to process huge volumes of money. However, the systemâ&#x20AC;&#x2122;s lack of resilience show's up, not in the information technologies where back-up systems are universally in place, but in the financial realm where no back-up systems exist. The hundreds of systemic crashes that have occurred over the past forty years demonstrate this. Such a

crisis, particularly a combined monetary and banking crash, is, other than a war, the worst thing that can befall a country. All evidence points to monopolistic national monies having evolved into an overly efficient and brittle system. This situationis illustrated in Figure 4.6. Svitllnabllltp 100%

Window of Current

Opo ration ol Financial System

<RtiillcntL [<IH

Elflatncy (A.}

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{Streamlined)

Figure 4.6: Todays global monetary ecosystem significantly overshoots the optimal balance between efficiency and resilience. This is due to an overemphasis on efficiency which leaves the overall system insufficiently adaptive. The general belief that all improvements must go further in that same direction (red arrow) will drive us yet further away from sustainability".

The path to monetary' sustainability will come as a surprise for Traditional Economic thinking, where de facto monopolies of national monies are considered a given. Monetary' sustainability' requires a diversity' of currency'

systems, so that multiple and more diverse channels of monetary linkage and exchange can emerge, as illustrated in Figure 4.7Sustainability

Optimum

100K

* Effect of complementary currencies

Window of Viability

Current

Operation of Financial System

<Resilience (O) (Diversity

*Ăż

interconnections}

-> Efficiency (A) (Streamlined)

Figure 4.7: The effect of diverse types of exchange media, The operation of diverse and multiple currencies pushes the economy back towards optimal sustain ability (green arrow), facilitating transactions via connections that would otherwise not exist and increasing economic resilience. The cost of this improvement is necessarily a reduction in efficiency',

Proponents of the Traditional Economics paradigm will raise a predictable argument against this idea: using multiple media of exchange within a national economy reduces the efficiencyâ&#x20AC;&#x2122; of the price formation process and of the exchanges between economic agents. The lesson from the physics of complex flow networks is that pushing for greater efficiency' when a system is already beyond the optimal balance increases the likelihood of the next crash, The analogy' would be to tell a driver that the more congested and

accident-strewn the road looks, the more he or she should accelerate rather than brake, Dealing with crashes, naturally? Natural ecosystems can also experience a crash: a major forest fire, a flood, a clear-cut harvest and or some other disaster exerting significant stress on the

overall environment. What happens to a natural ecosystem in such cases? The system responds by first operating at the extreme resilience level, where diversity is highest but where efficiency is extremely low. Then, as species best adapted to the new' context start thriving, the system gradually returns to the window of viability (see Figure 4.8) Sustainability Optimum

3LQ0*

*41

Window of Viability

/ <r Resilience (ÂŽ) (Diversity + Interconnections)

Efficacy (A)

(Stream fined)

Figure 4.S: The recovery path after the collapse of a natural ecosystem.

What do we do when the financial system collapses completely, as was the case in Germany in the 1920s, or Argentina in the late 1990s, or possibly a euro breakup or a dollar collapse? The beginning is similar to the case of a natural ecosystem: individuals and businesses resort to barter, where in principle all sorts of things can become 'survival' currencies. This is obviously very inefficient. Until now, the same old recipe has been applied: the banking system and the monopoly of bank-debt money are forcibly re-established as quickly as possible. Typically, the largest banks that are â&#x20AC;&#x2DC;too big to fail' are bailed out and helped to absorb the smaller ones, fuelling further concentration in a few financial institutions. Should we not learn from nature that growing to the point of becoming 'too

big to fail’ should never be allowed to happen? Instead, in the USA, the ten largest banks now control 42% of the market, compared to 28% before the 2008 crisis. This pattern is the perfect demonstration of what are known as ‘autocatalytic forces’ in natural ecosystems - forces that automatically lead to systemic crashes. The very1 institutions that were already ‘too big to fail’ are made to grow bigger still. This promotes higher volume, and possibly higher throughput efficiencyÿ but also a further increase in brittleness. Suitdlflablllty

Optimum

IOO H

Window

Viability

Reestablishment 0f Monopoly of Bank-debt Money

$20ÿ Q%

<r Resilience (tp) (Diversity + Interconnections)

Efficiency (A)

(Streamlined)

Figure 4.9: As soon as possible after a financial crash, the monopoly of bank-debt money is re-established, creating a loop where systemic crashes or crises are predictably repeated over and over again.

The autocatalytic forces in the business realm today take the political form of lobbying, which in the case of the financial system has proven remarkably effective. Wealth begets power and power begets laws that favour the interests of those who pay. This begets more wealth and the cycle continues until exorbitant excesses cause its breakdown. For example, in Washington in 2010 there were three high level registered lobbyists working for the banks for every elected person in town! Furthermore, practically all governments are now heavily indebted, further tilting the bargaining pow-er against them. As US Secretary of State Hillary' Clinton has said according to WikiLeaks, “it is

difficult to be tough with your banker... So, at least in the financial sector, a return to business as usualhas been taking place remarkably quickly.

The Wall Street Journal even reports that banking business is better than ever: the bonuses paid out for £010 by the twenty-five largest Wall Street institutions amounted to $135*5 billion, surpassing even the all-time record of 2007. For instance, the top executive of Goldman Sachs increased his bonus to $12.6 million while 738 executives of Citigroup each received more than $1 million.32 More disturbing still is information revealed by the Federal Reserve, after it had been forced to partially open its books from the bailout era by the Wall Street Act in £009. Bernie Sanders, the independent US senator from Vermont, who initiated the amendment that forced this unprecedented disclosure of the relevant data by the Federal Reserve said: “Our jaws are literally dropping as we're reading this". Some of the Federal Reserve rescue programmes, such as the Term Asset-backed Loan Fund (TALF), have revealed a blatant degree of cronyism. This programme was introduced after President Obama's election in November 2008 to spur consumer lending which had dried up during the financial crisis. “But instead of lending directly to consumers, credit card holders or students, the Fed handed out a trillion

dollars to banks and hedge funds.,. We have been caught in the loop shown in Figure 4.9 for several centuries actually since the time when a monopoly of bank-debt money was established. We now can predict with 100% certainty that more crashes will occur in the near future, as long as this currency monoculture is maintained.

Independent confirmation The application of network theory to financial and banking systems is not uniquely ours. Indeed, a growing literature is emerging that uses complex network theory in economics and finance.3B. For instance, several years after our published work on the application of complex flow networks to the financial system, a paper entitled 'Systemic Risk in Banking Ecosystems'ÿ was published in Naturet the world’s most cited interdisciplinary' scientific journal.Ai The two authors are prestigious: Andrew Haldane, the Bank of

England’s Executive Director for Financial Stability, and Professor Robert May, former President of the Royal Society in England. They, too, have been using complexity theory to model today’s financial system as an ecosystem. Although they use a different complexity methodology from ours4£, they come to remarkably similar conclusions: * Models from ecosystem research offer important and valid insights for understanding the resilience of the financial sector. “This quest to understand the dynamics of what might be called ‘financial ecosystems’ has interesting parallels with ecology.”43 The substantial knowledge accumulated from work on natural network systems can and shouldbe used in the evaluation of systemic risks in the banking sector. * Taking into account system-wide properties of the financial system rather thanindividual institutions is important. "The cornerstone of the current international regulatory agenda is the setting of higher requirements for banks’ capital and liquid assets. .,in regulating the financial system, [too] little effort has as yet been put into assessing the system-wide characteristics of the network."44 * Greater diversity' across the financial system is needed. "In rebuilding and maintaining the financial system, this systemic diversity' objective shouldbe given much greater prominence by the regulatory' community'", because "homogeneity' breeds fragility'".43 * Increased concentration in the financial sector is one key factor contributing to the brittleness of the entire network. "Tentative evidence comes from the fact that the world's five largest banks have shown increasing concentration of assets over the last ten years."4£ Because governments are cornered into bailing out institutions that are ‘too big to fail', the authors conclude, “In financial ecosystems, evolutionary' forces have often been survival of the fattest rather than the fittest".42 We have described this same phenomenon as the “autocatalytic forces' growing in size and power at the expense of the stability' of the whole. For two different and independent teams using different complexity methodology' to reach similar conclusions increases the robustness and

credibility of these findings. Further research efforts in this direction should obviously be worthwhile. Differences in the two approaches also exist. The most important difference is in the recommended solutions. Because Haldane and May remain within the paradigm of a single currency, they must live with the contradiction of needing to encourage diversity on the one hand and needing to advocate stricter regulation on the other.

6. Towards a Structural Solution? Our own position is best summarised in William McDonough’s quote at the beginning of this chapter: "The need for regulation is always a sign of a faulty design". This is why our solution considers the structural design of the monetary system itself. We recommend a monetary ecosystem, in which exchange media other than a monoculture of bank-debt money are allowed to play a role. This would provide greater structural diversity!n both the media of exchange and in the institutions creating them. If and when such complementary’ systems are in place, more spontaneous adjustments to economic instability and/or sudden scarcity of bank-debt money become possible. Such complementary arrangements would also reduce the extraordinary' stranglehold the banking system exerts now on governments and the entire economy.

Coming from a completely different perspective, Friedrich Hayek, one of the leaders of the Austrian school of economics, wrote a short book in 1976 that has remained mostly ignored, entitled Denationalization of Money.& His premise was that a monopoly can no more competently manage the equilibrium between the supply of, and demand for, money than it can for shoes, automobiles, food or health care. As a solution he recommended competition between financial institutions: each bank should be allowed to print its own paper money. Such competition between banks would keep the value of money stable, since money losing in value hurts creditors, while money gaining in value hurts debtors. Hence the market would select the ‘best

monies’, the ones that strike the best balance between depreciation and

appreciation. Although we do not agree with Hayek or the Austrian school in other domains, we certainly can agree with Havek’s assessment of the current monetary system: “It has the dejects of a// monopolies; one must use their product euen if it is unsatisfactory, and, above all, it prevents the discovery of better methods of satisfying a need for which a monopolist has no incentive. If the public understood what price in periodic? infaition and instability it pays for the convenience of having to deal icirh only one kind of money in ordinary fronsoefions, and not ocjcasiontdiÿ to fo c?ontempitite the adtfantuge of using other money than the familiar kind, it icould profcafc/p find it tfery excessive. For this convenience is much less important than the opportunity to use a reliable money that iciil nor periodical upset the smooth flow of the economy - an opporfunifp of tchich the pufciic? has been deprived by the government [enforced] monopoly. But the people have never been gitfen the opportunity to discover this advantage.”43

We similarly wholeheartedly concur with Hayek’s conclusion: need is a Free Money Movement comparable to the Free Trade Movement of the lg century. ...There is thus an immense educational task ahead before ice can hope to free ourselves from the gravest threat to social peace and continued prosperity inherent in existing monetary institutions. It will be necessary that the problem and the urgent need of reform come to be ufideZiÿ understood. The issue is nor one ichich, as may at fast appear to the Zapman, concerns a minor technicality of the financial system which he has never quite understood "PVhar

toe note

...I ufishIcould advise that u?e proceed slowly. Fur the time may be short. What is note urgently required is not the construction of a new system but the prompt removal of all the legal obstacles which have for two thousand years blocked the ivay far an evolution ufhich is bound to rhrou? up benefi ciaZ results ichich ice cannot note foresee.ÿ

However, like all economists of his time and like many still today, Hayek remained a prisoner of the paradigm we call Traditional Economics (shown in Figure 2.1 on page 28). His concern was predominantly to find an appropriate balance between inflation and deflation, two important but purely financial

issues. This is why his solution is about re-shaping the money creation process as a competition between financial institutions each emitting the same type of

bank-debt money. From our perspective, based on the Ecological Economics Paradigm illustrated in Figure 2.3 (page 31), the issue of keeping both inflation and deflation at bay is also relevant, but represents only one of several relevant issues with regards to sustainability.

The effects of crashes, as documented in Chapter Eli, are obviously detrimental to many aspects of sustainability. But what is taking place during times when the monetary system is nor in crisis, when it is operating smoothly in a â&#x20AC;&#x2DC;business as usualâ&#x20AC;&#x2122; mode? The next chapter describes five additional biases generated by our monetary system, directly due to the fact that money is created through bank-debt. Hayekâ&#x20AC;&#x2122;s solution is therefore one step in the right direction, but it does not go nearly far enough.

7. Conclusion This chapter has provided a step-by-step explanation, with backing from scientific evidence, that a structural cause is behind the repeated systemic crises described in Chapter EEL The complex flow network approach to monetary and financial stability is nor a metaphor: it is systemic bio-mimicry. Peer-reviewed theoretical and empirical evidence shows that any complex flownetwork is sustained only when diversity and interconnectivity- lie within a specific range. A monoculture - a plurality- reduced to only one single type of currency produced by one single type of agent - will, with 100% predictability-, turn out not to be sufficiently resilient. Our methodology allows the quantitative measurement of sustainability- for any complex flow network. However, it also requires detailed real-life field data. This methodology has successfully been applied to a wide variety of natural ecosystems, of very different scales and complexity-. No theoretical reason exists for it not being applicable to human-made complex flow networks. Please remember: two complex flow networks with the same

structure will behave in the same way.

There are two ideal candidates for empirically testing and proving our claims: electrical distribution networks and the banking system. In both cases, we are dealing with a complex flow network, which may run very efficiently most of the time; but both have also been victims of repeated large-scale systemic crashes, worldwide. The practical impediment to performing these tests is the same in both cases: the data exist, but are considered confidential because of competitive relevance. There is an urgent need for this methodology to be further tested with real-life financial data. We discuss possible next steps to do so in Chapter IX.

Three hundred years of cat-and-mouse games between regulatory authorities and the financial system have proven that regulation - while useful and necessary - may reduce the frequency, but never avoid the re-occurrence, of systemic crises. Paul Romer, a Senior Fellow at the Stanford Institute for Economic Policy Research, says: "Every decade or so, any finite system of financial regulation will lead to a systemic financial crisisâ&#x20AC;?.** Is infinite regulation really the only solution? Similarly, the likelihood that we might change â&#x20AC;&#x2DC;human nature' - Alan Greenspanâ&#x20AC;&#x2122;s explanation for the next crisis - amounts to renouncing on trying to stabilise the system. As long as we remain within the confines of a bank-debt money monopoly, there is indeedlittle hope. Let us conclude this chapter with a metaphor. Conventional money plays the role of the red blood cells in your blood stream: they carry vital oxygen to all parts of the body. While red blood cells are necessary, they are not sufficient to keep your body healthy. Such a focus on only one type of cell would ignore the

roles of white cells, platelets and dozens of other specialised hormones playing complementary functions to sustain your health. The existence of these complementary elements does not reduce the critical role or negate the existence of red blood cells. Likewise for the monetary domain, the key lesson from natural systems is to allow and even encourage the development of specialised media of exchange - other than a monoculture of conventional money created by bank debt - to circulate in parallel with the conventional

national currency. While this approach may seem unorthodox;, please remember that it is orthodoxy that has led us into our current troubles, Complex flow systems theory demonstrates that continued orthodoxy will compound the trouble, A plurality of media of exchange would provide new incentives and opportunities for all protagonists in the global economy, as will be illustrated in Chapters VIE and VIEI, The remainder of this Report will explain why a strategy of multiple media of exchange makes not only theoretical, but also pragmatic sense. Randomly implementing exchange media other than conventional money may not be the best w*ay forward. Rather, correctly designing and implementing exchange media to complement the current system and compensate for biases inherently generatedby the conventional monetary system wouldbe critically useful. The starting point for such a corrective, complementary strategy is to identify any existing biases and incentives that lead to unsustainable behaviour patterns, Only after understanding this built-in drift can we meaningfully choose from an infinity of potential new currency designs those that will best compensate for these propensities. Identifying these generally unacknowledged biases is the topic of the next chapter,

Footnotes i

3 4

£ 2

Kenny Ausubel, iVarure's Operating Instructions (2004), p.xiv, Interview on S September, 2009 on BEC2. ('bbc.co.uk ~ Reinhart & Rogoff (2009b) p.xxviii. This alleged bon mot was first put forward by H, R, Fox Bourne in The Romance of Trade (1S76), p,292. (see ivtvtv.archive.org ~ bir.lu/TPlinfcÿb However, it is unlikel that its attribution to Isaac Newton is valid, because we know that Newton himself lost quite a fortune in the South Sea Bubble. Joseph A, Schumpeter, Capitalism, Socialism and Democracy (1942), Charles P, Kindleberger, Manias, Panics, and Crashes: A History 0/ Financial Crises, 5th edition (2005). Eric Beinhocker, The Origin of Wealth; Evolution, Complexity and the Radical Remaking of Economics (2006), p.31, italics added. Specifically, Chapter 2 of Louis Poinsot’s Elements 0/ Statics (1S03), entitled 'On Conditions of Equilibrium Expressed by Means of Equations', was the source of

Walras's models. Even the title of Walras's Elements found its inspiration in this book. See Ingrao & Israel (1990), p.88 andMirowski (1989), pp.219-220. 9 Beinhocker (2006) p.74. 10 Ibid, p. 66. 11 Ibid, p. 67 12 ibid, p. 68. 13 Sir Arthur Stanley Eddington (1882-1944) was one of the most prominent and important astrophysicists of his time. It is often claimed that only Arthur Eddington and Albert Einstein had a full understanding of relativity until the mid-i920s.

14 Arthur S. Eddington, The Nature of the Physical World (1928), p.74. 15 The most prominent example is Nicholas Georgescu-Roegen. As we saw earlier, his work remains largely ignored by the dominant Traditional Economics paradigm, while it has deeply and durably influenced the Ecological Economics paradigm we are using here as a basis for our study, and which Beinhocker obviously espouses as well. 16 Beinhocker (2006) p.52. 12 Figure adapted from Sally J. Goerner, After the Clockwork Universe: The Emerging

Science and Culture of Integral Society (1999).

The Systems Vieu? of the World: A Ifolisric Vision for our Time (1996). For the definition and implications of mutual causality', see Joanna Macy, The Dharma of Natural Systems: Mutual Causality in Buddhism and General Systems Theory (1991). 19 Figure taken from Goerner (1999). 2£ See Robert manowicz and B. M. Hannon, 'Life and the Production of Entropy', Proceedings o/f/te Royal Society of London B, Vol. 232, pp.iSi-192. See also Sally J. Goerner, Robert G. Dyck and Dorothy Lagerroos, The New Science 0/ Sustainability: Building a Foundation for Great Change, (200S). 21 See, e,g,, Paul Ormerod (1994): Sunny J. Auyang (199S); and Robert Axelrod & Michael D. Cohen (2000). 22 Francois Roddier, Le pain, le leuain et les genes (2009), excerpts translated from PP-55-5S and 61-72. 23 Roderick Dewar, 'Information Theory Explanation of the Fluctuation Theorem, Maximum Entropy Production and Self- Organized Criticality in Non-Equilibrium Stationary States’, Journal ofPhysics A: Math. Gen. 36 #3 (2003), pp,63i-64i. 24 Eric Chaisson, 'Non -equilibrium Thermodynamics in an Energy-Rich Universe’, in A. KLeidon and R D, Lorenz (eds), Non-Equilibrium Thermodynamics and the

1§ A good summary of intertwined causality is provided by Erwin Laszlo,

Production ofEntropy; Life, Earth, and Beyond (2005), PP-21-3325 See, for example, Sally Goerner, Bernard Lietaer and Robert Ulanowicz, 'Quantifying economic sustainability: Implications for free-enterprise theory, policy and practice'. Ecological Economics, 2009, VoL 69(1), pp.yb'&i. 26 See, among others, Robert Ulanowicz, A Third PVindou;,' iVofuro/ foundations for

Life (200&).

Goerner, Dyck & Lagerroos (200S) 2S Robert £. Ulanowicz, Sally J. Goerner, Bernard Lietaer and Rodo Gomes, "Quantifying Sustainability: Resilience, Efficiency and the Return of Information Theory5, £ooiop£coi Compicjiritiÿ, VoL 6 (2009), pp.27-36. 29 Appends D has a synthesis of this paper with a more detailed graphic analysis than the one displayed here. For anyone interested in traditional Chinese philosophy, Appendix E shows some parallels between our framework and the Taoist view of yin-yang polarities as a universal dynamic. 30 Paul Hawken, Blessed Unrest (2007), p.183. 31 This is also called “window of vitality” in the ecological literature. See Ulanowicz 27

(200S).

Goerner (1999) p.153. Predrag Cvitanovie, Introduction to Universality in Chaos (1984), p.11. The Economist, 2 April, 2011, p.59. Milton Friedman, The Case for Flexible Exchange Rates5, £ssops in Posifu-e Economics (1953), pp.157-203. 26 Hillary Clinton was referring to China as “banker for the US”, but her choice of metaphor also reflects the validity of the image at the first degree, namely when it comes to actual banks. 32 Jer&me Fourel, 'Wall Street et ses bonus: $135,500,000,000 pour 20105, Le Monde, 7 February 2011. 3$ The Real Housewives of Wall Street5, Po/Zinÿ Stone, 4 November, 2011, 2Q See, for instance, M. Kosfeld (2004); Y. Leitner (2005): Frank Schweitzer ef aL (2009a): Frank Schweitzer etc/. (2009b): and C. Jones (2010). Andrew Haldane and Robert May, "Systemic Risk in Banking Ecosystems5, Nature, Vol, 469 (20 January, 2011), pp 351-355. 41 This ranking was computed in 2010 in the Journal of Citation Reports Science Edition (Thomson Reuters, 2011) See also: www.no fare.com/na fare/abou t/

33 33 24 35

4.2 Specifically, the Haldane-May team used agent modelling as their key tool to explore the complex flow network of the financial system. Agent modelling is the favoured methodology of the Santa Fe school of complexity. In contrast, our methodology is grounded on thermodynamics and information theory applied to natural ecosystems. 43 Haldane & May (2011) p.351. P-35544 45 7bid., p.355. Zbid., p.354. 47 Ibid., p.351. 4S This book was written two years after Hayek received the Nobel Memorial Prize in Economics. 40 Hayek (1976) p.aS. 5fi Zbid. pp.133-134. 51 Institutional Investor, May 2011, p.16.

Chapter V The Effects of Todayâ&#x20AC;&#x2122;s Money System on Sustainability "TheEarth is not dying - it is being killed. And the people who are killing it have names and addresses.77 - U. Utah Phillips*

We have seen how diversification of the types of exchange media, forming together a monetary ecosystem, would structurally be beneficial to an economy. From this perspective, the most pressing thing to do is not to get rid of the existing bank-debt money system, as many monetary' reformers claim

should be done. Instead, the focus should be on identifying the kinds of systems that best complement the existing bank-debt system. This chapter will therefore explore the relationship between money and sustainability by identifying biases built into the existing system and their impact on human behaviour patterns.* Money is generally assumed to be a passive accounting instrument that facilitates exchanges more efficiently than barter. Money is seen as an oil lubricating the exchange process, but not otherwise changing its nature. It is therefore automatically assumed that the type of exchange medium one uses does not affect the nature of exchanges, the time horizon of our investments, or the relationships between us as users. We will demonstrate why all these assumptions are wrong.

The modem money system should be credited with giving birth to the industrial age, with both its positive and negative effects. It has spawmed a quantum leap in scientific knowledge, and the most materially productive civilisation in the history of mankind. It has also been an extraordinary wealth-producing mechanism, and we hope that it can continue to play that

role in an evolving monetary ecosystem. However, there are unfortunately also several mechanisms that turn out to be incompatible with sustainability. Specifically, we identify five effects that are detrimental to sustainability, and we can trace them back to characteristics of b ank-debt money itself.

These five detrimental processes are: the pro-cyclical character of the money creation process which amplifies both the upturns and downturns of the business cycle 2. the systematic encouragement of short-termism because the interest feature of the money system programs â&#x20AC;&#x2DC;rationalâ&#x20AC;&#x2122; investors to discount the future 3. compulsory growth due to the mechanism of compound interest 4. concentration of wealth 5. a devaluation of social capital. 1.

From a systemic perspective, none of these effects is a simple linear cause-effect relationship. They also interact and even reinforce one another. The outcome is a set of built-in mechanisms that cause a bank-debt monopoly to be incompatible with sustainability in the long-term. We discuss each of these effects separately and attempt to describe their interactions at the end of

the chapter. i. The Pro-Cyclical Tendency

of Money Creation and Flow* â&#x20AC;&#x2DC;It

Never Rains, but it Pours* Because conventional modern money is created by bank debt, this money creation process amplifies the fluctuations of the business cycle.2 Banks often

display a herd instinct when making credit available or restricting it for particular countries, industries or individuals. When business is good, banks more generously provide credit and tend to fuel a shift from a merely good economic period to an inflationary boom period. Conversely, when the business horizon darkens, banks simultaneously reduce credit availability and thus can transform a small business dip into a full-blown recession. This is what is meant by a ‘pro-cyclical’ money creation process. The US real-estate boom of the 1990s is a perfect example of this process. The boom years led to a bust in 2007-2008 and, since then, desperate attempts to make banks lend money to businesses have followed, without much success. In the past, central banks were still able to have some influence by giving countercyclical interest rate signals. However we are currently at a point where central banks have tried everything without much success. The Economist concludes: “For central bankers in the rich world, unconventional is the new conventional"ÿ Interest rates hover around zero in the USA, Europe, and Japan, but without much impact. Euro zone banks prefer to deposit their funds with the European Central Bank rather thanlend them out to businesses.4 Let us emphasise that the actions of the banking system are not consciously intended to produce such results. Banks do not like recessions any more than other businesses do. However, they do not want to be the last ones to bail out if they see a sinking ship. Their decisions are thus similar to the actions of a portfolio manager not wanting to be the last to hold on to a stock with plummeting value. The net effect of these 'rational' micro-decisions is that the financial sector, as a wkole, tends to exacerbate the business cycle in both the up- and the downside directions. This finding has strong theoretical grounds* and is also amply supported by empirical evidence.ÿ The effects of pro-cyclical money creation

The typical boom-and-bust of the business cycle tends to wÿaste investment capital and many other resources. In an amplified business cycle, corporations are often under-equipped in plant, equipment and qualified staff during the boom period, then suddenly over-equipped and over-staffed during the downturn.

This results in joblessness and the host of social problems it causes. Most social indicators (such as mental health, crime or suicide) deteriorate significantly during recessions. Political instabilities including violent revolutions are usually triggeredby economic downturns.

The financial sector itself is not insulated against the amplified business cycle it helps to create. One typical cause of banking crises is a situation where borrowers cannot repay their loans, while the collateral upon which those loans are based depreciates. These conditions are understandably aggravated by an amplified business cycle.2

Furthermore, since the financial deregulation of the 1980s, the volume of â&#x20AC;&#x2DC;hot* money or money moving around the world in search of short-term returns has increased significantly. It further accentuates these pro-cyclical tendencies whenever it enters or leaves a particular market.fi Implications for sustainability Asset bubbles are an automatic result of this pro-cyclical money creation process. When asset price bubbles burst, banks tend to fail in great numbers. The assets on which these bubbles occur have varied in time and place. During the 1630s in Holland, it was all about tulips. Three hundred years later, in 1929, the object was US trust stocks; in the late 1980s, real estate in Japan; in the 1990s, high-tech US dot-com stocks; and during the first years of the 21st century, real estate in the USA. They all have in common the pro-cyclical debt-creation mechanism acting as their overheating engine. Such bubbles invariably burst with destructive consequences for society in general, and for the banking system in particular.a These boom-and-bust cycles negatively affect the formation and maintenance of financial, human and natural capital.

Why the Future is Discounted The second built-in bias we will discuss is related to short-term vision. 2* Short-Termism;

'Short-termismJ is the tendency to focus attention on short-term gains, at the expense of long-term success or stability'. In the business and financial world

this tendency has become widespread. Part of this process is independent of the monetary system: the further away events are in the future;, the more difficult it is to make accurate predictions about them, and thus the greater the risk, Short-termism can therefore be correctly associated with lower risk tolerance,

However, the Discounted Cash Flow' (DCF) technique used for financial decision-making should also bear part of the responsibility. The readiness to make long-term investments depends to a significant extent on current and anticipated interest rates. Interest is one of the three factors involved in discounting any future cash flow'. The other two are the intrinsic risk of the investment project and the cost of equity capital, (see Box 5.1) Box 5,1- Time Perception and Interest versus Demurrage The purpose of this box is to show how interest encourages short-term time horizons. Figure 5.1 below shows how interest rates affect the investment process. To keep the numbers simple, it is assumed that all numbers are inflation-adjusted and that the risk of investment is independent of the time frame. Furthermore, we will consider only a choice between two projects: planting a pine forest or an oak one. Here, a pine tree is assumed to be harvestable after ten years, when it will bring a yield of $100. An oak tree can only be harvested after a hundred years and it is estimated to be worth $1,000. So the two investments could be seen as equivalent as one could harvest and replant the pines every ten years, ending up with the same $1,000 in 100 years. When we put on financial glasses, things change. For example, a deposit of $61 in a bank account with a guaranteed interest rate of 5每 automatically becomes $100 after ten years,-i拢 That is why the $100 pine ten years from now is equivalent to only $61,39 today.

____ ----

Sustainability: The Monetary Engine Wtini do we invest in? i

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Figure 5.1: Investment behaviours differ according to the monetary system. Any current with a positive interest rate discounts the future. A currency with a demurrage fee equivalent to a negative interest rate - amplifies the value of the future.

Therefore, when the investor asks, "What are these two investments worth as seen from today?”, the answer depends on the applicable interest rate. We have seen that at an interest rate of 5 96, $100 in ten years is worth S61 as seen from today. This is so because at 5*6, only $61 would have to be deposited in thebank in order to have $ 100 in ten years ’time. At the same s 96 interest rate, the value today of the future $1,000 oak tree is only $7.60. This difference in value is only due to the interest rate on the money used to fi nance the investments. This explains why there is currently a lot of commercial interest in harvesting old -growth forest, but very little in planting trees with long maturation periods, This difference also generally explains why our society has diffi culty thinking of the proverbial seventh generation, Every rational investor’ is programmed by the interest feature of our money to focus primarily on the short term, In contrast, past societies have imposed a 'circulation fee’ to discourage the hoarding of a currency, a bit like libraries charging a date fee’ for books not re- circulated on time, Such a time-related charge on holding on to money is technically called a ‘demurrage’ fee, from the French demeurer - a term dating back to therailroads who charged for idle wagons not used

for transport. Viewed from the perspective of an investor, demurrage - or negative-interest-bearing - currencies dearly change the relationship with the future, ff the currency used in our tree-planting example carried a 5% demurrage fee, the oak tree would suddenly be worth more than ÂŁ168,000 when discounted to today. Planting oaks would become the obvious choice if such a currency were used to make the investment. In short, with demurrage- charged currencies, investment with longer-term horizons would increase in

value. This 'pine versus oakâ&#x20AC;&#x2122; metaphor shows that the time horizons of investments depend signifi candy on the currency type one ÂŁ nan dally analyses and plans with. All other tilings being equal, if the currency one uses has positive interest rates - as do all our conventional bank-debt moneys - then short-term priorities will logically prevail. In contrast, a demurrage-charged currency ivould automatically provide an incentive for taking into account longer-term priorities. Figure 5.1 synthesises this metaphorical scenario and illustrates the link between short-term dedsi on -making and the given monetary system.

The hypothesis that investment decisions depend only on risk profiles is therefore not valid. The type of money used also significantly influences what a society as a whole chooses to invest in. This is not just a theoretical statement: societies that used demurrage currencies - as in ancient Egypt for more than a millennium or in Western Europe from the 10th to the 13d1 century" - made investments in infrastructure and buildings that were designed to last forever, as evidenced by the fact that pyramids, Egyptian temples and European cathedrals are still standing today,AA Implications for sustainability

Conventional bank-debt money reinforces a particular perception of time: it mandates short-term priorities. If a different type of currency - one with a negative interest rate - were used, society andbusinesses wouldbe encouraged to value more long-term opportunities and costs. This change would affect the entire spectrum of economic and environmental activity and directly promote long-term sustainability. Greater concern for sustainable policies in relation to non-renewable resources and for humanity's relationship with the rest of the biosphere would result. These lessons will be used in the design of the TRC (see Chapter VII), a currency that would make it profitable to corporations to think long-term,

3. Compulsory Growth Pressures! On Debt and Compound Interest

â&#x20AC;&#x153;Ifind to my personal horror that 1have not been immune to naivete about exponentialfunctions... WhileIhave been aware that the interlinked

problems of loss of biological diversity, tropical deforestation,forest dieback and the climate change are growing exponentially, it is only this very year thatIthinkItruly internalized how rapid their accelerating threat really is - Thomas E. Lovejoyis Chief biodiversity adviser to the president of the World Bank

The third structural bias we will discuss is compulsory growth pressures due to compound interest* Too often, growth is confused with progress* Growth is the quantitative increase in size or throughput of an entity. In contrast, progress is the idea that the world can increasingly become better. The former is purely quantitative, while the latter is primarily qualitative. One should not automatically assume that all growth leads to progress. That is why American essayist Edward Abbey could claim that "growth for the sake of growth is the ideology of the cancer ceH".A3

Furthermore, while growth is a natural process, some types of growth are intrinsically sustainable and others are not. Figure 5.2 illustrates three classical types of growthM

Growth

Exponential

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Figure g-a: Three different types ofgroivth; Linear, exponential, natural S curve-

The first type is linear growth, which is the easiest to grasp. A second type is exponential growth, which, when it occurs in a finite world, becomes unsustainable at some point in time. According to systems theory, this is what occurs when a positive feedback loop is allowed to operate in an unmitigated manner. Nature embodies the third type of growth and almost always exhibits an S curve: all biological systems including cells, trees, animals and populations start out by growing rapidly and eventually asymptotically taper-off to a point of stability. From a systems perspective, this tapering off reflects increasing pressures from a negative feedback loop acting to stabilise theinitial positive feedback loop. This is a sustainable, natural growth process. A well-known example from nature is the relationship between predators and prey. If predators - 'foxes' - multiply too quickly, they eliminate the population they prey on - â&#x20AC;&#x2DC;rabbits'. All things being equal, insufficient prey will limit the growth of the predator population until the prey population has sufficiently recovered. At some point a state of relative balance is reached.

Since bank-debt money in our current system is created with interest, it is subject to compounded interest or ‘interest on interest’ which automatically implies exponential growth. In a finite world, exponential growth is mathematically incompatible with sustainability.-ÿ Indeed, what exponential growth processes all have in common is that the amounts involved increase at an increasing rate over time. For a complex dynamic system to be sustainable, feedback mechanisms must be in place to avoid exponential, runaway growth. The examples described in Box 5.2 demonstrate the mathematical impossibilities of exponential growth. BOX 5.a

- Two examples of exponential growth

Water lilies spreading in a pond

Let us assume water lilies double the surface they cover in a pond every day. Initially, their growth may seem quite reasonable. If a quarter of the pond is covered in 50 days, how many days will it take for thelilies to cover the entire pond? If the growth were linear, it would take another 150 days. If the growth were exponential, it would take one day to cover a second quarter of the pond and by day 52 it would be completely covered’ Caesars one- cent debt

If Julius Caesar had borrowed one cent at 4% compound inter est from a bank as he left Rome Gaul (52BC), by today, the interest on that one cent would have compounded to approximately 2,000 gold balls each weighing as much as the Earth, using the current price of gold! Had theinterest been compounded at 5ÿ instead of 436, several trillion gold balls would be needed to pay his debt two millennia later. In the real world, Caesar would have had to default many times on the way. If the accumulated debt were big enough at the moment of his default, he would bring down thebank and possibly the entire banking system. In short, without countervailing forces to stabilise them, exponential growth rates are mathematically impossible in the long run. In the language of general systems theory, compound interest is a perfect example of a positive feedback loop unmitigated by a correspondingly powerful negative feedback loop to stabilise it. Because of the interest feature of bank-debt money, and specifically because of compound interest, the monetary system is driving our economies into a reckless compulsory growth pattern, to conquer

The core question is therefore: what kind of growth does the financial system

require from the real economy? The short answer is that compound interest requires exponential growth. Compounded interest is a mathematical impossibility on a finite planet,-ÿ

The idea of a built-in exponential curve in the financial and monetary domain is not merely theoretical but has striking ramifications in the real world. Figures 5,3 and 5,4 illustrate the growth in the money supply of the USA and India, US Money Supply $14 T

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Notice how closely the growth curve follows exponential growth* We are fast approaching Ann Pettifogs prediction in her 2006 book The Coming First-World Debt Crisis whose cover was an ominous-looking time bomb.ifi This ‘exponential-growth' effect is not only relevant for developed economies*

Components of the money supply of India 1970-2007 3.000,000

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The same process also tends to apply to a developing country's external debt, After the G8 summit in Okinawa in 2000, President Obasanjo of Nigeria commented on Nigeria’s debt: “All that we had borrowed up to 1985 or 1986 was around $5 billion and so far we have paid back about $16 billion. Yet we are being told that we still owe about $28 billion. That $28 billion came about because of the foreign creditors' interest rates. If you ask me what is the worst thing in the world,I would say it is compound interest," At the time Obasanjo spoke out, the developing world was spending $13 on debt repayment for every' one dollar it had received in foreign aid and grants. For the sixty poorest countries in the world, $550 billion have been paid in both principal and

interest over the last three decades on a total of $540 billion of loans, and yet there are still $523 billion outstanding in debt burden.

Implications for sustainability The debt treadmill is most dangerous when the debt is incurred in a foreign currency. This is invariably the case for developing countries. Et feeds a compulsion to earn foreign exchange. The consequences can be drastic: as the debt burden increases, many developing countries recklessly exploit their natural resources and/or their people. Governments are forced to neglect their domestic economies since there is no alternative but to export an ever-larger proportion of their resources to service their debts. Sometimes, they are even driven into adopting policies that predictably reduce their future opportunities for servicing debt. For example, ‘structural readjustment policies’ imposed by creditors have often obliged countries to cut education, public services or maintenance of the transport infrastructure funding as a precondition for obtaining loans. In summary, our current monetary mechanisms do not promote long-term financial sustainability, even narrowly defined. From a broader perspective, the monetary' sector forces indebted entities and individuals into compulsoy growth, regardless of the environmental and social costs inflicted in the process.ÿ Highly indebted protagonists therefore get trapped into hurried, short-term growth paths. Such pressures are partly responsible for the erosion of non-renewable natural resources, pollution of the air and water, and mounting pressure with negative social and environmental consequences.

Ecological economist Herman Daly has referred to this as ‘uneconomic' growth or, growth whose short-term benefits are dwarfed by inadequately actualised future costs.ii Uneconomic growth can only continue to be called ‘economic growth', according to Daly, if some of the associated costs are not accounted for or kept invisible. This is what our current monetary' system does by requiring compound interest on money. Short-termism is thus ubiquitously embedded in our current monetary' system.

4•An Unrelenting Concentration of Wealths the Poor vs* the

Super-Rich The most profound danger to worldpeace in the coming years wilt not stem from the irrational acts of states or individuals, butfrom the legitimate demands of the world’s dispossessed*M - Statement of 100 Nobel laureates, January £00£££

The fourth built-in mechanism causing our current monetary system to be unsustainable is the tendency over time for wealth to become concentrated* The renowned historian Arnold Toynbee concluded that the collapse of twenty-one different civilisations couldbe attributed to just two causes: * the excessive concentration of wealth in the hands of the few * theinability to introduce significant changesin the fa ce of shifting circumstances* £3

A market economy must offer incentives to encourage people to take entrepreneurial initiatives* The remarkable innovations of the Industrial Age

triggered by the desire to achieve and create beyond the simple requirements of survival* This logic has also justified the existence of disparities of income and wealth over the past 150 years* w’ere

Nobel laureate economist Joseph E* Stiglitz writes: "Economists long ago tried to justify the vast inequalities that seemed so troubling in the mid-Jpÿ cenfury - inegua/iries that are but a pale shadoiv of tvhat u?e are seeing in America today The justifi cation they came up tvith was called ‘marginal-productivity theory’. Jn a nutshell, this theory associated higher incomes with higher productivity and a greater eonfribufion to society. Jt is a theory that has always been cherished by the rich. Evidence for its validity, however, remains thin. The corporate executives who helped bring on the recession of the past three pears ichose contribution to our society, and to their own companies, has been massively negative - ivent on to receive large bonuses. Jn some cases, companies were so embarrassed about calling such reivards ‘performance bonuses' that they felt

competed to change the nams to Vetenrion bonuses' (even if the only thing Zwing retained was had performarice). Those who have contributed great positive inncrafions to our society, from the pioneers of genetic understanding to the pioneers of the Jnformarion Ager have received a pittance compared u?irh fhote responsive for the fi nancial innouofions that brought our global economy to the brink of ruin."

Developments in compensation habits over the last two decades have led to a distribution of assets bearing less and less relation to individual achievement or willingness to take personal financial risks* What is the relevance of excessive concentration of wealth for overall sustainability? Hard-nosed geopolitical thinkers such as Zbigniew Brzezinsky, President Carter’s National Security Advisor, have always focused on raw power relationships: "Global furmoiZ manats in a i-ariely of ways. It is intensified, though not entirely Mused, by persistent mass poverty and social injustice. ...It does nor /end irseff to sZoganeering or rouse the AmeriMn people os uiseeraZZy as terrorism. Jr is more dyffieuZr to persona/ise toirhour a demonic figure like Osama bin Laden. Nor is ir congenial to self-gratifying proclamations of an epic confrontation between good and evil on the model of the titanic struggles with Nazism and Communism Ter nor to fi?eus on g/obaZ rurmoiZ is to ignore a eenrraZ reaZitp of our rimes: rfoe massii-e worldwide poZiriMZ awakening of mankind and its intensifying aioareness of intoZerab/e disparities in the human condition.1ÿ

We have witnessed a remarkable concentration of wealth over the past decades with resulting increases in wealth disparities* Depending on the definitions of poverty used, different pictures of wealth disparities can be identified* However, social tensions arise from the relative rather than from the absolute minimum level of poverty in relation to excessive concentration of wealth* This aspect is further discussed along with the different definitions of poverty in Appendix F. Economic effects of wealth concentration Economic equity is not just about justice* Economic development itself depends on a minimum of equity* Recent evidence shows that successful

economic development does not occur in the presence of too much or too little economic equality. Communism;, with its attempt to impose too much equality proved to be an economic failure. However, too little equality in a capitalist society is not economically advantageous either. For instance, a key reason for the difference in development between Latin America and ‘Asian Tiger’ countries in East Asian and the Pacific is that wealth inequality in Latin America is too high.ÿh Appendix F provides some of the evidence for these

economic effects of excessive inequality. Equity effects of wealth concentration

In his Theory of Justice, philosopher John Rawls formulates two central conditions for social justice (see box 5.3) under which an uneven distribution of income and wealth is, in the long run, acceptably just.*2 Box 5.3 - What is just? IVhat is unjust? John Rawls on inequality From his exploration of liberal-egalitarian political philosophy, Rawls extracts two practical imperatives: Social and economic inequalities must be controlled in such a way that they (a) offer those who are the least favoured the best possible prospects and (b) render ofS ces and positions accessible to all, thus providing the same opportunities for everyone. While Rawls justifi es differences in wealth and income, even relatively substantial ones, he places spedfi c conditions on them. Based on condition (a), it is morally unacceptable for the poorest to have no share in economic growth. Condition (b) points out that suffi dent sodal mobility must exist so that the fortunate do not occupy their positions permanently. This implies being critical of socio-economic systems with entrenched structurally unequal income distribution mechanisms that generate compound imbalances over time,

In summary, Rawls claims that freedom cannot exist if there is not enough equality. Communism went in the direction of too much equality and proved unsuccessful. Our recent history’ with capitalism is now giving a warning that market fundamentalism may push us too far in the opposite direction.

Wealth concentration: connection with the monetary and financial system The current economic system is thus not a 'rising tide that lifts all boats’. With

a track record suck as the one just presented, ‘trickle-down economics’ - the belief that the poor will somehowÿ get their fair share as the rich get richer has lost its credibility. The following paragraphs describe three systemic mechanisms built into the current monetary system that lead to wealth concentration. These mechanisms are interest, the money creation process and

the role of lobbies. We will treat each of them separately. Iinterest The first built-in mechanism or bias leading to wealth disparity is interest. The definition of interest is a charge or payment for the use of money. Interest is thus a transfer of money from those who do not have enough money, to those who have surplus money. In ancient Greece, Aristotle forcefully condemned the ‘chrematistic’ way of life, which consisted of making money from money. Judaism, Christianity and Islam each had strict rules against ‘usury’, defined as any interest on money. Today, only Islam still reminds people that interest w’as considered a problem of justice or, as it were, injustice. We have found only one study of the transfer of wealth via interest. It was performed in Germany in 1982 when interest rates were at 5.5%.fi£ The German population was grouped into ten income categories of 2.5 million households each. Over a one-vear period, transfers between these ten groups totalled Deutsche Mark (DM) £70 billion in interest paid and received. Graphing the net interest transfers (interest gained minus interest paid) for each of these ten household categories allows us to see the net effect (see Figure 5*5)*

Blltlon DM

2S 20

10 E

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Figure 5-5: Net Interest Transferred (billion DM) for 10 groups of households of 2.5 million each (Germany - 1982).

In this graph, we see that the highest interest transfers occurred from the middle class. Categories 3 to 8 each transferred approximately DM5 billion to the top 10% of households in category' 10, Category' 1, the lowest-income households transferred DM 1.8 billion in interest per year to the highest group, The net effect is that the top 10% of households received a net transfer of DM 34,2 billion in interest from the rest of society during that one year,

Figure 5,5 clearly displays the systematic transfer of wealth from the bottom 80% of the population to the top 10%. This transfer was due exclusively to the monetary' system in use. It is independent of the degree of cleverness or industriousness of the participants, the standard arguments given to justify' large income differences,

The money creation process

The second built-in mechanism or bias leading to wealth disparity is the money creation process itself. The common belief is that capital is financed through savings. In reality, capital is generated through credit. However, the catch is that credit is only given to people who already have savings.ÿ2 Good banking practice dictates that loans be backed by good collateral. The quip by comedian Bob Hope: “A bank is a place that will lend you money at the condition you can prove you don’t need it” has more than a grain of truth. In a society imposing a monopoly currency created through bank debt, an automatic bias towards concentration of wealth will predictably occur.

‘Lobbycracy’ The third built-in mechanism leading to wealth disparity is related to special interest groups, and lobbying. Lobbies can play a positive role in a democracy. They provide a feedback loop between the branch of government that creates laws and the citizens and organisations affected by those laws. Good lobbyists are expensive. Individuals and corporations who can thus pay for themhave an advantage over those who cannot afford them. Grass-roots organisations, some non-governmental organisations and ordinary people affected by the same laws are often unable to pay for those expensive lobbyists.

Thus, money begets power and power begets political influence, which in turn begets laws making it possible for the powerful to make more money. This positive feedback loop is well known in politics. It explains why so many of our laws favour powerful interests rather than the ordinary people that democracy should protect. At a certain point, the line between lobbying and crony capitalism can get blurred. When money speaks more powerfully than people, democracy gets replaced by plutocracy, which takes the form of a 'lobbyera cy’ today.3fi The manner in which money is currently created encourages this problematic bias by generating structural wealth concentration. Wealth disparities and implications for sustainability

Strongly unequal wealth tends to concentrate purchasing power in the hands of the people who adopt the most consumption-intensive, and hence

resource-intensive, lifestyles. But what is at stake is more than food or the necessities of life for the average wage-earners, or even justice and economic performance. As US Supreme Court Justice Louis Brandeis claimed, “We can have a democratic society or we can have great concentrated wealth in the hands of a few\ We cannot have both.”3i The Dalai Lama has said: “A society in which the rich are too rich and the poor too poor generates violence, crime and civil disorder. Agitators can easily excite the masses to make them believe that they are fighting for them,”32 Violence and war are the exact opposite of sustainability since they mean a lose-lose proposition for all segments of society - including the wealthy. As US President John F. Kennedy remarked, “Those

who make peaceful revolution impossible will make violent revolution inevitable".

5* The Devaluation of Social Capital: Why Competitive Behaviour CAN Overpower Cooperation Regions, countries and groupsfeeling left behind willface deepening economic stagnation, political instability and cultural alienation. They will foster political, ethnic, ideological and religious extremism, along with the violence that often accompanies it. Central Intelligence Agency (CIA), April 200733 The fifth and last mechanism leading to unsustainability in our current monetary system pertains to how it devalues and erodes social capital, Defining social capital

Sociologist Robert Putnam defines social capital as "Features of social organisation, such as trust, norms and networks, that can improve the efficiency' of society' by facilitating coordinated actions",34 The content of this concept has not evolved for almost a century', as illustrated by the 1916 definition by Lyda Judson Hanifan: “The whole community' will profit from the co-operation of its parts, and the individual, as a result of the links forged, will experience benefits such as help, compassion and community' spirit from its

neighbours ...When people in a community trust each other, and when it has become customary to come together for entertainment purposes, to exchange views or for personal pleasure, skilful leaders can easily employ this social capital for the general improvement of "welfare in the community as a whole* Hazel Henderson uses a very short but effective label for it all, referring to the “love economy”.36

Cohesion within a society arises not as a result of spatial proximity, common language, religious beliefs or relationships, but through that society’s ability to create mechanisms, rituals and behaviour patterns that generate a spirit of cooperation, trust and shared responsibility*ÿ These behaviours are learned and continually reinforced through socialisation* Studies have demonstrated that the acts of giving and receiving activate the same regions in the brain; and giving usually leads to greater happiness than spending on oneself*3ÿ Social capital can be private or public, can vary in formality and organisation, but always has an aspect of social commitment* It also defines the types of institutions and rules that give a society its identity* “A peculiar feature of social capital is that it is not accumulated through a standard mechanism of individual investment, since most of its benefits are not privately appropriable* Rather, or at least to a much greater extent, it is accumulated through social participation in group activities*”ÿ Social capital is therefore not a mere by-product of society* It is the 'glue’ that makes a collection of individuals into a human society* It is a precondition for a functional democracyÿ and for securing economic prosperity*4i Indeed, political action and efficient markets are both unthinkable without a modicum of social capital* Democracy' and economic prosperity become possible only when a society has a sufficient sense of responsibility, mutual trust, solidarity and cooperation* Increasing crime rates,42 poverty and the exclusion of ever-larger groups from society43 are the first indications of social capital erosion* Several studies have shown that social capital is not only dwindling in most parts of the world, but also undergoing a change in its very nature*44 One of its dimensions is the balance between competition and cooperation*

Encouraging Competition

The following story (Box 5,4) illustrates the way interest is woven into our money fabric, and how' it stimulates competition among the users of this currency* Box 5.4 - The EleventhRound Once upon a time, in a smalt village in the Outback, people used barter for all their transactions. On every market day, people walked around with chickens, eggs, hams, and breads, and engaged in prolonged negotiations among themselves to exchange what they needed. At key periods of the year, such as during harvests or when someone's barn required big repairs after a storm, people recalled the tradition of helping each other out, brought from the old country. They knew that if they had a problem someday, others would help them in return.

One market day, a stranger with shiny black shoes and an elegant white hat came by and observed the whole process with a sardonic smile. When he saw one farmer running around to corral the six chickens he wanted to exchange for a big ham, he could not refrain from laughing. "Poor people”, he said, "so primitive”. The farmer’s wife overheard him and challenged the stranger, "Do you think you can do abetter job handling chickens?” "Chickens, no”, responded the stranger, "But thereis a much better way to eliminate all that hassle. "Oh yes, how so?” asked the woman. "See that tree there?” the stranger replied. “Well,Iwill go wait there for one of you to bring me one large cowhide. Then have every family visit me. Ill explainthebetter way " And so it happened. He took the cowhide, and cut perfect leather rounds in it, and put an elab or ate andgr aceful little stamp on each round. Then he gave to each family 10 rounds, and explained that each represented the value of one chicken. "Now you can trade and bargain

with therounds instead of the unwieldy chickens”, he explained. It made sense. Everybody was impressed with the man with the shiny shoes and inspiring hat, "Oh, by the way”, he added after every family had received their 10 rounds, "in a year’s time, I will come back and sit under that same tree, I want you to each bring me back 11 rounds, That nth round is a token of appreciation for the technological improvement I just made possible in your lives.” "But where will the 11th round come from?” asked the farmer with the six chickens, "Youll see”, said the man with a reassuring smile, #**

Assumingthat the population and its annual production remain exactly the same during that what do you think had to happen? Remember, that 11th round was never created. In the end, one of the 11 families will fose its 10 rounds to provide the 11th round to the 10 others. This will occur even if every one man ages his or her affairs well.

next year,

So when a storm threatened the crop of one of the families, people became less generous with their time in helping to bring it in before disaster struck. While it was much more convenient to exchange the rounds instead of the chickens on market days, the new game also had the unintended side effect of actively discouraging the spontaneous cooperation that tradition ally existed in the village. Instead, the new money game generated a systemic imdertotb- of competitioti among aft fheparticipant.

This is how today’s monetary1system pits participants in the economy against each other. This story isolates the role of interest - the 11ÿ round - as part of the money creation process, and its impact on the participants.45 The point of the ‘nÿ1 Round’ is simple: competition to obtain the money necessary to pay the interest, which is not initially created along with the principal, is structurally embedded in our current system. How does such a permanent undertow affect social capital? Can we measure such an effect? Can social capital even be measured in the first place? Measuring social capital

Despite the relative stability in the definition of social capital, the capacity to measure it has not improved a lot over time. One reason is that "the idea of social capital sits awkwardly in contemporary economic thinking. Even though it has a powerful, intuitive appeal, it has proven hard to track as an economic good. Its difficulty to measure isn't because of a recognised paucity of data, but because it's not quite known what should be measured. Comprising different types of relationships and engagements, the components of social capital are many and varied and, in many instances, intangible.'’4$ The essentials of social capital are forms of goodwill mediated through generalised social exchanges,42 which includes social networking, feeling a sense of belonging to one's neighbourhood or community, and civil participation.

Perhaps the reason why social capital is so hard to quantity is that the term itself is an economic projection on a foreign realm. It represents a reductionist view, objectifying the human spirit and the most elevated of human capacities as just another input into material production. It implicitly assumes that material production is the only relevant criterion for the good and wellbeing of

a society.

Many indirect indices have been used to measure social capital. They have ranged from education and income, to the percentage of women at work; from forms of business organisation and social safety nets, to the degree to which we can participate in the running of our society; from the freedom of the press, to the legal constitution of states. The availability of jobs and the quality of working conditions has a key influence on the formation of social capital. Regardless of the definition or data set used, the tendency over decades is a decrease in social capital in most developed societies. One key question that remains unanswered is: What role does the monetary system have in these processes? The evidence comes from three different sources: from game theory, from neuro-imagining and from empirical behaviour testing. 1. The Input from Game Theory

The first input comes from Game Theory. The rtit-for-taf strategy in non-cooperative games can be described as, I â&#x20AC;&#x153; will give you something in the first place and you icifl giue me something ifI need it in the future; hut shou/d you decide not to giue anything back,Iwill end our col/aborarionâ&#x20AC;? The work of Robert Axelrod and Elinor Ostrom demonstrates that tit-for-tat (an essentially cooperative strategy) as a cultural norm is better than an attitude of competitive egoism. With competitive egoism behaviour, participants tacitly transmit to one another the message KI will, in each and every interaction, pursue my self- interest regardless of whether if benefits you or nor. Each of us should look our exc/usiceZy for him- or herself!* After fifteen repetitions of such games however, cooperative and altruistic behaviours start to dominate the competitive ones. They are more successful and attract more participants,Ăż We saw* in the above story' of the Eleventh Round that our money system has a built-in bias towards generating competition between its users. In contrast, evolutionary game theory lends broad support to the superiority- of cooperation over competition. Byextension, sustainability' is possible only in the presence of sufficient social cooperation and low* levels of socially disruptive competition and rivalry, In conclusion, because our money system generates competition rather than cooperation, it pushes us in a direction that game theory has demonstrated is the opposite of what would be

desirable.

s. Evidence from Neuro -imaging The second source of evidence of the role money plays in eroding social capital comes from clinical psychology. Neuro-imaging studies have demonstrated that the mere presence of conventional money can alter social behaviour. Greed, as well as other negative emotions such as fear, anger, intolerance, scapegoating, and panic are increased whenever money is present. It even measurably decreases the performance of the brain in making rational decisions! According to neuro-scientific findings, these processes involve two conflicting brain regions. One is the impulsive circuit每 responding to stimuli and seeks immediate reward; the other is the prefrontal cortex, which tries to rationalise, control and anticipate behaviours. In all addictive disorders the impulsive circuit is overactive and the same has been shown to be true for financial incentives involving conventional money. The activations that occur with conventional money are even stronger than activations from sex or crime[Si

3* Evidence from Clinical Psychology In 2006, Kathleen Vohs and her colleagues published in the journal Science empirical evidence on how the monetary system influences behavioural patter ns.SS They conducted a randomised controlled trial to demonstrate the effect of money on social behaviours. In this study, participants were randomly assigned to two groups and asked to answer identical questionnaires. During the study, one group was primed with visual symbols of money, such as an artistic dollar bill on the wall, while the other group was primed with a neutral symbol, such as a shell.

In comparison to the neutrally primed participant group, participants in the money-primed group demonstrated significantly higher rates of playing alone, working alone, and put more physical distance between themselves and their neighbours. The money-primed group also hesitated to ask others for help, and tended to respond to requests for help as if they were insensitive to others. They also preferred the pursuit of individualistic goals and individual freedom to that of collaboration. The results of this and other similar studies strongly support our hypothesis that money is non-neutral with regards to human interactions and behavioural patterns. Indeed, it increases social isolation and thereby a decline in human social capital.

desirable.

This might be the first ‘hard science’ evidence that conventional money acts as an unconscious programming device negatively affecting human values and behaviours. As discussed in Chapter IV, ‘human nature’ has often been blamed as the engine that drives financial follies and crises. We can now subscribe to that idea with one caveat. These problems are triggered by “human nature as programmed by a monopoly of bank-debt money ”, This monopoly of bank-debt money generates a specific human culture with associated

problematic patterns of behaviour The use of exchange media not created through bank-debt money leads to other types of behaviour patterns. Several examples of such systems will be presented in Chapters VII and VIIL53 ,

Social capital and implications for sustainability

If a monetary system fostering competition, fear, mistrust and anxiety is imposed as the only legally acceptable exchange medium, how can participants be expected to generate cooperation, trust, responsibility’ and confidence? Social capital is a mediator between different social variables. One measure of this is the prevalence of stress-related psychosomatic syndromes, which is inversely correlated to perceived social capital,Si Eroding social capital is also accompanied by large income inequality and higher mortality' rates,5S Such findings point to a link between social capital, money, wealth distribution and health parameters, A motivation system relying primarily on monetary' incentives to promote unconscious competition among its users may currently not be the best way forward. As explained above, we know that cooperative approaches yield superior results for all participants in the long run. In view of the sustainability' challenges we face in the 21st century' (see Chapter I), massive behaviour changes will be required. Is it time to reconsider the use of motivation tools relying primarily on conventional money based - and therefore competitive - incentives?

6* Money as an Attractor

We have covered a wide range of theoretical and empirical results that all confirm that bank-debtâ&#x20AC;&#x153;generated currency is not behaviourally neutral. We have described five systemic effects of the conventional money system which generate pressures that are not sustainable. They are pro-cyclical money creation, short-term thinking, compulsory growth, increased income disparity, and decline in social capital. All substantially affect the type of day-to-day economic activities w-e engage in. While these factors are differently generated and interconnected, they all play a crucial role in how the human brain is conditioned in relation to money. Our monetary system acts as an attractor towards which all other variables mentioned in this chapter are pulled. Figure 5.6 illustrates this in a schematic way. Growth pressure Procyclicalily

Built-in instability

Income disparity

impact on

social capital

Short-ternnism

Figure 5.6: The official monetary system as an attractor,

An attractor can be described as a dynamic process in which a wide range of variables converge over time, James Buchan in his book Frozen Desire captured the reason for this universal power of attraction of money Money is seen as the necessary- means to fulfil any mortal purpose, our very- personal dream. That dream may be different for each of us, but money has become its common denominator. This makes money elusive and, as a result, seductive.

That seduction power is captured in Figure 5.7.

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Figure 5.7: Money; everybody's different frozen desire.52

As shown in Chapters III and IV, the official monetary system is systemically unstable. This chapter has demonstrated that it is also not behaviourally neutral. Furthermore, the homo sapiens brain is sensitive to different incentive types, which leads to unconscious programming. Every time people interact

using conventional money, the five negative mechanisms explored in this chapter are perpetuated and mutually reinforced. These mechanisms counteract the painstaking efforts undertaken to secure a common sustainable future, and may be the most significant unacknowledged obstacle to attaining it.

7* Conclusion Far from being the behaviourally neutral and purely facilitative exchange tool that the Traditional Economics paradigm assumes, the conventional monetary' system acts as a large-scale, unconscious programming tool. It generates five processes that directly conflict with various dimensions of sustainability-. Today's monetary- system combines a pro-cyclical money supply with

deregulated capital flows, and uncontrolled speculative incentives, Furthermore, this money is created with built-in compound interest that makes growth obligatory and renders the concentration of wealth automatic, None of these features is a law* of nature. They are all conventions that can be system!cally counter-balanced by other systems to neutralise these effects, Before we can consider what form such adaptations could take, we still must elucidate perhaps the most sensitive topic of all: the role of power with regards to money. This is the topic of the next chapter,

Footnotes i Quoted in Naomi Klein, No Logo: Taking Aim ar the BrandBullies (2000), p.325. 2 See Appendix A for a layperson’s introduction to how bank debt creates money.

3 Heading of an article in The Economist January 7th, 2012 P.5S. 4 At the time of this writing (in January 2012) bank deposits held overnight at the ECE are reaching an unprecedented level of more than €400 billion (see The Economist, 31 December 2011, p.56). 5 All Austrian-school theorists consider the unsustainable expansion of bank credit through fractional reserve banking as the driving force of most business cycles. See, e.g. Detlev S. Schlichter (2011). From a different perspective, Irving Fisher in the 1930s, Hyman Minsky- in the 1970s and Barry Eichengreen nowadays have also pointed to this pro-cyclical money creation process as an amplifier of the business cycle. See also Milton Friedman, The Role of Monetary Policy’, American Economic Reuieiu, vol. 6& (196S), ppu-17. We are not claiming that this process is the onlycause of the business cycle, but that it is a contributing factor directly- attributable to the prevailing monetary- system. See Olivier J. Blanchard St Mark W. Watson (1987). See also 'Shadow Government Statistics’ at tuuJtu.shodotusfla fs.com £ See Milton Friedman St Anna Jacobson Schwartz (1993); J. P, Keeler (2001); Barry Eichengreen St K, Mitchener (2003); Carmen Reinhart ere/. (2004), 2 Adrian Blundell- Wignall and Paul Atkinson, Thinking Beyond Basel III: NecessarySolutions for Capital and Liquidity’, FinoneiaZMarkets Trends, vol. 2 (2010), issue 1, PP’9'33 $ See The G/ofeoZ Economic Crisis; Assessing VuZnerofeifitp PViffc a Poverty Lens (2009) ujujiu.siteresources.ujorfijfeonfe.org feit.ip/TFiinfe?? 9 Richard Duncan, The Dollar Crisis: Causes, Consequences, Cures (2003).

The multiplier in the formula is (i+i)(nÿi), where i is the interest rate and n the duration, in number of years, of the investment project. il These historical case studies are detailed in Lietaer (2000) and Lietaer & Belgjn 10

(2011).

Quoted in Meadows er a/. (2004) p.17.

