Whenever I consider discussions of Keynesian financial stimulus plans, I think of Richard von Strigl and his concept of the subsistence fund and Frank Shostak and his formulation of real savings. To explain further, let me provide an analogy.
Like his father before him, Richard farmed his piece of Equilibrium Valley – an isolated paradise. A wise and prudent man, Richard built three silos on his farm. The first one held the newly reaped grain bound for his kitchen and the weekly market. The second held the grain he stored to feed his family and pay employees during the winter and planting months. The third held the grain he used to pay workers to mend and improve his barn, fencing, and house.
In the valley were two other farms, each having a similar set up, with one of the farms producing corn and the other soybeans. In addition to the farms, three ranches raised beef cattle, pigs, and chickens respectively. Just like the farms, the ranches had three freezers that served the same purpose as the silos.
In the village situated by the stream that divides the valley lived twelve workers and their families. The men worked on the farms and ranches. This constituted the entire population of Equilibrium Valley.
On Saturdays, the farmers and ranchers would travel to the village to hold market. The folks settled their transactions by using slips of paper that entitled the holder to a portion of the foodstuff printed on the front. One slip might be worth a bushel of corn while another pound of chicken. The happy folks in the valley exchanged these slips of paper, redeeming some and holding onto others. Foodstuff not redeemed during the market was returned and stored for the following week.
On rare occasions, someone would ask for credit from one of the farmers or ranchers. A farmer might agree to issue a slip or two against his storage, which the debtor exchanged on market day. In a week or so, the debtor exchanged for circulating slips and returned them to the creditor, thus extinguishing the line of credit. No one ever failed to pay on time.
There being nothing fractional about Equilibrium, the slips in circulation never exceeded the amount of foodstuff held in silos and freezers. And everyone in the valley had a lockbox containing their slips which they would redeem when needed.
According to Shostak, the contents of the silos and freezers constituted the real savings of the community – the slips being nothing but paper. According to Strigl, silos two and three held the subsistence fund, with silo three specifically holding the capital replacement fund. Without sufficient storage in the subsistence fund, the community could have never survived the winter. And without sufficient storage in the capital replacement fund, capital could not have been maintained and the infrastructure would have collapsed as barns, fencing and houses slowly sank to the ground.
The economy of Equilibrium had been stable for years. The slips of paper – issued by each farmer and rancher – were trusted in all exchanges. Life was cozy and comfortable, until two strangers arrived one day: Ben and his uncle Sam.
Sam and Ben rented small rooms in the house of one the workers, paying him with slips of paper identical to those exchanged on market day. The worker and his family were happy since the collection of slips in their lockbox increased with the weekly rent.
Sam and Ben were not lazy roustabouts; they were planners with big ideas – real big ideas. One morning they sat with their landlord Dave and expounded on their latest project. Sam was going to build a monument in the village. Not just any monument, he was going to build a right grand one. Sam explained to Dave that in order to complete his project, he would need Dave’s labor. And Sam was willing to bid Dave away from Richard, his current employer. Dave was exhilarated.
Work soon began. Sam paid Dave a weekly salary of 10 slips, redeemable in one bushel of grain each, twice his normal wage. Dave started spreading these new slips of paper at the Saturday market. Valley residents sensed a boom.
A few days later, Frank, the cattleman, returned home to find Sam and Ben quietly waiting on his porch.
Ben started, “Frank, you know things are beginning to heat up in the valley. We thought you might want to get in on the action, so we are proposing to loan you enough slips to complete your new fence line. That way you can raise more beef, just like you have always wanted. We are so convinced of your project that we will loan you slips interest free.”
Frank was taken aback, with these new slips he could bid workers away from the other farms and ranches. And he could build his dream ranch. Interest free, nonetheless. How could he beat that? Frank shook Ben’s hand in agreement.
Soon the valley’s economy boomed as other dream projects broke ground. All the while, the workers would go to the market and exchange slips for produce. And since times were good, the workers exchanged slips for more produce than normal. Their stomachs and lockboxes were full.
One afternoon, Richard took stock of his silos. He opened silo three to find if empty. Panicked, he opened silo two to find it half empty. His heart raced. It was only late fall and his savings had dwindled.
Richard ran across the road to Frank’s ranch and told Frank of his find. Frank opened his freezers to the same condition. There was trouble in the valley.
Richard and Frank headed to the village and called a meeting of the valley residents. What were they all going to do? It would be lucky if the community survived until the next harvest. The residents had down-turned heads and ashen faces as they discussed their reality – they had depleted their subsistence fund by substituting their real savings for paper. All projects would have to stop so that the residents could forage food in the woods and meadows.
Sam and Ben would have none of this. They rose and said that they only needed to create additional savings by issuing more credit – more slips of paper – and then the boom would begin once again.
Now who are you going to believe? Richard and Frank? Or uncles Sam and Ben?