Book Review: How an Economy Grows and Why It Crashes – Peter Schiff & Andrew Schiff

The book “How an Economy Grows and Why It Crashes” is a wonderful tale written by Peter and Andrew Schiff. It is such a refreshing read after all the cumbersome economics books with lots of graphs and formulas. The author of the book, Peter Schiff, is the owner of Euro Pacific Capital, Inc. and is famous for his predictions about the housing bubble which every other economist and market analysts were denying. You can view the famous video here. Andrew Schiff is also a stock broker at the same firm.

The book totally demolishes the Keynesian economics that spending is necessary for the boosting of aggregate demand and the aggregate demand would lead to a rise in GDP. Keynesians say that with the magic wand of Fed Chairman, i.e. by debasing the currency and by expansionary fiscal policies i.e. by removing the private players from the system and excess of spending from the government (or one can say by giving the capital to its most efficient users) one can increase the GDP which would be beneficial for the country. The book doesn’t simply deny the Keynesian economics but totally demolishes it with a tale. After reading the book, one has no options left other than to laugh at the silliness of mainstream economics. No wonder that the Nobel Prize winner economists are saying that the alien invasion can help in boosting the aggregate demand. The understanding of economics becomes so simple and clear and one can understand the motive behind the moves of Federal Reserve Bank and mainstream economists when they support such silly fallacies (broken window fallacy).

The book has been divided into 17 small chapters and has a total of 233 pages excluding introduction. It is a small book and tale is written in such a wonderful comical prose that one can simply finish it in one sitting of four to five hours. The characters of the book are named so that one can relate it to the real world. There are takeaways after every chapter which are priceless and explains the economics concepts discussed in the chapter with some real life examples.

The book starts with the basics of an economic system i.e. labor. Earlier there were only labors and no capital. The efficiency was quite low and with the savings, the labor creates capital and that capital is used in improving the efficiency of the labor and trade is also born in between. This concept was explained by using an interesting tale of fishing. The fishers were very inefficient at the beginning but soon with savings and rise in their productivity because of savings, they created more and more products and became very prosperous.

It also explains a very important concept how barter system was developed at the earliest and how with the rise in economic production and production of various different goods, the most salable commodity becomes the money. In the tale, the fish becomes that salable commodity. However, in real life, it was gold and silver until the central banker planned something else.

The economy starts with production and then trade happens as the people share their wealth. With savings and use of credit, the productivity level rises and there is expansion in the economy. This is not the same expansion which is followed by a recession. That happens in a fiat money scenario where because of the excess supply of money, the expansion is artificial which has to be followed by a recession. As the economy prospers, it invites new kind of currency backed by the full reserve of fishes. This is similar to a paper currency backed by full gold reserves. However, with the passage of time, fractional reserve banking develops. It has been explained in such a nice and clear way in the book that one can applaud the simplicity.

After fraction reserve banking, the downhill starts and the government gets creative and debase the currency with money printing. This has been explained via the debasing of fish where they reduce the size of fish and make three fishes out of every two fishes.

The free money attracts the criminals. The money was still backed by the fishes but when people started converting their fiat currencies (which have been increased in supply due to expansionary monetary policies and excess of money printing) to fishes, the government decides to delink the paper currency from the fish. It was also done with the gold standard where the dollar was delinked from the gold in 1971 and the world was full of fiat trading currencies and with the help of this invention, the governments across the world simply collect as much as tax from its native (by printing excess of money and bringing rampage inflation which acts as inflation tax).

The expanding economy finally halts and crashes as people start spending more and producing less. The economy was once saved when one full boat of fishes come into the town from another town (like it’s happening in the USA where China is supplying the essential items and taking their fiat dollars in exchange of that). However, they soon will realize that dollar is nothing but a fiat currency with no backing at all. It is fiat and worthless backed by nothing but by the faith in the government. Soon the production becomes less and less as producers are harmed by the expansion in monetary supply and eventually the economy crashes.

The author also talks about the deflation that how everyone fears about the deflation but is okay with the inflation. The author points out that nothing can be further from the truth and puts his arguments in very convincing manners with the superb tale.

The author is an expert in Austrian economics and has learned many things from the Austrian scholars. The book is a must read for anyone who wants to understand the functioning of economy and history of money creation. The book has explained that by using the tale which is very easy to read and to grasp than the other mainstream economics where all you can understand is Y = C + I + G + NX!!



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A blog of the NYU Colloquium on Market Institutions and the Leipzig Colloquium on the Market Order

Fundoo Professor

Thoughts of a teacher & practitioner of value investing and behavioral economics

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