Mr Default Buyer and cow inflation

This is a reply to geerussell’s question at MNE. It’s too long to post in the comment section.

To give you a better illustration of my point, let’s use Bill Mitchell’s favorite analogy (with due respect) of the buffer stock of heads of cattle. But in this case, let’s use a recurring income transaction of selling milk, which is what would be more closely similar to a wage income stream. Imagine an economy with 1,000 heads of cattle, owned individually by different farmers, all of whom are each other’s customers for the milk.  Let’s imagine that each cow can only provide for one customer at a time, each of whom buys a long-term milk stream, say for 5 years.

 Now, imagine 200 farmers want to save, so there is demand for only 800 milk streams. This decreases the price of milk, which was say, $100/one year’s delivery, down to $80/year. But then, imagine that a default buyer arrives, and makes an open offer of $100 /year for each undemanded milk stream, thereby increasing total demand back for all 1,000 heads of cattle, and price back to $100.

This default buyer increases the income stream, and therefore, the ‘animal spirits’ of the cattle owners, and they then start demanding other milk-based products. Milk duds, milkshakes, and chocolate milk start becoming a common craving of the now better-off famers. Let’s say 50 farmers now require more than one cow, because they want to expand into these milk goodies, bringing the farmer end user demand to 850 heads. 

But since the default buyer keeps his open demand of $100 for all undemanded cows, not all cattle owners are willing to provide his cow to the other farmers now willing to buy more than one cow’s milk stream. Some farmers just got accustomed to the default buyer’s arrangement, perhaps because he is more convenient to transact with. So to attract some of the 200 providing their cows in service of Mr. Default Buyer, these 50 farmers up their offer to $110/year.  

30 farmers willingly transfer to the new buyers, leaving 20 more without a cow for their additional demand.  Let’s say and additional 10 were willing to pay for up to $115, which entices more farmers to shift, but still leaves 10 new owners unable to make their expansion. 840 cows are now providing milk for other farmers, 160 remain Mr Default’s suppliers.

Now, the farmer cum customers are getting even more prosperous, and demand even more milk-based products. Milk bonbons, cream pies, and designer ice cream now become the “new cool products” to have.  This entices more producers to come forward, as the profit margins for these can accommodate the now $115 clearing price for one cow’s year of milk, and then some.  Let’ say 80 farmers come forward offering $125.  This entices 50 of the 160 remaining suppliers to Mr Default to shift.

That still leaves 30 new producers unable to find suppliers for their new bonbon business.  Of those already serving other farmers, 20 indicate they’re willing to transfer again at $145.  So 20 of the 30 get their cows, but 20 other farmers that already had cows lose theirs, and the price to get new cows starts at $145. Meanwhile, the 110 that still remain with Mr Default stay with him. 

Now what happens when milk-based pastries, cream cocktails, and milk sauces become the norm? Bidding for the remaining 110 cows, or for any of the others willing to transfer from some other farmer customers, probably starts at $170.  Maybe Mr Default still will 80 cows left afterwards, but cow inflation has now risen 70%. Time to start tightening.

Just because you put a floor on a price for something does not tell you anything about how high its price will go. Not when you only have a finite supply of that thing. And when someone puts an open offer for all of the supply, the bidding starts higher and proceeds more furiously, whenever there's an expansion of general demand, than when the open offer is withdrawn when other offers are coming to the table.

addendum: Geerusell asks a good follow-up question:  “Why are farmers who supply Mr. Default presumed to be so sticky at the $100 level?” - It could be any reason in my mind. He’s easier to deal with, he doesn’t give hell when the cows want to take a cow holiday, is willing to accept a more flexible schedule, work is closer to home…a lot of other reasons. But I can imagine not everyone offered the first higher price will immediate jump on it. A sizeable number won’t jump until.. they’re made an offer they can’t refuse.