Stimulus Program

You've probably seen an email that goes something like this:

It's a slow day in a small town, and the 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 before deciding if he'll stay for the night.

As soon as he leaves, the motel owner grabs the bill and runs next door to pay his debt to the butcher.

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

The pig farmer takes the $100 and crosses the street to retire his debt with his supplier, the feed store.

The guy at the feed store takes the $100 and pays his debt to the local prostitute, who has also been facing hard times and has had to offer her services on credit.

The prostitute rushes to the motel and pays off her room bill with the motel owner.

The hotel owner then places the $100 bill back on the counter just as 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 out of debt and now looks to the future with a sense of optimism.

And that, ladies and gentlemen, is how a stimulus program works.

The point, apparently, is to ridicule government efforts to counter the effects of the global credit crisis that was precipitated by the failure of several large financial institutions.

The email economists fail to grasp that this story is a pretty good analogy of how the financial system actually works. They are under the mistaken impression that money has a concrete existence, presumably in coins and paper currency. Fact is, money exists mostly in electronic form on computers. Before computers, it existed on paper ledgers. Think about where most of your own "money" is.

Contrary to what's asserted near the end of the email, the problem isn't that the townspeople hadn't been working. Goods and services had been produced. The problem is, without money to pay for them, the townspeople have to stop working.

And money is created by lending, which is what the tourist, in effect, did when he left the $100 on the motel counter. That's why when a couple of big financial institutions failed a few years ago and other banks, fearful of not being repaid, refused to lend, the global financial system was in danger of seizing up. Without lending, money literally disappeared, businesses failed, and millions lost their jobs and homes. Governments, as the lenders of last resort, had to step in to save the system from complete collapse.

Banks, in fact, are permitted to create money by lending what they actually have on deposit many times over (about 15-20 times). The fact that these reserves of "real" money were too low in many cases was a contributor to the financial crisis, and efforts to prevent a repeat have focused on requiring banks to increase the ratio of deposits to loans.

So, if you'd like to stimulate the economy (and help yourself at the same time), here's an idea. That jar of change (mostly pennies) you have somewhere in the house? It's dead money, a bunch of metal disks -- unless you take it to the bank and deposit it. If all 35 million Canadians deposited the $2 in loose change from beneath their sofa cushions, banks could create over a billion (yes, with a "b") dollars of new money in the form of loans to stimulate the economy.

Pass it on.