Fairy Tale: the Community

Introduction

In a remote island of British Columbia, there is an isolated but progressive community of people who refer themselves as the Community. The Community has their own currency, the Pepto (P$), and advanced financial institutions. They live in special building structures called Bunga-Bunga-Gloos (BBG's)

The Community has allocated P$ 10,000 to cover their housing needs. In other words, the market size of all the existent Bunga-Bunga-Gloos is P$ 10,000, with an average price of P$ 100 per unit

Definition: Price is what you pay, value is what you get (Warren Edward Buffett)

These are the basic statistics for the Community:

Scenario: Capital Allocation Increase

The Community has just found that once every thousands years, when the Stars are properly aligned with the Planets in the Sky, money grows on trees overnight — but just for one night. As a result of this, there is more Peptos available for the same number of members of the Community and for the same number of Bunga-Bunga-Gloos. As a result, The Community increases the capital available to cover their housing needs, to P$ 16,000 from P$ 10,000

The new statistics are as follows:

When the amount of money allocated to an asset class increases, ceteris paribus, the value of money decreases and the price of the asset increases

Scenario: Population Increase

The Supreme Priest reminds to the Community their obligation to reproduce and conquer the Earth. As a result, all the members get to work hard making babies and the total population increases from 1,000 to 1,500 members almost overnight. The Government prints an extra 50% of their current monetary supply. As a result, 50 new Bunga-Bunga-Gloos are built on time for the new arrivals: there are now 150 BBGs with a total market price of P$ 24,000

The new statistics are as follows:

The value of money remains the same in terms of BBG's, even though the amount of money allocated has increased

However, the number of funeral caskets needed by the Community remain almost the same, since that their very low infantile mortality rate. As a result, the value of money must decrease in terms of funeral caskets (see Scenario: Capital Allocation Increase before)

The value of money does not always change when the amount of money allocated to an asset class increases or decreases

The value of money changes differently across different asset classes

Scenario: Capital Allocation Reduction

Now the Community discover that the money that grow on trees suddenly dissipates. As a result, the P$ 24,000 that were allocated to over their housing needs is reduced overnight to P$ 18,000

When the amount of money allocated to an asset class decreases, the value of money increases and the price of the asset decreases

How Money is Created

Government

Banks

Links

• Monetary Supply: Paul Van Eeden
• Depressions: How Depressions Work
• Assets and Liabilities of Commercial Banks in the United States
• When Stock Prices Drop, Where's the Money?