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

[Guest-5ty5s4]

I got sucked into this quite badly when I was young. Reading all the economics books, arguing with people online about banking, going through page after page of Wikipedia, history and so on.

In the end I realized it was such an appalling waste of my time. It doesn't matter one bit what the "real way" an economy works is, nor the "correct way" a given part of it should work. It doesn't care, those in power aren't concerned, the opinion of a peasant is valuable only to him and will change nothing.

Really it's a kind of indulgence in "fake aristocracy", that because I can enjoy my time doing these academic musings, I'm not so poor. But actually I was poor, and those musings were only distractions from that.

The only thing that ever actually mattered was the size of my bank account. Not whether it's "fractional reserve" one, nor if it's "backed by gold", not if the state's policies reduce its real interest rate. All of those things are trivial and distractions to the cold hard self-responsible numbers: how much is it, how much is coming in a week.

Is it true that money should be gold? Yes, but it won't be. Is it true fractional reserve banking causes problems? No (cash reserve requirements actually arise from competitive interbank clearing needs and not from statutes as most people mistakenly believe), but so what? Is it true the state's economic policies are foolish? Of course, but not for them, so it's screaming into the wind.

Hence I think the key question is more: "how does my economy work?".

The point of the question is to uncover the best way to grow your business.

For example, my grandfather built his business primarily by doing projects for other companies and borrowing money from banks to buy equipment, real estate, and add on to our facility.

It’s important to have a plan like this and it helps if you know why it works or doesn’t work.

So no, this is not a political or philosophical question. It’s purely intended to be pragmatic and practical.

 

[Guest-5ty5s4]

Basically, the economy we have (not the one I want) is Keynesian. Inflation is the name of the game and debt is pretty much the formula.

It’s not the only way, but it works.

Now, how long that economic system can last is a whole other political debate that we really don’t need on the forum. I know I and many here think printing money Willy Nilly is stupid.

But they’re doing it. So what do you do with that information to get rich?

 

[Guest-5ty5s4]

Call your representatives. Tell him to vote for Biden on his new tax plan. Tax the wealthy. UBI BABY!!!

Lmao not what I meant, more like “use loans to grow your business.”

But good laugh

 

[Raoul Duke]

Lmao not what I meant, more like “use loans to grow your business.”

But good laugh

You can use loans to avoid paying high taxes as well.

 

[Guest-5ty5s4]

Going off of the topic of this thread, here is a very informative article that answered some of my own questions about banks and personal guarantees.

The TLDR is that if you are a small business (legal small business - does not mean you make small amounts of money since small biz can make up to mid-8 figures), personal guarantees are the norm, even if you are a C-corporation:

https://publishedguides.ncua.gov/examiner/Pages/Content/ExaminersGuide/MBL/PersonalGuarantees.htm

 

[Guest-5ty5s4]

Can you guys recommend one book that is the best in that area about economy, how it works, what happens and what to do when market crash, if money doesn't have a value, then what to do?, you can't eat gold, but people still gathering it, nonsense... inflation subject and so on...?

I haven’t read it, but I have heard that “Principles” by Ray Dalio is good.

Watch his video called “the economic machine.”

Also watch anything by Peter Schiff.

 

[Deleted70138]

Here is the question:

Printing more papers while having same amount of goods = Inflation, I understand that, but from where does the inflation actually start? - If I own a bakery, I would not increase price of a bread unless price of electricity or flour increases, but it has to start somewhere.

 

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[Guest-5ty5s4]

Here is the question:

Printing more papers while having same amount of goods = Inflation, I understand that, but from where does the inflation actually start? - If I own a bakery, I would not increase price of a bread unless price of electricity or flour increases, but it has to start somewhere.

The main place it starts is with loans. That's where the "new money" enters the economy.

Federal reserve creates money, banks lend the new money, investors/business owners borrow large sums of said money, that drives up the value of things like stocks and real estate because the large sums of borrowed money are being used to buy assets...

The higher asset values also correspond with higher mortgage payments and higher property taxes, leading to higher rents.

The higher expenses on business owners lead to raised prices, which lead to other supply chain components raising their prices, which lead to consumer prices going up eventually.

But it really all starts with printing -> lending.

Our entire economy is a giant loan.

Everything is a new loan.

