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So Where Is The Money

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The banks are in a credit crisis because they've lent out so much money - so where is the money now?

If you borrow 1 million to buy a house someone gets that money - it's not like the money vanishes into thin air ...

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The money is created/borrowed from the future (loans), money is essentially destroyed when a company or individual goes bankrupt. Because the money has been borrowed from the future in the form of a loan it doesn't exist yet, so when it is destroyed it isn't really destroyed (if you follow). Money Supply, the rate money increases is at 14%, that is we are borrowing 14% more money each year from the future.... Anyone up for a what is money thread? ;p

Edited by moosetea

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Anyone up for a what is money thread? ;p

I think this is one.

This is something about economics that baffles me and probably always will. I think it needs it's own youtube video.

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Doesn't money disappear in a real sense, like vanish into thin air, when assets lose value? If a house has a value of £250K and then it drops to £230K, the 20K hasn't gone anywhere, it's just evaporated. Same with share values.

Edited by Sofa Spud

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If the house was sold for a million, the person who sold that house now has the million. But becuase that transaction took place, everyone else who had similar houses can now claim that thier houses are worth a million. And if those people bought them 10 years ago for 200k, then billions of phantom money has been created. Its not real yet cos it hasnt been liquidated to cash. Pundits will say how we have x trillion of housing wealth. But its not real. When the house prices falls 50 %, we arent losing all that money. It was never there.

Any lender who has lent money on this phantom asset is now exposed. As the sale of the underlying asset will not cover the outstanding obligation on it.

This is what it means to mark to market. And prices set at the margin.

Because all these assets have built a huge pryamid of phantom wealth, money can be seen to be destroyed. But it was never there. If everyone tried to liquidate to cash, the value fo the asset would have fallen so hard as there were way more sellers than buyers.

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SofaSpud & LifeChooser,

Welcome to the real world. You are on the path of becoming free from the matrix! ;)

Edited by Ursus

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In my limited understanding the key difference is between value and price. Price is based on value but is real whereas value is a chimera.

If a house is valued at £1M and bought at this price, the money has genuinely disappeared from the future if the house is then sold at £800,000. That is deflation in house prices.

If the house is valued at £800,000 for 5 years and is eventually sold after 10 years for £1.2M then real money has been added to the money supply...until the person that bought it sells it on for £1M after another 5 years...and so on.

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The banks are in a credit crisis because they've lent out so much money - so where is the money now?

If you borrow 1 million to buy a house someone gets that money - it's not like the money vanishes into thin air ...

the money hasnt so much disappeared, its more a case of stopped moving.

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The missing money, surprisingly, is in the past. It has already been spent.

The money is created/borrowed from the future (loans),

Exactly. The money has come from the future to fund purchases and consumption in the past. The books balance if one assumes that it will return to the future, with interest.

It will be returned to the future when the debtor expends time, skill and energy to earn the money to pay back the debt (with interest) in the future. Then the owner of the debt will have the money and the interest. In that case, there is no missing money. In the meantime, the debt can be bought and sold on the basis that it will return money in the future.

The problems arise if the debtor is not expected to earn the money to pay back the money with interest in the future. Then, there is less point in holding the debt, so the price of the debt falls. As this destroys the value of the debt used as money in the present, money has vanished from the present.

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OK, money is real where value is imaginary, but money is lent against assets that have value. That's where the problam lies.

If you haven't got enough cash on you to pay for a minicab fare on a Sunday, having a million pounds in the building society isn't much help!

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The banks are in a credit crisis because they've lent out so much money - so where is the money now?

If you borrow 1 million to buy a house someone gets that money - it's not like the money vanishes into thin air ...

It's been spent on new cars, plasma TVs, expensive holidays, etc. That's why we've had an economic boom for the last few years and everyone's been running two cars and having three holdiays a year. People have been borrowing money and spending it like mad. A lot of that money has ultimatey headed east (China now holds foreign currency reserves of over $1.5 trillion). Problem is that we now have to earn some money to pay all this back, or default. The banks are finding that a lot more people than they expected are going for the latter option.

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The banks are in a credit crisis because they've lent out so much money - so where is the money now?

If you borrow 1 million to buy a house someone gets that money - it's not like the money vanishes into thin air ...

Great question!

I think the answer to this is that it is invested by a small number of wealthy people... many of whom likely consider pension funds of several million... and it has been used to invest in "fixed income" securities - mortgage debt, for example.

While the money doesn't disappear into thin air, it can be invested in "illiquid" financial assets - supposedly to maximise long term yields.

Another example would be private-equity investments and leveraged buyouts of fledgling companies - where vast sums are "invested" in the hope of massively expanding the existing business... and, ultimately (maybe after paying wages, etc.) gets spent on imported goods/materials and outsourcing bills.

