Is my view of the world economy too simplistic?

[Ian]

Inflation in our world economy is determined by the amount of money chasing the available products and services. This is not the same as 'pricing' which is set by the demand for products and services.
Now, recently the world banking system lost billions. The money has not vanished into thin air but has only changed hands and is still within the system. Since the banks operate the system our goverments have had to prop them up with a massive billions strong cash injection from out of public coffers (money on the outside of the economic system).
This is going to leave us in the unfortunate position of having way, way too much money within the global economy chasing too few goods and inflation must rise as a result.
There is a recession coming, if not in some places already, so the economy shrinks and we have even less goods and services which makes the imbalance all the worse.
I am an engineer not an economist, but I was taught this precept in uni and it does worry me - is this too simplistic?

 

[Cyrus]

It's my understanding that ENRON caused so much trouble because they were allowed to 'project' their net worth based on what they thought they would do in sales for the next quarter. So their worth really did vanish into thin air -because it was never there to begin with!

I don't know how true this is in other places, or if this was particular illegal thing that caused their demise.

 

[vanesch]

Now, recently the world banking system lost billions. The money has not vanished into thin air but has only changed hands and is still within the system.

I'm also not an economist at all, and my understanding of world economy is probably even more naive than yours, but I don't think that "money was conserved" during the recent crash. After all, a large amount of "money" was in stock and worse, derived products, which is nothing else but a collective guess of what a company is worth (or is going to be worth, or...). Well, we now collectively guess that all those companies are worth way way less than we thought before. So that "money" has simply vanished in smoke from the moment we changed our minds.
You could say that we didn't really have it back then (the company *wasn't* worth it, but we thought so), but then that money didn't exist in the first place.

 

[Ian]

I thought the same at first, but Mr Madoff took from peter to pay paul, in other words, he simply gave away the banks money and lived on the semblance of being the world 'money guru'.
The money was actually physically there to begin with, it is not a question of what Enron did, which was 'false accounting'. Madoff hid paul from peter, but the money really was there to begin with. That is what makes this crisis so dangerous to the world system.

 

[russ_watters]

Now, recently the world banking system lost billions. The money has not vanished into thin air but has only changed hands and is still within the system.

That isn't quite correct.

When you buy something like a house, it has a value that it set by market forces. Later, you try to sell it, and the value has changed. Is the house any different from when you bought it? No. But market forces make the value different. If the house is worth 10% more than when you bought it, then you have gained 10% of the value of the house from nothing. If market forces dictate that the house is worth 10% less, then that value really has vanished into thin air. But money doesn't change hands unless money changes hands.

 

[russ_watters]

I'm also not an economist at all, and my understanding of world economy is probably even more naive than yours, but I don't think that "money was conserved" during the recent crash.

You are correct: money is not conserved.

 

[russ_watters]

I thought the same at first, but Mr Madoff took from peter to pay paul, in other words, he simply gave away the banks money and lived on the semblance of being the world 'money guru'.
The money was actually physically there to begin with, it is not a question of what Enron did, which was 'false accounting'. Madoff hid paul from peter, but the money really was there to begin with. That is what makes this crisis so dangerous to the world system.

You're describing a crime, whith doesn't have much of anything to do with how the economy works.

 

[koolmodee]

As far as money being destroyed and burned at the financial market, picture a situation with say ten people siting on a table and passing around a card. The first one sells it to the second one for 10 dollars, the second one to the third one for 20 dollars and so on.
The last one buys the card for 100 dollars, but now no one wants to buy it because they found out (or some of the other nine other guys knew before) that the card is worthless.

To expand the model, think that there are other tables in the room with cards being passed around. Now information is collected at what prices the cards are passed over on each individual table at each moment. One market price for all tables gets established. So one buys a card for 40 dollars and suddenly it is worth 100 dollars because on other tables some are willingly to pay and actually do pay 100 dollars. But after the crash, when no ones wants to buy, is worthless, too.