Monday, October 28, 2013

At the edge of time

This is a post published by Luis de Souza on his blog "at the edge of time."  Among other things, Luis is a researcher at the CRP Henri Tudor in Luxembourg and a PhD student at the Technical University of Lisbon. He is also one of the coauthors of the 33rd report to the Club of Rome titled "Plundering the Planet". Here, he presents an interpretation of the recent crisis as due to mineral scarcity.

Address on Raw Materials

 by Luis de Souza

I was recently invited by the JRC's Institute for Environment and Sustainability (INTESA) to participate at workshop entitled "Scenario Building for a Sustainable Europe". The goal was to provide INTESA by reflecting on past long term scenario building experiences and examining key trends relevant for scenario development. According to the organisers this should happen "by debating conceptual alternatives to conventional growth ". I was tasked with a 20 minute address on Raw Materials.

Unlike most other presenters, my address was mostly focused on what happened in the recent past. More than making forecasts I believe it is important to understand that the way we explore the Planet's resources has been changing deeply since the begining of this century.

Below the fold I reproduce this presentation and the main ideas accompanying each slide.

1. An early Warning

I would expect everyone at this workshop to have seen this graph before (and in all likelihood it is also familiar to most readers of this blog). These famous curves are not just that famous book published by the Club of Rome, it was actually the result of 15 years of research leaded by Jay Forrester at the MIT. This is the result of the standard run of World 3: resources are the main limiting factor of growth and the peak of industrial output is projected to happen right about now (2nd decade of the XXI century) in tandem with a peak in resource extraction.

The question is then if this particular model got it right or not. Searching for an answer I provide the movements of price and quantities extracted for some key raw materials. The prices are not adjusted for inflation, but since the data is for only the past decade the difference isn't large.

Silver has been one of the most spectacular raw materials in the market, with an increase of almost 800% in price between 2002 and 2011. Extraction rates are still growing strongly, about 50% plus in the decade, as the number of industrial applications of this metal continuously expands. But prices are moving up much faster.

With gold we see similar price movements, a 550% increase in a decade. But contrary to silver, mined volumes are mostly stalled. Actually gold mining declined between 2001 and 2008, with the recent rebound coming exclusively from China. There are those who doubt these recent mined volumes from China, but I'll stick the official figures.

Copper is somewhere in between, volumes mined are going up, but not as strong as for silver, and again the price movements are of a different order of magnitude, now over 500% of what they where in 2002. Another interesting aspect of this metal is that the price started moving strongly earlier (2005) than for the other raw materials.

Now moving to energy resources we can see similar patterns with Coal. Mined volumes are growing strongly, 50% in a decade, mostly on the back of China, where extraction has been increasing around 10% per year. Price movements appear not to be as strong as with other raw materials, but on a monthly basis there is was three fold increase from 2007 to 2008.

And finally Petroleum, which accounts for 45% of international trade by weight. Again we see very relevant price increases, over 450% in a decade, against what can be classified as a very shy response in quantities extracted. Growth between 2006 and 2012 was only 3%, possibly within the margin of error of the data.

Right or wrong?

Are these price movements confirming the projections made with the World 3 model? Perhaps, but let us look closer to the model.

These two graphs are taken from the original version of the book, on the left is the standard run and on the right an alternative run with the amount of resources doubled. In this alternative run pollution eventually becomes the overwhelming factor, but what is most important to observe is that with double the amount of resources industrial output peaks a mere decade later compared to the standard run. There was a reason the book was called "Limits to Growth", it is in fact an exercise on exponential growth: the higher you go the harder it gets to keep climbing.

There is a second aspect to this model that is also important to observe. This is a picture I stole from Ugo Bardi, showing the base mechanisms behind the World 3 model: there is a stock of resources that is used to build a stock of capital than in its turn allows for the procurement of the resource in a usable way by the economy. Since the resource is limited extraction initially goes up, reaches a peak and then declines, reproducing the classical logistic model proposed by Verhulst in the XIX century and applied in the XX century by Lotka and Volterra. The main criticism to this model is that it all depends on the resources stock and a proper assessment of its extent. In reality this is very hard to do and it is easy to make an erroneous estimate.

Let us then assume that this particular resource is infinite. If instead the efficiency of the process by which teh resource is procured is declining, i.e. that the return on the capital invested declines with time, eventually the same kind of logistic growth and decline takes place.

This is akin to the fruit tree metaphor. We start with the long hanging fruit and then go up the tree taking the fruit in higher branches. The tree can be infinitely tall, rise up to skies, but there will be a moment when it takes more energy to climb the tree than the energy the fruit provides.

3. The Supply curve

Let me now put this into an economic perspective.

This is an hypothetical supply curve for some raw material. It can be described as a function of ROI, at the right we have the low hanging fruit, say shallower mines, that can provide large quantities for a low price. To provide larger quantities of the material the price has to be higher as we move towards lower ROI resources, say deeper mines or lower ore grades. And as we move to the left the steps to the following ROI grade become steeper, producing the typical shape of the supply curve in Economics.

There are two basic dynamics that produce the sort of price rises we have witnessed the past decade.

In first place is the classical expansion of demand. As the economy grows larger flows of raw materials are required, translating into a rightward shift of the demand curve, penetrating into lower ROI territories, forcing relevant price hikes. This is the case we see with raw materials like Coal or Silver. Note that those able to supply the low hanging fruit start to make much more money without doing anything different, they can even reduce the quantities supplied and still make larger gains.

