Understanding Economics: How Markets Work & Government Intervention

Hello everyone, I'm Lao Ding.

The world we live in operates on a fundamental logic and set of rules for economic activity. Under these rules, everyone's earning and spending are influenced by the functioning of the economy. For instance, in the current economic downturn with deflation, it is generally felt that making money is difficult, whether through investment, entrepreneurship, or employment. However, if we fast forward a few years to when the macroeconomy recovers, people will breathe a sigh of relief.

In this video, we will discuss how the economy operates and what happens when the government intervenes in the economy to varying degrees. This will help you better understand some of the phenomena that have occurred in the past and present.

I. How are economies and transactions formed?

An economy encompasses the production, circulation, distribution, and consumption of all material and spiritual resources. At the beginning of the world, everyone was an independent individual. I had meat to eat but lacked water to drink, while you had water to drink but no meat. So, I gave you some of my meat, and you shared some of your water with me. This is the most fundamental action of economic activity—transaction.

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Initially, the world engaged in barter, but carrying large items was not convenient. Therefore, someone proposed using a special kind of stone as a measure of value. These stones were brought from other regions, were aesthetically pleasing, and not abundant. Many people, for the sake of beauty, were willing to exchange a bag of corn for a stone.

Over time, fixed exchange rates were established between the stones and corn, as well as other goods. Eventually, people no longer wanted to barter because carrying stones was convenient. So, everyone began to save stones, and when going out to shop, they would directly exchange stones with others for rice and meat.At this point, this stone became currency! In our ancient times, currency was gold, silver, copper coins, and so on.

Actually, at first, not everyone trusted gold, silver, and copper, thinking that a broken stone could have what value. Many people were still willing to barter.

However, in a country, several old men with power, wealth, and prestige sat together for a meeting. They were willing to use their family's grain reserves and their own credit as a guarantee to ensure the value of gold, silver, and copper. Because of the authoritative guarantee, currency was more accepted by people.

At this time, we look at what the core of currency value is? In fact, it is credit. When an economy in a certain country begins to collapse, the currency will depreciate sharply. For example, before and after the 1998 Asian financial crisis, the domestic currencies of Southeast Asian countries all depreciated sharply. After a crisis occurred in Turkey a few years ago, the Turkish currency lira also depreciated sharply. Today, we see that from 2018 to now, the lira has depreciated by 800%.

Every individual's economic behavior is profit-seeking and avoiding harm. When people find that they can obtain continuous wealth and resources as long as they can find gold, silver, and copper, many people are no longer willing to hunt and grow corn, but are more willing to find currency, that is, to find gold, silver, and copper.

So during the gold standard era, there were often gold rushes in the world. When a large amount of gold was discovered by people, more and more currency corresponded to limited supplies, and the price of supplies would rise. We call this phenomenon inflation.

From here, we can also see that actually finding a gold mine is equivalent to obtaining currency rights. If you can get currency rights, it means you don't need to create any labor and can directly use your own currency to buy goods produced by others.

In order to get something for nothing, a large number of people are issuing currency. In fact, the United States from 1837 to 1863, the law stipulated that anyone who could raise a certain amount of capital and meet some other requirements could open a bank. And these banks only needed a printing press to issue currency.

According to the statistics of the Chicago Tribune at that time, there were 1395 banks in the United States, issuing various denominations of currency as high as 8370 kinds. In that era when most people could print money, people did not trust many currencies. The credit of a currency only relied on the credit of the bank itself.

If language separates the exchange between people in regions and countries, then the difference in currency separates the economic exchange between regions. Now, most countries in the world have their own currency, but the credit of the Russian ruble is limited. If I go to the United States with rubles, I can't use them directly. At this time, if I want to trade with American businessmen, I need to stock up on some dollars. But I can't use dollars directly when I go to China, so I also need to have some yuan in my hand. In the future, when I go to other countries, if these countries can directly use yuan for transaction settlement, then I will stock up more yuan in my hand.At this point, as the issuer of the Chinese currency, the Renminbi, it actually gains greater monetary power. I have a mountain of gold, you have a mountain of silver, and he has a mountain of copper. When everyone uses gold as currency, I am, of course, the happiest... So here you also understand why we are vigorously promoting the internationalization of the Renminbi.

II. The Emergence of Debt

We say that the core of currency value is credit. Then the essential source of currency is actually debt...

You want to exchange a pile of broken stones and a pile of paper for the rice and flour in my hands. Why should I? Because I trust you, I believe that the stones and paper you give me are better than others, and I can also take your stones and paper to exchange for water and cloth elsewhere.

