Friday, April 24, 2020

4.1 Five Guys Analogy



4.1        Five Guys Analogy

  Because the intent here is to illustrate principles and specific points, very simple analogies will be used, studied in extremes. More complex models with more variables will confirm the process, given that one has sufficient time and the patience to work through the details.
The ideas are presented in two separate cases of one illustration. The first case will illustrate what the purpose of inflation is NOT and the second case will illustrate what the purpose of inflation IS.

Imagine a country with a currency called a dollar. This country defines their dollar as one-tenth of an ounce of gold. Therefore, each gold ounce is worth ten of this country's dollars.

Quantity
Object
Defined Value
0.1
Ounce of Gold
$1.00
0.5
Ounce of Gold
$5.00
1
Ounce of Gold
$10.00
5
Ounce of Gold
$50.00
10
Ounce of Gold
$100.00

In this country there are exactly five guys who each have ten ounces of gold. These five guys are the entire population of the country.

Quantity
Object
Total Value
10
Ounces of Gold
$100.00
10
Ounces of Gold
$100.00
10
Ounces of Gold
$100.00
10
Ounces of Gold
$100.00
10
Ounces of Gold
$100.00

50

Ounces of Gold

$500.00

Imagine that they like using receipt money, so their coins are in a vault.

Quantity
Object
Total Value
10
Receipt
$100.00
10
Receipt
$100.00
10
Receipt
$100.00
10
Receipt
$100.00
10
Receipt
$100.00

50
Receipts for
50 Gold Ounces

$500.00

Let's keep this simple. Imagine that they each grow different varieties of corn and that all corn is priced at $1 per bushel. These gentlemen grow flint corn, dent corn, sweet corn, popcorn and flour corn. Each type of corn is used for different purposes.

Illustrating what the purpose of inflation is NOT...


Here we begin our illustration for the first case. It involves two years.
In this imaginary world, the five guys have an economic summit on January 1st each year. In year one, they meet and then go about their business. In this simple low velocity economy, each man uses his one hundred dollars in receipt money to purchase one hundred bushels of corn.
In year two they meet and decide to “lubricate” their economy so they can be sophisticated like the neighboring countries. They casually ignore the definition of their dollar. They print and immediately distribute an extra one hundred dollars each in receipts, thereby giving each man two hundred dollars.

Quantity
Object
Total Value
20
Receipt
$200.00
20
Receipt
$200.00
20
Receipt
$200.00
20
Receipt
$200.00
20
Receipt
$200.00

100
Receipts for
50 Gold Ounces

$1000.00


Has the wealth of their nation increased?


The answer is no. The paper receipt is costless to produce and therefore valueless in its own right. The paper references the same 50 ounces of gold in the vault. Therefore, with double the receipts and no more gold, each receipt is instantly worth half as much.


Has the value of the corn changed?


The answer is no. The corn has the same nutritional value and other value attributes as it did before someone pressed the print button to create extra receipts. Corn is real property with identity and it can be weighed and measured.

Has the price of the corn changed?


The answer is yes. Since the receipts are half as valuable and the corn retains its same value, one now needs to spend two dollars (in terms of inflated receipt money) for each bushel of corn.
How many bushels of corn can each of the five guys purchase with their $200 of old and new receipt money? Corn is $2 a bushel now so they are able to purchase exactly what they could before; 100 bushels of corn. Nothing changed.

Therefore, one can see that inflation serves no purpose if everyone gets the new money on the  same day.

So what is the purpose of inflation?

Illustrating what the purpose of inflation is...


Let’s erase the last two years and start again in year one, this time with a different twist.
This time on January 2nd in year one, one of the five guys decides to become a central banker.
He prints an extra $500 in receipt money, places it on the ledgers in the bank and then borrows it. Instead of $500, all together they now have the same 50 gold ounces, but there is $1000 in receipt money floating around.
Remember in the previous analogy when the new receipts were printed, each of our five guys received his share of the new receipts. Because everyone knew the true ratio of receipts to gold, each of the five guys could go and get his, and only his, gold ounces out of the vault.
But this time, only one farmer, who is also the central banker, will get all the new receipts. Instead of ten, he will have his ten, plus the newly printed duplicate receipts which match the original receipts of his and the other four farmers. He will have 10+50=60 receipts, having a false face value of $600.


Quantity
Object
Total Value
60
Receipt
$600.00
10
Receipt
$100.00
10
Receipt
$100.00
10
Receipt
$100.00
10
Receipt
$100.00

100
Receipts for
50 Gold Ounces

$1000.00



Has the wealth of their nation increased?


The answer is no. The paper is costless and therefore valueless in its own right. The paper references the same gold coins and therefore each receipt is now worth half as much. They still have only 50 gold coins in the vault.
Previously, when the other four guys lost half of their purchasing power, they each received additional receipts at no cost which maintained their purchasing power at the same level.
This time, the paper in four of the guy’s pockets lost half of its value, but they received no replacement receipts. Instead, the banker gets all the new receipts. He enjoys an increase in purchasing power at least equal to the loss in purchasing power of the other four guys.

