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All the notions we thought solid, all the values of civilized life,
all that made for stability in international relations,
all that made for regularity in the economy...
in a word, all that tended happily to limit the uncertainty of the morrow,
all that gave nations and individuals some confidence in the morrow...
all this seems badly compromised.1

All human activity is a cry for forgiveness.2

Who shall absolve us from the guilt of the holocaust? Colonialism?
...A nuclear catastrophe? 3 The extinction of even one species?

Practical men, who believe themselves to be quite exempt from any intellectual influences,
are usually slaves of some defunct economist.4

SUSTAINABILITY: Presently, there are many ideas of what constitutes

sustainability.5 Our definition is simple and straightforward: sustainability is creating
real economic wealth in the world for the communities we live in. Economic wealth is always
founded on a binary bio-physical reality. Either the bio-physical systems that are
supportive of life (and economy!) on the planet are evolving toward sustainability. Or
they are moving towards collapse. 6

COMPLEX SYSTEMS & MARKETS: Most bio-physical support systems on earth

that are supportive of humankind’s economic activities are complex systems.7 They
are rarely in stasis. 8 These systems are dynamical and exhibit emergence. The impor-
tant function of markets is to allocate capital towards activities that are sustainable.
That is, markets, ideally, are to ensure that the allocation of capital, overall, produces
the growth of real economic wealth in the world for the communities we live in.

WHY MARKETS FAIL: Markets ultimately determine whether allocating capital for
particular investments to grow the economy are sustainable. 9 Non-sustainability is
typically signaled by sharp discontinuities of asset prices “largely unanticipated by
market participants. For, were it otherwise, financial arbitrage would have diverted
it.” 10 Markets regularly fail when they fail to manage risk.11

RISK: The primary task of markets is to allocate capital to timely projects that pro-
vide the technological innovation an economy requires for sustainable growth.12 An-
other primary task of markets is to protect the bio-physical services of the earth so
that sustainable growth can continue over the long term. When an economy success-
fully accomplishes these tasks of innovation, reallocation and protection, it is accu-
rately assessing risks: maturity, liquidity, market, credit, currency, technological obso-
lescence, and wider economic, ecologic, and political risks.

Market risk consists of the danger of mispricing assets; credit risk covers the po-
tential of financial promises not being honored; currency risk describes a mis-
match between the value of liabilities’ and assets’ respective currencies; techno-

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logical obsolescence describes the technological progress in achieving more out-

put with less input of labor, capital, and time; larger economic, ecologic, and po-
litical risks refer to black swans, those highly improbable events such as global
crisis, war, political upheaval, and ecological collapse that produce massive im-
pacts on markets.

The collective characterization of these risks, taken as a whole, is called systemic risk.
What characterizes systemic risk is that it is emergent (the final outcome cannot be
fully predicted by antecedent causes) and a consequent of the mispricing of inputs to
and outputs from market transactions.13 Systemic risk must be accounted for and
managed in order to produce a positive economic return on invested capital (EROIC).14

ALL MARKETS REQUIRE RULES FOR SUSTAINABILITY: Markets require struc-

ture (rules of the game) to function efficiently.15 Regulations help to define this struc-
ture as fair and equitable for all parties who wish to transact business in a market. 16
Unregulated markets tend to develop unfair practices that are driven by avarice.17
This leads to the inefficient allocation of capital. Over time, if capital is not efficiently
allocated to activities that are productive and that produce a real economic return on
invested capital, the market tends towards collapse. 18 Thus, the primary purpose of
regulations is to prevent the collapse of markets due to the inefficient allocation of
capital within those markets.19 By definition, collapsing markets have not been prop-
erly regulated. Markets that are not prone to collapse are sustainable.

MARKETS & SYSTEMIC RISK: Presently, markets are not efficient in pricing sys-
temic risk.20 The quality of governmental regulatory institutions maybe the single
most important forcing function for markets to accurately assess and price systemic
risk. 21 However, present regulatory institutions are overly tactically focused, piece-
meal, stove-piped and limited in their purview, and generally ineffective. Fundamen-
tal and structural inefficiencies in the government regulatory apparatus enable do-
mestic (and global) markets to misprice inputs to and outputs of the economy by ei-
ther deferring known economic costs to the future (externalities) or failing to account
for known economic costs and pushing these costs to public taxpayers (contingent
liabilities).

