Raw Thought

by Aaron Swartz

How Depressions Work

On Capitol Hill sit many powerful people — Congressmen, Senators, Justices — but also numerous others who do the daily work of keeping government running. And, like anyone with such a weighty responsibility, they sometimes want a break: a chance to see a movie or eat out with their spouse.

Kids always make these things difficult, so in the late 1950s someone thought of starting a Capitol Hill Babysitting Coop. The idea was simple: a bunch of families would get together and dole out scrip — little fake money — amongst themselves. Anytime you wanted to go out, you could just hire another family in the coop to watch your kids: one piece of scrip per hour. Later, of course, you’d earn the money back by watching someone else’s kids.

It was a brilliant system and much beloved, until sometime in the 1970s. See, when people left the babysitting coop, they got to keep the balance of their scrip. And so, over the years, the amount of scrip in circulation fell. Soon scrip was in short supply and people begun hoarding theirs for fear of losing it forever. There were few opportunities to babysit (and thus earn scrip) so people didn’t want to lose the scrip they had by paying it to a sitter. Which, of course, meant even fewer babysitting opportunities, making more people want to hoard their scrip, and on and on in a downward spiral.

Since the coop consisted largely of lawmakers and lawyers, they attempted a legislative solution to the crisis, requiring everyone go out at least once every six months. The proposal just made things worse. Eventually, someone tried the idea of handing out more scrip to everyone, and soon, the coop’s delicate balance was restored.

Book cover: Why the Real Estate Boom Will Not Bust

In the 2000s, house prices started rising and everyone started sinking their money into them. Average people would buy houses and mortgage them, banks would buy mortgages, investors would buy mortgage derivatives from banks, and so on. Pundits published books with titles like Why the Real Estate Boom Will Not Bust and many people just assumed housing prices would go up forever. At the peak of it, we had roughly $80 trillion in global financial assets.

Of course, it was clear to anyone who looked closely that this couldn’t go on forever — and that when it stopped, it would bring a lot down with it. And, sure enough, today housing prices are almost back to their usual level and we now have only $60 trillion.

Just like people taking scrip out of the babysitting coop, an enormous amount of money has been taken out of the economy. So naturally people want to hold on to what’s left. So they don’t spend their money, which means there’s less employment opportunities, which means more people want to hold on to their money, and on and on in a downward spiral.

Normally when this happens, as in a recession, the government has an easy solution: lower interest rates. What happens is the country’s leading bankers meet at the Federal Reserve and vote to lower interest rates. Let’s say they decide to lower them (as they’ve done a lot lately). Then the Federal Reserve Bank in New York starts buying up Treasury Bills (government IOUs) for cash, injecting money into the economy. This allows banks to lend out more money, lowering the interest rate at which money is lent out, and thus encouraging people to start spending again. (Later, when the economy is doing well, they’ll raise the rates again, pulling money out and making sure things don’t get out of hand.)

But this isn’t simply a recession. The Fed’s lowered the interest rate to zero — zero! they’re giving money away — and unemployment just keeps rising. Losing a quarter of global financial assets hurts. But now the Fed has a problem: it can’t lower the interest rate anymore. Interest rates don’t go any lower than zero.

Which means, as J. M. Keynes foresaw back during the first Great Depression, we need another way of getting money into the economy. This isn’t rocket science — Keynes suggested stuffing bills into bottles and burying them down mineshafts; Milton Friedman once proposed tossing cash out of helicopters. But as long as the government is spending money, we might as well spend it on something useful. And thus, fiscal stimulus.

We spend the money to build roads and trains and high-speed Internet connections. We give away health care and hand out welfare checks and mail people tax rebates. We do whatever it takes to get more money into the economy. Which people then turn around and spend on all the things they normally start spending money on and the engine of capitalism once again start to turn.

Keynes’ genius came in seeing that the Depression wasn’t a moral problem. We’re not being punished for our exuberance or our stinginess, just as the folks on Capitol Hill weren’t at fault for not wanting to go out. In both cases, the problem wasn’t legislative, but merely technical: there just wasn’t enough money to go around. And the technical problem has a technical solution: print more money.

The moralists insist it’s irresponsible for us to just print more money. After all, they say, debt got us into this mess; is more debt really going to get us out? This is what they told FDR, causing him to hit the break on a recovery that was pulling us out of the Great Depression. This is what they told Japan, ending their recovery and plunging the country into a “lost decade” of unemployment.

It’s not irresponsible to spend money; it’s irresponsible not to. Factories are lying idle, people are sitting at home unemployed, and our economy is slowing. We can spend money to make use of it all, or we can just continue downward spiral. The choice is ours.

Further reading:

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February 4, 2009


We don’t have to act through the Federal government to print money. There’s always the option of local currencies. “Joe, I don’t want to lay people off, so I’m going to give you the option of taking 25% of your salary in coupons that are good here and at some other local businesses.”

posted by Don Marti on February 4, 2009 #


Of course the scrip isn’t “fake” money — it’s different money. Instead of commodity money (usually exchangable for some precious metal), or fiat money, it’s service money — each unit of scrip is pegged to a value of one hour, and the members of the co-op were required (subject to availability, of course) to accept scrip as payment for services rendered.

