Every now and then, a natural storm destroyed a few houses, disrupted the supply of fish for a few days, and sometimes even drowned a few of the locals. The islanders knew that the world is full or surprises, so they were careful - they always saved part of the fish they caught in special reserves for a rainy day, appointed lifeguards to sit on the most dangerous beaches, kept themselves in good shape, and taught all their children how to swim.
One day, a bunch of local businessmen came to the island's government with a proposition: Give us a license to manage the ocean and we'll save you all these unexpected troubles! This way, you can spend more time on productive activities, and make long term plans. We can build a perimeter around the island to control the flow of waves. In addition, we can make sure that all of the fish in the special reserves are protected and well-nourished, and regulate the number of fish who reach the coast every day".
The government was not sure if this was a good idea, but when the businessmen promised that government will always get enough fish for its members and wave energy for its projects - the government agreed.
And so, a perimeter was built in the water around the island, everyone's fish reserves were handed over to the new Fish and Energy Depot (the FED), and the government informed the people that from now on everything is under control and there is nothing to worry about.
The new system worked well. The FED let through an ample supply of waves and fish and took reasonably good care of everyone's fish reserves. Of course, a good amount of the waves were channeled towards government projects, as well as some of the fish, but as long as things went well, nobody asked any questions.
The islanders got comfortable and started spending more of their free time on new activities. They no longer needed to keep fit or teach their children to swim. The government also kept less lifeguards on the beaches. Now that the islanders had a perceived security and more free time, they also started consuming more of the fish they had, and saved less of them. In addition, as you remember, some of the fish the people thought they had stored at the FED were no longer there (since the FED gave a percentage to the government, or to its founding members). Still, every islander received a piece of paper assuring him that his fish are all taken care of. This was called the Certificate of Adequate and Secure Holding (or, in short - CASH). To make sure people would not worry too much about the value of their CASH, the government assured them that all their fish are alive and well and insured by the newly founded Fish Deposit Insurance Committee (the FDIC).
Some people were concerned about this arrangement, but times were good! Even though theocean was the same ocean, people felt richer and spent more. The government also had more money and built new roads, schools, and even created a little army to make sure the island - and the archipelago at large - remains peaceful. Thanks to the new infrastructure set by the government, the people could catch more fish, and spend less time working. Still, the islanders managed to spend all their fish. In addition, in exchange for all the new services government was providing, the islanders agreed to give a few of the fish they caught to the new foundation for Indispensable Regimental Services (the IRS).
The government saw that things are going so well, and decided it would be good to try to teach people on other islands how to do things properly. It built ships and sent representatives to educate the world. Sometimes it worked, sometimes it didn't, but it always - always - required a lot of resources. So, the government pressured the FED to let bigger waves through the island's perimeter, and keep less fish in the special reserves. The owners of the FED did not mind, since the government promised to give them back a fish and a half for every fish it borrowed. More accurately, the government allowed them to take half a fish from the public reserves for every fish they gave to the government.
And so, as the FED let more and more waves through the perimeter, the beaches became dangerous again. And this time, since there were hardly any lifeguards and nobody knew how to swim, many people drowned. Many workshops along the beach were destroyed. People were not catching any new fish.
Things were not good. The FED and the government were worried that everyone will come to look for their fish in the special reserves and realize that they are not there. So, to start with, the government gave the FED the authority to print more CASH in order to finance new projects and keep people busy. Of course, there were hardly any fish left in the reserves to back the new CASH, but the government figured that if enough CASH will be given away, people would calm down and everything will go back to normal (after all, everyone loves CASH!). The FED was happy to do this since - as you remember - it still had a license from government to take half a fish from the public for every fish it gave to government. But now, since there there weren't many fish left, the government simply promised to give the FED half a fish for every CASH note it printed.
Still, the islanders were not happy. They asked government for explanations. "The problem", said the government, "is that we did not have enough lifeguards, and that the perimeter around the island was not strong enough. In addition, all of you people ate too many fish! So, you need to tighten your belt, and we need to increase the amount of government lifeguards and allow the FED to reinforce its perimeter around the island".
It worked! After a few months, things calmed down again. People spent the newly-printed CASH and felt happy again, the FED got more power, and new government lifeguards were appointed. In addition, since the islanders behaved so badly and the government had to provide more services, the IRS had to increase its annual fees.
