Wednesday 26 November 2008

Did all the money suddenly just disappear?

Many people have been asking me about the current financial crisis. How did it all begin? What exactly happen? Why so many companies suddenly go bankrupt or near collapse? Why suddenly so many countries in recessions (except for almighty Malaysia)?

Did all the money suddenly just disappear? It can't be, right?

The textbook answer to such question is blame the most talked about things in the world… “sub-prime”. Now, to understand what exactly happen will be very technical and I will probably have to write pages. Even that, I may not have written it accurately. So let’s leave that aside.

In addition to that, I believe sub-prime is not exactly the cause. I am of the zewtpinion that sub-prime is merely the point at which the real cause of the finally spill over. I believe the real cause to the current financial crisis is that there is a flaw in the law of wealth generation. Yeah, a pretty bold statement from a person who isn’t exactly an economist.

Generally, the law of wealth creation sounds rather simple. Tom has 10 bucks, he spends it on Dick’s restaurant for lunch. Then Dick spends the 10 bucks he earned on Harry’s restaurant for dinner. Harry then spends it on Zewt’s bar at night for a drink. In that single day, 3 persons recorded an income of 10 bucks; 3 persons can declare they made 10 bucks that day. 30 bucks will be recorded as GDP (correct me if I am wrong) and probably, 30 bucks will be taxed. But in reality, how much is there in the first place? Only 10 bucks.

That may seem rather simple and some may argue that perhaps Dick and Harry will have to record 10 bucks as expenditure. That is true, though not entirely accurate. But then again, the complexity will come when money is placed in the bank and then the same amount of money is lent out by the bank to another person. Top that up with business being carried out on credit terms, things just turned into one whole big mess.

Consider this…

Tom has 100 bucks, he places it in the bank.
The bank lends it to Dick for his business.
Dick shows his 100 bucks to Harry and purchase 100 bucks worth of goods from Harry.
But Dick tells Harry he will only pay him in 3 months.
Harry record 100 bucks worth of sales.
Harry pledges his business to another bank and to lend another 100 bucks.
Harry buys a 100 bucks house.

In reality, how much money is there in the above scenario? 100 bucks? Maybe 200. But Tom will claim he has 100 bucks in deposit. Dick has 100 bucks in cash. Harry has 100 bucks in receivables and another 100 bucks worth of assets. Do you get what I mean?

If you open up the published audited accounts of any profitable listed companies and if a company shows that it has a net profit of RM10m. Do you seriously believe that the company has got RM10min cash? Most probably not.

This is a signboard located in New York called the US debt clock. It records the amount of national debt of America. It has just been adjusted to add an additional digit as the amount keeps increasing and has not hit US10 trillion. And the amount will only keep increasing, indicating that America will never be able to pay off these debts.

In short, many people out there in the world, could be individuals, banks, companies or even countries have got receivables (i.e. debt) worth US10 trillion which will never be repaid. But these people think they have money as their deposit book or accounts show they do. But in actual fact, they don’t.

2 days ago, US announced
a US20b bail out for Citigroup. In that announcement, it was also said that they will guarantee “hundreds of billions of risky assets”. So suddenly, these “risky assets” aren’t so risky anymore; all because the US govt said so. But how much these “hundreds of billions of assets” now worth. Try and go ask around…

So if you think only Malaysians like to swipe the credit card, then you are wrong. The whole world have been swiping on a giant credit card and “sub-prime” somehow caused a malfunction in the credit card chip causing the whole mechanism to fail. Suddenly, the world realise that many people who claim to be rich aren’t exactly rich. And all these I guarantee this we guarantee that is just to make sure the world continue to believe that everyone is still rich, please continue to spend.

Did all the money suddenly just disappear? No, the money was never there in the first place.


Anonymous said...

nice article!!
agree with your points.

Letting the time pass me by said...

Great Article... I guess, many economist know this issues, and understand the economic "flaws" of this credit system, but, maybe there could be some element of greed that keep pushing this credit philosophy....

Well.. I used to term the economy as the "credit economy"... The economy that being driven by credits.. it is also intersting, people who use a lot of credits and they have a lot of debts... How this can be easily being confused? Do you have a lot of DEBIT or A LOT OF DEBTS? Hmm... I'm confused....

Anonymous said...

For someone like me who is dumb dumb in econ and all, your post is sure making sense. I can say I understand slightly better about the whole thing now. Hehe! Thank you so much for the enlightenment.

Huei said...

wow..very enlightening!

very that u mentioned..hmmm

Angie Tan said...

That's quite right.

The current financial crisis is a culmination of the perfect storm - sub-prime mortgage crisis and the impending personal credit crisis.

There wasn't any money to begin with. And the worse part is when people just hedging their bets on "virtual money".

missironic said...

The illusion of knowing that u have the money in ur bank is really dangerous, ya? cud it b part of greed?

"Joe" who is constantly craving said...

totally agree..but i suppose in US, it is many times over extreme then in your simple scenario..its basically lending to ppl who cant pay up as well with a higher interest rate to compensate the risk..packaging this risks as investments to the blind and when this ppl default..ur investments r worth nil..and the ppl who sold u..runs away and hide while the rest bcomes poor like we r now..

Anonymous said...

its not abt greed, but abt majority of ppl being 'roboted' to such mechanism edi, juz like avbody oso think democracy / US mechanism is the ultimate true system 4 a perfect world lar, well it works oni if av single human on earth act godly

"Did all the money suddenly just disappear? No, the money was never there in the first place."

yew T, thanks 4 putting it into words ya

lovegoddess said...

yea i get what you mean.

put it simply also its like make believe the $$ was there.

thats why i hold true to da' chinese saying "don't don a big hat if you don't have a big head"

never spend unnecessarily on what you don't have - some people stil do that sadly.. its up to them la, their life..

behind every victory there is a price to pay

taxy said...

