The Price of Progress - A Closer Look at Our Financial System

A Look at Where We Are and What We Can Expect Moving Forward

Introduction to Bitcoin & Stablecoin

A Look at Where We Are and What We Can Expect Moving Forward

Inflation
Debt
Wealth Inequality
Boom & Bust
**Conclusion**

As we discussed in the previous chapter, historically, money has often been backed by a commodity like gold. The benefits of this cannot be overstated. Not only did this connection mean that such money’s value was directly tied to the value of the commodity, but it also meant that the currency issuer, typically the government, was limited in how much money it could print as it would have to obtain more gold.

However, as we moved away from the gold standard, over the last 100 years, money has increasingly become more centralised, with central banks like the Federal Reserve and the US central bank gaining more control over the direction of money.

Today, central banks, alongside the treasury, basically have free reign over the direction of money and the monetary system. They possess the ability to increase the supply of money whenever they deem it necessary, as well as adjust interest rates to promote economic growth, and even provide bailouts to failing banks and businesses.

…but as with any form of intervention, there is no free lunch.

When central banks decide to intervene, although they may be able to print money out of thin air, they can’t create value. For this newly printed money to be worth something, its value must come from the previous currency holders.

What do we mean? Think of the money supply as a pizza, and imagine it cut into four slices. Doubling the money supply would not be equivalent to doubling the amount of pizza. Instead, it would be equivalent to cutting those four slices in half to create eight slices. We have not gained any additional pizza. We just have more slices, each smaller in size.

When we print more money, we devalue the money that is already in existence.

For central banks to bail out one area of the economy, they must take from another. Hence, there is no free lunch.

And with money no longer being tied to a commodity such as gold, there are fewer checks and balances that the government has to follow, giving them greater power to intervene whenever they feel it is necessary. For example, during economic downturns like the ones we faced in 2000, 2008, and 2020, central banks were able to intervene to levels never before seen. Injecting trillions of fresh dollars into the economy in an attempt to stabilise the financial markets.

This intervention has come at a significant cost to small businesses, the wage earner and the long-term stability of the economy, as this increased intervention has led to a ballooning of the national debt and rising inflation. This, as I am sure you can guess, has led to a rise in the cost of living, making it more difficult for individuals and families to afford basic necessities.

Overall, the centralised nature of money today has given central banks an unparalleled degree of power to intervene in the economy. While this may appear beneficial during times of economic hardship, it can also result in significant drawbacks like increased debt and inflation. With this in mind, let's take a look under the hood at these seemingly innocuous terms, debt and inflation and examine some of their byproducts.

Before diving in, you may notice that we reference the US as you read the following text. Considering the US dollar is the global reserve currency, what happens to the dollar will have downstream effects on all global economies and currencies. Therefore, we highlight some of the problems within the US system to illustrate the global challenges we face. Often, if you examine your own local jurisdiction, you may find that the state of affairs in your home country is potentially more dire.

Inflation

Inflation is an increase in consumer prices or a decline in the purchasing power of money due to monetary expansion. And it can be better understood as too many dollars chasing not enough goods, causing prices to rise.

As mentioned earlier, a useful analogy for the money supply is a pizza. When central banks inject newly printed money into the economy, they are not creating more pizza. Instead, they are slicing the pizza into smaller pieces. This leads to the devaluation of our currency, meaning that the value of each slice—or dollar—decreases over time. As more money is pumped into the economy, inflation rises, and the purchasing power of the dollar decreases, leading to higher prices for goods and services.

To give you an idea of the scale of money printing we are talking about, in the past decade alone, the amount of US dollars printed surpasses the total amount of US dollars printed throughout the entire history of the currency. That's right - more money was printed in the last ten years than in the previous two centuries combined! It's no wonder that the value of our money seems to be evaporating faster than a drop of water in the desert.

This can be hard to visualise, so let’s take a look at a hypothetical example.

Let's say we earn a salary of $30,000 per year, and we're planning to buy a new car that costs $15,000. After doing some math, we figure you can save $5,000 per year. That means, given zero inflation, it would take us three years to save up for the car. Sounds reasonable…

However, in such a scenario, we are failing to account for inflation. When we include inflation in the above scenario, we face a very different story.

Assuming our income and savings potential stay the same, after three years of 10% inflation, the car would now cost $19,965. We’re now $4,965 short, and by the time we save for another year and finally have the $19,965, it now costs $21,961. The car is quickly getting further and further out of reach.

All in all, given zero inflation, it would take three years to save for a $15,000 car if we’re able to save $5,000 per year. However, with inflation at 10%, we now have to save for 4.5 years. That is 50% more time! 1.5 years of our life we won’t get back.