The fact that the members of the co-op agree to require each other to redeem scrip for babysitting services make it, in some ways, more real than the fiat money issued by the U.S.

Now there is no redemption point of last resort — if all the other members of the co-op decide they are no longer interested in babysitting, the one participant still interested would be left holding a bunch of currency with no one willing to take it as payment for services. With commodity money, there can be a stock of some non-perishable good that can back the money, but a stream of services is, by definition, highly perishible. So the co-op scrip currency only works to the extent that there is a workforce behind it willing to accept it as payment for services rendered. But there’s nothing ‘fake’ about scrip.

Daniel Lawson

posted by Daniel Lawson on February 4, 2009 #

If printing money created wealth, Zimbabwe would be the wealthiest nation on earth…

To say the current depression is about a drop in the supply of script/dollars puts the cart before the horse.

It was the oversupply (the excessive leverage) caused by fractional reserve banking and central banks with inflationary and low interest rate monetary policies which led to an enormous amount of malinvestment which we must now pay for.

Printing money won’t and can’t make the economy better. Printing money doesn’t create wealth, it only transfers wealth from the people holding currency to the people that get the new currency first (the banks).

posted by Steve Dekorte on February 4, 2009 #

Yes, brilliant…

…print more money: That is expending MY money without my consent, in government spending (it tends to spend it worse than me). If you print one more billion dollar you are stealing the current dollars holders 1 Billion of wealth value. Hey, no problem, most of them are chinese and japanese!!

Sorry man, but that’s fckng stupid, I could admit that getting a little in debt when you are not could be wealthy(keynes theory, all extremes are bad), but getting MORE in debt when today America is one of the most in debt countries of the world is stupid. You don’t face the problems only delay and make them bigger in the future.

America is going down because you can’t spend for living four times per capita more of everything that the rest of the world forever.

You have been living at Japan expense first, now Chinese. They support the dollar because they need the export and artificially lowers their currency. Without them inflation in America would be enormous.

I had nothing against America, on the contrary, but recall what I said you today: You are used to live over your means,and you will learn it the hard way.

posted by Jose on February 4, 2009 #

What’s wrong with just letting the downward spiral continue until some level of equilibrium is achieved at lower levels of economic activity? What was great about the way things were before?

You’re sounding like President Bush (whom I voted for, before I realized he was fronting a cabal of whacky world domination neocons) after 9/11, when he said the way out was to spend.

But buying stuff when it’s not really needed is insane.

posted by Chris Ryland on February 5, 2009 #

Somewhere in there, you are talking about velocity of money.

It is not a fact that the velocity of money will go up with increased money supply, it is a guess.

Here’s an analogy for you.

You walk into a tshirt store with 10 dollars, and all the shirts cost 100 dollars, and none of them are your size.

You don’t want to buy any shirts, and even if you did, you don’t have enough money.

Someone walks in and gives you a 100 dollars. Are you gonna buy any tshirt in that store?

If the aggregate economy has no demand for a large portion of goods and services available, giving people more money isn’t going to get them to buy things they don’t want anymore.

posted by Ziad Hussain on February 5, 2009 #

What on earth makes you think that we need to continue printing more money? Printing more money means we need more people to work for that money, to keep the cogs turning.

This implies that we will have room for growth.

We DO NOT have any more room for growth.

We’re hitting the ceiling as far as ACTUAL, PHYSICAL resources go. This should be common sense.

Our planet is overpopulated, and things are getting cramped everywhere. Especially in the third world, whose unchecked growth we encourage for such profits.

Money is an abstract symbol. Of course more of it can be “made”.

But what about room for the human population to grow? Room to cut down more wilderness to keep industry rolling? We’re already running out.

Technology should’ve solved this problem with genetic engineering of crops, but it hasn’t worked because the population inevitably grew too large for that.

That’s what you’re asking. We need a better, long-term solution, and we can only start by running the current one into the ground before we can build a new one that works.

posted by Carl Erikson on February 5, 2009 #

You cannot Spend your way to Prosperity.

You cannot dig and fill ditches as ‘economic regeneration’ because all activity involves NET Energy input. You cant afford that when you are bankrupt. See ?

posted by av on February 5, 2009 #

“Interest rates don’t go any lower than zero.”

I’m trying to find an economist who can explain why. Institutions buy U.S. treasuries mainly for security, not for income.

And some of the experiments with “stamp script” or other money that automatically loses value over time — creating an incentive to keep the money circulating instead of hoarding it — seem to have been successful.

posted by JohnJames on February 5, 2009 #

Interest rates don’t go any lower than zero.


