John Tomlinson

A Challenge to Banking

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SECTION ONE - Dishonest Money

Inflation Is Not New

A young lad was walking down the streets of Baltimore in 1937. In his pocket he had 750 dollars in cash. He was on the way to the Ford agents to buy himself a new car. As he walked along the road, he passed a bank. In its window was a poster which urged people to purchase U.S. Government Savings Bonds. He stopped.

Then, remembering his grandfather's oft spoken advice to "be prudent and save your money", he entered the bank to make enquiries. He was told that his 750 dollars would buy him a Savings Bond which would be worth 1,000 dollars in ten years' time. He decided he didn't really need a car at the moment and bought the bond instead.

Ten years later, already in possession of a good car, he decided to renew the bond for a further ten years. Then, in 1957, in need of a new car, he cashed the bond. It produced 1,450 dollars, almost twice as much as he had invested. He was pleased, and headed for the Ford showrooms. To his shock, he discovered that his 1,450 dollars would only buy half a Ford.

I was told this story more than 30 years ago, while training for the New York Stock Exchange. The lecturer was emphasising the dangers of inflation. None of us in that lecture room had had any real experience of the effects of inflation. Most of us, however, could imagine the feelings of the shocked man in the story. He had lost half a Ford, and had not had use of that money for twenty years. He would have felt robbed. Angry. And full of distrust. Who would he have blamed? Not money: money was beyond suspicion. But he would have found someone to blame for his loss.

Money which continually loses value is dishonest. It acts as a thief. It steals from those who save, from those on fixed income, and from those who enter long-term contracts. Our present society is heavily dependent on money. We rely on it as a medium of exchange: we price other commodities in terms of it. We rely on it as a store of value: any surplus money saved we expect to retain a constant value. We rely on it as a unit of measurement of exchange value: to provide a standard for interchange between commodities and goods and services both domestically and internationally. Society needs to trust money, or the whole basis of our present monetary system collapses. To trust money we need an accurate, trustworthy and constant unit of money. Yet in an era of inflation, money is continuously losing value.

To understand how inflation causes chaos, let us look at another system of measurement with which we are all familiar: time. What would happen if the unit of measurement of time continually diminished in size?

Suppose that the United Kingdom used Big Ben as the standard for time. What would happen if Big Ben suddenly developed a mechanical fault which reduces the size of each minute by one second?

Following the development of this fault, two people, each using their own, accurate, timepiece might make an arrangement to meet for lunch at twelve noon in front of a specific restaurant in three weeks time. Both might verify their timepieces against Big Ben at some time during the ensuing three weeks. But they are unlikely to do so at the same instant. Unless they did, they would not meet. Their only other chance of meeting is if neither of them verified his watch.

Even if both did, the chances are that the restaurateur would have verified his watch at a different time, and the restaurant might not be serving lunch. By Big Ben, it would be 8.40 p.m. Our duo might manage dinner together, not lunch, and they would have to fit into the next day all the things they had intended to do after lunch.

Worse than that, each day would be getting shorter. More and more "missed" accomplishments would need to be fined into shorter and shorter days. The rate of change of schedules and of reappraisal and rearrangement of priorities would be continually accelerating. And each and every individual, whether or not he used a faultless chronometer, would be "out of sync" with Big Ben and with each other.

Imagine the chaos. At the restaurant, for instance, suppliers, waiters, cooks and customers would each be guided by his own watch, whose degree of synchronisation would depend on how recently each had been verified against Big Ben. Cooks might have prepared food when customers did not want it. Waiters might not have arrived to serve it. Suppliers might arrive when the restaurant was closed, or the staff far too busy to receive their goods. Good luck and good fortune with respect to the timing of the comparison against official, Big Ben, time would be more important than good planning and efficient arrangement of priorities.

Planning would become suspect. Change would be the order of the day. The rate of change would accelerate. Survival would depend upon one's ability to adapt to change. "If only I had more time", would be the constant cry.

Yet man cannot create time. Time would have begun to steal from man. Time would be dishonest. Man can, however, create money. Money, like time, is one of the units of measurement which we use to determine the priority for our individual expenditure of energy. In this respect it is similar to time. Where the size of a monetary unit continually diminishes, similar effects will occur: money will steal from man.

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Measuring money's dishonesty

Can we measure money's dishonesty? We can measure purchasing power in terms of other commodities. One choice against which to measure is a loaf of bread. Bread is made precisely to demand. Left on the shelf it goes stale and becomes unsellable. Historically, the one pound loaf is the most common size. Measuring other commodities against a one pound loaf of bread can give us a measure of money's dishonesty.

Consider for example, the price of oil in the years leading up to the major price increase in 1973. The price of oil had already increased substantially. In 1956, after a prolonged shut-down of its oil fields, Iran agreed with British Petroleum a price of 512.5 pennies per barrel of oil. This would have purchased 100.8 pounds of British bread in the same year.

By 1968, the price of oil had risen to 623.4 pennies per barrel of oil: 59.6 pounds of bread. By October lst 1973, immediately prior to the substantial increase, the price was 1315.9 pennies per barrel of oil - an enormous increase in nominal units of money since 1956. But that amount would still not buy the originally agreed 100.8 pounds of bread: it purchased only 73.2 pounds.

Value per barrel of oil

Date Pennies Pounds of Bread
1956 512.5 100.8
1968 623.4 59.6
1/10/1973 1315.9 73.2

In terms of bread, the Iranians had been losing out for over 16 years. They had, during the course of almost two decades, lost over 25 per cent of their purchasing power. Yet, when they tried to claw back some of that loss, they suffered all the opprobrium associated with insisting upon massive increases in the price of oil.

And there we face the essential conflict about which this book is written. Money is a thief: it no longer has a constant value. No one in his right mind trusts a thief. Yet we need to trust money.

Repair Big Ben, and the chaos created by the continuing diminution of the size of the unit of time evaporates. The standard unit of time becomes a constant, and all actions can once again be synchronised. If we wish to have honest money, then we must identify and repair the fault in our monetary system so that each unit of money can have a constant value.

Creating Distrust
Introducing why interest rates are the wrong tool to fight inflation and why we need to take a critical look at the basic mechanics of the monetary and banking system.

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