An exchange I had with a frequent poster on Property Talk in NZ some months ago.
The following two posts are verbatim quotes.
My reply
The following two posts are verbatim quotes.
Here's a little story I made up.
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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
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