The Solution to the Global Financial Crisis
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 taking place.
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 a 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 quickly goes to the hotel, as she was owing the hotel for her hourly room used to entertain clients.
At that moment, the rich Russian comes down to reception and informs the hotel owner that the room is unsatisfactory and takes his E100 back and departs.
There was no profit or income. But everyone no longer has any debt and the small town’s people look optimistically towards their future.
Could this be the solution to the global financial crisis?
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Source: Unknown
May 11th, 2009 at 12:20 pm
Yes, but what if everyone was NOT in debt?
Hypothetical #2.
• Russian gives banknote to the hotel.
• The hotel owner takes the banknote in a hurry and rushes to his meat supplier to buy some meat.
• The butcher takes the money and races to his supplier to buy more supplies.
• The wholesaler rushes to the farmer to buy some pigs.
• The farmer triumphantly gives the banknote to a local prostitute who gives him her services.
• The prostitute quickly goes to the hotel, and buy a room for the night.
• The Russian retakes his banknote from the hotel.
The banknote is irrelevant, it’s the net differences that matter.
May 11th, 2009 at 12:47 pm
So, the hooker’s hotel debt was used to settle all other debts, instead of going to the hotel? The hotel is out that money they would have otherwise collected at some point, no?
May 11th, 2009 at 12:49 pm
What you just described is exactly the opposite of how the bottom falls out. One person can’t pay and everything downstream falls like dominoes.
Unfortunately, in real life, the butcher would take the 100 and buy something nice with it. The hotel keeper would deny everything and the Russian would be an idiot for losing track of his cash.
However, if GS decided to get into the debt registry business and take a little off of each settlement, I bet this idea would have traction and some profit could be made from it.
May 11th, 2009 at 12:52 pm
the hotel keeper is out the 100 euro but it was a small price to pay for not being shot by the russian if he didn’t get his money back.
anyway, this is the do over i’ve spoken about before. debts (bank losses) get swept under the rug if they promise not to make the same mistakes over again, i.e., lend to people with no hope of getting repaid.
did anyone pay attention to the MA/GS arrangement being reported today? 60 million? laughable… with 50 of it going to homeowners? explain how that works…
May 11th, 2009 at 12:54 pm
Was Elliott Spitzer the farmer?
May 11th, 2009 at 12:58 pm
this is a sophmoric rip-off of Bastiat..
The Broken Window
1.6Have you ever been witness to the fury of that solid citizen, James Goodfellow,*1 when his incorrigible son has happened to break a pane of glass? If you have been present at this spectacle, certainly you must also have observed that the onlookers, even if there are as many as thirty of them, seem with one accord to offer the unfortunate owner the selfsame consolation: “It’s an ill wind that blows nobody some good. Such accidents keep industry going. Everybody has to make a living. What would become of the glaziers if no one ever broke a window?”
http://www.econlib.org/library/Bastiat/basEss1.html
no wonder ‘the Author’ didn’t sign it..
May 11th, 2009 at 1:01 pm
“the hotel keeper is out the 100 euro but it was a small price to pay for not being shot by the russian if he didn’t get his money back.”
LOL!
May 11th, 2009 at 1:09 pm
I’m w/ Karen. If the hotelier didn’t give the guy back his $100, its a sure bet he’s dead. Otherwise, he just lost a $100, but still has a room to let. But if the Russian could shoot him, and still get the room, what’s to stop him? Maybe he could flip a quarter like the villain in No Country for Old Men. Heads, and he points his compressed air cow slaughtering device at the hoteliers head. He gets the room and keeps his $100.25.
Of course, Godman would have lent the money for the compressed air cow-slaughtering device manufacturer, who, when the villain refused to pay, would have turned to Uncle Fed so as to macroprudentially ensure against the systemic risk that Godman might lose money.
May 11th, 2009 at 1:14 pm
I know this is just for fun but I hope people here realize that none of these people were really in debt – at least not net debt. They all owed $100 to someone else but were also owed $100 from someone else.
