Like sophomores cramming before a final, the Eurozone leaders who met in Brussels last December pulled an all-nighter. Their final exam was a real-world project: restore investor confidence in the Eurozone. They hoped that the steps they announced, bleary-eyed, at a press conference in the morning would do that: Eurozone nations would be brought under stronger central control, with budgets reviewed by the European Commission; deficits would have to be centrally approved, and member nations would have to balance their budgets over the business cycle—deficits in recession years would have to be compensated by surpluses in growth years. In the original system, member nations faced penalties if they ran persistent deficits — penalties that Greece consciously chose to ignore rather than see its economy sink into unemployment and recession under the onslaught of cheap imports from countries running a surplus. The new plan would have Eurozone member nations suffer larger, automatic penalties if they don’t obey the budget-balancing rules, and would reinforce the role of the Central European Bank as the arbiter of monetary policy within the Eurozone.

These measures haven’t been sufficient to restore investor confidence. Additional controls on the policy discretion of the Central European Bank might help do that, but they’re unlikely to solve the underlying problem. That’s because “restoring investor confidence” and “fixing the broken system” are two very different goals. They line up only if investors have a clear and accurate sense of the causes and cures of the crisis. With the notable exception of Jeremy Grantham and those who pay attention to him, most investors don’t. Like all of the policy makers who met in Brussels, most investors are working out of an old-fashioned and mistaken economic model. Restoring confidence in a system built on that model isn’t going to fix what’s wrong.

What, exactly, is wrong? The New York Times articulated the conventional thinking when it opined, a few days before the all-nighter in Brussels, that the root of the debt crisis is “lack of growth.” The first step toward success in solving any problem is to define it accurately, and the conventional diagnosis gets it wrong because it looks at just half the problem. A more complete diagnosis: Some of the European economies haven’t been able to grow fast enough to pay back the burden of debt that has been wagered on them.This formulation lets us see the path to a sturdy solution: if we want to avoid crises of debt repudiation, we need to limit the total creation of debt, public and private, to the amount that we can reasonably expect to be paid back through economic growth. Doing anything else perpetuates the boom-and-bust cycle that is a familiar feature of modern economies. Debt is a claim on the economy’s future production of goods and services; and if total debt expands too far beyond the ability of the economy to meet those claims, the bubble eventually pops, triggering a cascading crisis of debt repudiation, as debt-that-leveraged-growth becomes debt-that-leverages-contraction: bankruptcies, foreclosures, stock market crashes, pension fund defaults, job loss, the whole panoply of mechanisms by which expectations of future income are frustrated, and by which economic woe is visited upon the general public. Instead of solving the problem of recurrent (and increasingly painful) crises of debt repudiation by looking at the system as a whole, the policy makers who met in Brussels went after just the most recent and obvious symptom: government deficits and threatened government defaults by the weaker economies of the Eurozone. When sovereign governments — governments that have the power to print money – run deficits and create money to pay for them, the expansion of the money supply can stimulate the economy into growth. When a limit to the rate of economic growth is reached – and full employment is just one such limit—then additional monetary expansion is inflationary. And that inflation is one way that the system’s need for debt repudiation can be met.