If markets were efficient in pricing systemic risk and/or government regulations

were effective, by definition, there would be no threats from abrupt climate change,
freshwater resources would not be depleted, the global destruction of ecosystems,
and the extinction of species due to anthropogenic causes, etc. would not be
occurring. 22 For all these consequents of not managing the systemic risks of market
transactions are dis-economic. That is, the economic costs for not managing these
risks are greater than the profits derived by pushing the costs of these risks to the
future.

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MARKETS FOR ECOSYSTEM SERVICES: Ecosystem Services refers to those bio-

physical support services that constitute the foundation for every economy on earth.
Markets for ecosystem services are the mechanisms for costing systemic risk and pric-
ing this systemic risk in all the market transactions of the economy. For without accu-
rate pricing of inputs to and outputs from the economy, capital will not be allocated
to the most productive uses in the economy for producing sustainable economic
growth.23 Without sustainable economic growth, real economic wealth is not created
for the communities we live in, but destroyed. The mechanisms for costing systemic
risk and pricing this systemic risk in all the market transactions of the economy must
typically derive from market regulatory innovations, as markets, on their own, will
rarely adequately price systemic risk. 24 Without adequate pricing of systemic risk in
market transactions, instead of global GDP going from $60 trillion to an estimated
$240 trillion by 2050, it may instead collapse deeply to $6 trillion. 25

ENDNOTES

1 Paul Valery, “Historical Fact” (1932) reflecting upon the large effects of the Great Depression.

2Karl Barth, The Epistle to the Romans, trans. Edwyn C. Hoskyns (London: Oxford University
Press, 1933), 97-8.

3 Rowan Williams, A Ray of Darkness: Sermons and Reflections (Cambridge, MA: Cowley Publica-
tions, 1995), 4.

4 John Maynard Keynes, quoted in Justin Fox, The Myth of the Rational Market: A History of Risk,
Reward, and Delusion on Wall Street (New York: HarperCollinsPublishers, 2009), xvi on defects
in neoclassical economic theory based on St. Thomas Aquinas’ original notion that just prices
are “set by the market “( Fox, xiii).

5 Sustainability results from the timely process of transforming these economic systems un-
dergoing change to systems that are resilient (less susceptible to collapse) when shifting to
lower thermodynamic states. Economic systems are sustainable when thermodynamic state
shifts do not cause rapid disruptive nonlinearities - abrupt changes of the system to an unan-
ticipated, less-complex state.

One way to think about the thermodynamic states of economic systems is in terms of energy
return on energy invested (EROEI). For example, in this context sustainability might be more
technically described as the re-engineering of economic systems to transition from high energy
return on energy invested sources to systems capable of operating at lower thermodynamic
states: in 1930, EROEI of oil, natural gas and coal was 100:1; today EROEI of oil, gas, wind is
15:1; large hydropower 11:1; conventional coal 10:1 (when one adds the cost of CO2 emis-
sions); newly found oil, photovoltaic solar 8:1; clean coal 5:1 (better carbon emissions control
but coal ash and heavy metals pollution); fuel cell, geothermal, nuclear 4:1 (one one includes
the entire nuclear fuel cycle, nuclear is about as carbon intensive as clean coal); oil shale and
Alberta tar sands 3:1 (very carbon emissions intensive); LNG 2:1; ethanol (from corn) 1.3:1;
hydrogen 0.8:1; nuclear fusion (unknown). See, Charlie Hall, “Balloon Graph;” The Oil Drum
(www.theoildrum.com); Thomas Homer-Dixon, The Upside of Down: Catastrophe, Creativity, and
the Renewal of Civilization (Washington, DC, Island Press, 2006).

