Monday, October 11, 2010

Pen Meets Paper Oct. 11'10

Opinion by Helge Nome
Most people, even very well informed folks, develop a glazed over look when the subjects of economics and finance rear their heads. And, quite naturally, that’s because most of us have never learned too much about these subjects in school, or even university. At the same time we are bombarded with daily reports from markets involving trading of commodities, shares, currencies and the like, along with comments by all the “experts” who portend to know what is going to happen next. However, from experience we know that most of these people, in spite of all their prolific verbiage, are plain wrong most of the time. For example, none of the members of the prestigious “London School of Economics” predicted the financial crunch of 2008, even though bursting credit bubbles have occurred for the last umteen hundred years at regular intervals. The privilege of forecasting the 2008 event was left to “Dr.Doom” characters like economists Nouriel Roubini, Steve Keen and some others.
As it turns out, economics and finance are not really that complicated when it comes down to the nitty gritty. It ultimately comes back to an exchange between human beings of what is considered to have some kind of value. In the past a convenient way of doing this was by way of coins, made from metal considered to have intrinsic value, like gold and silver. Ownership of coins would be exchanged for ownership of a commodity or the provision of a service.
Very early in human history, however, the use of a “promise to pay”, instead of payment itself, was used in acquiring goods and service. And in our modern world, 97% or more of what we call “money” consists of “promises to pay” rather than coin (and bank notes for larger amounts).
So, if I am a fire wood provider, for the sake of simplicity, and want to buy some needed supplies from someone who does not need firewood right now, I could issue a promissory note, or “I Owe You” to that person and get what I need in return right now.
This is where it can get interesting: What happens if I keep issuing IOUs against firewood that has not been cut yet? And keep doing it? And then someone else creates bundles of these IOUs by putting string around them and makes up new IOUs as if the bundled IOUs were firewood in themselves?
At this point, any thinking reader will have figured put that the bundled IOUs are really only good for exactly that: Firewood. And they literally started a fire under the 2008 debt bubble, bursting it in short order.
This is what the great economists of our time could not figure out. The ones who advice our Queen, Elizabeth II, on economic matters. Advice: Hang on to your silver and gold!

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