13 Edward Abbey, The Second Rape of the ftVsr (975) p.i&3 14 Margrit Kennedy, Interest- and Inflation-Free Money (1995). 15 Hazel Henderson, The Politics of the So(ar Age; Alternorites to Economics (19&1) P.22S. and P. F. Henshaw, 'Linking Economics andNatural Systems Physics5, 20 March, 2009. Online at u?u?u\fjjnqpseo.com ~ 6it.(jj;/Trfinfc;?6 l£ In fact, our system’s permanent growth pressure is made up of at least three aspects: first, marketing strategies that inducing constantly shifting desires: second, planned obsolescence (where objects, services or practices are no longer wanted or usable even though they could still be); third, the credit system whose effects we are emphasising in this book. See Serge Latouche (2004) and (2005). 17 Source: u;mu;.chrismartenson.com bit.hj/TPlink,?? 1S Ann Pettifor, The Coming First- R'orid Debt Crisis (2006). 19 Source: h ttp:ffen.wikipedia.org bit.lu/TPlink$8 2fi H. C. Binswanger goes considerably further in citing reasons for forced growth. See H. C. Binswanger, GeZd und Nature Das wirtschaftliche tyocftsfum zwischen Okonomie und Okologie (1991) 21 See, e.g., Daly (1996). 22 iL-ajuj.ZoL’eorrfo.ner bit.lu/TPlinkÿo 23 Toynbee (1960). For more recent work along the same lines, see for instance Jared Diamond (2005). 24 Joseph E. Stiglitz, rOf the i%, by the 1%, for the i%\ Vaniftÿ Fair, May 2011, 2£ Zbigniew Brzezinski, The Choice: Global Domination or Global Leadership (2004),

p.217,

26 For instance, the Equity' Index developed by Franz Joseph Radermacher that empirically measures the full- range degree of income distribution in a country puts Brazil and Mexico at 0.27 and 0,28, respectively, (Theoretical communism, which w ould impose exactly the same income for everybody, w ould be at 1.00). In contrast, this index reaches 0.65 for China, 0.55 for Korea and 0.62 for Japan. (Note that the US is at 0.47 on that scale, and the European Union at 0,54.) It seems that economic growth is hurt when the index remains roughly below 0.45 or above 0.65, For full

details, see Franz J. Radermacher (2004) pp.8$-l20. 27 John Rawls, A Theory of Justice (1971). 2& Kennedy (1995) p.2& 29 Louis and Patricio Kelso, Two Factor Economy: How to inm a miiiion workers into capitalists on borrowed, money (1967) quoted in Hazel Henderson (2006) p.164. See, e.g., Belen Balanya etal. (2003) and Greg Palast (2003). 31 http://en.wikiquote.ora bit.lv/TFlink40 32 trmr.commondreoms.oro * bit.lv/TFlink4i 33 G/obai Trends 2015 (Central Intelligence Agency, April 2007). 34 Robert Putnam et at., Making Democracy Work: Citric Trodirions in Modern Italy (1994), p.167. One of Putnam's more recent definitions also remains very much in line with this: “Social capital refers to connections among individuals - social networks and norms of reciprocity that arise from them”. Putnam (2000) p.19. 35 Lyda Judson Hanifan, The Rural School Community Center1, Armais of the American Academy ofPolitical and Sociai Science, no. 67 (1916), p.130. See also Alexander Grimme (2009). 36 Hazel Henderson: RuiZding a Win-Win World: Life beyond Economic Warfare (1996) p.212. 32 Marcel Mauss (1920); Gaude Levi-Strauss (1949); Lewis Hyde (1983); Charles Eisenstein (2011). 3fi Elizabeth W. Dunn erai. 'Spending Money on Others Promotes Happiness1, Science 319 (21 March 2008), pp,i6S7-&. 39 Paolo Vanin et ai. ‘On the Possible Conflict Between Economic Growth and Social Development1, in Benedetto Gui St Robert Sugden (2005). 40 Putnam era/. (1994). 41 Francis Fukuyama, Trust: Sociai Virtues and the Creation of Prosperity (1995). 42 Manuel Castells, Das Jn/ormarionsreita/ter (Ed, II, 2002, pp.275sq) and (Bd, III, 2003, chapter 3), 43 Gerry Rodgers, Charles G, Gore and Jose B, Figueiredo (eds), Social Exclusion: Rhetoric, ReaZiftj, Responses (1995) and Enzo Minigione, LTrban Rouertp and the Underciass - A Reader (1996). 44 James Coleman (1990), especially Chapter 12, and Putnam (2000). 43 The story of the Eleventh Round is extracted from The Future of Money (Bernard Lietaer, 2001). It is a simplified illustration for non -economists, isolating the impact of interest on money on the system. To isolate that one variable, the hypothesis of a zero

growth society is assumed: no population increase, no production increases, or quantity of money increases. In practice, of course, ail three of these variables can grow over time, further obscuring the impact of interest. 46 Partha Dasgupta, 'Social Capital and Economic Performance: Analytics5 in Ostrom & Ahn (2003).. 47 Putnam (2000); Paul S. Adler & Seok-Woo Kwon (2002); Yaojun Li erai. (2003). 48 See e.g. Martin A. Novak ef a/. (2004). Among the seminal contributions to this vast area of evolutionary game theory, see Robert Axelrod (1984) and Elinor Ostrom

(1990). 4 Q: George Loewenstein, Scott Rick and Jonathan D. Cohen, *Neuroeconomics5, Annua! Reuieiu of Psychology, vol. 59 (200S), pp.647-672: Dan Ariely, PVedietabip Irrational: The Hidden Forces That Shape Our Decisions (2009). 5fi Including the Nucleus Accumbens, the amygdala and the uenfra! pa!!idum. 51 Alain Dagher, 'Shopping Centers in the Brain5, Neuron, vol. 53 (2007), pp.7-&; Brooks King-Casa etal. 'Getting to Know You: Reputation and Trusting in a Two-Person Economic Exchange5, Science, 308 (1 April 2005), PP.7S-S3. SI Kathleen D. Vohs etai, The Psychological Consequences of Money5, Science 314 (17 November 2006), pp.1154-6; Carole E. Eurgoyne and Stephen E. G. Lea, 'Money Is Material5, Science 314 (17 November 2006), pp.1091-2, 53 S.G. Lea, R.M. Tarpy and P. Webley, The Jndiuidua! in rhe Economy: A Textbook for Economic Psychology C19S7); and G. Seyfang and K. Smith, The Time of our Lives: Using time banking for neighbourhood renewal and community capacity building (2002). 54 Cecilia Aslund, Bengt Starrin and Kent W. Nilsson, 'Social Capital in Relation to Depression, Musculoskeletal Pain, and Psychosomatic Symptoms: A Cross-Sectional Study of a Large Population -Based Cohort of Swedish Adolescents5, BMC Public Healthy vol. 10 (2010), issue 715 (10 pages), 55 See I, Kawachi, B. P. Kennedy, K. Lochner and D. Frothrow- Stith, 'Social Capital, Income Inequality and Mortality5, American Journai o/Plib/ic ffeaith, vol. S7 (1997), no. 9, PP.1491-149S, 56 James Buchan, Frozen Desire: the Meaning of Money (1997). 52 Extracted from Margrit Kennedy and Bernard Lietaer, Regionalwaehrungen: Neue Wegezu nachhaltigem PVbhisfund (2004) p.30.

Chapter VI The Institutional Framework of Power "The study of money, above allfields in economics, is the one in which complexity is used to disguise truth, or evade truth, not to reveal it.” - John Kenneth GalbraithA The final aspect we must consider is how power relates to money, and vice versa. We do this by examining the respective roles of governments and the financial system in the monetary domain. Historically, governments and banks have had a complex and sometimes conflicting relationship. This chapter examines some aspects of this relationship. Semantic Traps The domain of money and the relationship between governments and the banking system is fraught with semantic traps. For instance, the usual label used to describe conventional money is ‘national currency', implying that the national government plays a key role in the creation and circulation of money. In reality, the money supply consists primarily of privately issued bank-debt money. This private proportion hovers now somewhere between 95% and 97% in most countries. 1.

There is also a great deal of emphasis on central banks being ‘independent',

meaning ‘independent from any political influence’. What is not meant is independent from the influence of the banking system’; however this remains unstated. For instance, the majority of board members of the US Federal Reserve are bankers.

Most economics textbooks define money as: a unit of account, a medium of exchange and a store of value. Because these are threefunctions of money, they characterise what money does. This is different from a definition of what money is. With such a widely accepted functional definition, there is actually little real inquiry into the nature of money. Our own working definition of money is as follows: ‘money is an agreement within a community to use something standardised as a medium of exchange\ In contrast with the

traditional functional definition, if an agreement does not work, one can at least imagine changing it. One might also envisage that different instruments could perform some - but not necessarily all three - functions.ÿ

There are other examples of language traps.3 When an individual or a business gets a loan, the word used is ‘credit'. With governments however, the word used is always ‘debt’. The two processes are identical. But ‘credit' has someone trusted you and considered you positive connotations ‘creditworthy'; while ‘debt’ has negative connotations (you are indebted to someone). Similarly, individuals pay ‘interest to the bank' while governments ‘service their debt’. Here again two different terms refer to the same process. However, servicing a debt is an anonymous process without an identifiable receiver. Many countries, including France, do not even have statistics separately tracking the interest they pay on their national debt. Only the total debt (principal plus accumulated interest) is actually published, so that neither the amounts nor the recipients of this ‘debt service' are visible. Notice that all these semantic signals are consistent: they always support what we will describe below as the ‘Official Paradigm’ of money and finance. These semantic signals are not accidental, even if some of them can be traced back several centuries. We can therefore assume that these semantic signals reveal a coherent power strategy related to the issue of control and power. Governments have the right to exert power over their citizens and over the

businesses active on their territory. Therefore;, whoever can control governments can project pow er all over the world. The Nexus of Power and Money

Power as conceived in this context is ‘power over’: the capacity to mobilise resources and control the behaviours of populations. A more powerful country or person is therefore one that can mobilise more resources, and motivate or control a greater number of humans, than another country or person. Many tools exist to obtain and exert power. They include the creation of specialised institutions (e.g. central banks, armies, etc.); the bestowing of hierarchical or honorific titles; the capacity to offer rewards or inflict punishments in conjunction with an effective enforcement mechanism (e.g. police, prisons). The most extreme forms of power are a country’s capacity to use coercion internally (e.g. requiring the payment of taxes or drafting someone into the army), or externally (through war or the threat of war).

Friedrich Nietzsche defined money as "the crowbar of power”.4 Napoleon similarly claimed that three things were needed to effectively wage war: “Money, money and money". Napoleon's realisation of an ironclad connection between money and war was hardly new. Twenty’ centuries earlier, the Roman statesman and orator Cicero concluded that, "the sinews of war are unlimited money".5 Political and financial historian Niall Ferguson provides an insightful analysis of the connection between money and power in modern times in his book The Cash Nexus. He show's how most significant financial and fiscal innovations of the past three hundred years have evolved from the need to finance wars. “The costs of war have fluctuated quite widely throughout history'. These fluctuations have been the driving force of financial innovation. Today's monetary' framework is therefore an institutionalisation of arrangements between government and the financial system, historically negotiated in a context of war.

Ferguson's ‘square of pow'er' singles out two key institutions as particularly relevant on the governmental side: the parliament (i.e. representative

democracy) and a professional tax bureaucracy. Within the financial system, he similarly bestows specific roles on the central bank and on national debt (see Figure 6.1).

According to Ferguson, the dynamic between these four institutions explains the evolution of the nexus between power and modern money. A particularly effective synergy among these four institutions emerged for the first time in Britain during the 18ÿ century. It is this synergy that made it possible for Britain to industrialise, defeat Napoleon, and build its empire. Let us briefly summarise the specific role played by each institution. Government Tax Bureaucracy

Parliament

Square of power

National Debt

Central Bank

Financial Sector Figure 6.1: Niall Ferguson's ‘Square of Powers

A professional tax bureaucracy was an innovation introduced in England in the early 18 century'. It proved significantly more effective at raising government income than the private ‘tax farmers' or individuals mandated by the king to collect taxes, as was still the practice in France at the time.

Today we could call the French approach a privatised tax collecting system. It is estimated that half the revenues that the French tax farmers generated

never reached the government, simply because they kept it for themselves,ÿ In contrast, between 1650 and 1715, the new fiscal bureaucracy in England managed to multiply government revenues by a factor of 8, and a century later by a factor of thirty-six,3 The relevance and importance of a professional tax bureaucracy prevails even today: when this institution appears too weak, as was the case during the Greek sovereign-debt crisis of 2011, the financial markets will tend to require higher interest rates, which can make the burden of servicing national debt unbearable,

The second player in the square of power is parliamentary institutions, which were created to represent taxpayers politically. Parliaments legitimised the budgetary process, thus enhancing a government’s capacity to raise revenue, ‘'For most of history, direct taxation could be collected only with the cooperation of the richer group of society. For that reason, the widening of the direct tax ‘base’ has very often been associated with extensions of political representation, as taxpayers have traded shares of their income for participation in the political process, a fundamental part of which is the enactment of tax legislation, „.The slogan ‘no taxation without representation’ neatly encapsulates the tr a de-off,”ÿ!£ The expansion of access to the electoral process from a wealthy landowner elite to universal suffrage was the keystone marking the political evolution of the 19th century. The final step in achieving universal suffrage was attained during the early 20ÿ century, when women were allowed to vote in most countries, On the side of the financial sector, the development of a marfcet for government debt made it possible to deal with sudden increases in expenditures, typically triggered by wars. For a government, the benefit of borrowing was to spread the costs of a war over time, and smoothing out the subsequent need for increased taxation over many years. While private debt has more than 5,000 years of recorded history, the emergence of public debt is much more recent. The earliest government debt goes back to 12ÿ century Venice, At that time, public debt was secured through a state tax monopoly on salt, of which the revenues were earmarked for debt service and redemption,

The modern market for governmental debt took off only after the English Consolidating Act of 1751, in what became known as the British 'consols’ (the

predecessors of today’s gilts’, and all other government bonds). The confidence that interest will be paid on such debt critically depends on the government’s capacity to tax its citizens.

Finally, a central bank w as created to become the ‘guardian’ of the monetary paradigm with the task of maintaining the monopoly of a single currency, created through bank-debt. Central banks were also given responsibility for stabilising the entire system - saving it even from its own follies if needed during a currency or banking crisis* In this way, central banks were also entrusted with the role of lender of last resort, a systemic fireman role* Whether central banks are willing or allowed to play that role can matter a lot to both governments and banks*!* Each of these four institutions has its own specific historical roots and characteristic path of evolution in different countries* The two strategic questions raised by the evolution of the square of power are: * Why should we expect that a synergy that was effective when money took the form of precious metals - during the early industrial age, a period of intense nationalism and empire-building in which environmental concerns couldbe ignored - still remain appropriate for a post-industrial society'? Since the 1970s and the official abandonment of any trace of the gold standard, money has officially taken the form of pure ‘fiat money', meaning pure information* The 21st century' is also a time when the notion of empire building has become obsolete, and when our society faces some unprecedented challenges* * Why do three out of the four corners of Ferguson’s square of power parliament, a tax bureaucracy' and national debt - all have as their common denominator the core issue of taxes? We will explore the critical role of taxes in defining the relationships between government and the financial system later in this chapter* How did we get Here?

Aristotle is acknowledged as the originator of the 'science of money'* He asserted that money exists "not by nature, but by law"*!2 Thus, money is not

something that comes out of a farm, a mine, a mint, even a printing press or a computer. Laws are created by those who exert sovereignty. How did the creation of money become predominantly privatised if it only exists by law? While the answer to this question and the timing are different in each country, they all share a similar sequence which Heinrich Rittershausen has well documented:-Ăż

In exchange for financing a w'ar, a private bank receives the exclusive licence to issue paper notes, thereby becoming a central bank, ÂŁ, Government tax offices accept these paper notes for tax payments in addition to metallic money, 3 The centralb ank b ecomes a sour ce of credit, 4, An emergency' occurs - usually another w'ar or major political crisis and a shift of power takes place between the government and the bank, 5, More paper money is issued than there are metallic reserves. To avoid a run on the bank, the convertibility' to metallic money is legally abolished and the acceptance of the notes becomes compulsory, 6, The paper currency becomes the only measure of value, 1.

The oldest agreement prototyping this sequence can be traced back to 1668 in Sweden, when the power of emitting paper money was granted to the Bank of the Estates of the Realm (now the Riksbank or Swedish central bank). This took place when the Swedish crown urgently needed to fund a war against Denmark, Similarly, the Bank of England, founded in 1688, was granted the monopoly of paper money emission by King William of Orange in 1694 to fund a ÂŁ1,2 million war against the French, From England, this approach to money creation spread throughout the world. The Old Lady of Threadneedle Street, as the British central bank in the City of London is still referred to, "is in all respects to money as St. Peter's is to the Faith, And the reputation is deserved, for most of the art as well as much of the mystery' associated with the management of money originated there."id For the USA, this same sequence was completed with the Federal Reserve Act of 1913,15

While it is often assumed that the relationship between the banking system

and governments has remained unchanged over the centuries, this has not necessarily been the case. The case study of the Banque de France and the French ‘Law of 3 January 19 73’ illustrates howT a more conflicted relationship between governments and the financial system can be generated. These tensions are currently being manifested in the ongoing sovereign debt crises of £011-12.1ÿ Box 6.1- Chronicle of a Predictable Debt Crisis

THE CASE STUDY OF FRANCEÿ

The creation of the French centra] bank, the 'Banque de France’, dates back to 18 January, 1800. It follows the sequence described by Rittershausen. It was initially set up as a privately owned joint stock company with a share capital of 30 million francs. Napoleon Bonaparte, still only 'Consul’ at the time, owned parts of the shares, as did several members of his entourage. Annual general meetings were open to the two hundred largest shareholders, who became known as France’s richest ‘deux- cents families’. Fifteen Regents were appointed to sit on the General Council administering the Bank, as well as the three Censors who supervised the

Bank’s management.

The B anque de France experienced several difficulties during its first years, including a crisis in the government’s finances and a fall in its gold reserves. This led to a restriction in the redemption of bank notes. As a result, Napoleon implemented reforms giving him greater say in the management of theBank. On 22 April, 1806, a new law replaced the Central Committee with a Governor and nvo Deputy Governors, all three of whom were appointed by Emperor Bonaparte. Two years later, the Imperial Decree of 16 January, 1808 set out the Basic Statutes ’which governed the Bank’s operations until 1936The political upheaval of 1848 led to the imposition of 'forced currency’ acceptance, freeing the Bank from the obligation to redeem its own notes for metal (i.e. step 5 in Rittershausen’s sequence). The Bank’s notes became legal tender and individuals were obliged to accept them for all payments. Forced currency and legal tender were eliminated by the law of 6 August 1850 but reinstated during the Franco- Prussian war of 1870. Thereafter, there were no further challenges to the status of the Bank’s paper money as legal tender.

Following the victory of the Popular Front in the 1936 general election, the French government decided that it was no longer in the public interest for theBank to be governed by private company law. The Act of 24 July 1936 gave the government the means to intervene more directly in the management of the Bank. Most of the Councillors were appointed by the Government to represent economic and social interests as well as the general interest of the nation. This was only a prelude to the nationalisation of the Bank, decided by the Act of 2

December, 1945, just after France’s liberation from German occupation. This Act stipulated that the capital of the Bank would be transferred to the State on 1 January, 1946. The shareholders were to receive four 20 -year bonds for each share. The last 3& Banque de France bonds were redeemed on 1 January, 1965.

Throughout its entire history, the Banque de France handled the Treasury’s cash transactions free of charge and granted the government interest-free advances to meet its financial needs. This changed with the Lawf of 3 January, 1973.ÿ2 Article 25 of this law states tersely: The national Treasury cannot present its own instruments for discounting at the Banque de France. In other wfords, for the fi rst time since 1800, the French government had to borrow' exclusively from the private sector, and thereby pay interest on any newf debt it contracted. Figure 6.2 shows what this has meant in practice. 1

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Figure 6.a: French government debt as % of GDP: Official debt vs, debt computed without interest, 1979-2009ÿ, Thelower line presents what would have happened to Frances national debt under the pre- 1973 rules: a drop from 2 1% to 8.6% today, In contrast, under the new rules, national debt surged from 21ÿ6 to 78ÿ6, No spendthrift government’ can beblamed in this case... Compound interest explains it all! At the end of 1979,2ÿ France’s government

debt was the equivalent of C2 3 9 billion or 21% of

its GDP at the time. Thirty years later, by the end of 2009, this almost quadrupled to €1,088 billion or 78S& of GDP. Had Article 25 of the Law of 3 January, 1973 not been in force, the French government would have saved €1,306 billion in interest by 2009, and the country’s total public debt would currently only be 8.6& of GDP. These figures should challenge the often made claim that increases in sovereign debt are due exclusively to 'spendthrift’ governments. For France, the cost of this additional interest amounts to "€45 billion per year, which represents the cost of building three 'Charles de Gaulle’ aircraft carriers every year-, or buying 600 Airbus A320 planes; insulating (at the rate of €10,000 per household] some 4,500,000 homes; or the salary (at a French median salary of €18,000) for 2,500,000 people!'ÿ Should commitments of this scale not be democratically debated before they are implemented? Does financing even one additional aircraft carrier not require some form of

parliamentary debate and approval? A version of the French Article 25 has been embedded in the EU’s Maastricht Treaty as Article 104, and in the Lisbon Treaty as Article 128. These decisions seem to have been reached without much open debate or explanation about their implications for future European governmental finances. As French economist Jacques Sapir stated:

‘The single [European] currency is a vector of [the] rise in debt, because it imposes on countries the obligation to finance rfcemsefoes on fheÿinancia? markets. The institutions of the single currency, from the Maastricht Treaty to the Lisbon Treaty, indeed forbid states either to go directly to the central bunt’s discount window, or to impose on banis the purchase of government debt in proportion to their assets. ...In France rbis wasforbidden by a 1975 Law. Bur what a law has done, anorber law can also undo. The financial markets become the only possible source ofpublic financing. As a result, they sanction heavily both the level of[government] debt and the weak growth prospects.

...

What changes are available to Europe that would reverse or soften the impact of today's monetary' arrangements? The most radical policy' option proposed used to be known as the ‘Chicago Plan' and dates back to the 1930s* While it would indeed be a far-reaching policy' shift, it is not an option we actually recommend for reasons explained at the end of this chapter* 7* The 'Chicago Plan*

aIf the American people ever allow private banks to control the issue of their currency,fi rst by infl ation, then by deflation, the banks and corporations

that will grow up around [the banksjwill deprive the people of allproperty until their children wake-up homeless on the continent their fathers conquered. The issuing power should be takenfrom the banks and restored to the people, to whom it properly belongsf US Congressional Subcommittee Record, 1937

Usually attributed to Thomas Jeffersonÿ After the 1929 crash, two banking reforms were proposed in the USA to make sure that ‘it would never happen again’. One of them was the Banking Act of 1933, also known as the Glass-Steagall Act. It strictly separated banking activities between Wall Street investment banks and high-street banks. However, the best-known academics of the time favoured another proposal known as the ‘Chicago Plan’. Its promoters included most leading American economists of the 1930s: Henry Simons and Paul Douglas from Chicago University, Irving Fisher from Yale (who published a book about it £4), Frank Graham and Charles Whittles!ey from Princeton and Earl Hamilton from Duke University. Among its supporters was also a young economist called Milton Friedman, later to be known for very different monetary views.

The quickest way to explain the Chicago Plan is that bank-debt money would be made illegal. The government would itself issue a currency" to be used in payment of all debts, public and private.25 Banks would thereby become simple intermediaries, service providers taking in deposits, holding a fraction as reserves and lending out the remainder. They would be forbidden to lend out more than the deposits they collected. In other words, banks wouldhave to apply a 100% compulsory reserves rule and, since no bank-debt money could be created at all, banks would defacto belimited to the role of money brokers. Ironically, that is exactly what those who believe the Official Paradigm have believed all along! Under powerful and effective pressure from the banking lobby, the Chicago Plan was abandoned and the Glass-Steagall Act was enacted. Banks presumably preferred this solution since it would lessen the impact on their core business model. They may also have thought it would be easier to

eventually repeal Glass-Steagall than to re-privatise money creation once governments had realised the advantages of the Chicago Plan. And right they were: Glass-Steagall was repealed with the Gramm-Leach-Bliley Act in 199 9? signedby President Clinton. Since then, this repeal has been blamed for having triggered the subprime crisis and the collapse of Lehman Brothers in September 2008, which precipitated the global banking scramble leaving so many governments over-indebted. Reinstating some form of the Glass-Steagall Act, or implementing some version of the Chicago Plan, are once again being debated. Predictably, it is the former that meets with more approval from both bankers and regulators. In the UK, the equivalent of the Glass-Steagall Act w’as enacted in 2011. In the USA, Paul Volcker, ex-Chairman of the Federal Reserve, is similarly pushing for some version of Glass-Steagall. In contrast, Congressman Dennis Kucinich is proposing the American Monetary Act,2$ an equivalent of the Chicago Plan. On 26 July 2011, Kucinich invited Professor Kaoru Yamaguchi from the University of California at Berkeley and Doshisha University in Japan, to give a congressional monetary briefing on this idea. Yamaguchi’s paper22 uses a systems approach to show that the liquidation of debts under the current monetary' regime will trigger multiple recessions and massive unemployment in the USA with contagion to other economies. In contrast, under the American Monetary' Act, debt reduction and even debt liquidation can be put into effect without causing recessions, unemployment and inflation, either in the USA or abroad.

Realistic debt reduction is not the only argument in favour of nationalising the money creation process. James Robertson2£ shows that this change would provide the government with significant additional revenue to spend on what it considers relevant. In the case of the UK, this would represent both: * an annual total bonus to all taxpayers of about £75 billion * a one-off benefit to the public purse totalling some £1,500 billion over a three-year period of transition from the existing commercial-bank-created money supply to the new debt- free money supply Professor L. Randall Wray from the University' of Missouri-Kansas City' offers

another strong argument: the availability of government“issued currency would make it possible to ensure zero unemployments without inflation,ÿ In conventional economic theory or practice, such an outcome is considered impossible - the equivalent to squaring the circle. Notwithstanding all these positive arguments in favour of the Chicago Plan and its contemporary variants, it is not the solution we recommend in this Report, Let us explain

why, Reasons for Not Recommending the Chicago Plan

While we appreciate the strengths of the idea of nationalising the monetaiy creation process, there are five reasons why we do not recommend this solution, 1,

Replacing a monoculture with another monoculture is not the way to generate diversity in exchange media. As was shown in Chapter IV, any monoculture leads to a structural instability. Replacing a private monopoly with a public one wouldn't resolve the problem of structural fragility, While it is true that a ‘Chicago Plan’ reform would eliminate the risk of widespread banking crashes and of sovereign debt crises, there would still be monetary’ crises. In other words, as was shown in Chapter III, the 145 banking crises and 76 sovereign-debt crises that have hit the world since 1970 wouldhave been avoided if such a reform hadbeen in place. The 208 monetary' crashes would not necessarily have been avoided, If governments were the only ones in charge of creating money, there might be a risk of inflation rising to a greater extent than it has in the past. Such a risk is real and most recently demonstrated in 2009 by the hyperinflation crippling the Zimbabwean dollar after President Mugabe instructed the central bank to print its currency' by the trillions, The fourth reason can be summarised as ‘political realism’. Any version of the Chicago Plan will be fought to the death by the banking system because it threatens both its power base and its business model. Even after the excesses triggering the 2007-2008 collapse, or in the middle of the Great Depression of the 1930s, the bankinglobby managed to deflect the implementation of any significant changes. Recall that in 2010, for every'

elected official in Washington, there were three high-levellobbyists working full-time for the banking system. Thomas Friedman writes in theNew York Times: “Our Congress today is a forum for legalised bribery. One consumer group using information from Opensecrets.org calculates that the financial services industry,including real estate, spent $2.3 billion on federal campaign contributions from 1990 to 2010, which w'as more than the health care, energy, defence, agriculture and transportation industries combined. Why are there 61members on the House Committee on Financial Services? So many congressmen want to be in a position to sell votes to Wall Street.”3i In Europe, there is no awareness of this problem because no legislation is in place requiring lobbyists to register at the European level. What are the chances of something as radical as the

Chicago Plan being implemented when legislators themselves are part of an army of bank lobbyists? 5. The final argument is about risk. Nationalising the money creation process cannot be done on a small pilot scale. It must be implemented on a massive, national scale or, in the case of the euro, a multinational scale. Any change always involves the risk of unintended consequences. Logically, large-scale change involves greater risk. It is certainly a higher risk than any of the options presented in the next chapters.

If not the Chicago Plan, then what can governments do at this point? Two stories are relevant. The one most people are familiar with is referred to as the 'Official Paradigm’ because it is embedded in the majority of financial media and mainstream economic textbooks.££ It does not offer governments many options except that of submitting to the dictates of the 'financial markets’. The second story is the 'Fiat Currency' Paradigm’ which opens up a very' different set of possibilities.33 3. The Official Paradigm Governments must, like any household, raise the money needed to pay for what they do, either through income (levying tax revenues) or debt (issuing governmental bonds). Banks are intermediary- service providers that collect

deposits, hold

small fraction as reserves, and lend out the remainder to creditworthy private or governmental entities that require it* a

If this story sounds familiar, it is because it provides the implicit and/or explicit background for most financial commentaries in the media, as well as for many banking and finance economic courses* It is the narrative used by rating agencies, which is not surprising since they are mostly bank-owned. This official story is what some politicians refer to as ‘sound government finances’, particularly when austerity measures are introduced. According to this story, governments are at the mercy of opaque ‘financial markets’* It justifies the joke by James Carville, the director of President Clinton’s 1992 electoral campaign: “I used to think that if there was reincarnation, I wanted to come back as the President, or the Pope* But now E w'ant to be the financial market: You can terrify anybody! ”34 A long time ago, this official story did indeed reflect reality* This was the case, for instance, when the Byzantine Empire issued the bezant, a gold coin issued with the same weight (4*55 grams) and same purity' (98%) for a record 700 years*35 Producing these coins on such a consistent basis required a continuous supply of the precious metal* This gold was obtained through

mining, conquest, trade and taxation* By the late 19th century', the official story' became less and less true* During

the latter days of the gold standard, the actual gold reserves of the Bank of England were treated as a state secret, because the amount of goldbacking for the pound Sterling was much lower than publicly claimed*ÿ President Nixon removed the last vestiges of the gold standard in August 1971 when he suspended convertibility between the US dollar and gold, thereby severing the last remaining link between the money system and any physical reality' or commodity'* The key point is that whatever governments choose to accept in payment of taxes automatically gives enormous power to those who produce or control that particular item* When sovereigns chose to be paid in wheat, as in Mesopotamia, everyone dealt directly or indirectly with wheat producers, and farmers played a pivotal role in such a society'* WTien governments chose to be

paid in gold, gold producers and gold hoarders held the power. If governments choose a fiat currency created through bank debt, it will be banks. If the issuer of the currency is the government itself, then it will be the government that is

empowered. 4. The Fiat Currency7 Paradigm Officially since 1971, all national currencies operate as pure ‘fiat’ currencies, he. where money is created out of nothing ('ex nihilo’) through simple bookkeeping entries. This fiat currency paradigm is succinctly summarised by James Galbraith: "When government spends or lends, it does so by adding numbers to private bank accounts. When it taxes, it marks those same accounts down. When it borrows, it shifts funds from a demand deposit (called a reserve account) to savings (called a securities account). And that for practical purposes is all there is."32 In other words, sovereign governments are not like any household, as claimed in the Official Paradigm.

"The government taxes us and takes away our money for one reason - so we have that much less to spend, which makes the currency that much more scarce and valuable. Taking away our money can also be thought of as leaving room for the government to spend without causing inflation."3fi This does not mean that there are no consequences when a sovereign government overspends by over-using these accounting entries. Such consequences take the form of inflation and/or reduction in value of the currency on the international markets. What is the role of the banking system in all this? Simply put, they administer the giant accounting system that keeps track of money flow. They are also in the business of creating bank-debt money with the expectation of making a profit. By ‘making loans', banks buy 10Us from borrowers in exchange for providing them with a credit in fiat money. In principle, banks can make loans only to the extent they have sufficient reserves.33 In practice, however, “banks do not wait for excess reserves before making loans and creating deposits. Rather, if faced with a credit-worthy

customer and a request for a loan, a bank makes the loan* It then operates to obtain reserves as necessary to meet legal requirements* If banks in the

aggregate are short of required reserves, the central bank automatically must

supply thermae In spite of rhetoric about Fed policy to discourage such borrowing it is simply impossible for the Fed to refuse to supply the reserves needed by the system."41 It is even harder for a central bank to get banks to make more loans if they are not inclined to do so* When central banks try to push banks to lend, as was the case after the crash of 2007-2008, it is like trying to â&#x20AC;&#x153;push on a stringâ&#x20AC;?. All four major central banks of the rich world those of the USA, Britain and Japan and the European Central Bank - have their lending rate near zero. Japanâ&#x20AC;&#x2122;s has basically been stuck there since the 1990s, without succeeding in a relaunch of its economy.Ai

So, contrary' to what is often claimed, the degree of control central banks exert over the creation of bank-debt money is more theoretical than practical* Central banks are reduced to the role of pricing the marginal cost of reserve funds for the banking system. They determine only the cost of getting additional reserves from the central bank, a cost that banks pass on to their clients with an additional mark up. They do not determine the amount or timing of bank-debt money being created by the banks. The development of the massive interbank market has further reduced the need for banks to go to the central bank's discount window. This has further marginalised the influence of the central banks. Central banks thus have more limited control over the banking system's money creation process than is generally believed.

They also seem to have difficulty grasping the notion that in a floating-exchange world, when a country' such as the USA pumps trillions of additional dollars into its economy, the inflation that is being created may manifest on the other side of the world. For instance, these additional dollars could end up being spent by wealthy Russians on real estate on the French Riviera, regardless of what the French or European Central Bank may want to do about it. In contrast, governments are not as powerless as they seem, at least in theory. Governments are needed continuously for giving value to any fi

at-crcated currency. However, based on their actions, governments are not making use of the pow er they have over the private banking system.

When governments require payment of taxes in a specific medium of exchange, they automatically increase its scarcity. As a result, that medium acquires more value. A sovereign government can therefore choose the instruments of payment it wants to give value to. In so doingr it can determine the kind of effort its citizens must make or the types of behaviour they must engage in to obtain these instruments. This conclusion will be critically important for the design of government-initiated monetary solutions, as discussed in Chapter VIII.

There is still one last veil to be lifted in the monetary domain. The financial system exerts power over governments by influencing beliefs. As George Soros pointed out with his reflexivity theory,44 belief creates reality. It is a world of self-fulfilling prophecies. In finance, if enough people believe gold will defy gravity and double in price, the price of gold will actually double! Although the belief may not be solid enough to keep the gold price at that level when real-life supply and demand manifest, a big price movement will have occurred in the interim. Similarly, if enough people believe a particular government will default on its debt, investors will divest themselves of enough bonds to create substantial real pressures on that government. These pressures can even directly provoke the default. Box 6.1- Academic backing for the Fiat Currency Paradigm

The ideas resulting from the Fiat Currency Paradigjn are not new, and certainly not our creation. They can even be traced back to Adam Smith in the heyday of the Gold Standard, Smith was aware of the role of taxation in creating value for a currency, including gold. He gives an example in which anon -redeemable paper money issued by a bank could even carry a premium over its face value in gold specie. UA prince, who should enact that a certain proportion of his taxes should be paid in paper money of a certain kind, might thereby give a certain ualue to flu's paper money; even though the rerm of its final discharge and redemption should depend altogether upon the will of the prince. If the i>anÂŁ Lohich issued this paper was careful to keep the quanfiry of it

always someivfcaf below ivliaf could easily be employed in flu's manner, the demand for it

mipftf be such as fo mate it ei/en tear a premium, or sell for someu/taf more in the market than the quantity of gold or silver currency for which it itfas issued. ”45 Smith thus already knew that the key to a paper currency's value is neither its conversion to gold, nor any 'legal tender laws'. Rather, the acceptance of this paper in payment of taxes was the key to give it value.

Many other economists have put forward this same idea. Here are some of the more significant contributors and a selection of their relevant ideas and sources appears in the corresponding footnotes.

The main proponents of the Fiat Currency Paradigm in rough chronological order include Mitchell Innes,4& Georg Friedrich Knapp,42 Irving Fisher, Abba Lerner43 and John Maynard Keynes.53 Fiat- currency economists sharing similar views have even been regrouped as an economic school variously labeled Chartalists, neo -Chartalists,Si the Endogenous Money School or the State Money School. They include contemporary economists like Paul Davidson,Si Nicholas Kaldor ,53 Hyman Minsky ,54 Stephen Rousseas,SS Warren MosIer,s£ Charles Goodhart,52 Wynn GodleySfl and Randall WrayS3. While these scholars don’t all necessarily agree on many topics, they all concur that rhe systemic role of taxes is to give value to a currency, which, in the case of a fiat currency, would otherwise have no intrinsic value whatsoever. If theseideas appear new or strange, it is because they have been systematically ignored in practice, rather than because they have been proven invalid or wrong.

5. Comparing the I\vo Paradigms The same components identified in Ferguson's “Square of Power’ (see Figure 6*i above) are present in both paradigms: governments and the financial sector, governmental debt, taxes and central banks* They fit together in different ways depending on which of the two stories one selects*

The advantage of the Official Paradigm’s storyline is that it is shorter, easier to understand and ties in with ordinary people’s daily experience* Most of us have first-hand experience with the constraints of living within budgets* Anyone who has opened a savings account or obtained a loan is privy' to the

idea that banks take deposits and lend money for interest. However, when this official story is applied to our current system, it presents governments as having no options except to do whatever the financial system desires. Moreover, it depicts the banking system as a passive intermediary and service provider, and not as a central protagonist creating fiat money through

bank-debt. The Fiat Currency Paradigm story is more abstract and does not neatly fit with ordinary peopleâ&#x20AC;&#x2122;s experience. This paradigm describes a significantly different power relationship between a sovereign government and the banking system. In this version, the banking system is totally and permanently dependent on governments to give value to bank-debt money. The government, on its side, also always has the power to require payments of tax liabilities in a currency other than, or in addition to, bank-debt money. 6. Conclusion A public debate about monetary reform that could include the Chicago Plan and/or other regulatory initiatives is overdue. If an initiative akin to the Chicago Plan wâ&#x20AC;&#x2122;ere implemented, it would still be necessary to introduce greater diversity in the exchange media as such diversity is an essential condition for the structural stabilisation of our economic system. Putting the public sector in charge of the system and making it the main beneficiary of a fiat money mechanism - instead of the private sector - would not solve this structural issue. It would, in structural terms, simply replace a private monopoly with a public one. As we showed in Chapter IV, a structural solution requires creating a monetary ecosystem with diver sity in terms of means of exchange and types of issuing institutions, including the government. If the objective is to create diversity, the most logical step is not to get rid of the one large-scale system already in place. The logical focus should be on innovative, non-financial incentive systems that can function in parallel and complement current financial incentives based on bank-debt money. The next two chapters provide examples of such complementary' incentive systems, some combinations of

which, taken together, would provide the diversity needed

structurally

stabilise our 2ist-century economies, One important source of hope is the explosive growth of NGOs that now number over a million organisations worldwide. According to Paul Hawken’s research: “By any conventional definition, this vast collection of committed individuals does not constitute a movement. Movements have leaders and ideologies. People join movements, study their tracts, and identify themselves with a group —Movements, in short, have followers. This movement, however, doesn’t fit the standard model. It is dispersed, inchoate, and fiercely independent. It has no manifesto or doctrine, no overriding authority to check with, Rather than a movement in the conventional sense, could it be an instinctive, collective response to a threat? „.Can it successfully address the issues that governments are failing to do: energy, jobs, conservation, poverty, and global warming?*,ÿ More significant than their sheer numbers is the qualitative shift from being simple observers and critics to being actors implementing innovative policies. We concur with Hawken that ‘this movement that isn’t a movement’ could become a key actor in finding a solution to the impending challenges coming our way. That is why five out of the nine solutions that we propose in the next two chapters are examples of initiatives that can be implemented by NGOs, if they so choose,

Footnotes Galbraith, Money: Whence It Came, Where It PVenr (1975), p.5. 4 For instance, the Natural Savings instrument presented in Chapter VII would mainly be a savings tool, not a medium of exchange or unit of account. In many civilisations, the unit of account was also different from the medium of exchange, A case in point is Homeric Greece, where the unit of account was the ox but where, for the sake of convenience, actual exchanges were often performed with ingots of bronze or other

1 John Kenneth

commodities,

3 For the arguments offered in this paragraph, see Philippe Derudder and Andre-Jacques Holbecq (2008) p,i7. 4 Friedrich Nietzsche, Thus Spoke Zarathustra, translated by Adrian del Caro and edited by Robert Pippin (2006). * from Cicero’s 5 The original is elegantly succinct: "Neruos belli, pecuniary

Fifth Philippic. See Jon Hall, The Philippics, in EriH's Companion ta Cicero: Oratory and Rhetoric, translated by Janies M. May (2002), pp.273-304.

6 Niall Ferguson, The Cash Nexus: Money and Power in the Modern World, 1JQQ-2OQ0

(200i), p.25. 2 Ihid., p.23. £ Donald Winch, 'Political Economy of Fublic Finance in the ‘Long’ Eighteenth Century', in Maloney (199&), pp.8~26. 9 Fatrick O’Brien and Philip Hunt, The Rise of the Fiscal State in England, 1485-1815’, ffistaricaf Research, vol. 66 (1993), pp.129-176. 19 Ferguson (2001), p.77. U Greece, Ireland, Portugal and other eurozone governments are discovering the consequences of the fact that the European Central Bank (ECB) is allowed to play this lender of last resort’ role only for the banking system, and specifically not for governments.

13 Aristotle, jYichomachean Ethics, v.5, 1133.

13 Heinrich Rittershausen, Die Zentralnotenbank (1962), pp.iS-19, quoted in Greco (2009) p.40. 14 Galbraith (1975). 15 The genuine conspiracy saga of how this law was passed in the USA on Christmas Eve, 1913, just before World War I, is the topic of Edward Griffin, Tke Creature From Jekyll Island: A Second Look of the Federal Reserve (1994). l£ Much of the description below is taken from the Eanque de France website: www.barque-trancefir

—-

hftp://fr.Ufifcipedia.oro http://bit.lu/TPlink4? ifi The laconic original in French is worth quoting: “Article 25. - Le Tresor public ne peut etre present ateur de ses propres effets a l’escompte de la Eanque de France”. 19 Taken from Derudder & Holbecq (200&) p,6S. 20 This series should be started in 1973, but given that France does not have a statistical series that tracks the interest paid on government debt separately, the interest data had to be reconstructed. But data were not available to reconstruct the interest payments before 1979. The difference by 2009 should therefore be still larger than this graph shows.. 21 /hid. p,&5 22 Jacques Sapir, Font i/ sorfir de I’Euro? (2011); p,i6 and footnote 1, italics added. 23 Although m a ny letters of Th omas Jefferson, 3rd President of the United States 17

(I743~1&26)J confirm that he was highly suspicious about banks, the attribution of this particular quote to him should be considered spurious. The first printed reference to this quote has been traced back to 1937 in the US Congressional Subcommittee

Record. 24 Irving Fisher, 100% Money (1935), re-edited in 2011 by ThaiSunset Publications. 2£ Notice that while the Chicago Plan or its most recent versions (such as the one presented in Huber & Robertson [2001] ) propose to nationalise the money creation process, they have no intention of nationalising the banking system itself. Banks would continue to compete with each other and to allocate financial resources as they do today. The only - but significant - difference is that their functioning would be based on 100% reserves and they would therefore not be able to create debt money ex

nihilo. 26 See tumtn.moneflanj.orjj * bit.tu/TPlinkÿ 22 The paper, Workings of a Public Monetary system of Open Macroeconomics', was presented at the 29th International Conference of the System Dynamics Society, Washington D.C., 25 July, 2011. See www.monetaruora bir.iu/TFimfcÿn 2& James Robertson, Future Money: Breakdown or Breakthrough (Totnes; Green Books, forthcoming). Chapter 3 of this text is available on ~ bit.lu/TPlinkÿ. See also James Robertson and John Eunzl, Monetary Reform; Making It .Happen (2003) and Huber & Robertson (2001). 29 Zero unemployment w ould correspond to a much higher rate of employment than what is know*n as the rate of unemployment associated with a constant inflation rate, technically defined as the NAIRU (“non -accelerating inflation rate of unemployment'1). However, zero unemployment would not necessarily mean that all

those who w ould like to work are indeed w orking. There could still be “friction alw unemployment (i.e., people in the process of changing jobs) or voluntary unemployment. 3£ See L. Randall Wray, Understanding Modern Money: The Key to Full Employment and Price Stability (1998). 31 Thomas Friedman, rDid you hear the one about the bankers?5, The New Fort Times, 21 Oct 2011. 32 For a conventional description of today’s system, see for instance Gregory Mankiw (2003); McConnel & Bruce (200S); or Mishkin (2007). These textbooks provide no critical analysis of the limitations of the prevailing system and, in particular, offer no comparison with alternative systems. 33 For a critical analysis of the limitations of today’s monetary' system, see for instance;

Wray (1990) and (199&) and Moore (19SS). One of the most readable pieces for the general public is the almost humorous text by Warren Mosier, Seiwrt Deadly Innocent Frauds 0/Economic Policy and Soft Currency .Economics, available on www.warrenmosler.com. A more complete list of relevant heterodox economists and their publications is given later in this chapter. 34 Finoncio/ Times, 4 February 199&. 35 Its official name was the soJidus. It was first issued by Emperor Constantine (306-337 AD), and circulated widely until well into the Middle Ages, even beyond the Byzantine empire in both Europe and Asia. 36 A governor of the Bank of England (a private company at that time) was being questioned by the British Parliament: - Can you please inform us about how much gold there is at the Bank of England? - In ample sufficiency, Sir. - Can you be more precise?

- No, Sir.

32 James Galbraith in the Preface to Mosler (2010) p.2. 3& Mosler (2010) p.27. 33 This is the usual way of explaining the process by which bank-debt money gets created, which is the one we used initially in Appendix A to explain the process. In practice, the reserve limit is basically not binding. 40 If a bank is short on reserves, this 'short1 is in fact an overdraft on its reserve account with the central bank. This overdraft is effectively a loan from the central bank. So there is no way that a central bank could deny credit to a bank. 41 Wray (199S) p.n&. 43 This is one of the reasons why central banks are even more worried about deflation than about inflation. To reduce inflationary- pressures, they can make loans more expensive by increasing interest rates. But when central banks are facing deflation, interest rates can only go as low* as zero to convince people to borrow* (although the Bank of Japan has even gone as far as charging a negative interest rate to the banks to stop deflation, without much success). 43 Central banks1policies in January 2012 w*ere compared to “crazy aunts on the loose* in their desperate attempts to use Quantitative Easing, a tool that “is best kept in a locker marked Tor Emergency Use Only1is how Charlie Bean, the Bank of England’s deputy- governor, put it in 2010* The Economist, 7 January- 2012 p,5&. 44 George Soros, The Alchemy of Finance (1987).

45 Adam Smith: The Wealth ofNations, Carman Edition (1937) p.312. 46 Mitchell Innes, "What is Money?’, Banking Law Journal, voL 30 (1913), no. 5,

PP-377-4°S. 47 Georg Friedrich Knapp claims that “All means by which a payment can be made to the State form part of the monetary system. On this basis, it is not the issue, but the acceptation, as we call it, which is decisive/ (Georg Friedrich Knapp, The State Theory ofMoney [Original publication 1924; republished, New York: Augustus Kelley, 1973, p.95]) 4§ Fisher (1935). 40 Lerner created a framework called the “functional theory of finance”, which builds on the premise that “money is a creature of the state. Its general acceptability, which is its all-important attribute, stands or falls by its acceptability by the state/ (Abba Lerner, 'Money as a Creature of the State’, American Economic Review, vol. 37 (1947), no. 2, p.313). See also Abba Lerner, ‘Functional Finance and the Federal Debt’, Social Research, vol. 10 (1943), PP.3S-51. 5S Keynes w*as aware that the value of money is not generated by its intrinsic properties. “Money is the measure of value, but to regard it as having value itself is a relic of the view that the value of money is regulated by the value of the substance of which it is made, and is like confusing a theatre ticket with the performance/ (John Maynard Keynes, The Collected Writings, VblJYJV Economic Articles andAcademic Correspondence, ed, Donald Moggridge [19&3], p.402). 51 For the first time, to our knowledge, The .Economist has provided a four-page briefing about “Heterodox Economics”, mentioning Warren Hosier as part of a “neo- chartalist” school. (The Economist, 31 December 2011, pp.49-52). 52 Paul Davidson, Afoney and the Real World (1978), 53 Nicholas Kaldor, The Scourge ofMonetarism (1985), 54 Hyman Minsky, Stabilizing on Unstable Economy (1986). 55 Stephen Rousseas, Rost-Afeynesian Monetary Economics (1986). $£ Warren Hosier, (1995), (1997/8) and (2010). 52 Charles E. Goodhart, Money, Information and Uncertainty (1996). sS Wynne Godley and Marc Lavoie, Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth (2007); Wynne Godley and T. Francis Cripps, Afacroeconomics (19S3), £9 Wray (1990) and (1998), 60 Hawken (2007) p.3,

Chapter VII

Examples of Private Initiative Solutions "Thefuture belongs to people who see possibilities before they become obviousâ&#x20AC;?. Anonymous

The most common complementary currency systems today are commercial loyaltv svstems, popularised initially bv the airline industry over thirty years ago under the generic name of â&#x20AC;&#x2DC;frequent-flyer programmes'. There are now more than 15 trillion â&#x20AC;&#x2DC;miles' in circulation managed by five airline alliances, each with their specific names. These systems have proven that it is possible to operate efficiently very large-scale complementary currency' systems. However, commercial loyalty systems are also the least interesting complementary' currency' applications from a societal viewpoint: they simply motivate customers to use the same airline alliance, or return to the same supermarket chain or shop. Using one airline instead of another doesn't make much difference for society', although it does, of course, for the specific airline or shop. We will therefore focus here only on complementary' currency' innovations that have a really beneficial impact on society'. There is a great variety' of such systems and they already exist in their thousands around the world; they have

been described - and their valuable effects abundantly documented elsewhere.-i In truth, the people participating in these systems have been the

real pioneers and trail blazers of a broad monetary awareness movement on which we are simply commentating here. However, many of these existing social purpose systems are intentionally small-scale (e,g, building social capital in a particular neighbourhood), and some of their design features limit their capacity to scale-up to meet the challenges that we can expect to face in the near future. Their function can be compared with that of capillary vessels: theyplay the important role of keeping us warm and give us a pleasant colour. However, it would be naive to expect capillary vessels to be able to replace the role of an aorta in the event of a heart attack. To use a different metaphor, in a natural ecosystem, life forms are needed at very different scales: from microbes, earthworms, frogs and rabbits all the way to buffaloes and elephants. Each is vitally important at its own scale. The health of a natural ecosystem depends critically on thriving subsystems at such different scales,

Similarly, in the monetary ecosystem that this Report recommends, systems of different scales are needed. That is why we focus here only on systems that meet two criteria: they should be capable of delivering a significant beneficial societal effect, and of scaling-up as necessary, Dozens of designs exist for innovative exchange media that meet these two criteria, some already operational, many still at the design stage. In combination with the conventional money system, mixes of these could create a great variety of monetary ecosystems. In the next two chapters we discuss nine examples. Each of the examples describes a system that: * is useful in todayâ&#x20AC;&#x2122;s unstable socio-economic environment, while government budgets are under pressure * addresses a different theme or socio-economic issue such as health care, education or the environment * can be implemented as a stand-alone system; and when combined in various ways, could play a useful role in unleashing the synergies that characterise a successful monetary ecosystem

We start with the least controversial and finish with the most controversial,

moving from systems against which we expect little resistance to those which wnll elicit the most. For instance, w*e proceed from purely voluntary systems not requiring anyone’s permission to be started, to compulsory systems that would require new' legislation. We are not claiming, however, that the most demanding systems are also the most desirable,

Obviously, not all these systems need to be implemented for significant improvements to materialise. The German ‘Iron Chancellor’ Bismarck is reported to have claimed that politics is the art of the possible. Each community, city1 or country1 can therefore decide how far it wants to go and how far it is possible, in practice, to stretch policies in new’ directions* We deliberately present a very broad range of pragmatic solutions simply to illustrate what is possible, Five innovations can be implemented without government initiative or new legislation: they are the ones presented in this chapter. The other four examples, more appropriate for governmental initiative, are presented in

Chapter VIII, For all their diversity, the nine systems we describe share two common denominators. First, they are all designed to act as complementary systems, i,e, they are designed to operate in parallel with the existing national bank-debt money system. Second, they should ideally all be as transparent for their users as possible. For example, before making an exchange, each party' couldhave the right to see the other party’s account. Transparency' allows these systems to be self-policing and reduce potential fraud. These systems would be most cost-effective if they used mobile electronic devices such as mobile

phones, Again, each of these initiatives could be made viable on its own. However, if several of them were to be implemented in parallel, their cumulative effect could demonstrate the synergistic power and resilience of what we refer to as a ‘monetary' ecosystem’ in Chapter IV, They could also combine with systems that are already operational, many of which have been documented elsewhere,*

We propose the nine examples as if they were on a menu in a restaurant, Choose the one(s) that are most intriguing or relevant to your own specific domain and interest. The page refers to the place where the detailed ‘kitchen recipe’ for that particular system is to be found. We do not recommend the average reader to study all nine, it could be like ordering the entire menu at one sitting and might lead to indigestion,.. Box 7.1- Menu of Motivation Systems

PRIVATE SECTOR

PUBLIC SECTOR

NGO Initiatives:

Dor aland p.142

Wellness Tokens p.144 Natural Savings p.151 Government Initiatives: Torekes at city level p.168 Biwa Kippu environmental project p.171 Civics at the city or regional level p.173 ECOs at thenational or European level p. 179

Business Initiatives: C3 on a regional or national scale p.155 TRCon a global scale p,158

Below is a brief description of the first five models, none of which requires governmental permission to be implemented, Doraland is a system that has been proposed to help Lithuania to become ‘A Learning Country’ by stimulating grass-roots educational initiatives. It wouldbe best implemented by NGOs, organised around a new Learning

Foundation,

Wellness Tokens is a NGO initiative in cooperation with health care providers to deal with health care issues in a preventive fashion, thereby 2

reducing society-wide medical expenses. 3. Natural Savings is a financial savings product fully backed byliving trees. It would be a savings currency superior to any national currency in terms of inflation protection. It would provide an incentive to reforest areas and promote the creation and maintenance of long-term carbon sinks. 4. C3 is a Business-to-Business (B2B) system that reduces unemployment by providing working capital to small and medium-sized enterprises outside the constraints of the mainstream currency. It is currently operational in Brazil and Uruguay. 5. TRC is a global B2B currency proposal that would make longer-term thinking profitable for multinational companies by resolving the conflict between short-term financial corporate priorities and long-term societal and environmental needs.

Doraland: Creating a â&#x20AC;&#x2DC;Learning Country7 Lithuania was the first of the three Baltic States to become independent from the Soviet Union in 1990. More than twice the size of Belgium, it has a population of only 3.2 million. During the 14Ăż century, it was the largest country' in Europe, stretching from the Baltic Sea to the Black Sea. Given its small current size and lack of stereotypical tourist attractions, Dalia Grybauskaite, the first woman to become Lithuanian president, would like foreigners to visit Lithuania in order to learn something. There are two areas in which Lithuania leads the world today: it is currently the most optically wired country' in the world, and it has mobile phone penetration reaching 120 96 of the population (many people have more than one SIM card).

In October 2011, a group of public sector representatives, business and NGO leaders as well as some students, were convened by Ms. Rasa Balciune, leader of an international consultancy' headquartered in Vilnius. They were asked the question: How couldLithuania become a *Learning Country â&#x20AC;&#x2122;?

Doraland was one of the proposals to emerge from that process.

The starting point was the formation of a Lithuanian Learning Foundation

with the working title ‘Doraland’, This foundation is designed to enable individuals or groups to make one of their dreams come true, in exchange for a contractually agreed amount of ‘Dora’ currency. This currency is earned through teaching and/or learning activities, such as offering courses in English, in computer skills, in Italian cuisine or in any other skill that can be contributed,

For example, one 17-year-old at the Vilnius event had the dream of learning Buddhism in the mountains of Burma, The Doraland Foundation would contractually promise to make this experience possible in exchange for 3,000 Doras, Doraland would not only raise the funds — through sponsorships and donations — to purchase the airline ticket payable in national currency, but also arrange for the necessary contacts in Burma, The teenager could earn 3,000 Doras by teaching 300 hours of conversational English to others, for example, or perhaps by training adults wanting to acquire computer skills, Another young person wanted to spend a weekend with her hero, a Nobel laureate in physics. In exchange for 2,000 Doras or the equivalent of 200 hours of teaching an art skill, the Foundation would facilitate the meeting with the physicist. Another group might want to learn to sail around the world or to create a neighbourhood greenhouse for year-round food production. The media attention attracted by these endeavours will help to raise sponsorships and donations and can also help generate more creative and socially useful dreams, as well as more offers to teach/train a range of skills,

Under this scheme, Doras will be obtained directly from the Foundation and can be easily tracked using mobile phone technology. Non-profits are to be involved in organising the learning activities. In addition, another new non-profit wouldbe created to independently audit the earning and exchanges of the Doras,

This Dora learning-economy is intended to operate in parallel with the conventional monetary system. We are, therefore, witnessing the beginnings of an exchange media ecosystem. At the end of the first planning session, one of the participants asked the 17-year-old whether he would be willing to teach English and get paid in Lita (the Lithuanian national currency’), in dollars or in

euros. His answer was, “No, I’d prefer to get paid in Dora, because that would get me closer to my dream. These other currencies only would get me the airline ticket!” For this teenager, the Dora had already become a ‘superior currency’, a currency that he preferred over all others. Doralandis an example of a complementary system that encourages non-spontaneous but desirable behaviour patterns. Figure 7.1 summarises the Dor aland model in a flow

diagram.

Doraland (Lithuanian Learning Foundation) n contract

Conventional Money,

DORA flows

Non-Profits

Citizen(s) Figure 7.1Doraland Flow Diagram. The process starts with a citizen's dream project. Doraland makes a contract with one or more citizens to help realise their dream in return for a certain amount of Doras. People who provide teaching/ training are compensated in Doras, Non-profit organisations would play the same role in the Dora economy as corporations do in the conventional currency world: organise, motivate and audit therelevant activities.

Tokens: Overcoming Market Failures in the Health Care System The cost of health care has been growing faster than GDP in most developed countries. One medical reason is that patterns of disease burden have shifted from infectious diseases to chronic diseases. In contrast to infectious diseases, which have shorter periods of illness and faster mortality, chronic diseases allow people to live with their illness for longer periods of time. While 2. Wellness

to treat both infections and non-infections conditions has continued to improve significantly over the past decades, preventing the development of chronic diseases has not. Furthermore, medical costs are expected to continue to rise steeply in the near future due to the demographic bulge of baby boomers reaching retirement age. The challenge for current and future generations is how to achieve and optimise the health of a population without having its costs absorb an ever increasing proportion of the economy,

technology

Identifying a Market Failure: The ‘sick and alive’ bias

Market failures in health care have been well documented. Causes of these failures include asymmetric information, adverse patient selection, entry barriers, absence of risk pooling and moral hazards We hypothesise the existence of an additional market failure. In fact, no developed country really has a health care’ system; rather, they are all funding ‘medical care’ systems, The economic incentives in a medical care system are therefore skewed towards keeping sick people alive, rather than preventively keeping the general population healthy. This is because medical care stakeholders, including the pharmaceutical industry*, medical technology* suppliers and health care professionals — all acting rationally — end up earning most of their money by treating sick or unwell individuals, as opposed to providing preventive health care to a healthy population,<4 Because the vast majority of the global medical care budget is spent on acute and chronic diseases, preventive health care accounts for only a very* small fraction of the overall health care services provided in industrialised countries.S For instance, recent studies in the USA estimate that 50% of all mortality* is linked to social and behavioural factors such as smoking, diet, alcohol use, sedentary* lifestyle and preventable accidents.ÿ Yet, less than 5% of the approximately US$i trillion spent annually on health care is devoted to

addressing the root causes of these preventable conditions.2 Even if the medical care market were a theoretically 'perfect' one - with fully informed actors, no moral hazard, less asymmetry, more efficiency', fair access and so on - the economic preference for “sick and alive’ clients would remain a

problematic bias. The current system thus makes it tempting to treat an obese patient who develops diabetes by using medication, rather than by using an early detection/ prevention approach with exercise and weight-loss programmes, to mitigate or even avoid the disease. In addition, improved technology has allowed an increase in the life expectancy of chronically ill individuals, with a corresponding increase in the consumption of health care resources. Prevention is thus side-lined in the face of this additional disease burden. The ‘sick and alive’ bias then becomes an additional cause for a market failure that contributes to the ineffective systemic organisation of health care services, A Wellness Token system is proposed next to counteract this specific market

failure. Interestingly, people who study the Tong wave’ of technological changes, called the Kondratieff wave, expect that Wellness technologies will be the breakthrough in the next technological wave,£ Wellness Tokens

Wellness Tokens are specifically designed to use a preventive approach to promote and maintain the good health of participants. Just as ‘Frequent Flyer Miles' are issued by airline alliances to induce a habit of taking the same airline for all one's trips, Wellness Tokens would be issued by a Wellness Alliance to induce healthy habits. The members of the Wellness Alliance would be those organisations that have a financial interest in keeping the population healthy (e,g, insurance companies, local government and local employers). One of the purposes of the Wellness Token would be to generate changes in habits towards health promotion and disease prevention by encouraging healthy behaviours and emphasising preventive health care. Such an approach would also be a means of financing supportive care so that the elderly, the chronically ill and the disabled can remain in their own homes, and delay for as long as possible their entry' into a long-term medical facility', where the costs escalate, Earning Wellness Tokens

The Wellness Token Alliance, which could be run by an NGO or by a group of insurance companiesÿ, would issue Wellness Tokens for two types of activities:

Promoting preventive health care programmes including primary, secondary and tertiary disease prevention measures, focusing on lifestyle modification for people with or without chronic conditions - including nutrition, physical activity and stress management interventions. Such health-educational programmes have an impact on health care costs and health outcomes.is The return on investment (ROI) of such preventive programmes is estimated to range from $00% to 1000% depending on the programmed That such rates of return are available in preventive programmes provides hard evidence that the â&#x20AC;&#x2DC;sick and aliveâ&#x20AC;&#x2122; market failure is quite real. Wellness Tokens would encourage the adoption and maintenance of healthy habitualbehaviours. The payment of individuals for maintaining specified healthy behaviours has already been documented through the use of conditional cash transfers, for example to remain HIV negatived For example, a family with two obese children could participate in a weight reduction programme, monitored either through weight or, even more precisely, through the Body Mass Index (BMI). For every kilogram or BMI improvement, the family would receive 10 Wellness Tokens. 1.

Helping the elderly or disabled people requiring chronic care. In industrialised countries, the proportion of people over 60 years of age is growing faster than any other age group due to longer life expectancy and declining birth rates. By 2050, the number of people over 60 will almost double. Technological advances tend to be less relevant for home care than for other health care fields andhome care is structurally linked to personal face-to-face interactions, which makes it less costly and more humane in many cases. Therefore, having recourse to home care instead of anonymous, hi-tech hospital treatment, even in the case of chronic conditions, will make a significant positive difference to health care costs and, in many cases, to 2.

treatment outcomesd

We should insist that while the Wellness Token system is indeed aimed at improving behaviour with respect to health, it does not fall into the category' of 'neo-Victorian' sanction mechanisms where people are denied financial

support when they fall ill due (arguably) to specific behavioural patterns (he, get lung cancer w'hile having been heavy smokers or get heart disease while having a history of detrimental eating habits). Our objective here, as we explained, is educational and has more to do with awareness building and the quest for personal autonomy. That is why the system clearly emphasises preventive rather than curative measures. The idea is not to use ‘financial incentives’ in order to scare people into changing their ways, as is the case with a sanction mechanism that kicks in when the disease is already present. There is indeed a personat-responsibility-building dimension to the Wellness

Tokens, in the direction of what has been called ‘genuine autonomy’ of the patient in recent literature inspired by Evan Ellich,M The system offers positive rather than negative incentives to motivate and reward people for their behaviours rather than punish them for ‘misbehaviours’. The perception shouldbe that the system increases the opportunities available to people rather than imposing restrictions on them, This approach would also be useful in setting up support groups. Creating pods of people who are tackling a weight problem can be a very effective way to get longer-term commitment. One could then create group objectives, which —when met — earn extra Wellness Tokens for the entire group. Group support is well known as a key for longer-term maintenance of changes and improvements, Spending Wellness Tokens

People earning Wellness Tokens could use them in a number of ways, including paying part of their insurance premiums with themis or purchasing goods and services related to prevention or health promotion from providers pre-qualifiedby the Wellness Alliance, After a formal audit, local and regional businesses providing goods and services supporting preventive health care would become certified if their services and goods met specific health promotion criteria. This could include partial payment in Wellness Tokens for preventive care, biological or organic food or restaurants, health promotion/ disease prevention courses, and sports equipment such as bicycles, to name just a few examples. In this way, a family earning Wellness Tokens

because their children are maintaining their BMI could go shopping within the local community to buy organic food or a bicycle from participating vendors.

