Understanding the Global Recession

[Raz]

THE CURRENT ECONOMIC CRISIS EXPLAINED>

> Pajja > is the proprietor of a Siri-Paya and Nehari Shop in Lahore .
> Sales are low and, in order to increase them, he comes
> up with a plan to
> allow his customers to eat now and pay later. He keeps
> track of the meals
> consumed on a ledger.
>
>
>
> Word gets around and as a result increasing numbers of
> customers flock to
> Pajja’s shop. Pajja’s suppliers are delighted
> and are very willing
> to sell more and more raw materials for the meals he
> prepares. Pajja shows them
> his ledger of receivables and they extend him
> credit.
>
>
>
> A young and dynamic customer service consultant at the
> local bank recognizes
> these customer debts as valuable future assets and gives
> Pajja a credit line
> and then increases Pajja’s borrowing limit.
>
>
>
> Taking advantage of his customers' freedom from
> immediate
> payment constraints, Pajja jacks up the prices of his
> Nehari and
> Siri-Paye. Customers dont mind as they are not required to
> pay on the spot.
> Sales volume increases massively; Banks and suppliers lend
> more; Pajja opens
> more outlets. He sees no reason for undue concern since he
> has the debts of
> the customers as collateral.
>
>
>
> At the bank's corporate headquarters, expert bankers
> recognize Pajja's customer
> loans as assets and transform these customer assets
> into BONDS. These
> negotiable instruments are given exotic names such as
> SIRIBOND, PAYABOND,
> MAGHAZBOND AND BONGABOND. These securities are then
> listed on the Stock
> Exchange and traded on markets worldwide. No one really
> understands what the
> names mean and how the securities are guaranteed but,
> nevertheless, as their
> prices continuously climb, the securities become
> top-selling items.
>
>
>
> One
> day, although the prices are still
> climbing, a credit risk manager of the bank
> decides that the time has
> come to demand payment of one of the debts incurred by
> Pajja. Pajja in turn
> asks his clients to pay up. One by one they refuse; the
> clients cannot pay back
> the debts. Pajja refuses to serve them any more. The
> clients stop coming.
>
>
>
> Pajja is really screwed now. He cannot fulfill his loan
> obligations and
> therefore claims bankruptcy.All Bonds drop in price by
> between 80 to 95%.
>
>
>
> The suppliers of Pajja, having granted generous payment
> due dates and
> having invested in the securities are faced with similar
> problems. The meat
> supplier defaults on payment to the sheep and cattle
> supplier and claims bankruptcy.
> The atta supplier is taken over by a competitor;
> Pajja lays
> off the cook and staff. Bankruptcies soar,
> unemployment mushrooms.
>
>
>
> The bank that lent the money in the first place is set to
> collapse. It is saved
> by the Government following dramatic
> round-the-clock consultations by
> leaders from the governing political parties with Pajja
> commuting back and
> forth in his Executive jet and Mercedes 500SEL, brokering
> the deal.
>
>
>
> The funds required to save the economic collapse are
> obtained by a tax levied
> on the citizens, most of whom do not eat Nehari or
> Siri-paye.
>
>
>
> UNDERSTOOD?
>

[Viceroy]

Ahhhh Now I got it
Thanks God i never bought sri paye or nehari from pajja but nevertheless what difference does it make ? I still have to pay

[Raz]

Originally Posted by MohsinShah

Ahhhh Now I got it
Thanks God i never bought sri paye or nehari from pajja but nevertheless what difference does it make ? I still have to pay

How was the illustraion? I think it's very clear to comprehend the issue.

[Viceroy]

@ Raz

Bro I'm a true duffer as far as economics is concerned and i seriously need a good basic tutorial ... This illustration was very understandable but as i am unaware of the actual reason so cannot say if it is true or not

Please link me to some good real life tutorial ... I dont know how banks work ... how prices increase and decrease ... what on earth is liquidity .... why is gold the international currency ... how currency values are determined .... and whats that thing called "afraat e zar".... I know your into this subject ... that's why i am asking you

[Kamran]

brother,enjoyed your explaination of Economic crisis....

well understood..

[nageen]

Hi Raz,

I'm also illiterate of the basics of economics but your illustration was interesting and easy to understand.

Originally Posted by MohsinShah

Please link me to some good real life tutorial ... I dont know how banks work ... how prices increase and decrease ... what on earth is liquidity .... why is gold the international currency ... how currency values are determined .... and whats that thing called "afraat e zar".... I know your into this subject ... that's why i am asking you

Same is the case with me.Though a lot of knowledge is available online to understand these basics, I am unable to get the concept of "Afraat-e-zar",so plz, try to make us understand in the same manner as above.

[Viceroy]

Originally Posted by nageen

Hi Raz,

I'm also illiterate of the basics of economics but your illustration was interesting and easy to understand.



Same is the case with me.Though a lot of knowledge is available online to understand these basics, I am unable to get the concept of "Afraat-e-zar",so plz, try to make us understand in the same manner as above.

