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Once upon a time there was a small island nation. The territory and of this nation was comprised entirely of the island itself. The total money in circulation in the country was £2 as there were only two £1 coins in circulation.
There were only 3 citizens of this country, all of who lived on the island. John owned the land and Ted and Connor each owned £1.
The following event came to pass:
1) Ted decided to purchase the land from John for £1. So, John and Connor now each owned £1 while Ted owned a piece of land that is worth £1.
The net assets of the country were £3.
2) Connor thought that since there is only one piece of land in the country and considering land is non-producible asset, its value must definitely go up. So he borrowed £1 from John and, together with his own pound, he bought the land from Ted for £2.
John has a loan to Connor of £1, so his net assets were £1.
Ted sold his land and received £2, so his net assets were £2.
Connor owned the land worth £2 but with his £1 debt to John, his net assets were £1.
The net assets of the country were £4.
3) John saw that the land he once owned had risen in value, and regretted selling it. Luckily, he had loaned £1 to Connor. He then borrowed £2 from Ted and acquired the land back from Connor for £3. The payment was by £2 cash (borrowed) and cancellation of the £1 loan to Connor.
John now owned the land that is worth £3. But since he owed Ted £2, his net asset was £1.
Ted had loaned £2 to John. So his net asset was £2 in the form of Ted’s debt.
Connor now had the 2 pound coins. His net asset was also £2.
The net assets of the country was £5.
4) Ted saw that the value of land kept rising. He also wanted to own the land. So he bought the land from John for £4. The payment was by borrowing £2 from Connor and cancellation of his £2 loan to John.
John now had his debt cleared and he obtained the £2 coins. His net asset was £2.
Ted owned a piece of land that is worth £4 but since he had a debt of £2 to Connor, his net assets were £2.
Connor loaned £2 to Ted, his net assets were £2.
The net asset of the country were £6. Even though, the country had only one piece of land and £2 in circulation.
5) Everybody had increased there worth and everybody felt happy and prosperous.
6) One day an evil notion entered into the mind of Connor. “What if the land price stop going up, how could Ted repay my loan. After all there are only £2 in circulation in our economy, I think that the land that Ted owns is probably only worth £1 at the most”.
Connor discussed his idea with John, who after some thought, agreed.
7) Shortly afterwards nobody wanted to buy land.
John owned the 2 pound coins, his net assets were £2.
Ted owed Connor £2 and the land he owned which he thought was worth £4 was now worth only £1. His net assets became £1 debt, so negative.
Connor owns the £2 debt of Ted. Ted is unable to pay this, so it is a bad debt. Although his net asset is still £2, he was getting a little nervous.
The net asset of the country were £3 again.
Who had stolen the £3 from the good citizen of this country?
Of course, before step 7 Ted thought his land worth £4. Actually, right up to just before the collapse, the net assets of the country were £6 on paper. Ted still owns £2 of bad debt.
The net asset of the country were £3 again.
8 ) Ted had no choice but to declare bankruptcy. Connor acquired the land from Ted so to recuperate his £2 of bad debt from Ted. The land was now worth £1.
John owns the 2 pound coins, his net assets are £2.
Ted is bankrupt, his net assets are zero.
Connor ended up with a land worth only £1 (C lost £1)
The net assets of the country are £3.
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Login next week to see what he has to say about the "Bonker Bankers"
