It's like a joke I heard about Icelandic banks a while ago. Neither of us have any money, but if we're banks I can sell you a cat for a billion dollars and you can sell me a dog for a billion dollars so that we're both billionaires. The way that insufficiently regulated banks and stock/commodity markets effectively allow certain people to create new money from nothing and then trade it for things of real value is only a tiny bit more subtle than that. Of course, sooner or later what happened in Iceland will happen anywhere that such things are allowed to occur.
Michael Lewis' "Wall Street on the Tundra" is classic.
> For the past few years, some large number of Icelanders engaged in the same disastrous speculation. With local interest rates at 15.5 percent and the krona rising, they decided the smart thing to do, when they wanted to buy something they couldn’t afford, was to borrow not kronur but yen and Swiss francs. They paid 3 percent interest on the yen and in the bargain made a bundle on the currency trade, as the krona kept rising. “The fishing guys pretty much discovered the trade and made it huge,” says Magnus. “But they made so much money on it that the financial stuff eventually overwhelmed the fish.” They made so much money on it that the trade spread from the fishing guys to their friends...
That was the biggest American financial lesson the Icelanders took to heart: the importance of buying as many assets as possible with borrowed money, as asset prices only rose. By 2007, Icelanders owned roughly 50 times more foreign assets than they had in 2002. They bought private jets and third homes in London and Copenhagen. They paid vast sums of money for services no one in Iceland had theretofore ever imagined wanting. “A guy had a birthday party, and he flew in Elton John for a million dollars to sing two songs,” the head of the Left-Green Movement, Steingrimur Sigfusson, tells me with fresh incredulity. “And apparently not very well.” They bought stakes in businesses they knew nothing about and told the people running them what to do—just like real American investment bankers!
The analogy is false. One of the problems with what Icelandic banks were doing was this:
"The rules prevent banks from posting their own debt as collateral (Central bank of Luxembourg). The three banks circumvented this rule by posting each other’s collateral at the CBL. This process is known as issuing ‘love letters’. However, CBL later restricted this type of funding. This, however, continued in other places such as Central Bank of Ireland (CBI)."
It's a funny thing about analogies and metaphors: they don't have to be absolutely perfect in every detail to have explanatory power. What actually happens is slightly more subtle (as I said) but the principle still applies. Thank you for providing an example.
Trust. After you sell me your cat for an imaginarily large amount of currency, why continue to spend your gains or buy my imaginarily intensely valuable cat?