When you give me the stones and I give you the rice, it is equivalent to you owing me a bag of rice. The proof that you owe me this bag of rice is the stone. At this time, I take the stone to the next door to exchange for cloth, saying that this stone is worth a bag of rice, so he gave me ten bolts of cloth and accepted the stone. This stone has truly gained meaning, and the beginning of this stone was actually that you borrowed a bag of rice from me.

In today's world, the central banks are the ones that issue stones and paper money to buy rice and flour from us.

We always say that the central bank has printed more money again. How do they distribute the money to society after printing it? Actually, it is through commercial banks...

The central bank gives money to commercial banks, and commercial banks distribute the money to people in society through credit. The total amount of funds in society increases.

There are three tools of monetary policy: reserve requirements, rediscount policy, and open market operations.

Suppose China Construction Bank only has 100 yuan, it cannot lend out all 100 yuan. For example, I deposit 100 yuan in China Construction Bank, and now you want to borrow 100 yuan, and he lends the 100 yuan to you. But now I have an emergency and need to withdraw 10 yuan. Since China Construction Bank has lent all the money to you, it has no money left, leading to a bank run.Therefore, the central bank has clearly stipulated that commercial banks must set aside some reserve funds with the central bank to be prepared for emergencies. This is the reserve requirement system.

Currently, the reserve requirement ratio for large financial institutions in China is 9.5%. This means that if I deposit 100 yuan in the Construction Bank, they must at least give 9.5 yuan to the central bank as a reserve, and the remaining 90.5 yuan can be used for lending.

The origin of loans is relatively simple. Your family needs to eat, but there is no rice today, so you borrow some money from the bank to buy rice. When your salary is paid in the future, you repay the money to the bank.

Since banks earn money from the interest rate spread, banks will try to encourage everyone to borrow money in order to make money. The climax of credit originated from the value-added services of American car companies at that time.

Cars are big-ticket consumer goods, and the price is still relatively high. It is still very stressful for ordinary families to buy cars in full. At that time, General Motors established a financial subsidiary, which specifically provided customers with installment payment services for purchasing cars. Customers only need to pay a 35% down payment to pick up the car.

In fact, the original intention of General Motors to establish a financial service company was to solve the problem of car dealers. At that time, dealers could only buy a few cars at a time due to capital restrictions, which seriously affected the sales efficiency of cars. If this financial company provided loans to dealers and car buyers, it could greatly promote car sales, thereby promoting the car production of the General Motors parent company.

It is because of this strategy that General Motors' market share quickly caught up with Ford. We can say that this is consumerism. They are trying every means to let people consume, even consume in advance. When this excessive consumption concept spreads in society, we also slowly ushered in the economic crisis.

III. How is the economic cycle formed?

Why are there economic crises, and how are they generated? Traditional economics believes that the debt cycle brings about economic crises.

When times are good, consumption increases, and businesses make profits. In order to pursue faster and higher profits, some people will borrow money to expand production, and consumers will also borrow money for consumption. In this process, whether it is due to rising raw material prices or natural development, demand will always stagnate, that is to say, even if everyone consumes in debt, there will still be a limit.However, there is always a delay between business operations and terminal sales, so it often happens that users have already started to reduce their consumption, but the production of enterprises is still expanding, and there is still a pile of inventory. This can easily lead to overcapacity.

At this time, the unsalability of products will lead to a decline in profits and revenue, and those enterprises that have been operating with debt are prone to bankruptcy. Once an enterprise goes bankrupt, the employment of employees working in the enterprise will be affected. However, these people had been consuming with debt before... This further reduces the social demand for consumption, and the profits of enterprises are further reduced, leading to a vicious cycle. An economic crisis then erupts...

In the original economic operation, it is very difficult to deal with when an economic crisis erupts.

There is a story that during the winter of the Great Depression in 1929 in the United States, a little girl asked her mother: "The house is so cold, why not burn coal to keep warm?" The mother replied: "Your father is unemployed and has no money to buy coal."

The little girl continued to ask: "Why is Dad unemployed?"

The mother replied: "Your father is a coal miner. The enterprise's coal is unsalable and bankrupt, so Dad is unemployed..."

This story tells us that the enterprise still has a lot of coal, and this worker's family also needs coal. However, after the economic crisis occurs, this kind of extreme situation will appear.

At this time, the visible hand must come out.

There is an economic theory called the "digging hole theory," which was proposed by Keynes. It means that when the economy is sluggish, the government should spend money to hire workers to start work, thereby driving the capital rotation on other related industrial chains. As mentioned above, the salary that workers originally received each month could only solve the food and drink problems at home. There was no money to solve the heating problem. At this time, if the government spends money to provide consumers with some subsidies for purchasing coal, which is what we call consumption vouchers, some workers will be willing to buy some coal. In this way, the enterprise's sales will increase, the enterprise's profits will be higher, and over time, they will be willing to increase some production capacity. With increased production capacity, they will be willing to hire workers at a higher price. Therefore, the economy will once again enter a virtuous cycle...

