How To Make Money

October 22, 2008 on 3:06 pm | In Business, Insider View, Musings by Josh Jones |

Ha, nice try kid! You're going to jail.

I know what you’re thinking, “Finally, a DreamHost Blog post I can USE!“

HA, you wish! Here we go…

Apart from being a mint, it seems to me there’s really only one way to make money.

Banking.

And I don’t just mean get money, like from people depositing it with you. Nor do I mean earn money that already exists, like you would from say, working or investing.

No, I actually mean it: MAKE NEW MONEY!

The fact that banks can actually create money is why they’re such a great business.. and also why the recent crash has been so hard.

I'm glad I had all MY money in stocks!

How It Works, As I Understand It.

(Correct me if I’m wrong.)

For the purpose of this explanation, imagine there was only one bank in the world (which is actually a pretty good approximation, thanks to all those overnight intra-bank loans we’ve been hearing so much about in the news).

Let’s say their first customer ever, Joe the Plumber (yes, THE Joe the Plumber) comes in to Bank of the Universe, and deposits his meager savings of $250,000 (now FDIC insured!).

Coming, 2020.

Great! Bank of the Universe (BofU) now has $250,000! Enough to run things for .004 femto seconds.

But, it hasn’t earned $250,000 .. it still owes that to JTP. And it definitely hasn’t created $250,000.. it just received it as a deposit. In fact, things aren’t too great for BofU at all … it probably has a deal to pay Joe some interest on that deposit. It’s also got to hold that cash / gold / pvc piping for Joe, pay rent on some buildings, employ some customer service people, manage a network of ATMs, and weave dozens of golden parachutes.

Not Great!

Which is why BofU has to make loans! Let’s say average guy John McCain comes in and needs a quick $250,000 for some campaign he’s running. “Sure,” says BofU, “you seem like a stand-up guy and this isn’t Fall 2008, take the $250,000 at only 5% interest!”

Well, now BofU is at least going to earn $12,500 a year! But.. they’re also kind of screwed when Joe Wurzelbacher comes in to get $20 for a back-siphon for the s-trap he’s funnelating.

Joe's Job.

But They’re Not

Because remember, BofU is not only the Bank of the Universe, they’re the only Bank of the Universe.. and so John just kept that loan in his account with them! And when he does spend that money, whomever he spends it with is just going to deposit it right back in their account with BofU!

In fact, just by making a little “John McCain owes us $250,000 at 5% interest” data base entry, BofU has now not only earned themselves $12,500 a year, they’ve also added $250,000 to the universe’s money supply!

Or, you could just plant one of these.

Right now, BofU would be leveraged 2-1 (they owe Joe and John $250,000 each, but they only have the $250,000 Joe deposited in the bank). But, everything is fine. In fact, everything is so fine, they can go ahead and loan out that $250,000 AGAIN (maybe to Barack)!

And again!

And again!

And one more time!

And then?

And then?

And then?

What's mine say?

Again!

It took thousands of years for banks to realize this, but when they’re big enough, they not only don’t need to back up their deposits with gold, they can actually pretty safely leverage their deposits at ratios of like 30 to 1, 50 to 1, or even 100 to 1.

And, the banks can earn a ton of moololah from this too. Not 100 to 1 (just because they’ve created this new money, doesn’t make it theirs), but at least 5% on that 100… instead of just 5% on that 1.

It just works out that very little of that actual money needs to be withdrawn by people on an average day.. and when they do there’s always those short-term inter-bank loans to fall back on!

(Except for in Fall 2008.)

It's funny because it's true!

But, despite the infrequent aberrations, overall I’d say it’s a pretty good system that works. It results in a much more efficient use of assets, which allows for faster growth and more “economic development”, than if everybody just did like the Russians and just hid their money in their sombreros.

And I should know, because we CREATE disk and bandwidth the same way!

As I may have mentioned before, we offer a lot more disk and bandwidth than we actually have on hand. We’re sort of like a “bank for computing resources.”

This is really the wrong aspect of banking I'm talking about.

Of course, nobody deposits disk with us, but we go out and buy a little, and then sell a lot, and then nobody uses it. And in the end, for all intents and purposes, we’ve really turned that little disk space into a lot!

And, it’s a useful service because if everybody had actually gone out and bought that lot of disk space themselves, they wouldn’t have used 99% of it, and it would have been a waste! A big waste! A universal waste!

And so, we’re “leveraged” in disk. And we’re “leveraged” in bandwidth. And we’re “leveraged” in CPU. And the ratios are a lot more than 100 to 1.

And it works.

But.. when does our Fall 2008 arrive?

If we go down, we ALL go down..

Should Be.. Never.

As similar as our businesses are, there are a few key differences between Banking and Hosting.