Lolz Lets hope some one makes us understand
I don't want to die with this term still unknown to me

[Raz]

Originally Posted by MohsinShah

@ Raz

Bro I'm a true duffer as far as economics is concerned and i seriously need a good basic tutorial ... This illustration was very understandable but as i am unaware of the actual reason so cannot say if it is true or not

Please link me to some good real life tutorial ... I dont know how banks work ... how prices increase and decrease ... what on earth is liquidity .... why is gold the international currency ... how currency values are determined .... and whats that thing called "afraat e zar".... I know your into this subject ... that's why i am asking you

How do banks work?

>Dear banks are intermediaries playing the role of middle man in our financial sector.

>Theses are middle man among two units 1) Surplus units 2) Deficit units

:Surplus units: Thos who are in possession of liquidity/funds/money/resources in excess of their needs.

What are their needs: 1) Transactionary (for day to day routine transactions such as for food, water, etc.)
2) Precautionary (for preventive needs such as for medicine, any emergency, simply for the rainy day)
3) Speculative (for sata bazi, i.e. stock game etc.)

>What is liquidity?It is the availability of funds at the disposal of subject matter. Technicaly it is the ability to transform wealth holding into any form without "loss of fare value" and "delay". Resources readily convertible into cash. That is why "cash" is the most liquid assets. Marketable securities are next to cash in liquidity descending order. Fixed assets/long term assets i.e. plant, machinery, building are the most illiquid assets.

>What are assets?
Assets are the economic resources of the entity to generate future cash flows or to run the business.

>Deficit units: Those economic agents which are in need of liquidity/funds/money/resources to meet their consumption needs (House purchase, car purchase, motor car, rickshaw, taxi, President scheme kingkies(chungchi) bila bila.......) or for business need purpose (manufacturers for Raw material, suppliers, employees, expansion etc. ; traders; exporters; service oriented persons (professionals i.e. doctors to hire building for clinic, purchase medical tools, plants etc., lawyers to construct their firms etc.).


It would have been difficult even impossible to trace the surplus agents and to locate the deficit agents if Banks were not in our system. This doesn't mean we can't survive without banks but it would have been difficult to manage. Barter system can well be recalled in which their was no concept of money.

Barter system: Exchange of goods in terms of goods without the involvement of money.


>Now how do Banks play middle man role?Banks work on one single factor that is Confidence of the customers. Banks mobilize funds from the surplus units who are ready to deposit in the bank to earn interest.

Interest: Price paid for the usage of utility of money.

Utility: Power to satisfy the needs of customers. Satisfying potential.

Now banks channelize these funds towards the deficit units who are ready to borrow funds by agreeing to pay interest rate to the bank. Here banks add some extra margin to the actual interest rate which they paid to surplus units (depositor).

Say for example Mr. A a surplus agent deposited funds in NBP. NBP pays interest to Mr. at the rate of 5%.
Interest rate on deposits=5%

Mr. B knocks the door of bank, he needs funds. He borrows from the bank. NBP charges 10% to Mr. B.
: Lending rate=10%

>Why did NBP charge 10% why didn't she charge 5%?
Actually banks work for profit motive. First they charge additional margin for profit. Secondly, banks are bearing risk of default or delayed payment. Hence they cover their risk by adding some more margins. Additionally banks run their business with their employees they have to pay salaries, taxes, utilities, rent etc. (In short their administrative cost or intermediation cost).

Hence we can suppose the break up of 10% as follows:

Lending rate 10%=5% deposit rate + 2% risk bearing cost +1% administrative cost + 2% profit margin.

By lending at 10% bank earned 5% spread.

: spread=lending rate - deposit rate.

>What are the principles of Banks?
Banks work on following principles:
1) Liquidity
2) Profitability
3) Security

>On which basis banks lend funds to borrowers?
Following Cs are considered:
1) Character
2) Capital
3) Cash flows / financial analysis (Operating cash flows, working capital management, ratios like current ratio, leverage, inventory turn over, receivable turn over, payable turn over: cash cycle of operating cycle etc.)
4) Collateral or security

Net working capital = Current Assets - Current liabilities.
: Liability= what one owes
: Assets= what one owns
: Current/short term=Maturing, payable, realizable, or to be expensed out within a period of one year.: Fixed/Long term= Maturing, payable, realizable, or to be expensed out in period longer than one year.


I hope most of the concepts will be clear after going through this post.



Regards

[Raz]

Originally Posted by MohsinShah

Lolz Lets hope some one makes us understand
I don't want to die with this term still unknown to me

Afrat-e-zar in Urdu and Inflation in English:

Before we discuss "inflation (afrat-e-zar)" it would be better to understand "value of money", and before understanding value of money it would be better to understand "money".