Prices go up as people bid against each other using money that isn't theirs. They are buying with borrowed funds.

We can see that every time a new loan program was backed by the government, the thing the loan is used to purchase for inevitably increased in price... and much faster than things that are not bought on loans.

Houses = bought with loans
College = paid for with loans
Even medical = often financed with loans

But yes, the newly printed money enters the economy through banks, when it is lent to borrowers.

 

[Deleted70138]

Federal reserve creates money, banks lend the new money, investors/business owners borrow large sums of said money, that drives up the value of things like stocks and real estate because the large sums of borrowed money are being used to buy assets...

Why do people borrow in such a risky environment?
At least here, it's become even harder to get a loan from a bank with even higher interest rate, so unless there are some special deals to institutional investors, borrowing money to buy even riskier assets does not make sense.
Even though almost nobody can get a loan here, inflation is at least 50%, even though government is saying it's just 5-6%.

It more has to do with people with money in their hands chasing too few products.

If I had an extra million dollars, I would still buy same amount of bread and use same amount of oil on my car.
Also, can't think of any product that is in scarcity, I could buy a spaceship today if I had money. So, is it a lack of products or increase of desire that increases prices?

And container shipping from China has gone up to about 4 times where it was just heart beat ago.

This could definitely be a reason, but why would it increase price of oil? or real-estate?

 

[Guest-5ty5s4]

Why do people borrow in such a risky environment?
At least here, it's become even harder to get a loan from a bank with even higher interest rate, so unless there are some special deals to institutional investors, borrowing money to buy even riskier assets does not make sense.
Even though almost nobody can get a loan here, inflation is at least 50%, even though government is saying it's just 5-6%.


If I had an extra million dollars, I would still buy same amount of bread and use same amount of oil on my car.
Also, can't think of any product that is in scarcity, I could buy a spaceship today if I had money. So, is it a lack of products or increase of desire that increases prices?


This could definitely be a reason, but why would it increase price of oil? or real-estate?

People borrow because they must.

Inflation is a vicious cycle with debt and printed dollars.

And it makes the market “appear” to go up because all that new money eventually finds its way into assets.

 

[WJK]

Why do people borrow in such a risky environment?
At least here, it's become even harder to get a loan from a bank with even higher interest rate, so unless there are some special deals to institutional investors, borrowing money to buy even riskier assets does not make sense.
Even though almost nobody can get a loan here, inflation is at least 50%, even though government is saying it's just 5-6%.


If I had an extra million dollars, I would still buy same amount of bread and use same amount of oil on my car.
Also, can't think of any product that is in scarcity, I could buy a spaceship today if I had money. So, is it a lack of products or increase of desire that increases prices?


This could definitely be a reason, but why would it increase price of oil? or real-estate?

"Why do people borrow in such a risky environment?"

Because of FOMO... They see prices going up and they feel like they are going to miss out. They feel like everyone around them is buying and the prices are going up. It's "herd" mentality.

"If I had an extra million dollars, I would still buy same amount of bread and use same amount of oil on my car. Also, can't think of any product that is in scarcity, I could buy a spaceship today if I had money. So, is it a lack of products or increase of desire that increases prices?"

We must be living in two different world. We're experiencing a whole bunch of scarcities. I'm having a bad time getting parts and goods.

Last time I bought a bunk of building studs (294 pieces of 2"X4"X8'), I paid $3.13 each. Last week I had to pay $8.43 each. And I had two other sources that wanted $11 each. I can't get a lot of building materials that I need such as treated lumber. My current project is going to require piles of sheets of plywood. The idea of buy those stacks is scary.

I bought the last fridge and kitchen range that my appliance store has on hand. They don't when they will have more appliances. Everything is back ordered.

And that just a couple examples. What world are you living in?

This could definitely be a reason, but why would it increase price of oil? or real-estate?

We were oil independent and exporting it one year ago. Biden's policies are making us import again and causing a scarcities. As far as RE goes, people are moving out of the cities and into areas creating a pressure on those markets. The RE markets that they left have declining prices due to less demand.

It's all based upon that balance between supply, demand, and available money/resources.

 

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[Antifragile]

@Zaratustra
Interest rate monetary policy increases the value of investments, causes purchasing on credit to become more lucrative, and lowers the carrying cost of existing debt burden. Interest rate policy also inflates asset values and puts money in the hands of the wealthy, focused on incentivizing spending.

