The Financial Crisis Explained to Joe the Plumber

When many people lose half their retirement plan, they are entitled to an explanation. Do not expect it to come from the politicians. They say 'It's a crisis' like they would say 'It's a hurricane'. We are left in the dark, grabbing any little hope we can find in the news and trying to understand, the best we can, how such a thing can happen to us.

For many centuries civilizations have used money based on gold and silver. They had one advantage. Their value was in their weight. The time could change but an once of gold was always worth an once of gold. It could also be divided into many little coins. That made it a convenient means of exchange. In the 20th century things started to change. In 1933 President Roosevelt outlawed ownership of gold by private citizens (except for jewelry). In 1971, President Nixon decided to put an end to the trading of gold at the fixed price of $ 35 / once. That was the end of the gold standard.

We needed to introduce more flexibility in the system and we got more flexibility than we could ever have dreamed of. A dollar bill became a means of exchange that was worth whatever you can get for it. The government was free to print as many dollars as necessary to satisfy the needs of the economy ... and its own. Politicians felt like a kid in a candy store. Whatever they wanted could have paid for by creating more dollars. They had a good excuse. The economy was growing. It created many more things to buy and that required many more dollars. The government was more than willing to oblige. It even created more dollars than needed by the economy. That is called inflation. It reduces the value of the dollars in your hand. We are supposed to know that. We have been told since 1971 that our currency is not a storage of value. We call it 'fiat' money. It is only a means of exchange. In other words: Use it or lose it. The system worked as long as the amount of money in circulation could be absorbed by the economy ... more or less. If you increase money faster than it can be put to use you will have inflation and prices will go up. If you increase the amount of money in circulation much faster than the economy can grow you will get to a point where the economy will get an indigestion of dollars. That seems to be our case. Our national debt has doubled in recent years. We had so much difficulty absorbing those dollars that the banks had to make loans to people who obviously could not pay them back. It was force feeding followed by throwing up.

Maybe the economy is not the beautiful machine we thought it was, with accountants making sure that what gets IN equals what gets OUT. A living organism may be closer to reality. It is made, after all, of millions of people like you and I who do not react like machines. They are driven by feelings that can not be expressed by numbers. We can abuse fiat money like we can abuse food. Kids like sugar but too many candies lead to bad teeth. Abuse it for many years and a day will come when you get a toothache. It hurts. You are going through a crisis. The government can not remove the excess dollars from the economy any more than you can remove excess candies from the child. The only solution is that somebody, somewhere will have to lose those dollars. This is what happened to your retirement plan. This living organism is trying to get rid of excess dollars in any possible way. Logic, reasoning and our sense of justice do not apply. It seems that the system will use any way at its disposal whether it is fair or not. It will make banks lose money on bad loans. It will sell businesses for 10 cents on the dollar. It will make companies and people declarable bankruptcy. A patient in a lot of pain has no morality!

You may think that adding more money to the system would be doing more of what got us in trouble in the first place. You may have a point there! Unfortunately, this is the only thing politicians know how to do. Do not expect much help from them. In October, 160 economists sent a letter to our treasury secretary to tell him that his second plan would not work any better than the first one. Our only consolation is that the dollars that we may be able to keep through the storm may be worth more in the future than the ones we are losing today.

By the time this crisis is over many ideas will be explored by people like you and I looking for an explanation. We are not experts. Our only tool is common sense. We could say, for instance, that we may have neglected a law of nature. Have you noticed that what was created by nature coming with a self limitation that you do not find in humanventions? Our stomach limits how much we can eat in one meal. Our sense of hearing is limited. We can not see outside the range between red and violet. Nature keeps us within limits. On the other hand, human technologies come without any self-limitation. Computer games are fine but nothing will prevent you from getting addedicted. Antibiotics and X rays are very useful but should not be abused. After learning how to use a cell phone, we have to learn not to abuse it. Credit cards are very convenient as long as your self control keeps you out of trouble. There is nothing to prevent a government from creating more money that the economy can absorb. Nature keeps telling us 'Use but do not abuse'. Unfortunately, we do not always pay attention.

Think of the way future historians will talk about this crisis. They will tell our grand children: 'There is some analogy between the way we learned to use fiat money and the way our ancestors learned to use fire: We got burned. We learn much faster when it hurts! For many centuries our commerce used only precious metals. It was in the 20th century that we developed the use of paper money and it was only in the 21st century that we learned not to abuse it, under the gentle but firm guidance of nature. We learned that creating, year after year, more money than the economy can use will lead to a lot of money piling up and a financial crisis. One way or another many innocent people will have to lose the excess money created. It seems to be a lot of pain and suffering to learn an idea as simple as: Use but do not abuse. '

If we learn that lesson we will say that it was well worth it. If we do not ... this crisis will only be vain suffering. The choice is ours. As you can see, there is a price to pay for everything!