Energy-Backed Currency

Intro

What follows is a framework for a monetary system based on energy. In this system the government operates and monopolizes the entire energy sector. The government issues a fiat currency in the same way it does today, but it recollects the currency through energy sales rather than direct taxation. This approach was influenced by an understanding of modern monetary theory (MMT) and by Joseph Tainter's Collapse of Complex Societies. (video).

Societal complexity is tightly intertwined with energy consumption. Societies require additional energy to become more complex, and additional complexity can allow a society to increase its energy input. Think of the deep-sea oil rig, which requires great societal complexity, and returns great energy value.

As a society advances it must constantly be solving the energy problem. We can roughly categorize all societal functions as serving as one of the roles.

• Economic - anything that creates wealth or productive capacity
• Regulatory - manages societal complexity
• Energy acquiring - provides energy to the society

In our current society the economic and regulatory functions are largely split between public and private sectors. The energy sector tends to straddle the public and private sides in an ad-hoc manner. In an energy-based monetary system, solving the energy problem becomes the foremost duty of the central government.

Energy

Tenet 1: Energy production is not an economic activity. 

In standard economics energy production is categorized as a supplier. Suppliers provide inputs to economic activity, be it materials, capital, energy, and any other products or services necessary. Energy is unique in that it is a requirement for all economic activities, in all political systems. Energy is also a product, as it is consumed by households, which is a complexity we will ignore for the moment.

When society is viewed through Tainter's model energy can be described as external to the economy. The size of the economy is limited by amount of energy that can be supplied to it. This externally required energy does not intrinsically add wealth to the society, but it enables wealth creation to take place. Some energy is used that does not directly contribute to production, such as home heating or leisure driving.

Currency

Tenet 2: Currency is synonymous with energy.

 Currency today is a token of wealth. It represents a claim on a portion of the real economy. But as I've mentioned, energy is always an input to economic processes. So currency is already an approximation for energy. When we pay for something, we are mostly paying for the energy that went into the production of the product. New cars cost in the tens of thousands of dollars, but only have a scrap value of a few hundred. The difference between the purchase price and the material scrap price is energy.

The US dollar is especially equitable with energy because of it the reserve currency for international trade of energy commodities. (see relevant post here) Dollars traded in the petroleum markets are often dubbed the petrodollar, which is emblematic of the close association between the dollar and energy. Ultimately however the dollar is not synonymous with energy. The dollar has value because if US government taxation, and it's worth is dependent on the value of the economy and the number of dollars in circulation. The price of energy in dollars is free-floating and responsive to market forces.

Free-floating currency

The dollar is free floating. It's value is not pegged to some resource, but it is determined by the market and subject to supply and demand forces. In our free floating currency the government has three methods of altering the value of money: spending, taxing, and modifying the reserve rate for bank lending. 

Gold-backed currency

Until the 1970s the dollar was backed by gold. It had value because anyone could take their dollars and exchange them for an equivalent amount of gold, and the ratio was set by government edict. The problem with gold is this: it is finite. As the economy grows larger, the underlying money supply must grow proportionally to prevent inflation or deflation. The money supply is limited by the gold supply, thus in a growing economy the money will tend to deflate, which government desperately try to avoid to prevent currency hoarding. Ultimately governments end up ditching gold because it is the only way to loosen the money supply.

Cryptocurrency

Cryptocurrencies such as Bitcoin are digital currencies that rely on theoretical computer science for their validity. A Bitcoin is a solution to a factorization problem, and are generated by computers that slog through the solution space. It is designed so that early bitcoins require little processing time but as more and more solutions are found it takes increasing amount of processing (i.e. energy) to find additional solutions. These diminishing returns are reflective of what is seen in nature when extracting gold, oil, and other resources. The value of Bitcoin is that it is a limited token that can not be forged, and its transactions can be tracked while granting a some anonymity to the user. It is sort of like gold with benefits. Its value is only in its intrinsic scarcity. Ultimately it is subject to deflationary forces.

Energy-Backed Currency

In a way Bitcoin is an energy-backed currency (ECB). They are mined by the application of energy and the supply steadily increases logarithmically. But the economy grows linearly (we hope) and is subject to oscillations. The supply of Bitcoin does not reflect where we are economically, but where we have been. This is also true of commodity-backed currencies like gold. Both types of currency will exhibit deflation when the economy is growing, and inflation when the economy sinks, and since we expect economic growth in the long run, we also expect currency deflation in the long run and a tight money supply.

Eventually the money supply can't keep up with economic growth.

What is desirable in a currency is that is backed by some valuable asset, and the quantity of that valuable scales linearly along with the size of the economy. As it turns out energy production scales very closely with economic growth.

(source)

Not only does energy production scale linearly with the economy, but it is also universally valuable as it is an input to all economic activities. Let's look for a second at what traits we need in a practical currency.

Valuable

There roughly are three reasons a currency might be valuable.

