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Solving the Global financial crisis

Nicked from the same blog as mentioned in the last post, here's a delightful example of where money in the right place at the right time can really help things:

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?

Now, back to doing actual MBA stuff....


( 7 comments — Leave a comment )
May. 14th, 2009 09:33 pm (UTC)
I don't know enough Economics to understand the moral of this story.

May. 14th, 2009 11:28 pm (UTC)
Re: Economics
I think the moral of the story is "none of the people in town understand double-entry bookkeeping."

Accounts payable (money you owe) is a liability. This is fairly well understood.

Accounts receivable (i.e. money owed you) is an asset. It's not as liquid an asset as actual cash, but it's still an asset. This is not so well understood.

After the "cash loop", everyone involved has reduced their total liabilities by EUR100, but they have also reduced their total assets by EUR100. The balance sheet still balances, and they have no more (and no less) equity. (The basic equation: assets = liabilities + equity.)

It's quite possible that they all feel better off because owing money is more noticeable to them than being owed money, but this doesn't change the underlying financial situation any.
May. 14th, 2009 11:29 pm (UTC)
Re: Economics
Well analyzed.
May. 15th, 2009 01:59 am (UTC)
Re: Economics
That's close to correct. The problem is that you normally have to assume that there's some probability that the folks who owe you money are going to default, while you tend to assume that you're going to have to pay your own debts. :)

The problem here is that there was insufficient liquidity in the money supply in the town. The Russian was the equivalent of a bank that would inject liquidity into the system by making a short-term loan of 100 Euros.

And right now, the world economy is suffering -- at least in part! -- from a shortage of liquidity, because banks are being unwilling or unable to lend money to even their more credit-worthy customers.
May. 15th, 2009 08:43 pm (UTC)
Re: Economics
I thought the world economy was suffering from a shortage of liquidity because the bankers took their bonuses away and stashed them offshore.
May. 17th, 2009 03:05 am (UTC)
Re: Economics
The great depression was a problem with liquidity. The current recession (great recession?) is more a problem with counter party risk. You can devise tests that distinguish between these two cases. One of them is to look at the spread between LIBOR and OIS. -chris
May. 15th, 2009 09:26 am (UTC)
Re: Economics
Makes sense. Although don't discount the micro-economic factors that affect psychology. But I think your analysis is essentialy correct; that what the tranactions changed is peoples' perceptions and not the reality.

( 7 comments — Leave a comment )


after all
Alice Bentley

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