Unfortunately, there are limits. One, as we approach near zero-rates it becomes less effective.

And two, the wealthy might not spend the money and instead save or invest, which drives up the value of investments such as real estate.

Quantitative easing (“QE”) monetary policy

QE policy is for central banks to buy bonds and other financial instruments, giving investors cash in return. The Bank of Canada was soinflarge-scale purchases of at least $5 billion per week of Government of Canada bonds.

When the interest rates approach zero, the interest rate monetary policy becomes less effective. QE policy has the same effect at later stages. At some point the price for assets is too high and returns are too low to motivate spending.

Other than interest rate and QE, Central Banks can do little to effectively motivate institutional buyers to spend.

That just leaves “Helicopter money” is the idea to put money in the hands of those who need it most and will spend it.

Hope this helps you understand “why would anyone borrow”. It’s not as simple as you made it seem.

 

[Guest-5ty5s4]

Interest rate monetary policy increases the value of investments, causes purchasing on credit to become more lucrative, and lowers the carrying cost of existing debt burden. Interest rate policy also inflates asset values and puts money in the hands of the wealthy, focused on incentivizing spending.

It's morbidly funny to me that politicians simultaneously print more money, "stimulate" the economy, while also griping about the "rich getting richer."

They are making the "rich richer" through the exact process that you described.

But they act like the solution is for them to do more of the same thing that is causing the thing they are complaining about...

 

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[Antifragile]

So, during QE price of bonds will increase partly due to increased demand from central bank and partly due to low interest rate, right?

Under QE, a central bank buys government bonds. Buying government bonds raises their price and lowers their return—the rate of interest they pay to bondholders. This rate of return is also known as the bond’s yield.

Government bond yields have a big influence on other borrowing rates. Lower yields make it cheaper to borrow money. So, QE encourages households and businesses to borrow, spend and invest. For example:

• CB can buy five-year government bonds, which will lower their yield. This would be reflected in lower interest rates on five-year fixed-rate mortgages, making it cheaper to borrow to buy a house.
• Or, CB can buy long-term government bonds, which mature in 10 years or more. In this way, we can make it cheaper for businesses to borrow and grow through long-term investments.

When they give out free money an asset, does anything go as a liability on central banks balance sheet? Or is it just... Poof... "magic" money from magicland?
Even though that money is digital, do they create numbers out of thin air?

Yes, there is a liability for sure! That's why so many countries are running trillion dollars worth of debt (think USA).

Yes, the money is printed by just adding zeros on a computer these days. From thin air, yes.

When Nixon (?) abolished gold standard, there is nothing pegging USD to any value. It's just fiat. Every country in the world is fiat money today. It means you can print and then get out of "problems" through letting inflation take care of the "debt". But the message to the public must be "GDP will grow with stimulus and we will work our way out of transitory inflation". This message must be there to be re-elected.

 

[Guest-5ty5s4]

Let's set the media aside here (where they belong) and just talk about the economy. Let's pretend for a moment that you were "the chosen 1" ha-ha, to lead policy. What would you do? The hard part is that when I get a lower rate on my loans and my properties just went up 50%, it's hard to imagine that I'll take that extra money and put it into a production facility or buy enough new lambos to promote a lambo company in Italy. At some point of my wealth, I start spending less as a % of my wealth. This means that it is factually true that these policies make the rich richer. But to say that it was intentional, probably isn't right either.

The other option is what Nassim Taleb promotes - let them fail. The more you let them fail, the stronger the remaining survivors will become. But let's be real here, do you or anyone here really want to see a major and prolonged depression, with 30%+ unemployment rates etc? It might as well lead to such desperation that the USA would become like what we just saw in South Africa.

So what do you suggest we do?

I don't want to see a massive correction take place.

Nobody does.

But the can has been kicked for decades, and everybody is scared of being "the guy" with all the red numbers on their hands.

After the massive deleveraging (a la Andrew Jackson, for instance), there would be a price floor, and things would become affordable...for everyone.

It would hurt a lot, it would hurt me too, but it would make the future better for everyone.

I just find it ironic that the narrative paints this picture that THAT is the type of sacrifice being made in our economy, when in reality, the OPPOSITE is the case.

