I know this might be very old, but based in the austrian economics theory, where is the error?
Thanks in advance and sorry for any english mistake.
Nobody really owes nobody anything, in your scenario.
Just consider the $100 the hotel owner handed to the butcher as ACTUAL PAYMENT, instead of late payment of debt, then it all comes clear.
By the way, people did produce and did earn, don’t just look at the money, look at the REAL product/service they provided and earned. Money is merely an exchange medium. The hotel owner got $100 worth of pork from the butcher, a product which he cannot produce himself, thus it is a gain for him, now follow the chain, you see everyone benefited. That’s the benefit of exchange/ trade / division of labor / comparative advantage whatever you call it. Everyone wins.
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.
However it wouldn’t arise in a modern market system since bonds are transferable financial assets and therefore work as cash.
That is, the “hotel owner” could effectively pay the “butcher” by transferring him his claims over the “hooker”, and the “butcher” could do the same, and so on, until all the debt was clear once the hooker got paid with the bonds she had issued to the hotel owner in the first place.
Of course, everyday people don’t usually have to deal with bonds since for everyday affairs like paying the butcher there is seldom shortage of cash, but in the higher financial echelons this is actually pretty common.
In real life, the circle doesn’t close. Banks lend money to people, who may lend it to others, but nobody ever lends the banker the huge sums he has lent people. Banks make money collecting interest, which they can do if they lend money, not if they borrow money.
Especially with fractional reserve banking, where for every dollar coming in they can lend out ten dollars.
Well see, the ironic thing here is that in this perfectly formulated situation everyone owed exactly the same amount of debt to everyone else. This meant that if a line means “to owe”: A-100B-100C-100D-100E-100A. Each one of these individuals has debt for services rendered to someone else. Therefore A could forward on E’s debt to B saying “here, I owe you 100 dollars, but E owes me 100 dollars, so E will pay you”. From here B could forward the debt to C in place of his payment C to D and D would have had 100 dollars of debt to E and E would have owed 100 to D. All they need to do is to exchange I.O.U’s and they are both 100 dollars richer because in this example total services rendered are exactly equal.
There is no need for the German’s money in this situation, just for one of these Greeks to write a f***ing I.O.U.
I think this issue has been well covered by everyone so far, so I just feel the need to point out some trivial detail here. Why does the prostitute sell sex for €100 when she must sleep with her client in a hotel room that costs €100? She makes no profit… She just had sex with a man who paid for the hotel room, essentially, for no gain.
At least she had not to sleep on a street - that may be enough.
Not quite.
Retail banks make money by acting as loan brokers and setting an interest rate spreads, which is the difference between the interest rate they charge on the loans they offer and the interest they pay to their depositors.
Let’s not confuse fiat money central banking, where you have a currency issuer institution lending newly printed money to commercial banks, and fractional reserve banking, which is something else entirely.
Fractional reserve banking is simply the business of collecting deposits and holding part as a reserve liquidity fund, and using the rest to make loans.
Since the deposit certificates issued by the bank to their depositors are redeemable in cash by the bearer, they can be used as cash substitutes, so long people trading them trust the banks solvency.
But they are not cash, since they bear the liquidity risk of the bank.
So, in a fractional reserve system, the private banks can only expand a secondary “money supply” constituted of the I.O.Us these banks have issued. But these are actually risk bearing financial assets.
At least in principle anybody, banker or not, can issue an I.O.U. titles that are redeemable in cash by the bearer, and those will be traded (with a small discount perhaps) as long as people think the issuer is solvent.
In principle that’s what constitutes a market of corporate bonds, with the difference that corporate bonds can not be redeemed in cash at any time, but they’re usually structured as a stream of pre-defined coupon payments of accrued interest and the restitution of the principal in the end.
They are nonetheless liquid assets traded everyday in the markets, and can be thought as a money supply.
So this secondary money supply (of credit) can be raised by everyone, so long as people believe the issuers of debt are credible.
The difference in a central bank system where a central bank institution is granted the power to issue cash is that the central bank posits itself as lender of last resort that will guarantee solvency to any member of its system.
In that case, the deposit certificates issued by the member become equivalents de facto (and usually de jure) of cash (fiat money issued by the central bank), since the default risk of the particular bank issuing the certificate was transfered to the central bank, which control the issue of actual currency.
There is still a problem of risk and credibility, but this time the risk is no longer of solvency, but of inflation.
So the credibility is transfered to the central banker, which operate under a different set of incentives.
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.
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.
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?
Exactly what is the difference that you’re pointing to Dave?
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.
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).
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.
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.
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.
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.
What is the cartoon trying to point out / arguing for?