Imagine a world in which suddenly all the tools disappear. All buildings, cars and machinery or even basic tools such as knives, hammers and shovels vanish. What would the economy look like if we had to do all the work with our bare hands? This is the situation in which the hero of this story used to live.
On a remote island there was a fisherman. Maybe ‘fisherman’ is too generous because in the world without tools his fight for survival was to jump in to the sea and make desperate attempts to catch fish by his bare hands. It was NOT an easy life. All this effort resulted in catching only one fish per day which is just as much as he needed to survive. One night, totally wet, with his eyes sore from the salt water, he was lying on the beach, staring at the stars, thinking about how he could improve his life. Then he came up with a brilliant idea! “If I can just extend the reach of my hand, I might be able to watch the fish from above the water and propably catch more.” He decided that in the morning he was not going to catch fish. Instead, he would devote this day to implement his plan. He searched the woods, looking for a strong, straight branch, which with great effort he managed to break off. Then, with a sharp shell found on the beach, he tried to sharpen the tip of the stick, which took him many hours. Finally, that evening he fell on the sand exhausted from hunger. He didn’t eat that day so he could build his invention, but he was happy because in his imagination he was already sitting on the heap of fish caught with the help of it. Falling asleep, he decided to call his invention “spear.” In the morning, motivated, he grabbed the spear and began to work. Because the salty water did not flood his eyes and a pointed end of the spear was more effective than his hands, he was able to catch two fish that day! Well, it was not a heap of fish yet but the economy of the island did grow by 100%. More importantly, it opened up for him many more possibilities. He could now fish every second day, consuming his catch from the previous day. He could also go fishing every day as before and dry the excess fish and store it for worse times. Another option was to use free time to implement new ideas, to increase his productive capacity. This would result in an increase in his wealth and expending the size of the island’s economy.
In this story, we come to a simple economic principle. Wealth is created through self-sacrifice and taking risks. The fisherman underconsumed and took the risk that his plan might not work and then he would go hungry all day producing the spear needlessly. The fisherman’s underconsumption, can be simply called savings. In this case, the savings was a fish, which he would surely have caught if he had gone fishing. He used his savings, to make a spear. The spear is a capital good, because it is part of the savings, which has no value in itself for the fisherman, but it serves him to get what he really wants. After all, the fisherman does not want to have a spear – he wants to have the fish! Capital is therefore a part of his savings, which he spent on increasing own productivity. Let’s fast forward to our world, to illustrate this example in real life. Two friends got a very well paying job in a company called Corporation X. The employer offered each of them $10,000 a month. Not believing his luck, one of them, let’s call him the Prodigal Pete, immediately bought a big house with a garden on credit, the monthly rent amounted to $3,000. He also bought a luxury car, also on credit, for which he paid $2,000 a month. Bills for the apartment, the cost of the car use, hiring a gardener and a cleaning lady amounted to another $2,000. Prodigal Pete spent the rest on eating in fancy restaurants, and hanging out with friends who “surprisingly” became more numerous after he got the new work. At the end of the month he had no money in his account left over. Meanwhile, his colleague, Thrifty Tom, knew the story of the fisherman that was told in his family for generations. After getting a job he rented a medium-sized apartment, for which he paid $1,500 because he thought that currently the apartments were too expensive to buy so he decided to wait for a better opportunity. His monthly ticket for the subway cost $100. The other bills for the apartment amounted to $400. Thrifty Tom also liked to dine in restaurants and meet his friends, but he decided that for his entertainment he would spend no more than $500 a month. Most days he ate meals at home, trying not to waste food, which cost him another $500. This way, Thrifty Tom could save $7000 every month. The years passed and Pete was laughing at Tom. He used to say to him, “Get a life, man, stop being a scrooge!” or “How’s your car, oh sorry, I forgot that you are still using the subway.” Tom felt upset, because he dreamed of a big house with a garden and a luxurious car, but common sense took precedence over whims. He invested his savings in various projects. He opened a small shop in the area, where he hired one employee. After paying for all the costs, his profit amounted to $1,000. Still, however, he did not increase his spending. After some time he opened a restaurant, from which he drew profit of $2,000. Later, he bought a real estate, partly on loan, and he rented it to various companies as office space. His gains after his loan payments amounted to $4,000. Tom kept acting. After a while, gains from all of his projects were already $15,000. Suddenly, hard times fell upon Corporation X. Because of some bad choices and a global recession, it had to fire 2,000 employees. Among them were Pete and Tom. Tom suffered a slight scratch on his honour, because no one likes to be fired, but other than that he didn’t care too much about the situation. He had an income in the amount of $15,000 per month from his investments and a large amount of savings. Pete, in turn, panicked; the bank demanded payments on a loan which Pete managed to pay only half! Friends invited him out for the first week, but when they saw that Pete had financial problems the invites began to fade quickly. Pete borrowed money from family to survive, but during the economic crisis, no one wanted to accept him, and certainly not for high salary he earned before. Finally, Pete decided to sell the house and car because he was not able to make the minimum payments. The value of the car – although it was in perfect condition – fell dramatically, because it was a few years old, and no one wanted to buy it, because people kept their money, uncertain of their future. The house lost it’s value because Pete bought it at the time of great prosperity and high availability of cheap credit, which pumped up the prices of the property. As a result, it turned out that the market price of his home and the car were as much as the value of the loans, which Pete still had to pay. Pete was really hurt by the fact that for so many years he was paying the loans and now was left with nothing. He still had to sell because he needed the cash right away. After a few days Tom called him and said that he would buy both the car and the house. During the transaction they talked for a while as old friends. Pete told about his situation, and Tom as a man full of empathy said, “Listen my friend, I was just going for an early retirement, I need someone capable to take care of my business, I know that you are a good specialist, how about I hire you for $3,000 a month?” Pete felt relieved, finally someone wanted to hire him, and he was no longer burdened with loans. He accepted the job from Tom, rented a small apartment and began to save. The story of the fisherman was based on the excellent book by Peter and Andrew Schiff – “How the economy grows and why it crashes.” We encourage you to read it. If you are interested in the conclusions of the second story, you can read them below.