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Money For (And From) Nothing

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I came across this simple account of how the financial system-in particular the shadow banking system- can spin apparent wealth from the most unlikely of sources.

What's interesting about this little tale is that at every stage those involved could probably offer a plausible account of exactly how they were creating some kind of 'value' via their contribution- but looked at in the round it's clear that all that is really happening is that the same nugget of genuine real world value added activity is simply being 'rehypotehcated' over and over to create the illusion of increasing wealth.

Imagine a man who makes his living digging ditches. He may hire himself out at a daily rate of, say, $25. The old capitalists would have paid no attention to him – he is just one of millions of small entrepreneurs getting by in life.

But today’s financial hustlers will spot the opportunity. Let’s take him public, they will say. We’ll raise his daily rate to $30…pay him his $25…and the rest will be our "profit." We’ll sell shares to the public at a P/E of 20…let’s see, 20 x $5 x 250 days per year = $25,000. All of a sudden, the ditch digger has a capital value of $25,000.

Then, they borrow $20,000 from a hedge fund…and pay it to themselves for structuring the deal. Now, the hustler has $20,000 in his pocket; the hedge fund has a high-yield bond worth $20,000; the shareholders have $25,000 worth of stock; and the poor man is still digging his ditches.

Then, an even more ambitious wheeler-dealer will come along and decide to "roll up" the whole industry – bringing the ditch diggers together into a multi-national consortium. Now they can all do cross-border transactions…including derivatives.

And now ditch-digging is a major business, suitable for large investors…with more investment coverage and a higher P/E ratio. Soon all the world’s banks, pension funds, insurance companies, and hedge funds have some of the ditch digging paper – debt or equity – and billions in fees and commissions have been squeezed out of ditches by the financial industry.

That, patient reader, is the way (the world-over) that industries and assets are now being bought, sold, refinanced, leveraged, re-jigged and resold. In the old days, companies went to investors or to banks for capital and cultivated a relationship with them that was long and fruitful.

Now, it’s all wham-bam-thank-you-ma’am capitalism. Inquiring capitalists now only want to know one thing – how fast can we do this deal? How many points can we get out of it and how much leverage can we get? And whom can we dump it on, when we’re done?

But in reality no new wealth creation has taken place as a result of this financialization of the ditch diggers efforts- all that has really occurred is that multiple, overlapping and mutually exclusive claims have been brought into being on the value created by the ditch digger.

So although I myself have said it many times- that bankers create money out of nothing- that's not quite right- what they create are spurious and impossible to meet claims on the pie of real world wealth- and they can manufacture these claims in a fashion that seems oddly magical - they just cast a magic spell of complex arcane language and behold! A derivative or other 'instrument' is thus created- and having been created can now exert a claim on the fruits of the labor of real people doing real things in the real world.

To be banker is to live in a magical world where mere spells and incantations- constructs of language couched in the correct legal format- can summon real wealth and power.

As someone once said- take from the bankers everything they own,but leave them the power to create these linguistic illusions and they will conjure enough 'wealth' to buy it all back again.

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I came across this simple account of how the financial system-in particular the shadow banking system- can spin apparent wealth from the most unlikely of sources.

....

But in reality no new wealth creation has taken place as a result of this financialization of the ditch diggers efforts- all that has really occurred is that multiple, overlapping and mutually exclusive claims have been brought into being on the value created by the ditch digger.

Yet another creative writing class gone badly wrong?

How much would you pay to forever receive an index-linked $5 a day? If they can genuinely allow the poor sod to make that much extra money, value has been "created". It might have just moved from people who previously had cheap ditches to the digger, but I bet he is not complaining. Would you really tell someone who could teach you how to charge your customers more that you won't pay them a penny for doing so?

BTW, I have seen a fair bit of waste that the financial intermediaries benefited from a lot more than their clients. But why bother with a horribly confused argument that barely makes any sense? Mortgage lending has been a wonderful negative sum game, and so have interest rates swaps sold by UK banks to naive customers. Why not start with that if you really need to prove a point as basic as that there exist examples of the financial sector being worse than useless?

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Yet another creative writing class gone badly wrong?

How much would you pay to forever receive an index-linked $5 a day? If they can genuinely allow the poor sod to make that much extra money, value has been "created". It might have just moved from people who previously had cheap ditches to the digger, but I bet he is not complaining. Would you really tell someone who could teach you how to charge your customers more that you won't pay them a penny for doing so?

