Thursday, February 25, 2010

Economics Lesson

There's an email going around that I've received that keeps economics simple.  It's true as far as it goes, which isn't very far.  I've added another layer to show what happens when the status quo changes, which it ALWAYS does.

It's a slow day in a little East Texas town. The sun is beating down, and the streets are deserted. Times are tough, everybody is in debt, and everybody lives on credit.....

On this particular day a rich tourist from back east is driving through town. He stops at the motel and lays a $100 bill on the desk saying he wants to inspect the rooms upstairs in order to pick one to spend the night.

As soon as the man walks upstairs, the owner grabs the bill and runs next door to pay his debt to the butcher.

The butcher takes the $100 and runs down the street to retire his debt to the pig farmer.

The pig farmer takes the $100 and heads off to pay his bill at the supplier of feed and fuel.
The guy at the Farmer's Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has had to offer her "services" on credit.

The hooker rushes to the hotel and pays off her room bill with the hotel owner.

The hotel proprietor then places the $100 back on the counter so the rich traveler will not suspect anything.

At that moment the traveler comes down the stairs, picks up the $100 bill, states that the rooms are not satisfactory, pockets the money, and leaves town.

No one produced anything.. No one earned anything.

However, the whole town is now out of debt and now looks to the future with a lot more optimism.

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

That was how we all did business prior to 2007, when the price of gasoline went up.

Now, imagine this little change:

The rich tourist is now a banker, who had obtained a loan of $1000 to fund his bank. The banker loaned $200 to the innkeeper to add a room to his inn. The innkeeper paid $100 to the contractor to build the room, and the remainder was the $100 he owed the contractor, which was the $100 that circulates in the story. This worked fine before 2007 because in a year, the contractor was paid from the receipts of the inn's business. The banker did this 4 times, leaving only $200 to operate his bank and cover the 10% capital requirement set by law. He was supposed to get 6% percent interest on the $800 he loaned out, which is of little matter when you see what happens, next.

In 2007, the price of gas went up. Everyone deducted $10.50 from the amount they were given by the previous person. 5 X $10.50 = $52.50 leaving $47.50 to pay the banker when the note became due. No one could afford to travel because of the higher price of gas, so the other $100 was not paid, either. The note went into default, and the bank had to foreclose and sell the inn at auction. Multiply all the numbers by 2,000,000 (except for the price of gas). That number is conservative and arbitrarily set just for fun in this argument. Because 2,000,000 properties were foreclosed upon, the value of the collateral was cut by a third.

And now you know why we are in deep shit.

(And I won't make your brain really fuzzy by adding in the 4 times each loan was sold to a security maker at Lehman's, Golden Sachs, and Merrill Lynch, the insurance against default that was funded and underwritten (promised to pay) by AIG, and all the loans it took to buy the securities created by these investment houses to fund this scheme, PLUS the insurance against default that was purchased to cover these third and fourth layer loans.  Not to mention the fact that every one of these securities was considered good collateral by the Reserve banks all over the world to secure additional loans to the commercial and retail bankers to give out more loans.  The eye's glaze over.)

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