Deflating the Ecological Bubble

Denis Hayes

CERES Keynote

New York, April 3, 2003

For the last half of the 20th century-encompassing the entire adult lives of most of us-the dominant international fact of life was the Cold War. Two Superpowers-each capable of annihilating the other-were engaged in a global ideological struggle for dominance.

The Cold War provided the rationale for everything from the Interstate Highway System to the Space Race to language labs.

Ultimately, communism spun into a death spiral and democratic capitalism emerged triumphant. The former Soviet Union splintered with astonishing speed into numerous nations, even the strongest of which now have Third World economies.

Many explanations-military, cultural, political-have been advanced for the overnight collapse of the Soviet Union from Superpower to basket case.

Many of these theories cite things that contributed in at least some small measure to the collapse.

However, the principal underlying cause was economic, and it relates directly to what I want to talk about with you today.

The Soviet Bubble

The Soviet Union was a classic bubble economy. Prices did not reflect reality. Prices were not allowed to reflect reality.

Economic success, even in a planned economy, requires good information and a Darwinian culling of uncompetitive enterprises.

But Soviet prices were set by bureaucrats. They often bore no relationship to supply and demand. They manufactured millions of items that no one wanted, and failed to grow the food that everyone needed.

Soviet resource allocations were so grossly inefficient that the Soviet economy simply could not produce enough high-quality, desirable goods and services to sustain its legitimacy.

In the end, the hidden costs finally overpowered the real assets, and Soviet society collapsed in on itself like a black hole.

The American Bubble

In the United States, we are still trying hard to shake off the ill-effects of our own recent experiences with a high technology and telecommunications bubble.

The term "bubble" has a frivolous connotation that belies the importance of the problem. About $7 trillion in stock market valuation has simply vanished in the United States (and much of the rest of the world has been sucked into our downdraft).

$7 trillion equals about $70,000 for every American household!

This bubble was partly caused by the irrational exuberance of a segment of the population that had acquired astonishing wealth during a prolonged bull market. They decided that profits and losses were a vestigial remnant of the "old economy," and turned to a series of fluffier ways to measure value.

More shocking, it was also the product of securities fraud on a level that left even hard-noses cynics agog -greed and sleaze and mendacity carried to an art form.

Having shaved the equity markets of $7 trillion, the aftermath of the bubble is now drilling its way down to bonds.

According to Moodys, a record 22 percent of investment grade corporate bonds were downgraded in 2002. Worldwide, a record $160 billion in bonds defaulted last year.

The bubble had an interesting energy component. Last week, in the latest installment of a long-running saga, the Federal Energy Regulatory Commission cast some light on a debacle that originated in California but cast a long shadow.

The FERC report presents a mountain of evidence demonstrating that California's shortages had nothing at all to do with environmental rules or capacity constraints. They were almost entirely created by energy companies who hired youngish energy traders to play the utility grid like a videogame. They won the game by creating bottlenecks and driving up prices.

It was, in other words, a bubble, where prices bore no relationship at all to objective reality. It left California with a budget deficit that is larger than those of the other 49 states combined. It forced the nation's largest electric utility into bankruptcy. And it created financial havoc for poor and middle class residents of California, Nevada, Oregon, and Washington.

Summary

Under the communist bubble economy, prices were not allowed to reflect economic reality.

During the high tech, telecom, and energy bubbles, profits and losses counted for less than web site hits, miles of dark fiber, and opaque accounting techniques for clever new financial instruments filled with hot air.

My theses today is that the world is now facing a far more serious bubble.

Throughout the global economy, prices don't reflect ecological reality. We've been liquidating our natural capital and no reflecting this on our books. Indeed, when we consume a natural resource, we stick this loss in the income column. It is more audacious - and of vastly greater scope - than anything Enron ever dreamed of.

We've been breaking a lot of little laws for a long time, and now the larger laws - Nature's Laws - are catching up with us.

Externalities

Environmental externalities were of mostly academic interest 40 years ago, when distinguished economists like Ezra Mishan and Joan Robinson began writing about the topic.

However, they have now outgrown the "academic" box.

Today, costs that are universally treated as "external" to economic decision-making are often larger and more important than the "internal" factors that actually drive the decisions.

Like other recent massive accounting frauds that move expenses off the balance sheets, this economic fiction contributes to a false sense of well-being.