May 11th, 2009 at 1:14 pm
If everyone’s net debt were 0 like in the case above. But real society is split into net creditors and net debtors. Now, try again when the prostitute owes E100 to the hotel owner and everyone else owes E100 to the prostitute. The total debt is exactly the same as above, but the situation is very different. I suppose everyone of you knew this, though.
rc
May 11th, 2009 at 1:20 pm
No farmer would pay €100 for a hooker. Well, not in Europe anyway. Farmers are the cheapest ****ards out there. He’d spend her entire worknight trying to bargain her down to €25, and then want a receipt for $150.
If he was a pig farmer he’d want to…..no, I’ve been at the Gin again, so it’s probably time to quit before I get m’self in a passel ‘o trouble.
May 11th, 2009 at 1:22 pm
That doesn’t make any sense at all. There was no debt to start with. Everybody owed E100 but also had somebody owing them E100.
I don’t know if the global financial crisis is the same thing. I don’t think anybody owes the home-owner who owes a massive amount of debt.
May 11th, 2009 at 1:24 pm
“Could this be the solution to the global financial crisis?”
What? legalize prostitution so that the government can collect taxes on that transaction?
May 11th, 2009 at 1:28 pm
New World Order – NOVUS ORDO SECLORUM
http://www.peacefreedomprosperity.com/?p=917
May 11th, 2009 at 1:28 pm
See if everybody was willing to work for free we would have none of these problems. This is where I think a lot of these “free lunch” ideas originate.
A lot of people’s optimism about the future is fundamentally related to their vision of their own place in it, and therein lies the problem.
It seems like economists just can’t get over the fact that people want to be compensated for working or lending and want to be able to accumulate wealth. If they didn’t everything would be just great!
I think modern economics has kind of lost its footing by becoming obsessed with the “paradox” that if people just weren’t people we wouldn’t be having the problems we’re having, so they spend all their time trying to deny or undo human nature. Keep obsessing about how Marxism should work.
I would suggest maybe genetics or biology is a better field for those with these kinds of ambitions.
May 11th, 2009 at 1:29 pm
What happens when one of these parties is a saver, rather than a net debtor? Let’s say the farmer gets the $100, and decides that since the economy sucks he’s just going to sit on the cash. Prostitute doesn’t get paid, hotel doesn’t have the $100 to return to the Russian. Hotel has to lay off the maid & shut the doors. Now there are two prostitutes & no available rooms. Rates drop. Farmer can now afford double hookers and blow, but he has no incentive to spend because it’s a deflationary environment & his money will be worth more tomorrow.
Town decides to force the farmer to spend by creating inflation. Farmer trades with the Russian to convert his holdings to gold. Russian realizes he’s holding trash paper & has been royally screwed by the town. WAR ensues.
May 11th, 2009 at 1:31 pm
I think a more relevant example would be if everyone owed the rich Russian money, for say oil, and the Russian basically hoarded the money and didn’t spend it. If the Russian finally decided to spend the money, then everyone could settle their debts with each other and the Russian, but more importantly, the net imbalance would be rebalanced.
In the global sense, the imbalance between net savers and net spenders has grown too large to service the debt demanded by the savers.
What would be best in this recession is if the savers bought more and the spenders saved more.
May 11th, 2009 at 1:33 pm
The hotel owner is out nothing. He paid off his food debt.
May 11th, 2009 at 1:34 pm
OT, but I like this new girl on CNBC Power Lunch wayyyyyy better than that dumb@ss Kneale:
Julie Roginsky
http://www.bigredtoybox.com/networkpages/julieroginsky.jpg
May 11th, 2009 at 1:35 pm
nobodySpecial –
The Russian retakes his banknote from the hotel.
May 11th, 2009 at 1:40 pm
So the problem isn’t the debt, it’s merely the velocity of money?
That means that all we have to do is persuade people who are losing their jobs, homes, and retirement savings to spend the little they have remaining … or better yet, borrow a ton of money from the bankrupt busted banksters, at ZIRP courtesy of Uncle Ben, and cheerfully spend like there’s no tomorrow.
Is that the idea here?
Somehow I can’t see the forest for all the green shoots.
