$$$ out of thin air?.

[MarkB]

An exchange I had with a frequent poster on Property Talk in NZ some months ago.

The following two posts are verbatim quotes.

Here's a little story I made up.

-------------------------

It all started with my friend John. He had $100, and I had a nice big safe, so he asked me to store it for him.

Next thing I know, my friend Bob asked me if he could borrow $90. I'm a kind person, so of course I said yes, and took the $90 out of the safe.

Of course Bob being Bob, he spent the lot down the pub that very night

Bob wasn't so happy, but my friend Ken the landlord was, and he came by the next morning and asked me to keep it safely for him in my safe.

Well word must have been getting round that I'm a soft touch, so blow me down if another friend Mick didn't ask for a loan. This time he only wanted $81, so I open the safe again

I knew that was a mistake. He's had this long-term gambling problem, and guess where the money went. Yep that's right, right into Dave the bookies pocket.

He's a careful chap, and asked me to keep it safe for him.

Then Pete asked for a loan. Only $72.90. I'm obviously too soft, but I give it to him from the money in the safe.

He's got quite a big family, and spent the lot at the local grocers. Ted the grocer came round that evening and asked me to put it in my safe.

At this point I thought I'd better start keeping some notes of all this. I'm starting to forget who borrowed what

Now, lets see, I started with $100 from John.

I've lent out:

$90 to my friend Bob.

$81 to Mick.

$72.90 to Pete.

So altogether I've lent out $243.90. And that's the total debt owed.

Hmmm, that's odd, because I only started with $100 ?(

But what do my various friends think they have now?

Well John thinks he has that original $100.

And Ken the landlord has $90.

And Dave the bookie has $81.

And finally, Ted the grocer has $72.90.

So all up, that's $343.90.

And they say you can't make money for nothing

I just hope my friends don't all turn up at once asking for their money back, or I'm going to get beaten up. I've just looked, and I still only have $100 in the safe

Does anyone want to borrow some money ?

My reply

In return you owe:

$100 to John

$90 to Bob

$81 to Mick, and

$72.90 to Pete [Edit 03/12/08: Actually, you owe it to Ted the Grocer, but the effect is still the same]

They cancel each other out except for the $100 you owe John, which still happens to be sitting in your safe.

Even 17 year old's studying economics at high school learn about the multiplier.

Sssshhh... a little secret.... even if the currency was backed by gold or silver or paua shells or vodka (or whatever), the multiplier would still be an issue unless you tightened the reserve requirements such that every dollar lent had to be backed by an equivalent amount in an approved security (ergo you restrict the money supply greatly).

But say they did tighten the reserve requirements (to the hilt) - that would effectively stop the creation of money that was not backed by the equivalent amount of security (by consigning the multiplier to the history books) - ergo it would restrict the money supply.

What happens to the price of something when (other things being equal) it's supply is greatly restricted - it becomes alot more expensive.

And NZers are starting to whinge about interest rates at only 10%!

They'd be waaaaaaaay higher with the money supply restricted.

M

 

[markpatric]

So where did you make money?, you still owe John the original $100, it is not yours you have made nothing.

 

[crc_error]

So where did you make money?, you still owe John the original $100, it is not yours you have made nothing.

your making 4 lots of interest and paying nothing to the orginal depositor!

 

[markpatric]

So who mentioned interest, and what was the point of the story?.

 

[crc_error]

So who mentioned interest, and what was the point of the story?.

the point of the story is how a bank can loan out your orginal $100 several times over. so they dont need to borrow each dollar from the money market

 

[boz]

So who mentioned interest, and what was the point of the story?.

May be if one day you'll go to the bank asking for a loan and they will refuse telling you there is a credit crunch and John decided to put his 100$ somewhere else and they are running a bit short of cash.

 

[markpatric]

OK, so is it a fact then that banks do not create money via loans and destroy it as it`s repaid as earlier stated?, that they use only depositors money to loan again and again?, so it would in fact be real cash at the source of loans? by way of deposits?.

Its just that the story seemed to point to money being made from the example when it wasn`t as far as I could tell, unless you want to start talking interest and fees etc.

 

[BayView]

You have asked a What is the meaning of life type question for an economist.

Apparently the answer is....42.

 

[boz]

OK, so is it a fact then that banks do not create money via loans and destroy it as it`s repaid as earlier stated?, that they use only depositors money to loan again and again?, so it would in fact be real cash at the source of loans? by way of deposits?.

Its just that the story seemed to point to money being made from the example when it wasn`t as far as I could tell, unless you want to start talking interest and fees etc.

