Saturday, November 22, 2008

Trouble at the Lemonade Stand

Sometimes it helps to illustrate a concept by breaking it down to its essential parts. A sort of elemental examination of the thing. So it is with understanding how money works - a simple illustration can make it easier to grasp a new concept. All you have to do is to learn a little of the language used to describe the new idea and you will see why this system cannot continue unless we fix the glitch in the way we create money and finance infrastructure.
There is a myth floating around, it's being repeated by some, and it goes something like this: If you borrow $100 and the interest is $50, there is a way to turn that $100 into $150 to pay your debt.
Is that true? Let's see.
To further illustrate, I recommend that the first few times through, you get two items - say, 2 chess pieces of opposing colors, or a cup and a glass, or a paperclip and a rubber band - anything small and different. These two items will represent the two main characters in this little episode: Owner and Bank. You can also add any props to this that you like, in order to make it easier to follow.
Next, get 5 small pieces of paper (Post-It Notes work well). Write "$50" on two of the pieces of paper, write "3 gallons of lemonade" on two of the pieces - with the fifth piece, keep track of who owes whom, as the story progresses. Move the $50s and the lemonade around as you follow the story and you will be confident, as you should be, that $100 cannot "turn" into $150 and this myth will be dispelled.
Ready to squeeze the juice out of this myth?
Let's start with the participants:
1. Owner - of the lemonade stand (one of the chess pieces or a cup, etc.)
2. Bank - the only place to get money, and then only as a loan (the other piece or glass)
3. Loan - $100 (the principal), to buy lemons ($50 on a Post-It + $50 on the other Post -It)
4. Interest - $50. What you owe (in addition to the $100) for borrowing from Bank
5. Debt - total of what you owe (principal + interest)
6. Teller - takes the payments for Bank
So, Owner wants to start a lemonade stand. He has no money and needs some lemons - and Owner has no debt - so he can borrow. So, he does. He takes out a $100 loan from Bank, to buy some lemons. Bank creates the new money on his computer when he enters it electronically into Owners checking account. Interest on the loan is $50 (interesting how, on even the simplest of examples, there is ALWAYS more debt [$150] than there is money [$100]).
Coincidentally, Bank sells lemons too! Owner buys $100 worth of lemons from Bank. Owner then makes 6 gallons of lemonade.
SCORE: Owner is $150 in debt, has $0 (he spent his $100 loan on lemons), has 6 gallons of lemonade (his "production"). Bank has $100 from selling lemons.
<< take a breather and re-read that if you need to - I did! Many times.>>
Owner owes $150 to Bank, so, he had better get busy and sell some lemonade! Fortunately, Bank likes to drink lemonade and buys 3 gallons of lemonade for $50 - he uses $50 of Owner's debt (the $100 that Owner borrwoed to buy the lemons) to make the purchase. Owner, glad to have made a sale, takes the $50 across the lobby to Teller. Owner makes his first loan payment of $50. Teller takes the $50 and applies it to Owner's principal. Principal payments, according to the Federal Reserve and the Congressional Research Service, are "extinguished" from circulation, so, that money is gone - it disappears, it's extinguished (it's OK to stick the Post-It under the table for now, if you're keeping track that way) .
SCORE: Owner is now $100 in debt, has $0, has 3 gallons of lemonade (his production). Bank has $50 left after buying 3 gallons of the good stuff for fifty bucks, and is cooling off, drinking the lemonade.
Owner notices that Bank is drinking the last drops of lemonade. Bank wants more. Owner offers to sell Bank the last 3 gallons of his lemonade. Bank agrees and buys the last of the lemonade for $50. Bank drinks the rest of the lemonade. Owner takes the fifty bucks, walks over to Teller and makes a payment of $50. Teller applies the $50 to principal and that money is extinguished from circulation.
SCORE: Owner is still $50 in debt, has $0, drank none of the lemonade, has no lemonade to sell, can't borrow any more because he has too much outstanding debt and can't work for the bank to get the last $50 he owes, because the bank has spent the $100 it created, on lemonade! - Owner is bankrupt. Bank has $0, drank all of the lemonade and is still open for business. But, Bank now has "bad debt" on his books and if too many lemonade stands fail, Bank may fail! Perhaps he needs a bailout. Either that or fix the problem. Which would rather see happen?
**RISK/REWARD: Owner took all the risk, did all of the work, drank no lemonade and ended up losing everything. Bank took no real risk - he created the money out of nothing on a computer in the first place, did none of the work, drank all of the lemonade and is ready to help another "customer" - provided Bank's "examiners" don't claim he has too much bad debt and threaten to close him down. Do you think Bank would ever feel pressure to "cook the books" to avoid being shut down? Naaa. If that happened, perhaps Owner would give him a "bailout"?
If that system seems just or even workable to you - STOP READING!
We cannot help you.
If that system seems unjust to you and in need of an "upgrade", read on.
Some well meaning people might say, "Yeah, well, it doesn't work like that if you pay the interest first".
Oh. OK.
Let's see what happens when the INTEREST is paid off first (you know the basics of the story, so we'll abbreviate further).
