Chapter #5
How Problems Lead to Solutions
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"Whoever controls the volume of money in our country is absolute master of all industry and commerce...when you realize that the entire system is very easily controlled, one way or another, by a few powerful men at the top, you will not have to be told how periods of inflation and depression originate."
5.0 Introduction to the Problem
In Chapter 4, you learned that the financial world relies on a system that might not be as strong as it seems. The fiat system, held up by constant additions of paper money, seems to benefit a few more than many. This chapter uncovers what the fiat system means for regular people and society. Finally, we explore the story of a group of individuals who noticed the problems and quietly worked to find a solution that could change the future of human society.
5.1 Decreasing Purchasing Power
5.1.1 Monetary Inflation and Its Effect on Purchasing Power
Monetary inflation is the increase in the money supply within an economy, directly impacting the average person by reducing their purchasing power. The cycle of price inflation starts when there's more money in circulation. This, in turn, boosts the demand for goods and services, ultimately causing prices to go up.
Let's imagine a small group of friends – Alex, Bob, and Charlie – each with a dollar in hand, and there's one bottle of water available for sale. The initial situation is simple: three people with a total of three dollars and one bottle of water. Now, suppose someone – let's say the local government – decides to give each friend an extra dollar. Now, they collectively have six dollars. With this newfound money, they all feel like buying that single bottle of water. As all three friends want the same bottle, they start bidding against each other.
The increased demand, fueled by the extra money, prompts them to offer more than the initial price for the water bottle. In the end, the bidding war causes the price of the water bottle to go up. This situation reflects a decline in their purchasing power. Even though they have more money, they can't buy as many bottles of water as they could before, showcasing the impact of inflation on the value of their money.
In this example, the friends experienced a decrease in their purchasing power because they were using a form of money that was influenced by external factors, such as the additional dollars introduced by the government. The lack of control over the money supply, combined with increased demand, led to a rise in prices, making it more challenging for the friends to buy the same amount of goods with their extra dollars.
This illustrates how the friends' purchasing power was impacted by factors beyond their control, emphasizing the importance of understanding and questioning the systems that influence the value of our money.
Now, let's explore how this plays out in real life.
Activity: The Effects of Inflation - An Auction Activity
Objective: To understand the concept of inflation and how it affects the prices of goods and services in an economy.
Definitions:
- ⭐ The Money Supply: the total amount of money in circulation within an economy at a specific time. This includes:
- Physical currency, such as coins and bills
- Checking accounts
- Savings accounts
- Money Market accounts
- Small time deposits (like CDs) under $100,000
- ⭐ Auction: A public sale in which goods or property are sold to the highest bidder.
Class Exercise. Follow the instructions below:
- You will receive a random amount of Monopoly money from the teacher. This represents the money supply in a society.
- Write down the total money supply in the chart provided.
- The teacher will auction a candy bar to the students. To win the candy bar, you will need to make the highest bid using your Monopoly money. Record the winning bid next to the money supply.
- The teacher will then add a significant amount of Monopoly money to the total money supply. This represents an increase in the money supply in an economy. Later, you will learn how money supply is added or reduced in an economy.
💡 Societies can often be unpredictable and unjust, exemplified by the simulation of a teacher randomly giving a significant amount of money to only a select few students. This mimics real-life situations where unequal distribution of resources and opportunities can occur, highlighting the inherent randomness and unfairness in many situations.
- The teacher will auction a second candy bar to the students using the same process as before. Record the winning bid next to the money supply on the chart.
- The teacher will repeat the auction a third time.
| Round | Money Supply | Winning Bid |
|---|---|---|
| 1 | ||
| 2 | ||
| 3 |
Conclusion:
- How did the increase in money supply affect winning bids for the candy bars?
- What is the relationship between increasing money supply and inflation?
- How is money supply relevant in the real world?
- When new money is injected into the economy, what do you think will happen to the prices of goods and services? Do you think the change in prices is temporary or permanent, and why? How do you think price changes affect citizens long-term?
5.2 The Global Debt Burden and Social Inequality
5.2.1 Impact on Individuals - Loss of Purchasing Power
Jaime is a college student who lives in a small apartment. He works part-time at a coffee shop to pay for his living expenses and tuition. As soon as he began living independently, Jaime became good at managing his own ledger.
