How an Economy Grows and Why It Crashes


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They consumed more because the economy grew. As their savings grow, they have more time to undertake other projects. They pool their savings and build a trap that catches 30 fish a week. They never have to fish again. Able starts a clothing company. Baker builds a canoe and a cart, while Charlie constructs a surfboard. Savings, ingenuity, hard work, risk taking, and prudent lending move the economy upward.

The island's prosperity attracts and is able to support immigrants seeking a better life. Some of them borrow fish to clear land for farming. People start offering services, such as cooking and fish-trap maintenance. The economy becomes more diversified. And as it does, they discover they need a better way to trade their goods or services.

Full text of "How An Economy Grows And Why It Crashes( 1)"

A spear maker may want the services of a chef, but the chef may not want any spears. What they need is something that can be traded for anything and that is acceptable to everyone. They need money. They settle on fish. Not only do fish serve to facilitate trade, they can also be saved for old age and emergencies. Money also allows people to specialize in what they do best.

Duffy, for example, can build a canoe with eight fish in savings rather than the ten fish that others require. By charging nine fish per canoe, he makes a profit and his customers save money. Over time, Duffy buys specialty tools with his savings that allow him to build a canoe with only four fish.

Duffy doubles his production, and by charging six fish, doubles his profit margin and sells canoes at a more affordable price six fish instead of nine. A luxury becomes an everyday commodity. As productivity increased, prices fell, benefiting the producer as well as his customers. Falling prices induce people to save, which swells the amount of capital available for loans. The Keynesian fear of falling prices was yet unknown. Not everyone on the island is willing to work for a better life.

Some of them turn to stealing fish.


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Seeing an opportunity, an entrepreneur named Max Goodbank decides to open a bank and charge a storage fee for safeguarding people's savings. With profits scarce from such a service, Max decides to loan out the savings. To entice people to deposit their fish he pays them interest. He charges borrowers a higher rate of interest so he can pay his expenses and earn a profit. Max calls his enterprise the Goodbank Savings and Loan. Max knows that a prosperous economy would increase fish deposits. Interest on loans would then drop, but so would interest paid to depositors.

As savings diminished, Max would charge borrowers a higher interest rate. He would also pay depositors a higher rate to encourage more savings, and eventually the loan rate would come down. The safety and convenience of the bank attracts depositors, and Max is able to finance a huge waterworks project to bring water inland.

New pipelines mean previously infertile land can be made into productive farmland. The steady flow of water can be used to harness machines, giving birth to new industries. To settle disagreements and protect themselves from violence, the islanders decide to form a limited government.

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They elect 12 senators and a senator-in-chief with executive authority. Able was able to devote some time to designing and constructing more functional — and more flattering— palm-leaf clothing. Baker expanded his diet and culinary skills by gathering coconuts, and Charlie built the island's first hut. He said, "If we can expand production with hand nets, why not kick it up a notch and go industrial?

He sketched out the plans for an elaborate fish-catching device that would revolutionize the island's economy. The gizmo involved a huge underwater trap with one-way doors that could catch fish continually day or night. That's right- But, Baker soon realized that the he was unable to handle such a complex project by himself.

He thought about the materials necessary, the netting, the framework, the construction.

How an Economy Grows & Why it Crashes

His savings, brawn, and ingenuity were simply not enough for such a colossal project. With these thoughts in mind, Baker decided to propose a joint venture. Having listened to Baker's plan, they began to discuss the potential risks. As with Abie's first net, there was no guarantee that the project would work. Even if it did, the whole contraption could fall apart in its first exposure to rough seas. But this time it wasn't just one fish they were risking, but more than 20! However, their demand for more fish overpowered their fear of losing their savings.

And Then There Were Three: How an Economy Grows and Why It Crashes

They moved forward. After a supreme effort, the three succeeded in building the island's first mega fish catcher. The trap delivered as advertised and racked up an average of 20 fish per week, with no fuss and barely any muss. Outside of some minor repairs and maintenance, the trap was almost entirely automated. Soon they were swimming in fish. With the savings that quickly piled up due to this latest advancement in productivity, the three soon built another mega fish catcher.

Fish became so abundant that they were able to dedicate all their time to other projects. In his spare time, he began working on his one-man stage play. For his part, Baker used his free time to focus on the island's vexing transportation problems, and developed designs for the island's first canoe and cart. They are an essential buffer that shields economies from the unexpected.

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Suppose a monsoon came through the island and wiped out both mega fish catchers? Although many economists today view natural disasters as stimulative to an economy, the truth is floods, fires, hurricanes, and earthquakes destroy wealth and diminish living standards. If the fish catchers were wiped out, the island's fish production would drop, and Able, Baker, and Charlie would have to underconsume again in order to generate savings to rebuild their capital. But, remember, a pool of spare savings prevents disruption and allows for immediate reconstruction of damaged capital.

follow That is why it is essential that Able, Baker, and Charlie continue to underconsume and save for a rainy day. Throughout much of our history American citizens typically saved 10 percent or more of their incomes annually. This discipline not only helped build a huge supply of savings to finance our growing industrial activity, but it also helped families and communities endure unexpected hardships. However, in recent years, economists have severely downgraded savings on the economic value chain. In fact, as far as many economists are concerned, savings are a drag.

Keynesians view savings as detrimental to growth because the act removes money from circulation and decreases spending which they assume is the crucial element in creating economic growth. Policy makers, influenced by these ideas, have made rules that reward spenders and penalize savers. As a result, Americans have, for years, spent more than we have earned. In a contained economy, like an island, this would be impossible. But in our modern world, the flow of money across borders and the seemingly magical qualities of the printing press have temporarily blinded many Americans to the simple truth that we can't consume more than we produce, or borrow more than we save When the economic headwinds began to pick up in earnest in , politicians and economists reflexively looked for a means to get consumers to spend even more and save even less.

Spending for its own sake means nothing. How would this benefit society? It would surely benefit the person who sold you the air. He would get the million dollars formerly belonging to you. Using our modern methods of economic accounting, such as the measurement of gross domestic product GDP , such a transaction would certainly look like genuine activity.

But the act of buying air does not improve the economy as a whole. The air was always there. Something has to be produced to give the spending any value. Spending is merely the yardstick that we use to measure production. Since everything that is produced will eventually be consumed, why does spending really matter? Even the stuff that no one really wants will be consumed if the price falls far enough. But nothing can be consumed until it is produced.

It's production that adds the value. Saving creates the capital that allows for the expansion of production.


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  • As a result, a dollar saved makes more of a positive economic impact than a dollar spent. Just don't try to explain this to an economist or a politician. Abie's initial willingness to create capital through his own personal sacrifice benefited the other islanders.

    How an Economy Grows and Why It Crashes How an Economy Grows and Why It Crashes
    How an Economy Grows and Why It Crashes How an Economy Grows and Why It Crashes
    How an Economy Grows and Why It Crashes How an Economy Grows and Why It Crashes
    How an Economy Grows and Why It Crashes How an Economy Grows and Why It Crashes
    How an Economy Grows and Why It Crashes How an Economy Grows and Why It Crashes
    How an Economy Grows and Why It Crashes How an Economy Grows and Why It Crashes
    How an Economy Grows and Why It Crashes How an Economy Grows and Why It Crashes
    How an Economy Grows and Why It Crashes How an Economy Grows and Why It Crashes
    How an Economy Grows and Why It Crashes How an Economy Grows and Why It Crashes

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