Gail E. Tverberg writes: We all know the world isn’t flat. Any of us would be laughed out of the room if we built a model with a flat earth as one of its major assumptions.

We also know that the world isn’t infinite. There are a finite number of atoms in the earth and its atmosphere. The ability of our atmosphere to absorb pollutants is limited. The ability of our soil to withstand repeated mistreatment is limited. The amount of our non-renewable resources is limited.

Fossil fuels, especially oil, are a particular problem. Even though the amount of resources seems huge, the cost of extraction (in terms of fossil fuel resources, man-hours, and fresh water) increases greatly after we have extracted the easy-to-extract oil, natural gas, and even coal. Substitutes (such as ethanol and solar voltaic) are expensive in terms of fossil fuel use, man-hours, and fresh water. It is also difficult to ramp up quantities to the level needed to substitute for fossil fuels.

In spite of the clear issue of a finite world, the financial community has taken as one of its central beliefs that Economic Growth is Good, and is in fact to be expected. A close corollary is that Leverage is Good. Our monetary system is very closely tied to debt, and would come to a screeching halt if lending stopped. Our banks and insurance companies depend on lending, with banks using lending as their primary source of revenue, and insurance companies using bonds for much of the asset side of their balance sheets.

How did we come to believe that never ending growth was possible? One way was a simple look backward. Growth has continued since the industrial revolution. There was a tie-in with energy resources all along. The industrial revolution brought coal to make creation of goods easier. We later added oil, natural gas, and uranium as additional energy sources. The world’s use of energy has ramped up over a long period, practically without interruption.

Another way we justified the idea of unending growth was through economic models that ignored the contribution of energy and, of course, ignored the fact that we are living in a finite world. Economic models of this type include the Solow-Swan Growth Model that considers the contributions of labor and capital, and the Cobb-Douglas production function that considers labor, capital, and productivity. Neither of these models has built in limits, either. ...

In a finite world, we will soon find ourselves in a level or declining economy, simply because there are not enough easily-extractible resources to support growth without causing huge price spikes, followed by debt defaults, and another round of credit contraction and commodity price crashes. The only solution I can see is to develop a new monetary system that is not debt based, and is not expected to grow. Ideally, it would decline as there are fewer resources, and as the economy naturally declines.

With a flat or declining economy, long-term debt no longer makes sense. The likelihood that borrowers will be able to repay loans with interest becomes quite low, because the economic system as a whole is not growing and producing a surplus that can be used toward interest payments. It is much easier for a borrower to repay a 20-year mortgage with interest when he is getting promotions and salary increases than when his employer is downsizing and cutting hours.

Somehow, a monetary system needs to be devised which operates without debt, except for very short-term debt to facilitate commercial transactions. In addition, we need to extract ourselves from the debt morass we have created. There is now far more debt and far more promises like Social Security and Medicare than can possibly be honored with existing resources.

The only way I can imagine transitioning to a new form of monetary system is by having an overlap period in which both monetary systems are in place. The new money might initially be limited in supply and only be good for food and energy products (somewhat like a rationing system). People would receive some pay in each monetary system. Eventually, the new monetary system would replace our current seriously problematic system. (11/21/08)