When there is only positive feedback in a system, or when the sum of all the feedback in the system is positive (just like basic math, where two negatives can equal a positive), the system produces a reinforcing result, where things get worse and worse or better and better, depending on the variables. There are many examples of this: compounding interest in a bank account, population growth or some important processes in climate change are just a few of the obvious ones. In the bank, more money means more interest is paid, which means there is more money, and so on — positive feedback plus more positive feedback. With population, more parents produce more offspring, who in turn become parents.
With climate change, more warmth means less white ice at the poles to reflect the sunlight, which makes the temperatures there warmer, which in turn leads to less ice. In this example, more CO2 makes more warming (positive feedback), more warming means less ice (negative feedback), less ice means more warming (negative feedback), and the net result is positive, creating a vicious cycle.
These two patterns — a combination of positive and negative feedback that results in equilibrium or in reinforcing increase or decrease — are called archetypes, which means a pattern of behavior over time that can be seen in a variety of different systems. There are many system archetypes, and understanding how patterns of behavior in systems can be changed is a key to understanding the economy as well.11 The economy’s behavior over time exhibits the characteristics of an archetypal system with cycles of expansion and contraction driven by positive and negative feedback from different variables. At a very simple level, one kind of economy — the boom and bust natural resource economy of gold rushes and fossil fuels — can be seen as an archetype called limits to growth. In this archetypal pattern of behavior, positive feedback on the right side of Figure 1 below leads to exponential economic growth (the result of reinforcing feedback), which finally hits the wall of finite resources on the left, which then leads to exponential decline as the positive feedback of the right reinforcing loop collapses in reverse on itself.
FIGURE 2.1. The Limits to Growth Archetype
Please remember: positive feedback does not mean more, or an increase — it means that both variables move in the same direction.12
Obviously, the global economy is more complex than this illustration, although on an aggregate level, this particular pattern of reinforcing feedback and balancing constraints is true. We live in a relatively finite world, where the only external input comes from the sun (ignoring meteorites and the contributions to science from the moon rocks collected 30 years ago), and yet we have structured our economy as if we had access to 10 — 20 similar planets. The subject of the archetype was explored extensively in the book The Limits to Growth by Dennis and Donella Meadows, Jorgen Randers and William Behrens in 1972 and then revisited by the authors in a new book called Limits to Growth: The 30-Year Update published in 2004.13Creating Wealth focuses more on the invisible structures of the economy (that drive the exponential increase and decline on the right side of the diagram) than the very visible limits we have been reaching on the left.
To consider the economy as a system, it is important to look at the flows through the system, the stocks where things accumulate in the system, as well as the variables and feedback patterns that drive change in the system. Money is a critically important flow through the economic system, and the ways in which it accumulates and provides feedback to all of the other variables can also be illustrated using the language of system dynamics.
When a bank issues a loan to a business or a mortgage to a homeowner, they repay the loan at higher rates of interest than the bank offers on its deposits, one of the basic equations of the current banking business model. A system diagram of this interaction would be as follows:
FIGURE 2.2. The Current Banking Business Model
In Figure 2, the more deposits a bank has, the more loans it can issue. The more loans it issues, the more interest it earns. The more interest it earns, the more interest it can pay on the deposits, which in turn will attract more deposits — a simple reinforcing loop with positive feedback. On this very simple level, banks are endless money machines. In much the same way, our individual accounts should make us incredibly wealthy with accumulated compounding interest over time. The same factors that reduce our compounding interest accounts — like the fact that to live we often need to make withdrawals to purchase goods and services — also mitigate the bank’s profits. Not all loans are repaid. The demand for loans fluctuates. The banks themselves need to be attentive to the interest rates of the central bank and the bond markets. The amount of money on deposit changes with the economy, as people are either saving or spending more.
The net effect of the money machines we have created when we authorized banks to have a monopoly on the creation of money is that over time, the real value of this bank-debt money declines. There is a built-in expectation that money needs to earn interest. When every dollar in circulation came into existence with the issuance of debt — either private debt from mortgages and business loans or pubic debt with bonds and public borrowing — those dollars had better be working as hard as they can to produce a return. This return comes in the form of interest payments on deposits or returns on investments made in productive enterprises.
If instead of putting my money in the bank or investing it in the stock and bond markets, I put it in a can under my bed at home, the money in that can will be worth less five years from now than it is right now. On a larger scale, the declining value of money is factored into business accounting through the use of a discount rate which includes the interest rate used to discount future cash flows.
Now look at it from the company side. The company gets a loan from the bank for its business, and has to repay it over time with interest. The cost of the loan is one of the company’s costs of production, along with resource costs, labor costs and other operating costs. In Figure 3, several key functions within a business organization are identified, with finance being pivotal to both the beginning of a business and its ongoing profitability.
