The

Public First Program

with

Shane Elson

 

email Shane

+61-3-5952 5780

+61-4-1349 7828

Sept 2008 # 2

(Right Click here to download Audio - MP3)

Back to Editorials 2008

Finance for Dummies

Here’s how economic life works. 

You want to buy something and I own or make what you want to buy. You don’t have enough cash at hand to pay for it. In order to obtain enough ready cash to purchase my product or good, you go to a bank and get a loan. This is called ‘being practical’. 

The bank gets you to sign a contract. Now, in the real world a contract is a document that sets out agreed terms that both parties negotiate. When you go to the bank, the real world stops at the door and you enter a parallel universe in which negotiated contracts with mutually agreeable terms do not exist. This is called ‘the invisible hand of the market’. But, seeing as how you really want what I have to sell you, you sign the contract and the bank raises a debt. This is called ‘debt financing’. 

The place it raises the debt from exists in the same parallel universe as the one that the contract came from. When you look at the contract you realise the loan will cost you over three times the amount you actually need to pay for the product or good you want to purchase. When you realise this you are meant to get a warm a fuzzy feeling inside, safe in the knowledge that the bank is as ‘safe as houses’.  

While you make your way back to my store, the bank is entering this new debt into its system. Having found that, at the present moment in time, you are fully capable of meeting the repayments, it classifies your debt as ‘Triple A’ rated. The banker knows that the product you are purchasing could not be insured or sold for the value of the debt so have written into the contract early termination or payout fees. They send the contract off and make an offer for your debt to be taken over by ‘the market’. This is called ‘business sense’. 

Across the highway or byway, a worker in an office reads the bank’s electronic communication notifying him that you have agreed to pay back a sum equivalent to three times the cost of the current purchase price. They realise that, over the life of the loan, they will potentially have two thirds of the cost of the loan to play with … I mean invest. This is called ‘an opportunity’. 

Back in the real world, you come to my business and purchase the goods or service I offer. I see that you’re all cashed up with a pre-approved loan. You try to beat the price down by saying that, with cash, you should get a discount. Of course, like the bank, you have now entered another parallel universe. In this one, I can’t offer you a discount because to do so would create a ‘distortion in the market’ by exposing the true cost and profit margins of the goods or services you want. So no, I won’t give you a discount but I will throw in a free meal and movie ticket. This is called a ‘purchase bonus’. 

While you’re sitting down enjoying the meal I place an order with my supplier. He checks my recent purchase history and notes that I am ahead in my monthly repayments and that I qualify for a free, all expenses paid trip to Hawaii. He tells me the good news and says the goods or services will arrive within the week. My supplier then rings the manufacturer to tell them I need another good or service. This is called ‘the wheels of commerce turning’. 

While you are watching the movie, the manufacturer is finding that he needs new machinery to make the goods or service that you ordered. He goes to the bank and asks for an extension on his current overdraft. The bank says that will be fine but the extension will increase his repayments. “Sure.” He says. “Things are looking up. No worries”. He then goes back to his factory and starts making your order. He gets his wife to book that trip to France and buy that new car she was eyeing off. This is called ‘an optimistic business outlook’.

By the end of the movie, the guy in the office of the company across the highway or byway has sold your debt – the extra two thirds of the amount you will pay back over and above the cost of the goods or service you purchase – to an investment broker. Over at the investment house, the bloke who receives the debt makes an informed decision on the best way to take this debt and turn it into a Ferrari. This is called ‘market speculation’. 

By now you’re on your way home from the free meal and movie. By the time you get home you are feeling rather queasy. By the time the sun rises the next day, you feel like death warmed up but struggle off to work. By the end of the week you are dead. That’s called ‘bad luck’. 

I try calling you to let you know your goods or services are ready to be collected. I can’t get through. After a week I give up and sell the goods or services I had ordered for you for less than half the cost we had agreed on. That’s called ‘a discount sale’. I don’t lose anything, nor does my supplier or the manufacturer. That’s called ‘market forces’. 

When the bank finds out you died, it seeks access to your estate to recoup the debt you left behind. Eventually it is able to get some of the debt. This is also called ‘bad luck’. However, the two thirds of the money you would have paid back is still being churned around the financial markets. This is called ‘market strength’. 

In about 10 years time, it will become apparent that you and hundreds of thousands of others just like you aren’t actually paying back any money. Some have died. Some have won the lottery and paid off their loan early. Others have given up and gone broke. While the banks have sold off your and their assets the amount raised doesn’t even cover the first third of the debt. This is called ‘market equalisation’. 

By the time the investment advisors and speculators realise they have no cash to pay out their debts, it will be too late to do anything about it. However, because there is still some real cash floating around, the investment advisors and the speculators decide they should retire and claim their pensions and superannuation in cash. They get out of the market just as it begins to fail. This is called ‘a market adjustment’. 

By the time all the people who are affected by this situation realise that their dollars are worth nothing and that they no longer have anything of any value, the investment advisors and speculators will have long gone. You will be little more than a vague memory to just a few people. This is called ‘a shame’. 

Just as people begin to realise that, in market terms, ‘they have been screwed’, the government will step in and say it has devised a ‘rescue plan’. It will pump millions of dollars into the banks so they can pay off the two thirds they owe to the investment advisors and speculators. This is called a ‘wise fiscal rescue plan’. This creates what is known as a ‘bounce’ in the markets. This is because the investment advisors and speculators are bouncing up and down for joy as they realise they don’t have retire and live off the cash they have squirreled away. Now they can go back to work. 

Meanwhile, your children see one of my advertisements and decide they want to buy what I’m selling ...

 

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