How a stimulus works…

Something I just read and would like to share….

It is a slow day in the small Saskatchewan town of Pumphandle, and streets are deserted. Times are tough, everybody is in debt, and everybody is living on credit.

A tourist visiting the area drives through town, stops at the motel, and lays a $100 bill on the desk saying he wants to inspect the rooms upstairs to pick one for the night. As soon as he walks upstairs, the motel owner grabs the bill and runs next door to pay his debt to the butcher.

The butcher takes the $100 and runs down the street to retire his debt to the pig farmer.

The pig farmer takes the $100 and heads off to pay his bill to his supplier, the Co-op.

The guy at the Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has had to offer her “services” on credit.

The hooker rushes to the hotel and pays off her room bill with the hotel owner.

The hotel proprietor then places the $100 back on the counter so the traveler will not suspect anything.

At that moment the traveler comes down the stairs, states that the rooms are not satisfactory, picks up the $100 bill and leaves. No one produced anything. No one earned anything…

However, the whole town is now out of debt and now looks to the future with a lot more optimism.

And that, ladies and gentlemen, is how a Stimulus package works

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6 thoughts on “How a stimulus works…”

  1. There’s a problems with this.  The tourist shows up broke but armed, and first thing he does is he appropriates thirty dollars from each of the hotelier, the butcher, the farmer, the co-op guy (what does he *do?*), and the hooker.  He places fifty in his pocket and presents a hundred to the hotelier “just for now”.  The hundred dollar bill blows off the counter and down the street, stimulating the magic dirt in the good town of Pumphandle.  The tourist hits the road — he has three more towns before sundown.

    For a long time, no more tourists came.  “Just this once” they all told themselves.  Then another, until finally it was daily that another tourist, sometimes two would ransack the peoples’ homes for cash and repeat the charade at the hotel counter.

    Years later, the butcher picks up the original tattered hundred dollar bill from behind a post.  Nobody will give him more than $80 for such a sorry specimen.  Tourists won;t even accept it.  Bacon at the hotel is a thing of the past.  The co-op guy (what *does* he do?) has meanwhile convinced himself that he and his girlfriend don’t have to pay back the hotelier, as really, “we just owe the money to ourselves anyway.”  Charlene does not appreciate being called a hooker, thank you very much — does a hooker have a nice $80 dress like this?

    Forty years later, the tourist’s son shows up at Hotel & Son with a brother, a seamstress wife and three children, and an IOU from the hotelier’s father for around four hundred dollars after interest.

    And that, my friends, is how revolutions get started.

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  2. Let’s think about this example for a second.   Apparently, in the recent the past in Pumphandle, there was borrowing that resulted in 500 dollars worth of real economic activity.   

    The butcher provided  meat worth 100 to the hotelier.

    The pig farmer provided meat to butcher – 100

    Co-op provided supplies to pig farmer – 100

    Prostitute provided … services… to the CO-op Guy   – 100

    Hotelier provided lodging to the Prostitute – 100

    Economic activity = 500

    we are told in the example that this was all done on credit. So…

    Debt = 500

    Now there is additional borrowing from an external source … the hotelier “borrows” the 100 from the tourist.

    This allows the original 500 debt to be retired AND the new, external debt to be repaid.   

    We end up with 500 of economic activity and zero debt!

    If this is how it works, then stimulus sounds pretty good.    

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  3. Ed K:
    Let’s think about this example for a second.   Apparently, in the recent the past in Pumphandle, there was borrowing that resulted in 500 dollars worth of real economic activity.   

    The butcher provided  meat worth 100 to the hotelier.

    The pig farmer provided meat to butcher – 100

    Co-op provided supplies to pig farmer – 100

    Prostitute provided … services… to the CO-op Guy   – 100

    Hotelier provided lodging to the Prostitute – 100

    Economic activity = 500

    we are told in the example that this was all done on credit. So…

    Debt = 500

    Now there is additional borrowing from an external source … the hotelier “borrows” the 100 from the tourist.

    This allows the original 500 debt to be retired AND the new, external debt to be repaid.   

    We end up with 500 of economic activity and zero debt!

    If this is how it works, then stimulus sounds pretty good.    

     

    If.
    In fact, there was zero net debt and zero net productivity.
    Another way to look at this is to say that stimulus only solves imaginary problems, and only breaks even when you ignore the tourist’s expenses in travel.

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  4. I’m not seeing the  “no net productivity” part.    The initial  round of credit/borrowing indeed resulted in productive activity.

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  5. Ed K:
    I’m not seeing the  “no net productivity” part.    The initial  round of credit/borrowing indeed resulted in productive activity.

    Net.  In order for the logic of this homily to work, this should be a closed system.  Each “loan” was exactly offset by activity somewhere else in the system, but each activity in the system was consumed by an individual who took out a loan.  To make this thing more tractable, let’s say that there is only the hotelier and the butcher.  Each borrows a hundred dollars from the other.  Whether that borrowing is of goods, cash, services, or any combination, it’s obvious that there is no net economic gain.

    But they are both very busy.

    Yet another way to look at this is that no money was actually necessary — just somebody who knew basic math.  This contrived solution is only applicable to equally contrived problems.

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  6. Haakon Dahl:
    Net.  …  Each “loan” was exactly offset by activity somewhere else in the system, but each activity in the system was consumed by an individual who took out a loan.

    Exactly.  Not to over-analyse what is a humorous story, but this illustrates the principle of basic classical economics that all forms of token money (as opposed to money with intrinsic value) are debt owed by one party to a counterparty.  At the time the story begins, all of the economic activity supposedly “created” by the “stimulus” had already occurred.  Each transaction was done on credit between a supplier and a consumer.  Before the tourist arrived, the net debt in the system was zero, because every party’s debt was equal to a credit owed them by somebody else.  All the tourist’s banknote accomplished was to create a means to net out these debts and credits without getting all of the parties together at the same time in one room and settle their mutual accounts.

    This is a fundamental function of money: it allows settling accounts for widely disparate things which it’s unlikely two individual parties would ever want to barter: for example, orthodontics and shoelaces.  Further, it provides a means of time-shifting settlements for transactions so they don’t have to all occur simultaneously.

    Here, there was no stimulus at all: just a mutual settling of accounts.  After that had been done, nobody was any wealthier or poorer than before, nor able to create any economic activity they couldn’t previously have done.

    The concept of government “stimulus” is generally based upon the idea of the Keynesian multiplier, which argues than injecting one unit of new currency into an economy stimulates more than one unit of economic activity.  There are both theoretical and historical reasons to believe that this does not work (if it ever did at all) when the amount of debt in an economy means that participants cannot further leverage their positions.  The colloquial phrase for this is “pushing on a string”.

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