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On the back of the Housing Bubble and credit collapse of 2008, Peter Schiff, a leading Stock Broker, decided to write a book on the underlying causes of these economic catastrophes. Written in 2010, the book focuses on how inflation, deficit spending, and central banking can all be driving factors behind the multiple economic crashes we have seen throughout history.
Although Schiff’s book offers multiple anecdotes and real-life examples, we have noted five clear themes that run throughout the 17 chapters of the book. Therefore, this book summary will aim to provide an outline of these five messages that underpin the book, so that you can gain a better understanding of the message Peter Schiff is trying to provide. This book is particularly important due to the lack of progress that has been seen within the field of economics, in comparison to other academic areas.
Underlying Theme 1 – Increasing Productivity
“I don’t want the technology of the 1950s, but I want the free market of the 1950s.”– Peter D. Schiff
Schiff defines the economy based on productivity and resources. In fact, Schiff states that the economy literally translates as the effort of society to maximize the availability of limited resources to meet as many human demands as possible. In the modern world, these human needs are increasingly complex. We all still demand the necessities of life, such as food and shelter, but we do not also demand more complex resources such as smartphones with the most advanced technology integrated and supercars that come with great acceleration and environmental bragging rights.
The economy has been growing because it now takes us less time to provide the same resources. Say that it previously took people an average of 0.2 working days to meet their daily demand for food. A thousand days to meet their demand for getting a shelter. 10 days to get that neat smartphone and 600 days for the supercar. Today, it only takes 0.1, 500, 5, and 300 working days, respectively, to meet those demands. An increase in productivity has allowed food, shelter, smartphones, and supercars to become more readily available to the general population. This is the goal of an economy. Compared to the first calculations, you can now get a house, a supercar, 10 smartphones for all your relatives and food for a thousand days, and still have 50 days left for leisure time. Compare this to buying just one house before. Schiff sees this as undoubtedly a good thing.
However, it is important to note that this reduction in working time and increase in leisure time is not by chance, it is related to productivity. It usually takes new tools that come from innovation which, in turn, come from savings and risk-taking. This risk-taking often already requires a degree of leisure time, as no person is particularly innovative if they have to work all day just to fulfill the basic need of putting food on the table for his family. For an economy to increase its productivity, then, which is the primary goal, savings are required to facilitate innovation. Therefore, Schiff then underlines the importance of savings.
Underlying theme 2 – Savings are Important for Everyone
In his book, Peter Schiff provides a clear and enlightening illustration of how the economy grows and why it crashes; however, we have attempted to apply the features of this illustration to savings, specifically. Just think about it like this: for every lodge, or semi lodge, project there must be savings. If no one in the economy saved up more than a single day’s worth of money, how would then, for instance, large infrastructure projects be built? New medicine be discovered? Industrial innovations be made? Such projects cost up to many thousand days of savings for many thousand individuals to complete.
Schiff points out that not all savings are created equal. Some help the economy grow faster than others. There are four primary ways which savings can be used.
- Money saved for a rainy day
- Money consumed for personal pleasure
- Money lent out to those in need
- Money invested
The first of these might not be helpful in allowing the economy to grow in a direct way, but it is important to consider how saving money for a rainy day is a vital buffer for times of turmoil. Some individuals, companies, and governments have learned this the hard way during the current Coronavirus pandemic.
The second alternative doesn’t help the economy grow. This is the worst use of savings. The economy doesn’t grow because we consume more. We consume more because the economy grows. According to Peter Schiff, thinking that we can spend ourselves out of economic troubles is the main problem with the current paradigm within the field of economics. Consuming more than we can afford today will eventually be troublesome, either for our future selves or for our children.
Loans are the third alternative. And if they are made for business purposes, rather than for consumption, they can really help an economy grow. Just think about the aspiring entrepreneur. Without savings from either himself or someone else, he or she can’t possibly build his own business because he’ll need a steady stream of income to put food on the table for his family.
The fourth alternative, which is investments, is great for the same reason that business loans are great. By looking at these four alternatives, it’s easy to see that a capitalistic economy works. The lender wants interest payments and the investor wants dividends. And these are both selfish motives, but they will have positive spillover effects on everyone else in the economy, too. A very important concept here is opportunity costs. Just like pretty much everything else, savings are limited. Savings that are used for consumption couldn’t be used for business loans or investments.
It is therefore harmful to the growth of our economies that most governments are running monetary policies that incentivize consumption but disincentivize lending and investments.
Underlying theme 3 – Comparative Advantages
One of the ways in which to consider productivity and how to maximize it is by considering how having individuals specialized within a specific field is integral to productivity. For example, imagine a society consisting of people A, B, C, and D. All of these people aspire to have the basic human needs of the modern world: food, shelter, smartphones, and supercars. However, these individuals are not equally efficient in producing these items. B, C, and D could produce one day’s worth of food in 0.2 days of work, while A could produce it in just 0.1 days. Comparatively, B was the most efficient shelter constructor, building one in only 500 days, while it took the others double the time. C was a gifted smartphone designer and it took him just five days to produce one, while it took the others 10 days. Similarly, D was the most skilled supercar maker, at a production time of 300 days, instead of double the time is shown by the others.