May 11th, 2009 at 1:41 pm
Where did the Russian get the 100 Euro note in the first place? Did it appear in his pocket by magic, or fiat?
May 11th, 2009 at 1:41 pm
I know, it’s all humor, but I keep mistaking it for government policy.
May 11th, 2009 at 1:44 pm
Isn’t this the classic tail of the multiplicity effect? Mr. Friedman? Of course without a willing creditor market in full recognition of a transparent balance sheet, none of the transactions would have taken place!
May 11th, 2009 at 1:47 pm
actually, the hotel owner can get paid/*aid by the prostitute in exchange for her debt to him… an exchange of services, so to speak and the government is out the tax on earnings..
May 11th, 2009 at 1:51 pm
The Administration TAXES each transaction at a 50% rate so everyone walks away owing the government $50 bucks…
The Russian takes his money out of the country…Then the Administration pays DOUBLE the market price to the Russians for their oil because they don’t want to drill for it here…So the Administartion has to sell T-Bills to account for the shortfall and raise taxes to 60%
May 11th, 2009 at 1:53 pm
karen:
If the hotel owner did the hooker after the farmer and her other clients, we’d need to add a doctor to the scenario. As these events take place in Europe, and they have universal healthcare, this scenario would never work in the US.
May 11th, 2009 at 1:53 pm
This is not an example of Bastiat’s Broken Window. What happened was a series of loans where no one paid any interest on the transactions. Assume that the hotelier actually “borrowed” the money from the Russian, he didn’t pay an interest for the use of the money (actually he embezzled the money from the Russian and put it back). In the real world people charge interest on their loans. If no one ever charged any interest, then the thing borrowed actually had no value, which also isn’t true in the real world where even fiat money has some value. So this example actually works–tautological, but it works.
May 11th, 2009 at 1:54 pm
this is the power of the money multiplier. that’s the bigger issue we’re facing. true, the staggering debt load v. gdp is awful, but what’s really bad is nobody is spending money. transactions have ground to a halt, even in places that had been doing well, like Houston, TX. Friends in the entertainment/food business say things fell off of a cliff in mid March, and it hasn’t come back at all…..
I’m assuming the shock of seeing the stock market careen to 600’s kept some of the more affluent members of society at home. Perhaps they come back when stock market “seems better.” Maybe Bernanke has a good idea here…print money, debase the currency in order to buy stocks. The rising stock market will “instill confidence.” We shall see.
Hope everyone locked in their utility rates for the summer….natty looks incredibly constructive next several months….
May 11th, 2009 at 1:57 pm
http://www.cnbc.com/id/30682346
White House Forecasts Higher U.S. Budget Deficit
This is kind of like the hug and chalk method of blind dates…
When she shows up she is a lot bigger than you thought…a lot bigger…so when you set out to hug her, you mark with chalk where you stopped, hugging and chalking until you get all the way around her…
….Leftback’s idea originally…
May 11th, 2009 at 2:01 pm
“I think modern economics has kind of lost its footing by becoming obsessed with the “paradox” that if people just weren’t people we wouldn’t be having the problems we’re having, so they spend all their time trying to deny or undo human nature.”
I always find it strange when some people bring “human nature” as argument to try to defend capitalism as it is and as something that is not supposed to be questioned, although capitalism as dominant economic mode has been around for merely about 500 years of a much longer human history.”
“Keep obsessing about how Marxism should work.”
I don’t understand this sentence. What does it mean? At whom is this aimed? Who is obsessed about what exactly?
rc
May 11th, 2009 at 2:02 pm
Funny, but then we have Obama saying we can ’save trillions’ on health care. Obviously, that means less money paid to doctors, hospitals, etc. – which makes sense since it all went to the bankers already.
Ha, ha… good joke on us all, eh?
May 11th, 2009 at 2:04 pm
@Bruce N Tennessee
At exactly which point, was it, that Obama said that he was going to cut the Federal Defecit in half?
May 11th, 2009 at 2:07 pm
What happens if everybody starts charging interest?