BTW, I have seen a fair bit of waste that the financial intermediaries benefited from a lot more than their clients. But why bother with a horribly confused argument that barely makes any sense? Mortgage lending has been a wonderful negative sum game, and so have interest rates swaps sold by UK banks to naive customers. Why not start with that if you really need to prove a point as basic as that there exist examples of the financial sector being worse than useless?

You need to read the post again- the ditch digger did not receive that additional $5 a day- that went to the bankers as a fee.

But here's your real problem- assuming the ditch digger's output was not increased by the financialization of his efforts- from where did all the money come from to pay the fees of those managing that process or the incomes given to those who invested in the instruments they created from the income stream generated by the digger of ditches?

The answer is that this additional 'wealth' consists of issuing multiple claims on the same asset- in this case the wages of the Ditch Digger.

If I took out multiple loans from different lenders using the same single house as collateral that would be fraud- If a banker 'rehypothecates' collateral belonging to his clients that's 'financial engineering'.

My point was not simply that the financial sector adds no value- rather that it creates false value by issuing those multiple and overlapping claims on the same single asset that then creates the illusion that new wealth creation has occurred. Then they charge a fee for this 'service'. :lol:

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Ah yes it's so easy to make free money.

£375bn or new narrow money says that making a little extra broad money is definitely a thing that can be done.

The expansion of broad money explains HPI.

Suggesting that you can't make free money just begs the question as to what you mean by "free". IMO the problem is that the banking sector was sanctioned to make free money, but there was a gentlemen's agreement that they would make that free money in the time honoured legitimate way, by extending loans to people who would be capable of repaying those loans, (especially given a tailwind of wage inflation and HPI). Unfortunately, wage inflation stopped and the HPI stopped and the loans were at a questionable level even if the wage inflation and HPI had continued...

And now the mainstream media would have you believe that house prices are on the march again...

Whatever.

There is something in the OP's post. Whaling on Wonderpup for sport doesn't make Wonderpup wrong. IMO getting to grips with what is meant financialization is important and not trivial.

Edited by ChairmanOfTheBored

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You need to read the post again- the ditch digger did not receive that additional $5 a day- that went to the bankers as a fee.

So you were serious.

It does not matter who the money went to. If he still gets the same number of hours digging the same ditches, they did create $5 a day worth of value.

The answer is that this additional 'wealth' consists of issuing multiple claims on the same asset- in this case the wages of the Ditch Digger.

Errm, no. The extra money appeared because he is willing to give up a chunk of his income over years to come, and it can be spent right now. It's just like a mortgage. You give up a couple of decades worth of earnings and get to buy a house there and then. No magic needed.

My point was not simply that the financial sector adds no value- rather that it creates false value by issuing those multiple and overlapping claims on the same single asset that then creates the illusion that new wealth creation has occurred. Then they charge a fee for this 'service'. :lol:

I don't see the example demonstrates anything of the kind, and especially not that it could be taken seriously even if it appeared to.

Do you really think companies can just magic money from thin air? Or buy assets way above their true value (as you imply)? And all because they are in finance where that is for some reason normal?

Do you think that Bear Sterns, Lehman, Merrill, etc etc are now history simply because they could not run whatever they were doing quickly enough?

If you think you know how to make a lot of money, why not try? An easy $20k made each morning will be more that enough to pay for all the lawyers and accountants you need. Assuming only that whatever you do is legal to the same extent as what the industry does.

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Do you really think companies can just magic money from thin air?

If you ask most people where the banks get the money they lend out they will probably reply that it comes from other people's deposits- but we know that's not how it works. In reality when you borrow money from a bank it is your signature on the loan agreement that brings that money into existence- there is no internal process at the bank whereby the money you borrow is shifted from some other account into your account- in reality the bank simply credits you account with the loan and balances it's books by treating your signed agreement to repay as it's asset.

So the banks do in fact create money from thin air. But- it is claimed- this is not 'free' money due to the strict requirements imposed on the banks as to how much of this money creation they can do relative to their reserves.

But suppose there were a way to get around these requirements- suppose we were able to invent a slew of 'financial instruments' that allowed us to perform the same sort of trick as the banks do when they lend money but without the pesky regulators getting in the way.

