How Money Works
THE BABYSITTING SYNDICATE

This article elegantly illustrates how money managed so as to maintain high levels of economic activity contains the germ of its own destruction, and how under certain eerily familiar circumstances careless holders of this money can be ruined.

A true story

In Washington a babysitting syndicate was once created which relied on tokens that were given to each parent, so that when each used a babysitter they paid a token, and when each sat for babies they received one. All parents started with the same number of tokens and the syndicate got off to a flying start - with everyone going out when they wanted to and eagerly offering their services as sitters to replenish their reserves.

Unfortunately those who were disposed to work more and play less (or those who fantasised about being able to spend a year going out every night without ever having to sit for the noisy brutes again) ended up accumulating all the tokens.

Within a few short months it was so difficult to earn a token that those who had a spare one were unlikely to choose to go out except for a decennial wedding anniversary. They all ended up staying in until an economist said they should issue a new tranche of tokens. They did, and pretty soon everyone was happy again for a while.

The business cycle

The problem which was overcome was an old one. Because of natural variations in their psychological condition and circumstances some people save, and some do not. If the velocity of money circulation slows both types of people choose to spend still less, and economic activity stalls in what we know as a recession, leaving money sitting securely in the savers' bank accounts doing nothing and earning nothing. Everyone lives less well under these circumstances even if savers don't mind too much, being generally patient.

As long as the monetary unit is in strictly limited supply this situation will arise regularly because there is a feedback into the loop of economic activity for both booms and busts. The widely recognised conclusion is that wherever money supply is limited economic activity at any level is inherently unstable, and subject to oscillate in what is called the business cycle.

The solution of the babysitting syndicate was to do away with money being in strictly limited supply. In other words the amount of money in circulation was allowed to be artificially adjusted to ensure that enough was around to maintain a respectable velocity and a decent way of life for everyone. This situation appears to offer to modern economists the prospect of stability at relatively high levels of economic activity, because if savers understand that the authorities' response to recession will be to increase money supply then the reinforcing effect of the feedback is broken. There is no longer a need to fear a vicious circle of tightening monetary conditions otherwise known as a slump.

In this happy and slump-free situation we have all enjoyed the last 70 years.

Paul Krugman's depression economics

This true story of the babysitters was paraphrased from Paul Krugman's book 'The return of depression economics'. He developed it further into a neat model where a central administrator issued tokens at a given interest rate to people who wanted to go out repeatedly and catch up with their babysitting later, and he refined it by introducing a winter and a summer to show how in winter, when people preferred to stay indoors, a token was less likely to be spent than in summer. In fact once the syndicate had got started there was always another wrinkle which needed ironing out, and the managers figured they were well up to the task.

Had he continued with his model before long, no doubt, there would have been options on tokens, and rates for exchanging each others tokens between neighbouring syndicates. But Paul Krugman never took it quite to the limit, which is a pity.  It probably would have ended badly.

An unhappy ending

Having got the hang of issuing further tokens the technique became the tried and trusted solution to managing GBP [Gross Babysitting Product].  More and more got issued each time babysitting activity started to slacken, and the keen sitters continued to accumulate them until there was a huge differential between the token rich, and the token poor - who at least were having all the fun.  Eventually, looking at the extraordinary number of tokens in issue, and realising that there really wasn't any chance of his using all these tokens (which could only be spent locally, and for the very specific purposes of the babysitting syndicate) one saver chose to sell his stash. Deciding he wanted to use the tokens for any purpose he exchanged them for dollars.

Having bought tokens soon his customers were out on the town, without returning the favour to other babysitters.  Armed with their own mini-stash of riches they didn't need to. Indeed they could afford to be unproductive as long as there was someone else prepared to work for tokens. Before long lots of members had spare tokens and fewer people felt the need to earn them. They had become asset rich, and lazy. So the demand for babysitting services increased but the supply of willing sitters dried up. Quickly the token price of babysitting rose, and on Saturday evenings people had to spend two tokens rather than one. This sucked in out-of-town sitters to work Saturdays, who started to accumulate the tokens themselves, in anticipation of moving into this affluent suburb and joining the syndicate properly.