A second dynamics is a leftward shift of supply, consequence of a reduction in the quantities that can be sourced from the low hanging fruit. Demand may be stable but to procure similar quantities of the resource higher prices become necessary. This is also known as depletion, and is the main reason behind the price rises of raw materials like Gold or Petroleum.

4. A new Resources market

The price movements of the last decade are giving rise to a rather different resources market, with somewhat different rules.

The POLINARES project was an unprecedented research effort funded by the European Commission through the 7th Framework Programme to assess these matters. It counted in its partners some of the top Universities in Europe, plus the BGR and Enerdata. The results mark a major progress in the way raw materials are thought in Europe.

There is a reason for the rise of what the POLINARES partners termed State Capitalism. This is a graph of petroleum consumption (grey) and production (green) in the UK, plus net imports (red) and net exports (blue). It is remarkable to see that the UK was a net exporter during a time of relatively low prices and became again a net importer precisely when prices started rising up again. Naturally countries rich in raw materials look at this and think: "we won't do it this way". And of course, since they are now making much larger monetary gains it seems easy to restrain extraction, especially for those that possess the "low hanging fruit".

These are some of the most important recommendations of the POLINARES project; again a new perspective on these markets is laid out that can only be acknowledged as an important progress.

Policy suggestions

I'll finally look into the future, contrary to the goals of the workshop, I won't provide scenarios, I'd rather lay out some policy suggestions that should steer Europe towards sustainability. I'll start this exercise with two important observations.

This graph shows in orange the Brent petroleum price index since 2007 and in blue the volume of the stocks held by OECD members during the same period. It is interesting to observe that to each price peak corresponds a low in stocks; conversely, each period of low prices is matched with stocks building up. It seems apparent that the IEA (whom coordinates these stocks) has been buffering petroleum prices between 100 $/b and 125 $/b, producing a stable plateau since late 2010. This action has been instrumental in bringing online marginal petroleum resources such as the deep-water pre-salt plays off Brasil, tight oil in the US or the tar sands in Canada

Secondly I'd like to make an exercise with you, imagine that the price of the following raw materials increases tenfold. What would happen?

Gold - it's industrial usage is marginal, hence we would hardly see any impact on our daily lives. But gold is a monetary metal, such a price hike would certainly push a liquidity run, bringing the monetary system under strain. Luckily there are plentiful above ground stocks (almost 100 times annual mining) that would provide short mechanisms to tackle monetary instability.

Silver - the above ground stocks of this metal are equivalent to only about one year of mining, almost exclusively privately held. In practice no short mechanisms exist to absorb such an hypothetical price shock. This metal has a broad range of industrial applications and we'd certainly see the price of some finished products going up: from electronic devices to solar panels, even in clothing. But overal it wouldn't be dramatic.

Note here that I'm intentionally neglecting the risk of silver triggering a liquidity run, since it is too a monetary metal. That would be the theme for another address altogether.

Copper - again there are no obvious short term mechanisms to tackle a price shock. But in the case of this metal the consequences could be quite different since it is the backbone of our electrical grid. How could the grid be maintained and secured sustainably if copper prices became markedly more extensive than today?

These policies I suggest point into directions that may not make economic sense according to standards, but try to provide resilience mechanisms to our economy.

And there are also things we can do from the demand side. Consumers should start getting feedback on their choices, not only on the energy spent by goods during their lifetime but also on the capital and resources spent on its manufacturing cycle.

This slide proved controversial since the concept of Emergy used by François Cellier seems to not entirely match the concept endorsed by the Emergy Society. In any case, the idea is to have a thorough methodology to tag each product and service with a sustainability label.


This book is the reason why I was invited to this workshop. "Der geplünderte Planet" (German for "The plundered Planet") provides a much wider and detailed account of our usage of raw materials; I am the author of a chapter on precious metals. An English language version should be published in the following months.

Q & A

The Q & A provided some further reflection worthy of report.

I didn't choose Gold, Silver and Copper by chance, these are the most conductible metals known to man. Returning to the hypothesis of a price spike of Copper we can see with this graph the options available for substitution:

Silver is the most conductible metal known (hence its multitude of applications) with Copper close behind. Silver is quite more expensive and rare, thus it is not an option for substitution, thus we would have to look down in that scale. Next comes Gold, and although its price is 60 times that of Silver we already lost a third of conductibility. The first metal in this scale that seems able to replace Copper price wise is Aluminium, but at a loss of almost half of the conductivity.

I don't exactly have answers to such a situation, hence the suggestion of non conventional policies like building strategic stocks. There's no guarantee that a wide substitution of Copper in the Economy is possible in a practical way.

Regarding the labelling suggestion, and correcting the reference to Emergy perhaps to Exergy, the question is if it would produce any sort of consumer behaviour change given that prices are the primary choice factor. We can perhaps look at the successful introduction of biological agricultural products in Europe, some sort of sustainability conscience is rising among consumers that should be fully siesed. But a sustainability label is primarily a governance tool, providing further policy options to steer consumer patterns, taxing being just one.

