The US Dollar

Yesterday I was trying to explain to my partner what I think has happened with the US dollar. I used the example of an island. Here is how my story goes....

Let's say you are living on an island and there is one man who goes out fishing each day and brings in a lot of fish. People then trade things with him for his fish. But when he brings in more fish than the people can eat in one day, the fish simply rot since they have no refrigerators.

Then one day someone figures out how to make a refrigerator. So he starts to take the fisherman's extra fish and store it. In exchange for the fish, he takes a leaf from a tree an writes "ten fish" on it. He explains to everyone on the island what is happening and explain that the leaf is now worth ten fish.

The fisherman can then store his leaves. And he can use them to buy things from other peole on the island. If he wants coconuts for example, he can give the coconut man a leaf with a number on it instead of some fish. This makes it easier to trade.

Then when the coconut man comes to the man with the refrigerator, who we will call the banker, he can turn in his leaf with a number on it and get the same number of fish.

That is the basic idea.

Now let's say the "banker" is corrupt. He one day realizes he can just take a leaf and paint a number on it, then he can take that leaf to the coconut man and get some coconuts. He doesn't worry about whether he actually has enough fish in the frig to cover himself if the coconut man, and the carpenter, and the baker, all want to turn in all their leaves on the same day and get fish in exchange. He feels sure that they won't all come to him on the same day because he has seen that they have a lot of extra leaves stored in jars in their homes. This is called "savings."

But let' say that the truth is that he has passed out the equivalent of 100 fish in leaves. Yet there are only 50 fish in his refrigerator. And then let's say someone starts to figure this out or even question it. What do you think he would do? Do you think he would be honest and apologize, and let them come count the fish in his refrigerator? Or do you think he would lie and not let them know what is really happening? In other words, would he try to keep all the numbers and data to himself? Or, again, directly lie about them?

Now let's say a man on the island wants to build a house and he doesn't have enough leaves to pay for it. So the banker has a good idea. He will paint some more leaves with numbers on them and give the to the man who wants the house, in exchange for a promise by that man to pay the banker back, with "interest."

So this is what they do. Now the man who wants to build the house has a lot of leaves. He spends a lot of money in the village and everyone thinks they are doing well and the little "economy" of the island is growing.

So another man comes to the "banker" and makes the same deal. So now let's say there are leaves around the island totaling 1,000 fish. And there are only 100 fish in the fish "bank" or refrigerator.

What would happen if

A) The people figure this out

B) Too many of them want to come get their fish on the same day

The banker thinks he can pull this off and in fact he does for a long time, because the fisherman keeps bringing in more fish than the island wants. Let's say they only want a total of 40 fish per day on a normal day, and the fisherman brings in 50 fish per day. So each day the deposits in the fish bank are growing. And he never runs out of fish. But he keeps "printing" more "money" than he actually has in actual fish.

Ok so that is my little story. Or the first part of it.

Now how does that compare to the USA? Well basically I'd say that what is called the "Federal Reserve Bank" and the US government together are doing what the fish banker did. But mostly it is the Federal Reserve Bank, or the "Fed:.

The US government actually "borrows" money from the Fed. I am not sure just who is printing it. But I am pretty sure it ends up in the Fed either way. The regular banks you know of, like Citibank, Bank of America etc, get their money from the Federal Reserve Bank.

At one time the USA was using what they called the gold standard.That meant they had to have as much actuall gold in Fort Knox Kentucy as they had printed on paper money.

This would be like saying the banker on the island was honest and didn't paint more money leaves than he actually had in the fish fridge.

Now let me say that I can think of two reasons the banker on the island would start to deceive his neigbors. One, as I mentioned was pure corruption. He realized he could print his own money and buy bread, coconuts, etc.

Another reason though might be to "stimulate the economy" and "create jobs." For example, when he printed some leaves to give the people who wanted to borrow money, they went out and bought wood, and nails and they paid carpenters to help them build their houses, so a lot of work and jobs were created.

Again, this all seem to be able to work assuming a few conditions are met.

1. The people don't know what is happening. (The banker controls all the information)

2. The people *believe* in the system (more later about this)

3. The people don't happen to all come in and want a lot of fish on the same day.

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Believing that your leaf with a number painted on it is critical to the success of this system. If you don't believe you can actually get fish or cocunuts when you need to eat, then you won't accept the leaves with numbers painted on them.

But over the next year, the price of fish doubles. So next year you take your note which said "10 fish" and you want to buy 10 fish. But the banker tells you that you can only get 5 fish. So you go to the fisherman directly and he tells you the same. You won't be too happy.

And you might not believe in saving your leaves anymore. You might think they are next to worthless. And your belief in the system starts to crumble.

Now let's say the banker sees that people aren't happy like the banker printing more money to keep people happy for a while.

Imagine you are the banker on the first island. And then one day you travel to another island. And you convince the people there that your leaves are worth something. So they sell you fruit from their island. And maybe they sell you a nice boat they made. But all you did was paint some numbers on some leaves before you went on your trip to the island.

As long as the people on the second island believe that they can go to your island and get some coconuts, fish etc wth the "money" you gave them, they will be happy. So they do go sometimes and buy some things and it all works for a while.

Since they like the system so far, they decide to start a similar system. And they start to trade leaves with you. You then can take your leaves to their island, get some of their leaves and buy things from the people on that island wth their leaves. The ones you exchanged your leaves with put your leaves in bottle in their homes as "savings."

Now let's say there is a 3rd island. It starts a similar system. As the banker you convince the people on that island that your leaves are the best to keep as savings. You tell them, "With my leaves you can go to any island and buy whatever you like and people there will accept them." So eventually a lot of people around the world start to believe in your leaves. And now if you want to go to, France, or England, you can just print more leaves and spend them in France or England. Your leaves have now become what is called the "world standard" or the "world currency reserve." That means people around the worl d like to hang on to your leaves, they believe in them. They save them and accumulate them.

But what if people around the world start to figure out what you have been doing? Then what?

I think that is bascially the situation we have now. So you can think about the consequences of lying to people around the world for years about the value of your leaves. While they thought they all together add up their leaves and come to you and collect 10,000 fish, for example, they realize you only have a few thousand fish in your fish bank.

And you can imagine they won't be too happy and they won't want to keep your leaves as their savings. They stop believing in your leaves. Then no one will accept them anymore. Maybe even people on your island won't want them. You now have a totally worthless currency. And a lot of unhappy people.

Of course this is a bit extreme but it helps me understand why the value of the US dollar has fallen about 25 percent since the euro came out and I used to be able to buy one euro for one dollar. Now I can only buy about 75 euro cents.

That means if I had 10,000 dollars saved in US dollars, it would only be worth 7,500 now. So I lost $2,500 thanks to the dishonest bankers in the USA.

S. Hein
Dec 25, 2011