A brutal cold spell has gripped much of the nation in the past week. Where is all this global warming? Mobile Alabama had temperatures in the 20′s, record lows. This cold snap has caused me to revisit some ideas on heat flow. Economic concepts have strong relationships similar to heat flow. Thermodynamics is to physics as accounting is to economics, the inexorable and indefatigable bookkeeper.
Stockholders of Enron were chagrined to find that when one firm is performing voodoo accounting, lying or cooking the books. The mendacity eventually comes to light when other firms are accounting for their business activity truthfully. It is impossible to lie over the long run in a free market. Remember that the government had nothing to do with the ending the Enron scandal; they did not discover, report or stop it. Market analysts cratered the Enron balloon via accounting diligence; monitoring the lifeblood of an economy, the flow of "money."
All economies are based upon energy flow, even if it is the energy of metabolic expenditure in a subsistence economy. Advanced economies use more energy per producer and consumer. The upward advance of mankind is based upon harnessing more and more energy for human usage. This is the driver of the industrial revolution. Energy and accounting are governed by rigorous mathematical relationships. Thermodynamics is relentless in accounting for energy flow, unflinching, the purest of truths.
I quote from Wikipedia:
"In physics, thermodynamics (from the Greek θερμη, therme, meaning “heat” and δυναμις, dynamis, meaning “power”) is the study of the transformation of energy into different forms and its relation to macroscopic variables such as temperature, pressure, and volume. Its underpinnings, based upon statistical predictions of the collective motion of particles from their microscopic behavior, is the field of statistical thermodynamics, a branch of statistical mechanics. Roughly, heat means “energy in transit” and dynamics relates to “movement”; thus, in essence thermodynamics studies the movement of energy and how energy instills movement. Historically, thermodynamics developed out of need to increase the efficiency of early steam engines."
The starting point for most thermodynamic considerations are the laws of thermodynamics, which postulate that energy can be exchanged between physical systems as heat or work. They also postulate the existence of a quantity called entropy, which can be measured for any system. In thermodynamics, interactions between large ensembles (groups) of objects are studied and categorized. Central to this are the concepts of the system and surroundings. A system is composed of particles, whose average motions define its properties, which in turn are related to one another through equations of state. Properties can be combined to express internal energy and thermodynamic potentials, which are useful for determining conditions for equilibrium and spontaneous processes.
A law of physics is a thing of beauty. It exists for all people, all cultures, all colors, and all creeds. It is the most undiscriminating thing possible. It is the same for all people, over all time and space. It has no bias, no hidden agenda, and has no need for spin doctors. It is not a child of government, it needs no approval. Unlike mathematics which has the concept of proof, a law of physics is only postulated to be true. It is accepted as true if it has been verified by sufficient experimentation. As long as it has never been shown to not be true, that is to be false, it will be accepted as a "law."
The Creator in his infinite wisdom put physical law into the Universe so that order would exist and that chaos (not the dynamical system kind) would not rule. The Creator loves beauty, loves symmetry. Just as all men are equal before the Creator on judgment day, they are equal today with respect to physical law. The Creator’s bond with mankind and all living things is physical law. The Creator’s gift for peace between men has been faith. Much of mankind has failed in being faithful.
Primitive man tried a variety of tricks to get around the binding of the Creator’s will which made real physical law. Magic was postulated. Magic was simply physical law subject to change based on some social rule that was subordinated to the will of man. Magic would give us magicians, sorcerer’s, demon’s et al. That would be abhorrence to the Creator, and thus is not allowed.
The brilliant movie Dragonslayer (1981) has a wonderful scene where the King and his Sorcerer are trying to get a magic amulet to turn lead into gold by applying some ego-based hocus-pocus: "Now lead be ye gold" they fecklessly incant. Had this experiment worked and if lead had been transmuted into gold the King would have been disappointed in the outcome; as another law would have taken over: economics. This fictional King, just like the actual King of Spain found: that when the gold supply goes up in the absence of more productive economic activity, then the price of gold just goes down. This would be the exact opposite of what the King had intended. Actually a very typical government program: the squandering of resources under political control achieving the exact opposite result. Economics under the dominion of man is just as inexorable as physics is under the dominion of the Creator, much to chagrin of legions of politicians over the centuries.
Back to the physics: thermodynamics was one the first scientific products of the industrial age. When steam power was created observations of steam engines led designers to seek a method of accounting for their behavior. It needed quantification to be useful. Observation led to the postulating of the three laws of thermodynamics by Sadi Carnot:
One popularization of these three laws is as follows:
- You can never win, you can only break even
- You can only break even at absolute zero
- You can never reach absolute zero
The inexorable nature of this energy accounting system or balance sheet is that matter and energy can neither be created nor destroyed. They are equivalent thanks to Einstein famous formula. The first law is what Milton Friedman canonized with his famous "there is no free lunch" statement. All production requires energy input. The second says that there is no perpetual motion, friction and other dissipative processes consume energy that is not available for work. Over the long run disorder (entropy) always increases. The garbage man is guaranteed his job security thanks to the second law, as waste products are always produced. The third law gives us time, it is an arrow pointing from the present into the future. Lots of socialists, crank economists, and lunatics have postulated perpetual motion, that is, free lunches; they do not occur in this Universe.
The quadrennial farce of the American Presidential Election is a monument to the denial of the first law: free lunches for everyone, the closer you are to the winner of this charade the more sumptuous the banquet. Still the banquet is not free and the wealth of the taxpayer is driven closer to zero in the attempt (law #2). The fact that this goes on as long as there is government is canonized in #3.