Finally someone asked if among the ways I propose to bypass the traditional markets to procure raw materials, military intervention would be included, given that other powers may compete with Europe. That wasn't exactly the idea, recent events with Iran show how it can take place, with the Islamic Republic convening with Turky the direct exchange of Petroleum for Gold. Beyond that, I'd also note that in some cases Europe would actually be better off had it staved away from military action. Libya is possibly the best example, the knee jerk action that turned Colonel Gaddafi from friend to foe overnight produced a cahotic situation for which a military solution may be the one. At least the re-emergence of the three states that originated Libya might be necessary for any sort of normality to return to the region.

Personal thoughts

I'm quite glad to have participated in this workshop. I learnt that resource scarcity is generally not included in models used to develop sustainability policies. Sustainability is composed by three pillars: Environment, Economy and Society, but so far research has focused mainly on the first. My presence, among other folks, intended to provide an alternative view on what it may take to transition our Economy to a sustainable future.

Things warmed up a bit between the Resources folks and the Environment side, but I must acknowledge that there is a serious effort to consider resource scarcity in these models (one presenter even had a picture of Jean Laherrère in his slides). INTESA is assembling an ambitious (but I hope useful) modelling framework for sustainability policiy that will include resource scarcity. I further learned that the Commission has already been working towards the identification of critical raw materials.

In the end, more than forecasting the future, the important thing is to identify the policies that can provide mitigation on one pillar without increasing risks on the other two. It will be by building bridges and finding overlapping policies that progress will be made.

The landscape provided by the Lago Maggiore is nothing short of breathtaking, perhaps helping with the abstraction needed to tackle the issues discussed.

Sunday, October 27, 2013


Donata Bardi gives her talk in Montespertoli (Italy) about neuro-economics. It is the fascinating subject of how the structure of the human mind influences our choices: what we do, what we buy, what we discard.

It is all related to the complex interactions occurring within the various structures of the mind. The "OFC" you see in the slide stands of "orbitofrontal cortex" but several other elements play a role; including neurotransmitters and the so-called "mirror neurons"

Donata is, of course, Ugo Bardi's daughter. You can see more pictures of the meeting that was held in Montespertoli on Oct 20, 2013 at this link, courtesy of Angelita Borges

Thursday, October 24, 2013

Crude oil: another collapse ahead?

Oil prices have been showing a downward trend, recently. Is this the start of a new collapse of the oil market?
(image above from

In January 2008, I was writing on the blog of ASPO-Italy that, "...[oil] prices could very well increase over $100 per barrel and even much more, but will continue to be extremely volatile. A temporary collapse would be nothing to be surprised about, in which case everyone will say that the oil crisis was a hoax. For a while.(translated from Italian)

As you can see in the graph below (from Stuart Staniford's "Early Warning" blog), I was right: I had foreseen both the price spike and the subsequent collapse. I was right also in several other predictions about the oil market that I made in early 2008 (as reported here, in Italian). 

In making these predictions, I was not using a special crystal ball; just ordinary common sense. Oil prices and production, as in all markets, are determined by the interaction of offer and demand. In the case of non renewable resources, such as oil, offer is affected by depletion which makes the resource gradually more expensive as it is extracted. As a consequence, prices increase in order to maintain the profits of producers. But there is a limit to what customers can afford to pay. That was the cause of the 2008 spike: prices went above that level; demand collapsed and with it prices.

After the big spike, the oil market managed to rebound; prices returned to high levels and production reached new highs. During the past few years we saw the development a nearly static situation in which oil producers managed to obtain profits high enough to keep production increasing- but not at prices so high to bankrupt their customers (not right away, at least). But how long can this stasis last? Not forever, because resources are being gradually depleted and production costs can only keep increasing. 

That is true also for the "non conventional" fossil resources, which have been the main factor that has permitted to the industry to avoid a decline in production. These resources are expensive to produce and their booming phase may be already over. This is almost certainly the case for shale gas (see here, and here) and possibly also for shale oil (see here). With several of the world's economies in deep trouble, today we have the right conditions for a collapse of the demand that would lead to another collapse of oil prices. That, in turn, would lead to reduced investments in new resources and to a decline in production. It would be 2008 again and this time a rebound to high productive level would be much more difficult.

Is the recent decline in oil prices a symptom that this scenario is unfolding right now? It is still too early to be sure, but we can be 100% sure that if we see prices collapsing people will say - again - that the oil crisis was a hoax.

(note: Gail Tverberg develops similar considerations, although at a more general level, on her blog "Our Finite World")

Tuesday, October 22, 2013

Limits to Nature

Guest Post by Graeme Maxton

We cannot manage the limits of nature because they are limits.

We want to live in a world without limits. Like long distance runners and racing car drivers, humankind is always trying to overcome limits, to achieve more. As we make breakthroughs, it is easy to think that we already live in such a world.

Even so, there is a maximum speed that we can run, even drug enhanced. There is a maximum speed that cars can drive, before they begin to fly. We don't understand where these limits lie, simply because we haven't reached them yet. One day we will reach them though, and we will understand then that they cannot be overcome.

When we talk about boundless oceans, endless horizons and infinite possibilities this is merely poetic. The oceans and the horizon are not limitless at all. They are bound by the planet. While possibilities may be many, they are never infinite. Even our universe has limits. What is in our head has limits too. Our imagination is limited by everything we currently understand. It is impossible to conceive anything more.

When we reach natural limits, even the best technology cannot overcome them. We only think that they can be overcome because we have not encountered many of them so far, and because the limits we have breached until now were man-made or were not really limits at all.

