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By Dr Frank Shostak, on 31 December 10
It is alleged that when the velocity of money rises, all other thing being equal, the buying power of money declines ie the prices of goods and services rise. The opposite occurs when velocity declines.
If, for example, it was found that the quantity of money had increased by 10% in a given year, while the price level as measured by the consumer price index has remained unchanged it would mean that there must have been a slowing down of about 10% in the velocity of circulation.
If the quantity of money had remained unchanged but there has been a 10% increase in the price level in a given period, it would mean that there must have been an increase in the velocity of circulation of money of 10% in that period. It would appear therefore that velocity is an important determinant of the purchasing power of money.
Main stream view of what velocity is
According to popular thinking the idea of velocity is straightforward. It is held that over any interval of time, such as a year, a given amount of money can be used again and again to finance people’s purchases of goods and services. The money one person spends for goods and services at any given moment can be used later by the recipient of that money to purchase yet other goods and services.
For example, during a year a particular ten-dollar bill might have been used as following: a baker John pays the ten-dollars to a tomato farmer George. The tomato farmer uses the ten-dollar bill to buy potatoes from Bob who uses the ten dollar bill to buy sugar from Tom. The ten-dollars here served in three transactions. This means that the ten-dollar bill was used 3 times during the year, its velocity is therefore 3.
In short, a $10 bill, which is circulating with a velocity of ‘3’ financed $30 worth of transactions in that year. Consequently, if there are $3000billion worth of transactions in an economy during a particular year and there is an average money stock of $500 billion during that year, then each dollar of money is used on average 6 times during the year (since 6*$500 billion =$3000).
In short, $500 billion of money is boosted by means of a velocity factor to become effectively $3000 billion. This implies that the velocity of money can boost the means of finance. From this it is established that
Velocity = Value of transactions / supply of money
This expression can be summarised as
V = P*T/M
Where V stands for velocity, P stands for average prices, T stands for volume of transactions and M stands for the supply of money. This expression can be further rearranged by multiplying both sides of the equation by M. This in turn will give the famous equation of exchange
M*V = P*T
This equation states that money times velocity equals value of transactions. Many economists employ GDP instead of P*T thereby concluding that
M*V = GDP = P*(real GDP)
The equation of exchange appears to offer a wealth of information regarding the state of the economy. For instance, if one were to assume a stable velocity, then for a given stock of money one can establish the value of GDP. Furthermore, information regarding the average price or the price level allows economists to establish the state of real output and its rate of growth.
Most economists take the equation of exchange very seriously. The debates that economists have are predominantly with respect to the stability of velocity. Thus if velocity is stable then money becomes a very powerful tool in tracking the economy. The importance of money as an economic indicator however diminishes once velocity becomes less stable and hence less predictable. In short, it is held an unstable velocity implies an unstable demand for money, which makes it so much harder for the central bank to navigate the economy along the path of economic stability.
Does the concept of velocity of money make sense?
From the equation of exchange it seems that money together with velocity is the source of funding for economic activities. Furthermore, from the equation of exchange it would appear that for a given stock of money an increase in velocity helps finance a greater value of transactions than money could have done by itself.
As logical as it sounds, neither money nor velocity have anything to do with financing transactions. Here is why.
Consider the following: a baker John sold 10 loaves of bread to a tomato farmer George for $10. Now, John exchanges the $10 to buy 5kg of potatoes from Bob the potato farmer. How did John pay for potatoes? He paid with the bread he produced.
Observe that John the baker had financed the purchase of potatoes not with money but with bread. He paid for potatoes with his bread using money to facilitate the exchange. In other words money fulfils here the role of the medium of exchange and not the means of payment.
The number of times money changes hands has no relevance whatsoever on the bakers’ capability to fund the purchase of potatoes. What matters here is that he possesses bread that can be exchanged by means of money for potatoes.
How is it that the fact that the same $10 bill used in several transactions can add anything to the means of funding? By what means does the speed of money circulation add to the real pool of funding? Imagine that money and velocity would have indeed been means of funding or means of payments. If this was so then poverty world-wide could have been erased a long time ago. Moreover, since rising velocity is supposed to boost effective funding then it would have been to everyone’s benefit to make sure that money circulates as fast as possible. This implies that any one who holds on to money should be classified as menace to society for he slows down the velocity of money and hence the creation of real wealth.
According to Mises the whole concept of velocity is hollow;
In analyzing the equation of exchange one assumes that one of its elements–total supply of money, volume of trade, velocity of circulation–changes, without asking how such changes occur. It is not recognized that changes in these magnitudes do not emerge in the Volkswirtschaft [political economy, or more loosely‘economy’] as such, but in the individual actors’ conditions, and that it is the interplay of the reactions of these actors that results in alterations of the price structure. The mathematical economists refuse to start from the various individuals’ demand for and supply of money. They introduce instead the spurious notion of velocity of circulation fashioned according to the patterns of mechanics (Human Action p 399).
Furthermore money never circulates as such;
Money can be in the process of transportation, it can travel in trains, ships, or planes from one place to another. But it is in this case, too, always subject to somebody’s control, is somebody’s property. (Human Action p 403)
Why velocity has nothing to do with the purchasing power of money
Does velocity have anything to do with prices of goods? Prices are the outcome of individuals’ purposeful actions. Thus John the baker believes that he will raise his living standard by exchanging his ten loaves of bread for $10 which will enable him to purchase five kg of potatoes from Bob the potatoe farmer. Likewise Bob has concluded that by means of $10 he will be able to secure the purchase of ten kg of sugar, which he believes will raise his living standard.
By entering an exchange, both John and Bob are able to realize their goals and thus promote their respective well-being. In other words John had agreed that it is a good deal to exchange 10 loaves of bread for $10 for it will enable him to procure 5kg of potatoes. Likewise Bob had concluded that $10 for his 5kg of potatoes is a good price for it will enable him to secure 10kg of sugar. Observe that price is the outcome of different ends, and hence the different importance that both parties to a trade assign to means.
In short, it is individuals’ purposeful actions that determine the prices of goods and not some mythical velocity.
Consequently, the fact that so-called velocity is ‘3’ or any other number has nothing to do with averages prices and the average purchasing power of money as such. Moreover, the average purchasing power of money cannot be even established. For instance, in a transaction the price of one dollar was established as one loaf of bread. In another transaction the price of one dollar was established as 0.5kg of potatoes, while in the third transaction the price is one kg of sugar. Observe that since bread, potatoes and sugar are not commensurable no average price of money can be established.
