The Parable of Saltwater



This is something I came up with for the Money and Banking class I teach to illustrate why artificially low interest rates distort the economy by misallocating assets.

Picture a beautiful ridge, perhaps in California.  On the left there were beautiful views and an easy path down to the ocean, and on the right, there is a rockier slope that leads to a crystal clear bubbling brook.  All day long hikers walk along this ridge taking in the beautiful scenery.  Part of the local culture of this ridge is that two old men, no one knows their names, sit at the top and play cards on an old wooden table.  Occasionally, they stop a hiker and ask him to go down to the bubbling brook and fetch some water to drink.  The hiker selected not only received a dollar for their troubles, but being asked to fetch water was widely considered to be good luck.

One day, one of the card players said to the other, "Guess what?  My uncle Ben Bernanke died last night and left me 4.5 trillion dollars."

The other card player says, "Wow.  That is fantastic.  What are you going to do with all of that money?"

The heir to the money replied, "Well, as you know, I have always wanted a saltwater pond.  You see this ravine behind me?  I am going to get these hikers to fill it up by paying them $5 for every bucket of saltwater they retrieve."

Shortly a hiker passed and the heir offered him $5 for a bucket of saltwater.  He gladly complied and the first bucket was dumped in the ravine.  He asked if he could bring another bucket under the same arrangement, and the heir nodded.  This went on all day, and the hiker walked down the ridge that evening with $180 in his pocket.

The next day the hiker showed up with two buckets.  The day after that the hiker showed up with two friends, each with two buckets of their own.  And word spread.  It was not long before others showed up and the ridge became a hive of people moving buckets of saltwater.  Within a couple of weeks one of the hikers devised a pulley system which allowed him to move more buckets than his competitors.  Another hiker with bad knees, realized that all of the new people on the hill built up a hunger running buckets of water all day long, so he set up a restaurant.  His food was good and lines were long, so it was not long before three other restaurants opened to handle the overflow. 

More ambitious people asked the heir if they could work later into the evening, and soon a market for temporary housing developed. A news station did a story on the miracle economy on the hill, and it was not long before economists were writing articles featuring charts and graphs of how monetary stimulus creates opportunity for all. This brought in more development by those hoping to cash in on this windfall.

Of course it was not all positive. Because a bucket of saltwater paid $5 and was an easier climb, the cost of freshwater skyrocketed to $7. Similarly, food was scarce, but everyone had money in their pockets, so the restaurateurs were able to continuously increase their food prices.   Fewer hikers came to the ridge because it was no longer sparsely populated and beautiful.  Billboards for the restaurant and hotel now dotted the hillsides, and there was litter everywhere. But the indisputable fact was, the hillside entrepreneurs were flourishing. 

After 18 months, the heir looked behind him and noticed the ravine was nearly full.  In fact, if one more bucket of water was dumped into it, it would overflow and the two men would no longer have a place to play cards. And so, just like that, all of the free money stopped.  The heir stopped paying $5 for saltwater. 

The very next day, the economy on the hillside crashed.  What had appeared to be a vibrant economy just the day before, seized.  The smartest waterfetcher on the hill and the dullest waterfetcher on the hill realized simultaneously that their investments and labors over the prior eighteen months contributed no real value.  They sickeningly came to the realization that the only reason they were asked to fetch saltwater at all was because the Heir had too much money and did not care if he used it wisely or poorly.

Within days, the number of people on the hill was down by half.  By the end of the week, the number was halved again. The only people still making the trek were those who had investments in lodging and eateries. But soon they realized without customers, there was no reason for them to come to the ridge, and they boarded up their establishments in very short order.  Perhaps most sadly, because the hillside was now spoiled with abandoned buildings and remnants from the "Saltwater Rush", hikers did not even come by anymore. Within a month, the hill was an empty, littered ghost town.

The two men had the hillside to themselves to play cards, but after "investing" $4.5 trillion dollars filling the ravine with saltwater, they no longer had anyone to get themselves any water to drink, so ultimately they disbanded their card game, and the culture and value of the ridge was finally and terminally decimated.