History of Economics: Creating Value out of Hope

In the beginning there was a GB who came into existence and wanted to continue existing.

Hence, everyone needed food to exist and so everyone was a hunter gatherer and was busy hunting and gathering food all day…the entire culture is named after the only available and possible profession of the people ie hunting and gathering…Everyone hunted and gathered only what they needed and kept doing it day after day till they were dead…

With Agricultural Revolution, this changed…Now a small percentage of the population was enough to produce enough food for everyone…So the other useless people kept on twiddlin’ them thumbs and so they came up with a store of the value of their effort and used gold as the measure, and called it money…now the fastest twiddler of thumbs had the max wealth…

All was well and people invested their gold in food, clothing and shelter and the remainder was invested in ventures of other people, which when successful, earned interest for the investors…

This was all well and good and population kept increasing and farming kept becoming more efficient and so now only 10% of people can produce food for everyone…and total population was 500 million and year was 1600…Now that problem was that 30% of people were busy being producers of food clothing and shelter and went about merrily exchanging food for clothing etc. at first and later, using gold coins as store of value….Now, say 30% were kids or old, that left 40% of the population ie 200 million people, free to twiddle their thumbs in other ways….

But why would a farmer sell you food while you get your startup off the ground? To solve this problem, Banks stepped in and said that if we allow everyone to do whatever they want, then some ideas (like google and facebook and STEM industries etc.) will become popular and will lead to creation of new industries and the world will keep getting better and better and a person who today can create value of 10 will tomorrow, thanks to efficiency and education and knowledge will be able to create value of 100…

So, if the productivity of people will increase 10 fold in the future, the bangs said, why not allow us to give out loans for 10 times the value of the gold (store of current value) in our reserve/vault (say 20% of the 30% producers had 1 gold coin each stored at the bank, so that makes the total coins to 100 million).

So then they started doing that…Now those 200 million jobless people lined up at the bank and the banks were ready to multiply the 100 million gold coins by 10 and give out 1 billion gold coins and sit back and wait for the interest to come pouring in…

But then they realized…ah…there are only 100 million gold coins in the world…so let’s send out people to mine gold..but then some lazy douche said, “why not just numbers on a piece of paper and use those instead…” so then he got promoted instantly and then they wrote 1 on a billion pieces of paper and distributed them amongst the 200 million jobless people…

But doesn’t that reduce the value of the gold coins by a factor of 10? Of course it does, but coz value is just a fiction in itself, it doesn’t really matter…The aim of Govt is not to ensure that the 20% producers be able to define value the same in 1600 (start of Fractional Reserve Banking) as they did in 1599, when value just means what was valueable to the society at that point of time in history and yes, in 1599, only food, clothes and shelter was valuable in the world, but in 1600, we had a dream that if these 200 million jobless people are allowed to do other things like Science and Engineering, then they will come up with things even more valuable than food clothing and shelter….

So yes, these 30% producers’ money lost 90% of it’s value, but not coz of banks, but as a society we agreed that we’ll create “Future Value Representations” aka “Credit” in form of these numbers written on paper, and give them out to the jobless people to go create stuff using their innovation and ingenuity and prove to the society that they were as valuable as they claimed to be (in their loan application and business plan)…

So off they went and some companies failed and some prospered and the only thing that matters is that GBs were thriving and the population rose from 500 M in 1600 to 6 Billion in 2000 ie it increased 12 times in 400 years or an average 13 Million per year….

