Island Economics-ammo To Use In Economic Arguments

[rdenner]

PLEASE BE KIND. It's a bit rough but should be a good primer..

I've broken it up into FOUR CHAPTERS... Please enjoy. If you like it BUMP IT UP...

CHAPTER 1

Explaining inflation and how it effects you(Long Long Post)


{{{{It seems like everything I see costs up wards of $2 or more. Of
course, it's from the shipping, packaging, and growing costs, }}}}



Just remember Gwen, that it's much more than just the energy costs.
The prices are rising because the amount of "new" money that is being
injected into the system.

It's always easiest to break things down to a simpler level to
understand them. I'll do my best to try and explain it to anyone who
cares to read..

Think about an island(the easiest economic model) where only 100
people live. On this island you have people who farm and make things
and gather things, just like any other society. This village starts
off as a barter only society. Joe gathers coconuts, but wants some
finished wood for his dwelling. So he would trade coconuts for wood.
But as with any barter system, this is very very inefficient. Because
what if the wood guy doesn't want coconuts, he wants sugar cane. So
Joe has to trade coconuts for sugar cane to get his wood.

So Joe comes up with an idea. He will start a bank. He will have
people bring him their wares and he will store them in a cave he
found. So when the sugar cane guy has his harvest he will bring it to
Joe, and he will store it in the nice cool cave, and when he needs
sugar cane the guy will come back and he will withdraw some.

Everyone gets on board with this idea. It saves them from having to
protect their wares, as Joe's cave is dry and safe. For this, Joe gets
a very small percentage of the harvest of these people.

Years go by and everyone is using Joe's bank. He has even taken on a
few people to help him. Now Joe has a revolutionary idea. Because the
bank hasn't done anything about the barter system, but having
everything centrally located has helped out, but it's still
inefficient. What Joe did accomplish though is a relative price and
cost system. 1 pound of sugar is worth 1 board. 1 board is worth a
gallon of water from the hill areas, etc, etc. So there is parity now
in the prices of things.

Joe's revolutionary idea is this. He knows of a place where sand
dollars wash up on the shore. He spent the past year collecting
thousands of these sand dollars. But now that the easy ones have been
harvested there aren't a whole lot more washing up. His idea is this.
Instead of everyone bringing all their wares to him and then bartering
with others. He will use the sand dollars as relative money. Meaning
you put your wares into sand dollars, and then those sand dollars will
act as "money" or as an intermediate form of wealth. The sand dollars
are very rare now so the number of sand dollars on the island should
remain very stable.(in reality this portion of history took centuries
to introduce to the public. This would be akin to when society moved
from barter to the first gold coin systems. These systems were
generally not voluntary at first, but were forced upon people by kings
and other monarchs).

Everyone seemed to like the idea. It would be a lot easier to just
take sand dollars to someone and get what they wanted. So an initial
pricing system was established after much fighting and debate. 1 sand
dollar equaled 1 board, 1 gallon of water, 1 pound of sugar cane, etc,
etc. Joe "put" the sand dollars into circulation initially based on
how much of their wares he had in his cave. When it was all said and
done over 2000 sand dollars were put into circulation. The efficiency
of the island was greatly improved. People could use their sand
dollars to buy anyone Else's wares, and they in turn accepted the sand
dollars for their wares or services. Some people actually made a
living out of finding "new" sand dollars by going to the ocean. But
the influx of new sand dollars was very very low. Under this new
system the island really flourishes. Over a period of decades the
number of new sand dollars has steadily risen. Up to 4000 sand
dollars. These were introduced VERY slowly over time. And it was very
transparent to people that it was happening. People were much more
productive, but they were also very aware of their surroundings.
Because the fair market was a very good mechanism for telling them
when something was wrong. One year when there was a drought, the sugar
cane guy couldn't make as much sugar. But everyone wanted his sugar,
so people started bidding up the price of sugar, and in the end there
was a shortage of sugar, and only those who REALLY wanted that sugar
got it. The others had to find something else or go without. But this
system also kept the sugar grower in check. Because the next year he
took all of these new found "profits" and expanded his sugar cane
fields. What he found the next year was that there wasn't any more
need for sugar cane, it just appeared that way last year, so he ended
up with lots of unsold sugar cane.

During all of this Joe is getting to be a rich man, because he is the
guy that keeps track of everything. Because there are so many sand
dollars, people use him as a bank still. He takes in all the spare
sand dollars and keeps a tally of who has what. And for this he gets a
small percentage of the sand dollars in the bank.

He then has another great idea. Instead of just leaving all these sand
dollars sitting around in his bank. He has the idea to loan them out
to people who need them. He will be the intermediary. He helps people
in his bank who have spare sand dollars "loan" them to other people on
the island who need them. He basically creates a credit system for the
island. So he changes how he charges people. He actually gives
interest to people who keep their dollars in his bank as opposed to
under their hammocks at home. He then takes a portion of the sand
dollars in the bank and starts loaning them to others at a higher
interest rate than he is paying to the people who are depositing. For
instance, he gives 1 sand dollar for every 100 sand dollars kept in
his bank for a year. But he charges 3 sand dollars for every 100 sand
dollars loaned to someone over a year. This is very good for Joe, and
it can be argued that it was very good for the island. Because now
people could start improving things even faster, because they didn't
have to save 100% of their sand dollars to start a new project. They
could borrow part of the money to do this.

This is where the island analogy gets muddy. There are many people who
feel that this is the best system in the world. You have all
commodities and services tied to a very slowly growing money supply.
This allows for very steady and limited growth. And the ability of the
bank to manipulate things are kept to a minimum. I am not saying this
is the best system, all I am saying is that this IS the system that
was in place though-out much of 1800's America. The system above is
called a 100% gold reserve system. Although more gold enters the
system every year, it's at a very slow pace. Silver and bronze comes
in much faster, but it's worth is reflected that way. So now back to
our island.