Of course, the FED's fish reserves were completely empty by now, and people were living only on the fish they managed to catch every day. But they still felt rich, because they had CASH, and the FDIC still promised them that the fish are all there. Things were good again!
(For another interesting story about people, fish, and economics, check out Irwin Schiff's classic How an Economy Grows and Why it Doesn't)
you are amazing! very interesting.
Nice. Of course, with good government regulation this scenario would not have unfolded as you describe. Government-protected funds must never be used for speculation, nothing of high risk. That's why they should also be very boring, paying the usual boring passbook rates of interest - a system that worked marvelously well from the early 1930s until 1986 when the Glass-Steagall Act was "reinterpreted" by the Fed and banks were given the green light to do their own thing and, in effect, not be banks anymore, at least not in the traditional sense.
You often say, correctly, that America has extraordinarily strong economic fundamentals. It does, because of its rules and regulations that keep things under control, checks and balances that, prior to the cultification of De-regulation, would have nipped Bernie Madoff and the S&L crisis and the fraud behind the current housing collapse in the bud. It was when the lines became blurred and the fox was allowed to guard the henhouse that it fell apart.
Richard,
The fox was allowed to guard the henhouse on the day the Fed was established. To my knowledge, that was in 1913. On that day, a privately-owned central bank was established in the US, with the responsibility to regulate the reserve requirements of all US banks. Of course, it is a bit strange that an organization that is owned by its member banks would be responsible for regulating banks... but that's how it is.
The Fed is responsible for providing the government with money. It does so by purchasing government paper, which means the US Government pays the Fed interest on every dollar that it creates.
The Glass-Steagall Act could have help to alleviate some of the symptoms of this problem. But even before it was abolished, banks were robbing the public like there's no tomorrow, and government did the same, with the help of banks. The Federal Reserve act puts them in bed together, and until you send each of them back to his own room, things will not get any better.
In addition, the dissolution of Glass-Steagall is a wonderful example of how every regulatory agency ends up being captured by the same interests it was originally supposed to regulate. This happened under both Republican and Democrat governments. What makes you think it will not happen again? (today for example - the government practically owns many of the big banks... and they have taken more money from us during the last 12 months than they ever did...).
Would it not be better to get the government out of it altogether, cancel the FDIC, take away the banking cartel's monopoly on printing money and let banks compete with each other in a free market? This way, bad banks would go bankrupt and good banks will gain the public's trust. In addition, people would spend time evaluating banks before deciding where to put their money (just like they do when they buy a new TV or a pair of shoes).
Look at the big picture. You cannot ignore the Fed, the FDIC, government history of bailing out banks, abolition of the gold standard, and other factors that made banks so powerful to begin with and then complain about one specific law and assume that if only we had it in place, things would have been great.
I know that Glass-Steagall is a favorite Liberal talking point, but it is a red herring, and you should dig deeper. The US has been on the bankruptcy path for a long time. It started long before Glass-Steagall was abolished.
A few charts to get you in the mood. You can see when certain trends began. Glass Steagall was abolished once banks got a critical mass of power (by holding the government and the public by the balls), it is a symptom of their power and not the cause of it: 1, 2, 3
I'll agree with you about the awful influence of the Fed, which is one of those great mysteries very few people can explain, and that has a near-religious aura around it. But I'm not ready to exchange my Democratic Party card for your ultra-Libertarian card. I do not believe the free market corrects all evils. (And those charts are too arcane for me, sorry!)
Thanks, Richard. This is exactly my point: I know that you are "not ready to exchange you Democratic Party card". This is the problem. I am trying to figure things out, and you are trying to justify your old beliefs. I am not affiliated with any of America's political parties, including the libertarian one (even though my name means freedom/liberty... so I guess Drorism could mean Libertarianism...). I believe that the government has an important role, but my basic point of departure on any issues is that government intervention should be avoided as much as possible.
And dismissing the Fed issue as some kind of a god-given problem is very much unlike you. It was not always there, and the people can abolish or fundamentally change it if they wish. For that to happen, they first need to understand what the problem is. Being comfortable within the confines of existing left/right talking point will not get us out of this mess.
The banks today, under Obama, are stronger than ever. You have a messianic president, control of both houses, and things are only getting worse. Any idea why?