Economics at work!

[midfielder]

It is August. In a small town on the South Coast of France, the holiday season is in full swing, but it is raining so there is not too much business happening. Everyone is heavily in debt.

Luckily, a rich Russian tourist arrives in the foyer of the small local hotel. He asks for a room and puts a Euro100 note on the reception counter, takes a key and goes to inspect the room located up the stairs on the third floor.

The hotel owner takes the banknote in hurry and rushes to his meat supplier to whom he owes E100. The butcher takes the money and races to his supplier to pay his debt.

The wholesaler rushes to the farmer to pay E100 for pigs he purchased some time ago.

The farmer triumphantly gives the E100 note to a local prostitute who gave him her services on credit.

The prostitute goes quickly to the hotel, as she owed the hotel for her hourly room use to entertain clients. At that moment, the rich Russian is coming down to reception and informs the hotel owner that the proposed room is unsatisfactory and takes his E100 back and departs.

There was no profit or income. There was NO real economic activity. But everyone no longer has any debt and the small town people look  optimistically towards their future.

COULD THIS BE THE SOLUTION TO THE Global Financial Crisis? Just sheer velocity of money?

 

[Ben]

Thats a very unlikely situation especially when everyone owes each other eactly the same amount. Although if the world were like this town then this would be the answer to our financial crisis

 

[jiggles]

this fails.

 

[dibo]

there is no value created there - debt is simply retired. it basically didn't *do* anything. it's a financial transaction only, not economic activity. nothing was produced.

there is value created through labour. transactions that involve someone mixing labour with goods to create goods of greater value* actually grow the economy - the product of their labour is increased wealth. chances are that the wealth will be stolen by some capitalist pig, but hey... it's increased wealth for the society.

in this situation, no wealth was created. the money moved around, people cancelled debts, but people's net positions (cash on hand and accounts payable minus current debts) didn't change.

thread fails.







* this includes things like profitable investments - i.e. someone converts capital through labour and organisation into infrastructure that delivers a profit through earning a return in excess of its cost.

 

[midfielder]

there is no value created there - debt is simply retired. it basically didn't *do* anything. it's a financial transaction only, not economic activity. nothing was produced.

there is value created through labour. transactions that involve someone mixing labour with goods to create goods of greater value* actually grow the economy - the product of their labour is increased wealth. chances are that the wealth will be stolen by some capitalist pig, but hey... it's increased wealth for the society.

in this situation, no wealth was created. the money moved around, people cancelled debts, but people's net positions (cash on hand and accounts payable minus current debts) didn't change.

thread fails.







* this includes things like profitable investments - i.e. someone converts capital through labour and organisation into infrastructure that delivers a profit through earning a return in excess of its cost.

You must have  failed economics the velocity of money and the confidence or lack of confidence factor it produces is arguably one of the most accepted economic theories .. google it .. it goes back to the great depression (not the time we lost the grand final) 

 

[dibo]

i'm a masters student in economics. what's your point again?

money moving only has a benefit if something actually happens with it. in this example, people are just rearranging their balance sheets. the only change is that all parties are moderately less in debt. they didn't create any value, no product came out.

*if* the butcher invested the $100 in a way that made him money, the prostitute invested it in such a way that earnt her $105...

...then the movement of money has an accumulated effect.

velocity of money isn't an end in itself. product is still the end game. velocity hitting zero is an issue because people not moving money means people don't spend, people don't invest *and there is no profit coming out the back end*. the movement isn't what we're chasing, it's the profit.

go back to your dr. seuss's guide to macroeconomics - 'the money's now flowing very fast/while the bourgeois screw the working class...'

oh, wait, that was marx...

 

[Ben]

I have my final test for microeconomics next wednesday and i am hoping i don't have to any questions that are along this line. But i agree that because there is no added value to the money there is no economic profit for anyone and essentially everyone has just erased 100 of their debts for no reason

 

[midfielder]

i'm a masters student in economics. what's your point again?

money moving only has a benefit if something actually happens with it. in this example, people are just rearranging their balance sheets. the only change is that all parties are moderately less in debt. they didn't create any value, no product came out.

*if* the butcher invested the $100 in a way that made him money, the prostitute invested it in such a way that earnt her $105...

...then the movement of money has an accumulated effect.

velocity of money isn't an end in itself. product is still the end game. velocity hitting zero is an issue because people not moving money means people don't spend, people don't invest *and there is no profit coming out the back end*. the movement isn't what we're chasing, it's the profit.

go back to your dr. seuss's guide to macroeconomics - 'the money's now flowing very fast/while the bourgeois screw the working class...'

oh, wait, that was marx...

Then you better brush up on the ... velocity of money ... or you will never get your masters..

BTW I hold a Masters In Taxation / Business Administration /  Degree in Accounting / Fellow of the CPA's , Registered Tax Agent, Registered Agent of the Australian Securities Commission, Fellow of The Tax Agents Association. Run my own practice advising clients amount other things about economics and lecture in a Master Course about the economic impact of taxes.

Just back from Fiji were I advised the TPAF among other things on building a financial model to restructure their income streams .. all based off economic models..