Here's a simplified version of how this could be done- think 'sub prime' in a bar;

Heidi is the proprietor of a bar .

She realizes that virtually all of her customers are unemployed alcoholics and,

as such, can no longer afford to patronize her bar.

To solve this problem, she comes up with a new marketing plan that allows her

customers to drink now, but pay later.

Heidi keeps track of the drinks consumed on a ledger (thereby granting the

customers loans).

Word gets around about Heidi's "drink now, pay later" marketing

strategy and, as a result, increasing numbers of customers flood into Heidi's

bar. Soon she has the largest sales volume for any bar in Dallas.

By providing her customers freedom from immediate payment demands, Heidi gets

no resistance when, at regular intervals, she substantially increases her

prices for wine and beer, the most consumed beverages.

Consequently, Heidi's gross sales volume increases massively.

A young and dynamic vice-president at the local bank recognizes that these

customer debts constitute valuable future assets and increases Heidi's

borrowing limit.

He sees no reason for any undue concern because he has the debts of the

unemployed alcoholics as collateral!

At the bank's corporate headquarters, expert traders figure a way to make huge

commissions, and transform these customer loans

into DRINKBONDS.

These "securities" then are bundled and traded on international

securities markets.

Naive investors don't really understand that the securities being sold to them

as "AAA Secured Bonds" really are debts of unemployed alcoholics.

Nevertheless, the bond prices continuously climb - and the securities soon

become the hottest-selling items for some of the nation's leading brokerage

houses.

One day, even though the bond prices still are climbing, a risk manager at the

original local bank decides that the time has come to demand payment on the

debts incurred by the drinkers at Heidi's bar. He so informs Heidi.

Heidi then demands payment from her alcoholic

patrons. But, being

unemployed alcoholics -- they cannot pay back their drinking debts.

Since Heidi cannot fulfill her loan obligations she is forced into bankruptcy.

The bar closes and Heidi's 11 employees lose their jobs.

Overnight, DRINKBOND prices drop by 90%.

The collapsed bond asset value destroys the bank's liquidity and prevents it

from issuing new loans, thus freezing credit and economic activity in the

community.

The suppliers of Heidi's bar had granted her generous payment extensions and

had invested their firms' pension funds in the BOND securities.

They find they are now faced with having to write off her bad debt and with

losing over

90% of the presumed value of the bonds.

Her wine supplier also claims bankruptcy, closing the doors on a family

business that had endured for three generations, her beer supplier is taken

over by a competitor, who immediately closes the local plant and lays off 150

workers.

Fortunately though, the bank, the brokerage houses and their respective

executives are saved and bailed out by a multibillion dollar no-strings

cash infusion from the government.

The funds required for this bailout are obtained by new taxes levied on

employed, middle-class, nondrinkers who have never been in Heidi's bar.

Once debts can be treated as assets all sorts of things become possible- for example one might take the mortgage payment of the lowest paid workers in america and transform them into triple A rated securities- it's magic!

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Imagine a man who makes his living digging ditches. He may hire himself out at a daily rate of, say, $25. The old capitalists would have paid no attention to him – he is just one of millions of small entrepreneurs getting by in life.

But today’s financial hustlers will spot the opportunity. Let’s take him public, they will say. We’ll raise his daily rate to $30…pay him his $25…and the rest will be our "profit." We’ll sell shares to the public at a P/E of 20…let’s see, 20 x $5 x 250 days per year = $25,000. All of a sudden, the ditch digger has a capital value of $25,000.

Then, they borrow $20,000 from a hedge fund…and pay it to themselves for structuring the deal. Now, the hustler has $20,000 in his pocket; the hedge fund has a high-yield bond worth $20,000; the shareholders have $25,000 worth of stock; and the poor man is still digging his ditches.

Then, an even more ambitious wheeler-dealer will come along and decide to "roll up" the whole industry – bringing the ditch diggers together into a multi-national consortium. Now they can all do cross-border transactions…including derivatives.

And now ditch-digging is a major business, suitable for large investors…with more investment coverage and a higher P/E ratio. Soon all the world’s banks, pension funds, insurance companies, and hedge funds have some of the ditch digging paper – debt or equity – and billions in fees and commissions have been squeezed out of ditches by the financial industry.

