Can somebody 'splain?

Way back in my long-ago childhood, Dad kept a clipping that read something like this: The rich are rich on paper, but poverty is in cash. Anyone else remember that?

Anyway, we keep hearing about the trillions of dollars lost in the current economic mess. We're treated to graphics that show piles of hundred dollar bills stacked high enough to orbit the moon or formed into bricks to build thousands of Empire State Buildings. But we were trying to figure out this morning how much of the loss is in cash, how much is "on paper". Has anyone tracked that?

I'm the first to admit to copious amounts of naivete when it comes to intricate financial stuff. But when friends in the banking biz just shake their heads and mumble, I don't feel so bad for that shortcoming. So, as for the part of the loss that is cash, it has to be somewhere. Where did it go?

If yes, who are they borrowing it from?

The US sells Treasury debt -- bonds, notes, etc. -- to anyone who wants to buy it. Currently, the Chinese are big buyers of treasury securities, but the Brits are even bigger.

The really sweet part (if dizzying) is how we use this debt to create our US dollars. It's called "monetizing the debt." If Mr. Soong in Shanghai wants to sell his $10,000 Treasury note, the Fed accepts it, says "thank you," and enters 10,000 in Mr. Soong's bank account. Presto, ten grand. It's good to be da Fed!

I mean, we have no jobs.

How does the US look like a good investment?

The usual line is "backed by the full faith and credit of the United States government." That, in turn, is an echo of "sound as a dollar."

So far, investors have maintained their faith in US treasuries, particularly if they are looking to park their money somewhere safe -- US treasuries more or less suck the least among the alternatives.

The issue of confidence you mention is right at the heart of the whole deal. You hear more talk recently, worrying "what if" -- what if all those bond holders started shifting their view and losing confidence? Financial asteroid-strike.

As shaky as their confidence might currently be, though, I suspect there's a stronger force that keeps them hanging on -- inertia. Habit. Psychology of previous investment. Literally.

Not THAT'S scary

:scared:

Thanks for the explanation!

I wonder then how this will impact other countries, especially eastern Europe.

I thought you'd have more replies than this. I've wondered the same thing, especially when I hear people using terms like "derivatives" and "financial instruments" when talking about this mess. I know that it's all causing very real and concrete problems for lots of people but at the same time there is an abstractness about it. Or maybe I'm just really dense when it comes to this stuff.

Definitely.

I've learned almost as much at DU about credit default swaps and derivatives as I have about Octomom, but I still sense there's something missing.

kick again

Say I sell you a dozen eggs and you give me a piece of paper saying "IOU for 1 dozen eggs". Later in the year you change the oil on my car. I give you back this piece of paper and 11 more saying "IOU11 dozen eggs", having come to the agreed upon conclusion that 12 dozen eggs is a fair trade for changing my oil.

You send 5 of these to your internet provider in exchange for one month's internet service, and they do something else with them then.

OK, that is the actual paper money. Now let's say I decided, in my eternal wisdom (as ruling government, queen of the universe), that I would send out another 3708678259023578475324 pieces of paper saying "IOU 1 dozen eggs" so people would have some sort of currency to trade amongst yourselves. But I don't have that many eggs. But whoah, lots of "money" out there stimulating the economy.

If people took them and used to trade among themselves, viola! (I know, voila. family joke)

At least, that is my simplistic take on money and cash.

Interesting -- your description is very similar to community currencies based on mutual credit, like LETS.

Money is just a concept, and a surprisingly simple one -- but I would add that it is also a social compact.

(family joke here, too)

That's an excellent explanation. Much like the Money as Debt videos on youtube.

I like words and word play. I am not average. Too bad for all those who are.

I always say that, I think it's a good pun. No one around me ever agrees however, they just look confused.

I always thought the word was spelled that way too, but I am always mixing up i's and other vowels, like the spelling of weird seems weird to me.

http://www.deepcapture.com/category/antisocialmedia-with-judd-bagley/

This is how I explained it to my parents:

Covered (Legal) Shorting:

Three stockholders own one share each of Widget Inc. which is valued at $100. A shortseller named Shorty believes that Widget Inc. is going to go under. He has $100. He pays $2 to Stockholder A to borrow his share which he agrees to return in a week. Note that there are now 4 theoretical shares in existence: Stockholders B & C still have their shares, Stockholder A's portfolio still shows he owns his stock of Widget Inc. even though he's lent it to Shorty. And Shorty is going around Wall Street claiming that he has a share of Widget Inc. to sell. That's four people claiming ownership to three shares. This drives down the price of Widget Inc. a tiny bit for a brief moment but theoretically, so long as everyone isn't shorting, it should all even out. Stockholder B thinks Widget Inc is doing great. He wants another share of stock. Shorty sells Stockholder B "his" stock (Stockholder A's stock) for $100. Now Shorty has $198 and no stock, but by the end of the week he has to give the note back to Stockholder A. This is called "covering" your bet. Luckily, Shorty is correct. Widget Inc. slides to $10 a share. Stockholder C wants to get the hell out of Widget Inc.! So he sells his share to Shorty for $10, who returns the note to Stockholder A. Once Shorty returns the stock to Stockholder A, there are once again only 3 shares of stock in circulation (giving the stock a little bump in value.) In the end, Stockholder A has his share, plus the $2 from Shorty (from $100 in net worth to $12 in net worth. A loss of $88.) Stockholder B has two shares of Widget Inc. Stock (from $200 in net worth to $20. A loss of $180) Stockholder C has $10 in cash (from $100 in net worth to $10. A lost of $90.) Shorty has $198 (from $100 net worth to $198 net worth. A gain of $98 dollars.)

