The Current Financial Crisis

The stocks are down. Banks go bankrupt. It just proves what I always knew: this system does not work. Does not work over long-term. Works fine short-term, for a few years, maybe decades. I am not a financial expert, just one of those laymen people who claim to know it better. But I know something about closed systems, mass and energy conservation, and all those formulas and equations which come from physics and which describe the world. Why should the financial/economic sector be exempt from these physical rules?

It always has bothered me that the world economic system is based on "growth". The economy always has to grow, otherwise there is gloom. Why? I could envision a stable non-growing economy... but evidently this does not work. And I actually understand why such a stable economy cannot work: consider a "closed system", one with no inputs or outputs, and consider just all the people in this system. Just let's say that the world is a closed system, for simplification. Everybody needs to earn a salary, for living. The sum of all salaries in any given year need to be paid from somewhere. This means that all the whole economy needs somewhere to come up with those salaries: someone needs to pay them. These salaries usually are among the expenses of businesses, which need to be offset by income. That is, all the businesses in the world together need an income that is at least as large as all the salaries together - otherwise these salaries cannot be paid. Under the "business categorie" I here include also government, whose income is taxes, and whose expenses are salaries of their employess and of course other expenditures. Now here it where I struggle: I understand that all the salaries must come from income of the business. But where does the income of those businesses (including the tax revenue) come from? Of course it comes from consumer spending. From all those people spending their earned salaries, and basically giving them back into the economy where companies use them to make profit. Of course, there are several intermediate players, e.g. companies who do not sell to private consumers but to other companies. But the sum must still remain the same, as these companies also have empoyees to whom they pay a salary, and the products are paid for by other companies who get their income from consumer spending.

This sounds all very logical, and one could devise a dynamic model with all those entities in it, who create the pump for the money circulation. It is necessary for an economy to have the money flowing in that circle: consumers earning salaries, and then spending it back - a closed loop in a closed system.

But my main question is: how can anybody make any profit?

Theoretically, the overall sum of all salaries must be at least what all the comanies receive as income. But that income of the companies is actually limited by those available salaries - people cannot spend more than they have. However, in order for a company to make profit, people actually must spend more than they have, so that a sucessful company receives more money than it spends - and the difference is its profit.

So how does this work? I really do not know. I assume it is a combination of several factors: banks give credit, so that consumers can spend more than their salary. This is borrowing towards the future. Aa a credit comes at the cost of interest, this interest must come from somewhere, must be generated, as it adds to the overall sum a deficit which is not covered. I assume that inflation helps here: governments can print more money to cover somehow that profit gap, and with a slight delay the inflation sets in as a consequence. In order to compensate inflation and to generate profit, companies have to "grow". Somehow this is how the spiral works, and the pump of money circulation get bigger and bigger all the time, generating prosperity and wealth, but also somehow pushing the possible financial problems (e.g. paying back credits) into the future. In addition, there is the factor of real estate: rising values of real estate provides a convenient automatic growth factor, backing up and covering somehow the deficiencies of the ideal closed loop. The question is: why should house prices rise? Is there any reasonable reason for this other than demand and supply? Why should a house no be 3 times more valuable than it was 10 years ago?

There is a lot of hot air in much of the system. Real estate is one of those hot air ballons. The high prices are based on true demand and limited supply, but not on actual cost and value. It is time that they come down and are back to levels so that ordinary people can afford a house.

There is something also fundamentally wrong with the financial system itself. Again, I am not an expert, so my opinion is not addressing all those intricacies of lending and borrowing. But just imagine a simple situiation: Let's say I make a deal with a friend, and I write him a note that I own him a Million $. Then he writes me a separate note that he owns me a Million $. We exchange notes, and have each other's note as a security (so that we are even). Now each of us can get out and "do business", as each of us can proof that someone owns us a Million $. This should get us credit, or we can even pay with parts of that note, giving away some of that debt to others. I think that is exactly how the real banking system works. Banks giving each other loans, investment firms betting on stocks, etc.

So no wonder this crisis is happening. Surprising is that it happened so late. And very surprising will be to see how fast the system will recover, as the human greed will win, and the growth ideology will continue to strive.