This is one of the situations that will occur after the visible hand begins to intervene in the economy. Yes, it's just one... Next, we are talking about some other situations.IV. What Happens When Economic Laws Are Violated?

The health of an economy depends on numerous factors, including consumer confidence, the looseness or tightness of monetary policy, and the environments that facilitate economic activities.

We just mentioned that the operation of the economy also requires the participation of a visible hand, especially when the economy falls into depression or stagnation. For instance, today, when the economy is in a period of stagnation, to alleviate the employment pressure on the people and the downward pressure on the economy, we have interest rate cuts and reserve requirement ratio reductions in monetary policy, and in fiscal policy, we also issue various subsidies and consumption vouchers. In fact, all these measures are intended to stimulate consumer spending or increase investment through certain means, thereby driving the operation of the economy.

At the same time, the operation of the visible hand in the real estate sector is even more classic. Historically, some countries or regions that have reached our current stage and have also encountered similar internal and external difficulties as today have basically collapsed...

In terms of financial policy, the free flow of capital, a fixed exchange rate, and the independence of monetary policy can only choose two out of three. Therefore, while maintaining a stable exchange rate and the independence of monetary policy, we use some unconventional means to prevent the collapse of things that should have collapsed.

However, any asset originally has ups and downs, and it is the funds that drive the rise and fall of asset prices. The expectations that affect the flow of funds are also expectations. Therefore, whenever the country begins to regulate real estate, it will affect our expectations in various ways. As long as we feel that house prices will no longer rise, then funds will temporarily no longer flow into real estate...

But here comes the key point. The original rule of assets is to rise and fall, and the law of the economy also has recessions and recoveries. But if the visible hand restricts asset prices, what will happen? This is the phenomenon we have seen in the past two years. Because everyone expects real estate to be a bear market, the original price should have fallen, but many governments have previously imposed price controls on real estate, restricting real estate developers from selling below a certain price. So, a thing that is worth 100 yuan at this time has to be sold for 200 yuan, and then fewer people will buy... Real estate companies also lack sufficient funds to be recycled.

Looking at various historical events, once a violation of economic laws occurs, several other phenomena always appear.

One is to reduce transaction volume. As we just mentioned, the real estate market. Reducing transaction volume means that if a product is worth 100 yuan, but the sales price is stipulated to be sold at 200 yuan, then buyers, if they buy, will feel that they are at a great loss and would rather choose not to buy. Transaction volume decreases...If both parties still wish to complete the transaction, a second phenomenon will emerge—the black market. The emergence of black market transactions means that although the grain is worth 100 yuan, you insist on setting a price cap of only 10 yuan. Due to the mismatch between price and supply and demand, grain priced at 10 yuan will definitely be snapped up, leading to a market shortage. Consequently, merchants will say, "You can buy this item, but you must also purchase a bottle of water from me, which is worth 90 yuan." Thus, the total price for grain plus water is 100 yuan. In real-life cases, to circumvent government-imposed housing price caps, some developers have offered "buy property, get gold" promotions in the past two years. This is akin to the "black market rules" brought about by price controls.

Chinese real estate has been under price controls, and this year, the government, seeing the lack of transaction volume in real estate, has also become anxious. This is because without capital recovery for real estate companies, their massive debts cannot be resolved. Therefore, this year, some local governments have gradually lifted price controls on new homes...

In summary, these are the advantages and disadvantages that arise when the visible hand intervenes in the normal development of the economy.

Conclusion:

At this point, everyone probably understands how the economy operates.

We will find that the economy has its own laws and rhythms. However, if left entirely unchecked, when the economic cycle fluctuates to its lowest point, the economy will experience a severe recession and an economic crisis may erupt.

At this time, when the visible hand begins to lend a helping hand, the economy will regain its vitality. But we might attribute this to the success of the visible hand and then attempt to involve it more in economic activities. Subsequently, price controls, sales restrictions, purchase limits, and other such measures emerge. We find that the visible hand begins to hinder the normal activities of the economy. So, adjustments are needed again...

Today, we are discussing the economy, but in reality, everything has its laws. Economic activities and nature both have their own inherent paths of operation, and natural laws are one of the greatest potential energies in the world. Individuals and groups find it difficult to go against the trend; no matter how many actions they take, they can only delay the occurrence of events, not change the direction...

When Yu the Great controlled the floods, the key to success lay in going with the flow!