economics thought excercises part 1: getting the feel
So it happened that a couple of months ago I had a long drive, 7 hours in fact, and I got to thinking. We have all these "schools" of economic thought, we have the keynesians who think governments should deficit spend like mad during recessions and save during the boom years, we have austrians who tend to oppose government activity in the economy in general and make some nice points about malinvestment and such. We have all of this discussion of monetary policy and interest rates and stuff, we have this, we have that. In all honesty I have never had any interest in economics save forced interest via my participation in markets these last 2.5 years, I had an econ class in college but I was drunk that semester and all I remember is supply and demand setting pricing and "there is no such thing as a free lunch". I struggled to make sense of it all, all these views (who frequently believe they are in conflict) and I couldn't.
See, when faced with large amounts of time to kill I generally try to kill it by thinking. Maybe, one day, you're thinking about some girl you just met, maybe you're thinking about the past, maybe think about an investment strategy. This time I decided to think about economics, but I was failing to make sense of all of the blogs I'd read about it, so I decided to think about it from the ground up. From ground zero. So, here are the first round of the thoughts experiments:
1. Imagine that all of us CAPsters got stranded on a desert island. In 1920. no cell phones, no satellites, no way for anybody to find us. We're stuck. We sit down, what, 100 of us? And we realize we need to start a new civilization.
We decide we need a currency, and as luck would have it, we find a huge bag full of small beads. We divy them up and assign values to each bead, and use them as money. Porte grows vegetables, he sells them to me for X number of beads, alstry writes a book and sells it, etc, etc, etc. It all works out and we get on. Lets just say that we each have 10,000 beads to start with.
One day we discover a weird device. For no input cost at all, it outputs whatever number of beads we like. We quickly realize that simply making more beads doesn't help anything, it just causes inflation. We now all have 100,000 beads, but we really aren'ta ny better off, prices just went up. Prices just went up because despite the increase in beads, no additional real output (crops, books, sermons, therapy sessions, products, wood, etc.) was created, because we are limited by manpower. So we just had inflation. No real mystery there.
lesson from this thought experiment: printing moeny cannot create wealth, it can only create inflation. no real mystery here
2. Now imagine that one day us merry 100 CAPsters were suddenly joined by the 500 people that follow Ibankcoin ... their boat crashes, and all of a sudden the population has gone up 500%.
We're each sitting on our 100,000 beads now ... so thats 10 million beads. But all of a sudden the population has swelled by 6 times. They all move in, start farming, cutting wood, building, preaching, therapizing, they open stores, etc. But we still have just the same 10,000,000 beads.
whap happens? prices plummet, we experience deflation. why? because all of a sudden the total amount of goods and services (real wealth) produced by our small society expands dramatically due to increased manpower. So we have a constant amount of beads trying to buy a vastly expanded amount of goods and services.
What would the right hting for our government to do be? Leave the number of beads constant, despite the dramatic increase in population? Hand out 100,000 beads to each newcomer from Ibankcoin so they start where we started? The former would result in significant deflation. Supply and demadn would suggest that prices should fall dramatically if product increases dramatically and moeny doesn't change. This deflation would have significant downside, debtors would be crushed, savers vastly rewarded, and as is the case with deflationary situations the economy would probalby suffer enormously.
If we created more beads, we would have a better chance of price stability and societal prosperity. We have 2 real choices for how to create them.
1. the government could spend them, giving the new IBCers a chance to earn them, as well as the existing citizens
2. we could just hand them out to the IBCers, as we handed them out to ourselves at the beginning, and let the economy work itself out.
over the long term, provided that the government didn't remain in the economy, we should eventually wind up in the same place. X citizens, Y productivyt (total goods and services produced) and Z beads chasing around after it all.
So I decided that it wasn't really important how we went about distributing the new beads, int he long run. in the short run it could be incredibly important, but I didn't bother to podner how or why.
lesson from this thought experiment: the supply of beads SHOULD NOT remain constant, increasing population and increasing productivity require increasing supplyu of beads lest we experience deflationary situations, which tend to be detrimental to economic activity. Sometimes, we need to makemore moeny.
3. So we originally found 1 million beads, andw e later created 9 million more beads. Before the IBCers showed up, we had 10 million total beads. Each of which was worth 1/10 millionth of the out put of society, or something like that.
It is a natural human tendency to save. Soem people save for a rainy day, its just what they do, and as such some of the money we created is coming out of the economy all the time.
Whats the most any one person could save, if we had created 10 million beads? 10 million beads, thats all the beads that exist. But, obviously, if the savings of one person approached 10 million beads we would have an economic collapse as so many beads were being taken out of the economy that there simply weren't enough to "go around".
