Nicole Foss on Money and Financial Crises

Building resilience in an era of limits to growth

We are approaching many limits to growth over the next decades: Economic contraction, peak energy and geopolitical stress. Nicole Foss explains how the deflationary dynamics that always follow finance and property bubbles will rapidly impact individuals and communities, while the longer acting forces of peak oil and climate change will determine and limit the nature of any economic recovery. So how can we adapt?

This talk offers a profound understanding from the systems perspective of the current realities of finance and economics, and the  serious predicament we are in. Here is the full audio recording of the talk, originally posted here, and it might be all that some readers need in order to absorb the excellent analysis in full:

For others, including me, the Foss talk has simply too many good arguments in such a rapid-fire stream of great points, with each requiring some considered reflection, that it is impossible to keep up with.

Each of the following sections of this article contains a far more digestible snippet of the audio, and a transcript to go with it. Together these should make it much easier to navigate, contemplate and absorb this great argument, piece by piece.

Good luck, and if you can manage to comprehend most of this rather sobering truth, you will be fully armed to engage in debate about the best way forward from here. 


The limits to growth

[2:00] I am looking at limits to growth and what we can do about it, and so building resilience in an era of limits to growth, because it is not just one limit we face, it really is an era of limits.  It has limits in many different ways: resources, finance, climate, the environment’s ability to absorb waste streams. There are many limiting factors that we are reaching all at the same time. But it is important to know which are the ones that you have to be aware of first: which are the ones that happen first, what timeframe do different things unfold over, so that we can prioritise what we are going to prepare for. There is different things that act over different times, you have to know which to prepare for first.

Finance is the first limit that we are going to be facing, because finance is “virtual”. Things that are virtual, rather than grounded in the real world, have really short times for change. Finance tends to be an area that people don’t understand so well. We are told that it’s terribly complicated: don’t worry your little head about it, just let us look after it. So the foxes constantly want to look after the henhouse, if you like. It is not that complicated. There is no reason that people shouldn’t be able to understand how the financial system works, and we need to, because there are some very significant limits coming in the world of finance, sooner rather than later.

So, why does it matter if we are about to have a financial accident? What difference does it make? If money is virtual you might think that it can go away, and maybe we’d be better off, since it’s the root of all evil anyway. But, unfortunately, the world doesn’t work like that. Money does serve some very significant functions in society, and if we don’t have those functions being served, then very real world consequences will follow from that.

The functions of money

[3:56] Money is an emergent property of scale. When you reach a certain scale of society you start to need something that looks like money. If you’ve got a group of maybe 150 people, you all know each other really well, you work with each other all the time, you do something for them and they do something for you. Nobody really needs to keep track, because you know and trust each other.

Scale it up to maybe a few thousand people, and now you are dealing with people you don’t necessarily know very well. So you don’t really know if I help him today will he help me tomorrow. People start to need to keep track. And as you go from one hundred people to several thousand, you go into much more differentiation, a more complex system, a bigger range of goods and services, and it is hard to know what amount of one thing is worth what amount of another thing. You start to need a means of comparative value, as you get to that larger scale, more complicated society.

Scale it up again to the size of a country, now you’re working with people you’ve never met before and never will meet, so there is no basis of trust there. Now the trust in the system has to go from the personal level, to the trans-personal level, the institutional level. So we place our trust in the governance structure for money.

Then we scale it up again to international level, and we have another layer of governance structure. So money has become more and more sophisticated and complicated, and so have the mechanisms for controlling it, as a function of the size of the society that we are trying to run with it.  When the functions are not being served, we are going to notice.

When Money fails

[5:40] Money is a means of exchange and a measure of comparative value. It can also be a store of value under some circumstances. It represents your freedom of action, because it’s your ability to put whatever you choose to do into practice. It is the lubricant of the engine of the economy, and we will look in more detail at that function in a little while. And it is the global operating system. When you crash the operating system, things happen as a result, and we are going to look at exactly what sort of things happen when you crash the financial operating system.

We have lived through a history of economic cycles, going all the way back to antiquity. As soon as you reach the scale of civilisation, boom and bust is built right in. We tend to think of it as the rise and fall of empire, but it very much has an economic component to it as well.

Now in some ways our situation is unique. We’ve never before had seven and a half billion people on a planet starting to approach resource limits, and that really is going to be an important circle to try and square over the next century, so that aspect is unique. But the financial bubble that we have created is not unique. There have been many, many, many of those throughout history, as soon as we reached that scale of civilisation. We are not very good at learning the lessons of history though. That is what we really need to do, to look at what has happened in previous eras, when we were facing financial bubbles and their aftermath, and say “what did the bubble look like?”, “what did the aftermath look like?” and “what can we do about it?”