Some of nature's limits are known. Light cannot travel faster than 300,000km per second in space. Nothing can be colder than -273°C. Ice cannot be heated above 0°C under normal pressure. That is the limit of its existence as ice.

If you think about it, everything is defined by its limits - even items that are man-made. A house is bound by walls and a roof, the limits of its physical presence. Bottles, fuel tanks and the hulls of ships are designed to limit the influence of whatever lies outside. The size of our society, from prehistoric times until now, is limited by the rules we impose.

These are not natural limits however, but artificial ones.

The difference between man-made limits and natural ones is that they are changeable. They can be overcome. We can knock down walls and smash the bottles we have made. We can change the laws.

Our technological advances support the idea that we can master what is around us, that we can push the limits of nature too. We can take energy from the wind, modify the contents of cells and split atoms. But this understanding of the world and our ability to manipulate it has also made us foolish.

Foolish, because our discoveries are really rather modest. When we take energy from the wind, we simply capture what is already there. When we change the contents of cells, we are only copying nature. And when we split atoms, we are really just looking inside.

When it comes to the natural world, there is so much that we do not understand. We do not know the limits of consciousness, or even what it is. We have not explored most of the oceans, the largest part of our planet. We do not even know what substance or force makes up more than 80% of the universe, and only discovered this recently.

We also keep changing our ideas. Our theories about the origins of life and the birth of the universe have changed completely in the last 150 years. Despite this, we now think we have all the answers, or at least most of the important ones.

That may be natural of course. We are ambitious and already understand the limits of most of the structures we use every day, because we made them. We know when things are likely to go wrong.

In nature however, warning signals often appear only when change is unavoidable. When a typhoon forms, there is nothing that anyone can do to stop the process, or change its path. We can only wait, and see what damage it unleashes. Similarly, melting Arctic icecaps, receding glaciers and rising sea levels are not warning signals, signs that we need to change. They are the start of a transformation that we will witness.

The changes we have unleashed already are unstoppable, certainly within any time frame that we really understand. The effects of our pumping large amounts of carbon into the atmosphere have become visible within a century, a flash of earthly time. It will take many hundreds of years before the effects have passed.

Nature is easily the most complicated system we know. We cannot survive without it. There is no other place, so far as we know, where the acidity of the oceans and the gases in the atmosphere are exactly as creatures like us require. We know too, that an average temperature rise of even a few degrees will change all this.

We have set a process in motion. Now we must do everything we can to stop that process, and quickly.

Graeme Maxton is a Member of the Club of Rome

Friday, October 18, 2013

The Legacy of the Club of Rome

Here is a written version of the speech I gave at the meeting held in Bucharest in occasion of the 20th anniversary of the foundation of the Rumanian section of the Club of Rome (ARCoR), on Oct 17, 2013. It was a somewhat formal reunion, so my speech was a little more formal than usual. What follows is not a transcription, but a text version written from memory. Thanks to Mr. Liviu Tudor, secretary general of ARCoR, to Mr. Mugur Isarescu, president, and to all the members of ARCoR for having invited me in this occasion. (The image above is from last year's ARCoR meeting, but the one I am reporting about was held in the same room in Bucharest)

Ladies and gentlemen, it is a privilege and a honor for me to represent the Club of Rome today. So, I can bring to you the greetings and the congratulations of the co-presidents of the Club, Mr. Anders Wijkman and Mr. Ernst Weizsacker; as well as those of the Secretary General, Mr. Ian Johnson.

We are celebrating today the 20th anniversary of the foundation of the Romanian association of the Club of Rome, ARCoR, which is a remarkable achievement. It is just as remarkable, I believe, the achievement of the Club as a global association which has already been existing for more than 40 years after it was founded by Mr. Aurelio Peccei in 1969.

What we are celebrating today, however, is not the memory of past glories. What we are celebrating, instead, is the growing realization of how important and how modern was the vision that appeared in the first report to the Club, the very famous book titled “The Limits to Growth”. Today, more than 40 years later, I had the honor to sign as the main author the 33rd report to the Club; a book titled “Plundering the Planet.” With this book, we re-examined several of the scenarios and the concept of the 1972 report. We found how consistently the ideas of the early report were on target and how closely the world's economy has followed the scenario that was defined as “base case” and that today we would define as “business as usual”. It is a scenario that sees the growth of the world's economy maintained up to the first decades of the 21st century, to be followed by a stasis and then by rapid decline.

Please be careful: “The Limits to Growth” was not a prophecy and never was supposed to be one. The authors clearly stated in the book that they didn't want the future to look like their “base case” scenario. Nobody would want the world's economy to collapse, with all the consequences involved, of course They said, correctly, that our future is something that we create with our actions and our decisions and that if we wanted to avoid decline, we had to make choices that would avoid it. But that wasn't done and the base case scenario is becoming more and more, unfortunately, like a prophecy. 

