How an Economy Grows and Why It Crashes ebook

Understanding how can economy crashes from the Austrian point of view can be very complicated. You have to know capital theory, what interest rates are, how resources are coordinated, etc. Many people do not have the time to learn all of this.

Peter Schiff’s book tries to take these complicated theories and teaches his readers through a short story about the progression of a small island economy. Peter’s book is an updated version of his father’s book How an Economy Grows and Why It Doesn’t by adding recent events and characters to the story.

The book introduces us to a little bit of history of the science of economics in the last hundred years. Peter talks about the early Austrians and the rise of Keynesianism in the 1930s as a counter to the Great Depression. Keynesianism became the dominant paradigm and has plagued economics and the world since.

Once Upon a Time

The story starts with three islanders – Able, Baker, and Charlie. They were in dire poverty. The only resource they can gather is fish, and only one per day since they are using their bare hands (just enough to survive in this story). Since they consumed everything they caught, there were no savings in case something bad had happened.

But they wanted more for their lives than spending the entire day catching one fish. Able came up with an idea to create a fish catcher, but in order to create this device, he must sacrifice a day and become on the verge of starvation to try and produce this net since there are no savings. When he created this net, his productivity doubled as he is now able to catch two fish per day.

Throughout the book, Peter slips in economic ideas by explaining what the islanders are doing and sums up these ideas at the end of each chapter. For example, when Able created the net, he had to sacrifice eating a fish for a day, which meant he underconsumed, in order to create a net, or a capital good.

As the story progresses, as there are now savings thanks to Able’s invention of the net, economic expansion accelerates. Able is able to do more than just fish because he now has a net. As they continue to save and create capital goods, their lives become better.

The story continues with the explanation of other economic theories, such as the interest rate and what they do, why banks are created, how trade expands, the division of labor, and finally, how governments inflate the currency and drive interest rates lower to create an economic boom with an inevitable crash.

Epilogue

The story ends and Peter shifts to the modern day, as he explains how the bursting of the dot-com bubble and George Bush and Alan Greenspan’s heavy intervention into the market has fueled the bubble for the housing bubble and created the crash. He continues to describe how the government, instead of learning from the lessons of the past, keeps trying the same thing that caused the last crisis. When Obama came to office, he did the same thing Bush did, which was to stimulate the economy in order to make it look good for re-election. So if you really want to understand the cause of recessions in an easy and fun manner, Peter Schiff’s book will tell you a good story.

What a fantastic book! I admit, when I put it on my Wish List, I had it confused with the author's FATHER'S insightful and fun book from years ago (which was purely a comic book, unlike this book). But this is better for several reasons: (1) It's a "real" book---not a comic book! (2) It's a handsome, well-made, coffee-table book; (3) It still has some comic illustrations, but only just enough to be entertaining and illuminate a point being made here-and-there; Make no mistake: This is for adults or older kids and teens.
More importantly, the book is a paragon of clarity, in teaching the basics of capitalism and free-market economics, and the harm of government intervention into the economy. It's fun, and addictive, to start with the simple analogy of a 3-man, desert island economy, ...and build from there, in discussing key concepts. To my surprise and delight, even my 12 year-old son saw it laying around and picked it up, and read the first two chapters non-stop---and said he found it "great."
I will say, that it does get a bit confusing at around Chapter 12 and a discussion of the "error" of global trade imbalances in a world where the Dollar has world-wide Reserve Status---and I'm not totally convinced the author isn't wrong on this point---but maybe I need to re-read the book from that point onward; My understanding of free-market economics was always that there is no such thing as a "trade imbalance"...

The book is pretty heavily biased towards conservative thinking and as a good liberal this bothers me.

I didn't like the tone but I kept reading because I wanted to see how the economy crashes.

Peter gets it right.

For thousands of years money was tied to tangible things with intrinsic value that couldn't be inflated or deflated on demand.

If you wanted more gold, you had to mine it. If you wanted more cowry shells you needed to find them. This mean that the simple act of saving was a safe thing to do. It was (and still is) physically hard to find more gold.

So when you saved gold, it held value. That value could be lent out. It could be put to use.

Now we have paper money. Most countries left the gold standard around the first world war. Winning a war will convince most any government to make bad choices. The US left the gold standard to try and hurry the end of the Great Depression.

$1 in 1918 is worth about $18 in today's money. Put another way that same dollar put into a shoebox for 100 years has devalued 95%.

$20.67 in 1918 was exchangeable for 1 troy oz of gold. Put this another way, you could have exchanged it for 48 mg of gold and that gold today would be worth $60.

... Why would anyone care though? We have paper money it buys things, right?

The problem as Peter puts it is ... any dollar as soon as it's earned is worth less. Most don't get raises at the pace of inflation. For hundreds of years prices in America were stable, or they fell as things got cheaper and more abundant. Since the supply of money was more or less finite, and since the amount of goods created increased prices fell. That's basic economics.

Prices made sense, because there was only so much money. Penny candy was .. a penny. There were stores called "the five and dime" (0.05 cent and 0.10 cent). Things got cheaper over time. Saving made sense as money was valuable.

Today's money, everything is always more expensive. It's always more expensive because the amount of money circulating is always growing. The amount of money circulating is always growing because the government needs debt because it can't raise taxes to pay for it's outlays.

That money must come from someplace.

Quantitative Easing (today's approved voodoo to print money) is where the central bank (not part of the government) buys government bonds (we agree to pay more dollars in the future for dollars today) in exchange for dollars. When the government can't afford the interest payments the government just issues more bonds which the central bank buys in exchange for more dollars.

Find a picture of the M2 money supply. We are talking oceans of new money, but it isn't printed, most of it is digital.

Since more dollars are circulating, everything is worth less, since everything is priced in dollars.

When everyone has more dollars (supply has grown) prices for things increase.

The 2008 housing crisis was caused by money oversupply. Instead of people saving to buy a house with finite money, too much credit was extended to weak borrowers. Suddenly there was a housing shortage because everyone was buying houses which drove prices up. Since prices were going up so fast, everyone wanted to invest. Since houses became investments (instead of a place to live), house prices became insane. Since there was a sudden housing shortage, builders went into overtime making houses no one really wanted that people purchased anyway, because they were great investments.

The bubble popped when interest rates rose. Interest rates rise when the central bank needs more money. Many of those loans were tied to floating interest rates. Many buyers didn't plan to actually live in their houses, they just wanted to resell them for a profit. Suddenly many buyers decided to default (no downpayment they aren't losing any of their money) The government rewarded people for flipping houses. The government guaranteed loans. Large sections of the housing financial market didn't have ANY risk or ANY incentive to use good judgement.

... Anyway, that's part of the book, or my understanding of it.

I removed a star because parts of it offend my liberal sensitivities, I really want to think we can just print money, be good socialists, tax the rich into oblivion, etc and it looks like there is a way (other countries do a much better job running their governments) but Peter doesn't want to give any solutions to the problems he points out. Most of the book is thinly veiled Libertarian Ayn Rand stuff, but ... parts of the ideology are correct.

Government does have a place but it's obvious sometimes the mistakes it makes are ... really, really bad.