So, honestly, the best course of action may just be to "let it fail." And then regroup. With sounder economic policies.

TLDR; just do the right thing, even if it sucks in the short term.

 

[Deleted70138]

@Zaratustra I wish I had more time to dig into this with you as it's something of a hobby of mine AND predicting the direction is how I make or lose money in my business.

I highly recommend you read Ray Dalio's work, he explains it eloquently and it's available for free.

One thing to note: the USA does benefit from being a currency of choice, USD is what your country considers dominant. The biggest fear for the USA is to lose that status. Without it, inflation would be like wildfire. Wealth would be obliterated. And China is trying to do just that. They never followed "the rest of the world" in terms of letting their currency float and be market driven on exchange rates. They decide what it is. Lots of hate because of this behaviour. No one else could get away with that (especially your country, being smaller).

We could write a book on this topic alone.

Thanks for your responses and recommendations. Asking every question that comes into my mind is the only way for me to get an education, as I have not had any.

 

[Antifragile]

@WJK
People’s memory in financial markets (economy) is so short that most think of 2008 as some distant past! It’s not that distant. And the next one isn’t that far out.
But I disagree with @thechosen1 - I don’t think USA is being evil, humans are just being humans. When a lion hunts, is it evil to the prey? We humans are just another type of animal and our behaviour is predictable. Sometimes very evil, but not with monetary policy, at least I don’t think so.

 

[WJK]

@WJK
People’s memory in financial markets (economy) is so short that most think of 2008 as some distant past! It’s not that distant. And the next one isn’t that far out.
But I disagree with @thechosen1 - I don’t think USA is being evil, humans are just being humans. When a lion hunts, is it evil to the prey? We humans are just another type of animal and our behaviour is predictable. Sometimes very evil, but not with monetary policy, at least I don’t think so.

The cycles are predictable for the most part. The economy has a heart beat and it repeats itself over and over again. I spend a lot of my time listening to that rhythm. I try to always play against the market. When everyone is buying, I'm selling and so on... I don't try to wait for peaks and hit them perfectly. It's like with hand grenade or playing horseshoes -- close is good enough for me. The market moves too fast and I don't wanna miss the whole thing.

 

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[Antifragile]

The cycles are predictable for the most part. The economy has a heart beat and it repeats itself over and over again. I spend a lot of my time listening to that rhythm. I try to always play against the market. When everyone is buying, I'm selling and so on... I don't try to wait for peaks and hit them perfectly. It's like with hand grenade or playing horseshoes -- close is good enough for me. The market moves too fast and I don't wanna miss the whole thing.

You are wise!
We do the same thing. Always in the market but fluid between aggressive and defensive action. When everyone is buying, we tend to sell more than buy but still look for hidden gems.

 

[Antifragile]

Thanks for your responses and recommendations. Asking every question that comes into my mind is the only way for me to get an education, as I have not had any.

I still plan to come back and answer questions. For serious responses I tend to need a computer as opposed to my phone. Easier to type… but don’t have the time ATM.
Good on you for asking questions! Best way to learn.

 

[Black_Dragon43]

Have you read or watched Ray Dalio?

View: https://youtu.be/PHe0bXAIuk0


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

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).



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.

 

[Black_Dragon43]

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

You pay it back through your increased productivity?

 

[Guest-5ty5s4]

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.

 

[Guest-5ty5s4]

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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[Guest-5ty5s4]

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.

 

[Guest-5ty5s4]

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]

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.

 

[socaldude]

I’ve always wondered how the economy would work if the US government printed its own money over at the US treasury.

I guess printing money and buying government bonds is the only way to pass the risk on to taxpayers.

Even all throughout history wealthy families would bail out bankrupt governments.

Banks would have to go full reserve banking and taxpayers would pay less taxes.

 

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[Guest-5ty5s4]

A very quiet group of private investors who take a nip out of dollars that they handle in our economy.

On further reading, it looks like it's owned by the largest member banks, like an MLM or hierarchy of banking.

 

[socaldude]

try this youtube link for Money Masters 1994 for more information

View: https://www.youtube.com/watch?v=1t0CkzD-Bv8

Bill Still is good. He was a presidential candidate in 2012. I think he ran as an independent. He is very smart and very knowledgeable about how Washington works.