FIGURE 2.3. The Corporate Process
The financing of a business is usually a mix of debt and investment. The more investment that is available, the less debt needed, but there are often perverse incentives built into our tax and accounting systems that make debt more desirable than it would be otherwise. So even if it isn’t absolutely necessary, businesses will often have debt on their books. Debt comes with interest payments, so the interest — the cost of the money — is deducted prior to determining whether or not the business is profitable. This is illustrated by smaller black feedback loops in Figure 4.
The total financing available will drive the production capacity, which in turn is a combination of the natural resources needed, the labor costs and other operating costs. Once there is a product, it is sold for a particular price, and the income from sales (after taxes and other costs of production) are deducted. This is what determines the return on investment (ROI in the diagram). ROI is the profit that is distributed to the investors in the business, and the cycle starts over again — the more profit, the more reinvestment is possible, the more production capacity and (assuming there is demand for the product) the more sales.
The external factors that influence the outcome of any business venture are the demand for the product, competition for sales of the same or similar products, the costs of production, tax rates and the cost of money. Most of these cost factors are directly related to the product, and need to be considered in the overall business plan when determining if the venture will be profitable.
Money is the one systemic cost which influences both the profit margin on a particular product and also how profit is calculated and the total value of the returns. On a systemic level, the cost of money is a big part of the reason that it is not sufficient merely to make a profit. Companies need to make a profit that continues to increase at an increasing rate when the costs of capital and the value of money throughout the
system are in a constant state of inflationary devaluation. Figure 4 illustrates the reinforcing nature of this dynamic.
FIGURE 2.4. How Bank Money Interacts with the Corporate Process
Of course, resources and labor are not unlimited, and so this reinforcing system will eventually hit the wall described earlier in Figure 1. Peak oil, resource depletion, scarce fresh water, climate change, exponential population growth, the widening gap between the rich and the poor — all of these are symptoms that indicate we are approaching these outer limits to growth. When there are scarcities of key resources — oil, water, pollination, food — costs go up. When people’s health deteriorates because of poor nutrition, lack of safe water, poor health services — costs go up. The profit derived from a depletion of human and natural capital is necessarily a short-term gain at the cost of long-term well-being. It’s like spending the principal in your bank account — it might get you another meal on a hungry day, but there will be no more money in the bank tomorrow.
If costs go up as the limits to growth are reached, then yet another delayed loop which provides additional reinforcing feedback to a cycle that was already growing exponentially is added in. Higher costs mean that profit and return on investment will be lower. This in turn will drive the need for more debt, more inflation and more pressure on already limited resources.
FIGURE 2.5. Adding Higher Costs
In our current era, where high priced oil and overleveraged assets triggered an economic collapse which forced the US government to provide huge “bailout” loans to banks (created with government bonds and debt) and then other huge “stimulus” grants to state and local governments and businesses (also created with government bonds and debt), this system dynamics hypothesis seems to hold true. As long as the fundamental assumptions and conditions don’t change, this is a trap — a systemic spiral that threatens not only the health of our money system, but also our well-being and the life-support systems Earth provides.
This hypothesis isn’t just theoretical — it is proven by the graph in Figure 6. Anytime you observe an exponential growth curve like this, you know that there is a reinforcing system of positive feedback behind it.
The total US credit market, i.e., borrowing by governments, corporations and individuals, is as close to a statistical fit of an exponential curve as is scientifically possible. (For those with an econometric background, the R2 value of .9889 means that it is almost a perfect fit.)14
FIGURE 2.6. The Exponential Curve of Money Creation in the US. The light line represents a perfect exponential growth curve. The dark line represents the growth in Total US Credit Market Debt. The R2 figure represents how closely the trend tracks to perfect exponential patterns – 98%. Source: Flow of Fund Accounts of the United States. Federal Reserve Statistical Release #Z.1, September 17, 2010. [online]. [cited October 23, 2010]. federalreserve.gov/releases/z1/current/
Exponential growth in money supply can only end up with an inflationary blowout. We should remember the warning of one of the foremost economists of the 20th century, John Maynard Keynes: “By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”15
Systems Change
What are the fundamental assumptions and conditions needed to intervene in this destructive cycle? Where are the leverage points, those interventions where a relatively small amount of effort can achieve much larger results? Often, a systems diagram can help identify promising possibilities. In this vicious cycle, there are two important drivers — the bank-debt source of our monetary system and the economic policies we have enacted to facilitate the process of human and natural capital depletion for the sake of the ever higher profits that the system demands. These are the two variables where policy interventions could have an important impact on the destructive force of the system.
