Cobden’s Christmas Teaser

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.

11 Comments

  • Peter says:

    Not.

    In this instance, each and every debtor was also a creditor. In other words, each produced as much as he/she consumed. All that was lacking was a medium of exchange. As all true Austrians know, money is created by the market. In this case, the local market would have created money. For example the publican might have paid his debt with a bottle of whiskey which would have made the rounds and come back to him.

    The bailout works more like this:
    A bandit extorts 100 Euros at the point of a gun, and pays his debt to the bartender, who in turn pays his debt and so on. Everything happens the same except the 100 Euro note does not come back to the bandit who is unproductive and therefore has no money coming to him in return for goods or services. The net loser is the person who got mugged (the taxpayer).

  • sconzey says:

    Peter above has it. Here’s what I posted on Samizdata:

    This is sound economics. Let’s look at this another way:

    There is no german tourist. The hooker comes to the hotelier and says “hai, i owe you €100, but the barkeep owes me €100. how about i tell barkeep to pay you instead of me and we call it quits.” The hotelier says “sure.” The hotelier then uses this same policy and goes to the butcher and says “hey, I know I owe you €100 but the bartender also owes me €100, how about I tell him to pay you instead and we call it quits?” The butcher says: “fo sho!”

    The bartender heads to the farmers co-op dude says “hey, I owe the butcher €100, and you owe me €100. how about you pay the butcher and we call it quits?” The co-op guy goes, “Certainly, Comrade, for the motherland!”

    The farmers co-op guy goes to the pig farmer and says “Greetings Comrade, I know you owe me €100, but I too am indebted to the filthy capitalist butcher for the sum of €100. How about you pay him instead and we call it quits?” and the farmer goes: “lols, he owes me €100 too, so sure!”

    No German tourist required. The town was solvent, just required securitisation to resolve the chain of debts.

    Furthermore, even with the German tourist, no new money has been added to the system. No one has produced anything, but neither has anyone got any richer either.

    Pre-tourist, each actors’ balance sheet looks like:


    Assets === Liabilities
    ----------------------
    €100 | €100
    Total: €0

    After the Tourist, each actors’ balance sheet looks like this:


    Assets === Liabilities
    ----------------------
    Nil | Nil
    Total: €0

    The only thing remotely dubious about the scenario would be if the hotelier wasn’t aware that he was going to get the €100 back, but as far as I know “intent to defraud” isn’t a crime in and of itself.

    I’m kinda cheating because I’ve heard this before, just told as a joke, so at first it was hard to see the analogies; but I think in the spirit in which it was originally intended, this was supposed to abstract away the “productive” part of the economy and talk about the circular debts in an FRB banking system.

    Mencius Moldbug argues that the best way to resolve this is to nationalise the banks (hedge funds, etc.), resolve the circular debts, transfer over to a metallic standard, and then sell the banks assets back into your brand shiny new unregulated free market financial system in a Dutch auction.

    For the curious: http://unqualified-reservations.blogspot.com/2008/09/maturity-transformation-considered.html

    This idea of putting the entire financial system into effective receivership crops up repeatedly and all of his essays on economics warrant a read; even if you disagree with everything he says you’ll still learn something (kinda like Common Lisp). They’re enumerated under the heading “Economics” here: http://moldbuggery.blogspot.com/

    • Current says:

      I like Common Lisp but I’ve never got on with Mencius Moldbug’s thinking. Most of the things he knows can be learnt much more quickly elsewhere.

      • sconzey says:

        I like Common Lisp too, and learning it taught me a lot about writing good programs, even if I can’t use it every day. :P

        You make a fair point. One of the main reasons I read Moldbug is I like his prose on an aesthetic level; he moves his arguments so gradually that the reader is willing to at least consider propositions that — put more efficiently — they would have rejected out-of-hand.

        • Current says:

          I agree with you about that. But, I’ve never ended up agreeing with anything he’s said in the longer run. I still think he’s wrong about maturity mismatching, f.e.g.

          I think he’s too cautious.

  • Robert Sadler says:

    This wouldn’t work because Euros are not legal tender in Scotland… :-)

  • David Farrer says:

    “This wouldn’t work because Euros are not legal tender in Scotland… :-)”

    I believe that Scottish money is not legal tender here either! Nevertheless, Mathers Bar will sell me a pint of heavy in around an hour’s time…

    • Current says:

      Notes issues by Scottish commercial banks aren’t legal tender anywhere, not even in Scotland. But they are accepted by the market of course.

  • Current says:

    The point that Keynesians are trying to make here is about the risk associated with each debt.

    Each person has a debt and a credit but, each person doesn’t trust the debt they own. The “outside money” that comes into the economy can be trusted by everyone though, and that’s why it helps the economy. After exchanging a possibly bad debt for the people can spend more freely.

    The scenario suggested by the story could happen, and the improvement in the situation of the individuals involved could happen. However, it’s not really very likely.