For one, we don’t owe our computer resources to our customers like banks do their money. We bought them. So there can’t really be a “run on the host” with everybody saying “give us back our disk and bandwidth we bought!”

For two, there can’t even be a “run on the host” .. what, is there going to be some awesome Internet news and suddenly everybody’s website gets 100 times the traffic and uses 100 times the disk?

For three computer resources are not money. Although it may be nice for us if they were… even if we were to somehow (remember, 100% hypothetical!) run out of disk or bandwidth or CPU, we’ll still have our money. And that means our people can still get paid, and we can buy more resources, or we can rejigger something, or whatever… but when a bank runs out of its leveraged resource, bam.

As in, bam, you just start using the hand-drawn ones!

That’s It.

And I don’t just mean that’s it for the bank, I mean that’s it.

For this blog post.

Period.

(P.S. I hope all that stuff I said about banks is right.)

19 Responses to “How To Make Money”

  1. Tim Says:
    October 22nd, 2008 at 3:48 pm

    I hope you guys don’t somehow over sell RAM/CPU on your Private Server accounts.

  2. kestasjk Says:
    October 22nd, 2008 at 5:58 pm

    I think it’s a good system too, problem is they lent to people who couldn’t afford it

  3. 3 Says:
    October 22nd, 2008 at 8:42 pm

    Overselling rules… despite what all the little kiddie hosts on WHT that can’t compete with the big boys claim. Too bad they all decided to be hosts before learning basic math.

  4. Clay Says:
    October 22nd, 2008 at 9:52 pm

    Umm… $250,000 in liabilities versus $0 in liquid assets is an infinite debt ratio(Well, ignoring the whole dividing-by-zero issue). If they loaned out $249,999 instead, they’d be leveraged 249,999-1. They couldn’t loan out another ten bucks unless they got a loan or another deposit.

    Your analogy really only works if, oh, instead of real loans where the money is given to someone else, the bank said, “John, you now have a credit limit of $250,000″. So long as no one actually made it near their credit limit, they could make the same statement to a lot of people.

    …and thus ends my nit-pick. Hopefully my understanding of leverage is not terribly flawed.

  5. Albright Says:
    October 22nd, 2008 at 10:24 pm

    The iStockphoto watermark on the money tree picture is totally classy.

  6. Tim Linden Says:
    October 23rd, 2008 at 5:10 am

    We could have a virtual run on the host.. Everyone quick go make really really really really really big websites!

  7. Chris Says:
    October 23rd, 2008 at 3:13 pm

    You got the basic concept of banking correct, but I thought I would throw in some info for extra economic knowledge. After all, we all want to know how it all works don’t we?

    There is a concept in banking known as the money multiplier. The money multiplier explains how new money is created within our economy. New money creation is a fundamental part of the US monetary policy which is controlled by the Federal Reserve.

    The money multiplier works like this: (assuming there are many banks, not just one.)

    1) I deposit $100,000 into my bank.
    2) My bank holds a required reserve of say 20%, which comes to $20,000.
    3) This leaves the bank with $80,000 to loan out.
    4) The bank makes an $80,000 loan to Joe the Plumber.
    5) Joe the Plumber takes this $80,000 to his bank and deposits it.
    6) Joe the plumber’s bank now has $64,000 to loan out (80,000 - 20% required reserves).
    7) Joe the plumber’s bank makes a $64,000 loan to John McCain

    and the cycle continues until there is no additional money to loan out.

    From an initial deposit of $100,000, assuming that the required reserve rate is 20%, a bank can create $500,000.

    This is how banks create new money in our economy. The Federal Reserve is also able to control the money supply by adjusting this reserve rate to control how much new money banks can create.

  8. Gwyneth Llewelyn Says:
    October 24th, 2008 at 3:41 pm

    Aye, @Chris has got it right — sorry, Josh, but it’s nowhere as bad as you paint the picture ;)

    Still you’ve got a point, yes, banks make money.

  9. The One Says:
    October 26th, 2008 at 7:03 am

    Gwyneth, reality is actually worse than how Josh described it.

    If a bank has $10,000 in its reserves in its account at the central bank (Federal Reserve), it can loan out $100,000 in commercial bank money, which is just a number on a computer in someone’s account, if the fractional reserve ratio is 10%.

    As other banks receive new checks, written on this account, they get to increase their own reserves at their own account at the central bank and continue the cycle, until no more new money can be lent out.

  10. Chris Says:
    October 27th, 2008 at 12:21 pm

    The One, For simplicity’s sake I decided to leave out the complicated matter of commercial banking. Partly because it is so complicated and partly because the typical model of commercial banking is changing. The commercial paper market is a completely different concept that I decided not to get into.

