Economics Lesson
By Pauline Yong
17-6-2009
readers. The story started with a rich tourist came to a town in which everyone
living there was in debt. The tourist put down a 100 Euro note for the hotel
owner as a deposit while he went round to check the conditions of the rooms.
With the 100 note on hand, the hotel owner quickly ran to pay off his debt – his
supplier, the butcher. The butcher received the money and he quickly settled his
debt with the pig grower. Next, the pig grower used the receipt to pay off his
debt with his supplier of feed and fuel. And this supplier ran to pay off his debt
to his creditor - the prostitute, and finally, the prostitute went to the hotel
owner and settled her debt with the hotel owner with the same 100 Euro note.
The hotel owner then put the 100 Euro note back on the counter as it was the
deposit of the tourist. The tourist decided not to stay and took his money back.
After all these drama, amazingly, the whole town is now without debt and
everyone looks to the future with a lot of optimism. In the final sentence of the
story, it says: “This is how the United States Government is doing business
today.”
“Does the story make any sense?” I’m sure most of you are pondering hard
about this story. In fact, I’m truly amazed that this little story has embraced a
number of important economic concepts that I’m going to explain next.
First, the story has brought out one major economic theory - the Keynesian
mulitiplier theory. The initial 100 Euro note has changed a number of hands,
from the hotel owner, to the butcher, to the pig grower … and back to the hotel
owner. Starting with 100 Euros, the economy has created 600 euros worth of
market transactions. In order for the Keynesian multiplier theory to function,
the initial 100 Euro has to be an autonomous (independent) injection in the
form of investment, government spending or exports to the economy. In this
case, the rich tourist’s 100 Euro note is treated as exports because the rich man
is a foreign tourist, the money is considered as an outside independent source of
injection to the economy. (For simplicity, I have left out the multiplier formula
here)
Next, we come to the most important concept of the multiplier theory that says
that the injection of money creates round after round of spending. In other
words, the cycle of ‘one man’s spending creating another man’s income’
repeats itself round after round just like the story.
But the story says each of them “pay back” their individual debt, not
“spending” as stated in the multiplier theory. I would argue that the spending
has been performed before each one received the 100 Euro note, which means
they spend first and pay later. Just like the Americans are doing now. Everyone
knows that the Americans are debt ridden, but do you know why they get
themselves into this trouble? It’s because of the borrowed money that came to
them too easily (easy credit) from wealthy lenders like China and Japan. These
trading partners are eager to sell their exports to the U.S., so in order to sell
more, they have to lend money (at low interest rates) to the U.S. so that the
Americans can have money to buy the Chinese and the Japanese goods. It’s a
vicious cycle. As the Americans increase their spending on credit, they are
getting themselves into deeper debt.
So, did the people in the town really get rid of their debt? The answer is “Yes!”
provided that they stop spending on credit. Because during each round of
spending, income is created at the receiver’s end. This means that no matter
what is the source of income (be it borrowed money or earned money), the
economy is stimulated in the form of more economic activities created by the
many rounds of spending.
The only thing I do not agree with the story is the statement “this is how the US
government is doing business today” should be “this is how the US government
and citizens are doing business today.” Because not only the government has
huge appetite in its fiscal spending, its citizens has poor attitude towards
savings too. And they all have taken the wealthy Asian (China and Japan) for
granted.
Finally, can Obama save the American economy using the trillion dollar fiscal
stimulus package? Well, I'll leave it to my readers to answer.
Happy investing,
Pauline Yong
By Pauline Yong
17-6-2009
readers. The story started with a rich tourist came to a town in which everyone
living there was in debt. The tourist put down a 100 Euro note for the hotel
owner as a deposit while he went round to check the conditions of the rooms.
With the 100 note on hand, the hotel owner quickly ran to pay off his debt – his
supplier, the butcher. The butcher received the money and he quickly settled his
debt with the pig grower. Next, the pig grower used the receipt to pay off his
debt with his supplier of feed and fuel. And this supplier ran to pay off his debt
to his creditor - the prostitute, and finally, the prostitute went to the hotel
owner and settled her debt with the hotel owner with the same 100 Euro note.
