‘Super members urged not to panic’ reports the Sydney Morning Herald. ‘Share panics hits nest eggs’ is the heading in the Herald Sun. ‘Black Friday for the markets’ writes Robert Gottliebsen. Once again it seems that the economy and financial markets have jumped from the business pages to the front page of the paper. But don’t worry says the Treasurer, "Growth remains strong in Australia ... our fundamentals are strong and I remain confident that we will return to surplus in 2012-13." Whilst Saul Eslake argues that Australia should be okay because the Government is in a position to stimulate the economy if needed whilst the Reserve Bank can significantly cut interest rates.
Maybe it’s just me but it seems that the vast majority of media commentators, economists and politicians seem far from convincing when attempting to explain either the problems plaguing the global economy or in how their proffered solutions will improve the situation. One reason for this maybe because the events that are unfolding around the world don’t fit into the comfortable little prism through which they view the economy.
Before offering an alternate view, one that explains where we are and where we are likely to go, a small but necessary detour. A US Air Force fighter pilot, Colonel John Boyd is famous for developing the OODA loop (OODA stands for Observe, Orient, Decide and Act). After studying the disproportionate ratio of aerial combat victories by US pilots over their adversaries in the Korean war, Boyd concluded that it was as a result of better pilot visibility which allowed improved observation and hence orientation to the situation, and more responsive controls, allowing decisions to be turned into actions faster. The faster decision action cycle of the US pilots resulted in the actions of the North Korean and Chinese pilots becoming increasingly inappropriate over time until the US pilots gained a position of advantage from which they could shoot their opponents down.
The OODA loop is particularly relevant now as we look at the current state of the economy. Stepping back to 2008, the worlds leading politicians, economists and bankers observed events such as the collapse of Lehman Brothers and near freezing of credit markets, a situation which they felt compelled to respond to.
With a crisis to resolve they orientated themselves to the situation. According to Boyd, orientation is the key step in the loop as it shapes observation, decision making and hence action. Orientation is a complex process that involves factors such as previous experience, cultural norms or world views, developing an understanding of the meaning of new information all of which is analysed and feeds into the decision making process. The decisions made and actions implemented were of course massive economic stimulus packages around the world which, for a period of time at least, appeared to work.
Unfortunately despite these massive injections of fiscal and monetary adrenaline it seems that it has come to nothing. The second stanza of the GFC appears to be commencing. How can this be so? The answer can be traced back to the orientate part of the OODA loop and some fundamental, if not fatal, flaws in contemporary economic thought.
In his latest book ‘The Wealth of Nature: Economics as if survival mattered,’ John Michael Greer, building on the works of E.F. Schumacher’s ‘Small is beautiful: Economics as if people mattered’ provides an overview of these flaws, such as the unshakable belief in the infallibility of free markets and the law of supply and demand. Perhaps the most glaring failure however is the inability to see economics as a subset of a much larger world that is in the end governed by non-economic forces.
One of Greer’s key insights is his model of the economy based upon three tiers. The primary economy is the natural processes that provide goods and services to humans without the need for human labour. These goods include things such as fossil fuels and mineral ores whilst the services include pollination and the water cycle. The secondary economy is where humans become involved, namely through the transformation of the goods and services provided by the primary economy, that is nature, into the goods and services required by humans. The final tier is the tertiary economy, the purpose of which is to allow for the distribution of goods and services of the primary and secondary economies. Critical to an understanding of this model is that the different types of wealth that these three tiers produce are not interchangeable. In short, you can’t eat money and you can’t grow food without the natural wealth provided by the earth’s primary economy.
Another crucial point in this model is that whereas the primary and secondary economies are subject to negative feedback loops and essentially self regulate; the tertiary economy, as currently structured, is not. Fiat currencies, fractional reserve banking and exotic financial instruments allow the money supply to increase independently of the primary and secondary economies.
Of course there is only so long that the abstract world of the tertiary economy can remain disconnected from the real world of the primary and secondary economies. The economic drama of the last five years, which Bill Bonner dubs the ‘Great Correction,’ is merely a natural consequence of the tertiary economy attempting to realign itself with the primary and secondary economies. With an enormous discrepancy still remaining between what Niall Ferguson calls Planet Earth and Planet Finance, with Planet Finance still being seven times overvalued, we can expect the Great Correction to continue for many years to come.
This discrepancy is further complicated by the various limits to growth that are impacting upon the primary and secondary economies. For example, the peak of conventional crude oil production was five years ago according to the International Energy Agency and looking forward, a number of the key inputs required by industrial society are likely to become increasingly scarce in the years and decades ahead.
Economists, policy makers and politicians and arguably the majority of people in the Western world, whose world view is framed through the (narrow) prism of economic growth, scoff at notions such as resource depletion and limits to growth whilst ignoring factors such as the laws of thermodynamics. Perhaps this is why virtually all economists failed to predict the GFC and perhaps this is why the European and US debt crises bumble along from one hiccup to the next.