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6 “Perhaps the fundamental question – is how can the operating institutions for the modern
world be changed so that economic activity both protects and restores the natural world.” See
James Gustave Speth, The Bridge at the Edge of the World: Capitalism, the Environment, and Cross-
ing from Crisis to Sustainability (New Haven & London: Yale University Press, 2008), 7.

7 Complex systems are comprised of networks of linked activity nodes. Energy, materials, and
information are exchanged via these links among the nodes. Networks come in two main
forms: (1) Random networks resemble the interstate highway system: nodes are cities and towns
and links are the highways between these nodes. No node has a large number of links to other
nodes; (2) Scale-free networks resemble the air-traffic control network with most nodes having
few connections with other nodes and a few hubs with connectivity to many nodes. Scale-free
networks include most ecosystems, the Internet, the U.S. electric power grid, the global oil
refining and distribution system, the global banking system, most water distribution systems,
and modern food-processing and supply networks.

Almost all complex systems are interconnected with other systems. Generally, the systems that
support modern life are complex systems that exhibit emergent properties that are unpredict-
able from their component parts. The links between nodes and the interconnections between
systems become brittle if accumulating stresses have eroded a system’s resilience over time.
Systems are resilient if, under stress, they can reorganize themselves and continue to function.
Complex systems that can do this are said to be adaptive. Adaptive complex systems tend to go
through adaptive cycles of growth, collapse, regeneration, and then growth again, but with dif-
fering thermodynamic flows and interconnection novelty.

All systems have a tipping point, a set of stresses (an overload beyond a threshold rate of change
of inputs) beyond which they breakdown (loose complexity and cease to function within normal
ranges) and sometimes collapse (recovery is uncertain) or suffer deep collapse (multiple systems
experience synchronous failure [the concurrent collapse of multiple support systems] when sys-
tems are tightly coupled [operate with dependencies that deplete resilience]). As failure pro-
ceeds, moments of contingency arise (there is an absolute timeliness for rescuing the system from
collapse e.g. if rescue measures are applied in time x, the cost is y; if rescue measures are ap-
plied in time x+1, the cost is 100y. Think New Orleans pre-Hurricane Katrina: the cost to
strengthen the levees to Lake Pontrain before Katrina hit was a fraction of the cost to clean-up
the devastation in New Orleans post-Katrina.)

8The apparent equilibrium states of complex systems may be due to misperception. We often
miss "large scale, long duration problems. We are not wired to see large systems, as being in
motion. The larger the phenomenon, the more stationary it is likely to appear to us." See
http://gregor.us/coal/jevons-and-the-six-day-car-crash/.

9 Sustainability results from the timely process of transforming these economic systems under-
going change to systems that are resilient (less susceptible to collapse) when shifting to lower
thermodynamic states. Economic systems are sustainable when thermodynamic state shifts do
not cause rapid disruptive nonlinearities - abrupt changes of the system to an unanticipated,
less-complex state. See http://www.scribd.com/doc/9714755/Sustainable-Economy.

10“Bubbles seem to require prolonged periods of prosperity, damped inflation and low long-
term interest rates.... History also demonstrates that underpriced risk – the hallmark of bubbles
– can persist for years.” See Alan Greenspan, “We need a better cushion against risk,” Financial
Times (26 Mar 2009).

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11Derivatives help to diversify risks among a multitude of counter-party relationships. These

counter-party relationships produce a more robust economic system that is able to self-correct
against small shocks. Yet, due to interconnections among parties, the economic system be-
comes more vulnerable to black swans that produce massive, tumultuous effects in markets. See
Daron Acemoglu, “The Crisis of 2008: Structural; Lessons for and from Economics’ (January 6,
2009), 3.

12 “The transition to a clean-energy economy should be modeled not on pollution control ef-
forts, like the one on acid rain, but rather on past investments in infrastructure, such as rail-
roads and highways, as well as on research and development…. This innovation-centered
framework makes sense not only for the long-term expansion of individual freedom, possibil-
ity, and choice” but offers the best probability of achieving real, economic wealth creation of
benefit to the nation. See Ted Nordhaus and Michael Shellenberger, Breakthrough: From the
Death of Environmentalism to the Politics of Possibility (Boston & New York: Houghton Mifflin
Company, 2007), 15

13 Market mispricing of inputs to and outputs from the economy discourages timely techno-
logical innovation, slows down technology adoption cycles, and inhibits the reallocation of
labor and capital to those more productive sectors of the economy, thus putting the entire na-
tional economy at a competitive disadvantage. In particularly egregious situations and over
time, this mispricing creates unsustainable economic conditions resulting in collapse of asset
values, markets, and/or economies that careen from one financial crisis to another.