What could the businesses accepting Wellness Tokens do with them? The owmers of participating businesses could use them in the same way as their customers, to start their own wellness programme. However, the more typical option would be to cash the Wellness Tokens in for conventional currency through the Wellness Alliance. The business case for Wellness Tokens

The logic for the insurance companies and other members of the Wellness Alliance to pay for cashing-in practices works only if the savings in the cost of an unhealthy population are higher than the costs of the programme. For instance, if the cost of a non-lethal heart attack is €100,000, and if we know that losing 5 kg in weight will reduce the probability of a heart attack by 20%, this would generate an expected cost saving of €20,000 for each at-risk individual achieving that target. The rate at which Wellness Tokens are redeemed would be calculated in such a way that half the savings would be used for “Wellness Token redemptions, while the other half would reduce costs for the members of the Wellness Alliance. In the above example of an expected saving of €20,000, €10,000 could be used to redeem the tokens used. The other €10,000 wouldbe used to reduce the costs incurred by Wellness Alliance members. For the preventive care providers, the Wellness Token could function as a loyalty* currency by attracting customers who might otherwise not patronise them. From a purely financial viewpoint, the role of a loyalty currency’ is to ensure that the value to the business generatedby an exchange is always larger than the marginal cost in conventional money of serving an additional customer. The most logical participants are therefore businesses with comparatively low marginal costs. This is the case for many preventive health care providers. Some businesses have virtually no marginal monetary' costs think, for example, of a massage therapist who is not fully booked. But even a restaurant, for example, typically has marginal costs of about one third of its customers’ bills. This means that only one third of what customers spend pays

for the food itself. There is usually another third that goes to fixed costs: renting the location, heating the room, paying the staff, etc. The final third is profit. Therefore, as long as a restaurant would not otherwise be full, it makes economic sense to bring in additional customers who pay partly1 in conventional money* and partly in complementary* currency*.

The Wellness Token is a win-win approach. Going back to our example, the children become healthier and less prone to illness; the family* has additional resources to spend on health-related and health-promoting goods and services; the insurance alliance incurs fewer health care costs as a result of healthier clients; and healthcare providers increase their turnover. On a macroeconomic level, society* benefits through lower rates of sick leave, increased productivity*, less unemployment and greater social capital. Wellness token = steering towards a healthy socieh* Partial Health insurance Premium Payment + Partial Discounted CASH IN

Vtellness

ALLIANCE

Wellness Tokens

Pr&venlion

Chronic care

programs

{home support)

Regional market of certified weiinesa goods and services

Figure 7.a Wellness Token system running in parallel ivith the conventional medical care system.

Although research on these aspects is incomplete, the existing literature on conditional transfer systems has proved that they can have a positive health

impact on the population.ÿ While simple cash transfers in conventional currency may have similar effects, they do not ensure that the cash flow remains within health-promoting goods and services. We believe this is crucial when it comes to introducing diversity: the Wellness Token system allows a durable preventive health sector to develop in a parallel economy. Would this create entrenched privilege and generate monopolistic behaviour on the part of care providers? We do not believe so, for two reasons: first, the mentality in prevention is probably quite different from the ‘big bucks’ approach that prevails in the curative care industry, since preventive care is intrinsically less

lucrative, less technology-intensive andless open-ended; second, the conditions for participating, if appropriately designed, would allow dubious firms or practitioners to be expelled from the system if necessary. The ideal is that the advantages of participating should be so desirable that exclusion is the only punishment needed.XZ Wellness Tokens introduce an alternative w’ay to encourage and finance preventive health care and home care programmes. This approach would also allow long-term cost reduction for insurance companies, and for governments subsidising them.-ifi The Wellness Token program provides positive encouragement - rather than punitive threats - for individuals to acquire healthy habits. Finally, by making people more explicitly responsible for their own health, Wellness Tokens counteract moral hazard and risk pooling, which are two other major market failures at play in health care. 3. Natural Savings This idea w-as initially developed as a micro-savings instrument for India, but can easily be adapted to many other environments.-ÿ It consists of a savings instrument fully backed by a natural growth process and useable as a local medium of exchange. The backing could be any commercially valuable product that grows organically over time, whose ownership can be secured and which can be maintained and harvested without unduly high costs. Examples of such products include trees or any other commercial plant that grows organically in value over years, or breeding fish in a protected lake, or wild

game in an enclosed forest. Here we will focus on the example of a tree plantation, because the benefits are wide ranging. Forests act as carbon sinks and deforestation is a growing global ecological concern that makes a significant contribution to climate change,

Objectives of Natural Savings

The proposed savings toolhas four objectives: to provide an inflation-proof and robust savings instrument, 2, to reduce the wealth gap between rich and poor without having to rely exclusively on tax redistribution mechanisms, 3, to encourage sustainable resource management, including reforestation and sustainable forestry, with the positive environmental benefits it entails, 4, to make available a local medium of exchange that increases liquidity

and thus fosters on-the-spot economic activity, Investing in a natural resource as a secure long-term savings tool is not a new idea andhas been done on an individuallevel for millennia. Even from an institutional standpoint, major insurance companies today own large forest plantations in Europe and the US for exactly that purpose. The novelty of this proposal is that such investments would be made available as an inflation-proof savings tool for everyone, including the poorer segments of the

population,

Natural Savings step by step Let us assume the initiative comes from a local government and/or NGO owning a piece of land suitable for a commercial forestry' project. The process would start with the creation of a legal entity', which we will call a â&#x20AC;&#x2DC;Natural Savings Companyâ&#x20AC;&#x2122;, This entity' becomes the owner of the timber but not of the land, which remains the property' of the government or NG0,2ÂŁ The Natural Savings Company issues 100,000 shares backed by the trees planted on the land. The labour costs for planting and maintaining the forest are payable in those shares. To avoid dilution of the value of the shares, the company is not allowed to issue more shares without creating additional

plantations

to back further issues. This underlines the need for a robust governance structure to ensure the transparency of the system and all

managerial decisions, further strengthened by periodic external audits and other safeguards against fraud. A value curve would be established using the value of the timber over time based on a conservative growth estimate of the species of trees in the particular climate, and on their market value at maturity. If there were 100,000 ‘tree shares’ in the Savings Company, then one share would represent 1/100,000 of the total timber value in the plantation. If the trees wjere ready for harvest after twenty years, the value curve between planting and harvest would resemble figure 7.3 below. The curve provides an easy reference for the number of shares paid for a day’s work. As long as the members of a community clearly understood the value of a ‘tree share’ in their own terms, the exchange of the shares for goods and services among themselves would be facilitated. Hereafter, we will express the value in terms of workdays. Workdays

14 Value of one ueo share In Workdays in each Year

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Figure 7-3: Example for the value over time of one tree share, expressed in workdays,

Let us assume that the value of a 'tree share’ at maturity after twenty years is fourteen workdays, and that its growth is reflected in the value curve above,

expressed in workdays. For the first two years of the project, one day’s work earns one share. But by the ninth year the shares have grown in value to be worth four days of work, so a day’s work is payable with a quarter of a share. (Note: it is always possible to pay labour partially in tree shares, and the rest in conventional money.) At maturity', the forest would be harvested and the timber sold for conventional money'. All the shares earned by' workers up to that point w'ould

be redeemed with the proceeds of the sale of the timber. Because the value curve w*as based on a conservative estimate of the timber value, this would have the potential of windfall profit. The entire process could begin again with a new’ plantation on the same land and a new issue of shares for the next generation of workers.ÿ

Risk management Any investment carries some form of risk. These risks could be reduced with well-known approaches, such as fire insurance in the case of a forest. The Natural Savings Company should purchase insurance against this and other hazards.

It would also be possible to diversify the risk ex ante by launching a variety' of natural savings products such as different tree species, different maturities, or even totally different natural savings bases such as a fish-breeding project in a local lake. Diversification can occur ex post by facilitating exchanges of shares of one project for another in the same region or country', or beyond.

Using the Natural Savings shares What can a community member who has earned some tree shares in the Natural Savings Company do with them? The shares could be kept to full maturity' and then cashed in for the proceeds of the harvest, thus using the tree share purely as a savings instrument. This would be a valid option for anyone saving for retirement or any other long-term goal such as higher education for one's children. A second option would be to trade shares for goods or services within the

community. The tree shares would thus function as a local medium of exchange and provide some additional liquidity in that community. In principle;, the value of the exchange should reflect the value of the tree currency at the time of the exchange, but the owner of the shares and the person accepting them could decide for themselves the most appropriate arrangement, A third option, requiring prudent management, would be for the Savings Company to allow the shares to be ‘cashed in’ for payment in conventional money before reaching maturity. This would be useful to build trust in the system. In situations w’here immediate cash was required, such as after an accident or disease, or for a wadding, this option would allow' an individual or family to address the situation without having to dump the shares at a price below their real value,

The value of an early redemption could be based on a value curve such as that shown in Figure 7.3, less a transaction fee. This fee would encourage share owners to use them primarily as a store of value continuing exchanges within the community rather than cashing shares in for conventional money. If this third option were made available, the Natural Savings Company would need to have access to sufficient cash (e,g, by securing a line of credit with a bank), to avoid a 'run on the savings company' - the equivalent to a 'run on the bank' in a conventional system, Some theoretical considerations

Notice that this 'tree currency' is intentionally designed not to perform all three classical functions of money. Its main function is as a store of value, and it would play that role better and more reliably than any national currency'. Even the Deutsche Mark (the world's least inflationary' currency' between 1945 and 2000) lost more than half its value during that time period. In contrast, trees have biological growth between 3% and 7% per year and this growth has been historically more reliable than any government bond. The ‘tree currency'' could occasionally function as a medium of exchange, but not as a unit of account, nor as legal tender. With regards to these later functions, the national currency' would continue to play its usual role,

Natural Savings could potentially reduce the gap between rich and poor. The conventional way of reducing this gap is to increase taxes on the rich and redistribute the proceeds in programmes benefiting the poor. In the Natural Savings system, those willing to work could create real wealth by themselves with long-term protection against inflation, banking or monetary crashes. The best way to earn tree shares would be by participating early in the tree plantation project or other community project approved by the local government and the Natural Savings Company. Those in the poorest levels of society could thus be able to reliably accumulate wealth. An investment in living trees wâ&#x20AC;&#x2122;ould not only be inflation-proof and secure against monetary crashes, but would organically grow in value until maturity. 4. C3: â&#x20AC;&#x2DC;Commercial Credit Circuits* for Small and Medium-Sized Enterprises In most countries, the vast majority of private jobs (75% to 95%) are created in small and medium-sized enterprises (SMEs). Addressing unemployment as a genuine and serious social sustainability" challenge is one way of improving the rates of development and survival of SMEs. The problem SMEs frequently have difficulty' obtaining working capital. These smaller firms are pressured by their suppliers to pay in cash or within 30 days, while the customers of SMEs (which are often larger enterprises) may operate on a 90-dav payment basis. This cash-flow quandary becomes deadly for SMEs when banks refuse to provide them with bridge financing, or charge prohibitive interest rates, or impose disproportionate collateral requirements. This problem has become critical in many industrialised countries where, as a

result of the financial crisis, banks have stopped offering reasonable credit conditions to other businesses. However, it has long been endemic in developing countries. The solution

The ‘Social Trade Organisation’ (STRO), a Dutch Research and Development NGO, has developed a financial innovation to address this challenge structurally. Their model has been successful in several Latin American countries. The process uses insured invoices or other payment claims as liquid payment instruments within a Business-to-Business (B2B) clearing-network. Each recipient of such an instrument can choose between cashing it in at a cost for conventional money or directly paying his or her own suppliers with the clearing-network proceeds backed by an insured invoice.

C3 step by step The C3 mechanisminvolves the following seven steps: An SME we call business A makes a sale and issues an invoice to a larger business we call business B. Business B agrees it will pay the invoice in 90 1.

days.

Business A secures insurance on that invoice with an insurance company. In practice, the cost of this insurance can be as low as 1% because the likelihood of payment default by Business B - the larger, well-established firm - is small. 3. Business A then opens a ‘current account' with the clearing network and exchanges the insured invoice for the same amount of ‘clearing funds'. It can then pay its supplier, which we can callbusiness C, with these funds via the 2.

clearing network. 4. To receive its payment, business C simply needs to open its own ‘current account' with the network. C thenhas two options: it can either cash-in the clearing funds for conventional money at the cost of paying the interest for the outstanding period of 90 days plus the banking fees, or spend the clearing funds in turn within the network at no cost. 5. No matter when the invoice of business A is paid, business C can use the positive balance on its clearing-network account, for instance to pay its

supplier, business D. 6. Business £>, in turn, now simply needs to open its own account with the network. It thenhas the same two options as business C: cash its clearing funds in for conventional money at a cost or spend them at no cost within the

network. And so on,.. 7* At maturity of the invoice, the network gets paid the amount of the invoice in national currency, either from business B or from the insurance company in the case of a payment default on the part of B. Whoever owns the proceeds of the insured invoice at that point can cash them in for conventional money without incurring any interest costs. Benefits

The benefits for businesses are as follow's: * Because participating businesses have access to short-term funds as needed, they increase their productive capacity at a substantially lower cost than they otherwise could through bank loans. The level of credit can bebuilt up to a stable level ranging between a quarter (an average of 90 days of invoices) and half of annual sales, * Because suppliers are paid immediately regardless of the original buyer's payment schedule, substantial liquidity’ is injected into the entire SME network at very’ low cost. This extra liquidity attracts participation in the C3 network,

* The technology’ to do this already exists and the necessary’ Open Source software is available. It does not require new legislation or government approval. C3 encourages more efficient use of information technology’ infrastructure among SMEs, including the opening of new markets and marketing channels through e-commerce.

What are the benefits for governments? The greatest one is additional revenue from transactions that would otherwise not occur. Because this additional income ultimately becomes available in conventional national currency', the clearing-network does not upset existing procurement policies. The most effective way for governments at any level to encourage the implementation of the C3 strategy’ is for them to accept payment of taxes and fees in the C3 currency-. As we argued in Chapter VI, this will encourage people to accept the C3 currency- in payment. Uruguay is the first country- to have applied this concept: it accepts C3 units for payments of all taxes and fees. The other advantages to governmental entities are listed below,

Tlie C3 approach is a dependable way of reducing unemployment without costly subsidies and without needing to nationalise money creation as in the

â&#x20AC;&#x2DC;Chicago Planâ&#x20AC;&#x2122;, * Any profits on transactions performed via the C3 system are taxed exactly as if they were in conventional money. Furthermore, C3 helps shift economic activities from the black or grey economy to the official economy, because SMEs must formally be incorporated to participate, and all exchanges are 100% electronic and traceable, * In order to remain at a manageable scale, C3 systems are best organised at a regional level. Businesses within the network have an incentive to spend their balances with each other, thus stimulating the regional economy. * All C3 networks should use the same insurance standards so they can connect across networks and facilitate exchanges, even internationally. Sizeable benefits for banks and the financial system also exist: * The win-win situation also extends to the financial system. Because the network is computerised, lending and management for the insurance and loan providers are streamlined. SMEs become a more profitable sector for banks because credit lines can be negotiated with the entire

clearing-network rather thanindividual businesses. This also automatically provides for risk diversification. â&#x20AC;˘ Banks and other financial institutions already provide factoring services similar to the C3 process; however, these are cost effective only for large amounts and thus available only to large firms. The computerised streamlining of the C3 system makes it possible for all parties to obtain the same results at lower costs. * Most banks now also provide insurance services. C3 opens a new market for insurance and credit, all the way down to micro-finance enterprises. With C3 computerisation, even such small-scale entities can be serviced at low cost.

5* The TRC; an Initiative for Multinational Businesses The Trade Reference Currency (TRC) is a global currency proposal first published in 2ooi.££ Its relevance has increased significantly because of the financial crisis of 2007-2008. A leadership group for the TRC has recently been formed and is currently undertaking a feasibility study, with a view to implementation of this system.

The problem

Monetary" instability has become the leading concern for international business — often greater than political or market risks. In a Fortune 500 survey in the USA, all corporate participants reported foreign exchange instability as the largest risk of doing business internationally.ÿ

The TRC system provides an effective solution for this while making it profitable for corporations to think long-term. It does this by resolving the ongoing conflict between shareholders' short-term priorities and the long-term requirement of society at large. It also stabilises the world economy through its counter-cyclical impact. The TRC mechanism

The TRC is a privately issued currency" carrying a demurrage charge. It is fully backed by an inflation-resistant, standardised basket of a dozen of the most important commodities and services in the global market. The TRC’s characteristics

Complementary' currency. The TRC is designed as a complementary' currency circulating in parailel with national currencies. All existing monetary and financial products or practices could therefore continue to exist. The TRC mechanism wouldbe an additional option for those international economic players voluntarily choosing to use it. * Trade reference currency. The TRC is backed by a standardised basket *

of the most important commodities and standardised services traded on the global market. Though conceptually similar to a fully backed gold standard, the TRC backing would consist of a dozen of the main international commodities, including gold. Since it is fully backed by a physicalinventory of commodities, it wouldbe a secure, robust and stable mechanism for international contractual and payment purposes. Private issuance. The TRC wouldbe issued as an inventory receipt by the TRC Alliance, a non-governmental initiative with an organisational structure open to all those meeting certain pre-established criteria. In this sense, the TRC Alliance would play for the non-financial sector a role similar to the one that the Visa credit card alliance plays for participating financial institutions. The inventory receipts, called TRCs, are issued by the TRC Alliance in payment to the producers selling commodities in the TRC

basket to the Alliance. These sales are based on the market values of the commodity involved and on the value of the TRC basket at the time of the transaction. As a private initiative, it does not require governmental negotiations or international agreements. From a legal and taxation viewpoint, the TRC is simply a standardisation of internationalbarter technically called â&#x20AC;&#x2DC;countertradeâ&#x20AC;&#x2122;. Legislation and reporting requirements for countertrade already exist in over 200 nations around the world. * Demurrage-charged. The TRC is a demurrage-charged currency. As described in Chapter V, a demurrage charge acts like a linear parking fee applied to a currency, imposing a cost on its holder over time. The cost for holding on to the TRC currency is estimated at 3.5% to 4% per annum and corresponds to the costs incurred for storing the physical commodities included in the TRC basket. This demurrage charge ensures that the currency is used as a planning, contractual and trading device: it would not be hoardedbut would remain in circulation. Thus it would strongly activate commercial exchanges and investments wherever it circulates. In sum, the TRC deliberately fulfils only two of the three traditional monetaryâ&#x20AC;&#x2122; functions: it acts as a unit of account and medium of exchange, but not as a store of value. * Inflation-resistant. The TRC is designed as an inflation-resistant currency' by its very' composition. Inflation is always defined as an ongoing,

durable process by which a standardised basket of goods and services changes its value. By selecting the appropriate ingredients to be placed in the basket, the TRC wouldbe protected against inflation. For example, the composition of 100 TRCs couldinclude 1barrel of oil, 5 bushels of wheat, 10 pounds of copper, 3 pounds of tin, plus I/IOÿ1 of an ounce of gold, 10 Carbon Emission Rights, container cargo rates and so on, How the TRC w orks in practice

The key steps involved in the TRC mechanism, from the creation of TRCs to their final cash-in are illustrated in Figure 7.4* The numbers in parentheses correspond to the steps labelled in Figure 7,4.

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(1) The TRC creation process (la) Excess inventory sale. The creation of the Trade Reference Currency begins with the sale of excess commodityinventory to the TRC Alliance by one of its backer members. For example, this could be one millionbarrels of crude oil sold to the Alliance by an oil producer, (lb) Commodity valuation in TRCs. The value of this sale of oil to the TRC Alliance and the amount of TRCs the one million barrels of oil are worth is calculated at market prices. Using an agreed-upon procedure, this is accomplished by determining the commodity prices at the time of the sale for both the inventory in question, in this case oil, and the sum of each of the commodities in the TRC basket. The formula used to calculate the commodity* valuation is: [Commodity value per unit x number of units]/TRC Unit Value = Y TRCs Let us assume that the commodity* price for a barrel of oil at the time of the sale is $100 and the price for each item in the TRC basket at the time of the sale (he., copper, grains, lead, one unit of carbon emissions rights, including oil) totals $200, Let us further assume that one millionbarrels of oil are sold. Therefore, 500,000 TRCs are issued: [$100 per barrel of crude oil x one million barrels]/$soo = $oorooo TRCs (IC) Inventory balance. The TRC Alliance rebalances its portfolio to account for the inclusion of the one millionbarrels of oil. This may be accomplished through future market transactions (i.e, a purchase or sale today at a given price for delivery at some future date) or through spot transactions (at the market price of the day). Thus, a TRC in circulation always has a backing in the appropriate physical or future commodity. (id) TRC creation. The TRC Alliance credits the oil producerâ&#x20AC;&#x2122;s account with 500,000 TRCs. (TRC currency' movements are denoted by the thicker continuous arrowedlines in Figure 7,4.)

(2) TRC circulation among users

Once tile TRC is created, it remains in circulation for a period determined entirelyby the users. For example: (2a) First user - The oil producer decides to pay one of his or her suppliers (e,g,, a German engineering company for the construction of an off-shore rig) partly or completely in TRCs, (2b) Next user(s) â&#x20AC;&#x201D; The German engineering firm decides, in turn, to purchase speciality steel from a Korean steel mill partly or completely in TRCs, The Korean mill then uses the TRCs to pay a mining company in Australia and so on, (2c) End user - Each TRC remains in circulation for as long as its various users continue to use it. This couldbe for just one transaction or an infinite number of transactions, without any particular date of expiration. The process comes to an end when a particular user decides to cash in the TRCs,

thereby becoming the End User, (3) Demurrage

Throughout the circulation life of each TRC, from its creation to its final cash-in, a demurrage fee of 3,5% to 4% a year is in effect. Demurrage is a time-related charge on money. The demurrage fee acts in a similar manner to a linear parking fee, with the charge increasing in proportion to the time the car is occupying a parking spot. Financially, it corresponds to a negative interest rate. Whoever is holding the TRC is, therefore, charged the demurrage fee in proportion to the time they hold on to it. With a demurrage charge of 3,5% to 4%} the actual cost of holding it for a few days or even a few months is still low compared to todayâ&#x20AC;&#x2122;s international currency transaction costs. Because the TRC exists only in electronic form, it is easy to know exactly how much time has elapsed between the moment a user receives TRCs and the moment they are transferred to others, The demurrage charge serves two key functions: * TRC circulation incentive, The demurrage charge is an incentive to keep the TRCs in circulation and ensure they are being used as an exchange mechanism rather than a savings instrument, * TRC operational cost coverage, The demurrage charges are calculated

to cover the costs of operating the entire TRC system: storage costs of the basket, administrative overhead, and transaction costs in the futures markets, to name a few.

The demurrage fees for a particular TRC transaction may be calculated bv

the following formula: (TRC Operation Costs/time unit) x (TRC holding period) x (TRCs on account) = Demurrage Charge Let us assume the TRC operation costs are calculated at 3.65% per year, or 0.01% per day. If the German engineering firm (2a in figure 7.4) received all 500,000 TRCs from the oil producer and kept them on account for a period of 10 days before paying the Korean steel mill (2b), the demurrage charge wouldbe calculated as follows: o.oi% per day x 10 days x 500,000 TRCs = 500 TRCs (4) TRC cash-in

The existence of a TRC unit comes to an end when any user (designated the End User in our diagram) decides to cash it in, perhaps to pay its taxes and/or payroll and needing national currency to do so. A transaction fee is charged at the time of cash-in and proposed at 2% of the amount of TRCs cashed in. This serves two purposes: * TRC circulation incentive. The transaction fee is an additional incentive to keep the TRCs in circulation rather than being cashed in. The 2% amount is based on the consideration that cashing in the TRCs is equivalent to paving demurrage for more than six months. TRCs probably will be used as payment before this time as most suppliers prefer being paid earlier rather thanlater. * Cash-in operational costs. When the end user decides to cash in TRCs, the TRC Alliance sells the necessary' volume of commodities from its basket to the commodity markets in return for conventional currency. The End User returns the TRCs to the TRC Alliance (4a). They are converted either to national currency' or a corresponding volume of TRC commodities (which is called â&#x20AC;&#x153;taking delivery' in the commodity' market)

chosen by the End User, minus the transaction fee of 2%, The cash-in may take place directly with the TRC Alliance or through an intermediary bank, just like any foreign exchange transaction today (4b), (5) Reference currency

Once the TRC mechanism is operational and the advantages of using an inflation-resistant international standard are known, there is nothing to prevent two entities (user X and user Z in the diagram) with no direct involvement in the TRC mechanism from denominating contracts in TRCs, even if the final settlement is in conventional currency. Here, the TRC functions purely as a trade reference currency, or a reliable international standard of value. This is how the gold standard functioned (contracts w’ere denominated in gold whether or not the involved parties owned gold). The difference with the TRC is that it is backed by a dozen or more commodities and services which makes it a more stable reference

than the gold standard, Benefits of the TRC Benefits for the global economic system

There are two main benefits for the world economy and for humanity as a whole: * The TRC promotes long-term sustainability. As we argued in the section on ‘short-termism’ in Chapter V, today’s financial practice is to focus on short-term profits. The demurrage function of the TRC makes long-term thinking profitable and, therefore, long-term sustainability more likely, * The nature of the TRC basket counteracts the normal business cycle, thereby creating a more dependable economic environment, Each of these benefits deserves further explanation. First let's look at the realignment of financial interests with long-term concerns. The demurrage feature of the TRC would provide a systematic financial motivation that realigns financial interests with long-term concerns. This is in direct contrast

to the current discounted cash flow of conventional national currencies in which positive interest rates lead agents to emphasise the immediate future at

the expense of the long-term. The same discounted cash flow* with a demurrage-charged currency produces the exact opposite effect, reducing the conflict between stockholders’ financial priorities and the long-term priorities of humanity as a whole.

Second, let’s look at the TRC’s role in business cycle stabilisation. The TRC counteracts fluctuations of the business cycle and thus improves the overall stability and predictability of the world’s economic system. When the business cycle weakens, corporations typically have excess inventory and a need for credit. When these excess inventories take the form of raw* materials included in the TRC basket, they could be sold to the TRC Alliance, which would place these inventories into storage. The corporations would be paid in TRCs, giving them immediate access to a means of payment, often necessary* during such phases of a business cycle. The demurrage charge would encourage rapid payment of their suppliers, who have a similar incentive to pass on the TRCs to their own suppliers. The spread of this currency* (with its builtin incentive to trade) would swiftly activate the economy at this point in the cycle. In contrast, when the business cycle booms, both suppliers and corporations have an increased need for raw materials and demand for them goes up. The TRCs could be cashed in and used in the commodity markets. The amount of TRCs in circulation would decrease when the business cycle is at its maximum and counteract inflationary' pressures. In summary', by providing monetary' liquidity' during phases when credit gets tight in the conventional system and contracting when business is booming, TRC-denominated exchanges would

stabilise the overall business cycle. Benefits for participating businesses

The TRC offers corporations the following advantages: * It allows for the swift conversion of illiquid assets, such as inventories of excess raw materials into liquid working capital. This is a twofold advantage given that inventories are otherwise a cost item.

* It provides a robust international standard with a consistent value in real purchasing power for international contracts. It low'ers the costs of doing business by reducing expensive currency hedging counter-measures, providing dependable, Iow'-cost insurance against international currency uncertainties, and offering a more cost-effective exchange system than conventional corporate barter.

Benefits for financial services and the banking sector

The TRC would provide two main advantages to the banking system: * It would standardise countertrade and make the countertrade mechanism bankable. Our banking system currently plays no role in the countertrade field which is growing at a rate of \$% per year - three times faster than trade facilitated by conventional currencies. Banks could provide services such as TRC account management as is currently done for any foreign exchange. * The counter-cyclical impact of the TRC mechanism would stabilise the value of banking loan portfolios. The numerous banking-related crises often occur whenborrowers cannot repay their loans and the collateral on whichloans are based depreciates. These conditions are aggravatedby the boom/bust cycle and currency fluctuations. Therefore, because the TRC mechanism would help stabilise economic cycles, the number and severity of crises in bank portfolios would also be reduced. Differences from earlier proposals

The TRC is a commodity-basket currency. Well-known economists have put forward several proposals for commodity-basket currencies over the past century.ÂŁ4 The main reason they have not been implemented is because they aimed to replace the conventional monetary' system, thus jeopardising powerful vested interests. This is not the case with the TRC proposal. The win-win strategy of the TRC mechanism includes the financial sector. Everything in the current monetary' system would remain in operation after the introduction of the TRC because it is designed to operate in conjunction with existing bank-debt currencies.

The political context for an international monetary treaty does not exist. The TRC avoids this difficulty by relying on private initiative. As we have already emphasised, from a legal or tax standpoint, the TRC functions within the official framew’ork of countertrade and does not require any formal governmental agreements to be made operational.

Perhaps the most important difference between the TRC and all previous proposals is the introduction of demurrage. Demurrage provides a powerful incentive for circulation, but also has a built-in mechanism to cover the storage costs of the basket. It thus resolves the biggest problem that previous commodify proposals faced: Who will pay for it all? We believe the TRC mechanism is a win-win approach for all participants in the global trading system, and can succeed where other proposals for monetary innovation have failed. Conclusion

The five examples discussed in this chapter are just a small sample of the complementary’ systems that are possible; many others are already in existence. They include for instance: 487 operational systems providing non-medical elderly support at no cost to the government in Japan; a B2B system currently used by 65,000 Swiss businesses (that is one out of every four corporations in Switzerland) which has been in operation for the past seventy-five years and has been proven to contribute macroeconomically to the legendary’ Swiss economic stability; and a Time Dollar system that proved successful in reducing teenage crime in Washington, D.C. and which the US Justice Department is now encouraging other American cities to adopt. As explained at the beginning of this chapter, we are not elaborating on those useful and highly relevant systems here because they have already been described in detail elsewhere. They obviously could, and should, be part of an emergent monetary’ ecosystem.

The next chapter will complete our discussion of the range of systems that would be relevant in such a monetary- ecosystem. Please remember (from Chapter VI) that bank-debt money acquires its value only because governments

require it in payment of taxes. Therefore, the full potential of a monetary ecosystem will manifest itself only when governments and government bodies throw their weight behind the process.

Footnotes 1 Lietaer (2001); Lietaer & Kennedy (2008): Greco (2009): Lietaer & Belgin (2011); Hallsmith & Lietaer (2011). 2 For applications at a city level, see in particular Gwendolyn Hallsmith and Bernard

Lietaer, Creating Wealth; Growing Local Economies luif/t Local Currencies (2011). 3 Arrow (1963) and Reinhardt (2001). 4 M. Rothschild and J. E. Stiglitz, “Equilibrium in Competitive Insurance Markets” (1976) : D. Cutler and R. Zechhauser, Insurance Markets andAdverse Selection:A Handbook for Health Economists (1998). 5 Committee on Capitalizing on Social Science and Behavioral Research to Improve the Public’s Health (2000) Institute ofMedicine. £ U.S. Health (2005) National Center for Health Statistics, Department of Health and Human Services, No: 2005-1232. 2 Beh avioral and social interventions therefore offer great promise to redu ce disease morbidity- and mortality, but as yet their potential to improve the public’s health has been relatively poorly tapped.” Committee on Capitalizing on Social Science and Behavioral Research to Improve the Public’s Health (2000) Institute 0/ Medicine, £ L.A. Nefiodow, Der Sechste Kondratiejf (2001). See also Appendix G for more information on Nicolai Kondratieff and long waves’. 9 In the Netherlands an alliance involving the largest insurance company is planning to introduce several city-scaled experiments for motivation systems to deal with the ageing wave of the next decades. Indeed not all preventive programmes are cheaper than the treatment Studies show that it is more cost effective to treat tuberculosis rather than prevent it. See Borgdorff era/, (2002). Influenza vaccination is not cost effective for healthy working adults, See Bridges era! (2000), However, all of these studies only compare the costs for treatment and the costs for prevention, They do not take into consideration the decrease in productivity' and the absenteeism due to illness, U The most significant benefits occur after the second or third year of the programme. One hundred dollars or euros spent on preventive care programmes per year and per employee will have an ROI after the third year of 300 dollars or euros. See Goetzel K

(l999)> Erfurt (1992); Powell (1999) and Chapman (2003). 12 Lia craf. (200&): Bastagli (2009). 13 See www.cdc.Qov ~ i.usQ.oov/TElink42n 14 See Christian Leonard, Croissanoe confre sarcfe; Quelfe response 6iiisafion du malade? (200S). While Leonard, a leading Belgian health care expert, is strongly critical of the current ideology of punitive ‘responsibilisation* of patients, he does argue in favour of a “genuine” autonomisation, which he links to Ivan Ulich’s ideas of autonomy and conviviality: genuine personal responsibility can only flow from a reappropriation, by the patient him/herself, of his/her health. This requires preventive measures, which are under-financed in the current “alive and sick” logic. The Wellness Token system, therefore, moves in the direction called for by Leonard. 15 The Elderplan insurance company in the New Y ork area has implemented successfully part of this idea with a Time Dollar currency. They have discovered that people participating in a Time Dollar system remain on average healthier because of a better social capital environment. Lia efaf. (2008); Paxson & Schady (2007). 12 The Swiss business-to-business currency system WTIR has been successfully operating on this principle for 75 years. iS C. J. Ruhm, Macroeconomic Conditions, Health and Government Policy (2006). 19 The text of this section is extracted and summarised from Marek Hudon and Bernard Lietaer, Natural Savings: A New Microsavings Product for Inflationary' Environments - How to Save Forests with Savings For and By the Poor?5, Sayings and Development, vol 4 (2006), PP.357-3S1 2Q. If the property is owned by a third party, one could also arrange for a long-term lease of the necessary land and pay the ow ner in part or whole with shares in the Natural Savings Company. 21 Depending on the size of the land and the community', one could make this a continuous process, with new* plantations and harvest on parts of the total forest on a periodic, rotating basis. Well-known forestry' management techniques should be applied as appropriate, 21 Lietaer (2001). 2Z Dolde(i993), 24 See for example: Harmon (1959): Graham (1937) and (1944); Hart et al. (1964); Grondona (1975); Gondriaan (1932) and Jevons (1&75).

Chapter VIII

Examples of Governmental Initiatives "In a democracy dissent is an act offaith.â&#x20AC;? J* William Fulbright

This chapter focuses on the second half of the 'solutions menu', the ones where government at various levels could or should act as initiators* We will present four examples of such solutions* The appropriate level of government involvement will be specified in each case* It varies from a city, to a region, a country, and even an EU or worldwide scale* First a summary of these four last examples before we describe them in full: 6* Tbrefees is a city-based initiative to encourage volunteering while promoting green behaviour and social cohesion in a poor neighbourhood* It is currently running in the city of Ghent, Belgium* 7* Biiua Kippu is a proposal for the restoration and maintenance of Lake Biwa, the largest and oldest lake in Japan, without burdening the local

government's budgets* 8 * Civics is a proposal empowering a city or region to fund civic activities without burdening the local public budget* Such activities could provide the labour component for social, educational and/or ecological projects* 9* ECOs is a national or Europe-wide initiative that funds components of large-scale ecological project or climate change adaptation projects, that couldbe part of our near future*

6. Torekess A City-Initiated System to Encourage

Volunteering Our sixth example is running in the city of Ghent in Belgium, having been started in 2010. Although a relatively wealthy town of 250,000 inhabitants, the neighbourhood called Rabot is statistically the poorest in Flanders. Half of its 8,000 inhabitants are immigrants living in low-income apartment towers called Torekesâ&#x20AC;&#x2122; (Flemish for â&#x20AC;&#x2DC;Little Towersâ&#x20AC;&#x2122;). Its population density is among the highest in the country. More than twenty languages are spoken there, the most prevalent of which is Turkish. The City of Ghent wanted to encourage ecological and health-promoting activities, beautify the neighbourhood and improve the overall qualify" of life in Rabot. They started with a survey asking local residents what was most desirable to them. The answer was access to a small plot of land to grow vegetables and flowers. The city made land available, including an unused factory lot, on which over a hundred 4m2 gardens were created. These little gardens have been made available for a yearly rent of 150 Torekes, payable only in Torekes. Torekes are earned by engaging in a variety' of activities in the community". The activities are organised bv the local community centre, run bv the citv government in the neighbourhood and by several local NGOs. The activities started with the building of these small gardens themselves. They also included more modest efforts such as putting flowers on windowsills and helping to clean up a football field after a match. Thelist is open to local suggestions.

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Figure 8.1: Photograph in the Spring of 20 11 of theindividual garden plots rented in Tor ekes.

In addition to being used to pay rent for the gardens, Torekes can also be used to buy from local shops specific goods which the city encourages, including low-energy light bulbs and seasonal vegetables* Torekes can also be used to buy tickets for public transport and for the cinema (where otherwise empty seats would have remained unused)* Businesses can exchange the Torekes for euros at the community centre office* These simple arrangements with participating stores benefit the residents, the local economy and the environment* Since its launch in November 2010, the system has been so successful that it even faced an excess of volunteers during the spring of 2011* At the request of the participants, Torekes were introduced as a paper currency' (see Figure 8*2)* During the first year, a total of 50,259 Torekes were earned for 526 different activities** 494 users have officially registered, but the number of actual

participants is larger than this because exchanges also can take place directly between the residents. \

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First-year results: Earning Torekes

The most popular activities were preparation of the little gardens themselves, which resulted in 21,424 Torekes being earned by 161 participants. Other activities included the creation of a little facade garden in front of some of their own residence towers (4,850 Torekes earned by 97 participants), the planting of flowers in common spaces (3,565 Torekes earned by 29 participants) and the installation of windowsill flower boxes facing the street (720 Torekes earned by 72 participants).

Spending Torekes

Of the 50,259 Torekes issued, £1,855 were spent on purchasing fresh vegetables and low-energy lamps at local shops. The rent of the Torekes gardens accounted for 8,400 Torekes and 2,640 were spent on movies and bus tickets. The balance is still in circulation, or saved for next year’s garden rental.

Exchanging Torekes The city reimburses businesses exchanging Torekes with Euros drawn from existing budgets allocated to the neighbourhood. The pilot experiment has had a broad social impact. Even at this early stage, the results obtained for the budget allocated in euros have been estimated at three times more than what was thought possible without the Torekes system. Because some of the operational costs are fixed, this could rise to a factor of 10 as the number of participants in the project increases.

7* (Bhva Kippu’: Funding a Regional Environmental Project Lake Biwa in the Shiga Prefecture of Japan is one of the world's oldest lakes and is graced with a very diverse and unusual ecosystem. However, the lake has become prone to a number of environmental problems: poor maintenance of water source forests; water contamination from industry, agriculture and households; algae blooms; as well as invasion of exotic fish species that have overwhelmed the native fish population. The Shiga prefectural government has used both environmental regulations and subsidies as policy instruments to address these issues. However, the question was raised: can additional policy instruments be used to obtain greater environmental results without increasing the budgetary' burden on public authorities. The Biwa Kippu has been designed to be just such an instrument. Objectives The primary' objective of the Biwa Kippu system (literally “Biwa Tickets') is to improve the Biwa Lake environment. Biwa Kippu, therefore, aims to promote environmental activities by residents and non-profit organisations in Shiga Prefecture without creating additional costs for the prefectural government,

which is already too highly indebted. While job creation and community building are not the primary objectives, such benefits wÿould be welcomed as positive side-effects. Scope

The Brwa Kippu system is intended to focus on activities by residents and non-profit organisations in the Shiga Prefecture, rather than on businesses. It could be expandable so that it could deal with environmental issues relating to the whole river basin. The Biwa Kippu System

The intention is that the prefectural government should issue a new' ordinance requiring resident households to contribute a certain amount of ‘Biwa Kippu' environmental activities each year, for example 10 Biwas per family. One Biwa would roughly correspond to one hour of environmental service activities. This wouldbe an obligation for every family, but obviously with appropriate exceptions for special circumstances such as people with handicaps or other valid excuses. Biwa Kippu would either be issued by the Prefecture itself or by an appropriate entity such as the Lake Biwa Environmental Research Institute in exchange for undertaking specific, measurable, environmental activities. The Prefecture would determine the scope of these activities each year. Residents or non-profit organisations carrying out these activities would receive Biwa Kippu. The prefectural government would not accept payments in Yen to replace the contributions in Biwa Kippu, nor would it set any exchange rate between Biwa Kippu and Yen. However, residents would be able to exchange Biwa Kippu among themselves on a free local (eBay-type) electronic market. By balancing the quantity' of contributions and the opportunities for earning Biwas, an 'ecological economy' wouldbe activated at whatever scale is deemed appropriate for the Prefecture, and democratically accepted by the population.

Step-by-step approach

The prefectural government would launch the Biwa Kippu system using the following eleven steps: Planning for the Biwa Kippu Interv ention: Implement a fea sibility study toidentify the major environmental problems in Shiga prefecture and prioritise these problems in terms of ecological impact, scalability, measurability and ease of implementation, 2, List the measurable environmental activities needed to solve the problems prioritised in the previous step and determine the value in Biwa for each of these activities. For instance, if it takes one hour on average to catch an exotic fish, one could estimate that one Biwa wouldbe the value of that type offish's head. Determine the number of Biwa provided to the non-profit organisations performing the quality control and payment function, 3, Choose the activities and geographical areas where a pilot scheme for the l*

first year wouldbest be run, 4, Identify all relevant stakeholders, including existing or nascent citizen groups and non-profit organisations that couldbe mobilised to support such activities, as well as the relevant governmental administrative departments and research centres, 5, Make the necessary' agreements with the mobile phone providers to electronically issue, exchange and collect Biwas, 6, Issue an ordinance to introduce Biwa Kippu, Implementing Biwa Kippu:

Decide the amount of Biwa Kippu required as contribution by each family for the first year (e,g, 10 Biwas in the first year, corresponding to roughly one full day of activity') as well as the number of Biwas that couldbe obtained for each environmental activity-, 8, Recruit non-profit organisations as intermediate agencies to administer Biwa for each environmental activity'. These non-profit organisations would also be paid in Biwa for their verification and implementation activities, 9, Launch a communication campaign to explain how residents participating in the environmental activities decided in step 2 can obtain 7,

Biw*a, Have the prefectural government and local non-profit organisations co-organise two weekends of environmental activities where participants

could earn their 10 Biwas in a communal way, Issue Biwas using an online system via mobile phones and collect the Biwa contributions through the existing prefectural online taxation system, Feedback to the participants about progress on each activity could be provided in real time by using the electronic Biwa payment system as an accounting and communication tool, 11, After one year of pilot testing, evaluate the results and problems; fine-tune the system, and gradually increase over time the range of environmental activities and geographical reach, 10,

Advantages of a Biwa Kippu System For the Shiga prefectural government the advantages of this Biwa Kippu initiative are that it would: * allow a variety of environmental activities to take piace without requiring additional Yen budgets, * measure environmental activities more precisely than is currently the case: the number of Biwa issued is a direct measure of these activities, * effectively mobilise all households in the Shiga Prefecture to take an interest, and participate, in environmental activities, For environmental non-profit organisations, the advantages wouldbe:

the sale of Biwas earned by individuals or non-profit organisations to people who have not earned enough of them through their own environmental activities would provide an income source, * the emergence of more non-profit organisations with a focus on environmental issues in Shiga Prefecture, *

The advantages for the residents of the Shiga Prefecture would include: * living in a better-quality environment,

* receiving real time online feedback about environmental improvements obtained through the Biwa Kippu system. This has the potential to motivate them to personally put in more work towards these improvements. the creation of additional and specialised non-profit organisations (encouraged by the Biwa Kippu system), which would provide a range of activities that can be tailored to their personal interests or preferences.

8. Civics: Funding Social, Cultural or Civic Activities Suppose a city, region or a country would like to become a model of social capital or a beacon for culture and the arts.

The conventional approach

This governmental entity would start by preparing an implementation plan, which would conventionally include all labour costs at market rates. Suppose this civic entity were a city of 100,000 households politically agreeing to encourage social capital and the arts at a cost for required annual subsidies of €1,000 per household.

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the non -profits whose cash is obtained through tax deductions. This graph will be most useful when compared later with Figure 8.4 below.

Conventional ways of raising funds include raising taxes or incurring debt, Although the latter involves the same amount of tax revenues over time, plus interest, both avenues directly affect city budgets. Non-profits -would typically also be involved in such projects and their funding through tax-deductible donations indirectly reduce governmental income. Another approach: Chics

Another way to fund the labour components in such a project and to strengthen a cooperative local economy in the process is through Civics, The city starts by requiring its residents to make an annual â&#x20AC;&#x2DC;Civicsâ&#x20AC;&#x2122; contribution. A Civic is an electronic unit issued by the city that is earned by residents through activities that contribute to the city's publicly agreed upon aim. The unit of account could be one hour of time, valued at the same rate for everybody. For example, if the aim of a city is to be more green, the activities could include growing food on terraces or rooftops, or taking responsibility for plants and trees in the neighbourhood and parks, or training people in city-based horticulture, and so on. Non-profits would play a key role in the Civics economy by organising the associated activities and verifying the qualify and quantify* of the work performed. They would actually play in the cooperative economy exactly the same role that businesses play in the competitive economy - the role of initiating projects, organising activities, coordinating and motivating people. A specially-created new type of non-profit would be in charge of auditing all the non-profits involved in this economy to ensure transparency and trust in the system. It would play the role that auditing firms play in the competitive economy, and their reports would be published on the cityâ&#x20AC;&#x2122;s website. The benefit to non-profits would a powerful new way to reach their objectives, a big increase in their volunteer base, as well as the opportunity to pay their staff partially in Civics.

Objective of the Civics system The first objective of the Civics system is to fund the labour component of desirable civic projects. Because manpower is often the largest component of a budget, a Civics system makes the funding of otherwise unaffordable projects possible. With Civics, a city can accomplish big goals, even in times of economic downturn. It is in bad economic times that labour is automatically more available and eager to find an alternative income stream via Civics, With conventional jobs currently in short supply, this would have a beneficial effect on individuals and the community. A Civics system also gives opportunities to build a stronger sense of

community. Modern societies suffer high levels of isolation and fractured social networks and family systems. Shared work in a local community is an effective way to counteract this loss of social capital while generating economic and environmental resilience,

The Civics system could operate at any scale: local, city, region, or even across a country as a whole. Engagement by the population in the decision-making process about which projects get implemented is essential for success. Various processes exist to accomplish this and modern civil society may still have something to learn from forms of governance in traditional communities. For instance, the Balinese banjar system has been working for over twelve centuries and has proven adaptable to modern environments,* New systems like sociocracyS and holacracyi also look promising, Operation of the Civics system

The government would issue an ordinance requiring residents to contribute a certain number of Civic tokens each year. As a rule of thumb, one Civic is equivalent to one hour of service in civic activities. Every' household would have this obligation, with appropriate exemptions for people with handicaps, people caring for young children or elderly parents or other reasons. Civics would be issued by the city and used to reward specific measurable civic activities. Payments could be in the form of paper tokens as in the case of

Torekes, or of electronic units tracked via mobile phone as in Doraland, The governmental entity would accept only Civics as a form of payment for this obligation and would not set a fixed exchange rate between the Civic and the national currency. Residents could exchange Civics for national currency on free-market principles, A local online market (like eBay could be set up to facilitate such exchanges and assure transparency and trust, From an economic theory perspective, the Civics approach amounts to a Keynesian stimulus by creating additional demand for services at the city scale, The main difference is that the process is much more bottom-up than the usual central government Keynesian stimulus. Even more importantly: it doesnâ&#x20AC;&#x2122;t generate any additional debt for anybody. Furthermore, the process can be targeted to specific population segments, and should be counter cyclically fine-tuned to local conditions. For instance, specific programmes paid in Civics can be implemented for young people when their unemployment level is abnormally high (as is the case now in Spain, Greece, Ireland, etc,). The contributions requested in Civics should be highest during an economic

downturn, and scaled back to zero when close to full employment has been restored. The timing can also be fine-tuned: Civics contributions could be requested on a quarterly basis instead of an annual one, thereby matching more closely real-life conditions. Please remember also that when more Civics contributions are demanded, their value in euros would also increase in the local eBay type market, thereby providing a higher income in euros to the most active participants,

In order to tailor the activities to different sub-populations, the process of choosing Civics-earning activities should be done democratically and in a decentralised fashion, even down to the neighbourhood level. Citizens themselves should also be able to propose Civics-earning activities to the dty. Fairness of the Chics system

In Chapter VI, we saw that governments can make a fiat currency valuable by requiring taxes to be paid in that currency. Governments have always required involvement on the part of their citizens. For example, paying taxes is universal and militaryâ&#x20AC;&#x2122; service is veryâ&#x20AC;&#x2122; common. Whether or not these are fair depends

mainly on the system’s governance. Consultation and transparency can help create a Civics system that is welcomed bv the population. From a purely economic angle, if an annual tax of €i,000 can be replaced with 10 hours of civic activity per household, anyone earning less than €100 per hour should be interested in joining the system. Ideally, however, the Civic Economy’s goals and activities would have the support of the residents, as something they1 would gladly volunteer for if they didn’t have to earn a living. The Civics system has the added benefit of allowing people to earn an income from the activities; see Figure 8.4. Civics

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Figure 8.4: The government requires payment of taxes on the commercial activity, as well as a contribution payable only in Civics that the government its elf issues. People who earn extra Civics can exchange them freely on a local online market,

Notice that there is no obligation to personally perform any of the tasks rewarded in Civics. There are two ways to avoid participating at all. The first wouldbe opting out by paying an extra amount in euros as part of one's annual taxes. Based on our example, a logical amount would be the €1,000 per year

estimated in the conventional process described at the beginning of onr example. The second option for people not interested or without the time to personally perform the tasks, wouldbe to purchase Civics via the online market openly and transparently. People having earned more Civics than they needed for their annual contribution could sell them on that market. The buyer of the Civics could make the purchase in conventional money or as an exchange for any good or service acceptable to the other party.

The governmentâ&#x20AC;&#x2122;s role would be to ensure that fake Civics were not in circulation and that exchanges are transparent and fair. The government would not fix the value of the Civic in terms of national currency. If it wanted the value of the Civics to rise in terms of the national currency, the most effective way wouldbe to require a higher contribution amount payable only in Civics. If it wanted the value to drop, the easiest way would be to reduce the quantities requested.

Advantages of the Chics System For the governmental entity involved, the Civics system would: * Generate an abundance of civic activities with minimal financial cost. * Measure and track civic activities more precisely than is done currently, and thus encourage and improve this very important aspect of civil society". * Effectively mobilise widespread participation in civic activities. For non-profit organisations the advantages wouldbe:

Non-profits in this cooperative economy would play the same role as businesses do in the competitive economy: motivating and organising people in their respective domains. * Non-profits would gain an income stream in conventional currency' from the sale of excess Civics to those preferring to purchase rather than earn them. * More people volunteer and volunteer-turnover is reduced when a complementary' currency' is used as reward.5 This is the case even when there is no obligation to earn that currency'. * Non-profit organisations now tend to be in stiff competition with one *

another for operating funds, particularly those with similar aims that depend on the same type of donors. Such competition can become an obstacle to cooperatively attaining their goals. The Civics system would essentially give non-profits their own valuable currency. Their very activities would earn them Civics, There would stillbe healthy competition over how to attain the best results, but less rivalry for conventional money, For citizens, the advantages wouldinclude:

could and better quality of flourishing - Residents Residents with time and/or interest in civic activities could additional enjoy a

community

life,

earn income from others needing Civics or preferring to purchase them,

Some legal issues

The first question usually raised is whether such a system is legal. Article 104 of the Maastricht treaty and article 128 of the Lisbon treaty’ specifies "The European Central Bank shall have the exclusive right to authorise the issue of euro banknotes within the Union, The European Central Bank and the national central banks may issue such notes. The banknotes issued by the European Central Bank and the national central banks shall be the only such notes to have the status of legal tender within the Union,” When describing the Civic system, the words ‘money', ‘currency’' or ‘legal tender' w’ere never needed or used. The EU treaty’ refers to ‘euro banknotes’ and ‘legal tender'. The Civic does not need the status of legal tender' in order to function. It is more cost-effective for the Civic to exist only in electronic form with a mobile phone system as the platform rather than be issued as notes. We will use the word “contributions' when referring to Civics, and reserve the label ‘taxes’ for levies that can only be paid in euros, Some countries, such as the Netherlands, have already defined a special legal status for what is called 'civil service’. Even more familiar is the concept of a ‘ticket’ that is required to participate in a particular event. The Civics can be seen as tickets needed to live in a particular city'. If legal difficulties were to arise, a full consideration of the overall benefits of the Civics system could lead

to a change in some laws* What one law created, another law* can undo.

9. ECOsi Declaring War on Climate Change Niall Ferguson’s study of ‘The Cash Nexus’ has shown that all major innovations in the domain of government finance over the past three centuries were triggered by wars* Armed conflict seems to trigger innovations and

technologies that otherwise might never come to light* The scale of destruction caused by the most-likely climate change scenarios is worse than any war ever fought on this planet and is one of our main motivations for publishing this report now. (Please refer back to Figure 1*1 and Appendix A as evidence for this statement.) Eecause the devastation will unfold over decades, and reducing its likelihood will require collective action by humanity as a whole, this ‘war’ may also be more difficult to wage than any previous one* It may not have to be so hard if governments require ECOs to win a war against climate change* While the ECO shares many similarities with the Civic previously described, it differs from it in the following ways: * The Civic works best on a decentralisedbasis (e.g* cities and neighbourhoods) whereas the ECO must be implemented on a much larger scale such as on a national or a EU-wide scale* It wouldbest work on a global scale* * The Civic mobilises manpower for a variety of civil activities chosen by the population itself* The ECO focuses exclusively on mobilising material resources that contribute to the reduction of climate change* The Civic applies to households and citizens; the ECO applies only to medium and large corporations with for example, more than $1million sales per year* * The Civic is on the fringe of what is currently legal; the ECO would definitely require new legislation* * The Civic couldbe started on a small local scale and would thus be easy to implement; the ECO wouldhave to start on a larger scale and might initially encounter resistance from corporate lobbies* It would therefore be a greater challenge to implement it*

In other ways, the ECO system is conceptually similar to the Civic, as illustrated in Figure 8.4, It would start with a governmental authority such as a national government, requiring an annual contribution of ECOs proportional to the total sales volume of each individual corporation. For instance, all corporations would have to contribute 1 ECO for every $1 million of global sales to the government of the country where their headquarters were located,

The ECOs would be created by governments electronically and bear no interest* Corporations would earn ECOs by providing quantitatively verifiable evidence of investment and activities reducing the risk of climate change* There would be a clear description of how many ECOs a business would earn for each type of activity* An independently verifiable audit trail would be required before any ECO payment could be obtained* Qualifying activities could include: reductions in carbon emissions (e*g,, 1 ECO for each 1000 tons of verified carbon reductions), investments in natural carbon sinks (e*g, 1 ECO for each 1000 tons of carbon sequestration in new, sustainably managed forests) or in other sequestration technologies* Corporations unable to earn ECOs would need to obtain them by buying them using conventional money from corporations earning more than their requirement* A specialised online market wouldbe set up, as in the case of the Civic*

Wide consensus exists in both the scientific and the business world that the development of technologies to switch to a post-carbon world is possible but will require strong governmental leadership* Because many governments will experience a budget squeeze over the next decade, and because government subsidies are the usual way to fund environment conservation and protection measures, many corporations will be left passively waiting for funding to become available before deciding to tackle these issues on their own* The ECO changes this dynamic* In order to wage a war against climate change, governments could require contributions payable only in ECOs, thus giving value to the ECO* As discussed in Chapter V, any fiat currency (including bank-debt money) becomes valuable when a government requires it in payment of fees and taxes* The ECO would also spur serious innovations to

reduce climate change.

Such an approach will undoubtedly be unpopular in many business circles. But let’s see it in the context of what took place in President Roosevelt’s office on 27 December, 1941, when he signed his executive order 9001 stating: “The Office of Production Management will bring about the conversion of manufacturing industries to w'ar production, including the surveying of the war potential of industries, plant by plant; the spreading of wer orders; the conversion of facilities; the assurance of efficient and speedy production... The only argument given was that the United States had been at w*ar since 7 December, and until that war was over, things would run differently. This was the only justification available and the only one needed.

If we want to reverse humanity’s collective suicidal rush towards irreversible climate change, governments may have to declare war on it. From this perspective, would not corporate ECO contributions be a rather modest change, compared to what Roosevelt was ordering? tf #

We can now pull together all the strings of the logical key elements of this Report, to check their overall coherence.

Fulling all the strings together The central thesis of this report is that systemic financial meltdowns are pervasive because of a significant structural flaw in our monetary system (Chapters II and III). To systemically improve the resilience of our economies and the health of our societies, we must shift our monetary paradigm from a monoculture of debt-based, interest-driven money to a monetary ecosystem (Chapter IV). We also identified five negative effects of the prevailing monetary' monoculture on sustainability' (Chapter V). Our monetary' monoculture needs to make room for sufficient diversity' in both the types of exchange media and in the types of agents creating and managing them. Within this framework, we can map how the innovations described in Chapters VII and VIII could correct andbalance out the overall economy.

We will regroup these effects in the same sequence used to identify the five problematic influences in Chapter V.

Pro-cyclical money creation process and flow: 'It never rains, but it poursâ&#x20AC;&#x2122; Both the C3 and the TRC, if implemented on a sufficient scale, would have a counter-cyclical effect compensating for the pro-cyclical effect of the conventional system. There is quantitative proof that such built-in countercyclical behaviour works, and that the availability of a Business-to-Business (B2B) complementary currency spontaneously tends to stabilise the business cycle and the overall economy, A detailed analysis of the WIR system, a BÂŁB system in use for seventy-five wars in Switzerland, provides the evidence for this claims and allows us to conjecture that the same result would occur with the C3 and the TRC, Both these systems are business initiatives, and neither requires any new legislation or permission. They are also voluntary, with substantial advantages for participating businesses, even without any interest in sustainability. Therefore, the ball is completely in the court of the business community. 1*

It would also be possible for governments to stimulate the economy deliberately in a counter-cyclical wâ&#x20AC;&#x2122;ay with Biwa, Civics and ECOs. When a country or city experiences recession in the bank-debt money economy, and unemployment is high - as is the case today in Europe or the USA - the government at the appropriate level increases the quantities of Biwa, Civics or ECOs that it requires from citizens or businesses. If and when an inflationary boom occurs, governments can correspondingly reduce the requirement for

government-issued currency", 2.

Short-term thinking: Why we do not take the longer-term

future into account

The precise purpose for the design of the TRC is to correct corporate short-term thinking. In a different domain, the Wellness Token prioritises preventive care and encourages citizens to acquire long-termhealthy habits,

3- Coinpulson7 growth pressure: On debts and compound interest

None of the nine systems proposed has an interest mechanism built into it* Therefore, compulsory growth is not a part of these motivation systems. 4. Unrelenting wealth concentration: The never-ending story of the poor versus the super-rich

Poverty is caused as much by lack of appropriate savings tools as by lack of income. A widely held prejudice that the poor do not have the desire or capacity to save is false; it turns out that the demand for secure and convenient saving services is often stronger among the poor than the demand for credit services.每 This has been confirmed numerous times by empirical evidence, particularly from studies in the field of micro-finance.3 Natural Savings provides a better savings instrument than any savings account, and it is able to deal with very small sums. g. Devaluation of social capital: Why competition tends to

overwhelm cooperative behaviour Systems like Doraland, Wellness Tokens, Natural Savings, Torekes, Biwa Kippu, and Civics provide environments for people who otherwise would never meet to work together on projects that develop their gifts and the health and strength of their community. If people are given a powerful voice on which projects are chosen, these systems can rebuild and strengthen social capital over time. #

Another way to understand what an economic ecosystem would look like is to imagine what would currently be different if some of the solutions we are proposing had been well established before the 2007-2008 crisis. The C3 system would have reduced the level of unemployment resulting from the crisis. Civics would have empowered municipal governments to address their social and environmental challenges even with shrinking bank-debt money budgets. Together they would have provided an effective choice of tools to

generate healthy local and regional economies.

Five years after the start of the crisis, there is much that local communities can do to dampen its effects and to address austerity measures. The Doraland Foundation, city-generated Torekes and Civics systems all demonstrate ways to mobilise local human resources and make a significant difference without burdening city finances. In the event of a euro or dollar crisis, the role of the TRC in preserving a global web of vital trade would become obvious. It could, for instance, rescue us from the biggest andbroadest global trade disruption in

human history if a dollar crisis were to occur.

All nine innovative systems could also interact with the thousands of local and social currency experiments already under way around the world. The pioneers who started this movement should be recognised andhonoured. They have started at grassroots level a massive education and learning process about monetary' literacy that couldbecome essential for informed decision-making in the aist century*

Footnotes I All data about the Torekes are taken from a private report about the first year of

operation of the Torekes, by Wouter Van Thillo, dated November 2011. See also www.torekes.be.

2 See Bernard Lietaer, *A World in Balance1, Reflections (Journal of the Society for Organizational Learning - SoL), vol. 4, no, 4 (2003) and Bernard Lietaer and Stephen De Meulenaere, 'Sustaining Cultural Vitality in a Globalizing World: the Balinese Example1, international Journal for Social Economics vol. 30, issue 9

3 4

£ 2

£ 9

(2003), pp,967-9&4, See http://en.wikipedia.org/wikifSociocracy. See www.holacracjj.ora. Robert Wood Johnson Foundation, Service Credit Banking Project Site Summaries (1990), See tiftciLf -presidency -ucsfc.edu bit.ly/TPUnkÿS James Stodder (2009) and (2000), See, e,g, Daryl Collins etal. (2009), Beatriz Armendariz de Aghion and Jonathan Morduch, 'Microfinancer Where Do We

Stand?', in Goodhart (2004), pp.135-148: and Graham A. N. Wright, "A Critical Review of Savings Services in Africa and Elsewhereâ&#x20AC;&#x2122;, working paper, (1999), 35 pages.

Chapter IX Beyond the Limits to Growth?

We shouid be cutting lies instead of trees - Jerry Martien, Salvage Thisi

Exactly forty years ago, the first Report for the Club of Rome, The Limits to Growth, was published.每 It provided the first scientific demonstration that by remaining on our current development path, critical limits in raw materials, pollution and food production would be experienced during the first two decades of the 21st century. The Limits to Growth has been the launch pad for a growing awareness of how the biosphere constrains the economy as an open system. Using a methodology drawn from systems dynamics, novel at that time, computer simulations of hundreds of interacting variables were produced to support its claims and recommendations. The Limits to Grouch was highly praised for legitimising a new paradigm, Ecological Economics. It also attracted a lot of criticism, especially from believers in the Traditional Economics paradigm, who rejected it as a doomsday scenario.

Monetary Instability How can we prepare for the possibility of a iwonatary crash?

The Age Wave How will society provide the elderly with (tie money lo maw their

longevity?

2005 to 2020

Climate Change Howto realign stockholder's pooriltei wrth tong-term thinking?

Information Revolution How can ws provide a living to Additional billions st people when technology creates jobless growth?

Figure 9.1: Convergence of four megatrends, each with a â&#x20AC;&#x2DC;money question1that cannot be

resolved within the existing monetary paradigm.

Thirteen years ago, one of the authors of the present Report published The Future of Money.S The core argument was that four megatrends - the information revolution, climate change, monetary' instability' and an ageing population would converge to create unprecedented challenges before 2020 (see Figure 9*1).

Each megatrend was summed up in a money question, as follows: * How can society' provide the elderly with the money to match their longevity'? * How can we provide jobs for billions of people when technologies create

jobless growth? • How can we realign corporate financial interests with the longer-term thinking that society needs? How can we prepare for a global financial crash?

Addressing these issues, so The Future of Money argued, would force a redesign of the monetary system before 2020, because a monopoly of a single currency created by bank debt could not possibly allow citizens, businesses and governments to develop workable solutions. Only by opening up the possibility of a plurality of exchange means could we overcome the obstacles that we are facing in the 21st century. In a sense, The Future of Money focused on the need to re-think money in order to answer the questions formulated by The Limits to Growth Essentially this was because the conventional principle of creating money through interest-bearing bank credit has a systemic growth obligation built into it not even necessarily out of ideological choice (although this can also be present as an additional factor), but out of sheer mechanical necessity. Therefore, seeking to counteract all the deleterious effects of economic growth without questioning the omnipresent monetary tool that drives this growth, could not work. But getting to the solution requires us to find a way to see some way around the monetary blind spot that we identified in Chapter II.