If our salary does not increase with inflation, we are earning less money as time passes. This is because the cost of living is increasing, but our salary is staying the same. This leads to a decrease in our purchasing power, making it more difficult to afford the same standard of living as before.

Debt

Historically, governments were constrained in their abilities to fuel economic growth since they had to acquire more gold to obtain capital for stimulation. This limited their ability to grow and expand indefinitely, as they had to abide by the laws of physics.

However, after the Nixon Shock, when the US abandoned the gold standard, governments and central banks worldwide gained the ability to expand the money supply at will, as a physical asset no longer backed currency. This shift initially enabled the US central bank to stimulate the economy more easily during periods of economic stress. However, what started as a measure to spur economic growth quickly became the norm and was instead used to stimulate artificial growth.

Over time, the US and other governments developed an unhealthy appetite for debt, leading to our current situation. The US has spent more than it has earned through taxation and other sources of income in 20 of the last 21 years. If we were to apply this spending pattern to our personal finances, we know how quickly it would lead to financial challenges.

Central banks now find themselves in a difficult position. Given the debt burden, they have few options other than to artificially suppress interest rates in an attempt to reduce the burden of debt– If interest rates are lower, then debt service payments are, too. If rates were to rise, many sectors of the economy would likely be unable to service their interest payments, quickly leading to default.

However, this suppression of interest rates comes at a cost: It makes capital more easily available. As a result, individuals, businesses, and governments are more inclined to take on additional debt, thereby exacerbating the overall debt burden. This creates a challenging balancing act for central banks, which must keep interest rates low enough to manage existing debt while also preventing the accumulation of new debt that could harm the economy in the long run.

This balancing act isn’t going quite as planned…

Figure Debt vs GDP

When we add together Federal, corporate, and household debt, the resulting figure is a staggering $63.14 trillion, in contrast to the United States Gross Domestic Product (GDP) of $26.13 trillion. This means that the US has a total debt-to-GDP ratio of 241%. In other words, for every $1 of GDP generated, there is a whopping $2.41 in debt.

$63.14t / $26.13t = 241%

Let’s assume conservatively that the average interest on this debt is 3%.

3% * 241% = 7.23%

The scale of the US's debt burden is such that even servicing the interest payments on the debt would require an annual growth rate of 7.23% - a rate significantly higher than the average GDP growth rate of 3.13% over the last 70 years.

7.23% - 3.13% = 4.1%

Even in the best-case scenario where the US stops running deficits and manages to balance its books, the debt would still increase by 4.1% per year. This is because the country's GDP growth does not fully cover the interest on the debt.

You can probably see where this is going. To address the burden of debt, those in positions of power are compelled to intervene by injecting more money into the economy, devaluing the currency, and leading to higher inflation. We are in a debt spiral with no clear way out.

While this approach provides temporary relief, ultimately, we’re only exacerbating the underlying problem of excessive debt. Finding a long-term solution to reduce debt is going to require difficult choices and a willingness to make tough decisions in the short term. But that's for a whole other course. In the meantime, let’s take a look at why debt and inflation don’t impact everyone evenly. It disproportionately impacts the wage earner.

Wealth Inequality

When money enters the economy, it tends to pool in certain areas: Assets!

Why? You might ask. When central banks increase the money supply by printing new currency, the value of each individual unit of currency decreases. This means that prices for goods and services tend to increase over time, leading to higher costs for basic necessities like food, housing, and healthcare. This inflationary pressure on prices erodes the purchasing power of those who rely on wages and salaries for their income.

With this in mind, are you incentivised to store your hard-earned savings in the currency? Of course not. If you have the capacity, you go out and purchase assets. Given the artificial demand for assets, their value rises. Therefore, those who hold assets such as stocks, bonds, and real estate benefit, to a certain extent, from inflation as the value of these assets tends to increase with inflation. As a result, inflation exacerbates wealth inequality by creating a divide between those who hold assets and those who rely on wages and salaries, leading to a concentration of wealth in the hands of the upper class.

Let's use our newfound understanding to analyse real estate.

With the constant barrage of social media and news coverage, you’ve probably noticed the issue of rising social unrest and wealth inequality on a global scale. One of the underlying causes of this growing unrest is the increasing difficulty for the average person to afford a house, as evidenced by the fact that the ratio of house prices to wages has increased from just above four in the 1980s to above seven today. In other words, the average person must now spend seven times their annual wage to afford an average-priced house.

