Friday, March 17, 2006


"Farmer Chang only grows oranges. Farmer Jones only grows apples. Each grows only the fruit that he produces most efficiently, trading the surplus for the fruit grown by the other. Both farmers benefit from comparative advantage and free trade. The sole reason that Farmer Chang 'exports' oranges is to 'import' apples, and vice-versa.

Suppose that one year a frost wipes out farmer Jones' apple crop. Not having any fruit to trade, but hungry nevertheless, he proposes to trade apple IOUs for farmer Chang's oranges. Since Farmer Chang cannot eat all of the oranges he grew anyway, and since farmer Jones' IOUs will pay 10% interest (in extra apples of course) he agrees.

Farmer Chang only accepts farmer Jones' offer because of the apples that Farmer Jones' IOUs promise to pay. By themselves, the IOUs have no intrinsic value. Farmer Chang cannot eat them. It is only the promise to pay apples that gives them value."

And what happens next is about to unfold.

A Tale of Two Farmers

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