Imagine a society where the only thing of value is eggs. This is a society where food, transportation, retailing – everything except eggs – are in infinite supply and therefore effectively free. The only thing people value, produce and trade is eggs.
One day EggVille decides to introduce a currency to facilitate the sale and purchase of eggs without involving actual eggs. A convenience. At the time of introduction of this currency there are 10 eggs in existence. And so they introduce ten dollar bills, and peg the price of eggs at one dollar each.
The following month 5 more eggs are produced, and none consumed. Now there are 10 dollars but 15 eggs. The people with the dollars discover that they can negotiate a lower price for eggs, since there are more eggs than dollars. The price of eggs falls. People who loan dollars profit beyond the interest rate charged because they get paid back in more valuable dollars – dollars that can buy more eggs because eggs are cheaper. And people in debt discover that they actually owe more in terms of buying power than they expect.
This is called deflation.
The village elders of EggVille decide that the solution is to issue more dollars. One additional dollar per egg. The price of eggs remains constant – since there is no actual demand for eggs, and the number of dollars tracks the actual production of eggs.
But the people of EggVille discover that eggs are tasty, and begin to eat them. As they eat them, the price rises, since there are fewer of them. The village elder decide, wisely, not to expand and reduce the supply of dollars as eggs are consumed since the price should go up. They are more valuable. And a higher price will incent more people to create them.
Now the elders have a problem. They can’t figure out how many dollars should be issued to achieve price stability except for changes in supply and demand – where price stability isn’t desired.
So they create the Federal Reserve, and empower it to control the supply of dollars, based on all kinds of complex simulations.
Unfortunately the elders, in an attempt to stay popular, borrow money from the neighbor village, GiantEggLand, and give it to the people of EggVille in exchange for exactly nothing. Now what should happen is that this is highly inflationary. More dollars for the same number of eggs. So prices rise. But this isn’t what happens, because GiantEggLand has the ability to produce truly massive numbers of eggs for a very low cost, owing to their large population of peasants.
So for a while this works. The people of EggVille get free dollars to purchase cheap eggs. And the people of GiantEggLand get richer.
But eventually EggVille owes far more to GiantEggLand than they can possible hope to repay.
But the wise elders discover that by issuing truly massive numbers of dollars – far more dollars than makes sense given the number of eggs, they can “repay” loans in increasingly worthless dollars.
This is called inflation.
Because it is so fundamentally broken and dishonest, the elders need to cloak it in a fancy sounding name.
This is called quantitative easing.
It’s so fancy that you can’t understand it. You simply have to trust Paul Krugman.
The elders, seeing that this would eventually cause the dollar to be become worthless, and realizing that GiantEggLand would stop loaning anything to EggVille, or demand a 50% interest rate to compensate for the worthless dollars, bought gold.
The elders will be OK.
Pay attention to the price of gas. You are getting poorer because the dollars are becoming worthless.
This is how we will “repay” the 16 trillion. In worthless dollars.
The rich will be OK.