Monday, July 12, 2010

Peter Schiff's Parallel Universe and Ours

Under discussion: How An Economy Grows And Why It Crashes by Peter D. Schiff and Andrew J. Schiff, 233 pages, $19.95, Hardcover.

In that parallel universe Peter Schiff is probably winning his race for Senate.

But here in the United States of Criminals, Celebrities, and Corporations, he barely has ballot access in the Connecticut race to replace Chris Dodd where he trails such Republican heroes as WWE First Lady Linda McMahon and former congressman Rob Simmons before Simmons dropped out.

The groundswell for a Schiff candidacy emerged in the aftermath of the 2008 financial collapse which Schiff had predicted for years, explaining that the illusion of wealth created for the housing boom could not be sustained and that the inevitable bust would spread to other sectors of the economy. A mash-up video of his appearances on various financial TV shows in 2006 and 2007, where he was openly derided and actually laughed at, is titled “Peter Schiff was Right” and has been a Youtube sensation with over one million views.

So just how did Peter Schiff, president of Euro Pacific Capital brokerage firm, know that the economy was going to crash when almost every pontificator on both sides of the aisle was promising that the good times would never end? Did he have a crystal ball? Was he imbued with special powers to see when those unpredictable financial catastrophes are barreling down the road?

Well, one thing Peter Schiff was blessed with was a father who discovered the Austrian school of economic thought after breaking out of the New Deal orbit sometime during the 1950’s.

Schiff’s father, Irwin, is well-known among anti-IRS crusaders and perpetual victim of the income tax tyranny. At 82, Irwin is currently in federal prison (not for the first time) after unsuccessfully challenging the tax code.

But when Irwin was much younger, he entertained his boys in long car rides with economic lessons disguised as stories. One such story was “The Fish Story” which Irwin turned into a book in 1979 entitled, How an Economy Grows and Why It Doesn’t. In 2010 “The Fish Story” was modified and turned into How an Economy Grows and Why It Crashes.

At first, How an Economy Grows almost seems an odd selection for a traditional review because it is so simple and straightforward. Since the inspiration for the book is a children’s story, it’s written on a level anyone can understand. And with many of the fictional characters (from Ben Barnacle to Tricky Dickson) based loosely on real people it is certainly entertaining for adults.

The narrative can really be split into two sections. The first half is about how a primitive society began on a remote island. From there the reader is introduced to basic Austrian economics through fish. Since fish is the abundant material on the island and holds real value for the islanders it is the obvious choice for currency. The fish had value everyone on the island could appreciate and understand. Someone wants a canoe? That’ll be nine fish. That might be a lot of fish, but a canoe was a luxury and cost a lot to construct.

Then as time progressed and people had more fish on hand they discovered they needed some form of fish repository – a bank!

With depositors fish could be loaned out to prospective entrepreneurs. If the would-be businessman had a good opportunity to repay the loan with interest then there was a better chance he could get the loan in the first place. The bank might have to turn people down for loans, but they had to because they were at risk themselves. What if the loan was issued to someone who couldn’t handle it and defaulted? Who would bail them out?

Here the reader learns about the basics of banking, lending, credit, and saving.

As the people of the island increased their numbers they realized they needed some form of government and so the second half of the story begins and the republic Usonia was born. Governed by 12 senators including an executive Senator in Chief, a constitution was written so that the senators would not overstep their authority.

But after a few generations, the Senate’s wise and prudential statesmen were replaced by more appealing “go-getters.” Schiff portrays the moment things changed when Senator in Chief hopeful Franky Deep came into power:

“He observed that people loved getting stuff for free. Similarly, they hated paying taxes. So, he devised a plan: if he could find a way to make it look like he was giving something to the islanders for free, then he could gain their unconditional support. Unfortunately, all the government had was what it raised in taxes. The Senate didn’t catch any fish. They could only give by taking. How could they give away more than they took?

“After a particularly bad monsoon, Franky sensed an opportunity (politicians never let a crisis go to waste).

“He preached, ‘My fellow islanders, the storm we have just been through has wrought untold hardship on our people. Many of our citizens are now hutless and fishless.

“’We cannot stand idly by and do nothing. If elected, I will institute a government reconstruction program for our neediest citizens to repair the damage.’ But he assured the citizens that the cost of the construction would be paid for by the economic activity the spending generated.

“His opponent, Grouper Cleveland, offered nothing, except wise stewardship of the island’s savings and a promise not to interfere with the liberties of the citizenry.

“Not surprisingly, Franky Deep sailed into office as Senator in Chief.” (104-105)

With the institution of paper money in the form of Fish Reserve Notes, redeemable pieces of paper backed by real fish in the vaults, the rest of the story is laid out:

“The new bank director . . . was not crazy about the new fish notes. He thought the ease in which the notes could be printed would create dangerous incentives for the senators. Yet, he could sleep soundly at night provided that the government maintained enough actual government fish in the bank to redeem all the notes.

“Not surprisingly, his confidence didn’t last long.

“Soon, Franky and his agents had handed over far more Fish Reserve Notes than the government’s account had fish to redeem.”

“’Franky, stop the presses! . . . I have only nine fish available for every 10 notes that you guys have handed out. If the savers figure out that there really aren’t enough fish to cover their deposits, there will be a run on the bank and I’ll be out of fish. . . .’” (107)

Slowly but surely all of his successors followed Franky’s lead. The newly-appointed bank chairmen, beginning with Ally Greenfin and later with Ben Barnacle, followed in giving the government what they wanted. After Franky Deep came Lindy B, promising to

“Furnish the canoe navy with bigger spears, but he would also help the sagging economy by 'providing emergency unemployment fish notes to all laid-off workers' prevailing over Buddy Goldfish who offered nothing but careful stewardship of the island’s savings and boring protection for the islander’s economic liberties. More importantly, Buddy argued that the island could not afford such an extravagant ‘spears and fish’ policy.

“Not surprisingly, Lindy won in a landslide.” (126)

And comparably broad parallels to modern America finish out the story.

Humorously illustrated, Schiff’s story is a pleasurable read. It demonstrates that basic knowledge of economics is simple and that the laws of economics apply the same to complex societies as they do for simple ones. In short, if more saving is necessary for people on a small island to recover from disaster then saving is what is necessary to rescue a large society.

Peter Schiff will certainly not win his election for U.S. Senate in Connecticut. But he has bequeathed a valuable chapter of economic education to his country.

Perhaps this time people will listen.

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