So Joe has gotten very rich over the next 5 years. He uses the
interest he has earned to make the biggest hut on the island. He has
bought a lot of nice things, and his family is very well cared for.
But he notices that there is a problem with a new thing called
liquidity. What he finds is that people are coming to him asking for
sand dollars to borrow. But more times than not, he has to say no.
Because there are now only 4500 total sand dollars on the island. And
they are all in use. This hasn't bothered him, because he just charges
higher interest to people who want the spare dollars. But he thinks to
himself what if we could just print new sand dollars. Well obviously
this wasn't going to happen. There are only so many sand dollars to be
found every year. So Joe has another revolutionary idea. It's one that
will take all of his persuasion powers to enact. He spends a year
creating a machine that will take palm leaves and prints them in
different denominations. He makes it look really nice and
very "official". He then gathers everyone together to unveil his
new "money". Everyone is taken back at first. "why do we need this?",
is the general question. Joe talks about how much easier it would be
to carry around these nice new bills as opposed to the unwieldy sand
dollars. And these dollars are easier to break up into smaller
amounts. Something you can't do with sand dollars. This will allow the
islanders to more closely price things..

People are sceptically at first, but the money is very convenient and
after a short amount of time the new money is put into circulation and
everyone starts accepting it. Joe is still running a 100% fractional
reserve system. Meaning that if you had 500 sand dollars deposited
with him, he gave you ONLY 500 palm leaf dollars. This move did
nothing to alleviate the liquidity problem, because there was an EQUAL
amount of palm leafs relative to sand dollars relative to the
commodities on the island.

{{ This is where the free market system breaks down in my opinion.
Commodities and services are now two full steps away from the money
that represents them. This is where monetary manipulation starts. And
this would represent the start of the Federal Reserve system here in
the U.S.}}}

Now you can make your own mind up about Joe. Maybe he really was
trying to help the island, or maybe he is just a greedy bastard. But
as with all people given this much power, the allure of power is
sometimes to much to bare. After years of people accepting his palm
leaf dollar, they start to wear out. So he has to start to replace
them. So he cranks up the printing press and starts to exchange palm
leafs one for one. But one fateful day, one of the more morally
challenged men on the island approached Joe. He says to Joe, why don't
you let me keep the old leaf as well as the new ones. This had never
occurred to Joe. And this is his epiphany. He says no to the man,
because people trust Joe and he doesn't want that trust broken,
because that trust is the BASIS OF THE ENTIRE ISLAND ECONOMY. But this
gives him an idea about how to solve the liquidity problem. He starts
off innocently enough. For now there are 5000 sand dollars in
circulation and exactly 5000 palm leafs in circulation. He decides
that the next time someone comes to ask for a loan and there aren't
enough sand dollars/leaf dollars to finance it, he'll just turn on the
printing press and just make a few.

So along comes Al, he wants money to start a new business. The idea is
to make a thing called a hula hoop. The idea was never financed before
because Joe thought the idea didn't warrant the use of the very hard
to come by palm leaf/sand dollar currency. Not when there are really
needed things, like cane sugar, and corn production. So Al approaches
Joe one more time and asks for the money. Surprisingly Joe says yes
and hands over 100 brand new crisp Palm Leaves. Now unbeknown to Al,
Joe has just created that money. Now instead of there being 5000
perfectly balanced palm leafs vrs Sand Dollars, there are now 5100
leaf dollars vrs 5000 sand dollars. The value of every single sand
dollar has now been deluded by just under .1%(math may be off here).
So Al merrily runs off to start his business. With his new found
wealth he goes and buys wood, this wood normally wouldn't have been
available to him, but now he has injected 100 new dollars into the
economy. Al GAINS by being the first person to get to spend this
money, before it's negative effects have been felt. So now everyone
else who truly owned 100% fraction dollars are now competing with Al's
99.9% dollars. Without even knowing it Al has an advantage. He has bid
up the price of wood for everyone else. Because now the wood making
guy is going to have 100 dollars less wood to sell to others, creating
a shortage and thus a rise in prices.

Now if you assume that Joe really liked his position as business king
maker, it wouldn't be to hard to figure out what happens from here.
Slowly but surely Joe would benefit his fiends FIRST with
this "MONEY", because they would have the benefit of using the money
first and therefore the inflation would not yet be in the system. They
are in fact CREATING INFLATION. As soon as the newly created money is
injected into the system, and that money starts working its way from
the wood making guy who in turns spends it to buy sugar, etc, etc. The
whole of the money system is deluded, UNTIL.......

1971, the United States of America basically declared bankruptcy. You
wont' find it in any history book but it happened all the same. Using
our island analogy. From 1913(federal reserve created, when Joe took
the island from Sand Dollars to Leaf Dollars), till 1971, the actual
value of the dollar was dictated by it's relative worth to
gold/silver. But every year that fraction kept getting smaller until
1971 it became unstable and something had to be done. At that point in
US history, we became a debtor nation. The dollar could no longer be
converted directly into gold. In a sense the island left the Sand
Dollar system and went 100% on the leaf system. NO LONGER could you
take a paper dollar and demand gold/sand dollars for them.

Imagine the power that this represents. It is the power to truly
create money out of thin air. And it is this power that is destroying
you, me and everyone in this country, save those "friends" that are
given the money first, ala the regional banks. They are given first
crack at the "new" money, they in turn loan it out to their "friends"
until all of it sloshes all the way down to every day Joe's and Jane's
like us. By then, the dollars we earned yesterday are deluded to a
point where they are worth less today than they were yesterday. And
God forbid you just stuck that money under your mattress 5 years ago,
because when you pull it out, you'll find it's been deluded by about
15 to 20%. Meaning you will have to spend 1200 dollars or so to buy
something that would have cost 1000 just 5 short years ago.

And this trend is increasing, much like the factors of a calculator.
Take a calculator and go 2 x 2, then keep hitting equals. It goes 4 8
16 32 64...........and at some point the number looks pretty
manageable for the calculator and then suddenly you push equal one
more time and it goes.....E00000000 and crashes... Well guess where we
are in the world now??

[rdenner]

Bump

[Virginia Libertarian]

bump

[rdenner]

Chapter 2

This is part 2 of My island economy paper.



So you say, how does this all fit into our world now? Because we
aren't an island we are a world of nations. Well we can continue
with our imaginary island and figure out what happens when things
get more complex..

We are back on our Island. Which for a lack of a better name, we'll
name it Joe's island. Seeing as that he is the richest man there and
is responsible for the great growth on Joe's island..

As we left them last, we will remember that Joe had just started
experimenting with fractional reserve banking. Meaning that he had
just upset the perfect equilibrium he had attained, by loaning 100
leaf dollars to Al. Thereby creating 5100 leaf dollars vrs 5000 sand
dollars (remember Sand dollars are rare, and leaf dollars are as
close as his printing press).

