Naked Economics Wheelan, Charles (books to read for 13 year olds TXT) 📖

Examine that wad of $100 bills in your wallet. (If necessary, $1 bills can be substituted instead.) Those bills are just paper. You can’t eat them, you can’t drink them, you can’t smoke them, and, most important, you can’t take them to the government and demand anything in return. They have no intrinsic value. And that is true of nearly all the world’s currencies. Left alone on a deserted island with $100 million, you would quickly perish. On the other hand, life would be good if you were rescued and could take the cash with you. Therein lies the value of modern currency: It has purchasing power. Dollars have value because people peddling real things—food, books, pedicures—will accept them. And people peddling real things will accept dollars because they are confident that other people peddling other real things will accept them, too. A dollar is a piece of paper whose value derives solely from our confidence that we will be able to use it to buy something we need in the future.

To give you some sense of how modern money is a confidence game, consider a bizarre phenomenon in India. Most Indians involved in commerce—shopkeepers, taxi drivers, etc.—will not accept a torn, crumpled, or overly soiled rupee note. Since other Indians know that many of their countrymen will not accept torn notes, they will not accept them either. Finally, when tourists arrive in the country, they quickly learn to accept only intact bills, lest they be stuck with the torn ones. The whole process is utterly irrational, since the Indian Central Bank considers any note with a serial number—torn, dirty, crumpled, or otherwise—to be legal tender. Any bank will exchange torn rupees for crisp new ones. That doesn’t matter; rational people refuse legal tender because they believe that it might not be accepted by someone else. The whole bizarre phenomenon underscores the fact that our faith in paper currency is predicated on the faith that others place in the same paper.

Since paper currency has no inherent worth, its value depends on its purchasing power—something that can change gradually over time, or even stunningly fast. In the summer of 1997, I spent a few days driving across Iowa “taking the pulse of the American farmer” for The Economist. Somewhere outside of Des Moines, I began chatting with a corn, soybean, and cattle farmer. As he gave me a tour of his farm, he pointed to an old tractor parked outside the barn. “That tractor cost $7,500 new in 1970,” he said. “Now look at this,” he said angrily, pointing to a shiny new tractor right next to the old one. “Cost me $40,000. Can you explain that?”*

I could explain that, though that’s not what I told the farmer, who was already suspicious of the fact that I was young, from the city, wearing a tie, and driving a Honda Civic. (The following year, when I was asked to write a similar story on Kentucky tobacco farmers, I had the good sense to rent a pickup truck.) My answer would have been one word: inflation. The new tractor probably wasn’t any more expensive than the old tractor in real terms, meaning that he had to do the same amount of work, or less, in order to buy it. The sticker price on his tractor had gone up, but so had the prices at which he could sell his crops and cattle.

Inflation means, quite simply, that average prices are rising. The inflation rate, or the change in the consumer price index, is the government’s attempt to reflect changing prices with a single number, say 4.2 percent. The method of determining this figure is surprisingly low-tech; government officials periodically check the prices of thousands and thousands of goods—clothes, food, fuel, entertainment, housing—and then compile them into a number that reflects how the prices of a basket of goods purchased by the average consumer has changed.

The most instructive way to think about inflation is not that prices are going up, but rather that the purchasing power of the dollar is going down. A dollar buys less than it used to. Therein lies the link between the Federal Reserve, or any central bank, and economic devastation. A paper currency has value only because it is scarce. The central bank controls that scarcity. Therefore a corrupt or incompetent central bank can erode, or even completely destroy, the value of our money. Suppose prison officials, in a fit of goodwill, decided to give every inmate 500 cans of mackerel. What would happen to the price of a prison haircut in “macks”? And mackerel is better than paper, in that it at least has some intrinsic value.

In 1921, a German newspaper cost roughly a third of a mark; two years later, a newspaper cost 70 million marks. It was not the newspaper that changed during that spell; it was the German mark, which was rendered useless as the government printed new ones with reckless abandon. Indeed, the mark lost so much value that it became cheaper for households to burn them than to use them to buy firewood. Inflation was so bad in Latin America in the 1980s that there were countries whose largest import became paper currency.3 In the late 1990s, the Belarussian ruble was known as the “bunny,” not only for the hare engraved on the note but also for the currency’s remarkable ability to propagate. In August 1998, the Belarussian ruble lost 10 percent of its purchasing power in one week.

Massive inflation distorts the economy massively. Workers rush to spend their cash before it becomes worthless. A culture emerges in which workers rush out to spend their paychecks at lunch because prices will have gone up by dinner. Fixed-rate loans become impossible because no financial institution will agree to be repaid a fixed quantity of money when that money is at risk of becoming worthless. Think about it: Anyone with a fixed-rate mortgage in Germany in 1921 could have paid off the