An economy based on several currency’ systems running in parallel would actually not be new. In reality’, it would be the recovery of an ancient idea. In Dynastic Egypt and the Central Middle Ages in Western Europe - to name two examples - such an idea was considered totally obvious. As Jean Houston put it elegantly: “The icons of old are the codings of tomorrow. And tomorrow

holds the promise of recovery' of forgotten wisdom.“4 Still, the assimilation into common sense today of such an old idea requires that it be heard, understood, accepted and internalised. This is a very’ ambitious goal, as some learning will be needed on almost everyone's part. For today’s elites, particularly financial elites, revisiting the classic works of Arnold Toynbee* or more recently the writing of Jared Diamond, might be

useful Toynbee is tie economic historian who demonstrated that the collapse of 2i different civilisations could be attributed to just two causes: too much concentration of wealth and an elite that, confronted with changing circumstances, remains unwilling to shift its priorities until it is too late, Diamond focuses on environmental degradation as a proximate cause for the collapse of civilisations. We are currentlypushing the limits on all three causes, at the same time! Being part of an elite is no real protection in a collapsing civilisation. Is the advent of a monetary ecology, even if it implies some losses compared to the status quo} not a suitable terrain for compromise? Box 9.1- A Terrain for Compromise? Is there a terrain of compromise that might also be acceptable to the protagonists of the fi nan dal system? Anyone enjoying the privilege of a monopoly will tend to fi ght to retain it. Legitimising non-fi nan dal incentive systems will therefore not be an easy path for the fi nandal system, and even harder to accept for some central banks. However, in contrast to the Chicago Plan, what is proposed here keeps the core of the banking system's business model intact. Interest in a Chicago Plan reincarnated under the name of 'Modern Money Theoryâ&#x20AC;&#x2122; (MMT) is now spreading, even at the grassroots level. Just one example: a public conference entitled 'the MMT Summit5 was held in Rimini, Italy, on 24-26 February 2012, It attracted

several thousand partidpants!2 Men assessed in terms of its sodetal consequences, maintaining the monetary status quo and the Offi dal Paradigm seems increasingly irresponsible, perhaps untenably so, European countries have been fi nandally cornered into dismantling sodal safety nets that took generations to build, and into retracting the promises made to people who contributed through out their entire working lives to a pension and health care system. Governments will also be obliged to privatise cultural heirlooms that have, in many cases, been public property for centuries or even millennia. Most regrettably, universal austerity will render them totally unable to exert the leadership required for the kinds of investment needed to avoid runaway climate change, The Fiat Currency' Paradigm makes it dear that our money system is an 18 century legacy information system, rendered quite convoluted and sclerotic by 300 hundred years of use and abuse, How will we explain to our children and grandchildren that thanks to the technological means available in a new Information Age, we were able to update all our information systems except our monetary system? Who will take responsibility' for telling them that we saerifi ced the planetary biosphere in order to keep our monetary system operational for one more decade?

Thomas Friedman’s op-ed piece from the New York Times, previously mentioned in Chapter VI, concludes: "Capitalism and free markets are the best engines for generating growth and relieving poverty - provided they are balanced with meaningful transparency, regulation and oversight. We lost that balance in the last decade. If we don’t get it back - and there is now a tidal wave of money resisting that - we will have another crisis. And, if that happens, the cry for justice could turn ugly. Free advice to the fi nan dal services industry: Stick to being bulls. Stop beingpigs.w &

For the rest of us, a bit more learning may also be the best first step for the

immediate future, * For anybody trained in economics, the required mental switch is to look at the paradigm used in the teachings they have received, and compare it with the approach used in this Report, The Ecological Economics paradigm - in contrast with the Traditional Economics still widely taught in universities allows to re-think the role of money within an open-system economy that uses up natural andhuman resources, throws off waste, and needs to feed and protect a growing and ageing populations Endless growth is impossible without terminal harm to natural, social and, eventually, even narrowly defined economic capital. However, “sustainable abundance"-ÿ is also available, and quite different. It requires devising a differentiated monetary' system in which specific means of exchange target urgently required activities. It is not the first time in history* that worldview changes have been needed in order to forestall catastrophe. Sometimes they happen in time; but more often they do not, as Jared Diamondhas shown. In the present case, we have no excuse for ignorance. The evidence, the concepts, the analytical tools and pilot experiments are all openly available, * For the scientific community, there are two domains where quality data exists to test our core theoretical framework empirically. These two domains are the electrical distribution networks and the banking system. We can measure the real-life resilience of a sufficiently diverse and interconnected network flow system versus that of one in which efficiency' is the only criterion. The data, however, remain in the hands of organisations that consider them to be confidential. People with access to the data wouldbe performing an enlightened and immensely beneficial task were they to make

them publicly available, if necessary in a manner which protects the anonymity of the individual institutions involved. Or they could use these data to test for themselves the theory whose technical and mathematical content are available in Appendix D. * For the population at large, perhaps the most important learning needed is to grasp non-linearity, and specifically to integrate the difference between linear and exponential growth. Although this does not appear particularly difficult to achieve at first sight, this challenge should not be underestimated. When a scientist such as Lovelock admits “I find to my personal horror thatIhave not been immune to naivete about exponential functions", it would appear that our brains have difficulty in assimilating such concepts. We are now dealing with a world with increasingly non-linear challenges. There are thresholds or ‘tipping points’ beyond which catastrophic events become highlylikely, something which climate scientists, and experts on debt are warning us about, validly, and with increasing urgency.

Exponential growth in population, greenhouse gas emissions or cumulated deficits is mathematically incompatible with sustainability', however the term is defined. However, there also exist ‘good’ non-linearities in the form of dampening mechanisms that can slow down growth when and where needed, and stabilise otherwise explosive dynamics. This is what logarithmic or self-slowing growth makes possible. Judicious steering of our current economy requires a subtle combination of positive and negative feedback mechanisms. A monetary' ecology' is one of the centrepieces of such a combination. Some of the complementary' motivation systems described in Chapters VII and VIII offer counter-cyclical stabilisation. Combining several of them may create an economy in which a global reduction in environmentally and socially harmful activities is matched with a local build-up of ecologically and socially beneficial ones. Sustainable abundance is not generalised poverty' - on the contrary, it is generalised prosperity on the basis of a plurality' of means of exchange allowing people to gain more awareness and control over their social lives, and over their interactions with the rest of the biosphere. Suggesting several domains of learning to many people sounds like an

unusually ambitious aim. However Chapter VII showed that some of the necessary innovations are already working in practice. Citizens, NGOs, businesses and political decision-makers are already using the concept of a monetary ecology, simply by creating it. Fortunately for all of us, these courageous pioneers are following Sophocles’ centuries-old advice: “One must learn by doing the thing; for though you think you know it, you have no certainty, until you try." Recent monetary history demonstrates that those who officially manage the system are also concerned. The EU sovereign debt crisis and the associated euro crisis clearly have their roots in the functioning of the current monetary system. Faced with the threat of a eurozone breakdown, European governments are scrambling to combine bailouts, commitments to future bailouts and extreme austerity measures to ‘save’ the monetary system in its present form. This is exactly what will not succeed simply because the crisis is only the latest symptom of the same underlying structural flaw,

Whenever someone considers the possibility of a euro breakup, the only option that seems to be debated is a return to the old national currencies. One popular definition of insanity comes to mind: “doing the same thing over and over again, and expecting different results". Not enough has beenlearned yet at the official level, while a ‘blessed unrest’ ripples through citizens and NGOs on the planet. Is humanity suicidal, as sociobiologist Edward 0, Wilson claims in one chapter of his book The Future ofLife We do not believe so. However, if the forces behind the current status quo believe it can continue to do ‘business as usual' for one more round and continue to make money out of a failing system - they may well send all of us tumbling into the abyss of a collective demise.

We need to collectively usher in a new age of monetary’ and societal experimentation, and this requires us to accept new knowledge and experience in areas where it was previously unheard-of, ‘Thinking outside the box’ of conventional monetary arrangements may have to become the new common sense - not out of a taste for ‘newness’ per se} for anarchy, or for new age

ideology', but simply because our future welfare depends on it,

Ultimately, our plea for a monetary ecology is a call for a new mode of economic governance. The aim is to allow two types of economy to coexist peacefully: on the one hand, the mainstream economy will continue to use conventional money in the competitive economy and, on the other hand, the rebirth of a cooperative economy will see regions, cities, neighbourhoods, NGOs and grass-roots citizens’ organisations develop the full potential of their projects without needing to depend on the supply of bank-debt currency. Most crucially, we need to revisit our monetary governance. This is a highly unusual question in the current framework. Democratic governance is a w'eak spot for all monetaiy systems, be it the official one, or the ongoing complementary’ experimental systems. Due to our monetary’ ‘blind spot’, we are used to leaving governance of the monetary system to an opaque and highly centralised set of institutions. We can hardly envisage what the democratic management of a plurality’ of currencies might look like. This may be the most crucial unresolved organisational question we need to deal with, if we are serious about sustainability'.

Friedrich Hayek (quoted in Chapter IV) showed remarkable vision when he concluded that, "What is now urgently required is not the construction of a new system, but the prompt removal of all the legal obstacles which have for two thousand years blocked the way for an evolution which is bound to throw up beneficial results which we cannot now foresee.”-ÿ

Actually, many of the beneficial results of these complementary systems can now’ be foreseen. Each community', business group or geographical area can begin something at its own scale, if it feels so inspired. What matters is to be able to learn from each other’s experiences. What works? And even more usefully: what failed and why? We need a learning movement that anyone can join. The relevant technologies for communicating this learning are also, for the first time, available on a planetary level. On the website www.moneu-sustainabilitumet (formally a part of this Report) we invite public input on how to deal with the matters presented in this Report. The potential number of issues worthy of attention and debate is

infinite. They can be as rich as life itself. Here are just four examples of topics

well worth some attention: * What initiatives or experiments can be started now* to help the government and citizens of Greece deal with their country’s economic collapse? Why could Greece not stay within the eurozone for its international transactions (tourism, shipping, exports and imports), while allowing its cities to start Civics systems to replace the vanishing governmental social support mechanisms? Would this not help reduce the Greek central government’s budget deficit while giving a breath of hope to the millions affected by savage cuts in jobs and vital social programmes? * How can we address horrendous youth unemployment,-U in countries like Spain (45% official youth unemployment), Slovakia (33.6%), Lithuania

(33.2%), Ireland (29.8%), Portugal (28.7%) and Italy (27.7%)? Why not implement C3 systems at the regional level? Wanting ‘regional development’ while using only the euro has been shown to be an economic oxymoron, a contradiction in terms.-U * Why not mobilise the European Investment Fund for launching C3 systems? Several billion euros are available through the JEREMIE program (‘Joint European Resources for Micro to Medium-sized Enterprises’),-ÿ if a 2010 administrative decision to make these funds available only for SMEs starting brand-new activities backed by a formal business plan is reversed. How many SMEs in today's economic environment are able to start brand-new activities, when they are dying like flies from not getting paid on time for their existing sales? As a consequence, most of these JEREMIE funds will expire unused in 2015. How can such administrative blockages be lifted? * Much of our approach to education still involves preparing children for an industrial world that no longer exists. Why not experiment with systems such as the Doraland that considers everyone a potential teacher and learner? How might learning multiply with mutual-learning approaches, in and out of school?-!ÿ With an infinite number of domains requiring learning in a world of ever-accelerating change, should we not use all of our

collective intelligence, well beyond the mechanisms andhorizons

encouraged by our out-of-date industrial-age structures? We are facing the greatest challenges ever to be faced by humanity. We know that we must switch to a post-carbon economy, and swiftly, if we are to avoid disaster. We know that this is technologically possible, but that it can be implemented within the time available only with massive government support and funding - something which reined-in budgets in conventional money will not allow for at least the next decade. At the same time, we face caring for a booming greying population that will no longer be contributing to the economic base, but will need to rely on social support programmes that are now' under frontal attack. We face all this with shrinking economies, under brutal compulsion by an anonymous â&#x20AC;&#x2DC;financial marketâ&#x20AC;&#x2122; to reduce enormous public debts, bloated by the cost of the 2007-8 banking meltdown and its immediate economic consequences.

The stakes are unprecedentedly high. But the possibilities for creative solutions are also near at hand - solutions that do not further strain public budgets, that have already demonstrated their effectiveness in practice, that can turn populations from hopeless rage to fruitful engagement within their communities, and that can preserve corporate profits, but not at the expense of social and environmental health. We still have a fighting chance to give birth to a sustainable world that works for everyone.,. Is this scenario pie-in-the-sky? Are we offering just one more miraculous panacea? We do not think so. We have never claimed that a monetary ecosystem would be sufficient to address the challenges of today. We hope to have shown, however, that rethinking our money system is a necessary part of any solution. This is the core message of this Report. Our sincere hope is that as the world of the old economy breaks down, the seeds of a new and more humane economy may be given a chance to emerge. â&#x20AC;&#x153;There is a rabbinical teaching that if the world is ending and the Messiah arrives, you first plant a tree; and then see if the story is true. Islam has a similar teaching that tells its adherents that if they have a palm cutting in their hand on Judgement Day, plant the cutting.1"12

Appendices The following appendices are available online at bitAv/TPmissinalink A: A Primer about Money E: Climate Change

C: Mapping Paradigms D: Complex Flow Networks

E: A Chinese Insight F: Wealth Concentration G: Kondratieff and the 'long wave' Videos: http://www.triarchypress.net/videos.html

Acknowledgements Brussels, May 2012 This Report is the result of two waves of efforts* The first wave, from eooi to 拢004 ? involved an international working group of 15 experts* It resulted in a German-language publication in 2005*每 The current Report is the product of a second wave of work from 2010 to 2012. It required an autopsy of the 2007-8 financial crash, and the lessons we should draw from it.It also made possible a number of theoretical updates from recent peer-reviewed publications* This report has been substantially enriched with suggestions by academic colleagues from various backgrounds* It was not possible to reference all of them in footnotes, for which we apologise* The responsibility for any remaining errors and omissions rests with the co-authors* Given the mixed linguistic background of the authors, the editing for this work has been laborious. We want to express our gratitude to a group of important women who made this publishable version possible* Among them, Jacqui Dunne has delivered much of the initial heavy language lifting* Gwendolyn Hallsmith contributed many substantial ideas for Chapters II and VII* Sherry Cox has contributed clarity to all chapters. Last but not least, Stephanie Tache managed to incorporate a feminine sensitivity to what would otherwise be a heavier Report* The illustrations were produced with help from Thibault d'Ursel* Finally, Andrew Carey and Alison Melvin from Triarchy Press helped publish this book in record time, without compromising on quality* Our gratitude also to the thousands of pioneers who have already initiated monetary experiments on their own scale! What they are learning - by doing -

is more important for humanity than they may realise themselves,

Footnotes l

Quoted by Paul Hawken (2007), p.27.

2 Meadows ef a/. (1972). 3 The German edition was published thirteen years ago, the English edition two years later. Bernard Lietaer, Das Geld derZukunft: Ober die destruktive Wirfcunp des existierenden Geldsystems und die Enfiuick/imp von Xompfemen fidrLudhruripen (1999) and The Future of Money: Creating New TVeaffih, Work, and a Wiser World (2001). Force: The Psychohistorical Recovery of the Self (199$), p.13. 4 Jean Houston, 5 Toynbee (1939). For a mercifully abridged version, see Toynbee (i960). £ Jared Diamond (2005). 2 See a 2-minute video about the atmosphere at the summit: bit.lv /TPlink40. An analysis of the intellectual content is available at

http://dandelionsalad.wordpress.com ktr.fp/TFfmkÿo & Thomas Friedman, 'Did you hear the one about the bankers?5 op. cir. 9 These two aspects - growing population, ageing population - are not necessarily mutually exclusive. The population of the planet as a whole is still growing quite strongly, whereas in the so-called “developed* world the “age wave* is imminent and, in fact, already starting to come in. 10

13 14

See Lietaer (2001) pp.17-30. Edward 0. Wilson, The Future ofLife (2002). See http://mises.oro bir.hj/TFfinfcÿi p. 34. http://ec.europa.eu ~ bit.ly/TPlink$2 Documentation about the arguments for a regional development strategy' has been provided in: Kennedy & Lietaer (2004): Lietaer & Kennedy (200S); Lietaer & Kennedy

(2010),

15 See mtum.eftorp bit-fy/TF/inkÿ?. The data available as of January' 2012 date back to the 2nd quarter of 2011, 1$ Anne Querrien, L’ecole mutuelle: Une pedagogic frop efficace? (2005). 12 Hawken (2007) p.4. l£ Stefan Brunnhuber and Harald Klimenta, Wie wir wirtschaften werden: Szenarien und Gesfa/mnpsmop/ichkeiten fur zukunftsfdhige Finar&markte (2005).

About the Authors Bernard LIETAER has been active in money systems for 35 years in an unusual variety of functions* While at the Central Bank in Belgium he co-designed and implemented the convergence mechanism (ECU) to the single European currency system and served as President of Belgiumâ&#x20AC;&#x2122;s Electronic Payment System, He was General Manager and Currency Trader for the Gaia identified him in 1990 as the worldâ&#x20AC;&#x2122;s top Hedge Funds, when Business trader. He is currently Research Fellow at the University of California, Berkeley, and Visiting Professor at the Finance University in Moscow, He is the author of fifteen books relating to monetary and financial issues*

xvww.lietaer.com

Christian ARNSFERGER received his PhD in economics from the Universite Catholique de Louvain* He is a Senior Research Fellow with the Belgian National Science Foundation (F.R.S-FNRS) and a Professor in Economics at the Universite Catholique de Louvain. He specialises in the epistemology of economics; the existential underpinnings of economic rationality; the link between economy, natural resources and the environment; the link between money and sustainability; and the transition to a green economy. He is the author of six books and numerous articles in academic journals* www.eco-transitions.bloasDotxom

Sally GOERNER is the Director of Triangle Center for the Study of Complex Systems, President of the Integral Science Institute, and Economic Development Coordinator for the Greater Pittsboro Community' Development Corporation* She has advanced degrees in engineering, systems physics (MS,

PhD) and psychology (PhD/ABD), and is the author of 5 books, including After the Clockwork Universe and The New Science of Sustainability. She is one of the leaders of the international movement to integrate the findings of â&#x20AC;&#x2DC;intricacyâ&#x20AC;&#x2122; research and apply them to human systems from economics to urban planning, www.integralscienceinstitute.orofabout ISLhtml

Stefan BRUNNHUBER has two PhDs, one from Medical school (MA, MD, Dr, med, habih) and studied socioeconomics (Dr, rer, Soc,) with Lord Ralf Dahrendorf , He is vice-chairman of the European Institute of Medicine and has multiple international Visiting Professorships, Former Visiting Fellow at the C, G, Jung Institute in Zurich, he is currently Medical Director and Chief Medical Officer at the hospital for integral psychiatry in Saxonia, Germany, He has written and delivered over 300 publications and presentations and is a member of the European Academy of Sciences and Arts and the Austrian Chapter of the Club of Rome, www.stefan.brunnhuber.de

About the Club of Rome The Club of Rome, an affiliation of individual members and over thirty associations all over the world, is unique* The network of Club members and their institutions is extensive* It draws on all sectors and disciplines, including senior individuals from the banking and financial sectors, scientists, academics, technologists, social scientists and philosophers* Many are world renowned, Nobel recipients and exceptional personalities* The members of the Club of Rome work on a wide variety of issues relevant to the future of humankind* The mission of the Club of Rome is to undertake forward-looking analysis and assessments for the betterment of humanity and to provide a range of options and ways forward towards a happier, more contented, resilient and sustainable planet For more information please visit www.clubofrome.ora

The Club of Rome EU Chapter is an independent, Brussels-based, non-profit Association* It is registered under Belgian law, and affiliated with the Club of Rome* It aims to build bridges between the institutions of the European Union, their constituencies and the Club of Rome as a leading think-tank at world level* Its mission is to act as a catalyst of reflection on sustainable development in Europe and at the global level* Its specific aims are: * To identify the most crucial sustainability problems facing European society'; to analyse them in the global context and to reflect on alternative

future solutions for a sustainable society, including the elaboration of specific scenarios for the future of the European continent*

* To initiate and facilitate cutting-edge research in which the major theme is the development of ground-breaking concepts for globally sustainable development and for the specific contributions that Europe can make. To organise a societal discourse on the implementation of European policies for sustainable development in a global context, involvingkey public authorities and private sector decision-makers, the media as well as the public at large.

For more information please visit www.clubofrome.atfcor-eu

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Soft

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A Primer on How Money Works ‘Your’ Money in Its World Money and Sustainability: Appendix A “Money is the crowbar of power” Friedrich Nietsche

“The only people who claim that money is not an issue are those who have sufficient money that they are relieved of the ugly burden of thinking about it.” So thought the American writer Joyce Carol Oates. This Primer will explain why now even those fortunate few should think about it. Have you ever wondered where your money comes from? How the value of your money is determined? Who is really in charge of your savings? To start answering these questions, we need to understand the rules of the global money game, know who the players are and why they act the way they do. In this Primer, you will meet the key actors in our money system, and learn the essentials of the map of the current system that we will refer to later, when we explore the fundamental changes taking place in the system. Never before have monetary issues had such an influence on public policy worldwide, so this is a good time to educate ourselves about what is at stake. All of this will dramatically affect your money and your own future as surely as a radical climate change would affect the flowers in your garden. The starting point is to become aware that “your” money really represents a partnership between you and your country’s banking system. In this chapter, you will learn how banking originated and how any form of storing value (real estate, stocks, bonds and currencies) can be transformed into additional new money by banks. Because banks have proven historically to be very fragile institutions, specialized emergency “firemen” or intervention organizations have been created: a Central Bank in each country, and on 1

a global level the International Monetary Fund (IMF) and the Bank of International Settlements (BIS). Their role in managing the growing instability of the global money system will be assessed. We will then return to the initial questions on how all this affects your own money and future.

“Your” Money

Mlle Zélie’s paycheck Mlle Zélie, a French opera singer on a world tour during the 19th century, gave a recital in the Society Islands. It was a great success, and for her fee she received one-third of the proceeds. By the way, some things do not change: this is still what Placido Domingo takes home from a performance. But Mlle Zélie’s share consisted of three pigs, twenty-three turkeys, forty-four chickens, five thousand coconuts and considerable quantities of bananas, lemons and oranges. Unfortunately the opera singer could only consume a small part of the total and (instead of declaring a public feast as would be local custom) found it necessary to feed the pigs and poultry with the fruit. A handsome fee ended up going to waste.

“When I was young, I thought that money was important; now that I am old I know that it is,” was Oscar Wilde’s view. Perhaps you have come to the same conclusion. Whatever you want to do with your life, you will invariably require some money to achieve it. Money is a most convenient medium of exchange, certainly more convenient than its barter alternative, as the story of Mlle Zélie illustrates (see box). However, your money is never really “yours” in the same sense that you own your eyes, your hands or your car or home, once all the payments have been made. “Your” money is more like “your” marriage: another party--your husband or wife--is intrinsically involved in the arrangement. Modern money is also a bipartisan agreement. It is an asset to you only because it is someone else’s liability. And the modern banking system has been the necessary counterpart of such “credit-money.”

How does Banking Work? The first party to whom you need to be introduced is therefore your bank, not because that is where you keep your money, but because that is where your money is created. How Did Banking and “Modern” Money Start? During the late Middle Ages, gold coins were the highest denominated currency. Goldsmiths were considered most qualified to check the purity of these coins. Even more important, they owned strongboxes for keeping the gold safe from thieves. So it became a prudent practice to give gold to the goldsmith for safekeeping. The goldsmith would give a receipt for the coins and charge a small fee for the service. When the owner needed to make a payment, he or she would cash in the receipt and the goldsmith would pay out the coins. After a while, it became more convenient and safer to make payments by just using the receipts. If the goldsmith was known by everybody to be a trustworthy fellow, why take the risk of moving the physical gold? The goldsmith receipts soon became tokens for a promise to pay. So that whenever someone accepted the token as payment, they were implicitly entering into a loan agreement with the goldsmith. Thus we gradually shifted from money based on commodities, in this case gold, to money based on credit or a bank loan. This is the arrangement that remains today. Soon the most successful goldsmiths noticed that the bulk of the coins stayed in their strongboxes most of the time. Thus, one enterprising goldsmith observed that he could issue receipts in excess of the gold coins he stocked, because the depositors would never retrieve all their coins at the same time. In this way, he could increase his income without having to increase his gold reserves.

So it was that European paper currency and “modern” banking were born simultaneously on the goldsmith benches of 13th century Italy; and why the word bank derives from banco, the Italian bench where those early transactions took place. 1 All the key ingredients were already there: paper money as a counterparty’s liability, the importance of a good reputation for that counterparty and, what is now called “fractional reserve system.” The latter’s intimidating label belies the simple process it represents of enabling the banking system to create more money than the deposits it holds. The Secret of “Modern” Money The secret to creating money is being able to persuade people to accept one’s IOU (a promise to pay in the future) as a medium of exchange. Whoever manages that trick can derive an income flow from the process (e.g., the medieval goldsmith fees, or, today, the interest on the loan that creates the money). Such income is called “seigniorage,” a word derived from the right of the Lord of the manor (“Seignior” in Old French) to impose the use of his currency on his vassals.

Non-Western Money Innovations This Primer focuses on Western money and practices, not because they were historically the most advanced or important, but because the current world system is a direct evolution of these Western institutions. But the West was really quite a latecomer in this domain. For instance, the earliest samples of writing date from 3200 BC in the Sumerian city of Uruk and describe deposit banking, “foreign exchange” transactions, secured and unsecured lending both locally and with neighboring city-states. The first official banking laws were part of the Code of Hammurabi (around 1750 BC). The oldest private bank whose full name has been preserved is the “Grandsons of Egibi” incorporated in Babylon in the 7th century BC. These Babylonian banks, “by the detailed organization, by the number of branches and employees, by the daily records and accounts kept of the capital invested in them, may well be compared with the greatest banks of the nineteenth and twentieth centuries AD.” The first “modern” style paper currency was issued in China during the reign of Hien Tsung (806-821 AD) as a temporary substitute for the traditional bronze coins. Paper money was quite commonly in use in China by 900 AD, and in 1020 that country had also attained the dubious honor of living through the first hyperinflation in paper currency, as excessive paper money had been issued for a total of 2,830,000 ounces of silver in nominal value. “A perfumed mixture of silk and paper was even resorted to, to give the money wider appeal, but to no avail; inflation and depreciation followed to an extent rivaling conditions in Germany and Russia after the first World War.” The first time the West heard about paper currency - with total disbelief - was through Marco Polo who was in China from 1275 to 1292. “In this city of Kanbalu is the mint of the grand khan, who may truly be said to possess the secret of the alchemists, as he has the art of producing paper money... All his majesty’s armies are paid with this currency, which is to them the same as if it were gold or silver. Upon these grounds, it may certainly be affirmed that the grand khan has a more extensive command of treasure than any other sovereign in the universe.” Kublai Khan’s paper currency became also one of the first world currencies as it was accepted at its maximum extension from mainland China to the Baltics, almost 500 years before the practice became widespread in Europe.

As the nation-states became the powers-that-be, a deal was struck between the governments and the banking system. The banking system obtained the right to create money as “legal tender”2 in exchange for a commitment to always provide whatever funds the government needed. The longest surviving agreement of this kind can be traced back to 1668 with the license of the “Bank of the Estates of the Realm” in Sweden (whose name was changed in 1867 to Riksbank as the Swedish Central Bank is still known). The model was copied in Britain, a

Durban, Charles F. “The Bank of Venice” Quarterly Journal of Economics Vol. 6 number 3,April 1892

“This note is legal tender for all debts public and private” is written on every US$ bill. What this means in practice is the following: if you owe someone money and she refuses your offer to pay with US$ bills, you can walk away and simply declare the debt void. If needed, the courts will back you in such a declaration. 2

generation later at the founding of the Bank of England (1688)3 from where it spread around the world. The Little Old Lady from Threadneedle Street, as the Central Bank is referred to in the City of London, “is in all respects to money as St. Peter’s is to the Faith. And the reputation is deserved, for most of the art as well as much of the mystery associated with the management of money originated there.”4 For the US, this same deal--money as bank credit for the guarantee that governments would always get the money they want--was part of the Federal Reserve Act of 1913. That is why the US Federal Reserve Bank accepts any government bond that the public does not buy, against which it issues a check for the corresponding Money Alchemy amount. This check pays for the government’s expenses, and in turn the Modern money alchemy (officially called “fractional reserve recipients deposit it in their own bank multiplier”) starts with the injection of say $100 million “high powered money” into the banking system, for instance, by accounts. That is when the magical “fractional reserves” come into play. For every deposit that any bank receives, it is entitled to create new money, specifically, in the form of a loan to a customer of up to 90% of the value of the deposit.5 That new loan--for example, a mortgage that will enable you to buy a house--will result in the seller of the house making a new deposit somewhere else in the banking system. In turn the bank receiving that deposit is entitled to create another loan for 90% of that new deposit; and so the cascade continues from deposit to loan down through the banking system. What started as a $100 million check issued by the Federal Reserve (called “high powered money”), by the time it works its way through the commercial banking system, has enabled banks to create up to $900 million of new money in the form of loans (see box).

having the Fed pay government bills for that amount. These funds end up being deposited somewhere in the banking system by the recipients, which enables the bank that received the deposit to provide a loan for $90 million to someone (the other $10 million becoming “sterile reserves”). The $90 million loan will in turn lead to a deposit for that amount, enabling that next bank to provide another loan for $81 million, etc. 100 million (High Powered Money)

Loans (millions)

Deposits (millions) (no’s rounded) 100

90 90 81 81 72 etc. Total: 900 million.

etc. 1000 million

This is how what started as $100 million Fed “high powered money” can create $900 million in “credit money” as it trickles down the banking system.

To be more accurate, while the Charter of the Bank of England dates from 1688, the monopoly of emission of paper money was assigned by King William of Orange to that institution only in 1694, when he urgently needed an additional 1.2 Million Pound for a war against the French. In the case of Sweden, the power of emission had similarly be transferred to the Bank of the Estates of the Realm when the crown needed urgent money to fund a war against Denmark. While the introduction of paper money made the transfer of the power of emission of money from sovereigns to banks possible, the proximate cause of that process was war. 3

Galbraith, John Kenneth, Money: Whence it Came, Where it Went(London: André Deutsch, 1975).

5 Because the regulations specify that only 10% of a deposit need to be kept as “reserves” in case the customer withdraws the funds. Therefore up to 90% is available to make new loans. Changing that percentage is one of techniques whereby the Fed controls the quantities of credit money the banks will be able to create. The exact percentages also vary with the kind of deposit made: the longer the term of the deposit, the lower the percentage of “reserves” are required. The 90% rule of this example, enabling a “multiplier” of about 9 to 1 is an illustrative average.

If you understand this “money alchemy” you have understood the most arcane secret of our money system. According to this theoretical scheme, however, it appears that banks can make loans only to the extent they have sufficient reserves. In practice, however, “banks do not wait for excess reserves before making loans and creating deposits. Rather, if faced with a credit-worthy customer and a request for a loan, a bank makes the loan. It then operates to obtain reserves as necessary to meet legal requirements. If banks in the aggregate are short of required reserves, the central bank automatically must supply them.6 In spite of rhetoric about Fed policy to discourage such borrowing it is simply impossible for the Fed to refuse to supply the reserves needed by the system.”7 As a consequence, the quantity of "high powered money" created is in reality controlled by the banks themselves as the central bank has not really the possibility to refuse providing the necessary reserves. Its influence is limited to the interest rate that it charges on those additional reserves. It is even more impracticable for a central bank to get banks to make more loans if they are not inclined to do so. When central banks try to push banks to lend, as was the case after the crash of 2007-2008, it is as if they were trying to “push on a string.” 8 This is the convoluted mechanism by which the deal struck between governments and the banking system is implemented, and why “your” money ultimately involves the entire banking system of your country. Money and debt are therefore literally the two sides of the same coin. If we all were to repay all our debts, money would disappear from our world, because the entire process of money creation illustrated in the “money alchemy” would reverse itself. Reimbursing all the loans (the left side of the graph in the sidebar) would indeed automatically use up all the deposits (on the right side). Even the Fed’s high powered money would evaporate if the government were able to repay its debts.

“Old” and “New” Banking In his classic book, The Bankers (1974)9, Martin Mayer recounts the following true story. A man was honored for 50 years of loyal service to a Virginia Bank. At the party celebrating his long service, he was asked what he thought had been “the most important change that he had seen in banking in this half century of service?” The man paused for a few minutes, then went to the microphone and said “air conditioning.” In his follow-up book The Bankers: the New Generation, Mayer notes: “Twenty years later, this story is prehistoric. It’s still funny, but it’s incomprehensible. In these twenty years, banking has changed beyond recognition. ….Almost nobody who has a job in a bank today works as his predecessors worked as recently as twenty years ago.” 10

If a bank is short on reserves, this “short” is in fact an overdraft on its reserve account with the central bank. This overdraft is, for all purposes, a loan from the central bank. So there is no way that a central bank could deny credit to a bank. 7

L. Randall Wray, Understanding Modern Money, op. cit., p. 118.

8 This is one of the reasons why central banks are even more worried about deflation than about inflation. To reduce inflationary pressures, they can make loans more expensive by increasing interest rates. But when central banks are facing deflation, interest rates can only go as low as zero to convince people to borrow (although the Bank of Japan has even gone as far as charging a negative interest rates to the banks to stop deflation, without much success). 9 10

Mayer, Martin The Bankers (New York: Weybright and Talley, 1974) p. 16 Mayer, Martin The Bankers: the New Generation (New York: Truman Talley Books/Dutton, 1997) pp. 16 and 19.

Banking has indeed changed more in the past 30 years than it has in hundreds of years. The 1970 US bank holding company law still defined a bank as an institution which “agglomerates the transaction balances of a community to lend it at interest to its commercial enterprises,” a definition quite consistent with Adam Smith’s two centuries earlier. It is also, at its core, the same “banking” business that the Babylonians and the Italian goldsmiths had started on their benches when they too gathered local savings and lent them out to businesses for a fee. Today there are few such banks. Most surviving banks are involved in different businesses. By 1996, almost 85 % of the banking industry’s resources came from sources other than insured deposits. Instead of loans to businesses, credit card loans to consumers are the lifeblood of the largest banks. In short, banks take their money where they can find it and use it for whatever activity the law allows that looks profitable. They have abandoned traditional banking and entered the “financial services” business. The deeper reason for this unprecedented shift is the impact of the Information Age. It has fundamentally transformed competitive factors in the credit markets.

Credit Markets Mayer notes that in the “olden days” of 20 years ago, “banks used to fancy themselves as advisors to their clients.” In actuality, they simply took advantage of the monopoly they had over financial market information. When computers suddenly made it possible for anybody to have direct access to financial market quotes, the ground shifted under their feet. Many corporations used this access to issue Magic Money their own commercial paper, bypassing the commercial A man fell asleep on May 30, 1887 and banks in the process. For instance, General Motors woke up on September 30, 2000. Finance Corporation (GMFC) issues its own Among the most amazing things he “commercial paper” (i.e. short term borrowing in the discovered was that Americans still form of notes that raise capital directly in the capital counted in dollars and cents, but paid market), and then lends it out to consumers who buy for everything in large mall-sized warehouses with “pasteboard credit General Motors cars. The largest financial lender in the cards.” This is the starting plot of a US today is not a bank; it is General Electric Capital novel published in 1888 by Edward which completely finances itself without a penny of Bellamy entitled Looking Backward: bank loans. 2000-1887. Novelists will invent the craziest things...

Traditional banks did not cope well with this massive change. Since 1980, over one-third of US banks have merged or disappeared in the turmoil that ensued. Even those that remain have shrunk their staff dramatically. “Banking hours” are now history. The proliferation of Automatic Teller Machines (ATMs) has taken care of that and eliminated more than a third of a typical bank personnel over just one decade (1983-1993). Even all of this does not fully take into account the impact of the second wave of computerization which has just begun--the Internet revolution--the creation of a new cybereconomy and a whole new world of Open Finance . Credit Cards Credit cards started as a convenience for the purchase of gasoline, frequent oil changes and repairs needed in the early automobiles in America. They were issued by oil companies to encourage brand loyalty--exactly as the airline industry is doing today with Frequent Flyer miles.11 In 1949, I will show that Frequent Flyer Miles are gradually becoming a private currency [“corporate scrip” in the jargon]. Are frequent flyers .one of the currencies of the future?

Diners Club created the first modern “charge card” on the back of which it proudly listed all 27 restaurants “the finest in the country” where the card was accepted. As in Bellamy’s time trip, they were in pasteboard (see sidebar). In 1955, Diners Club switched to plastic.12 By 1958, the Bank of America and the American Express Company, which had already established itself as “the traveler’s check company,” each launched their own plastic credit cards. Money Troubles End Empires BankAmericard was relaunched as the Money can go wrong in different ways, the worst one being VISA card alliance after a major hyperinflation, the extreme form of inflation when currencies reorganization in 197l. Twenty years become practically valueless. Social disorder, even collapses of later,VISA involves no less than 20,000 Empires have been the outcome whenever the cost or prestige of an Empire made it issue too much money, thereby provoking financial institutions all over the world, hyperinflation in its currency. 400 million card members and an impressive $1.2 trillion in annual turnover. Although it is the biggest, this is only one Sumer, the oldest city empire historically well documented, of the thousands of credit card systems collapsed when continuous warfare with its neighbors provoked hyperinflation in 2020 BC. After Alexander the Great’s that have proliferated around the globe. death, as vast treasure looted from Persia was brought back Most significantly, a whole new way of home, hyperinflation resulted and destroyed the once-mighty lending money into existence has been Greek Empire. The same thing happened 2000 years later, with created. the Spanish Empire, when the gold and silver looted from the New World was imported back to Spain.

Interest rates applicable to credit card loans are much higher--often a multiple--of Hyperinflation is still a scourge in many countries. Among the what banks would be able to obtain from more extreme examples during this century : Germany in the normal business or consumer loans. This is 1920s, Latin America in the 1970s and 1980s, Yugoslavia in 1989-91 and Russia in 1991-92 and again in 1998. In all these what made this form of creating money cases, hyperinflation invariably provoked serious social and irresistible to the issuers. However, political disruptions. making it so easy to obtain credit has predictably also reduced the standards of credit-worthiness, i.e. the verification that the card-holder will have the income flow necessary to service that debt and those high interest rates.

Your Savings: Storing Value Now that you have obtained your hard-earned money, how can you preserve it for the proverbial rainy day? This is important not only for you personally. Whatever form the storage of value takes, it also becomes potential collateral for any additional bank-debt money that can be created, as seen above in how the banking system works. Contrary to what some people believe, money itself is not a good store of value. At best it is “a temporary abode of purchasing power,”13 a way to keep value in the short-term between the moment you receive income and when you spend it. If you stuff money under your mattress as savings, or even leave it in a bank account, the following inflation scorecard should warn you.

Moore, Carl H. And Russell, Alvin E. Money: Its Origin, Development and Modern Use (Jeffesrson NC: McFarland, 1987) pg 74

13 Friedman, Milton “Quantity Theory of Money” in Money (New York, London: W.W.Norton “The New Pelgrave”, 1989) pg. 15.

A Scorecard The clearest way to see what has happened to the value of your money is to look at what it purchases on a day-to-day basis. In recent years, most major currencies have kept enough of their value so that some people even claim that currency depreciation (“inflation” in the jargon) is now dead forever. However, before accepting such a conclusion, it is worth examining this issue over a longer time period, say twenty-five years. Let us look at the scorecard. For example, consider the performance over two decades of the Deutsche Mark, the world’s most “stable” currency since the World War II. If you had kept 100 Deutsche Mark since 1971, its purchasing power would have shrunk to about 40 DM by the time that the Euro replaced it.14 In other words, even the best performing currency in the world lost more than half of its value in that period. Similarly, 100 Swiss Francs, the second best performing national currency would be worth only 39.79 SF from 20 years earlier. The purchasing power of 100 US$ shrunk to just over 24 US$; 100 French Francs to about 19; 100 British Pounds, to 12 Pounds; 100 Italian Lira to about 8; and so on. In practice, this means that a house bought in 1971 for $247,200 and valued two and a half decades later at $1 million has not appreciated by one penny. Its price merely kept pace with inflation. Sometimes, inflation can get really out of hand, with devastating consequences for the societies which experience them (see sidebar). What stock is new under the sun?

Managing savings intelligently therefore boils down to allocating cash between the three classical major asset classes: real estate, bonds, and stocks. Over the past decade, another major asset class has appeared that is of particular interest to us: currencies. A few words about the changing role of each asset class over time puts this development into perspective.

Real Estate

The earliest stock offerings date back to seafarer and caravan trips lost in the mist of time. They were already practiced among the Phoenicians in antiquity, and became openly tradable among the general public in Venice and Genoa by the 13th century. “Men and women from all ranks of life owned shares. ...They were regarded as particularly good security for one of the favorite forms of investment across the sea, the sea loan...which was repaid only if the ship arrived safely.” The oldest currently still functioning public stock exchange, dealing in all manner of corporate stocks, is the one in Amsterdam, dating from the 17th century.

From the beginning of the Agricultural Revolution until last century, real estate, particularly land, was the dominant form of savings available in the world. The wealth of individuals could usually be evaluated by the quality and the size of the real estate they had accumulated. This all changed with the Industrial Age when stocks and bonds in commercial enterprises became a favorite investment vehicle. Today, most people’s real estate holdings are limited to their house, and typically even that is mortgaged.

Source of data from 1970 to 1990 from Table P.1 Deane, Marjorie and Pringle, Robert The Central Banks (New York: Viking, 1995) pg. 352-354 , completed with the International Labor Office Monthly Bulletin of Statistics from 1990 to 1996.

Stocks A stock is a fraction of ownership in a business. Contrary to most people’s perception, it is a very old investment instrument. (See sidebar). More recently it has become the norm for even small savers to have the bulk of their liquid assets in the stock markets. Notably, the only other period during the 20th century in which this was prevalent was in the 1920’s. However, during this past decade, all stock exchanges around the world have become much more intimately interlinked. There used to be a theory that by diversifying geographically it was possible to decrease stock investment risks. This theory was blown out of the water in the simultaneous global stock market panic of 1987 which demonstrated that it has become harder to reduce risks through global diversification. Even if you only invest in domestic stocks, today the message is: think globally and act globally, for everything is impacted by global events.

Bonds A bond is a loan to the organization In Bonds we Trust on whose behalf it was issued. It is a promise to pay the loan back at Bonds presuppose a public trust in the long term future of the value of the currency in which they are denominated. Therefore the length to maturity. By purchasing a bond, one maturity of a bond gives some idea about the level of confidence gives up liquid cash in exchange for people have in the future of that currency. The “champions” of such that promise. The key feature that long term trust are the Dutch “dike-building-bonds” which have no justifies doing so is the payment of expiration date, and on which interest has been paid faithfully since interest on a periodic basis. “Usury,” the 16th century. In 1903, the British government could afford to issue 300 year “gilts” at 2.5% interest. Compare that with today’s “long” or charging interest, has been bonds of 30 years maximum and % interest. frowned upon since their founding by all three religions (Judaism, Christianity and Islam) that have followed the Book of their beliefs as revealed by God.. Only Islam has remained true to the tradition of non-usury to this day. Henry VIII, after his break with Rome, legalized interest in Britain for the first time in 1545. But it was not until the 18th and 19th centuries that this investment option displaced real estate in people’s portfolios. This was true even in Protestant countries. The Catholic church “forgot” about the sin of usury only towards the end of the 19th century, thereafter including bonds or any other form of interest-bearing loans even in ecclesiastical portfolios. Currencies Historically, for some specialists, such as moneychangers and banks operating internationally, currency has always been a significant type of asset. Any modern global portfolio has also, by definition, a currency component (e.g. holding a Japanese bond or stock means automatically having a position in Japanese Yen). So holding positions in currencies by themselves has become a logical extension.. It has now become a significant factor in most professional investors’ portfolios.

Quiz Question Assume that you have a printing press in your garage that produces dollar bills at the rate of one per second. When would this printing press have to be started for it to produce the four trillion dollars worth of a typical foreign exchange market day? During World War I, the American Revolution, at the birth of Jesus Christ, the Neolithic, or under Cro-Magnon?

Something extraordinary has been happening over the past decade: the currency market has become the biggest single market in the world. Foreign exchange transactions (purchases and sales 9

of currencies) today dwarf the trading volume of all other asset classes, even of the entire global economy. As a result, currency markets are becoming vitally important to almost everyone for the first time in recorded history-although it is probable that the majority of people are still quite unaware of this.

Foreign Exchange Markets

Currencies: an Ideal Speculation Tool? As a tool for speculation, today’s foreign exchange markets offer some very useful features compared to any other asset class: A 24-hour very liquid market: this is the most liquid of all asset classes (more liquid than bonds or stocks whose trading is limited to local market hours, and more liquid than real-estate). Very low transaction costs: buying or selling a currency in volume is far cheaper than buying stocks, bonds or real estate. The only cost is a small spread between buy and sell in foreign exchange, which locks in the bank’s profits. Depth of the foreign exchange market: when professional

If you have traveled anywhere abroad, investment managers have a large amount of money to place, buying a stock will drive up the price of the stock. Similarly, when you have dealt in the foreign exchange they will sell this stock, again their own trade will make the market market. You went to a bank or money move against them. No such problems in foreign exchange: the exchange office and exchanged your depth of the currency markets is such that even billions of dollars little bits of paper against more exotic won’t make a blip. looking local bits of paper. The day after someone invented money, her neighbor must have started a money exchange. So what could be new in foreign exchange markets? Actually, quite a lot. The first sign that something different is afoot is the sheer volume of currency transactions. Back in the prehistoric days of the 1970s, the typical daily volume of foreign exchange transactions, worldwide, fluctuated between $10-$20 billion. By 1983, that had risen to $60 billion. By 2010, that daily volume had reached a staggering $ 4 trillion.15 16 The main reason for this is that currencies have now become the ideal speculation tool (see sidebar). What has taken place to provide such a stimulus to speculation on currencies? This extraordinary build-up of speculative activity can be explained by three cumulative changes over the past decades: 1. A Structural Shift: On August 15, 1971, President Nixon disconnected the dollar from gold, inaugurating an era of currencies whose values would be determined predominantly by market forces. This gave rise to a systemic change in which currency values could fluctuate significantly at any point in time. This was the beginning of the “floating exchanges” and a market that would prove highly profitable for those who know how to navigate in it. 2. 1980s Financial Deregulation: The governments of Margaret Thatcher in the UK and Ronald Reagan in the US embarked simultaneously on a massive financial deregulation program. The Baker Plan (a reform package named after the then US Secretary to the Treasury, Mr. Baker). imposed a similar deregulation in 16 key developing countries in the wake of the developing

Bank of International Settlements (BIS): Triennal Central Bank Survey of Foreign Exchange and Derivatives Market Activity (September 2010) 15

None of the above. 4 trillion seconds mean more than 126,839 years. That means somewhere in the Paleolithic time. Neolithic period started about 10,000 BC; while Cro-Magnon emerged around 45,000 years ago.

countries’ debt crisis. These deregulations enabled a much larger array of people and institutions to become involved in currency trading than would have previously been possible. 3. Technological shift: In parallel to the above, the computerization of foreign exchange trading created the first 24-hour fully integrated global market ever. This shift raised to a whole new level the speed and scale with which currencies could be moved around the world. During his survey of 5,000 years of money’s history, Glyn Davies identified electronic money as one of only two exceptionally important technological innovations in money. “There have been two major changes, the first at the end of the Middle Ages when the printing of paper began to supplement the minting of coins, and the second in our own time when electronic money transfer was invented.”17 We know in retrospect that the first change enabled banks to take away from ruling kings and emperors the lead role in money creation, but what will the second change create?

Barings The Duc de Richelieu said in 1818 that there were six great powers in Europe - France, England, Prussia, Austria, Russia and Baring Brothers. This reputation did not help in February 1995 when one single young trader lost $1.5 billion--two times the bank’s capital--in a few days on the Singapore derivatives market. The surprise must have been biggest inside the bank itself as Ron Baker, the head of the Financial Products Group of Baring Bank had made an enthusiastic assessment of the activities of Nick Leeson: “Nick had an amazing day on SIMEX ...Baring Singapore was the market... Nick just sees opportunities that are phenomenal, and he just takes them”

A titanic struggle has begun in relation to the control of emerging forms of money. Banks are now acting mostly like computerized telecommunications companies. But companies involved in telecommunications, computer hardware and software, credit card processing, Internet shopping, even cable television, have also discovered that they can perform many of the services of the banks. Whoever wins control over the new electronic money systems will ultimately be endowed with the power to issue money. As the banker Sholom Rosen claimed: “It’s definitely new, it’s revolutionary - and we should be scared as hell.”18 If well-informed bankers get scared of the scale and speed of money changes, what should the rest of us do? Derivatives Besides revolutionizing banking and accelerating the movement of currencies, computers have also played another role in the foreign exchange markets: they made possible the explosive development of a whole new wave of financial products, generically called “derivatives.”19 Derivatives make it possible to unbundle each piece of financial risk, and trade each one 17

Davies, Glyn A history of money from Ancient Times to the Present Day (Cardiff, University of Wales, 1994) p. 646

Quoted by Weatherford, Jack The History of Money (New York: Crown Publishers Inc.) p. 264

The main types of currency derivatives are futures, forwards and options, whose technical definitions are: • Futures: A currency futures contract is an agreement to buy or sell a currency at a specified time and place (a commodity exchange) in the future at a specific price agreed to today. • Forwards: Similar to Futures, except that the price is today’s price and the contract is not traded on an exchange but directly with one specific financial institution (“Over the Counter”). • Options: A currency option is the right, but not an obligation to buy (“call”) or sell (“put”) a currency at a specific price. The development of the options market is credited to the theoretical breakthroughs by Professors Robert Melton and Myron Scholes in option pricing, for which they were honored by a Nobel Prize in June 1997.

These instruments are the building blocks whose combinations enable the transfer of many risks. Some of these combinations [“exotics”] can become quite complex. All these instruments also exist for commodities other than currencies, but the volume of currency derivatives particularly of “Over the Counter” trade, now dwarfs those of all other commodities.

separately. Charles Sanford, ex-chairman of Bankers Trust and one of the pioneers of the business, described derivatives as building a “particle theory of finance.” For example, a Japanese Yen bond can be unbundled in at least three pieces of risk: a currency risk (the risk that the Yen drops in value against your own currency), an interest rate risk (the risk that Japanese interest rates go up after you purchase your bond), and an issuer risk (the risk that the company issuing the bond defaults on the bond). Derivatives enable an investor to select exactly which component of those risks they want to include or exclude from their portfolios. Imagine that, instead of buying a ticket to a concert or opera, you are suddenly able to separately select and combine for yourself your favorite soprano, your favorite tenor, your favorite violinist, conductor, and so on, all interpreting your favorite compositions. If you know what you are doing, the result of this new freedom could be quite extraordinary and superior to what you can get in a normal “prepackaged” performance. But, if your knowledge is limited, your personal creation also could turn out quite catastrophic. Derivatives provide that kind of freedom for financial portfolios, but similarly require a lot more knowledge than average investors have mustered.

Why are Banks so Fragile? Banks have always been accident-prone. Only counting the most recent bank crises, in the US major banks got in trouble in Latin America in the 1980s and the largest bailout in history occurred with the Savings and Loans debacle in the 1990s. The Scandinavian banks needed rescuing in the early 1990s. Japanese banks got in trouble three times in a row: first the Less Developed Countries crisis in the 1980s, a real-estate crunch in the 1990s, and the 1997 Southeast Asian meltdown. German banks got badly burned during the Russian debacle of 1998. The trickiest situations are those involving banks that are active globally, such as the BCCI debacle of 1991, which is still being cleaned up in courts around the world. Why have banks remained so fragile? The stark answer is a dilemma that nobody has really solved so far. By the nature of banking, banks take lowrisk assets (deposits) and invest them in higher risk assets. When the risks pay off, these investments pay off and the bank’s owners reap all the rewards. When the risk does not pay off and the bank fails, the losses are spread between the bank’s owners and the depositors (or the governmental insurance safety net, which now protects the depositors). There is therefore a built-in temptation for banks to take high-risk/high return gambles. This is called a “moral hazard” in Central Bank jargon. The dilemma is therefore: if banks are not allowed to take any risks, there is no banking; but if a major bank takes excessive risks, should it be allowed to fail? Big bank failures can destabilize the entire financial system. Worse still, when loans to thousands of businesses are withdrawn the rot can spread quickly to all kinds of economic activities. Suddenly millions of jobs and livelihoods for real people can be at stake. Banking is different from any other business for one more reason: bank troubles tend to become everybody’s problems...

Shifting risks from one place to another is fine as long as the party that ends up with the risk is both knowledgeable and strong enough to bear it. However, Martin Mayer made a law of the fact that “Risk-shifting instruments ultimately shift the risk onto those less able to deal with them.”20 Although I think this is too sweeping a generalization, there are many institutions that have been badly burned without understanding what it was that hit them. Barings, a top name in the City of London for 233 years, became one of the first spectacular victims of this process (see sidebar). Since then, similar problems have emerged in various banks around the world.

Mayer, Martin The Bankers: the New Generation (New York: Truman Talley Books/Dutton, 1997) p. 324. His argument: “The obvious illustration is the S&P 500 futures pit at the Chicago Mercantile Exchange, where a couple of hundred extaxi drivers working as “locals” were expected to carry the dynamic hedging of “portfolio insurance” when the stock market broke on October 19, 1987.” 20

Derivatives are nevertheless here to stay, primarily because, when used correctly, they can be both useful to society and profitable to the financier. So we should get used to the idea that they may also provide us with some startling surprises, just like some of the amateur orchestral combinations in our earlier musical metaphor. As Dr. Jekyll turned into Mr. Hyde, so the blip on a computer screen can change the nature of a derivative position at the drop of a hat.

Capitalism’s Central Nervous System It is insufficient to look at currencies as just another asset class. A country’s currency is indeed also much more. It plays the role of the central nervous system that commands the values of all asset classes in that country. This becomes clearer when we look at how all the other three traditional asset classes are affected directly by what happens to money. We have seen already that bonds are an attractive investment only to the extent that the currency in which they are denominated keeps its value (i.e. when inflation is low or dropping). It is also well known that stock prices drop when interest rates rise, and interest rates tend to shoot up when a currency gets in trouble. The last asset class, real estate, presents a more complex situation. On the one side, real estate is the best protection available against inflation. On the other side, however, it is also very illiquid (i.e. difficult to sell in a hurry); so when serious financial problems arise, people who cannot meet their mortgage payments may have to liquidate their real estate at undervalued prices. This makes real estate investing a double-edged sword. For instance, after the stock market collapse of 1929, real estate got just as depressed as In July 1944, 45 countries signed the first written global monetary constitution at the hotel “Mount Washington” in Bretton Woods, stocks. Government bonds turned New Hampshire. According to that agreement, all countries had to fix out to be the best refuge at that their currencies to the US dollar, and the US committed in time, because the government counterpart to keep its dollar convertible into gold upon request could not go bankrupt (it just from any Central bank at the fixed rate of $35 per ounce of gold. This system put the US$ in a de facto commanding role as linchpin of the printed money when needed) global system. A new institution--the International Monetary Fund and everything was cheap to buy. (IMF)--was created to police the system. Any change in the value of a A currency collapse today could currency required a preliminary approval from the IMF. The system potentially be worse than that, worked well for over two decades until President Johnson introduced because it would bring down not his “guns and butter” strategy during the Vietnam War, putting welfare with warfare at the top of the political agenda. This triggered only the stock market and real an unprecedented dollar outflow from the US. Some years later, it estate, but even the last refuge of was these substantial dollar holdings in the hands of foreign Central government bonds. That is why I Banks that were to force President Nixon in 1971 to renege on the agree with Professor Robert convertibility promise of dollars into gold, thus officially ending the Guttmann that a money Bretton Woods Agreement. However, the dollar’s role as official linchpin of the world’s money system remained intact. This further meltdown is the only way a true increased the influence of the US in global monetary matters, and the depression could manifest again dependence of the world on the dollar, its linchpin currency. in our lifetimes.21 Money as the Note that this remains true even with the Euro, whose international Achilles’ heel of the capitalist value remains linked to the dollar. system is not a new idea: “Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency.”22 Bretton Woods Agreement

Guttmann, Robert: How Credit-Money shapes the Economy: the United States in a Global System (Armonk, NY and London, UK M.E. Sharpe, 1994). 22 Keynes, John Maynard The Economic Consequences of Peace (London, 1920) p. 220 13

When we discover that all our eggs end up in one money basket, I suggest keeping a close eye on that basket. Some well-qualified people are paid to do exactly that. Let me introduce you to them, and thereby complete the picture of the world’s key money players. Central Banks and Other Firemen The financial sector has always been “special.” Even today the finance industry is not treated as just another service industry. There are positive and negative reasons for this: • On the positive side, financial institutions--even the private ones--are really performing the vital public function of providing, hopefully, a stable currency for use by the participants in the economy. • On the negative side, financial institutions have often proven the most fragile component of any society (see sidebar). And it has been demonstrated time and again--from Sumer to Yugoslavia-that whenever money gets into trouble, whole societies can crumble. National Level Fires are rare, but when they occur they can be devastating. Entire cities have burned down because one single person has been careless, hence the invention of fire brigades and fire inspections. So it is with money: because financial institutions have proven so accident-prone, Central Banks were invented.

Whence Central Banks? In the 19th century, the name “Central Bank” referred to a bank, head-quartered in a nation’s capital, that enjoyed the monopoly of issuing paper notes in the national currency. Once in a while, these banks would provide some simple mutual support to each other. Such was the case in 1825, when the French helped the Bank of England by swapping a shipment of gold for silver when there was a run on gold in London; a favor which the English returned in 1860, when the Banque de France was in dire straits. But such cases of mutual help were rare, little publicized and certainly would not have been considered part of the official duties of a Central Bank. When the US Central Bank, the Federal Reserve system, was created in 1913, it was inspired by that model. All this changed with the Bretton Woods agreement, which set up the framework for the post World War II global environment (see sidebar). Central Banks now play much more complex roles. • They serve as “emergency firemen” whenever a bank or the whole system gets in trouble. This is called respectively “lender of last resort” and “systemic risk management” in the jargon. • They carry the ultimate responsibility for controlling inflation in the country. Over the past decades, this last task has been the one most closely identified by the general public as a central bank function. • They achieve this inflation control mission through various mechanisms that influence the quantity of money that the banking system can create. They do not give direct orders to achieve this, but only provide “signals” such as changes in key interest rates, or purchases and sales of government bonds (called “Open Market” transactions) and currencies in the foreign exchange markets (called “interventions”). • Central Banks are also banks, although they don’t have retail customers: their customers are the banks of their country, for which they settle payments.

“Money’s Family Tree” The following chart shows a “family tree” of how all the main monetary players relate to each other. It forms a kind of inverted pyramid, with thousands of commercial banks on top, a layer of 170 Central Banks in the middle (regrouped here in three types according to who owns them), and two supra-national organizations at the bottom.

Country A

Banks

Central Banks

Country B

Bank X

County C...

Bank Y

Private Bank-Owned Central Bank

(ex: Federal Reserve Swiss National Bank, etc.)

Bank Z

Government Owned Central Bank (ex. UK, France, China, etc.)

Mixed Ownership Central Bank (ex: Belgium, Japan)

SupraNational International Monetary Fund

Bank for International Settlements

(IMF, Washington, DC)

(BIS, Basle, Switzerland)

Policy Implementation

Private Club owned by “10+1” Central Banks

Organization Chart of Today’s Global Monetary System

I have placed banks in each individual country on top of the chart, as they are the front-line issuers of credit-money. The Central Banks were initially only their backstop, their fire extinguishers, in case of trouble. Until 1936, almost all Central Banks were directly owned by the main private banks in each country. To this day, nine of the Central Banks are still private corporations owned by private banks, including the US Federal Reserve, the Swiss National Bank, the Bank of Italy and the South African Reserve Bank. By the 1950s, there were 56 countries with Central Banks. Now there are 170, with most of the newcomers being government controlled. But there are also Central Banks whose ownership situations involve both government and banks (e.g., Belgium or Japan). Contrary to expectations, there has been no evidence that the various ownership arrangements have made any significant difference to either Central Banks’ actions or effectiveness. Some of the most prestigious and effective Central Banks can be found in all three types of ownership, as have some at the bottom of the league.

The Supra-National Level Finally, there are two important family members who represent the main supra-national coordinating tools among Central Banks: • One is a policeman--the International Monetary Fund (IMF). • The other a private club--the Bank of International Settlements (BIS). Created in 1945 as the enforcer of the rules of Bretton Woods, the IMF is the auditor of Central Banks around the world, and is the official political arm of the global money system. As of 1997, 182 countries are members. A 24-member Executive Board supervises a staff of about 2,300 professionals, mostly economists. The IMF is the “lender of last resort” from whom member countries can obtain loans in case of emergencies from a pool of $210 billion obtained as “quotas” from all member countries. Typically, such loans are conditional upon strict economic austerity measures, hence its reputation as a global economic policeman. The US has a dominant influence at the IMF. Not only does the US have veto power on decisions, but it also happens to be physically “close at hand” in Washington DC. The BIS has a more peculiar history. It was created in 1930 ostensibly to deal with German war reparation payments. It was to become a private club owned and operated by the key “10+1” Central Banks. The “10+1” are so-called because there are 10 founding Central Banks on one side, plus Switzerland as host country on the other side (as a result of its “active neutrality” strategy, Switzerland is often “in” and “out” at the same time; it still does not “officially” belong to the IMF or the UN, for instance). The mission of the BIS was to address any important issues that would best be handled with efficient discretion. No politicians, no Treasury officials, no Ministers of Finance, not even Presidents or Prime Ministers are welcome. One almost forgets that the BIS is also a bank, although its only customers are Central Banks. Hence its nickname as “Central Bank of Central Banks.” It even has a substantial currency-dealing room recently installed to enable it to monitor the global money system in real-time, and to provide wholesale market transactions for its member Central Banks. It remains a modest institution for the influence it wields: even today it has only 450 staff members including a research team of about 50 economists, who bring forth, among other things, a well-respected annual report on the state of the world financial system. The BIS has made its name in fire extinguishing operations in the past; it undoubtedly will be part of any future fire brigades as well. We have seen a snapshot of the key players in this piece. However, any notion that this money game is a static one is dispelled as soon as we put all the pieces of the money puzzle together.

Money as a System The monetary game is indeed mutating in front of our very eyes. The changes that are occurring involve unprecedented speed, scale and complexity. Two different perspectives illustrate that point: the one of the “firemen,” and the one for the rest of us.

The Firemen’s Viewpoint From the perspective of the Central Banks, the world is definitely becoming tougher and more complex year after year. The explosive developments in the currency markets in particular have a series of implications that I divide under three headings: Power Shift 16

Increased Volatility Stable or Unstable, that is the Question

Power Shift A major power shift in the world system has already occurred. Every government in the world, including the most powerful ones, such as the US, is actually being policed by the global foreign exchange markets. If a government anywhere in the world dares to challenge these financial “diktats,” capital flight will almost instantaneously force it back into orthodoxy. President Mitterand in France in the 1980s; John Major in Britain and the Scandinavians in 1992; the Mexicans in 1994; the Thai, Malay, Indonesian, or South Korean governments in 1997; the Russian in 1998 – have all paid the hefty pound of flesh that is extracted under such circumstances.

Even Business Week concludes: “In this new market...billions can flow in or out of an economy, in seconds. So powerful has this force of money become that some observers now see the “hotmoney” (funds that move around quickly from one country to another) becoming a sort of shadow world government--one that is irretrievably eroding the concept of the sovereign powers of a nation state.”23 The trickiest times occur when power shifts. They are by definition times of uncertainty. The form of uncertainty that Central Banks and other guardians of monetary order fear most is currency volatility.

Increased Currency Volatility Currency volatility is a measure of change in the value of one currency against all the others. Central Banks predictably do not like volatility in their currency, and volatility happens to be one of the unexpected consequences of the massive increase in speculative activities. Back in the 1960s, the proponents of freely floating currency exchanges used to argue that currency volatility would drop as soon as a free market was established. Foreign exchange markets are certainly now a lot more open and free than they were in the 1960s, when the Bretton Woods fixed exchange rate system was operational. However, an OECD (the Organization of Economic Cooperation and Development based in Paris) statistical study brought up some sobering conclusions, directly contradicting the theoretical forecast.24 The past 25 years of floating exchanges have revealed an average foreign exchange volatility four times higher than under the Bretton Woods fixed exchange system. It does not require a statistical rocket scientist to understand why the volatility increases with the speculative volume of the trades. Simple common sense explains it just as well. Let us assume that your currency is under pressure, and that a modest 5% of the major currency traders “take a negative view about that currency.” This means in practice that those who own your currency will sell it, and those who don’t own it sell short.25 In 1986, when total daily volume was around 60 billion dollars, such a move by 5% of the market volume would have represented a $3 billion move

Business Week, “Hot Money” (March 20, 1995), p. 46

Edey, M. and Ketil Hviding: An assessment of Financial Reform in OECD countries (OECD working paper #154) 1995.

In foreign exchange, all positions are always simultaneously long one currency and short another. In our example, people could buy Deutsche Mark or Dollars (go “long” in the jargon), while selling French Francs (go “short”).

against the currency in question, certainly a challenge to a Central Bank, but a manageable one. Today, with volumes of $4 trillion per day, the same proportional move would generate an overwhelming $200 billion transfer against your currency, which no Central Bank would be able to withstand.