We follow Al on his quest to create a new business. He has gone and
purchased some wood, which now reduces the total of wood available
to everyone else by that amount. He also buys a lot of other things
and thereby reduces those raw goods by that amount. In the end he
creates a bunch of hula-hoops and starts selling them for a single
leaf dollar. It's a moderate success, as he sells about 20 of them a
month. If this continues for a year he would make back his initial
100 dollar investment plus the interest plus some more(he makes a
gross profit of 240 and after paying the original 100 back plus 3
interest, he is left with 137 dollars).

""All of this works great, so long as everyone has FAITH and TRUST
in Joe's bank. Because in reality, Joe's bank is now showing a
deficit. Because if everyone in the village decided to cash in their
leaf dollars for their sand dollars, there would be 100 more leafs
than sand dollars. If this happened, this would be characterized as
a "run" on a bank. The depositors would panic and demand payment,
and the bank would be unable to comply with 100% of the demands."""

But this is Joe we're talking about, and to be honest, he only
injected .1% of inflation into the system. Prices would raise so
little in response to this. He is very happy with the success of Al.
Al has hired a few people to help him. The "liquidity" problem seems
to be licked. Joe hasn't thought the whole problem though, as we
will see later on. So in comes John, after hearing about how easily
Al got a loan, John thinks his idea has merit and should be
financed. His idea is to harvest different roots and berries to
create an art painting kit. He thinks it will be a big success.
People seem to have more time on their hands, since Joe's bank took
over finances on the island. The wood guy is planting new trees
everywhere, and over the past 10 years has made a science out of
creating wood planks. Those wood planks have made it easier for the
water guy to get his water down from the hills. This in turn has
created a boom for the sugar cane guy, who can irrigate his crops
better. The corn guy is also benefiting from better irrigation, and
was able to construct a silo, to hold grain for longer periods of
time. Making famines a thing of the past. And on and on the benefits
grew. From the fishing guy, to the seed oil lamp guy. The people who
were at the lowest part of the supply chain, meaning those that
created the BASIC NEEDS of this little society, were booming. This
in turn allowed the rest of the society to start to branch out into
other things. Things that weren't necessarily of a NEEDED nature,
such as hula-hoops and art kits.

So in comes John and he makes his proposal. Joe is still giddy from
his experiment with Al, and readily agrees to loan 200 leaf dollars
to John. Part of the 200 comes from real saving(meaning there were
100 sand dollars available), and part of it he creates on his
printing press. So now we have 5000 sand dollars and 5200 leaf
dollars. John takes his money out into the community and starts
buying commodities. Wood for his kits, and buys berries and other
things for the paint. And again the total amount of money is
deluded, and again it's only a small amount.


Things are going very well in our little village, so well that some
people decide it's getting too crowded. Because now there are well
over 300 people in the village. So 50 people pick up their
belongings and decide to move to the other side of the island and
see if they can start again. Taking the best of what they were doing
there and replicate it on the other side of the island. The leader
of this new clan is lead by none other than Joe's son Joe Junior. He
grew up with his dad and knew all the insides and outs of the
banking industry, save one trick. Joe Jr's dad hadn't told him about
the secret of beating the liquidity problem(remember liquidity is a
lack of funds. To much demand for to few sand dollars).

At this point there are over 7500 sand dollars deposited in the
bank, and because of Joe's very careful "injection" of new dollars
into his system, there are 8000 leaf dollars in circulation. So Joe
Jr and the intrepid band of adventures take off into the wild to
start a new village. Once in their new location, they realize how
great things are. Things are tough, no doubt, but there are so many
things on this side of the island that didn't exist on the other
side. They find glue trees, and trees that drip syrup. They find a
stream that has a great hard substance that could be used for tools
or agriculture. The hardest things they had found on the island so
far was rocks and wood. So they immediately start setting up their
village.

A year goes by and the new village is up and running. They are
getting ready to sell goods like glue, maple syrup, raw metal, and
something even better. They found a new cache of sand dollars.
Almost 5000 to be exact. So Joe Junior true to his dad's teachings
began a new bank on that side of the island. This was called the 2nd
bank of Joe. He also followed his dad's teaching and published his
own 5000 leaf dollars from a press he got from his dad. The dollars
were similar to his dad's but they had the markings of the new
village upon them. He deposited the sand dollars according to the
amount of new goods people had accumulated over the first year. And
after all the same fighting and bargaining, the full 5000 sand
dollars/leaf dollars were put out into the new village.

In the mean time Joe's village is really thriving. The amount of
leisure goods are starting to flourish. But a little problem has
started to crop up in the normally very well mannered village. Many
of the people are starting to get mad at the core producers(like the
sugar cane, wood and corn guys). Because their prices just seem to
be going up and up. The core producers are getting angry, because
it's getting harder and harder to find people to work for them. It
was hard after the 50 people left to train new people, but that was
easy to get around. They trained a few new people and life went on.
This new problem started surfacing about 6 months ago. More and more
people had started leaving the Core producers shops in favor of
more "fun" jobs at the hula-hoop factory and the paint guy(along
with a dozen more "new" shops that opened up under the leadership of
Joe) and they had to start paying their guys more just to stay in
their jobs, and they had to pay more and offer more to new guys to
come work for them.

"this is the unseen or unintended consequence of inflation. You see
in Joe's rush to speed along 'progress' and beat the liquidity
problem, he created a new problem. If Joe had not injected all that
new money into the system, the amount of leisure goods would not
have leapt ahead of real savings. There would have been a time in
the village's development that leisure goods would have appeared.
But by adding fake(fiat) money into the picture he creates shortages
in the system. In this case, it's man power. This in turn causes
prices to rise, as people start bidding up the price of labor. This
can manifest itself in many other ways. I thought this was just a
fun way to show it."

In Joe Jr's camp, there are no such problems. They are gearing up to
start exporting things from their village to the old village. The
first year really was just about self survival and building. Now
they are really ready to get going. "And just to remember where we
are financially let's have a little count". There are now 10000 sand
dollars in the old village and 5000 in the new village. But
inflation has really raged in the past year in the old village,
there are now over 14000 leaf dollars in circulation. And in the new
village it is a perfect balance of 5000 each. So on we go.

