A friend of mine forwarded this mail to me on what is an asset bubble or an inflated market. The reality of recession and functioning of the market economy.
Once there was a little island country. The total money in circulation was 2 dollar as there were only two pieces of 1 dollar coins circulating around.
1) There were 3 citizens living on this island country. A owned the land. B and C each owned 1 dollar.
2) B decided to purchase the land from A for 1 dollar. So, A and C now each own 1 dollar while B owned a piece of land that is worth 1 dollar.
The net asset of the country = 3 dollar.
3) C thought that since here is only one piece of land in the country and land is non produce able asset, its value must definitely go up. So, he borrowed 1 dollar from A and together with his own 1 dollar, he bought the land from B for 2 dollar.
A has a loan to C of 1 dollar, so his net asset is 1 dollar.
B sold his land to C of 1 dollar, so his net asset is 2 dollar.
C owned the piece of land worth 2 dollar but with his 1 dollar debt to A, his net asset is 1 dollar.
The net asset of the country = 4 dollar.
4) A saw that the land he once owned has risen in value. He regretted selling it. Luckily, he has a 1 dollar loan to C. He then borrowed 2 dollar from B and acquired the land back from C for 3 dollar. The payment is by 2 dollar cash (which he borrowed) and cancellation of the 1 dollar loan to C. as a result, A now owned a piece of land that is worth 3 dollar. But since he owned B 2 dollar, his net asset is 1 dollar.
B loaned 2 dollar to A. So his net asset is 2 dollar.
C now has the 2 coins. His net asset is also 2 dollar.
The net asset of the country = 5 dollar. A bubble is building up.
5) B saw that the value of land kept rising. He also wanted to own the land. So he bought the land from A for 4 dollar. The payment is by borrowing 2 dollar from C and cancellation of his 2 dollar loan to A.
As a result, A has got his debt cleared and he got the 2 coins. His net asset is 2 dollar.
B owned a piece of land that is worth 4 dollar but since he has a debt of 2 dollar with C, his net asset is 2 dollar.
C loaned 2 dollar to B, so his net asset is 2 dollar.
The net asset of the country = 6 dollar. Even though, the country has only one piece of land and 2 Dollar in circulation.
6) Everybody has made money and everybody felt happy and prosperous.
7) One day an evil wind blowed. An evil thought came to C’s mind. “Hey, what if the land price stop going up, how could B repay my loan. There is only 2 dollar in circulation, I think after all the land that B owns is worth at most 1 dollar only.”
A also thought the same.
8) Nobody wanted to buy land anymore. In the end, A owns the 2 dollar coins, his net asset is 2 dollar. B owed C 2 dollar and the land he owned which he thought worth 4 dollar is now 1 dollar. His net asset become – 1 dollar.
C has a loan of 2 dollar to B. But it is a bad debt. Although his net asset is still 2 dollar, his Heart is palpitating.
The net asset of the country = 3 dollar again.
Who has stolen the 3 dollar from the country ?
Of course, before the bubble burst B thought his land worth 4 dollar.
Actually, right before the collapse, the net asset of the country was 6 dollar in paper. His net asset is still 2 dollar, his heart is palpitating.
The net asset of the country = 3 dollar again.
9) B had no choice but to declare bankruptcy. C as to relinquish his 2 dollar bad debt to B but in return he acquired the land which is worth 1 dollar now.
A owns the 2 coins, his net asset is 2 dollar. B is bankrupt, his net asset is 0 dollar. (B lost everything) C got no choice but end up with a land worth only 1 dollar (C lost one dollar) The net asset of the country = 3 dollar.
There is a however a redistribution of wealth.
A is the winner, B is the loser, C is lucky that he is spared.
Once there was a little island country. The total money in circulation was 2 dollar as there were only two pieces of 1 dollar coins circulating around.
1) There were 3 citizens living on this island country. A owned the land. B and C each owned 1 dollar.
2) B decided to purchase the land from A for 1 dollar. So, A and C now each own 1 dollar while B owned a piece of land that is worth 1 dollar.
The net asset of the country = 3 dollar.
3) C thought that since here is only one piece of land in the country and land is non produce able asset, its value must definitely go up. So, he borrowed 1 dollar from A and together with his own 1 dollar, he bought the land from B for 2 dollar.
A has a loan to C of 1 dollar, so his net asset is 1 dollar.
B sold his land to C of 1 dollar, so his net asset is 2 dollar.
C owned the piece of land worth 2 dollar but with his 1 dollar debt to A, his net asset is 1 dollar.
The net asset of the country = 4 dollar.
4) A saw that the land he once owned has risen in value. He regretted selling it. Luckily, he has a 1 dollar loan to C. He then borrowed 2 dollar from B and acquired the land back from C for 3 dollar. The payment is by 2 dollar cash (which he borrowed) and cancellation of the 1 dollar loan to C. as a result, A now owned a piece of land that is worth 3 dollar. But since he owned B 2 dollar, his net asset is 1 dollar.
B loaned 2 dollar to A. So his net asset is 2 dollar.
C now has the 2 coins. His net asset is also 2 dollar.
The net asset of the country = 5 dollar. A bubble is building up.
5) B saw that the value of land kept rising. He also wanted to own the land. So he bought the land from A for 4 dollar. The payment is by borrowing 2 dollar from C and cancellation of his 2 dollar loan to A.
As a result, A has got his debt cleared and he got the 2 coins. His net asset is 2 dollar.
B owned a piece of land that is worth 4 dollar but since he has a debt of 2 dollar with C, his net asset is 2 dollar.
C loaned 2 dollar to B, so his net asset is 2 dollar.
The net asset of the country = 6 dollar. Even though, the country has only one piece of land and 2 Dollar in circulation.
6) Everybody has made money and everybody felt happy and prosperous.
7) One day an evil wind blowed. An evil thought came to C’s mind. “Hey, what if the land price stop going up, how could B repay my loan. There is only 2 dollar in circulation, I think after all the land that B owns is worth at most 1 dollar only.”
A also thought the same.
8) Nobody wanted to buy land anymore. In the end, A owns the 2 dollar coins, his net asset is 2 dollar. B owed C 2 dollar and the land he owned which he thought worth 4 dollar is now 1 dollar. His net asset become – 1 dollar.
C has a loan of 2 dollar to B. But it is a bad debt. Although his net asset is still 2 dollar, his Heart is palpitating.
The net asset of the country = 3 dollar again.
Who has stolen the 3 dollar from the country ?
Of course, before the bubble burst B thought his land worth 4 dollar.
Actually, right before the collapse, the net asset of the country was 6 dollar in paper. His net asset is still 2 dollar, his heart is palpitating.
The net asset of the country = 3 dollar again.
9) B had no choice but to declare bankruptcy. C as to relinquish his 2 dollar bad debt to B but in return he acquired the land which is worth 1 dollar now.
A owns the 2 coins, his net asset is 2 dollar. B is bankrupt, his net asset is 0 dollar. (B lost everything) C got no choice but end up with a land worth only 1 dollar (C lost one dollar) The net asset of the country = 3 dollar.
There is a however a redistribution of wealth.
A is the winner, B is the loser, C is lucky that he is spared.