According to Mises, (Human Action p402)
Media of exchange are economic goods. They are scarce; there is a demand for them. There are on the market people who desire to acquire them and are ready to exchange goods and services against them. Media of exchange have value in exchange. People make sacrifices for their acquisition; they pay “prices” for them. The peculiarity of these prices lies merely in the fact that they cannot be expressed in terms of money. In reference to the vendible goods and services we speak of prices or of money prices. In reference to money we speak of its purchasing power with regard to various vendible goods
Now, if the average price of money can’t be established it means that the average price of goods can’t be established either. Consequently, the entire equation of exchange falls apart. In short, conceptually the whole thing is not a tenable proposition and covering a fallacy in mathematical clothing cannot make it less fallacious.
According to Rothbard (Man Economy and State p 730)
The only knowledge we can have of the determinants of price is the knowledge deduced logically from the axioms of praxeology. Mathematics can at best only translate our previous knowledge into relatively unintelligible form.
Even if we were to accept that the essential service of money is its speed of circulation there is no way that this characteristic of money could explain the purchasing power of money. On this Mises explains (Human Action p 400);
Even if this were true, it would still be faulty to explain the purchasing power–the price–of the monetary unit on the basis of its services. The services rendered by water, whisky, and coffee do not explain the prices paid for these things. What they explain is only why people, as far as they recognize these services, under certain further conditions demand definite quantities of these things. It is always demand that influences the price structure, not the objective value in use
Velocity does not have an independent existence
Contrary to mainstream economics velocity has not got a “life of its own”. It is not an independent entity – it is always value of transactions P*T divided into money M ie P*T/M. On this Rothbard wrote (Man Economy and State p 735)
But it is absurd to dignify any quantity with a place in an equation unless it can be defined independently of the other terms in the equation.
Since V is P*T/M it follows that the equation of exchange is reduced to
M*(P*T)/M = P*T, which is reduced to P*T = P*T , and this is not a very interesting truism. It is like stating that $10=$10 and this tautology conveys no new knowledge of economic facts.
Should we then be alarmed with growing money supply despite the fact that the so called velocity of money is falling? Does the fall in the velocity of money imply that no damage to the economy will occur?
What matters right now is the fact that money is growing at an alarming rate which sets in motion an exchange of nothing for something and hence economic impoverishment and consequent boom-bust cycles. Furthermore, since velocity is not an independent entity it as such causes nothing and hence cannot offset effects from money supply growth.
Finally, does so-called unstable velocity imply an unstable demand for money as the popular thinking has it? The idea of labelling the demand for money as stable or unstable is preposterous. What does it mean? The fact that people change their demand for money doesn’t imply some kind instability. As a result of changes in an individuals goals he may decide that at present it is to his benefit to hold less money. Some time in the future he might decide that raising his demand for money would better serve his goals. So what could possibly be wrong with this? It is simply the same that goes for any other goods and services – demand for them changes all the time.
Conclusions
The recent strong increases in money supply raise the likelihood of acceleration in the rate of growth of prices of goods and services in the months ahead. The effect of these increases cannot be neutralised by the fact that the so-called velocity of money is declining. Contrary to popular thinking the velocity of money doesn’t have a life of its own. It is not an independent entity and hence it can’t cause anything, let alone offset the effect of an explosion in the supply of money on prices of goods and services. The apparent simplicity of the equation of exchange and its consequent widespread acceptance by mainstream economists has been instrumental in the erroneous assessments of the true state of the economy. Hence it is an urgent requirement that this fallacy be removed from the economic literature and from economic textbooks in order to prevent future theoretical confusions and their practical consequences.
By Toby Baxendale, on 30 December 10
Walter Bagehot’s 1865 obituary of Richard Cobden, from the Online Library of Liberty
(H/T Sean Corrigan).
Twenty-three years ago—and it is very strange that it should be so many years—when Mr. Cobden first began to hold Free-trade meetings in the agricultural districts, people there were much confused. They could not believe the Mr. Cobden they saw to be the “Mr. Cobden that was in the papers”. They expected a burly demagogue from the North, ignorant of rural matters, absorbed in manufacturing ideas, appealing to class-prejudices—hostile and exciting hostility. They saw “a sensitive and almost slender man, of shrinking nerve, full of rural ideas, who proclaimed himself the son of a farmer, who understood and could state the facts of agricultural life far better than most agriculturists, who was most anxious to convince every one of what he thought the truth, and who was almost more anxious not to offend any one”. The tradition is dying out, but Mr. Cobden acquired, even in those days of Free-trade agitation, a sort of agricultural popularity. He excited a personal interest, he left what may be called a sense of himself among his professed enemies. They were surprised at finding that he was not what they thought; they were charmed to find that he was not what they expected; they were fascinated to find what he was. The same feeling has been evident at his sudden death—a death at least which was to the mass of occupied men sudden. Over political Belgravia—the last part of English society Mr. Cobden ever cultivated—there was a sadness. Every one felt that England had lost an individuality which it could never have again, which was of the highest value, which was in its own kind altogether unequalled.
What used to strike the agricultural mind, as different from what they fancied, and most opposite to a Northern agitator, was a sort of playfulness. They could hardly believe that the lurking smile, the perfectly magical humour which they were so much struck by, could be that of a “Manchester man”. Mr. Cobden used to say, “I have as much right as any man to call myself the representative of the tenant farmer, for I am a farmer’s son,—I am the son of a Sussex farmer”. But agriculturists keenly felt that this was not the explanation of the man they saw. Perhaps they could not have thoroughly explained, but they perfectly knew that they were hearing a man of singular and most peculiar genius, fitted as if by “natural selection” for the work he had to do, and not wasting a word on any other work or anything else, least of all upon himself.
Mr. Cobden was very anomalous in two respects. He was a sensitive agitator. Generally, an agitator is a rough man of the O’Connell type, who says anything himself, and lets others say anything. You “peg into me and I will peg into you, and let us see which will win,” is his motto. But Mr. Cobden’s habit and feeling were utterly different. He never spoke ill of any one. He arraigned principles, but not persons. We fearlessly say that after a career of agitation of thirty years, not one single individual has—we do not say a valid charge, but a producible charge—a charge which he would wish to bring forward against Mr. Cobden. You cannot find the man who says, “Mr. Cobden said this of me, and it was not true”. This may seem trivial praise, and on paper it looks easy. But to those who know the great temptations of actual life it means very much. How would any other great agitator, O’Connell or Hunt or Cobbett look, if tried by such a test? Very rarely, if even ever in history, has a man achieved so much by his words—been victor in what was thought at the time to be a class-struggle—and yet spoken so little evil as Mr. Cobden. There is hardly a word to be found, perhaps, even now, which the recording angel would wish to blot out. We may on other grounds object to an agitator who lacerates no one, but no watchful man of the world will deny that such an agitator has vanquished one of life’s most imperious and difficult temptations.