1. Rarity. If something is rare and can't be forged, it can be used as a token of exchange. Gold, silver, and diamonds are the most common, as well as cryptocurrencies.
2. Intrinsic value.  Gold may have once held this trait, but today there are many cheap alloys that can be substituted for gold in most of its applications. 
3. Debt value. From Modern Money Theory (MMT), which describes modern fiat money as having value because they must be acquired to settle tax debts.

Energy would have value for all three of these reasons. Rarity because there is only so much energy production in a country. Intrinsic value because it is used as an input to all economic activities. Debt value because currency would be issued as an energy debt to be repaid. Because energy is not fungible, it would have to be represented with paper currency, just as gold-backed currencies are.

Energy-Backed Currency Lifecycle

At its simplest the lifecycle can be described in 3 steps.

1. The government spends money into existence. If it spends a dollar, it creates an energy bond.
2. Citizens and business trade goods and services to acquire the money.
3. The money is used to purchase energy. A dollar spent on energy annihilates one dollar of energy bond.

Anyone who's been reading my MMT posts (click the MMT label at the bottom to see them) will see the analogy in play. Just as the concepts of energy and money have been merged, so have the concepts of energy purchases and taxation. The completely removes the need for a national tax code. The government no longer controls that side of the loop. Currently the government tinkers everywhere. Think of how chaotic it is. Every aspect of our lives is peered into by the government for purposes of taxation. Pick up a side job? The government wants its piece. Loan money to a family member? Even it was interest free, Uncle Sam demands a cut of it, under threat of physical force. Future generations will be amazed at how much meddling into our day-to-day interactions we permitted.

Tenet 3: Energy purchases and taxation are equivalent.

Spending

The government will still maintain large control on society through spending. I can already hear objection to the plan on the guise of it being a regressive tax scheme. That it unfairly targets the poor. But it is not really a tax scheme at all. There is no tax code. There is nothing for the government to tinker with on that end. If citizens feel the system is too hard on the poor, they lobby the government to shift spending in a way to make the desired changes, and in a way that is more upfront and transparent to everyone. The current system is like a two-ruddered ship. It is inherently unstable.

Temporalness

The tricky aspect to this is the temporal nature of energy production. For convenience we will think of spending in annual budgets, just as we did for the MMT thought exercises. So at the beginning of the year the government creates energy bonds equal to the amount of energy it that it will be able to generate in one year. Let's just assume it's 100 megawatt years (MWy). This means the government is expecting to generate an average of 100MW over the course of the year. 

This brings up many questions. What if the government spends too much money into existence? Is it limited to one year's supply? As we've shown before in MMT, excess government money must always be backed by bond financing, or the money will have no value. EBC does not inherently change that dynamic. Should the government expand the money supply (i.e. borrow and put the cost on future generations) to maintain status as global reserve currency? These are finances questions, and not impacted by EBC. We've not at this point talked at all about finance or the role of the central bank, and we may not need to, as they seem to be unrelated to merging of money with energy, and of the requisite political restructuring.

Tenet 4: EBC changes are orthogonal to finance and banking

Political Shifts

In addition to backing the currency with energy, the political structures would be realigned to properly balance society with the understanding of the roles of complexity and energy in the rise and fall of civilizations. As mentioned before there are now three roles within society: productive, administrative, and energy.

Productive

This what we consider to be the non-governmental sector of society, but that definition doesn't quite describe things. For instance, there is no real difference between a private clinic and a state-run clinic from an economics perspective. Much of this is due to the fact that people these days tend to believe it is the role of government to provide certain services to the people. Generally anything we consider as contributed to GDP falls into this category

Domestic Administration

This is everything to do with managing societal complexity. Policing, schools, social programs, everything that is internal. The governing structure could take several forms. In America the states would adopt almost the entirety of the role, and in fact that is pretty much how it was intended by the Founders. But other countries are meant as a collection of states, like the US, and have relatively strong federal governments. For those countries internal aspects of government would be largely separated from the rest.

Energy & International Affairs

The top level of government issues currencies, monopolizes the energy sector, and provides all the outside facing structures of government, such as the military, foreign ministry, intelligence, and so forth. Ideally the outer government would operate almost completely isolated from the domestic government. Such a division allows the outer government to primarily on its task as energy provider, and its ability to operate in the world to acquire and defend those resources. However they would be tied in one key aspect: spending, which is a topic to discuss in another post.

Further Topics

Other topics to explore are how the government takes control of the energy sector, a further discussion on the relationship between the inner and outer governments, how different energy forms are valued (for instance gas is cheaper than electricity) without distorting markets, and how markets might be intentionally distorted, such as by encouraging renewable energy use. As worthy of exploration are the societal impacts. Clearly the economic shifts will change incentives. Driving to work will get much more expensive, but incomes won't be taxed in half.

There are political benefits to an EBC system. It will government control of society simpler and more transparent. It will drive efficiency of energy usage, which will increase the improvement to standard of living per energy consumed. But most importantly at all, it will prolong the energy we need to power our advance civilization long enough to make the next leap forward in energy technology. Otherwise we will sink back into the valley behind us. I view this as the fundamental existential threat to modern civilization.