Question, what is the underlying, most basic premise of current global economy system?
What prove to this answer? The pervasive application of interest rate to borrowed capital. An interest means that the borrower will somehow get more money in the future than what he had borrowed today. Without growth, it’s impossible to expect that the borrower would be able to do such a thing. We have been so used to growth, so expectant of growth, that we often forgot that without growth, interest is impossible.
Ok, since this is pervasive, everyone who borrows money needs to pay an interest, what is the implication of applying a perpetual growth assumption into an economic system?
As some people had mentioned: In an economy system based on perpetual growth – There’s only 3 paths: actual increase in production, inflation, or bankruptcy.
Now, I argue there’s two type of money: “vocational money”, money that are created when someone create a product or service and gets paid for providing such product or service, and then there’s “computer money” money that are produced in computer screen (or people’s mind) when a bank charge interest rate to its borrowers, an investor enjoys rising stock price, a house owner dreaming that he will always enjoy good increase in his property value.
There’s a main difference between this two type of money, vocational money represents real increase in production, computer money represent…whatever value a group people assigned to a set of papers or assets (there’s even a computer computer money, which is money that represent a value that a group of people assigned to computer money, this computer computer money is called derivatives)
Now, in the current financial system, both vocational money and computer money are mixed and called money. Sometimes this is ok, when banks charge interest, the bank makes computer money, but one day the borrower will obtain enough vocational money to pay for the entire loan plus its interest.
But in other times, like at the construction of a bubble, the amount of computer money simply gets out of control. Feed by expectation of growth, the value of stocks rise and rise, with all owner of the stock dreaming that their wealth has indeed increase. This dream is based on the assumption that when the shareholder is ready to cash in his stock, there will be another guy with money (regardless of vocational or computer) who is also willing to buy the stock at the listed price. But what if everyone wants to cash in? The computer money burst. Doesn’t matter whether its stock, houses, tulips, this is how computer money burst.
In the event where so many people share this collective dream of ever increasing value in assets, there’s more and more money being feed to support this dream of increasing value in assets. This creates a firestorm of computer money being created. “My house will increase its value by 30% in 1 year”, “My stockholding increase its value by 50% during the last 5 years”, “that hedge fund delivers 37% annually for the last 7 years”. Computer money ladies and gentleman, lots and lots of computer money. Then bad news came, and well, the assets owners want to make the computer money into money. Since its bad news, there’s no counterparty that are willing to put money in exchange for computer money. This is what happens in 1930, 2001, 2008. Please note, that such an event is called a financial crisis.
So now, a bubble had burst? What to do? Options:
1. Produce enough goods and service to match the amount of computer money created (impossible).
2. Let the assets owner take their losses in computer money, even if that means they go bankrupt
3. Create money in equal amount to computer money, regardless of how much vocational money is being created at the moment. Creating money without equal amount of vocational money being created means inflation.
What does the US government decide to do? After Lehman go bankrupt, the holders of computer money gets super nervous, “oh man, the US gov is unwilling to create money to cover my computer money, computer money is worthless”. We still see this even now don’t we? Wholesale reduction in the value of computer money. It’s out there on our trading screens, our ticker box, and Bloomberg terminals.
Then the US government responds, a response that the owners of computer money love so much, it’s called a bailout. Only when it is proven that the computer money has been bloated so big, that even the $ 700 Bn is not enough to cover the computer money, the bailout was trashed by holders of computer money. Again the value of computer money goes down. Dow stands at about 9277 by today (31 October 2008), compared to at 13,089 at 25 April 2007.
Some computer money owners even now believe that the computer money has been so bloated that we will expect to see even more decrease in value of computer money.
Quite early on, I mentioned that the vocational money and computer money are mixed together as money. The current economic system also allows holders of computer money to convert their holdings into money at 1 to 1 exchange rate. What does this mean to vocational money? This means when computer money gets worthless, vocational money also goes down the drain. Savings are eaten up by inflation (those $ 700 Bn are not backed by vocational money of the same value, the fed simply decide to create $ 700 Bn), business owner with real products cannot get access to money, corporations that had produce real product and service now finds that the vocational money they earn are gone because they have morph it to computer money. Such an event is called a real crisis.
So, there’s two type of money, and two type of disaster that happens when each type of money falls in value.
Computer money and the financial crisis
Vocational money and the real crisis
As long as computer money and vocational money can be mutually exchange at 1 to 1 exchange rate, a financial crisis will translate to a real crisis.
What we need now, is a system that allows computer money to go down the drain without dragging vocational money with it. We need to allow computer money to go bankrupt, yes, go bankrupt, because the value that the computer money represents is not simply there in the first place.
If we are unwilling to let computer money go bankrupt, and we still attached vocational money to computer money, we will have inflation, destroying both the value of computer money and vocational money.
How do we contain computer money and vocational money in separate place to prevent spillage of disaster?
That’s an answer I don’t have yet. Now, I’m just introducing the fact that there are vocational money and computer money.