Wealth Is Not (Quite) Like Energy

by Policywatcher (Oct. 2008)

There is a common tendency to equate wealth with energy – and various pundits often talk about wealth and energy in similar terms.  There are beguiling similarities:

       Like matter and energy, wealth and energy appear to be relatively interchangeable commodities.  Those with great amounts of reserves of energy can freely convert them to great wealth, and those with great wealth can convert it readily enough to ownership of reserves of energy.

       Wealth appears to obey basic gravitational laws, whereby large agglomerations of wealth attract additional wealth to themselves – in the same way that energy does when converted to mass.

       The possession of either wealth or energy provides availability of power.
The implied E=Wc2 [Energy = Wealth * the square of the speed of circulation of money in a free market, perhaps?] can however mislead.  Because wealth does not obey the same conservation laws that so simplify the mathematics for Physicists.

I’ve seen it often suggested that property crashes and other financial crashes do not destroy wealth.  And I’ve seen claims that “like energy, wealth is not created or destroyed – it’s just moved around”.  Indeed, energy can neither be created nor destroyed, but only transferred (and only from high temperatures to lower) or converted into other forms such as matter.  It can be lost to practical use, by becoming converted to randomized low-level heat too weak to be recovered – as happens to most of our waste heat, from car engines to electric light bulbs to the lost heat we sweat off when walking – but never actually destroyed.

However, wealth can most assuredly be both created and destroyed.

The work of entrepreneurs – and most specifically of that special type that actually builds businesses that can CREATE something and employ people in doing so – creates wealth by adding value to materials and selling the result to others in order that the buyer obtains additional value, and so that their employees also gain what they regard as an acceptable wage for their efforts.  Wealth has indeed been created.

As for the long-term destruction of wealth – if you own land, and either the value of land in general goes down or specifically the value of your land goes down – perhaps due to some natural catastrophe, somebody else does not thereby automatically have to get richer.  Nor is the wealth represented by the land merely getting spread around and diffused into low-energy forms – there are no thousands each getting a nickel of your lost capital.

It can, perhaps, be harder to understand that the speculation and leverage employed in the Stock Markets do also create wealth, when the appearance is often indistinguishable from simple gambling, and leverage, buying on margin, and other uses of the derivative markets do seem to be effectively using the power of money that does not even exist.

Yet they do contribute to the creation of wealth, because the “pseudo-capital” they represent is not itself passive – it is invested in entrepreneurial and manufacturing businesses that need access to capital to create wealth, and provided that they do so in a timely manner and create more wealth than the capital they were created with, there is no real problem.  In these markets, where wealth is being created and destroyed at a furious rate, we may perhaps draw somewhat fanciful comparisons with the zero-point energy of empty vacuum, where energy is constantly created and destroyed in a seething foam of energies at incredible levels – nothing is as busy as “empty space” just as no wealth creation is as busy as the speculative markets.  And just as science writers have dreamed of tapping the zero point energy, and warned of the significant risks that imbalances in it could represent, we have tapped the zero point markets, and occasionally suffer the consequent explosions.

To take a minor aside – those who have “borrowed” money from their employer with a similar objective in mind to the wealth creation of the speculative markets, and perhaps fallen foul of the authorities when their speculation falls at the fourth fence, have found that the law draws a distinct difference between their position and that of a merchant bank performing the apparently similar operation.  The critical factor is of course the informed consent of someone with the right to make such risk judgements.  That the public are unaware of the (supposedly) informed consent being expressed by financial institutions on their behalf is merely an unfortunate effect of the complexity of the systems – and not necessarily an evil one – after all, people are similarly unaware of the complexity of the work of their Doctor, IT consultant or the designers responsible for the huge range of day-to-day electronics that they take for granted.

Setting aside the speculative markets for a moment, and concentrating on the real creation and destruction of wealth.

During a period of growth, you will hear many economists extolling that "business is not a zero sum game".   At this point they invoke games theory (rather than the then-inconvenient comparison with physics) to describe the fact that just because one company in a deal gets richer, it doesn't mean the other company gets poorer - it is regarded as entirely normal that both can profit on the deal.  You hear of “Wealth Creation” being used to justify the high salaries of those who are in charge of businesses – particularly in financial businesses where, in fact, wealth is probably not created, but merely magnified or concentrated.

Yet somehow when the market falls, the mantra changes to try to create the perception that wealth is not destroyed, just moved about...

