Book review: How an Economy Grows and Why it Crashes (2010)

Posted by Luke Boyle on the

Filed under economics, books

How an Economy Grows and Why it Crashes (henceforth known as "the book") is written by Peter and Andrew Schiff. The book is an allegory for the economy based on a fantasy island where every man needs one fish a day to be satisfied. The book outlines the ways the inhabitants of the island increase their productive capacity using capital investment and under-consumption in a very approachable and easy to understand manner. Peter and Andrew Schiff borrowed the central allegory from a book written by their father Irwin Schiff (revered tax protestor who wrote one of only two books to be banned in America called The Federal Mafia), entitled How an Economy Grows and Why it Doesn't. Having not read the original, I have to assume that the primary differentiating factor between the books is that the adaptation includes an explanation for the cause and the aftermath of the 2008 housing crisis.

The book is very entertaining, and it's a very easy read (took me probably 5 hours, and I'm a particularly slow reader). I went through with a highlighter and emphasised the key points, but I found that as I got to the middle of the book, the insights started to dry up. As I got to Chapter 8 (A rebublic is born), it started to drag. I suspect - though I may be wrong - that this is approximately where the original allegory of Able, Baker, and Charlie growing the economy ended, and where the younger Schiff's original portion began. It was still entertaining, but unlike the start which was packed with easy to understand explanations for economic principles, the middle part leading up to the housing crisis was mostly a rushed re-telling of history with a healthy helping of fish puns.

When the authors got past the historical portion and into the future, the book did read better, and it ended very strongly. As this book came out in 2010, the authors envisioned a future where America had to face the music, and Obama took responsibility for his economic policy blunders. Unfortunately, with hindsight, we know that sort of happy ending is rare in politics. Obama and the Fed's policies became worse, which Trump then inherited, and continued. Ten years after publish, the crash described in the book hasn't arrived as the authors expected, but given the state of the American economy it seems more likely by the year.

Here's some key takeaways from the book:

Demand and consumption do not equate to economic growth

(After increasing the productive capacity of the island; that is, catching more fish) "This didn't happen because the three guys were unsatisfied with their limited lifestyle. Their hunger, which is labeled "demand" in economic terms, was necessary to spur economic growth but not sufficient to achieve it."

"With their extra fish, the islanders can finally eat more than one fish per day. But the economy didn't grow because they consumed more. They consumed more because the economy grew."

Denying loans with no pay-off

(About Able giving a loan to someone to take a holiday) "Not only would such a transaction put his savings at unnecessary risk, but it would mean that the capital would be unavailable for more productive loans."

"In actuality, loans to consumers that do not fundamentally improve productive capacity are a burden to both the lenders and the borrowers."

Falling prices are good for everyone

"Steadily dropping prices also encourage savings as islanders begin to understand that their fish would likely buy more goods in the future than they do in the present."

Keynesians react to falling prices like a vampire reacts to a crucifix. Such a reaction is understandable when you realise that their theories are predicated on the idea that spending (i.e. consumption) equates to economic growth. This is why their primary course of action when faced with an economic contraction is monetary stimulus. Inflation is the best way to ensure people spend what they make, because if people know prices are going to rise, they are more likely to spend their money on goods they'll need in the future.

I'd suggest this book for people with a cursory interest in economics but without much of a background. It's quite easy to grasp and would be good for young high school students.

I give it a 6/10.