Owner needs money for lemons - borrows $100 from Bank, buys $100 in lemons from Bank and makes 6 gallons of lemonade. Bank takes the $100 in payment for the lemons.
SCORE: Owner is $150 in debt, has $0 (he spent his $100 loan on lemons), has 6 gallons of lemonade. Bank has $100 after selling lemons and is a bit parched after all the loan work - hopes he can buy some lemonade.
Owner notices that Bank is thirsty and sells 3 gallons of lemonade to Bank for $50, takes the fifty bucks, goes to Teller and makes his first payment - Owner asks Teller to apply it to the INTEREST on the loan. Because that is not a principal payment, but, instead, an interest payment, that money is not extinguished; Bank considers it "profit".
SCORE: Owner has $100 in debt, has $0, has 3 gallons of lemonade left to sell. Bank has $50 left from the lemon sale and after buying 3 gallons of lemonade, plus Bank has $50 in "profit"; mmm... good lemonade.
Bank is still thirsty and buys the last of the lemonade from Owner for $50. Owner is desperate and takes the $50 and runs to Teller to make a payment. Teller applies the $50 to principal and that money is extinguished.
SCORE: Owner is still $50 in debt, has $0, never did have any money that was really his, did all the work, has no lemonade to sell (no production) never got to drink the lemonade, and is bankrupt. Since he has no production to sell, the only thing left is to perform a service, but the money he would make would just go to pay the rest of his debt and he would have done all the work and never gotten any benefit! You can imagine that it's about at this time that some Owners walk away from this type of "deal" from Bank - when, all Owner wanted to do was make enough money for his family, his retirement and his favorite charity, it seems he ends up with nothing or worse.
**RISK/REWARD: Owner took all the risk, did all of the work, drank no lemonade and ended up losing everything. Bank took no real risk - the money was created out of nothing on the computer!, did none of the work, drank all of the lemonade, has $50 in "profit" and is ready to help another "customer" - provided Bank's "examiners" don't claim he has too much bad debt and threaten to close him down. Do you think Bank would ever feel pressure to "cook the books" to avoid being shut down? Naaa. If that happened, perhaps Owner would give him a "bailout"?.
Owner realizes that this system needs to be upgraded.
Owner supports The MINNESOTA TRANSPORTATION ACT authorizing the monetization of infrastructure (gives Bank the legal OK to make money that is not debt, whenever new infrastructure is built - like the US Constitution says, so that everyone gets to benefit).
Owner applies for financing and is approved (jobs created). He hires an authorized engineer and architect (jobs created) to design his lemonade stand. That is also approved (jobs created). He hires a contractor (jobs created) who hires a team (jobs created) to build the lemonade stand.
Bank creates new money, just like he did before, on the computer, but with one exception - Bank does not create it as a debt. It is not a loan.
Inspectors (jobs created) are on hand for the building of the lemonade stand, to ensure that it is a solid project. Owner's project is a really smart one that everyone wants to see completed and showcases his entire community as a modern, positive, forward thinking and pro American example of business - it's worth at least $200. Bank electronically deposits $200 into Owner's checking account and Owner pays his hired help. Then Owner buys $100 worth of lemons from anyone that has the best lemons. Since there is neither debt nor interest in the equation, Owner can drop the price to what it should be, instead of trying to inflate the price of the lemonade, in an attempt to get out of debt. Bank has lots of money to buy all the lemonade it wants because more people are able to pay off their loans. Owner has $100 left, and can send his children to lemonade school, with enough left over to take his spouse on a little trip and even save some money for later!
They all spend the new money that is debt free, interest free, tax free and inflation free, into the economy - where it belongs and where it stays!. After all, the people did the work, it's only right that they get the fruits of their lablor.
We call that "Clean Capitalism" because the people own the means of production (the business), the production (the stuff the business makes) and their money (the fruit of their labor). It's not Capitalism if the people do not own their money. Now, the way our current system is, we don't. We don't own our money, so we can never own the means of production, therefore, to that degree, we are not engaged in "capitalism". Do you think it's right to change that?
It's not socialism - because the people, instead of the government, own their own lemonade stands and set their own prices based on competition and the market mechanisms that hold balance in a dynamic economy. If citizens want wealth, for the first time in their life, there would be enough of it around, that if they wanted to work for it, they could have it - but no give-aways, that's not right either.
It's Clean Capitalism because the people really do own the "means of production" (their property, their businesses, and their money too!). .
Bad for families.
Bad for working Americans.
Bad for business.
Bad for banking.
Bad for government.
Every illustration breaks down eventually; this one is no exception. After all, we are talking about infrastructure and not lemonade stands, but, for the sake of demonstrating a concept, you get the idea.
A real solution who's time has come.