Has the value of the corn changed?


The answer is no. The corn has the same nutritional value and other value attributes as it did before someone pressed the print button to create extra receipts. Corn is real property with identity and it can be weighed and measured.

Has the price of the corn changed?


The answer is yes according to math, but no according to knowledge. Since the receipts are half as valuable and the corn retains its same value, corn should now be priced at two dollars (in terms of inflated receipt money) per bushel. However, the other four guys don't know about the new money so they continue to trade corn at the price of $1 per bushel. Over time, the market will reflect the decrease in purchasing power, but bad things happen along the way.
Consider how this plays out. The banker started with $100 like everyone else, then secretly printed
$500 in new receipts. Then he borrowed the extra $500.
The banker now has $600 dollars to spend.
The market will always cause price changes to occur when the money system is manipulated. However, to keep the math simple, let's stipulate that the price changes in our analogy do not occur until the January 1st economic summit a year from now.
In the meantime, the banker is purchasing more corn than normal with the secretly printed new receipt money. The four guys are going to be quiet, but happy, because each thinks that he is making really big money this year as he sells more corn than normal and his account swells from $100 to $200. The other four farmers are thinking about all the extra corn of other varieties they will be able to buy next year. And an imported fishing boat.
For the purpose of illustration, let's specify that each of the four guys winds up with $200 dollars at the end of the year. The banker has $200 from the variety of corn he grew and sold that year along with some trading of the corn he purchased.
The four guys have 100 bushels of corn at the end of the year.
The banker, on the other hand ends the year with 500 bushels of corn.

What Happened?

At the economic summit it quickly becomes clear that the banker has inflated the money supply, which halved the value of the dollar receipts already in existence. The farmers discover they should have been selling corn for $2 a bushel.
Since everyone is now aware of the true value of the inflated receipts, in the upcoming year they


will only be able to buy 100 bushels of corn with their deceptively big $200 dollar bank account. After all, $200 dollars in receipts are really only worth the same 10 ounces of gold they have in the vault.

What is the Effect?


Since everyone ended up with the same amount of dollars relative to one another, one might conclude there is not really any harm done, but that conclusion would be incorrect. Remember that the banker now has 500 bushels of corn when he should only have 100 bushels.
Next year, the banker will be able to sell 500 bushels of corn at $2 a bushel. With his $1,000 income he will pay off the $500 bank loan and pocket $500 in profit. In that year or the next he will also begin printing more receipts which are not tied to any gold ounces and the process will repeat.
Since no one understood the game yet and the receipts each say that they can be redeemed for one gold ounce, the banker uses his $500 in profit to redeem the gold ounces from the vault. Now the banker has all the gold.
When the other farmers finally catch on, they will come to pick up their gold, but it is already gone. The solution for the banker is to pass a law that says it is illegal to own gold and all transactions must take place using the receipt money he is creating.

Purpose of Inflation


So now we can see the purpose of inflation.

“When inflating with costless money, the purpose of inflation is to use NEW MONEY to purchase REAL ASSETS at OLD PRICES, thereby causing a wealth transfer from the people who get the new money last, toward the people who get the new money first.” ~ Shane Coley

Restated:

When inflating with costless money, the purpose of inflation is to use THE BANKER'S NEW RECEIPT MONEY to purchase THE FARMER'S $2 CORN at THE OLD CORN PRICE OF $1,
thereby causing a wealth transfer from the four farmers who get the new money last, toward the banker who gets the new money first. After the banker has the corn, he sells it for cash and then takes all the gold.

Observe the illustration closely. Remember when the new receipts were created in the first case and all the guys received the new money at the same time? In that case no one's purchasing power changed. Prices doubled, but everyone had twice as much money, so the purchasing power was unchanged. The new receipts were meaningless.
In the second case only the banker knew about the new money. No one else suspected prices should be doubled.
Since in both cases the new receipts decreased the purchasing power of the other four guys, whose money was the banker actually handing over when he made his purchases of corn?
The banker was actually giving the other four guys their own money back again and taking the fruits of their labor at the same time.
The banker was buying the farmer's corn with the farmer's own money!
What does this mean for those who are members of a society which operates under an inflationary monetary system? Whoever gets the new money first has artificially increased his purchasing power, and that increase is paid for by the people who get the new money later. This is how our savings and retirements disappear.
The new money is used to purchase real property, like the corn, from the producer, using the producer's own purchasing power. It is no different than the banker just coming and taking the farmer's corn by force, except this method gets the job done in secret using differing weights and measures.
Perhaps these illustrations help explain this popular quote attributed to a past Chairman of the Bank of England:

“Banking was conceived in iniquity and was born in sin. The bankers own the earth. Take it away from them, but leave them the power to create money, and with the flick of the pen they will create enough deposits to buy it back again. However, take it away from them, and all the great fortunes like mine will disappear and they ought to disappear, for this would be a happier and better world to live in. But, if you wish to remain the slaves of bankers and pay the cost of your own slavery, let them continue to create money.” ~ Sir Josiah Stamp, Director of the Bank of England (appointed 1928).

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