The new village people have many of the same goods that were
available in the old, things like a saw mill, and sugar cane. These
businesses are much smaller and much less advanced as in the old
village. But they have an advantage now, and they don't even know
it. Because they haven't been back to the old village in a year,
they don't know about all the inflation that has taken place. As far
as they know a board is still a single leaf dollar and a gallon of
water is still a dollar. But in reality the price of boards has
soared to 1.20.

So another fateful day appears. The people in the old village are
told that the new village is now open for business. But to be honest
most people don't care. They are pretty happy with things in general
even if the prices were starting to rise. Because their standard of
living really has not been effected.

""" I feel I have to take a break here and explain how this ties
into the real world. The people in the village aren't too concerned
now because the inflation is relative. Their lives have not yet been
adversely affected by Joe's attempt to better their lives though
monetary inflation, in fact things have seemingly improved. Joe in
this world is not an evil man; he really thinks he is helping. He
just doesn't realize that evil people can ruin the best laid plans
of anyone, as we'll soon see. This part of the village's development
would be closest to the 1800's America still, where more and more
banks opened up. In the 1800's there were competing currencies,
there wasn't just one. If Bank 1 was very successful it's "paper"
was accepted by more and more people. That trust was built over long
periods of time. The more trustworthy the bank, the further its
effect were felt as more people accepted the money. This trust only
existed when the bank kept monetary inflation to a minimum. But as
we'll see in the next interlude, the 100% gold/sand dollar system
has some VERY harsh mechanisms built in to protect itself..""""

If you'll remember there was that man back in the first chapter that
approached Joe and wanted to keep both the new bills and the old.
Joe had told the man no, and sent him on his way. We'll call this
man Thomas. Thomas is a man of very low moral values. He is known by
everyone in the village as a slacker and a corner cutter. Since
Thomas was "in between" jobs at the moment, he decides to go over to
the new village and see what's up. He is absolutely astonished by
the prices at the new village. Boards still cost 1 dollar!!!! Thomas
is absolutely floored. And his scheming mind starts racing. He
quickly runs back to town and decides to sell off his meager
belongings and gathers about 100 leaf dollars for his stuff. He then
high tails it back to the new village with his old village bills in
hand. Since they bear the mark of Joe's 1st Bank upon them, everyone
is more than willing to accept them. EVERYONE TRUSTS JOE SENIOR! So
Thomas starts at the wood guy, he buys 100 boards for his 100 leaf
dollars (with Joe's 1st bank logo on them). He immediately takes the
wood back to the old village and sells them in the market for the
usual 1.20 that everyone in the old village is now paying. Thomas is
beside himself with joy. He just made almost 20 dollars FOR DOING
NOTHING. All he did was take his 100 bucks and buy something he
could get here for 120 and bought it there for 100, and sold it back
here for 120. What a racket. Thomas tells a friend about his little
racket and asks him if he wants a piece of the action. The new guy
has a lot more money than Thomas, so he agrees and gives Thomas 400
dollars to take back with him. Thomas mixes it up this time and buys
wood and sugar this time. He immediately brings the goods back to
town and sells them the next day for the market price of a 1.20. He
has now made a total of 100 dollars profit for doing absolutely
nothing. He has doubled his original 100 dollar investment in less
than 2 days.

Now here is where the fun starts. First in the old village the old
millers and sugar sellers are stumped by sales over the past 2 days.
They found that they were off by close to 20%. But the real fun
comes later as the people in the new village deposit the first of
their Joe's 1st Bank dollars into the 2nd Bank of Joe. At the end of
the 3rd day all of the notes are deposited and Joe Jr does his
books. As usual there are 5000 leaf dollars(his own), 5000 sand
dollars, and now 500 Joe's 1st bank dollars. This leaves Junior in a
bit of a quandary. You see Junior learned from dad that imbalances
are bad. So now he is sitting on 5500 notes and only 5000 sand
dollars. So he knows what must be done. So first thing next morning
he loads up the 500 1st bank notes and walks them to his dad's bank.
He puts the money on the desk and says he needs 500 sand dollars to
even things up. He is shocked by his dad's reaction. He hems and
haws about giving him the sand dollars. For you see, Joe Sr is
really up a creek now. If he gives up his reserve of Sand dollars,
that puts him in a very precarious position. Because now he has
14000 leaf bills out there, and if he gives his son 500 sand
dollars, he will now only have 9500 Sand dollars in reserve. He is
at a loss as to what is happening. In the end he gives Junior the
Sand Dollars as he doesn't want anyone to know what he is doing. But
unknown to Senior, someone does know, even without knowing it.
Thomas that morally bankrupt man has caught onto his little game.
And is using it for his own ends, not for the betterment of his or
anyone else's village. Junior trucks his haul of Sand Dollars back
to the 2nd bank of Joe and adds 500 dollars to the reserve of his
bank. He makes the correct entries for the business that had
deposited the bills, and if need be, he can now print 500 new bills
without causing ONE BIT OF INFLATION. That's because the increase
was savings based not inflation based. The people in his village
really did something to create that money.

In the meantime Thomas and his friend are just having a fun time
spending their "new" money. They buy up some of those neat new
luxury items that used to be out of his reach. This has the
unfortunate effect of bumping up the price of those items ever so
much. Because when he goes into the store, he sees a mother wanting
to buy a little something for her son. It's the last one on the
shelf and he's about to sell it to her. In comes Thomas with a
fistful of dollars he didn't even earn. So what does he care. He
offers the seller a dollar more for the last item. The lady responds
by offering even 50 cents more, and then Thomas one ups her and
offers 2 dollars more than the asking price. In the end the lady
relents and Thomas gets the do-dad. So starts the reduction in the
living standard of the old village.

I will end this chapter with these thoughts. As we can see, Joe
senior had the best of intentions but was outwitted by a man of low
moral character. Sure, if there was only one village and one
currency then this charade could have continued potentially for a
very long time. Prices would have continued to rise, and at some
point someone would have called Joe on his charade. Because at some
point they would have tried to take their notes into the bank and
demand sand dollars in return. Then the illusion would be shattered
as everyone realizes that there are way more leafs than sand
dollars. In a closed system this wouldn't be all that bad. The board
in a sense would be reset, a new more honest banker would take over,
and things could continue. But now there are more than one banks on
the island, and in the next chapter we shall see how quickly Joe
Senior's village is dragged down by the notorious Thomas and his
friends.

