A drama starring:
• The USA as: Family A
• Western Europe as: Family B
• China as: Family C
• India as: Family D
• The rest of the world as: Family E
• Gold as: Pearls
• Adolf Hitler as: Adolfo
• Barack Obama, Gordon Brown, Mervyn King, Ben Bernanke and Jean-Claude Trichet as: The Modern Day Leaders of Families A and B
Once upon a time 5 families lived on a small tropical island in the South Pacific. The island was divided up evenly amongst the families and each family was responsible for cultivating a specific animal, fruit or vegetable. Each Friday the families brought their produce to the island’s centre where they traded goats’ milk for bananas and chickens for potatoes.
The families grew in size and the need for buying and selling goods on more days than just Friday became necessary. Each family opened their doors daily to other families to barter. However, it became tiresome to carry a bag of rice to the neighbour’s farm and then carry 3 chickens all the way home. To solve the problem the families agreed to create certificates that would represent their produce. Instead of carrying a chicken to the neighbour’s farm, a family could write up a paper ‘chicken certificate’. They could carry the certificate to their neighbour and hand them the chicken certificate in exchange for a bag of rice. The neighbour receiving the chicken certificate could redeem the certificate for 1 chicken at the same neighbour any time in the future. The system worked well but eventually it ran into problems.
Sometimes a family would bring a chicken certificate to a neighbour that did not eat any chicken, so they could not exchange it for anything. The neighbours agreed that they would allow the certificates to be traded for similar value goods. For example, Family A could exchange their potatoes for a chicken certificate from Family B. If Family A eats no chicken they could take their chicken certificate and exchange it for goats’ milk at Family C. The new improved system worked well. Each year the families would draw up the exact number of certificates for the specific produce they had in store and they would trade the certificates with each other, and buy produce with them. The families eventually gave names to their certificates. Family A called their certificates ‘milk bucks’ while Family B called theirs ‘chicken bucks’. Scholars refer to these certificates as ‘Commodity Money’.
As the generations passed, families began to innovate and added new products to their existing produce. One family built canoes for fishing while another family made fabric and clothes from plant fibres. A number of new products became available for purchase and it became increasingly confusing as to how many chicken bucks could be exchanged for a canoe or how many shirts one could get for a milk buck.
After some long meetings and heated arguments, the leader of Family A came up with a solution. Pearls were the most sought-after commodity on the island. Every family wanted a collection of pearls. They were so treasured because they were beautiful and they were durable. The pearls were also rare and difficult to find because the oysters in which they were found were only to be found deep on the ocean floor. The families were prepared to exchange a lot of produce for a single pearl. The gentleman suggested that they use the pearls as a common unit of exchange because every family wanted them. To start, they drew up a table of all the goods and produce available on the island and gave them each a value in pearls. One pearl could be exchanged for 5 chickens or 7 buckets of goats’ milk. A canoe cost 3 pearls. The families discarded their various chicken bucks and milk bucks and used their pearls to buy what they needed. The system worked very well because the value of a pearl was pre set so there was no more confusion as to how many chicken bucks were required to purchase a canoe. They called the system ‘The Pearl Standard’.
Occasionally a family would lose some pearls while walking in the forests or swimming in the ocean. This infuriated them, especially considering they were carrying more pearls on them as each year passed. They met to discuss the matter. They decided that they would make use of the certificate system again, except this time the certificates would be denominated in units of pearls and not in chickens or bags of rice. Each family agreed to write up a paper certificate for every pearl they possessed. Each family placed their pearls in a secure vault in their houses. They carried their certificates, which they called ‘pearl bucks’, on them to use to purchase goods from other families. Whenever a family found another pearl, they would place it in the vault in their house and write another pearl buck for it. This meant each pearl buck had a pearl hidden in a vault to back it up.
The families printed their family insignia on the pearl bucks that they issued. This was a way to promote their family name, but more importantly it meant that someone who held a pearl buck knew that if they wanted to collect the actual pearl, they could go to the family that issued that certificate and demand the actual pearl.
The new system worked wonderfully well and the people on the island multiplied and lived happily together. Sadly, after a number of generations, a member of Family B became corrupt and evil. His name was Adolfo. Adolfo decided that he didn’t like the people in his and other families. He wanted to take over their farms and kill the people he didn’t like, so he invaded the other 4 families. Those 4 families teamed up and fought back. Many family members were killed on both sides of the war, which lasted for many years. Eventually the 4 combined families defeated the evil uprising.