Perhaps some of our readers may remember as vividly as we do a curious instance of Mr. Cobden’s sensitiveness. He said at Drury Lane Theatre, in tones of feeling, almost of passion, curiously contrasting with the ordinary coolness of his nature, “I could not serve with Sir Robert Peel”. After more than twenty years, the curiously thrilling tones of that phrase still live in our ears. Mr. Cobden alluded to the charge which Sir Robert Peel had made, or half made, that the Anti-Corn-Law League and Mr. Cobden had, by their action and agitation, conduced to the actual assassination of Mr. Drummond, his secretary, and the intended assassination of himself—Sir Robert Peel. No excuse or palliation could be made for such an assertion except the most important one, that Peel’s nerves were as susceptible and sensitive as Mr. Cobden’s. But the profound feeling with which Mr. Cobden spoke of it is certain. He felt it as a man feels an unjust calumny, an unfounded stain on his honour.
Mr. Disraeli said on Monday night (and he has made many extraordinary assertions, but this is about the queerest), “Mr. Cobden had a profound reverence for tradition”. If there is any single quality which Mr. Cobden had not, it was traditional reverence. But probably Mr. Disraeli meant what was most true, that Mr. Cobden had a delicate dislike of offending other men’s opinions. He dealt with them tenderly. He did not like to have his own creed coarsely attacked, and he did—he could not help doing—as he would be done by; he never attacked any man’s creed coarsely or roughly, or in any way except by what he in his best conscience thought the fairest and justest argument. This sensitive nature is one marked peculiarity in Mr. Cobden’s career as an agitator, and another is, that he was an agitator for men of business.
Generally speaking, occupied men charged with the responsibilities and laden with the labour of grave affairs are jealous of agitation. They know how much may be said against any one who is responsible for anything. They know how unanswerable such charges nearly always are, and how false they easily may be. A capitalist can hardly help thinking, “Suppose a man was to make a speech against my mode of conducting my own business, how much would he have to say!” Now it is an exact description of Mr. Cobden, that by the personal magic of a single-minded practicability he made men of business abandon this objection. He made them rather like the new form of agitation. He made them say, “How business-like, how wise, just what it would have been right to do”.
Mr. Cobden of course was not the discoverer of the Free-trade principle. He did not first find out that the Corn-laws were bad laws. But he was the most effectual of those who discovered how the Corn-laws were to be repealed, how Free-trade was to change from a doctrine of The Wealth of Nations into a principle of tariffs and a fact of real life. If a thing was right, to Mr. Cobden’s mind it ought to be done; and as Adam Smith’s doctrines were admitted on theory, he could not believe that they ought to lie idle, that they ought to be “bedridden in the dormitory of the understanding”.
Lord Houghton once said, “In my time political economy books used to begin, ‘Suppose a man on an island’ ”. Mr. Cobden’s speeches never began so. He was altogether a man of business speaking to men of business. Some of us may remember the almost arch smile with which he said “the House of Commons does not seem quite to understand the difference between a cotton mill and a print work”. It was almost amusing to him to think that the first assembly of the first mercantile nation could be, as they were and are, very dim in their notions of the most material divisions of their largest industry. It was this evident and first-hand familiarity with real facts and actual life which enabled Mr. Cobden to inspire a curiously diffused confidence in all matter-of-fact men. He diffused a kind of “economic faith”. People in those days had only to say, “Mr. Cobden said so,” and other people went and “believed it”.
Mr. Cobden had nothing classical in the received sense about his oratory; but it is quite certain that Aristotle, the greatest teacher of the classical art of rhetoric, would very keenly have appreciated his oratory. This sort of economic faith is exactly what he would most have valued, what he most prescribed. He said: “A speaker should convince his audience that he was a likely person to know”. This was exactly what Mr. Cobden did. And the matter-of-fact philosopher would have much liked Mr. Cobden’s habit of “coming to the point”. It would have been thoroughly agreeable to his positive mind to see so much of clear, obvious argument. He would not, indeed, have been able to conceive a “League Meeting”. There has never, perhaps, been another time in the history of the world when excited masses of men and women hung on the words of one talking political economy. The excitement of these meetings was keener than any political excitement of the last twenty years, keener infinitely than any which there is now. It may be said, and truly, that the interest of the subject was Mr. Cobden’s felicity, not his mind, but it may be said with equal truth that the excitement was much greater when he was speaking than when any one else was speaking. By a kind of keenness of nerve, he said the exact word most fitted to touch, not the bare abstract understanding, but the quick individual perceptions of his hearers.
We do not wish to make this article a mere panegyric Mr. Cobden was far too manly to like such folly. His mind was very peculiar, and like all peculiar minds had its sharp limits. He had what we may call a supplementary understanding, that is, a bold, original intellect, acting on a special experience, and striking out views and principles not known to or neglected by ordinary men. He did not possess the traditional education of his country, and did not understand it. The solid heritage of transmitted knowledge has more value, we believe, than he would have accorded to it. There was too a defect in business faculty not identical, but perhaps not altogether without analogy. The late Mr. James Wilson used to say, “Cobden’s administrative power I do not think much of, but he is most valuable in counsel, always original, always shrewd, and not at all extreme”. He was not altogether equal to meaner men in some beaten tracks and pathways of life, though he was far their superior in all matters requiring an original stress of speculation, an innate energy of thought.
It may be said, and truly said, that he has been cut off before his time. A youth and manhood so spent as his, well deserved a green old age. But so it was not to be. He has left us, quite independently of his positive works, of the repeal of the Corn-laws, of the French treaty, a rare gift—the gift of a unique character. There has been nothing before Richard Cobden like him in English history, and perhaps there will not be anything like him. And his character is of the simple, emphatic, picturesque sort which most easily, when opportunities are given as they were to him, goes down to posterity. May posterity learn from him! Only last week we hoped to have learned something ourselves:—
- “But what is before us we know not,
- And we know not what shall succeed”.
The day after Cobden’s death.
Matthew Arnold, “The Future”.