  11. Evocatus Says:
    October 27th, 2008 at 4:22 pm

    To all the money wizardry here above I would add that repealing the Glass-Steagall Act of 1933 contributed very much to the present day financial crisis.

    When deregulation was all the rage this act curbing and separating conflicting financial services was an offence to the idolators of the free market ideology. An ideology where the profits were privatized and the problems socialized (=government bail-outs)so to say. Thus creating inflation as a hidden tax.

    #2 kestasjk said:
    “I think it’s a good system too, problem is they lent to people who couldn’t afford it”
    1. I honestly think it is a very bad system, this predator capitalism.
    2. The problem is only partly that they lent money to people who could not afford it. The real problem is that they made these people BELIEVE that they could afford it! This is immoral.

    By the way it was a nice(sic) sight to see Alan Greenspan say that he made a mistake. Aha… Mr. Greenspan. All this started much earlier (1987) when Alan Greenspan replaced Paul Volcker at the FED. Commercial banks wanted to sell new securities and Volcker did not like that.

    Greenspan was the *man*, after all he served ten years on the board op J.P. Morgan. Classic case of job hopping between Banks, Corporations and Administrations. Where does come “Hank” Paulson from? Yep, Goldman Sachs.
    Ave, Evocatus

  12. Chris Says:
    October 28th, 2008 at 9:56 am

    True the repealing of the Glass-Steagall Act of 1933 and the deregulation of financial markets is partially what has gotten us here today, however, I reject the notion that the blame for this can be pointed at Alan Greenspan.

    Yes he had a hand in the deregulation of financial markets, but that doesn’t mean that he should take the blame for this crisis. Like I posted in a recent blog entry, it is nothing but our collective greed that has put us in this position. Blaming Alan Greenspan or anyone else in government is like blaming your parents for getting arrested for hurting somebody. Everyone has a hand in this crisis.

    #11 Evocatus said:
    “All this started much earlier (1987) when Alan Greenspan replaced Paul Volcker at the FED.”

    You must remember that only 2 months after becoming chairman of the Federal Reserve he had to deal with Black Monday. Surely he could not have caused Black Monday in a matter of 2 months.

    What I am getting at is that it seems as though we all like to point fingers at who *caused* this, when we should focus more on who is going to get us out of it. Economics is an evolving study. As soon as you think you understand how everything works, it changes. There is no way that anybody could have had the foresight of our collective greed that got us in this mess.

  13. Woodrow Wilson Says:
    October 31st, 2008 at 6:16 am

    We screwed you over in 1913. Up until Christmas of that year the United States of America was not shackled to the Federal Reserve System. Which, by the way, is why we had that little spat years ago called The American Revolution to become a Republic in the first place.

    I knew it was wrong, but JPM paid my way into the Executive Mansion and I owed him. And hey, I got my face on the $100,000 bill which you gotta admit was pretty neat!

  14. Daniel Runyon Says:
    November 1st, 2008 at 6:48 pm

    Very educational… much appreciated Mr. Wilson!!! I knew what you had done to us, but I did not realize the significance of a fed res type system to the Revolution, and I did not know anythang about who was on the $100,000 bill… you are a real piece of shit, but I do thank you fer havin the sack to come out all these years later and tell us about it.

  15. Ignatius Says:
    November 6th, 2008 at 8:45 pm

    I been saying something like that to bankers and businessmen for a couple of years.

    Look who’s crying now.

  16. biooya Says:
    November 29th, 2008 at 12:45 pm

    Evocatus - Did you state free markets are at fault because loses are socialized?

    Anyway, when businesses are “too big to fail”, whether its banks, autos, or otherwise, the taxpayer gets to pay for a bail-out. How did these business get so big? Manipulation of government regulations which make it nye impossible for smaller businesses to compete. Bigger government will result in bigger business. Hence, the banks using the bail-out money to buy other banks. We’re making the hole deeper. The only difference between republicans and democrats is which big business they are doing favors for.

  17. Appealfgefjaw Says:
    December 10th, 2008 at 2:19 pm

    If anyone is looking for a no nonsense way to make money fast, these guys are the best
    it took me a few days to get going, but they were very helpful. Two weeks in and i just
    got my first $1,000 check. This works by spreading the word, so I’m spreading the word.

    Check it out here: http://www.17getmoney.info

  18. Mark Says:
    January 4th, 2009 at 7:21 pm

    Nothing like lending money out to people who can’t afford to pay the mortgage alone.

    On a side note, what’s with the banks charging high interest rates for their credit cards. 29.9% is insane, no matter how your creditworthiness is.

    http://www.gomarkymark.com

  19. Darren Says:
    January 20th, 2009 at 3:00 am

    The Zeitgeist Addendum and Zeitgeist Final Edition videos will explain all this way better. It’s basically all about the Federal Reserve.

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