Use The Dollar

Why Such a Big Deal?

Why are the feds and the investors making such a fuss about our current banking crisis?  The American Car industry is in the very same condition as the banks, yet there is no $700 billion bailout plan put in place for them.  What’s unique about the banking industry that requires so much extra attention and concern?

In the American economy all business is done between households and firms.  This business is done in the Final Goods Market and the Resources Market.  Goods like televisions, cars and lamps are sold in the Final goods Market by firms to the households in exchange for revenue.  Resources used to manufacture these goods such as Labor and Raw Materials are purchased by the Firms FROM the households in exchange for income for the homes.

Though it may seem that the Firms actually own resources like raw materials, they don’t.  Firms are divided into shares and shares are owned by households.  (Even the CEO belongs to a household) So all resources are actually transitively owned by households, and must be paid for.

So if a firm produces a television for $1000, the homes must have been paid $1000 for their resources (including labor) — They then return that $1000 in exchange for the television.

Economy in a Nutshell

Theoretically, this is the way our economy should work.  We have a problem though.  Americans save some portion of their income.  On average Americans spend about $0.75 out of every dollar they earn.  For our example, let’s be conservative and say that they spend $0.80 out of every dollar and save $0.20 — This would mean that though the Firm had paid them $1000 for resources and manufactured the television, the households would only be able to spend $800 in the Final Goods market.

Clearly, our economy needs some sort of system to re-funnel that savings into the market.  If not, the Government will be required to continue printing money to meet the need of a growing market and shrinking monetary supply, which will cause inflation to skyrocket.

And So We Have Banks

So we introduce the banks.  With banks, people no longer keep their money under their mattresses, but invest it into savings accounts instead.  The banks then re-lend this money to firms and households.

Let’s say that the bank takes the $200 invested by the households and lends $120 to the firms (who then reinvest it into the Final Goods Market) and $80 to the households (who then purchase more goods from the final goods market).  We now have our full $1000 returned to the Final Goods market.

Banks act as a means of putting money from savings back into the spending market, completing the cylce, and solving the problem of savings.

In the American Economy the banks serve as a way of re-funneling the money saved by Americans back into the spending market.

Without the banks, we are destined to suffer the constant reprinting of the dollar.  Inflation would run rampant causing Wall Street to collapse (sounds awfully familiar…).

This is why the Feds are so concerned by the potential collapse of the Banking Industry.  It has only happened one other time- 1928, the cause of the Great Depression.

Will our economy survive the current recession without a huge collapse?

Tags: bailout, banks, goods, government, market