Once upon a time, there was a man named Jack, who had survived a terrible crisis with a giant some years ago. Jack eventually took up bean farming to provide sustenance for himself and his family. Indeed, beans had become the main medium of exchange in his local town and Jack had established the habit of consuming most of his annual crop and saving a portion, enough to plant for the next season, plus a little extra “just in case.”
Those future investments would be what fed Jack and his family next year. The percentage of saved beans, relative to his entire crop, was his savings rate, since the consumption he delayed today was his investment in the next season’s production capacity.
Life was great because Jack had reached a state of equilibrium. Jack’s own common sense dictated to him this key economic point:
Increasing his personal economic growth is only possible by increasing his rate of investment (planting more beans next year) … and increasing his investment is only possible through an increase in savings (having more beans to plant) … and an increase in savings demands a decrease in his current consumption.
Jack had taken some basic bean counting accounting classes and kept track of his stock in a spreadsheet. He knew precisely the number of beans he had available to satisfy his consumption demands for this year and for planting next season, plus his reserve. The numbers that Jack tracked in his spreadsheet represented actual beans, a “gold standard” of sorts. Those beans were real and the numbers didn’t lie.
But having pawned the golden harp to buy his land and having eaten the hen that laid the golden egg for Christmas dinner, Jack yearned to buy some new oxen, more clothes for his family, a new wagon, a beautiful horse, proper schooling for the kids, and many other “finer” things. It occurred to Jack one day (after keying in a typo) that if only his spreadsheet would tack a zero on the end of his current reserves and savings, inflating the numbers, he would be able to use some of his beans to buy those “finer” things he and his family wanted. On a lark, he added the zero himself, just to see what it would do to his income statement.
“Wow,” Jack thought to himself, “I could get those things now and just worry about replenishing my seed stock later.” And that’s exactly what he did. Jack and his family were suddenly in utopia with all the newer, finer things they wanted. Jack’s family nominated him for Father of the Year in the local town and since he had 12 kids, and they all voted for him, he won in a landslide. It felt great! Economists would call this the boom phase of an inflationary business cycle.
But planting time rolled around shortly thereafter, and Jack planted what remained of his beans, knowing he would never harvest enough, even with newer technologies in fertilizers and pest control. “But, I can always borrow some beans from Mr. Chow,” Jack reasoned. “He knows I’m good for it.” Sure enough, Jack experienced a predicted shortfall at harvest time as his new, “finer” things weren’t so new anymore. Jack bought more things, hoping to get that euphoric feeling again, but it was a little hollow this time around.
You don’t get out of debt by going into more debt.
That year, his needs consumed everything he harvested … and it still wasn’t enough. He approached Mr. Chow who willingly lent him some beans for next year’s planting, based on the spreadsheet Jack showed him. “I’ll lend you 50 pounds of beans, but next year, you have to pay me back with 100 pounds of beans!” Mr. Chow drove a hard bargain. The interest rate was large, but Jack disregarded it because of his intense need for more beans. He didn’t worry that his fiat currency, his loaded books so to speak, were incorrect because once again, his needs were temporarily met and life was again good. There would always be time to worry later.
What happened in the next season? Since typing another zero didn’t actually create more beans, Jack was unpleasantly surprised when his bean stock (his capital) suddenly ran out, and wasn’t sufficient to meet his planned or unplanned expenses. He sold his new clothing in a rummage sale, and many of those “finer” in things were traded, pawned, or returned to the store from whence they came. Jack found out that without a true accounting of his available investment capital (the seed stock), accurate long term planning became impossible and short term needs trumped everything. Welcome to the bust phase of the inflationary business cycle!
The best way for Jack to get back on track is for him to drastically cut his consumption rate, pay down his debt, and restore his seed capital and reserves.
If Jack could learn from his economic failures and fallacies, make some wise decisions, and cut his current consumption to restore his savings and pay his mounting debts, he could pull himself up out of the hole he had dug. But suppose he petitions some bureaucrats, convincing them that “HIS farm CANNOT fail because its too important to the local economy?” When the bureaucrats decide to implement a “bailout plan” by adding some more zeroes to his spreadsheet so Jack can get more loans to support his unsustainable consumption level, what happens in future seasons?
Jack may temporarily “rescue” his personal economy this season with the help of bureaucrats but it’s at the cost of further depleting his investment capital. He won the “vote” of his kids but has even less capital reserves for next season. Rather than making hard decisions to recover his personal economy, he further distorted his grasp of reality. Now he has no idea how many beans were available to consume, and how many he needs to save. He can attempt to borrow more beans from his neighbors, but unless he can drastically cut consumption to pay the interest, those neighbors will eventually grow impatient and refuse to lend any more. The more he tries to convince himself that the illusion is real, the more out of touch he becomes. Alas, as the falsified numbers on his spreadsheet showed exponential growth, his actual consumption plummeted toward zero. It was all a lie.
No one can correct over consumption with more consumption.
So what did Jack do? He drastically cut his consumption rate. He rented out a portion of his home to business travelers. He set up a co-operative that would allow farmers to buy fertilizers and pest controls in bulk (taking a small cut for storing those items on his farm), he learned to make his own clothing, he leased out 25 acres of his land that he couldn’t farm himself to a share cropper, in short, he learned to make extra money to help get himself out of debt.
Few people actually behave like Jack and deny the objects and events that happen before their very eyes. But in economics, too many people, including politicians, “mainstream” economists, and investors unconsciously follow the philosophical principles that reality is driven by social consensus, and the success or failure of our markets depend only on the optimism or pessimism of consumers and investors. This goes far beyond the fairy tale belief that wishes affect reality, this is a belief that one’s wishes ARE reality if enough people share the delusion.
Economic principles are really quite simple. The key to is to understand that the same principles that apply to your personal finances, and even to your dealings with your local merchants apply equally to the world at large, at all levels of economy activity. Don’t delude yourself or allow yourself to be deluded. Violating basic economic principles will eventually come back to haunt you