12 July 2008
How the Money Disappears
Posted by Joy Bischoff under: World Economy .
The following will help us understand a little better why were are in such an economic quagmire:
Guest Blog by Peter Anderson
Let’s suppose that a lender starts with a million dollars and the borrower starts with zero. Upon extending the loan, the borrower possesses the million dollars, yet the lender feels that he still owns the million dollars that he lent out. If anyone asks the lender what he is worth, he says,”a million dollars,” and shows the note to prove it.
Because of this conviction, there is, in the minds of the debtor and the creditor combined, two million dollars worth of value where before there was only one. When the lender calls in the debt and the borrower pays it, he gets back his million dollars. If the borrower can’t pay it, the value of the note goes to zero. Either way, the extra value disappears. If the original lender sold his note for cash, then someone else down the line loses.
In an actively traded bond market, the result of a sudden default is like a game of “hot potato”: whoever holds it last loses. Self-liquidating credit is a loan that is paid back, with interest, in a moderately short time from production. Production facilitated by the loan - for business start-up or expansion, for example - generates the financial return that makes repayment possible. The full transaction adds value to the economy.
Non-self-liquidating credit is a loan that is not tied to production and tends to stay in the system. When financial institutions lend for consumer purchases such as cars, boats or homes, or for speculations such as the purchase of stock certificates, no production effort is tied to the loan. Interest payments on such loans stress some other source of income.
Pt 1 http://lynncoins.com/deflation1.htm
Pt 2 http://lynncoins.com/deflation2.htm
4 Comments so far...
M.G. Says:
12 July 2008 at 12:58 pm.
The banks were forced to give credit to people who didn’t have to verify anything including lots of illegals. We are paying the fiddler and it is going to hurt.
T. Fan Says:
12 July 2008 at 3:35 pm.
That’s crazy. Talk about cooking the books. With that kind of accounting, no wonder the credit market is in trouble.
SGS Says:
14 July 2008 at 3:23 pm.
Peter has the right idea on the actual value and the perspectival value. The unfortunately thing is that it does not stop right there with the borrower. Think of this. Suppose this borrower uses a million dollars to purchase a property. This borrower now has a property worthy a millions dollars, and the builder now has a million dollars in bank. The bank can use it for loan all over again. Yes, many of us who work in the financial industry and other economy-related activities (for example, HP sells a lot of printers and computers to support those financial people). Our economy is running on a lot of “nothings”. This is why we have been emphasized by good teachers to be self-reliable — we need to have something concrete to survive. We do not have to work in this field (construction, food process, etc…), but rather, we need to have the basic skills to actually make something, rather than being busy making something virtual possible.
CindyL. Says:
14 July 2008 at 3:26 pm.
Great advice, SGS. That’s how my parents raised us to think and I think that kind of thinking will help us through rough times.
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