However, independently of what will be the evolution of the world's economy in the coming years, I think that the main legacy of “The Limits to Growth” today, is to remind to us how important material resources are for our livelihood and for our prosperity. Wealth is not created by banks or other financial institutions; it is created by what we call “natural resources” that are produced, are processed by our industrial system, and finally transformed into products: it is what we call “the economy”. Without natural resources, there would be no economy, and money would be worthless because there would be nothing to buy. That should be obvious, but sometimes we are so worried – I'd say obsessed – by the vagaries of the world's financial system! We tend to forget something that my friend and colleague, professor Giorgio Nebbia, used to tell me “Economics is the science of all material things”

So, were do we stand on these “material things” today? Well, for one thing it is clear that we are NOT running out of anything: the production of most important minerals is not declining and no major mineral commodity is missing in the market, at least if you are willing to pay for it. It was sometimes said that the message of “The Limits to Growth;” was that we would soon run out of mineral resources. But that's not true. “The Limits to Growth” never said anything like that. It was clear from the calculations reported in the study that we wouldn't ever run out of major mineral resources before the end of the 20th century. The point is quite a different one: much before of physically running out of resources, we'll run out of cheap resources.

And that's exactly what's happening. We are not running out of anything, but we must pay more for what we need. As you surely know, oil prices have increased of about a factor five over the past 5-6 years and the average price of mineral resources has increased of a factor of about three over the same time span. This is a robust trend and it is not painless for the economies importing countries.

Let me give you some data: in 2012, the European Union countries imported about 500 billion euros worth of fossil fuels (1), that is about 4% of the European GdP. Single countries show slightly different values, for instance for Italy it was about 66 billion euros of imports, corresponding to more than 4%; of the Italian GdP. For Romania, the fraction is smaller, in part because Romania produces a relatively large amount of fossil fuels in comparison to the size of its economy.

Consider that these are just the costs of importing fossil fuels; more has to be spent for importing other mineral commodities which normally “embed” a lot of energy in the form of fossil fuels used for their extraction, processing, and transportation. But let's remain with fossil fuels. Let's ask ourselves a question: is 4% is a lot or a little? Well, it is one of these questions that must be answered with a classic “it depends”. If the economy could grow, then the increasing costs of fossil fuels wouldn't be much of a burden – they would remain more or less the same fraction of the whole economy. But that has not been the case. The European economy is growing, but growth has been far from robust in the past years and in several countries the economy not growing at all. And these countries are seen their “energy bill” growing up and becoming a heavy burden. A good example is Italy; but the same kind of troubles are everywhere. As we speak of percentage points of the European economy we are speaking of hundreds of billions of euros which move from Europe – mostly an importer of mineral commodities – to producers, which are mostly outside Europe.

This gigantic transfer of wealth cannot remain without consequences and I think that it is one of the major reasons of the troubles we are experiencing today. As I said before, the main legacy of “The Limits to Growth” is to remind us that our prosperity is based on material resources and we shouldn't forget that. I invite you to consider this element when you try to understand what's happening.

But there is another element that we can consider as the legacy of the Club of Rome today, and it goes straight to the core of the matter. You see, the scenarios that are at the basis of the study “The Limits to Growth” were created using a technique called “system dynamics”. It has to do with solving differential equations in a computer but, in reality, it is nothing more than formalized common sense.

Let me explain: I would define “common sense” in a very simple manner: it is just thinking of consequences and, in particular, thinking of the long term consequences of what you do. Using a computer means that you can project your common sense further in the future and to consider more complicated systems than those you deal with normally. But common sense - thinking of consequences - remains a quality of human thinking that, unfortunately, at times we refuse to utilize.

Considering our present situations we are facing choices that will have profound consequences for our future. For instance, should we drill for more oil and gas? We can, of course, choose to invest large amounts of our current resources in order to exploit the so-called “non conventional” resources. But the consequence will be that we'll become even more dependent on a resource that is becoming more and more difficult and expensive to obtain (to say nothing of the worsening of the climate problem). So, everything has consequences and we should think about that before we take these important decisions if we want to take them wisely.

To conclude, I'd like to cite a phrase that's often attributed to Robert Luis Stevenson. It is, “Everyone of us, sooner or later, sits down at a banquet of consequences”. What will be served at the banquet will depend on the choices we are making now. In this sense, the methods and the ideas developed by the Club of Rome already in the 1970s can help us to make wise choices (if we want to). This is the legacy of the Club of Rome

Tuesday, October 15, 2013

The physics of money

Italian "mini-checks" ("assegnini"). For some reason, in the second half of the 1970s, the Italian state mint was unable to produce enough coins for the needs of the economy. As a result, coins were replaced for a few years by these "mini-checks", released by private banks. The result was that the Italian economy in this period is perhaps the only modern example of an economy running without metal coins. 

There is a question that has been nagging me for years: why do we keep in our pockets both paper money (banknotes or bills) and metallic coins? It wouldn't be difficult to write higher numbers on coins just a little bit larger than the ones we use today. In Europe, the largest coin is worth 2 Euros, but what would prevent the mint to make coins worth 10, 20 or even 100 Euros? In any case, the metal of the coins is worth very little in comparison to the face value. On the other hand, why do we need coins at all? Why can't we have pieces of paper worth just cents rather than euros or dollars? After all, the Italian economy in the 1970s ran for years almost without metal coins; all on the basis of paper money used also as small change.

It took me a while to understand this point and only recently I found an explanation based on physical factors. Probably, this point is clear to economists, but, it doesn't seem to be common knowledge or, at least, I couldn't find it in the Web, so I thought I could discuss it here. Of course, I am not an economist, I am a physical chemist, but since I'll be telling about the physics of money, I think I can try. So, let me start.