That, patient reader, is the way (the world-over) that industries and assets are now being bought, sold, refinanced, leveraged, re-jigged and resold. In the old days, companies went to investors or to banks for capital and cultivated a relationship with them that was long and fruitful.

Now, it’s all wham-bam-thank-you-ma’am capitalism. Inquiring capitalists now only want to know one thing – how fast can we do this deal? How many points can we get out of it and how much leverage can we get? And whom can we dump it on, when we’re done?

What a load of old cobblers.

First of all, raising his rate to $30 suggests that the market can support a price of $30. Why was he not charging $30 to start with if that is his market rate?

Perhaps they have added value in some way, through branding and a nice website etc so that it is worth the labourer agreeing to it. The $5 dollars is now profit, so you could argue that a bond/shares paying 5% is justified. However, as this bond is only for 20 years, there is no provision for the repayment of $25000 at the end of the term. The investors in this case are simply making an interest free loan to be repaid over 20 years. To get the repayment and the interest the investors would want $10 a day. The bond is now only worth $12500. Basically, we need an extra $5 from somewhere.

Next, we have the absurdity of borrowing $20,000 from the hedge fund to pay themselves a bonus. Presumably the hedge fund wants to be repaid with interest, but there is no other income stream to pay them. The hedge fund would not lend the money.

So basically we have a few badly thought out assertions and calculations that do not add up or make any sense. Pity really, because the point trying to be made about the financialisation of the economy over the last few decades is valid, but presenting nonsense examples just damages the argument.

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If you ask most people where the banks get the money they lend out they will probably reply that it comes from other people's deposits- but we know that's not how it works. In reality when you borrow money from a bank it is your signature on the loan agreement that brings that money into existence- there is no internal process at the bank whereby the money you borrow is shifted from some other account into your account- in reality the bank simply credits you account with the loan and balances it's books by treating your signed agreement to repay as it's asset.

So the banks do in fact create money from thin air. But- it is claimed- this is not 'free' money due to the strict requirements imposed on the banks as to how much of this money creation they can do relative to their reserves.

But suppose there were a way to get around these requirements- suppose we were able to invent a slew of 'financial instruments' that allowed us to perform the same sort of trick as the banks do when they lend money but without the pesky regulators getting in the way.

Not quite.

Loans and deposits are created simultaneously. When a bank agrees to make a loan it debits its Loans Receivable account to the value of the loan and balances its books by creating a new liability account in the name of the borrower, no different than if the customer had made a cash deposit with the bank. Reserves don't come into play except for the requirement that a bank has sufficient reserves in its asset account with the central bank to back the newly made loan. AFAIK, under UK law there is no minimum reserve requirement on account deposits, effectively permitting an infinite amount of credit-money creation.

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What a load of old cobblers.

First of all, raising his rate to $30 suggests that the market can support a price of $30. Why was he not charging $30 to start with if that is his market rate?

Perhaps they have added value in some way, through branding and a nice website etc so that it is worth the labourer agreeing to it. The $5 dollars is now profit, so you could argue that a bond/shares paying 5% is justified. However, as this bond is only for 20 years, there is no provision for the repayment of $25000 at the end of the term. The investors in this case are simply making an interest free loan to be repaid over 20 years. To get the repayment and the interest the investors would want $10 a day. The bond is now only worth $12500. Basically, we need an extra $5 from somewhere.

Next, we have the absurdity of borrowing $20,000 from the hedge fund to pay themselves a bonus. Presumably the hedge fund wants to be repaid with interest, but there is no other income stream to pay them. The hedge fund would not lend the money.

So basically we have a few badly thought out assertions and calculations that do not add up or make any sense. Pity really, because the point trying to be made about the financialisation of the economy over the last few decades is valid, but presenting nonsense examples just damages the argument.

yes, the role of the financier isnt the problem. a financier moves money around and takes a cut for moving this money around. they are a go between between 2 parties.

the financier is the agent in between, and they are providing service which is the matching of those 2 parties. even if they manufacture an instrument from thin air, that instrument is simply designed to match 2 parties together.

a supermarket is matching 2 parties together. almost everything we do in society is a long chain of relationships that match 2 people together.

an iphone is just the matching of a series of suppliers, with technicians, manufacturers, with consumers.

so you cant really say financiers dont create anything. they provide a service, and that service helps grow the size of the pie. i think what the issue really is, is that people dont like that they seem to be taking too big a piece of the pie.

the reason they can do this is that there is a oligopoly on the supply of money, and that oligopoly is created, maintained and rubber stamped by the actions of the government and central bank. they will only allow you to use the dollar, the pound the euro because they control it.

the only way to break this control of money is to allow the creation of alternative money in the form of competing currency's, but the powers that be wont allow that to happen.

if you created a local cornish pound or a north east dollar, and it actually became popular, the government would find a way to shut you down and ban it because they dont control it.

