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HOT TOPIC How does the economy really work? (Banks, loans, value, economics)

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thechosen1

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So I'm trying to formulate my idea of how the economy works and would like others to think about this too.

New money is created via debt - yes or no?

Banks lend out money, often in the form of either a business loan or a mortgage.

So let's say that I get a business loan and I hire 20 people. Those 20 people each get mortgages. Their work pays down my business loan over time, and in return I pay them wages or salaries, which they use to pay down their mortgages over time.

This would eventually cancel out my debt and their debt. New value and new wealth was created! ...Right?

Is that true? Can it really work that way across the board, or is more debt always necessary?

I'm trying to figure out how this all fits together intuitively.

Honestly, @JScott ... your expertise would be great for this question.

edit: guys...I know what value is and that it isn’t money. I’m asking people how the government, banks, etc actually function. I’m not asking for people to tell me my own ideology! I am already pro-capitalism and value :)
 
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BizyDad

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So I'm trying to formulate my idea of how the economy works and would like others to think about this too.

New money is created via debt - yes or no?

Banks lend out money, often in the form of either a business loan or a mortgage.

So let's say that I get a business loan and I hire 20 people. Those 20 people each get mortgages. Their work pays down my business loan over time, and in return I pay them wages or salaries, which they use to pay down their mortgages over time.

This would eventually cancel out my debt and their debt. New value and new wealth was created! ...Right?

Is that true? Can it really work that way across the board, or is more debt always necessary?

I'm trying to figure out how this all fits together intuitively.

Honestly, @JScott ... your expertise would be great for this question.
Why don't you make this it's own thread? Makes for a good discussion. A lot of people don't visit the rant thread...
 

MJ DeMarco

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Why don't you make this it's own thread? Makes for a good discussion. A lot of people don't visit the rant thread...

Done.
 

thechosen1

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Económics is a notoriously divided field. I’ve read tons of books and I’m no expert. But I’ve come up with key ideas that help me bypass the complexity of an economy.

1. It’s all about who owns, controls and allocates the resources.(You want enterprising men and woman to allocate the resources, not the schmucks over at the government).

2. Wealth gravitates towards those that can optimize utility and efficiency the best.

3. Technology is the most powerful driver of productivity. Economists call it “capital”(No, not like the capital in finance).

4. Money is an abstract and extrinsic unit of exchange. Fiat money is efficient BUT only if the entities that control it are ethical and responsible.(No, the fed is not responsible)

5. Supply and demand is simply the intersect of utility and scarcity.


New money is created via debt - yes or no?

Yes, Banks control all our money. That’s why there is no such thing as bank runs anymore because they don’t need me or you. They got their buddies at the Fed to loan them the money. I think Citi bank owns most of the shares over at the Federal Reserve bank of New York.
 

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If you have ten apples and I have ten gallons of milk, you will value your tenth apple less than your first apple, I value my tenth gallon of milk less, so we exchange apple for milk and we each get something we value more (my first apple!), in that process we have created profit.

That's the basis for the whole thing.

Debt is the wrong word. The driver of wealth creation is capital investment, which comes from savings.

Capital investment funded by inflation is a wealth transfer, the debased money doesn't magically have value, it steals value from other people's savings.

Productive value creation and voluntary exchange is what makes an economy work.
 

Black_Dragon43

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This misunderstanding all stems from the line of thinking that money is value. But money isn’t value, it’s just a means of exchange. If we were all given $100,000 by the government, but all production stopped, then we would all starve. And having more money wouldn’t prevent that. Can’t eat ehm moneyes!

Now trade can facilitate win-win exchanges which leads to higher overall production and therefore more wealth. But remember, it’s the production that is ultimately the wealth and value of a society, not the money.

If we have just 5 gold coins, and we’re 3 people, that might be enough to facilitate trade between us. - you sell me 1 sheep for 1 coin, I go buy a pig for that coin, etc. @Tom H. explained it very well above, the whole marginal utility thing.