By Sean Corrigan, on 29 December 10
The more financial history one reads, the more powerful the sense of deja vu becomes and also the greater grows the appreciation of the wisdom of those who went before us as commentators and analysts. Truly, in political economy we do not ‘stand on the shoulders of giants’ like Newton claimed to do in the hard sciences, but rather we allow each new generation of intellectual pygmies to perpetrate the same old errors over and over again.
Here is just such an instance of an exposition whose clarity – and whose relevance – stands undimmed by the passage of the more than 150 years since it was written by the financial editor of the London Times.
As a note of interest, though some of us bemoan – as did many of Sampson’s contemporaries – the phony government privilege of limited liability, especially when afforded to fractional reserve bankers, he asserted the converse: seeing its continued, selective prohibition as exactly that same kind of deplorable, arbitrary, state intervention in men’s private dealings. In supporting its extension to banks (as it had recently been to non-financial companies), Sampson viewed it, not as we do, as a vehicle for the unscrupulous, managerial exploitation of executive office (peculation, we might say), but as a false lure for interest-hungry depositors and creditors who could rely upon access to the full estate of the unlimited shareholders to make good any erroneous use to which their funds had been put, much in the same way that we today decry deposit liability and the latest, ad hoc protection of bondholders using taxpayers’ money.
There is nothing more easy than the Currency question. In a recent debate in Parliament, Mr. Gladstone declared that it has made more lunatics than love. As far, however, as the majority of the public are concerned, its perplexities are occasioned solely by distrust of their own plain sense. Instead of asking themselves what it is they consider to be Currency, and would take as such on all occasions, they consult a multitude of discordant writings; and because they find each more or less incomprehensible, and at variance with all the others, they fancy there must be something in the matter scarcely to be grasped by the highest exercise of reason. In this way they come to distrust such intuitive perceptions as would present themselves to any one to whom the subject might be broached for the first time, and are afraid to suggest the truth in its simplicity, lest they should find they have exhibited ignorance, and provoked the scorn of philosophers.
Those who hope to find any abstruse propositions in the following chapters will be disappointed. Their only object is to enforce the facts which have been known ever since the world began, that when men enter into mutual contracts, no means can ever be invented honestly to alter the nature of such contracts, at the pleasure of one party, and without the consent of the other; and that if a man parts with a commodity called wheat, coal, cotton, or anything else, for the commodity called money, he is entitled to have the agreement fulfilled in the precise terms in which it was made.
A nation can select any commodity it chooses to adopt as money or currency. Some have decided upon silver, and others upon less convenient materials. In our case it has been fixed, that when a person promises to pay a certain amount of money, he shall be held to have meant simply a definite weight of gold. If a man buys 3 bushels of wheat for a pound, to be paid two months hence, the contract might be simply put into these words :—” I take from you 3 bushels of wheat, and promise in sixty days to hand you 113 grains of fine gold.” The principle is just the same as if he were to agree to deliver 10 yards of cloth in exchange for a watch. Each would be a case of barter, but all men find it more convenient to barter gold than anything else.
What would be thought, however, if any set of persons were to rise up in Parliament or elsewhere to proclaim the doctrine that an individual who had entered into a legal contract to deliver 10 yards of cloth, in exchange for a watch, should be allowed, when the time for carrying out the contract came, to deliver something else that might be more easily procurable ? That if cloth, for instance, had become scarce, and leather cheap, he might hand over a pair of boots; or that, if this seemed too outrageous, he might give his own promise, or the promise of some other parties to deliver the cloth at a future day ? “Would the proposition seem so difficult of comprehension that the whole Legislature would discuss it night after night, to determine if it were consistent with the principles of justice, and such as ought to be entertained ? Would the public buy pamphlets on the question, and go mad in the hopeless endeavour to avoid its fascinations, or understand its real merits ?
Yet this is the sole point involved in the great Currency controversy. Men who have engaged to deliver a certain number of pounds sterling,—that is to say, a certain number of grams or ounces of gold, and who have used and enjoyed the goods for which they have agreed to give this gold in barter, are always clamouring, when the hour arrives for the fulfilment of their part of the contract, that some method should be adopted by the Government either to increase the supply of gold, or to allow them to substitute for the promised amount a written note engaging to pay it at some future time. In great crises, the public are divided into two parties, that may be represented by the clothier and watchmaker just referred to. The portion that stand in the place of the watchmaker say to the other portion, we have delivered to you one hundred watches, now hand to us one thousand yards of cloth. The indebted portion repel the demand, by the cry that they are under terrible pressure; that when they promised to deliver the cloth, it was cheap, and they thought the profit of the bargain was to be all on their side; that there has since been a sudden rise in its value; that those who, under such circumstances, would require them to meet their obligations, must be cold-blooded extortioners; that although they could get the cloth well enough in the open market, by consenting to some sacrifices, or by the exercise of their credit, if they had any, they will neither make sacrifices, nor employ their credit, nor honestly admit that, being without sufficient property or credit, they have made engagements which they had no certainty of being able to fulfil, and must submit to the usual course provided for such cases.
They insist that Government should come to their aid;—that is to say, that the body constituted for the sole purpose of maintaining equal justice between the two parties, should step in to the rescue of one against the other. The Minister consents, and declares that he will allow notes to be issued in the name of the Government, promising to deliver the cloth upon application, while he knows he has no means of doing so, except by taking it from a store set apart for another body of persons who also hold similar notes, and that if by chance they were to come upon him at the same time, he would be obliged to avow that their cloth had been made away with—and this for the sake of cheapening the market, for the “relief” of those who had to deliver cloth, and the loss of those who were to receive it.
To expose the character of such movements, to defend the rigid enforcement of contracts, and to point out the demoralizing effect of the doctrine, that the State may sometimes with advantage sanction the violation not only of the statute law, but also of the natural law that regulates the general course of trade, is [my] sole purport…
[Other]… observations will be found on the laws which regulate the formation of Joint-Stock Banks ; and here again the point contended for is simply the old one, of the right of all men to make such contracts as may seem proper in their own judgment, always provided that such contracts involve no violation of the rights of others. Both on this and the Currency question, the grand dogma involved is the propriety of an adherence to principles or fundamental truths at all costs; and although in the debate on the introduction of the Bank Indemnity Bill, it was remarked by one member, that he hoped the Government of the country would never fall into the hands of any individual hardy enough, in the latter case, to carry them out; and by another, that no minister should be ” so infatuated in favour of an abstract principle, sound enough in itself, as to refuse to incur the responsibility of relaxing it,” the belief may still be entertained that in this, as in every other case in which a similar battle has been fought, consistency against expediency will ultimately prevail.