Boom times are inflationary. Inflation is an increase in the supply of money plus credit, relative to available goods and services. As you have an economic boom, or a period of expansion, we seek to expand the money supply in order that people can expand the range of economic activity, because they are optimistic – they want to reach out and do more things, trade with more people, provide a bigger range of goods and services, so you need a larger money supply in order to allow that to happen. So you end up with that larger money supply, we find ways to increase the money supply, that stimulates demand, someone else comes along and supplies that demand, and then you go around the circle again. So you have a virtuous circle on the way up, with ever increasing money supply, a sophisticated, complex, hierarchical economy.

A pile of promises

[8:10] One of the ways we expand the money supply is we start writing IOU’s to each other: we create a pile of promises. Promises have value, as long as the promise is credible. If we believe the promise to repay, then the promise itself is as good as money. So we have expanded the effective money supply by creating a large pile of promises.

But eventually, the debt that you take on in writing IOU’s reaches such a magnitude, that all the income streams of a productive economy can no longer service that level of debt. At that point, you have reached a limit to your expansion, your virtuous circle becomes a vicious circle, and what you get is the collapse of the value of promises, because they are no longer credible. That means that the money supply falls, you have a liquidity crunch, and you have a period of demand collapse and economic depression. So this is what happens when you move into the bust phase, and that is what we are on the verge of at the moment. Finance becomes the key driver to the downside under those circumstances, for a number of years.

I wanted to show you what I mean by expansionary money. Money was originally a physical commodity: it was gold, then it was gold and silver, then it was promissory notes backed by gold, then promissory notes backed by faith, virtual representations of promissory notes backed by faith, promises to repay promissory notes backed by faith, and bets on the price movements of underlying assets – derivatives in other words. So you can see that the last few of these are credit instruments, and you can see from that progression we moved further and further away from anything that’s grounded in anything real. So we originally started with something that was more tangible, but money has become more and more intangible. We have created more and more virtual wealth in the years of our expansion.

Credit gained “moneyness”, but credit can lose moneyness just as easily. In fact, far more quickly, because the trust that credit instruments enjoy takes a long time to build, and very little time to destroy.

So I think you will agree that this quote is a reasonable representation of our current circumstances:

“Beautiful credit, the foundation of modern society, who shall say this is not the age of mutual trust, of unlimited reliance on human promises? That is a peculiar condition of modern society, which enables a whole country to instantly recognise point and meaning to the familiar newspaper anecdote, which puts into the speculatory lens and minds, this remark: “I wasn’t worth a cent two years ago, and now I owe two million dollars.”

So, I think apart from the fact the numbers seem perhaps a little small, that is a good representation of our current situation. But just to illustrate that we have been here before, Mark Twain wrote that in 1873, at the dawn of the great depression of 1873, which was considerably worse than the Great Depression of the 1930’s, but it has moved out of living memory – we don’t even remember there was a depression, we don’t remember the boom, we don’t remember the bust. Even the great depression of the 1930’s is on the verge of moving out of living memory.

Money goes global

[11:30] Our expansion phase really began in the 1980’s, with an event called the big bang, which was the financial liberalization that took place under Reagan and Thatcher. Originally we had capital controls that prevented money from moving all over the world, so money was more or less trapped within nation states. In 1982 those capital controls were removed, to allow money to go anywhere in the world that it wanted. So of course, it did, on a massive scale. This is really why we needed to institute a whole range of transnational governance mechanisms, we needed to control the flows of money as they moved around the world, because now money was going everywhere.

So we had the General Agreement on Tariffs and Trade, the North American Free Trade Agreement, the European Union, the World Trade Organisation, the European single currency the euro, the Trans Pacific Partnership – all of these are transnational mechanisms for governing flows of money. We increased the scale of everything we did. We increased the scale of trade, we increased the length of trading relationships, and the importance of them – we trade across the world for essentials these days, and we trust that that will continue. We increased the scale of governance, we off-shored a lot of production, we created a tremendous trade dependency, and we built up a system that’s Just In Time, with no margins for error. So we have a very brittle system at the moment at the international level.

In the process we blew a major financial bubble, based on a huge expansion of credit and debt. It is in fact the largest financial bubble in the history of the world, because we turbocharged it with fossil fuels. So we were able to reach for the sky, in terms of complexity, because we had access to a really cheap energy source.

So what we had was an enormous credit expansion, as I said, And as I said before, inflation is an increase in the supply of money plus credit, relative to available goods and services. The implication is that there are two ways you have inflation: either by increasing the money fraction, or the credit fraction. If you increase the money fraction, you’re taking your real wealth pie, and cutting It into many, many more pieces, each of which will be very small. That’s currency hyperinflation, like modern day Zimbabwe, like Weimar Germany in 1923. So that’s what happens if you’re getting out a printing press and generating real physical currency. But that’s not what we did.