Treasury bills are the government borrowing money, not loaning it. The government doesn’t loan money directly, it aids banks so they can loan money. But no bank would loan money at less than zero — they’d have to lose money on the deal! So if you loan money to banks at interest rates less than zero, they just keep the extra money and keep loaning out at near-zero.

posted by Aaron Swartz on February 5, 2009 #


This “scrip” story is one of Krugman’s well-known favourites, and the standard answer to it is always that it’s not a problem of the lack of liquidity, but a problem of price fixing.

Why does one hour have to worth 1 scrip? Why not let people ask and bid however many scrips they want for one hour?

In this case, fluctuating prices according to demand and supply take care of the problem. As this is not a moral question but something that simply has price, just let people offer a high price for it if they want it that badly and problem solved.

And this isn’t a good enough example, because the price of houses and other goods in real life isn’t fixed this way.

This crisis has more complicated reasons.

The core economic reason is insanely low Fed interest rates between 2002-2005. Look it up. If money is cheap, of course there is a big temptation to invest them into foolish investments and/or bid the price of houses up and/or get into debt, as debt is cheap.

There are also cultural causes, a general culture of present-orientedness as opposed to future-orientedness, a culture of immediate gratification, immediate satisfaction.

This again has many causes which goes a bit beyond the limits of one comment.

posted by Miklos Hollender on February 5, 2009 #

Miklos: Keynes addresses this in detail. If there’s too little money in circulation, then the solution would be to bid down the price. But to bid down prices, you need to bid down wages. And if you bid down wages, people both have less money to spend and are even less likely to spend it, since they fear their wages will be even lower in the future. Which means even less money in circulation, and the downward spiral continues.

Sure, one can think of many causes of our situation; what I’m discussing here is how to avoid a depression.

posted by Aaron Swartz on February 6, 2009 #

When you print more money, you also devalue your currency, which leads to inflation since we import so much. The solution isn’t to print more money, it is to produce more things that people want. America is responsible for more innovation in the last 100 years than any other country and for this reason it is (was?) the most prosperous nation in the world. Instead of financial innovation, we need product innovation and I believe we can get out the mess we find ourselves in…

posted by Abbi Vakil on February 7, 2009 #

Amused by all the rants in the comments above!

This is a favourite example of mine, and as Miklos points out, one way to get the co-op working again is to let the price float. The other is to print money, but I don’t like the explanation you give:


The reason printing money works is, I think, that it changes the calculus of whether to go out tonight (spend) or next month (save), because next month you will need to use more coupons for the same service. So you’re more likely to go out tonight, which give someone else employment, and so the ball is rolling again.

Maybe that’s equivalent, because after a period of inflation, or after prices have fallen, there are more evenings’ worth of scrip in circulation…

posted by improbable on February 7, 2009 #

the flip-side of hoarding because there is too little money in the system is hoarding because there is too much.

imagine that the co-op decides to give each person left an extra 1,000 scrips, just so nobody will run out. so some of the people stop babysitting other’s kids. why would they? they have enough scrips to last them for a good long while.

so it becomes harder and harder for people that go out to find people that will actually babysit their kids for the price of a scrip. they have to resort to spending 2 scrips, or 20, or even return to spending actual dollars again.

print enough scrips, throw money out of helicopters, at some point some important people decide that “your money is no good here”. and pretty soon people are carting wheelbarrows of cash around to buy loaves of bread (it’s happened before).

value of money can only remain consistent if the cash remains sufficiently scarce. diamonds are valuable because they are rare, and because they are finite.

take the finite-ness out of cash, and you take out its value.

[side note: who does that hurt the most? the poor (who don’t have much to begin with), and the elderly (who don’t have the opportunity to earn more wealth to keep up).]

posted by nic on February 9, 2009 #

@nic I had the exact same thought, down to making up the example with “1000 scrips for everyone” ;-)

Is it so unconceivable that the economy might need readjusting/healing (which would be the original use for depressions, I think). Yes, in theory the people could still produce, but their products had been bought with borrowed money. Now the economy needs to readjust so that products get bought with real money.

Trying to think about another example: suppose you work as a street cleaner or something, and the bank has given you a good credit to buy your house. What could go wrong? They have your house as a safety, and they assume it’s price will only rise. Since you have so much credit, you decide to buy a TV set for every room of your 10 bedroom house. So the TV industry flourishes. They build factories to output millions of TVs every day. Then the crisis sets in, and suddenly they realize that all you could offer them in return for their TVs is your street cleaning services, as your house has become worthless. Sure, they still have the factories that can output millions of TVs every day. But they decide that they don’t want to give you 10 TVs in return for a measley street cleaning job.

What is needed is somebody who produces something that the TV makers want, so that it is still worth for them to keep producing their TVs.

Maybe the economy can adjust as such, some car manufacturer steps up and decides to swap TVs for cars. Or maybe the economy can’t even adjust as such so far - there might be more important things to buy than a TV for every room, so if you are one of the “players” who actually produces something worthwhile, you might still decide to not exchange your product for TVs.

So yes, the production capacity of the society might not have changed, but people might be producing the wrong things. The depression is needed to readjust the production to worthwhile things.

posted by Björn on February 10, 2009 #

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