Hence the existence of a clearing house in the stockmarket: cross off debt and credit in the whole market. Every one in your story has 100 credit and 100 debt which makes them worth 0. Aligning that in the right way makes a lot of sense :-)

This is a brilliant explanation of what a clearinghouse does

First time I’ve understood it intuitively

Interestingly, the scenario does not include transaction costs. In the general sense that is money that stays in the cycle (economy) ?

To recast this in accounting terms, everyone had $100 in accounts receivable and also had $100 in accounts payable.

To anybody who has ever had accounting (and nightmares of t-accounts), this balances to zero.

But everybody also knew everyone else was broke, so they had mentally discounted the future value of their accounts receivable (though obviously not to the point of actually writing it off yet). So their subjective sense of their future worth was negative, until the stranger showed up and injected liquidity into the market.

Shouldn't their future worth still be zero? Everyone has $100 owed to them (which is never coming) and $100 that they owe (which they aren't paying).

"Alice is never gonna pay me, which means I'm gonna have to go to Bob and tell him I can't pay him back, and he'll tell everyone in town and I'll never get credit again" - a future situation with negative value.

Vs.

"I may be out of cash, but at least I'm debt free. I wonder if Carol will lend me $10?" - a future situation with zero - or maybe even positive value?

I appreciate you asking this question, as it wasn't obvious to me either

Sure, but it's not stable or dependable. If one person goes bankrupt or dies or moves away, then everybody would go bankrupt one after the other. Compare to a scenario where everyone actually is at zero.

This is how banks, and by extension - entire economies, implode when an over leveraged something fails, taking down all the other over leveraged players dependent on their success in a series of dominoes.

I saw an old PSA, maybe from the 50s or 60s, that had a similar situation (sans prostitute). The twist is, it's a paprr check instead of cash and the guy who wrote the check is broke. There's this whole chain of endorsements as the check is passed around town before it gets back to the guy who wrote it, saving him from the shame of a bounced check.

but a cheque has a giver and a receiver, the receiver cannot then give the check to someone else as payment since the giver and receiver printed on the cheque are different

Yes they can. By simply writing "Pay to the order of: X" in the endorsement area, the original recipient can create what's called a "third-party cheque". A bank would probably not accept this today, but it was certainly done in the past.

Interesting, I used to do that all the time (up until 2018 maybe?) to let friends or family cash checks for me and it worked with no problem, even though I wasn't even in the country. I just Googled it and apparently many banks still accept third party checks, although it does seem to be partly at the discretion of the bank manager and often requires both people present. Here's a decent list of banks' conditions: https://firstquarterfinance.com/where-can-i-cash-a-third-par...

That almost sounds like it's endorsing check fraud

Makes sense, all the people in town had $100 in debt and $100 in outstanding invoices.

That one is much simpler though, it's just a closed loop of people owing each other.

The interesting part is that it seems the motel owner was aware that the loop existed and would end up back with him, otherwise he would've been caught stealing from the tourist.

If he already knew this he would be able to get people together and agree to cancel all the debts, with no need for the external $100 to show up.

Getting everyone in a small community to agree to cancel all debts would be like a biblical Jubilee[0].

So it is not too far-fetched of an idea to have happen.

[0]: https://en.wikipedia.org/wiki/Jubilee_(biblical)?wprov=sfti1

In an economy which was only weakly monetised and where it would be rare to have debt tenures of more than one growing season, debt jubilees are minimally disruptive. Imagine getting a mortgage in those conditions.

Immediately following a Biblical Jubilee, a 30 year mortgage is perfectly manageable. 10 years later it is still manageable. 10 more years later, and you might want to cap it at a 25-year mortgage. 10 more years later and new mortgages don't go much past 15 years. Then there's a space of 5+ years that people can only get 10-year mortgages. Then no mortgages for 10 years. Then we jubilee and everything busts open again.

I think it would be very hard to predict all the side effects of such a controlled cycle. It's easy to predict some of the effects. But I wouldn't have any confidence in any model that purported to tally it all up without actually living though several cycles in real life.

This isn't strictly related to the biblical jubilee (wherein land ownership is reset every 50 years), but they also had debt cancelation every seven years (Deuteronomy 15). The Bible warns followers that they must not avoid lending as the seventh year approaches, calling this a sin.

Well that didn't work out too well, and at some point (end of the second temple Era, about two millenia ago) the rabbinic leadership led by Hillel invented a legal loophole to work around the law without explicitly overturning it, allowing debts to persist past the sabbatical year. To read more, search the web for "prozbol" (פרוזבול).

Anyway the takeaway is that good intentions aren't always enough, you have to think through the second order effects of the laws you create. The sabbatical year law was presumably invented to protect the poor, in effect it discouraged lending and helped no one.

It's much easier than a biblical jubilee, because all the debts cancel, so everyone gains the certainty of not having to worry about failed repayment and people only lose in proportion to their intent to default. That is probably a win for most people, and also those individuals for whom it's not a win probably have some trouble admitting that.

Link to the actual post: https://www.econlib.org/archives/2012/01/an_answer_to_a.html

This doesn't seem that puzzling to me. It only happens to work because all the debt in the whole town just so happened to form a perfect cycle, or equivalently (I think), everyone in town was owed the exact same amount that they owed. That seems exceedingly unlikely to occur and thus doesn't lead me directly to any conclusions about the absurdity of the real economy.

Not only that, in the real world the people in debt and the people they're in debt to are usually of different economic classes, making a cycle even less likely

They don't have to line up perfectly for there to be a cycle and thus some minimum amount of debt everyone has that's not real. Someone in the loop might think they owe $1000 and actually owe $900, while someone else thinks they owe $100 but actually owes nothing.