14 Ever since St. Thomas Aquinas proposed that market-set prices resulted in true economic
value, this has served as an article of faith in the Christian West. Most recently, this faith-based
belief has been bolstered by mathematical formulations and economic theory (validated with
Nobel prizes for economics). However, despite the math and theory, the underlying predicates
are the tenets of the rational choice theory: human beings act rationally as if to maximize their
utility. That is, market transactions must be efficient (the Efficient Market Theory) as no person
would pay more in the transaction than their derived utility for the good or service in question.
Gene Fama summarizes the Efficient Market Theory: “The primary role of the capital markets
is allocation of ownership of the economy’s capital stock. In general terms, the ideal is a mar-
ket in which prices provide accurate signals for resource allocation.... A market in which prices
always ‘fully reflect’ available information is called ‘efficient’” (“Efficient Capital Markets: A
Review of Theory and Empirical Work,” Journal of Finance (May 1970); 383 quoted in Fox, 104)

If one subscribes to the wisdom of markets, then the following corollary is that any govern-
ment regulation of markets is bad for as Fredrich Hayek intimated in a 1945 article, “The Use
of Knowledge in Society,” “Any attempt to regulate prices or business activity was doomed to
thwart the movement of knowledge needed to make the economy run smoothly” (Fox, 91-2).
This mentality was most vigorously marketed by Milton Friedman, a professor of economics at
the University of Chicago in his Capitalism and Freedom that expresses the idea that “whatever
the government does is bad” (Fox 93-4). This Chicago School understanding of economics de-
volved into what some refer to as Disaster Capitalism: making a huge fortune specifically from
natural and planned disasters exacerbated by poverty, social tensions, environmental degrada-
tion, ineffectual leadership, and weak political institutions. Disaster capitalism’s raison d'être
may be the promotion and generation of market inefficiencies – pricing signals that distort real
prices for goods and services and their real cost to the environment, public health, and social
justice. The checkered history and deleterious results of disaster capitalism is well documented
in Naomi Klein’s, The Shock Doctrine: The Rise of Disaster Capitalism (New York: Henry Holt and
Company, 2007). The most recent result of this economic theory is the 2008 financial crisis.

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15 The business community often has an aversion to government regulations. Even the word,
regulations, is a non-starter. This is because the government has often relied on two forms of
regulations that are anathema to business: Thou Shalt Not and If....Then regulatory forms. Add-
ing to industry’s woes, these regulations are often promulgated in a piecemeal, disjunctive
fashion and collectively are dis-economic, producing results that are as or more harmful to the
economy than the good the regulation was intended to achieve. Often these forms of regula-
tions lend credence to Fredrich Hayek and Milton Friedman’s mantra that “whatever the gov-
ernment does is bad” (Fox 93-4). However, at least in theory, a well-regulated market should
be more efficient and more profitable for participants (overall) than an unregulated market.
The quality of importance is well-regulated. That is, regulations assist in managing market
transactions to reduce overall risk (systemic risk) that if not managed could potentially destroy
any profits from market activities over long periods of time. This is, of course, what occurred
in 2008 with the collapse of the CDO (collateralized debt obligation) derivates U.S. financial
markets.

An important innovation that other capitalistic, industrialized, democratic countries of the

world are investigating are regulatory mechanisms based on behavioral economics. Behavioral
economics advances the discussion concerning rational choice theory by discussing the the-
ory’s limitations when psychological principles of individual behavior are taken into account.
For example, behavioral economic theory looks at decision-making in light of: prospect theory
(generalized expected utility of decision making under uncertainty), bounded rationality (sat-
isfaction vs. maximized utility), overconfidence, projection bias, effects of limited attention,
time-inconsistent choice (behavior not based on expected utility, but on previous historical
reinforcement experiences), hyperbolic discounting (changing discount rates based on length
of forecasting period), fairness, reciprocal altruism, etc.