Unfortunately the war devastated the island. The families had planted and manufactured very little in the war years. The people were hungry and most of the island needed to be rebuilt. The families wanted to rebuild the island as soon as possible and feed the remaining people. However, rebuilding the houses, building new canoes, manufacturing new clothes and planting new crops would cost a lot of pearl bucks. There were not enough pearls or pearl bucks on the island to pay for the rebuild, and it would take many years to dive for that many pearls. The members of all the families met again and decided the only way to rebuild the island was to allow families to write pearl bucks for pearls they did not have. This would allow them to purchase what was necessary – the need was immediate. They would gather the pearls later. It would also get people working. They managed to rebuild the island successfully, but by the time they had done that, they had written so many new pearl bucks that they would never be able to find that many pearls in the ocean. They realised a canoe now cost 4 pearl bucks instead of 3. A pearl buck could purchase less because there were more pearl bucks on the island than there were goods. Producers could therefore demand more for their goods and the level of prices rose. They called this phenomenon ‘Inflation’.
They also thought it silly to continue searching for pearls when there were clearly not that many pearls in the ocean. They decided to scrap the rule that said pearl bucks needed to be backed up by pearls in vaults. They said the value of a pearl buck would be backed up by confidence in the pearl buck. Scholars referred to the new pearl bucks as ‘Fiat Money’.
They also formed a committee of all the heads of the families. The committee agreed that their families would be ‘responsible’ in issuing pearl bucks – they agreed not to issue ‘too many’ pearl bucks. They called this agreement the ‘Bretton Woods Agreement’. Families went on issuing pearl bucks when necessary and everything worked well until the middle of 2008.
In the middle of 2008 it became known that the leaders of Family A and Family B had granted carte blanche to some of their family members to print and issue pearl bucks. These family members became very rich because of all the pearl bucks they issued. They formed elite clubs. Family A’s club was called ‘The Wall Street Club’. When asked by Families C, D and E why they had allowed their members to issue pearl bucks willy nilly, the leaders of Families A and B defended themselves. They said that they trusted the members of The Wall Street Club. They believed they should give their family members freedom. They called this freedom ‘Capitalism’ and said they believed in it.
Because their members were printing so many pearl bucks, Family A and Family B were able to buy many nice things from the other families and live very comfortable lives in big lovely houses. Families C, D and E were also happy to keep receiving payment in pearl bucks issued by Families A and B because they were seen to be prestigious families. They even took to storing these pearl bucks in their vaults. They called these stores ‘Foreign Currency Reserves’.
In 2008, people became aware that these families had been printing ridiculous amounts of pearl bucks for many years. The family members that were responsible immediately stopped printing pearl bucks, realising that they had possibly gone overboard. Now the heads of these 2 families found that they had been living beyond their means – now that they were not printing pearl bucks anymore, they did not have pearl bucks with which to buy as many nice things.
So what did the heads of the Families A and B do?
When the heads of Family A and Family B saw that their family members were not as happy because they could not buy as much as before, they were outraged. They said that it wasn’t right for peoples’ standard of living to drop. They said their people deserved to live a good life and they deserved to have jobs. In response they proposed a plan. The head of Family A said that he himself would start printing pearl bucks, but that things were different this time. He said he would personally guarantee that any other family would be able to redeem the pearl bucks that he had issued. He called his plan a ‘Stimulus Plan’.
The families all agreed that it was better to print more pearl bucks now so that people would not go hungry. They would be able to work it back in the future – that would not be a problem. And so Family A and Family B began printing pearl bucks again. They used the pearl bucks to build new houses and manufacture new things that they could sell to the other families. They denied that it was reckless spending. Scholars called the new issue of pearl bucks ‘Quantitative Easing’.
The other families seemed satisfied with this state of affairs. They believed what the leaders of Families A and B told them. They believed that it would be better for all to continue printing pearl bucks because all the families were so dependent on one another. They continued to exchange their goods for these newly issued pearl bucks and continued to store these pearl bucks in their Foreign Reserves. Things were tough for a while but soon people were living not much differently to the way they were before. They thanked the leaders for the Stimulus Plan, who slammed their critics by proving that Quantitative Easing did work. And that is how we find the island at the present day...October 2009.
What will happen next?
The ending to the drama is still being written. One of two things will happen – they will either raise taxes or they won’t. If the leaders of Families A and B raise the taxes on their family members, they will be able to pay back the trillions of pearl bucks they have issued. This would be unpopular for the leaders’ own leadership careers. Also their family members would get angry because they would have less pearl bucks to spend on things that make them happy.
If the leaders don’t increase taxes, one fears Families D and E, and especially Family C, will eventually lose confidence in storing and accepting pearl bucks from Families A and B. In time they will realise they don’t need these families as much as they did in the past. They might start redeeming their pearl bucks en masse. The value of the pearl bucks with the insignia of Families A and B will decrease – inflation. If Families A and B are lucky they will be able to give the other families something for these redeemed pearl bucks, and at best will suffer inflation. If they are unlucky and cannot give them something for the redeemed pearl bucks then...oh let’s not think about that, it would be too tragic.