New Economy

[fraction]

This one is interesting....

__________________________________________
New Economy

It is the month of August, on the shores of the Black Sea.
It is raining, and the little town looks totally deserted. It is tough times, everybody is in debt, and everybody lives on credit.

Suddenly, a rich tourist comes to town.

He enters the only hotel, lays a 100 Euro note on the reception counter, and goes to inspect the rooms upstairs in order to pick one.

The hotel proprietor takes the 100 Euro note and runs to pay his debt to the butcher.

The Butcher takes the 100 Euro note, and runs to pay his debt to the pig grower.

The pig grower takes the 100 Euro note, and runs to pay his debt to the supplier of his feed and fuel.

The supplier of feed and fuel takes the 100 Euro note and runs to pay his debt to the town’s prostitute that, in these hard times, gave her “services” on credit.

The hooker runs to the hotel, and pays off her debt with the 100 Euro note to the hotel proprietor to pay for the rooms that she rented when she brought her clients there.

The hotel proprietor then lays the 100 Euro note back on the counter so that the rich tourist will not suspect anything.

At that moment, the rich tourist comes down after inspecting the rooms, and takes his 100 Euro note, after saying that he did not like any of the rooms, and leaves town.

No one earned anything. However, the whole town is now without debt, and looks to the future with a lot of optimism.

And that, ladies and gentlemen, this is how the United States Government is doing business today.

[Cos]

^^ how do you think it happens anyways? That is what happens now just not so direct and you have to pay the bank everytime you pay off your debt.

My investments are what the bank used to lend you the money for you to buy a car or house. It is all the same.

[extm88]

very interesting read!
:thumbsup:

[chkolny541]

clever

[Masked Bandit]

The story just simplifies the process that is already in place. You can't say that nobody "earned" anything as work / services / products were already supplied by each party at some point to create the debt in the first place.

It's still a funny read though.

[bigboom]

that story only gives you one "circle" of the money. what happens to the money that they earned but was spent? ie. the hooker must have bought some blow with the money she earned so that starts a whole other transaction that isnt captured in the story.

[in*10*se]

^no, hooker did her services on credit.


i just want to know who the "rich tourist" is.... i'm fine w/ the whole analogy, but who in reality represents the rich tourist? China?

[Sorath]

im in china right now, definately no recession here :rofl:

[broken_legs]

Originally posted by Cos
^^ how do you think it happens anyways? That is what happens now just not so direct and you have to pay the bank everytime you pay off your debt.

My investments are what the bank used to lend you the money for you to buy a car or house. It is all the same.

Despite the common belief that banks lend your deposits they actually do not.

Banks create credit out of thin air and lend it at will.

[Destinova403]

Originally posted by broken_legs


Despite the common belief that banks lend your deposits they actually do not.

Banks create credit out of thin air and lend it at will.

by law they need to have a certain percentage of it backed up by cash which would be in the form of customers deposits... other than that most of the money in the economy is created out of thin air and only exists because we all accept that it exists.

i think in canada its 20 percent? im sure someone will know.

[nusneak]

Originally posted by broken_legs


Despite the common belief that banks lend your deposits they actually do not.

Banks create credit out of thin air and lend it at will. qft!

[G]

http://en.wikipedia.org/wiki/Fractional-reserve_banking

[broken_legs]

Originally posted by Destinova403


by law they need to have a certain percentage of it backed up by cash which would be in the form of customers deposits... other than that most of the money in the economy is created out of thin air and only exists because we all accept that it exists.

i think in canada its 20 percent? im sure someone will know.

Nope. I'm bored right now so I'm going to try and explain this but I suck, so bear with me.

Although banks do use some customer deposits as reserve the vast majority of lending happens before those reserves are available. I believe it also depends on the type of bank. IE Commercial Bank, Investment Bank, etc... All have different reserve ratios or capital requirements.

ie for a 10:1 lending bank:

AAA rated Corporation comes to bank and wants to borrow $1,000,000 for a new business venture with low credit risk.
Bank only has 100$ in deposits meaning their current reserve requirement limits them to $1000 in loans.

Do you think the bank turns down the opportunity to make that loan and make all that money? Of course they take the loan.

The Bank makes a loan for $1,000,000 to the corporation. Only after the loan is made does the bank start thinking about finding reserves. At that moment money (credit) was just created out of thin air with no reserve. So does the bank go out and hustle people for deposits now? They've got 10 more corporations who want 1,000,000 loans now too. Going to be hard to get all those deposits.

They borrow the money through interbank lending, and use other banks money (or more likely credit from thin air) as reserves. One bank creats money (credit) and lends it to another bank so that bank can meet its reserve requirements from creating money out of thin air and so on.

So there you go. banks make credit out of thin air. Reserve requirements are kind of silly with this system.

Its like the story in this thread. Theres only that one $100 bill but all the banks lend it to eachother to infinity because they make the loans *before* having the reserves.


Originally posted by G
http://en.wikipedia.org/wiki/Fractional-reserve_banking

I prefer this:

http://en.wikipedia.org/wiki/Federal_funds_rate

The main difference being that in fractional reserve lending with strict reserve requirements (eg 10%) in place are limiting the amount being loaned to a theoretical limit:
1000 + 900 + 810 + 729 + 656 etc....

^^ The amount being loaned out is decreasing due to reserve requirements and will eventually reach a theoretical limit.


Now in real life there is no limit because loans are made that exceed existing reserves, and reserves are borrowed after the fact which creates the need for more loans etc..

Credit is only limited by the banks will to create it, and borrow reserves to meet requirements. Limiting factors are usually the interest rate set by the central bank, willingness of banks to lend to eachother, and of course willingness of people/corporations/governments to take out loans.

A bit long winded but I think that explains it.

[autosm]

Worth the time to watch


http://www.youtube.com/watch?v=vVkFb26u9g8

[broken_legs]

Originally posted by autosm
Worth the time to watch


http://www.youtube.com/watch?v=vVkFb26u9g8

Again this isn't actually how things work.

Video # 2 in that series talks about bank lending and how money (credit) is created through fractional lending.

It talks about a multiplier or theoretical limit of money that can be lent out based on deposits.

"Each new deposit has the potential for a slightly smaller loan"
1000 + 900 + 810 + 729 + 656 .... = $11,111

"Now if the loan money is not re-deposited at another bank, the process stops"

Just plain wrong. This is not how things actually work.

When there is demand for credit, the bank just creates it, then borrows reserves, which is just a loan (more credit) from another bank. There is no limit on the amount of credit that can be theoretically created.


Edit:
Watched the video till the end... says that bank credit creation is limited by willingness to borrow, so I like it now haha.