Tangible standards to measures long-term wealth creation dynamics

In a world where, de facto, current fiat monetary units have lost all meaning (Third Challenge) it has become vital to assess wealth creation dynamics on the basis of a constant standard of value that be relevant in the face of the four Challenges that we have just reviewed. In order to do so some simple but fundamental considerations are necessary:

• Without energy, no life and no wealth. Energy is the one and only resource that cannot be replaced with another. As such it must be recognised as the only tangible, primary source of wealth creation. The other fundamental source of wealth, human intelligence, can come into play only if sustained through energy flows. One Joule in 1900 and one Joule now are exactly the same. A Joule is never lost nor created (1st of thermodynamics) – exactly like gold that has been treated since the origins of money as a fundamental store of wealth.

Figure 3 – Oil – Gold Link [1]

Figure 3 highlights that, since the early days of the oil era in the 1860s, the price of oil expressed in gold has remained fairly flat between 1g and 6 g of fine gold per oil barrel (gold curve). In regard to this stability, since President Nixon terminated the fixed convertibility of the US$ to gold in 1971 and forced the world to adopt a fiat monetary system, the price of oil in US$ has increased 50 fold (blue curve). However, except concerning jewellery, dentistry, and some industrial uses as in electronics, gold’s main use remains that of an unproductive, long-term store of value while energy is the fundamental source of wealth creation. It is thus not only legitimate but also advisable to examine the wealth creation capacity of industrialised countries in terms of an energy standard of value.

Let’s be clear, we are not talking here of considering some ratio of Gross Domestic Product (GDP) by energy inputs. Instead we are focusing on using a unit of energy, for example, the barrel of oil equivalent (Boe) that is often used to present global energy statistics as an invariant standard of value.

One cannot cheat with the 2nd principle of thermodynamics. Put in simple terms, the 2nd principle states that any transformation of an energy flow into another entails a certain level of energy losses (for example, the extraction of motive power from the combustion of gasoline in an internal combustion engine generates a large amount of waste heat that must be eliminated through the car’s radiator). Globally the energy losses taking place between primary energy flows and end-users’ energy flows are in the order of 88%, which is no longer viable. [2]

Except engineers working in some well-confined industrial settings, most decision-makers think (very badly) in terms of the 1st or of “energy savings” although according to the 1st itself so to speak, and what is at stake concerns instead the 2nd entropy increases in dynamic systems operating far from equilibrium. They also concern themselves with improving “energy efficiency” without ever considering the 2nd set of “free energy” flows in Gibbs’ or Helmholtz’s sense where, again, the 2nd Monumental policy nonsense ensues.

For example, many so-called decision makers seek to put in place policies to entice or force end-users to achieve “energy savings” that on the longer-terms will not be able to amount to much more than very few percents of the total energy flows put into play along energy value chains. In doing so they ignore the fact that the main “pools” of inefficiency are not at end-users’ levels but at the generation and transport stages and that those are intimately related to declining EROIs. These upstream losses are out of reach of the hapless end-users or tax-payers who end up having to pay a great deal for things that achieve very little. The overall “inefficiency” of “energy efficiency” policies is also due to the fact that most efficiency gains at end-user levels entail substantial indirect energy costs that cannot be reduced in the absence of high EROI technologies (e.g. the energy cost of materials used in the refurbishment of old buildings). It is also well known among “old timers”, those of us that have been in this business for decades now, that the effects of efficiency drives tend to be short lived. Consumerist society rules. Monetary gains achieved one way tend to be spent somewhere else so that overall energy use keeps increasing with the GDP. [3]

With the above two considerations in mind we can now select a standard of value relevant to our purpose. Notwithstanding Nixon’s decision, worldwide gold has kept a monetary status and, beside the US$, remains an important part of central banks’ reserves. Presently gold constitutes approximately 11% of total global reserves and the US$ 55% (a decline from some 63% in 2000). However, as we have already noted, gold is not directly involved in any significant level into productive activities as energy is. As for oil, it is the source of some 95% of transport fuels globally and without oil-based transport none of the other energy forms (such as electricity) and other primary energy sources (such as coal, gas, uranium, biomass, wind, solar, hydro, and so on) could continue being delivered. In this specific sense oil remains the most critical of all energy sources.

The fairly stable link between oil and gold that we have observed in Figure 3, and oil’s key energy role, justify using oil as a tangible and stable standard of value on a par with gold, i.e. one that has not changed over the last 150 years (a barrel of oil in 1870 is the same as a barrel of oil in the present, with the same energy content and thus capacity to be a source of wealth creation just like a gold bar has remained the same within the same period). [4]

By the same move we can treat oil as a proxy for energy, since it remains the most critical resource used to generate wealth and since to date there is no alternative able to be developed and deployed rapidly and globally. Using the Boe as a standard of value (expressed as Boev) and converting GDP statistics expressed in monetary units into Boev at current oil prices for each year also enables us to take roughly into account 2nd monetary cost, and thus monetary GDP values are presented net of such accumulated losses. In using the Boev we enables us also to consider long-term evolutions independently from any monetary effect such as inflation. This is important since currently many observers have become critical of what they see as numerous manipulations of inflation statistics.

[1] The data in figures 3 to 10 are from the British Petroleum PLC statistical series and from MeasuringWorth.com or from indiviual counties’ statistical sources.

[2] See Murray, James, and King, David, 2011, “Oil’s tipping point has passed, The economic pain of a flattening supply will trump the environment as a reason to curb the use of fossil fuels” in Nature, 26 January, Vol. 481

[3] See Hall and Klitgaard, 2012, Op. Cit., pp 199-205.

[4] Note that when valued in gold the prices of tangible wealth items tend to remain static, for example, the price of a luxury car paid in gold now is about the same as the price of another luxury car also paid in gold and bought around 1900.

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