Economics...

Mercantilism (1400's - 1700's): A nation's wealth is how much gold it can accumulate for it's monarch. Positive balance of trade (imports > exports). Governments role is protectionist, encouraging exports and discouraging imports, this is enforced by the use of subsidies and tariffs. 


Philipp Wilhelm Von Hornick was a champion of mercantilism and gave 9 succinct tenants of mercantilism.

1. Every inch of a nation's soil should be used for agriculture, mining or manufacturing. (He must have been popular with the progenitors of modern environmentalists.)
2. Raw materials should be manufactured into finished goods, (example, furniture is more 'valuable' than raw wood. My classmates and I would be familiar with this from America's colonial history. Colonies were established to send raw materials back to England where they were manufactured into other items like furniture then sent back. Colonials were forced to buy goods from England at premium prices rather than make their own.)
3. Large populations are preferable.
4. Prohibit exporting any gold or silver.
5. Prohibit importing and goods.
6. When importing is absolutely necessary use bartering with other goods instead of gold.
7. Import only raw materials and finish them in the home country
8. Try to sell as many goods as possible to other countries in exchange for gold
9. Don't import anything that can be produced at home

This resulted in the 'Golden Triangle.' A trade route between Europe, Africa, and America. Boats would load up on copper, beads, guns and ammunition and sail to Africa. Once in Africa goods would be bartered for slaves. The slaves would be taken to America where they would be traded for raw materials, sugar, cotton, tobacco etc and return to England. 

Mercantilism summary: More is better, especially gold. This is very complementary of the nationalism and expansionist ideals that Western Europe had during the time. 

Critical Problem: Quantity affects prices. If the quantity of gold in a country increases then it becomes less rare and therefore less valuable. Conversely, if the quantity of gold in a certain country is declining, then the value or price of that gold increases. Mercantilism was actually hurting itself by hoarding huge amounts of gold.

Solution = Classical economics/Adam Smith (1700-1900): Although a number of people started to recognize the shortcomings of mercantilism, Adam Smith is generally credited as being the 'Father of Modern Economics.'

Adam Smith redefined the wealth of nations. The wealth of nations was not in the treasuries of the monarchs but in the productivity of its citizens. Smith believed that specialization and trade were better alternatives to protectionist trade practices. Smith theorized that if people pursued their self interests, they would be let by 'an invisible hand' to an exchange which would be mutually beneficial. The point at which this exchange takes place is called the 'Price.' 

Adam Smith promoted the idea of a 'free market' and defined the role of a limited government as follows; a government's role is to

1. Provide a national defense and transportation infrastructure
2. Provide a currency
3. Enforce contracts and copyright law

Critical Problem: An unrestricted capitalist economy creates a polarized population. Relatively few businesses and therefore business owners accumulate huge amounts of wealth and the  general populace is exploited, overworked and underpaid.

Solution = John Manard Keynes (1900 - Present) - Presented theories about Macroeconomics.

Formula for GDP = Consumption + Investment (Savings) + Government Spending + (Exports - Imports)

In response to Adam Smith and free market follies, Keynes suggested government intervention in order to mitigate the extremes of the business cycle using fiscal and monetary policy as tools.

Fiscal Policy: Government legislation. Examples of this are tariffs, taxes, subsidies and  printing money. This process is usually slow and enacted by congress.

Monetary Policy: Usually controlled by the central bank of a country. In the case of the US, this is the Federal Reserve and Ben Bernanke. Monetary policy has the same goal as fiscal policy, that is to mitigate the business cycle but it uses interest rates instead of taxes. The federal reserve will either buy or sell government bonds. These are called, 'open market transactions.'

When the Federal Reserve puts buys US government Bonds, it increases the money in the economy. By buying bonds the 'demand' for bonds increases and prices increase accordingly. This is the important part, when bond prices go up, interest rates go down. When interest rates go down, people and businesses spend more, boosting the economy.
 
"Priming the pump"

Keynes also coined the phrase, 'priming the pump.' The analogy relies on a working knowledge of water pumps. In order for a water pump to work, it needs to be full of water first and sealed before it can create a vacuum and move water. If there is no water in the pump, it cannot create a vacuum, so people need to fill up the pump with a little water to 'prime' it, before it work properly and move a large amount of water.

The analogy applies to the economy in this way. If the economy is in a recession people begin to save what little money they have. When they save, that is bad for the overall economy because no products are purchased and therefore another person's paycheck is less and they begin to save. If the government steps in and begins to 'prime the pump' they will increase government spending on government projects.

Some of the best examples are the CCC camps around World War II. Unemployment was skyhigh from the depression so the government basically made up jobs to put people to work. Now that they had a paycheck they could buy products from the local merchants, providing them with income to do the same.

Money Multiplier

This introduces the concept of the Money Multiplier, which Keynes also advocated. Consider this, you get a paycheck, pay your expenses and put the rest in the bank. Then the money just sits in a big vault until you take some out of an ATM right? Wrong.

You deposit your money in the bank and they turn around as quick as they can and give it away to people in the form of loans. Say a computer software company receives the loan to expand business. Once they get the money they just hold on to it right? Wrong again.

The computer company now has the obligation to pay that money back and a little extra called interest. So as fast as they can they use the money to buy more computers or servers or employees. They do whatever they can do to make more money than the amount they borrowed. So now the money is gone right? Nope.

The computer company bought the servers from a supplier who had to pay their own employees, who took their paycheck and deposited it in the bank. Therefore repeating the cycle. That effect of that original paycheck was magnified or multiplied because it was either used or put in the bank.

"So how big is the multiplier?"
How much money is multiplied depends on the amount the bank is required to hold at all times. This is called Required Reserves. If a bank is required to only have 5% of total deposits on hand, then the inverse is the multiplier. If the reserve required is increased however, the multiplier is decreased by the difference, say the reserve goes from 5% to 10%. Now there is less money in the system to get multiplied.

This is one of the events that caused the 'Credit Crunch' or 'Financial Meltdown' in 2007. Because more people we unable to repay their loans and defaulting. The banks decided to hold more in reserve, when they held more in reserve, other businesses could not get loans to continue business. When businesses and other banks began to default, then a huge number of people were laid off and no longer had a paycheck to buy things with so more businesses went out of business in a downward spiral.  This is exactly what happened during the Great Depression.

As a recap, these are the three main things that Keynes suggested the government can do to make the booms and recessions of the business cycle less potent.  When there is a boom:

1. Increase taxes (think of the earlier equation, increased taxes means consumption goes down)
2. Decrease Government spending (another part of the equation)
3. Increase interest rates (same as #1, but accomplished through open market operations)

 When there is a recession government can take the opposite course

1. Decrease taxes (increases spending)
2. Increase Government spending
3. Decrease interest rates

So what are we doing in the current recession? Ben Bernanke is the head of the Federal Reserve, and before he was at the Federal Reserve, he was an Economics professor at Princeton, and one of the countries leading experts on the Great Depression. When you read about massive amounts of "Quantitative Easing" that really just means he is buying tons of treasury bonds, therefor increasing the money supply and now, you know the rest!