Do you ever stop to wonder why prices for the great range of consumer goods and services relentlessly increase over time? (I like the "TP Index": toilet paper - something we all use, doesn't require much explaining, demand stays consistent. Price has roughly doubled in the past decade.) Most of us are struggling these days to maintain an adequate lifestyle in the face of stagnant or declining (or absent) wages, and this is made more difficult by the fact that the cost of living seems to go up year after year after year.
We commonly think of this as inevitable as the laws of physics, yet money is a human-created institution. How does it come to be that money buys less each year? Why should prices routinely increase? An apple in the year 1914 is still an apple in year 2014, but why does it now cost 10 or 20 times more?
(Answer below the orange whatchamadoogie)
A common response is to blame it on human greed -- greedy people always want “more”. Yet this is really a side-effect of something more fundamental. Before we start blaming people for moral failure, let’s take a look at the way relentlessly rising prices - also known as inflation - are a built in result of our current monetary system.
The national economy is so complex that even economists can get lost in the details and miss some basic principles. So let’s illustrate this with an example that will make it clear in about five minutes. Consider a very simple scenario:
Imagine a tiny community that has two members and a bank. Farmer Andy grows rice and farmer Bob grows beans. And the bank is willing to make loans at a simple interest rate of 20% (this number makes the example easy to understand, but the principle is the same, regardless of the interest rate).
The first half of the year is rice growing season and Farmer Andy grows enough rice to feed himself 10 pounds per month and to sell a 10 pound sack to Farmer Bob - for ten dollars each month.
In the second half of the year, Farmer Bob grows enough beans to feed himself and to sell a 10 pound sack of beans to Farmer Andy - for ten dollars each month.
Now at the start of the year, Farmer Bob needs to buy rice, but his beans won’t be ready to harvest until July, So how can he get the money to buy from Farmer Andy? The answer: he has to go to the bank and borrow $10 each month. By the end of June then, Farmer Bob has borrowed $60 and paid it to Farmer Andy, who is now $60 richer.
Come August, the rice season is over and Farmer Andy needs to start buying beans from Bob. No problem, because Andy has $60, and can afford to pay $10 per month. And that in turn enables Farmer Bob to start repaying his bank loan.
But wait! Bob not only has to repay the loan, but there is now also interest to be paid on that loan - six dollars for the year. How can he cover this additional cost? Simple! Bob just needs to raise the price of his beans to $11 for each 10-pound shipment.
Farmer Andy grumbles about this, but since he doesn’t want to starve, he pays $11 per month for beans. This works fine July through November, but in December, Andy realizes he has spent 55 of his original $60, and is now short by $6. “I know” says Farmer Andy, “I’ll get a loan from the bank, and I can repay it when I start selling rice next month”.
If Andy is smart, he’ll repay this loan quickly, to minimize interest charges, but he’ll still have to come up with a bit more than $6 that he didn’t have to spend last year. Moreover, Andy remembers that he ran out of money before the end of last year. So to accommodate these additional costs, he’ll need to raise the price of rice to slightly more than $12 per sack.
Now it’s January, and Farmer Bob needs to start buying rice again. The price is now $12 plus some change per sack - and guess what? Bob has spent all his money paying off last year’s loan. So now he must again borrow from the bank -- twelve dollars and some odd change per month.
And this upward cycle continues - year after year.
Note that our simple community has experienced approximately a 20% rate of inflation, which (surprise, surprise) is about equal to the interest rate charged by the bank.
Now if you take the above scenario and multiply it by millions of people, conducting millions of transactions each day, you begin to see why the economy can be such a rollercoaster ride.
Some people will argue that the above example is overly simplistic; that in the “real” economy, other forces will balance things out. They may drag out a tidal wave of arcane concepts and terminology about markets and demand and depreciation and amortization schedules, shareholder equity, derivatives, and the like - all in hopes that the basic imbalance of the above example will somehow get lost in the fudge. Yet in the end, it cannot. The events leading up to and following the crash of 2008 indicate that the proverbial fudge-pot is beginning to overflow.
However there is a solution.
Despite the complexity of the present day economy, there is a surprisingly simple solution to the above. The ground for such imbalance is set when money is initially issued as debt rather than as credit. To resolve this, rather than borrowing money from the Fed (a private, for-profit corporation), the US Treasury might itself simply issue currency in an amount sufficient to conduct the business of the country. The result: no debt, no interest payments -- and far less need for taxation in order to pay for these.
There are also non-governmental solutions. In the context of our simple example: deciding to abandon the bank, the community (farmers Andy and Bob) form their own “mutual credit clearing association”. Based on analysis and past experience, the Association determines that the local economy needs $60 in circulation in order to function. By the powers vested by its members, the Association creates $60 of new money and distributes it equally among the accounts of the members. Andy and Bob now have a credit balance of $30 each.
Come January, Bob begins buying rice from Andy for $10 each month. At the end of June, Bob has a negative balance of $30 and Andy has a positive balance of $90. In August, Andy begins buying beans from Bob for $10 each month. At the end of the year, both parties are back where they started, and the cycle can begin again the following year. No inflation.
While such a solution may be simple in principle, implementation in today’s national economy is a different matter. Not the least of the problem are the special interests who benefit by the current system and would mightily resist such a change. It is not likely to happen without a struggle. Yet if the economy continues to tighten for the 99 percent-ers, something will eventually have to give.
In view of trends like the “Occupy” movement, it is likely that an existential decision point is approaching for this country: Is the country organized first and foremost for the benefit of special interests, or for its citizenry?
And you get a vote.