16This is entirely keeping with Adam Smith’s vision of capitalism that relies on free markets to
function. For Adam Smith, as for most modern economists, free markets must be ‘regulated’
for the common good. Otherwise, unscrupulous individuals operating from the premise of
avarice and utility (as defined by them personally as opposed to the common good), will de-
stroy the value of market transactions to efficiently allocate capital to the most productive uses
in the society. Either the intrinsic values of market participants provide the regulation of these
markets, or extrinsic means are employed, usually requiring government intervention in mar-
kets. This is universally true. There are few legitimate, lawful, free markets operating any-
where in the world today that are not regulated. [Whether the regulations imposed on markets
are useful to improve the efficiency of markets or they harm market transactions is a another
matter.] See http://www.scribd.com/doc/19538880/Capitalism-Socialism-Corporatism.

17Max Weber and others have argued persuasively that greed and the unrestrained pursuit of
profit are not foundational to the tenets of capitalism and never were so. For without the re-
straint of rational calculation and support of government to make legal the economic activity
in question, economic progress would grind quickly to a halt. In fact, the progress attributed to
capitalism and its use of free markets might be better attributed to this-worldly asceticism that
emphasized hard work, education, and deferred gratification as the noblest of virtues for the
amassing of capital and investing this capital to good effect. See Zygmunt Bauman, “Building
a Capitalist Society in a Postmodern World,” in Peter Beilharz, ed., The Bauman Reader (Malden,
MA & Oxford: Blackwell, 2001), 65.

18 For example, if achieving a 350 PPM atmospheric concentration of CO2 is necessary to avoid
an atmospheric tipping point, the economic reallocation of capital necessary for achieving this
level of CO2 in the atmosphere may be $20,000 billion. This is not a cost. This means that either
we are allocating capital for a sustainable economy by addressing the systemic risk of anthro-
pogenic abrupt climate change or we are spending our way towards economic collapse.

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19 Technological innovation and the reallocation of capital to more productive purposes are the
two pillars for fostering economic growth. But, only when properly regulated do these factors
foster economic growth by enabling risk sharing and diversification. What government regula-
tions provide is the trust to make long-term investment commitments necessary to increase the
wealth of the society. See Acemoglu, 8 and Martin Wolf, Fixing Global Finance (Baltimore: The
Johns Hopkins University Press, 2008), 20.

20 The most glaring recent instantiation of markets not pricing systemic risk and the impact on
the global economy appeared in costing of the price of insurance premiums for CDOs (collat-
eralized debt obligations derivatives based on the underlying asset values of mortgages on real
property) on Wall Street. Premiums for individual tranches of CDO’s were priced at a risk-
adjusted price that assumed no systemic risk. As the CDO market collapsed, U.S. taxpayers
were required to put up approximately $17,489 billion in reserves (potential future taxes to
make good on underpriced CDO insurance).

21 What government regulations theoretically provide, at their best, is the enduring trust to
make long-term investment commitments necessary to increase the wealth of the society (Wolf,
20). For example, when regulations or lack thereof result the mispricing of inputs to and out-
puts from the economy, this creates instability in markets that results in an economy that
lurches from crisis to crisis with ever-spiraling costs to taxpayers and that shatters lives of its
victims. This situation may not only be a source for waves of financial crises, but also of an
increasing propensity for local resource wars and terrorism as preferred methods for sorting
out temporary winners and losers in a Ponzi-like scheme where real, economic costs are borne
by the losers (often present-day taxpayers, citizens of other countries when industrial pollution
is exported overseas, or to future generations of citizens when payment of debt from contin-
gent liabilities is put off to the future).