The hotel owner then put the 100 Euro note back on the counter as it was the
deposit of the tourist. The tourist decided not to stay and took his money back.
After all these drama, amazingly, the whole town is now without debt and
everyone looks to the future with a lot of optimism. In the final sentence of the
story, it says: “This is how the United States Government is doing business
today.”
“Does the story make any sense?” I’m sure most of you are pondering hard
about this story. In fact, I’m truly amazed that this little story has embraced a
number of important economic concepts that I’m going to explain next.
First, the story has brought out one major economic theory - the Keynesian
mulitiplier theory. The initial 100 Euro note has changed a number of hands,
from the hotel owner, to the butcher, to the pig grower … and back to the hotel
owner. Starting with 100 Euros, the economy has created 600 euros worth of
market transactions. In order for the Keynesian multiplier theory to function,
the initial 100 Euro has to be an autonomous (independent) injection in the
form of investment, government spending or exports to the economy. In this
case, the rich tourist’s 100 Euro note is treated as exports because the rich man
is a foreign tourist, the money is considered as an outside independent source of
injection to the economy. (For simplicity, I have left out the multiplier formula
here)
Next, we come to the most important concept of the multiplier theory that says
that the injection of money creates round after round of spending. In other
words, the cycle of ‘one man’s spending creating another man’s income’
repeats itself round after round just like the story.
But the story says each of them “pay back” their individual debt, not
“spending” as stated in the multiplier theory. I would argue that the spending
has been performed before each one received the 100 Euro note, which means
they spend first and pay later. Just like the Americans are doing now. Everyone
knows that the Americans are debt ridden, but do you know why they get
themselves into this trouble? It’s because of the borrowed money that came to
them too easily (easy credit) from wealthy lenders like China and Japan. These
trading partners are eager to sell their exports to the U.S., so in order to sell
more, they have to lend money (at low interest rates) to the U.S. so that the
Americans can have money to buy the Chinese and the Japanese goods. It’s a
vicious cycle. As the Americans increase their spending on credit, they are
getting themselves into deeper debt.
So, did the people in the town really get rid of their debt? The answer is “Yes!”
provided that they stop spending on credit. Because during each round of
spending, income is created at the receiver’s end. This means that no matter
what is the source of income (be it borrowed money or earned money), the
economy is stimulated in the form of more economic activities created by the
many rounds of spending.
The only thing I do not agree with the story is the statement “this is how the US
government is doing business today” should be “this is how the US government
and citizens are doing business today.” Because not only the government has
huge appetite in its fiscal spending, its citizens has poor attitude towards
savings too. And they all have taken the wealthy Asian (China and Japan) for
granted.
Finally, can Obama save the American economy using the trillion dollar fiscal
stimulus package? Well, I'll leave it to my readers to answer.
Happy investing,
Pauline Yong
ATRTICLES
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It is the month of August, on the shores of the Black Sea. It is raining, and the little
town looks totally deserted. It is tough times, everybody is in debt, and everybody lives
on credit.
Suddenly, a rich tourist comes to town.
He enters the only hotel, lays a 100 Euro note on the reception counter, and goes to
inspect the rooms upstairs in order to pick one.
The hotel proprietor takes the 100 Euro note and runs to pay his debt to the butcher.
The Butcher takes the 100 Euro note, and runs to pay his debt to the pig grower.
The supplier of feed and fuel takes the 100 Euro note and runs to pay his debt to the
town’s prostitute that in these hard times, gave her “services” on credit.
The hooker runs to the hotel, and pays off her debt with the 100 Euro note to the hotel
proprietor to pay for the rooms that she rented when she brought her clients there.
The hotel proprietor then lays the 100 Euro note back on the counter so that the rich
tourist will not suspect anything.
At that moment, the rich tourist comes down after inspecting the rooms, and takes his
100 Euro note, after saying that he did not like any of the rooms, and leaves town.
No one earned anything. However, the whole town is now without debt, and looks to the
future with a lot of optimism….
And that, ladies and gentlemen, is how the United States Government is doing
business today.
Below is the actual story.
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