So now the banks had 2 problems…Firstly, the people who had taken the above 1 billion paper money were returning the same paper money as principal and interest payment…So now, if the original 1600s rule of “loan only 10 times the amount of gold” would not work coz gold amount is not changing and there are 13 million people queuing up every year asking for more Credit…

So then the only way to continue to grow the economy (ie allow every GB to flourish and produce more GBs) was to keep printing numbers on paper letting go of the gold restriction…

But wouldn’t that cause runaway inflation? If left unchecked, YES, but that’s were the Government steps in and controls the amount of money in circulation at any point of time using Interest Rate as the lever…How? If the Govt offers more interest, people will save money in bank instead of investing it elsewhere or spending it and vice versa…

But why would I want interest on my wealth? Let’s take a step back..so in 1600, say  I was one of the 200 million who lined up for a loan, and got say Rs 1000…Now, I build up my startup using this loan and now, people have paid me Rs 10000 over the last 5 years and after paying back the interest and loan and salaries etc. I have Rs 5000 left….Now, before I invest these 5000, let’s see what that even means…Let’s dig deep…So, in 1600 I had an idea that I could create a service that would trigger pleasure inducing Dopamine receptor in your head (via a drug that I invented)..Now, I do mkt research to find out how much people will be willing to pay for this and then GBs paid me buckets full of their value ( that they generated by doing a job) coz turns out GBs live for pleasure (who knew ;))

Let’s move on..so now what do I do with this 5000 notes? I can stuff them under my pillow and sleep well…Except that after 2 yrs since the stuffing, I see that other borrowers have given even their surplus to the bank, coz the bank is giving them interest on this saving….WTF…

So I decide to investigate what’s going on here…I visit the bank and see 13 million people queued outside, waiting to get Credit…Ah…Everything starts to make sense…The only way Bank can lend money to these people is by having more reserves and the only way that’s possible is when the original borrowers from 1600, save their surplus with the Bank, so that the bank can conveniently multiply it by 10 and lend it all out to these 13 million folks…

Ok, so because this original 1 billion Credit (Anticipated future value) in 1600, led to 10 million savings done by folks which the bank gave out as loans worth 10*10 ie 100 million in 1601 and so in 1601, the total money in the world was 1.1 billion, but the production ie value creation was less than the demand (coz of the new 13 million people added in that year and due to increase in efficiency and productivity of folks leading them to have more free time to consume the available goods and services and also coz people themselves took credit to buy everything coz why not..if businesses can take credit, why not people…and this caused demand to soar even further, coz a family which cannot afford a car is also able to buy a car on credit) leading to the price of goods to increase aka Inflation…

Hence because of this inflation, the 5000 notes that i had stuffed under my pillow lost some of the value they represented coz the total future representation of value (credit) in the market increased from 1 billion in 1600 to 1.1 billion in 1601 and 1.3 billion in 1602…ie in 2 yrs, the world’s anticipation of future value increased 30% while the actual real world increase in value of goods and services increased less than that, leading to the available goods and services to become dearer ie more expensive…In this eg. let’s say inflation has been 5% year on year (note that inflation of year 1601 has nothing to do with 1.1 billion credit in 1601 vs 1 billion in 1600, coz this credit has led to production of goods and services and that production has increased ove the last year, but not as much as the credit in mkt leading to soap price increasing by 5% hence govt. says that inflation is 5%)…

Ok, so having realized this in 1602, I finally took my 5000 notes to the bank and found that that the interest that the bank was offering on my saving was 5%.. I wonder why it’s the same as the inflation rate….Let’s think about it..inflation rate is a rough estimate of the rate at which your money is loosing it’s value…Now, I as lender will not give out loan if I cannot even preserve the value of my principle over the duration of the loan period…my intention in loaning you the money is to make profit and not loss…hence I declare that anyone who wants my store of value must pay me back 6% interest atleast so that after inflation adjustment, I can make 1% profit…

Now, the 13 million people in queue outside the bank are seeing this same inflation happening in the mkt and realizing that the credit in this economy is increasing super fast (leading to 5% inflation) so that means that if I launch my business now, in 1 yr, my product will be 5% more expensive and so i’ll use that additional 5% profit to pay as interest to this lender…so I will no incur any net-net loss as long as my interest rate is close to the inflation rate… so these 13 million people are willing to take a loan at 6.1% interest …so Banks are happily giving out these loans and after giving me 6% interest, they’re happily making 0.1*10 (remember the factor of 10 multiplication that’s allowed for every loan/reserve ie fractional reserve ratio) ie 1% profit on my 5000 ie 500 rs pure profit…

