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From: atanu@netcom.com (Atanu Dey)
Subject: A puzzle. Who paid for the Englishman's Vacation?
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Date: Sat, 13 May 1995 18:25:30 GMT
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I found this on sci.econ and liked the viewpoint of the
author. I asked for his permission to cross-post it to my
favorite group. I hope you like it too.
Cheers,
Atanu
----------------------------------------------
[ Article crossposted from sci.econ ]
[ Author was Gustave Rabson ]
[ Posted on Thu, 11 May 1995 15:04:02 GMT ]
I have a puzzle for you. According to Maurice Levi in his book
"Economics Deciphered" it was a Ph.D. exam question in economics at
the University of Chicago. I guess I would never have gotten my
Ph.D. in Economics from the University of Chicago because I think
their answer is wrong. But more of that later. First let me present the
question.
I will use Maurice Levi's wording verbatim:
"There once was an upright and very proper Englishman who
regularly took his summer vacation on a tiny, agreeable, Aegean
island. The Englishman had returned to the island so many times that
his credit worthiness had been established beyond any possible
doubt. There was absolutely no chance that this Englishman's bank
would fail to honor his checks and, indeed, all of them had always
been honored promptly.
"Since the Englishman's credit was so sound, the islanders were
totally happy to allow him to pay by check, with the certain
knowledge that they were good checks. Indeed, so well known and
trusted was the Englishman on this tiny island that the islanders
were happy to accept the Englishman's checks from each other. For
example, if the restaurateur wished to pay the grocer partly with a
check he had received in payment for a meal, the grocer was happy
to accept the check. The grocer was then able to buy gas with the
check, and the Englishman's checks circulated in this way around the
island. Indeed, the checks were never returned to the Englishman's
London bank for collection.
"Who paid for the Englishman's holiday?"
Well, who did? Here is Maurice Levi's answer:
"Clearly, the Englishman did not pay, since the checks were
never returned to London. Then it was obviously the islanders, but
which one of them? Because there is no last person to hold the
checks - since everyone can spend the checks and everyone will
accept them - it is not the last people holding the checks. O.K., then,
who?
"The answer is that all the islanders paid, and not just the ones
who sold things to the Englishman. They all paid because their
willingness to accept the Englishman's checks had put the Englishman
in the position of being able to "print" money. He had become like the
central bank in every country, which can print money that people
are willing to hold. (Indeed, they must hold central bank money
since it is legal tender. It is against the law not to accept it.) By
"printing" money, the Englishman had raised the tiny island's money
supply. And as we know from the quantity theory of money, if we
print more money, we raise prices. How, then, had the islanders paid
for the holiday? They paid by being left with reduced buying power
because of the higher prices. They paid through the inflation brought
about by the circulation of the checks.
"The goods and services consumed by the Englishman with his
newly created 'money' - **given an unchanged output of goods and
services on the island** [emphasis mine, G.R.] - leaves fewer goods and
services for the islanders to enjoy."
My Comment:
Well - it sounds reasonable. The Englishman increased inflation
on the island and that was essentially a tax that everybody paid.
But wait. What if the "output of goods and services on the island"
increased because of the influx of capital. What if the waiter who
served the Englishman his kippers every morning used the checks he
got from the Englishman to complete the down payment on a new
ceramics factory he had dreamed about opening. Suppose the general
wealth (in goods and services) of the islanders increased because the
Englishman's "money" made investments possible that were not
possible before. Then inflation would have hurt nobody. Who paid in
that case?
In fact, is that so different from what happens when an
American entrepreneur borrows $60,000 to modernize his factory.
The bank loans him the money, that is they add $60,000 to his
account. But who paid for that $60,000? Well, the Federal Reserve
System requires that the bank have $10,000 in reserve, but where
does the extra $50,000 come from? [See Secrets of the Temple by
William Greider, pp.59 - 61.] And who pays the banker's salary? The
bank can create money because people trust it. Just like the
Englishman on his beloved Aegean island.
On the other hand, suppose the Englishman (by the way, no
racial slurs are intended, some of my best friends are English) had
paid with pound notes, instead of personal checks. Then everybody
would say that HE clearly paid. But the islanders would circulate the
pound notes among themselves, just like his checks. And if the notes
never left the island the situation with respect to them would have
been exactly the same as it was with the checks. Would you say that,
in this case, the Englishman's holiday was paid for twice? Once by the
Englishman himself and once by the islanders?
So what's the answer? The answer is that the question is
wrong. The crowd that calls itself conservative
has been trying to convince us that everything must
be paid for. That, in any interaction somebody wins and somebody
loses. If something good happens then something bad has to happen
in order to balance the books. Somebody must pay. They seem to
believe this although it is plain to everybody who cares to look that
the air is free, the sunrise is free, the rain is free. Good friends are
free. Love is free. Water used to be free. Wild berries are free. Who
pays the wood thrush for his concert?
Who pays for the wonderful gifts of our forbears? Language,
literature, art, music, mathematics, the wheel, the idea of money,
science, central heating, plumbing, the idea of machines - all that.
We accept it all and exploit it, yet nobody pays.
It is the task of economists to trace and explain the flow of
goods and money. To do this they must deal with the fact that
sometimes goods and money are created out of nothing more than
trust, sometimes not even that - and sometimes they are destroyed.
But the question "who pays" is a religious question not an economic
one. I believe this is always the case. I believe that asking who is
going to pay for health care, welfare, education, etc. makes no more
sense than asking "who pays for our delight when we spend an
evening with our friends?" Or "who paid for the Englishman's
vacation?"
I believe that there is such a thing as a free lunch. Indeed we
are all guests, every moment of our lives, at a sumptuous free feast.
We can contribute to it, if we wish, and make it even more
sumptuous for everybody. All it takes is a certain amount of respect
for our fellow guests at the banquet table.
--
Show me a business that is not in debt
and I will show you a business headed for bankruptcy.
Gus