4.1
Five Guys Analogy
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
|
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.
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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