Edited by mfp123

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If you ask most people where the banks get the money they lend out they will probably reply that it comes from other people's deposits- but we know that's not how it works. In reality when you borrow money from a bank it is your signature on the loan agreement that brings that money into existence- there is no internal process at the bank whereby the money you borrow is shifted from some other account into your account- in reality the bank simply credits you account with the loan and balances it's books by treating your signed agreement to repay as it's asset.

Completely incorrect. The money multiplier is real, but it's not as simple as just signing on the dotted line. And yes, the bank *must* have any money they want to lend you on deposit, own it, or borrow it from someone who does. That is why they bother collecting debts, which is surely harder than just writing new loans for free. Or indeed why they turn some borrowers away.

The newly "created" money appears because the person whose money was lent still has it in their account, and the borrower also now has it in theirs. But the borrower promised to repay all of it and then some, so he also owes roughly the same amount as he borrowed. Hence the total bank balances have increased, but so has the borrowers loan balance. The overall wealth hasn't changed much, if at all. So no new money was created, and especially no free money for the bankers.

The system is sufficiently broken as it is without having to make up reasons .....

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AFAIK, under UK law there is no minimum reserve requirement on account deposits, effectively permitting an infinite amount of credit-money creation.

There are minimum reserve requirements in the UK, which came in with the FSA's CP 09/13.

For retail balances, banks need to hold between 10% & 20% of balances in reserve. It is not a simple number because money from different sources is treated differently.

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What a load of old cobblers.

First of all, raising his rate to $30 suggests that the market can support a price of $30. Why was he not charging $30 to start with if that is his market rate?

Perhaps they have added value in some way, through branding and a nice website etc so that it is worth the labourer agreeing to it. The $5 dollars is now profit, so you could argue that a bond/shares paying 5% is justified. However, as this bond is only for 20 years, there is no provision for the repayment of $25000 at the end of the term. The investors in this case are simply making an interest free loan to be repaid over 20 years. To get the repayment and the interest the investors would want $10 a day. The bond is now only worth $12500. Basically, we need an extra $5 from somewhere.

Next, we have the absurdity of borrowing $20,000 from the hedge fund to pay themselves a bonus. Presumably the hedge fund wants to be repaid with interest, but there is no other income stream to pay them. The hedge fund would not lend the money.

So basically we have a few badly thought out assertions and calculations that do not add up or make any sense. Pity really, because the point trying to be made about the financialisation of the economy over the last few decades is valid, but presenting nonsense examples just damages the argument.

Did it make sense to invest in the income stream generated by sub prime mortgage borrowers treating the resulting securities as triple A rated? Of course not- but profits could made by ignoring the absurdity of the proposition.

The point of the Ditch digger analogy is not to present a rationally argued case for the ability of the financial sector to make money- it's to demonstrate how complexity and obfuscation can create the illusion of wealth where no wealth in fact exists.

If the market were the rational place you seem to imagine those trying to peddle the debt of some of the poorest paid workers in america as a triple A rated product would have been laughed at- instead they not only sold that product they even held onto some of it themselves.

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Did it make sense to invest in the income stream generated by sub prime mortgage borrowers treating the resulting securities as triple A rated? Of course not- but profits could made by ignoring the absurdity of the proposition.

The point of the Ditch digger analogy is not to present a rationally argued case for the ability of the financial sector to make money- it's to demonstrate how complexity and obfuscation can create the illusion of wealth where no wealth in fact exists.

If the market were the rational place you seem to imagine those trying to peddle the debt of some of the poorest paid workers in america as a triple A rated product would have been laughed at- instead they not only sold that product they even held onto some of it themselves.

this is the point...not a penny of wealth is added by anyone other than the ditch digger, but a whole chain of "products" appear on bits of paper.