[rdenner]

CHAPTER 3 Island Economics.



We last left the island, when Thomas and his friend were busily bidding up the price of the new consumer items that had emerged on the island. If you remember, the speed at which these consumer items appeared was fairly quick. And everyone had gotten used to them. They made life much easier to bear and to be honest, once you started using these items, life without them seemed very bleak. Thomas made his money by calling out Joe and his fractional reserve banking policy, which if you remember came about, by him printing more palm leafs than he had of Sand dollars in his bank vault (the cave). Joe's fractional reserve system worked great for almost a year with no problems. But as we read, when Joe Jr. and his band of adventurers went out and started a new village and a new bank, things got weird. That's when Thomas used a thing called currency speculation. He used his inflated 1st bank dollars to buy commodities from a village (country or in the case of 18th century America, another bank), he took the commodities he bought from the influence of Joe 2nd bank and sold them back in his village where the Joe's 1st bank has influence. And he took the net difference (100 bucks), and used it to buy things before his inflation had a chance to spread. For you see if he held the money, then within a short period of time the money he held would have been worth less. But by bidding up the price of something (buying the toy away from the child), he avoids watching the worth of his money delude. He actually got something for his money. In modern times, this practice has actually brought entire countries to their knees. A notable (notorious), example of this was done in modern times by billionaire George Soros. His was a classic case of a single person using his leverage to call out a corrupt currency and almost single handedly ruining a country.(google currency manipulation and George Soros to get a taste of what this does).





We pick up the story in the back room of Joe Seniors' bank, the 1st bank of Joe. Joe had just said goodbye to his son as he watched 500 sand dollars walk out the door of his bank. Joe thinks about his options and realizes there are only 2 possible outcomes. Number one, this was some sort of a rogue wave that wouldn't repeat itself, or number 2, his son would be back again in 3 days to take more of his sand dollars, and 3 days later, and 3 days later, until all of his sand dollars had been taken away. Joe decides that this isn't a rogue wave, and figures he must take action to make sure that Joe's 1st bank does not get destroyed.



"This will be the first of many interjections into the story by me. For you see, this is a great inflection point for the islands inhabitants. If Joe would just level with the people, and come clean that he has betrayed their trust, the fall down for the islands inhabitants might not be that far. The infrastructure that holds the island together is still in tact, and if they would just take the hit that is coming to them, things would get bad, but would improve fairly quickly. I feel as if I would need to write two concurrent stories to show both forks in the road Joe is faced with. But this is a story and decisions must be made, and as we'll see Joe is only human and makes the wrong choice. For it's in the nature of most men (using men as a catch all here) to want to avoid pain and suffering. Joe would suffer humiliation and the islanders would face suffering in the reduction of their standard of living if he "fesses" up. Because if he told everyone about what he was doing, he would create a "run" on his bank. Back when the imbalance was only 10000 to 10200 sand dollars vrs leaf dollars, this would have only created a ripple, but now the imbalance has grown to 9500 vrs 14000. Some people would get hurt. So back to the story"



Joe feels like he has no choice. The people put so much trust in Joe and he desperately doesn't want people to suffer. So he does the only other thing he can do, he calls his son over to have a talk. Joe Junior shows up the next day and is stunned by what his father has to say. Joe tells Junior about how he was running an imbalance at his bank. He told Junior about the spectacular advances that occurred while he was gone. People were so happy and content. It wasn't until Junior opened his bank that things got hairy. Junior thought about the problem for awhile and he realized what happened. He remembered Thomas coming to town over the past week, and the amount of money he was throwing around. They both realized what happened. Thomas was playing them for fools. So they come up with a plan to stop Thomas from playing the system at everyone's expense.



The next day there is another meeting and everyone from both villages is invited. Joe and Joe Junior announce that their banks are merging and are adopting the currency of Joe's 1st bank. Joe's 2nd bank will continue to run, but anyone holding the currency of Joe's 2nd bank will be given a 1st bank' s note to replace the ones they have. No one really thinks much of this change. To be honest they don't really care. The new villagers actually look forward to the change, as they notice how well old villagers had done in their absence. They think Joe Senior is a God send to them all. Everyone is happy except Thomas, he sits stewing in the corner angry that his "business" had been shut down.



"Just another interjection just to give you a sense of where this analogy falls into the real world. This would be akin to the consolidation process that took place throughout the 1800's in America. There were numerous banks that opened up thought-out the country. Some were like Junior and were VERY conscious of the trust that others placed in them. They kept very tight reserves (although most banks were already practicing fractional reserve banking at this time). Other bankers were like Senior, only I bet they didn't really care about people like Joe did, and they built trust only to use it against people who held their money. And any time there was a big imbalance between Bank A and Bank B, you can bet there was a Thomas there to take advantage of it. They would take money from Bank A(inflated), to the area of influence of Bank B(closer reserve ratios), and did just like Thomas did, only they walked away with the gold. And they didn't live on an island, they were free to move about a giant country that provided an infinite amount of imbalances upon which to prey. These currency speculators were responsible for entire regions falling into depressions (although they were NEVER as bad as the great depression of the 30's. Depressions throughout the 1800's were generally localized/regionalized and were generally short lived). These depressions were always the hardest on the trusting souls that believed in their bank and led many people to "bury" their money in the back yard. This is where that practice came from. People felt better to just keep their money than trust a banker. Remember there wasn't an FDIC(bank insurance) to help these people. When a bank run started, it could literally be over in a few hours, leaving hundreds of people penniless and destitute and the bank closed. Now back to the island.