Stable or Unstable, that is the Question From the above, we can surmise that Central Bankers are becoming increasingly uncomfortable. Not only are they dealing with a world of increasing uncertainty and currency volatility, but they themselves are getting out-gunned in the currency markets as well. Even people who profit from explosive speculative activity are becoming seriously worried. For instance George Soros, widely considered one of the biggest players in this game states: “Freely floating exchange rates are inherently unstable; moreover, the instability is cumulative so that the eventual breakdown of a freely floating exchange rate system is virtually assured.”26 Joel Kurtzman, business editor of The New York Times, is even more damning. He titles one of his books The Death of Money: How the Electronic Economy has Destabilized the World’s Markets 27. A master of understatement like Paul Volcker, ex-governor of the Federal Reserve, goes on record expressing his concern about the growth of “a constituency in favor of instability,” i.e. financial interests whose profits depend on increased volatility.28 Just to illustrate this last point, a typical comment by a foreign exchange trader quoted in the Washington Post reveals how a period of relative stability is perceived: “You can’t make any money like this. The dollar ...movement is too narrow. Anyone speculating or trading in the dollar or any other currency can’t make any money or lose money. You can’t do anything. It’s been a horror.”29 The net effect of the actions of these “constituencies for instability" are the monetary crises that regularly make the front-page headlines. The question nobody dares to ask is: Who is next? When will the US, the largest debtor country in the world, become a target? What would that mean?

Back Full Circle to You We started this Primer with the questions: How is the value of your money determined? Who is really in charge of your savings? We can now answer these questions: 1. The value of your money is ultimately determined in an increasingly volatile global casino where 98% of the transactions are based on speculation. 2. Whether your nest egg is your house, some investment portfolio, or even the cash in your wallet, your savings are all highly interconnected within the money system. Therefore,

Soros, George: The Alchemy of Finance: Reading the Mind of the Market (London: Weidenfeld & Nicolson, 1988) p. 69

Kurtzman, Joel: The Death of Money: How the Electronic Economy has destabilized the World’s Markets and created Financial Chaos (New York: Simon and Schuster, 1993). 27

Volcker, Paul and Gyohten Toyoo : Changing Fortunes: The World’s Money and the Threat to American Leadership (New York: Times Books, 1992) 28

Carmine Rotondo, foreign exchange trader with Security Pacific Bank, quoted in Rowen, Hobart “Wielding Jawbone to Protect the dollar” Washington Post (March 15, 1987 p. H-1).

whatever form you will give them, the future of your savings will depend significantly on what happens to your currency. 3. Even if you believe that you don’t have anything to do with “global finance”, because you haven’t invested yourself in the international money game, this is usually an illusion because your pension fund or your bank is directly or indirectly involved in such activities. 4. Even if you have no investments or savings of any kind, your life will be touched because your country as a whole will be affected when money gets in serious trouble somewhere in the world. The stakes are enormous. Ultimately money is trust, which lives and dies only in human hearts and minds. Money systems, including our current one, are mechanisms and symbols that aim at keeping that trust alive. Historically, entire civilizations have been built on trust, because it is at the core of the self-confidence required for a civilization to grow or even survive. On the negative side, when a society loses confidence in its money, it loses confidence in itself. “The debate about the future of money is not about inflation or deflation, fixed or flexible exchange rates, gold or paper standards; it is about the kind of society in which money is to operate.”30

This is Appendix A to Money and Sustainability: The Missing Link. To read more about the book or to order a copy, visit: www.triarchypress.net/money-and-sustainability

Georg Simmel Philosophy of Money (original German edition 1900) (2nd English edition: London & New York: Routledge, 1990)

Niles Eldredge An actionbioscience.org original article We are in a biodiversity crisis, the fastest mass extinction in Earth’s history, largely due to: human destruction of ecosystems - overexploitation of species and natural resources - human overpopulation - the spread of agriculture - pollution. About 30,000 species go extinct annually.

There is little doubt left in the minds of professional biologists that Earth is currently faced with a mounting loss of species that threatens to rival the five great mass extinctions of the geological past. As long ago as 1993, Harvard biologist E.O. Wilson estimated that Earth is currently losing something on the order of 30,000 species per year — which breaks down to the even more daunting statistic of some three species per hour. Some biologists have begun to feel that this biodiversity crisis — this “Sixth Extinction” — is even more severe, and more imminent, than Wilson had supposed.

Extinction in the past The major global biotic turnovers were all caused by physical events that lay outside the normal climatic and other physical disturbances which species, and entire ecosystems, experience and survive. What caused them? The previous mass extinctions were due to natural causes.

First major extinction (c. 440 mya): Climate change (relatively severe and sudden global cooling) seems to have been at work at the first of these-the end-Ordovician mass extinction that caused such pronounced change in marine life (little or no life existed on land at that time). 25% of families lost (a family may consist of a

few to thousands of species). Second major extinction (c. 370 mya): The next such event, near the end of the Devonian Period, may or may not have been the result of global climate change. 19% of families lost. Third major Extinction (c. 245 mya): Scenarios explaining what happened at the greatest mass extinction event of them all (so far, at least!) at the end of the Permian Period have been complex amalgams of climate change perhaps rooted in plate tectonics movements. Very recently, however, evidence suggests that a bolide impact similar to the end-Cretaceous event may have been the cause. 54% of families lost. Fourth major extinction (c. 210 mya): The event at the end of the Triassic Period, shortly after dinosaurs and mammals had first evolved, also remains difficult to pin down in terms of precise causes. 23% of families lost. Fifth major extinction (c. 65 mya): Most famous, perhaps, was the most recent of these events at the end-Cretaceous. It wiped out the remaining terrestrial dinosaurs and marine ammonites, as well as many other species across the phylogenetic spectrum, in all habitats sampled from the fossil record. Consensus has emerged in the past decade that this event was caused by one (possibly multiple) collisions between Earth and an extraterrestrial bolide (probably cometary). Some geologists, however, point to the great volcanic event that produced the Deccan traps of India as part of the chain of physical events that disrupted ecosystems so severely that many species on land and sea rapidly succumbed to extinction. 17% of families lost.

How is the Sixth Extinction different from previous events? The current mass extinction is caused by humans.

At first glance, the physically caused extinction events of the past might seem to have little or nothing to tell us about the current Sixth Extinction, which is a patently human-caused event. For there is little doubt that humans are the direct cause of ecosystem stress and species destruction in the modern world through such activities as: transformation of the landscape overexploitation of species pollution the introduction of alien species

And because Homo sapiens is clearly a species of animal (however behaviorally and ecologically peculiar an animal), the Sixth Extinction would seem to be the first recorded global extinction event that has a biotic, rather than a physical, cause. We are bringing about massive changes in the environment.

Yet, upon further reflection, human impact on the planet is a direct analogue of the Cretaceous cometary collision. Sixty-five million years ago that extraterrestrial impact — through its sheer explosive power, followed immediately by its injections of so much debris into the upper reaches of the atmosphere that global temperatures plummeted and, most critically, photosynthesis was severely inhibited — wreaked havoc on the living systems of Earth. That is precisely what human beings are doing to the planet right now: humans are causing vast physical changes on the planet.

What is the Sixth Extinction? We can divide the Sixth Extinction into two discrete phases: Phase One began when the first modern humans began to disperse to different parts of the world about 100,000 years ago. Phase Two began about 10,000 years ago when humans turned to agriculture. Humans began disrupting the environment as soon as they appeared on Earth.

The first phase began shortly after Homo sapiens evolved in Africa and the anatomically modern humans began migrating out of Africa and spreading throughout the world. Humans reached the middle east 90,000 years ago. They were in Europe starting around 40,000 years ago. Neanderthals, who had long lived in Europe, survived our arrival for less than 10,000 years, but then abruptly disappeared — victims, according to many paleoanthropologists, of our arrival through outright warfare or the more subtle, though potentially no less devastating effects, of being on the losing side of ecological competition. Everywhere, shortly after modern humans arrived, many (especially, though by no means exclusively, the larger) native species typically became extinct. Humans were like bulls in a China shop: They disrupted ecosystems by overhunting game species, which never experienced contact with humans before. And perhaps they spread microbial disease-causing organisms as well. The fossil record attests to human destruction of ecosystems:

Wherever early humans migrated, other species became extinct.

Humans arrived in large numbers in North America roughly 12,500 years ago-and sites revealing the butchering of mammoths, mastodons and extinct buffalo are well documented throughout the continent. The demise of the bulk of the La Brea tar pit Pleistocene fauna coincided with our arrival. The Caribbean lost several of its larger species when humans arrived some 8000 years ago. Extinction struck elements of the Australian megafauna much earlierwhen humans arrived some 40,000 years ago. Madagascarsomething of an anomaly, as humans only arrived there two thousand years ago-also fits the pattern well: the larger species (elephant birds, a species of hippo, plus larger lemurs) rapidly disappeared soon after humans arrived. Indeed only in places where earlier hominid species had lived (Africa, of course, but also most of Europe and Asia) did the fauna, already adapted to hominid presence, survive the first wave of the Sixth Extinction pretty much intact. The rest of the world’s species, which had never before encountered hominids in their local ecosystems, were as naively unwary as all but the most recently arrived species (such as Vermilion Flycatchers) of the Galapagos Islands remain to this day.

Why does the Sixth Extinction continue? The invention of agriculture accelerated the pace of the Sixth Extinction.

Phase two of the Sixth Extinction began around 10,000 years ago with the invention of agriculture-perhaps first in the Natufian culture of the Middle East. Agriculture appears to have been invented several different times in various different places, and has, in the intervening years, spread around the entire globe. Agriculture represents the single most profound ecological change in the entire 3.5 billion-year history of life. With its invention: humans did not have to interact with other species for survival, and so could manipulate other species for their own use humans did not have to adhere to the ecosystem’s carrying capacity, and so could overpopulate Humans do not live with nature but outside it.

Homo sapiens became the first species to stop living inside local ecosystems. All other species, including our ancestral hominid ancestors, all pre-agricultural humans, and remnant hunter-gatherer societies still extant exist as semi-isolated populations playing specific roles (i.e., have “niches”) in local ecosystems. This is not so with post-agricultural revolution humans, who in effect have stepped outside local ecosystems.

Indeed, to develop agriculture is essentially to declare war on ecosystems - converting land to produce one or two food crops, with all other native plant species all now classified as unwanted “weeds” — and all but a few domesticated species of animals now considered as pests. The total number of organisms within a species is limited by many factors-most crucial of which is the “carrying capacity” of the local ecosystem: given the energetic needs and energy-procuring adaptations of a given species, there are only so many squirrels, oak trees and hawks that can inhabit a given stretch of habitat. Agriculture had the effect of removing the natural local-ecosystem upper limit of the size of human populations. Though crops still fail regularly, and famine and disease still stalk the land, there is no doubt that agriculture in the main has had an enormous impact on human population size: Earth can’t sustain the trend in human population growth. It is reaching its limit in carrying capacity.

Estimates vary, but range between 1 and 10 million people on earth 10,000 years ago. There are now over 6 billion people. The numbers continue to increase logarithmically — so that there will be 8 billion by 2020. There is presumably an upper limit to the carrying capacity of humans on earth — of the numbers that agriculture can support — and that number is usually estimated at between 13-15 billion, though some people think the ultimate numbers might be much higher. This explosion of human population, especially in the post-Industrial Revolution years of the past two centuries, coupled with the unequal distribution and consumption of wealth on the planet, is the underlying cause of the Sixth Extinction. There is a vicious cycle: Overpopulation, invasive species, and overexploitation are fueling the extinction.

More lands are cleared and more efficient production techniques (most recently engendered largely through genetic engineering) to feed the growing number of humans — and in response, the human population continues to expand. Higher fossil energy use is helping agriculture spread, further modifying the environment. Humans continue to fish (12 of the 13 major fisheries on the planet are now considered severely depleted) and harvest timber for building materials and just plain fuel, pollution, and soil erosion from agriculture creates dead zones in fisheries (as in the Gulf of Mexico) While the human Diaspora has meant the spread, as well, of alien species that more often than not thrive at the detriment of native

species. For example, invasive species have contributed to 42% of all threatened and endangered species in the U.S.

Can conservation measures stop the Sixth Extinction? Only 10% of the world’s species survived the third mass extinction. Will any survive this one?

The world’s ecosystems have been plunged into chaos, with some conservation biologists thinking that no system, not even the vast oceans, remains untouched by human presence. Conservation measures, sustainable development, and, ultimately, stabilization of human population numbers and consumption patterns seem to offer some hope that the Sixth Extinction will not develop to the extent of the third global extinction, some 245 mya, when 90% of the world’s species were lost. Though it is true that life, so incredibly resilient, has always recovered (though after long lags) after major extinction spasms, it is only after whatever has caused the extinction event has dissipated. That cause, in the case of the Sixth Extinction, is ourselves — Homo sapiens. This means we can continue on the path to our own extinction, or, preferably, we modify our behavior toward the global ecosystem of which we are still very much a part. The latter must happen before the Sixth Extinction can be declared over, and life can once again rebound. © 2005, American Institute of Biological Sciences. Educators have permission to reprint articles for classroom use; other users, please contact editor@actionbioscience.org for reprint permission. See reprint policy. http://www.actionbioscience.org/newfrontiers/eldredge2.html?print

Paleontologist Dr. Niles Eldredge is the Curator-in-Chief of the permanent exhibition “Hall of Biodiversity” at the American Museum of Natural History and adjunct professor at the City University of New York. He has devoted his career to examining evolutionary theory through the fossil record, publishing his views in more than 160 scientific articles, reviews, and books.

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Consequences of the Sixth Extinction The article “How Will Sixth Extinction Affect Evolution of Species?,” on our site, describes how the current loss of biodiversity will affect evolution in the long run.   http://www.actionbioscience.org/newfrontiers/myers_knoll.html

BioScience Article “Global Conservation of Biodiversity and Ecosystem Services.”   Habitat

destruction has driven much of the current biodiversity extinction crisis, and it compromises the essential benefits, or ecosystem services that humans derive from functioning ecosystems. Securing both species and ecosystem services might be accomplished with common solutions. Yet it is unknown whether these two major conservation objectives coincide broadly enough worldwide to enable global strategies for both goals to gain synergy. In this November 2007, BioScience article, Will Turner and his colleagues assess the concordance between these two objectives, explore how the concordance varies across different regions, and examine the global potential for safeguarding biodiversity and ecosystem services simultaneously. Read the abstract, or log in to purchase the full article.   http://caliber.ucpress.net/doi/abs/10.1641/B571009

Biodiversity in the next millennium

American Museum of Natural History’s nationwide survey (undated) “reveals biodiversity crisis — the fastest mass extinction in Earth’s history.”   http://cbc.amnh.org/crisis/mncntnt.html

National Geographic

A 2/99 article about the Sixth Extinction, with views from several leading scientists.   http://www.nationalgeographic.com/ngm/9902/fngm/index.html

Extinction through time

Find out about cycles of life and death and extinction patterns through time.   http://www.carleton.ca/Museum/extinction/tablecont.html

Is Humanity Suicidal?

Edward O. Wilson asks us why we stay on the course to our own selfdestruction (5/93).   http://www.well.com/user/davidu/suicidal.html

A Field Guide to the Sixth Extinction Niles Eldredge writes in 1999 about a few of the millions of plants and animals that won’t make it to the next millennium. The second link takes you to the site’s main page, entitled “Mass Extinction Underway — The World Wide Web’s most comprehensive source of information on the current mass extinction,” which provides links to numerous other resources.   http://www.well.com/user/davidu/fieldguide.html   http://www.well.com/user/davidu/extinction.html

Global Environment Outlook 3 The United Nations Environment Programme released this major report in May 2002. The report collated the thoughts of more than 1,000 contributors to assess the environmental impact of the last 30 years and outline policy ideas for the next three decades. It concluded that without action, the world may experience severe environmental problems within 30 years. The entire report can be read online or purchased online.   http://www.unep.org/geo/geo3/index.htm

Test your environmental knowledge This quiz covers issues that have been discussed in the media. The questions are designed to tell us how much accurate information people are getting from television, newspapers, magazines, and other sources.

http://www.neefusa.org/resources/roper2001-b.htm

World Atlas of Biodiversity — interactive map The United Nations Environment Programme (UNEP) released the firstWorld Atlas of Biodiversityin August 2002. This link takes you to their online interactive map that helps you search for data about species/land/water loss, extinction over time, and human global development. Click on the “?” for a help page that explains how to interact with this map.   http://stort.unepwcmc.org/imaps/gb2002/book/viewer.htm

The Sixth Great Extinction: A Status Report Earth Policy Institute’s 2004 update on the status of loss of biodiversity.   http://www.earth-policy.org/Updates/Update35.htm

Read a book » The Biodiversity Crisis: Losing What Countsby The American Museum of Natural History (New Press, 2001). » The Sixth Extinction: Patterns of of Life and the Future of Humankindby Richard Leakey and Roger Lewin (Doubleday and Company, 1996).

Mapping Paradigms â&#x20AC;&#x201C; by Christian Arnsperger

Money and Sustainability: Appendix C Christian Arnsperger Contents: C.1.

Three examples

C.2.

The mirage of neutrality

C.3.

The inevitability of paradigms

C.4.

Paradigms and their basic dynamics

C.5.

The workings of Traditional Economics

C.6.

The twofold reductionism of Traditional Economics

C.6.1. The economy as an interactive system C.6.2. Traditional Economics and the loss of process C.6.3. Two versions of equilibrium C.7.

Beyond Traditional Economics: The post-neoclassical paradigm

C.7.1. Instrumental rationality: From parametric to strategic C.7.2. Non-cooperative games and the dynamics of interaction C.7.3. The Nash solution and the return of the independent-agent approximation C.7.4. The flaws of game theory and the advent of bounded rationality C.7.5. Elements of complexity economics C.7.6. Elements of behavioral and neuroeconomics C.8.

Beyond the post-neoclassical paradigm: Integrating ecological economics, monetary behaviorism, and critical political economy

C.8.1. Making the post-neoclassical paradigm ecologically rational C.8.2. Making the post-neoclassical paradigm sensitive to the behavioral efficaciousness of money C.8.3. Opening the post-neoclassical paradigm to critical and existential rationality C.9.

Toward a new economic paradigm?

Let me start out with a cautionary note. This Appendix is clearly very long but it is, in another sense, way too concise. I will, for obvious reasons of space, not be able to deal with the whole landscape of approaches in economics. Therefore, I have made a choice: I will confine most of my discussion—that is, the core sections C.5 to C.8—to mainstream economics, i.e., that subset of the discipline that has been and still is taught and practiced predominantly in the vast majority of the worlds economics departments. Consequently—and with apologies to many of my colleagues—I will not touch upon the frequently used distinction between “orthodox” and “heterodox” economics. I will leave out many so-called “alternative” approaches, although sections C.8 and C.9 will quite definitely sound “alternative” to my more mainstream colleagues. If you enroll as a student in a contemporary economics department, chances are you won’t hear much about paradigms. You will most likely be taught that economics is a scientific discipline— with its own specific problems, such as “inexactitude”1—based on assumptions that allow the construction of deductive models. To this end, you will be instructed to learn mathematics and logic so that you can develop a capacity to “translate” most economic theories (whether it be that of Karl Marx, Vilfredo Pareto, Léon Walras, Thorstein Veblen, John Maynard Keynes, or Nicholas Georgescu-Roegen) into the appropriate formal language. We might call this the hypothetico-deductive method of modeling and testing, although in most economics classes it isn’t even called that. (You’ll come across that expression only if you take a course in economic methodology or epistemology. This subject matter isn’t systematically available at all departments, even in the top-ranking ones.) It is routinely presented as a thoroughly non-dogmatic, non-doctrinaire endeavor—a mere “linguistic” attempt at casting various thinkers’ theories in the “rigorous” terms needed to test their conceptual coherence and/or their empirical validity. Let me give three examples.

C.1. Three examples The first example is the so-called “neoclassical synthesis” of Keynes’s theory. In the 1980s, economists using the assumptions and tools of neoclassical economics came up with a version of Keynesianism that became known as the “new Keynesian” approach. Taking their cue from prestigious predecessors such as John Hicks (the creator of the infamous “IS-LM” model in the 1940s) and Don Patinkin, the new Keynesians built a hypothetico-deductive approach to liquidity traps and structural unemployment, essentially relying on the language of instrumental rationality, decentralized markets, sticky prices, and coordination failures. This gave birth to a cottage industry of formalized neoclassical models yielding “Keynesian” conclusions—and often blaming the economy’s problems on the very agents (obstructive trade unions, interventionist governments, or ill-guided monetary authorities) who in Keynes’s worldview were to be the saviors of capitalism. In the process of “translating” Keynes with a language that was alien to Keynes’s own intellectual universe, new Keynesianism arguably lost most of the complexityrelated as well as the political-economy aspects that made Keynes’s theory so revolutionary. Accordingly, the neoclassical synthesis came under attack from both process- and dynamicsoriented Keynesians (such as Robert Clower and Axel Leijonhufvud) and from more politically

See Daniel M. Hausman, The Separate and Inexact Science of Economics (Cambridge: Cambridge University Press, 1992).

radical post-Keynesians (such as Joan Robinson). Both of these had entirely different views on what working within Keynes’s intellectual heritage meant. The second example is the self-styled school of “analytical Marxism” which emerged in the 1980s as a result of analytical philosophers (Gerald Cohen, Jon Elster, Philippe Van Parijs) and neoclassical economists (John Roemer, Samuel Bowles) seeking to revive Karl Marx’s intellectual heritage. They intended to salvage it from the “bullshit Marxism” that had used the all too imprecise language of dialectics, alienation, and historical materialism, and to translate it into neoclassical categories including methodological individualism, instrumental rationality, and equilibrium analysis. Revolutionary movements—so analytical Marxists claimed—could be analyzed using non-cooperative game models, and the workings of socialism could be modeled with the tools of general equilibrium analysis. These “no bullshit” tools would provide the clarity and rigor that Marx had foregone by being both Hegelian and German—a twofold handicap that could only be remedied by recasting his grand theory in terms that any Anglo-American logician could grasp. Here too, a cottage industry of formalized neoclassical models yielding “Marxian” conclusions arose—systematically relying on assumptions about agents such that socialism became a variant of (pro-regulation) liberalism and revolution became a quest for the right “principles of justice.” In the process, many more traditional Marxists felt the central elements of Marx’s original view of the world and of human rationality were lost in translation. While my first two examples are clear illustrations of the principle traduttore, traditore (“the translator is always a traitor”), my third one goes even further in erasing any explicit reference to paradigms. I have in mind the gradually developing area of so-called “axiomatic” collective choice theory, pioneered by such brilliant minds as Hervé Moulin, William Thomson, Marc Fleurbaey, and François Maniquet. The basic idea here is that the economist—in fact, the particular economist trained in the neoclassical hypothetico-deductive method—is a mere translator of collective values into formal axioms, with a view to testing their mutual coherence and to suggesting possible “solution concepts” that might be applied to resource allocation problems. Suppose the aim of the political decision maker is to combat poverty or unemployment, or to equitably distribute the access to a given natural resource such as water or forest land. What, the axiomatic collective choice theorists ask, are the values you want to promote? Non-dictatorship? (Surely yes…) Pareto optimality? Equal treatment of equals? No envy between agents? Undominated diversity? Etc. Given the list of basic axioms thus established, they then proceed to delineate the set of solution concepts—or allocation mechanisms—that are compatible with these axioms, supposing the latter are themselves mutually compatible. Should we implement a competitive auction based on an initially equal split of access rights? Should we create a tradable quota mechanism, or a nonmarket mechanism that allocates resources to agents in proportion to the “relative intensity” of their preferences? This is a highly technical and formal area of research, basically a branch of social engineering in the tradition of the “mechanism design” approach pioneered by Leonid Hurwicz and Eric Maskin. It has, once again, given rise to a cottage industry of heavily formalized neoclassical models purporting to enlighten politicians, and citizens in general, as to the true content of their often muddled and imprecise normative criteria—but using neoclassical assumptions about agents such that, within the models themselves, no politician or citizen actually cares about normative issues at all.2

For a detailed explanation of this—to me—fundamental criticism, see Christian Arnsperger, Critical Political Economy: Complexity, Rationality and the Logic of Post-Orthodox Pluralism (London: Routledge, 2008). 2

C.2. The mirage of neutrality I have personally had the good fortune of being exposed to these three examples while studying economics at one of the better European departments (at Université catholique de Louvain in Belgium, seat of the famous Center for Operations Research and Econometrics, or CORE) and of experiencing them from the inside. What do they have in common? Not much, except for one absolutely essential aspect: They all consist of using a scientific paradigm to “translate” other paradigms into the “right” language, while denying that there even are such things as paradigms. Although the analogy has its limits, this is a bit as if you translated all the world’s literature, both prose and poetry, into English and then claimed that there is actually no plurality of languages— just a bunch of muddled and imprecise tongues (German, French, Greek, Japanese, Mandarin) and one language, English, that allows to express in clear and understandable grammatical form what these tongues try to express in inconsistent, flawed ways. Any linguist in his right mind would find this completely preposterous. In fact, the teaching of economics these days proceeds in much the same way. What students are mainly—and sometimes exclusively—taught under the generic, apparently neutral label of “economics” is a language, a set of grammatical tools that are supposed to frame ex ante any debate about ideas and theories. This language is actually very specific and carries, as we shall see below, quite a few strong presuppositions. In other words, like any language, it is not only a set of grammatical rules for composing ideas, but it is also a set of semantic tools for giving specific meaning to the world—but it is routinely presented as “the economic method” without any historical, semantic or conceptual earmarks whatsoever. This misleads both students and those who instruct them into believing that the “language of economics” does not contain a worldview but, rather, forms the pre-condition for any acceptable worldview: However interested you might spontaneously be in the intellectual and political cosmos of Marx, Veblen, Hayek, Rawls or Georgescu-Roegen, you must be wary of your own enthusiasm, for the only parts of their worldviews (if any) that you can actually use to carry on a debate are those that can be made intelligible through the “language of economics.” The reason most economics instructors nowadays can get away with this sort of thing is that the notion of paradigm is no longer part of the toolbox of the economist. And the reason for that, in turn, is that grammar and method have been divorced from semantics and worldview. The general attitude— which reigns unreflectively in the minds of most economists—is that the formal rules of composition of a scientific discourse (i.e., the rules that dictate how you are supposed to say things) are neutral with respect to the substantive content of that discourse (i.e., what the rules of discourse allow you to say, make you say, or prevent you from saying). Hence the almost exclusive focus on the language, methods, and tools that the student must use in order to be part of the circle of people who can legitimately address each other as “economists.” However, when discussing the three examples in the previous section, we saw that this sort of neutrality is a mirage. The language in which you try to express Keynesian or Marxian ideas, for instance, will profoundly affect the extent to which you can even claim to still be Keynesian or Marxian. Seeking to “translate” Keynes’s or Marx’s theory—their respective views of the world and of human agency, as well as their underlying conceptions of freedom, of society, and other things—into neoclassical language is not a merely grammatical endeavor: It colors the brand of Keynesianism or Marxism you put forward, to such an extent that many careful readers of Keynes or Marx may claim that you are, in fact, betraying the very core of their thought. Purporting to make Keynes’s or Marx’s thought more rigorous by casting it in the “language of economics” actually means that you are using part of one paradigm p—the language L(p) in which it instructs

you to express all your theories—in order to express a theory T whose core assumptions c(T) actually belong to a distinct paradigm p’. What lurks behind any claim of “neutrality” is therefore, actually, often a form of intellectual hijacking. More precisely, and less polemically, someone who claims to be a neutral or merely “more rigorous” translator of a certain theory T into a certain language L may, in actual fact (and perhaps unconsciously), be acting as if L were tied to no paradigm at all—making it a seemingly neutral “means of exchange” between theories. In this way, the translator is actually concealing the fact that he or she is using a paradigm p to critically reformulate theories coming from another paradigm p’. This amounts to acting as if adopting p were a necessary precondition for any valid utterance within p’, and it implicitly conveys the notion that p is not really a paradigm, but rather a metaparadigm used to filter and judge all paradigms. Every time you claim to be neutral, you’re in fact hiding your particular options behind a veil and making people believe that they, regardless of their own options, have no option but to adopt your options… That’s why insisting that economics is necessarily and inevitably a paradigm-rooted science is so essential. But what, in fact, is a paradigm?

C.3. The inevitability of paradigms When we take economics as an object of reflection—as we do in epistemology—we necessarily hit upon a collective dimension: There is a group of individuals out there (and/or in here…) that we can stake out as the group of all those who, regardless of whether or not they agree with each other on the use of the term, call themselves “economists.” Economics is the set of all mental objects produced and circulated by the members of the class of all individuals who are self-declared economists. Of course, within that class of individuals there is a very substantial amount of conflict going on about who can legitimately declare him/herself an economist, and who on the contrary is a fraud. That conflictuality is part of the internal politics of the class of economists. It is, to a very large extent, an irreducible conflict that goes on in a context of very asymmetrical power relationships and very differentiated institutional circumstances. Each proper subset—or “sub-class”—of the class of economists purports to offer a paradigm for the practice of economics as it sees it. A paradigm is a set of assumptions, worldviews, and rules of practice (including rules on which methods to use, which techniques to use, and how to use in the right way) that defines how “we”—as a collective of “economists”—do economics. As the renowned philosopher of science Thomas Kuhn has put it, by a paradigm we should understand … some accepted examples of actual scientific practice—examples which include law, theory, application, and instrumentation together—[which] provide models from which spring particular coherent traditions of scientific research. […] The study of paradigms […] is what mainly prepares the student for membership in the particular scientific community with which he will later practice. Because he there joins men who learned the bases of their field from the same concrete models, his subsequent practice will seldom evoke overt disagreement over fundamentals. Men whose research is based on shared paradigms are committed to the same rules and standards for scientific practice.3

More formally, we could say that if E is the set of all individuals who, from one perspective or another, declare themselves to be economists, then we can break this set down into a number P of distinct paradigms p = 1, …, P, so that E ≡ {E1, …, EP}. Thus, Ep is the collective of individuals who

Thomas Kuhn, The Structure of Scientific Revolutions (1962), new edition (Chicago: University of Chicago Press, 1070), p. 11. 3

declare themselves to be economists according to the criteria of paradigm p. We could say they are not simply economists, but more precisely “p-economists.” Notice from the quote that for Kuhn, any paradigm p is a “concrete model”: it is embodied in individuals who “provide models” by teaching and practicing p-economics according to certain theoretical conceptions [θp] of economic reality, to certain rules on what formal tools [φp] to use to model that economic reality, and to certain regulations on what techniques [τp] to use to empirically grasp it. Within any paradigm p, there is a triplet 〈θp, φp, τp〉 that summarizes the paradigm’s knowledge-producing technology. But beyond this technology, there is a very personalized, even individualized aspect of the paradigm: it is a way of intellectual life carried by paradigmatic individuals who serve as “models” for the upcoming generation; therefore, a crucial aspect of a paradigm is the dimension of intergenerational transmission by which younger people learn the tools of the trade and become members of a community—what Kuhn calls “membership in the particular scientific community with which he will later practice.” One of the main upshots of this is that no economist can speak from anywhere but inside a paradigm. He can change paradigms, but he can never stand without any paradigm at all—that would mean having no structuring theoretical conceptions, no formal toolbox, and no empirically oriented techniques; in short, it would mean this economist would claim to be producing his knowledge out of nothing but pure and immediate “reality.” Such a position of naive realism— which claims that knowledge can be obtained without any other tools except our five “objective” senses and our “natural” capacities for reasoning—will be rejected in this book. We will adopt a position that could be called paradigmatic perspectivism. This means simply that while an independent reality is indeed postulated to exist, the perspective you come to adopt on economic reality can never be independent of some paradigm, i.e., some theoretical, formal, and technical toolbox. In line with Kuhn, Ken Wilber has summarized the general notion of “good science” with three basic principles which underlie any well-constituted scientific paradigm: A practical injunction or exemplar. […] “facts” are not lying around waiting for all and sundry to see. If you want to know this, you must do this—an experiment, an injunction, a paradigmatic series of engagements, a social practice: these lie behind most of good science. This is actually the meaning of Kuhn’s notion of “paradigm,” which does not mean a super-theory but an exemplar or actual practice. An apprehension, illumination, or experience. Once you perform the experiment or follow the injunction—once you pragmatically engage the world—then you will be introduced to a series of experiences or apprehensions that are brought forth by the injunction. These experiences are known as data. […] All good science […] is anchored to some degree in data, or experiential evidence. Communal checking (either rejection or confirmation). Once we engage the paradigm (or social practice) and bring forth a series of experiences and evidence (or data), it helps if we can check these experiences with others who have also completed the injunction and seen the evidence. A community of peers—or those who have already completed the first two strands (injunction and data)—is perhaps the best check possible, and all good science tends to turn to a community of the adequate for confirmation or rejection. […]4

Whether any existing economic paradigm, especially the currently dominant ones, actually conforms fully to these three principles has yet to be determined later in this book. However, the

Ken Wilber, A Theory of Everything: An Integral Vision for Business, Politics, Science, and Spirituality (Boston: Shambhala, 2000), p. 75. 4

idea that a paradigm is a set of practical, exemplary injunctions on how to engage economic reality has a very important, immediate implication. Discussing the reasons why she believes the great late heterodox economist John Kenneth Galbraith was, to her mind, not an “economist,” one recent writer on contemporary economics has put it this way: The reason many economists think Galbraith isn’t really one of us lies in his methodology. His work covers the terrain of economics—the operation of business, growth and wealth, running public services, inflation, and so on—but it uses the methods of sociology and history. The point isn’t just that Galbraith’s books are literary and contain no equations; Paul Krugman is another wonderful writer and popularizer, in the same political spectrum as Galbraith, but we in the profession count Krugman as a bona fide economist. By contrast many of us spurn Galbraith because he wasn’t a modeler. Models don’t have to be expressed in mathematical equations, but the thought process a modeler brings to trying to understand the world involves trying to select a small number of variables and relationships which can perhaps, with elegance and economy, explain the phenomena we observe. So we modelers can read The Affluent Society [one of Galbraith’s most influential books], and even agree with it, without finding it persuasive. It gives us no grip on how to confront its hypotheses and claims with empirical evidence. Economics isn’t defined by its subject matter but by its way of thinking.5

When Diane Coyle claims that a non-mainstream economist like Galbraith was “not one of us economists,” because he was not using the “right” methods, what she is really only saying is this: I, Diane Coyle, have come to believe that paradigm p is the best way to produce knowledge about the economy; therefore, to my mind, “economics” has become synonymous with “p-adequate economics”; since Galbraith did q-adequate economics and since I believe paradigm q to be unsatisfactory, I equate this with saying that he was “not an economist,” when all I can really claim is that he was not a p-adequate economist—which, of course, is true but hardly a basis for rejection. In other words, any individual’s self-declaration as an economist must be “indexed” by some paradigm p that characterizes what kind of economist that individual is. Correlatively, erasing the perspectivist dimension and claiming that “economics ≡ p-adequate economics” implies an abuse of power by the members of Ep. In a sense, the plurality of paradigms that exists in economics corresponds to the plurality of perspectives that exist on the economy. No economist can claim that he or she is speaking from nowhere. The paradigm he or she chooses to work with represents the intellectual and political cosmos within which he or she is developing his or her ideas, and it is therefore the place he or she is speaking from.6 Some paradigms are rather like political parties, with very clear hierarchies and sanction mechanisms—the criteria for a “good” publication, the standards for “rigorous” discourse, and the procedures for the designation of the “right” colleagues within academic positions. Clearly, the long-dominant paradigm of neoclassical economics has been characterized by this sort of centralized, often authoritarian structure. So was the paradigm of Marxist-Leninist economics which reigned supreme in Soviet Russia for decades, which condemned economists working with other worldviews and tools to be disparaged as bourgeois class enemies. Other paradigms are more like social movements, emerging spontaneously and haphazardly from the crumbling remains of a

Diane Coyle, The Soulful Science: What Economists Really Do and Why It Matters (Princeton: Princeton University Press, 2007), pp. 231-232. 5

For a detailed analysis of the issues of pluralism in contemporary economics, see Christian Arnsperger, Critical Political Economy, op. cit.

previous paradigm. I would claim that the currently emerging post-neoclassical paradigm—which comprises complexity economics, behavioral economics, neuroeconomics, and experimental economics—is of this nature.7 So are many paradigms that languish at the fringe of the mainstream, such as the French “régulation” and “conventions” schools. In fact, one might think that paradigms start out as social movements and then, sometimes, become more like political parties or even like small banana republics. The latter is the case when a small group of individuals champion a self-declared “paradigm” and behave like sectarian autocrats looking for allegiances—mainly through publication in specific journals—even though their paradigm is still so small and insignificant within the overall scientific landscape that they might profit from more openness and ecumenism. More generally, all paradigms as collective human structures are prone to the weaknesses and imperfections of all human communities. They are nevertheless inevitable as the cognitive structures within which any economist has to develop his or her ideas.

C.4. Paradigms and their basic dynamics Neoclassical economics—or what, in line with Eric Beinhocker’s analysis,8 we have in Money and Sustainability called the Traditional Economics paradigm—has been, for many decades, the dominant paradigm in the profession. To say that it is “dominant” immediately indicates that there have always been, alongside it, other paradigms that were dominated by it. A paradigm rarely, if ever, stands alone in the landscape; paradigms do not succeed each other like points on a line, one at a time, each paradigm neatly following on its predecessor. A paradigm, let us insist, is not just thoughts but people practicing thoughts with methods, tools, and validation injunctions. A paradigm is, before anything else, an exemplar-producing community: no pworldview would have any existence if it were not for real people taking up that worldview and making it the “engine” of their everyday intellectual and institutional lives. Now, this does not mean they have necessarily freely chosen their community—they may have become members out of habit, mindless opportunism, or fear—or that they deeply know why they are using the toolbox they are using—they may have learned the tools mechanically or even out of laziness, not bothering to search elsewhere; these are standard perversions in any community. However, that does not make the paradigm as a whole just arbitrary or random: key members of the community—often the so-called “elite” members—do know why they have adopted the paradigm p, what are its strengths but also its weaknesses, and what are the limitations of the tools they use. They may not make their thoughts on those matters public, and especially they may not teach these second thoughts and limitations to the younger members—another standard phenomenon in communities. Like any human community, a paradigm seeks to preserve its internal cohesion as long as possible. That is the reason for the various injunctions to which members of the paradigm—especially the junior members, whose minds are still malleable—are subjected: injunctions on which “core principles” of knowledge construction to start from; injunctions about which theoretical tools to use when building upward from these core principles; injunctions about how to approach I have carried out a detailed analysis of the neoclassical and post-neoclassical paradigms in Christian Arnsperger, FullSpectrum Economics: Toward an Inclusive and Emancipatory Social Science (London: Routledge, 2010). I will provide elements of this detailed analysis further down in this Appendix.

See Eric Beinhocker, The Origin of Wealth: Evolution, Complexity and the Radical Remaking of Economics (New York: Random House, 2006). 8

empirical data and how to process them; injunctions about what techniques to use in order to validate theories with data; and injunctions on how to formulate, present, communicate, and write up one’s research results. Since paradigms have a definite intergenerational dimension, these various injunctions are definitely part of any p-community’s education and “disciplining” strategy. None of this, however, implies that a paradigm is nothing but a sociological power structure from which scientificity and the connection to Truth are absent; that can, and does happen in extreme cases, but in actual fact power and recognition within a paradigm are obtained via the right application of these injunctions, whose ultimate goal is the revelation of scientific Truth. The highest ideal of a scientist is to be able to completely sacrifice his or her first-person, subjective sides (linked to the Good and the Beautiful) to the production of “pure” knowledge. Thus, the instruments which p-economists use to exercise power over one another and over the younger generation are “well-meaning” instruments: They aim to reflect the highest ideals of truth-seeking and to translate them into p-injunctions. Such injunctions are, by definitions, “dogmas”: so it does not help at all to criticize anyone by accusing them of being “dogmatic,” since this is inevitable within a paradigm. It is part of what Kuhn calls the process of “normal science,” a process characterized by the rigid, disciplined, and therefore largely non-reflexive, application of the paradigm’s injunctions. In periods of normal science, the p-community exercises strong internal discipline and views any critique from outside as irrelevant; internal critique can only be accepted if it respects the paradigm’s basic tenets: If you’re a p-economist, do p-economics or leave! Such an attitude, Kuhn claims, is a normal feature of a paradigm that is seeking to “flesh itself out,” to perfect its toolbox and its methods for using those tools, and to investigate how far its core principles will go in permitting the production of true knowledge. Truth is measured against the world—that is, against empirical data. A paradigm possesses internal truth-validation technologies, and these have to be used consistently if the build-up of internal criticism is to be legitimate. As the period of normal science gets longer, more and more evidence may accumulate of the type, “We’ve been using the prescribed methods of data-oriented testing and of validation, and alas, our theories and models—built up from our core principles and worldviews—seem to be falsified more and more often by the data.” Two key elements usually precipitate the end of periods of normal science: Accumulating falsification, which according to Karl Popper means the empirical invalidation of ptheory-based utterances. When too many falsifications have accumulated, and when the paradigm’s “core” worldview, theoretical methods, and practical tools and techniques are no longer able to supply “quick fixes” (patching up models by adding ad hoc “sub-models,” adding some new assumptions, inventing new equilibrium concepts, etc.), then more and more peconomists tend to come to the conclusion that p has run its course, and they look for the next paradigm p’. Elite dissatisfaction, which according to Colander, Holt, and Rosser is a main driving force for internal shifts even while the practices of normal science are still in full swing. High-ranking peconomists may, largely on intuition and also because they are more curious and open-minded than the average p-economist, lend an ear to the critical and constructive work done by brilliant— usually younger—q- or k-economists (including some who were members of the p-paradigm but left). The basic attitude is, “Well, that’s non-p, but pretty interesting.” Accumulating falsification and elite dissatisfaction combine to create what Kuhn has called “scientific revolutions.” This expression has sometimes been misunderstood as a sort of Marxist moment where the palace gets stormed, as it were, and the old paradigm is burned on the public square surrounded by the cheering crowd of its former members. Reality is not quite as spectacular because a dying—and even dead—paradigm can remain propped up for a long time

by its most mediocre members who are simply too afraid to venture out into the new paradigms. This is all the more so if, as often happens, the now dead p-paradigm was massively dominant for decades, in which case the aftermath can linger for yet many more decades as pure power games within keep it fictitiously alive within enduring p-institutions (university departments, schools, etc.). In other words, a “scientific revolution” is a more or less invisible and gradual event, and the dissatisfied elite that drives the revolution will often be decried as “traitors” or as “senile” for a long time before the paradigm finally crumbles. At any rate, paradigms always coexist to a significant degree: p and its “internally generated” postp rival, p’, usually coexist; and both of them usually coexist with q, k, etc. which are and have always been non-p paradigms; it may be, but need not be, that p’ has taken up some features from q or k. How all these paradigms coexist is a matter of how the educational and research institutions are organized; there is no general empirical pattern, and general normative theories of paradigm coexistence are not yet very widespread in economic epistemology.

C.5. The workings of Traditional Economics What we have termed in this book the Traditional Economics paradigm has frequently been called neoclassical economics within the profession. The word “neoclassical” is said to have been coined by the economist Thorstein Veblen to characterize the emerging Marginalist School of the 1870s, with people such as Stanley Jevons, Carl Menger, and Léon Walras. (Just like it is Karl Marx, so it appears, who in the 1840s popularized the description of the work of Adam Smith, David Ricardo, and Thomas Malthus as “classical” economics.9) By a “neo-classical” approach, Veblen obviously meant something that took its root in classical doctrine but superseded it towards a new vision. Essentially, what Veblen objected to the marginalist economists is that they neglected some deep traits of human nature—such as our tendency to want to dominate others, to want to “show off” with our wealth, etc.—and that at the level of method they built a formalistic approach that neglected evolution and dynamics. So, in a sense, Veblen was nostalgic of the good old days of classical dynamics and preoccupation with growth, even though (perhaps less so than Marx) he also had strong reservations with respect to Smith’s or Ricardo’s worldview. We could summarize the “neo-classical” approach as a formalistic, mechanistic, and static approach—three properties which, when put together, generated a type of economics that Veblen disliked because it left out some of the most important insights from the classics and kept some of their most important errors. We will see whether Veblen’s assessment is warranted; to announce the cards, I do believe he essentially was right, and that post-neoclassical methods (to be studied in section C.7.) are first and foremost an attempt, by the neoclassicals themselves, to take into account the sort of criticism that Veblen had already started to articulate in the 1890s. According to Ernesto Screpanti and Stefano Zamagni,10 the Traditional Economics paradigm— henceforth called TE-paradigm—succeeded in displacing the classical orthodoxy for both “internal” and “external” reasons. These offer a good illustration of the (messy) dynamics of paradigms. The internal reasons were (a) “the inability of the classical orthodoxy to solve a series of theoretical problems” (in particular, the defects of Ricardo’s labor theory of value and of his theory of the cost of production, which John Stuart Mill strongly criticized) and (b) the fact that

See David C. Colander, Richard P.F. Holt and J.B. Rosser, The Changing Face of Economics: Conversations with Cutting Edge Economists (Ann Arbor: University of Michigan Press, 2004), p. 8.

Ernesto Screpanti and Stefano Zamagni, An Outline of the History of Economic Thought (Oxford: Oxford University Press, 2005), pp. 170-172.

“the classical economists had not been managed to produce a satisfactory theory of income distribution” (in particular, the controversy around whether, as Malthus claimed, wages were bound to get pushed down to subsistence level as the population grew—an idea which Jevons criticized strongly and for which the Ricardians offered no convincing alternative). The external reason was (c) the increasing identification of socialist-minded economists with the Marxian paradigm, which people like Wicksteed, Böhm-Bawerk, and Pareto felt was deeply defective in its analysis of value and of agents’ rationality. Thus, the combination of a defective classical theory and a perceived need for a “scientific” alternative to Marxian socialism seems to explain why more and more classically-oriented economists shifted towards new tools, new methods, and a new worldview. This led to the gradual emergence of the TE-paradigm. According to the excellent analysis offered by Screpanti and Zamagni, this new paradigm offered six crucial innovations. (1) It focused much less on evolutionary systems dynamics than on the careful analysis of how given resources get distributed at a given instant in time. This led to a fundamental recasting of the “core” worldview guiding economic analysis: In the analysis of the conditions ensuring the optimal allocation of given resources among alternative uses, the neoclassical economists identified a universally valid principle, one which was able, alone, to embrace the entire economic reality. As Robbins said: “Scarcity of means to satisfy ends of varying importance is an almost ubiquitous condition of human behaviour. Here, then, is the unity of subject of Economic Science, the forms assumed by human behaviour in disposing of scarce means” […]. The tendency to extend the basic model to every branch of economic investigation was reinforced during the course of the [twentieth] century until it culminated in the argument of P.A. Samuelson that there is a simple principle at the heart of all economic problems: a mathematical function to maximize under constraints.11

(2) The TE-paradigm accepted utility-maximization, i.e., the idea that what individuals pursue is exclusively the purposeful satisfaction of their tastes and preferences: … human behaviour is exclusively reducible to rational calculation aimed at the maximization of utility. They considered this principle to be universally valid: alone, it would have allowed the understanding of the entire economic reality.12

(3) The TE-paradigm rests on a methodology—absent from classical economics—of explaining individual economic decisions by “substitution,” or arbitrage through the continuous variation of proportions: The analysis is carried out in terms of the alternative possibilities among which the subjects, both consumers and producers, can choose. And the objective is the same: to search for the conditions under which the optimal alternative is chosen. This method presupposes that the alternatives at stake are “open” and that the decisions taken are reversible […].13

(4) Within the TE-paradigm, methodological individualism gradually became all-pervasive. The fundamental entities of scientific explanation, so it was claimed, had to be as small as possible, which leads to individualistic reductionism: If they are subjects able to make rational decisions with a view to maximizing an individual goal, such as utility or profit, they must be individuals or, at the most, ‘minimum’ social aggregates characterized by the individuality of the decision-making unit, such as households and companies. Thus the collective agents, the social classes and the “political bodies,” which

Ibid., pp. 165-166.

Ibid., p. 166.

Ibid.

[…] the classical economists and Marx had placed at the centre of their theoretical systems, disappear from the scene.14

(5) The TE-paradigm claims that the “laws” it discovers with the help of its methodological tenets (3) and (4) are a-historical. They are not connected to any specific, historically located social relations or political-cultural background: Economics was likened to the natural sciences, physics in particular, and economic laws finally assumed that absolute and objective characteristic of natural laws. […] [F]or this to make sense, it is necessary to remove social relations from the field of economics, exorcizing them as superstitions, a waste of time, a subject not in line with the new scientific achievements. With the marginalist revolution also originated that reductionist project of economics which has marked all the successive neoclassical thought, a project according to which economics has no other field of research than technical relationships (the relationships between man and nature). Thus, while individualistic reductionism had led to the elimination of social classes, the antihistoricist reduction led to the elimination of social relations—which also meant that the study of their change also lost importance.15

(6) Finally, closely connected to tenet (2) is the idea that according to the TE-paradigm, since agents have preferences which they maximize under constraints, and since it is these preference that jointly determine the value of things, it follows that all values in society are both individual and subjective: “Individual” means that they are considered always as the ends of particular individuals. On the other hand, values are “subjective” in that they arise from a process of choice: an object has value if it is desired by at least somebody. […] In the opposite conception, that of objective value, values exist independently of individual choices [one of these objectivist approaches being the Smith-Ricardo-Marx approach of labor-related value which occupied center stage in classical economics].16

Thus, the TE-paradigm emerged in response to flaws in the older, classical paradigm but, as Screpanti and Zamagni note correctly, Veblen actually coined the expression “neoclassical” with respect to Alfred Marshall’s work, about which he had many reservations; the prefix neo did not, in his mind, refer to the whole of what Marx, a few decades earlier, had termed “classical.” So there is little point in trying to pin every feature of the TE-paradigm against a hypothetical corresponding feature of classical economics. Still, in broad brush, there does seem to have been a scientific revolution in Kuhnian terms, since after 1900 hardly any significant remains of the classical period seemed to have subsisted, and the TE-paradigm gradually evolved to take over virtually the whole of the academic establishment in Britain and in the US—a hegemony which became synonymous with a monopoly on young, brilliant minds.17 The six tenets singled out by Screpanti and Zamagni cover the ground fairly well, although they neglect to make explicit one very important concept: equilibrium and its practical correlate, the tool of “comparative statics.” (It may in part be recovered through their tenet (5), by spelling out the way traditional economists construct their “laws.”) For the rest of this section, I would like to offer a more concise characterization of the TE-paradigm based on three “pillars”18: 14

Ibid.

Ibid., p. 167.

Ibid.

See e.g.

See Christian Arnsperger and Yanis Varoufakis, “Neoclassical Economics: Three Identifying Features”, in Edward Fullbrook (ed.), Pluralist Economics (London: Zed Books, 2008), pp. 13-25. 18

methodological individualism, methodological instrumentalism, and methodological equilibration. Traditional Economics can, I claim, be circumscribed fairly exhaustively by its axiomatic imposition, in any move of knowledge construction about the world, of instrumental rationality at the agent level and of static equilibrium at the inter-agent level. In fact, Traditional Economists never ask themselves what correlates in agents’ organisms and brains go along with the functioning of the economic system. And this functioning is analyzed as the coordination between instrumentally “rational” particles indirectly connected to each other through equilibrium “variables.” The “core” methodology of the TE-paradigm therefore has three main components: (1) Methodological individualism (henceforth M.Ind) says that at the level of explanation any phenomenon must be analytically broken down into the actions and interactions of the individual atoms that make the phenomenon emerge; (2) Methodological instrumentalism (henceforth M.Inst) says that any individual atom’s action can be rationalized as the result of optimization (i.e., rational, purposeful interest fulfillment) subject to perceived constraints that either pre-exist to the interaction or emerge from the interaction itself. (3) Methodological equilibration (henceforth M.Eq) says that any social phenomenon can be rationalized as an equilibrium in the interaction of individual atoms. The TE-paradigm is therefore designed to explain all social phenomena exclusively as equilibria computed from the mutually compatible actions of optimizing individual atoms. (Note carefully that I have just written “computed from” rather than “emerging from,” and “mutually compatible actions” rather than “interaction.”) It is hard to imagine how any Traditional Economist could deny that this is what he or she is doing, and has been doing, in every single piece of research he or she has ever offered to the scientific community. Whether it is general equilibrium theory, non-cooperative game theory, nonWalrasian equilibrium theory, social choice theory, industrial economics, economic geography, political economics, analytical Marxism, public economics—all of these approaches differ widely in numerous aspects that can be, and actually are, hotly debated, but none of them strays from explaining all phenomena exclusively as equilibria computed from the mutually compatible actions of optimizing individuals. In a significant sense, these three “core” principles of the TE-paradigm can be seen as nested axioms: individualism is broader than instrumentalism, which in turn is broader than equilibration. To be more precise, M.Ind does not prescribe that all individuals be instrumental maximizers; in turn, M.Inst does not prescribe that all phenomena be the instantaneous, computable result of mutually compatible actions. The M.Eq axiom is extremely stringent in that it imposes that there be, in fact, no interaction—only actions which are already in equilibrium, so that any interaction which may have occurred can only be assumed, and remains forever invisible. The M.Inst axiom, too, is extremely stringent in that it imposes that there be, in fact, only self-centered individuals, in the sense of individuals who are purposefully pursuing their ends, towards which they mobilize whatever means their environment makes available to them. As Jason Potts has argued recently, these three axioms, and especially the third one, make the TEparadigm into what he calls a “complete field” approach.19 The economic situations as analyzed by Jason Potts, The New Evolutionary Microeconomics: Complexity, Competence and Adaptive Behaviour (Cheltenham: Edward Elgar, 2000), pp. 11-30. See also Sunny Y. Auyang, Foundations of Complex-System Theories in Economics, Evolutionary Biology, and Statistical Physics (Cambridge: Cambridge University Press, 1998), pp. 115-140. 19

the TE-paradigm are always already equilibrium situations: all the relations between the agents, all their connections, are assumed to already have been discovered and established, with the implication that their gradual emergence through interaction need not be analyzed; moreover, these connections between agents are assumed to be completely covering and instantly informative, so that whatever any agent does is supposed to get transmitted instantly—in the form of “information”— to all the other agents, with the implication that the actual interactions between agents need not be analyzed, either. Thus, Traditional Economists methodologically summarize all interactive processes of search for connections, and all processes of transmission of information, between agents as equilibrium states.

C.6. The twofold reductionism of Traditional Economics The TE-paradigm is a reductionist sub-variant of an already in itself strongly reductionist approach that has pervaded economics almost from its inception. C.6.1. The economy as an interactive system Ever since it originated in the writings and practices, as well as the policy recommendations, of the seventeenth- and eighteenth-century economists—physiocrats, mercantilists, classics—economics has been a discipline oriented through and through towards a system-reductionist stance. From the very beginning, the various schools of economic analysis and governance that developed in England, France, and Germany had a fundamental interest in viewing “the economy” as a huge machine, or organism, made up of smaller machines or organs, all the way down to the individual “cells” that are considered by Traditional Economists to be the individual building blocks of social reality. True enough, the deep individualism of the TE-paradigm was slow in coming. Initially, the preclassical and classical approaches were much more holistic and functionalist; they saw the economic system as a whole and when they did decompose it, the did so into broad subsystems such as sectors, industries, classes, “bodies,” or types of agents, or into broad mechanisms such as flows, sectorial inputs and outputs, and so on. The physiocrat Quesnay saw the economy essentially as a system of accounts with inflows and outflows between sectors, which he attempted to synthesize statistically in his famous Tableau Économique. Ricardo believed that he could, through his theorization of labor-value and the gravitation of market prices around natural prices, rely only on macro-laws base implicitly on the diversity of individual rationalities—but rationalities rendered irrelevant in the aggregate by a “law of large numbers” analogous to the one later used in statistical physics. The “scientific” later Marx of Capital can be interpreted as having proposed an explicitly interactive model with heterogeneous agents (since he was interested in how class struggle drives the dynamics of history), but he used a quite coarse-grained typology of agents, using at most two or three categories of representative or “average” agents (capitalists, proletarians, and rentiers); moreover, he considered the rationality of these classes of agents to be rather simplistic (reducible to the desire to appropriate material surplus) and he established between them very simplistic connections (reducible to the desire to own what the other is taking) which he considered sufficient in order to generate his interactive theory of historical change—in fact, he eventually ended up considering even such simplified interactions as being subsumable into the macro-laws of history, thanks to a fairly un-analytical and formally underspecified notion of “dialectics.” Thus, classical economists were much more systemic holists than methodological individualists. This “whole systems” heritage is deep and tenacious. Even Alfred Marshall, at whom Veblen leveled the adjective “neoclassical” in the first place, borrowed from evolutionary biology and

Darwinism his organic, holistic image of an industry as a forest and of individual firms as trees that grow or wither along the competitive process. Traces of an incomplete individualism can still be found in the TE-paradigm when it treats firms as optimizing agents even though they are, quite obviously, a composite agent made up individuals—and it is this last remnant of holism inside the Traditional Economics which has been attacked and destroyed by the Coase-Williamson approach of firms as aggregate mechanisms that minimize the transaction costs incurred by its individual members. Thus, even though Traditional Economics has grown gradually more individualistic and less interactive, it is clear that the basic interest of economics as a discipline has always been—across paradigms—the analysis and comprehension of systems-in-process, that is, of the economy (or any subset of the economy) as a system of interacting components whose mutual relations are strong compared to their relations with any component of the system’s environment. In systems vocabulary, such systems are called complex adaptive systems (CAS’s). They are, and have always been, the basic object of interest of any economist. As a result, economics has from its very inception been haunted by the temptation to mimic the natural systems sciences—physics or biology.20 The ambition of economics as a sort of “social physics” dates back to the very beginning, and the perpetual search for economists for formal tools of conceptual analysis and empirical mastery of systems has its explanation mainly in this ambition.

C.6.2. Traditional Economics and the loss of process The classical economists relied on the reduction to dynamic systems in order to study the phenomena of growth and, more generally, of wealth generation. This can certainly be explained by the fact that growth, rather than distribution of whatever had been produced, was considered in the eighteenth and nineteenth centuries as the main goal of economic management: increase the size of the pie, before investigating how any pie ought to be divided. As Screpanti and Zamagni emphasized above, the neoclassical economists gradually gravitated towards a less dynamic—and eventually totally static—analysis of resource distribution. This had, of course, also been on the agenda of Smith, Ricardo, Malthus, or Marx, but their preoccupation with first overcoming aggregate scarcity had overshadowed their analysis of how to manage scarcity, so that their distributional theories seemed in need of improvement. This shift in preoccupation has meant an additional reductionist move within the already reductionist discipline of economics: Traditional Economics focused on what systems theorists have called “synthetic microanalysis” within a methodology of “independent-agent approximation.” This has led the paradigm to a gradual loss of the interactive components of the complex adaptive economic system, and also to a loss of the aspect of mechanical and/or organic dynamics that was so central for the classics. The TE-paradigm created a massive shift of focus from process to state, and from interaction to isolated action. In fact, when we speak of “isolated” action, we need to be careful. The TE-paradigm is individualistic but not micro-reductionist: it does not reduce all economic reality to the actions of individuals at the micro-level, as if there were no macro-level at which those actions needed to be aggregated. Macro-aggregation is crucial for the TE-paradigm, since it is by aggregating optimal individual decisions that it hopes to be able to explain all phenomena in the economic (and, more

For a detailed and enlightening discussion of the attraction of economists—mainly classical and neoclassical—for mathematics and physics, see Philip Mirowski, More Heat Than Light: Economics as Social Physics, Physics as Nature’s Economics (Cambridge: Cambridge University Press, 1989).

broadly, in society). However, what makes the TE-paradigm special is its particular method for micro-to-macro aggregation—a method known as synthetic microanalysis under an assumption of independent agents. How can independent micro-agents generate interdependent actions that “feed back” to the macro-level to generate aggregate phenomena? This is where the concept of equilibrium, in its neoclassical sense, becomes central. As we already saw earlier, Sunny Auyang has characterized the method of synthetic micro-reductionism as follows: Suppose we imagine the description of systems and the description of their constituents as distinct two-dimensional conceptual planes, variously called the macro- and microplanes. Microreductionism rejects the macroplane, holism rejects the microplane, isolationism rejects the connection between the planes. They are all simplistic and deficient. Actual scientific theories of composition are more sophisticated. They open a three-dimensional conceptual space that encompasses both the micro- and the macroplanes and aims to consolidate them by filling the void between them. This is the approach of synthetic microanalysis.21

The properties of the economy are located on a distinct—or “higher”—level compared to the properties of the agents, yet you do need to know the mechanisms of action choice of the agents, as well as the mechanisms of interaction between them, to be able to deduce through (re-)composition the operation of the economy. So (a) there is a macroplane, which corresponds to the aggregate phenomena occurring in the economy; (b) there is a microplane, which corresponds to the agents of the economy if it is analyzed into its “parts”; and (c) there is a “bridge” between the two planes, which corresponds to the effects that emerge from the interaction of the agents, once they have been “re-synthesized,” so to speak, and the economy has started to operate. This emergence of aggregate phenomena from interactions between individuals is what makes most systems into complex interactive systems: Large-scale composition is especially interesting because it produces high complexity and limitless possibility. […] Myriad individuals organize themselves into a dynamic, volatile, and adaptive system that, although responsive to the external environment, evolves mainly according to its intricate internal structure generated by the relations among its constituents. In the sea of possibilities produced by large-scale composition, the scope of even our most general theories is like a vessel. […] Large composite systems are variegated and full of surprises. Perhaps the most wonderful is that despite their complexity on the small scale, sometimes they crystallize into large-scale patterns that can be conceptualized rather simply […]. These salient patterns are the emergent properties of compounds. Emergent properties manifest not so much the material bases of compounds as how the material is organized. Belonging to the structural aspect of the compounds, they are totally disparate from the properties of the constituents, and the concepts about them are paradoxical when applied to the constituents.22

Such a system can sometimes be reduced to a non-interactive system by an operation called an independent-agent approximation: In short, independent individual models replace familiar relations among individuals by the response of each individual to a common situation, or statements of the form “Each individual xi has character Ci and engages in relation Rij to every individual xj other than itself” by statements of the form “Each individual xi has situated character C*i and responds to the situation Si, which is a rule generated by and common to all individuals in the system.” The replacement eliminates the double indices in Rij, which signify binary relations and cause most technical difficulties.23

Sunny Y. Auyang, Foundations of Complex-System Theories, op. cit., p. 55.

Ibid., pp. 1-2.

Ibid., p. 119.