We had a credit hyper-expansion, in which case you don’t cut your real wealth pie into smaller and smaller pieces, you create – for the same number of pieces of pie – more and more claims to each and every one of them. So you create excess claims to underlying real wealth. It is still inflation, because you are still increasing the effective money supply, but it doesn’t look like having to use a trillion dollar note to buy a cup of coffee – it doesn’t end up working in that same way, and it doesn’t resolve itself in the same way either.

Financial collapse

[14:37] Credit is now of the order of 99% of the money supply, which means that 99% of the money supply is excess claims to underlying real wealth. We took a small amount of collateral, and we backed an enormous number of loans with it, so we now have a crisis of under-collateralisation. This means we are all playing a giant game of musical chairs, there is about one chair for every hundred people playing the game, and as long as we are all up and dancing to the music and enjoying ourselves, we don’t really notice how few chairs there actually are, and not all of us entirely understand the rules of the game we are playing either. But, when the music stops, the people best positioned to understand the rules of the game are going to grab a chair as quickly as they possibly can. The great collateral grab will be on, and everybody else’s excess claims to underlying real wealth will be rapidly and messily extinguished. This is deflation, by definition, and that is what we stand on the verge of today. So, the expansion phase lasts quite a long time, but the contraction phase can actually be quite rapid, and that is what we stand on the verge of, globally.

So we are moving into that contraction phase. You are going to hear a lot about financial contagion, which is simply the spread of fear. Deleveraging is underway, in the places at the leading edge of this dynamic already. This is not theoretical; this is already happening in some parts of the world, and there are other places are poised to follow in the same direction. It just isn’t happening everywhere at the same time. But the places where it is happening we are already seeing the deleveraging.

Deleveraging is the process of going from a small amount of underlying real wealth, and a huge amount of outstanding loans, down to a number of outstanding loans that bear more resemblance to the underlying collateral, mostly by defaulting on those loans – by breaking those promises to repay. Deleveraging will continue until the small amount of remaining debt is acceptably collateralised to the few remaining creditors, but we are nowhere near that point at the moment. This will involve the disappearance of an enormous amount of virtual value. We created this enormous sphere of virtual wealth, but there is no substance behind it, or nowhere near the amount of substance required to sustain it.

The great collateral grab

[16:57] So the great collateral grab is underway, in places like Greece, where people are being told, or the government in particular is being told: “sell us your ports, and your railways, a few islands, the Parthenon.” Greeks are going to be tenants in their own country at this rate, they are not going to actually own anything anymore, because the creditors are coming for the underlying real wealth. So this is happening throughout the European periphery at the moment, and that same dynamic is going to take hold in other places too.

We are going to see capital flight to safety. Money goes from where the fear is, to where the fear is not. So money is leaving places like Greece and Spain, and it’s ending up in places like Switzerland and the United States – places that are perceived to be safe havens. But when lots of money is moving around, this is very destabilizing. So what governments will do is respond with the reintroduction of capital controls, the very thing that was removed, that initiated the era of globalisation is going to be replaced, and it is going to mark the end of the era of globalisation, because we are going to start re-imposing controls on what money can do, where it can go, what access people can have to it. This is already underway in parts of the European Union.

What we are going to see is falling prices. People think “oh that means that things will be cheaper”, but unfortunately it doesn’t. It is not price that matters; it’s affordability. It’s the ratio between how much something costs and how much money you have in your pocket, and if the amount of money in your pocket is disappearing faster than prices come down, which is exactly what happens in deflation, then even as prices fall, things are becoming less affordable than they were before. So this is the paradox of deflation: falling prices, but nevertheless, less affordability, because prices follow changes in the money supply. The money supply changes, and prices change as a result. On the way up we increase the money supply, and then we watch people bid up the price of everything, including housing for instance. So prices rose as a result of the increased money supply. When the money supply is decreasing, prices fall as a result, but the falling money supply comes first.

At the same time, as you end up with this underway, unemployment starts to rise. It can rise very precipitously. It is of the order of 25 to 30 percent in the European periphery, youth unemployment is greater than 60% in a number of different countries, so this is very painful there already. At the same time, wages and benefits get cut, public entitlement programs disappear, taxes rise, rates rise, user fees get imposed on things that were previously free. So this becomes a perfect storm, in financial terms. There is a very high risk of a systemic banking crisis under these circumstances, and just so as you know, the money you have in the bank is not your money. As far as the system is concerned, it’s an unsecured loan that you have made to the bank. They may or may not keep that promise to repay you, depending on whether they are capable of doing so.

Across the entire developed world there either is already – or is being developed – legislation to allow the banks to be bailed out with the depositors funds. This already happened in Cypress last year, and the foundation has been laid for that to happen in many other places when a systemic banking crisis comes along. So be very careful about trusting in the solvency of middle men – it’s not a very good bet at the moment.