But within the Eurozone, the European Central Bank is required to hold inflation in check, so the necessary and expected debt repudiation has to take a different form. It has come this time as Greece’s move to renegotiate bond liability under threat of complete default — holders of Greek government bonds will get fifty cents on the dollar, not the full amount they expect. The conventional view sees that and thinks, “if Greece didn’t run deficits it wouldn’t have to default.”That’s true, but too limited to get at the root of the problem. What the conventional frame of analysis doesn’t foresee: If you let the burden of total debt grow unchecked, and if you control both inflation and governmental default by mandating balanced budgets, you’ll simply displace the pressure for debt repudiation to somewhere else in the system. That pressure will eventually out. We can’t forestall the next crisis of debt repudiation unless we rein in the total creation of debt.Conventional thinking has it that the EU is on the verge of a choice between two alternatives: either achieve greater fiscal integration, becoming more centralized, or devolve back into a looser common market in which member nations retain sovereign control of their budgets and budget deficits. Fiscal integration would control inflation and bond default as methods of debt repudiation by imposing austerity budgets on struggling Eurozone members. (There are no penalties for the countries, like Germany, that create the other half of the problem by running trade surpluses.) Governments will have to cut social services and regulatory enforcement — cuts that will be touted as the best way to restore growth, and which will work to the benefit of the 1%. The rich get richer and government gets smaller — an outcome that sits well with neoconservatives and moneyed interests.As plenty of commentators have noticed, fiscal integration under the new budget rules and procedures means a loss of national sovereignty within the Eurozone. As only some of those commentators have cautioned, this makes government in Europe less democratic and less responsive to citizen concerns. “No problem,” say bankers and financiers. Democratically empowered citizens are likely to demand the level of governmental services and environmental protection that well-to-do nations are expected to provide — and the conventional wisdom is that those are luxuries their countries can’t now afford, not if their economies are to grow rapidly enough to pay back the burden of debt they labor under.If you’re going to impose austerity on a democratic country, you have to do one of two things. You can convince its citizens of an idea that is logical within the conventional system but puzzling on its face: a commitment to economic growth requires a decline in their standard of living. (It helps if you can make it look like their fault: a declining standard of living is necessary and well-deserved because they have been profligate in the past). Or, you have to make that nation less democratic by ensuring that monetary and fiscal policy are well beyond the influence of its voters. The movement toward fiscal union and budget austerity thus represents the victory of growth-for-the-sake-of-growth over democracy-for-the-sake-of-democracy.On an infinite planet, the two need not be at odds, and in fact can be seen to support each other. They certainly seemed to track together through much of the nineteenth and twentieth centuries, as market economies expanded into an underdeveloped world. That world seemed infinitely capable of hosting an expanding economy. In a world built out to the limits of what ecosystems can handle, it becomes increasingly obvious that there’s a tradeoff.As should be obvious to policy makers, the expansionary phase of human economic history is over. It is no longer possible to have both democracy and robust, footprint-expanding growth. The freewheeling creation of debt, public and private, has driven economic expansion to its environmental limit. To preserve debt creation as a very profitable feature of the economy, bankers and financiers are perfectly willing to sacrifice democracy. That’s the deep and troubling lesson of the European Debt Crisis: today, the largest threat to democratic forms of government is the fact that the planet hosts a human debt-creation system suited for perpetual growth on an infinite planet.Because an economy deals in physical reality — that is, it runs on matter and energy drawn from a finite planet — it is impossible for economic production to grow infinitely. Debt, being entirely imaginary, can grow however rapidly we choose to let it. A crisis of debt repudiation is the unavoidable result of a mismatch between the two. The conventional frame does not admit this, and it leads us straight toward regressive and destructive policies, including the elimination of environmental and social safeguards. Those safeguards set limits to what we let ourselves do in pursuit of economic growth, and thereby give us a higher standard of living by protecting us from environmental harms and economic insecurity.Since a higher standard of living, and not growth for its own sake, is the ultimate purpose of the economy, it makes sense to allow for the possibility that the solution to our system’s regular crises of debt repudiation lies in controlling the creation of debt. The alternative — demanding more and more economic growth, ever larger throughput of matter and energy — is impossible to sustain on a finite planet, and can only be continued in the near term by rolling back democratic freedoms.So, even in the short run, the infinite growth model is counterproductive. It leads to a declining standard of living and a loss of democratic freedom for the majority of the world’s population — Americans no less than Greeks, Italians and other Europeans. It does so because whether we’re prepared to admit it or not, we’ve reached the limits to growth. More often than not, further growth in GDP is uneconomic growth, because it costs us more in lost ecosystem services and other “disamenities” than we get in benefits.

Pro-growth people don’t see it that way, of course, no doubt because many of them are the ones who receive those benefits by imposing losses on the rest of us. Many of those losses emanate from, and aren’t fully contained within, the rapidly developing nations of China and India — countries whose leaders have mistakenly accepted a demonstrably flawed element of neoclassical thinking, the Environmental Kuznets Curve. This is the idea, much beloved of pro-growth advocates and members of the 1% everywhere, that environmental quality is a luxury that nations will be able to afford only after they develop more — which they can do by cashing out their natural capital for sale on world markets, and by hosting “sink” services, poisoning their land and mortgaging their future by absorbing the global economy’s waste stream. The EKC proposes that with increasing national wealth, pollution reaches a “tipping point” and begins to decline. By this logic, the reason we have climate change is that the richest nation the planet has ever seen—the U.S.—is simply not yet rich enough to afford it. The ecological footprint of the global economy is currently larger than the globe it inhabits. But you don’t have to believe that we’ve reached the limits to growth in order to see that the basic problem behind the European Debt Crisis is the mismatch between our rate of debt creation and the rate at which we can grow real wealth in order to pay that debt off.How much can real wealth grow under reasonable environmental safeguards and with reasonable protection of worker (and citizen) health and safety? The answer is, in part, empirical: we can have a continually increasing standard of living with a sustainable throughput of matter and energy thanks to innovation and technological efficiencies—development that lets us do more with less. The rate at which these increases can be achieved can be postulated from historical data. The non-empirical part has to do with those environmental and health and safety standards: what counts as “reasonable”? Opinions will differ, but only an out-and-out infinite planet theorist can argue that environmental constraints need to be lessened, and only an unreconstructed robber baron could argue that workers ought to be free — “free” — to starve or take on employment that could kill them.Here’s how to begin to fix the broken system: Agree to minimum standards for environmental and health and safety regulation, such as those promulgated by the UN; find the sustainable rate of economic activity that’s possible within those limits; and limit the growth in debt — all debt, public and private — to what’s needed to support that activity. With such a fix, the human standard of living would be raised not though footprint- expanding growth, but through technological innovation that allows us to achieve more benefit from a constant, sustainably sized throughput.If more investors understood that the excessive creation of debt in all its forms — not just government deficits — is the driver of our crises of debt repudiation, this reining in of the creation of debt would be the only way to restore their confidence.Educating investors and policymakers about the economic and financial realities of a finite planet is a huge task, but eventually they’ll come around. They’ll have to. The planet is, after all, finite, and it’s going to keep offering the lesson until everybody gets it.

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