A typical and well-known instance of this is the Walrasian model of general market equilibrium, in which the direct interaction of agents, bargaining, “higgling and haggling” about prices and/or quantities in pairwise negotiations, searching for the best price-quality ratio by trial and error, and so on, is replaced by a non-interactive setting in which each agent, in isolation, reacts to a price vector p. If this price vector happens to be the Walrasian equilibrium vector p*, no matter how it was attained—and even if it was just “thrown in” by fiat by some external agent without there having been any previous interactions out of equilibrium—then each agent will be able to buy or sell the quantities she desires to buy or sell at those prices: no one will experience any rationing, and the economy will “be in equilibrium”. Be careful: you cannot say it has reached equilibrium, because there is no process involved. The independent-agent approximation allows for completely static setups in which agents just receive the equilibrium prices that, in a truly dynamic interactive system, would have had to emerge from their interactions. At best, we could say that in the Walrasian approach, each agent i endowed with her preferences and her initial resources and all agents responding in parallel instantaneously generate the equilibrium price vector p*, which is such that when it is “fed back” to each agent, it elicits the set of “optimal” choices that generated it in the first place … All this happens in an instant, without interactions in real time (figure C.2). C

A p* ?? D

B A

Figure C.1 – Interactive model

Figure C.2 – Non-interactive model

(with interdependent agents)

(with independent agents)

In figure C.2, the agents do not interact; each agent reacts in isolation to a shared “situational variable,” the unique market price vector p (each reaction is represented by a small upward arrow). In equilibrium—which exists under certain technical assumptions about the agents’ preferences, about the technologies of production, and so on—the value taken by this shared variable will be p*, and when this is “fed back” to each agent (through the big downward arrow) it leads each agent to “replicate” the reaction he had previously “sent up.” In figure 1, there are multilateral interactions—assuming, here, that all agents are already connected to all others, which is a very specific assumption akin to what Potts calls a “complete field.” These interactions generate pairwise prices (one for each double arrow), and it is only by amazing chance that these “local” prices will, when gathered together, coincide with p*. This sort of setup, which is part of the core of the TE-paradigm, assumes that agents have parametric rationality: in her choice of action, each agent takes her environment as a parameter which she cannot affect, and she includes in that parametric environment the actions of all the other agents. Such an assumption really makes sense only if we take each agent to be of “Lebesgue measure zero,” i.e., to be a point on a continuous line segment.24 With just four agents as in See Robert J. Aumann, “Markets with a Continuum of Traders”, Econometrica 32: 39-50 and “Existence of Competitive Equilibria in Markets with a Continuum of Traders”, Econometrica 34: 3-27. The “Lebesgue measure” is a criterion for

figure C.2, this makes no clear sense since it must be the case that such agents would perceive their bargaining power and the possibility of looking up each other agent individually in order to negotiate a deal for a higher- or lower-than-Walrasian price. Outside of the Walrasian setup with an “infinite” number of traders, the assumption of parametric rationality is not plausible. However, as we will see later, even non-cooperative game theory which introduces strategic rationality—and is the basis for recasting a lot of non-Walrasian, “imperfect-competition,” and/or “imperfect-information” economics in a post-neoclassical format—has recourse to the independent-agent fiction when it assumes common knowledge of (instrumental) rationality and uses the concept of Nash equilibrium. One quite important issue connected with figure C.2 is whether the shared “situational variable”— in this case, the price vector p*—that all agents face in isolation is not, in fact, provided by some “hidden” institution. Many economists within the TE-paradigm have come to the conclusion that the independent-agent fiction can only make sense if the agents are again made mutually interdependent through a centralized agency such as the Walrasian “auctioneer.” Thus, whereas figure C.1 represents an economy with decentralized interdependence between agents, figure C.2 would really represent an economy with centralized interdependence between agents who have no direct contact with one another. Some, such as Abba Lerner and Oskar Lange in the 1930s, have gone as far as saying that the independent-agent approximation is really a covert model of a planned economic system in which the constituent components are “steered” by some central agency—or central computer—into computing the “right” values of the shared situational variable so that the system will solve its set of multiple demand-and-supply equations. This insight provided a rationale for many National Planning Agencies—and it already indicates that TE-type systems analysis is by no means to be equated with “neoliberal” or “free-market” doctrine. Indeed, recall that as Screpanti and Zamagni emphasize, the TE-paradigm emerged in part as an attempt to “salvage” socialist ideas and ideals from the Marxist way of treating these ideals. Hence, it is no surprise that there are very many Left-wing, even Marxist, Traditional Economists: Their position is that even Left-wing ideas can be formalized and promoted with the toolbox of the TE-paradigm. To the idea that the independent-agents approximation presupposes a central coordinating agency, Sunny Auyang replies the following: The self-consistently determined situation [such as the equilibrium vector p*] is characterized in its own terms, which are qualitatively different from the concepts we use to describe the individuals. Despite its endogenous nature, its direct effect on the independent individuals is similar to that of external forces. Since an individual in a large system is insignificant compared to the aggregate effects of all the rest, the situation constrains individual behaviors and appears to be dominant. […] Since the competitive market model is an equilibrium theory that neglects dynamics, an auctioneer is invented to initiate and control price movements, enhancing the image of exogenous domination. […] The individuals are easily mistaken for isolated beings and the situation is mistaken for an externally imposed institution or norm. Ideological dispute follows.25

What she is thus suggesting is that figures C.1 and C.2 should not be taken as the representations of two distinct economic systems, but rather figure C.2 should be seen as an “as if” reduction of figure C.1: agents really are interacting, the price vector really is endogenous and really does emerge gradually from these interactions, but for purposes of simplification we can subsume this

evaluating the “size” of a subset of Euclidian space; a point on a continuous line, or continuum, is the simplest example of a set that has a Lebesgue measure of zero. 25

Sunny Y. Auyang, Foundations of Complex-System Theories, op. cit., p. 121.

interactivity into a static, non-interactive model. As long as we are conscious of what we are doing, she seems to say, no harm is done and the TE-paradigm’s massive recourse to methodological equilibration is vindicated as a valid “shortcut.” (Note in passing that Auyang herself is prone to conflating Traditional Economics with “economics” proper, as is evident from the title of her book and from her discussions of economics.) Thus, the Lange-Lerner suggestion that the centerpiece of the TE-paradigm—i.e., the system of decentralized Walrasian markets and its self-consistent prices—is really a centralized planned economy becomes, for her, an “ideological dispute” that misses the point. This sort of position has been frequent in the TE-paradigm: It says that completely unrealistic assumptions—such as independent, perfectly informed agents facing an anonymous vector of market prices—can be made as long as the results of these assumptions, the predictions and explanations they make possible, are valid and acceptable.26

C.6.3. Two versions of equilibrium Since the TE-paradigm locates itself within systems analysis and seeks—as we saw in the previous section—to gain “insights into” the (still external) operation of the system, its supporting community of Traditional Economists believe that the underlying concepts of individual rationality and systemic equilibrium are absolutely unavoidable. Indeed, they claim that without these concepts economic science itself would be impossible—by which they actually mean that their own preferred, TE-framed conception of science would break down. And they are, of course, quite correct. Without these two notions, the “as if” reasoning suggested by Auyang could not get off the ground. In fact, these two notions are two sides of the same coin: in equilibrium, the agents do not really make decisions; their “optimal” decisions are pre-inscribed into them by the system’s need to be in equilibrium. In other words, rational individuals in the TE-setup are individuals who are functionally constructed so as to respond only to equilibrium values of the situational parameters. This reminds us of the German philosopher Leibniz, who saw all of Reality as composed of selfenclosed “monads” who aggregate and disaggregate by obeying to what he called a “preestablished harmony”: since Reality exists (rather than nothing) and since moreover Reality’s way of existing is to be what it is (and not some other reality), it necessarily follows that some “principle of sufficient reason” must be at work which constantly coordinates the billions of monads into equilibrium—they have no choice but to form the Reality-That-Is! … Even though this may sound like remote metaphysics, it is in fact what the TE-paradigm’s core axiom of methodological equilibration says: since the world exists, and since there are economic events and occurrences out there, something—or some things—must be “in equilibrium” at all times; if not, reality would not be self-consistent and would not exist. In fact, there is some deep truth to this. Since the analysis of collective systems is essentially an analysis of the causes of rational collective order, it is indeed the case that, from a systems-analysis perspective the absence of order makes no sense at all, since disorder is synonymous with external invisibility! What does not respect some ordering principles simply does not appear in external reality. Thus, if we equate “equilibrium” with “consistency-creating order,” there is indeed no way that Reality cannot be an “equilibrium.” This is, in fact, what Karl Popper meant by his “rationality

For a detailed defense of this sort of position, usually called “instrumentalist,” see Milton Friedman, “The Methodology of Positive Economics”, in Milton Friedman (ed.), Essays in Positive Economics (Chicago: Chicago University Press, 1953), pp. 3-43.

principle”:27 if one is going to construct a scientific explanation of how reality is structured, one cannot avoid imposing on one’s concepts some notion of macro-consistency (i.e., systemic “equilibrium”) as well as some notion of micro-consistency (i.e., sub-systemic, individual “rationality”) that is congruent with the requirements of macro-consistency. This is also what Sunny Auyang was saying when she earlier described the general method of synthetic microanalysis. In that sense, we indeed cannot live without the concepts of individual rationality and systemic equilibrium. The question, however, remains as to whether the TE-paradigm’s way of conceiving of rationality and equilibrium is the best way. Here the difference between figures C.1 and C.2 becomes crucial. They can only be seen as interchangeable if we can be certain that the complex interactive process of figure C.1 eventually converges on the situation portrayed in figure C.2. In other words, as long as we do not have a mediating mechanism that “links” these two figures, we are not certain at all that figure C.2 can be serenely taken to be the “summary” description of anything externally visible! This is one of the oldest and most puzzling questions in the TE-paradigm: under what conditions can the independent-agent approximation of figure C.2 be seen as the plausible outcome of a real-time, dynamic process such as that of figure C.1? Now, we should note immediately that this question is not confined to the Walrasian model where p* is a market-price vector. The exact same question can be put to the non-Walrasian model of “fixed-price equilibria” where p* is replaced by a quantity vector q* reached through so-called “quantitative rationing schemes,”28 and to any equilibrium model—possibly imperfectly competitive—that treats agents’ interactions as secondary. To make sense of this whole discussion, we need to distinguish two senses in which both rationality and equilibrium can be understood: Weakly functionalist (“basic-reality”) interpretation: Since reality exists, there has to be order somewhere rather than total chaos. In other words, some things have to adjust at various places in the system of reality at any moment in time, so that the world appears to us and is intelligible. All entities in reality have to adjust in some way, at all times, to ensure the macro-coherence of ThatWhich-Is (independently of what it is or whether it is acceptable, etc.). Therefore, micro-entities have to obey a rationality that makes them fit into the overall scheme of reality, which they de facto make up at all instants of time. Strongly functionalist(“system-at-rest”) interpretation: Within existing reality, there are situations of restful order in which all interactions have stopped because given the micro-entities’ rationality, all opportunities to “optimize” have been exhausted. Such situations are characterized by a fixedpoint situation: given the values x* of the adjustment variables, each micro-entity has as its “optimal” choice a vector of actions a*i such that x* → [a*1, a*2, …, a*n] → x*. This implies that in the absence of any exogenous change in some or all micro-entities’ environments, none of these microentities has any incentive (given its rationality) to change its optimal choices. Clearly, version (A) is compatible with figure C.1 as well as with figure C.2, while version (B) is compatible only with figure C.2. (B) selects within (A) those particular situations for which interaction, search, exploration, connection-building, etc., can be neglected because they are assumed to have “played themselves out” completely so that only something from outside the system—affecting some or all agents’ micro-environments—can generate new interaction, search, exploration, connection-

See Karl Popper, “The Logic of the Social Sciences” (1962), reprinted in K. Popper, In Search of a Better World: Lectures and Essays from Thirty Years (London: Routledge, 1994).

See Jean-Pascal Benassy, The Economics of Market Disequilibrium (New York: Academic Press, 1982).

building, etc. It is because of this quite restrictive interpretation of the notions of rationality and equilibrium that, almost as a pun, we can say that in “perfect competition” as the TE-paradigm understands it, there is no competition at all. The main reason why the TE-paradigm has strengthened its core concepts of rationality and equilibrium from (A) toward (B) is that it has long been obsessed with the project of emulating physics and begging the prestigious status of classical mechanics. In fact, both classical and neoclassical economists were obsessed with the idea that economics should be made into a “social physics.” This is, of course, due to a quite narrow interpretation of what systems analysis means. For the Traditional Economist, a system’s operation is of interest only at its (B)-equilibrium states; thus, what sequence of (A)-equilibria might make the system go from one (B)-equilibrium to the next has long been deemed irrelevant, and for many decades this has been impressed upon students and junior researchers through the all-pervasive recourse to the method of comparative statics, which is also part of the TE-paradigm’s “core” toolbox. To see how a change in the system’s exogenous variables affects the system, one needs to compare the static (B)-equilibrium before the exogenous “shock” to the static (B)-equilibrium after the shock. The totally amazing part of the story is that this methodology has actually served as the basis for decades of econometric estimates and economic-policy advice. Now, to avoid any misunderstanding, let us emphasize yet again that one can perfectly well maintain at the same time the absolute necessity of version (A) while rejecting the necessity of the more restrictive version (B). When Traditional Economists vocally defend “their” paradigm by arguing that the notions of rationality and equilibrium cannot be dispensed with because of Popper’s “principle of rationality,” they are conveniently confusing (B) with (A). In reality, it is perfectly thinkable that there is an orderly reality, in the sense of (A), that never, ever converges on a restful reality, in the sense of (B). One can have a dynamic economic reality in which, at all moments, complex interactions between myriads of agents generate the emergence of order-creating variables (as in (A)) which are nevertheless not interaction-stopping equilibria (as in (B)). This is indeed a very trivial insight once one retrieves it, but it has been obscured by the TE-paradigm’s obsession with classical mechanics and the naïve, “comparative-statics” analysis of economic systems. As we will see later on, the majority of Traditional Economists only came around to this problem starting in the 1990s. It is a question whether they did so because more and more of their elite members (such as Kenneth Arrow or Alan Kirman) had started to listen to, and interact with, young mavericks such as Brian Arthur? Samuel Bowles or H. Peyton Young thought their ideas were good—or whether the shift happened first and foremost because of a dramatic improvement in computer technology and in simulation techniques. In any case, the non-Traditional economists who were working more in the tradition of Schumpeter and Hayek had seen the problem very much earlier—which testifies to the plausibility of Kuhn’s notion of “normal science.” In fact, already in 1945, the conservative economist Friedrich A. Hayek, very much a skeptic vis-à-vis the fledgling TE-paradigm, which he called “Mathematical Economics,” explained why he believed it would fail: Any approach, such as that of much of mathematical economics with its simultaneous equations, which in effect starts from the assumption that people’s knowledge corresponds with the objective facts of the situation, systematically leaves out what is our main task to explain. I am far from denying that in our system of equilibrium analysis has a useful function to perform. But when it comes to the point where it misleads some of our leading thinkers into believing that the situation which it describes has direct relevance to the solution of practical

problems, it is high time that we remember that it does not deal with the social process at all and that it is no more than a useful preliminary to the study of the main problem.29

None of what Hayek said in 1945 is incompatible with (A). His message is, in essence: Equilibrium yes, comparative statics no; rationality yes, independent-agent approximations no! In more contemporary terms, which we will flesh out in section C.7, complex adaptive systems or “dissipative structures” have equilibria, too, though not of the (B)-type. Thus neither methodological individualism nor systemic equilibrium per se imply the absolute need for Traditional Economics; the specific “core” axioms of the TE-paradigm can be dispensed with—and have been since then—without rationality and equilibrium in themselves being at issue.

C.7. Beyond Traditional Economics: The post-neoclassical paradigm In the wake of the TE-paradigm, a relatively diverse constellation has started to emerge. I choose to call it “post-neoclassical” economics, even though some of them have kept a strong connection to the core of the TE-paradigm—to the point of looking merely like a fleshed-out Traditional Economics. In one sense or other, each of these extensions can be seen as a development called for by the TE-paradigm itself in its effort to maintain itself while adapting to the demands of some of its most brilliant elite members. In her recent survey of the developments in “economics” after the 1980s, Diane Coyle has written: The key elements of economic methodology, unchanged from the classical days, are the status of rational choice and the use of equilibrium as a modeling concept. If these are limitations, so be it: every subject has core restrictions in its methodology, which in fact represent its strengths and distinctive insights. It’s not that we believe that everybody chooses rationally all the time— on the contrary, the most orthodox of economists is interested in learning from behavioral research. Nor do we think the economy is always in equilibrium. That would be just as silly. Nevertheless, both elements are core to our way of thinking. […] [T]he paradigm is unchanged, if that means the essential elements of economic methodology, but economists are unified by a new consensus as to what economics is about. Not the study of competitive markets, but rather an understanding of society as the aggregation of millions of individual decisions, in specific contexts shaped by history and geography, and by our own evolutionary history.30

To fully understand her point, we need to remember our key distinction between directly interdependent agents and the approximation through “independent”—that is, indirectly interdependent—agents. Coyle is in fact claiming that while equilibrium has been abandoned in the strongly functionalist sense of a system at rest, it has been kept on in the weakly functionalist sense of an ordered reality. The “new consensus” of which she is speaking is, to a large extent, the result of the TE-paradigm’s basic methodological stance as expressed by Hayek at the end of section C.6 above: equilibrium yes, comparative statics no; rationality yes, independent-agent approximations no. “Aggregation” and “heterogeneity” are indeed new buzzwords at the front line of Traditional Economics, and Coyle is correct when, in her book, she explains the key role played in this evolution by the emergence of new computer technologies and new simulation techniques. The “new” economics is out to explain how social situations emerge as ordered patterns out of the direct interactions of rational individuals; it wants to eschew both parametric rationality and static equilibrium and replace them with strategic rationality and ordered but out-of-equilibrium

Friedrich A. Hayek, “The Use of Knowledge in Society”, American Economic Review 35 (1945): 519–30; reprinted in F.A. Hayek, Individualism and Economic Order (Chicago: University of Chicago Press, 1948), pp. 77–91. 29

Diane Coyle, The Soulful Science, op. cit., pp. 251-253 passim.

dynamics. In the “new” view—which is really the older, classical view resurrected—the economy is a mechanistic system endowed with order by agents’ rationality, but rendered “restless” by their strategic interactions and by the imperfections in information and calculation. In that sense, it is reasonable to talk about a “post-neoclassical” movement, even though—as we will see—the remnants of the usual TE-type of reasoning are strong. In particular, independent-agent approximations have not completely lost their appeal. The development of game theory in the 1940s and 50s, and its “invasion” of the economics territory after the 1970s, has been heralded by some as a fundamental scientific revolution in the sense of Kuhn. This is, alas, both true and untrue—it all depends on which core axioms one is looking at. As we will try to show, game theory has revolutionized economists’ views about instrumental rationality and some of the basic characteristics of social “optimality,” but it has done very little, if anything, to revolutionize their views about equilibrium.

C.7.1. Instrumental rationality: From parametric to strategic When Coyle states that the core axioms of the TE-paradigm have not changed, she is basically correct: game theory, just like Traditional Economics, relies entirely on the notion of agents’ instrumental rationality. In that sense, one could even claim that game theory merely represents a more sophisticated version of the exact same M.Inst axiom. Indeed, Coyle’s claim that mainstream economists do not “believe that everybody chooses rationally all the time” is not true; being essentially pessimistic liberals, they do believe that whatever people do is intended to be instrumental: you and I are, according to M.Inst, constantly looking out for our best interests as we conceive them and for this purpose we are constantly attempting to mobilize all the means available in our environment. This is the key idea of the M.Inst axiom: Means-to-ends rationality, using whatever your environment makes available to you to realize your valued personal objectives, expressed as “preferences.” The question is: What sort of elements are available? Rationality will be said to be parametric if the agent takes her environment as a set of parameters—including not only the preferences, but also the actions of all the other agents. In independent-agent approximations, where interdependence is indirect or mediated, environmental parameters are usually assumed to be “summarized” by one (or a very small number of) situational variable(s) such as market price. However, one could also assume—if the agent had more detailed information as to who is contained in her relevant environment—that the agent perceives not just a “summary” constraint but a detailed vector of all other people’s actions and uses this to compute her own optimal action. This could still count as an independent-agent approximation, if we assume that all agents get to know the vector of all agents’ actions, including their own, so that the publicized vector of all agents’ action would be the same for everyone. Graphically, we would have figure C.3 overleaf.

a = (aA, aB, aC, aD, aE)

Figure C.3 – Non-interactive model with detailed action vector

However, it is immediately apparent that in such a system of indirect interdependence, “rationality” is meaningless: the agent sends out an action ai which, gathered with all other agents’ actions, is “sent back” to her. There is no guarantee at all that, given the actions of all others, she can still consider her initial action as optimal. In other words, once it is other people’s actions themselves, and not a “summary” of them, which gets sent back towards agents, the question of they are to be coordinated becomes even more difficult. In fact, moving from a summary variable to a vector of actions uncovers an important aspect of the “hidden structure” of Traditional Economics: By working with independent-agent approximations, it actually forbids agents from reacting directly to each others’ actions and fully taking into account their de facto interdependence; mediated interdependence presupposes that agents either are unable to, or agree not to, face up to their immediate interdependence. If they are unable to—as is the case for very large, complex systems such as the capitalist market system— then summarizing all actions into an aggregate adjustment variable is a way for everyone of economizing on information gathering and transaction costs; this is a point which transaction-cost economics has exploited to the full, while “Austrian” economics has rejected it by rejecting the relevance of the TE-paradigm’s notion of equilibrium. If agents have agreed not to face up to their immediate interdependence, this must mean that there is some hidden institutional constraint that prescribes specific “price taking”—or, more generally, “summary-variable-taking”—behavior to all participants to the system; this has led to the fiction of the “Walrasian auctioneer” and the idea that so-called perfect competition is, in fact, a centrally engineered coordination device using ultraspeed adjustment technologies so that the real-time adjustments required by the “back-and-forth” between the auctioneer and the agents can be neglected for practical purposes. The absurdity of these scenarios is apparent: parametric rationality makes sense only if every agent is effectively and fully separate from all other agents—in other words, if each agent lives in an environment where no one’s actions except her own have any impact on the satisfaction of her preferences. Such fully autarchic situations are rare enough in life, and in economic systems they are nonsensical—indeed, it is the very inter-dependence of people’s fates that creates and maintains the economy as a system of systems! Thus, all that we can say about the assumption of parametric instrumental rationality in economic contexts is that it is a degenerate case where each agent treats other agents’ actions as if they were irrelevant to her own choice of action. This leads

us back to the idea of “zero Lebesgue measure” discussed earlier: Only if agents are effectively part of an infinite continuum of points can this “as if” reasoning be viewed as a conceptually satisfactory approximation. For practical purposes, this means that in economics—and, more generally in social science—the assumption of parametric rationality makes sense only in trivial cases where all interdependence has been resolved into an equilibrium situational variable. Although somewhat surprising, this insight is a deep one: if one assumes parametric rationality for agents, one is de facto locating one’s whole analysis within an already settled “equilibrium” situation, in the strongly functionalist sense discussed earlier. In other words, the neoclassical assumptions about rationality and about equilibrium are not separate: In Traditional Economics, axiom M.Inst is functionally subordinated to axiom M.Eq; the latter is the reason why the former is adopted. The immediate corollary of this is that if one gives up the restriction to strongly functionalist equilibrium, i.e., if one abandons the fiction of modeling people’s “optimal” choices within a system already at rest, then it becomes more problematic to assume that each agent treats all other agents’ actions as mere parameters in her choice. The reasoning is as follows: if each i knows that other people’s actions are directly relevant to her instrumental optimization, surely she must also admit that her own action is, in principle, directly relevant to all other people’s instrumental optimization; thus i ought to instrumentally take into account other agents’ reactions to her action. Thus, we arrive at the idea of strategic instrumental rationality: People form beliefs about other people’s actions and reactions, take actions on the basis of those beliefs, observe the discrepancy between the result they had expected and the result that actually materializes, learn by inference from that discrepancy, and adapt their beliefs, take new actions, and so on. Of course, generally speaking, such a dynamic sequence of action, observation, and cognitive adaptation could also exist in a completely parametric world where no parameter’s value depends on anyone else’s actions; learning from the discrepancy between our expected utility on the basis of our prior knowledge of the environment and our actually realized utility is something we do quite often, even when “the environment” is made up entirely of objects. In other words, imperfect information (due to unobservable elements in reality) and uncertainty (due to stochastic elements in reality) are part even of a purely material, non-human environment; so why focus here on human interdependence? The answer is that an agent’s relation to her unknown and/or uncertain non-human environment can hardly be called “strategic”: contrary to the case where you are fighting a battle against a human opponent, when you are battling material nature you do not devise strategies; you build techniques and tools to master nature, but you do not enter into strategic interaction with nature. You may, like the Chinese Taoists in their effort to “go with the flow” of their environment, come to treat human opponents like natural obstacles; but the reverse, i.e., treating natural obstacles like human opponents, is called clinical madness … Natural obstacles can pose problems of mastery due to lack of knowledge, but they are not conscious opponents—strategic interaction has an “infinite-mirror” aspect and occurs between consciousreflexive individuals. (Perhaps it makes sense to say I strategically interact with a panther or a gorilla, which are non-human but conscious-reflexive animals, but such issues are not central to economics and social science more broadly.) So strategic instrumental rationality is the most general meaning of the M.Inst axiom. What is the relationship between strategic and parametric rationality? Basically, parametric rationality is a degenerate case of strategic rationality when the environment is made up of “non-reactive” parameters. Let Ei be agent i’s environment and let Mi(Ei) be the “model” she uses to formalize her environment. Finally, let M.Inst(p) and M.Inst(s) denote the parametric and strategic versions of the M.Inst axiom. We then get the following conversion formula:

[M.Inst(s) + parametric Mi(Ei)] M.Inst(p) Thus, what determines the parametric content of instrumental rationality is the purely parametric character of the agent’s model of her environment. Independent-agent approximations are a way of making each agent’s environment “artificially” and trivially parametric—in the case of the Walrasian model, we get simply Mi(Ei) = p* for all i. So it is not so much that agents’ instrumental rationality is parametric but, rather, that their strategic instrumental rationality gets applied to a non-strategic environment.

C.7.2. Non-cooperative games and the dynamics of interaction Non-cooperative games are the most natural extension of the idea that people in the economy are in interactive, hence strategic, situations. In non-cooperative game, agents do not cooperate; they do not communicate with each other or perform any prior coordination of their decisions. All agents are assumed to live in a decentralized world where they simply maximize their payoff given their knowledge of the overall situation, called the “game situation.” Competitive interaction is a large part of non-cooperative games: The more I obtain, the less you will have, and vice-versa. (A very specific case of competitive games is that of “zero-sum” games where the payoffs add up to zero in all possible outcomes.) However, non-cooperative games are also used to try to understand how rule-guided cooperation might emerge from initial decentralized noncooperation. The essence of strategic interaction is “groping along in the dark”: one starts to act, observes the result, learns from it by revising one’s beliefs about others and perhaps even revising one’s knowledge about who the others are in the first place, acts again, observes again, infers again, and so on. Each of these actions can be modeled, at the level of each agent, as a “game” against the environment, given the agent’s knowledge and beliefs. In other words, each strategically rational individual will, at the very best, construct her own representation of what she believes the “game” she is playing in looks like—either drawing up an extensive form given what she knows and believes (who is playing against her, what the opponents’ payoffs are as they conceive them, how rational she believes these opponents are and what she believes they believe about her own rationality and about her own beliefs, and so on), or summarizing this extensive form in a strategic-form game matrix that associates to every n-tuple of strategies an n-tuple of payoffs. The agent may then “solve” this, her own perceived game, in order to get an idea as to how she ought to act in her best interest. Let Gi(t) be the game as perceived by agent i at moment t, and let pi[Gi(t), σi(t)] be the optimal payoff which i expects to get in t given what she knows and believes and given the solution concept σi(t) she uses. Thus we get the following decision sequence guided by instrumental rationality: [Gi(t), σi(t)] → pi(t) → a*i(t) → ρi(t) ≠ pi(t)

(C.1)

This decision is then confronted to the reality of the strategic interaction, which—given what all the other actual agents in the game, some of whom i may not even be aware of in t, have similarly decided to do—yields for the agent some payoff ρi ≠ pi. Since by axiom M.Inst(s) all this agent cares about is her payoff, she will use this discrepancy to revise her beliefs and/or to search for and acquire new elements of knowledge about the game situation: who is playing along, what sort of decision criteria they use, and so on. This revision process, called learning, may be carried out via Bayesian methods or non-Bayesian ones; what matters most is that it does occur but may itself be very “imperfect,” in the sense that it may take a very long time for i to arrive—by exploration and connection-building—at the stage where she is perfectly informed about all relevant aspects of the interaction. That is, it may take a near-infinite number of periods until we arrive at a stage where

[Gi(t), σi(t)  pi(t–1), ρi(t–1)] → pi(t) → a*i(t) → ρi(t) = pi(t)

(C.2)

This would be a stage where, given the past discrepancy between expected and realized payoff, the agent has revised her game form and her solution concept in such a way that now, her expected payoff leads her to act in a completely self-fulfilling way given what all other agents do (which is captured in her knowledge of G and σ). Of course, even this very complicated sequential process is based on the assumption that “all” the agent has to so is discover the structure of the game which she and others are playing over repeated time periods—a structure assumed to be preexistent and already fully formed when the exploration process starts. In actual fact, as complexity and evolutionary economics has emphasized, the game form G itself changes and shifts as the various agents i explore and build it… This means that the process is not just one of discovery but of construction. The system of strategic interaction is not just sitting “out there” waiting to be discovered by each agent; it changes as the agents interact. Strategic interaction is so complicated and anxiety-generating that it is just crying out for some theoretical “pain killer” to be offered by game theorists. In fact, just as was the case for Traditional Economics earlier, one major source of appeal of game theory as a sub-discipline of applied mathematics was the need for decision-makers—for instance, army officials or corporate planners—to get their hands on analytical tools that would help put some order into the above process. In fact, if one looks at the two above formulae, one sees immediately that with a good knowledge of the structure of game G but with no idea as to how that game gets “solved” in interaction—i.e., without an idea of what the solution concept σ might be—the agent i is virtually “lost in translation.” Thus, offering a plausible solution concept for non-cooperative games has been regarded as a feat worthy of several Nobel Prizes in economics over the past two decades. By far the most widely used solution concept is the so-called Nash solution, pioneered by John Nash in the late 1940s and early 1950s.

C.7.3. The Nash solution and the return of the independent-agent approximation In 1950, Nash published a two-page note in which he changed the face of Traditional Economics forever. As I have suggested above, what non-cooperative game theory has done is to uncover and put out in the open the “hidden truth” of Traditional Economics—namely, that no economic agent is ever really a parametric optimizer and that most economic situations are in fact non-cooperative games in which agents confront their strategically rational actions. Here is how Nash himself described his key concepts: One may define a concept of an n-person game in which each player has a finite set of pure strategies and in which a definite set of payments to the n players corresponds to each n-tuple of pure strategies, one strategy being taken for each player. […] Any n-tuple of strategies, one for each player, may be regarded as a point in the product space obtained by multiplying the n strategy spaces of the players. One such n-tuple counters another if the strategy of each player in the countering n-tuple yields the highest obtainable expectation for its player against the n–1 strategies of the other players in the countered n-tuple. A self-countering n-tuple is called an equilibrium point.31

Holt and Roth offer the by now standard translation of this into the language of game theory:

John F. Nash, “Equilibrium Points in n-Person Games”, Proceedings of the National Academy of Sciences of the United States of America 36 (1950): 48-49, pp. 48-49. 31

… a Nash equilibrium is a set of strategies, one for each of the n players of a game, that has the property that each player’s choice is his best response to the choices of the n–1 other players. It would survive an announcement test: if all players announced their strategies simultaneously, nobody would want to reconsider.32

Graphically, this means the following as illustrated in figure C.4.

s* = (s*A, s*B, s*C, s*D)

Figure C.4 – Nash equilibrium and the “announcement test”

Contrary to what was the case in figure C.3, here the agents’ actions are all self-consistent, as expressed in Holt and Roth’s idea of an “announcement test”: if after having computed the Nash solution of the game we were to tell each agent, who does not know any features of the overall game situation, her Nash strategy, and if all agent were to play their Nash strategies simultaneously, the payment received would be such that no agent would feel she ought to have played another, different strategy. Equation (C.2) would be realized at once for each i. As the authors express it, When the goal is to give advice to all of the players in a game (i.e., to advise each player what strategy to choose), any advice that was not an equilibrium would have the unsettling property that there would always be some agent for whom the advice was bad, in the sense that, if all other players followed the parts of the advice directed to them, it would be better for some player to do differently than he was advised. If the advice is an equilibrium, however, this will not be the case, because the advice to each player is the best response to the advice given to the other players. This point of view is sometimes also used to derive predictions of what players would do, if they can be approximated as “perfectly rational” players who can make whatever calculations are necessary and so are in the position of deriving the relevant advice for themselves.33

This is an extremely important point. It draws attention to the fact that Nash equilibrium is not just a weakly functionalist, but a strongly functionalist notion of equilibrium: it assumes that a “frustrated” or “groping” agent [in the sense of equation (C.1) above] would do everything to unsettle the game’s result, so that only a “game situation at rest” can be in equilibrium. As we saw earlier, this is indicative of an independent-agent approximation: Holt and Roth’s “announcement test” is, in fact, such an approximation since it states that, were we to tell each agent in isolation to play her part of the Nash strategy vector s*, the outcome of the game would be immediate mutual compatibility of all strategies. In fact, as was the case for the Walrasian equilibrium price vector p* earlier, here also there is nothing else but s*: given the assumptions necessary to have an equilibrium, non-equilibrium strategies—in the strong sense of equation (C.1)—are simply not part

Charles A. Holt and Alvin E. Roth, “The Nash Equilibrium: A Perspective”, Proceedings of the National Academy of Sciences of the United States of America, 101 (2004): 3999–4002, p. 3999.

Ibid.

of intelligible reality. That is the main reason why, rather astonishingly, Robert Aumann is able to simply equate the notion of Nash equilibrium with the notion of strategic instrumental rationality, confirming our earlier point that from the point of view of independent-agent approximations, axiom M.Inst is functionally subordinated to axiom M.Eq: The Nash equilibrium is the embodiment of the idea that economic agents are rational; that they simultaneously act to maximize their utility. If there is any idea that can be considered the driving force of economic theory, that is it. Thus in a sense, Nash equilibrium embodies the most important and fundamental idea of economics, that people act in accordance with their incentives.34

Aumann’s candid conflation of axioms M.Inst and M.Eq is the direct consequence of the fact that the Nash solution concept is an independent-agent approximation of an interdependent-agent situation. Let us be careful, however. We saw above that while such an approximation makes sense when agents can be imagined to receive—through some centralized agency or through the economy’s information-dissemination mechanisms—a “summary variable” such as price, it makes no sense when agents are directly taking into account each other’s actions. Thus, in figure C.4, there seems to be something crucial missing to justify the independent-agent approximation, or—equivalently— the centralized interdependence inherent in the Nash solution. The missing element is to be found in what is one of the most crucial assumptions in post-neoclassical game theory, namely the assumption of common knowledge of rationality (CKR). Recall that in order to imagine a gradual process of convergence from equation (C.1) towards equation (C.2), there had to be many complicated revisions, by the agent, of her beliefs concerning what others will do, as well as concerning what they believe she believes, etc. The CKR assumption cuts this very long story short: … expectations regarding what others will do are likely to influence what it is (instrumentally) rational for you to do. Thus fixing the beliefs that rational agents hold about each other is likely to provide the key to the analysis of rational action in games. The contribution of CKR in this respect comes in the following way. If you want to form an expectation about what somebody does, what could be more natural than to model what determines their behavior and then use the model to predict what they will do in the circumstances that interest you? You could assume the person is an idiot or a robot or whatever, but most of the time you will be playing games with people who are instrumentally rational like yourself and so it will make sense to model your opponent as instrumentally rational. This is the idea that is built into the analysis of games to cover how players form expectations: We assume that there is common knowledge of rationality held by the players [which means that] I know that you are instrumentally rational and since you are rational and know that I am rational you will also know that I know hat you are rational and since I know that you are rational and that you know that I am rational I will also know that you know that I know that you are rational and so on… […] Formally it is an infinite chain as follows: each person is instrumentally rational each person knows (a) each person knows (b) each person knows (c) …and so on ad infinitum.35

Robert J. Aumann, “What is Game Theory Trying to Accomplish?” (1985), reprinted in R. J. Aumann, The Collected Papers, volume 1, Cambridge, MA: MIT Press, 2000, pp. 5–46, quote from p. 19.

Shaun Hargreaves-Heap and Yanis Varoufakis, Game Theory: A Critical Text (London: Routledge, 2004), p. 27.

Together with the equally crucial assumption that each player knows the extensive—or at least the strategic—form of the “game situation,” CKR generates an independent-agent approximation based on two very strong, but nearly always implicit ideas: first, that somehow all agents have been taught the form G, and second, that all agents have been immersed in a “culture of shared instrumental rationality.” Apart from that, there is nothing that differentiates figure C.4 from figure C.3. In both cases, we have a centralized interdependence (either through an “auctioneer” or through extensive shared knowledge) masquerading as mutual independence. Despite being initially prepared to take explicit account of direct, face-to-face interactivity between agents, noncooperative game theory has ended up sacrificing once more the full implications of the M.Inst axiom to a strongly functionalistic version of the M.Eq axiom. The main reason why this has occurred should be familiar to us by now, and it is well expressed in Holt and Roth’s earlier idea that for purposes of prediction and empirical-analytical mastery of social reality, agents may “be approximated as ‘perfectly rational’ players who can make whatever calculations are necessary and so are in the position of deriving the relevant advice for themselves.” An M.Inst axiom functionally subordinated to the M.Eq axiom is instrumental to game theory’s pretension of being a tool for management-oriented comprehension; this is what Aumann has in mind when he writes, somewhat cryptically, that game theory purports to describe not Homo sapiens, but Homo rationalis; and that it actually is descriptive of Homo sapiens only to the extent that he can be modeled by Homo rationalis. On the other hand, when we come to advise people, it is clear that we should give them rational, utility-maximizing advice, i.e., precisely what Homo rationalis would do; so that the two aspects [descriptive and normative] are in this sense quite close.36

In a sense, the Nash solution concept is merely an expression of the “hidden truth” of Traditional Economics and its focus on perfect competition—a focus that was due to the fact that Traditional Economists believe a “perfect” market to be one in which no direct interaction takes place so that there is never any strategic reasoning. This focus has been shown to be abusive by game theorists, who have driven home the very important point that such “perfect” markets are highly specific, and usually degenerate, sub-cases of more general non-cooperative games. It is this characteristic of Nash equilibrium being a “generalizer” of much of neoclassical theorizing, and more generally of the TE view of society, that has led Roger Myerson to make a grand claim: … Nash’s theory of noncooperative games should now be recognized as one of the outstanding intellectual advances of the twentieth century. The formulation of Nash equilibrium has had a fundamental and pervasive impact in economics and the social sciences which is comparable to that of the discovery of the DNA double helix in the biological sciences.37

Similarly, Holt and Roth claim that “game theory, with the Nash equilibrium as its centerpiece, is becoming the most prominent unifying theory of social science.”38

C.7.4. The flaws of game theory and the advent of bounded rationality The realization that strategic rationality is one of the “bedrocks” of interaction in any economic system has come at a cost—that of having to reduce and eliminate the interactivity in order to focus on the solution of the interaction, the “rest” situation that would be attained if we could 36

Robert J. Aumann, “What is Game Theory Trying to Accomplish?”, loc. cit., p. 14.

Roger B. Myerson, “Nash Equilibrium and the History of Economic Theory”, Journal of Economic Literature 37 (1999): 1067–82, p. 1067. 37

Charles A. Holt and Alvin E. Roth, “The Nash Equilibrium: A Perspective”, art. cit., p. 3999.

assume that all truly strategic interactions had played themselves out (this was equation (C.1)) and had led to a situation of perfect mutual compatibility of actions, beliefs about actions, beliefs about beliefs, and so on (this was equation (C.2)). Symptomatically, this has led even cutting-edge game theorists such as Joseph Greenberg to focus on what they call “social situations”39 rather than on social systems and processes—the difference being that a “situation” is a cross-section of a process in which all the relevant variables have fully adjusted. What non-cooperative game theory has allowed us to discover is that once one takes into account the strategic nature of instrumental rationality, any “situation”—such as the one modeled through the solution concept of Nash equilibrium—is in fact a momentary step in a process. The difficulty with usual game-theoretic settings, and this shows that they are still very much heirs to the TEparadigm, is that the strongly functionalist notion of equilibrium employed allows basically only two ways to introduce “unrest”: either an exogenous shock to the players’ preferences or to the game’s structure (leading in both cases to an exogenous change in the structure of the game’s payoffs), or a repetition of the game at given preferences and structure. The exogenous-shock approach leads to the well-known practice of comparative statics: what is the “post-shock” Nash equilibrium and how does it compare with the “pre-shock” one? The repetition approach leads to a dynamic path of sorts, but a largely exogenous one: unless the interaction itself generates the motivations for players to repeat the game, all we will have is a modeler-engineered sequence of the same game played over and over again. This makes sense only if one assumes that there is an (again) exogenous social process forcing the agents, so to speak, to go through repetitions of standardized games. To summarize, the way game theory has tended to view situations and their possible succession has been—somewhat like the “temporary equilibrium” approach within Traditional Economics— characterized by a lack of emphasis on both (a) the endogeneity of the process of mutual adjustment and (b) the endogeneity of the interaction structure itself. Comparative statics and repeated games are clear symptoms of this neglect of endogeneity. What economists focus on is how a given interaction structure, defined by a game form G, “resolves itself” into a profile of mutually compatible actions, beliefs, and meta-beliefs of n degrees. This profile has to be shown to exist (which explains the space taken up in formal economic analysis by “existence theorems”), and the analysis then goes on to assume that reality is structured “as if” the existing equilibrium were in place, sui generis. The endogeneity of mutually adjusting actions can thus be “summarized” in an instant equilibrium: actual interactivity is relinquished and time is viewed as a sequence of exogenized “nutshell instants” connected by exogenized “propelling technologies”—either exogenous shocks or exogenous instructions to repeat the game. Alan Kirman has had the following critical things to say about this state of affairs—and note that his point exactly mimics the difference we established earlier between equations (C.1) and (C.2): There are a number of ways of moving from considering a static equilibrium notion to that of studying the dynamic evolution of […] systems […]. One approach is to think of a repeated series of markets or games, each of which is the same as its predecessor and in which the payoffs of any specific action in the current game are unaffected by the players’ actions in previous rounds. […] [Another approach is to ask] under what circumstances players will, by simply learning from previous experience, converge to some particular state which would correspond to the equilibrium that would have been obtained by much more complicated game theoretic reasoning. The difference between the two approaches, which [can be] described as “eductive” and “evolutive,” should not be underestimated. […] When agents take account of

Joseph H. Greenberg, The Theory of Social Situations: An Alternative Game–Theoretic Approach (Cambridge: Cambridge University Press, 1990).

the consequences of their own actions and those of other agents for current and future payoffs the situation becomes highly complex. There are two ways of dealing with this. Either one can try to solve the full-blown equilibrium problem ab initio or, alternatively, one might ask whether players would learn or adjust from one period to the other and whether such behavior would converge to any specific outcome. Then one can compare the limit point with an equilibrium that might have occurred if all the actors had solved the problem at the outset. The idea that individuals learn in relatively simple ways from their own experience and that of others is more persuasive than the alternative idea that they solve highly complicated maximization problems involving calculations as to their own course of action and that of others.40

Notice here again that Kirman, just like Aumann earlier, conflates rational action and equilibrium action: the reference point—the ab initio equilibrium—is “an equilibrium that might have occurred if all the actors had solved the problem at the outset,” and this makes sense only if one assumes “that they solve highly complicated maximization problems involving calculations as to their own course of action and that of others.” In other words, it is the demands of equilibrium analysis that make agents’ supposed “calculations” so difficult: they need to be assumed to be as smart as the economist himself (!) in order for their “rational” actions to make sense. M.Inst(s) functionally subordinated to M.Eq implies that each agent i immediately plays her i-coordinate s*i of s*, and this puts very stringent demands on agents’ calculative capacities if we want to assume, in accordance with CKR, that they “can make whatever calculations are necessary and so are in the position of deriving the relevant advice for themselves” (in the previously quoted words of Holt and Roth). What is the main problem here, according to Kirman? In both Traditional Economics and in game theory, agents are taken to be “too rational” because they are assumed to be theorists with an economist’s or a game theorist’s mind: they can solve games in such virtuoso ways that it seems they have the whole system inside their minds and can act in isolation from one another, so that actual hands-on interaction becomes a secondary feature of existence for them. In fact, actual interaction is forbidden in most models of strategic interaction! That is because the strongly functionalist version of M.Eq has taken priority over the complex dynamics that would be generated by the actual, full-blown exercise of M.Inst(s). In essence, both Traditional Economists and game theorists are telling us, through their fundamental explanatory strategy, that reality can be considered rationally intelligible only if one assumes that individuals are merely the functional “servants” to an overall order that has been pre-inscribed into them: they are, in fact, not really individuals but “monads” in the sense of Leibniz, formal analytical entities deduced from the M.Eq axiom in order the Whole to make sense. This explains the strong criticism expressed by Hayek against Traditional Economics (a criticism he would no doubt have leveled at game theory as well): a science based on functionally subordinating M.Inst to M.Eq is actually not an individualistic but a holistic science—so that Traditional Economics and game theory might in fact be considered to violate the M.Ind axiom! The notion of systemic order imposed by Traditional Economics and by Nash-game theory are simply too stringent and make individuals into mere puppets of the system’s “need for equilibrium.” Individual rationality is really “rationality-for-equilibrium.” This offers us the occasion of insisting again on an important, and often neglected point: One can speak routinely of “individuals” and still be reductionist. Just because economists speak of “individuals” when explaining the working of an economic system does not mean they are exiting

Alan P. Kirman, “The Economy as an Interactive System”, in W. Brian Arthur, Steven N. Durlauf and David A. Lane (eds), The Economy as an Evolving Complex System II (Cambridge, MA: Perseus, 1997), pp. 491–531, quote from pp. 493-494 passim.

the mechanistic realm; in Traditional Economics and game theory, the way in which such “individuals” are modeled is simply dictated by the imperative of intra-systemic explanation. The homo economicus is therefore not an individual in the moral and political sense. He is a formal entity constructed for the purposes of respecting an ontology of equilibrium-as-system-at-rest that molds the way agents must act. No wonder a significant minority of Traditional Economists, including Kirman himself, have long suspected that the TE-paradigm as well as the Nash solution concept are shortcuts to the theory of a centrally planned economy. A “truly” individualistic society—and economy—is one in which aggregate reality emerges from, rather than being the precondition for, individual rationality. This implies, however, that a weaker notion of equilibrium, a weakly functionalist version of M.Eq has to be found—one that no longer “pre-formats” M.Inst(s) and therefore becomes truly compatible with M.Ind. The answer has been found in the alternative approaches that developed after the 1950s but gained prominence only after the 1990s, namely the approaches gathered under the name of bounded rationality and adaptive rationality. One of the pioneers of this direction has been Herbert Simon, who was awarded the Nobel Prize in 1978. One of his many contributions is to have offered the notion of “bounded rationality,” rooted in the criterion of “satisficing,” as an alternative to the usual interpretation of the M.Inst(s) axiom as Nash-equilibrium-optimization. Simon’s basic idea is that any economic phenomenon arises out of a multitude of actual interactions which are inscribed within what he calls “artificial” systems— by which he simply means man-made, as opposed to natural, systems. He is therefore completely in line with the cybernetic, engineering view of economics; and he was in fact himself educated in engineering and did a lot of work in the areas of computing and Artificial Intelligence. Individuals are viewed—correctly but partially—as “intelligent systems” and the economy as an artificial coordination system. An absolutely crucial assumption in the whole bounded-rationality literature is that, in line with the Hayekian critique, individuals do not have, and do not attempt to acquire, “global” knowledge of the world but are restricted to “local” environments. Agents use their reason in three sorts of ways: to discover the main features of their environment, they use cost- and cognition-constrained exploration devices; to discover the kind of adaptive behavior suited for their environment, they use their procedural rationality; and to actually adjust to their environment through calculation and decision, they use their substantive rationality. Thus, individual rational action is no longer just the immediate “application” of a “contemplative” knowledge of the world—of a world that manifests as intelligible equilibrium. Here, on the contrary, agents are essentially exploration devices which initially can make almost no sense of what is around them; they grope around and very slowly gather up the limited information which their limited capacities for reasoning and computation allow them to process. Here is how Simon formulates his point: Human beings viewed as behaving systems, are quite simple. The apparent complexity of our behavior over time is largely a reflection of the complexity of the environment in which we find ourselves. […] [B]ehavior is adapted to goals, hence is artificial, hence reveals only those characteristics of the behaving system that limit the adaptation. […] The evidence is overwhelming that the [human information-processing] system is basically serial in its operation: that it can process only a few symbols at a time and that the symbols being processed must be held in special, limited memory structures whose content can be changed rapidly. […] The claim [is] that the human cognitive system is basically serial […].41

Herbert A. Simon, The Sciences of the Artificial, 3rd ed. (Cambridge: MIT Press, 1996), pp. 80-81.

We notice immediately that Simon is claiming to be basing his ideas on brain science and cognitive science. This is indeed a central characteristic of the more recent advances in the post-neoclassical paradigm. Let us briefly investigate the implications of Simon’s position. First of all, notice that he qualifies the cognitive functioning of humans as that of “behaving systems”—not, for instance, of behaving animals or of behaving organisms. In fact, the focus on artificial systems means that Simon (who admits to this quite lucidly) is reducing biological-organic features to computational ones. While he views the economic systems as artificial because they are obviously man-made (if not man-mastered), he also reduces the cognitive organism to an artificial system by reinterpreting the functioning of the brain as that of a Turing machine which sequentially accesses bits of environmental information; in this way, Simon attempts to ground economics in a generalized systems science. While he certainly does not literally believe that the human brain is a digital computer, he nevertheless completely artificializes the biological brain—and the derived behaviors—by inserting it into a generalized science of artificial (i.e., man-made and/or man-interpreted) systems. As Jean-Pierre Dupuy has quite rightly noted, this means that the underlying scientific project is that of a “mechanization of the mind”: The mind, or rather each of the various faculties that make it up […], was conceived as a Turing machine operating on the formulas of a private, internal language analogous to a formal language in logic. The symbols—the marks written on the tape of the machine—enjoy a triple mode of existence: they are physical objects (being embodied in a neurophysiological system) and therefore subject to the laws of physics (in the first instance those of neurophysiology, which is supposed to be reducible to physics); they have form, by virtue of which they are governed by syntactic rules (analogous to the rules of inference in a formal system in the logical sense); and, finally, they are meaningful, and therefore can be assigned a semantic value or interpretation. The gap that would appear to separate the physical world from the world of meaning is able to be bridged thanks to the intermediate level constituted by syntax, which is to say the world of mechanical processes—precisely the world in which the abstraction described by the Turing machine operates. The parallelism between physical processes subject to causal laws and mechanical processes carrying out computations, or inferential or syntactical operations, ceases to seem mysterious once one comes round to the view that the material world contains physical versions of Turing machines: computers, of course, but also every natural process that can be regarded as recursive. […] Turing-style functionalism constitutes the heart of what is called “cognitivism,” which remains today the dominant paradigm of the sciences of cognition [and which claims] that thought, mental activity, this faculty of the mind that has knowledge as its object, is in the last analysis nothing other than a rule-governed mechanical process, a “blind”—might one go so far as to say “stupid”?—automatism.42

Thus, in Simon’s perspective, the economy is indeed a system, but one whose individual components are themselves to be viewed as systems: as thinking automata who use their powers of symbolic computation for the sake of adapting to their local environments in “satisficing” ways. In other words, given the feeble powers of the human computer and its sequential access to data with a very limited memory, bounded rationality has to replace (Nash) equilibrium rationality viewed as the agent’s ability to compute “on his own” the equilibrium of the games in which he acts. But even though the Simon-type automata are characterized by so-called “bounded” rationality, they are in fact significantly more sophisticated than the TE-type automata because they explore their environment and discover interactive connections through adaptive interaction with other,

Jean-Pierre Dupuy, The Mechanization of the Mind: On the Origins of Cognitive Science (Princeton: Princeton University Press, 2002), pp. 38-39.

similar automata—whereas the TE-type automaton receives the data from its environment. The Simon-type agent is still a programmed automaton—it has an “internal model” created by its programmer—but it is much less pre-programmed than its TE counterpart, so that it is much more sophisticated in its behavioral patterns. However, in standard competitive-market settings the aggregate results of the interaction of such “stupid” little machines closely mimic what happens in independent-agent approximations: There have been many recent laboratory experiments on market behavior, sometimes with human subjects, sometimes with computer programs as simulated subjects. Experimental markets in which the simulated traders are “stupid” sellers, knowing only a minimum price below which they should not sell, and “stupid” buyers, knowing only a maximum price above which they should not buy, move toward equilibrium almost as rapidly as markets whose agents are rational in the classical sense.43

Actually, it is puzzling that Simon should present such results (drawn in particular from laboratory experiments about which we will say more in section C.7.6) as surprising or interesting. In fact, it all depends on what we mean by “rational in the classical sense.” Agents who react mechanically to prices that lie within some interval of values are more, but barely more, sophisticated than agents whose supposed “rationality” consists—as in the TE-approach—in reacting to one single preordained “equilibrium” price. Thus, if by “rational in the classical sense” Simon means agents who directly act in equilibrium, the experimental results with “stupid” agents are not really surprising: such agents are doing barely more calculating than “already-inequilibrium” agents. However, if by “rational in the classical sense” he means agents who have beliefs about the game form and beliefs about the solution concept, and engage in a real-time dynamic process of learning about and revision of their beliefs (as in equation (C.2) above), then what is surprising is the fact that repeated market games with “stupid” agents converge on the equilibrium “almost as rapidly,” and not much more rapidly, than the games where there is real dynamics. Hence, under both meanings of “rational in the classical sense,” the fact that stupid agents converge almost as quickly is classical agents is not surprising—it just confirms the idea that independent-agent approximations are more conceptually comfortable and analytically tractable than truly interactive models… The significance of Simon’s approach is that it uncovers another “hidden truth” of the TEparadigm. As we saw earlier, game theory uncovered the hidden truth that in the TE-paradigm instrumental rationality is never parametric and is always strategic, and that it is only agents’ perception of their environment as parametric that makes their strategic rationality seem parametric. Now, we see that in the TE-paradigm instrumental rationality is never infinite and complete and is always bounded and incomplete, and that it is only the independent-agent approximation—which allows boundedly rational agents to react to one single parameter computed for them by the all-knowing economist—that makes their bounded rationality seem unbounded. To put it differently, in Traditional Economics as well as in the Nash-solution approach, the enforcing of an independent-agent approximation makes bounded and unbounded rationality observationally equivalent: [IAA, “in-equilibrium action”] ⇒ [bounded rationality ⇔ unbounded rationality] With a strongly functionalist, timeless equilibrium approach such as that which has pervaded Traditional Economics all the way into its game-theoretic extensions, one can treat boundedly rational or even “stupid” agents as if they had by chance “stumbled upon” the full equilibrium solution computed for them by an economist—or, if the latter is also too “stupid,” by a powerful computer. Once this scenario is in place, it even allows economists and game theorists to entertain 43

Herbert A. Simon, The Sciences of the Artificial, op. cit., p. 32.

the fiction that, to use Holt’s and Roth’s phrase yet again, “‘perfectly rational’ players […] can make whatever calculations are necessary and so are in the position of deriving the relevant advice for themselves.” This fiction crumbles to dust as soon as we ask—as Hayek, Simon, and their followers have asked—how these agents could arrive at that solution alone, in real time, without an economist or a central computer looking out for the self-coherence of their experienced environment. The implication has been yet another a deep revision of the basic interpretation of the axioms M.Inst(s) and M.Eq. The most basic feature of bounded-rationality economics is its reinterpretation is that it views strategic instrumental rationality in a very modest, “local” way that replaces Nash calculation by a “satisficing,” “myopic,” adaptive way of thinking. As Simon expresses it, Finding a local maximum is usually easy: walk uphill until there is no place to walk. Finding the global maximum, on the other hand, is usually exceedingly complex unless the terrain has very special properties (no local maxima). The world of economic affairs is replete with local maxima. It is quite easy to devise systems in which each subsystem is optimally adapted to the other subsystems around it, but in which the equilibrium is only local, and quite inferior to distant equilibria that cannot be reached by the up-hill climb of evolution. […] [F]rom the fact that an economic system is evolving, one cannot conclude that it has reached or is likely to reach a position that bears any resemblance to the equilibria found in the theory of perfect competition. Each species in the ecosystem is adapting to an environment of other species evolving simultaneously with it.44

Thus, Simon’s work allows us to write down the following crucial idea: a strategic rationality that is bounded becomes a form of adaptive rationality. [bounded rationality] ⇒ [M.Inst(s) ≡ adaptive instrumental rationality] Now Simon was no adversary of markets. In fact, he viewed them as formidable, evolutionarily emerging “solutions to the central problem of accommodating to our bounded rationality”.45 What he rejected, however, just like Hayek, is the idea that the way in which markets coordinate agents’ actions can be modeled through independent-agent approximations: … the evolution […] of economies does not lead to any easily predictable equilibrium, much less an optimum, but is a complex process, probably continuing indefinitely, that is probably best understood through an examination of its history. As in any dynamic system that has propensities for following diverging paths from almost identical starting points, equilibrium theories of an economy can tell us little about either its present state or its future.46

This means effectively that once we accept that strategic rationality is fundamentally adaptive and that economic institutions are “solutions” to this “defect,” we must replace the independent-agent approximation—which is really a form of indirect interdependence— by interdependent-agent description. [M.Inst(s) ≡ adaptive instrumental rationality] ⇒ [IndAA’s replaced by IntAD’s] This shift has two aspects. (a) We replace “independence as indirect interdependence” (Ind) by “direct interdependence” (Int), which is what game theory already wanted to do but shied away from, as we saw. (b) As a corollary, we shift from an “approximation” (A) to a “description” (D): the models of strongly functionalist equilibrium (= system at rest) have to be replaced by models of … something else, which has to respect the basic need for weakly functionalist equilibrium (= ordered

Ibid., p. 47.

Ibid., p. 49.

Ibid., p. 48.

system) while giving up the idea that in equilibrium no agent has an incentive to change his behavior. What is this “something else”? To put it briefly, it will be called emergence from adaptation. It is a concept of “out-of-equilibrium order” that relies on one key idea: once rationality is adaptive within a myopically experienced environment, any number of agents may have an incentive—a strong desire even—to leave the situation that has emerged from their interactions with others. Failure, crushed expectations, unfulfilled aspirations—all this plays a crucial role in actual economic life and accounts for the dynamics of innovation and competition which, for a pessimistic liberal, are the core of social interaction. This, however, implies something quite significant which Traditional Economics as well as Nash game theory have consistently ignored: market outcomes, whether perfectly or imperfectly competitive, emerge as messy interactive processes rather than “pop into the world” as neat equilibrium situations. The weakly functionalist idea of equilibrium as order of course still requires something to adjust so that reality can make sense; reality, that is, cannot be self-contradictory; it has to be an ordered, consistent reality—but what adjusts along gradual processes of emergence is not a small set of centralized equilibrium variables undergoing exogenous shocks. Rather, complex processes of emergence are propelled by learning, error, suffering, desire, and so on: our individual perceptions of the world are what mainly adjusts to the chaos of disequilibrium prices and quantities, of failed products and inadequate technologies, and so on. Thus, the new research in economics launched by Simon’s bounded-rationality program amounts to breaking down the functional subordination of M.Inst to M.Eq. Simon’s starting point is that if we are going to take the limits of agents’ rationality seriously, we need to reform the content of the M.Inst(s) axiom, independently of what we would like reality to look like; and this, then, implies that we give up the too stringent content of the M.Eq axiom: “order” can be, and has to be, be conceptualized without independent-agent approximations that tie the actions people take to the sort of “equilibrium” we—as economists—want them to generate. Instead, recognizing that M.Inst(s) is in fact an axiom of adaptive rationality, which implies myopic agents in environments that are initially too large and complex for them, forces us to replace “M.Eq as Nash equilibrium” by “M.Eq as emergence”: [M.Inst(s) ≡ “local” adaptive rationality] ⇒ [M.Eq ≡ emergence processes, evolutionary paths] These crucial shifts in conception have given rise to a thriving research domain which, for lack of a better expression can be called “evolutionary complexity economics.” It has many strands and cannot possibly be studied exhaustively in all its details in the short time and scant space we have here. However, we do need to gain some understanding about this project because it is spreading currently and becoming the “front line” of much of post-neoclassical research.47

C.7.5. Elements of complexity economics The turn of economics to complexity theory is due in large part to the increasing influence of both cognitive science in biology and psychology and “emergence” approaches in the explanation of aggregate phenomena, whether they are natural or social. As we saw with the development of Simon’s work, there has been a strong impact of cognitive science on Traditional Economics. Local

For analyses of how the complexity project fits into today’s overall landscape in front-line economics, see the studies gathered in David C. Colander (ed.), The Complexity Vision and the Teaching of Economics (Cheltenham: Edward Elgar, 2000). 47

cognition and adaptive rationality have crowded out unbounded rationality. The complexity approach has today become intimately connected with the name of the Santa Fe Institute in California and its exploration of complexity in all its dimensions. A small but fast-growing group of post-neoclassical economists is seeking to model emerging phenomena and qualitative leaps in dynamic trajectories. The intent is to move away from independent-agent approximations and to really—finally—take the heterogeneity of agents and their direct interactions seriously. The independent-agent formalism can in fact support neither interactive resource allocation nor interactive exploration, but as Jason Potts has perceptively shown,48 allocation can be mimicked by a non-interactive, “fullfield” fiction (which is the essence of the independent-agent approximation) whereas exploration is intrinsically an “incomplete-network” affair. Both interactive resource allocation and interactive exploration require a network view of economic life.49 Kirman argues that this is indeed how truly interactive models should be built: One way of bringing back finiteness of dependence and, thus, to restore the unique relationship between individual and aggregate probability laws is by assuming that agents are influenced by a finite number of “neighbors”; but this requires the specification of a graph-like structure on the agents and the study of local interaction […].50

If we look back to figure C.1, this sort of graph is what Potts and Kirman have in mind: a graph in which each agent can be represented as a node connected to some—but not necessarily all—other nodes by lattices that represent the agent’s connections within the social network in which he is evolving. Adaptive instrumental rationality means that these connections have to be looked for locally at first, then constructed and consolidated, then generalized through other connections, and so forth. The “fully covering” network drawn in figure C.1 is already itself a limit case of an initially much less tight network. Thus we have two main components to the truly interactive model: Given each “local” network nk, the interactions between agents generate emergent phenomena specific to that network. Within the set of all networks, N = {n1, …, nK}, there are thus K simultaneously arising emergences; these may be prices, quantities, worldviews, or anything else that “comes out of” agents’ interactions in a network. Agents also launch explorations across networks and this exploration generates network-extension phenomena, which means the creation of a modified set N, and so on. The cycle going from (1) to (2) is what propels the general dynamics of the economy: intra-network emergences combined with cross-network extensions. Emergence is a very specific phenomenon of ordering, linked to the idea that individual constituents in a system often generate aggregate results whose properties could not be predicted from the properties of the constituents. Sunny Auyang has described it as follows: Large-scale composition is especially interesting because it produces high complexity and limitless possibility. […] Myriad individuals organize themselves into a dynamic, volatile, and adaptive system that, although responsive to the external environment, evolves mainly

Jason Potts, The New Evolutionary Microeconomics, op. cit.

For an introduction to social networks, see Alain Degenne and Michel Forsé, Les réseaux sociaux (Paris: Armand Colin, 1994). A more detailed and elaborate treatment can be found in StanleyWasserman and Katherine Faust, Social Network Analysis: Methods and Applications (Cambridge: Cambridge University Press, 1994). 49

Alan P. Kirman, “The Economy as an Interactive System’, loc. cit., p. 502.

according to its intricate internal structure generated by the relations among its constituents. In the sea of possibilities produced by large-scale composition, the scope of even our most general theories is like a vessel.[…] Large composite systems are variegated and full of surprises. Perhaps the most wonderful is that despite their complexity on the small scale, sometimes they crystallize into large-scale patterns that can be conceptualized rather simply […]. These salient patterns are the emergent properties of compounds. Emergent properties manifest not so much the material bases of compounds as how the material is organized. Belonging to the structural aspect of the compounds, they are totally disparate from the properties of the constituents, and the concepts about them are paradoxical when applied to the constituents.51

What propels the dynamics of emergence and extension is the use, by individuals, of simple rules of adaptive behavior based on Simon’s idea that “human thought processes are simple”.52 In a groundbreaking book, Robert Axelrod and Michael Cohen claim that today’s overarching concept for an economic context is that of a complex adaptive system: Whether or not we are aware of it, we all intervene in complex systems. We design new objects or new strategies for action. […] Whether simple or sophisticated, such actions change the world and […] lead to consequences that may be hard to imagine in advance. […] The complexity of the world is real. We do not know how to make it disappear. […] For us, “complexity” does not simply denote “many moving parts.” Instead, complexity indicates that the system consists of parts which interact in ways that heavily influence the probabilities of later events. Complexity often results in features, called emergent properties, which are properties of the system that the separate parts do not have.53

Recapitulating some of the pioneering research of John Holland 54 and others at Santa Fe, the authors offer the following definition of such a system: Agents, of a variety of types, use their strategies, in patterned interaction, with each other and with artifacts. Performance measures on the resulting events drive the selection of agents and/or strategies through processes of error-prone copying and recombination, thus changing the frequencies of the types in the system.55

The agents that make up the nodes of the social graph interact through strong connections by individually using various elements drawn from three sets of rules. There is a set R1 of interaction rules which are particular ways of realizing, activating, or deactivating, the various available connections between vertices. There is a set R2 of credit-attribution rules which allow the agent to evaluate the relative success or failure of her actions. Finally, there is a set R3 of revision rules by which the agent modifies her interaction rules in the hope of obtaining higher credit in the next round of interactions. Such a system is complex if the interactions between agents generate socalled emergent properties that are more than just the sum of all individual-level properties. In other words, individual actions aggregate in nonlinear fashion through interaction. The system is adaptive in a twofold sense: (a) the emergent properties of interaction generate certain credit measures (profit, fitness, etc.) which may allow the agents to learn from mistakes and successes, and (b) perceived lack or loss of credit may trigger adaptation, i.e., a change in agents’ interaction rules.

Sunny Y. Auyang, Foundations of Complex-System Theories, op. cit., pp. 1-2.

Herbert A. Simon, The Sciences of the Artificial, op. cit., p. 85.

Robert Axelrod and Michael D. Cohen, Harnessing Complexity: Organizational Implications of a Scientific Frontier (New York: Basic Books, 2000), pp. 1-2 and 15.

See e.g. John H. Holland, Hidden Order: How Adaptation Builds Complexity (Cambridge: Perseus, 1995).

Robert Axelrod and Michael D. Cohen, Harnessing Complexity, op. cit., p. 154.