Investment bankers got some pretty impressive bonuses in 2006/2007 too. :)

Edited by A.steve

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the money hasnt so much disappeared, its more a case of stopped moving.

The perception is that the money has dissapeared from the future. Therefore, the perceived value of the debt in the present has fallen. There is currently a gap between the prices holder of the debt will sell for and the price buyers will buy for. Therefore no deals are being done, and this debt has stopped moving.

Once buyers and sellers agree on how much money has been lost in the future, the debts will start moving again. This is (sort of) what people mean when they cry for debts to be marked to market. But to do that, we need to open the debts so the buyers can see how much future money is likely to be in them. Then a market price can be agreed. So transparency is key.

Transparency is exactly what Central Banks and Govts are trying to avoid. Instead, they are "injecting" short term debt into the markets to get them moving again, whilst doing all sorts of deals behind closed doors. Why you ask? Well thats what lots of people are asking. Its part of the reason people are so scared, and some people are saying that there is way less money in those debts than logic might suggest. This increases their unwillingness to strike deals, and is leading to them calling in debts in the present, the money for which, often is not there yet. This is the "vicious circle".

Oh and finally, that short term money? The inflationists suspect that that it will effectively never get paid back. That of course, is the other great question.

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If the house was sold for a million, the person who sold that house now has the million.

And if the bank repossesses the house and only recovers half a million, the bank has lost half a million. Now the bank probably has billions in deposits and other funds, but it can't take the half-million from those -- the money belongs to other people. It loses half a million of its own capital.

How do the players stand once the house has been valued at 500k, and sold at that price?

House seller: sold a house that turned out to be worth 500k for 1000k, so he's 500k ahead. Whoopee for him!

House buyer: started with nothing, ended with nothing (in this scenario we assume he's defaulted i.e. bankrupt)

Bank: Lost 500k of its capital.

On the face of it, bank's losses = seller's winnings but the lost capital was 'high-powered' money that enabled the bank to lend. in other words you might see reduced lending or loans being called in, i.e. less money being created, or money being destroyed. Enough defaults would wipe out the bank's capital entirely, of course, and then the depositors find out how good their local insurance/compensation scheme is, and how much of their money has been destroyed :ph34r:

Edited by huw

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The quick answer is that its been spent by the "winners"

Let's look at the flow of cash in housing.

Let's imagine a new build in California.

The land is orginally owned by a landowner, lets call him Albert.

A developer, lets call him Bob, pays Albert a sum of money for the land, "$A". The developer then builds a house on that land. This costs him labour and materials "$B" and "$C". In 2005 he then sells that house to a random punter, Charles. Since its at the peak of the boom, Charles pays a high price, "$D" for this house.

Now, again, since we're in a boom, D will be greater than A+B+C, i.e. the developer makes a profit, "P", where P=D-A-B-C .

Bear in mind also that, since it's boom times, there's a lot of building going on, so A, B and C will also be higher than you would expect in usual times. We'll come back to this later.

Charles, the purchaser, goes to a bank to borrow money. Lets imagine that he gets a 100% mortgage, with a standard variable interest rate (i.e. he's a prime customer).

The Bank basically gives Charles the whole purchase price, "D", which Charles then gives to the developer.

Fast forward 3 years and suddenly the house is worth a lot less. Let's assume that its dropped 30% in value, and is now worth 0.7D.

Theoretically this fall in value has been borne by Charles, the owner, who has "lost" 0.3D in equity. What actually happens of course is that Charles hands back his keys. The bank respossesses and then resells the property at 0.7D, losing 0.3D.

Obviously this is a very bad thing for the bank, and, on the face of it it looks as if that 0.3D has genuinely disappeared. This is not the case. In fact the 0.3D loss is perfectly counterbalanced by a 0.3D gain. Where is this? Well it's in A,B,C and P - i.e. its in the money that the landower, the building labourers, the providers of building materials and the developer made. All of these were higher than the would have been if the newbuild had originally been sold for 0.7D.

The question is where has this money gone? Here's where the real problem lies.

The money has, in most cases, been spent, either on locally produced or imported consumer goods. (O.k, they may have saved some of it.... but this is the US!)

The bank's loss of 0.3D has been transferred to these consumer goods manufacturers, resulting either in higher overall domestic GDP growth than would have been possible with a lower original selling price, or more profits for foreign manufacturers.

This is the real problem. The US has, overall, spent the wealth "generated" by the housing price boom, and therefore there isn't any offset to the huge inevitable asset based write offs. Oh dear.

BUT, lets not forget that the developers, labourers and landowners managed to consume a lot more in the past 3 years than they would have done under non-bubble circumstances. There were some winners...