In the beginning, there was gold

Starting from some 5000 before our time we see gold objects appearing in the archeological record. Jewelry, death masks and all sorts of elaborate objects show that kings and chieftains were using gold as a means to show off their power and their wealth. Soon, gold became a world recognized commodity, the objective of military raids and of commercial transactions. However, in order to see the appearance of "currency" in modern terms, we must wait for the 6th century BC, when the first coins were minted in Lydia, a region part of modern Anatolia and perhaps at the same time in China.

Minting coins was a remarkable technological feat. It takes hard dies that must be able of multiple strikes on gold or silver disks, always leaving the same impression. Making these dies required sophisticated methods but, once the technology was developed, the capability of creating standard gold or silver pieces led to the global diffusion of the concept. Coins were practical: easy to transport, easily recognizable, easily exchanged. Gold coins also retained their value even at long distances from where they had been minted and could be used for international commerce. It took just a few centuries after the Lydian invention for coins to become a stable feature of the world's economy. They would maintain that place for more than two thousand years.

Now, if you get into coinage, you have to take into account two basic physical factors that have to do with gold and silver. The first one is that they are scarce and expensive to produce, the second one is that they have specific mechanical properties.

If you make a gold coin, you need to take into account its mechanical properties: you cannot make it too small and not even too thin. Make it very small, and it would be easily lost. Make it very thin, and it would easily bend and lose its shape. In short, you have a minimum amount of gold that you need. In practice, no ancient gold coins weighed less than about 3.5 grams ( around 0.1 oz, the weight of a Florin, minted by the Florentine Republic during the Renaissance). More commonly, a gold coin would weigh more than that. The Roman "Aureus," for instance, was a true imperial coin, weighing in at 8 grams each. Similar weights are typical of silver coins. There are records of heavier coins, but this range of weight is the most common.

The second physical property of gold to be considered is its geological scarcity. That affects not the size of the coins, but their number. In practice, in ancient times it was never possible to mint enough gold or pure silver coins to put coins in the hands of everybody. Today, the above ground stock of gold is estimated to as something that goes from 150,000 tons to 170,000 tons. For a comparison, the amount of silver mined so far is estimated to be over one million tons. The world stock today correspond to 22 grams per person. It is much more difficult to estimate this amount for ancient times, but the various estimations give us at least an order of magnitude. According to Govett (1982), the gold stock per person has always remained in the range of 30-50 grams over history. The Gold money foundation estimates much smaller amounts in ancient times, even less than one gram per person  although, personally, I think they are too pessimistic.

So, if you have 40 grams of gold and a gold coin weighs 4 grams, your allotted stock of coins is just 10 coins. But, of course, coins were not equally distributed. The rich had hundreds or thousands, the poor had none. For the rich, gold coins were the currency of choice for large transactions. Cicero's purchase of a house on the Palatine Hill required 3.5 million sesterces which would have required a few tons of silver denarii or hundreds of kilograms of gold aurei (as described by Verboven). A hundred kg of gold in the form of 4.5 grams coins corresponds to some 20 thousand coins. Carrying out transactions with this large number of coins was surely unwieldy, but not impossible for the few who were lucky enough to have them.

But there was another problem, under many respects the opposite: how to carry out small everyday transactions using high-value coins? In ancient time,s it was common knowledge that a gold coin was worth approximately one ewe (curiously, that has not changed so much, even today). So you can buy ewes with gold coins and also oxen, camels and the like. If you are rich, you can buy entire estates by thousands of gold coins. But what if you want to buy something much smaller and less expensive? A loaf of bread, for instance? For this purpose, gold coins are useless. It would be as if in our world there existed only $ 100 bills and nothing smaller.

The problem is similar with silver. True, silver is more abundant than gold, but not so much more. In practice, over the centuries the exchange ratio of gold to silver has oscillated around a value of 10 - that is, as a first approximation, a gold coin was worth 10 silver coins. This is better in terms of having small change available, but still not so practical. Suppose, again that you wanted to buy a loaf of bread, surely it took more than ten loaves to buy an ewe and a silver coin was still too large. The problem had to be solved in a different way.

Petty money and big money

The problem of having small change for everyday monetary transactions - say, for a single loaf of bread - was solved already in very ancient times by developing what was often termed "petty money", to be seen as something apart from the "moneta grossa" ("big money") as the Italian merchants of the Renaissance would call pure gold and silver pieces. Petty money was usually an alloy of silver and copper or, sometimes, pure copper. Using an abundant metal such as copper, it could be issued in large amounts and in terms of low-value coins.

Petty money was not simply a question of low denomination. It was a completely different form of money. The "moneta grossa" had a value corresponding to its weight. The coin was normally just a convenient way to measure this value by counting coins rather than weighing bullion. It was what modern economists call "commodity money". Petty money, instead, was a form of "fiat money", a kind of currency that had a face value unrelated to, and normally much larger, than its value in terms of the component metals.

This fundamental difference stabilized the system: two completely different kinds of currency co-existed in ancient times. Indeed, the two currencies had different purposes and different diffusion. Moneta grossa, pure gold or silver coins, were for the rich and were used for important or international transactions. The poor had no use for gold coins and it is likely that most of them wouldn't even see a gold coin during their lifetime. The intrinsic value of these coins made them valuable even at long distances from the places where they were minted. So, we find Roman coins that made their way up to China to buy silk. It didn't matter to the Chinese that these coins had the face of a Roman Emperor on them. They could always be fused and re-minted or the gold used for other purposes.

