Once upon a time, a King called Bill ruled a large island called Isla. Isla was rich in all kinds of resources: fisheries, forestry, mines, agriculture and could provide for all the islanders needs. They bartered their produce, a fish for a coconut for example, between themselves, but gave a percentage of what they made or grew to King Bill. King Bill was a good king who had the support and loyalty of most of his subjects.
One day King Bill had an idea. He decided to introduce a currency to bring his kingdom into the modern era. He didn’t have very much gold or silver so decided on what we now call the fiat system. He printed many banknotes, and he called the currency the Bill after himself. Kings are like that, even good ones. He issued many coins, and gave samples to all his subjects and told them that the price of a big fish should be 2 Bills a small fish would be one Bill, A loaf should be half a Bill etc. They weren’t impressed. They said they would rather keep their big fish than sell them for 2 of these so-called Bills. Some islanders drilled holes in their coins to use them as washers. They couldn’t think of anything to do with the banknotes except mount them in picture frames to hang on their walls as they had a nice picture of King Bill on them.
King Bill was very unhappy. He sat moping in his palace all day long. Then he remembered his fairy Godmother had always promised to grant him one wish and he had never used it. She was quickly summoned to the palace. ” Please Fairy Godmother,” he said: “Can you cast a spell to make my subjects use these Bills properly?” ” Oh, that’s an easy one”, she said. “There’s no need for any spells. All you need do is demand that your taxes are paid in Bills. When I heard that you wanted a wish I thought I was going to be up all night working on really hard spells like turning pumpkins into carriages, or frogs into beautiful princesses!”
The King was too worried about his failing currency to be thinking about beautiful princesses at the time and he wasn’t amused. ” Why would I want to do that said the King? I already have a warehouse full of Bills that no-one wants!”
Reluctantly, King Bill did as his fairy Godmother had suggested and switched his tax system from one based on a percentage of produce to one based on the new currency units. He sent out lots of tax demands. A big house would be taxed at 20 Bills. A small house 15 Bills. A big boat at 10 Bills etc He paid his tax collectors, his army, his police and all his servants in Bills too. They didn’t like that one bit and it caused a lot of resentment. They all went on strike! Everyone wanted to be paid in coconuts and bars of chocolate just like they always had been. They all said his currency was worthless! They thought the King was going mad too. Why would he want his taxes paid in worthless pieces of paper currency when he already had a warehouse full of the stuff? He had thousands of notes and coins that no-one wanted. In any case, if he ever did run out of Bills it was easy enough to print off some more.
King Bill had to promise to pay everyone six months’ salary in advance and also promise that if it didn’t work out with his new Bills he would pay them again in bottles of the finest wines from his cellars. This convinced everyone to give the new system a try. His tax inspectors, his policemen, and all his other officials set out to the villages and towns in the four corners of the Kingdom.
Much to their surprise, when they arrived to collect the King’s taxes they found their Bills much in demand. The islanders needed them for just those taxes. They found themselves offered much better lodgings than previously, they were offered much better food and clothing too but, of course, only if they paid in Bills!
So, thanks to the advice of his fairy Godmother everything went very well for the King. He happily spent and taxed his currency into existence. After a time everything settled down and prices become well established. He experimented with how it all worked. Sometimes he spent lots of Bills and taxed only a little. But then people would complain that the prices of fish and bread were becoming much too high. There seemed to be quite a lot of strikes too. Public opinion was divided between those who blamed the workers for being greedy and forcing up prices with excessive wage demands, and those who said the striking workers were just trying to maintain the purchasing power of their wages.
Then he went the other way and spent less and taxed more. He noticed this caused businesses to fail. They couldn’t sell everything they made. People lost their jobs and marched on his palace waving big red flags and carried placards that said things like, “power to the people”, “we demand the right to work!” They chanted slogans like ‘King Bill Out, King Bill Out King Bill OUT OUT OUT ! The king noticed that when this happened his subjects became very intolerant of anyone who had come to live on Isla from other islands and they blamed them for taking their jobs. If they didn’t have a job they called them ‘dole bludgers’ and said they were sponging on the hard working Islans and should go home.
Eventually the King got the hang of how to spend just enough, but not too much, and to tax just the right amount too, and became very good at what we would now call demand management. His kingdom prospered and his subjects became richer than they had ever dreamed possible.
Just as everything seemed be going marvellously well, with inflation well under control, and with nearly everyone, who wanted one, in jobs the King had an unexpected problem. His subjects suddenly got anxious when he decided to publish figures that showed he’d created 50 million Bills and all but about 1 million were out in circulation. Some of his subjects who claimed to be experts in economics, said this meant the national debt from that alone was just about half of the annual GDP of the island.
Some people had become very wealthy. They’d saved their Bills in the King’s bank and which the King had supposedly “borrowed”. However, as he had created them all in the first place he didn’t see it as borrowing. He said he could make as many as he liked anyway so why would he need to borrow any more? He had actually chosen to pay out interest on these accounts, he said, so the holders should think themselves lucky.
Then there was a problem, or at least many people considered it to be a problem, with a neighbouring island. They weren’t so wealthy, their wage rates were low and so they could grow coconuts very cheaply. They sold lots and lots of coconuts to the people of Isla but hardly bought anything back in return. They seemed quite happy to keep all their money in King Bill’s bank. This added to the National Debt. That’s what the experts said.
That all added up to another 100 million Bills. So their National debt was now 150% of their total GDP. Then someone said that wasn’t counting the unfunded pensions that were due to be paid out soon. That was much too high they said. They said things like: “You need to be more fiscally responsible”. ” You cannot spend more than you earn”. “You need to balance your budgets”. “Money doesn’t grow on trees, you know.” The King said that his orchard workers were paid very well and it probably would work out to be more expensive to pick the money from the trees if it did. No-one laughed at his joke.
“The end is nigh” cried the islanders. Or at least the ones who had listened to the claimed experts. “We are bankrupt. How can we ever afford to repay such a large amount?”
“Well it’s like this, ” said the king. “Once upon a time……”
(c) Copyright 2013 Peter Martin. All Rights Reserved.
Reblogged this on alittleecon and commented:
Don’t often reblog stuff, but this is from a new blog I’ve just come across, and wanted to share it more widely. This post explains fiat money and what gives it value by way of a pretty neat ‘Fairy Story’.
Reblogged this on HUMAN RIGHTS & THE SIEGE OF BRITAIN POLITICAL JOURNAL.
Scary but true. Loved it.
“The end is nigh” cried the islanders. Or at least the ones who had listened to the claimed experts. ”We are bankrupt. How can we ever afford to repay such a large amount?”
“Well it’s like this, ” said the king. “Once upon a time……”
There was a great debt…………………………………..
Reblogged this on koenigal86 and commented:
Pingback: Where does money come from again? And why do we have taxes? (Guest post) | koenigal86
Hi there, I’m finding it little hard to understand the end part. That is from the islanders near by could make coconuts for cheap.
My Question is what has that got to do with King Bills country?
Say we consider two islands A and B which trade freely with each other. The two currencies will naturally adjust in value so as to equalise trade except that if the individuals in island B prefer to hold island A currency there will be a slight imbalance.
But say the Government in island B steps in and makes it Government policy to prefer island A’s currency. Its own currency (B) will fall meaning that its exports to A will be higher than its imports from A. The wages in Island B seem lower than in island A. If it wishes to run a continuous export surplus it must always depress the value of its own currency and save in country A ‘s currency. Just like China ends up with lots of saved US$. Saved as Treasury bonds.
So the islanders with the cheap wages end up saving their money in King Bills bank (in King Bills currency) which adds to his National debt.