But now imagine we’re 10,000 people. Obviously production is much higher. The money supply of 5 coins is no longer enough to facilitate smooth trading. So we need to mint some more, hence why small inflation is preferred by governments. Printing some more in this case makes trade easier, BUT devalues/discourages savings. (ofc things get a bit more complicated due to credit, but that's the basic idea)

Now it seems we’re stuck between two evils... ineffective trading due to a small money supply that doesnt keep up with production OR inflation. Now all this trading difficulty could be solved if we could subdivide the initial 5 coins infinitely. Then we could go on trading just as well, without any inflation. Hence crypto :)
 
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Antifragile

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So I'm trying to formulate my idea of how the economy works and would like others to think about this too.

New money is created via debt - yes or no?

Banks lend out money, often in the form of either a business loan or a mortgage.

So let's say that I get a business loan and I hire 20 people. Those 20 people each get mortgages. Their work pays down my business loan over time, and in return I pay them wages or salaries, which they use to pay down their mortgages over time.

This would eventually cancel out my debt and their debt. New value and new wealth was created! ...Right?

Is that true? Can it really work that way across the board, or is more debt always necessary?

I'm trying to figure out how this all fits together intuitively.

Honestly, @JScott ... your expertise would be great for this question.


Have you read or watched Ray Dalio?
View: https://youtu.be/PHe0bXAIuk0


https://economicprinciples.org/down...hine_works__leveragings_and_deleveragings.pdf
 

Black_Dragon43

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This is a strong video to give you an introduction. However, as Ray Dalio drew this graph, it suggests that long-term, the effect of credit on productivity is 0. Meaning that long term, we'll get the same result (the straight line), as if we allowed for credit (the sine curve). Of course, this is wrong. If Dalio was right, credit should be shunned since there would be no benefit to having it, since ultimately we'd end up with the same result in terms of productivity gained (real wealth).

Screenshot 2021-04-22 at 13.27.58.png

If we were to use credit in a smart way, we should be able to get the productivity curve to increase upwards exponentially and the credit curve would effectively fluctuate around a mean that is different than the current linear productivity line. This should be accounted for in the drawing imo, since otherwise there is no explanation for why we have credit in the first place.
 
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Deleted78083

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The mistake most people make is to focus on money. It's wrong. You should be focusing on production instead.

Imagine a village with a baker, a butcher, and a tailor.

They each produce their own goods (bread, steak, and suits). That's the economy. The strength of it depends on whether they produce a lot or not and on whether the goods are highly sought after or not.

If the baker only produces one piece of bread, the butcher one steak, the tailor one suit, the whole village will be poor and all of the goods will be expensive cuz demand will be higher than production.

If the baker produces three pieces of bread per day, the butcher three steaks, and the tailor three suits, then the village will be rich because everyone will exchange their good with the others' goods and they'll enjoy opulence.

Money is the neutral value of exchange you use when you create wealth that others consume. The more others consume what you produce, the more money you get.


Where does money come from?

At the beginning:

Baker's inventory: 3 breads, will eat one and sell two
Bucther's inventory: 3 steaks, will eat one and sell two
Tailor's inventory: 3 suits, will wear one and sell two

How will these people exchange their goods?

With money.

Money is borrowed from the central bank. Le's say each good cost 1 euros. Each of our villagers will borrow 2 euros to buy the two goods from the other two villagers.

The baker: buys one suit for one euro, and one steak for one euro. Receives one euro for his bread from the butcher, and one euro from the tailor.

The butcher: buys one bread for one euro, one suit for one euro, and receives one euro from the baker for his steak, and one from the tailor.

The tailor: same thing.


Now that our villagers have bought and sold their goods, they go back to the central bank to give back the two euros they each borrowed.

This explains why fundamentally, all money is debt since all money is de facto borrowed. Money is meant to temporarily enable individuals to exchange their own production against a neutral value they can use to go buy other stuff later on. Money fundamentally prevents people from bartering.

That, in a nutshell, is how the economy works. This is why Jeff Bezos encourages you to produce more than you consume - because he understands how the economy works and that if everyone produced more than they consumed, no one would be poor.

Congratulations! You now have a bsc in economics!
 

thechosen1

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Yes, I’ve seen this.

I know what value is, too @Tom H. Most of the people here probably already know this. A lot of the comments here are explaining something more basic.

But the question is really about how more money enters the system and what it means. Obviously money is just a means of exchange - that’s rudimentary.

Obviously money is not value - value can be many things. That is also rudimentary.

The real question is how the banking, lending, and government work in reality.
 

thechosen1

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The mistake most people make is to focus on money. It's wrong. You should be focusing on production instead.

