A financial market fairy tale

Antony Mueller
Jun 27 · 8 min read

Once upon a time, two farm boys were sent to the local market: one of them to sell the family’s cow and buy a horse, and from a different village a boy was sent to sell the family’s horse and buy a cow.

When the two boys came to the market, one of them cried. “One million for my horse — a cow wanted!” The other boy, who wanted to sell the cow, heard the call not too far away from him, and thought: “One million — that sounds good!”, and so he cried: “One million for my cow!”

When the two boys came together, they said to each other “One million for me — one million for you!” — “Deal is done!” both of them screamed almost at the same time, and the boy who had the cow exchanged it for a horse, and the boy who had a horse exchange it for the cow.

Proudly they went home, and each of their parents was quite satisfied, because the boys had done what they were told, with the one boy selling a cow and buying a horse, and the other boy selling a horse and buying a cow. None of the boys said anything about a million for they did not really know what that meant. After all, they knew a lot about horses and cows, but very little about money.

It was different in the marketplace. Here, the news spread like wildfire: “Horses are valued at one million the piece!” people said to each other in awe. Yet some doubt remained.

But on the other day, the headlines at the Cow Street Journal (CSJ) and The International Horse Times (IHT) made the rest of the doubters keep their doubts to themselves. In the Cow Street Journal, the headline read “Cow Prices Hit One Million”, and in The International Horse Time the headline announced: “Horse Prices Set New Record”.

Thus, the doubters shut their mouths and kept silent, particularly after the evening news-show had already brought a “special” on the market event the night before, with academic pundits explaining that you can’t second guess the market because it is efficient, and horse and cow market experts said that the prices for cows and horses had just begun to recover from a long period of depressed valuations and that now was the best time to buy.

After the evening news, and after the message appeared in the local news, it was also heard at the homes of our two boys what a magnificent deal they had done. The village folks turned exuberant. “Have you heard?”, they asked, “Bill’s boy sold his father’s cow for a million!”, and in the other village, the farmers exclaimed in astonishment: “One million for a horse — wow!”. In their minds, the horse farmers multiplied the number of their horses by a million, and the cow farmers did the same with the number of their cows. They all were very rich now; even the poor farmers who owned just one horse or one cow.

Right the next day, after reading the news in the Cow Street Journal and in the International Horse Times, the bankers smelled a business. They sent their sales force to the cow farmers and to the horse farmers across the country to explain them a deal. “We’ve come to help you to raise some cash,” they said. This message did not fall on deaf ears, particularly after the bankers’ salesmen continued to say: “As the price of your livestock will rise in price, your loan will get paid by itself.”

Some of the farmers took the loan to buy a new car or a nice gift for their wives, but almost every farmer across the country got into cow and horse dealing and borrowed money to buy more horses and cows, and the prices of the horses and cows were rising more and more. Prices that once appeared absurdly high now seemed quite normal, and those who earlier had claimed that prices were “insane”, now felt they themselves were insane, and silently said to themselves “I better keep my mouth shut or they will put me away.”

Prosperity came to the countryside. Economists who commented the situation spoke of the “wealth effect” in action as the farmers began to spend more and more, and the villages began to bloom.

Soon the word spread around the world that there is a country, where they trade horses for five million and horses for six million with the prices soon going further through the roof. Foreign money poured now in, and the interest rate fell. While those who did not borrow felt poor and incompetent, the borrowers thought they were very smart as they got richer and richer. For the cow and horse farmers, the world was like magic: the more they borrowed, the richer they got. Some time ago, they had already stopped breeding horses or cows, as dealing with horses and cows had become much more profitable than raising them. Someone invented horse and cow derivatives. Thus, one could trade them even though neither the cows nor the horses that were traded existed in reality. The market for certified cow papers (called CCPs) and for certified horse papers (which were named CHPs) boomed.

After a while, it became common to call a horse paper simply “one horse”, and a cow paper simply “one cow”. When a trader in horse and cow papers got home for the weekend he would say to his wife and kids, for example: “We’ve made half a horse and two cows this week”. Only once in a while, it was heard that “the market” was down by “a quarter of one horse” or “a fifth of one cow”. When that happened, the central bank quickly jumped in to inject new money into the banking system because the economy had become highly dependent on the horse and cow papers trading business by now and the next presidential election was coming.