Yes the velocity of money and the speed it moves is a critical part of any economy ... BTW the thread was a in tongue in check way of explaining how it works..

A simple formula for you it is kinda the starting point..


In practice, attempts to measure the velocity of money are usually indirect:

    V_T =\frac{nT}{M}

where

    V_T\, is the velocity of money for all transactions.
    nT\, is the nominal value of aggregate transactions.
    M\, is the total amount of money in circulation on average in the economy (see Money supply for details).

(Given the classical dichotomy, nT may be factored into a product P\cdot T of a price level P and a real aggregate value of transactions T.)

Values of nT and M permit calculation of VT.

As applied to an economy expenditures on final output are of interest, the relation may be written:

    V =\frac{nQ}{M}

where

    V\, is the velocity for transactions counting towards national or domestic product.
    nQ\, is nominal national or domestic product.

(Analogously with nT, given the classical dichotomy, nQ may be factored into a product P\cdot Q.)

 

[Arabmariner]

I'm trying to find a smiley for a wee brain exploding!!!!

 

[FFC Mariner]

I confess I only studied enough Economics to enable me to get qualified as any subject that doesnt know if its an art or a science bothers me.

There was no profit or income - yes there was, the economic activity had already taken place. These are balance sheet transactions not p& l

. There was NO real economic activity - see above

. But everyone no longer has any debt therefore their personal balance sheets had capacity for them to begin the economic cycle again

and the small town people look  optimistically towards their future confident enough to repeat the cycle and get into more debt

The "pump some cash into the economy and everything will work theory is what drove f**k knuckle (Swann) to dump billions of dollars into the economy. Where that will fail is that ultimately all that money ends up overseas - in this example, if the hotel owners meat supplier was in another town, the whole cycle breaks down.

 

[jiggles]

Here you go Arabmariner:

 

[Jesus]

Might it be suggested that "growth" is a)unsustainable indefinately, and b) not the basis of every possible economic system.

 

[dru]

I don't think there is enough intergration symbols, derivatives or i in those formula. hardly seems worth the effort

 

[dibo]

I confess I only studied enough Economics to enable me to get qualified as any subject that doesnt know if its an art or a science bothers me.

There was no profit or income - yes there was, the economic activity had already taken place. These are balance sheet transactions not p& l

. There was NO real economic activity - see above

. But everyone no longer has any debt therefore their personal balance sheets had capacity for them to begin the economic cycle again

and the small town people look  optimistically towards their future confident enough to repeat the cycle and get into more debt

The "pump some cash into the economy and everything will work theory is what drove f**k knuckle (Swann) to dump billions of dollars into the economy. Where that will fail is that ultimately all that money ends up overseas - in this example, if the hotel owners meat supplier was in another town, the whole cycle breaks down.

this situation is simply one of accumulated debt and credit that cancel one another out. the paying off of debt and credit doesn't create activity, like you said the activity had already happened. any profit or whatever is already assumed.

the important thing here is that while the agents were in debt, they also had current debts owing to them. either they weren't in a position of net debt at the beginning or they are still in net debt at the end. their positions hadn't changed. they're no more wealthy than they were, they wouldn't be any more confident at the end than at the start.

let's assume that each agent owes interest on their debts but equally they charge interest on the debts owing to them at the market rate (so as to cover them against the cost of not being able to put that cash to work in the market). the interest earned cancels out the interest owing. no net effect. it doesn't matter whether the debts are paid off or not.

for argument's sake, given they were in a position of zero net debt, there's no reason why in the absence of the russian fella they couldn't have gone to the bank to refinance the debt owing to their creditor - borrowed a hundred euros at the market interest rate, paid off the debt, set the wheel turning etc. they could have had their cash back plus the interest and paid the bank off.

at the end of the day, activity is still zero, none of them is earning any money all the same, so if they're optimistic it's for no good reason.

---

for an analogy to the GFC (the point of the original post)-

if every agent in the economy calls in all loans, banks will call in all finance, so we all sell our houses. at the same time, we run on the banks to claim our deposits back (as any cash deposited is in itself simply a loan from us to the bank) and put it in our mattresses.

there will be no finance available for investment - banks will simply liquidate their assets and go out of business in order to give us back our deposits.

as the flurry of repayments, asset sales and all the rest happens cash will be moving alright (velocity of money will be stunning), but it won't be doing us any good.

as the final destination of money is the mattress of the individual depositor, velocity of money then hits zero.

business will freeze over. we won't be optimistic or confident, the whole process is one of blind animalistic fear. the only people doing any business will be those selling shotguns and canned food.

this is why wherever possible we don't allow banks to fail.

---

I don't think there is enough intergration symbols, derivatives or i in those formula. hardly seems worth the effort

they also don't show how velocity of money is an end in itself. in my earlier post i didn't say it's not important (and acknowledged how if it hits zero we're screwed) i just said that it's not an end in itself.

Might it be suggested that "growth" is a)unsustainable indefinately, and b) not the basis of every possible economic system.

i disagree with that. unless you're willing and able to freeze (or reverse) innovation and population growth, economic growth is natural and desirable.

