Understanding Money through what we are GOOD at — STORIES
The welfare of a nation can scarcely be inferred from a measurement of national income as defined by GDP. The man who invented GDP never thought it was a measure of welfare and nor should anyone else. If the copy of a religious book sells at the same price as Fifty shades of Grey, they are all the same as far as GDP is concerned. Your brain weighs 1500 grams and so does 3 bags of sugar. But the fact is you value your heart more than the sugar. So the concept of mass is not useless. And thus the concept of GDP is also not useless. The “more” growth of a nation can be measured by other index such as ‘human development’ , ‘poverty rate’ , ‘human well being’ etc.
Numerous economists have conducted experiments and all of them converge on the fact that recessions do much more damage than what is actually seen. People who try to get jobs during recessions end up far away from their actual field of work. They try to get any kind of job even if it doesn’t suit their profile. The point is why does recession happen? Sometimes the reason can be easily pointed out. If a country has gone through a war or a sudden decline in the exports the country does. At other times, economy takes to its bed for no specific reason. Frustratingly for economists, this happens all the time. In an economic act, the immediate consequence is seen, while the others are unseen. We are fortunate if we foresee them.
What is seen and what is not seen. Macroeconomics is all about what is not seen.
A group of lawyers formed a small Babysitting co-op with around 100 families. The co-op gives 20 scrips to each of its members, where each scrip is worth 30 minutes of babysitting. ‘Scrip’ is a babysitting currency that holds a value only in the Babysitting circle. As soon as a couple joins the co-op, they are given 40 scrips. They cannot buy new scrips in the future. Once a couple thought that the scrips were worth only 10 hours of babysitting. If they plan to go out for a movie it will cost them 5–6 hours and they will loose 12 scrips. If sometimes in the future they have an emergency all the remaining scrips might get exhausted. So the couple thought of cancelling their movie plan and thought of saving some Scrips. Reasonable plan. The plan is so reasonable that almost everyone thought the same. Couples were afraid to spend their scrips and everyone was into the saving business. Now no one was going out and everyone was with their families on weekends. So who would babysit? How will someone earn scrips? Everyone was frustrated since they all wanted to have an outing but couldn’t because they also wanted to save. And thus the economy resulted in a babysitting recession. This is exactly what happens in the wider economy. The factories, raw material, people to be employed do not disappear suddenly. Industries want to employ more people, increase their profits but somehow cannot. Likewise the members of the Babysitting co-op would have been in a booming babysitting economy, partying one week and babysitting the next week. Somehow this was not happening. The committee eventually got hold of the problem and passed a law making it compulsory for the couples to go out once in 6 months. However even this solution did not work. So eventually the lawyers had to come back to the economics. The solution of printing more Money(Here scrips). All the members were given 10 hours of extra scrips while the departing members only had to return 5 hours of scrips. This eventually resulted in couples spending scrips for babysitting. One week they were babysitting and earning scrips while the next week they were enjoying their weekend. And thus the recession was abated. But is printing money a good solution? No it does not always work. Printing money will not get you out of the recession always. Printing money does not create more roads, buildings or workers. Production depends on the underlying resources available. Eventually printing more money did solve the Babysitting recession because there were parents who were willing to go out and parents who were ready to baby sit. However in the longer run the method made problems. The ending was not a happy one. Now the couples were reckless and no one was ready to babysit. Everyone wanted to go out since they had enough scrips. Deciding how much money to print is exactly what the central banks do. The Babysitting recession gives us two important lessons. First, It shows that even a small economy with around 100 couples is difficult to manage. Leave apart the economy of 1.3 billion people. Second, it is remarkable how simple stories can tell us so much about how the economy works.
Let me tell you a true Story. A man once received a message that his salary was being cut. Furious by this, he stormed into his Manager’s cubicle and resigned from his post. You would have done the same since no one likes an unnecessary salary cut. A few years later, the same man received another pay cut. This time there was no display of emotions. In fact he was pretty content! Why such ambiguous behavior? Was he battling dissociative identity disorder? Or he probably just lost his marbles? Or he admires Naval Ravikant and realized that desire causes Unhappiness? NO. Luckily he was sane and a normal human just like you and me. This is because the actual pay cut didn’t look like a pay cut, it looked like a pay rise. The man had got an increment of 3% when the inflation rate was 6%. This is what Economists call ‘Money Illusion’. Let me digress a bit and go into some mathematics of inflation rate. Imagine you were saving for a book by Naval Ravikant and the cost of the book was 10$. The moment had finally arrived when you were about to increase some profit of Jeff Bezos. But as philosophers say, Nothing is certain. Your closest friend requested a loan of 10$ and you couldn’t deny. Since he was a good friend he agreed to return your money at an interest rate of 5% after an year. However, The inflation rate that year was close to 10%. Hence this book by Naval would cost you
10$ + 10% of 10$ = 11$ after an year. The amount your friend will return after an year will be
10$ + 5% of 10$ = 10.5$. And you need to wait again for that Book :(. You can now do the math for that man and know how he had been actually fooled by giving an increment. Even when we understand that we should try to take inflation into account, we may not always go to the mental effort of adjusting the numbers since they lack the emotional punch. Psychological research says that nominal salaries (not adjusted to inflation) influence our thinking even though real salary gives us the purchasing power. A real salary is the goods and services that a nominal salary can buy. So the next time you lend someone money, make sure you compound the interest monthly.
Lt me tell you another story..
On 22 August 1994, two retired musicians of the KLF band, Bill Drummond and Jimmy Cauty, flew to the west coast of Scotland along with a Cameraman, a journalist and twenty thousand £50 notes bundled and tightly wrapped in plastic bags. Around $2.5 million. The next morning they made a small pile of these bundles of notes while the others acted as witness. Slowly and steadily, note by note, they set the money ABLAZE! Not even a single note was spared. Within an hour or two the notes were turned into ash.
WHAT A WASTE!!
There was a lot of criticism when the world got to know this. Cauty and Drummond had committed a dreadful waste of resources. This money could have been used for feeding poor, providing shelter to homeless and what not! SUCH A HUGE SUM OF MONEY! According to them it was their grand artist gesture. Every sane person couldnt understand how such wanton stupidity be considered as an art. The musicians appeared in one of the talk shows where they faced sharp and critical questions from the host as well as audience. The musicians defended themselves by saying that their act of burning a million pounds does not mean any less loaves in the world, any less apples, any less anything. The only thing less is a PILE OF MONEY! BUT the anchor argued there could have been more apples, more loaves of bread had they spent the money wisely.
WHAT IF I TELL YOU THAT THE MUSICIANS WERE RIGHT AND THE HOST WRONG?
Yes. You read that right. According to the Federal reserve it would take no more than £2000 to print twenty thousand £50 notes which the musicians incinerated. All Drummond and Cauty had destroyed was £2000 worth of paper. They hadn’t destroyed bread or apples, but only paper. Think about everytime the Bank prints more money. If there’s not enough demand for goods and services, then the extra money should mean more demand for existing resources at the same price. But if people are already demanding everything that’s being supplied in the economy, then prices will have to rise instead.
If Drummond and Cauty were burning money in an economy already suffering from deficient demand, then they were making a bad situation worse. But they were burning money in an economy where they supply and demand balanced out, the result effect is simple — average prices in the economy would drop. Something that cost £100 would on average have a price loweres by one penny as a result of burning money. By burning money Drummond and Cauty had effectively given a million pounds away in the form of slightly lower prices to everybody in the world who owned pounds.
P.S — To all the Ambanis out there, please burn some money and make this world a better place to live.