"Then it is dark; a night where kings in golden suits ride elephants over the mountains." - John Cheever

Tuesday, January 08, 2008

Cityphilia

As ever, a great article by John Lanchester in the LRB. I never really understood how things like derivatives and hedge funds worked until I read this.

In fact, I didn't wholly appreciate how banks worked either:

"Imagine a country with only one bank. A customer goes into the bank and deposits £200. Now the bank has £200 to invest, so it goes out and buys some shares with the money: not the full £200, but the amount minus the percentage which it deems prudent to keep in cash, just in case any depositors come and make a withdrawal. That amount, called the 'cash ratio', is set by government: in this example let's say it's 20 per cent. So our bank goes out and buys £160 of shares from, say, LRB Ltd. Then LRB goes and deposits its £160 in the bank; the bank now has £360 of deposits, of which it needs to keep only 20 per cent – £72 – in cash. So now it can go out and buy another £128 of shares in LRB, raising its total holding in LRB Ltd to £288. Once again, LRB Ltd goes and deposits the money in the bank, which goes out again and buys more shares, and so on the process goes. The only thing imposing a limit is the need to keep 20 per cent in cash, so the depositing-and-buying cycle ends when the bank has £200 in cash – all the cash there is – and £800 in LRB shares; it also has £1000 of customer deposits, the initial £200 plus all the money from the share transactions. The initial £200 has generated a balance sheet of £1000 in assets and £1000 in liabilities. Magic! In real life, it's even better: the UK cash ratio is 0.15 per cent, so that initial £200 would generate £133,333 on both sides of the balance sheet."

3 comments:

Colin said...

Forgot to post the link:
http://www.lrb.co.uk/v30/n01/lanc01_.html

Tom said...

Yes, I read it - a great piece. John Lanchester is one of my favourite writers at the moment. His stuff in the LRB, whether it's on climate change or finance, manages to be crisply informative while also very funny and opinionated.

I think it was the Italian marxist Gramsci who once said: "it's difficult to say who the greatest criminal is, the man who robs a bank or the man who builds one".

john said...

Antonio shortest-ever-career-in-the-Polizia Gramsci?