Imagine a village with a baker, a butcher, and a tailor.

They each produce their own goods (bread, steak, and suits). That's the economy. The strength of it depends on whether they produce a lot or not and on whether the goods are highly sought after or not.

If the baker only produces one piece of bread, the butcher one steak, the tailor one suit, the whole village will be poor and all of the goods will be expensive cuz demand will be higher than production.

If the baker produces three pieces of bread per day, the butcher three steaks, and the tailor three suits, then the village will be rich because everyone will exchange their good with the others' goods and they'll enjoy opulence.

Money is the neutral value of exchange you use when you create wealth that others consume. The more others consume what you produce, the more money you get.


Where does money come from?

At the beginning:

Baker's inventory: 3 breads, will eat one and sell two
Bucther's inventory: 3 steaks, will eat one and sell two
Tailor's inventory: 3 suits, will wear one and sell two

How will these people exchange their goods?

With money.

Money is borrowed from the central bank. Le's say each good cost 1 euros. Each of our villagers will borrow 2 euros to buy the two goods from the other two villagers.

The baker: buys one suit for one euro, and one steak for one euro. Receives one euro for his bread from the butcher, and one euro from the tailor.

The butcher: buys one bread for one euro, one suit for one euro, and receives one euro from the baker for his steak, and one from the tailor.

The tailor: same thing.


Now that our villagers have bought and sold their goods, they go back to the central bank to give back the two euros they each borrowed.

This explains why fundamentally, all money is debt since all money is de facto borrowed. Money is meant to temporarily enable individuals to exchange their own production against a neutral value they can use to go buy other stuff later on. Money fundamentally prevents people from bartering.

That, in a nutshell, is how the economy works. This is why Jeff Bezos encourages you to produce more than you consume - because he understands how the economy works and that if everyone produced more than they consumed, no one would be poor.

Congratulations! You now have a bsc in economics!
I agree with all of this, but I’m asking how the system of banking and lending works in reality, disregarding my beliefs of how it SHOULD work.
 

thechosen1

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For the sake of the question, assume my business is creating real value, and so are the employees, which is why I am paying them.

Now getting back to the topic: what happens to all this debt?
 

thechosen1

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You pay it back through your increased productivity?
Right so, the debts cancel out and are slowly paid off by each side of the hierarchy, right?

So does that mean this system actually...works? I mean, issuing debt as a way to "keep up" with the value creation? But it does seem to mostly just inflate asset prices because that's what the intelligent people use debt for.
 

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Right so, the debts cancel out and are slowly paid off by each side of the hierarchy, right?

So does that mean this system actually...works? I mean, issuing debt as a way to "keep up" with the value creation? But it does seem to mostly just inflate asset prices because that's what the intelligent people use debt for.
Ok, so let's take a simpler scenario. I have a connection of mine who needs 1000 parts of whatever, and I have the know-how of how to produce them. Unfortunately, I don't have the cash. You on the other hand already have the raw materials I need. So I tell you, look, I don't have the cash to pay you, but give me these raw materials on credit (read, on TRUST), and I will pay you more than you want right now for allowing me to pay you later.

Now this simple transaction based on credit enables me to produce the 1000 parts, and, down the line, my connection to produce the 1000 cars he needed the parts for. Thus we're all 1000 cars richer. My debt to you is paid out of those 1000 cars. So credit/debt is repaid/settled out of increased production in the future. Without the credit/debit though, there would be no increase in productivity. And without the increase in productivity, there would be no way to repay the debt.

So yes, credit is a way to increase productivity faster and "inject" virtual money where the system needs it to facilitate the sort of exchanges that lead to greater productivity.
 

thechosen1

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Ok, so let's take a simpler scenario. I have a connection of mine who needs 1000 parts of whatever, and I have the know-how of how to produce them. Unfortunately, I don't have the cash. You on the other hand already have the raw materials I need. So I tell you, look, I don't have the cash to pay you, but give me these raw materials on credit (read, on TRUST), and I will pay you more than you want right now for allowing me to pay you later.