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Completely incorrect. The money multiplier is real, but it's not as simple as just signing on the dotted line. And yes, the bank *must* have any money they want to lend you on deposit, own it, or borrow it from someone who does. That is why they bother collecting debts, which is surely harder than just writing new loans for free. Or indeed why they turn some borrowers away.

The newly "created" money appears because the person whose money was lent still has it in their account, and the borrower also now has it in theirs. But the borrower promised to repay all of it and then some, so he also owes roughly the same amount as he borrowed. Hence the total bank balances have increased, but so has the borrowers loan balance. The overall wealth hasn't changed much, if at all. So no new money was created, and especially no free money for the bankers.

The system is sufficiently broken as it is without having to make up reasons .....

If the person whose money was lent still has it in their account- but the borrower also has it in their account- then we have a problem, since we now have double the amount of money- so where did the extra money come from? It seems to have been produced from nothing.

What you suggest here is that the borrower has the ability to create money from nothing simply by signing a piece of paper. And if that's true then why does he not repay the loan by signing another piece of paper and sending it to the bank?

Are they going to argue that his signature has no validity- no- because if they did then this would mean that the signature they took from him in the first place was also invalid- which would invalidate their claim that he owes them something.

The truth is that this entire process does not stand rational analysis- it's a game of abstraction in which the only limitations are those imposed by the players- which is why we can arrive where we are today, in a world where there are far more claims on wealth than there is wealth to meet those claims.

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If the person whose money was lent still has it in their account- but the borrower also has it in their account- then we have a problem, since we now have double the amount of money- so where did the extra money come from? It seems to have been produced from nothing.

What you suggest here is that the borrower has the ability to create money from nothing simply by signing a piece of paper. And if that's true then why does he not repay the loan by signing another piece of paper and sending it to the bank?

Are they going to argue that his signature has no validity- no- because if they did then this would mean that the signature they took from him in the first place was also invalid- which would invalidate their claim that he owes them something.

The truth is that this entire process does not stand rational analysis- it's a game of abstraction in which the only limitations are those imposed by the players- which is why we can arrive where we are today, in a world where there are far more claims on wealth than there is wealth to meet those claims.

there are two types of money...cash and credit. both are spendable interchangeably whilst the banking system exists...without the banks, there is little useful credit. (cash isnt necessarily a note, but can be an electronic balance at a bank, but not in an account for a client at a bank)

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Did it make sense to invest in the income stream generated by sub prime mortgage borrowers treating the resulting securities as triple A rated? Of course not- but profits could made by ignoring the absurdity of the proposition.

The point of the Ditch digger analogy is not to present a rationally argued case for the ability of the financial sector to make money- it's to demonstrate how complexity and obfuscation can create the illusion of wealth where no wealth in fact exists.

If the market were the rational place you seem to imagine those trying to peddle the debt of some of the poorest paid workers in america as a triple A rated product would have been laughed at- instead they not only sold that product they even held onto some of it themselves.

Analogies are an excellent way to present an argument, when they work and make sense. This one does not, so it is an ineffective analogy and so weakens the point that the poster was trying to make.

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If the person whose money was lent still has it in their account- but the borrower also has it in their account- then we have a problem, since we now have double the amount of money- so where did the extra money come from? It seems to have been produced from nothing.

What you suggest here is that the borrower has the ability to create money from nothing simply by signing a piece of paper. And if that's true then why does he not repay the loan by signing another piece of paper and sending it to the bank?

Are they going to argue that his signature has no validity- no- because if they did then this would mean that the signature they took from him in the first place was also invalid- which would invalidate their claim that he owes them something.

The truth is that this entire process does not stand rational analysis- it's a game of abstraction in which the only limitations are those imposed by the players- which is why we can arrive where we are today, in a world where there are far more claims on wealth than there is wealth to meet those claims.

Let's break this down into something simple - credit is just a promise.

Anyone can make loads of promises. However, if they can't deliver on the promises, then the person making the promises has a problem. So does the person expecting the promise to be kept.

However, if every time you fail to deliver on your promises, someone steps in and bails you out with stolen money, you have an incentive to keep making bad promises. EDIT: If that same person who bails you out also forces everyone to keep trusting your promises, it compounds the problem.

The problem here isn't people making promises; they create social capital, removing the need for physical/financial capital. The problem is the theft, the encouragement of bad promise making, the lack of consequence for bad promise making and the inability to sidestep the promise makers.