The opposite was true for petty money. It had value only close to the place where it was minted and this value was created, normally, by the fact that the local king or warlord or chief brigand would accept these coins as payment of taxes. As the local king/warlord/chief brigand controlled the local army, that was the crucial point that guaranteed value for these objects that, otherwise, would have had no value at all. Even today, if our government were to accept squirrel skins as means of payment of taxes, then banks would be soon turned into tanneries and the old men sitting on park benches would carry with them poisoned crumbs.

So, petty money was a very "modern" tool for commerce. Among its characteristics, one was that it was subjected to inflation; a characteristic that often was obtained in the mint by debasing it; that is by reducing the amounts of silver the coin contained or, sometimes, making the coin smaller. Because of this characteristic, there was little or no overlap of the two currency systems: they had different purposes.

The evolution of currency

Now we are in the position to be able to understand the origin of our currency system. Simply, the coins we carry in our pockets are the descendants of the old petty money while banknotes are the descendants of gold and silver moneta grossa. We are still having two currency systems, one used to buy small items - you usually pay your coffee with a coin, but larger purchases are regulated with greenbacks or - in more recent times - using credit cards which are an evolution of paper money.

Today, petty money coins are not made anymore in silver/copper alloys. They tend to be made in low-cost metals, sometimes gold-colored brass, or steel or even aluminum. They have retained their characteristic of local currency. You can use them in the country that has issued them, but not elsewhere and, normally, banks will not change them into different currencies.

Paper money used to be simply a token that indicated a certain amount of gold and silver that had to be paid to the bearer. Still today, banknotes printed by the Bank of England carry the sentence, say, "I promise to pay to the bearer the sum of 10 pounds" which, of course, doesn't mean anything today. With time, paper money has evolved into a purely "fiat currency" and even transformed itself into "plastic money" that takes the form of credit cards. Still, this apparently worthless kind of currency retains an international aspect. Dollars are accepted everywhere and you may be surprised to learn that about two thirds of the existing $100 bills are to be found somewhere outside the US.

This story shows how our ways are often influenced by events and uses of the remote past that we don't understand any longer. The double-currency system we used today is something akin to the bicameralism of most democracies which originates in a time when social differences were much larger than they are today (although those old times may be returning)

Also, we shouldn't be surprised about the existence of multiple monetary standards. Human creativity is such that anything can be used as a medium of exchange provided that it is sufficiently rare and difficult or impossible to over-produce: works of art, antiques, real estate and more. Humans and money are strictly linked to each other, but it is a complex relation that has been going on for many century and it changes all the time. Will gold coins return, one day? Who knows?

This essay is largely based on Carlo Cipolla's book "Money prices and civilization in the Mediterranean world", 1956)

Saturday, October 12, 2013

The strategy of dragons: hoarding your gold

 Have you ever wondered why dragons hoard gold? Well, there may be a reason. It has to do with the concept of "commodity money" as described by economists and with the history of early Medieval Europe.
(image;"Conversation with Smaug" from Wikipedia)

Here is a recent picture of a walled up apartment building in Italy. Apparently, the owners thought that it was better to keep the building empty rather than rent it; and also they made sure that no squatter would even dream to move in.

No matter how you want to see this story, we can only describe it as a monumental failure of the market. It is true that the housing market in Italy has collapsed, but housing prices didn't go to zero (not yet, at least). There are plenty of people in town who desperately need low priced housing. Renting these apartments to them would have guaranteed an income for the owners: not large, surely, but a small income should be always better than no income at all. Then, walling up all those windows must have cost some money, to say nothing of having to pay the property tax anyway. So, why?

It is a case of what I would call "the dragon strategy". The owners of this building are hoarding their assets just as Smaug, a dragon described in a novel by Tolkien, does with his gold. They were seeing their building as a form of money - their gold. It is a behavior that has to do, I think, with the very concept of "money". 

Economists say that there are two kinds of money: "commodity" money and "fiat" money. The first case, "commodity" money is when you use as money something that has an intrinsic value: say, oxen, sheep, bananas, or gold. The second kind, "fiat" money, is the current situation in the world today; it is when money is just a token, a IOU, a piece of paper with something written on it and, now, just a digital record in a computer.

Some people say that money should always be linked to a commodity of some kind; gold, for instance. But even even in a situation where money is purely "fiat", as in our times, some commodities may take the aspect of money. It is the case of the housing market. If you think about that, the whole housing bubble that exploded in 2008 was due to the idea of seeing homes not just as commodities. No, homes started having a value that went well beyond their use as places to live in. They had become tokens for exchange and for the accumulation of wealth: a form of money; objects of speculation. 

One characteristic of money is that the more you have, the happier you are; there is no such a thing as having too much money (at least for the owner of the money). That creates no problems as long as money is pure numbers in the computers of some bank. But when money is a commodity, it is a different story and two bad things may happen. The first is that the tendency of accumulating money creates too much of it. This is a waste of resources and it is detrimental to the manufacturing of other necessary commodities. The opposite one is that commodity money can be hoarded - dragon style. In this second case, a useful commodity is removed from the market, to the detriment of those who need it.

We have seen both things occurring with the housing market. With people seeing homes as money rather than just a commodity, they built too many of them. One result was the paving of agricultural land that can't be used for food production any more. Then, the overproduction of homes generated the kind of feedback we call "speculation" where evidently overpriced homes were seen as good investments. The final result was the housing bubble that burst in 2008 in the US, nearly destroying the world's financial market. It was a classic case of the evolution of interlocked feedbacks that we call speculation. In Europe, the housing situation is more complex and not everywhere the bubble has burst, yet. But surely the housing market is heading that way.