Now this simple transaction based on credit enables me to produce the 1000 parts, and, down the line, my connection to produce the 1000 cars he needed the parts for. Thus we're all 1000 cars richer. My debt to you is paid out of those 1000 cars. So credit/debt is repaid/settled out of increased production in the future. Without the credit/debit though, there would be no increase in productivity. And without the increase in productivity, there would be no way to repay the debt.

So yes, credit is a way to increase productivity faster and "inject" virtual money where the system needs it to facilitate the sort of exchanges that lead to greater productivity.
Nice explanation!! Yes, this makes perfect sense.

More people need to see how this works so they can understand credit and its productive role.
 

Kak

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If you have ten apples and I have ten gallons of milk, you will value your tenth apple less than your first apple, I value my tenth gallon of milk less, so we exchange apple for milk and we each get something we value more (my first apple!), in that process we have created profit.

That's the basis for the whole thing.

Debt is the wrong word. The driver of wealth creation is capital investment, which comes from savings.

Capital investment funded by inflation is a wealth transfer, the debased money doesn't magically have value, it steals value from other people's savings.

Productive value creation and voluntary exchange is what makes an economy work.
Yes. This is great.

Dollars in circulation are “backed” (essentially) by the trade value everyone has universally accepted.

Newly minted dollars are only “backed” by yesterday’s accepted value, and as days go by that becomes a problem. There is zero commerce, capital investment, or exchange behind that dollar.

Just like a stock doing a split. If the market cap is 500B, and you split the stock, doubling the shares, the market cap is probably up a little because now people are moving some paper, so let’s say 550B. But it is stimulated and nothing about the management, or profitably of the company have changed.

Our total productivity as an economy can be looked at like the market cap. They stimulate it with new dollars and pat themselves on the back while they rob the buying power of existing earners and people with dollar denominated savings, and bonds.

It would be akin to me taking an investment from someone of 10% in my company, and then unilaterally deciding to just quadrupole the outstanding shares and issue them to myself. Now they own 2.5%.

We are like metaphorical shareholders in the US economy, by force. The shares, dollars, are always headed down. We can mitigate or exceed that loss by owning stock, assets foreign and domestic, and commodities.

Henery Hazlitt’s Economics in One Lesson is very good. I saw another person mention Sowell...

Sowell is a great economist, but he is Chicago Theory and Hazlitt is Austrian. They are both capitalists that disagree on the role of the fed. They’ll both nail supply and demand micro economics perfectly. And, while I love Thomas Sowell, and Milton Friedman for that matter, I prefer the Austrian take.

The Mises Institute has everything you need to understand the economy. Much of it for free. Check out podcasts from Bob Murphy as well.
 
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Kak

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Honestly, JScott ... your expertise would be great for this question.

Don’t call JScott (see, don’t use the tag) :rofl: out of hibernation unless you want the thread to turn into an argument for argument’s sake.

Just because he is the loudest and most aggressive guy in the room, doesn’t mean he is somehow uniquely qualified. He uniquely qualifies himself for every discussion he inserts himself into.

His problem is he doesn’t understand metaphorical discussion and tends to argue with anything that isn’t super literal and source cited out of a government approved, bootlicker, Stockholm syndrome, handbook.

I know, I know, I should be super impressed with his glory days because he tells me to. M&A and Microsoft, wow, he did what he was told to do and was paid for it. Damn. Innovative. Amazingly cutting edge. Time Magazine should really call him about a cover, if he has time for them of course.

And let’s not forget real estate! No one ever invests in real estate! Doors! Lots of doors! Let’s all massage his, undoubtedly massive, balls for it (yet again) when he shows up here to enlighten us plebes in all of his “expertises.”
 
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Kevin88660

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So I'm trying to formulate my idea of how the economy works and would like others to think about this too.

New money is created via debt - yes or no?

Banks lend out money, often in the form of either a business loan or a mortgage.

So let's say that I get a business loan and I hire 20 people. Those 20 people each get mortgages. Their work pays down my business loan over time, and in return I pay them wages or salaries, which they use to pay down their mortgages over time.

This would eventually cancel out my debt and their debt. New value and new wealth was created! ...Right?

Is that true? Can it really work that way across the board, or is more debt always necessary?

I'm trying to figure out how this all fits together intuitively.

Honestly, @JScott ... your expertise would be great for this question.

edit: guys...I know what value is and that it isn’t money. I’m asking people how the government, banks, etc actually function. I’m not asking for people to tell me my own ideology! I am already pro-capitalism and value :)
What you are asking is more about monetary economics, how money runs in the modern economy.

