I need an economics wiz to explain to me, in 5th-grader terms, why no one has any money these days.
Big business is hurting. Corporate accountants and marketing execs are staying up nights searching for creative but sneaky methods to wring more nickels from their customers: airlines charging for carry-ons or forgoing meal service, banks inventing new fees within fees within fees, layoffs, salary reductions, slashed benefits. Corporate America is hurting for money; who’s got it all?
Government? Nope, ain’t here. Budget cuts, layoffs, tax increases, reduction of services (police, emergency), mail going to four days a week (?), cities with huge deficits.
Ahhh…the people must have all the money. Obviously, no. Record unemployment / widespread layoffs, house foreclosures, rampant credit card (and other) debt.
Where did all the money go? Who has it, if everyone is short of it?
Do we just have too many people on this earth? What if half of the world’s population died overnight - would this put us all in better financial stead?
If no one is spending, no one is earning. If no one is earning, no one is paying salaries. With no salaries, no one is spending.
The economy is a big loop. If I buy food from my company and they pay me for farming that food as their employee, then we’re just passing the same money back and forth. But, if we look at our balance sheets, the more often I buy food and the more food I buy, the more money the company makes. The more often they pay my salary or the higher my salary rises, the more money I make. And yet, again, it’s all the same money. It’s just adding up the same money over and over as it travels around the loop.
There’s money, and there’s liquidity. There is plenty of money, it’s just that not many people with it want to lend it out. The government has plenty of revenue (taxes), but is spending at record deficit levels.
Then there’s me. I’ve got money. Do you need some?
It hasn’t gone anywhere, because it was never there to begin with.
Look. If my 100 shares in ACME Industries jump from $50/share to $100/share overnight, does that mean that there is now an extra $5,000 lying around to set along side with the $5,000 that I had the day before?
No. When ACME’s stock price doubled overnight, all that meant was that suddenly, someone was willing to pay $100 for something (a share of ACME stock) that used to only cost $50.
But at that higher price, I now have more leverage to do a lot of things that I didn’t have before. I can borrow more money against it. I can convince a bank to loan me more money for a down payment on a house. I can actually sell the stock and earn a capital gain, and then give lots of that money back to the feds April 15 in the form of a capital gains tax.
Everybody has more money, but it’s not real money.
Money is an idea, it is not a real, tangible item. All of the billions and billions and trillions of dollars that existed before the house bubble burst and the resultant fall in value and the banking crisis that followed that, never really existed.
If your home and property had a market value of a million dollars 3 years ago you might have actually got someone to give you a million dollars for it. So at that time it really was worth that price.
Today if the only way you can sell the same thing is to take $300,000 for it, then that is all it is really worth now. The banks may have gambled on the value of your property and loaned you a high mortgage for it.
Now you are asking yourself “who has the $700,000 that is missing?” Answer is nobody has it, it never existed beyond the idea of it’s value.
Imagined equity, the difference between what you thought something was worth and the actual amount you or the bank can sell it for, went ‘poof!’ and disappeared just like that. So banks will no longer loan money on imaginary value, business will not gamble on expansion and hiring based on potential earnings, people cannot get jobs and thus cannot increase there own spending, government relys upon tax revenue to increase and instead it falls.
All because money isn’t real and never has been and a significant portion of the money in the world just vanished. Nobody is holding the missing money, it is gone, until prosperity leads to optimism, which leads to more gambling on value.
The investment banks have plenty of money. Banks in general have money - but they are not lending it, out of fear that those who they lend it to are bad risks, which means businesses don’t have the capital to expand, which means that they don’t hire, which means that unemployment is high, which means that there is no consumption, which means the banks consider businesses bad risks.
I had no trouble getting money to refinance. When I bought a car, the dealer would have loved to lend me the money. (I paid cash.) The money is there - it is not flowing.
](Market Bubbles « Reason for a New Age)
The money doesn’t disappear, it just ends up in the hands of people who needed more, and out of the reach of the people who were expecting it, throwing everything into a standstill.
Alright, let’s talk about real - not imagined - cash.
Bob’s Widget Corp. used to sell 10 widgets a day at $10 each.
Now he sells just 5 a day.
That $50 less a day that he is seeing now stays in the pockets of his customers.
But not quite. Customer Jim - who only buys half of what he used to - is hurting too. His utility bills have doubled. So the electric company now gets twice what they used to from Jim.
But wait…the electric company’s health insurance for its employees has doubled. Now Blue Cross gets the money. And so on.
Here is where I get confused.
Back in the good olde days, when the economy was rockin’, this goes-around/comes-around scenario was playing out just as it is now, except nobody was hurting. Jim could order from Bob, and the utilities could collect from Jim, and the insurance company could maintain its rates with the electric co., and everything was stable.
Well I guess everything is ‘stable’ still, just on a much different level. Everybody in that great, circular loop is struggling.
Seems as though it would work much the same if everyone were thriving.
