The United Isle of Absinthe (UIA)
I’m not going to conclude anything for you. I’ll just tell you a story: you draw your own conclusion. I’ll explain how the financial system works and why are we in crisis.
Let us assume we – Me, You and John Smith – flew on an aircraft over Pacific Ocean. On the way we three get drunk on absinthe. We break off the door of the toilet. For this they throw us in the sea through the emergency exit. Luckily enough, next to the point of our impact was a small nameless Polynesian island. After being washed to the coast, we consulted, and decided to consider this island a new state: The United Isle of Absinthe (UIA).
When they threw out us of the aircraft, naturally our luggage did not follow us. So, our only material and tangible asset is the toilet door, which You managed to keep with you. And in spite of the absinthe, you prove to be thriftiest – you have £100 with you in your wallet.
This is our economy. We have one real estate asset – a door, worth £100. With Your £100 our national assets total £200.
When we sober up, we decide that it is necessary to settle in somehow. The fastest of us proves to be John Smith. He is a man of work: he can’t just lie down and not do anything. He declares that he has created a bank and it is ready to take our money for 3% interest.
You give him the £100 and he writes it in his notebook into articles of “Liabilities ->Debits”. But I, who wasted my time learning about the financial world, know how to get that £100 and the door as well. I propose to You to borrow £100 from you for 5% APR. I pull out a page of my notebook and write on it, “Promise for £100 at 5% APR”.
You think that you have got lucky. You withdraw your money from John Smith’s bank and you lend it to me in exchange for my Promise.
I take your £100 and deposit it into John Smith’s bank.
Obviously it’s time for us to stop, go shake a palm tree to get some coconuts, or dive to catch couple of crayfish, or work out what to eat tomorrow.
If you think so, you don’t know Me! While I was walking across the island, 50 steps to the north and back, I created a genius financial scheme!
I approach You and tell you how you can earn 1% more annually out of nothing. All You need to do is to borrow money from Smith’s bank at an interest rate of 4%, and to purchase from me one additional Promise with 5% APR. Simple!!! Right?
I write on a page of my notebook the second Promise of £100, and I wave it in front of your nose. You don’t have to think longer than a second. You run into the bank and borrow £100 under the guarantee of my first Promise of £100. The money is there: I placed it there as a deposit. You lend me the borrowed £100 and hide the second Promise in your wallet.
Now You have £200 of my Promises: the first is now in John Smith’s bank, and the second is in your wallet.
I return the £100 into Smith’s bank as a deposit, and I have got £200 in the bank. Do you think I will stop? You wish! I already wrote out a third Promise for you …
In the evening, after ripping all pages from my note book of Promises, we have the following picture: You have £5000 worth of my Promises, while I have £5000 deposited in John Smith’s bank.
Now, I feel, is the right time to get Your door! I propose to purchase it from You for £100. But You are the clever one. There is only one door, and you are asking £1000 for it. £1000! Who cares? I have £5000 in the bank! I ask the bank to transfer £1000 from my deposit account into your account, and I take away Your door.
If our bookkeeping reached an economist who graduated from Oxford, he would say that the economy of UIA has £1000-worth of real-estate assets – the door -and £10,000 in financial assets in the form of Promises and Deposits. So, the value of our national assets increased by more than 2200% in one day!
A less well educated person would say that we are three morons, given that all we have is one door, which didn’t increase in value, and £100 in cash. Only complete idiots would spend the whole day playing with pages from a notebook instead of collecting coconuts and making fishing nets. Which of them is right? You decide…but this is the system we live in.