When the value of things drops, those with sufficient faith in the market like to claim that the wealth is conserved, and that someone else gets richer because they acquire the land at a lower price.  However, this assumes that the (future) potential value of land can be used to balance the equation, and that this potential value of the land equals your loss.  In practice, the potential value of land is not as deterministic as the potential energy used to balance conservation laws in physics, and even those with faith will tacitly admit this in their follow-on – the sometimes unstated but always present assumption that the buyer’s gain may well exceed your loss – or that if it does not, it will do so for yet another buyer further down the chain.  The only alternative they are reluctant to accept is that wealth can indeed be destroyed.

Whether they wish to admit it or not, those who claim a conservation of wealth are lying to themselves and others – they do not believe in the conservation of wealth at all.  Instead, they believe something very much odder – that wealth can be created, but not destroyed.
There are a several reasons for this, and reasons why the public and the authorities are complicit in conspiring to pretend that it is so.

In times of growth, the idea that wealth can be created by hard work of many seems clear and obvious. 

And the understanding of this is essential, because otherwise where is the incentive for the entrepreneur to take risk and genuinely create new businesses, rather than simply seeking to exploit others? 

And in times when markets are falling?

For government and banks, the “wealth is conserved” idea becomes important, because the idea that it can be destroyed would be extremely politically sensitive at this time, and the public becoming aware of it could aggravate the problem.

For the public, the myth that “wealth is conserved” is also important, because the desire to place blame is strong - and if wealth cannot be destroyed, then clearly it must have gone to the greedy execs managing the businesses...   the fact that their bonuses, large as they are, are barely a drop in the ocean compared to the losses either doesn't register, or, paradoxically creates more anger as various members of the public conclude that not only have they salted away wealth of their own, but that they have enabled others to do so on an even larger scale.
The announcement of criminal investigations by the FBI at Fannie Mae and Freddie Mac can be seen as being as much to do with maintaining public order and confidence as with any real desire to clean up Wall Street’s act. 

Right now, I would suggest that we have essentially three problems – as crashes of various sizes have had before. 

       The first is that it is likely (as before) that during the boom times, there have been serious levels of financial dishonesty that only get exposed as a downturn forces people into looking where their money has really gone.

       The second is that the extent to which the value of assets was correctly evaluated cannot now be known.

       The third is that an unknown amount of wealth has actually been destroyed, as prices of property have fallen, and so have the prices of banks and other companies.
The result of these factors is that not only do we not actually now know accurately what the total wealth of the global financial system is, we cannot be sure that we have known in the past what it was, nor by how much it has changed.

In dealing with the current situation, the comforting mantra that wealth cannot be created or destroyed, useful in the ways I have already commented upon, carries another risk – that the risk of certain types of action is ignored.  The bailout for example, is not, as some have suggested, $700bn.  The small print is that it’s $350bn, then another $350bn with approval...  and then additional releases of $700bn as needed.  And that is not all of it.  Around the world, dozens of economies are all pumping huge sums into their own equivalents of the bail-out – including various European countries that until only days ago were patting themselves on the back that they should be substantially immune to the current crisis.  The total sums at hazard – like the cost of the Iraq war, which has spiralled far beyond its proponents’ (or indeed its opponents’) wildest speculations – are becoming mind-boggling.

If wealth cannot be destroyed, then in a way, such approaches can do no real harm – the wealth would still exist, and would merely be circulating in a different way, with mostly the same long-term benefits to society.  Apart, perhaps, from a question of how the distribution of such wealth affects the health of societies.  But if wealth can be destroyed, then an ongoing bailout, unless spectacularly closely monitored, could be nothing more than repeatedly throwing all that wealth into a black hole.

For years now, the Anglo/US/European culture has argued to itself that the great problems of the third world are too expensive to deal with.  Clean water, adequate food, education, all of which would create new players in the global market place, and do more than anything to increase the net wealth of the world, have been left to faith, hope and charity.  Yet in under a month, we have mobilized sums as great or greater, to support the financial institutions, and have done so in ways that are arguably little more than a modern institutional Potlach.

Yes, as I have noted earlier, these institutions are not the parasitic entities that their opponents would paint them as.  But neither are they all the vital organs of our society that Bush and Paulson have sought to portray in order to get their way – keeping them is as much a matter of dogma as need.

Suddenly, one thing is starkly exposed.  All the time, for these great problems around the world, we actually had the wealth – we just lacked the energy.

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