I was recently forwarded this email:

“In a small town in the United States , the place looks almost totally deserted. It is tough times, everybody is in debt, and everybody lives on credit.

Suddenly, a rich tourist comes to town.

He enters the towns only hotel, lays a 100 Dollar Bill on the reception counter as a deposit, and goes to inspect the rooms upstairs in order to pick one.

The hotel proprietor takes the 100 Dollar Bill and runs to pay his debt to the butcher.

The Butcher takes the 100 Dollar Bill, and runs to pay his debt to the pig farmer.

The pig farmer runs to pay his debt to the supplier of his feed and fuel.

The supplier of feed and fuel takes the 100 Dollar Bill and runs to pay his debt to the town’s prostitute that in these hard times, gave her “services” on credit.

The hooker runs to the hotel, and pays off her debt with the 100 Dollar Bill to the hotel proprietor to pay for the rooms that she rented when she brought her clients there.

The hotel proprietor then lays the 100 Dollar Bill back on the counter so that the rich tourist will not suspect anything.

At that moment, the tourist comes down after inspecting the rooms, and takes back his 100 Dollar Bill, saying that he did not like any of the rooms, and leaves town.

No one earned anything………. However, the whole town is now without debt, and looks to the future with a lot of optimism.

“And that, ladies and gentlemen, is how the United States Government is doing business today.”

Nice, right? However, the anonymous author of this story neglects two important facts. First, he assumes a 0% savings rate and a 0% interest rate. In reality, the $100 loan would allow the hotelier to pay something like $80 to the butcher, the butcher to pay $64 to the farmer, the farmer to pay $51 to the feed supplier, the feed supplier to pay $41 to the hooker, and the hooker to pay back $33 to the hotelier. Meanwhile, the rich tourist would expect $105 in return for his loan.

Second, and more importantly, the story works so neatly because the hotelier both begins and ends the circle of debt. That means at the outset of the story, the hotelier owes $100 to the butcher, but also holds $100 of the hooker’s debt, for a net liability of $0. The hotelier does not need the rich tourist’s $100 to pay off the butcher; he could just sell the hooker’s debt to the butcher (again assuming an interest rate of 0% and that the butcher prefers to hold the hooker’s debt equally as well as the hotelier’s), so that the butcher has a net liability of $0. The town’s citizens can continue to buy and sell each others’ debt until the feed supplier pays off his debt to the hooker with $100 of her own debt. Both before and after the rich tourist comes, each citizen of the town has a net liability of $0; his presence does nothing to alter that fact.

However, that circular debt structure is extremely unlikely. It’s more likely that some citizens will hold others’ debt without issuing any debts of their own. Thus, I offer a more plausible story: In a respectable society, social opinion would frown upon illicit activities. The hotelier, as a pillar of the community, would not provide any services to the hooker. In that case, the hooker would just keep the rich tourist’s $100 as payment for services she provided in an earlier period. Meanwhile, the hotelier, who was in debt $100 to the butcher, would then owe $100 to the rich tourist and have no way to pay him back.

I suppose the original author meant for his story to show how the government “helps” the economy by borrowing money and then spending it. In this case, the hotelier represent the U.S. government and the rich foreigner giving money to the government represents the Chinese. The more plausible version of the story illustrates that government’s deficit spending doesn’t reduce the total amount of debt in the economy; it just shifts who actually holds the debt. Eventually the government has to repay that debt and it has to get the money from somewhere.