I'm not sure what you mean. Assuming that everyone knows all of their own debts and credits, then they already know their net balance. In the riddle, everyone already knows their net balance is 0, so I would question why everyone is so pessimistic about the future unless the terms of their debts are less favorable than the terms of the credit they've given out.

Here's the article[1]. It is important to note that there is no net wealth increase and the "much optimism" embodies so many unproductive value judgements.

[1]: https://www.econlib.org/archives/2012/01/an_answer_to_a.html

That’s the classic stock/flow issue.

What people forget is that values like turnover and wages are denominated in $/month not $.

Mixing up the two is like mixing up miles per hour and miles.

Not at all. I can't convert between miles per hour and miles given an interest rate.

You can convert between the two with an acceleration rate.

The rich tourist isn't even required if everyone communicated about their respective debts.

Which no one will do because you want to put on a good front.

Then why was the motel owner confident that the $100 bill would come back to him so he wouldn't be caught stealing from the tourist?

Clearly he knew this was happening.

It's not clear from the story, at best he was very much betting on it.

Because they'd all gang up on the tourist if he'd asked for his money back.

This is why the central banks have been printing money.

This is absolutely the correct answer. This joke/riddle gets to the heart of what "money is". It's a form of communication, it's merely a catalyst that enables trade.

Another way to look at it: The debt (or the $100 bill) allowed all these different professionals to offer services to each other, without a direct back-and-forth barter. If they had started with the prostitute renting the room with a $100 bill, there would have been no debt.

The reason why the physical $100 is so important (and why the Fed prints money), is that it allows for trade to occur without this accrual of debt. The existence of the debt creates the perception of risk, which prevents further trade from occurring.

It’s just double entry bookkeeping

There is no print money operation.

There is federal spending which creates net financial assets by first issuing new bonds in exchange for existing reserves and then spending those reserves back into the system.

There is swapping reserves for bonds either as they mature or as repurchases.

There is federal taxation which destroys net financial assets by draining reserves.

That’s it, there is nothing called “print money”.

There is. Interest on Excess Reserves and the Open Market Operations are all done with magic dust as input.

The creation of that money is no different from any other government spending though. Usually people call swapping bonds for reserves "printing money" (AKA Quantitative Easing) or issuing reserves without the Treasury first issuing bonds on the primary market "printing money". But there is very little difference between issuing bonds "out of thin air" and issuing reserves "out of thin air". Most notably, from the perspective of the private sector, the fact that banks can satisfy their regulatory requirements by owning bonds just as well as they can by having reserves (and the fact that they can typically swap that collateral for reserves as required directly with the Fed) means that there is literally no immediate difference between the two.

So the term "printing money" is fallacious -- either that or you must call all bond issuance and federal spending "printing money" but that would make the term far less dramatic.

Hm, yes, but ..

You're mixing up the fiscal - Treasury, bond auctions, taxes, deficit, debt service - with monetary - central bank, interest rates, reserve requirements, QE.

The Treasury doesn't have the authority to create money [0], and the Government has to pad its balance sheet with debt.

The central bank on the other hand doesn't have this requirement. (They have the dual mandate to keep PCE at 2% and keep unemployment low [at NAIRU].)

Of course this is "simply" a giant technicality, but people find it useful. (Bond auctions function as an important signaling mechanism. Also credit default swaps issued for sovereign debt, and their secondary market is a kind of useful indicator. Plus the swaps, and the interbank "overnight reverse-repos for reserves" themselves are useful instruments for managing/handling/pricing-in/reifying risk.)

Again, you're right that theoretically anytime someone says "i owe you" they are creating money. And you can run a local bank easily with a spreadsheet and a large initial equity (as criminals oft do).

[0] this might not be true technically, as they might be able to mint coins without Congressional approval and need for appropriations (and hence collecting taxes or issuing debt), but the Fed still has to buy the coins so it's again the Fed that's creating the monetary base for the coin ... ¯\_(ツ)_/¯ - https://en.wikipedia.org/wiki/Trillion-dollar_coin

In reality there is very little difference between creating money (reserves) and creating bonds. The notion that private market discipline stops profligate government spending by limiting the issuance of bonds by treasury is proven false by two things:

Firstly if push comes to shove the Fed would never refuse to honour a Treasury payment and secondly that the bid to cover ratios in bond auctions always indicate a higher demand for bonds than the self imposed/legislated constraints of congress would allow.

So the real constraint on spending is legislation, we could just as easily legislate full employment instead of legislating a balanced budget target.

What are the "reserves" made of?

Numbers.

Well the main reason they print money is so that there will be money. That's where money comes from. It's printed. Hence the pictures on it.

Most money doesn't have pictures on it.

That's a good story about how debt works. I hadn't heard that one before, thanks for that!

However it's a completely different story than the original post, which is about Amazon claiming credit for "producing value" when trading one thing for another thing of equal value.

In real life, the butcher will use the $100 to buy drugs; and the drug dealer takes the money outside of the little town. You can't have that much debt build-up in this society without previous liquidity, and since liquidity suddenly disappeared, injecting it again will not fully fix the issue.

The reserve banking system works. The problem is that once some people in the chain stop making payments, the whole system collapses (liquidity crisis). A bailout by injecting money is basically all the economic players bailing out the defaulters (ie: people who got services but didn't pay for them).

There are many things that can screw your chain: Imports (negative money), Financial institutions making profits from some schemes without injecting the money back (negative money), or your own citizens taking dollar bills outside the country (again, negative money). Injecting liquidity is not always the answer.

What was the motel owner's plan if the $100 didn't come back her way?