Here is a rather lengthly post that compliments the one from yesterday. Believe it or not, this is a short segment of the post by a UW professor with a rather interesting background. Jerry will appreciate the take on energy. I recommend the whole post as it discusses markets at length.
It turns out that as long as buyers are generally making more income over time (or believing they will in the future) and there are ever more buyers entering the markets over time, the economic measure of the market (not its intrinsic aggregate value) can rise without seeming to cause too much of a problem. These conditions are met as long as the economic system in which the particular market is embedded is growing. The housing market in the US and earlier in Japan are examples. And that condition had been met as long as energy flow was increasing throughout much of history. But starting around the early 1970s things started to change. Energy flow was still growing but at a slower pace each period. It had entered the top part of an ‘S’-shaped curve. This is the point beyond which the marginal return on energy (and money) invested in getting more gross energy out of the ground went into serious decline*. And as economists are fond of reminding us, such conditions cause a decline in period to period profit growth.
When the rate of marginal energy return started to diminish the real work that needed to be done to support the production of real (actual physical) wealth began to diminish as well. Almost nobody noticed because nobody paid attention to net energy and its role in production. The energy inputs to production are relatively small for any one firm, so the marginally rising costs of those inputs could be easily ignored. Nor were they paying attention to the declining growth rate of real assets. Instead financial wizards had started to push financial ‘instruments’ and ‘products’ onto the financial markets. Ordinary people started thinking of their homes as investment that paid dividends. Everyone was fooled into believing the economy was still growing over the last several decades The sales of these products and consumer goods based on money borrowed from supposedly appreciating asset values fluffed up the GDP. Indeed the demand for services in the artificially buoyed economy led to the creation of many jobs. All of which led economists to declare the economy healthy.
In reality it was moribund. Real wealth was being produced at declining rates. What was being called real wealth, trinkets and toys made in China, further enhanced the illusion that our material wealth was expanding. Behind the scenes, as is now painfully obvious, governments ignored important infrastructure investment letting entropy work its will on bridges and power grids were not upgraded to deal with the growing demand. We let slide the deep basis of society and the economy for superficial and illusory marks of a healthy economy. We, in the west, shipped manufacturing and other jobs off to Asia because it was expedient and supported maintaining the bottom line. Of course a few companies that could not sweep their cost structures under the Asian rug were stuck looking for another way out through creative bookkeeping. Companies did what they had to to keep the illusion of America and the other OECD countries as economic engines producing wealth, when in fact it was producing hot air to pump into the bubbles.
Without real growth in the real asset base, especially when there is growth in population, you will find that markets will crash and fail at the slightest provocation — call it the trigger effect. One little hitch and a bubble or two will bust and bring the whole edifice down with it. That is what we are witnessing now.
And further in his conclusion that these conditions are necessary for the proper functioning of markets. I do not have quite the same confidence in regulation as it currently operates but do believe it can be made more effective and at the same time not overly disruptive.
To summarize, markets work when:
- Buyers have adequate information
- Sellers are restricted to reasonable profit margins
- Competition among buyers is regulated to assure best uses
- Competition among sellers is regulated to assure non-overuse of resources
- Not expected to provide coordination over larger scales (smaller is better)
- The system as a whole is either in steady-state or growing