Economy

I wanted to give a simplistic example of the challenges that our economy faces. Let’s pretend that there are two people—one builds tables and the other farms chickens. They trade back and forth, ten chickens for one table. That becomes cumbersome so they use gold as an intermediary. You can’t easily produce more gold so it has a high value. But it’s heavy and not divisible, so they switch to paper currency.

If ten chickens are $10 and one table is $10, every time one buys products from the other, it’s counted as gross domestic product. So over the course of the year, if 50 chickens and five tables are purchased, the GDP is $100. GDP is calculated as the velocity of money times the currency. In this example, $50 X 1 + $10 X 5 = $100. The more traded, the higher the GDP.

Then the government gets involved. The paper currency used to be backed by gold but the government ended this program. The government decided how much currency could be printed.

Then banks got involved. The banks loaned the table builder $1,000 at 10% interest. As long as he sold 30 tables, he could cover his $100 in interest. The banks got the money from the government, which created the money from thin air and selling bonds to foreign governments. The table builder was able to use additional credit and buy cheap goods from the foreigners. The foreigners paid their employees less because their countries had experienced devastating wars a few decades ago and had a less educated work force.

The problem is that demand for the tables dried up. The customers were growing older and didn’t need to buy new tables. Because sales fell, the table maker couldn’t make his payments and went into default. This in itself wasn’t a problem for the bank but for every $30 in loans it had outstanding, it had $29 in customers’ deposits. It took only a few bad loans to put the bank out of business.

The government had some ex employees of the bank in charge of government finance. There is a process called bankruptcy where the bond holders take control of the bank and the managers are fired. This didn’t happen. Instead, the government bought stock in the companies, which is rare. The management stayed on. Again, the government printed money from thin air to pull this off.

So the banks were back in business. The problem was that all of the people whom the banks were trying to loan to were in the same predicament as the table builder—their goods were not in high demand. People didn’t want them anymore.

On the other hand, we have the chicken farmer. People would come to his farm and offer their services. Foreigners wanted the chickens and would use their strong currency to compete with locals. A stock broker tried to trade financial advice to the farmer but the farmer wasn’t interested. He pointed out that the stock broker wasn’t able to predict the financial mess and the company whom he worked for couldn’t even manage its own finances. A loan broker came by but the farmer didn’t want a loan. However, a doctor was able to cure the farmer’s cough and was able to procure 30 chickens for his services.

Foreign countries were dependent on people like the table maker to buy their cheap goods. People like the table maker stopped spending, so the foreign countries had to begin trading amongst themselves. Though the foreign countries had problems, their problems paled in comparison and their foreign currencies strengthened. The stock and loan broker had to go back to school and become like the doctor whose services were valued. The government got smart and stopped printing money because it was hurting their currency and causing goods that the foreigners wanted, like chickens, to skyrocket. The government had to cut its spending and raise taxes to take care of the people who were growing older whom the government had made financial promises. Everyone eventually changed their ways but it took several years.

THE END