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"Why Our Economy Has Gone to Sleep - An Analogy"

By guest blogger, Leonard Gaffga – Adjunct Professor of International Economy at University of South Carolina Beaufort

It has been said that the lifestyle we live today is not “real”.  We have lots of material things, but when you come down to it, we don’t own them.  We don’t own the houses we live in, for example, the bank does.  Our “real” wealth is a lot lower than it appears to be – just try selling the house you live in.

Trying to understand the essence of debt and its effect on our economy reminds me of the story of wine-making related to me by a fourth generation vintner at a stop on a Rhine River cruise two years ago.  It provides a good analogy for understanding the effect of debt on an economy, especially how debt can eventually bring an economy to its knees.

The wine maker mashes the grapes and throws in the skins for flavor.  He then adds yeast and allows the mixture to ferment until wine, fine or otherwise, is produced.  The yeast in this analogy is us.  We consume raw materials as the yeast consumes the sugar in the grape juice.  The wine that it produces, of course, includes alcohol as a byproduct of the process.

As long as the fermentation process continues, the population of yeast increases and prospers.  They feed and multiply as they consume the sugar in the mixture.  The volume of wine produced increases, and so does the quantity of alcohol.  Everything seems to be humming along at this stage in this economy.  (Even non-producers benefit, but that is a different story.)

But when the volume of alcohol reaches a sufficiently large proportion of the mixture, the yeast begins to go to sleep and eventually die.  That’s why the alcoholic content of wine or beer, or any fermented beverage, can only reach a certain level before the process stops.  It’s because the workers are put to sleep!

So it is in our economy:  as the quantity of output that we produce continues to increase, we have a better and better standard of living.  The workers are working hard to turn the raw materials we possess into products we can consume.  We call this process “wealth creation”.  But in the process of producing consumable wealth, our system also produces debt.  Producers and consumers alike shift tremendous financial obligations far out into the future in the form of debt.   Workers, for example, may accept the promise of a pension when they retire as partial compensation for goods they produce now.  Consumers may move into a house now and agree to pay on a mortgage for 30 years.  Eventually when these promises cannot be kept, the system breaks down.  The threat of default, whether it’s the Federal government in danger of defaulting on its debt, or a sizable number of individuals whose houses are in default to the bank, has the cumulative effect of a paralysis that puts our economy to sleep.

The solution to this problem can also be found in the analogy to wine making.  If we could add more inputs (grape juice containing sugar), increase the number of workers (ones who are alert, not numbed), and reduce the amount of debt in society (the amount of alcohol), the process would resume on its own.  (This is good news for von Hayek followers.)  So the natural question for me becomes:  What country has a lot of productive workers, very little debt, and growing access to the world’s raw materials?  It is China, of course.  (See “Monsoon” by Kaplan which details China’s quest for raw materials.)

It has been observed that if it weren’t for debt, far fewer of our citizens would own houses.  And this conclusion is true.  We accept it as the price of prosperity.  In essence we in developed economies have accepted debt (and the future obligations that go along with debt) in exchange for a higher standard of living now. 

From my experience living overseas (teaching at the University of Jordan, Amman, Jordan) I have observed that typically, a young family acquires a house through the collective contribution of many family members who chip in to pay cash for the first level of the house to be built.  Later generations will build the second level and so on, again without resorting to debt.  The growth of the stock of housing in Jordan is slower than in the US – witness the recent housing boom in the US stoked by easy credit.  In Jordan they really don’t have the option of a US style housing boom.  In spite of the many banks in Amman, the banking system available to the residents of that country is very primitive, that is, it is primarily a cash based economy. 

For tourists, of course, charge cards are always welcome.

Leonard Gaffga – Adjunct Professor of International Economy at University of South Carolina Beaufort

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