M. B. Sampson – ‘The Currency under the Act of 1844’
London, 1858
By Toby Baxendale, on 29 December 10
Dalibor Roháč of the Legatum Institute and Matthew Sinclair of the Taxpayers’ Alliance have jointly authored a report on the risks of new global financial regulations:
Around the world politicians and officials are advancing major new regulations of the financial services industry. Those regulations are a response to a major financial crisis, but real care needs to be taken to ensure that they help avoid future crises, and won’t precipitate or exacerbate crises instead.
…
- The increased internationalisation of financial regulation risks amplifying future global booms and busts. Global regulations lead to global crises as organisations are encouraged to hold similar assets and respond in similar ways when things go wrong. As a result, the new regulation could increase the systemic risk to the world economy.
- Attempts to focus regulation on the institutions that contribute the most to systemic risk carry their own risks. If institutions understand that they are seen as “too big to fail” then that will encourage excessive risk taking.
- Despite attempts to address the issue, the Basel regulations may still be procyclical, imposing more onerous requirements on institutions at times when the system is in trouble.
- Some measures proposed, like attacks on tax havens and hedge funds, are motivated by other agendas and do not actually address the problems that led to the financial crisis.
- There is an important debate over whether or not effective “macro-prudential” regulatory policy is possible. However, the policies introduced since the financial crisis do not live up to that standard. Some of the measures announced are disingenuous political posturing while others continue existing mistakes partly responsible for the problems we are facing today. It is entirely possible that the new regulations being implemented could hurt established financial centres like the City of London while increasing the frequency and strength of global financial crises.
Download the full report (PDF).
The Taxpayers’ Alliance announcement is here:
By David Howden, on 28 December 10
From where did Europe’s recession come? To listen to some commentators one would think that it came from nowhere. Indeed, the idea that a contagion is engulfing Europe – that one insolvent member state could cause innocent bystanders to fall – is so pervasive that its mere mention seems redundant. It is unfortunate that such a belief is prevalent as it ignores not only common usage of the English language, but also some very simple and relevant economic facts.
Like many economic phenomena, the important aspect is not what is seen and readily apparent. As Frédéric Bastiat was able to so cogently stress over 160 years ago, the crucial role for the economist is to discern the unseen economic effects.
While it is all too easy to focus on European member states’ burgeoning public debts, widening credit default spreads, dwindling tax bases and climbing ranks of dissatisfied unemployed citizens, the hidden causes are what are needed to be assessed to correctly foresee a prosperous future. While it is increasingly becoming accepted that European governments spent more money than they had, and that the ECB held interest rates too low for far too long, the specific reasons why these events manifested remain largely shrouded in mystery.
Philipp Bagus has just written the first coherent book explaining the origins, functions and consequences of the European Central Bank. An understanding of how this institution functions is essential to anyone – from the general population to the pundit to the politician – to grasp how a seemingly beneficial institution could reap such detriment.
In particular, I would like to focus on two of the most important consequences of the formation of the common currency area.
First, let us turn our attention to the now well-recognized fact that the ECB held interest rates too low for too long. Accession to the Eurozone meant that a member state would become subordinate to a common interest rate policy set in Frankfurt. While one base nominal interest rate pervaded throughout Europe, divergent inflation rates quickly created distinct real rates. In the high inflation periphery countries – the PIIGS of today – real interest rates dropped to levels lower than most of their citizens had ever witnessed. The result was an expansion in interest-rate sensitive projects. Investment in housing, for example, flourished.
The Spanish economy illustrates the worst of these excesses. In 2006 Spaniards constructed over 700,000 new homes – more than Germany, France and the United Kingdom combined could tally. That 2006 was also the midst of a housing boom in the United Kingdom should more than allude to the severity of this problem. Today more than 1 million Spanish housing units stand empty – more than the whole of the United States.
This common interest rate policy was heralded throughout the 2000s as allowing the periphery countries access to cheap credit markets. This would allow, in turn, for quick and easy development of infrastructure to enable their rise to power. If a housing bubble qualifies as a positive buildup of infrastructure, mission accomplished.
Next let us turn our attention to the common exchange rate imposed throughout the Eurozone as a consequence of the shared currency. During the convergence to the common currency throughout the 1990s the member states of the future Eurozone saw their respective currencies more or less equalize in value. In retrospect the situation was like two sides of the same coin. In Northern Europe, especially Germany (but also Netherlands, Austria and to a lesser extent, Belgium) the once powerful Deutschmark declined in value to meet the future euro’s shared value. In contrast, along the Eurozone’s periphery a sharp increase in currency values coincided with the eventual appearance of the euro. As the common currency replaced the individual member states’ currencies a single foreign exchange rate was imposed throughout the whole of the monetary union.
The consequences are all too painfully obvious today. Italians, Spaniards and Greeks – countries and people accustomed to less valuable currency units – were able to buy foreign goods at much lower prices than was possible just a short period earlier. A spending boom developed which saw the demand for imports grow at a fevered pitch.
At the same time the uncompetitiveness of producers in these countries against foreigners was becoming apparent. Indeed, as Bagus explains on page 43 of his book, unit labor costs of the PIIGS countries soared anywhere from 10 to 35 percent over the decade from 1999 to 2009. The consequence was a drastic decrease in exports coupled with an increasing demand for cheap imports. Severe trade imbalances developed, as savings from these periphery countries flooded overseas markets in exchange for cheap goods.
Not surprisingly, the situation was the opposite in the economically stronger Northern European countries. German unit labor costs declined about 10 percent from 1999 to 2009, largely because of its newly devalued currency shared with its Southern European neighbors. The large trade surplus that Germany enjoys today and which is largely viewed as a positive glimmer of light from the otherwise dismal continent is caused by the same phenomenon that plagues the peripheral countries: a shared currency with a shared foreign exchange rate, the value of which is the average of the implicit currencies of its component countries. Unfortunately, very few individual data points comprise an average. A consequence in the Eurozone is that no one country has a currency valued at a sustainable level.
Europe’s unsustainable state of affairs did not come into existence from nothing. Nor is the current threat of “contagion” founded on any application of the real phenomenon. The same malady affects all Eurozone economies the same as every other one. More striking is that this disease has continued unnoticed for over a decade… until now.
The effects of the common currency are now apparent. While knowledge of how a car’s engine is of secondary importance when it is in good repair, as soon as it breaks down such knowledge is essential to make it roadworthy again. The Eurozone is an analogous case. Understanding how the euro functions, and how regional politics play a role in forming the common monetary policy is essential to understanding where the current recession came from and how we will get out of it.
