Recently a story has been circulating around the web. It goes something like this:
A small, isolated town in the country has never been rich but has always drawn tourists to its bucolic setting. But, in the recent economic downturn, things got a little, well, depressing. Everybody was borrowing from everyone else.
Finally one day, a tourist comes along and visits the hotel. He's told a room for the night will be $100. He puts a $100 bill into the hands of the hotel owner and heads to his room.
Immediately, the hotel owner runs down the street to his most important supplier, the butcher, and pays off the $100 dollars that he owes to him.
The butcher gets in his truck and drives outside the town to a farmer, and pays him the $100 he owes for meat he bought the week before.
The farmer drives into town and visits LuLu, a whore, and pays the $100 he owes her.
Finally, closing the circle, LuLu goes to the hotel and pays the hotel owner the $100 she owes for the several times she has rented rooms by the hour.
The tourist comes out of his room, grabs the $100 from the hotel owner saying that he's not satisfied with the room, gets in his car and leaves. All debts are satisfied. So goes the story.
Now a friend of mine jokingly suggested that the tourist wasn't needed for the story. Had the townspeople spoken together they could have swapped debts until all was settled.
So, let's see how that works:
The hotel owner has in his hands an IOU from LuLu the whore for $100.
He takes that note and goes to the butcher. The butcher agrees to erase the hotel owners debt in exchange for the note. [ for simplicity, we'll not discount the IOU .. yet ].
In turn the butcher goes to the farmer and the same transaction occurs: the farmer erases the butchers debt but now holds the $100 IOU.
Happily (and I know you could see this coming) the farmer goes off to see LuLu to erase the $100 he owes her by giving her the IOU.
This is why trading IOU's is "discounted". Here is the final story:
The hotel owner possesses an IOU of $100 from LuLu, a whore, who occasionally rents rooms in the hotel by the hour when she sells her trade in the hotel bar.
The hotel owner despairs of ever collecting $100 from LuLu and the butcher is demanding payment. The hotel owner goes to the butcher and hands over the $100 IOU. The butcher is only partly satisfied, takes the IOU and reduces the hotel owners debt to $33.
The butcher then drives out to see the farmer, and a similar transaction takes place. The butcher's debt is reduced to $33 as well in exchange for the $100 note.
The farmer goes to visit LuLu. LuLu agrees to take the IOU but at discount! So the farmer still owes LuLu $33!
In the end:
The hotel owner has no money, no receivables and a debt of $33. ( -33)
The butcher has no money, a debt of $33 and receivables of $33. ( 0)
The farmer has no money, a debt of $33 and receivables of $33. ( 0)
The whore has no money, no debt and a receivable of $33. ( +33)
Who is richest?
The whore of course. She has $33 in receivables AND more inventory to sell.
The oldest profession just keeps the economy going, doesn't it?
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