One way or another, the total savings of citizens (in beads) would be 10 million at all times. Because thats how many beads exist. If you spent yours, that would mean somebody else got them and they were (at least temporarily) added to their savings.
lesson from this thought experiment: the total savings of a society, in money, is exactly equal to the amount of moeny that society has created. exactly
4. Arriving of the Seeking Alphans. So the lads, numerous as they are, from seeking alpha show up one day in boats. They look around our island, and they see our beads. Our beads are amazing to them, and they offer us various things for our beads. Fro 10 beads they will bring us a cow. For 1000 beads they will bring enough timber to build a house.
This is amazing to us, as the beads cost us nothing to create. So we begin to import "things" from Seeking Alphaville in exchange for our beads. Its amazing. We give up our beads, we get stuff.
But what happens when we have given away all of our beads? We're screwed. We have no currency left, we cannot conduct our economy except by barter. Economic collapse is the result of excessive importing in a fixed-amount-of-currrency situation.
When we are out of beads, the SA folks don't want to bring us any more stuff, do they? It was the beads that they wanted all along, wasn't it? Maybe they show up to trade timber for wheat if markets in each country allow a profit for this, but our heyday of importing stuff for beads ends when we run out of beads, adn our entire economy would probably collapse, at least temporrarily, without a currency to back it.
lesson from this thought experiment: a finite amount of currency in a society quite literally limits the amount of total trade deficit that it can run. An economy probably needs a currency to function successfully. Barter probably isn't very efficient, because billy thepig farmer can't go to a market and get currency, and then immediately go buy milk, he has to find someone who wants a pig in exchange for milk.
5. But rmeember our bead machine? We have that magical machine that shoots out as many beads as we wish, with no input required!
What about our ability to import now? Its unlimited! We can simply sit around get everything we need from Seeking Alphaville! we can just make beads, for free, and get everything.
Well, until the Seeking Alphans don't want any more beads, because they think they have enough. Then the game is up, and we have to go back to work.
But until that game is up, our little CAPsville can literally live for free.
lesson from this thought experiment: having a currency that other societies desire is a great advantage for your society. you can import REAL things (cows, wheat, aluminum, wood, whatever) in exchange for what amounts to nothing: your currency
6. So we have Seeking Alphaville and its insatiable desire for our beads. We can literally live for free. The government creates the beads, and so it has to decide how to distribute them.
It decides to simply give 10,000 beads to each citizen each year. As long as the SA folks still want the beads, this is more than enough for our society to get by.
What happens now? Some people are more motivated that others and, despite not needing to work, choose to do so. They work to build relations with SA exporters, they open stores, restaurants, bars, and more.
What happens now? Those workers, entrepreneurs, collect more beads than the rest of the people, because some of the people wind up spending their beads on their goods and services (giving htem their beads).
So what does that lead to? An imbalance of wealth. Those who went out and started businesses wind up with more beads than those just living for free, because SOME of the beads those living for free spend go to SAville, but some go back to the entrepreneurs.
lesson from this thought experiment: government hand outs literally create wealth imbalances
These are the first 6 thought experiments. We have learned alot.
We have learnd that simply creating mroe currency cannot create wealth.
We have learned that prices will be unstable of the amount of currency in the economy is stable. Productivity and population increases call for the creation of more currency.
We have learned that the total savings, in currency, of the population is literally equal to the amount of currency created.
We have learned that a trade deficit (importing stuff) can lead to reduction of currency in our own country, unless more currency is created. Thus, importing things eliminates savings (in currency) of our own citizens unelss more currency is created.
We have learned, and brace yourself for this one, that imports are a benefit to a society. All we're giving out is those beads that we can create for free, and as long as the rest of the world wants those beads (our currency) we can gte REAL stuff for them, that is a benefit to us. We, for free, get stuff. Stuff being materials, labor, etc.
And, critically, we have seen that government handouts lead to wealth imbalances. Some choose to do nothing if nothing is all they have to do, some choose to work and save. This creates a disparity in wealth.
More to come. I think I can explain the economic system and sitaution of the US in the next few blogs. Thank god for Binve, for through him I found pragcap.com, where I found Modern Monetary Theory. MMT is very,v ery, very, very good. It is the best thing we have going for us as a nation and ascitizens of the world. It needs to be spread, understood.
It has only one misunderstanding, in my view. It doesn't realize that the total debt of the US Government is $0, which I will show in a forthcoming blog. And they don't really grasp the downside of government spending (hinted at in #6 above) and how right he Austrians are about government intervention causing problems (although they go to far, and they have no idea how the US's monetary system actually functions). But it is amazing, and it hsould be read up on.
So, if it pleases you, read my blogs. But alot of this had already been thought of whenI ran these little thought experiments, and MMT concludes much of the smae. No need to reinvent the wheel, so if you liked these thoughts and they made sense, please read up on MMT. I'll do the very little and pointless amount that I can toadd to what they already talk about.
It can literally save the economy, the country, the middle class, and such. It explains why JGB yields are the worlds lowest when they have the highest deficits. It is RIGHT.
Godspeed, merry CAPsters, may you spend your 100,000 beads wisely.