Philipp Bagus’ new book “The Tragedy of the Euro” is essential reading to everyone who wants to gain a better understanding of both these points.
By Prof Peter J. Boettke, on 28 December 10
As previously blogged at Coordination Problem…
Russ Roberts interviewed me on EconTalk about the life, work and continuing relevance of Ludwig von Mises. I just hope I did justice to the great work of Mises and his heroic life, and thank Russ for the opportunity.
The interview is here (MP3, 1:15:31).
By Robert Sadler, on 26 December 10
It has been impossible not to notice the widespread student protests over the past couple of months against the government plans to raise tuition fees. News reports have fluctuated between scenes of peaceful protest and more frequently, of scenes of chaotic violence, street brawls and vandalism. Clearly if a point is worth being made, it is worth being made aggressively.
To more mature eyes these protests can appear to be nothing more than an almighty temper tantrum. After all the justifications for the protests seem somewhat incoherent, ranging from refrains of “it’s not fair” that students should have to pay because the bankers created a crisis or “it’s not fair” since their parents attended university for “free”. “It’s not fair” is the refrain of many a child when a parent refuses them “sweeties” or a stuffed toy for reasons known only to the “mean” parent. As a child is dependent on its parents for its day to day living, many in this country have become dependent on the State for food, shelter and education.
Doubtless it has occurred to very few prospective students that perhaps paying for your own education, of which you will likely be the main and possibly exclusive beneficiary, is perhaps quite reasonable. Certainly, in other countries — notably the USA — this is perfectly normal.
Interestingly enough, the debate appears to have taken place within a certain vacuum, in which certain questions have not been asked and have certainly not been answered. The first question to ask is why students should not pay for their own education?” The second, and more important question is whether the Government afford to pay anything at all towards education, university or otherwise?
The answer to the first question is intertwined with questions of fairness and entitlement. In the UK over the past say, sixty years, we have been brought up to believe that we should all compete on a level playing field. We are entitled to a free education, free healthcare, guaranteed employment or unemployment benefit when we are out of work. We have a right to housing and a free pension when we retire. There are countless other “rights” and “benefits” that we should have by virtue of being alive. Not only are we entitled to a psychologically rewarding job but we are entitled to a fair wage.
It is fair to say (no pun intended) that the State has created an entitlement society where citizens without question assume these rights are self-evident and that they will continue indefinitely. The mere notion that these rights are unsustainable is inconceivable to the citizens. The idea that a student should pay for his own education is therefore too preposterous a question to pose.
At every turn the State has convinced the citizenry that these rights can be provided at will and continuously. The dogma we are taught at school or fed to us through the media keeps us convinced. Everything in society should be “fair”. Unfortunately, the State’s own insistence that it can and should provide these benefits has provided the foundation for the massive protests we have seen and worse protests to come. The State has studiously avoided explaining to its citizens the economics behind the benefits it offers. To ask the average person the question of how these benefits are are to be paid for, it is as if one were speaking a foreign language. Most people have a vague notion that taxes will somehow cover it. They are aware that there is something called a “deficit” and something else called a “debt” but have little clue as to what these concepts have to do with them. For some time, it has been to the advantage of the State to promote this kind of ignorance. But now, the money is running out. The benefits need to be cut. And unfortunately the children do not understand.
This feeds naturally into the next question: can the British Government afford to pay for its citizen’s university education?
Britain currently has a budget deficit of approximately £149bn and official gross debt of £1.1 trillion (tn) – according to the Maastricht definition – forecast for 2010 to 2011. Interest payments on this debt are forecast to be £44bn. If we hold the budget deficit constant for the foreseeable future it is plain to see that the debt will increase by £149bn each year. This in turn means that interest payments will increase each year. Looking at this simplistically, drawn to its logical conclusion, this means that the interest payments will eventually crowd out the rest of the budget leaving no money for students, single mothers, the police or anyone else. We would all be paying taxes just to pay the debt.
Most likely the Government would default a long time before reaching this point. Therefore, it is important to gauge how close Britain is to bankruptcy. Current GDP is just over £1.4tn. We will leave aside the theoretical issues with GDP and for now assume it is a good proxy for the national income of Britain. In this case we have a debt to GDP percentage of 79%. The last time it was so high was during the mid-sixties when Britain was still recovering from an astonishing post wartime high (late 1940s) debt of over 230% GDP. The average debt to GDP percentage over the past 20 years was 40%. Total government expenditure for 2010-11 is forecast to be £697bn (50% of GDP). Receipts forecast for 2010-11 are £638bn.
It might be objected that historically speaking the current debt figure is not disastrous since Britain survived the post-war debt. However, while Britain survived the post-war debt crisis the British Empire did not. As one colony and then another departed the ever diminishing Empire, ultimately Britain lost its “Great Power” status and was replaced by the United States in many of the regions that Britain previously dominated. Furthermore, because Britain was virtually bankrupt after the Second World War, it was forced to accept the onerous Anglo-American Loan Agreement from the only friendly “World Power”, the United States. Britain endured decades of economic depression and turmoil, suffering the loss of its manufacturing base and becoming known as “the sick man of Europe”. Britain only really began to recover in the mid-Eighties. It is fair to say, this is not a time we want to revisit.
According to the Government’s recent spending review (November 2010) the recent spending cuts will result in total spending cuts of £81bn by 2015. This implies that the country’s debt will rise to 93% of current GDP by 2015 and interest payments will rise to £63bn per year (the third largest line item on the Government’s budget and larger than the entire education budget). If no cuts are made then Government debt could rise as high as 121% of current GDP with interest payments greater than £78bn. If the cost of servicing the debt rises above 13% of government revenues the country will have its credit rating downgraded (a definite prospect in the latter case). This in turn leads to higher interest payments, greater difficulty in securing debt financing and increases the probability of cash-flow insolvency.
None of this considers the upward pressure on expenditures caused by the rising pension liability (contributing to a total on-balance sheet and off-balance sheet gross national debt of £6.5tn). So while GDP may or may not increase over the next five years, expenditure certainly will increase.
As we can see, Britain is teetering on a knife-edge. Another crisis such as the recent banking crisis (and it has not finished yet) could push Britain over the edge into bankruptcy and a repeat of the misery of the early post-war years. Britain cannot afford to pay for student university fees or much else at the moment. Clearly, the relatively conservative spending cuts will still result in a dangerous increase in debt and interest payments. Without these cuts being made today, harsher and more drastic cuts will be made in the future. The welfare state has had its day and it is crumbling.
