Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Strategies & Market Trends : Booms, Busts, and Recoveries -- Ignore unavailable to you. Want to Upgrade?

To: Moominoid who wrote (68793)	1/3/2007 11:44:36 AM
From: Maurice Winn	Read Replies (1) \| Respond to of 74559

David, a bank could take a gold deposit, say a 1kg bar from a time travelling Aztec who wanted it in safe-keeping for 20 years. The bank would issue said Aztec a piece of paper saying, "This certifies that AZ has 1kg of gold on deposit". They put a sign in the window saying "Who wants to borrow some money at 10%?" J6P thinks, "Well, I have been saving a stash of gold with which to buy a house, but at the rate I'm going, it'll take me 20 years to buy a shack". So he pops into said bank, Azzie Bank, who ask him how he'll repay the loan and what can he offer as collateral. "I have been working flat out and my job is very stable. I can pay 20% of the price of the house already, so as security, you can have a mortgage over the land and building and be quite secure as I can't imagine house prices falling 10% let alone 20%" Sold! So AZ moves into the house and the builder gets a piece of paper from Azzie Bank saying he owns 1kg of gold. AZ goes to work and starts paying the loan, using pieces of paper from other banks [who also have lumps of gold in their vaults] saying he, the bearer, owns gold. AZ works hard as he wants to pay the minimum interest to reduce his total work. He invents some software in the evening and it sells like hot cakes. AZ gets lots of paper from other banks saying he now owns gold at their banks. So he gives those papers to Azzie and repays the loan after one year instead of his planned 20 years from his drain-laying job. Now, he is free and clear. He has a house, the builder has 1kg of gold, the bank has 1 kg of gold and the original depositor has 1 kg of gold. The builder's gold is actually held at another bank which gave AZ the paper which AZ used to pay Azzie. As you can see, credit has been created, with each credit backed by a chunk of gold. The gold has just sat in a vault. Meanwhile, somebody else had gone in to borrow some money, and Azzie, figuring that AZ was repaying the loan really quickly, decided to write a piece of paper saying "The Bearer is the holder of 1kg of gold at Azzie Bank". They loaned it to the borrower who wanted to buy a swanky new Rolls Royce so they'd look good while selling software. Azzie crossed their fingers and hoped that AZ would indeed work hard and pay off the loan so that they would soon have paper from other banks so that the latest loan is good. Sure enough, AZ paid on time and meanwhile, Azzie was getting 10% from the Rolls Royce buyer even though they didn't have any gold to lend. Azzie figured the loan was good because software is very popular and a Rolls Royce is as good as gold. That was so much fun and so profitable that they did lots of it. Sure enough, the payments and profits came in and pretty soon the bank was rolling in paper and people were out there buying houses, car and trim soy lattes flat out and having a lot off fun. There was credit being issued when there was actual gold backing each loan. When Azzie issed paper for phantom gold, that's when the fun started. You know what happens one day. Yes, there's a run on the bank, all the loans are called in and we see who has been issuing lots of unbacked paper with loan times not matching up. As Warren Buffett says, "It's when the tide goes out we see who isn't wearing any togs". Mqurice