Tuesday, December 23, 2008

Exponential Theft

Tuesday, December 23, 2008 | Posted by Chris Waner | Edit Post
Legend has it that a sixth century Asiatic sage and mathematician created a little game called Chaturanga, which consisted of a square board with 64 small squares (8 squares on the length and 8 on the width). This game caught on among the people and eventually found its way into the hands of the king. So enamored was the King with the game that he ordered that the sage be brought to him. The king praised the sage's accomplishment and offered the sage one gift of the sage's choosing. The sage refused, but the king persisted and demanded that the sage request a gift. The sage made a simple request: fill the first square on the game board with one grain of rice, the second square with two grains, the third square with 4 grains, the fourth with 8 grains, and so on until the board is full. The king marveled at such a modest gift and ordered that it be done as the sage requested. The first row of squares was filled, but as the second row began filling it it became obvious that the board would not hold all the rice. Bags were brought in, and as the 20th square was filled, the king was forced to give rice fields over to the sage. By the time the 30th square was filled all the rice in the land belonged to the sage. The king became furious and ordered the sage killed for his treachery and banned the game from the land. But the game only grew in popularity, and as it came to the west it became known by a different name, Chess. Had all 64 squares been filled, all the rice on earth for several decades would have belonged to the sage.

As mathematician, Albert Bartlett, famously said:

The greatest shortcoming of the human race is our inability to understand the exponential function.

No truer statement was ever said. And our inability to perceive the exponential curve is used against us in a number of important ways. Lets create a simple example to examine the problem. Let's say the Government promises you a $100 raise per year for hard work. The first year you earn $100 dollars; the second year you earn $200 dollars; the third year, $300, and so on. The government informs you that it will keep inflation (the amount of money in the economy above and beyond assets--clothes, cars, houses, etc.) at a steady 2% increase per year, to keep the economy from getting out of control. This sounds pretty good and looks pretty good on paper too, at least for a while. However, something insidious has occurred. One quantity (income) has a linear growth while the other (inflation) has an exponential growth. The 2% inflation the first year will be $2 per $100; however, the second year it will be $2.40 per $100. What starts off as a very small increment becomes a big problem over time. Let's look what happens in this economy over 150 years. The red line on the chart below represents income while the green line represents the amount of newly printed money in the economy:



Each dollar in the economy that does not directly represent an asset (house, car, shoes, a company, whatever) in the economy makes every other dollar have less buying power (see my Inflation Tsunami article for a detailed explanation of this). The graph above, therefore, can also be viewed in another way. Instead, in our simple mock economy, the red line represents the rate that money comes into your account, and the green line represents the rate that money is leaving your account. If you've ever wondered why it seems that your standard of living is decreasing even as more and more money is coming in, you've discovered, intuitively, that your income is not keeping up with the cost of goods and services.

If this is what's happening in the economy in the US today, then why do we see that wages and inflation are more or less the same? How can I be experiencing these losses if the government statistics say that income is rising at the same rate as inflation (2.3% since 1967). The answer is that unlike our graph above everyone is not gaining at the same rate in the US. The rich are getting richer much fast than the poor are.



The rich are getting richer because they are exploiting the exponential system. They understand it and position themselves to benefit. How? By using what money they have to ensure that they get first access to the new money in the economy. If they spend the new money on investments, houses, cars, etc., then they are buying things at a lower price than you and me, who get the new money that they already spent. They build a house and pay a contractor, and the contractor pays me, the worker. The money is already aging. If you work at a retail shop or a restaurant, the money has already been filtered several times. By the time we get it, the market has adjusted and the prices are already higher.

The system is set up to make the rich richer and the poor saddled with more and more debt as they try to keep up with the increased cost of living. Who creates the money in this county? The banking and Federal Reserve System. This is yet another reason that it has to end.

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