You might replace locusts and wolves in this short story with central banks and governments… but that didn’t quite have the dramatic effect that I was after and I would have had to break the flow of the story a bit to explain a whole bunch of other stuff. So, for what it’s worth, here’s some bed time reading for the kids.

Once upon a time…

Imagine a village of around 100 farmers producing enough food that each of them can eat two lamb chops and a couple of tomatoes per day. The famers work hard and save – i.e. they delay immediate consumption. They don’t eat all the tomatoes that they could and they don’t cull all the spare lambs to make chops… instead they invest their savings to replant the seeds of the tomatoes that they don’t eat and let their flocks of sheep grow in number.

For a while, life is pretty tough. They have to get by on a single lamb chop and a single tomato per day, but after a while they manage to improve their productive output such that they now have enough tomatoes and lambs for each farmer to eat 3 tomatoes per day and 3 lamb chops per day. Clearly the standard of living of our village of farmers, in this example, has improved substantially and without doubt their improved standard of living can be attributed to the increase in their productive output, which was made possible by the initial hardship that they endured and consequent savings.

Now let’s imagine that the gods are angry with the farmers for some reason and smite them somehow. Perhaps a swarm of locusts is sent to eat the tomatoes and a pack of wolves attacks the flock. The nature of the disaster is unimportant. For whatever reason, imagine that the locusts eat some of the tomatoes that were set aside for replanting and imagine that the wolves eat some of the lambs that were supposed to be saved to maintain the number in the flock. The result is that the farmers now only have enough tomatoes and lambs to either:

• 1. Continue to eat 3 chops and 3 tomatoes a day until the end of the year, but only replant sufficient seeds and leave sufficient sheep in the heard such that next year their output will drop to previous levels… levels that would only sustain 2 lamb chops and 2 tomatoes per day.
• 2. Delay consumption immediately and eat less tomatoes and lamb chops now, so that they are able to replant enough tomato seeds and maintain enough reproducing sheep that they will be able to maintain their productive output for next season… meaning that next year they will be able to eat 3 chops and 3 tomatoes per day again.

As such, our farmers now have a fairly easy choice to make. The locusts and the wolves have come and gone – and they’ve taken some of the famer’s savings with them… as such, there’s going to be some hardship. The farmers are going to see their consumption impacted negatively and all that is left for them to decide is when: now or next year? They have a choice between current consumption and savings (i.e. future consumption).

However one of the farmers is an economist and, after thinking for a bit, he comes up with a theory that he thinks is pretty solid – which he calls the “paradox of thrift”. Basically his theory runs along the lines, look if we start consuming less then farms are going to have less income and thus they’re going to have to cut production to reduce costs, which will mean they’ll be paying farmers less and farmers will have less to spend so they’ll cut consumption even further and on and on until eventually we’re just not producing anything at all. As such, although it might seems a bit counter-intuitive, actually what we need to do is stop saving and consume more. It is not savings that drive our economy, but consumption – it is eating that is the back bone of this community and we have to keep eating in order to maintain our production.

The other farmers find this argument quite persuasive. If the economist is right then they don’t have to delay consumption at all. Their standard of living doesn’t have to drop temporarily… indeed the economist has made it sound like it might not ever have to drop. The main thing that they have to focus on is eating, and eating is something they do best.

Consequently, the farmers agree to continue eating at previous levels, so that their farms can retain the “high incomes” that they had before. However their choice was initially one of current or future consumption and nothing that the economist said has changed that. In choosing to continue current levels of consumption the farmers neglect to keep enough tomatoes and reproducing sheep aside to maintain the size of their crops and flocks and thus, rather predictably, come the next season the farmers are only producing enough to be able to eat 2 lamb chops and 2 tomatoes per day if they want to keep enough tomatoes and reproducing sheep aside to be able to replant crops and maintain the size of these.

The economist is adamant though. He believes the current “recession” is a temporary lull and that all that it will all be fine as long as the farmers can simply maintain a good solid level of consumption. The farmers aren’t so sure any more and they don’t want to eat through yet more savings – they’re worried that perhaps next year they might find themselves down to only a single lamb chop and a single tomato per day… which wouldn’t leave them much room to save and reinvest in production. Still, they don’t really like the idea of doing that immediately either and so they agree to borrow some tomatoes and lambs from the Chinese farmers down the road (who have just had a bumper crop).

The Chinese farmers agree. They say OK look, we’ll lend you 3,650 lamb chops and 3,650 tomatoes (enough for one per famer for an entire year). However when you’ve managed to turn your economy around next year we expect each of you to give us 4000 lamb chops and 4000 tomatoes back. This is decided to be a satisfactory arrangement and so the farmers continue to eat 3 lamb chops and 3 tomatoes per week. For the time being and, as the economist predicted, they have managed to avoid the negative consequences of the locusts and the wolves – they are not had to delay immediate consumption in favour of future consumption (i.e. they have not had to save) and their economy keeps “rolling along”.

Come the next year though, the farmers find them selves in the same situation. Having maintained consumption of 3 chops and 3 tomatoes a week they weren’t able to save any more tomatoes or reproducing sheep to increase their output and so they once again find themselves in the situation where they either need to cut consumption immediately or borrow from the Chinese once again.

The farmers continue to consume more than they produce and they have a consistent and ever growing trade deficit with the Chinese famers. The economist passes away, but has 4 healthy sons and daughters who continue his tradition of recommending that the farmers focus on eating since eating, it is now agreed, is the backbone of their faming community (constituting now well over 60% of “total economic activity” – a fact the farmers find rather peculiar since everything that gets eaten has to be produced right?… They wonder where the other 10% comes from).  As such, and as always, it is recommended that any inclination to increase the level of savings be avoided and indeed the famer’s sons and daughters even go so far as to recommend that should the farmers show any inclination to save then the faming community’s local bank should step in to print money and the farming community’s city council should use that money to purchase lamb chops and tomatoes if necessary, to maintain the aggregate demand in the economy or even increase this if possible.

After 37 years of this kind of carry on the cumulative total of the trade deficit between the local famers and the Chinese famers is half the total yearly output of the local famers and every year the local farmers have to borrow more and more from the Chinese. The Chinese famers start to wonder what the likelihood of them ever getting those tomatoes and lamb chops back is… but they don’t want to stop lending to the village because exports to the local farmers now constitute a fairly significant portion of the Chinese economy. If they stopped lending to the local farmers then that would negatively impact the “incomes” of the Chinese farmers who export to them wouldn’t it? It would cause massive unemployment and unrest, so the Chinese continue lending and the local farmers continue borrowing.

Until one day, the gods decide they’re not very happy with the Chinese farmers either and they send a swarm of locusts and a pack of wolves to visit them.