Why is it so much harder to purchase a house? It is becoming significantly harder to purchase property for two reasons.

Inflation is devaluing our currency’s purchasing power. With a deteriorating currency, people are no longer incentivised to save. This forces Individuals with wealth to direct their resources toward financial assets while individuals without wealth towards consumption. As consumption directs money toward corporations held by the wealthy, and smart money directs their cash toward assets, we see the knock-on effect of rising asset prices due to increased demand. This is all while inflation is wreaking havoc on the purchasing power of the currency.
Due to our excessive debt burden, governments are incentivised to suppress interest rates. In doing so, debt consumption becomes more enticing, especially to those with wealth. When the cost-of-capital is so cheap, people borrow beyond their means, funnelling more capital into assets and driving up prices. This is great for asset holders; however, prices are becoming ever more unobtainable for those trying to get on the property ladder or dip their toes into the financial markets. A simple rule of thumb is that as interest rates decline, asset prices increase as capital is more freely available.

How does this inflation amplify wealth inequality? Considering the upper class holds assets and the lower class tends to hold currency, what ensues is greater and greater wealth inequality as the purchasing power of the currency diminishes and the cost of assets steadily rises, becoming more and more unobtainable. This can be seen in “Figure X” below. You’ll notice a significant difference in the appreciation of assets compared to wages.

Performance By Asset Class

Asset Class	Total Growth (Jan 2010 - Jan 2021)	Annualized Growth (Jan 2010 - Jan 2021)
Stock Market	236.84%	11.67%
Real Estate	66.38%	4.74%
Gold	73.10%	5.11%
Average Hourly Wage	33.37%	2.65%

Figure: Performance by Asset Class (Stocks, Real Estate, Gold, Wages)

With this lagging of wages to asset prices, we have seen one of the greatest transfers of wealth from the lower class to the upper class in recent history

Figure: Share of Total Net Worth

Boom & Bust

In a natural, free-market business cycle, expansion and contraction refers to the recurring patterns of growth and decline in an economy driven by market forces. During the expansion phase, businesses experience growth, consumer spending increases, and overall economic activity expands. This phase is typically characterised by increased investment, rising employment rates, and higher profits.

However, economic expansions also contain the seeds of their own contraction. Factors such as excesses in investment, rising debt levels, or changes in market sentiment can lead to a slowdown in economic activity. This contraction phase, often referred to as a recession or economic downturn, is marked by reduced consumer spending, lower business profits, and potential job losses.

Economic contractions, though challenging, serve as a necessary cleansing process, holding irresponsible behaviour and those burdened by debt accountable for their actions. They create financial pressures incentivising individuals and businesses to rectify their behaviour or face consequences. This natural ebb and flow of market expansion and contraction promotes innovation and growth during expansion and purges fiscal irresponsibility during contractions.

However, this process can only occur effectively when interest rates are allowed to freely adjust based on supply and demand. Why, you might wonder? Interest rates serve as a measure of economic risk, rising when demand for debt exceeds available capital and falling when capital is abundant but demand is low.

Regrettably, our current system deviates from this ideal. Central bank interventions intended to stabilise the economy often have unintended consequences. Manipulating interest rates disrupts the natural market signals, distorting the functioning of these cycles. Artificially suppressed interest rates encourage excessive borrowing and speculative bubbles, while abrupt rate increases for inflation control lead to financial instability and economic slowdown.

As a result of interest rate manipulation, economic expansions tend to be prolonged, leading to increased debt levels and fiscal irresponsibility. Conversely, economic contractions become more severe, exacerbating instability and hardship for those at the bottom of the social ladder.

Conclusion

Our current path of monetary intervention is not sustainable. The ever-increasing debt burden, coupled with uncomfortable inflation and rising costs of living, is leading to greater wealth inequality and social unrest. We can only expect these problems to worsen if we continue down this path.

Fortunately, there are options available to us. With the emergence of Bitcoin, we now have the ability to opt out of the traditional fiat monetary system and into an alternative system that places control back into the hands of the community. The decentralised and transparent nature of Bitcoin offers a more equitable and secure financial system free from the control of central banks and governments. This allows individuals and communities to transact with greater freedom and confidence without being subject to the inflationary pressures and wealth inequality created by traditional monetary policy. And with stablecoins, those living under far greater monetary pressures can easily exit their local currency and move into something more stable, i.e. the USD.

As we move forward, we encourage you to approach this new technology with an open mind and a critical eye, exploring how it can offer an alternative to our present-day financial systems. By doing so, we have the potential to address the problems of rising inequality and social unrest while building a more sustainable and equitable economic future.