Economics Questions

Re: where is the error with this image?

Peter Sidor — Wed, 01 May 2013 15:54:39 GMT

Marko:
What is the cartoon trying to point out / arguing for?

Apparently the urgent need for more beefy German tourists with a lot of money. If only there was more of those, the world would be a much better place.

Re: where is the error with this image?

Andris Birkmanis — Sun, 24 Mar 2013 20:15:23 GMT

And I'm not sure whether you can transfer someone else's debt to you over to someone else and clean your hands of your obligation.

Not unilaterally, but you can convince the creditor that the new debt is worth at least as much as your old one (you basically sell your rights for some other debt's collection to your creditor).

Re: where is the error with this image?

Albert — Sat, 23 Mar 2013 16:02:27 GMT

Of course debt between countries(or people or corporations) can cancel each other out. That is the basis of trade. As long as the same principle players are involved. Country A buys American corn from the agriculture department and sells agriculture chemicals back to us. We may choose to offset each other and the bigger debtor can just pay the difference or ask for it to be held as a debt until they can produce more product- no problem. Only problem is that the word "country" is too big. If the Agriculture department is owed money but the tourism department or the military gets the repayment benefit, it does not offset.

Of course debt and repayment can be handed around in a circular fashion like described. That is all money does anyway, it serves as a visible representation of the value of your services or products so you can exchange. All money is, is a promise to pay.

They could just as easily have written each other a check and then take all the different checks to the bank and then the banker figures out it is all a wash. This works because each member of the circle has alreafy produced his labor. Nowhere in this circle is there a person who borrows the money without producing, thus breaking the cycle.

You cannot just hand it off to another person who has not yet performed his part and pray that he shows up though. In the scenario it works because each player had already previously provided a valuable product or service of acceptable equal value. The note was not given to anyone who was promising to deliver at a future date.

Re: where is the error with this image?

Marko — Sat, 23 Mar 2013 09:55:43 GMT

What is the cartoon trying to point out / arguing for?

Re: where is the error with this image?

Wheylous — Sat, 23 Mar 2013 05:27:58 GMT

Suppose, though, that the debt is circular like this. At the moment, countries owe tons of money to each other. The debts don't just cancel out, though.

And I'm not sure whether you can transfer someone else's debt to you over to someone else and clean your hands of your obligation. When you're in debt, you're responsible for the creditor getting his money - you can't offload the debt onto others even if the others owe you money. Because if you could, then you could just give the debt burden to a person who would never pay it back and wipe your hands clean.

Re: where is the error with this image?

Albert — Fri, 22 Mar 2013 17:51:41 GMT

Arguments about what is wrong with fractional reserve banking and what is wrong with the Fed aside:

There really is no error in this image. In an extremely comical world where cartoon characters act on a screen this could actually happen.

The error is that the scenario presupposes it happens in such a short period of time (the time it takes him to inspect the rooms) that it is treated as if it happened instantly and there was no time cost calculated. It was as if an entity provided a short term loan at no interest. In real life people like you and me do not get interest free loans. It also disregards the "handling costs" of each person taking time off from work and physically tracking down the other person and manually paying him. Normally each step has costs incurred by middlemen.

If for instance you hacked a bank at night and made instant payments online and received back your money before morning and repaid the bank, exactly that could happen.

In real life there would be a time delay between when the funds are used to pay off the first debt, and then all through the chain, before it gets back to the hotel owner. If the lender returns before that and demanded his money back, or alternatively if the hotel owner insists on keeping the deposit for lets say one month, the cost will become evident. He will ask for interest on his money.

Re: where is the error with this image?

ToxicAssets — Fri, 22 Mar 2013 11:57:24 GMT

Peter Sidor:

ToxicAssets:
It depends on the terms under which the "potential costumer" deposited the money with the "hotel owner".

If the hotel owner was supposed to keep the money in a safety vault and to return to the costumer if he decided not to stay, then yes, it was "stealing" from the costumer escrow account.

But he had just borrowed money from the costumer, than there was no fault, since the costumer knows he faces credit risk. Defaulting is not stealing.

Your final conclusion ("Defaulting is not stealing.") is correct, but the the image does not seem to imply that this was a credit transaction. It seems more like an agreement to return the money at any time, whenever the tourist returns.

That's because you're taking the situation on the image literally as opposed to understanding the underlying phenomenon it attempts to simplify.

It does little good to over analyze such a ridiculously artificial situation in itself. It's interest is not the story of the hotel owner and the others, but the underlying mechanism of money and credit circulation.

In any case, what something "seems to imply" isn't necessarily what it really is.

Take for instance the online poker rooms that were shut down by federal government in the 2011 episode that became known as "black friday".

Many of these rooms were actually fractional reserve banks, that kept only a relatively small reserve of liquidity to account for the usual cash outflows. The rest of the money was used for advertising and offers to attract new players, and a part was even diverted into financial markets. When they were shut down, they turned out to be insolvent, and defaulted on many players.

If you thought that your bankroll in chips implied that an equal amount of cash in a reserve somewhere, you were wrong.

Re: where is the error with this image?

Peter Sidor — Fri, 22 Mar 2013 09:14:42 GMT

ToxicAssets:
It depends on the terms under which the "potential costumer" deposited the money with the "hotel owner".

If the hotel owner was supposed to keep the money in a safety vault and to return to the costumer if he decided not to stay, then yes, it was "stealing" from the costumer escrow account.

But he had just borrowed money from the costumer, than there was no fault, since the costumer knows he faces credit risk. Defaulting is not stealing.

