What you don’t learn at school
January 28, 2013 in Economics
The Two Things You Don’t Learn at School
Whether you’re 17 or 70, there are two things you should know that will change your understanding of money forever.
Firstly, the Exponential Function. What is it and why is it important?
The Exponential Function is a very simple math formula that predicts how quickly things will grow.
70 is the magic number. It’s really all you need to know. 70 is the number that determines the ‘doubling rate’. For example, if you invested $100 at 7% interest, it would take 10 years to double it to $200. At 10%, it would take just 7 years to double your investment. That’s it – that’s the Exponential Function.
When applied to inflation, it explains why things are so expensive today compared to before.
Inflation is the direct result of the watering-down of our currency.
Imagine making a cup of coffee using the last of your coffee grinds. You’ve only got enough for one cup. After drinking half the cup, you want to stretch the drink so you top it up with hot water. You may not notice much of a difference to the flavor. But repeat the process another 10 times and you’re drinking dirty water.
Make sense? Well this is exactly what’s happening to our currency – it’s being watered down!
Indeed, our dollar today is only worth 3% of its value from 100 years ago. Today’s dollar is worth 10 cents compared to that same dollar just 40 years ago. This really hits home if you’re a parent trying to save for kid’s college, or a worker trying to secure their retirement.
This explains that ‘gut-instinct’ you’ve been feeling for a few years now, wondering why you can never get ahead.
Welcome to the world of inflation. Real inflation today is 10%. Applying the Exponential Function, that means in just 7 years the dollar in our wallet will only be worth 50 cents. This month is the tenth anniversary of 9/11. In 2001, the average price of gas was $1.46. By 2018 it will be $8. Remember, it’s not that prices are increasing, but that our dollar is decreasing in purchasing power.
The second item is the “Mandrake Mechanism”.
Every month our Treasury department auctions around $20 Billion in debt to finance the nations’ spending deficit. This auction has two types of buyer – private and public. Private investors include pension funds, insurance companies and foreign nations like China. The public buyer is the Federal Reserve Chairman, Mr. Ben Bernanke.
If private investors buy the lot then that’s great, the Feds don’t need to buy any debt. However when private investors do not purchase the debt, either because they cannot afford it or the interest rate on the Treasury Bond is too low; Bernanke buys the debt. During 2009, Bernanke bought 80% of all Treasury debt.
Here’s the Mandrake Mechanism:
When the Federal Reserve purchases Treasury debt it writes a check to the Treasury for the full amount. For 2009 that averaged $16 Billion per month. This ‘check’ is not backed by money in a bank account, as our own checking account requires, but is money created out of thin air.
The Fed then ‘sells’ the debt to banks at a discounted interest rate. Today it’s close to 0%, in other words, free money.
These banks then lend the money to citizens and businesses and charge the market rate of interest (4%+), and pocket the profit.
However using an accounting trick called Fractional Reserve Banking, the banks may lend up to 9 times the money they buy from the Fed. So the banks take free money from the Fed and lend nine times that amount to companies and citizens. Infuriating.
But the banks don’t just stop there. They repeat the process up to 28 times. They take every dollar of ‘discounted’ Fed money and magically convert it into as much as $28.
1) The Treasury sells bonds to finance the nation’s spending.
2) The Federal Reserve purchases the debt that private investors don’t buy and sell it to the banks through the ‘discount window’.
3) The banks convert each dollar into 9 dollars and then lend it to citizens and companies at market rates.
4) The banks repeat this process up to 28 times, further diluting the money.
That’s why you cannot afford to fill your car with gas, buy groceries, put your kid through college or pay for retirement. That is inflation.