Central banks create base money but credit/debt is generated by the private banking sector.

The banks can create far more debt than the money they own, through the double entry book keeping system.

When Jack the business wants to borrow one million dollar loan for business from Bank A. Bank A approved his loan by not taking from its banknote reserve. Bank A just key in digitally 1 million dollar in Jack’s account. Debt in the form of digital money is created. It is an asset for the bank, because Jack now owe 1 million dollar the bank. It is also a liability for the bank, because the digits represent the obligation to provide banknote once the owner choose to withdraw (even though they rarely do so).

So whatever transfer of the money across account is simple a transfer of “promise to pay”.

Because most of the money is in this form rather than base money or money notes, we say when money is created, debt is created.

Jack the business owner wants to make a profit. He targets a 50 percent return on investment for the year through business profit. He spends the one million dollar away buying equipment and hiring staffs. One million credit is spent. For that 50 percent return to be possible there must be at least 1.5 million of credit in the system. It means new money/credit/debt must be issued other than the existing 1 million in circulation.

In short most people want to “make money”, having more credit/money, than yesterday. This means that banks have to constantly “create money” which is issue new debt into the system. Only then it is possible to have more money than yesterday. Only then it is possible for Jack to earn an revenue large enough to pay down its debt plus interest and have a profit. If banks all stop giving out new loans we will have massive bankruptcy and financial collapse.

Ideally banks in aggregate should expand credit proportional to the real economic growth (value creation), to avoid economic stagnation or too much inflation.
 
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thechosen1

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What you are asking is more about monetary economics, how money runs in the modern economy.

Central banks create base money but credit/debt is generated by the private banking sector.

The banks can create far more debt than the money they own, through the double entry book keeping system.

When Jack the business wants to borrow one million dollar loan for business from Bank A. Bank A approved his loan by not taking from its banknote reserve. Bank A just key in digitally 1 million dollar in Jack’s account. Debt in the form of digital money is created. It is an asset for the bank, because Jack now owe 1 million dollar the bank. It is also a liability for the bank, because the digits represent the obligation to provide banknote once the owner choose to withdraw.

So whatever transfer of the money across account is simple a transfer of “promise to pay”.

Because most of the money is in this form rather than base money or money notes, we say when money is created, debt is created.

Jack the business owner wants to make a profit. He targets a 50 percent return on investment for the year through business profit. He spends the one million dollar away buying equipment and hiring staffs. One million credit is spent. For that 50 percent return to be possible there must be at least 1.5 million of credit in the system. It means new money/credit/debt must be issued other than the existing 1 million in circulation.

In short most people want to “make money”, having more credit/money, than yesterday. This means that banks have to constantly “create money” which is issue new debt into the system. Only then it is possible to have more money than yesterday. Only then it is possible for Jack to earn an revenue large enough to pay down its debt plus interest and have a profit. If banks all stop giving out new loans we will have massive bankruptcy and financial collapse.

Ideally banks in aggregate should expand credit proportional to the real economic growth (value creation), to avoid economic stagnation or massive inflation.
Thank you - this is exactly what I was asking about.

The question is how the banking and monetary systems work. Not how value or entrepreneurship work.

Great explanation - eye opening.
 

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In all reality, I must reiterate, the Mises Institute is really a gold mine for this type of stuff. It won’t be summed up in a thread. There will be days and days of multifaceted learning required to really get even a working understanding of our system.

I actually like Mises.org so much that I do donate to them now.

 

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The question is how the banking and monetary systems work. Not how value or entrepreneurship work

There are two ways you can approach this. You can buy a used college textbook on monetary policy and learn all the money supply graphs and statistics on how printing money is great. Also, Funny how Woodrow Wilson was a college professor.

OR

You can learn all of this from what I call the “anti-brainwash” perspective. In other words you reject everything academia says and look at things from a fresh perspective. In that case watch the 1996 documentary “Money Masters” by Bill Still.

I already researched all of this. And my views align more with the second.

Banks create all our money and the loan it out through collateralized lending so some other schmuck takes the risk and they incur no opportunity-cost. Oh, and you don’t get “free money” loans if you are not in “the club” of private bankers.

