Rob’s comments below are in italics.Derek’s comments below are in normal font.

As we record it’s Monday, 23rd of February. I want to comment on what seems to me the most critical cliffhanger in the world at the moment — the movement of two American battle groups closer and closer to Iran, along with lots of threatening rhetoric. It’s difficult to know what will happen. It seems quite suicidal to attack Iran.

They’re unlikely to destroy its retaliatory capabilities with the opening salvo. The retaliation — probably on Israel, certainly on American bases, and probably on the American fleets — is likely to be utterly devastating. How America would respond, and what that means for Israel, is anybody’s guess. Many of those things could be very hazardous to all of us. It’s difficult to view any of that with equanimity.

I’ve come to the assessment that they basically just do whatever’s most profitable. If it’s most profitable to go to war, they’ll go to war. If it’s more profitable to have peace, they’ll have peace. War would appear to generate trillions of dollars.

Well, as we’ve said before, in terms of the amount of real wealth at the end of the process, it’s a lot less than it was at the beginning.

Anyway, on the topic of putting together our Sovereign Finance worldview—if we’re looking at the money system, the obvious place to start would be the academic discipline that supposedly deals with these matters. That’s called economics, sometimes called the ‘dismal science’. That’s a misnomer, because in real terms it’s not a science at all.

The main reason I say it’s not a science is that we don’t discredit paradigms or theories when they fail to make accurate predictions. That’s what happens with any of the so-called hard sciences. To take one example: there was a time when the theory of combustion held that a substance within the material called phlogiston was emitted during burning. On the face of it, it looks obvious. If you set fire to a piece of wood, flames come off — it appears to be emitting something. So it was a reasonable theory.

But when people looked into it experimentally in a controlled, sealed environment, they found that at the end of the burning process, once everything had cooled down, some of the air had been consumed. It wasn’t that anything within the fuel was emitted. Rather, it was combining with something in the air, which they eventually discovered was oxygen. That’s the way a real science progresses. It makes predictions based on a theory or hypothesis.

It’s hypothesis, then evidence, then a new hypothesis. Plus no hypothesis can ever be beyond question. If you can’t question it, it’s not science.

Yeah, exactly. That alone rules economics out as a science. There are also various dogmas which appear to be sacrosanct. There’s the image of the rational actor who is trying to improve his own circumstances at everybody else’s expense, essentially motivated by egocentric considerations.

That’s probably where the adjective “dismal” comes in — it’s a very dismal view of human nature, that everybody’s trying to do everybody else down. There might be plenty of people who do that, but there are also plenty of people who are motivated by all kinds of things other than selfishness. That obviously needs to be taken into account in any model of human behaviour we’re trying to construct.

There’s another facet of economic theory: the idea of things seeking equilibrium in the marketplace. This is a complete fiction. The marketplace is in a continuous state of flow, and in particular, it requires a constant input of energy for anything to happen at all — something that is largely ignored. I’ll come back to that in more detail.

Market fundamentalists, as George Soros described them, hold up Adam Smith as a poster boy for modern capitalism. That wasn’t really the point he was trying to make at all. His writings are predominantly ethical, promoting upright moral behaviour rather than dog-eat-dog competition.

I’ll link back to the episode we did on Adam Smith and the various other economists, because a lot of these people are partially represented by a small number of things they said.

Yeah, exactly. When he spoke about the marketplace, he had in mind a literal market where people met once a week

I have a lot of issues with the word “marketplace” anyway. What on earth is this fabled marketplace that I’m supposed to be in?

Yeah. Even 50 years ago, the stock exchange was a real marketplace where the same people met each other every day. You’d only survive in that if you were regarded as trustworthy. Now it’s become a complete abstraction. Many people never even meet those they’re conducting transactions with. It’s all done - not even over the telephone - but through a computer screen.

The danger for sovereign entrepreneurs as well is that “the marketplace” implies you’re just a vendor — just another supplier of a commodity. That isn’t what most of us are doing.

Yeah. In Adam Smith’s time, the marketplace was where people actually met. They were all part of the same community. Establishing a bad reputation for honesty or quality of goods would be self-defeating very quickly.

It was also a predominantly Christian society. Even if people weren’t deeply motivated by the golden rule — do unto others as you’d have them do to you — they’d have to make at least a reasonable show of it, or they’d be ostracised. None of those factors applies to the theoretical modern global economy.

Many early economists regarded the economic process as involving labour, capital, and land. After the Industrial Revolution, when the agricultural part of the economy became less dominant relative to the factory economy, the discussion narrowed as though only labour and capital were involved, and what might be an equitable or practical distribution of rewards between them.

Marx felt that labour was entirely responsible for the addition of value and should therefore receive a larger share of the rewards. In fact, all of these analyses ignore one critical thing: without energy flowing through the system, none of this happens. Labourers can’t do anything unless they’ve had enough energy — in the form of food — to provide the muscle power for whatever work is involved.

Empty sacks don’t stand up, as my dad would say.

Yep. Capital, in terms of industrial machinery, doesn’t do anything until you put the coal into the furnace, or whatever source of energy you have. This means it’s not an equilibrium system — it’s what’s called an open system.

Ultimately, it’s powered by the flow of energy from the Sun to the Earth, then released as lower-quality energy after whatever operations have been performed. It’s a continuous flow. It’s been supplemented for the last two or three hundred years by energy that came from the sun millions of years ago, stored in the form of fossil fuels. We’ve burned through those at a great rate, and still — as we’ve noted elsewhere — failed to properly account for the fact that as they become more exhausted, they’ll become increasingly expensive in energy terms to harvest.

Finally, an important part of the analysis, almost entirely missing from mainstream economics, is the insights of system dynamics. This is the study of complex systems with multiple interacting feedback loops. Some of those loops are reinforcing, creating increasingly large results as output increases. Others are stabilising ones, bringing things back into balance by feeding output back into the system — the classic example being the thermostat. If the room gets too hot, the heating turns off, and vice versa.

The equilibrium framing is mistaken. Energy flows through the system and must be replenished to keep it going. That’s why we need to bring these other factors in, if we’re going to build an economics that really reflects how things work and provides useful tools for strategising and selecting tactics.

It sounds to me like economics, as it stands today, largely just serves the existing power structure.

Exactly. Economists know which side their bread is buttered. They can’t afford to rock the boat, or they won’t get promotion and tenure. Those employed by banks or financial institutions are obviously there to serve the interests of the people paying their salaries.

Economic theory also has nothing to say about the role of banks and how banks create money.

That’s another major missing factor.

The other thought I had on the subject of energy — we’ve discussed in the past that money in its purest form is energy, assuming it represents people trading for goods and services rather than speculating. Most transactions going on at the moment are the latter. But that movement also implies energy moving around.

Yeah, exactly.

It feels to me like if you fix the money, you solve a lot of the problems. There’s just a lot of vested interest against fixing it.

Yeah. I was thinking about this the other day. We’ve talked at times about pensions and how far short they’re falling of how they’re supposed to work. It occurred to me that a major factor in the failure of the pension system is inflation.

If you imagine a world of stable purchasing power — as existed in this country for 300 years before the disruption of the two world wars undermined Britain’s financial position — the theory of pensions makes sense. You accumulate a fund over a lifetime by paying in regular amounts, which grows via compound interest into a sum large enough to provide an income in your post-work years.

The earliest payments into the account have the most effect o...

The (Quite Serious) Shortcomings of Economics