Edited by Traktion

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If the person whose money was lent still has it in their account- but the borrower also has it in their account- then we have a problem, since we now have double the amount of money- so where did the extra money come from? It seems to have been produced from nothing.

What you suggest here is that the borrower has the ability to create money from nothing simply by signing a piece of paper. And if that's true then why does he not repay the loan by signing another piece of paper and sending it to the bank?

Are they going to argue that his signature has no validity- no- because if they did then this would mean that the signature they took from him in the first place was also invalid- which would invalidate their claim that he owes them something.

The truth is that this entire process does not stand rational analysis- it's a game of abstraction in which the only limitations are those imposed by the players- which is why we can arrive where we are today, in a world where there are far more claims on wealth than there is wealth to meet those claims.

they dont create the money per se, but they do create credit which acts like money. your bank statement merely show how much credit you have with a bank.

banks can create credit from nothing but so can i.

if bob does some work for me i could give him a piece of paper saying iou £100. if rather than collecting his debt from me, bob trades that iou with john to get something he wants, my iou effectively acts like money.

thats just how the system works. the reality is that most of our economic system revolves around trading ious with each other. if we cash in our ious the credit supply (and effectively money supply) shrinks.

thats why money supply is broken down into m0, m1, m2. m0 is actual money in the system, m1, m2 are things like bank credit in the system (which is the thing banks create when they give you a loan), and which act like money.

Edited by mfp123

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they dont create the money per se, but they do create credit which acts like money. your bank statement merely show how much credit you have with a bank.

banks can create credit from nothing but so can i.

if bob does some work for me i could give him a piece of paper saying iou £100. if rather than collecting his debt from me, bob trades that iou with john to get something he wants, my iou effectively acts like money.

thats just how the system works. the reality is that our economic system revolves around trading ious with each other. if we cash in our ious the credit supply (and effectively money supply) shrinks.

thats why money supply is broken down into m0, m1, m2. m0 is actual money in the system, m1, m2 are things like bank credit in the system (which is the thing banks create when they give you a loan), and which act like money.

Except that the credit creation of banks has state sanction and backing. Moreover the government is willing to accept that private sector bank credit in payment as tax.

I have none of those, and if I attempted to pay my taxes in alex-credit, or anyone else who took alex-credit did so, well we'd be doing a few years behind bars.

How do you or I compete with that??

Edited by alexw

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Except that the credit creation of banks has state sanction and backing. Moreover the government is willing to accept that private sector bank credit in payment as tax.

I have none of those, and if I attempted to pay my taxes in alex-credit, or anyone else who took alex-credit did so, well we'd be doing a few years behind bars.

How do you or I compete with that??

unfortunately we cant because we would get shutdown however with the digital age things will turn because it will make it easier for us to trade virtual "stuff" which can act like money.

a basic example of this could be as simple as something as nectar points. nectar points give you credit with sainsburys, and anyone part of the nectar points ecosystem. but if you and i trade nectar points with each other then nectar points effectively act like money in itself.

with the rise in apps and paying for stuff using your phone, it will make it easier to trade with someone using something other than pounds and dollars. i dont need coins or a card that has been issued by a bank.

nectar points are backed by sainsburys and the companies that use it which provides the confidence in that currency. maybe one day we will all have our own individual credit system.

we may create a new system of working out how to calculate a value and thus confidence on mfp123 or alexw iou's.

Edited by mfp123

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Except that the credit creation of banks has state sanction and backing. Moreover the government is willing to accept that private sector bank credit in payment as tax.

I have none of those, and if I attempted to pay my taxes in alex-credit, or anyone else who took alex-credit did so, well we'd be doing a few years behind bars.

How do you or I compete with that??

Exactly. It isn't a problem that promises are made, it is who is making them and how they are sanctioned/backed.

Bitcoin* is interesting because it is impossible to shut down. They can make it illegal to use as a last ditch effort, but even that won't stop it functioning in a black market. Ultimately, the countries where it is illegal will lose out though, just as they would if they banned email in order to save snail mail - it just harms the economy.

* EDIT: Bitcoin is not credit based, but it is an alternative money/settlement system. Credit can be a layer on top, if needed (coloured coins, ripple credits etc).

Edited by Traktion

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