Operating system crash

[20:37] We are looking at an operating system crash, so this is something that happens quite quickly. It is something that pulls the rug out from under people’s feet, and it’s a crash of a virtual system, so you wouldn’t expect that to play out over a long period of time. We can’t say exactly when something like this might happen in any specific place, but it is already happening in a number of places, and the places where it hasn’t happened yet look a lot like the places where it was happening a few years ago. So if you look at say Iceland, and Ireland, and Spain at the peak of their bubble, they look a lot like places like Australia, New Zealand, Canada and Brazil, places where we haven’t seen the bubble burst yet, but all the risk factors are in place for it to do so.

Now when you crash the operating system, you are not going to be doing much of anything until you have rebooted it. So it is our job today to start to think about how we might:  a) prepare for an operating system crash;  b) get through the crunch period that will come as a result;  and c) how do we reboot the system into something that looks a lot less like a planet killing Ponzi scheme than our current economy does, because our current economy is thoroughly pathological. We don’t want to reboot the system into the same form, so we need to start thinking about how we might have a system reboot into something that’s a lot more sustainable, that is based on a lot more solid foundation. So we need to start thinking about that up front. We have a lot more capacity to do that now, before we are in the thick of a period of crisis.

It is important to understand the role of the velocity of money, the importance of liquidity and the velocity of money. Liquidity is important because it represents a pile of choices, or a handful of choices if you like, that you have a right to make later, at a point where you have a lot more information about what choices to make, and a lot more opportunities. So if you preserve capital as liquidity, through a period of liquidity crunch, you are preserving your freedom of action. That is one of the fundamental functions of money. But it is not just the amount of money that is available, that exists, that matters; it is the rate at which it circulates in the economy that really determines the level of economic activity that can be supported.

Now, under normal circumstances, money circulates in the economy all the time, changing hands from person to person, to business to government and back to people again. Very little of it is at rest at any given time. But when people and businesses and governments don’t know where their next influx of cash is coming from, they stop spending, and of what money is left after you have subtracted the credit fraction, a much larger percentage of it ends up at rest. So you end up with a liquidity crunch – there is almost no liquidity in circulation. This means there is almost no economic activity that can be supported. You can’t connect buyers and sellers, and producers and consumers, because there is no money to change hands in the other direction, because another fundamental function of money is as the lubricant in the engine of the economy. It is like driving your car with the oil light on: you know what will happen to your car if you do that, the engine is going to seize up on you.

Now in the 1930’s people said we had everything except money. It was true, they had all the people they had before, all the resources they had before, a virgin continent’s worth of resources, but they couldn’t do anything with it, because they had crashed the operating system. So what we create under these circumstances is a situation of artificial scarcity, where all the things you had before the crash, you suddenly can’t do anything with them. So we need to start thinking about how to address that situation of artificial scarcity – this is about how you get through the crunch period, because there are ways of creating alternative forms of liquidity, that make it a lot easier to ride out a situation like this.


[25:11] This is going to be an era of deglobalisation. As I said, the re-imposition of capital controls will really mark the end of globalisation. Trade does really badly in times of economic contraction. In the 1930’s trade fell by 66% in two years, and we are far more dependent on trade than they were back then. What you get is protectionism and trade wars. The homogenizing effect of trade is lost. Right now, it doesn’t much matter what you have and don’t have where you are, because whatever you don’t have, you buy from somewhere else that makes it. But trade depends on access to letters of credit, or goods won’t move, and you don’t have those letters of credit in a period of credit crunch. So very little is going to move. Our local reality is going to become our total reality at some point. We have to learn how to live within that local reality, and most of us don’t even remember what our local reality even is, so it is going to be a very steep learning curve.

Another thing that happens in periods of economic contraction is the trust horizon contracts. Trust takes a long time to build up, very little time to destroy. So it built up during our era of expansion, when we expanded trust ever outwards. We were able to say “yes, we can do business with these people over the other side of the world, they are not so different from us, we can trust in the systems that we’ve built to control trade with them.” So we did that, we scaled up trust and reached out all over the world, and built relationships of trust in our governance structures. But when the economy is contracting, that trust will be withdrawn. The trust that makes those levels of governance effective will disappear, leaving national and international institutions as stranded assets, from a trust perspective.

When you lose trust, you lose political legitimacy. You cease to become an effective form of governance, because trust determines effective organisational scale, and as the trust horizon contracts the effective organisational scale is going to get a whole lot smaller. You can already see, if you look at the places where protests are spreading, the loss of political legitimacy in national governments. In places like Spain, where you get a million people on the streets of Madrid, because the government is up to its eyeballs in corruption, even the royal family is implicated, so people don’t regard their government as legitimate, because they no longer regard it as acting in the public interest, because it is so clearly not doing so. So that ceases to become an effective level of governance. We might actually find that municipal government, or local government, ends up being the only level that still works, because it might be the only level that lies within the trust horizon.

