The track to a steady-state economy

When a train derails, the first instinct is to set the wheels back on the tracks and get the train moving again. This instinct often serves people well–it’s the sign of a can-do attitude, and it’s exactly what government agents, Wall Street financiers, and Federal Reserve economists are scrambling to do with the stalled economy and crisis-riddled financial system. Before maneuvering the train back onto the tracks, however, a wise engineer will consider why it derailed in the first place. An even wiser engineer might consult a map and ask whether the train was headed in the right direction in the first place.

So why did the train skid off the tracks—why did we experience the financial meltdown and why are we now facing economic turmoil? Although pundits have supplied some answers, most have not dug deep enough to uncover the root cause of the problems.

Theories about liquidity shortages and credit slowdowns aside, it is clear that financial instruments, even really complex ones, can only be as valuable as the real assets they represent (e.g., land, homes, durable goods, companies, infrastructure and information). No matter what the charts and financial wizards declare, those real assets exist in a world governed by physical and ecological laws—they can only grow so far and so fast.

The current financial crisis occurred because paper assets grew much faster than real wealth.  When investors started to realize that paper assets were out of sync with reality, they attempted to sell them. As these pieces of paper flooded the market, their value dropped, triggering an even bigger sell-off. All the paper assets that we thought had value suddenly didn’t, and people lost their retirement funds and other savings, and now they are losing their jobs and their ability to pay for basic necessities.

The growth-based economic system is the underlying culprit. Our entire monetary system depends on the creation of debt and imparts a grow-at-all-costs mentality to practically all economic actors, from CEOs to politicians to stockholders to workers. Even if the costs of economic growth outweigh the benefits, more growth is promoted. Institutional investors, corporations and individuals comply with the growth imperative by seeking the highest returns to capital. The problem is that investment decisions, whether based on sophisticated financial models or gut feeling, tend not to account for the physical limits to growth. Often this growth occurs in the form of bubbles—such as the dot com bubble in the 90s, the housing bubble more recently and the financial bubble—that pop. The financial bubble is particularly illustrative of what’s wrong with the current system. When biophysical limits prevented real industries from growing, we simply grew the paper that represented those industries. Overshooting these limits is the ultimate cause of the financial fiasco.

No matter how fast we get the train moving again (and the decision to bail out failing financial institutions occurred amazingly fast), it won’t do us much good if it’s headed the wrong way.  Is economic growth taking society in the right direction? The answer is critical because, as the bailout and other rescue plans demonstrate, the authorities are working feverishly to fix the system by encouraging more growth.