Chain mail for chains of credit
Do any of you remember that time, far, far away - about 10 years ago - when people sent each other email chains? In this edition, we would like to share with you a story that came to us by email and that, for some random reason, we still remember.
It presents a case that is somewhat strange the first time it is read, but not for those who have ever gone through a couple of economics classes, and which should immediately relate to some works on the subject. In addition to the joke, the case distributed by mail allows us to explain a key concept to understand some economic measures that are currently quite controversial.
It's August, in a small coastal town, in the middle of the season; Torrential rain falls and the city seems deserted for several days. The crisis has been hitting this place for a long time, everyone has debts and lives on credit.
Fortunately, a millionaire, loaded with money, arrives and enters the only small hotel in the place. He asks for a room. He puts a 100 euro bill on the receptionist's table and goes to see the rooms. The hotel manager grabs the bill and runs off to pay his debts to the butcher. He takes the bill and runs to pay his debt to the pig farmer. Immediately he runs off to pay what he owes to the animal feed mill. The owner of the mill takes the ticket on the fly and runs to settle his debt to María, the prostitute whom he has not paid for a long time. In times of crisis, even she offers services on credit. The prostitute with the ticket in hand leaves for the small hotel where she had brought her clients the last few times and where she had not yet paid and gives the ticket to the hotel owner. At this moment the millionaire comes down, who has just taken a look at the rooms, says that none of them convince him, takes the ticket and leaves. No one has earned a cent, but now the entire city lives debt-free and looks to the future with confidence.
The moral of this story, as summarized by popular wisdom, would be something like: “if money circulates, the crisis ends.” However, technically speaking, the problem of this small economy is nothing more than a coordination failure.
Let's see a little what this concept is about. The following definition is personal: a coordination failure exists when independent agents are unable to solve a problem that would be completely trivial for a planner with perfect information. Let's look at a couple of interesting examples.
In the example, the coordination failure is that everyone in this small town has zero net debt. Each of them is a creditor and debtor of one hundred euros, but all with different people! A planner could write off the net debts, of course. Do the math and set everything to zero. But omniscient planners do not exist and individually it is very difficult to achieve this. Everyone wants to pay, but they don't know if the other is going to pay them. So, the hotel boss doesn't spend money to pay the butcher. The butcher does not spend to be able to pay the pork producer. And so. But if no one spends, no one sells, and if no one sells, no one has income... this way no one can pay off their debt.
And what happens if one of these actors gets tired and decides to legally enforce their debt against another? Imagine if the butcher sues the hotel for his debt, and since it cannot pay, it goes bankrupt (it won't cost a hundred euros, but it could happen with a larger debt). Or if you go to bankruptcy proceedings and end up negotiating a payment that is less than the entire debt. Then the entire payment chain is broken and the economy is exposed to a chain of defaults. The butcher cannot pay, the pig producer cannot pay, etc.
Another similar story, but in South Park
The episode "margarita ville” from the popular series South Park, deals precisely with the problem of credit chains. It is worth clarifying that we have grown tired of finding hidden economic theories in the apparently meaningless jokes of this program, to the point that we suspect that one of its writers must have a master's degree in economics.
Alert spoiler! In this chapter, after a financial debacle that plunges the city into a severe crisis, Stan's father blames the superfluous spending of Americans for having “angered the economy” as if he were God; and he encourages all the people to live in frugality, which obviously only accentuates the crisis. Meanwhile, a boy sacrifices himself for social good by buying the debt of others, in a clear parody of the passion of Christ.
To access a synopsis of the episode, you can access it here: [link]. It is noted that, although popular, the series is considered very controversial, for being extremely irreverent and even rude. However, for the purposes of the case, the chapter is extremely illustrative.
Is something similar happening in Argentina? What does the theory say?
It doesn't all end with South Park. In the article that we make available for download, we show more examples of one of the great problems of the economy, including Argentine inflation. Indeed, as we approach the end of the year, feints are beginning to appear between unions, the government and the business sector around the issue of joint ventures. In the article we show precisely how one aspect of inflation can be thought of as a coordination problem.
Our note concludes, with a brief explanation of one of the papers most important of macroeconomics of the last decade, and that serves to understand the behavior of the FED after the bankruptcy of Lehmans Brothers, and also, why not?, critically acclaimed films like The Big Short (T).
Enjoy it!