Economic Policy Change
The legal structures and policies we have enacted and the public investments we have made to enable companies to be as profitable as possible number in the thousands. In much the same way as cities cannot transform the monetary system on their own, they do not have the ability to change the dominant policy context. There are a few policies worth mentioning, however, which deserve particular attention as we move into a new era.
Looking back over the long arch of history, there are several important changes we encounter in the 21st century which are significantly different than prior centuries. Up until the late 20th century, human beings lived in a world where nature was abundant and human beings were, by comparison, scarce. The natural world was awesome and scary — the raw power of storms, earthquakes, floods, volcanoes, droughts, plagues — all kinds of natural disasters gave humans a clear sense of their inferiority on the scale of things. It’s no wonder that conquering nature was a goal (at least for Western civilization — more successful and less violent relationships with nature had been cultivated in the East and among North American First Nations) when we were regularly defeated by these overwhelming forces.
But nature was also abundant. There were lots of fish in the sea, and fresh water flowed in pristine streams down mountains where the air was clear and crisp. Agriculture had its ups and downs, but the 20th century dawned in the United States with over 80% of our population living on farms and growing their own food. The wood from forests had already gone to warships in Britain, but in the US trees were plentiful, and the steel industry had taken the pressure off the trees that had been used for ships.
Today, in the 21st century, we are facing a different world. Nature is increasingly scarce, and humans are increasingly abundant. The policies that were enacted in an era of abundant nature need to be changed. In that era, the prices of natural resource extraction were at zero cost to a company, and were often even subsidized by government. Machines created by these resources did the work of more and more people, and emissions into the air, water and soil were allowed without regulatory limits or fines. Arguably, even the mathematics of the banking system itself, which seems to rely on an infinite capacity of the world to continue to grow and produce profits, needs to be rethought in a new era of obvious limits. The paradigm of infinite growth has allowed and even fostered the increasing concentration and centralization of wealth through the tacit assumption that there’s more than enough for everyone: a rising tide floats all boats. Yet on the natural resource side of the equation, the tide is not rising, it’s receding, and some oversized yachts are crushing the canoes in their wake.
The enabling policies which need to be addressed to change the system fall into two main categories: Earth and corporations. The Earth policies are all those which form and regulate our relationship to the natural world. The corporate policies are those which structure the key institutions we have created to foster collective action and wealth creation. This is a tall order, obviously, and full details are beyond the scope of this book. But the ethic that is needed to shape these policies on any level (local, state and national) can be described here briefly.
Earth Policies
The values and ethics that govern our relationship to Earth need to embody a deep and abiding sense of respect and care for all life. Just as the 20th century saw the realization of the Human Rights movement’s demands for equality, the 21st century needs to recognize the critical importance of biodiversity and abandon those practices which erode the wealth of species we need to survive into the 22nd century. Our policies need to make all destructive practices prohibitively expensive and morally impermissible. These include, but are not limited to, monoculture crops, genetic engineering, destruction of habitat, emission and disposal of wastes beyond Earth’s assimilative capacity and extraction of nonrenewable resources from Earth’s crust.
The precautionary principle has been introduced into several legal systems as one way of turning back the tide and valuing the integrity of Earth’s ecological systems above narrow corporate goals of production, consumption and profit. Most legal systems now place
the burden of proof on parties who object to a new technology, development project or innovation to demonstrate that it does harm. The introduction of the precautionary principle shifts the burden of proof to the proponent of a new idea, so that they would need to demonstrate that it will not harm important biological, human or community systems before it was introduced.
Other policies need to be introduced that reward activities which enhance the ongoing capacity of ecosystems, human and community systems to continue to produce the assets that meet our needs. Tax breaks for ecosystem restoration, educational programs and organic food production are three possible examples, along with incentives for lowering consumption, reducing population, paying livable wages and investing in renewable, local, energy generation.
In summary, the policies we need eliminate harmful practices, curb the introduction of new practices that would do more harm than good and encourage practices that are life-enhancing and promote more harmony among all the different inhabitants of the Earth community.
Corporate Policies
To follow the model we’ve described for Earth policy changes, we need to identify and eliminate policies that are destroying the ecosystem, exploiting human beings or undermining democratic governance. We then need to curtail the introduction of new ideas and policies that would have harmful effects. Most importantly, we need to introduce policies that bring corporate life into harmony with the life-support systems on Earth, so that these two most powerful processes do not continue to work at cross-purposes.
The modern corporation emerged at the end of the feudal period in Western history, when the European powers were exploring other parts of the world and engaging in expanded colonization and international trade. The original corporate charters enabled individuals to band together in a common body to undertake enterprises that were beyond the capacity of even the wealthy aristocracy of the time. The idea of a corporation being its own entity, a legal person of sorts, goes hundreds of years back in time.
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