Lemonade Stand Economics
Summary: Timmy, a precocious ten-year-old opens a lemonade stand and learns about unbacked currencies.
“Dad, I’m excited and ready for business. Mom made me sign an IOU when she gave me sugar and frozen lemonade so I have stuff to sell.” Timmy looked up at his father and smiled in anticipation.
“Great job! This’ll be a learning experience. Here comes your first customer.” James, his father, wanted to be helpful, but expected Timmy to interact with customers.
A retired gentleman pushed his walker toward the lemonade stand and said, “Hi little fellow, I want a cup of that lemonade.”
Timmy poured lemonade into a twelve ounce plastic cup and handed it to his first customer. “That will be one dollar.”
The man handed Timmy a dollar bill, sipped his drink and shuffled away.
James said, “That was easy.”
Timmy examined the dollar bill and said, “It’s paper and says one dollar, but what is it worth?”
James groaned. This is what I get for raising an intelligent kid. “Timmy, the dollar bill is valuable because you can buy books, food, video games, or pay your mom back for the sugar and lemonade mix. And you can deposit the dollar into your bank account.”
Timmy looked puzzled and said. “So it’s monopoly money, but because other people will exchange it for goods, this dollar has value.”
James said, “That’s correct, but it’s better than monopoly money. The central bank of the United States, the Federal Reserve, issued this dollar and stands behind it.” That explanation should satisfy him.
“So the Federal Reserve puts ink on a piece of paper and makes it valuable? That doesn’t make sense.” Timmy sounded confused.
James tried again. “The Federal Reserve issued and backs this note, so people trust and accept it for goods. You took the dollar in exchange for lemonade as an example.”
Timmy frowned as he looked at the dollar bill. “It says ‘Federal Reserve Note’ and ‘This Note is Legal Tender’ but it doesn’t say it’s money. What does that mean?”
This is getting out of hand. “Well, Timmy, it isn’t money, it’s a debt or promissory note issued by the Federal Reserve. That dollar is similar to the IOU you gave your mom for the lemonade supplies. This is an IOU from the Federal Reserve. They acknowledge this dollar bill as a debt they owe to you. But it’s valuable because we know the Federal Reserve supports the debt.”
“So the Federal Reserve owes me a debt. What backs that debt?”
Uh-oh. Got in too deep. James sounded defensive as he said, “That dollar is backed by the ability of the government to collect taxes and issue debt, basically faith and credit.”
Timmy looked puzzled. “So what happens if people lose faith in these Federal Reserve debts, or they no longer trust the government?”
Definitely too deep! “Timmy, that’s a very astute question, but few people worry about the dollar. However, many other currencies became worthless because nothing real backed them, and everyone lost faith in their usefulness.”
Timmy looked satisfied. But a moment later he asked, “So people might lose faith in the dollar?”
“Well yes, I suppose they could.”
Timmy looked up at his dad and asked, “Why did those other currencies fail?”
James cleared his throat and said, “Their governments went deep into debt, and their central banks printed trillions of their currency notes.”
“But dad, I heard you complaining about the massive debts our government created, and you’re critical of the Federal Reserve for printing trillions of dollars in the last several years. What’s the difference?”
“Well, Timmy, there isn’t a difference except those other currencies and governments were poorly managed.”
“So dollars and our government are managed well?” Timmy looked confused.
“I didn’t say that. I said the other governments were worse. Oh look, here comes another customer.” Just how smart is my son? I didn’t think about this stuff when I was ten.
A young woman jogged up to Timmy and said, “One cup of lemonade please. I assume you take plastic.” She jogged in place waiting for her lemonade.
Timmy stammered, “I don’t take plastic, only cash. Sorry.”
“If you want to run a business, you have to take plastic. Well, next time.” She jogged down the street.
Timmy looked up at this dad and said, “Dad, I need help. How can I take credit cards? I’m not Wal-Mart.”
“You already have a checking account, and you can buy a cell phone and a slide attachment. Then you register with a bank for a commercial VISA account. But that might be more trouble than it’s worth.” James struggled to sound positive and upbeat.
Timmy asked, “Sounds expensive. How much will that cost?”
James explained, “The cell phone has a monthly fee. I’m not sure about the bank’s Visa account or the slide attachment. The bank will take three or four percent of your sales and deposit the remaining dollars in your checking account.”
“So I pay extra to take a credit card, and the bank charges me for every transaction?” Timmy sounded disgusted.
“Visa claims their system is a convenience that boosts sales. In return they take a slice out of every transaction. Someday all transactions will run through the banks and there’ll be no need for cash.”
Jimmy frowned for the tenth time and said, “So I get paid with paper dollars that are unbacked debts from the Federal Reserve, while the government destroys the value of those dollars by issuing too much debt. They want to eliminate cash, and the banks demand a piece of every transaction. There must be a better way. I feel cheated.”
James looked at the grass and said, “A long time ago dollars were real silver coins, and nobody used credit cards. Paper dollars could be exchanged for silver, banks didn’t run the world, and people trusted banks and the government. But those days are gone forever.”
James sighed and continued, “People aren’t better off, but the bankers are wealthy because they made it easy for everyone to go into debt and spend dollars. Legally changing dollars from real silver into paper IOUs and computer digits encouraged everyone to fall into the debt trap.”
“Dad, I’ll stay a cash only business, and if that hurts sales, too bad.” Timmy sounded decisive.
James agreed, “Probably a good idea.” I won’t mention sales taxes, income taxes, business licenses or health inspections. He’s already overwhelmed with the real world of unbacked paper and digital currencies.
Another customer arrived and paid with cash. Timmy served him and sketched a “Cash Only” sign after the customer walked away.
He looked up and asked, “Dad, how do I trade these paper IOUs into silver coins? I want to save something valuable, not debts from the Federal Reserve.”
“Timmy, that’s a good idea. When you have enough paper dollars I’ll take you to a coin store or you can call Miles Franklin at 1-800-822-8080. They’ll accept a check and ship the silver coins to our front door.”
“Okay dad, I want to buy silver.” Another customer approached, glanced at the cash only sign and ordered lemonade. Timmy smiled as he served his customer and accepted a paper dollar while imagining shiny silver coins.
Gary Christenson is the owner and writer for the popular and contrarian investment site Deviant Investor and the author of the book, “Gold Value and Gold Prices 1971 – 2021.” He is a retired accountant and business manager with 30 years of experience studying markets, investing, and trading. He writes about investing, gold, silver, the economy and central banking.
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