Wednesday, July 31, 2013

The Financial System Doesn't Just Enable Theft, It Is Theft

It's not just inflation that is theft.


It is painfully self-evident that our financial system doesn't just enable theft, it is theft by nature and design. If you doubt this, please follow along.

Inflation is theft, but we accept inflation because we've been persuaded it benefits us. Here's the basic story: our financial system creates new credit money (i.e. debt) in quantities that are only limited by the appetites of borrowers and the value of assets they buy with freshly borrowed money.

If this expansion of credit money exceeds the actual growth rate of the real economy, inflation results.

Since our economy is ultimately based on expanding debt in every sector (government, corporations, households), inflation is a good thing because it enables borrowers to pay back old debt with cheaper money.

For example, if J.Q. Citizen makes $50,000 a year and owes $50,000 on his fixed-rate mortgage, what happens if inflation jumps 100%? Assuming J.Q.'s wages rise along with prices, his earnings jump to $100,000 while mortgage remains at $50,000. Though prices of everything else have also doubled, the debt remains fixed, making it much easier for J.Q. to service the mortgage. Before inflation, it might have taken ten days of earnings to make enough money to pay the mortgage payment; after inflation, it only takes five days' wages to make the payment.

This apparent benefit evaporates if wages do not rise along with the price of goods and services. If earned income stagnates during inflation, the purchasing power of wages declines. If it took two days' earning to pay for groceries and gasoline before inflation, now it takes three days' wages. The wage earner is measurably poorer thanks to inflation. How much poorer? Take a look: (chart by Doug Short)


Using the governments' flawed consumer price index (CPI), household income has declined over 7%. But this understates inflation in a number of ways; as several readers pointed out after reading What's Up with Inflation? (July 25, 2013), such calculations of inflation do not track the reduction in package contents that mask the fact that our dollars are purchasing less goods even though the package remains unchanged: the cereal box is the same size as last year but the quantity of corn flakes has declined.

There are other reasons to be skeptical of official measures of inflation. As I note in the above link, how can healthcare be 18% of the GDP but only 7% in the CPI's weighting scheme?
The obvious fact is that inflation is stealing purchasing power from every household with earned income, for the simple reason that wages are not rising in tandem with prices.

In 19th century Britain, the price of bread remained stable for most of the century: the price of a loaf of bread in 1890 was the same as it was in 1850. Any increase in wages in a no-inflation environment means the wage earner's purchasing power has increased. In an inflationary financial system, as earned income stagnates, everyone without access to credit and leverage loses purchasing power, i.e. becomes poorer.

The advent of unlimited credit and leverage enabled new and less overt forms of expropriation, otherwise known as theft.

Let's say that two traders enter a great trading fair seeking to buy goods to sell elsewhere for a fat profit. That is, after all, the purpose of the capitalist fair: to enable buyers and sellers to mutually profit.

One trader uses the time-honored method of letters of credit: he buys and sells during the fair by exchanging letters of credit which are settled at the end of the fair via payment of balances due with gold or silver.

Ultimately, the trader's purchases are limited by the amount of silver/gold (i.e. real money) he possesses.

Trader #2 has access to leveraged credit, meaning that he has borrowed 100 units of gold with a mere 10 units of gold and the promise of paying interest on the borrowed 90 units.

This trader can buy 10 times more goods than Trader #1, and thus reap 10 times more profit. After paying 10% in interest, Trader #2 reaps 9 times more profit based on the credit-funded expansion of his claim on resources.

The issuance of paper money is an even more astonishing shortcut claim on real-world resources. Trader #3 brings a printing press to the fair and prints off "money" which is a claim on resources. The paper is intrinsically worthless, but if sellers at the fair accept its claimed value, then they exchange real resources for this claim of value.

Needless to say, those with access to leveraged credit and the issuance of fiat money have the power to make claims on resources without actually having produced anything of value or earned tangible forms of wealth.

Those with political power and wealth naturally have monopolies on the issuance of credit and paper money, as these enable the acquisition of real wealth without actually having to produce or earn the wealth.

This system is intrinsically unstable, as the financial claims of credit and fiat money on limited real-world resources and wealth eventually exceed real-world resources, and the system of claims collapses in a heap. Though this end-state can easily be predicted, the actual moment of collapse is not predictable, as those holding power have a vast menu of ways to mask their expropriation and keep the game going.

For example, quantitative easing (QE), which is ultimately the issuance of unlimited credit and leverage to the chosen few at the top of the heap of financial thievery: Are We Investing or Are We Just Dodging Thieves? (July 29, 2013).

"The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists." Ernest Hemingway, The Next War 



Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

go to print edition1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Kindle edition: $9.95       print edition: $24 on Amazon.com
To receive a 20% discount on the print edition: $19.20 (retail $24), follow the link, open a Createspace account and enter discount code SJRGPLAB. (This is the only way I can offer a discount.)



Thank you, Patrick T. ($50), for your splendidly generous contribution to this site -- I am greatly honored by your support and readership.Thank you, Ernest L. ($10), for your most generous contribution to this site -- I am greatly honored by your support and readership.

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