Joined: 02/Sep/2006
Location: India
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Posts: 9319
Posted: 16/Oct/2008 at 10:58pm
Concept of a bubble
If you could read patiently and understand, it's very very intriguing...
Once there was a little island country. The land of this country was the
tiny island itself. The total money in circulation was 2 dollars as there
were only two pieces of 1 dollar coins circulating around.
1) There were 3 citizens living on this island country. A owned the land. B
and C each owned 1 dollar.
2) B decided to purchase the land from A for 1 dollar. So, now A and C own 1
dollar each while B owned a piece of land that is worth 1 dollar.
* The net asset of the country now = 3 dollars.
3) Now C thought that since there is only one piece of land in the country,
and land is non producible asset, its value must definitely go up. So, he
borrowed 1 dollar from A, and together with his own 1 dollar, he bought the
land from B for 2 dollars.
*A has a loan to C of 1 dollar, so his net asset is 1 dollar.
* B sold his land and got 2 dollars, so his net asset is 2 dollars.
* C owned the piece of land worth 2 dollars but with his 1 dollar debt to A,
his net residual asset is 1 dollar.
* Thus, the net asset of the country = 4 dollars.
4) A saw that the land he once owned has risen in value. He regretted having
sold it. Luckily, he has a 1 dollar loan to C. He then borrowed 2 dollars
from B and acquired the land back from C for 3 dollars. The payment is by 2
dollars cash (which he borrowed) and cancellation of the 1 dollar loan to C.
As a result, A now owned a piece of land that is worth 3 dollars. But since
he owed B 2 dollars, his net asset is 1 dollar.
* B loaned 2 dollars to A. So his net asset is 2 dollars.
* C now has the 2 coins. His net asset is also 2 dollars.
* The net asset of the country = 5 dollars. A bubble is building up.
(5) B saw that the value of land kept rising. He also wanted to own the
land. So he bought the land from A for 4 dollars. The payment is by
borrowing 2 dollars from C, and cancellation of his 2 dollars loan to A.
* As a result, A has got his debt cleared and he got the 2 coins. His net
asset is 2 dollars.
* B owned a piece of land that is worth 4 dollars, but since he has a debt
of 2 dollars with C, his net Asset is 2 dollars.
* C loaned 2 dollars to B, so his net asset is 2 dollars.
* The net asset of the country = 6 dollars; even though, the country has
only one piece of land and 2 Dollars in circulation.
(6) Everybody has made money and everybody felt happy and prosperous.
(7) One day an evil wind blew, and an evil thought came to C's mind. "Hey,
what if the land price stop going up, how could B repay my loan. There is
only 2 dollars in circulation, and, I think after all the land that B owns
is worth at most only 1 dollar, and no more."
(8) A also thought the same way.
(9) Nobody wanted to buy land anymore.
* So, in the end, A owns the 2 dollar coins, his net asset is 2 dollars.
* B owed C 2 dollars and the land he owned which he thought worth 4 dollars
is now 1 dollar. So his net asset is only 1 dollar.
* C has a loan of 2 dollars to B. But it is a bad debt. Although his net
asset is still 2 dollars, his Heart is palpitating.
* The net asset of the country = 3 dollars again.
(10) So, who has stolen the 3 dollars from the country ? Of course, before
the bubble burst B thought his land was worth 4 dollars. Actually, right
before the collapse, the net asset of the country was 6 dollars on paper.
B's net asset is still 2 dollars, his heart is palpitating.
(11) B had no choice but to declare bankruptcy. C as to relinquish his 2
dollars bad debt to B, but in return he acquired the land which is worth 1
dollar now.
* A owns the 2 coins, his net asset is 2 dollars.
* B is bankrupt, his net asset is 0 dollar. ( he lost everything )
* C got no choice but end up with a land worth only 1 dollar
* The net asset of the country = 3 dollars.
************ **End of the story; BUT ************ ********* ******
There is however a redistribution of wealth.
A is the winner, B is the loser, C is lucky that he is spared.
A few points worth noting -
(1) When a bubble is building up, the debt of individuals to one another in
a country is also building up.
(2) This story of the island is a closed system whereby there is no other
country and hence no foreign debt. The worth of the asset can only be
calculated using the island's own currency. Hence, there is no net loss.
(3) An over-damped system is assumed when the bubble burst, meaning the
land's value did not go down to below 1 dollar.
(4) When the bubble burst, the fellow with cash is the winner. The fellows
having the land or extending loan to others are the losers. The asset could
shrink or in worst case, they go bankrupt.
(5) If there is another citizen D either holding a dollar or another piece
of land but refrains from taking part in the game, he will neither win nor
lose. But he will see the value of his money or land go up and down like a
see saw.
(6) When the bubble was in the growing phase, everybody made money.
(7) If you are smart and know that you are living in a growing bubble, it is
worthwhile to borrow money (like A ) and take part in the game. But you must
know when you should change everything back to cash.
(8) As in the case of land, the above phenomenon applies to stocks as well.
(9) The actual worth of land or stocks depend largely on psychology.
Life can only be understood backwards—but it must be lived forwards
Dr Shah
has titled his study, ‘Teji ma time nathi, mandi ma mood nathi (No time
for sex during a bull run, no mood for it during a crash)
“Most of my patients
are directly or indirectly linked to the stock market. When the sensex had
touched the 21,000-mark, I got women patients complaining that their husbands
had no time for sex. Now that it has crashed, men are turning up by the dozens,
saying they don’t feel like having sex. Poor performance in the bedroom
further pushes them into depression and leads to marital discord,’’
says Dr Shah.
Life can only be understood backwards—but it must be lived forwards
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but not for too long. Time to put it to work.