Mind you, the upwards loss for Shorty is unlimited. If Widget Inc. stock shot up to $1000 a share he would have had to cover his bet and left with a total loss of $902. This is all legal because it doesn't really disrupt the system, theoretically. Covered shorting is not embezzlement.

Naked (Illegal) Shorting:

But the market doesn't work with people meeting face to face or an open system where everyone knows who has what. All trades go through the DTCC (Depository Trust) which reportedly holds all the records of trades on computers, but its records are secretive. (The DTCC is also protected by machine-gunned guards and it's almost impossible to get inside.) Moreover, the transition to internet trading has changed another aspect of the system--there is so much volume and it all happens so fast that no one expects to ever receive the physical piece of stock. This is how naked shortselling operates. It is termed "naked" because the seller never intends to "cover" their bet.

Three stockholders own one share each of Widget Inc. which is valued at $100. A shortseller named Shorty believes that Widget Inc. is going to go under. He borrows Stockholder A's share and sells it to Stockholder B for $100. Now four shares exist in the system. Maybe he sends the actual note. But more likely he is a trader "known" to have a lot of money and can float on his credentials. He tells Stockholder B that he has another share to sell if he wants it. He sends an IOU. In fact, because of internet trading, all these IOUs act as stock now. No one ever expects to receive a piece of stock in the mail, just like domestic airline carriers no longer send paper tickets. It's a "paperless" society. Shorty sells another imaginary share to Stockholder B at $100. Now there are 6 shares in the system. In fact, Shorty sells 1000 IOUs. He makes $10,000 out of thin air. At the end of the week, he hands the piece of stock back to Stockholder A. He keeps "borrowing stock" for the sake of keeping up appearances. Most of the time he is just borrowing an IOU anyway. There are now 1000 "shares" of Widget Inc. floating around the market instead of 3. The value of a perfectly sound company is diluted. If naked shorters hit a company with a coordinated attack, say entire companies devoted to shorting, they can "bet" that a company will fail by making it fail through selling IOUs they don't have and diluting the stock. The shorters make billions. The companies fold.

Now, imagine how much power someone like Cramer would have if he hooked up with the WSJ and the Street and they raised the price of stocks just to short them. It'd be pretty crazy. Deep capture says there's not enough money in the world to pay out all the fake stock circulating.

because most of it never existed in the form of cash.

Most of the assets of a wealthy person are typcially in the form of real estate, stocks, and other investments.

The value of those assets are simply what others are willing to pay for them. A mansion might have sold for $10M back in 2006, but now no one would pay more than $5M. That's a 50% loss even though nothing has changed about the property itself.

Same with stocks -- a share is worth a fraction of the company. Two years ago, others might have been willing to pay $50 for a share of Bank of America. Now, with massive losses and the possibility of nationalization, others would pay less than $1. While the company has certainly changed, the difference is in the outlook, expectations for the future, and the reduced amount of capital worldwide available for investing in the market.

to people who bought insurance on the housing market securities. When the securities lost money, AIG had to pay the hedge fund managers their insurance money. The hedge fund managers gave that money out to people who invested in the hedge fund. Rich people.

So rich people got actual money and will get more and more as their policies come due.

Something like that, right?

When, in good times, you would take out a loan (or use a credit card), a bank created money. They didn't go get money out of a safe and hand it to you, they issued a check (or OK'd a credit). Sure, they had to have reserves to stand behind their ability to make money, but not as much as they were making by giving loans.

Why did this work? Because we all trusted the money making. You trusted that you could cash the check the bank issued, or a merchant trusted that a credit would be forthcoming on the basis of your using a credit card. The bank trusted that you would pay back the loan (or pay back part of the credit card bill, while they charged outrageous interest on what you didn't pay back fast enough). Other banks trusted the bank making the loan, so loaned them money -- made new money to give to them as loans. It all works on trust.

When a bubble bursts, trust is gone. And when it comes out how stupidly banks were making money, on what little ultimate promise of being paid back (not just bad mortgages, but bad mortgages sliced and diced into "instruments" that those who bought them up did not know what was in them -- then there was no more trust. So, banks that have adequate reserves are reluctant to use them to make more money, to loan. And bigger banks are reluctant to loan to those banks.

All that is left is cash, and there is not enough cash to keep the economy going. And cash itself is just paper that represents -- trust. If you don't believe that, let me sell you some Zimbabwean cash. ;-)

Nice explanation!

that I shouldn't try to play poker the way these bankers conducted business, right?