Talking of set theory (as I was yesterday in the introduction to the post), the intersection of the set of regular readers of this blog with the set of people who know less about economics than me is also likely to be very small indeed. In any case, those who know something about economics may well find the following painful reading. It derives from an attempt to explain the subject to myself while cycling up a tall and steep mountain:
If I lend my friend Sam €10 (I don't seem to have a pound sign) to buy a blouse she's seen in Zara and wants for Friday night but she only has a Saturday job and won't have the money before then, she gets her blouse and I am out a tenner, at least until Saturday.
Or am I?
Later, feeling peckish, I go down the road to the market to see my friend Tony at the chicken stall. Let me have a chicken, I say, and I'll pay you on Saturday, because Sam's going to give me €10. Ok, he says. Now Sam has her blouse, I have my lunch, and that €10 has been spent twice.
My friend Tony, on the strength of the sale, is feeling chipper and buys some earrings for his wife, who is made happy by them, and in consequence she makes Tony happy.
The €10 has now been spent three times, everyone involved has what they wanted and is happier because of it. But money has not in fact been created. My original €10 has not become €30. What has been created is liquidity. A chain of possibilities has been called into being, virtual money, a chain which collapses back on itself on Saturday when Sam goes to work, gets paid, gives me €10 which I pass on to Tony, and he puts them back in the account he took them from. Now there is are just €10 again, sitting in Tony's bank, but the goods that have changed hands, and the happiness caused by those exchanges, are real and continue to exist.
The key to all this is confidence. I am sure that Sam will pay me back, and Tony knows I'll pay him. (If he really wanted he could get me to sign soemthing, but in fact his knowledge that I will have the money and will give it to him is worth more than a piece of paper.) But what if he doesn't have that certainty.
What if he thinks €10 is too much to give on credit? For whatever reason. He tells me he can't let me have a whole chicken, but he can do me a leg. A leg is not lunch, so I give him the money, Sam doesn't get her blouse, Amancio Ortega doesn't get a bit richer and his employees get a slightly smaller bonus. Tony gets his money, but he sticks to it, so his wife doesn't get her earrings, and Tony doesn't get... whatever he might have had.
Or perhaps I munch a chicken leg so Sam can have her blouse, but, because I may have to go hungry, I decide that if Sam really wants her blouse she can pay me back €11, instead of the €10. I have put a price on my inconvenience, my risk. Either way, the lack of confidence of one or other of us has left us all without the things, and the contentment, we might otherwise have had. Liquidity has been lost.
And that, boys and girls, is the idea behind fractional reserve banking (er no, it isn't*), the multiplier effect, and the fact that greedy bankers can't get rich, and much less cause a recession, unless there are lots of other greedy people squealing for money they might not be able to pay back. Welcome to the economy, boys and girls- we're all in this together.
Is any of this even remotely accurate?
*Mark Wadsworth, in the comments, patiently explains that I haven't said anything about FRB, which is a different matter entirely.
Fathom 18 Out Now!
1 hour ago