Your final conclusion ("Defaulting is not stealing.") is correct, but the the image does not seem to imply that this was a credit transaction. It seems more like an agreement to return the money at any time, whenever the tourist returns.

Re: where is the error with this image?

ToxicAssets — Thu, 21 Mar 2013 15:40:15 GMT

The reason why Ponzi-schemes are generally considered fraud and crime is due to their financial structure, whose stability is conditioned on an exponentially growing number of participants.

Since the prospective base of participants in any short term endeavor is bounded, the required exponential growth eventually reaches saturation and the scheme collapses.

Interestingly, most countries adopt a retirement pension fund that mimics this ponzi-structure. However the return rate is kept low enough (generally by inflation) so that the growth in required new participants is somewhat adjusted to the expected demographic growth, thus keeping the scheme solvent, at least until population growth start behaving unpredictably. But as Thomas Sowell likes to say, "some things never happen until they do".

And that explains why many countries which are not growing as fast as expected are now facing problems concerning their social security structure of payments.

Re: where is the error with this image?

ToxicAssets — Thu, 21 Mar 2013 15:11:37 GMT

Absent a central bank, if I understand you correctly, why banks just do what a company does when it issues corporate bonds, "with the difference that corporate bonds can not be redeemed in cash at any time." But hey, let's not nitpick, you are saying. That tiny little difference makes no difference.

I didn't say corporate bonds and redeemable deposit certificates are exactly the same thing.

One proposes a structure of pre-defined cash payments in time. The other allows the holder to withdraw a pre-defined amount of cash anytime.

But both of them have a proviso: the institution that issued them must have the funds to honor the payments, otherwise, these debt papers are basically worthless.

So they are conceptually equivalent, in the sense that the holder of such securities is (or at least should be) aware of their inner risk concerning the solvency of their issuers.

The question is why someone would choose to hold these risky securities instead of cash.

In the case of bonds, they are seeking to collect the long term interest payments, or they are perhaps speculating on a shock in short-term interest rates that would make their bond holdings appreciate.

In the case of deposits in an FRB, I think the chief reason for their use is that checking accounts substantially reduce risks and costs of transporting and transacting large quantities of cash, making them basic requirements for everyday life. And they generally pay small interest rates as well. So a banker can expect that most people will leave their cash deposited most of the time (an assumption that does not always hold true).

Re: where is the error with this image?

ToxicAssets — Thu, 21 Mar 2013 14:52:21 GMT

You make it sound like FRB is not a problem unless there is a central bank.

I've just said these are different things, but I've never qualified any of these things as problems.

I try not think of any given circumstance as a problem in itself.

The same circumstance can be a problem for one fellow and a desirable or at least non-problematic situation to another fellow.

Of course some circumstances are considered undesirable by the great majority of people so they create laws to avert them. Stuff like murder, rape and such.

Maybe FRB is one of these things, and will eventually be considered a crime, like Ponzi-schemes and other forms of defrauding, but I consider the case for such a ban up until now very weak.

I mean, there are even people out there that consider interest rates to be a sin, and charging it was effectively outlawed in the west during the Middle Ages.

To me, FRB provides a very cost-effective financial method and should not be seen as a crime, provided it was made clear that FRB is a risky business, and depositors are facing default risks when they let put their cash in the bank.

And that was pretty much the case before the rise of central banking.

Re: where is the error with this image?

Jargon — Thu, 21 Mar 2013 14:41:09 GMT

Exactly what is the difference that you're pointing to Dave?

Re: where is the error with this image?

Smiling Dave — Thu, 21 Mar 2013 14:23:53 GMT

Toxic,

You make it sound like FRB is not a problem unless there is a central bank. Absent a central bank, if I understand you correctly, why banks just do what a company does when it issues corporate bonds, "with the difference that corporate bonds can not be redeemed in cash at any time." But hey, let's not nitpick, you are saying. That tiny little difference makes no difference.

Have you even read any AE? Or have I misunderstood you?

Re: where is the error with this image?

ToxicAssets — Thu, 21 Mar 2013 14:17:07 GMT

It depends on the terms under which the "potential costumer" deposited the money with the "hotel owner".

If the hotel owner was supposed to keep the money in a safety vault and to return to the costumer if he decided not to stay, then yes, it was "stealing" from the costumer escrow account.

But he had just borrowed money from the costumer, than there was no fault, since the costumer knows he faces credit risk. Defaulting is not stealing.

Re: where is the error with this image?

Peter Sidor — Thu, 21 Mar 2013 13:10:26 GMT

ToxicAssets:

The error is that everybody was not "in debt".

Each had $100 worth of credit and debit, to different people, netting zero.

But for some reason that economy was cashless and thus the payments were not possible until cash was injected.

Of course, the problem does not explain why the economy was cashless in the first place. If people were for instance hoarding cash, there would be no reason to expect that the first thing the "hotel owner" do with his cash holdings to be paying the "butcher", especially since he would potentially have to return the money to the costumer afterwards and he probably had no reason to expect that all these payments would go around and he would get the money back.

To know that in advance would require him to know the whole credit structure of the economy and also to anticipate correctly the behavior of all actors, which is quite difficult even in such a simplified model.

This leads us to two possibilities:

The hotel owner knew how exactly how future would unfold and how the money would circulate, in which case he didn't need it, as noted, or
The hotel owner didn't know what would happen, which means he stole the money from the tourist and was lucky to get enough cash back before it was noticed.

Although in fact, he stole the money even in the first scenario.

However, if this magical recipe would work, why don't we have some guy from IMF or wherever running around the world with a suitcase full of money and making sure all the debts cancel each other out? If this works, I'm applying for the job.