It never ceases to amaze me how many people I know don’t get this. How does the economy work?
- You put money in the bank.
- The bank loans (invests) your money to others (debtors) by charging interest.
- When payments and interests are paid, everyone makes money (banks more than you).
- If the debtors fail to make these payments, the bank loses money but still owes you, making up the difference with assets gained from other investments.
Simple, right? So what’s happening now?
- Too many debtors can’t pay back loans (a default).
- The bank may not have enough assets (at the moment) to cover everyone who has money in the bank.
- People withdraw money because they fear the bank won’t be able to cover their assets.
- Because more money is being taken out than is available to cover the debt, the bank fails and closes, causing the very situation to occur that everyone was afraid would happen.
So what is this credit crunch? Why are people afraid businesses are going to fail?
- Both people and banks are afraid to invest money to give for credit and loans.
- If the banks have no new money coming in, there’s no money to loan for purchases.
- If consumers can’t borrow money to make a purchase, they may not buy anything at all.
- If no one is borrowing or buying, there’s no way for the banks to make money or business to keep selling.
Which brings me to the point. No one wants to be the last person standing without a chair (read: “golden parachute”) when the music stops (everything closes down). So how exactly was a $700 billion… I’m sorry, $850 billion “stimulus package” suppose to fix anything?
- If banks and investors believe more money is coming in, maybe they’ll stop taking their money out.
Nope, it didn’t happen. All anyone can do is let it fail and have everyone hold onto everything they’ve already got really tight until the smoke clears, kind of like a economic hurricane. The ones with assets and cash (read: liquidity) to re-invest in what ever is left and can buy a lot of tangible stuff for really cheap prices. Then what happens next?
- It starts all over again!
Orignal From: Weathering an Economic Hurricane