To the post-neoclassical economists, a key element in such a system is that nontrivial aggregate behavior—or systemic behavior—can be generated by trivial rules in R1, R2 and/or R3. Agents may be endowed with bounded rationality, such as myopic horizon, small calculative abilities, simple routines, or rules of thumb. They may base their behavior on expectations which may not at all be consistent with past observations. They may, for all practical purposes, be downright “idiots” in the neutral sense of the word—entities limited to extremely narrow procedures and routines. And still, they may interact to produce very elaborate-looking patterns in certain aggregate variables such as share prices, inflation rates, or attendance of a nightclub. Complexity theorists pride themselves of having dispelled the illusion that to generate such intricate patterns as can be viewed in nature or in society, there has to be either an omniscient designer or a cognitively sophisticated population. How does adaptive learning work? The two keys to understanding how agents adapt in a complex adaptive system are the notions of an internal model and of credit attribution. They are closely linked, in the sense that the agent is assumed to use his internal model to undertake actions whose high or low credit value subsequently may lead him to partly modify the internal model. An internal model is an evolving module in any agent’s cognitive setup. It represents that agent’s more or less formalized, more or less exhaustive and more or less rigorously scientific, view of the array of situations in which he believes he can find himself. This array is formed either on the basis of the agent’s own past experience in the interaction, or on the basis of the experience communicated by other agents through the interaction. A boundedly rational agent will obviously not deduce his decision rules from an “overall model” of the whole economy, be it only because of the cognitive limitations he experiences or of the enormous cost of acquisition of expertise on this full-scale model, if it existed. Moreover, such an agent will not usually submit his partial internal model to the most extensive inter-subjective testing available at any moment, since experience is itself a way of spreading the testing costs over time, and economizing on testing as long as things do not go too wrong. An action that “goes too wrong” means simply an action that fails to fulfill the agent’s aim as measured by his own interests. This failure implies that the action is given a low credit value. The agent’s interest consists in accumulating high credit, or at least sufficient credit (as in Simon’s approach of “satisficing”), in order to survive according to the system’s norms of evaluation. Therefore, a low credit value signals to the agent that he must learn quickly if he wants to stay on board. There are essentially three ways in which learning will affect the internal model: Suppose the model is used by the agent as a credit prediction device. This means the internal model is a cognitive tool that yields an expectation of the credit value of the agent’s action in a perfectly defined momentary context. In that case, failure implies that the internal model has to be modified in congruence with what the agent believes will be his future (also perfectly defined) context. In other words, he needs to change his internal model contingent on his expectation of the new situation with which it will have to help him cope. (The extent to which this will have to be done obviously depends in part on how “flexible” or “open-ended” the internal model is.) Suppose the internal model is used by the agent as a situation interpretation device. This means it as a hermeneutic tool that yields a description of the momentary context in which the agent will have to maximize a perfectly defined credit function. In that case, failure implies that the internal model has to be modified so as to provide a less incongruous description of the future context— independently of how the credit function to be maximized will evolve into the next period. Suppose finally, as is most likely, that the internal model is used to do both (1) and (2). This means that neither the situational context nor the expectation function are well-defined. In that case,

subtle practical judgment is required to understand the reasons of the failure and, hence, the direction in which to look for improvement. Either of the three improvements is carried out through direct or indirect interaction with other, similarly struggling agents. Experiences are shared, “best practices” are pooled, and so on. It is crucial to realize that the agent’s perception of his action’s credit value is clearly a situated perception. So is his perception of his consequent need for a modified internal model. Maybe he truly does not realize that the locally perceived signal comes to him from a subjectless, emergent aggregate phenomenon. Or maybe he does realizes it, but he decides he has no choice anyway. In either case, the adaptive consequences are exactly the same. This means that the agent’s awareness of the “origin” of the perceived failure or success in no way affects the subsequent adaptive sequence. The reason is that not only the triggering signal, but also the ensuing criteria for a better adaptation, are considered to flow from the emergent phenomenon. In the complexity approach, the agent’s behavior is passive in a paradoxical sense. He is passive because he is purposefully, actively, “busily” adapting to emergent signals whose genesis he uncritically accepts because these signals are “given.” This suggests that in a complex adaptive system you can, as an individual agent, be “busily passive.” It all depends on how, in your busyness, you stand towards the emergent phenomena. Axelrod and Cohen define “harnessing complexity” as “seeking to improve but without being able to fully control.” They view it as “a device for channeling the complexity of a social system into desirable change, just as a harness focuses the energy of a horse into the useful motion of a wagon or a plow”.56 They suggest three key questions which, according to them, summarize these instrumental strategies: What is the adequate balance between diversity and uniformity? What should interact with what, and when? Which agents or strategies should be copied and which should be destroyed?57 They then offer eight practical principles for the rational agent who—provided she has any power to intervene in the system at the right levels—wishes to optimally manipulate the prevailing complexity: (I) Arrange organizational routines to generate a good balance between exploration and exploitation. (II) Link processes that generate extreme variation to processes that select with few mistakes in the attribution of credit. (III)

Build networks of reciprocal interaction that foster trust and cooperation.

(IV)

Assess strategies in light of how their consequences can spread.

(V)

Promote effective neighborhoods.

(VI)

Do not sow large failures when reaping small efficiencies.

(VII)

Use social activity to support the growth and spread of valued criteria.

(VIII) Look for shorter-term, finer-grained measures of success that can usefully stand in for longer-run, broader goals.58 56

Ibid., pp. xvi and 2.

See ibid., pp. 22-23.

Axelrod and Cohen establish this list partly on an inductive basis, using concrete examples of successful instrumentalizations of a complex system, and partly on a deductive basis, using the general abstract properties of complex adaptive systems. In the survival-oriented adaptations reviewed here, the emergent signal is taken as an imperative “message” from the environment that you had better learn something quick. This corresponds to what we could call opportunistic harnessing. The agent’s instrumental calculations boil down to mere adaptation to the “circumstances of change.” Today’s widespread discourse on “flexibility” in organizations relies on this kind of harnessing. A significant portion of the management literature even values opportunistic harnessing when it comes to normatively prescribing the “right” actions. An enduringly fascinating aspect of complex adaptive systems is that even such passive, mechanical, rule-following adaptation on the part of the individuals can generate aggregate emergents whose behavior is far from simplistic and does not just reproduce at the aggregate level the mechanical rules used at the sub-aggregate level. As is well known, this is in fact one of the hallmarks of complexity models: Agents adapt—they are not devoid of rationality—but they are not hyper-rational. They look around them, they gather information, and they act fairly sensibly on the basis of their information most of the time. In short, they are recognizably human. Even in such “lowrationality” environments, one can say a good deal about the institutions (equilibria) that emerge over time. In fact, these institutions are precisely those that are predicted by highrationality theories […]. In brief, evolutionary forces often substitute for high (and implausible) degrees of individual rationality when the adaptive process has enough time to unfold.59

Such models are adequate if one seeks parsimony in scientific explanation—especially if the behavior of the aggregate matters more to you than the understanding of individual particles’ trajectories. They are also adequate if, like Simon and most engineers converted to economics, one believes the central task of social science is to understand what can hold together a collection of blind or strongly myopic automata. This cognitive and reflexive minimalism is one of the cornerstones of post-neoclassical economics. Its core question is: What are the most idiotic and unsophisticated agents we can assume so that the aggregate phenomena we find important can be accounted for? In a sense, post-neoclassical economics perpetuates the enduring fascination with emergence out of interacting idiots. To the extent that the agent is treated like a sophisticated grain of sand or a self-propelled billiard ball, the notion of “critical mass” that complexity theorists want to convey is fascinating but ultimately technocratic. Reductionism has not been left behind by postneoclassical approaches, quite to the contrary. The mastering of scaling laws and patterngenerating mechanisms is mainly useful for city planners, park and museum designers, or other professional planning experts who have learnt that well set-up incentives are much less selfdefeating than attempts at outright control. Does this mean complexity economics is useless? Of course not. It is true that a limited number of contexts really do require little or no knowledge about “deep human aspirations” and can be carried out much more easily if one can isolate the “idiotic automaton” (sometimes also called the “automatic pilot”) that coexists in each of us along with our more sophisticated aspects. Criticallyminded people with a broad range of motivations may still maniacally invest in the stock market. Highly reflexive people with very diverse aims in mind may still routinely walk through Central 58

See ibid., pp. 156-158.

H. Peyton Young, Individual Strategy and Social Structure: An Evolutionary Theory of Institutions (Princeton: Princeton University Press, 1998), p. 5.

Park every day. Social activists and humanists may still single-mindedly drive their cars through city avenues and into traffic jams. In these specific, limited contexts it does indeed seem useful to be able to explain the formation of a “critical mass” with the tools of cellular automata, of the mechanics of gases, or of condensed-matter physics. The striking thing about complexity economics is that it insists both on the importance of modeling interaction (so that it rejects traditional equilibrium theories’ strategy of independent-agent approximation) and on the possibility of dispensing with the interacting components’ reasoning and reflexivity. This gives the whole research area an aspect indeed well captured by the expression “social physics.” Society is a more or less sophisticated pile of grains of sand. The following two passages illustrate both the potential and the limitations of the approach: In a system of interacting agents, emergent properties are those that cannot be reduced to statements about the individual elements when studied in isolation. […] One important aspect of emergence is that it breaks any logical relationship between methodological individualism and reductionism. What I mean is that emergent properties cannot be understood through the individual elements of a system, as they are intrinsically collective. This is so even though the behaviors of these elements determine whether or not emergent properties are present.60 Think of a pile of sand on a table that has a continuous flow of sand falling on the top of the pile. For a while, the sand builds up into a large conical sandpile, but at periodic times, when the sandpile builds up to what Bak calls self-organized criticality, there is an avalanche or series of avalanches until the pile “relaxes” back to a state where avalanches cease. […] The distribution of sizes and “relaxation times” of these avalanches follows scaling law patterns, e.g., Zipf’s law, Pareto’s law, power law, etc.. The study of complexity tries to understand the forces that underlie the patterns or scaling laws that develop.61

Critical mass, here, is an aggregate phenomenon which the theory seeks to explain without endowing the grains of sand with more than the physical properties (attraction, repulsion, and so on) required to explain the observed aggregate. This means that complexity economics will be interested essentially in empirically observable and “persistent” patterns, as characterized by John Holland: Emergence occurs in systems that are generated. The systems are composed of copies of a relatively small number of components that obey simple laws. Typically these copies are interconnected to form an array […] that may change over time under control of the transition function. The whole is more than the sum of the parts in these generated systems. The interactions between the parts are nonlinear, so the overall behavior cannot be obtained by summing the behaviors of the isolated components. Said another way, there are regularities in system behavior that are not revealed by direct inspection of the laws satisfied by the components. […] Emergent phenomena in generated systems are, typically, persistent patterns with changing components. Emergent phenomena recall the standing wave that forms in front of a rock in a fast-moving stream, where the water particles are constantly changing though the pattern persists […]. Persistent patterns often satisfy macrolaws. When a macrolaw can be formulated, the behavior of the whole pattern can be described without recourse to the microlaws (generators and constraints) that determine the behavior of its components. Macrolaws are typically simple relative to the behavioral details of the component elements.62

Steven N. Durlauf, “A Framework for the Study of Individual Behavior and Social Interactions’, Sociological Methodology 31 (2002): 47–87, quote from pp. 71-72.

William A. Brock, “Some Santa Fe Scenery”, in David C. Colander (ed.), The Complexity Vision and the Teaching of Economics, op. cit., pp. 29–49, quote from p. 30.

John H. Holland, Emergence: From Chaos to Order (Cambridge: Perseus, 1998), pp. 225-227 passim.

There is no denying that complexity economics has represented a breakthrough compared to the TE-paradigm and to game theory, by combining adaptive rationality and emergence within a dynamic, evolutionary perspective that takes explicit account of agents’ heterogeneity and of realtime, face-to-face as well as institution-mediated interactions. One of the pioneers of the approach, Joshua Epstein, has offered the expression of “generative social science”63 to describe what he presents as a new, post-neoclassical paradigm. This seems close to an adequate characterization: the rationality axiom has been transformed beyond recognition by the “invasion” of strategic rationality by bounded rationality, which has generated the general concept of adaptive rationality; the equilibrium axiom has also been transformed beyond recognition by the replacement of spot-on coordination by complex emergence, which has generated the general concept of evolutionary trajectories. The M.Ind axiom remains essentially untouched and still rules in the background; in fact, as we indicated earlier, it is only within radically interactive and process-oriented models that the notion of “individual” really comes into its own—before, both in Traditional Economics and in Nash game theory, the stringent demands of the independent-agent approximations meant that what were presented rhetorically as individuals were, in fact, just functional entities pre-programmed to “play” equilibrium strategies “fed” to them by the economist. Epstein calls the individuals in the complexity approach “autonomous,” by which he means that “There is no central, or ‘top-down,’ control over individual behavior in agent-based models”.64 Thus, we may write the new axioms as follows: [M.Ind + generative approach] →→→ [Autonomous agents] [M.Inst(s) + generative approach] →→→ [“Simple” adaptive rationality] [M.Eq + generative approach] →→→ [Emergence, evolutionary trajectories] In fact, the very demanding notions of rationality and equilibrium that was so central in Traditional Economics and in Nash game theory becomes just one, quite small, “province” of the overall conceptual landscape: To begin, the agents differ differently in the different models. [Sometimes] they differ by age and fertility. [In other models,] they have different decision rules. Some decide by tossing coins; some (very few!) decide like homo economicus; and some play a coordination game in their social networks, where the social networks are themselves heterogeneous and dynamic. [The agents may also] differ by what they store in their memory (their recent interactions), […] by dynamic search radius, [they may] exhibit diversity in ages and levels of accumulated wealth, [they may be] heterogeneous by economic hardship, as well as by local information and political grievance, both of which are dynamic, [or they may] face different and dynamic local environments. [Moreover, for the generative social scientist,] to explain a pattern, it does not suffice to demonstrate that […] if society is placed in [a specific] pattern, no (rational) individual would unilaterally depart (which is the Nash equilibrium condition). Rather, one must show how a population of boundedly rational (i.e., cognitively plausible) and heterogeneous agents, interacting locally in some space, could actually arrive at the pattern on time scales of interest— be it a wealth distribution, spatial settlement pattern, or pattern of violence. Hence, to explain macroscopic social patterns, we try to “grow” them in multi-agent models. The preceding critique applies even when the pattern to be explained is an equilibrium. But what if it isn’t? What if the social pattern of interest is itself a nonequilibrium dynamic? What if equilibrium exists, but is not attainable on acceptable time scales, or is unattainable outright? […] [T]he

Joshua M. Epstein, Generative Social Science: Studies in Agent–Based Computational Modeling (Princeton: Princeton University Press, 2007).

Ibid., p. 6.

agent-based generative approach can be explanatory even in such cases—where “the equilibrium approach,” if I may call it that, is neither infeasible or is devoid of explanatory significance.65

Epstein’s claims show how far the complexity paradigm has moved from the initial TE-paradigm. It offers a mix between reductionist brain science—with the claim that the human brain is basically a low-performance Turing machine—and highly sophisticated systems analysis. The idea of “growing” artificial societies and economies,66 just like one grows flowers or biological cells, is made possible by this specific combination of simplified individual cognition—which makes agents into so-called “finite-state automata”—and complex collective evolution: the economist can artificially create aggregate patterns as emergent phenomena from the automata’s interactions and then see how these patterns change when small changes in initial conditions are introduced. This can be of great help for the management of traffic flows and other planning and management tasks. As Diane Coyle has rightly emphasized, most of the work currently done by complexity economists on systems with simple but heterogeneous agents would have been totally unthinkable just a few decades ago because the computer technology was missing. In fact, Epstein and Axtell are wish to view society as a computer and to consider each agent to be an autonomous processing node in a computer, the agent society. Individual agents (nodes) compute only what is best for themselves, not for the society of agents as a whole. Over time, the trade partner network describes the evolution of connections between these computational nodes. Thus there is a sense in which agent society acts as a massively parallel computer, its interconnections evolving through time.67

To the question of what has allowed economics to change so much in its analysis of systems of interaction, Coyle offers two conjoint replies. One is that economics has evolved more towards what she calls an “economics for humans,” and this is connected to the topic of our section C.7.6: the incursion of economists into behavioral psychology, neurology, and laboratory experimentation more generally; it is this which has made it possible to move away from TE- and Nash-types of agents. The second reply is The availability of cheap computer power. […] [C]omputers transformed economics, just as they transformed biology and geology and other sciences whose theoretical underpinnings were previously, as it turns out, limited by the amount of computation that was feasible. […] [O]ne of the appeals of the textbook model (rational, identical agents, linear equations, and so forth) was its analytical tractability. This kind of model can be solved and estimated econometrically. More recent theoretical approaches, whether in behavioral economics or drawing on network theory […] are not so neat analytically. But it doesn’t matter: it’s now possible to simulate the results of the new types of model. […] The simulations make it easy to see, visibly on the screen, the emergent properties of a nonlinear model with nonidentical individuals.68

In other words, where previously the economist was constrained by his own brain and the need to be able to solve his models in reduced form on paper, now he or she is able to use sophisticated

Ibid., pp. xiii, xvi passim.

See Joshua M. Epstein and Robert L. Axtell, Growing Artificial Societies: Social Science from the Bottom Up (Cambridge: MIT Press, 1996).

Ibid., p. 13.

Diane Coyle, The Soulful Science, op. cit., pp. 240 and 244-245 passim.

software that will compute the emergent patterns and display them. (Epstein’s 2007 book indeed contains a CD-ROM for the display of simulations.) There is thus less need than before to make drastically simplifying assumptions about preferences, technologies, and so forth. What is more, if a powerful computer is unable to converge on a solution, this implies that the model is not only analytically intractable, but in fact describes what Epstein calls a “hard social problem” that may possess a “nonconstructive” equilibrium—i.e., an equilibrium that can be said to exist in theory— but not a “constructive,” actually attainable one: [Let us] adopt the definition that social states are hard to attain if they are not effectively computable by agent society in polynomial time […] In a number of models, the analogous point applies to economic equilibria: There are nonconstructive proofs of their existence but computational arguments that their attainment requires time that scales exponentially in, for instance, the dimension of commodity space. In our tentative definition, then, computation of (attainment of) economic equilibria would qualify as another hard social problem.69

Computer simulation in fact allows to create a sort of “artificial real time” in which, following an idea of Herbert Simon, time is defined as the number of elementary computational steps needed to solve a problem. This allows to gain much more insight into the way an interactive system generates its evolutionary trajectories. To round out this discussion of complexity economics, we still need to reflect on what may be its most central issue, apart from the many fascinating technical advances it has produced: have generative social scientists, and complexity-evolutionary economists really been able to get rid of all independent-agent approximations? And to the extent they have, how far from such approximations has the combination of “stupid” agents and sophisticated dynamics allowed them to move? There are two closely connected, but analytically separate issues here. First, in many dynamic, sequential, and interactive models economists still put agents in non-cooperative game situations. Does this not a blatant violation of Simon’s bounded-rationality principle? Not necessarily, unless the economist also imposes the Nash equilibrium as a solution concept for each game; in that case, the dynamic interactive model becomes nothing more than something we dismissed as irrelevant earlier—namely, a repeated game which, in every period, is played according to the Nash solution and whose only endogenous features are the agents’ “memory” of past strategies. This may perhaps allow us to explain some interesting things. However, it is not what we have had in mind here within complexity economics. The basic idea is, rather, that agents should be allowed to start anywhere in strategy space and gradually “discover” the stable solution(s) to the game—if the game form G is assumed to be invariant—or the game form and the corresponding solution(s)—if G itself changes over time. In other words, agents should be allowed to go through many steps such as equation (1) before anything like equation (2) can be postulated as an “equilibrium.” This means that, in a Prisoners’ Dilemma, agents who do not already know the game form and who are not endowed with CKR may start with completely self-defeating strategies and only very gradually learn (i) that they are perhaps better off playing other strategies, (ii) that they are playing a Prisoners’ Dilemma, and perhaps also (iii) that the form of the game they are playing is changing gradually as they play it. This sort of terribly complicated problem is the stuff that evolutionary game theory is, in principle, made of. As can be seen by glancing at any textbook on the subject, the actual advances of the discipline have been focused on still quite impressive, but less complicated issues. Game forms G

Joshua M. Epstein, Generative Social Science, op. cit., p. 25.

are usually considered fixed and what varies is the agents who play it; in other words, the Prisoners’ Dilemma—or any other game, usually symmetrical, such as Hawk-Dove or Coordination—is viewed as the basic structure for the repeated interaction between “species” in a “population.” The basic idea, somewhat simplified to a two-type setting, is that whenever an agent of type A or B meets any other agent, also of type A or B, they play a Prisoners’ Dilemma. The difference, now, is that each “species” is assumed to be programmed to play a given strategy, based on a “behavioral code.” Initially “stuck” in their strategies, agents within species can nevertheless switch behavioral codes over time—for various reasons, perhaps due to a “trembling hand” (a haphazard error that may become beneficial) or to mere inquisitiveness (wanting to experience “the other thing”), but mainly through inductive learning. Anyway, agents play certain strategies, try out others, and depending on which strategies are played by the opponents, who are similarly programmed and similarly experimenting, they reap the payments in the corresponding box of the game’s matrix—which they do not know beforehand but which is assumed to remain invariant. In some cases, this can lead to mutations, in others it can lead to extinctions. The main issue tackled by evolutionary game theory is whether “at the end”—meaning, once learning and experimentation have stabilized—the equilibrium that would have been attained by the Nash solution will come into force as an evolutionary equilibrium, implying that the Nash strategies that eventually get “discovered” are evolutionarily stable strategies. There are thus two distinct notions of equilibrium involved: In each game played by an n-tuple of agents, with each of them programmed to play a given strategy or some of them trying out new strategies, “equilibrium” means—rather trivially—that some combination of strategies is played and can be observed. This is not the Nash combination, except by pure chance. It means simply equilibrium as order, or what we have called weakly functionalist equilibrium: “something” occurs, rather than “nothing.” As time goes by, more and more such games end up being “solved” through the evolutionary solution, i.e., more and more of the n-tuples of agents play the n-tuple of evolutionarily stable strategies—if they exist, which is not guaranteed in all cases. Thus, eventually, some equilibrium stabilizes and becomes dominant—it becomes “the” way interactions get ordered, and it may be called an “institution” or a “norm.” If we look at the economy at that end point in the process, we may be misled into thinking the agents always had the sort of knowledge and rationality that would make them coordinate on the evolutionary equilibrium immediately, but this is not so. The evolutionary equilibrium is simply a stabilized combination of strategies after a long process of emergence with errors, extinctions, learning, and so on. Still, it mimics what we have called strongly functionalist equilibrium: at the “resting point” of the system of interaction, what occurs is not just “something” rather than “nothing,” but “something definite” generated by the history of the interactions. This is indeed a version of the general problem formulated ealier—namely, will a sequence of equations of type (1) converge on equation (2)? Along the way, mutation and learning combine to create convergence—in the best cases, since quite a few evolutionary games circle or cycle without converging. In a passage we already quoted in part, Peyton Young has explained the basic idea in terms quite similar to Epstein: Agents adapt—they are not devoid of rationality—but they are not hyper-rational. They look around them, they gather information, and they act fairly sensibly on the basis of their information most of the time. In short, they are recognizably human [or what Epstein calls “cognitively plausible”]. Even in such “low-rationality” environments, one can say a good deal about the institutions (equilibria) that emerge over time. In fact, these institutions are often precisely those that are predicted by high-rationality theories—the Nash bargaining solution, subgame perfect equilibrium, Pareto-efficient coordination equilibria, the iterated elimination of

dominated strategies, and so forth. In brief, evolutionary forces substitute for high (and implausible) degrees of individual rationality when the adaptive process has enough time to unfold.70

By stressing the central importance of learning, Young represents most post-neoclassical economists in throwing a bridge between the logic of independent agents and the logic of interaction. He shows how high-rationality solution concepts in game theory can emerge in a world populated by low-rationality agents [so that] the evolutionary approach is a means of reconstructing game theory with minimal requirements about knowledge and rationality.71

This means the answer to the question, “Have independent-agent approximations been relinquished?” is affirmative. However, there is still the second question: How far from such approximations have postneoclassical economists been able to move? Here, the answer is: not very far… In fact, Young envisages four main learning mechanisms for “low-rationality agents”: natural selection, reinforcement, imitation, and optimal response.72 Of these four, only the latter two are really interactive, while the two former ones are closer to an independent reaction of each “isolated” agent facing a common situation that emerges from the whole set of interactions. As to what regards the two interactive mechanisms, we could call them ultra-low density interactive mechanisms. The reason is that neither the imitation of others nor the hypothetical calculation of what I would do if others did x (this is revealingly called “fictitious play”) require any strong social connections. Nor do they require any dense communication network. In fact, most ultra-low density interaction mechanisms can easily be transformed into mechanisms with isolated agents, either through emergent phenomena such as fashion or through purely additive phenomena such as a publicly available list of agents having pursued “winning” or “losing” strategies (bad bill payers, debtors, successful entrepreneurs, and so on). The actual part of dense, direct interaction is quite reduced, or even nonexistent. Independent-agent approximations are no longer literally there, but they loom in the background in the form of ultra-low density interactive mechanisms that can be—in whole or in part—rendered anonymous and that can be redefined in terms of shared situational variables. True, these are no longer always “equilibrium” situations, so the strongly functionalist notion of equilibrium is gone; but the difficulty of having close, real-time interaction within n-tuples still shows in the way Peyton Young conceives “learning.” Such ultra-low density interactive mechanisms are about as far as complexity-evolutionary economics currently goes in terms of actual communication between people and in terms of their shared reflection on the economic system in which they live. In short, there is no inter-subjectivity and the inside of the collective is nonexistent. Thus, although complexity economics is truly postneoclassical in having gotten rid of independent-agent approximations, it is bound to remain stuck in a view of economic interaction with no inter-subjectivity and, even more so, no subjectivity.

C.7.6. Elements of behavioral and neuroeconomics

H. Peyton Young, Individual Strategy and Social Structure, op. cit., p. 5.

Ibid., p. 144.

Ibid., pp. 27-28.

Whereas Nash-style game theory has remained firmly rooted in a (sophisticated) version of the TEparadigm, complexity economics does indeed appear to have inaugurated a new, genuinely postneoclassical paradigm. As we saw earlier, one of the main reasons for this radical novelty is that, notably under the influence of Herbert Simon, and also thanks to significant improvements in computer technology, complexity economics has been able to inaugurate a truly “bottom-up” way of modeling which has become known as agent-based modeling and is being used in “generative social science” to understand the emergence of economic phenomena out of the real-time interactions between boundedly rational individuals. Replacing M.Eq as “system at rest” with M.Eq as emergence, and thus decoupling M.Inst(s) from the Nash requirements and accepting a truly autonomous, adaptive rationality—these two new features mean that the frontier of mainstream economics has now definitely left the TE-paradigm and has established itself in the postneoclassical paradigm. Individuals endowed with—“recognizably human”—bounded rationality practice two things simultaneously in their interactions: they apply their substantive rationality in order to satisfice within the environment in which they are immersed, and they apply their procedural rationality in order to learn about that environment. This means that within an objective—but, to the agents, unknown—environment, economic phenomena emerge out of the interaction between agents who hold a subjective “model” of their environment: each objective environment and the phenomena that emerge in it are a function of agents’ subjective model-beliefs about that environment. Whether the false subjective belief-models will all, in the end, through inductive learning converge on the true objective reality (which is itself a constantly emerging function of all these false subjective beliefmodels) is a deep and unsolved question—but we saw that the legitimacy of most “equilibrium” notions used in economics hangs on what answer we give to this question. A crucial feature of the new, post-neoclassical paradigm is that the M.Inst axiom is no longer functionally subordinated to the M.Eq axiom: on the contrary, whatever “equilibria” emerge from interactions cannot be predicted from any requirement of Nash equilibrium—emergence means order (the weakly functionalist version of “equilibrium”) but it does not mean a situation where every agent has reached his global optimum given the global optima of all other agents. Satisficing interactions mean that there is room for an individual’s desire to change, and for an individual’s exploration of the social network. However that gradual process of exploration, learning, and revision takes place, one thing is certain: post-neoclassical economics is genuinely individualistic, in the sense that the basic building block of the analysis is now individual instrumental rationality and no longer the search for (strong) equilibrium. This implies that individuals’ procedural as well as substantive rationality have to be studied for their own sake, in order to be able to construct the “right” agent-based models of emergence. Important issues arise: How exactly is rationality “bounded”? What is the meaning of “satisficing”? How does our “recognizably human” psychological structure impact on the way we reach our decisions? As we witnessed when we discussed Simon’s automaton-based approach, these questions require that the post-neoclassical paradigm build a clear basis for its agent-based strategy. Not surprisingly, therefore, two closely related developments have coincided with the emergence of the new paradigm: one the one hand, theoretical work on economic psychology, behavioral economics, and so-called “neuroeconomics”; on the other hand, empirical work in experimental economics. These areas of economic research have literally exploded since the 1980s; as with the other domains of innovation, we will not be able to offer here an exhaustive account of the whole diversity of approaches and results. The aim, rather, is to understand how post-neoclassical economists have tried to construct their own reductionism—which they rightly view as a “broadening” compared to the previous narrower reductionism of the TE-paradigm.

It is notable that most post-neoclassical economists identify “psychology” with behavioral psychology—that is, the subfield of psychology that focuses on observed behavior and on measurable motivations and actions. Psychoanalysis, for instance, is left out of the picture, as is most of clinical psychology and, more generally, “logotherapy” which relies on a one-to-one, language- and interpretation-based relationship between a patient and a therapist. The focus on behavioral psychology is intimately bound up with the requirements of macro-management, as Colin Camerer, a tenor of the behavioral economics movement, makes quite clear (and Herbert Simon would not have disagreed): “Behavioral economics” improves the realism of the psychological assumptions underlying economic theory, promising to reunify psychology and economics in the process. Reunification should lead to better predictions about economic behavior and better policy prescriptions. Because economics is the science of how resources are allocated by individuals and by collective institutions like firms and markets, the psychology of individual behavior should underlie and inform economics, much as physics informs chemistry; archaeology informs anthropology; or neuroscience informs cognitive psychology. […] A recent approach, “behavioral economics,” seeks to use psychology to inform economics, while maintaining the emphases on mathematical structure and explanation of field data that distinguish economics from other social sciences.73

There are two striking claims in this passage. First, there is Camerer’s claim that behavioral economics is just a “re-unification” of economics with psychology—the underlying idea being that such a unity used to exist and was gradually abandoned. The second claim is that the use of “psychology” to inform economics is still put in the service of hypothetico-deductive formalism— the underlying idea being that the way psychology is to be used has to remain consistent with mathematization and with formal modeling. The claim to reunification is based on the idea that behavioral economics is not “a brand new synthesis” but rather a return to “early thinking about economics [which] was shot through with psychological insight”.74 Unsurprisingly perhaps, the precursor here is considered to be Adam Smith—not so much the author of The Wealth of Nations as the author of The Theory of Moral Sentiments: Adam Smith’s psychological perspective in The Theory of Moral Sentiments is remarkably similar to “dual-process” frameworks advanced by psychologists […], neuroscientists […] and more recently by behavioral economists, based on behavioral data and detailed observations of brain functioning […]. It also anticipates a wide range of insights regarding phenomena such as loss aversion, willpower and fairness […] that have been the focus of modern behavioral economics […]. The Theory of Moral Sentiments suggests promising directions for economic research that have not yet been exploited.75

The idea of a “dual-process perspective” means here the fact that, in Smith’s approach, “passions” and the “impartial spectator” coexist within individual agents’ observed behavior, hence their preferences, so that there is a balance to be struck between agents’ passionate facets which lead them to fear loss, to make wrong intertemporal choices, and to frequently display overconfidence, and their impartial facets which impel them to be altruistic, to demand fairness (for themselves and others), and to build and value trust in institutions.

Colin F. Camerer, “Behavioral Economics: Reunifying Psychology and Economics”, Proceedings of the National Academy of Sciences of the United States of America 96 (1999): 10575–7, quote from p. 10575.

Ibid.

Nava Ashraf, Colin F. Camerer and George Lowenstein, “Adam Smith, Behavioral Economist”, Journal of Economic Perspectives 19 (2005): 131–145, quote from p. 132.

To take just the case of loss aversion and intertemporal illusion, Daniel Kahneman (who was awarded the Nobel in 2002) and Amos Tversky demonstrated in the late 1970s that rational individuals routinely display a behavioral asymmetry between their reactions to gain and their reactions to loss. “Modern research,” claim Ashraf, Camerer and Loewenstein, “has produced a wealth of evidence from human behavior supporting [loss aversion], and Capuchin monkeys also exhibit loss-aversion […]. Brain imaging technology has shown that losses and gains are processed in different regions of the brain […], suggesting that gains and losses may be processed in qualitatively different ways” (Ashraf, Camerer, and Loewenstein 2005: 133).76 Such properties may help explain observed aggregate patterns on labor markets, financial markets, or housing markets. This is all, indeed, old stuff which only a century of the TE-pradaigm’s obsession with equilibrium-induced rationality could obscure. Note, however, Ashraf’s, Camerer’s and Loewenstein’s insistence on “behavioral data and detailed observations of brain functioning.” This sort of approach is partly different from the one initially inaugurated by Simon which, as we saw, aimed at modeling human agents as finite-state automata, i.e., small machines with internal “states” composed of a set of parameters that can take on a finite number of values. Here, there is more emphasis on laboratory work and bio-magnetic brain imagery—something which Simon could hardly envisage in the 1950s and 60s when the numerical computer unleashed enthusiasm and today’s sophisticated, non-invasive PET-scan machines were far from existing. What the current behavioral approach and Simon’s strictly computational approach have in common is a focus on individual exteriors: Brain states and behavioral patterns, yes; feelings, emotions, and states of consciousness, no. The reason, of course, is that there is still an ultimate privilege given to “mathematical structure and explanation of field data,” and this requires objectivizable (i.e., quantitative and/or easily quantifiable qualitative) concepts—for which brain waves and behavioral patterns are much better suited than subjective, messy, verbal expressions of emotions, intuitions, and feelings. None of this means, of course, that emotions or feelings may not become objects for behavioral economics. What it does mean, however, is that they will become such objects only to the extent that they can be measured in ways that allow their insertion into hypothetico-deductive, formal models. In other words, emotions and feelings will become objects of behavioral economics to the extent that subjectivity can be reduced to brain states—or, which comes to the same, subjectivity-related aspects not reducible to brain states can be neglected. Emotions, so it is argued, are mental states based on beliefs, and these beliefs trigger behaviors in interaction, which in turn can be modeled in classical ways such as with the toolbox of evolutionary game theory. Another tenor of the behavioral economics movement, Richard Thaler, has offered the following (actually quite classic) example of a behavioral study of the consequences of “emotion”: How can emotions be incorporated into economic analyses? The ultimatum game offers one simple example. In the ultimatum game one player, the Proposer, is given a sum of money, say $10, and makes an offer of some portion of the money, x, to the other player, the Responder. The Responder can either accept the offer, in which case the Responder gets x and the Proposer gets $10–x, or reject the offer in which case both players get nothing. Experimental results reveal that very low offers (less than 20 percent of the pie) are often rejected. Speaking very generally, one can say that Responders react emotionally to very low offers. We might get more specific and say they react indignantly. What is certain is that Responders do not act to maximize their

Ibid., p. 133.

own payoffs, since they turn down offers in which they receive a small share of the pie and take zero instead.77

It is important to note that the “emotions” underlying the agents’ behaviors—such as “reacting indignantly”—are not mediated by language and interpretation. In fact, the economist observing this Proposer and this Responder has no idea at all of what is going on in their minds. Emotion is induced from the observed behavior, it might be induced from brain imagery in addition, but it is not—expect by accident—based on the agents’ own words. We might call this a differential induction of emotivity, based on the implicit assumption that emotion appears in the “gap” between how a fully self-interested person would have behaved (accepting any x>0) and how the actual person behaved (refusing even x=0.2). In essence, behavioral economics is—well, about behavior, meaning the directly visible effects of whatever goes on in agents’ brains. Motivations are inferred, or induced, from what one observes, just as in Traditional Economics preferences could sometimes be viewed as being “revealed” by observed choices. This follows a basic stance that has been, in economics, attributed to Stanley Jevons, who is supposed to have claimed in 1871 that “men will never have the means of measuring directly the feelings of the human heart. It is from the quantitative effects of the feelings that we must estimate their comparative amounts.” Our earlier remarks on “emotions” in the Ultimatum Game went in the same direction: behavior is the quantitatively visible result of alleged brain processes and also—as Jevons rightly remarks—feelings “of the human heart,” meaning the psyche or the spirit. In other words, for the Marginalist economists who built neoclassical economics, as well as for their successors all the way into behavioral economics, the human brain and heart are “black boxes.” This is a limitation which the newly arising “neuroeconomics” claims to have overcome. As Camerer, Loewenstein, and Prelec put it in a passage worth quoting at length, Neuroscience uses imaging of brain activity and other techniques to infer details about how the brain works. […] [N]euroscience has proved Jevons’s pessimistic prediction wrong; the study of the brain and nervous system is beginning to allow direct measurement of thoughts and feelings. […] Neuroscience […] points to an entirely new set of constructs to underlie economic decision making. The standard economic theory of constrained utility maximization is most naturally interpreted either as the result of learning based on consumption experience […] or careful deliberation—a balancing of the costs and benefits of different options—as might characterize complex decision making […]. While not denying that deliberation is part of human decision making, neuroscience points out two generic inadequacies of this approach— its inability to handle the crucial roles of automatic and emotional processing. First, much of the brain implements “automatic” processes, which are faster than conscious deliberations and which occur with little or no awareness or feeling of effort […]. Second, our behavior is strongly influenced by finely tuned affective (emotion) systems whose basic design is common to humans and many animals. […] Human behavior thus requires a fluid interaction between controlled and automatic processes, and between cognitive and affective systems. However, many behaviors that emerge from this interplay are routinely and falsely interpreted as being the product of cognitive deliberation alone […]. These results […] suggest that introspective accounts of the basis for choice should be taken with a grain of salt. Because automatic processes are designed to keep behavior “off-line” and below consciousness, we have far more

Richard H. Thaler, “From Homo Economicus to Homo Sapiens”, Journal of Economic Perspectives 14 (2000): 133–41, quote from pp. 139-140.

introspective access to controlled than to automatic processes. Since we see only the top of the automatic iceberg, we naturally tend to exaggerate the importance of control.78

In other words, we are back with a Simon-type project of modeling sophisticated automata—but not just on the basis of computer science and “naïve” computational views, and adding the newly acquired insights of state-of-the-art neuroscience which views the brain as a sort of “biocomputer.” In a sense, the bias toward cognitive science, which was inherent in early cybernetics, is now being replaced by a bias toward neuropsychology. This is certainly more intriguing than the mere “intelligent systems” view initially propounded by Simon that considers the brain like a calculator, or the purely behavioral approach that considers the brain like a black box. Camerer, Loewenstein, and Prelec identify some of the following new techniques that have reshaped economic psychology (in the same way as new mathematical tools and new computer techniques have reshaped economics as a whole in the more or less recent past): brain imaging (PET scans, functional MRI), “single-neuron measurement,” electrical brain stimulation (EBS), cognitive psychopathology and the study of brain damage (especially “transcranial magnetic stimulation” [TMS]), psychophysical measurement (heart rate, sweating, muscle micromovements), and “diffusion tensor imaging” (DTI). These tools, they claim, are useful not just to get an image of what zones of the brain “light up” under what behavioral circumstances; they are aimed, ultimately, at understanding how the human brain uses its neural wiring to solve decision problems: … the long-run goal of neuroscience is to provide more than a map of the mind. By tracking what parts of the brain are activated by different tasks, and especially by looking for overlap between diverse tasks, neuroscientists are gaining an understanding of what different parts of the brain do, how the parts interact in “circuitry,” and, hence, how the brain solves different types of problems.79

This neuropsychological approach “views consciousness as anchored in neural systems, neurotransmitters, and organic brain mechanisms. Unlike cognitive science, which is often based on computer science and is consequently vague about how consciousness is actually related to organic brain structures, neuropsychology is a more biologically based approach. Anchored in neuroscience more than computer science, it views consciousness as intrinsically residing in organic neural systems of sufficient complexity.”80 In fact, neuroeconomists take a relatively balanced approach combining cognitive/ computational aspects (= the brain as a digital computer) and affective/ emotional aspects (= the brain as an elaborate organ/ biocomputer). Cognitive processes and affective processes coexist in the brain; roughly, they correspond to David Hume’s old split between “reason” and “passion”—or to the split between deliberation and reflex, perhaps even between the conscious and the subconscious. Camerer, Loewenstein, and Prelec suggest their own “four-quadrant” model:

78 Colin F. Camerer, George Loewenstein and Drazen Prelec, “Neuroeconomics: How Neuroscience Can Inform Economics”, Journal of Economic Literature 63 (2005): 9–64, quote from pp. 9-11 passim. 79

Ibid., p. 14.

Ken Wilber, “An Integral Theory of Consciousness” (1997), reprinted in Ken Wilber, Collected Works, vol. 7, Boston, MA: Shambhala, 2000, pp. 369–402, quote from p. 370.

Cognitive processes

Affective processes

Controlled processes

Automatic processes

III

Here is how they briefly summarize its meaning of their quadrants: Quadrant I is in charge when you deliberate whether to refinance your house, poring over present-value calculations; quadrant II is undoubtedly the rarest in pure form. It is used by method actors who imagine previous emotional experiences so as to actually experience those emotions during a performance; quadrant III governs the movement of your hand as you return serve; and quadrant IV makes you jump when somebody says “Boo!”81

Neuroeconomics and behavioral economics are very closely related in their basic theoretical aim, which is to give various post-neoclassical as well as older-style TE-approaches (complexity theory and evolutionary game theory in the post-neoclassical paradigm, conventional “Nash” behavioral game theory in the TE-paradigm) a mix of cognitive and neuropsychological foundations. We have seen repeatedly that neuroeconomics, but above all behavioral economics, rely very heavily on experimental data—from field research sometimes, but mainly from the laboratory. How are these data generated? This is the third, more empirically oriented component of the post-neoclassical paradigm—namely, so-called “experimental economics,” which seeks to ground the basic behavioral assumptions used in the area of behavioral economics. Vernon Smith (Nobel laureate in 2002) has pioneered the experimental approach to economic modeling. An experiment, in his vocabulary, is a combination of several elements.82 Within a “laboratory” context—which is, in itself, a heresy for many social scientists who believe social reality cannot be replicated as it can be in physics or in chemistry—one draws up an environment which specifies agents’ endowments, their preferences and the costs they have in exchanging. Usually, creating this environment involves monetary rewards calibrated for the purposes of the experiment. One also creates an institution which specifies the sorts of messages to be exchanged and how they are to be communicated, as well as the rules under which they can become binding contracts. Invariably, creating this institution involves drawing up experimental instructions to be given to the “participants” in the laboratory. Most experiments are computer-driven, but some also have human participants in addition. Finally, one observes the participants’ behavior within the environment and institution. This combination of environment, institution, and behavior basically takes literally Herbert Simon’s notion of an economic system being an “artificial” system, and Hayek’s idea that, after all, Colin F. Camerer, George Loewenstein and Drazen Prelec, “Neuroeconomics: How Neuroscience Can Inform Economics”, loc. cit., p. 19. 81

The following paragraph draws on Vernon L. Smith, “Economics in the Laboratory”, Journal of Economic Perspectives 8 (1994): 113–31.

economic institutions and modes of interaction are created by humans through a long and winding process of evolution—but it stylizes these insights into the idea that artificial systems can be created in an instant within a confined setting, without the long evolutionary path that makes real-world artificial systems emerge. When Smith started his pioneering work in the 1960s, it was the heyday of neoclassical general equilibrium theory and Simon’s work, though already prestigious, was not yet influential. Smith believed that to study the functioning of markets, the Walrasian as well as the non-Walrasian independent-agent approximations were far from sufficient, and one had to study actual interactions; short of being able to conduct large-scale ethnological surveys, one could at least try to replicate experimentally the functioning of markets, viewed as institutions and not just formal coordination devices. Part of Smith’s impetus came from the lack of data-based falsification and of inductive—as opposed to deductive—reasoning in standard neoclassical economics: Economics as currently learned and taught in graduate school and practiced afterward is more theory-intensive and less observation-intensive than perhaps any other science. I think the statement [by Milgrom and Roberts in 1987] that “no mere fact ever was a match in economics for a consistent theory” accurately describes the prevailing attitude in the profession […]. This is because the training of economists conditions us to think of economics as an a priori science, and not as an observational science in which the interplay between theory and observation is paramount. Consequently, we come to believe that economic problems can be understood fully just by thinking about them. After the thinking has produced sufficient technical rigor, internal coherence and interpersonal agreement, economists can then apply the results to the world of data. But experimentation changes the way you think about economics. If you do experiments you soon find that a number of important experimental results can be replicated by yourself and by others. As a consequence, economics begins to represent concepts and propositions capable of being or failing to be demonstrated. Observation starts to loom large as the centerpiece of economics. Now the purpose of theory must be to track, but also predict new observations, not just “explain” facts, ex post hoc, as in traditional economic practice, where mere facts may be little more than stylized stories.83

Experimental economics locates itself firmly within the bounded-rationality paradigm and aims to understand how “normal” humans interact and what emerges from their interactions—with the idea that it is what emerges that has to be made sense of by theory, and not theory that has to use experiments to validate itself ex post. “Aprioristic” economics of the hypothetico-deductive sort has to be replaced—at least according to Smith—by “aposteriostic” economics in which theory is guided by experimentally observed facts. Joining in with Camerer, Thaler, and others, Vernon Smith pays homage to Adam Smith, to Bernard Mandeville and to David Hume, those “Scottish philosophers” who had originally, so he claims, offered an approach to rationality quite distinct from what the TE-paradigm made of it: … experimental economists have reported mixed results on rationality: people are often better (e.g., in two-person anonymous interactions), in agreement with (e.g., in flow supply and demand markets), or worse (e.g., in asset trading), in achieving gains for themselves and others than is predicted by rational analysis. Patterns in these contradictions and confirmations provide important clues to the implicit rules or norms that people may follow, and can motivate new theoretical hypotheses for examination in both the field and the laboratory. The pattern of results greatly modifies the prevailing, and I believe misguided, rational SSSM [= standard

Vernon L. Smith, “Theory, Experiment and Economics”, Journal of Economic Perspectives 3 (1989): 151–170, quote from pp. 169-170. 83

socioeconomic science model], and richly modernizes the unadulterated message of the Scottish philosophers.84

In other words, taking seriously the actual results of behavioral experiments, rather than viewing all of reality through the lenses of the M.Inst(s) and M.Eq axioms of the TE-paradigm, will lead to an across-the-board abandonment of that TE-paradigm—and to a return to “the unadulterated message of the Scottish philosophers,” which is the one we have already encountered: when boundedly rational persons interact, the result is an “ecological” emergence from limited adaptation through rules of behavior guided by low-capacity human brains. It is worth quoting Vernon Smith on this, since what he says of the deep aims of experimental economics ties in perfectly with complexity economics and its behavioralist foundations: Ecological rationality uses reason—rational reconstruction—to examine the behavior of individuals based on their experience and folk knowledge, who are “naïve” in their ability to apply constructivist [i.e., TE-style and Nash-style] tools to the decisions they make; to understand the emergent order in human cultures; to discover the possible intelligence embodied in the rules, norms, and institutions of our cultural and biological heritage that are created from human interactions but not by deliberate human design. People follow rules without being able to articulate them, but they can be discovered. This is the intellectual heritage of the Scottish philosophers, who described and interpreted the social and economic order they observed. […] In experimental economics the eighteenth-century Scottish tradition is revealed in the observation of emergent phenomena in numerous studies of existing market institutions […].85

The a posteriori attitude here consists in asking oneself what sort of rationality—probably not TEstyle or Nash-style, which are usually contradicted in experiments—agents may have used in order to interact in such a way as to generate emergence. To study the operation of adaptive instrumental rationality, experimentalists ask: “What is the subjects’ perception of the problem they are trying to solve?”86—and then they feed their findings into computers and run simulations, rather than analytically solving a hypothetico-deductive model on paper. Sometimes, experimental insights allow us to falsify not only a model as a whole, but the core assumptions. Thus, it is no surprise that the core axioms of the TE-paradigm have finally been destroyed not so much by theoretical critique but by the persistent evidence coming from the experimental arena that axiom M.Inst(s) was untenable in its strongly functionalistic version subordinated to axiom M.Eq. But once the cause of a theory’s failure have been diagnosed, experimental work can “range beyond the confines of current theory to establish empirical regularities which can enable theorists to see in advance what are the difficult problems on which it is worth their while to work.”87

C.8. Beyond the post-neoclassical paradigm: Integrating ecological economics, monetary behaviorism, and critical political economy Sections C.5, C.6, and C.7 have offered a detailed discussion of today’s two mainstream paradigms—the one that is on the way out, called Traditional Economics (TE), and the one that is

Vernon L. Smith, “Constructivist and Ecological Rationality in Economics”, American Economic Review 93 (2003): 465– 508, quote from p. 466. 84

Ibid., pp. 469-470.

Ibid., p. 471.

Vernon L. Smith, “Theory, Experiment and Economics”, loc. cit., p. 114.

on the way in, termed the post-neoclassical paradigm. For both historical and conceptual reasons, despite the fact that the latter pretty much “revolutionized” the former, these two paradigms remain closely linked and share some common limitations. This is why, in Money and Sustainability: The Missing Link, Bernard Lietaer, Stefan Brunnhuber, Sally Goerner, and myself have endeavored to promote yet another approach, based on three crucial elements we find missing in even the post-neoclassical paradigm:

Much of complexity science and behavioral psychology, as used and applied in mainstream economics, continues to neglect the fact that the real-world economy is actually an open system: It draws resources (some of them non-renewable, others renewable but at finite rates) from a universe that is essentially a closed system; and it transforms those resources in ways that inevitably produce wastes. In other words, the economy as an open system draws on upstream sources and fills downstream sinks. The laws of thermodynamics rule the whole economic process, meaning that one cannot do economics as if the agents who satisfice, learn, and adapt over time do so within an “empty world.” As Money and Sustainability emphasizes, the issue of building an economic system that can function on a permanent basis over time is not merely a side issue for economists: It is part and parcel of any economist’s work, to the extent that he or she has come to terms with the absolutely binding character of the biosphere’s finiteness. In that sense, any future paradigm in economics cannot avoid embracing ecological economics. Both the TE-paradigm and its post-neoclassical successor share a neglect of the behavioral efficaciousness of economic and social institutions. Changing institutional environments may lead agents to satisfice, learn, and adapt more or less “easily” over time, accumulating fitness credit in different manners and through different channels, but the basic content of people’s relationships to one another is assumed not to change. In other words, institutions are supposed to affect people’s choice sets—i.e., the “bundles” of goods they can reach for through their interactions—but not the type of social relations these people engage in or the qualitative ways in which they produce and exchange goods and services. In particular, money (defined, let us recall from Money and Sustainability, as any means of exchange that members of a community agree to accept in their mutual operations) is assumed to be behaviorally neutral: It is taken as a mere technical tool to facilitate exchanges and transactions that, by assumption, would have occurred in any case. One central message of Money and Sustainability is that this assumption—which lies at the very core of the TE- and post-neoclassical paradigms—is wrong. One cannot do economics as if the monetary or non-monetary incentive systems that are in place did not affect people’s deeper aspirations and the kind of relations they cultivate—even the very kinds of goods and services they are prepared to provide to one another. Institutions, and money in particular, simply are behaviorally efficacious. In that sense, any future paradigm in economics cannot avoid embracing institutional, and in particular monetary, behaviorism. Nowhere in the post-neoclassical paradigm are economic agents assumed to be endowed with any capacities for critical reflection on the economy and for active analysis of the rules and institutions under which they would like to live their lives. Whether it is under the axiom of strongly functionalist equilibrium with the associated strong assumptions on (parametric or strategic) instrumental rationality, or under the axiom of weakly functionalist equilibrium and the associated assumptions on bounded and adaptive rationality, people are never assumed to be able to “look up” from their immediate tasks—whether it be all-embracing calculation or patchy, local adaptation—and deliberate on the mechanisms and constraints of the economy itself. Thus, no amount of “citizens’ economics” can be made sense of in the way complexity and behavioral economics models agents. However, another central message of Money and Sustainability is that this epistemological posture

vis-à-vis individuals and groups is incorrect: In actual fact, citizens do think about, and then create, new economic tools and institutions. In fact, complementary currencies are one of the areas in which bottom-up citizen activity is extremely important. Our conclusive call for the involvement of businesses, citizens’ movements, and NGOs in the creation of an appropriate “monetary ecology” demonstrates that we conceive of economic agents as active participants in the mediumand long-term shaping of the economy itself, not just in its day-to-day functioning. One cannot do economics as if citizens were mere mechanical or bio-computers busying themselves solely with the tasks of strategic adaptation and narrow-range thinking. Economic agents, if inserted in the right sort of social and political environment, are willing and able to think critically and to form aspirations as to what “adaptation” and “thinking” are supposed to mean. In that sense, any future paradigm in economics cannot avoid embracing agents’ critical rationality and the construction of a “critical political economy” in which they actively exercise that rationality.

C.8.1. Making the post-neoclassical paradigm ecologically rational While, for obvious reasons, all ecologists are sensitive to complexity science and behavioral psychology—since they study ecosystems which are, by their very nature, complex adaptive systems and, in many case, complex flow systems—I should emphasize that not all economists preoccupied with complexity science and behavioral psychology within the post-neoclassical paradigm are also sensitive to ecological issues. In fact, as we saw in section C.7, what led to the emergence of the new paradigm was an enduring dissatisfaction with the TE-paradigm and its axioms—but Traditional Economics is, in and of itself, not at all attuned to ecological matters. The post-neoclassical paradigm started out from an impulse to revise the neoclassical notions of equilibrium and rationality, in order to bring process and interactivity into the picture, thus harking back to many intuitions harbored by the classical economists: Smith, Malthus, Ricardo, or Marx. But none of those prestigious eighteenth- and nineteenth-century thinkers were very much concerned with the economy being an open system within a closed biosphere. They were preoccupied by—at the time, quite legitimate—questions of population and economic growth, resource allocation, the development of industry and trade, technological progress, and so on. When Vernon Smith talks about “ecological rationality,” he is actually attempting to create an alternative to what he calls “constructivist rationality,” which he sees as pervasive and problematic within Traditional Economics. He takes the opposition from Hayek. According to Smith, The SSSM [standard socioeconomic science model] is an example of what Hayek has called constructivist rationality (or “constructivism”), which stems particularly from Descartes (also Bacon and Hobbes), who believed and argued that all worthwhile social institutions were and should be created by conscious deductive processes of human reason. […] Cartesian rationalism provisionally assumes or “requires” agents to possess complete payoff and other information— far more than could ever be given to one mind. […] These considerations lead to the second concept of rational order, as an undersigned ecological system that emerges out of cultural and biological evolutionary processes: homegrown principles of action, norms, traditions, and “morality.” Ecological rationality uses reason—rational reconstruction—to […] discover the possible intelligence embodied in the rules, norms, and institutions of our cultural and biological heritage that are created from human interactions but not by deliberate human design.88

Basically, ecological rationality as understood by Smith is a form of reason used by the economist—not the agents themselves—to reconstruct a posteriori the emergent genesis of social 88

Vernon L. Smith, “Constructivist and Ecological Rationality in Economics”, loc. cit., pp. 466-470 passim.

institutions and rules. It embodies all types of “invisible hand” arguments whereby an economist rationalizes an outcome or a set of rules by explaining how they might have been the result of the “blind” interaction of boundedly rational agents adopting rudimentary adaptive strategies. This sort of account of the genesis of outcomes and rules is “ecological” in a very broad and general sense: It mimics the idea of non-intentional evolution which tries, on the basis of simple survival strategies on the part of genes or individuals, to explain how elaborate aggregate patterns grew, unintended and unpredicted, out of simple or even simplistic individual patterns. Clearly, one can build models of bounded rationality in which interaction between agents generates the emergence of polluting industries or of steep economic growth paths. Adam Smith’s famous “invisible hand” model of a capitalist market economy is an ecological-rationality explanation of the emergence of an ecologically destructive economic system.Simply because one happens to be using the vocabulary of “evolution,” “adaptation,” “ecosystems,” and “organic emergence” does not mean one is also heeding the necessities of the thermodynamics of natural resources. One can build models of the “evolution” of heavy industries, of the “adaptation” of the oil industry to new market conditions, of “ecosystems” of chemical SMEs, or of the “organic emergence” of low-cost airlines. Such models are far from “ecological” in another sense—i.e., embodying a concern for the finiteness of natural resources and of natural sinks. In his otherwise pathbreaking book, Eric Beinhocker comits this exact same conflation of the two meanings of the word “ecological” when he explains that financial markets do not conform to the efficient-market thesis because they are “ecosystems”: A fundamental claim of Traditional finance is that any patterns or signals in the market will be arbitraged away by ever vigilant and greedy investors. […] Traditional finance assumes that all investors have access to the same information, and if there are any patterns in stock prices, investors will see them and take them into account in pricing decisions, thus driving the market beck to its random walk. [Physicist Doyne] Farmer found, however, that […] markets form a kind of evolving ecosystem. The markets are populated by heterogeneous traders and investors with a variety of mental models and strategies. As those agents interact with each other over time, they constantly learn and adapt their strategies—in fact, one could say they deductivelytinker their way through the Library of All Possible Investment Strategies. The complex interactions of these agents, their changing strategies, and new information from their environment causes patterns and trading opportunities to constantly appear and disappear over time. The Santa Fe Institute’s Brian Arthur poetically once called markets “ecosystems of expectations” to describe this interplay between agents and their strategies. […] The results of the Santa Fe model did a good job of replicating the key statistical characteristics of real-world markets, such as clustered volatility (i.e., punctuated equilibrium).89

While such formal properties of markets certainly can be compared to the similar properties harbored by actual ecosystems in nature, there is no connection at all here with what the newly emerging paradigm of ecological economics views as the central aspect of a genuinely scientific economics: … conventional economics sees the economy, the entire macroeconomy, as the whole. To the extent that nature and the environment are considered at all, they are thought of as parts or sectors of the macroeconomy—forests, fisheries, grasslands, mines, wells, ecotourist sites, and so on. Ecological economics, by contrast, envisions the macroeconomy as part of a larger enveloping and sustaining whole—namely, the Earth, its atmosphere, and its ecosystems. The economy is seen as an open subsystem of that larger “Earthsystem.” That larger system is finite, nongrowing, and materially closed, although open to solar energy. […] [I]f the economy is the whole, then it can expand without limit. It does not displace anything

Eric Beinhocker, The Origin of Wealth, op. cit., pp. 391-393 passim.

and therefore incurs no opportunity cost—nothing is given up as a result of physical expansion of the macroeconomy into unoccupied space. But if the macroeconomy is a part, then its physical growth encroaches on other parts of the finite and nongrowing whole, exacting a sacrifice of something—an opportunity cost, as economists would call it. […] The Earth-ecosystem is not a void; it is our sustaining, lifesupportive envelope. It is therefore quite conceivable that at some point further growth of the macroeconomy could cost more than it is worth. […] Growth can be uneconomic as well as economic. There is an optimal scale of the macroeconomy relative to the ecosystem. How do we know we have not already reached or passed it?90

In the context of ecological economics, the notion of “ecological rationality” implies that we—both as top-down policy makers and as bottom-up citizens—ask ourselves how we can manage the economy as a subsystem of the Earth-ecosystem, i.e., how we can use the powers of reason in order to build and operate an economy that will durably remain within the strict boundaries prescribed by the closed Earth-ecosystem. Being ecologically rational means building an ecologically literate economic paradigm which, although it does not reject the important acquisitions of the post-neoclassical paradigm, broadens or deepens it to include various ecologically crucial concepts and tools, both at the level of macrocommunities (bio- and geoscientific knowledge, entropy thinking, systems thinking, resilience, intergenerational calculus, evaluation of ecosystem services, etc.) and at the level of the microcitizens (commons thinking, ecological intelligence, grounded economic awareness, etc.).91 Economic agents simply can no longer be assumed to be the myopic, narrowly adaptive entities postulated by the post-neoclassical paradigm. Nor can the economy as a whole be conceived as if the material limitations of sources and sinks did not exist. In fact, the basic thermodynamic facts of entropy have to become part of individual agents’ rationality, along with basic aspects of systems thinking and commons thinking. In other words, any economic paradigm building on today’s postneoclassical mainstream will have to quite significantly alter its conception of people’s rationality and values. This does not mean we have to naively postulate that all agents already care equally strongly about ecological issues—they do not, of course, as recent experimental fieldwork on denial attitudes demonstrates.92 However, we do have to include the notion of denial itself in our reflection on the economy: How is it that so many “rational” economic agents can be induced, by the very economic system within which they interact, to neglect their own critical potentials and forego a higher level of environmental awareness? What are the deep-seated fears and anxieties that lead so any agents to remain in denial vis-à-vis ecological threats, and how is the functioning of the economic system instrumental in solidifying these fears and anxieties? This crucial theme— which I view as part of a paradigm of existential ecological economics to be developed urgently—ties in with the topic of “critical political economy” to be developed in section C.8.3 below. Is ecological economics constructivist? Is it a threat to the “ecological rationality” put forward by Hayek and Vernon Smith? Yes and no. There is, indeed, a constructivist element in ecological economics, in that certain large environmental externalities can only be dealt with at an aggregate level through partly non-market mechanisms that involve planning and political consensus. Particularly because of the problem of denial, and because of the related difficulty of the dominance of short-term reasoning among agents in the current economic system (a feature which 90 Herman E. Daly and Joshua Farley, Ecological Economics: Principles and Applications, second edition (Washington, DC: Island Press, 2011), pp. 15-16.

See e.g. Arran Stibbe (ed.), The Handbook of Sustainability Literacy: Skills for a Changing World (Totnes: Green Books, 2009).

See, in particular, Kari Marie Norgaard, Living in Denial: Climate Change, Emotions, and Everyday Life (Cambridge: MIT Press, 2011). 92

Money and Sustainability also connects with the functioning of our monetary system, as we shall see in section C.8.2 below), bottom-up emergence through market interactions or collective action cannot necessarily be counted on. The agents postulated in the mainstream post-neoclassical paradigm are way too unaware of global ecological issues to be entrusted with spontaneously creating the conditions for the survival of humankind within the Earth-ecosystem. In that sense, a strong element of constructivism has to be present: Political decision makers, as well as more ecologically aware or enlightened citizens, need to take the lead in setting up mechanisms and institutions that will create incentives for even non-committed, non-enlightened agents to contribute to sustainability. (Some of the complementary currencies discussed in Money and Sustainability are driven by this realistic philosophy.) However, bottom-up emergence is not thereby rendered useless. We saw that the agents postulated by the post-neoclassical paradigm do have a capacity, and a will, for inter-individual learning. Therefore—and this, again, ties in with the “critical political economy” theme of section C.8.3 below—if the mechanisms and institutions initially constructed succeed in raising the level of sustainability awareness of a sufficient number of economic agents (consumers, entrepreneurs, investors, etc.), the spread of new ideas and practices may get triggered, and markets as well as NGOs may gradually become more and more conducive to sustainability generated from the bottom up. Ultimately, the distinction between top-down regulation and bottom-up emergence may vanish completely, as critically and ecologically rational economic agents end up internalizing by themselves the necessities of sustainability and cooperate politically to create the mechanisms and institutions subject to which they wish to interact. We would then have a framework in which to make sense of ecologically driven social complexity. Thus, intersecting the current post-neoclassical paradigm and the ecological economics paradigm is certainly an urgent task for any economist who wishes to contribute to a sustainable world while firmly remaining within the state-of-the-art canons of his or her profession.93 In Money and Sustainability we have not developed such an intersection fully at the methodological level, but we have endeavored to offer the reader sufficient operational elements in the area of monetary reform so that he or she can get a taste for what the new paradigm might feel like.

C.8.2. Making the post-neoclassical paradigm sensitive to the behavioral efficaciousness of money It is striking that different findings from neuroscience seem to have opposed implications when it comes to the behavioral efficaciousness of institutions, and of money in particular. Let me highlight three findings put forward by Colin Camerer, George Loewenstein, and Drazen Prelec. 1. First, “neuroscience findings raise questions about the usefulness of the most common constructs that economists commonly use, such as risk aversion, time preference, and altruism.”94 Degrees of risk aversion, preference for the present, or other-regarding behavior may differ across situations for a given individual, because of a property of the brain called “modularity,” which

A good example of what is already being done in this area is Giuseppe Munda, “Conceptualising and Responding to Complexity”, EVE (Environmental Valuation in Europe), Policy Research Brief #2, Cambridge Research for the Environment, 2000.