22 Two structural problems of free markets exist today: (a) capital is oftentimes not allocated
efficiently to its most productive uses; and (b) profits from business activities are used to guide
investment decisions where, because of faulty accounting for the economic costs of systemic
risk (such as the discounting of ecosystem services value), little or no actual profits may actu-
ally have been produced (even as they are reported in the firm’s financial statements). Accord-
ing to the logic of the efficient market theory (a pillar of neoclassical economics), if the markets
actually priced goods and services at their true (intrinsic) value, there would be no global
warming today (at least from anthropogenic sources), the Chesapeake Bay estuary would not
be threatened with destruction, the nation’s freshwater resources would not be imperiled, cy-
bersecurity for the nation’s cyberspace would not be at risk, etc. What all these problems indi-
cate is that markets are sometimes highly inefficient in arriving at the true economic prices of
inputs to and outputs from the economy.

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23Fixing present fundamental and structural regulatory inadequacies may require, in tandem,
legislation, policies, and administrative practices that:

• Restores industry’s and the people’s trust in government through more thorough
oversight of markets and the imposition of economic incentive regulations that
encourage trust in market institutions.

• Restructures tax policy to add market cost adjustment surcharges on some inputs to
and outputs from the domestic economy as a means to correct market mispricing and
to reduce taxes on income and adds corrective tariffs to imported goods so as to not
disadvantage domestic manufacturers;

• Provides economic stimulus that encourages technological innovation and the

reallocation of skilled labor and capital towards strategic projects that creates new
jobs.

24Nassim Nicholas Taleb (b. 1960) describes why it is so hard for markets, on their own, to
price systemic risk in his Fooled By Randomness (2001) and The Black Swan (2007). He outlines
Benoit Mandelbrot (b.1924) proofs of the incomputability of the probability for consequential
rare events from empirical observations ("black swans"). From empirical studies of risk in a time
series, it appears that in the process of achieving generalizations from this data and/or deriv-
ing general rules from particular observations, hidden properties in the data are routinely
missed. Decision-makers end-up overestimating the value of rational explanations of past
data, and underestimate the prevalence of unexplainable randomness in the data. The result is
managing systems as if a black swan will never occur, even though they almost always do.

Taleb believes decision-makers ignore black swans because humans are more comfortable see-
ing reality as something structured, ordinary, and comprehensible (i.e. rationally explainable).
Taleb calls this blindness to the Real the Platonic fallacy and argues that it leads to three ex-
planatory distortions when developing models of reality in time: (a) narrative fallacy: using
retrospective historicity to ‘explain’ the past. That is, the past occurred this way because of x, y,
and z; (b) ludic fallacy: modern probability theory, utility theory, rational choice theory, and
game theory that assumes a normal Gaussian distribution probability curve mistakes simple
models of reality with the Real; (c) statistical regress fallacy: believing that the structure of the
probability of x occurring that actually exists in reality can be fully developed and described
from a set of data.

Taleb also believes that people are subject to the triplet of opacity, through which historical de-
scriptions of reality is distilled even as current events are incomprehensible. The triplet of
opacity consists of (a) an hubristic illusion of understanding of current events; (b) a retrospec-
tive distortion of historical events to ‘fit’ current socially acceptable ways of describing reality;
(c) an overestimation of what constitutes ‘factual information,’ combined with an overvaluing
of the value of ‘expert knowledge’ (typically rendered by ‘experts’ possessing certain creden-
tials, experience, or notoriety)) concerning the subject being discussed.

25 Global GDP estimate is from CIA http//www.cia.gov/cia/publications/factbook/. For ex-

ample, the economic game theory behind nuclear deterrence that provides the foundation of
national defense illustrates how economic misunderstandings of and mispricing of systemic
risk (e.g. value/cost of nuclear weapons) distort capital allocation decisions. In the case of na-
tional defense, over the past 64-years, $60,000 billion has been spent worldwide on defense.
Can the world’s economies today afford a trajectory of expenditures where another $60,000
billion will be spent over the next 64-years for national defense? If we spend available capital
in this fashion, what other investment decisions must be forsworn, delayed, or forgotten? See
http://www.scribd.com/doc/20228926/Economic-Games-Behind-Nuclear-Deterrence.

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