Money Problems (written just before
the so-called "Credit Crunch" but added to later :-)
It all started with the first credit
card. Or did it?
Every country has a currency that's
worth, at any point in time, an equivalent in terms of other
currencies of other countries.
This makes things a bit messy when it
comes to international trade.
A long time ago we had a thing called
the Gold Standard. If you wished, you could convert your cash
into gold, then back again into folding money without losing
out.
Each country subscribing to the gold
standard would have loads of gold bars stashed away somewhere,
say at Fort Knox, or in a vault belonging to the Bank of England.
Whenever the country got short of cash, they would simply fetch
another gold bar and make some more money.
This was jolly good in terms of international
trade, because you could simply weigh the coins received from
a customer and you knew exactly how much you were getting paid.
Part of the original principle of the
Gold Standard was the issue of coins made from gold but, because
it wasn't convenient to have tiny little gold coins with which
to buy bread and stuff, silver coins, then copper coins were
introduced. The same principles that applied to gold coins also
applied to the new silver and copper coins. The raw material
from which the coins were made was worth the same as the face
value of the coins.
This principle was jolly good. For a
country to expand its worth, it merely had to dig up more gold
for example, then stamp out more coins in its mint.
Around 1797 or thereabouts the principle
started to creak a little. Copper began to fall in value compared
with gold and silver and this resulted in copper coins getting
very big. Just before then, copper had been pretty scarce and
rather than mint plenty of copper coins of low denomination the
mints just didn't bother making any. It would have been too expensive
so lots of industrious people used to make their own coins. Some
of these were legal because they were described as tokens. Places
such as Liverpool and Swansea made halfpennies and even large
businesses made some. After a few years copper began to get more
plentiful and a lot cheaper resulting in enormous coins because
the coin still had to reflect the value of the raw material.
Sometime during the reign of Queen Victoria,
when some people began to get very rich, it became a trifle inconvenient
to carry around shed loads of gold coins to pay really big bills,
so some bright spark thought up folding money.
As long as the Bank that issued the
currency notes promised to pay the bearer in gold, these notes
were quite acceptable.
Cheques also appeared. These were just
instructions to ones bank to give the recipient loads of gold
coins when passed over the counter.
But the gold standard started to go
pear shaped once a particular country needed more cash than was
available in its reserves of gold bars.
Initially the scheme started to slide
once base metal was added to silver. No longer was a sixpenny
piece solid silver, it was only say 75% silver, with a bit of
copper added. This meant that a country could suddenly get a
lot richer. A million pounds of silver coins would overnight
be worth £1,250,000. Or put another way. The 25% of silver
pinched from the good coins would make about 33% more coins.
True you had to provide some copper but that was something like
30 times less expensive than silver.
An early action was to withdraw from
circulation all the gold coins and substitute for them some bits
of paper promising to pay the bearer whatever was the value of
the note in pounds.
When it came to dealing with foreign
countries, even the ex-colonies like the USA, these new bank
promissary notes were looked upon with some disdain.
What was the solution then, when it
came to repaying a large loan to the USA? Well, after World War
1, the UK owed the USA pots and pots of money for bullets and
guns etc. How about if we give you a very large bag of nice fresh
crinkly Bank of England notes said the Chancellor of the Exchequer?
No fear, you must be joking was the response. What could we do
with pound notes? Either it's dollar bills or gold bars or even
silver ingots was the response.
Where can we get silver ingots thought
the Chancellor?
After some head scratching and jangling
in his pocket he came up with the solution. I'll issue some nice
shiny new silver coins. I'll tell everyone that these are jolly
good, hard wearing and of course brand new and loads better than
the old worn out stuff dating back to goodness when... I'll collect
all the old coins and melt them down, back into silver ingots,
and give them to those whining ex-colonials.
Initially the idea was frowned upon
by the purists and, after collecting most of the old silver coins,
the Chancellor decided to re-issue new coins with only 50% of
the original silver. Suddenly the country had twice as much silver
money as before. Actually, it didn't because the USA had taken
half for its guns and bullets.
This was a wonderful solution to money
problems as it hadn't really cost us a penny to pay the USA.
The USA was happy because it had wagon loads of silver ingots.
The British public were happy because they now had nice shiny
new silver coins. The Government was happy because the US bit
of the war effort hadn't cost them anything.
This super idea was used again at the
end of World War 2.
Debased silver coinage was gathered
in and even newer and shinier coins were issued in place of the
currency in circulation. This didn't happen in one fell swoop.
When the Government needed a bit more cash, it just collected
some old "silver" coins and put back into circulation
some almost worthless cupro-nickel stuff.
This process is still going on today
would you believe. Now the Government are even pinching copper
from pennies and twopenny pieces and using iron to make up the
weight. If you don't believe me try a fridge magnet held against
various "copper" coins.
What about the present economic problems?
Since we left the gold standard, bits
of paper have been used in place of proper money. As long as
the value printed on a bit of paper can be retrieved, all is
well.
In the last few years however, organisations
have been anticipating future values of houses. A house for which
someone paid £100,000 is worth just that to the buyer.
If there were oodles of houses, or if everyone was ecstatically
happy with their current house, and no-one wanted a new house,
then the value on the open market of our £100,000 house
would be lots less. If there was a big shortage of houses and
lots of people were looking for somewhere to live, then the £100,000
house might be sold to the highest bidder and fetch lots more.
