Sunday, February 8, 2009

Global Economic Crisis: Who are the Winners?

I don’t know about you but I’m feeling quite depressed nowadays. When one hears about people being retrenched and the spike in the unemployment rates, the blood pressure usually goes up and moodiness sets in. There’s something wrong with this picture somehow and this post is an attempt to answer a puzzling question I have about what’s happening right now.

Physical Wealth
From a global perspective, nothing major has happened in the physical realm that we live in. There were no major wars, earthquakes, tsunamis or any form of massive destruction of our assets, people or resources. I feel that I’m correct to say that if the entire planet’s resources were valued monetarily, there would be no significant changes from 2007 vis-à-vis 2008.

Financial Wealth
From a financial perspective, there has been a major seismic shift originating from the US. Major financial institutions have either collapsed or required government bailouts. These include branded names such as Citibank, AIG and Lehman Brothers. Additional bailout packages are being debated and approved as we speak, to help jumpstart the US economy. The effects of this seismic shift in the US have begun to reach the shores of other countries causing contraction in the major economies of other countries including Europe, Asia, China and Japan.

The Zero Sum Game
One of the reasons why I have always abstained from gambling is because it is purely a zero sum game. If you win, someone else loses. There’s just a transfer of wealth since nothing of value is being created. Let’s compare this with the current crisis. Is there something not quite right here?

The Cake Analogy?

A simple analogy should suffice here. Assume that the global resources of the earth are represented by a cake. Now instead of cutting this cake and handing a slice of this to everybody equally, everybody is given coupons as a claim over the cake. Assume the global population of the world consists of 100 people.

Ever person has a 1/100 coupon. Let’s denominate these 1/100 cake coupons as 1 cake dollar. So, the entire global resources are worth 100 Cake Dollars. Every person has a Cake Dollar and his happy with this arrangement. All these Cake Dollars are being held with ABC Bank Inc. One fine day, ABC Bank Inc says that 60 Cake Dollars have gone missing. Where has it gone? ABC Bank Inc says that’s not important, what’s more important is that it needs all the existing citizens to subsidize the losses. So, it asks the government to print an additional 60 Cake Dollars to make up for the shortfall. Each Cake Dollar is worth 60% less due to inflation. In other words, each Cake Dollar allows the citizens to claim 0.4/100 of the world resources.

Wait a minute here! Let’s see… So 100 persons now have 100 Cake Dollars. The total of these 100 Cake Dollars has a stake of 40% over the world resources due to inflation. Heck, who’s swindled off the remaining 60% of the global resources of the world?

Well, perhaps if you look hard enough, it’s likely that the original 60 Cake Dollars couldn’t just have disappeared, could it? Money just doesn’t disappear into thin air. Most likely, the missing 60 Cake Dollars were cashed out by the winner and he’s just taken the 60% slice of the entire cake from the table. And his gain is at whose expense? It’s the people still holding the Cake Dollars being asked to subsidize for the losses of ABC Bank Inc that’s left picking up the pieces.

How Could the Bank Lose?
As an analogy, assume ABC Bank Inc betted 60 Cake Dollars against *someone* that Roger Federer would win the Australian Open in 2009. ABC Bank Inc lost.

Normally, we would just let this bank fail. You made a bad call, you pay the price. Unfortunately, all the Cake Dollars are held with this bank. If it fails, there would be a run on the bank and everyone would start realizing their Cake Dollars are worthless. So, the 99 persons in the world have to absorb the 60% losses by ABC Bank Inc to avoid starting a world wide panic and riots.

In Real Life
The 2009 Australian Open bet is akin to the gambles taken by the financial institutions in CDOs, CMOs, CDS and the like. How could the derivatives arm of these major investment banks and financial institutions earn returns in excess of 20 or 30% per annum? Only if you play the zero sum game! And when you win big, you can also expect to lose big sometimes. And the banks have lost BIG against someone. The fact they need so much money is that they’ve used the depositor’s money to pay of their bad bets. Now, they don’t have any money left to pay the depositors money they were supposed to hold on trust for us.

As we are talking about huge losses of trillions of USD, *someone* must have made a hefty gain at the expense of the banks and tax payers. In addition, since everyone is feeling depressed, prices of commodities (i.e. real resources) are under priced. This *someone* is going to have a bonanza time taking over commodities and companies at fire sale prices.

Anyone has any idea, who this *someone* is?


Damien Tan

In zero sum you can only take out what you put in so IMHO it can only happen in a system where the variables don't change. We typically inject capital and labor into the mix, turning one cake into 10 cakes. So if the game involves the production of real goods, then we've got legitimate wealth creation. You can indeed take out more than you put in.

However if the cake never grew and value is determined by speculative trading and not the value of real goods, then someone is playing the system. The question no one seems to be asking is with all its brokerages and banks, what has Wall Street actually produced and do its activities strengthen or weaken the system?

Personally I feel the foundation of the whole banking system is suspect. Its like a ship whose engine is crippled because its badly designed. Hate to say it but pumping more diesel into it will not make it a better ship.

I think what's needed is a drastic revolution in the way the world conducts its finance. Perhaps even a rethink of the current demand and supply concept. Unfortunately the amount you need to dismantle in order to rebuild is so disruptive and far-reaching it will make such a move politically suicidal.

For now, it seems the world is more content pumping more diesel into a limping ship than searching for a whole new ship.

Anyway, welcome back to blogosphere. ^_^


Dear Damien,

Good points. There is of course real growth that you mentioned, which is organic in nature and sustainable. IMHO, such growth rates should not exceed 10% per annum, at most. The returns that Wall Street produced during the roaring boom were astronomical, which must have been at someone else's expense.

There are too many vested interests in the current system to let it fail. Still, it doesn't hurt for us to try to explore how a new economic and monetary system might assist in building a new ship.

Pump priming and more of the same is just madness... but that's exactly what governments all over the world are trying to do. I fail to see how this will improve things. In the short term, things will improve but they're setting things up for an even more drastic fall later on.

It's good to be back blogging :)



that's really a long break.

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