May 11th, 2009 at 2:14 pm
Actually Steve Keen’s, to my mind interesting, observation here:
http://video.google.com/videoplay?docid=1375113008927627575
(good god – he’s in Trondheim of all places, way north in Norway).
is that France is the _only_ major OECD nation _not_ to have grossly over indebted itself since some relatively early date that Keen uses. 1970? Somewhere around there I think. It was several weeks ago that I watched the video.
May 11th, 2009 at 2:23 pm
Yes… but lets believe that no one is in debt…. and…
*The hotel owner rents the hotel room to the Russian, and takes the E100 in a hurry and rushes to his meat supplier to buy steaks.
• The butcher takes the money and races to his supplier to purchase more stuff.
• The wholesaler rushes to a farmer to purchase pigs he’ll sell.
• The farmer triumphantly calls his local prostitute.
• The prostitute purchases more lube and condoms from Walmart.
And… Uncle Sam… collects tax on all this velocity of money in the market place. And can pay down the national debt… and provide universal health care, and education to it’s citizens… and hire regulators that ensure rules are followed… and people like Madoff don’t defraud the system.
Unfortunately this vacationing debtors… have caused the economic system to collapse… it’s time to move back to you MUST HAVE CASH TO PLAY… game.
May 11th, 2009 at 2:35 pm
What a fabulous idea. I keep saying on my blog that the only solution to this crisis is to restructure EVERYONES debt and start over. Why should the banks get all the fun from suspending mark to market? Isn’t it that ijiot on CNBC, Dennis something or other who’s always saying, “well no one complained when the party was going on.” He’s the devil in bad glasses. The banks are the first Wendy’s to whine to the Congress and accountants.
May 11th, 2009 at 2:39 pm
What ever happened to the jubilee year, anyway?
May 11th, 2009 at 2:49 pm
This demonstrates money as a medium of exchange where barter is impractical.
May 11th, 2009 at 2:57 pm
Is this scenario a trial ballon cooked up inside the Obama administration this weekend and out for a float here? Maybe Timmay has stretching his intellectual legs? It seems to fit what I’ve heard of his stature.
I think GH at 1:29 is on to something.
May 11th, 2009 at 3:04 pm
The story presumes individuals are lending to each other, and not taking on loans from the banks.
Add on the banks and then the interest begins compounding and the whole story falls apart.
Somebody has to take a loss (which the inkeeper sort of did) but I’m assuming he’s free and clear on his property with no debt.
May 11th, 2009 at 3:13 pm
“…prostitute who gave him her services on credit.”
We need strong regulators to “tighten-up” this loose credit, else we risk systemic collapse. We should also develop some sort of hooker-credit rating agency if we want this to work, maybe the WHO.
May 11th, 2009 at 3:14 pm
Well it was conjectured that canceling out circles of debt ‘might’ be one function of a CDS clearing house. And that house is now in existence
http://en.wikipedia.org/wiki/Credit_default_swap#Government_Approvals_Relating_to_Intercontinental_and_its_competitor_CME
But to cancel out the circles of debt (that net to zero) would have required it to be done retroactively which I think was/is very hard to do. So the clearing house is only forward looking.
I was, um, very surprised when the clearing house was announced and that it would be handed to InternationalExchage (based in Atlanta). They were also the authors (and beneficiaries) of the ICE exchange in London where the unregulated overseas trading of WTI crude futures was allowed by US legislation and was a key enabler to the runup in crude prices in the summer of 2008.
So that was rich (as it were). But then I read now, from the wikipedia article, that GS (and JPM and UBS) are in on the mix with the clearing house and fees on transactions.
So you were right (whomever [plural?] above). About GS taking fees on canceling debt. In some sense.