Oh, and the federal reserve system is cleverly designed so that if shit hits the fan, they can blame someone else for it. Hyperinflation? What are you talking about?
 
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thechosen1

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There are two ways you can approach this. You can buy a used college textbook on monetary policy and learn all the money supply graphs and statistics on how printing money is great. Also, Funny how Woodrow Wilson was a college professor.

OR

You can learn all of this from what I call the “anti-brainwash” perspective. In other words you reject everything academia says and look at things from a fresh perspective. In that case watch the 1996 documentary “Money Masters” by Bill Still.

I already researched all of this. And my views align more with the second.

Banks create all our money and the loan it out through collateralized lending so some other schmuck takes the risk and they incur no opportunity-cost. Oh, and you don’t get “free money” loans if you are not in “the club” of private bankers.

Oh, and the federal reserve system is cleverly designed so that if shit hits the fan, they can blame someone else for it. Hyperinflation? What are you talking about?
I agree with you about the problems, about how they aren't taking the risks, and about how all of this is corrupt.

I agree.

But that doesn't answer the question.
 

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Our monetary system has been developing over time from a bartering system. My grandfather fitted glasses for his whole little corner of the world. He had his regular office in our home town. He also took his tools and went around to the different neighboring towns where he set up shop on a regular route. He had no set prices. He charged what he thought they could pay. He didn't keep books on who owed him. It was all done on the honor system. And most of it was done by barter. We'd come to their house and there would be a lug of apples, a ham, a mess of fish, or something sitting in his back porch. I'd ask him where it came from. He'd answer, "I don't know. Someone owed me something." He died young. For more than 20 years after his death, people were still bringing stuff to my grandmother to pay their debts for their glasses that he had provided.

I learned a lot from him. I learned that you can go a long way without using paper money. Bartering works. And I learned a lot about using an honor system with those around me.

I learned about paying forward. My grandpa tested every child's eyes in our town when they first started school. If their family couldn't afford any needed glasses, he gave that child a pair so they could go to school. We had a brilliant man who used to visit us after we moved to California. He worked at the military base where they tested rocket engines and he had helped set up Radio Free Europe after WWII. He was an American native man. Every time he visited us, he would tell my little brother and me about how our grandfather gave him his first pair of glasses. His family was too poor to pay for them. He always reminded us that he could not have done anything in his life without those glasses, which allowed him to learn to read. The man's grateful humility combined with my grandfather's generosity has been a guiding light in my life.

Yes, banks borrow $ from the Feds -- which is also a privately owned bank at a lower rate and then lend it out at a higher rate. They sell mortgages to the secondary market after they "generate" them. The secondary market is guaranteed by the Federal Government -- and therefore the taxpayers. And now, a lot of that "paper" is packaged and sold on Wall Street as securities. Yes, as expressed in this thread, it's a carefully managed house of cards. Does anyone remember the 2008 melt-down?

A history lesson... During the Dark Ages in Europe, the church did NOT allow any Christians to collect interest on loaned money. One could only sell what they personally produced. They were not allowed to make a profit on anyone's work or product -- no mark-ups. They could not start a bank nor be a merchant. Jews were not allowed to own land so they didn't farm. Most Christians were farmers( serfs) who worked the land of their overlords on a share-crop basis. Only the Catholic priests were usually literate. Most kings and queens couldn't read or write. Within the Jewish faith, education was highly prized and their children were routinely educated. So the Jewish people started banks that lent money for interest. They became the professionals (doctors, lawyers, etc.) and merchants. And that, in a nutshell, is how the modern banking system was started all those centuries ago. It's also how we came out of the Dark Ages as these church-sponsored rules inflicted on their members were lifted.
 

thechosen1

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banks borrow $ from the Feds -- which is also a privately owned bank
I've heard this a lot, and the question I always come back to is - who owns the Fed?

All the Rothschild conspiracy stuff aside, this is a very convoluted and backwards banking setup, IMO.

It would appear we are all slaves to the Federal Reserve, at least on paper.
 

WJK

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I've heard this a lot, and the question I always come back to is - who owns the Fed?

All the Rothschild stuff aside, this is a very convoluted and backwards banking setup, IMO.
A very quiet group of private investors who take a nip out of dollars that they handle in our economy.
 

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