After the bursting of the housing bubble, many people found themselves in possession of something that they judged highly valuable; but they found no customers for it when they tried to sell it or rent it at the prices they wanted. In a sense, they found themselves having money, but unable to spend it; something like being stranded on a desert island with a wallet full of dollars. In many cases, the reaction was to remove the house from the market - hoarding it - waiting for better times. Since you can't bury homes underground, hoarding a building may take extreme forms as when homes are boarded up or walled up. 

It is curious to think how the behavior of some modern home owners reflects that of dragons of fantasy stories. As normal, all stories have an origin in something real and that's the case of gold-hoarding dragons. Not that there have ever been such beasts, but, if you think about that, the myth has a specific origin in late classic times and early middle ages. Do you remember Fafnir - the dragon that Sigfried kills in the saga of the Volsungs? Well, Fafnir is the first gold-loving dragon in the history of literature (apart, perhaps, for a similar character of the Beowulf saga). So, why does Fafnir hoard gold? Well, at the time when the Volsungs saga was written, people did hoard gold. The Roman empire had collapsed and with it its economic system. Even if you had gold, there was nothing to buy with it. So, people would bury their gold (together with silver, jewels and the like) hoping to be able to use it in better times. In practice, they just created those buried hoards that are today the joy of archeologists. As a result, gold disappeared from circulation. That was surely noticed and some creative person invented the myth of dragons hoarding the gold in their caves. You see? There is a logic for so many things, even for the behavior of dragons!

Would you like another example of the dragon strategy? There is an ongoing one, although with some peculiar quirks: it is the "gas bubble" in the US. It is the idea that natural gas obtained by "fracking" is the start of a new era of prosperity. It is, much more likely, another flare of speculation, this time based on natural gas as a form of commodity money. It has all the characteristics of a financial bubble, with the classic effect of overproduction generated by excessive expectation, with companies most likely producing at a loss. But, in this case, there is a problem: unlike gold and homes, gas cannot be stored: it can only be burned. As a consequence, this specific bubble has seen market prices collapsing rather than soaring; as usual for speculative bubbles. That doesn't mean that the gas bubble won't burst; it is already showing evident signs of bursting. It is just that we won't ever hear stories of dragons sitting on a gas hoard!

So, all kinds of speculations are more or less the same. People come to believe that something has a value that goes well beyond its need and they start accumulating it - it becomes "money." Then, they accumulate too much of it and the result is the collapse of the market (the bursting of the bubble). If it is just pieces of paper ("fiat money") the final result may be banknotes burned in stoves, as it happened in the Weimar Republic after the first world war. But, if it is some kind of a commodity, people usually try to hoard their beloved "money" in any possible way; usually burying it or, if that's not possible, walling it up, as it is happening for homes.

In the end, anyway, money is only worth something if there is an economy that makes it possible to buy something with it. And if the economy collapses, money becomes worthless - no matter what form it takes. It has happened for gold at the time of the fall of the Roman Empire just as it has happened for homes in the early stages of the fall of the Western Empire (aka "globalization"). We are not yet arrived to the point of burying our gold in our backyards but that, too, may come to pass.

Wednesday, October 9, 2013

Davos: some images from the World Resources Forum 2013

Some photos from the World Resources Forum, held in Davos, Switzerland, Oct 6-9 2013. This set of photos has no pretense of being exhaustive, just a few snapshots that I took when I could

To start, here is yours truly (Ugo Bardi), giving his presentation on the first day of the meeting. The image is a rather famous graphic, originally made by David Murphy. You can read the details of my presentation in this post. (photo by Francesca Galeazzi)

Solitaire Townsend giving her talk. She has been incredibly brave in showing up to an audience of bespectacled and betied professionals with a talk titled "The Naked Environmentalist: how sex will save us" (!!). But her seminar turned out to be an extremely interesting discussion on the importance of social networks and on how to use advertising techniques in order to pass the message on sustainability.

One of the slides presented by Micheal Dittmar - physicist at the ETH Zurich. He is correctly very critical about how the concept of "sustainable development" - noting how, despite all the noise and the many conferences, it didn't bring to the world anything concrete.

Francesca Galeazzi giving her presentation. She works at ARUP in Shanghai, and her talk was about the quantification of the advantages of sustainable buildings. It is a difficult subject in China where, apparently, the need of sustainable buildings is still not well understood.

Rolf Widmer, ETH Zurich, leading a seminar on automotive recycling. 

One of the results of the discussion at the panel chaired by Rolf Widmer. It is not easy to recycle old cars - but we tried to find ways. 

Scientific meetings often offer prizes for the best papers - they don't usually pay attention to the worst ones. However, if there is a best paper, there has to be the worst one. About the World Resource Forum in Davos 2013, I propose as a purely personal nomination this poster for the worst paper not just of this meeting but perhaps in absolute terms, the worst paper I've ever seen. 

One of the several panel discussions at the meeting. Yours truly is participating in this one.

To conclude, what would a conference be without a conference dinner? Here it is!


Ugo Bardi is a member of the Club of Rome, faculty member of the University of Florence, and the author of "Extracted" (Chelsea Green 2014), "The Seneca Effect" (Springer 2017), and Before the Collapse (Springer 2019)