Eh... tak boleh ler macam tu.

There are three people claiming to have $100 each. There are three pieces of assets worth $100 each. The cash, the goods and the house. So, there is $300 actually there, if not entirely in cash, in kind at least.

The only "person" who is trading on the time value of money is the bank. So, I suppose the question should be, "Is there value in stretching the time for making good your payables?"

So, maybe... just maybe, this was a result of not having a proper impairment valuation put in place for the time value of money, the trustworthiness of your debtors and the likelihood of the goods spoiling and a landslide to bury the house. But at the date the transactions took place, there's $300.

That be my 2 cents. :P

Anonymous said...

true...what taxy mention is somewhat related...and furthermore..."interest" add value without proper justification..their definition of risk=money ++

bla bla bla


baggie said...

its just a number.... a figure... there were never that much money in bill gate's account..

myop101 said...

bro... physical money in circulation is merely a tool to represent what you own physically.

in modern banking, we don't take wards of cash to walk around (ok...i have to qualify that...most people don't...) so the necessity for banks to print all the monies to match the actual amount everyone has is not there.

the problem is clearly about over-leveraging. people just assume too much the future will very much be the same as present and over-borrowed ahead of time. when things turn bad, these sums cannot be repaid and losses will be recorded.

these losses obviously mean that whatever assets one assume one had in the past are no longer there. so how do we get money out of thin air/losses?

the cashflow in circulation likewise will begin to slow.

i guess we have lost the whole idea of what money is. it is not really an asset. it is just papers with figures printed on it. it is supposed to just be a tool to facilitate trade and transactions. when we put it into a spin / circulation, the multiplier effect will obviously kick in. but how it multipliers really depend on how we see the outlook of the future will be.

so yeah, things went wrong because we just got too greedy and complacent. the money lost merely reflect the lies we put ourselves in, believing in a future peppered with too much roses; forgetting about the thorns.

Anonymous said...

ah... finally... i am enlightened.

Anonymous said...

I shudder at your last line, and I shudder for it is the truth.

Anonymous said...

I can name many ppl who are below 30 with so much credit card debt that their annual total income can never clear it. They're stuck. The consequence of a consumer society who's ego requires them to live 'latest lifestyles'. Its sad to see.

Eons ago, those who wanted credit cards, loans, etc had to fix in a certain amount with the bank. But now it is kinda 'freely give, freely receive'.

Anonymous said...

Geez, I often wonder how food bloggers blogged about those restaurant they patronized day after day (almost everyday, they will tell the whole world where they have their breakfast,lunch, dinner, supper in 5*stars restaurant). How many times do they get to have free food/ or invited to have complimentary food reviews from the restaurant?? I'm talking about restaurant and not hawkers or foodcourts though. Some bloggers even 'complained' about having to travel for vacations and finally back to 'Home-Sweet-Home' for a night before travelling again the next day. Pictures in their blogs showed all smiley faces with fun captions. Gosh, I've being thinking how these bloggers managed their lifestyles. In Malaysia/Singapore, that kind of lifestyle..only for those who born with 'lazy mind' with a silver spoon in the mouth ( I did mention 'lazy-mind',hor) Even those holding Highest positions in a big company won't have time to indulge in this kind of living.

Thanks for this article, and I totally learn from your last sentence.

Anonymous said...

nice writeup! i'm enlightened too, finally. :P

Anonymous said...

wow, this is a great enlightenment to me! very well presented!


so, we turn out not to be so rich after all! =)


SuLee said...

awesome post!!
i learned so much

CV said...

as always zewt, with a simple story, u've made me understand clearly what's happening even though i'm not into economics at all

Anonymous said...

Very technical. I did not quite understand the whole post until I read the last sentence. Ya, I think you are right in this.

Ummie said...

Easiest way to achieve a dream - swipe the card & waaahhh... the dream has come true. Very fulfilling fantasy until all the dreamers are shaken all at the same time.

zewt said...

Erictan7 - hey there, welcome to AZAIG. thanks :) glad u like it.

Letting the time pass by me - hello and welcome. what a long nick :) your debit vs debts analody is just... superb!

Jennifer - i will be glad to offer more enlightenment :)

huei - so u think you are rich? or poor? :)

Angie Tan - trust me... come early next year... the credit card crisis will cripple a lot of ppl.

zewt said...

missironic - greed is always part of everything, isnt it?

constant craver joe - well, that's what the great investment banks are good for. and now, most are bust. haha!

anon @ 26/11 9.43am - if God can be put into the picture, the world would be a much better place :) you're welcome... whatever your zewtvolution name is...

lovegoddess - yup... if you dont have a big head, dont wear such a big hat... perfect saying for the not so perfect situation.

taxy - hahaha... accounting principles are being blamed for all these leh.

erm - too complicated for my little brain :P

zewt said...

evelynholic - maybe half is real lah.

myop101 - though it's just paper, it's still very powerful. so powerful that many are blinded by it. the whole system is flawed and many are aware of it. but none can do something about it.

Siew - that's good... :)

life for beginners - indeed... and we will all continue to be make to believe that it's not.

pinknpurplelizard - yup... most ppl are buying things they do not need to impress people they do not like... that's the sad thing.

anon 26/11 11.22pm - well, i suppose most of the those bloggers you mention do have a silver spoon... or have very sweet daddies or mommies... :)

zewt said...

kyh - good.... i should write more about money then haha...

lynnwei - we just think that we are...

SuLee - we should learn more in times like these.

Noble - well, more knowledge is always a good thing.

jam - it's a make belief world isnt it?

ummie - and that is exactly what is happening right now... all shaken.

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