Note that this year on year increase in Credit in compunding fashion from 1 billion to 1.1 to 1.3 in just 2 yrs, means that in 2016, the total money in world is $80.9 trillion (this is a fact, but i’m not sure if in 1600 there was 1 billion in the world or what is the avg compounding rate yr on yr for last 400 yrs). The point i’m making is that most of this money doesn’t exchange hands and so doesn’t need to be in paper form and so is in electronic form instead)

Then there are stock markets where companies can raise money (not credit) against ownership of the company and that’s not very interesting as it’s pretty straightforward…people investing not in your ability to pay back (and guranteeing payback by shifting default risk to the intermediary ie bank) the loan (indirectly your savings are converted to loans by banks) but by investing in the company itself…and there’s the common high risk high gain rule that applies to all investments..70 of the 80 trillion $ in the world today is invested in Stock Mkt..

So what is the net worth of a company? It’s the anticipated future value of the company, decided by the market…So when information of some failure in the company comes out, the anticipated value goes down in form of the stock price falling and opposite for positive information…Hence, when people ask how money can vanish into thin air, like they did after the 2008 crash which lost $22 Trillion, the answer is simple…all money is credit and so represents future anticipated value and not the present value…and when that future expectation fails, then value goes away…For instance in 2008, the sub prime bubble burst meaning that people that had bought new houses started to default on their loans, the value of their mortgages went down and so People lost money because they had bought these housing market derivatives (which started life as bundles of sub prime mortgages) for a high price (coz no one except the banks knew that the mortgages were sub-prime and rating agencies were bought out hence giving them AAA ratings)and had to sell it at a low price. Simple.

Nobody can borrow to stock shelves, buy inventories, purchase equipment, buy cars, or much of anything else. Companies have to lay off employees. Those employees go on various forms of public assistance and stop paying taxes. Companies collapse into bankruptcy. The economy begins to wheeze. The real estate market is glutted with homes that won’t sell and can’t get mortgages. Banks and other lending institutions are stuck with billions of dollars of real estate they are ill-prepared to fix and sell. Mortgages go missing in the confusion. Now a general panic sets in, which becomes cyclical. Consumers quit spending. The Fed lowered interest rates to nearly zero, but couldn’t get any takers to borrow even at that rate.

Investors pulled out of the stock market, seeking more secure ports in the storm. Stocks correspondingly lost value for a time. Paper wealth disintegrated. It took huge efforts by Treasury and the Fed to stabilize some of the investment banks and prevent an even worse catastrophe. Major commercial banks had also taken a flier at derivatives, and suffered hugely for it. Some of the biggest mortgage originators in the business fell apart. Home prices plummeted. 401Ks fell in value, preventing many Americans from retiring on schedule.

The fact that total money in world is $80.9 trillion simply means that it’s the anticipated value of the future of the world as of today’s estimation…and when businesses succeed and pay back their loans, banks will give out ten fold the amount as new loans to new potential businesses hence the total money will keep increasing on and on, until people’s faith in future is lost. When that happens, most of this amount will disappear overnight…

Let’s move on to Derivatives, which are just gambling on the stock price ie the sentiments of people and incomplete information…There is $1.2 quadrillion invested in derivatives alone.

As for money owed by every single person and country in the world, the grand total is $199 trillion, with some 29% of it borrowed since the 2008 financial crisis.

The U.S. is responsible for nearly one-third of that global debt, while Europe follows at 26% and Japan at 20%. China, for all the criticism about its debt-fueled economic growth, owes 6% of the total.

And despite the attention bitcoin has received in recent years as an alternative currency, it clearly has a long way to go. The value of all bitcoin in circulation is estimated at $5 billion, a proverbial drop in the bucket. (ref)