Thomas is forced to go back to real work and the island doesn't have to face any kind of negativity or strife. The potential of a run was contained and not a single person knew how close to a calamity they all had come. Thomas wasn't even aware of the danger he had placed the villages, all he knew was that there was free money to made. So on the villages go, the inflation from the old village is transferred over to the new village and a new equilibrium is attained, because Junior and Senior both agree not to let a run happen again. Since both villages are using the same currency the accounts would look like this. The 1st and 2nd banks now hold a total of 15000 sand dollars and now there are a total of 19000 outstanding 1st bank leaf dollars against them. In short order the prices in the new village reflect those in the old village. There is no longer an advantage to buying wood/sugar in the new village to sell at the old. Those new business are quickly bought out by the old village business' as the new guys have no way of competing. The older guys have all the best equipment and the most experience. They have no choice but to sell out. But there are plenty of other things the new village does well. They make glue and syrup and a new thing called metal. The raw resource manufacturers of the new village start to thrive and grow, and again the liquidity problem surfaces. Because these new guys want to expand and grow like the old guys did. But they are competing against the old village's "luxury" industry for the limited dollars in circulation. Joe and Joe Junior had decided to reign in their monetary expansion following the "Thomas" incident. And once again the expansion of the village was slowed to a more sustainable level. But the cat was already let out of the bag. People really wanted to move forward. They had a taste of the "good" life and they wanted more. But for almost a year, Joe and Junior kept a lid on inflation, refusing to loan any more than was already out there (15000 vrs 19000). And to exacerbate the problem(at least as the villagers saw it), they were actually contracting the size of the deficit by not re-loaning out the money as it came back into the bank, in the form of repaid debt. So when Al (hoola-hoop guy) paid off the last of his loan, that 100(remember it was printed not earned), it was taken out of circulation. Thereby reducing the banks cash to reserve ratio (reducing the 19000 palm leafs to 18500 versus 15000 sand dollars). And on the contraction went, as debts were repaid, the money was taken out of circulation.



"Interjection time again. What Joe and Junior were doing here, was the only rational and reasonable thing they could have done. They had to pull in the excesses of the villages, excesses that Joe had created. Sure all those luxuries were nice, but they would have started cutting into real progress. Because the Core producers are the bottom of the economic pyramid, without them nothing else gets done. And with a limited amount of dollars to spend (which remember, IN REALITY those dollars are just a reflection of the real raw goods that exist on the island. Just because Joe printed 4000 new "dollars" 4000 more trees didn't grow, and 4000 pounds of sugar didn't mysteriously appear), any money loaned to a luxury producer comes at the cost of future growth in the form of the Core producers expanding. If the villagers were just told the truth, maybe they would have understood and they would have accepted the fact that their "standard of living" would have to adjust down to reflect the reality of the situation, or as history has shown us, they will react much like they will in the next installment.."

[rdenner]

Island Economics Chapter 4

We last left our thriving little island, after Joe and Junior had
stopped a potentially calamitous run on the 1st bank of Joe. The
banks had decided to merge and create a single currency. If I had to
place this in a rough historic context, this would be closest to the
late 1800's. There were several attempts made by the US government
to consolidate the money creation process under the US treasury.
This is an enumerated right given to the government by the
constitution. This right though, DID NOT exclude the right of
private banks to issue competing currency. A bank or country that
practices unlimited printing of paper money is known to have gone
into "hyper-inflation". This means that the issuer of the paper
money has lost control of the situation and that people are catching
on to the charade. People would storm into banks demanding their
savings. The banks would respond by giving them more paper money.
The people would spend the paper money as quickly as they got it in
an attempt to get anything of worth for that paper. And the
situation would just snowball out of control. If you want a really
good example of "hyper inflation" at work, Google the terms Weimar
Germany and the hyper-inflation of the 1920's. You will see after
reading the numerous example of hyper-inflation that it usually
doesn't end well for the offending bank or country. And if my
reading of history is correct, countries that find themselves
heading towards hyper-inflation, more times than not end up in a war
of some sort, in an effort to save themselves.

But on Joe's Island we are no where near that situation (yet). So if
we had to make a VERY rough comparison, Joe's island is now entering
a period similar to that of the early 1900's in America. We have a
fractional reserve bank, and a standard paper note which more or
less is tied to a definable amount of gold err I mean sand dollars.
I personally think this marks the end of America as we never knew it
(obviously pre-dates almost everyone currently alive). 1800's
America saw the biggest increase in the real standard of living in
this country's history. We built a huge savings pool upon which all
the growth of the 1900's was built. Much like the way Joe's island
has built up it's lumber/metal/corn/sugar production. These advances
allowed Joe's island to start branching out into other things such
as luxuries or even to new advances such as metal, syrup and glue.
But as we saw at the beginning of last chapter, Joe tried to "jump
start" this process by printing money. People got a taste of the
good life and now as we'll see, they DON'T want it to end. Joe and
his son are doing the right thing by reigning in the excesses of the
island by deflating the previously inflated money supply. But now
there are more devious people who have caught onto the game.

If you remember from the 2nd chapter, Thomas (the morally challenged
man), had a partner in his currency speculation. This man remained
anonymous as all he did was supply Thomas with money; it was Thomas
that did the dirty work. We'll call this guy Mike. Mike is a hard
worker on the island and is very bright, but like Thomas he is
cursed (he'd call it blessed), with the ability to ignore the social
norms as it were. He feels that he has moral and mental superiority
over everyone in the villages. When Thomas came to him with his
currency speculation scam a while back, Mike immediately understood
what was happening, even if Thomas didn't. Thomas understood only
one thing, and that was how to get by without working. Thomas was
just lucky is all, but Mike on the other hand, he knew all about
working hard, and he very clearly understood what Joe and Joe Junior
were up to.

He watched in dismay, as the two banks of Joe merged together,
effectively ending their business before it started. And he watched
in anger as Joe and Junior continually said NO, time after time to
potentially new and wonderful ideas. He sensed the anger that was
building in both the villages. What gives Joe the right to dictate
what does and doesn't get done on this island? For Mike it was less
a matter of wanting to make things better for others on the island,
for Mike was well situated. He had loads of money and people on the
island respected him and knew him as a hard worker. For Mike, the
idea of being dictated to by the Joe's was just too hard to swallow.
Who were the Joe's to tell him or anyone else what to do? Few other
than Thomas knew of Mike's more devious and megalomaniacal side. So
after a year of watching the Joe's imposing their will upon the
village (and him), he finally had enough. Without telling the Joe's
what he was up to, he used his expertise and money to create his own
printing press. He took a Joe's 1st bank bill and made an exact copy
of it. Mike considered at first just making the bills and using them
for himself, but he reconsidered (this would be considered
counterfeiting). He knew that the Joe's would catch on quickly and
they would expose him and destroy his reputation.