Well, the system is a bit more complex as banks don't get money just from depositors, in the last year they get a lot of money from the RBA that also can create money. I believe also money is created if overseas investor buy AU$ in a higher quantity then the sell AU$.
But what is the real tricky thing for banks?
I am not a banker but here how I see it:
We have seen in previous post how banks can create money, to give you an idea that is in a quantity more like 100$ reserve make 1000$ in loans (much more then the 243.90 in the example above). The bad thing that happened in USA first is that when home price drop by just 10% same is for those homes backed by loans. So if those 1000$ that was lend out become 900$ the bank didn't loose 10%, they are bankrupt as 100$ is all they got to start with. This is why you see banks rising money to increase their reserves through government bailout or release of new shares. But untill you get inflation and assets prices are going up all will be ok

 

[Sunfish]

Apparently the answer is....42.

I'm not an expert hitch-hiker but hadn't they forgotten the question by then?

 

[BayView]

I'm not an expert hitch-hiker but hadn't they forgotten the question by then?

Dunno. I never read the book. Is it worth reading?

I saw a t-shirt once with 42 on it, and asked the girl wearing it (she was very hot, but I promise I was looking at the t-shirt ) what it meant.

 

[mrsdawnrazor]

I'm not an expert hitch-hiker but hadn't they forgotten the question by then?

No they just had to build another computer (the earth) to work out the question

"so long and thanks for all the fish"

 

[seank]

2 novice questions
1.So a country prints off heaps of cash, how is this tracked or recorded? Can't a government some-how conceal the amount printed to avoid de-valuing their dollar?
2. Why is the Pound worth so much?

 

[MarkB]

In response to Sean K:

Yeah, I'm sure concealing it would go down just dandy in the annals of history (if they could hide it, not easy, btw, it still doesn't change the fact that the blatant injection of massive sums of cash into any economy is highly inflationary).

As for the pound, my immediate thoughts are:

1. the UK government is seen as more fiscally responsible than the US Govt,
2. the UK economy seen as a better bet than the US economy, and
2. unlike the rest of the EU, they still have a central bank with some influence.

 

[Sunfish]

Thanks mrsdawnrazor, I remember now.

Dunno. I never read the book. Is it worth reading?

Somehow i've never read it all either. It's one of those things I'll get around to, hopefully.

But Douglas Adams' mind must go down in history beside Dr. Seuss and Edward Lear as crazies the world needs.

On a much more serious note he also wrote Last Chance To See about Madagaskar. They take the worthy too soon.

 

[boz]

In response to Sean K:

As for the pound, my immediate thoughts are:

1. the UK government is seen as more fiscally responsible than the US Govt,
2. the UK economy seen as a better bet than the US economy, and
2. unlike the rest of the EU, they still have a central bank with some influence.

Those immediate thoughts are not correct.
The reason is that the pound is not in good shape at all. It is not doing as bad as the AU$ but it is still doing very bad. Today for example is at 0.86 with the euro and touched the all time low (at least on my charts that are going back 30 years). The UK government is running a deficit that together with the US one are far worse then any other major country. The UK central bank is a joke and once they decoupled from the EU bank in setting rates the pound has just not stop falling.
Finally the pound compare to the US$, it was aaround 2 US$ for 1 pound untill august (was around 2 US$ for 2 years), now it is at 1.47 US$. I think last time it was lower then 1.4 was briefly during the Falkland war against Argentina in the early 80's.
I trade the GBP quite often and I never go long on it against any major currency, if technical analysis point that way I'll just don't trade it

 

[crc_error]

Slightly offtopic, but 50 billion Zimbabwe dollars are worth less than $US1 now... however I would be willing to pay more than $US1 to get my hands on a crisp 50 billion dollar Zimbabwe note, just to stick on my fridge. I'm willing to bet others would pay for the novelty too.

I think your reffering to 50 million Zimbabwe dollar note.. $100,000 zimbabwe is worth $US1.

Anyway, since we last spoke, a 100 million note and a few days later, 200 million was released into circulation!

How crazy is that!

http://www.theaustralian.news.com.au/story/0,25197,24763214-12377,00.html

What is causing such inflation there anyway? If the government just stopped printing new money, wouldnt that stop the problem?

 

[kum yin lau]

Hi Boz, just for the sake of comparison. I have no interest in forex now.

I went long on sterling in 1992, that's the year or something like that. It was 1.53 against USD

I later found out I was going the opposite direction to George Soros.

I cut loss at 1.5, bought in again at 1.49 and 1.47

When the dust settled, I squared at 1.53

With interest, I think I made 12.5%

In 2002-03, it was 1.6 and euro 1.12 against USD I made very little because I didn't want open positions.

You're right in that the British pound has taken a hammering. Don't know what's the story there.

I have a soft spot for the stock market & forex because they gave me the seed capital for my properties. I don't do that any more because I don't need that kind of high risk high return. Property is just dandy because it's so stable.

KY