Dymphna said...

I'm not the swiftest knife in the drawer, but this does not make sense to me as a small business narrtive.

Let's say I invent a new widget, or even better, adapt an old widget to a new use.

I have a business plan, *some* financing, and an idea of how many widgets I am going to have to sell to break even, and how many to make a profit.

I go to the bank with my plan, my good credit history, and a breakdown of how much I will need when. The bank looks it over, approves my plan (even better, approves my plan w/ a lower interest rate if I can secure it with property, savings or have a backer).

I take the bank's money. First, I use part of the money to make the widgets, part to advertise them, and then as the business grows, part to hire more people because I have now more customers than I can handle by myself.

The business continues to grow and I pay off the loan ahead of time, opening up a money market account with aforesaid bank as a place to keep the growing funds.

If the bank happens to want to buy some of my widgets, all fine and dandy, but making them my customers was never part of my business plan.

I plow my profits back into my business and it continues to do well.

I end up with employees who are very happy to have work in an environment they enjoy.

The only lemons in the deal come in the form of stupid government hindrances like municipal, state, and federal taxes, regulations on the use of my garage as the building I use to make my widgets, and bureaucratic mindlessness like OSHA, paying unemployment tax, etc.

Because of the aforesaid lemons, I finally have to hire an accountant. The costs of doing over-regulated business include things like this that cut into the bonus I was planning to pay my employees.

Shrugging that off, I hire a business coach for advice on improving my business. Thanks to his/her mentoring, my business really increases to the point that I have to move to a larger facility.

Obviously growth brings more problems, but that's another area.

Meanwhile, the person who opened that lemonade stand should have stayed an employee in someone else's business.

How Cynthia Rubio Turned an Idea Into a Million Dollar Business

That's just one of many stories...

Money as Wealth Stories said...

Dear Dymphna:

OK. So, you missed the point a little bit (a lot). And I agree with your first statement - so let me send you the sharpener.

This should help:
1. You said you would "plow... profits back into... business"...
If you are going to "plow" profits, you are going to need some money - or, at least, someone is! In order for money to be in circulation AT ALL, it first had to be borrowed into existence. There. Are. No. Exceptions.
All money is "created by extension of credit (loans) by private commercial banks". Who says so? The United States Treasury, The Federal Reserve Bank and the Congressional Research Service said so.

The Awful Truth is that banks create ALL OF THE MONEY and they only do so when they make loans. And when they make loans, they only make the principal. Yep. So, before you can do any of that "plowing" someone is in debt. Maybe it's not you - but someone.

This is conceptual thinking and you need to understand this to understand how our monetary system works. You DO NOT need to understand it to graduate from business school and make a business plan and borrow some money and pay your bills and really start "plowin'" (Read "If Milk Were Money" on the blog's main page).

Some people can only handle a small dose of reality - I hope that is not you and I hope that you read, reread, search and research.

RECAP 1: If you "plow", it's with someone else's loan principal, because we literally use debt for money. When you have your AH-HA moment - you will ask yourself why you did not see it the first time around, but you will see it.

2. When a loan is paid back to the bank - the principal is "extinguished" (it's how they do the accounting). True story. Ask the Treasury, the Fed and the CRS - we did. They wrote us back and told us what happens to that money. Extinguished. Gone. No longer available to anyone.

So, you see, the elementary yet subtle trading at the lemonade stand, was to illustrate the difference between paying interest first, which does NOT get extinguished and is considered "profit" by the bank, and paying principal first, which does get extinguished.

If I pay interest first, and the bank keeps it as profit, then that means that I might have a chance to sell something to the bank and get some of that money so that I can pay my loan off.

You see, when banks create money, they only create the principal and NEVER the money they want back as interest - so we (We The People) are forced to use loan principal to pay interest payments with and I am sorry, you cannot borrow your way out of debt (have you watched the news lately?).

3. I agree about the government meddling. The only reason that a government, which can coin it's own money, wants any of yours in the form of taxes, is to influence your behavior. Just think about it. If you could make your own money would you need any of mine? And, ultimately, since the taxes are paid to the government - which turns around and pays the bank for THEIR debt, taxes are a form of interest collection for the banks. You should be ticked about it. Now learn about how to fix it. It's your government. If they are messing up - organize and help them fix it. It's America. Hey, the bad guys do it, time some good guys did it. Agree?

4. Help us change the law. Own your money and cut your taxes - WE THE PEOPLE don't need taxes for roads and bridges etc., like gas taxes - we can create our own money. Debt, interest, inflation and tax free. And we should.

5. Any discussion on money before this is fixed, is small talk. There is a place for that. But, we are in deep trouble here. Fresh, newly created loan money is NOT being pumped into the system fast enough and the game is grinding to a hault. But, loans are being paid off and that money is gone. The money supply is drying up. That's why they are all about "loan/stimulus/borrow/bailout". They can't get the money into the system fast enough.

Passage of The MINNESOTA TRANSPORTATION ACT will create millions of jobs, a vibrant economy, lower taxes and give us the safest, most modern transportation system in the world.

Let me know if you want to help: