Day 12: How the Economy Works: The Merry-Go-Round

Yesterday, I invited a couple of real estate agents to perform an appraisal to our house. After two years of home-ownership, they told us that the house value has increased by 27%. Well, actually that’s our conservative number. They predicted a more upbeat number of 35%. So there we were, woke up one morning, and poof! We’re $70,000 richer. Not a bad day, eh?

A "dizzifying" merry-go-around we're riding here.

The national real estate institute released the median house price data in Melbourne recently which shows an increase of more than 18% since early 2009. Amazing!

All this talk made me think about how you can create money out of thin air and change the mood of the economy. The idea is wild, but that’s what keeps the economy going.  Money is an idea. Think about the billions of dollars created and lost in the share market every day. Sometimes it is hard to imagine how the value inflates and vanishes behind the complexity of the market; unless you worked for Enron.

To illustrate how ridiculous it can be, here’s a story from D. Wright about how imaginary money could change the economy of a little town. I might have changed some minor details since I read it a while ago, but the main idea stays the same.

There was a little tourist town in a remote area of Australia. Due to global crisis, the business has been down and people are feeling the pinch. One day, a tourist from overseas visits the town. He enters a hotel and pays $150 for a room. The hotel owner hands him the key then he walks to his room. The hotel owner runs to the local butcher and pays him the $150 he owes for the food supply.

The butcher then visits the local bar owner and pays him with the same $150 for the tab he’s been keeping for the past month.

The bar owner uses the $150 to pay his debt to his brother.

The brother decides to use the money to pay the prostitute whose service he has benefited from in the past; no judgment.

Finally the prostitute visits the hotel owner and pays him $150 for using his hotel room last week.

A few hours after he checks in, the tourist complains about the condition of the room and demands for his money back. The hotel owner complies. The tourist is gone and keeps his $150 but the town feels a little bit more optimistic than before. Bear in mind that nobody in that town is richer, but at least five people in that town have benefited from the “short-term loan” provided by the tourist even though none of them keeps the money.

And that’s how the economy works… unfortunately.

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Comments
6 Responses to “Day 12: How the Economy Works: The Merry-Go-Round”
  1. theruffstuff says:

    Did the tourist complain because the prostitute had left the room in a bad condition, or because it didn’t come woth a prostitute?
    And where is this town?
    🙂

  2. Bytta says:

    Errrr… uncomfortable 🙂
    I will send you the longitude and latitude coordinates of that town on email.

  3. Hi Bytta,
    that’s a great explanation of how the economy works, thanks for that.
    Thanks also for stopping by my blog. I agree, it’s so hard to find other Aussies who are writing about finances, and so much of what the overseas people write about doesn’t apply here. I’m loving your blog, by the way, you’re very inspirational. I’m also in Melbourne, working in the city (at the moment) and living in Croydon area. It’s really nice to find you 🙂

    Nicky

    • Bytta says:

      Hi Nicky,
      Thank you for your visit and your kind words.
      I’m working close to city area too. It will be great if we can gather other Aussie personal finance bloggers and make a strong community; ultimately providing a voice in the finance area that is not influenced by the big financial companies.
      Great to find you too.
      Cheers,
      Bytta

  4. That’s a great story, Bytta! It’s also another reason to pay attention to cash flows, whether its for a company you’re interested in investing in or for your own budget. The hotel owner can show a profit but has no cash, and we can find ourselves in the same position if we’re robbing Peter to pay Paul at the end of each month. Bills get paid but you have no cash.

    If I ever have the opportunity to teach business classes again (I taught a few courses for a small local business college a few years back) I will definitely use this story.

    • Bytta says:

      Hi David,
      Thank you. I read this story a while ago and like it too. I also suspect that it would not be as memorable if I deleted the prostitute part 🙂 kidding… but true.
      This mechanism is practiced from the top down; government lends to big corporates, which then lend to small businesses and individuals, then we pay tax back to government. We borrow from each other and in the end, it’s just money going around. If you have cash left, then you will survive and thrive.
      Thanks for including me in your blogroll too.

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