Economics in 5 pages

Before you start reading and get bored, the first few paragraphs are just for some background knowledge and dramatic effects. So hang on!

You may be wondering: Why am I here? Why should I be reading this? Well you do not need to, but I am confident that most of you will invest your money at some point in your life, and will be looking at economic news and tips as to how best to protect or grow your money. With some understanding of economics, you will be a much more well-informed investor/saver/discerning news-reader.

Over the past century, we have people graduating from schools with so much knowledge about economics (or do they?). Unfortunately, I would like to contend that the economics taught in school is simply the wrong one. To be specific, it’s called Keynesian Economics. The economics school of thought that makes most logical sense to me is Austrian Economics. I will venture to say that 99% of the world doesn’t have a clue of what it is, and I would be the first to admit that I was once part of this 99%.

Keynesians basically contend that DEMAND AND SPENDING are the important stuff, and Central Banks can manage the economy by inflating or deflating the money supply. Austrians, on the other hand, say that SUPPLY AND SAVINGS are the important stuff, and Central Banks only screw things up (a problem compounded by the fiat paper monetary system).

CONTENTS

Chapters

1.       Savings vs. Spending, Productivity

2.       Inflation is Theft

3.       The Boom is the Disease

4.       The Bust is the Cure

5.       Conclusion

=========================================================================

Okay so on and on goes the debate. Here, I will try to come up with something that even my young sister can understand, something that is irrefutable, something that will settle the score once and for all. So please bear with me, it’s really simple to understand. The illustrations I’m about to made are my own ones, developed in the past few years. But I have to admit that the savings part is adapted from the great Peter Schiff.

=========================================================================

CHAPTER 1: Should we save or spend? What is productivity?

I think most of the confusions of modern day economists come from our usage of paper money. So first, we shall agree on what money is. Money is just a representation of value (remember this!). It facilitates trade. And without it, we will be stuck in the wild days of bartering our goods. No issue here, right? So, let’s take paper money out of the equation. And venture into a world of apples and fish. Forget about paper money, pretend it has never ever existed. Pretend there’re none in your wallet, in the banks, whatever.

For simplicity, let’s say that the world consists only of apples and fish. The western nations are great at foraging for apples. The eastern nations are great at fishing. So each part of the world does what they do best, and then trade apples and fish with each other.

AN APPLE A DAY KEEPS MY STOMACH HAPPY

Suppose that each westerner needs an apple to fill his stomach for a day. Each of them needs to spend hours climbing a tree, and at the end of the day each of them only manages to pluck an apple. So they spend each day going into the forest foraging for their precious food. They have no time for anything else.

One day, Newton decided to go hungry and take a chance to invent a tool to increase his speed of foraging. He invented what later came to be known as the ladder. With this new tool, he was able to increase his productivity, and get 2 apples in a day!

Newton has 3 main options now: 

1.  Save his extra apples and continue to forage almost every day, so that he can keep his apples for a rainy day or vacations later (this is his SAVINGS)
2.  Loan his savings out to someone else, who may invent something to be more productive, and then get repaid with interest (extra apples)
3. Spend that extra apple a day to hire someone to give him a massage. In effect, the massager is exchanging his labour for Newton's labour (apple). When this exchange happens, this is what constitutes "demand", the way that most people today understand the word. Demand comes from exchange of goods/services, and goods and services are productions. You must produce first before you can consume (or demand for other people's production).

Now along comes Einstein. He wants to borrow apples from Newton, so that he can spend some days on his research and build a game-changer. He promises to repay Newton 50% in interest for whatever he borrowed. Einstein spent a week with a boy he hired (and paid for with apples), and together he came up with a chainsaw. Now he is able to chop a tree down and simply pick the apples on the tree! With the help of his employee in creating this new tool, he was able to increase his productivity and get 4 apples in a day!

Along comes Uncle Sam. He borrows apples from Newton and Einstein. And he proceeded to consume those apples. He gobbled up the apples. He paid a dancer an apple a day to entertain him. He paid builders to build a house for him. He hired an artist to carve a statue of him using wood.

Now why is he doing all these? Well, Uncle Sam reasoned that his DEMAND and SPENDING actually boost the economy! Without his voracious appetite for apples, people like Einstein and Newton will have no reason to forage for apples. Without his ability to spend like a mad-cow, these dancers and builders won’t have jobs. He did not realize that his CONSUMPTION could have been used by other people, people like Einstein and Newton, to increase productivity!

MORAL OF THE STORY #1

With increased productivity and savings, entrepreneurs can borrow and set up businesses or projects. Consumption is not the same as economic growth. The nation grows poorer because of consumption. The nation grows wealthier with savings and productivity.

Uncle Sam spends his apples on entertainment and fancy things. Einstein spends his apples to hire a boy to help him in his project. Notice that both use their apples differently. Einstein created productive jobs. Uncle Sam created unproductive jobs.

When you hear the economists say we need more spending to boost the economy, you have to be very careful. After the crisis in 2008, governments around the world spend money to hire workers (clerks, admins, population surveyors, construction workers, etc.) and claim that they are creating jobs. Now we know that these jobs are unproductive, and they only drain the nations’ resources. The private sectors are the ones that can create productive jobs. “But the private sectors are not creating jobs because of a lack of spending”, they would argue. Okay, we will examine this issue later on.