Prospective university students are a fairly small and powerless group which is probably why they were among those targeted for these relatively minor cuts. Given the considerable amount of disruption this small group has caused after being asked to contribute more for their subsidised education, it is disturbing to contemplate the public disorder that would likely erupt should more drastic cuts occur down the road. It is not fair that the students should pay for university when their parents attended for free. Likewise it is not fair that people who do not attend university should subsidise those that do. More importantly, it is not fair that any of us living today should contribute to the future bankruptcy of this country and the squandered opportunities of our descendants.
The only moral and fair solution is a continuous and sustained reduction of the size of government in Britain. This will result in an increase in the prosperity of everyone living in this country and will make Britain a shining example of free-market economics to the rest of the world.
By Robert Sadler, on 24 December 10
Eric Cantona, the former professional football player, recently called for a “bloodless revolution” against the banks. The idea, according to Cantona, is that people should, en masse, withdraw all of their money from the banks, causing a general banking collapse, ensuring the end of the current system and hopefully, a better tomorrow.
The attempt predictably failed but as a result of his suggestion, Cantona was heavily criticised by various bankers, politicians and journalists for his irresponsibility. Cantona was told to stick to football and leave economics to the “experts”. His proposal was suicidal and would lead to ordinary people losing their money were it successful.
Perhaps the fairest criticism of Cantona’s suggestion would centre on whether or not it would achieve the aims it appears to represent. Cantona’s objective of bringing down the system was crystallised within the context of a popular protest in France in October of this year, against government plans to raise the retirement age from 60 to 62. Clearly, if “the system” was brought down there would be no government pension for anyone.
The issue for the pension system in France is similar to that in the UK. As indicated in a recent IEA report the pension liabilities of the UK government are now so large it is impossible that they will ever be able to honour all of the payments. What will happen is that the UK will default on these obligations. The retirement age will continue to rise until it is unlikely that anyone will live long enough to draw a significant pension. It is instructive to note that when Bismarck created the national pension in 1889 he set the retirement age 20 years beyond the average life expectancy existing at that time in Germany. Either something similar will happen in the UK or these pension liabilities combined with the other debts of the UK government (now estimated to be £6.5 trillion) along with the persistent budget deficit, will precipitate a complete financial collapse of the government.
The primary criticism directed at Cantona is that a general banking collapse would cause more harm than good, that we need banks as much as they need us. If banks go down we all go down with them. This is the same rationale for the various banking bail-outs.
Apparently, without these banks economic growth will be sluggish and life would be more difficult (without electronic cash, banks to give us mortgages etc.). We would have no online purchases, no credit cards, and would be forced to keep a pile of cash in the house.
The truth of this is apparently self-evident and I have heard many an intelligent and educated person make many similar comments. Of course it takes very little thought to conceive of alternatives to the present system and indeed, these alternatives do exist. Depositary institutions that keep 100% reserves are available, non-bank lending marketplaces are popping up all over the Internet and you can buy cash-cards that allow you to transact online or wherever else you like. I would venture to say that banks in their current form are rapidly becoming obsolete.
However, in amongst the criticisms, as we would expect crucial questions are left out. None of these experts asks why our banking system is so fragile that provocative comments from an eccentric French footballer can create such consternation. After all, Cantona has merely pointed out an obvious flaw in the banking system which has continuously led to bank failures. The most crucial question to ask is why we have such a dangerous system that not only is so fragile that it tremors at the merest criticism but if we do not reach into our pockets to bail it out it will drag us all down into financial oblivion.
Why indeed do we have a banking system the existence of which is heavily dependent on the confidence that people have in it?
The answer of course, is that powerful interests in Western societies depend on this system as a surreptitious method to extract wealth from the population at large. Banks earn significant profits from fractional reserve banking but even more importantly, they provide a cheap source of funds for Western governments. These governments have a tremendous interest in protecting fractional reserve banks and allowing them to operate their confidence game. In fact, one could argue that governments could not exist in their current form without the fractional reserve banking system. And arguably, fractional reserve banks could not exist as they do today, without the government. So while publicly disparaging banks for their reckless lending, at the same time governments are taxing future generations in order to save their brothers in arms at the banks.
Of course, now it appears that the European governments cannot find a bucket big enough to bail out the sinking ship. Germany’s appetite for bailing out other countries banks appears to be sated amid concerns that these continual bail-outs threaten Germany’s financial stability. Thus it appears that the process of bailing out banks may drag us all down the sinkhole anyway.
It is possible that the reality of the situation is beginning to dawn on Western governments. Fractional reserve banking is unsustainable in the long run. And Keynesians are possibly, just possibly, beginning to realise we are all still alive in the long run. There is only so much (real) money and eventually we will run out if we continue to consume our capital – capital consumption being a key effect of fractional reserve banking – in this case by having European governments overtly divert resources from wealth generators (i.e. productive individuals) to failing and unproductive fractional reserve banks.
There is nothing new in stating this. But the important take away here is that people at large are beginning to realise how fragile the banking system is. Cantona’s interview is a YouTube hit and there are plenty of people who are angry at the banks or who have realised that banks are not safe places to keep your savings.
The idea that fractional reserve banking is fraudulent and risky is beginning to take hold. It is at its early stages yet but this idea will spread. It has been said before that ideas, especially ideas that are compelling in their simple truth, can spread like viruses and become impossible to stop. This is how regimes can appear to collapse almost overnight (such as the Soviet Union). Nobody accepts the old idea anymore and it is replaced with a new one.
There is however, no need to name a date for everyone to yank their savings out of the system. Unfortunately, at the moment most people would not know where to put their cash (if they have any) afterwards. However, as the knowledge eventually spreads, savings will transfer from fractional reserve banks to either 100% reserve institutions or be invested in transparent lending marketplaces at rates far higher than what one can earn in a savings account. There is no need for a con-man acting as middleman.
The collapse of fractional reserve banking is inevitable and it will be the market process that causes this collapse, no matter how governments or bankers fight to preserve it. It is only a matter of time and as Cantona suggests it is unlikely blood will need to be spilt. Reality has a way of making itself known sometimes brutally and abruptly, and other times more gradually. It remains to be seen how swiftly the process of monetary revolution occurs.