Physics is the same everywhere, Mars, Andromeda, Iran and North Korea. It does not respect ideology. This puts constraints on the state. Austrian economics is where these constraints are applied. Like Thermodynamics, Austrian Economics is a qualitative theory, that is, it is expressed in inequalities, not exactitudes. It bounds behavior but does not proscribe details, it provides limits.
The Federal Reserve is the great gas station/energy source in the sky, where the pumps are always open. The Federal Reserve acts as gold would have in Dragonslayer. The Fed’s transmutation of political promises into currency for "all debts public and private" acts to drive, inexorably, the value of the currency down.
Driving the value of currency down has a name: Austrians call it inflation. It is the economic equivalent of thermodynamics third law of entropy increasing. Just like the King’s program of lead into gold for wealth creation in the Kingdom, the Federal Reserve always has the opposite result: the business cycle, mal-investment and unemployment. Inflation is entropy degrading the value of economic productivity. It is an unlegislated tax on all current holders of the currency being inflated (as they all sadly are).
The Federal Reserve has only one tool: currency creation. When they perform this magic act at the behest of the political elite it is called a stimulus. When you and I do this it is called a crime: counterfeiting.
Economic down-regulation occurs from currency creation. Larger and larger doses of the drug, currency creation and devaluation, provide less and less result, liquidity, until finally with an infinite dose, the result goes to zero, no stimulus at all.
Let us try an Einsteinian gedanken, a thought experiment. In this model a currency is only the medium of exchange, and has nothing to do with the economic activity transacted. The currency does not perform useful work, produces no economic activity intrinsically. You could print a trillion pink coupons, and I could print a gazillion orange coupons and we could trade them ferociously (the cuckoo stock exchange), but there would be no economic activity at all from this exercise, except that you and I might run out of breath from the ferocity of the exchange. Since we would burn caloric fuel during this effort and generate heat (warm skin and breath) the entropy of our Universe would increase and the third law would be validated once again. I would have turned my breakfast into entropy by not performing useful work thus exchange has no affect on the end result, hence the futility of the task.
There is no instantaneous action at a distance, that is real things like information, propagate at a finite speed. That is what the Federal Reserve is all about. The politically favored get to belly up, like hogs at a trough, to the "Discount Window" where the currency creation is doled out. It propagates into the economy at a finite speed so the first in line gets the most efficacies since the devaluation does not occur until after the money is spent. This is where the inequality comes into play. The elites get money at near full value, it always finds its way into the pockets of the benighted masses (salary, compensation, wages, etc.) and when it comes out of our pockets it has lost purchasing power. You and I find, over time that our currency aliquots procure less and less desired result: goods and services because shortage exists, and/or prices have risen.
Thermodynamics bounds the work done by physical processes. Austrian Economics bounds the work done by economic processes. Life exists on Earth because the Sun continually pumps energy into the physical world we live in. This provides the thermodynamic input to all the biological systems that transform the energy into physical work, chemical work (metabolism and excretion) all running downhill and increasing entropy. The continuous input from the Sun more than compensates for the entropic loss which is why biological systems persist over long periods of time.
The Federal Reserve has no analogy to the Sun. It injects pure entropy by differentially degrading the units of accounting. The thermodynamic equivalent for your car would be gasoline at a fixed price but the refinery is allowed to deliver less hydrocarbon fuel at the same unit volume over time. You as the consumer see that you get fewer and fewer miles per gallon in your car. You are being cheated out of the energy content you paid for. The obverse of this is that purchasing power has decreased; entropy has crept in to the system.
The net result of a Central Bank, fractional reserve banking, and a fiat currency is an entropic-based reordering of the system in favor of the elite and against the masses. They get more useful work and we get more entropy. This is socialism pure and simple. Socialist societies fail and spread misery and death along the way.
Capitalism, the laissez-faire kind, not the crippled-market/fascist/socialist hybrid that masquerades as capitalism, does have a tool, and this is the tool that allows the planet to support more than 6 billion souls. The economy of utility from the division of labor leads to productivity increases. Thus man’s knowledge increases over time and can be used to drive productivity up and prices down. This and only this provides the abundance of the modern world.
Let’s be clear: the free market and socialism are mortal enemies, one prospers at the expense of the other, and one provides life while the other is out to destroy it. Socialist societies are hallmarked by the economy of shortage, and the distribution of goods politically absent markets. Let’s call the fiat currency what it really is: rationing coupons.
Socialist societies continually misallocate resources by the use of rationing coupons instead of money. Rational calculation cannot occur since there is no meaningful pricing mechanism. Entropy increases until eventually no work is done at all. Entropy and disorder are maximized at this point and life is no longer possible absent continual work input which the Central Bank cannot provide.
This is where the battle between capitalism and etatism (socialism) is fought. The distribution of energy governed by thermodynamics is analogous to the distribution of goods by the market process. Just as the Sun counteracts the dissipative tendency of entropy for the benefit of life on Earth, so can social organization via the capitalist model counteract the shortage of prosperity by using the division of labor to increase supply of desired goods? This is where the market provides the cornucopia of goods and services available in a market economy.
Governments, all governments, dissipate, consume and destroy; they have no creative power in and of themselves, and they are agents only for the transference of wealth from one party to another. As we have seen in thermodynamics every transfer dissipates. They are social embodiment of entropy. As it consumes more and more of the economy less and less useful work is done.
George Giles [send him mail] is the founder of the Gonzo School of Economics, the radical branch of Austrian Economic Theory. He was the youngest Republican ever elected in 1972 at age 17. You could be elected at age 17 if the office was not assumed until after age 18. It only took 3 months of local GOP meetings to become a virulent Libertarian ever after.