💡 A ledger is a detailed record of all of your monetary transactions. Whether it’s money you’re earning or spending, a ledger helps you keep track of it all.
At the beginning of 2023, he budgeted $10,000 for his living expenses for the entire year, including rent, food, and other necessities. These were his transactions for January 2023:
| Date | Description | Amount | Type | Balance |
|---|---|---|---|---|
| 01/01/2023 | Starting Balance | $1,600.00 | ||
| 01/01/2023 | Rent for January | $800.00 USD | Debit | $800.00 |
| 01/05/2023 | Groceries | $100.00 USD | Debit | $700.00 |
| 01/15/2023 | Part-time paycheck | $500.00 USD | Credit | $1,200.00 |
| 01/20/2023 | Gas for car | $50.00 USD | Debit | $850.00 |
| 01/30/2023 | Textbooks | $150.00 USD | Debit | $650.00 |
This ledger shows that Jaime’s starting balance was $1,600 out of which he spent (a debit) $800 to pay rent for the month. He then spent $100 on groceries and received $500 USD (a credit) in pay for his part-time job, bringing his balance to $1200. He then spent money on gas and textbooks, bringing his balance down to $700 at the end of the month.
Twelve months later, Jaime is having lunch with his grandfather with whom he shares the details of his budget for 2024. Jaime notices that his budget is not stretching as far as it used to and that his cost of living has increased significantly over the past year. While Jaime is wondering how this could be, his grandfather shows him the next image.
Jaime cannot believe his eyes. This is the moment he discovers that the cost of goods and services increase drastically over time, leading to a decrease in his purchasing power.
His grandfather says: “In 1956, I was just a young man starting out in the world. I remember that I used to earn $380 a month as a factory worker. It may not seem like much, but it was a decent wage at the time. In fact, I was able to save up enough money to buy my own house in the suburbs.”
The grandfather continues: “The costs of things were very different in the past century. For example, in 2020, purchasing 30 Hershey’s chocolate bars would cost you $26.14. However, if we go back in time to 1913, the cost for the same quantity of Hershey’s chocolate bars would only be $1.00.”
This significant difference in price highlights the change in purchasing power over time and how it has shifted over the years due to inflation.
Jaime: _“What? That’s crazy. I can't imagine how low my rent would have been then compared to now.”_
Grandfather: _“Well, yes your rent would have been much cheaper back then. I have another example to illustrate this: back then, $1.00 would have bought you about 10 bags of pretzels. In 2020, I paid $9.69 for the same amount. Imagine how much 10 bags of pretzels would cost today.”_
Jaime: _“Wow, that’s really interesting, Grandpa. How did you experience this yourself when you were younger?”_
Grandfather: _“Oh, Jaime, all things were just much cheaper when I was young. A loaf of bread would only cost $0.18, and you could buy a gallon of gasoline for just $0.29. It is unbelievable how much the cost of living has gone up.”_
After the conversation with his grandfather, Jaime goes home to take another look at his ledger. He quickly discovers that he needs to budget an additional $1,000 for 2024 to be able to buy the same basket of goods and services that he purchased in the previous year. This means that his purchasing power has decreased by $1,000 as he now has to spend more money to buy the same goods and services. While Jaime's salary only increases minorly, his costs for living skyrocket every year.
The following table shows Jaime’s costs in the first year and second year, as well as the percentage increase in price.
In order for Jaime to live under the same standard of living, he will need to work more hours per week to receive an additional $1,000.
Based on information from the U.S. Bureau of Labor Statistics, prices today are about 30 times higher than they were in 1913. This means that a dollar today can buy only around 3% of what it could buy back then.
| Item | Cost Year 1 | Cost Year 2 | % Increase |
|---|---|---|---|
| Rent | $4,000 | $4,500 | 12.5% |
| Groceries | $2,000 | $2,300 | 15% |
| Necessities | $4,000 | $4,200 | 5% |
| Total | $10,000 | $11,000 | 10% |
To illustrate, someone offering Jaime a time-travel choice – either take $100 in 1913 or wait until 2023 and receive only $3 – is like choosing between a past shopping spree or getting just a few small treats today. The significant difference in value shows how much money's purchasing power has decreased over the years.