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The quick answer is that its been spent by the "winners"

But spending money <> destroying money, it just means moving it around. Your wages aren't destroyed when you spend them, so why should the profits you made off the back off selling an overpriced house? Similarly, spending money abroad doesn't destroy it, it just moves it onto the balance sheet of some Chinese company or sovereign wealth fund ;)

I maintain that if the 'winners' invested their profit in shoring up the capital of the bank that lent it in the first place, then no money would be destroyed by the default because the 'lost' capital would still be on the bank's balance sheet. All that would have happened is that the ownership of the bank would have changed slightly.

Note that depositing the money with the bank would not have the same effect.

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The quick answer is that its been spent by the "winners"

Let's look at the flow of cash in housing.

Let's imagine a new build in California.

The land is orginally owned by a landowner, lets call him Albert.

A developer, lets call him Bob, pays Albert a sum of money for the land, "$A". The developer then builds a house on that land. This costs him labour and materials "$B" and "$C". In 2005 he then sells that house to a random punter, Charles. Since its at the peak of the boom, Charles pays a high price, "$D" for this house.

Now, again, since we're in a boom, D will be greater than A+B+C, i.e. the developer makes a profit, "P", where P=D-A-B-C .

Bear in mind also that, since it's boom times, there's a lot of building going on, so A, B and C will also be higher than you would expect in usual times. We'll come back to this later.

Charles, the purchaser, goes to a bank to borrow money. Lets imagine that he gets a 100% mortgage, with a standard variable interest rate (i.e. he's a prime customer).

The Bank basically gives Charles the whole purchase price, "D", which Charles then gives to the developer.

Fast forward 3 years and suddenly the house is worth a lot less. Let's assume that its dropped 30% in value, and is now worth 0.7D.

Theoretically this fall in value has been borne by Charles, the owner, who has "lost" 0.3D in equity. What actually happens of course is that Charles hands back his keys. The bank respossesses and then resells the property at 0.7D, losing 0.3D.

Obviously this is a very bad thing for the bank, and, on the face of it it looks as if that 0.3D has genuinely disappeared. This is not the case. In fact the 0.3D loss is perfectly counterbalanced by a 0.3D gain. Where is this? Well it's in A,B,C and P - i.e. its in the money that the landower, the building labourers, the providers of building materials and the developer made. All of these were higher than the would have been if the newbuild had originally been sold for 0.7D.

The question is where has this money gone? Here's where the real problem lies.

The money has, in most cases, been spent, either on locally produced or imported consumer goods. (O.k, they may have saved some of it.... but this is the US!)

The bank's loss of 0.3D has been transferred to these consumer goods manufacturers, resulting either in higher overall domestic GDP growth than would have been possible with a lower original selling price, or more profits for foreign manufacturers.

This is the real problem. The US has, overall, spent the wealth "generated" by the housing price boom, and therefore there isn't any offset to the huge inevitable asset based write offs. Oh dear.

BUT, lets not forget that the developers, labourers and landowners managed to consume a lot more in the past 3 years than they would have done under non-bubble circumstances. There were some winners...

in synopsis.. all the future money has gone to china/sovereign wealth funds?

Edited by moosetea

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in synopsis.. all the future money has gone to china/sovereign wealth funds?

Some has.

Other money has been re-invested buying mortgage debt - and will only be spent again, in future, if people pay off their mortgages.

Edited by A.steve

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The banks are in a credit crisis because they've lent out so much money - so where is the money now?

If you borrow 1 million to buy a house someone gets that money - it's not like the money vanishes into thin air ...

As another poster said, It is in China.

This is one reason, in my opinion, why the Fed is printing all this money: If they can inflate away the problem by devaluing the dollar then they lose the chinese debt of 1.t trillion.

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When a mortgage defaults the bank is down in its balance sheet by the value of the asset pledged.

Until it is sold, the bank needs to ABSORB back money from the system to replace its lost capital.

The bank cant lend this money out again as it is required to balance its books.

Some money is therefore removed from the system

It is exactly what we are seeing now in the credit crunch on a huge scale. The CBs are being asked to replace this lost money. At the moment they are doing this as loans based on dubious collateral. When they start doing it without collateral, then we are in trouble.

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The money has gone to people's STR funds, which in turn has been invested into gold, NR bonds, NS&I and foreign utilities. I'm not taking a moral stand on this; I would sure as hell done the same given the opportunity, but that is where the cash is.

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The money has gone to people's STR funds, which in turn has been invested into gold, NR bonds, NS&I and foreign utilities. I'm not taking a moral stand on this; I would sure as hell done the same given the opportunity, but that is where the cash is.

Yes, THAT money may have, but money is like a pool, so a default will drain some out of the total pool back to its root- the banking system.

Edited by Bloo Loo

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  • 293 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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