There is a village with over 200 people.
At the west end of the village is the village chief's house. Everyone pay attention, this village chief is called Xiao Mei.
Xiao Mei is tall and strong, she beats up anyone she catches, and her position as village chief is as secure as an old dog.
One day, Xiao Mei plans to renovate her house. After calculating, she needs 1 million.
But Xiao Mei's annual salary is only 200,000, saving money will take several years.
Xiao Mei thought for a moment and decided to borrow money.
There are over 200 households in the village, who doesn't have some spare cash?
So Xiao Mei started borrowing money and wrote IOUs. Some were to be paid back in a year, some in two years, and there were even ones to be paid back in 10, 20, or even 30 years.
Everyone saw that the village chief was borrowing money, her credibility was solid, and as the village chief, she couldn’t run away.
Although the interest was only 1% per year, it was stable.
Lending to her~ even flies are meat.
Thus, Xiao Mei easily borrowed 1 million with an annual interest of 1%, which is 10,000. She wrote many IOUs, planning to pay them back slowly over the next 30 years.
With her annual salary of 200,000, the 10,000 in interest each year wouldn’t affect her life, it was stable.
Building the house took several years, and as everyone knows, it went over budget.
Xiao Mei didn’t want to lower her living standards and thought, why not just keep borrowing money? That’s quick.
So every year she borrowed a little more money, issuing more IOUs.
Thus, her debt slowly increased from 1 million to 2 million, 3 million... A few years later, it turned out she borrowed 10 million!
And since she borrowed too much, the villagers weren't foolish; 1% interest was too low. If you don't give us a little more, we won't lend.
So Xiao Mei's interest slowly increased to 2%.
With an annual income of 200,000 and a 10 million debt at an overall interest rate of 2%, the annual interest would be 200,000.
How would she live?
At this point, two problems arose:
1. Old debts come due every year, but all income goes to interest, leaving no money to pay back the principal.
2. The house was just torn down and the foundation built, and she needed to spend even more money.
Xiao Mei thought again—why not borrow new debt to pay off old debt?
This year, 500,000 of old debt is due, so I'll borrow 500,000 again, it’s a perfect substitute~
Xiao Mei thought again—if I borrow 550,000 in new debt, wouldn’t I have an extra 50,000 for myself?
Paying off debts? Next time when the debt is due, I can just borrow 600,000, right?
At worst, I can just give them a little more interest.
That's how life went on day by day.
Suddenly, one day, a family in the east of the village called Xiao Rizi encountered a problem. Their parents died and needed to arrange a funeral, but they couldn’t find urgent money anywhere.
Xiao Rizi suddenly had a brilliant idea—IOUs! I still have village chief Xiao Mei's IOUs!
Xiao Rizi took out all the IOUs they had saved and calculated, wow!
Xiao Mei now has a debt of 30 million, and Xiao Rizi has 2 million. If I urgently cash out 1 million, wouldn’t the funeral expenses for my parents be covered?
At this time, the village had already established an 'underground trading market for Xiao Mei's IOUs.' After all, every household had her IOUs, and it was okay to use them as money.
But Xiao Rizi needed cash today, and the 1 million IOU with an annual interest of 3% was hard to sell immediately.
After all, Xiao Mei had gotten used to borrowing money, issuing new IOUs every day with an interest of 3.1%, making it more cost-effective for everyone to buy new debt from her.
Xiao Rizi thought, if I can't sell for 1 million, 980,000 works too! Just means a little less dirt on my parents' grave.
The villagers found this amusing.
Because buying 'second-hand Xiao Mei debt' from Xiao Rizi calculated out to an interest rate of 5.1%, not 3%!
Everyone is after the interest; who would still go to Xiao Mei's doorstep to buy her 3.1% new debt?
Xiao Rizi sold the original 1 million Xiao Mei old debt for 980,000 and happily went to arrange the funeral for his parents.
But Xiao Mei cried.
The villagers all went to buy old debts from Xiao Rizi, and her new debts remained unsold and sat in her hands.
But today, exactly 1 million of old debt is due.
If I can’t sell the new debt, not only can I not pay the interest, but I also can’t pay back the 1 million principal of old debt, and the village chief's credibility is ruined~
If the villagers hear she can’t repay her debts, who would still lend her money? They would all come to collect debts.
So Xiao Mei thought, I will also borrow money at 5.1% interest! Borrow 1 million!!! Pay back in 10 years!!!
The next day, Xiao Rizi's neighbor, Xiao Tu, was bored and wanted to watch someone jump off a building.
Xiao Tu is a person who has a lot of money, having bought quite a bit of Xiao Mei's debt before.
Since he was bored, and after seeing what Xiao Rizi did the previous day, he heard Xiao Mei crying at home for half the night about borrowing money with high interest; the whole east side of the village could hear it, it was amusing.
So when Xiao Tu heard that Xiao Mei had 2 million old debts due today, he also took out 1 million of Xiao Mei's old debts and went to the village's 'underground trading market for Xiao Mei's IOUs.'
As soon as he entered, he shouted: 'I'm bored today, 1 million Xiao Mei debt, selling for 970,000!!!'
On the day Xiao Mei was going to hang herself, the interest on her new IOUs was 6.18%.
She didn’t jump because the house wasn’t finished yet.
This is the story of Xiao Mei's debt. It has nothing to do with any beautiful stocks, beautiful bonds, or the USD exchange rate~
(If you want to repost, please respect the original and remember to circle me...)
Supplementary explanation:
Xiao Rizi's 1 million has a face value of 1 million with an annual interest of 3%, receiving 1,030,000 at the end of the year.
But if sold for 980,000, for example, if Xiao Bangzi buys it, his principal is actually 980,000, but he would still receive 1,030,000 at the end of the year.
So for Xiao Bangzi, the yield is no longer 3%, but [(1,030,000 - 980,000) / 980,000] * 100% = 5.1%.
Xiao Tu's 6.18% is the same reasoning.