After some time, as the country became wealthier as shown by the profits with horse and cow papers trading, the people of the country felt less the necessity to save and to invest in production at home. Real horses and real cows had lost their meaning anyway. Now, it was all about horse shares and cow shares, and even when kids heard the name “one cow” or “one horse” — they did not think of a real cow or a real horse anymore, but of a kind of money that was much better than the old money and definitely much better than saving money.

Even our two farm boys learned to think that way. After all, as they had grown older, they had only vague memories left about what a real cow and real horse was. They had long left the farm and gone to the city to make a fortune as CDP and CHP brokers.

The country’s “National Horse and Cow Papers Exchange” had grown into the largest papers exchange market of the world, and the news of prosperity spread around the globe, and everywhere in the wide world, the prices of cows and horses were rising — at least on paper. Even in countries where there were no cows or horses at all or just a few, people began to trade paper horses and paper cows. In these places, the evening news pundits explained that the less real horses or real cows “we have”, the more valuable they would be — and that this would fully justify current prices at the exchanges — no doubt about it, they affirmed.

Yet while the financial market was booming, the domestic industry was getting weaker. While the horse and cow papers trading business got ever more frenzied, there were less and less real horses and real cows in the countryside. At first, the declining employment in production did not raise the unemployment rate because jobs service jobs rose, particularly in banking and finance.

The government announced: “Our economy is fantastic!” Central bankers looked at their macro statistics and constructed averages and proclaimed “According to our indicators, the economy will continue to grow at its non-inflationary steady pace of expansion.”

There were a few people who wondered somewhat about these statements because they felt that they weren’t actually not doing so well. In the population, there was also disbelief why prices could be called as being “stable”, when in fact for many items they had to pay quite a lot. But most of the citizens slept well in their belief that government and central bankers would take good care of them.

With the domestic industry steadily weakening, wages had already been stagnant for quite some time, and then they began to fall. Meanwhile, borrowing costs began to rise. While the high exchange rate still allowed the import of cheap foreign goods, prices for services that could not be imported from abroad — such as medical care and education — rose drastically. More households needed additional loans to finance their old debt, and “to stay even”, as they said. It was as if in everyman’s wallet there a big hole had shown up where all the cash disappeared. While there was apparent prosperity all around, a rising number of people felt uneasiness and began to worry.

The bankers wearily noticed what was going on, as more and more of their old customers showed up in need of additional loans. Just a short time ago, house prices were rising faster than debt, now it was debt that was rising faster than the house prices, and even the prices of the horse and cow shares became more and more wobbly. It dawned upon the bankers’ minds that with wages stagnant or falling and the prices for horses, cows, and houses no longer rising, a problem was ahead: many of the borrowers never in life would earn enough to service their runaway debts.

The bankers decided to trim their easy lending. Credit tightened, and distrust and lack of confidence crept into the markets. Everything had seemed so fine for so long, but now, all of a sudden, confusion and fear gripped the traders in a shock, and they noticed that they had lost any yardstick of sound valuation.

On that same morning, one of our two boys, sitting in his office at Cow Street, began to scratch his head when he was overcome by a revelation: “What the heck”, he said to himself as he looked at the screen with the market quotations, “how come that cow papers and horse papers trade at these prices when in fact almost no real cow and no real horse is left in this country?” — and in a wild attack of panic and sweating from all pores, he pushed the “sell all”-button, said a bad word and waited for the bids — yet there was no response. Everyone else had also hit the sell-all button.

How did the story end?

After the crash, banks, investment houses, and brokerages were going broke. Their top managers and big investors claimed an emergency. If the government won’t save us, the economy will collapse, they said. Save the nation’s farms, was their mantra. They knew it was a lie. They knew that banks, and investment houses, and brokerages are not the economy, but the government was scared to death, and the nation’s news spoke of gloom and doom in case that the government should not act.

Thus, the government and its central bank handed over trillions to the bankers, the investment houses, and the brokerages. Nobody asked where the money came from. Nobody asked who will pay the bill. The banks were saved but now the economy was broke.

The two boys could retire as very rich persons. They moved back to the countryside where farmland became as cheap as dirt.

And if they did not die, then they still live today.

Antony Mueller

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Dr. Antony P. Mueller is a German professor of economics who currently teaches in Brazil. See his website: http://continentaleconomics.com/