In other words house prices reflect
supply and demand. One superfluous house could affect the market
a lot by driving prices down. One house too few could affect
the market also, by driving prices up.
House prices are very unstable. There
has to be a fine balance, reflecting the desire to move house
coupled with the cash available to the buyer.
If there's a housing shortage house
prices will rise dramatically. If demand increases, say from
economic migration, demand will rise and prices will be driven
up.
A bank, whose main activity is to make
money from handling cash, will seize upon a housing shortage
as a super opportunity. House prices are rising. Security is
in bricks and mortar. They can lend money to buyers, knowing
full well that at the end of the day, even if a buyer defaults,
it at least has the house as security. With rising house prices
they can't go wrong. The buyer defaults and the bank sells the
house for loads more than the original loan.
Unfortunately, banks seem to have been
too greedy, or too competitive (after all there are loads of
banks looking to make pots of money from rising house values)
and they may only be slightly better off than break even if their
customer defaults. This margin can be pretty low given lots of
competition or bad forecasting of the price rises.
If we had the gold standard, things
wouldn't go much wrong, but given essentially worthless pieces
of paper, things can go wrong in a big way.
A promise to pay a bank isn't worth
the paper its written on if the organisation that issued the
promise has gone bankrupt and the coffers are bare.
Would you believe, these bits of worthless
paper have been bought and sold by banks worldwide.
It only took one day of reckoning to
bring the whole system crashing down.....
What was the root cause?
Any builder seeing the rise in house
prices will love to build a house and sell it. After all labour
is labour. If he can get twice the return for his labour he'll
ditch day to day activities and build a house.
This seems to have started in Florida....
however, in the UK for example...
Any budding entrepreneur, seeing the
rise in house prices will run up a "portfolio", doing
up ruinous properties and putting them back onto the market.
Once supply outstrips demand, house
prices tumble, negative equity follows and soon the entrepreneur's
debts are bigger than their assets.
A 100% mortgage for £100,000 for
a house worth only £80,000 is nonsense. Walk away and leave
the bank to deal with the debt is the result.
The bank will then sell the house for
£80,000 and make a loss of £20,000.
Now where do credit cards fit in?
Essentially there is a period of at
least 30 days when actual cash hasn't changed hands anywhere
in the chain of purchase of an item for which a credit card was
used.
Re-financing through several different
cards can increase this period almost indefinitely. Some people
even buy houses with credit cards...
This results in more pieces of worthless
paper floating around the banks. Worthless, because a proportion
of debts will never get paid.
Next will be the collapse of businesses.
Most businesses, the bigger they are the worse they are, rely
on not paying their bills promptly. A period of 30 days is about
the best one can hope for before a bill is paid.
With money in short supply, how many
businesses will be forced into liquidation? When the bank doesn't
extend a loan how can a business buy more stuff for sale when
it's own line of credit gets exhausted, or even pay it's staff
if things get really bad?
Liquidation means that bills won't be
paid and the knock-on effect will be like a falling line of dominoes.
What will Governments do?
Probably just print more bank notes....
It's called "Government Borrowing",
but if there isn't any money to be had actual borrowing is impossible,
so bits of paper are printed and these used to effectively order
more folding money from the printers.
Normally this is a bad idea because
ones currency will be devalued compared with ones neighbours
currency, but if everyone does it then no-one will notice.
The really clever thing is making best
use of all these nice new bank notes.
Put it this way. In the back garden
of 10 Downing Street is a big shed stuffed with boxes and boxes
of new money and inside the house a group of public schoolboys
trying to figure out what to do with the proceeds of the loan
(ie. the contents of the shed).
We can't keep all our new money in the
garden shed can we Eustace?
No PM, I think we ought to put it in
the bank. After all they're telling us they haven't got any and
that's what I do with my salary.
Good idea Eustace. We'll hire a furniture
van and take it to some banks tomorrow morning.
Can I have a box PM, after all it was
my idea and it'll be a painless way of paying my consultation
fee?
A week or two later..... the phone rings
on the PM's desk.
What is it Eustace?
Those dratted banks, you know... the
ones that took our boxes of money.. they're just keeping it.
What do you mean Eustace?
Well PM. They tell me they're keeping
it because they need it all to make up for the shortfall between
their mortgage loans and the value of the houses they foreclosed
on.
Just that Eustace? Well they say that
they need some for "administrative purposes".
Oh dear Eustace what do you propose
next?
Why don't we get the printers to run
off a few more boxes and buy the banks. That way we'll own all
their money. After all it's our money anyway.
Super idea Eustace. See to it will you.
The usual commission PM?
Later... at a well known bank, Northern
Crock
I thought the cupboard was bare Jeffery
old boy?
No you old duffer, when you were swanning
around on your hols that chappie Gordon gave us pots and pots
of loot.
You know him... pal of that pillock
friend of yours at Cambridge...
Good heavens Jeffers, are you pulling
my leg?
No Hilary old chap there really are
untold riches in the old coffers.
By jiminy Jeffers, quick, dole out a
bonus to everyone. We must deserve it after all, we were on our
uppers the other day and with all our hard work and dedication
we've come good.
Your word is good enough for me Hilary,
so let it be done... a bonus for all, can't let all that loot
go to waste.
(re statement 21/1/2009)
