How an economy grows and why it crashes, a book written by the American economist and stock broker Peter Schiff , published in 2010.
It covers multiple topics about economics and finance through the story of three men: Able, Baker and Charlie living on an isolated island.
These 3 men go fishing every day for one fish which they eat that same day. No fish saved and no investment is made to improve their ability to catch more fish which would give them more free time. Abel decided to make a net giving up one day of fishing. Because he took the risk of not eating for one day he now can catch 2 fish a day, create savings and have more free time. This shows how the possibility of using tools along side reducing consumption and risk taking creates financial wealth. Baker and Charlie see how able now catches 2 fish a day they also want to have more fish and more free time. The only way they can achieve this is by producing their own fishing nets. In order to spend the day building nets and not fishing they each take a loan of one fish from able. Now they each have one net and able has got fish without working at all. The reason why able helped Baker and Charlie was that he made a profit not that he cares about his friends. This example demonstrates how as a result of the risk able took the standard of living of all of the people on the island was increased. Abel was motivated by a purely capitalistic interest which helped all of the island’s residents. And this is how the first investments and loan system was created on the island a system which increased production and boosted the economy by allowing greater consumerism.
Over time Able, Baker and Charlie build a trap that allowed them to catch 20 fish per day with almost no effort at all. Building the fish trap allowed the people on the island to save for hard times ahead and for investments. Over the centuries different specialties develops which allowed the island dwellers to increase their standards of living, each person became skilled at something which allowed him to maximize his profits.
Of course increased profit isn’t only expressed in terms of money. When money was invested to increase the production capabilities of a particular business production increased and the costs decreased. For example instead of carrying the fish from the sea to the huts in his hands one of the island dwellers decided to build a wheelbarrow, increasing his efficiency enabled the delivery man to transport more fish at the time this allowed him to reduce the price of transporting the fish to the cottages which benefited the fishermen while still earning more than he would have earned if he continued to carry the fish in his hands. As a result of specialization and investments the price of most products went down allowing even the less wealthy people to buy more. This reduction in prices is called deflation. Deflation is a natural market process. As the amount of fish in savings increased the fishermen started to run out of room, someone on the island decided to open a “fish bank”, the bank had a low interest rate for secure loans and higher rates for riskier loans.
Since the ongoing disputes and fights between the island dwellers which couldn’t be resolved peacefully they decided to dedicate a small percentage of the income into a police force and a judicial system and elected officials. The government services were paid for by the manufacturers, they were very limited at first today government monopolies control entire industries. After several hundreds of years the island was flooded which cause financial hardships for some of its residents as a result the island elected a government official who promised to improve the economy by investing public money, in addition he decided to replace the fish with the bank notes whose value is equivalent to one fish however in the interest of jump starting the economy so many public projects were started and the official began to run outs of fish, to hide the problem he decided to issue more bank notes even though he was creating more bank notes that the number of fish being kept by the bank. Worse, a significant number of investments were made out of political considerations and not financial ones. Production was not increased, harming future production and consumption.
One day the island dwellers discovered that on the neighboring island people were still catching fish by hand the ruler of the neighboring island decided to send fish to trade for bank notes to allow trade between islands. This may sound strange but trade between islands in general was based on competitive advantage meaning each island produces the item that was cheaper for it to make and traded it for products that did not produce. Most of the jobs related to production moved to the neighboring island since the people there could be paid with bank notes.
People spend more because the value of the money decreased instead of increasing they preferred to spend the money as soon as they own it instead of investing in savings. This created a new industry, a service industry which replaced the production industry.
People on the island spent their free time surfing therefore a need was created for more people to sell surfboards in stores and teach stuffing in schools. The surfboards themselves are being made on the neighboring island and paid for bank notes so there was no need for production.
when the export industry keeps decreasing the main industry becomes a service industry based on increased consumerism all of which increase debts.
Because the people on the island live in huts and the service industry didn’t require a very high investments there was nothing to impress the fishing as a result the bank decided to grant loans to people who wanted to buy a hot. For the bank this was a low risk loan, if the loane wasn’t being paid back the bank could seize the huts.
Over time, instead of paying for a hut with the fish that was saved people took bigger and bigger loans to buy bigger and bigger houses. people who had a hard time buying a house received a grant from the government.
Social pressure and government’s encouragement to get a degree in surfing caused many people to study surfing but this didn’t result in an increase in production or decrease in the price of the surfboards. These investments didn’t boost the economy and increase production capabilities but rather increase the amounts of public debts. Eventually sales of huts dropped off, there were no new buyers in the market there were plenty of sellers. Now instead of profiting from their investments the owners of the huts were struggling to repay the loans they took. The housing market crash and all story is the subprime mortgage crisis.
Instead of allowing the economy to recover the government tried to give incentives to buy a hut, in addition it created projects which were unnecessary from a business point of view such as building a lighthouse far from safe so that unemployment on the island would stay low. These investments only made the financial situation worse.
In contrast, the ruler of the neighboring island decided to change its policy, instead of exchanging fish for bank notes and leaving his citizens hungry he decided to focus on internal trade and stop exporting products.
To summarize the story illustrates how instead of investing in production the governments today are investing in political interests with money that it doesn’t really have. As a result, not only is the economy not thriving consumer debt is rising.
Takeaways:
. Increasing Productivity:
Schiff defines the economy based on productivity and resources. He states that the economy translates as the effort of society to maximize the availability of limited resources to meet as many human demands as possible.
.Savings are Important:
In his book, Peter Schiff provides a clear and enlightening illustration of how savings help the economy grow and improve the wellbeing of the population. If no one in the economy saved up there would be any infrastructure projects built, no Industrial innovations made, no service industry.. and so on .
.Comparative Advantages:
One of the ways to consider productivity and how to maximize it is by considering how having individuals specialized within a specific field. If workers in an economy, specialize in what they are best at, the productivity of the economy will grow. Therefore, comparative advantages are important for the economy within the country.
. Governments are Complicit in Stunting Economic Growth:
Schiff encourages the reader to consider that politicians want to be reelected. For this reason, governments spend savings when it is politically most critical to do so. Private lenders, on the other hand, only spend savings where it is economically defensible to do so. Because of this, private lending is more efficient in helping the economy grow.
. Banks are Integral to Whether an Economy Grows: Banks are vital within society as they help people to save money in a safe way, and allocate and invest money in more educated ways. Banks help maximize the productivity and efficiency of savings.
Oeconomia 