When we think in numbers, Jaime earns many more dollars in a year than his grandfather ever did, but the dollars that Jaime’s grandfather possessed were much more valuable and could buy much more back then.
In today's world, the significant impact of inflation discourages people from saving money. Instead, most choose to spend their money immediately because its value decreases rapidly. This pessimistic outlook hampers their ability to plan for the future. As seen in the graph, the average individual's salary growth remains stagnant when adjusted for inflation, meaning they aren't receiving raises at the same rate as the decreasing value of their money, despite working harder.
Jaime's example is just one among many. In the fiat world, it's quite common for governments to create money out of thin air to further their own agenda, leaving individuals worldwide to bear the consequences. Prices of everyday items, from bread to housing, groceries to holidays, increase each year. While the rich benefit from inflation due to owning assets, ordinary folks see their hard-earned money lose its value. The result? People and families worldwide struggle due to the decrease in their purchasing power.
People around the world find themselves working more jobs and longer hours just to maintain the same standard of living. It's like being on a treadmill – running faster and faster but never really getting ahead. The fiat system leaves individuals feeling like they are in a perpetual race against rising prices.
In their struggle to keep pace with increasing costs, many turn to credit, which is like using a small Band-Aid on a very deep wound. People take on loans or make impulsive decisions just to get by. Fast money becomes a necessity, and individuals find themselves in a cycle where survival today takes precedence over planning for tomorrow.
The fiat system, with its constant money printing, impacts humanity’s psychology. It instills a high time-preference – a focus on short-term gains over long-term planning. Just like a quick fix for immediate relief, individuals in the fiat world tend to prioritize short-term benefits. It is a survival instinct, creating a cycle of dependency where individuals seek any means to obtain fast money, even if it is not sustainable or workable in the long run.
In essence, the impact of the fiat system paints a challenging picture for individuals globally. In the fiat system, prices rise, incomes stagnate, and the struggle to survive becomes a daily battle. While certain groups get richer, most individuals worldwide stay dependent on a system that makes them poorer and poorer.
5.2.2 Impact on Society - Increasing Wealth Inequality
In a society based on sound money, a government’s financial decision-making is tied to the people's approval. However, in the fiat system, governments can go into unlimited debt on the backs of its citizens.
The power to print money at will often leads to political centralization. The fiat system enables governments to accumulate massive debts, making decisions that benefit themselves rather than the majority. Superpowers, like the United States, gain a competitive edge due to this phenomenon. They can print money endlessly to fund their plans, including wars. This ability allows these dominant nations to control, influence, and engage in geopolitical conflicts, creating a global power imbalance. Wars and major actions to control others become financially feasible for superpowers, while others without the same financial flexibility face limitations.
Under the fiat system, wealth does not distribute itself evenly. Instead, it tends to concentrate in the hands of a select few. This phenomenon is like playing a game of Monopoly where a handful of players possess almost all the hotels and properties while the majority struggle to stay afloat. The fiat system has become a tool for certain groups to concentrate wealth. Money printing allows governments and their tight collaboration with central banks to inject more currency into the economy, and the receivers of this newly created money are those with existing wealth and status – powerful entities and individuals. These groups benefit from the freshly printed money before its negative effects, like a decrease in purchasing power, start to manifest through the economy.
Wealth inequality is not just about the haves and have-nots; it is about suppressing economic mobility. Those from less privileged backgrounds find it increasingly challenging to climb the economic ladder, akin to starting a race with a heavy backpack. The growing gap between the rich and the poor causes problems for everyone, with the wealthy shaping policies in their favor. This makes things harder for regular people, leading to social unrest, a lack of trust in institutions, and communities falling apart like to a house of cards. The fiat system's instability manifests in economic uncertainty, political unrest, and global repercussions when the Western world faces an economic downturn.
This is a global phenomenon, affecting societies in developed and developing nations alike. The wealthy, often operating on a transnational scale, use the global financial system to their advantage, further widening the gap between the upper and lower classes.
