Monday, May 28, 2018

One Way to Run an Economy

There is more than one way to run an economy. Today, let's explore a single way.

In our imagination, we have an isolated island with it's own currency. With sunny days and pristine beaches, they wish to join the wider world's economy.

They collectively decide to advertise their island, offering a one week stay for XX.XX in their currency or YY.YY in a number of other currencies. It seems to me that they are setting their own foreign exchange rate. They would need to decide among themselves how the divide the cost of providing that one week experience.

OK. With a plan in place, they begin the experiment. After one year, they find that they have a booming business. They have more people arriving than they can handle. What do they do? Change the exchange rate? Put people on a waiting list? Send guest home dissatisfied?

Whoa. We have too many possible answers! We need to more accurately examine how this island's business is economically arranged. Let's assume that government has been issuing local currency in exchange for foreign currency. This local currency has been obtained from a stable system of taxation that results in an agreeable balance within the island's economy.

Returning to the problem of excessive success, the island government decides to decrease the exchange rate, which results in a decrease in the amount of local currency for each unit of foreign currency. In other words, the price of a week on the island has increased in terms of foreign currency. This action stabilizes the tourist industry but leaves it running at a high and nationally profitable level.

Let's continue this story for 50 years. Our island has a stable, successful tourist industry. Government routinely spends part of the foreign currency and saves part in the form of bank deposits and safe investments in the currency of foreign origin. After 50 years, large sums of reserves are held in some nations.

Could this really happen? Think China? Think Japan? "Whoa!" someone shouts! "Those are both exporting nations. Just the opposite of this story." Hold that thought until later in the article.

Now we add a new twist to the story. An enterprising journalist (who is also an amateur economist) notices the large sums held by a single nation. He also notices the large number of tourist on vacation. He writes a story. The story is read by a politician. We have a political moment.

The story expresses concern about the large overhang of potential spending by this single island economy. There is concern that people are off vacationing rather than working, which just continues the trend long in place. Something must be wrong, but an exact problem and suggested solutions are not part of the article.

Eager politicians begin blaming this island nation for causing unemployment in other nations by failing to spend all of it's earnings (Like the critics were doing?).  Politicians begin expanding the argument by complained that vacations spent on the island could have been provided in-nation to reduce the unemployment numbers and improve the balance of payments. Obviously, according to some politicians, the island nation was doing some things wrong. Maybe the exchange rate was not correct.

This seems to be a good place for ending the story. The political story has developed into something that we can learn from. A single government is controlling the exchange rate. The method of money exchange allows the controlling government to claim a repeated annual share from the labor and resources provided by the entire economy. The situation has gone on long enough to attract the attention of media and political elements.

Except for the critics, everyone seems happy with the stable economy described. Is there REALLY a need for change?

I would suggest that need for change is in the eye of the beholders. The island described is neither China nor Japan, but the effects on reserves and unemployment can be made to sound the same. Every national economy has the ability to arrange a division of resources within it's borders. Whatever arrangement is made has potential interactions with other national economies, which will be developed if mutual benefits for each side can be found.

The economies and economic interactions we have in today's world are the result of political and individual decisions on thousands, maybe even billions, of levels. The illustration provided in this article is just one way to run an economy.

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