It is the month of August; a resort town sits next to the shores of a lake. It is raining, and the little town looks totally deserted. It is tough times, everybody is in debt, and everybody lives on credit. Suddenly, a rich tourist comes to town. He enters the only hotel, lays a 100 dollar bill on the reception counter, and goes to inspect the rooms upstairs in order to pick one.
The hotel proprietor takes the 100 dollar bill and runs to pay his debt to the butcher. The Butcher takes the 100 dollar bill and runs to pay his debt to the pig raiser. The pig raiser takes the 100 dollar bill and runs to pay his debt to the supplier of his feed and fuel. The supplier of feed and fuel takes the 100 dollar bill and runs to pay his debt to the town’s prostitute that, in these hard times, gave her “services” on credit. The hooker runs to the hotel, and pays off her debt with the 100 dollar bill to the hotel proprietor to pay for the rooms that she rented when she brought her clients there.
The hotel proprietor then lays the 100 dollar bill back on the counter so that the rich tourist will not suspect anything. At that moment, the rich tourist comes down after inspecting the rooms, and takes his 100 dollar bill, after saying he did not like any of the rooms, and leaves town.
No one earned anything. However, the whole town is now without debt, and looks to the future with a lot of optimism.
The first comment on the post gets the answer right-
This town seems to have reverted to the barter system of economics. It’s not much of a brain twister and becomes more obvious if only two people (barterers) are involved: the baker gives the cobbler $100 worth of bread for $100 worth of shoes. They could continue the fiction that each owes the other $100, but on their respective balance sheets, payables and receivables perfectly cancel out.
and another one a few comments later, but its disheartening to see people tie themselves up in knots by bringing in “macro economics,” economic models and even suggesting fiat currency! The hotelier could have written a promissory note on a piece of toilet paper, signed it as Karl Marx and sent the note on its way and things would have evened out because of the circular nature of the debt.
The trouble is that such crackpot analogies are used by statist economists to support the “stimulus,” either “quantitative easing” (let the printing begin) or credit expansion by fiddling with the central bank-determined reserve ratios. Since Friedman’s helicopter is defective by design, those who get their hands on such money last are the ones who get screwed, every time. What’s missing in the teaser is an acknowledgment of the fact that though consumption drives production, something has to be produced first before it can be consumed. If Scrooge McDuck left the hotelier a trillion dollars in cash, there’s nothing he can do within the ghost town with that kind of money because there are no goods to buy because there’s no one producing them. He could at most buy out the butcher’s entire production and hire the prostitute for the whole year, but what are the recipients of his largess going to do with those dollars? That’s the dirty secret of the stimulus. It doesn’t produce anything, stimulate anything, create or save anything. It only lets those who see the money first take advantage of that fact. Everyone else gets the shaft.
Krugman and his economics. Some of his ideas are, to use a phrase his colleague(?) DeLong used to describe Mises’ monetary theory, “batshit insane.” His ideas being part of the mainstream, therefore, tells us a lot about the quality of the mainstream. His brilliant idea, which he keeps repeating every few years or so, the babysitters’ co-op/ club/ whatever-
The Sweeneys tell the story of–you guessed it–a baby-sitting co-op, one to which they belonged in the early 1970s. Such co-ops are quite common: A group of people (in this case about 150 young couples with congressional connections) agrees to baby-sit for one another, obviating the need for cash payments to adolescents. It’s a mutually beneficial arrangement: A couple that already has children around may find that watching another couple’s kids for an evening is not that much of an additional burden, certainly compared with the benefit of receiving the same service some other evening. But there must be a system for making sure each couple does its fair share.
The Capitol Hill co-op adopted one fairly natural solution. It issued scrip–pieces of paper equivalent to one hour of baby-sitting time. Baby sitters would receive the appropriate number of coupons directly from the baby sittees. This made the system self-enforcing: Over time, each couple would automatically do as much baby-sitting as it received in return. As long as the people were reliable–and these young professionals certainly were–what could go wrong?
Now what happened in the Sweeneys’ co-op was that, for complicated reasons involving the collection and use of dues (paid in scrip), the number of coupons in circulation became quite low. As a result, most couples were anxious to add to their reserves by baby-sitting, reluctant to run them down by going out. But one couple’s decision to go out was another’s chance to baby-sit; so it became difficult to earn coupons. Knowing this, couples became even more reluctant to use their reserves except on special occasions, reducing baby-sitting opportunities still further.