But then other savers - and a few of the out-of-towners - started to sell their tokens too, and the accumulation of years of token injections poured out into circulation. The administrators realised the problem of all the tokens previously issued by them flooding on to the market. Their reaction was to pull a confidence trick. They measured the rate at which all these tokens were changing hands (which was formidable, even if few people were actually doing any babysitting) and published the numbers as evidence that their system was in good health. This was effective in persuading the diminishing number of productive sitters to continue accepting tokens for their efforts. But even though the faithful workers were still accepting them all transactions converting them into dollars were being done at worse and worse prices - which of course appeared as more and more activity in those wretched statistics. The managers finally realised they had to take some tokens out of circulation to prevent sitters starting to demand dollars for their services.

The problem was finding something the managers could give in return for redeemed tokens. They had been issued like magic, when the value of them was unchallenged and each could easily be converted into babysitting. But now they had nothing to pay them out with at redemption, so there was no easy way of getting people to surrender them. So the private sales of savers' hoards continued, getting still lower and lower dollar prices until people took to wandering the streets with carts full of tokens, hoping to trade them for something worth having.

The lucky sitter who got out first was the only one who really did well out of the whole affair. Unfortunately even he later made one small mistake. He started to mix with the rich set, and one day one of his friends came to visit him in his fine house. The visitor was so impressed with the house he offered $250,000 over and above an estimate which, by co-incidence, the man had received from an experienced and trusted valuing agent only that morning. So he accepted immediately and went to live in a hotel for a while. By the time he'd thought about it long enough to appreciate the irony it was too late. He later bought a second hand bicycle.

Now a real token system

A staggering $6,800,000,000,000 of debt has now been issued by the US government to pay for the injections of demand into the American economy over recent years. There is no credible way of diminishing this colossal debt, so politicians have to gloss over it, as they daily issue billions of dollars of public debt to inject activity into the US economy.

You can watch it grow yourself at http://www.publicdebt.treas.gov/opd/opdpenny.htm

Here is one week’s progress :-

12 Nov 2002   -$6,270,943,936,131.68  
13 Nov 2002   -$6,273,282,463,524.76   -$3bn
14 Nov 2002   -$6,282,138,550,697.26   -$12bn
15 Nov 2002   -$6,324,046,866,798.58   -$54bn
18 Nov 2002   -$6,325,418,923,385.89   -$55bn
19 Nov 2002   -$6,330,526,863,880.25   -$60bn

In the ten years between 1950 and 1960 the US national debt rose $33 billion. In 2001 it rose by $360 billion, and in 2002, in one lousy November week, put on about $60 billion. Every cent of this expenditure is injected in a similar way to the babysitting tokens, and each is required to retain the high velocity of money which keeps Americans working to assimilate yet more of them.

Meanwhile the dollar denominated asset rich have accumulated what they regard as wealth - mostly in the form of real estate which they live in, and investments which yield almost nothing.  They feel wealthy because they own capital assets valued in dollars at many times their personal annual expenditure.  But these assets wouldn't yield the cash to pay more than a tenth of their living costs, because they have no cash generating capability. 

America's asset riches are illusory, but like the babysitting syndicate they have still encouraged America to become collectively unproductive.  This is easily seen from the US trade deficit, which at $5,000 per household per year is a clear sign of a nationwide failure to produce.  It does not matter how loudly dollar denominated GDP growth is quoted as a sign of health.  It is a false statistic, easily manipulated by allowing one government department to buy something from another. The trade figures tell a truer and much uglier story. 

The US economy is a token syndicate based on dollars. One of these days a few dollar savers will look at the extraordinary over-issuance and conclude that these vast balances will soon flood onto the market and lose all their purchasing power. Currently about a third of US Treasury dollar assets are foreign owned, having been accumulated as the balancing figure of the annual $430bn US trade deficit. A shrewd strategist in Beijing might even today be pointing out to his political bosses just how big a stick the Chinese US dollar reserve is.

Consequently the US dollar is likely to collapse in one of the greatest economic turnarounds in history. Within the foreseeable future there will be dollars sloshing around all over the world, and there will be no takers.

One way out is to buy gold. If you buy it now your timing will not be perfect, but you will be sitting on the right side of the curve, so you will be able to forget about it and carry on with your life. One day soon you will be a free man in a world of slaves.