Everything is never stable. You are seeing net stability at the macro level, and lots of individual instability at the micro level. We just have a lot more individual instability now. In economic terms, we really just slid back a few years, that’s all. It’s not like there’s some law that says the economy has to always grow.
Consider Jim a few years ago. He made a good salary.
Consider Jim today. He’s lucky, he still has a job, and still makes that same good salary.
Four years ago unemployment was low, so he felt confident he would keep his job. The value of his house (or the houses of his neighbors who sold) was going up. Being a fiscal conservative in the good sense, he in no way was going to get a loan based on it. However, he didn’t mind spending a lot of the money he did have on trips and luxuries.
Consider Jim today. The value of his house went down. Even if it is still way above water, he feels less wealthy. Lots of his friends lost their jobs. He knows no job is safe. So, instead of spending his extra money, for forgoes that trip and puts it the bank. He does without a dinner out, or that new shirt, or that new gadget. The multiplier effect is working in reverse.
I had to buy a new car earlier this year, since my old one died. If I was 100% sure of my job, I would have spend $1,000 more and gotten the next level up. it turned out I was safe and I wish I had spent the money, but I’m basically a cheapskate. Multiply me by all the people with jobs, add in the reduction in spending of those without jobs, and you see the problem.
Plus. that extra money is sitting in the bank building up capital reserves and not being lent to help stimulate the economy.
If you’re really interested in the subject, you might want to read Krugman here, where he really does explain it like you’re a 5th grader: The Unofficial Paul Krugman Web Page
As Sage Rat said, aggregate demand is the quantity of money X the velocity of money. The velocity of money has fallen. It could be made up for by lowering interest rates or printing more bills until aggregate demand is a few percentage points above aggregate supply.
There’s plenty of money out there. That is not an issue. The issue is the effect of money.
Money only has an effect when it is moving. If it doesn’t move, then nobody other than the holder benefits from it. More-so, the holder of the money wants it to keep moving so its value (perceived or otherwise) will increase. You can stuff your money under a mattress but if everybody does that and and the money doesn’t move then the money in your mattress will be of less value than the cotton that is stuffed there. It’s not a great thing to be holding on to a lot of money that is losing value. Economic stimulus to get the money moving is actually a good thing.
Economic vitality: money is moving. Economic stagnation or depression: money is not moving at a rate that encourages spending.
Economics in a nutshell: if you want prosperity then you have to keep the money moving. That’s why the government does all these crazy, insane things to promote economic stimulus. You can argue about whether they are wise or misguided but doing something is critical to sustaining the economy.
so with all this talk of imaginary money being created out of thin air, does this mean that if tomorrow, a giant space bat were to deposit a million dollars into every peasant’s account including the notion (so as to cancel the effect of having everything else being proportionately expensive because of supply) that this bounty has always been the case and is accepted, everyone would be in a better position? or would money simply be useless without the poor?
Fundamentally, people don’t exchange goods for money, they exchange goods for goods. Money is a very useful way to exchange goods. The abstraction of economic value into money makes it easy for multilateral trade of goods. E.g.: If you’re a shoemaker, you don’t have to buy only from people who want shoes, you can sell shoes, get money and use it to buy from people who themselves will use it to buy from others (maybe the people you sold shoes to).
Money is a system of abstract tokens that facilitates the exchange of goods, it is not wealth itself. If everyone woke up tomorrow with twice as much money as they do today, the goods wouldn’t have changed. The prices would simply be doubled.
In the example you give, what would happen is that there would be a great redistribution of wealth from non-peasants to peasants since prices would go up for everyone, but not as much as the bank accounts of the peasants did. I’m afraid you couldn’t cancel out the effect of everything else being more expensive in the example you give; aggregate demand would have gone up without aggregate supply going up. That means inflation. If you wanted to cancel it out, you’d have to take the quantity of money from other people or slow down the velocity of money or increase supply (of goods).
That’s also why we spent our way out of a recession in 2001 when GWB did the “patriotic spend” push. Its why tax cuts along with reasons to spend work in a recession. But, of course, spending your way out of a recession is a short term thing - bills need to be paid, and taxes can’t be cut forever. So an economy requires balance between saving and spending. We haven’t had much balance for a number of years.
In theory what would happen is massive inflation at all prices to find a new equilibrium similar (if not exactly so) to the situation before this magical money suddenly appeared.
Speaking from American experience, people who used that windfall to pay down would benefit from not having any debt, but might (or most likely, will) suffer from the high prices and inflation that will inevitably, if not immediately, result. Unfortunately, most people would rather consume than pay off debt. Then, the crushing effects of high inflation would settle in. Debt holders would benefit because their debt is worth less nominally. However, if the job situation remained the same, the recessionary effects would continue and look even more bleak (in the short term at least) because of the high prices and the inability to buy anything (because of those high prices). Hopefully, prices would come down quickly. Though, as the US is mostly a service economy, and with wages being generally sticky, it’s quite possible that high prices and no employment will make the Great Depression look like a cakewalk.