 

[ryan]

I have my final test for microeconomics next wednesday and i am hoping i don't have to any questions that are along this line. But i agree that because there is no added value to the money there is no economic profit for anyone and essentially everyone has just erased 100 of their debts for no reason

On a side note good luck with your test. I did economics in high school and have forgotten everything

 

[bjw]

kutgw son

 

[TerrigalUtd]

I confess I only studied enough Economics to enable me to get qualified as any subject that doesnt know if its an art or a science bothers me.

There was no profit or income - yes there was, the economic activity had already taken place. These are balance sheet transactions not p& l

. There was NO real economic activity - see above

. But everyone no longer has any debt therefore their personal balance sheets had capacity for them to begin the economic cycle again

and the small town people look  optimistically towards their future confident enough to repeat the cycle and get into more debt

The "pump some cash into the economy and everything will work theory is what drove f**k knuckle (Swann) to dump billions of dollars into the economy. Where that will fail is that ultimately all that money ends up overseas - in this example, if the hotel owners meat supplier was in another town, the whole cycle breaks down.

this situation is simply one of accumulated debt and credit that cancel one another out. the paying off of debt and credit doesn't create activity, like you said the activity had already happened. any profit or whatever is already assumed.

the important thing here is that while the agents were in debt, they also had current debts owing to them. either they weren't in a position of net debt at the beginning or they are still in net debt at the end. their positions hadn't changed. they're no more wealthy than they were, they wouldn't be any more confident at the end than at the start.

let's assume that each agent owes interest on their debts but equally they charge interest on the debts owing to them at the market rate (so as to cover them against the cost of not being able to put that cash to work in the market). the interest earned cancels out the interest owing. no net effect. it doesn't matter whether the debts are paid off or not.

for argument's sake, given they were in a position of zero net debt, there's no reason why in the absence of the russian fella they couldn't have gone to the bank to refinance the debt owing to their creditor - borrowed a hundred euros at the market interest rate, paid off the debt, set the wheel turning etc. they could have had their cash back plus the interest and paid the bank off.

at the end of the day, activity is still zero, none of them is earning any money all the same, so if they're optimistic it's for no good reason.

---

for an analogy to the GFC (the point of the original post)-

if every agent in the economy calls in all loans, banks will call in all finance, so we all sell our houses. at the same time, we run on the banks to claim our deposits back (as any cash deposited is in itself simply a loan from us to the bank) and put it in our mattresses.

there will be no finance available for investment - banks will simply liquidate their assets and go out of business in order to give us back our deposits.

as the flurry of repayments, asset sales and all the rest happens cash will be moving alright (velocity of money will be stunning), but it won't be doing us any good.

as the final destination of money is the mattress of the individual depositor, velocity of money then hits zero.

business will freeze over. we won't be optimistic or confident, the whole process is one of blind animalistic fear. the only people doing any business will be those selling shotguns and canned food.

this is why wherever possible we don't allow banks to fail.

---

I don't think there is enough intergration symbols, derivatives or i in those formula. hardly seems worth the effort

they also don't show how velocity of money is an end in itself. in my earlier post i didn't say it's not important (and acknowledged how if it hits zero we're screwed) i just said that it's not an end in itself.

Might it be suggested that "growth" is a)unsustainable indefinately, and b) not the basis of every possible economic system.

i disagree with that. unless you're willing and able to freeze (or reverse) innovation and population growth, economic growth is natural and desirable.

---

---

???

 

[marinermick]

The "pump some cash into the economy and everything will work theory is what drove f**k knuckle (Swann) to dump billions of dollars into the economy. Where that will fail is that ultimately all that money ends up overseas - in this example, if the hotel owners meat supplier was in another town, the whole cycle breaks down.

I did enough economic theory at uni to understand that economic theory is just that - theory, and applies little in the real world because there are so many different variants and people and markets do not act as rationally as the theory suggest.

Case in point is the example FFC Mariner used above. He used the assumption that the money would end up overseas. That may be the case and it may not be the case and the money that stayed here would have stimulated other areas of the economy. At the end of the day, since the second stimulus package we have seen a decrease in imports and an increase in exports as shown by the national GDP figures.

Midfielder can have pretty models and stories but at the end of the day it is called Economic Theory for a reason.

Nice to theorise about scenarios as the academics and academic minded on this forum will do, but "the solution to our financial crisis" - who knows?

 

[FFC Mariner]

Just wait for the 2nd wave Mick, unemployment will rise just as the 1st homeowners bubble bursts at the "bottom" of the market.

Banks are restricting credit in that space and tightening fixed rates already

 

[marinermick]

Just wait for the 2nd wave Mick, unemployment will rise just as the 1st homeowners bubble bursts at the "bottom" of the market.

Banks are restricting credit in that space and tightening fixed rates already

in theory

we will wait and see in practice

my hunch is that there will be an even bigger commodidies boom around the corner as the world, and especially asia recovers, thus returning to even bigger surpluses

china is already starting to increase demand (wish i bought BHP shares at $25 when i was considering it)

one thing for sure is that unemployment will rise regardless because it is a lag indicator