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How an Economy Grows and Why it Doesn’t: A Review

This article first appeared in Issue 21: Bitcoin & Art

A Book by Irwin Schiff

I often cop a lot of flack for claiming that the fundamental laws of economics, like the laws of physics, are immutable. I stand by this statement because the basic principles of economics are based on scientific logic. The only reason they are so poorly understood is because they are made deliberately confusing by those who benefit from your ignorance.Economics is routinely cloaked in technical jargon and obscure terminology. I am a huge fan of any work that can explain these principles simply and make them accessible. For this reason I maintain that Irwin Schiff’s 'How an Economy Grows and Why it Doesn’t' is the single best book on economics ever written. It was adapted recently by Irwin’s son, Peter Schiff, and re-titled 'How an Economy Grows and Why it Crashes.'I’m a greater fan of the original work by Irwin Schiff, with its emphasis on simplicity. The story is an allegory. It is presented as a children’s picture book. The fundamental role of savings, inflation and capital formation are presented clearly. Economics makes perfect sense after reading this book. There can be no confusion about its fundamental operations and laws.

The Allegory

We start from the earliest possible point with an economy. There are three men stuck on a deserted island: Able, Baker and Charlie. They are living a life of subsistence. They fish. Whatever they catch, they eat. They catch just enough to live, with their bare hands. There is no savings, no capital, no investment and no credit.Able is struck with inspiration one day. He has the idea for a ‘net’. He becomes the first entrepreneur. He sacrifices eating one day (underconsumption). Instead, he spends the day building the net. The risk he takes is rewarded. He is successful and the island now has its first piece of capital. This allows Able time to catch more fish on a given day. He now has spare time to do other things.7653942924_4ec250dc7e_bThe net also provides lots of extra fish. The island’s first savings (fish) accumulate. Able has a choice. He can relax for a while, taking a holiday and consume all the extra fish. He can also loan them out, invest them, or any combination of these choices.Able is greedy. That’s okay. Abel is also fearful. There is the chance to have more. However, he could lose everything. The two forces play on his mind.Able can only do so much. The surest way to increase his wealth is to loan his savings to Baker and Charlie. It’s better than going on holiday. He has a chance to benefit even more in the future. Assuming, of course, that Baker and Charlie can make good use of the loans, they will all benefit. That, again, is Able’s risk.Able loans the capital to them, on the condition they spend it on further capital production (net production), not on a holiday (consumption).Baker and Charlie do well, they use the large amount of savings to build an even bigger net. The savings (fish) really start to roll in. This is free market capitalism in all its glory. There is no zero sum game. All three participants benefit.The savings accumulate to the point that they must be stored. A bank is started by Mr. Max Goodbank: ‘Fish Savings and Loan.’ Mr. Goodbank lives up to his name. He only lends to people who have good project ideas to build capital, creating the chance for a better standard of living in the future.The island is really flourishing at this point. It is a fully functioning economy. The island now has savings (underconsumption of fish), credit (through Mr. Max Goodbank) and investments (loaned out fish). The loaned out fish continue to sustain people while they are working on projects that will increase the amount of capital (nets), providing the possibility of greater future consumption and a better future for their children.In a decisive move, the Islanders decide they will form a government. This government will help them grow by doing the simple task of protecting life, liberty and property. That is all. The islanders will feel safer this way. This will help them work.Franklin Dee is eventually elected as a Senator. He makes some decisive moves. As a politician he does not have the correct incentives. Only interested in reelection, he passes a law forcing Mr. Goodbank to extend credit to different groups who can never pay it back. The economy is drained of critical savings.Franklin Dee also creates the Franklin Reserve Note system. These notes are bits of paper that will fund the government’s ambitions beyond the island. Every note is declared redeemable for real fish with Mr. Goodbank. The government goes nuts creating these notes.Mr. Goodbank eventually realises there are too many notes floating around the island. Worse still, his vault has no more fish. The people cannot eat the paper. What savings will they use to feed themselves while they build important capital (nets) for the island?Franklin Dee and his senators have another plan. It’s a fraud. They employ some ‘fish technicians’. They pass a law forcing islanders to deposit any fish skeletons with Mr. Goodbank. The senators plan to engineer fish that look like the originals but are really half the original size. These are deemed Official Fish by the Senators. Only these Official Fish can be used. Mr. Goodbank does not like the fraud. He protests and is removed by the senators.They are able to create so many fake fish with this scheme that prices on the island double, a result of the excess of so-called Official Fish in circulation. The island has inflation for the first time.The senators get even more greedy. These fish skeletons are eventually engineered with only one-third the amount of flesh as the real fish from the ocean. Prices skyrocket.Eventually the islanders notice these fish are not sustaining them, there is not enough flesh on them. They are clearly less valuable than what they catch in the ocean.The islanders start using offshore fish banks. The senators realise there is a threat if no one is using their fake fish and their Franklin Reserve Notes, issued against them. They pass laws to stop islanders from using these fish banks on other islands.PoliticalInterventionsThe islanders go to the underground economy for real fish. Real fish become so scarce that there is a shortage. No one wants to exchange them for the fraudulent Franklin Reserve Notes. Prices increase rapidly. Inflation gets out of control. Unemployment is a problem for the first time on the island.The senators initiate an unemployment insurance scheme. They print so many notes to cover it that there is a run on the fish bank.The senators at this point are out of ideas. There are no real savings and capital accumulation is stagnant. The senators have come to the limit of their fraud under the Franklin Reserve Note scheme. The fish engineers cannot help.Franklin Dee begs the islanders to start fishing again. However, there are too few people who know how to fish and many more that need fish.

The Legacy

When the fundamental principles and operations of an economy are presented so clearly it is difficult to refute them. This is Irwin’s Schiff’s legacy with this book. The key operations themselves are clear.You first need sacrifice and risk to create capital, which leads to savings. Savings are the physical representation of human sacrifice. They demonstrate a desire to consume more in the future, by consuming less now. They are the manifestation of our will to leave our children a better future. They cannot be printed. YOU CANNOT PRINT HUMAN SACRIFICE. Only savings allow you to invest in further capital production. Anything else is just inflation. This positive feedback loop allows for greater future consumption, provided the savings are invested wisely.Economic actors must be motivated by both fear and greed. Anyone motivated by votes will act irrationally and to the detriment of the economy. Greed is good, so long as it is also balanced by fear. You can not have greed and remove fear. In this situation, again, economic actors will act irrationally and to the detriment of all others.Most importantly, free markets are not zero-sum. That is why they are noble. When they are left to function rationally all benefit from their operations.Ultimately the island must start again, by sacrificing. All individuals must forego present consumption to build real savings and create the economy anew. This means the senators must get out of the way of the process’s good operation.

Tristan Winters


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