    I think it wrong to suggest that debt cancellation could solve the problem. If it could then there would be little reason to use money at all, we could just exchange our debts for other things. The problem is trust, that’s what makes cancellation complicated. That is why money can’t be considered to simply be a “numeraire”.

    The more important flaw in the logic suggested is Hume’s “specie flow”. Money flows to who will pay the most for it. Those who are in debt and want to get out of debt would pay more for money than others. If the characters in the story were concerned about their debts they would obtain money to cancel them from their income or by selling assets.

    I’m not arguing that supplying more money in certain situations can’t improve the economy. I think that it can be satisfying the demand for money. However, the demand for money isn’t as local as this story implies.

  • Peter above has it. Here’s what I posted on Samizdata: This is sound economics. Let’s look at this another way: There is no german tourist. The hooker comes to the hotelier and says “hai, i owe you €100, but the barkeep owes me €100. how about i tell barkeep to pay you instead of me and we call it quits.” The hotelier says “sure.” The hotelier then uses this same policy and goes to the butcher and says “hey, I know I owe you €100 but the bartender also owes me €100, how about I tell him to pay you instead and we call it quits?” The butcher says: “fo sho!” The bartender heads to the farmers co-op dude says “hey, I owe the butcher €100, and you owe me €100. how about you pay the butcher and we call it quits?” The co-op guy goes, “Certainly, Comrade, for the motherland!” The farmers co-op guy goes to the pig farmer and says “Greetings Comrade, I know you owe me €100, but I too am indebted to the filthy capitalist butcher for the sum of €100. How about you pay him instead and we call it quits?” and the farmer goes: “lols, he owes me €100 too, so sure!” No German tourist required. The town was solvent, just required securitisation to resolve the chain of debts. Furthermore, even with the German tourist, no new money has been added to the system. No one has produced anything, but neither has anyone got any richer either. Pre-tourist, each actors’ balance sheet looks like: Assets === Liabilities ———————- €100 | €100 Total: €0 After the Tourist, each actors’ balance sheet looks like this: Assets === Liabilities ———————- Nil | Nil Total: €0 The only thing remotely dubious about the scenario would be if the hotelier wasn’t aware that he was going to get the €100 back, but as far as I know “intent to defraud” isn’t a crime in and of itself. I’m kinda cheating because I’ve heard this before, just told as a joke, so at first it was hard to see the analogies; but I think in the spirit in which it was originally intended, this was supposed to abstract away the “productive” part of the economy and talk about the circular debts in an FRB banking system. Mencius Moldbug argues that the best way to resolve this is to nationalise the banks (hedge funds, etc.), resolve the circular debts, transfer over to a metallic standard, and then sell the banks assets back into your brand shiny new unregulated free market financial system in a Dutch auction. For the curious: http://unqualified-reservations.blogspot.com/2008/09/maturity-transformation-considered.html This idea of putting the entire financial system into effective receivership crops up repeatedly and all of his essays on economics warrant a read; even if you disagree with everything he says you’ll still learn something (kinda like Common Lisp). They’re enumerated under the heading “Economics” here: http://moldbuggery.blogspot.com/

  • corrigan says:

    In the first instance, this is only a clearing problem, not an invitation to state intervention, as it is so often presented. If the interested parties simply agreed to meet in the pub and trade liabilities for assets, the problem would be solved before the first pint was downed.

    Secondly, you notice the key point that the newly introduced money – which was used fraudulently by the hotellier, by the way – is later removed from the system before it can alter price relations and so distort the structure of production. Hardly likely under banking bail-out terms, alas, as can already be seen in the fact that the nominal sterling price of a host of everyday necessities is daily hitting new highs even as wages and, eg, house prices are stagnating.

    Thirdly, the bail-out idea, as actually effected, is to try to avoid recognising that many credit claims have gone bad (because the monies to which they gave rise have been spent unproductively) by making ALL claims worse than they should be through that generalized and unfocused process of inflation euphemiestically known as ‘Quantitative Easing’.

    Finally, in this toy example, which, you will note is a free market process – albeit one founded upon an initial act of dubious morality – the solution led to a lowering of gross debt across the community. In a world where the debtor/creditor offsets are not quite so pat – and where the element of time intrudes – this is likely to involve some of its members temporarily buying fewer goods than they otherwise might, in order to discharge their debts and leave their ‘frozen’ obligees with the means to pay off their own, in turn.

    In the real world, the intelligentsia’s horror is that if the good citizens should ever attempt this heinous act of ‘saving’, in order to prevent a violation of the nonsensical Keynesian creed that everything must be continually burnt up as soon as it is produced, someone else – i.e., the state – must borrow and spend in their place jamming everyone between the rock and the hard place impasse of financially unsustainable deficit spending or politically, unpalatable ‘austerity’ where we are all so stuck today,

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