May 11th, 2009 at 3:42 pm
Include GS here that takes the $100, issues equivalent of $1000 in derivatives. Some insurance company comes along and sell insurance for $100 on the derivative. GS pays congress and SEC , and execs $200. sells the 1/2 of derivatives for $500 to unsuspecting 401Kers as AAA investments. The Russian returns demands his money. GS doesn’t have it . 401K s go bust. GS books look bad. Now they have $300 derivatives on the books worth -100$. Government collects taxes from every body for $100, plus sells some bonds to Chinese for $300. Pays GS $200. GS now has $100. Government Pays $20 to stimulate the framer/Economy,through the prostitute. GS issues another $200 of new well regulated stocks. $01Kers are happy to jump on the next great investment! . The Hooker beats the estimate, Banker beats the estimate,Every body beats estimate! Every body is happy!
May 11th, 2009 at 3:44 pm
Include GS here that takes the $100, issues equivalent of $1000 in derivatives. Some insurance company comes along and sell insurance for $100 on the derivative. GS pays congress and SEC , and execs $200. sells the 1/2 of derivatives for $500 to unsuspecting 401Kers as AAA investments. The Russian returns demands his money. GS doesn’t have it . 401K s go bust. GS books look bad. Now they have $300 derivatives on the books worth -100$. Government collects taxes from every body for $100, plus sells some bonds to Chinese for $300. Pays GS $200. GS now has $100. Government Pays $20 to stimulate the framer/Economy,through the prostitute. GS issues another $200 of new well regulated stocks. $01Kers are happy to jump on the next great investment! . The Hooker beats the estimate, Banker beats the estimate,Every body beats estimate! Every body is happy!
May 11th, 2009 at 3:52 pm
Unfortunately……….no. The way business is done today, from government contracting to outsourcing to simple purchases, there are far too many middlemen who take their cut for doing practically nothing. Thus, the hooker would be shafted in the end and the process would stop there on her, and every other common laborers, back. (Pardon the pun) This can be evidenced in who is really paying for all of the malfeasance on wall street and beyond…….the taxpayers.
May 11th, 2009 at 4:48 pm
Seems the velocity of money was temporarily high and suddenly dropped to zero: a good parallel to the last 8 months in the US.
What happens next? The velocity of money in the town’s economy is now zero. No one is able to print any. The town economy flew over a cliff when the Russian departed. So everyone goes further into debt or loses their livelyhood and ends up on the unemployment rolls.
I’d bet everyone in the town is heavily bullish on their economic future regardless.
May 11th, 2009 at 4:49 pm
“Could this be the solution to the global financial crisis?”
Uh, no. Total (inflated) debts far out weigh total (deflated) assets. Unless they print money and monetize the debt. Oh yeah, they are doing that aren’t they? I guess it could work then, afterall.
May 11th, 2009 at 6:01 pm
Better story:
The 3 Stooges…
They have one dollar. Each owes the other $2.00. They pass the same dollar around two times, settle the debt at which point Moe slaps Larry and Curly in the face…same logic…
May 11th, 2009 at 6:13 pm
This is not really debt but accounts payable/receivable since a service or product was provided.
Money for nothin and chicks for free.. yeah thats the way to do it. Dire Straits
May 11th, 2009 at 8:46 pm
This joke was going around the former Yugoslavia when it was breaking up with the only difference being the currency in use was the Deutschmark.
May 11th, 2009 at 9:08 pm
As has been noted above, this little story only sees the liability side of the balance sheet – but it ignores the asset side. While each person has a 100 euro liability, they also have a 100 euro asset and so each one has net worth of zero.
In the real world, individuals rarely all have debts equal to assets.
The only relevance to the real world is that in the aggregate, since we can’t borrow from other planets (or from the future), all debts cancel out and we are left with our real assets and our equity claims on these real assets.
May 12th, 2009 at 3:36 pm
How was the hotel owner able to give the Russian back his E100?
I think a better ending to this story would be for the Russian to keep his room long enough to have sex with the prostitute.
May 12th, 2009 at 6:06 pm
It wouldn’t have worked if the farmer was David Vitter. The prostitute would have had to charge extra for the diaper.
May 16th, 2009 at 9:55 am
[...] Finally, Prieur Du Plessis contributed a very funny joke/ allegory to Barry Ritholtz’s The Big Picture. It concerns a sum of money being paid and repaid around a town and asks whether or not anyone is “richer” for it at the end of the day. [...]