Colin F. Camerer, George Loewenstein and Drazen Prelec, “Neuroeconomics: How Neuroscience Can Inform Economics”, loc. cit., p. 31. 94

means that the brain “composes” our motivations out of a number of basic modules which get combined differently in different situations. All intertemporal tradeoffs, and all “me-or-him” tradeoffs, may not be the same even for the same agent. 2. Second, “the existence of specialized systems [within the brain] challenges standard assumptions about human information processing and suggests that intelligence and its opposite—bounded rationality—are likely to be highly domain-specific.”95 The basic idea there is that (to focus just on the cognitive half) our brains work with certain specialized, quadrant-III subsystems which work incredibly fast and effortlessly but also with certain serial and effortful, quadrant-I processes; thus, to solve a given problem some agents may have an automatic process available and look like very rational individuals, while others may have to do the same task in a conscious, controlled way and look like clumsy flat-foots… There are some domain-specific expertises in some areas for some agents, so that using an across-the-board assumption of bounded rationality or of unbounded rationality is unwarranted. 3. Third, “brain-scans conducted while people win or lose money suggest that money activates similar reward areas as do other ‘primary reinforcers’ like food and drugs, which implies money confers direct utility, rather than simply being valued only for what it can buy.”96 Findings seem to suggest that the same brain areas are activated when subjects perceive a beautiful face, a funny cartoon, a sports car, a drug, or money. This means that money enters agents’ utility functions not just indirectly as a source of purchase, but also directly—and that, therefore, parting with one’s money may be painful even if one is buying a pleasant or desired object. “The pain-of-paying may also explain why we are willing to pay less for a product if paying in cash than by credit card.”97 What is striking about the way in which these three findings are presented is that while the first two point toward a capacity of the human brain to be highly modular and to mobilize very contextual competences—i.e., a capacity to be very flexible depending on the overall situation in which the agent finds him- or herself—the third appears to put “money” on the same level as “a beautiful face” or “a drug.” Never do the researchers ask: What kind of money? Are we sure that what we are detecting in our experiment is the effect of “money per se,” or are we in fact seeing the neurological effects of monopolistic bank-debt money? Thus, money is presented as a generic “thing” on a par with other things that have fixed neurological effects: an addictive substance or a perception of beauty. This makes money—which in these contemporary experiments can only be monopolistic bank-debt money—into an all-purpose, neutral object. This reflects the commonly held view that “money” is a homogenous substance. In fact, as we argue at great length in Money and Sustainability, this view is erroneous. That it should slip even into the research presuppositions of high-ranking experimental and behavioral economists is revealing of how deep the problem is. Here is how Richard Douthwaite expresses this problem: Most people think that there’s only one type of money because one type is all they’ve ever known. […] Money is money, they think, regardless of the form it takes. Only the few who know a little monetary history, or are members of a Local Exchange Trading System (LETS), realize that this is not the case. There are, potentially at least, many different types of money, and each type can affect the economy, human society and the natural environment in a different way. Most economists think that there’s only one type of money too. That is when they think about it at all. […] David Hume, one of the founding fathers of economics, referred to money as “the oil which

Ibid., p. 32.

Ibid.

Ibid., p. 37.

renders the motion of the wheels smooth and easy,” and this attitude persists to this day. Indeed, Paul Samuelson’s well-known economics textbook defines economics as “the study of how men and society choose, with or without money, [my italics] to employ scarce productive resources.” In other words, economists see money acting as a catalyst that eases and speeds up economic interactions that would have taken place anyway. […] However, very few seem to have ever considered the possibility that the particular type of monetary catalyst in use might be affecting the outcome of the economic interaction, and that if other forms of money were used the results might be quite different. […] [H]istory is littered with examples of monetary systems that operated on quite different lines to the one we know at present. If these systems had survived, they would have produced cultures most unlike today’s unsustainable, unstable global monoculture. […] Certainly, if we wish to live more ecologically, it would make sense to adopt monetary systems that make it easier for us to do so.98

Similarly, Thomas Greco writes that Money is the vital medium within which we live our economic lives. It is the central element around which many of our interpersonal relationships are organized. It is no exaggeration to say that the quality and essence of our medium of exchange, our money, are crucial to the quality of our lives—our social interactions, our personal priorities, our relationship to the earth, and our ability to satisfy basic human needs. As water is to the fish, so money is to people. Though we are largely unconscious of it, its quality (as opposed to quantity) is crucial. When the water is polluted, the fish sicken and die; when money is “polluted,” our economy malfunctions, and people suffer as their material needs go unmet and social dynamics are distorted.99

There is a widespread consensus among monetary reformers that the unspoken reduction of monopolistic bank-debt money to a generic, unqualified entity called “money” is a major source of intellectual as well as political powerlessness. In fact, the very notion of “economic rationality,” with its postulated primacy of competitiveness over cooperativeness, is partly a by-product of a specific way of creating and circulating money, as Bernard Lietaer has suggested: When the bank creates money by providing you with your £100,000 mortgage loan, it creates only the principal when it credits your account. However, it expects you to bring back £200,000 over the next twenty years or so. If you don’t, you will lose your house. Your bank does not create the interest; it sends you out into the world to battle against everyone else to bring back the second £100,000. Because all other banks do exactly the same, thing, the system requires that some participants go bankrupt in order to provide you with this £100,000. To put it simply, when you pay back interest on your loan, you are using up someone else’s principal. […] In summary, the current monetary system obliges us to incur debt collectively, and to compete with others in the community, just to obtain the means to perform exchanges between us. No wonder “it is a tough world out there,” and that Darwin’s observation of the “survival of the fittest” was so readily accepted as self-evident truth by the 18th century English, as well as by any societies that have accepted, without question, the premises of the money system that they designed, such as we have today.100

The intense focus of individuals and groups—such as businesses—on growth is also a by-product of interest-bearing bank-debt money. So is, for instance, our postmodern civilization’s obsession with novelty and obsolescence, as well as our tendency to demand and consume low-quality, non-

98 Richard Douthwaite, The Ecology of Money (Totnes: Green Books, 1999), pp. 9-10. (Italics added except for those already added by Douthwaite.)

Thomas H. Greco, Money: Understanding and Creating Alternatives to Legal Tender (White River junction: Chelsea Green, 2001), p. 3. 99

100

Bernard Lietaer, The Future of Money: Creating New Wealth, Work and a Wiser World (London: Century, 2001), pp. 51-52.

durable goods.101 By contrast, different ways of creating and circulating means of exchange have, in the past, led to substantially different cultures and civilizations. The Central Middle Ages are one example: Two different types of currencies functioned in parallel to one another throughout much of Western Europe during the Central Middle Ages. One type of currency consisted of centralized royal coinage, with many features in common with present-day national currencies. Its usage was primarily for long-distance trading and for the purchase of luxury goods. The second type of currency consisted of an extensive network of different local currencies, used primarily for community exchanges. Many of the local currencies had a very peculiar feature—a demurrage charge. Similar to a negative interest on money, the demurrage feature functions like a parking fee, which is levied for holding onto the currency for too long without spending it. […] In technical terms, when demurrage is applied, money continues to function as a “medium of exchange” but no longer as a “store of value,” that is, something worth hoarding. Though saving was much encouraged, it was not done by storing currency, but took the form of productive assets. Examples of such investment were land improvements or high-quality maintenance of equipment such as water wheels or windmills, or enduring investments in the community such as the cathedrals. […] In effect, a pattern of longer-term investments became the norm rather than the exception. […] Demurrage-charged complementary currencies also help to explain the particular Central medieval economy. Given that savings [through hoarding] were inherently discouraged by demurrage, these currencies would remain in circulation and were exchanged with far greater frequency at all levels of society, in contrast to other forms of money. The greater velocity of circulation […] enabled the less privileged classes to engage in substantially more transactions, which significantly improved their standard of living.102

It is therefore time to move from what we could call monetary essentialism—i.e., the misguided view that “money” is a neutral, almost metaphysical entity whose effects remain the same regardless of the concrete shape it takes—to monetary behaviorism: the empirically correct view that money can take different concrete shapes and that depending on the shape it takes, its effects will actually vary greatly. This second property is, as we saw, vindicated by the neuroscientific findings that tell us that the human brain is characterized by modularity and context-specific competences—with the implications that engineering new forms of money beyond the monopolistic bank-debt form is, in fact, likely to profoundly modify the behavioral basis of our culture and our civilization. Monetary behaviorism can and should be—as we have begun to do in Money and Sustainability— intersected with the “ecologically driven social complexity” approach. In doing so, we can promote a paradigm that recognizes the foundational character of money as an incentive mechanism while allowing us to focus some of those monetary incentives on sustainability issues within a complex economy.

C.8.3. Opening the post-neoclassical paradigm to critical and existential rationality Intersecting the post-neoclassical paradigm with the ecological economics paradigm and with monetary behaviorism creates a rich methodology, which we want to promote through Money and Sustainability. However, there is an element still missing—one we have already touched upon briefly in section C.8.1 when we discussed the two meanings of “ecological rationality”: is it the

See e.g. Michael Rowbotham, The Grip of Death: A Study of Modern Money, Debt Slavery and Destructive Economics (Charlbury: John Carpenter, 1998).

101

102

Bernard Lietaer and Stefan Belgin, New Money for a New World (Boulder: Qiterra, 2012), p. 68-70 passim.

economist’s own rationality as a “thinker”’ who realizes the importance of ecological and sustainability issues and then constructs the “right” incentive mechanisms (from the top down, as it were), or is it also the citizens’ rationality as they gradually become aware of the ecological threats and urgencies weighing upon the planet and begin to take action (from the bottom up)? What we have found consistently disturbing in our detailed study of post-neoclassical economics in section C.7 is the deeply ingrained mechanicism that pervades even the most sophisticated approaches. Complexity, behavioral, and neuroeconomics have been found lacking because they consistently present collective and individual economic life as mindless—not as “brain-less,” of course, since quite to the contrary the role of the human brain’s chemistry, electricity, and emergence-generating complexity has become more and more central; but as mind-less, in the sense that individual systems embedded in larger collective systems are seen as highly sophisticated “problem-solving” devices, as individual biocomputers within collective sociocomputers. The disturbing issue is: What if this is indeed a true description of what we are? Not true in an absolute sense, but true given the lives we lead and have been leading for centuries or even millennia? What if the majority of humanity is indeed, in its current state, a collection of “subjectless” entities scurrying around in a “blind” natural world, determined by “blind” natural processes, and generating the emergence of “subjectless” social processes? To put things differently, is not the way in which post-neoclassical economics portrays social and economic life simply the “hidden truth” of how we actually lead our lives? Are we, in fact, more than mechanical entities interacting with other mechanical entities to generate emergent mechanical entities? What if exteriors without interiors are all there is? Recall, for instance, Camerer, Loewenstein and Prelec’s discussion of “affective” processes their survey of neuroscientific contributions to economics. They made it quite clear that what goes on in our affective neural processes is not conscious and is not linked to feelings or emotions as conscious experiences. I quoted them as saying the following: Most people undoubtedly associate affect with feeling states, and indeed most affect states do produce feeling states when they reach a threshold of intensity. However, most affect probably operates below the threshold of conscious awareness […]. As Rita Carter [in her book Mapping the Mind, 1999] comments, “the conscious appreciation of emotion is looking more and more like one quite small, and sometimes inessential, element of a system of survival mechanisms that mainly operate—even in adults—at an unconscious level.” For most affect researchers, the central feature of affect is not the feeling states associated with it, but its role in human motivation. […] Affective processes […] are those that address “go/no-go” questions—that motivate approach or avoidance behavior.103

This can be seen as a positive, “scientific” description of the way things are—or it can be seen as a critique of the habitual “mechanicalness” of human behavior in the world as we humans have shaped and consolidated it. In other words, it can be seen as scientific support for a critique of our fundamental spiritual alienation! Jeanne de Salzmann has written the following, which could be considered as a conscious subject’s pained reaction to the sort of neuroscientific data described by Camerer, Loewenstein, and Prelec: I have the power to rise above myself and to see myself freely … to be seen. My thought has the power to be free. But for this to take place, it must rid itself of all the associations which hold it captive, passive. […] Otherwise, our thoughts are just illusions, objects which enslave us, snares in which real thought loses its power of objectivity and intentional action. Confused by words,

Colin F. Camerer, George Loewenstein and Drazen Prelec, “Neuroeconomics: How Neuroscience Can Inform Economics”, loc. cit., p. 18. 103

images, forms that attract it, it loses the capacity to see. It loses the sense of I. Then nothing remains but an organism adrift. A body deprived of intelligence. Without this inner look, I can only fall back into automatism, under the law of accident. […] Each time, the first step is the recognition of a lack. I feel the need for real thought. The need for a free thought turned toward myself so that I might become truly aware of my existence. An active thought, whose sole aim and sole object is I … to rediscover I. So my struggle is a struggle against the passivity of my ordinary thought. Without this struggle a greater consciousness will not be born. […] Without this effort, thought falls back into a sleep filled with words, images, preconceived notions, approximate knowledge, dreams, and perpetual drifting. This is the thought of a man without intelligence. It is terrible to suddenly realize that one has been living without a thought that is independent—a thought of one’s own—living without intelligence, without something that sees what is real […].104

In other words, what the neuroeconomists are describing is not false, but it might not be spiritually acceptable: if something here is “spiritually ill,” perhaps it is not the economics profession as such, with its focus on the post-neoclassical paradigm, but the psychosomatic and socioeconomic reality it apprehends via that paradigm. More precisely, it may be that post-neoclassical economists dismiss the autonomy of personal subjectivity and collective intentionality because, in actual fact, the economic agents they are modeling—you and I—are themselves virtually unaware of the existence of subjectivity and collectivity in their own ongoing awareness… This amounts to implicitly assuming that the agents themselves use a paradigm of knowledge that instructs them to “treat” their environment as if they were the sorts of agents which neuroeconomics conceives them to be—sophisticated, information-processing automata with no awareness of any “I” or any “We.” Thus, we would have two paradigms coexisting: the economist’s paradigm and the agents’ paradigm. From the point of view of the economist, the agents’ paradigm is something like the four-quadrant model set out by Camerer, Loewenstein, and Prelec in section C.7.6. The issue we are grappling with at the moment can now be reformulated as follows. Given the nature of what we could call the agents’ “spontaneous” paradigm, economists seem to be justified in structuring their scientific paradigm in the way they have—i.e., as a paradigm combining the agents’ paradigm with complexity economics. Why, then, should we insist that economists “open up” their approach to agents’ awareness of “I” and “We”? Is not everything conditioned by the agents’ own narrow and mechanical view on reality, which it is the duty of economists to study as such, something which we epistemologists seem to have no right to criticize them for? Asking the question in this way is disturbing because it implies that, as long as the agents themselves do not, at their own level, open up their awareness to “I” and “We,” economics need not, at its own level, “force” empirical reality and study subjectivity- and culture-related issues which “real agents” are indifferent to. If neuroeconomists and the neurophysiologists who inspire them are empirically right that we humans and our societies are basically nothing more than sophisticated biocomputers without ultimate interiors, there is no rush to build an economics that denies this, is there? However, powerful as it is, the objection does not ultimately hold water. In fact, what if awareness of oneself as more than a mere computer and of the world around oneself is, indeed, constantly active—though not always acknowledged nor even always “remembered”—in any agent’s awareness? Then the only way to make sense of this is to accept the idea that the agents observed by neuroeconomics, and combined with complexity economics in the post-neoclassical paradigm, are people who

Jeanne de Salzmann, “The Awakening of Thought” (1958), reprinted in Jacob Needleman (ed.), The Inner Journey: Views from the Gurdjieff Work (Sandpoint: Morning Light Press, 2008), pp. 2–3. 104

live their lives in actual “forgetfulness” of their own interiority and of the “big picture” surrounding them. These agents cannot be called anything else but existentially and culturally alienated, though actually real, people. Most spiritual traditions qualify such people as “asleep” or “unaware,” even “unintelligent” as Jeanne de Salzmann’s above text shows (and contrary to Herbert Simon who talks about adaptive economic agents as “intelligent systems”). Positive economics of a post-neoclassical variety can legitimately take such people and their interactions as their object, since indeed these people are real as attested by the data collected by brain science and experimental economics. However, what such positive economics will thereby do is simply reinforce the empirical validity of alienation. By structuring economic knowledge along the lines of the post-neoclassical paradigm, we are bound to reinforce the “automaticity” or the “mechanicalness” with which most empirical economic agents spontaneously go about their economic lives, without an experienced sense of “I” and of “We”—spiritual traditions would say, without any “self-remembrance.” How exactly does post-neoclassical economics reinforce the reality it studies? Simply by teaching and disseminating a theoretical and empirical picture of human biocomputers who seem to have lost all capacity to perform what de Salzmann calls “the first step,” which is “the recognition of a lack.” This lack, she says, is the fact that most of the time, most of us are oblivious to “free thought turned toward myself so that [we] might become truly aware of [our] existence”—both individually (which is what she dwells on most) and collectively. She also calls this the “inner look,” without which we “can only fall back into automatism.” Echoing this insight, and insisting on the fact that automatic action is—even when “rational”—connected only with exteriors, Piotr Ouspensky has said the following: What does it mean that man is a machine? It means that he has no independent movements, inside or outside of himself. He is a machine which is brought into motion by external influences and external impacts. All his movements, actions, words, ideas, emotions, moods, and thoughts are produced by external influences. By himself, he is just an automaton with a certain store of memories of previous experiences, and a certain amount of reserve energy.105

One could not dream of a more exact description of the sort of human agent complexity and neuroeconomists have in mind, and use successfully in experimental economics in order to explain real-world phenomena. The question is, Is this “real world” spiritually acceptable? Without an ability for the same agents to actually exercise free thought and to perform the “inner look” so as to validate that external reality existentially, who can say that the reality economists successfully describe is humanly adequate? Humans may be unconsciously, and without any awareness of it, living in systemic hell of their own—mechanical—making. And they are the only ones who can, through subjective experience (“I”) and communication of that experience (“We”), find out whether it is hell and, if so, what to do about it. This requires ceasing to be mere machines: In the English language there are no impersonal verbal forms which can be used in relation to human actions. So we must continue to say that man thinks, reads, writes, loves, hates, starts wars, fights, and so on. Actually, all this happens. Man cannot move, think, or speak of his own accord [i.e., man has no interior]. He is a marionette pulled here and there by invisible strings. If he understands this, he can learn more about himself, and possibly even things begin to change for him. But if he cannot realize and understand his utter mechanicalness, of if he does not wish to accept it as a fact, he can learn nothing more, and things cannot change for him. Man is a machine, but a very peculiar machine. He is a machine which, in right circumstances, and with

105

Piotr D. Ouspensky, The Psychology of Man’s Possible Evolution (1950) (New York, NY: Vintage, 1974), p. 12.

right treatment, can know that he is a machine, and, having realized this, he may find the ways to cease to be a machine.106

The question is whether the post-neoclassical language which speaks of “rational” action within a setting without any interior experience of “rationality” can be of any help in “find[ing] the ways to cease to be a machine.” The answer is clearly negative: Without interiors explicitly taken into account, and not reduced to sophisticated sorts of exteriors, sophisticated biocomputers will remain what they are—and an economic science which presents them as such will consolidate the perception by the users of economics, that agents are indeed mere biocomputers and can, especially for macro-management purposes, be treated as such. So, often without being fully conscious of it, harbor an intellectually as well as socially perilous agenda; they would devise macro- or micropolicies—to implemented on us—subject to the “working assumption” that our interiors do not “really” matter. These are often harsh measures which neglect human frailty and ambiguity and make it sound as if, when you are unemployed or poor, there is something wrong with your functional fit into the system. “Incentive schemes” are being built up so that, on the basis of simplistic behavioral stimulus-response models, you can be expected to react in such a way that it will be your rational choice to fit back into the system, regardless of whether the function then assigned to you is a humanizing, potential-deploying function. That is not part of social statistics, and it is not part of cutting-edge neuroeconomics and complexity economics, either. Keep It Simple is the standard economics instructor’s motto when he educates budding economists—and it means: keep it mathematically and/or computationally tractable. Who needs interiors when exterior macromanagement of the economy, and hence parsimonious “explanation-to-manage,” is what is ultimately involved? As David Weissman (2000: 212) has so strikingly put it, “separable if distinguishable is our social policy.”107 And he adds, more explicitly: Never doubting that we humans have a distinguishing character and privacy, I challenge the psychological and moral self-sufficiency ascribed to individual persons. The individuating conditions for persons—our separate bodies—are not in doubt. The conditions for our psychological, moral, and cultural identity are a different matter. Their development is a process of engagement and dependence, nit one of monadic self-articulation. […] Our bodies are separate; yet, our psychic postures are distinguishable, not separable, from the postures of others.108

Economists who adopt such an ontology are, regardless of their very high intellectual abilities or professional integrity which are not in question here, permanently stuck in mechanistic and topdown territory. Such an application of a purely systemic perspective to individuals who are themselves unaware of their own subjectivity and of the broad issues surrounding them is bound to reinforce the alienation of “unintelligent machines.” It may well be that contemporary economics is antihumanistic not so much because it wrongly portrays us human agents as unreflexive automata, but because it correctly portrays us as such and, thereby, consolidates and reinforces the reality of our spiritual alienation. Only a genuine access to our subjective and cultural dimensions can bring the hope for a less spiritually alienated economic reality. This means basically two things:

106

Ibid., pp. 12-13.

107

David Weissman, A Social Ontology (New Haven: Yale University Press, 2000), p. 212.

108

Ibid., p. 21.

Economics should become post-post-neoclassical in the sense of introducing individually and collectively interior dimensions explicitly into its theories and models. This will make economics into an initially unrealistic discipline, since it will theorize possible but unactualized, rather than empirically observable, agents. Economics should study the economic factors which have, up until today, tended to make us empirically into biocomputers. This will make economics into a critical discipline, since it will theorize on systemic factors which make us into the sorts of agents we are but ought not to be. What sort of economics might we start building? We might certainly start from the recognition that the fact of the post-neoclassical paradigm’s being empirically relevant implies that we are a kind of individual we ought not to be. As de Salzmann and Ouspensky above, like so many other spiritual thinkers through history, have emphasized, an interior-less economic agent is an automaton that goes through routines and optimizes without any awareness or consciousness of what she is doing. In particular, as long as we remain such agents we have no ability to form a judgment about what is wrong with our “sleepy” lives in the ongoing economy, or about what aspects of that economy should be changed if our lives were to be truer to what, through her religion, spirituality, and/or culture, she views as her fullest human potential—namely, an “awakened” awareness and a socially critical reflexivity. In other words, as automaton-agents we are able of neither existential nor critical judgment because we are devoid of a deliberate, conscious individual interior (subjective) and are foreign to any deliberate, conscious collective interior (cultural). So, as a first step, economics has to make room, within the notion of “economic rationality,” for existential rationality and critical rationality. It hence must aim to understand an economic system’s existential performance: How do agents experience their deeper existential dimensions within the system? an economic system’s critical performance: To what extent does the system allow the agents within it to develop, and act upon, critical abilities? One of the main implications of this is that economics has to become evolutionary in a way that it is not yet today: it has to embrace our ability, and our (often stifled) desire, for individual work on what it means to be “economically rational” and for collective work on what a truly “human-potentialenhancing” economic system would be. In short, post-post-neoclassical economics has to fully honor our ability for conscious evolution, while at the same time explaining why we have remained so deeply “asleep” and why we are so “mechanical” and have so little conscious desire for such conscious evolution. On the contrary, today’s post-neoclassical complexity economics is still stuck within a narrowly adaptive and computational form of consciousness and allows reflection and ideology to intervene only to explain agents’ low-consciousness “adaptation” to “changing circumstances” through time. Intersecting the post-neoclassical paradigm with an approach that allows for the exercise of agents’ critical and existential rationality—this is, in my view, one of the most urgent tasks at hand for economists. I call it the creation of a “critical political economy”: the model of an economic system within which economic agents are (a) aware of their own personal interior and of the quest for meaning that goes on there, and are (b) willing and able to reflect critically on the kind of system they inhabit and on the kinds of rules and mechanisms they want to live their lives and carry out their economic activities. The agents modeled by the post-neoclassical paradigm, with their bounded rationality of a very specific kind, are by definition devoid of these “reflexive” features. In Money and Rationality, we have begun to introduce these features by showing that, under the right circumstances, some citizens will mobilize from the bottom up, out of actual concern for the

world around them—because they have reflected critically on the meaning of the economic system and on the urgent demands of its sustainability—in order to create complementary currencies. At the same time, we are aware that not all citizens will spontaneously mobilize in this way—there are many of us who are still “asleep” and “mechanical” in de Salzmann’s and Ouspensky’s sense. Therefore, top-down governance—in the form of the government imposing taxes in certain complementary currencies, or legally imposing the circulation of certain currencies such as the ECOs—is also a part of the setup.

C.9. Toward a new economic paradigm? As I emphasized at the very beginning, despite its length and detail this Appendix is desperately partial and fragmentary. Many economists, especially at the more “heterodox” fringes of the profession, will feel their paradigmatic approaches haven’t been done justice, and they’re right. I have chosen—in sections C.5, C.6, and C.7—to stay within the currently developing mainstream and to investigate the directions in which that mainstream could be further developed. Of course, in the process, I have suggested—in section C.8—additions and extensions which venture into resolutely heterodox territory. This is, as we saw in section C.4, part and parcel of the very dynamics of paradigms. The general orientation of my discussion is that the currently developing post-neoclassical paradigm still possesses some features in common with its neoclassical, or Traditional Economics, predecessor which need to be overcome. This is why I have offered up a threefold intersection. Essentially, the post-neoclassical paradigm—which encompasses complexity economics, behavioral economics, neuroeconomics, and experimental economics—should be intersected with (a) ecological economics, in order to integrate structurally into its analytic tools the laws of thermodynamics and the concepts of entropy and finiteness; (b) monetary behaviorism, in order to acknowledge the primacy of the creation and circulation of means of exchange not only as incentives but as shapers of people’s aspirations and social relations; and (c) critical political economy, so as to come to grips with the fact that economic agents, as citizens of a cultural and political community, do not only react to incentives like lab rats but are actually active in creating and legitimizing the incentives to which they agree to submit. This new paradigm, which for lack of a better expression I would call complexity-based, ecologically oriented monetary behaviorism with critically rational agents, is the paradigm we have tried to put forward in Money and Sustainability. Our approach still has things in common with key features of the post-neoclassical paradigm. Because it recognizes inescapable social complexity as well as the complexity inherent in natural ecosystems, it is not completely hypothetico-deductive. It can use analogy and intuition to sketch out predictions—for instance, what might happen if citizens adopt such and such complementary currency—but it does not bank on the possibility of “resolving” formal models in any simple way. Consequently, in keeping with the tenets of experimental economics, our paradigm relies heavily on social experimentation—with the difference that the experiments being looked at are full-scale, real-life ones built by citizens, companies or governments with the help of experts. (Bernard Lietaer, in particular, is often called upon to assist communities in setting up special-purpose payment systems or complementary currencies.) In that sense, our approach is even more heavily inductive and “aposterioristic” than what Vernon Smith suggests; it might therefore benefit from a more rigorous anchoring in the clinical-trial type of methodology pioneered in poverty economics

by Esther Duflo and her colleagues.109 However, there remains a big difference between our approach and Duflo’s: Many of the complementary currency experiments we look at would need to be so large-scale that the technique of clinical trials—which implies the creation of two groups, one that experiments and one that serves as a control group—will not necessarily be feasible. On the other hand, “control groups” already exist naturally in any monetary regime in the sense that the default compared to using any complementary currency is the routine use of the established, official national bank-debt currency. The ecological as well as monetary literacy of economic agents—entrepreneurs, consumers, workers, investors—is crucial to our approach. In fact, as Money and Sustainability argues throughout, the two types of literacy are closely linked in today’s world: Without better knowledge of what money is about and how it works now and could work in the future, many opportunities for ecological sustainability remain untapped. The current monetary system acts as an intellectual and behavioral straightjacket. This is the reason why our proposed paradigm insists so much on agents’ critical (and existential) rationality: Contrary to what is often the case in clinical-trial experiments when it comes to basic education, basic health or other poverty issues where experts and political decision makers target disenfranchised populations, in the case of “new money” there is often a very vibrant and committed fringe of citizens who seek to launch experiments and who already have a fairly elaborate idea as to why they want a new monetary tool and what they wish to attain with it. In fact, within a complex and non-linear economy, the learning processes triggered by local experiments can sometimes produce unexpected, large-scale effects. That is why Money and Sustainability calls on decision makers to facilitate monetary experimentation, to allow it to happen wherever possible, and to participate in the evaluation and generalization of what worked well. This is the very essence of any deliberate process of “harnessing complexity,” as described in detail in section C.7.5 above. One of the key messages underlying our proposed paradigm is that money is not just an incentive tool to make existing institutions work better and to facilitate exchanges that would have taken place anyway. It is, in fact much more than that—a tool that can be shaped so as to create new types of exchanges and new types of social relations that would not take place and could not exist under the current monetary regime. How do we know which new exchanges and which new types of social relations are desirable? The urgencies of long-term sustainability certainly impose themselves on anyone’s plans and decisions, but in a complex, free society the orientations of sustainability policy—hence the kinds of money that should be created—emerge from the interaction of experts, political decision makers, and citizen groups. Economics can become a science in the service of freely thinking, freely acting, self-aware, and world-oriented citizens.110 This is the picture that Money and Sustainability wants to offer.

Christian Arnsperger

This is Appendix C to Money and Sustainability: The Missing Link. To read more about the book or to order a copy, visit: www.triarchypress.net/money-and-sustainability

See Abhijit V. Banerjee and Esther Duflo, Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty (New York: Public Affairs, 2011). 109

This statement, which informs this whole Appendix, is motivated in great detail in Christian Arnsperger, Critical Political Economy, op. cit. 110

Complex Flow Networks

Money and Sustainability: Appendix D This appendix presents more of the theoretical framework on which the proposed scientific approach towards sustainability used in the Report is based. The approach used here is mathematical. It is completely based on conventional Western science, integrating thermodynamics, network theory and information theory.

Mathematical Demonstration for Quantifying Sustainability of a Complex Flow Network: Evidence for Yin-Yang in Nature1

Contemporary science is preoccupied with that which exists; it rarely accounts for what is missing. But often the key to a system’s persistence lies with information concerning lacunae. Such unutilised reserve capacity is complementary to the effective performance of the system, and too little of this attribute can render a system brittle to 1

This appendix is summarising parts of the paper by Ulanowicz, Goerner, Lietaer and Gomez “Quantifying Sustainability: Resilience, Efficacy and the Return of Information Theory” in the Journal of Ecological Complexity Vol 8 #1 (March 2009). In this appendix only the bare mathematical bones of the argument are extracted from this paper. The reader who wants a step-bystep justification for the underlying logic, its implications and concrete examples of this process should consult the original paper. A variation on this Appendix has also been published separately in Simon Mouatt and Carl Adams (ed.) Corporate and Social Transformation of Money and Banking `(Palgrave MacMillan, 2010) pp. 238-245.

the point of collapse. We can now measure with a single metric any complex flow network system’s sustainability in terms of the trade-off allotment of each. This approach provides heretofore missing theoretical justification for efforts to preserve biodiversity whenever systems have become too streamlined and efficient. It is critically important to understand that the findings described below arise from structural variables of a network. This means that they apply to any other complex flow network with a similar structure. This makes them directly applicable to economic processes and particularly to the flow of money in a financial network or an economy. The starting point is Boltzmann’s classical equation of surprisal,

s=− k log p ,

(D.1)

where s is one’s surprisal at seeing an event that occurs with probability p, and k is an appropriate (positive) scalar constant. One can read this equation as defining s to gauge what p is not. That is, if p is the weight we give to the presence of something, then s becomes a measure of its absence. If p is very small, then the ensuing large magnitude of s reflects the circumstance that most of the time we don’t see the event in question. We will show that the interplay between presence and absence plays a crucial role in whether a system survives or disappears. It is the very absence of order (in the form of a diversity of processes) that makes it possible for a system to persist (sustain itself) over the long run. The product of the measure of the presence of an event, i, (pi) by a magnitude of its absence (si) yields a quantity that represents the indeterminacy (hi) of that event,

h i= − kpi log pi

(E2.2)

When pi ≈1, the event is almost certain, and hi ≈ 0; then when pi ≈ 0, the event is almost surely absent, so that again hi ≈ 0. It is only for intermediate, less determinate values of pi that hi remains appreciable, achieving its maximum at pi = (1/e.) It is helpful to reinterpret (2) in terms germane to evolutionary change and sustainability. When pi ≈ 1, the event in question is a virtual constant in its context and unlikely to change (hi ≈ 0.) Conversely, whenever pi ≈ 0, the event exhibits great potential to change matters (si >> 1), but it hardly ever appears as a player in the system dynamics (so that, again, hi ≈ 0.) It is only when pi is intermediate that the event is both present frequently enough and has sufficient potential for change. In this way, hi represents the capacity for event i to be a significant player in system change or evolution. Seeking a perspective on the entire ensemble of events affecting a system motivates us to calculate the aggregate systems indeterminacy, H, as

H= ∑ hi = − k ∑ pi log p i i

(D.3)

which we can now regard as a metric of the total capacity of the ensemble to undergo change. Whether such change will be coordinated or wholly stochastic depends upon whether or not the various events i are related to each other and by how much. In order better to treat relationships between events, it is helpful to consider bilateral combinations of events, which for clarity requires two indices. Accordingly, we will define pij as the joint probability that events i and j co-occur. Boltzmann’s measure of the non-occurrence of this particular combination of events (1) thus becomes,

s ij= − k log pij .

(D.4)

If events i and j are entirely independent of each other, the joint probability, pij, that they co-occur becomes the product of the marginal probabilities that i and j each occur independently anywhere. Now, the marginal probability that i occurs for any possible j is j occurs regardless of i is

p . j = ∑ pij i

p i.= ∑ p ij j

, while the likelihood that

. Hence, whenever i and j are totally independent, pij = pi.p.j .

Here the assumption is made that the indeterminacy sij is maximal when i and j are totally independent. We call that maximum sij*. The difference by which sij* exceeds sij in any instance then becomes a measure of the constraint that i exerts on j, call it xi|j ,where,

x i j =sij − s

ij − k log pi . p . j − [− k log pij ]=k log

p ij =x j i . p i. p. j

(D.4)

The symmetry in (4) implies that the measure also describes the constraint that j exerts upon i. In order to calculate the average mutual constraint (X) extant in the whole system, one weights each xi|j by the joint probability that i and j co-occur and sums over all combinations of i and j:

X= ∑ pij x i j =k ∑ pij log i,j

i,j

p ij pi . p . j

(D.5)

The convexity of the logarithmic function guarantees (Abramson 1963) that: H≥ X ≥ 0

(D.6)

In words, (6) says that the aggregate indeterminacy is an upper bound on how much constraint (order) can appear in a system. Most of the time, H > X, so that the difference Ψ = (H – X) = − k ∑ i,j

p 2ij pij log pi . p . j

≥0

as well. In the jargon of information theory Ψ is called the “conditional entropy.” Relationship (7) can be rewritten as:

For the remainder of this essay a dot in the place of an index will represent summation over that index.

(D.7)

H = X + Ψ,

(D.8)

and it makes a very valuable statement. It says that the capacity for evolution or self-organisation (H) can be decomposed into two components. The first (X) quantifies all that is regular, orderly, coherent and efficient. It encompasses all the concerns of conventional science. By contrast, Ψ represent the lack of those same attributes, or the irregular, disorderly, incoherent and inefficient behaviors, which conventional science tends to overlook. Up to this point we have spoken only vaguely about events i and j. Without loss of generality, we now narrow our discussion to consider only transfers or transformations. That is, event i will signify that some quantum of medium leaves or disappears from component i. Correspondingly, event j will signify that a quantum enters or appears in component j. We now identify the aggregation of all quanta both leaving i and entering j during a unit of time ― or, alternatively, the ﬂow from i to j (or the transformation of i into j) ― as Tij. Thus, Tij might represent the flow of electrons from point i to point j in an electrical circuit; the flow of biomass from prey i to predator j in an ecosystem; the transfer of money on a microeconomic scale from economic actor i to actor j in an economic community; or the transfer of money or from sector i to sector j at the macroeconomic scale. Here again we use the convention (introduced earlier in footnote 6) that a dot in the place of a subscript indicates summation over that index. Thus Ti. (

= ∑ T ij j

) will represent everything leaving i

during the unit time interval, and T.j will gauge everything entering j during the same duration. In particular, T.. (

= ∑ T ij i,j

) represents the total activity of the system and is given the name “total

system throughput” (which corresponds roughly to the concept of GDP in economic theory).

These definitions allow us to estimate all the probabilities defined above in terms of their measured frequencies of occurrence. That is,

p ij ~

T ij T .. ,

p i. ~

Ti. T .. ,

T. j

and p . j ~ T . ..

(D.9)

Substituting these estimators in equations (3), (5) and (7), yields

H=− k ∑ i,j

T ij T ij log T .. T .. ;

X=k ∑ i,j

T ij T ij T .. log T .. T i .T . j ;

and Ψ=− k ∑ i,j

T ij T 2ij log T .. T i .T . j

, (D.10)

Respectively (Rutledge et al. 1976). The dimensions in the definitions (10) remain problematic, however. All of the ratios that occur there are dimensionless (as required of probabilities). To change that into a useable metric, we will scale each index by the total system throughput, T.. , which conveys the overall activity of the system. In order to emphasise the new nature of the results, we give them all new identities. We call

C=T . . H=− ∑ T ij log i,j

T ij T ..

(D.11)

the “capacity” for system development (Ulanowicz and Norden 1990.) The scaled mutual constraint,

A=T . . X= ∑ T ij log i,j

T ij T . . T i. T . j ,

(D.12)

converts into the measure of a system’s throughput volume per unit of time which we will define as “efficacy” 3, measures the capacity of a system to process volumes of whatever that particular system deals with (e.g. biomass in an ecosystem, electrons in an electrical distribution system, or money in an economy). The scaled conditional entropy,

T 2ij Φ=T . . Ψ=− ∑ T ij log , T i .T . j i,j

(D.13)

we rename the system “reserve”4, for reasons that soon should become apparent. Of course, this uniform scaling does not affect the decomposition (8), which now appears as C = A + Φ.

(D.14)

In other words, (D.14) says that the capacity for a system to undergo evolutionary change or selforganisation consists of two aspects: It must be capable of exercising sufficient directed power, enough efficacy A, to maintain its integrity over time. Simultaneously, it must possess a reserve of flexible actions that can be used to meet the exigencies of novel disturbances. According to (D.14) these two aspects are literally complementary. A system lacking throughput efficacy has neither the extent of activity nor the internal organisation needed to survive. By contrast, systems that are so tightly constrained and honed to a particular environment appear “brittle” and are prone to collapse in the face of even minor novel disturbances. Systems that endure ― that is, are sustainable ― lie somewhere between these extremes. But where? In order to be able to answer that question, we define a = A/C and notice that 1> a >0. Here a is a relative measure of the organised power flowing within the system. Using Bolzman’s formulation, – klog( a ),we shall call an ecosystem’s “fitness for evolution”,

We will abbreviate this variable simply as efficiency. The original ecological literature refers to this variable as “ascendency”, hence the choice of the letter A for this variable. (Ulanowicz 1980)

From here on “reserve” will apply to what heretofore has been called “reserve capacity”.

F = –k a log( a ),

(D.15)

our measure of the system’s potential to evolve or self- organise. F = 0 for a =1 and approaches the limit of 0 as a 0. One can normalise this function by choosing k=elog(e) (where “e” is the base of natural logarithms), such that 1 > F > 0. One way to permit the maximum to occur at an arbitrary value of a is to introduce an adjustable parameter, call it β, and to allow available empirical data to indicate the most likely value of β. Accordingly, we set F = – k a βlog( a β.) This function can be normalised by choosing k=e/log(e), so -

1 β

that Fmax =1 at a=e , where β can be any positive real number. Whence, our measure for Sustainability of a complex network - its “fitness for evolution” in natural ecosystems systems – becomes: F = – [e/log(e)] a βlog( a β)

(D.16)

The function F varies between 0 and 1 and is entirely without dimensions. It describes the fraction of activity that is effective in creating a sustainable balance between A and Φ. That is, the total activity (e.g., the GDP in economics, or T.. here) will no longer be an accurate assessment of the robustness of the system. Our measure, T.. , must be discounted by the fraction (1-F). Equivalently, the robustness, R, of the system becomes R = T... F .

(D.17)

This measure of robustness, R, can be employed to indicate which features of a given configuration deserve most remediation to attain sustainability. In terms of graphic representations of the relationships between all these variables, it has proven useful to plot the networks, not on the axes A vs. Φ, but rather on the transformed A

axes n= 2 . and c= 2

Φ 2

The reasons for this choice of this particular exponential scaling are fully explained in Zorach and Ulanowicz (2003). The variable n gauges diversity a natural ecosystem, defined as multiplicty of parallel pathways effectively available in the network. Technically, in ecological literature it represents the effective number of trophic levels in the system; or how many transfers, on (logarithmic) average, a typical quantum of medium makes before leaving the network. The variable c measures the effective connectivity of the system in links per node, or how many nodes on (logarithmic) average enter or leave each compartment. These two variables n and c have revealed themselves the two most important structural variables of any complex network. They are the common reference variables for all our graphic analyses in chapter 2, because they best capture the structural issues that emerge in complex flow networks.

What can we tell a priori, mathematically, about the shapes we should expect of the variable C, A and Φ in terms of these two structural variables? The functions C, A and Φ all happen to be homogeneous Euler functions of the first order. This means that the derivatives with respect to their independent variables are relatively easy to calculate (Courant 1936.) Starting from our definition of robustness (17), we seek to establish the direction in which this attribute responds to a unit change in any constituent flow. That is, we wish to calculate (∂R/∂Tij.) Employing the chain rule of differentiation, we see that

∂R ∂F =F+T .. ∂ T ij ∂ T ij ∂R ∂a =F+T .. F' ∂ T ij ∂ T ij

{ [ ] [ ]}

T .. F' T ij T .. T 2ij ∂R =F+ log +a log ∂ T ij C T i .T . j T i .T . j

(D.18)

Where F' is the derivative of F with respect to a , i.e.,

F'=− eβa β− 1

[

log a β log e

]

(D.19)

In particular, when the system is at its optimum (F = 1 and F' = 0) we see from (18) that a unit increment in each and every flow in the system would contribute exactly one unit to system robustness. Once away from the optimum, however, contributions at the margin will depend on which side of the optimum the system lies, and where in the network any particular contribution is situated. When a<a opt , then F’ will be positive, so that those flows that dominate the inputs to or output from any compartment will result in a positive sum within the braces, and the contribution of that transfer at the margin will be >1. For the relatively smaller flows, the negative second term in braces will dominate, and the contribution of those links at the margin will be <1. As we have seen, the notions of both presence and absence, respectively what the Chinese tradition called the Yang and the Yin energies, are explicitly built into this framework. Such architecture accounts for relationships like (8) and (14) wherein complementary terms of ‘what is’ and ‘what is not,’ share the same dimensions and almost the same structure. That is, one is comparing apples with apples. Furthermore, the effects of lacunae no longer remain external to the statement of the dynamics; they become central to it. The model just discussed highlights the necessary role of underused capacities in sustaining ecosystems or any other complex flow system. It contrast with Darwinian theory, which unfortunately

is espoused by many simply as the maximisation of efficacy (e.g., the survival of the fittest.) Such emphasis on efficacy is evident as well in some mistaken approaches to ecology, such as optimal foraging theory; and is practically universally assumed in economic theory. Our results alert us to the need to exhibit caution when it comes to maximising efficiencies. Systems can become too efficient for their own good. Autocatalytic configurations can expand to suck away resources from nonparticipating or marginally participating actors, leaving them to wither and possibly to disappear, and thereby increasing the brittleness of the whole system. It is exactly what is claim to have happened, and is continuing to happen, in the monetary domain.

References Courant, R., 1936. P108 in Differential and Integral Calculus, Vol. 2. Interscience Publishers, New York, p. 681. Rutledge, R.W., Basorre, B.L., Mulholland, R.J., 1976. “Ecological stability: an information theory viewpoint”. Journal of Theoretical Biology 57:355–371. Ulanowicz, Goerner, Lietaer and Gomez “Quantifying Sustainability: Resilience, Efficacy and the Return of Information Theory” Journal of Ecological Complexity Vol 8 #1 (March 2009) Zorach, A.C. and R.E. Ulanowicz. 2003. “Quantifying the complexity of flow networks: How many roles are there?” Complexity 8(3):68-76.

This is Appendix D to Money and Sustainability: The Missing Link. To read more about the book or to order a copy, visit:

www.triarchypress.net/money-and-sustainability

A Chinese Insight

Money and Sustainability: Appendix E This appendix uses philosophical language to shows that, for the first time, Western science is demonstrating the validity of the insights of ancient Chinese philosophy. Specifically, it shows that Taoism provides a better insight into the behaviour of living systems than the Aristotelian linear cause and effect model.

“When Yin and Yang combine appropriately, all things achieve harmony.” Lao Tzu

Rudyard Kipling observed: “East is East; and West is West. And never the twain shall meet”. Yet today, met they have and interact they do, with vital trade and financial exchange. However, we are not only referring to the geopolitical and economic realities of the awakening of China, that Napoleon predicted would “astonish the world”.1 What we are referring to is the epistemological lack of understanding between two forms of common sense about the way nature operates: the Aristotelian approach that is underlying the

1 Napoleon is purported to have made two comments about China. The first dates to 1803, before he was emperor, when he pointed to China on a map: “Here sleeps a dragon [or a lion in another version]. When it awakens it will astonish the world”. The second dates to 1812 during his exile in Saint Helena: “Quand la Chine s’éveillera, le monde tremblera” [when China wakes up, the world will tremble]. The French politician Alain Peyrefitte, after his visit to China in 1971, took that second quote as the title for his best-known book, first published in 1973. In it, he forecasts that because of the sheer size of its population, when China decides to equip itself with 20th century technologies, it will return to a central economic and political role in the world, which it had held for several millennia, before the Industrial Revolution.

West’s common sense and most Western science; and the Taoist viewpoint which is part of the Eastern common sense and tradition.2 The Aristotelian approach that has long predominated in the West is based on a linear mental chain of cause and effects; it would have us move from point A to point B in linear fashion. That is why Western philosophy tends to look at the origin of everything for a “primordial cause” which can take the form of the creative God, a Logos, the Monad of Leibniz, or a primordial Big Bang hypothesised in Modern cosmology. 3

In contrast, Eastern philosophy sees at the origin Nothingness, the Void. According to Taoism, what emerges out of this Void is a dynamic interaction between the two polarities of Yin-Yang. These concepts, always combined as Yin-Yang, as necessary complements to each other, have a history of thousands years, with its origins traced back to prehistoric shamanism, and in written form to the Yi Jing (the Book of Changes, often spelled also I Ching), attributed to King Wen of Zhou (1099-1050 BC). The explicit Weltanschauung in Chinese philosophy is the necessity of an appropriate balance between Yang and Yin energies, in all aspects of nature and life. New insights from the study of complex flow networks provide clear evidence that Taoism contributes a more fertile approach than Aristotle, at least to explain the conditions of sustainability for living systems. We will be using here the Yin-Yang vocabulary, at the risk of appearing exotic, simply because we don’t have precise equivalent words in our Western languages. C.G. Jung was one of the first to express regret that our Western culture is not more familiar with this concept: “Unfortunately, our Western mind, lacking all culture in this respect, has never yet devised a concept, nor even a name, for the ‘union of opposites through the middle path’, that most fundamental item of inward experience, which could respectably be set against the Chinese concept of Tao.” In the Chinese philosophical tradition, respectively yang and yin characteristics were assigned to all natural systems. Oriental philosophers have developed an infinite number of ways to describe the Yin-Yang relationship and polarity. The following figure offers those selected as most relevant for our purpose.

A view close to the oriental one was developed in the West by the pre-Socratic philosopher Heraclitus of Ephesus (ca. 535 - 475 BCE) about whose work we have unfortunately have today only fragments quoted by others. The most relevant fragment has been preserved via Diogenes (3th century ACE), who claims that Heraclitus stated “All things come into being by conflict of opposites, and the whole flows like a stream” (Diogenes Laërtius: Lives and Opinions of Eminent Philosophers. Book ix. 8). However, the Eleatic school of Greek philosophy (including Socrates, Plato and Aristotle) completely overshadowed Heraclitus’s contributions, to the point that the earlier approach was practically lost in the West, until Hegel recovered part of it with his epistemology in three steps: thesis, antithesis, synthesis. 2

This view of a primordial Void is shared by Hinduism among others. What Hinduism calls Purusha, pure consciousness without any manifestation, “The Absolute Truth is that from which everything else emanates”, according to the Bhagavata Purana [Sutra.1.1.1] 3

Yin-Yang Characteristics Yang Coherence Competition Hoarding, accumulating, concentrating Goal Setting, Performance-Growth Having, Doing Peak Experience Rational, Analytical Logic, Mental, Linear Pursuit of Certainty Technology dominates Bigger is better, Expansion Independence Hierarchy works best Central Authority Planning , Control of future Cause and Effect Parts explain Whole(Reductionism)

Yin Coherence Cooperation Circulating, giving, connecting Caring, Quality of life (not quantity) Being Endurance-sustainabililty Intuition, Empathy-Synthesis Paradox, Physical-Emotional, Non-linear Ability to hold ambivalence Interpersonal Skills Dominate Small is Beautiful, Conservation Interdependence Egalitarian Works Best Mutual Trust Self-Organizing “Chaos”, Faith in Future Synchronicity Whole explains Parts (Holism)

Figure 1: Yin-Yang Coherences and Polarities This figure can be read vertically, emphasising the internal coherences. Or it can be read horizontally, emphasizing the polarity between them. One advantage in using the Yin-Yang vocabulary is that Taoists never separate such polarities. They emphasise the connection between them – their Yin-Yang complementarity. In clear: both are indispensable! These ways of looking at reality are not competing ways to relate and interpret reality, any more than your right eye competes with the left one. Instead, because of their differences, together they provide you with range and depth of vision, something which neither one can do by itself. For the past millennia, all patriarchal societies have tended to impart legitimacy to the vision contributed by only the Yang half of its “eyes”. We have thereby projected a hierarchical duality on concepts such as activity/passivity, creative/receptive, state/flux, culture/nature, mind/senses, spirit/matter; invariably claiming the former to be somehow “better” than the latter. What matters here is not to deny the qualities inherent in the Yang viewpoint, but to empower the Yin to an equal level. A shift in consciousness towards giving equal emphasis on both views is about more than fairness; it may be the key to provide a synergistic impulse towards the sustainability of our species. A paper that obtained the Vickers Award from the International Society for the Systems Sciences expressed the Yin-Yang approach in gender terms: “The feminine and the masculine are not objects, not things, not simply biological bodies we are attempting to unite, but rather complex,

archetypal organisations of consciousness…What is needed is a recognition of the synergy between these polar opposites. Synergy is evident everywhere in nature, and is an important source of causation in the ongoing evolutionary process. Since the relationship between male and female is fundamentally synergistic, it is essential that we rethink and recreate our cultural and symbolic understanding of the feminine and its relationship to the masculine to increase the possibility that the human species will co-create an evolutionary change that is advantageous to the entire biosphere. If we do not, we are in danger of bringing about our own extinction…”4 It is only recently that Western science has reached this conclusion. However, some Westerners understood this much earlier. For instance, the poet John Keats coined the term “negative capability” for the often overlooked Yin trait of human personality and experience: the capacity to hold uncertainty without angst – the capacity to live with the unknown as an ally rather than something to be eliminated. Such “undecideness” is not hesitant fence-sitting, indifference or laziness; nor is it a skill in the usual sense of the word, although it can be cultivated. It is more like a connection to an undifferentiated ground that resists form, which continually invokes questions and reflection and is potentially multi-dimensional, a space of “both-and” and neti-neti, the Hindu concept literally meaning ““neither this, nor that”. Such a new approach would give a chance to Taoist master Ho-Shang Kung's two-thousand year old claim to “take care of the spirit without effort, and bring peace to the world without struggle”5. Returning to the claims made about the conditions under which any complex flow network can be sustainable, we have seen that natural ecosystems are sustainable because they have both sufficient self-directed order and identity (Yang) and absence of the same attributes (Yin) to provide flexibility to change. The polarities necessitate each other in an appropriate balance in harmonious complementarity. Let us remember that nature must have solved many of the structural problems in ecosystems. Otherwise, these ecosystems simply wouldn’t exist today. They are our best living examples of large scale sustainability in action. When will be willing to learn from these myriad natural examples to apply their lessons for our human-made complex flow networks? This is Appendix E to Money and Sustainability: The Missing Link. To read more about the book or to order a copy, visit: www.triarchypress.net/money-and-sustainability

Dwyer, Molly “Complexity and the Emergent Feminine: A Cosmological Inquiry into the Role of the Feminine in the Evolution of the Universe” (Winning Paper of the 1999 Vickers Award International Society for the Systems Sciences, Asimolar, CA) 5

Ho-Shang Kung: Heshang Gong (ca 159 BCE). English translation : Eduard Erkes: Lao-tzu-chu (Switzerland: Artibus Asiae, 1950). Red Pine: Lao-Tzu's Taoteching with selected commentaries (Port Townsend, WA: Copper Canyon Press, 2009) p. 2.

Concentration of Wealth

Money and Sustainability: Appendix F Many different definitions of poverty are in use. For example, the European Union defines poverty in relative terms as an income level of less than 50% of the average income. In contrast, the US and the World Bank define poverty in absolute terms as an income below a fixed minimum level. By using the latter definition one finds a silver lining in some of the worldwide poverty statistics of the recent decades. In particular, if one uses the lower threshold levels ($1 per day), the past decades have seen significant drops in the most extreme poverty. This is much less clearly the case if one uses a higher threshold level (e.g. $10 per day). Over 80% of the world population lives on less than $10 a day; over 50% live on less than $2 a day; over 20%, on less than $1.25 dollars a day. In 2008, 17% of the people in developing countries were starving, and the number of undernourished people in the world remains close to one billion.1 In the European Union, the number of people at risk of poverty was 84 million in 2007, or 17% of the population. If tax-based social transfersâ&#x20AC;&#x201D;that is, government-sponsored programmesâ&#x20AC;&#x201D;were not in place, this would add another 34% of people in poverty.2 Toynbeeâ&#x20AC;&#x2122;s historical research shows, however, that one of the two major types of social crisis that threaten civilisations arises from excessive concentration of wealth, i.e. from relative tensions, and not from an absolute minimum level of poverty.

Data taken from The State of Food Insecurity in the World: Addressing Food Insecurity in Protracted Crisis (Rome: FAO, 2010).

Data taken from Wikipedia as well as Eurostat, Combating poverty and social exclusion: a statistical portrait of the European Union 2010 (Brussels: European Union, 2010).

Figure F.1: Global Poverty at different threshold levels. Source: World Bank Development Indicators, 2008

Over 80% of the world population lives on less than $10 a day; over 50 percent live on less than $2 a day; over 20 percent, on less than $1.25 dollars a day. In 2008, 17 percent of the people in the developing countries were starving, and the number of undernourished people in the world remains close to one billion.3 In the European Union, the number of people at risk of poverty was 84 million in 2007, or 17 percent of the population. If tax-based social transfers—that is, government-sponsored programmes—were not in place, this would add another 34% of people in poverty.4Toynbee’s historical research shows, however, that one of the two major types of social crisis that threaten civilisations arises from excessive concentration of wealth, i.e., from relative tensions, and not from an absolute minimum level of poverty.

Runaway concentration In 2011, world leaders at the World Economic Forum in Davos claimed that “Wealth inequality as the most serious challenge for the world.” 5 Regardless, the topic still remains one of the most censored issues in the mainstream media.6 Here are some current figures on income and wealth distribution. In 2006, the top 0.01% averaged 976 times more income than America’s bottom 90%. At the same time, people earning more than a million dollars paid just 23% of their income in

Data taken from The State of Food Insecurity in the World: Addressing Food Insecurity in Protracted Crisis (Rome: FAO, 2010).

Data taken from Wikipedia as well as Eurostat, Combating poverty and social exclusion: a statistical portrait of the European Union 2010 (Brussels: European Union, 2010).

See http://www.telegraph.co.uk/finance/financetopics/davos/8283310/Davos-WEF-2011-Wealth-inequality-is-themost-serious-challenge-for-the-world.html

See http://www.projectcensored.org/publications/2005/1.html and http://www.inequality.org/. See also Edward N. Wolff, “Recent Trends in Household Wealth in the United States: Rising Debt and the Middle-Class Squeeze—an Update to 2007”, Working Paper No. 589 (Bard College: Levy Economics Institute, 2010).

federal tax.7 1% of the world population own 40% of the global assets. The richest 2% of the world population own more than 51% of the world’s assets, while the richest 10% own 85%. At the same time, 50% of the world population own less than 1% of the world’s assets.8 On a global scale, the so-called established wealthy (people who own over $5 million in net assets), representing 0.1% of global households, have increased their ownership of all private wealth from 19% in 2008 to 21% in 2010. The highest wealth concentrations are found in the Middle East, Africa and North America.9 Similarly, the top 1% of households in these countries accounts for 70 to 90% of all their respective countries’ private financial and real-estate ownership.10 The resulting socio-political tensions will predictably become more explosive whenever the cost of basic necessities rises, as has recently became clear in 2008 when street riots broke out in many poor places in the wake of globally soaring food prices. Recent hikes in food prices alone are expected to add a net 44 million to the population that lives below the $1.25 poverty line.11 Current data reveal that the share of total income going to the richest 10% of the US population has never been so high (see Figure F.2).12

Figure F.2: Income share in the US going to the top 10%

See http://www.thenation.com/image/extreme-inequality-chart.

Data taken from Wikipedia as well as Eurostat, Combating poverty and social exclusion: a statistical portrait of the European Union 2010, op. cit.

Data taken from Jorge Becerra, Peter Damisch, Bruce Holley, Monish Kumar, Matthias Naumann, Tjun Tang and Anna Zakrzewski, Global Wealth 2010: Regaining Lost Ground—Resurgent Markets and New Opportunities , (Boston: Boston Consulting Group, 2010).

Some claim that this systematic debt build-up in third-world countries and the corresponding concentration of wealth are in fact the result of a conscious, deliberate imperialist strategy that started as early as the mid-1950s and got into full swing from the 1970s onwards. See John Perkins, Confessions of an Economic Hit Man, op. cit.

This is the net between the 68 million additional people who fell into poverty and the 24 million food producers who were able to escape extreme poverty thanks to these same price increases. See Poverty Reduction and Equity Group, Poverty Reduction and Economic Management (PREM) Network, (Washington, D.C.: World Bank, 2011).

Emmanuel Saez, “Striking it Richer. The Evolution of top incomes in the USA”, Working Paper (UC Berkeley: Institute for Research on Labor and Employment, 2010). [http://elsa.berkeley.edu/~saez/saez-UStopincomes-2008.pdf]

Two thirds of the total income gains in the US during the period 2002 to 2007 went to the top 1% of US households. This income bracket grew more than ten times faster than the income of the bottom 90% of households. The last time this happened was in the 1920s. In contrast, the total number of individuals living in poverty has never been higher in the past 50 years, as illustrated in Figure F.3.13

Figure F.3: Absolute headcount in poverty (upper line) and poverty rate (lower line) as a percentage of the US population

This goes hand in hand with the well-known phenomenon of an eroding middle class. The bottom line is that the distribution of wealth is increasingly uneven in almost all countries of the world.14 The government’s ability, or lack of will, to tax and redistribute capital income and assets has been weakened—a fact which is linked both to potential capital migration and to the internationalisation of business groups. Businesses and wealthy individuals will migrate to wherever the best tax deals reside. As more nations worldwide compete for direct investment, the threat of a trans-national group closing down a facility is ever present and, as a direct consequence, feeds a continuous “race to the bottom” among states.

We are presenting a lot of data from the US in this section. There are two reasons for this. First, the data are more readily available on a consistent basis than in Europe. Second, and more importantly, the social safety nets which explain the biggest differences between the US and Europe are now under direct assault from the austerity programmes that Europe is implementing at present. By looking at the United States, we are probably looking at what may well be Europe’s medium-term future if we remain on the monetary path we are now embarked on.

One should not assume that the level of income is automatically related to happiness. The perceived happiness with high income is more transitory. Individual perspectives and options as well as social contacts determine the amount of perceived subjective happiness on the long run. See Daniel Kahneman, Anne B. Krueger, David Schkade, Norbert Schwartz and Arthur A. Stone, “Would You Be Happier If You Were Richer? A Focused Illusion”, Science 312 (23 June 2006), pp. 1908-1910.

The United Nations Development Programme (UNDP) has developed the Human Development Index (HDI) first published in 1990. The HDI takes into account different variables beyond simple GDP measures. In addition to income, the most recent version of this metric considers inequality, life expectancy and school enrolment. Excessive wealth concentration has had a significant impact on living standard, education and health status in different regions of the world.

Societal implications Countries with lower income gaps do better along almost all relevant social and ecological dimensions. If one looks at income inequality in relation to a compounded social well-being indicator including childhood mortality, obesity, mental disorders, drug abuse, homicide, crime rate, social mobility, social trust, working hours, and ratio of developmental aid, one sees that this compound index and the inequality indicator are positively correlated. This means that the higher the income inequality in a region or nation, the worse the outcome for inhabitants.

This is Appendix F to Money and Sustainability: The Missing Link. To read more about the book or to order a copy, visit: www.triarchypress.net/money-and-sustainability

Kondratieff and the ‘Long Wave’

Money and Sustainability: Appendix G

In 1926, Nicolai Kondratieff (1892-1938), at that time the head of Russia’s Economic Research Institute in Moscow, published a technical paper in a German statistical journal documenting the discovery of a 60-year ‘long wave’ in modern economies, starting in the eighteenth century. 1 On this basis, he forecast a depression period for the 1930s, at the completion of the third Kondratieff wave. Although a communist himself, he opposed the Stalinist elimination of the market mechanism, resulting in him being sent to Siberia and executed for ‘anticommunist agitation’.2 Joseph Schumpeter, and Nobel laureates Simon Kuznets and Jan Tinbergen have substantiated the validity of Kondratieff’s findings. It has also become clear that the Kondratieff cycle is not just an economic phenomenon, but is driven by technological and societal shifts. Figure 7.2 represents schematically the five waves already experienced so far, as well as the sixth, expected to play out over the next decades.3 Each long wave relates to a technological breakthrough called a ‘core innovation’ initially working itself through the economy as a powerful growth carrier. As its effect on the economy wears out, an economic downturn occurs and the impact of the next core innovation begins to manifest. Starting around 1800, the first Kondratieff wave was triggered by the steam engine and textile machinery automation and bottomed out around 1850. The second wave relates to steel and railroads shortly followed ending in 1890 and so on. (See Figure G.1.) Leo Nefiodow, one of today’s foremost researchers on the long cycle, forecasted the peaking-off of 1

Kondratieff, N. “Die langen Wellen der Konjunktur” Archiv für Socialwissenschaft und Socialpolitik 1926.

Harry Maier, “Wellen des Fortschritts”, Die Zeit, 19 March 1993.

Nefiodow (2001) p.133.

the fifth Kondratieff wave, related to Information Technologies, during the late 1990s.4 This occurred in Asia by the mid-1990s, and in Europe and the US a few years later. In 2006, the same author published his forecast for the sixth Kondratieff wave, which will take place during the first decades of the twenty-first century.5 He reports four findings that are directly relevant for Wellness Tokens. (Wellness Tokens are discussed at length in Chapter VII of Money and Sustainability: The Missing Link.)

•

First, the next wave will be based on what he calls ‘psychosocial technologies’, or individual, community and environmental healing processes. The difference of this sixth wave compared to the previous five is that for the first time, the core technology would not primarily be rooted in the material and quantitative realms. Social and qualitative change in human and environmental conditions would predominate instead.

•

Second, the best way for a country to reduce the pain of the transition from any one of the waves to the next is to invest early in the next wave’s core technologies. This will ensure that new workplaces are created in markets created by the new wave, while jobs in the markets of the old wave are scaled down. Similarly, private investment in core technologies of this transition will allow one to be ‘carried by the wave’. It is analogous to investing, for instance, in railroads and steel in the 1850s, in Ford Motor Company or GM in 1935 or in IBM and Microsoft in 1980.

•

Third, a new wave always integrates the strengths of the old one as a tool for its transformation: in our case, this means that the sixth wave will build on the information technologies of the fifth one.

•

Finally, the skills that most need development for this specific sixth wave are those of cooperation and interpersonal communication.

If Nefiodow is right, the best areas to invest in today are the technologies supporting the move towards ‘integral wellness’ thanks to ‘psychosocial health’ technologies. Wellness Tokens are one way to achieve this. They are taking advantage of the new means developed during the Fifth Wave through IT and mobile phone technologies. And they address an issue that is otherwise doomed to grow predictably to unprecedented levels over the next decades.

Nefiodow (1991) and (1994).

Nefiodow (2001)

Figure G.1: The six Kondratieff cycles, their corresponding ‘core technologies’ and the societal domain in which they predominantly express themselves. The sixth Kondratieff wave, the one that will be driven by technologies providing ‘Integral Wellness’, is expected to become dominant during the first decades of the twenty-first century. 6

This is Appendix G to Money and Sustainability: The Missing Link. To read more about the book or to order a copy, visit: www.triarchypress.net/money-and-sustainability

Each wave is generated through the interaction of the previous wave with the next wave. The dates marked at the bottom of each wave correspond in reality to the end of the previous Kondratieff wave, not the beginning of the next wave. Nefiodow (2001) p.xxx.