So we must decentralise and re-localise, we need to work at the scale at which we can be effective. There is not a whole lot of point focusing all your effort on the scale that is not going to be effective anyway. There tends to be a focus on – well if only we got the right people in power at the national level, suddenly it would make a big difference – it is very unlikely to make any difference at all, because it’s the system that controls the way these thing happen – the kind of policies that are introduced and the way they are implemented, and that system has its own momentum – it’s essentially unreformable. So we need to work at the level where we still have the ability to be effective.

The Australian situation

[28:34] The situation in Australia is enormous amounts of leverage, very much the same kind of risk factors we saw in Iceland and Ireland and other places that have suffered the consequences since. There is an incredibly high level of personal debt, and private debt throughout the economy, not just personal but corporate, for instance, and banking system debt. There is less in the way of public debt, but it’s the private debt that really is at the heart of the issue that causes the economy to seize up.

One of the major reasons that there is such a high level of personal debt is that there is an absolutely enormous housing bubble in Australia today – not just in Australia, by any means, but there certainly is one of the largest in the world here. So the big three housing bubbles in city terms are Hong Kong, Vancouver in Canada, and Sydney, but it is not just Sydney, there are many cities in Australia that have enormously inflated housing prices. In other words, there is a very long way to fall. When the credit is withdrawn, and people can’t get mortgages anymore, and interest rates go through the roof, which they will – as soon as debt is perceived to be risky the interest rates will go through the roof – people won’t be able to service that debt, they won’t be able to access mortgages, the pool of buyers will disappear, and then there will be no price support at anything remotely like current levels. So, housing prices have a very long way to fall. There is going to be an absolute epidemic of negative equity, where people owe more than their house is worth, and then they can’t sell. So the market will be illiquid and then prices will be coming down. So this is going to cause a major amount of pain in Australia.

This is a commodity exporting economy, with a big trade dependency, very globalised, looking very much out to the rest of the world, feeding 60 million people all over the world with agricultural exports, exporting enormous amounts of resources to China, and importing an awful lot as well. But when trade starts to fall apart, that model doesn’t work so well. Australia badly needs a Plan B that involves looking more internally and focusing on self sufficiency. So the business model for Australia at the moment could best be summed up as: dig it up and sell it to China as quickly as you possibly can.

So of course there is a massive dependence on what is happening in China. This is a major vulnerability, because it is an enormous overexposure to something that is actually going to prove to be extremely risky. The success of the mining sector in recent years has pushed up your currency to the point where your manufacturing became uncompetitive, so an awful lot of it got off-shored. So you don’t make as many things in Australia as you used to – there is less self sufficiency here than there was years ago, because there has been such a focus on the mining sector. But mining is starting to find itself in a world of hurt now, mostly because of the effect of falling Chinese demand, and when mining contracts start to get cancelled, and unemployment starts to go up in Western Australia, there are going to be effects ricocheting throughout the country.

The good news here though is you have a pretty decent resource base, and you don’t have a ridiculous number of people living here – yes the carrying capacity is not that high either, but if you did focus more internally, there is actually a great deal Australia could do to be vastly more self sufficient than it currently is. So the good news is the transition to something workable can be done – but the sooner you start doing it, the better it will go.

There is a large banking vulnerability here. The banks are enormously overleveraged, they’re entirely disproportionate to the size of the host country’s GDP, and their health rests on an extraordinarily overvalued asset base, not just homes but commercial real estate and land as well. So all of these assets are overvalued, and its lending on these assets that rests the foundations of the banking system, so the foundations are going to be very shaky. Be very aware of banking system instability.

There is a tremendous amount of complacency here, not just here but in the entire developed world really. Human beings only really have two operating modes: there is complacency, and then there is panic. There is not a whole lot in between. I am trying to create a sort of useful third space, a kind of informed sense of urgency as to the need to do things differently, because this really is quite urgent – this isn’t something that can wait for our children and grandchildren to address. We have been encouraged for years and years, as we scaled everything up, to upload responsibility for almost everything to some higher level of governance. What we need to do now, urgently, is to download responsibility, to say we are the ones we have been waiting for, and what are we going to do about it. Don’t expect your government to tell you anything, they are not really in a position to. It really isn’t something where the solutions are going to come from the top down. If we want to be proactive we have to work at the small scale, we have to do things ourselves, and say “how can we reinvent our society from the bottom up?”

Australia’s dependence on China

[33:57] Now, this is a Chinese city. It’s enormous. It has everything you would expect a city to have, except any people whatsoever. This is what your Australian resources are building at the moment. This is a giant exercise in turning capital into waste – a giant exercise in negative added value – taking perfectly good resources and turning them into something that has no use to anybody.