So he came up with an even better idea. What better way to compete
with the Joe's than to beat them at their own game. So he starts a
new bank, with an emphasis on loaning money to others. He gathers
the villages together for a meeting and he announces in front of
everyone that he is starting a new bank called Mike's 1st Savings
and Loan. Mike looks directly at Joe and Junior with a knowing look
in his eye and dares the Joe's to stand up and say something. Mike
announces to everyone that he will base his loans on several
criteria, the ability of the person to repay it, and the validity of
the idea. No more will we be hamstrung by the Joe's telling us no!
He harkens them back to the year that Joe was loaning money to the
likes of Al and John (the hula hoop and art supply guys), and how
good things were getting. It was just as things were getting good,
that Joe pulled the plug on everyone. Mike promises everyone that
this won't be the case with his bank. He will make sure that growth
continues on the island.

Everyone walks away from the meeting feeling much better. For they
were getting angry at the way things were going. Most of the new
luxury manufacturers had gone out of business. Only Al remained, and
the amount of new toys and gadgets he created were few and
expensive. Obviously only people like the Joe's or Mike could afford
them.

Interjection time again. What the people in the village are feeling
is understandable. They were shown something new and exciting, and
then had it taken away. They would have been better off not having
known it existed in the first place.

But under the new way of doing things (a real savings scheme), Al's
Hoola Hoops and Stuff Inc business was starting to take root. He was
no longer relying on the easy money practices of Joe's bank. He was
creating a product from real savings. And although the product was
expensive and only attainable by the "rich" people on the island, he
was working hard to lower his prices and make his wares more
affordable. This wasn't seen by anyone in the village, all they saw
was that Joe's and Mike's kids got the neat new things. They weren't
willing to wait for the market to do its thing. If given time Al
would have perfected his toy making process and he would have made
more things available to more people. But as I said before, the cat
was out of the bag. People were used to the luxuries and they wanted
them back, and Mike was just the man who was going to do it for
them. Now back to the island.

Mike figures that the Joe's will be very interested in talking to
him as soon as the meeting is adjourned. As people file out of the
meeting, on cue the Joe's approach Mike and ask to see him in
private. Once in the back room of Joe's 1st bank, Joe senior starts
into him. He asks him what he thinks he's doing, and how did he make
a printing press that makes Joe's 1st Bank money? Mike lays it all
out there for Joe Senior. Mike tells the Joe's that he thinks what
they were doing before was a good thing (meaning the monetary
inflation). The only thing that was stopping the Joe's from printing
more notes was the trust factor. Obviously, if they printed too much
money too fast, than things would spiral out of control. But if they
did it right, and injected just the "right" amount of money into the
villages, than they could sustain faster growth and make everyone
happy. And here was Mike's plan. He would setup 3 Mike's Savings and
Loans banks. Joe would change his bank's name to Joe's Island
National Bank and Reserve and there would be only one of them. Joe's
bank would be the highest bank on the island. All Sand dollars would
remain under guard in his vault. Mike would then take printed palm
leaf dollars from Joe's bank and loan them out to the people of the
villages though his Mike Savings and Loan. There would be one
stipulation though. ONLY Joe's bank had the right to print money on
Joe's Island. Mike would help in this Endeavour by convincing the
island inhabitants that this was a good thing. So in a sense Mike
and the Joe's were entering into a financial monopoly. Up till this
point, really anyone could have started a bank. It just so happened
that Joe was trusted by everyone, and he never gave anyone a reason
to doubt that trust. And let's be honest here, Joe senior really
liked his position as king maker. His only doubt came when Thomas
spoiled it all, by being a selfish bastard. Joe Senior always felt
like his fractional reserve banking idea was a good one. Mike just
showed him a way to make it a reality. Mike's last piece of advice
was to make sure that there was NEVER an accurate accounting of the
sand dollars that he held in his cave/vault. For if this knowledge
ever got out, there would be a run on all of their banks, and the
whole of Joe's island would be pushed into anarchy.

I guess if I had to place the above scenario anywhere, it would be
1913 America and the creation of the Federal Reserve System. Before
1913, there had been numerous attempts to establish a single
currency for the whole country. In 1913 this became a reality and
the reserve system was born. Basically the Fed (as its known now),
is a private bank, but is given a special charter by the US
Government. This is known as a GSE or a Government sponsored entity.
They are given the right to print money and coinage and in a sense
set interest rates (which is just another way of saying; they set
the price of money). And as we'll see in the coming chapters, once
this power was unleashed on an unsuspecting country or island, it
didn't take long for them to foul it up. But to setup how the Great
Depression happened and to come up with a decent island equivalent I
need to introduce how International commerce fits into the picture.
Because, right now Joe's Island National bank is a monopoly. They
are the sovereign bank of the island, but there are no other
influences affecting them. This of course is not how it works in
reality. Because our banks have to deal with things such as imports
and exports. And as I hope to show in the next chapter, I will show
how these factors effect everyone involved.


Chapter 5 island economics.


Several decades have elapsed since we last checked in on our island.
The island has grown by leaps and bounds. Many more villages have
sprung up all over the island. And as per the agreement with Joe and
Mike, there is only one currency and only ONE Joe's National Bank.
But now there are several other banks. Mike's is the oldest and most
revered, but many other "friends" of Mike and Joe have opened banks.
And if you remember correctly from earlier chapters, it's these
friends and the bankers themselves that benefit from this money
creation the most. Because remember, they get to spend the new money
first before the affects of the inflation have spread out and raised
the cost of everything. So these friends and bankers are now the
richest men on the island, an island which now has several thousand
people inhabiting it. These favored men all take their lead from Joe
and now Mike, who has given up his ownership (but the name is still
Mike's Savings and Loan), in order to work at the Reserve bank of
Joe. Mike and Joe and to a lesser extent Joe Junior spend their days
pouring over the books, looking at reports, and taking
the "temperature" of the islands economy. It's their job to find the
right mix of expansion. Sometimes in the past 20 years they overdid
the inflation and costs would soar. A whole bunch of businesses
would open up and start to sap the labor market, pushing prices up
to fast. Or a new crop of Core businesses would start cropping up,
challenging the supremacy of the existing ones. The old guard would
have none of this, and they would pressure Mike or Joe to change the
monetary stance of the bank. If things were getting to heated and to
many new businesses were starting up and straining things, Joe and
Mike would meet and they would decide to pull back a little. If you
remember, to slow the economy down, all you do is not put money back
into the island economy when loans are repaid. When a loan is repaid
you pull that money out of the economy, thereby making money more
scarce and in turn, more expensive. This would make it harder on new
businesses that rely on cheap loans to keep expanding. With just the
stroke of a pen, Mike and Joe have the power to dictate who can
start a business.