=========================================================================

CHAPTER 2: Inflation is Theft

The Westerners trade with the Asians for their fish with their apples.

Now imagine that the Western government invented a new tool called the apple-machine, and gave it to their central bankers. It can churn out fake apples with a press of a button. Over-time, they create more and more apples out of thin air, increasing the apple supply in circulation. The western population realize that they need more and more apples to do the trading, because they use their bloated supply of fake apples to compete for the limited amount of Asian fish.

Now what has the western government done? Have they increased the wealth of their populations? Not quite. What they’ve done is to STEAL their populations’ purchasing power away! Now their citizens can buy less and less stuff with the apples they’ve worked so hard to forage for.

MORAL OF THE STORY #2

Quantitative easing and stimulus packages are just euphemisms for money-printing. And money-printing is THEFT from the population. Well, for those who argued that this magic money will eventually “trickle-down” to the average man, history and statistics are not on their side. Living expenses increases faster than wages. Those who get the magic money get to spend first and bid up prices. The rest of us suffer the loss in purchasing power.

=========================================================================

CHAPTER 3: The boom is the DISEASE

The Western central banks created lots of fake apples, and for a while everyone was happy. With so many (fake) apples in “savings’’, interest rates become very low. People borrowed to set up businesses. People borrowed to speculate in stocks. People borrowed to build houses, thinking that prices will always go up. The society was in a state of euphoria.

Inflation started to pick up. The central banks, in an attempt to tame inflation, decided to stop creating fake apples for the time being. Businesses, investors and other borrowers that depended on the supply of these fake apples began to fight each other for the remaining apples. This sent interest rates soaring. Unable to cope with the higher interest rates, businesses folded.

MORAL OF THE STORY #3

Economic booms throughout history are preceded by easy credit. The people in power created too much money. It became cheap to borrow. And everyone thought that they are rich and they do crazy and unsustainable things.

=========================================================================

CHAPTER 4: The bust is the CURE

Everyone on apple-land was drunk on cheap apples. Apples are being thrown into places where they are just simply being squandered away. Now that interest rates are higher and lots of unsustainable businesses are folding, the bust is finally here. It’s time for the hangover. It’s time to rid your system of the alcohol, and be on your way back to recovery again. It is time to put your precious apple savings to productive use again. It is time to re-allocate resources back to the sectors where they are supposed to be had it not for the fake boom. The bust is the cure!

But wait! The hangover is painful! Jobs would have to be lost temporarily in sectors with excesses. The government does not want people to revolt! The government reasoned that the crash was due to lack of demand and spending. So what do they do? Create more apples to stimulate demand and spending! Not a smart move here!

AND IT’S IMMORAL! This is what bothers me the most. Remember, inflation is theft.

MORAL OF THE STORY #4

In the US, the Fed created lots of paper money out of thin air in the 1990s, and this fueled the dot.com bubble. When it bursts around 2000, the Alan Greenspan came in again and printed even more money. He bailed out companies to prevent a job crisis. The George W. Bush government reasoned that people need to spend more to revive the economy. And Americans, with the printing press and borrowings from overseas, went on the greatest spending binge in history.

The money-printing lowered interest rates to 1% and created lots of mal-investments, especially in the housing market. As inflation starts to rise, Greenspan raised the rates by slowing down his printing presses. This sent interest rates soaring, and the result was the sub-prime crisis in 2008. What do Obama and the incumbent Fed chairman Ben Bernanke do next? You guessed it: more stimuli, more money-printing and more borrowings from overseas. They propped up failing companies to keep the jobs there, but what good is it to prop up unproductive jobs and jobs that the market doesn’t need? The resources could have been used more productively by the private sector, as shown in Chapter 1.

Now you know why central bankers are lying when they say they have exit strategies for their stimulus programs. They can't do that, because once they do it, the very people whom they've bailed out (and more) will fail once again.

=========================================================================

CONCLUSION

Although I used more examples of the US, the situation is similar in all countries. All countries use this flawed Keynesian Economics theory. All countries have a central bank that can print money without restrain. And all countries experience inflation.

When we try to make sense of the economic stuff around us, think in terms of apples and fish (although I prefer cows and fish, I used apples instead for the purpose of this article). Leave the distorting paper money out of the picture because they are just representations of values. The real stuffs with real values are the apples and the fish, not the paper money.

If you think this through, it will become apparent that most of the stuff we get from the media is just nonsense.  If we truly understand this, we will know why deflation is not such a bad thing as espoused by economists, and we will understand why inflation is REALLY bad, economically and morally.

Now that we know the nature of money, and the nature of booms and busts, we will be able to discern the correct news from the wrong news. We will be able to make more informed decisions when trying to protect or grow our hard-earned money. We will be able to pass this basic yet unquestionably critical knowledge down to our future generations.

I can go on to write about how we got into this screwed-up system in the first place, but that will take another 5 pages. I can go on to write about how various government policies and regulations (together with the monetary stuff mentioned in this article) distorted the market greatly. Most of these stuff can be found on my informal and simple blog www.silvernjin.blogspot.com

Thanks for reading!