Money=Latin Word "Moneta"
Money=Money means that by delivery of which debt contracts and price contracts are discharged and in the shape of which a store of general power is held.
Money is some thing which serves as medium of exchange, common measure of value, unit of account, and safe mean of transfer and storing of wealth.

Value of Money= By value of money we mean purchasing power of money-its capacity to command goods in exchange for itself i.e. the number of goods and services that can be purchased by one unit of money.
Value of money is defined in terms of goods and services purchased because money is not needed for its own sake but for the purchase of goods and services.

Inflation= something which erodes the real value of money. Erodes purchasing power. It is persistent rise in general price level. Persistent rise in the prices of goods and services.
Too much money chases too few goods.Aggregate demand>aggregate supply

When supply of goods falls short of demand. There is a pressure on prices.

Suppose when we were in our childhood (1980s) one could by a 100-page note book in Rs.3 but now in 2009 that 100-page note book costs Rs.10. The difference of Rs.7 is just because of inflation. This means Rupee has lost its purchasing power i.e. now Rs.3 can't purchase that much quantity of goods and services which could be purchased in 1980s.

An illustration:

How to measure inflation?

Formula> Rate of inflation (Year t) = ((Price Level Yr t - Price level year t-1)/Price level Year t-1)*100

Example: Let consumers buy three commodities: Food, Shelter, and Clothing.
Year 2001: A hypothetical budget survey finds that consumers spend 50% of there budget on food, 30% on shelter, and 20% on clothing.
Using the 2001 Yr as base year, we set the price of each commodity at 100, so CPI is also 100.
CPI= (0.50*100) + (0.30*100) + (0.20*100)
CPI=50+30+20
CPI=100 of Yr2001

Let in the 2002 food prices rise by 3% to 103, shelter prices by 4% to 104, and clothing price rise by 6% to 106.

CPI of Yr2002= (0.50*103) + (0.30*104) + (0.20*106)

CPI of Yr2002= 51.5 + 31.2 + 21.2
CPI of Yr2002=103.9

Inflation Rate= ((CPI of Yr2002 - CPI of Yr2001)/CPI of Yr2001)*100
Inflation Rate= ((103.9-100)/100)*100

Inflation Rate=3.9% per year.

10 groups of the commodities forming the CPI basket:

1) Food and Beverage
2) Fuel and Lighting
3) Apparel, Textile, and footwear
4) Housing rent
5) Household furniture and equipment
6) Transport and Communication
7) Education
8) Cleaning, Laundry and Personal appearance
9) Medicare
10) Recreation and entertainment.

There are around 25 different markets dispersed all our Pakistan where the prices of these ten categories are determined. Kunri (Umur Kot Marich Mandi) is one of these markets.


Inflation is caused by two factors:
1) Demand pull: When too money chases too few goods. aggregate demand>aggregate supply
2) Cost push: Increase in the general price level due to the rise in prices of factors of production.


> Factors of production and their prices: Land-Rent, Labor-Wages, Capital-Interest, Entrepreneur- Profit

Some key concepts:

>Head line inflation VS Core inflation
>Demand Pull inflation vs Cost push inflation
>CPI (Consumer Price Index) vs WPI (Wholesale Price Index) vs SPI (Sensitive Price Index).
>Stagflation: The simultaneous occurrence of substantial unemployment and inflation. Or simultaneous inflation and recession.
>Stagflation = Inflation Rate + Unemployment Rate
>Hyper inflation = An alternative term for “runaway” or “galloping” inflation, where as so great increase takes place in the amount of money in circulation that eventually it becomes almost worthless and new currency has to be instituted.
>Galloping inflation = Hyper inflation
> Reflation = The easing of credit restrictions to encourage and expansion of production, it is the milder sort of inflation that accompanies the upward swing of trade cycle.
> Inflationary spiral = A term used for persistent inflation in which a rise in price causes demand for higher wages, the granting of which increases the costs of producers. Who then again put up their prices and so increases in prices through increases in wages induce further increases in prices, which in such circumstances become increasingly difficult to check.
> Ceiling Prices = Maximum prices imposed under a system of price control. (Cap on prices)
>Buoyancy = A term applied to the revenue from taxation in an inflationary period.
> Depression of currency = A deliberate reduction in the value of home currency in its relation to foreign currency to reduce imports and promote exports.
> Devaluation of currency = A reduction in the value of home currency in its relation to foreign currency due to market factors of supply and demand.



Major results: A fall in the internal value of money (occurance of inflation) will lead to a fall in the external value (depreciation of the native currency)
Hence a rise in domestic inflation results in depreciation of domestic currency.

For further understanding go through following link

http://www.cssforum.com.pk/central-s...ost111402.html

http://www.cssforum.com.pk/central-s...ost110302.html


Regards

[shah110]

Raz Brother ... Assalam-0-ALikum .. Peer Maula Ali Madad...

Great effort mady be you, nice presentation of current economic crisis.. and thanks a lot for explaining the terms like Inflation, Value of Money and other economic terms with full of their extent. thanks