The reason that this is happening is that China has a state directed development model – it takes the savings of the nation and builds infrastructure with them – but there is no feedback in terms of what is or is not productive infrastructure under these circumstances, and worse than that, there are active incentives for the people that run the state owned enterprises to overbuild everything, because they get paid for doing it. They get paid up front for building things like this enormous city, whether or not it’s of any use to anybody. They don’t really care because they got paid up front for doing it. So you have a situation where there is no brake on this enormous overdevelopment of infrastructure, and not only has China overbuilt absolutely everything, it has stockpiled absolutely everything as well. So its demand for your resources could fall off a cliff in a very, very short space of time.

Just to put in context the scale of the building boom in China, in the last two years, China used more cement than the United States used in the entire twentieth century. Let that one sink in – that’s the scale of the building boom in China, and this is not building that is mostly going to be useful – some of it is, but there is simply no demand for most of it. So as wonderful a country as China is, with its rich cultural history, it is in a world of hurt right now, because its economy is the biggest ponzi scheme ever seen on the face of the Earth, based on an absolutely enormous amount of reckless lending and bad debt, a huge overdevelopment of the shadow banking system, that is going to be absolutely prone to credit collapse. This is what Australia’s resource exporting economy rests on, and this is not a firm foundation for anything. There is a serious need to move to a Plan B.

If you want to know what places like this are likely to look like in say 30 years time, well bear in mind that bubble infrastructure is not well built – the point was not to build something that would last, the point was to build something that looked good enough to get paid for today, and what happens to it tomorrow is not the problem of the people who built it – they really don’t care. So if you look at what bubble infrastructure typically looks like a few years down the line, the image I am showing you here [Images in external link] is Japanese bubble infrastructure. Japan’s bubble peaked in 1989, so they are approximately 30 years into the period of decay. This was once a resort, a posh resort. It is absolutely falling apart because as soon as the bubble burst – and this was built in the 1980’s – but as soon as the bubble burst, there was absolutely no demand for this – it was simply abandoned. An awful lot of rural Japan looks like this today, because there has been such an enormous fall. You used to have to take out intergenerational mortgages to buy a flat in Japan – 100 year mortgages were needed to buy a tiny little space – you would take out the mortgage and your grandchildren would finish paying it. Prices have absolutely collapsed in comparison with where they were at that peak, and an awful lot of the overbuilt infrastructure is collapsing with them.

This reveals an important point. It is not panics that destroy capital – panics merely reveal the extent to which capital has already been destroyed, by its betrayal into hopelessly unproductive works. That Chinese ghost city is a hopelessly unproductive work – it’s an entire waste of capital. So that capital has already been destroyed, and when we finally wake up and realise that the emperor has no clothes, and these things are abandoned, the capital will have long since been destroyed. Just to illustrate once again that people have figured this out before, John Stuart Mill wrote that in 1867. [Quote Required]

Energy and Resources

[38:31] I wanted to look briefly at energy and resources, because this is probably going to be hurdle number two. It depends where you are, because resources are not evenly distributed, so exactly what will be the limiting factors following on from finance is, to some extent, a matter of guesswork. But energy is going to be a very big limiting factor in an awful lot of places. Energy is simply critical. It is the capacity to do work. And if you look at the energy sources we’ve built our society on, the ones that allowed us to reach these enormous heights of complexity, they had a very high energy-profit ratio, and there was more and more, every year we produced more and more and more.

Production is now flat to falling from those high energy to profit ratio energy sources. The energy profit ratio matters enormously, because it is the ratio between how much energy you put in, and how much you get out as a result. So in the early days of the oil industry, you invested a unit of energy in energy production, you’d get 100 units of energy in return, now maybe 10 to 15 globally. But if you look at the things we are considering as future energy sources, they are about a factor of 10 lower, so maybe 1.5 to 1. That’s not a very high energy to profit ratio, to put it mildly. And if your energy profit ratio falls by a factor of 10, your gross production would have to rise by a factor of 10, just to keep you in the same place, in terms of access of a society to energy, but gross production is flat to falling. So when you have production falling, and the energy-profit ratio falling very steeply as well, that equals a very large energy crunch, so we are going to have an awful lot less energy in the future than we do now.

Now we are looking at all these unconventional sources, to seamlessly supply what the old oilfields have been supplying for the last several decades. To compare conventional and unconventional energy, think if you’re thirsty, you want another drink, conventional energy supplies are like going up to the bar, ordering another beer, and sitting there and drinking it in peace and comfort. Unconventional energy supplies are what you do when the bar is closed – you can’t get another pint of beer, but you’re still desperate and you still want another drink – desperate enough to suck the spilled beer out of the carpet. Even if the bar patrons were remarkably messy, and spilled an enormous amount of beer into that carpet, you’re not going to get a whole lot, you’re going to get a mouthful of dirt, the flow rate will be really low, and it’s going to be a thoroughly unsatisfying experience. It simply does not provide what the conventional supplies were capable of providing. This is not any kind of energy future, and in fact our ability to frack and drill horizontally, and all of these complex things, entirely rests on the supply of conventional oil that we have. We are using up the last of our conventional, high energy-profit ratio energy sources to build infrastructure for these unconventional sources that are never going to supply what we think they are going to supply. So this is another complete conversion of capital to waste.