Within this analogy, which is what our modern world is like if each individual uses their talents in an optimal way, they should let A produce the food, B build the shelters, C assemble the smartphones, and D make the supercars over a lifetime. This will clearly maximize productivity. On average, we can expect they will each demand food for about 30,000 days; five houses, 500 smartphones, and 10 supercars. Now, if they don’t use their skills or comparative advantages in an optimal way and produce everything themselves, they would each have about 10 to 11,000 days of leisure over a lifetime. However, if they use their comparative advantages and let each do what he is best at, and then trade goods with each other, they’ll have between 18 and 20,000 days.
Basically, if workers in an economy, specialize in what they are best at, the productivity of the economy will grow. Therefore, comparative advantages are important for the economy within the country. However, we must also consider how international trade can be equally important in improving productivity and the amount of leisure time we have. Consider if K and L from other countries than A, B, C, and D are capable of producing food in just 0.05 working days and shelters in just 250…everyone could have even more leisure time. Moreover, more savings would be available for business loans and investments, which could increase the productivity of the economy even further down the line.
Some might worry that there then wouldn’t be enough jobs to go round. Schiff challenges this by pointing out that the goal of an economy is not to provide jobs, the goal is to maximize productivity in an economy where productivity is increasing and comparative advantages are maximized. Therefore, prices should actually be decreasing. L can sell shelters at the price of 350 working days and still make a profit, while B had to sell them at the price of 600 working days to make the same profit.
Underlying theme 4 – How the Government are Complicit in Stunting Economic Growth
“Boom/bust cycles are not inevitable and would not occur were it not for the inflationary monetary policies that always precede recessions.”– Peter D. Schiff
Schiff accepts that there are some services that should arguably be universal to everybody within an economy. This is partly because the free market does not offer a solution for providing these human needs in an effective way. These are personal safety and justice. For example, A, B, C, and D might consider giving away some of their production to hire E for security and F for justice. And E and F would then be hired as this country’s governmental employees. One important thing to notice here is this: the government itself doesn’t produce the basic needs of the economy. It uses the taxpayer’s savings to provide services. For this reason, government spending is the same as the taxpayer’s spending. Schiff states that we must never forget this. A bit more questionable is when the government starts to provide services like healthcare, infrastructure, education, and banking. The important question to always be asking is whether the government can provide these human needs in a more efficient way than the marketplace can.
Schiff encourages the reader to consider that politicians want to be reelected. For this reason, governments spend savings when it is politically most critical to do so. Private lenders, on the other hand, only spend savings where it is economically defensible to do so. Because of this, private lending is more efficient in helping the economy grow. Here is the important part: if the savings are wasted, the economy grows much slower than it could have. In some cases, it even causes it to crash. During the financial crisis, for instance, it could be argued that the government played an important part in the downfall. The boom that occurred in housing prices was partly caused by governmental actions. The federal interest rates had been lowered to make borrowing cheaper and banks were incentivized to issue riskier mortgages, as they knew that they could sell these loans immediately to governmental entities. In other words, the government decided that American private savings should go towards an upgrade in the housing standards of its people, especially people with limited finances.
Underlying theme 5 – Banks are Integral to Whether an Economy Grows
“They should let my son be Federal Reserve chairman. At least he’ll play with his toys and not ruin the economy.”– Peter D. Schiff
Banks are vital within society as they help people to save money in a safe way, while also allowing people to allocate and invest money in more educated ways than they would know. In this way, banks help maximize the productivity and efficiency of savings. The interest rates, or payments to those who decide to lend their money to banks, are decided by three factors.
- A desire to maximize one’s returns on deposits
- A fear of losing capital on risky projects
- A time preference for consumption
Here is how the relationship between the government and banks limits our productivity. Schiff encourages us to consider this scenario: If the government decided that a smartphone must cost $500, most people would describe these actions as communism. We do not enjoy it when the government intervenes with the price and production of goods. However, for some reason, we are okay with the government setting the price of savings and loans. In the US, the Fed is effectively determining the price of money by deciding the interest rates at which all other banks can borrow and lend through the federal funds rate.
Schiff provides three reasons for why it is potentially a better idea to have individual banks decide on rates themselves, as opposed to a centralized entity deciding on these rates for them.
- Federal representatives make short term decisions that the business owner of an individual bank would never do. It is very questionable if the centralized Fed can make more informed decisions than the aggregate of millions of independent decisions. The Fed typically makes decisions that are based on political rather than economical factors. The chairman of the Fed, for example, is nominated by the president of the US, so the fate of the presidents and the Fed chair is intertwined.
- The inflationary, monetary policies that are followed today are harmful to our economies. They are harmful because they incentivize spending instead of saving. Inflation is simply a means to transfer wealth from anyone who has savings in a particular currency to anyone who has debt in the same currency.
- Misuse of credit and leverage has been one of the primary reasons for all five of the greatest economical crashes in history.
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