What you need to know:
- Effectively, the market crashes to the extent that the perceived value of the traveller’s deposit falls from the $100 he advanced to the innkeeper to what the latter can probably raise from other debtors/customers.
- Crashes are driven by panic as much as by underlying economic factors. In our case though, it is not necessarily the pandemic that will have caused it, but rather the inability to have a compensating mechanism for the prostitute’s loss.
Last week, we met the traveller, the innkeeper, the butcher, the farmer and the prostitute who were all caught up in a web of money exchanges. The point about why the system worked for them was the fact that everyone kept their part of the bargain.
In the riddle, the traveller is the equivalent of a clearing house (read bank) in an economy. His ‘arrival’ temporarily increased the town’s money stock by $100. In effect, he has made a short-term loan of the $100 bill, thereby increasing liquidity.
The $100 provides the residents with a medium of exchange that allows them to clear their (offsetting) debts. By ensuring that the chain is not broken, his “short-term” loan has provided liquidity for transactions to the town and the exchanges that occur result in transfer of money from one person to the next at a fast rate (which economists call velocity of money).
Of course real life does not work like that. It is more complicated. The traveller (bank) in making the loan to the innkeeper would demand an interest payment (the time value of money) and the principal which is the $100 bill.
To make that interest payment, the innkeeper would expect that by the time the $100 is returned to him by the prostitute it includes the interest, his profit and of course the $100 itself. So along the chain of moving to the butcher, the farmer and prostitute there is an unspoken assumption that the $100 bill multiplies. That means along the value chain, there must be some creation of value. That cannot be explained by the riddle but at least you get the point.
What we need to understand is what happens when the chain is broken. Suppose, for arguments sake, the farmer diddles the prostitute. The latter cannot pay the innkeeper who in turn cannot pay the traveller. So the traveller must now raise hell in order to get paid. That was the point at which we left off last week.
We had arrived at a point, where because of the lockdown, many economic agents were denied the capacity to produce while being expected to pay the traveller who continues to compute interest on his $100 bill. Because the economic system begins to experience more leakages than injections, it sub optimises and the market crashes.
In the financial crash of 2008, loans were given to people who had no income, no jobs and no assets! These were called ‘ninja’ loans. The ninja loans were then securitised (converted into marketable securities for sale to other investors) and sold on to banks in countries as far afield as Iceland and the UK.
These loans became toxic (non performing) very quickly and this is what happened as the housing market collapsed. This is the risk that we too run unless we can come up with a smart solution.
The mall owner or residential landlord who has a loan is demanding for payment from his/her tenant whose little shop is closed or is now a ninja (meaning they have been sent on unpaid leave or laid off).
The bank in turn is demanding for payment from the landlord and has ingenuously offered a moratorium on the due payments. As to whether those payments will be made is another question.
Depending then on how you perceive the likelihood of the traveller (bank) being paid, you begin to reimagine his worth in terms of the former $100 which our farmer made off with.
Effectively, the market crashes to the extent that the perceived value of the traveller’s deposit falls from the $100 he advanced to the innkeeper to what the latter can probably raise from other debtors/customers.
Crashes are driven by panic as much as by underlying economic factors. In our case though, it is not necessarily the pandemic that will have caused it, but rather the inability to have a compensating mechanism for the prostitute’s loss.
Prof Sejjaaka is country team leader at Mat Abacus Business School.
[email protected] @samuelsejjaaka