Adapting to low energy

[41:58] When we have less energy available, as we will, our society will have to simplify, because the energy-profit ratio determines the level of complexity that you can maintain. When we are working on lower energy-profit ratio energy sources, societies will have to simplify. But simplified societies don’t frack and they don’t horizontally drill, so we are not going to be able to do these things in the future anyway. What we need to do is be a lot cleverer, and look at how we might use what we have to create infrastructure that will be able to be maintained, that will still function in a much lower energy future. We need to think a lot more about how we might cope when energy supplies are a lot less plentiful than they are now. Right now we just throw cheap energy at every problem that we have. That’s not demonstrating that we’re clever. In the future we are going to have to prove whether in fact we are clever or not.

Planning horizons are going to change remarkably, over the next few years. There is an economists’ concept called the discount rate, that’s the rate at which we discount the future in comparison to the present. When people have all the major bases covered, they’ve got enough to eat and drink, they’re not cold, they’re not penniless, they start to think more about the long term – they have the luxury of the longer term view – if they’re not in a state of short term crisis. So at the moment, we think a little bit more about the future – we are not terribly good at thinking about the future as human beings, but at the moment when we have most bases covered, we are better at it than we usually are. But, when you move into the contraction phase, and you start to get into that short term crisis situation, the discount rate will go through the roof. You’ll be lucky to find people thinking much beyond next week, let alone next year, or longer term priorities.

However, if we can be proactive, and build supply cushions for the essentials, then we can preserve the luxury of the longer term view, because if we let ourselves get pitched into a state of short term crisis management, we don’t do our best thinking under those circumstances. We really need to keep ourselves in a cool head space where we are thinking constructively. To do that, we need to be proactive, to build those supply cushions, even if they are relatively small, they will make a big difference to our ability to maintain a cool head in the future. Because if we can do that, we keep people from defaulting into movements of anger and fear that do nothing but give political mandates to extremists.

Building community

[44:31] We absolutely must build community. That’s thing number one. The most important thing you can do is to come together and work with other people, and build relationships of trust. It’s about pooling resources: time, skills, space, facilities, tools, enthusiasm, and money. Everyone has something to offer, and if you pull those things together, the whole will be greater than the sum of its parts, and this will allow people to face a future together, and this be much easier to face the future together than it would be if people were only focusing on individual actions.

Empowerment and engagement matter a lot. In an era of expansion we disempowered people, because we scaled everything up so enormously, we moved so far beyond human scale that people didn’t think what they did would make any difference, and they were working hard on the treadmill, and kept running faster and faster, so they disengaged. You have much less civic engagement today than we did several decades ago. But when we start working at a smaller scale again, because effective organisational scale will shrink so much, this will be much more like human scale, so our activities as individuals are going to make a significant difference, and we can expect a much greater degree of civic engagement under those circumstances. So this is where we need to start with the process of downloading responsibility, and looking at our individual actions and how they can affect our local reality.

So we need to start thinking about initiatives that build social capital and relationships of trust. Things like time banks, local currencies, community gardens, transition towns initiatives, permaculture programs, intentional communities, eco-villages. There are many ways that people can come together and build something functional. Local government decisions can make an enormous difference. Local governments can start by getting rid of barriers to people looking after themselves. Right now, there are often bylaws in a lot of places that prevent people doing things that would make them a lot more self sufficient. Getting rid of those barriers doesn’t even cost anything. And if you don’t think you local government might do something like that, I would strongly suggest that you step up to the plate and stage a coup, essentially, and run for local government

Relationships of trust are absolutely foundational, and this is really where we need to start. So if we can build a top-down bottom-up partnership between the municipality and the grass roots, that is a very powerful structure indeed.

Time banking can be very important, because it is an exchange of time and skills without the need to exchange money in the other direction. If you are just doing something for someone, you are trading skills directly one on one, then it depends what skills you have and what the other person has as to whether that trade works. It is difficult to scale that up, but if you put in place a time bank, where you are simply keeping track of how many hours people have done, whoever they did them for, how many hours people have contributed, how many hours they have withdrawn from the system, it doesn’t have to be a one on one exchange anymore. So you can create a situation where you can scale up reciprocity, and that can make a very large difference, because you are building interdependence, social networks, trust and respect, and that is very, very foundational.

