Hod Did We Get In This Mess?
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How did we get in such an economic mess? To understand the answer, It will be useful to start with a very simple economy. The simplest model is a simple barter economy between two people. Tom raises a cow which he milks. Bill grows corn. Bill wants milk and Tom is willing to trade a gallon of milk for ten ears of corn. Both produce a product, and both benefit as a result of their production by trading their produce. Unfortunately, although this is the basic model, it is so simple as to make it difficult to understand what happens. We will add two more people.
John raises sheep and shears them for the wool. Al prospects for mineral deposits, and melts them down to produce metals for tools. He trades some to Bill for some corn, Bill doesn’t particularly want the metal, but he knows that John needs some metal. Bill wants milk and Tom wants some wool so Bill trades the metal for some of John’s wool, which he then trades for milk. Again everyone profits from their production and trading.
Because it is such a hassle carrying the different products around until he is able to make a trade, Bill accepts a note promising a piece of metal to whoever has it. When he discovers that John wants the metal, Bill trades Al’s note for a similar note promising a bundle of wool. He then trades that note to Tom for some milk. A second advantage is that if some one decides they’d rather have something else They can trade their note for something else. Those notes are a form of money.
Corn can only be harvested during certain seasons, so Bill runs out and writes notes promising to deliver when the next crop is harvested. If the others believe he will fulfill his notes, they accept his notes as money, and make the trade. They give him credit. If Bill honors his promises everyone still profits from their work.
Should Bill fail to honor his obligations, whether because a lack of rain caused reduced production, or because he was lazy and didn’t plant enough, If the situation, people will discover that they have traded for notes, and can no longer have anything to trade for other products. You now have a recession. Trade is reduced because credit removed products without replacing them.
Should Bill accelerate production and meet his notes. the recession will end and trade will resume. Perhaps Bill decides he still needs more of the other’s products and persuades them to accept more of his notes for their products, with out increasing his production. John continues to trade his wool for Bill’s notes and depletes his supply of wool. Al and Tom only trade with Bill for the wool he received from John. John may begin to run short of wool and offer notes for future production. They are approaching a depression.
Perhaps they realize that Bill will not be able to catch up, and so begin to value his notes for what they think he can produce, rather than face value. This is inflation. The note promises ten ears, but they think he will only produce five and trade as if it just said five. They still value his corn just as they did before, but his promise, his currency, has lost value. He has to promise more and more for the same amount of other products.
If he continues to run a trade deficit, to purchase more than he produces, eventually the others may refuse to accept his notes at all causing him to experience a monetary collapse. If they refuse to trade until his notes are paid off, he will experience total economic collapse, being unable to obtain anything until his bills are paid. The economy of each of the others will be affected by how much credit they gave him.
Bill’s economic woes are the result of excessive credit. His promissory notes are called fiat money. It’s only value is based on the trust of the others. As their trust erodes, it’s value dissipates. If trust is lost, monetary collapse and possibly economic collapse are certain.
Because there are wild animals that eat crops and kill cows or sheep, and threaten the traders, they periodically have to stop production to protect themselves or their belongings. Ron offers to join the group and provide protection by building a stockade around the homes, and standing guard with weapons at hand. In exchange they are to give him a certain amount of their products. The service will enable them to be more productive and all agree.
Ron is successful at driving the enemies away, and the traders make even more profit. They are still giving Ron the same as at first, and he begins to want to share in the wealth. He may offer other services to obtain additional products. He may also begin to offer a protection racket, in which he promises not to attack them if they pay him extra. Because he has better weapons, more experience with them and isn’t busy producing, they dare not refuse and he becomes increasingly demanding.
Aware of their resentment, Ron decides to enlist Bill, who is still not producing as much as he is consuming, thus not enjoying the same level of wealth. Ron offers to Help Bill get more of the wealth if Bill will support him in his demands. It is no longer a four against one struggle, but a three to tow two struggle. Superior weapons give Ron a decided advantage and efforts to rein in his greed fail. As long as Bill supports him, he is free to demand as much as he can take.
To maintain Bill’s support, Ron demands that they honor bills notes even when he doesn’t produce the promised product. Between Ron’s demands for himself, and what they are forced to give Bill, the other three are producing far more than they are receiving in return. There is less and less incentive to continue to produce. There is no longer a free market.
If Al joins Ron and Bill, so he can share their benefits, the economy goes into recession. Because his income decreases, Ron may demand a bigger share, further reducing John and Tom’s rewards. When they no longer receive enough rewards to maintain production, They will be forced to stop and the Entire economy will collapse.
While the above story is simple, it portrays the effects of different parts of an economy. We have ignored how the economy those effects, believing that one can be purely a consumer. A producer cannot continue to produce unless he receives equal product in return.
A stable economy requires a balance between exports and imports, between consumption and production. When they balance, the economy can grow indefinitely. Deficit spending, whether in the form of credit purchases or trade deficits, always leads to financial crisis if not corrected promptly. Non producers, can provide valuable services, but they will drain an economy if they become too strong.
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