I want to buy a bird table and the man that makes them is selling them for 10 pounds
I only earn 1 pound a week so I have to wait 10 weeks before I can buy one
Another man (let’s call him Rob) has the money and he will lend it to me but I have to pay him 50p a week for 24 weeks.
I borrow the money and buy the bird table.
Rob likes the idea of getting back £12 in return for his £10 and so he decides to lend to more people. More people can buy the bird tables so the man that makes them can put the price up to 15 pounds.
Now people that used to buy the bird tables for 10 pounds can’t and either have to wait longer (and worry that the price might go up again) or borrow the money to buy it now. So they borrow the money now which means there are so many people tying to buy bird tables that the price goes up again. We are on our way to economic growth hooray.
Now Rob realizes that he is running out of money to lend and although a lot of people owe him money it is not currently available to him. He decides to swap some of this “future” money with someone (let’s call him George) for real “now” money. Obviously now money is worth more than “future” money (well nobody knows for sure what will happen in the future) so Rob won’t get quite as much from George as George gets from Rob (but he will still end up with more than he originally gave out plus he will have it immediately.).
However Rob is sly and he knows that not all the people that owe him money will pay it all back so he swaps the “future” money from those people he thinks are most likely to not pay back all of their loans.
Of course George doesn’t know about this little rouse (although if he could have been bothered to check whose “future” money he was swapping it would have been fairly obvious.)
So more money gets lent out and more bird tables get sold (although the price does keep creeping up.)
Sooner or later one of the people that brought a bird table with a loan find that they cannot pay it back. This just happens to be part of George’s “future” money (what are the chances?) and George begins to get a little worried. “What happens if none of my future money is paid to me?” he asks. I will have no money.
Well oddly, even though it is unlikely that George would lose all his “future” money, he begins to panic and decides to behave as if all his “future” money from Bob is lost. He decides to hold on to his “now” money at all costs so when Bob comes along asking to borrow some more money he refuses. Bob of course can’t lend any money to people wanting to buy bird tables so the man selling them starts to get a little concerned.
Now it might be argued that if people still had to wait 10 weeks to buy them he would have had a nice steady stream of customers that he could have easily kept up with but as everyone wanted a bird table “NOW!” he had to borrow some money from George to buy the wood to make them and to pay some people to help him. Unfortunately now that no one can borrow the money to buy his bird tables he is struggling a little to pay back the money to George. George is in no mood to be generous at this point and so demands that he be given all his money back now. The bird table man decides to stop paying his helpers.
Now the panic is starting to spread and everyone decides that actually they don’t need Bird Tables at all so they stop buying them altogether. The Bird Table man stops making them and tells George he can’t pay back any of his money.