Community finance

We need to re-localise finance. As I said before, a bubble creates a situation of artificial scarcity, where there is still people and resources, but no money to connect them. So we can think about addressing the liquidity crunch with alternative currencies, with different forms of liquidity. A money monopoly is a significant power, and it will be defended, but eventually that money monopoly will simply break down. So, if we have thought in advance of how we might introduce additional forms of liquidity, those can serve us very well.

Local currencies are fiat currencies, fiat means trust, in other words they only operate within the trust horizon, by definition, so they define a local area. What you have is something that circulates only in this local area because it doesn’t count as money anywhere else. And it is money circulating within a local area that defines what level of economic activity you can support. If you build in a feature called demurrage, then they can become even more effective. This is where you have to stamp the local money every month, in other words it devalues over time, so that’s a disincentive to horde it – it is a specific support for the velocity of money that keeps money in circulation within that local area.

Slow money is an important initiative. The goal of slow money is to get a million investors to commit 1% of their investment income to the real economy. That’s a woefully unambitious goal, because essentially that means people would be leaving most of their investment funds in a Ponzi scheme that might just disappear on them. So I think what we need to do is take the concept and vastly expand the scope of it, to say that what we need is to invest in the real economy – we need to invest in things that are real, that are foundational, that won’t simply disappear, because they are not purely virtual wealth.

Now there is an enormous demand for things like local organic produce, but these small producers, the cost of capital is high for them because they are perceived to be risky. If people extracted money from financial assets and put them in the real economy, then there would be an enormous increase in the scope of what can be done, and we would be building businesses in the real economy that had local supply chains and local distribution networks, and this would allow communities to become much more self sufficient. Bear in mind that those financial assets are going to get re-priced at pennies on the dollar at some point, so this is not a capital preservation strategy. People invest in financial assets because of the yield, but when you chase yield you chase risk – the risk is that you will lose the income and the capital. If you invest in something that’s real, that you genuinely understand, the risks are very much lower, and in the process of shifting investment into the real economy you can serve your community tremendously well, by ensuring the supply of local goods and services.

We are trying to build a robust system here. Dependency is vulnerability, so if we can create local self sufficiency, we are better able to face uncertainty with flexibility – to replace brittleness with flexibility by restoring safety margins. We need to minimise the consequences of being wrong, so if we are completely betting on the current system continuing its expansion, and the trend change hits, the losses are catastrophic and there is no way back. Now, contrast that with the situation where you assume the trend change is coming, and you prepare accordingly, you hold liquidity, you get out of debt, you build community, you gain control over the essentials of your own existence. If it doesn’t turn out to be as bad as you thought, you haven’t really lost anything, you’re just really well prepared to face whatever the future has to throw at you. So the risk is highly asymmetrical. Bear that in mind, because the future belongs to the adaptable – it is as simple as that.


[51:58] In conclusion, we are preparing for a very different kind of world, We can expect a major initial shock and then a long period of adjustment. We need to decentralise and reestablish local control. No more business as usual. Local grass roots solutions are not going to give you business as usual – that’s a creature of cheap credit and cheap energy – both of those are going away.

Now some years ago former Vice President Dick Cheney in the United States said that the American lifestyle was not negotiable. I would generalise that to the whole world, the whole developed world anyway, and say that’s true, because reality is not going to negotiate with you. Reality is going to determine what is and is not physically possible, and it is our job to get our expectations in line with what reality can hope to deliver. If our expectations are pinned on ever increasing material prosperity, we are probably going to be disappointed. But it’s not a new iPad every year that makes people happy; it’s community, it’s relationships of interdependence. If we shift our expectations towards voluntary simplicity and working with other people, then we can rediscover what it means to be human, and this is a profoundly positive thing.

So, to sum up I would say you can’t change the waves, but you can learn to surf. These swings of expansion and contraction are bigger than you are. Nobody is controlling them. You can’t prevent the fact that bust will follow boom – it always has and it always will – what you can do is identify where you are in the cycle and act accordingly. It is about learning the lessons of history and applying them in our time. We are the first generation that has ever had the opportunity to do that, and it is an opportunity we simply can’t afford to waste.

Thank you very much.

Review article section: The limits to growthThe functions of money, When money fails, A pile of promises, Money goes global, Financial collapse, The great collateral grab, Operating system crash, Deglobalisation, The Australian situation, Australia’s dependence on China, Energy and resources, Adapting to low energy, Building communityCommunity financeConclusion

3 Replies to “Nicole Foss on Money and Financial Crises”

  1. I have just fixed a problem with the audio tracks, that must have started when WordPress went through a complete upgrade. Anyone paying attention who wants to listen to them should try again.

    If they work, then why not share this post with others who might benefit from a proper understanding of the dynamics of finance. And if they don’t work for you, please let me know.

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