Wednesday, September 9, 2009

Sea Shells and Sports Cars

I would like to take a moment and try and make two simple concepts even simpler. The first concept is that of debt.

There is a clock running to my left and a clock that is running at the very bottom of this page. One is approaching $12 trillion and the other is approaching $75 trillion. But what does that mean? Those numbers have no significant impact on the lives of Americans. In simple terms: they could care less.

The situation is easier to understand when you think about it in terms of an every day person.

Imagine someone borrows $1 million. They go out and buy a new car, a new house, a new boat, and a new wife. If that person did not have to pay back the million they would be rich.

But what happens when they do have to pay it back? This is the important question. Not only does the new spending have to go, they must also cut expenses below what they were before they borrowed the money. They must reduce their standard of living significantly.

The second concept is even simpler:

Imagine that three young men wash up on a deserted island. They decide to divide the labor between them so they will be more efficient and productive. One gathers coconuts. The other fishes. The third plants banana trees. The coconut gatherer and the fisherman exchange their products with each other.

But what about the banana planter? It will take a couple of years before his bananas are ready to eat; how will he survive?

The other two men recognize the benefit of what he is doing and look forward to eating bananas. They decide to give him coconuts and fish.......with the understanding that they will get paid back in bananas when they are ready. To effect the transaction, the banana planter issues "money" equal to his entire crop. It is understood that these little shells may be exchanged against his bananas, and thus do the other two men begin amassing their fortunes, feeling wealthier each time they acquire another shell.

But what if the banana planter decided to double the supply of money? What would be the point of it? The fish and coconut suppliers might think they were getting richer-but there would still be only so many bananas, no more.

These two examples help a beginner in economics and finance see how our global economy works. The United States has run up a massive debt and has positioned itself as the "wealthiest" country on the planet. Since they have no coming banana crop to pay back this debt, they have just decided to pay it back with sea shells.

How would you feel if you were the gatherer of coconuts or the fisherman? What if the banana planter decided to stop growing banana's, go on vacation, and just hand out shells instead of bananas?

Do not be confused by the large numbers or the fact that it is our country borrowing instead of an individual. The concepts are the exact same, and the story will end the same way it will for the three men on the island and the man that decided to borrow $1 million and spend it on luxuries.

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