By David Howden, on 23 December 10
As Europe continues bailing out its troubled economies, a subtle point is sidestepped. Providing additional doses of liquidity has brought short-term relief to some of the most troubled countries. Greece’s €110bn bailout earlier this year allowed it to save its burgeoning government payroll from starving. Ireland’s drawing on the €750bn. European bailout fund to the tune of €85bn. has saved some privileged banks. The next country to get bailed out will likely also see its troubles sidestepped for another day.
But the problem that no one wants to answer relates to what type of crisis this really is. Providing additional injections of liquidity may be a good Band-Aid solution if we are faced with a liquidity crisis. By expanding its balance sheet over the last two years, the European Central Bank has provided ample liquidity to keep its Eurozone banking institutions from failing. And if the ECB’s liquidity facilities weren’t enough, America’s Federal Reserve has been on hand to make U.S. dollar funding available at request. Tuesday’s extension of its U.S. dollar liquidity swaps reinforced the Fed’s commitment to maintaining a European banking system awash in credit.
Yet in continually ratcheting up the provision of liquidity, the ECB and the Fed have been battling yesteryear’s fight. Today’s crisis is fundamentally not of liquidity. It is one of solvency.
For a decade European governments spent beyond their means. Indeed, the ECB was one of the prime culprits allowing the newly formed Eurozone to pursue such prolific sovereign deficit spending. By allowing government debt to be used as collateral for its refinancing operations, the ECB ensured that Eurozone governments, especially Southern Eurozone governments, had access to cheap credit. With artificially reduced interest rates on their sovereign debt, Europe’s PIIGS economies were able to partake on a spending binge, with little heed for the coming liquidity crunch. The ECB, after all, had its hand on the lever to keep the liquidity coming.
Implicitly the ECB has treated the whole of the last decade as a liquidity crisis. Instead of functioning in its traditional role of lender of last resort, the ECB became a lender of first resort.
Today the use of liquidity has already largely been exhausted. The prolific spending of the past has created a solvency crisis. The governments of the Eurozone, aided by the excessive liquidity provided by the ECB during the last decade, have partaken on spending paths far overreaching any semblance of sustainability. An imbalance created in the past is now becoming apparent as these countries’ past debts come due.
In fact, the today’s recession is at its core not the result of “tight credit conditions”, “debt contagions”, or any other frivolous explanation. At its core we are faced with the realization that the previous fiscal state of affairs was unsustainable. By the time entrepreneurs realized that we were living in an unsustainable situation, it was already too late.
Of course, once you realize that the crisis is one of insolvencies the question that must be raised is what the best course of action is to get these insolvent situations solvent again. If we were indeed in the midst of a liquidity crisis, keeping the credit channels open may (and we must use the word cautiously) aid affected businesses.
An insolvency crisis implies one of two things. Either institutions are unable to pay off their debts as they are falling due, or, institutions have negative assets – liabilities in excess of assets.
The former seems to accurately describe the sovereign debt situation in Europe. Bond auctions are increasingly dismal. National governments are having difficulties raising the capital to meet their operating expenses. Normally capital is raised primarily through the financial markets – banks, mutual funds, insurance companies and the like purchase government debt as a “safe” asset for their portfolio.
The problem today is that this group of financial companies that typically funds government debts is under the second form of insolvency. The banking system in particular functions in an insolvent position as a normal state of its business affairs. Liabilities are always issued in excess of the assets available to pay them off – this is the fundamental basis of the fractional reserve banking system we are bound to today. As loans are issued in excess of deposits, a ballooning set of liabilities is permitted to be issued against a dwindling balance of assets.
The ECB allows the Eurozone domiciled banking system to issue up to 50 times the liabilities than assets are available to fund them. The Bank of England pursues an even more extreme path. With a reserve ratio on demand deposits set at zero, an unlimited amount of banking sector liabilities can be pyramided off an inexistent base of assets.
An insolvent financial system is unable to purchase additional amounts of government debt. Consequently, the sovereign debt crisis is unable to continue. The ECB pumping additional liabilities into the financial system cannot change the unalterable fact that assets cannot be created from thin air. Insolvency crises require a different exit plan than their less troublesome illiquidity counterparts.
Lacking a quick and easy method to create assets, the only solution to an insolvency crisis is to allow insolvent institutions to fail. Purging the bad debts from today’s financial system is an essential step in creating a sound foundation for recovery. Iceland, over the course of the past two years, has witnessed the bankruptcy of an insolvent banking system – one which had three large banks dominate the economy with liabilities amounting to 1100% of GDP. One would think that permitting such a dominant and centralized part of the economy to “fail” would cause undue hardship.
The purge of insolvent assets from Iceland’s financial landscape allowed for a fresh start. Government spending was forced to be cut as revenues were sharply curtailed. Talk of austerity measures that Britain and the Eurozone only hesitantly discuss became quick reality for Icelanders. An unsustainable situation came to an end, and Icelanders have commenced rebuilding with knowledge of the flaws of their past.
If the Eurozone could realize the same fate it too could have a quick exit. Past mistakes have been made, and insolvent institutions have been created. Allowing them to flourish further will do nothing but prolong the current economic malaise.
By Gordon Kerr, on 22 December 10
We at CC know that the story below is not actually a fair parallel. Students of the banking bailout are invited to submit answers in the “comments” section explaining the difference between this story and the bailout format…
It is a slow day in a damp Scottish town. The rain is beating down and the streets are deserted. Times are tough, everybody is in debt, and everybody lives on credit. On this particular day a rich German tourist is driving through the town, stops at the local hotel and lays a 100 Euro note on the desk, telling the hotel owner he wants to inspect the rooms upstairs in order to pick one to spend the night. The owner gives him some keys and, as soon as the visitor has walked upstairs, the hotelier grabs the 100 Euro note and runs next door to pay his debt to the butcher. The butcher takes the 100 Euro note and runs down the street to repay his debt to the pig farmer. The pig farmer takes the 100 Euro note and heads off to pay his bill at the supplier of feed and fuel. The guy at the Farmers’ Co-op takes the 100 Euro note and runs to pay his drinks bill at the pub. The publican slips the money along to the local prostitute drinking at the bar, who has also been facing hard times and has had to offer him “services” on credit. The hooker then rushes to the hotel and pays off her room bill to the hotel owner with the 100 Euro note. The hotel proprietor then places the 100 Euro note back on the counter so the rich traveller will not suspect anything. At that moment the traveller comes down the stairs, picks up the 100 Euro note, states that the rooms are not satisfactory, pockets the money, and leaves town. No one produced anything. No one earned anything. However, the whole town is now out of debt and looking to the future with a lot more optimism.
And that is how the bailout package works.
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