Economics on the back of a napkin
Well, actually in the intro of a book that came out more than a year ago. I read this a long time ago and really thought it did a good job of describing why American consumerism was non productive and non sustainable.
Today I searched around and found this intro on the web under someone else’s blog.
Sometimes I agree with Peter Schiff (the author) and sometimes not. But for this little parable, I have always thought he was right on target.
If you are interested in his book, you can buy at Amazon. Just click the image of the book below.
Crash Proof – Peter Schiff.
Let us suppose six castaways are stranded on a desert island, five Asians and one American. Their problem is hunger. So they sit down and divide labor as follows: One Asian will do the hunting, another will fish, the third will scrounge for vegetation, the fourth will cook dinner, and the fifth will gather firewood and tend the fire. The sixth, the American, is given the job of eating.
So five Asians work all day to feed one American, who spends his day sunning himself on the beach. The American is employed in the equivalent of the service sector, operating a tanning salon that has one customer: himself. At the end of the day, the five Asians present a painstakingly prepared feast to the American, who sits at the head of a special table built by the Asians specifically for this purpose.
Now the American is practical enough to know that if the Asians are going to continue providing banquets they must also be fed, so he allows them just enough scraps from his table to sustain them for the following day’s labor.
Modern-day economists would have you look at the situation just described and believe that the American is the lone engine of growth driving the island’s economy; that without the American and his ravenous appetite, the Asians on the island would all be unemployed.
THe reality, of course, is that the American is not the engine of growth, but the caboose, and the best thing the Asians could do would be to vote the American off the island–decoupling the caboose from the gravy train. Without the American to consume most of their food, they’d have a lot more to eat themselves. Then the Asians could spend less time working on food-related tasks and devote more time to leisure or to satisfying other needs that now go unfulfilled because so many of their scarce resource are devoted to feeding the American.
Ah, you say, but that analogy is flawed because in the real world the United STates does pay for its “food” and Asians do receive value in exchange for their effort.
Okay, then let’s assume the American on the islands pays for his food the same way real-world Americans pay, by issuing IOUs. At the end of each meal, the Asians present the American with a bill, which pays by issuing IOUs claiming to represent payments of food.
The castaways all know that the IOUs can never be collected since the American not only produces no food to back them up, but also lacks the means and the intention of ever providing any. But the Asian accept them anyway, each day adding to the accumulation of worthless IOUs. Are the Asians any better off as a result of this accumulation? Are they any less hungry? Of course not.
Suppose an Asian Central Banker suddenly washes up onto the island and volunteers his services. Now each day the central banker taxes the other Asians on the island by confiscating a portion of the scraps of food the American throws them each day from his table. The central banker then agrees to return these morsels to the other Asians each day, in exchange for each Asian’s daily accumulation of the American’s IOUs, less a small percentage for himself because he, the central banker, also has to eat.
Does the existence of a central banker change anything? Do the Asians have any more to eat because their own central banker gives them back a portion of the food he took from them in the first place? Do the American IOUs have any more value because they can now be exchanged in this manner? Of course not.
The Asians will be better off without us
The real world lesson is that if it doesn’t make sense for the six make believe Asians to support millions of real-world Americans. The fact that they do so in exchange for worthless IOUs in no way alters this reality.
There is no question that in the short run, by allowing the U.S dollars to collapse (in effect, voting millions of Americans off the island), there will be some disruptions of Asian economies. Of course, there will be some initial losers, particularly among those Asians who currently profit from the present arrangement. However, these profits come only at the expense of greater losses borne by the entire Asian population.
In the end, the cessation of America’s excess consumption, which is not a benefit Asians enjoy but rather a burden they now disproportionately bear, will be the best thing that can happen to them. Like the serfs being liberated from their lords, their scarce resources will be freed to satisfy their own needs and desires, and their standards of living will rise accordingly. As their savings finance increased capital investment, rather than being squandered on American consumption, their future standards of living will rise that much faster as well.
Investment thoughts for the “about to retire”
Ah, wouldn’t it be nice to be able to sit back and live comfortably off your nest egg? Well, maybe one day. In the meantime, it makes sense to learn everything you can and be prudent about saving. There are a few fellows at MSN money who I think are pretty saavy and I like their columns. One is John Jubak – I have made some good money of his stock picks. Another is Tim Middleton, who focuses more on portfolio management (especially using ETFs – exchange traded funds – rather than stocks).
A couple of years ago Mr. Middleton wrote a column on a method for making the most use of your retirement nest egg. The question posed is: How one can get a guaranteed annual income from a nest egg while waiting out any roller coaster dips, yet have the nest egg pay off for 20+ years before running out? His proposed solution really appeals to me; the concept is so simple. Basically you buy 4 treasury bonds with laddered maturity dates (i.e., one matures in a year, the next in 2 years, etc) to provide a guaranteed 4 years of income. The remainder of the portfolio is in a solid/reliable growth mutual fund (he suggested T Rowe Price Capital Appreciation Fund [PRWCX], but there are many good ones to choose from). In one year when the first bond matures, you sell enough out of the mutual fund to buy another bond to stick at the end of the 4 year ladder. After year 2 you repeat the process. And so on. The mutual fund should provide enough growth to help buy those bonds without running out of money itself too fast.
What a simple idea, yet it makes so much sense. The amount of income you get every year depends, of course, on your nest egg, inflation, etc. You make that decision. But the example he gives provides $30,000/year (going up as inflation goes up), lasting 20 years or more, starting with a $500,000 nest egg. Read the whole article here. And better start saving up!
PS: After reading Middleton’s column almost exactly 2 years ago, I put some money into PRWCX – the mutual fund he suggested. The average annual return as of today is 16.36% (all dividends and gains reinvested). Not too shabby.
What a crazy stock market
Today was an example of what a nutso economic climate we are in. At lunchtime the Dow was up 125 points and commodities (oil, precious metals) – the "safe" investments people run to when things are bad – were sky high as well. Weird. By day's end the commodities had held their own, and the Dow ended up by only 35 points. No good reason for any of it. I have been pretty skittish about the economic picture for a while now. The consumer debt, along with our national debt, is gonna eat us alive. I do not see a way out of it. To cool inflation (which is primarily in the commodities I think) the Fed will have to keep raising rates and that will just hang the debt-laden American consumer. What to do?
Make the sacrifices NOW and pay down debt as soon as possible. Scrimp and save. If you are lucky enough to be able to invest, start an emergency fund in a money market account. Then look to funding retirement. Max out your 401k match – not the 401k but just the match – if you have one at work). Then go to Roth for more IRA savings. Stay away from too much in the 401k. I think the government will tax the bejesus out of it before you get any.
Finally, if there is anything left, invest but be prudent. Returns on short term CDs and money market accounts are darned good and relatively risk free. Playing equities (stocks) is tricky. Pick the right areas to invest in and diversify, diversify, diversify. Overseas stocks look better now than in the past because of the US weak fundamentals.
Read everything you can get your hands on to self-educate.
It's your life and your future. Uncle Sam is NOT going to be there for you so learn to take care of yourself. Be careful out there.