In short, the co-op had fallen into a recession.
His solution, print more “coupons” because as far as he’s concerned, people are after coupons. But why not print a gazillion coupons and borrow the Friedman-Bernanke Helicopter Co.’s one and only helicopter and shower them all over Washington D.C.? Oh no. That would cause a problem of plenty. The system that must be followed is one central coupon printing authority which controls the coupons in the “market” based on how the market is stocked up on the same. If there are few coupons because everyone has stockpiled them, flood the market with coupons by allowing couples to “borrow” coupons and then “repay” them when they do earn their own coupons. Thus the recession is averted. So, instead of spending money on babysitters, thus getting rid of all these calculations and fear psychosis, one should give up control over one’s life, at least partially, to a coupon printing authority. There, such a simple story has taught an excellent lesson in economics-
If you think this is a silly story, a waste of your time, shame on you. What the Capitol Hill Baby-Sitting Co-op experienced was a real recession. Its story tells you more about what economic slumps are and why they happen than you will get from reading 500 pages of William Greider and a year’s worth of Wall Street Journal editorials. And if you are willing to really wrap your mind around the co-op’s story, to play with it and draw out its implications, it will change the way you think about the world.
Of course one could also use Mankiw’s trick of declaring “coupons” with a particular end digit invalid as long as the recession continues. That way everyone will be rushing out to visit places they don’t want to visit thus spending money they wouldn’t have spent, or imposing on people who don’t want to have them there at that particular time. In the long run, it would have been much better if they had hired the damn babysitter. But if people start doing that, what will the poor bureaucrat who’s manning the coupon printing authority do?
The tale is so flawed that its astonishing that people are taken in by it. But then people are taken in by fiat money too. The first mistake, if one is not careful, is assuming that the demand is for coupons which it is not. The demand is for baby-sitting hours. The demand for coupons exists only because it is supposed to guarantee such hours. If we kill the “co-op” idea and adopt laissez faire, as long as there are more baby-sitters than “baby-sittees,” there is no problem in the market. The couples could have different kinds of agreements amongst themselves, “borrow” and “repay,” take turns, hire someone from outside—the free market is extremely versatile in this sense. But we have an economist who’s a rabid anti-freemarket type, or miserly couples, or a combination of the two. So everyone has decided to adopt the authoritarian model of baby-sitting instead of the free market one. That is the first “wrong.”
Okay, babysitting for profit is banned in the city and the only way to get babysitters is if you are registered with the co-op. Even then, the system would work well if the bureaucrat stopped meddling in the affairs and the couples stopped paying attention to the “face value” of the coupons. If there are a limited number of coupons in circulation, those who don’t have it would be willing to offer more hours than what the face value promises. A desperate couple could offer three hours of service for two coupons or any ratio which the market could settle upon. Its only the bureaucratic mindset of the couples which prevents them from thinking about the issue in these terms. After all, they are all employed by the government, or those who make money by being in power (“congressional connections”). Thus the market could take care of itself, decide its own rate without the authority being involved at later stages. “This,” the increase in the purchasing power of the coupons, is deflation. It helps those who save, and penalizes those who don’t. And that’s why Keynesians hate it so much. He, Keynes, did advocate the “euthanasia of the rentier”. And then there’s the so-called “paradox of thrift” blah blah blah—excess savings cause recessions.
But the authority won’t let this happen. Any attempt at trading coupons at more than face value will be treated as usury, exploitation etc etc, and the authority will lend to profligate couples who have a track record of zero savings plus living beyond their means. The assumption here is that these couples will somehow pay them back, which might not happen. Further, the new coupons have been produced out of thin air with no baby-sitting hours to back them. (Actually so were the original coupons. One still doesn’t know how the original distribution took place.) And these couples will enter the market with their new found wealth. In this limited scenario, one doesn’t know how the couples who saved fared, but Krugman has a little gem tucked in the long piece “Eventually, of course, the co-op issued too much scrip, leading to different problems …” Which is what happens in the real world because the central bank is as clueless as the co-operative looking over 150 families. What didn’t work, can’t work, at such a small scale is supposed to be a lesson for countries with gazillion dollar economies.
If this is economics, I prefer witchcraft.
[Read the Mises Institute's David Gordon writing about the same tale. He completes the story using Krugman's book. Krugman is not a fool; I take back my "batshit insane" comment w.r.t. him, and only him. He's merely anti-free market. That's his religion.]