On the island there is a plethora of new gadgets and widgets to
choose from. But a nagging problem has raised its head amongst the
Core producers. This time it isn't a man power problem. They are
finding it increasingly harder to produce enough of everything to
keep people happy. The corn guy has planted everywhere he can, as
has the sugar cane guy. The water guy is finding that his aquifer is
getting low, and the summer rains aren't replenishing them. This is
a serious problem for everyone on the island and it's a situation
that no one on the island has any experience with.

Joe at this point is getting to be a very old man and really just
wants to retire. He decides he has had enough and decides to step
down. And to Junior's dismay, Joe leaves the reigns of power to Mike
and not to him. Junior throughout the past 20 years has always been
urging Mike and Joe to reconsider what they were doing. Junior
always felt that things were moving forward too fast. Sure things
looked good on the surface but he always felt that there had to be
some negative side to this.

And then that negative side became apparent the day after Joe Senior
retired. The Core producers asked to meet with Junior and Mike. They
told them about how hard it was getting to keep things going. Mike's
pat answer was to offer them more paper money. The Core producer's
response puzzled Mike; they said it wasn't a money problem. They had
plenty of money; they just couldn't make anything more. But everyday
the demand from the people on the island kept increasing. They had
no choice but to start rising prices higher in an attempt to break
the demand of the island. In the past, all Mike would do in response
to rising prices, was to print more money to counteract this.
Because as prices rose, people would just get more money, by this
point the ratio of palm leaf dollars to actual sand dollars is
astronomical. No one really knew exactly what it was, but probably
50000 sand dollars versus 1,000,000 or more leaf dollars.

The problem this time was not financial, it was thermodynamic.
There was only so much space, only so much water, and only so much
food on the island. So in typical Mike fashion, he strives to figure
out a way, to grow them out of the problem.

I am just going to go ahead and post this much. The next chapter
will illustrate how Mike plans to save the island once again. Not by
telling the truth, but by once again, expanding his way out. He will
go off island in search of MORE.

[Melissa]

Thanks for putting this up will give you questions after I read it all lol

[rdenner]

One more bump.. It's worth the time to read if you have a hard time understanding inflation and the Fed

[rdenner]

Blump(blimp bump)

[mrchubbs]

bump... good stuff...

Will be directing some friends to this.

Thanks for posting it.

[Rintrah54]

Hmm. I read every word of this and it was very informative and entertaining.

I you could touch on it, I would like to know what the solution to lack of liquidity is from this school of thought? Surely you have to expand the money base at some point to account for population growth? I mean I guess not necessarily, I suppose in the case that you dont.... the value of the dollar rises with increased demand?

Sorry if I am jumping the gun here, but according to this analogy, the 100% gold/sand dollar backed currency slows possible economic growth right?

Btw, thanks for posting this.

[rdenner]

Not sure if you'll come back to check this post. But here is your answer.

YES the gold standard keeps an economy in check by reigning in UNREALISTIC growth. Remember that gold/paper money is nothing ONLY REAL commodities and real labor mean anything. Gold/paper are just ways of expressing those real things.

The way you increase liquidity is through REAL productivity gains. Real expansion of the labor(service) pool or the commodities within the society.

To be honest Gold/Silver is no better in my estimation than paper money. The only reason Gold/Silver is considered better is because they are limited. Paper is as close as the nearest printing press.

Gold is constantly being mined as is silver. When it's added into the system it will allow for added liquidity in the system.

Robert

[Fields]

Thanks for the post.

[rdenner]

Thank you for the bump.. I'm hoping people are getting a lot out of this.

I based this story on the Austrian Theory of Economics that both I and Dr Paul share.

It's a repudiation of the top down economic model of Keynsianism that this country currently uses.

In an argument with a socialist who's first line of defense goes like this "WELL your free market is working great now isn't it. Look at all the people being thrown out of their houses."

You're come back would be "Yea, You're socialistic controlled economy is working wonders. This country is in no way shape or form a FREE economy".

You cut them off before they even get started.

Robert

[slydecix]

Thanks for this! I can't wait for the next parts. I wish my past econ professors would've laid the whole historical context out like this.

(btw, I think you mean 'diluted', not 'deluded')

Also, are you thinking about eventually turning this into visual/video content? As I was reading, it reminded me of http://www.storyofstuff.com

[rdenner]

I should take the time to proof read it and make it more professional.

This was something I created for an energy blog about a year ago. I just pieced it together literally as I typed it. I didn't really put a lot of deep thought into it.

I posted the first chapter and I had like 5 or 6 people clamoring for what happens next. So I just kept writting chapters until people stopped reading them.

I'm glad you like it. This may be the motivation I need to fix it up and add some more chapters.

Robert

[Rintrah54]

Not sure if you'll come back to check this post. But here is your answer.

YES the gold standard keeps an economy in check by reigning in UNREALISTIC growth. Remember that gold/paper money is nothing ONLY REAL commodities and real labor mean anything. Gold/paper are just ways of expressing those real things.

The way you increase liquidity is through REAL productivity gains. Real expansion of the labor(service) pool or the commodities within the society.

To be honest Gold/Silver is no better in my estimation than paper money. The only reason Gold/Silver is considered better is because they are limited. Paper is as close as the nearest printing press.

Gold is constantly being mined as is silver. When it's added into the system it will allow for added liquidity in the system.

Robert

Yeah, I was waiting on an answer...didnt know if it would come :)

This all makes sense to me. Money is really just an idea which we hold to represent tangible goods. You certainly can't eat greenbacks or silver coins. I was just thinking about that fact that population growth is probably more exponential than gold mining. I suppose that would make the value of the dollar grow on the same order and it could eventually be a problem hampering business startups and whatnot.

Thanks for taking the time to do this. It has been very useful.

[rdenner]

Just pimping my own post... Shameless..

[mrchubbs]

I would love to have a polished version of this out there somewhere.

Do you still have a place to post it? blog or otherwise..?

If not I'd be happy to add you as a contributer to Liberty Maven and have you
polish it up and post it there.

If you do polish it up and post it somewhere I'd certainly link to it from LM at least. I would think all of the Ron Paul bloggers/site owners out there would link to it as well.

Thanks again and enjoy!