5 Chinese and 1 American on an Island

I was re-listening to an audiobook I bought a few years ago, actually my brother bought it logged in as me, so I ended up listening to it. It was Peter Schiff’s “Crashproof”, released in 2006 where he predicts the fall of the US dollar and standard of living.

He gives an interesting and funny analogy of the US consumption and trade relationship with China. Many people say that China needs the US to consume its goods and Schiff compares this to 5 Chinese and 1 American stranded on a desert island.

Basically, for many years now, the US has been importing much more (much of that from China) than it exports, which creates a trade deficit. The American economy has shifted from producing products to mostly providing services. Production has been mostly taken over by China and countries with cheaper labor.

What happens when a Chinese company gets payment for its goods by a US consumer is that eventually the country, China, accepts US debt in the form of treasuries/bonds and other financial instruments. Basically they just accept IOUs, which is an instrument that promises to pay a certain amount of dollars in the future, this instrument also pays interest.

In our analogy of the 5 Americans and 1 Chinese the 5 Chinese are in charge of finding and preparing food: 1 goes hunting, one goes fishing, another rummages the forest for fruits, another will cook dinner and the last finds wood and prepares the fire… Meanwhile the American’s job is to simply run a private tanning service, tan himself on the beach and eat the feast provided by the 5 Chinese.

The American knows the Chinese must eat something if they are going to continue to produce food for him to keep up their strength so he gives them some left over scraps.

Upon hearing this analogy one might say, that is not the case because Americans pay for the goods they receive and Chinese do receive value in exchange for their effort.

Ok, so after eating each night, the Chinese present a bill to the American on the island, he in turn gives the Chinese IOUs which represent future payments of food. The Chinese know that the IOUs can never be claimed since the American lacks the means or intention to make good on them. But the Chinese accept them anyway and they accumulate.

Are the Chinese any better off working for the American and accumulating his worthless IOUs? What would happen if they kick the American off the island? Is the American the engine of growth for the Islands economy?

Schiff continues with the analogy sticking some central bankers in it but I think we get the point already. The Chinese doesn’t need to keep accumulating US debt in exchange for its good and they should probably stop before it becomes completely worthless. The US has printed in the last 2 years more money than it has printed in the last 200 years.