Thread by @JasonYanowitz

The simplest explanation of inflation I've ever read comes from a story about cigarettes and prisoners.

It's written by @yanisvaroufakis and it perfectly describes why inflation hurts savers.

Here's a story about a prisoner-of-war camp...

1/ Periodically, the Red Cross would place a few more cigarettes in the prisoners’ packages but keep the quantity of chocolate, tea, and coffee the same.

When extra cigarettes arrived, each cigarette now bought less coffee, less chocolate, and less tea.

Why?

2/ Since a larger number of cigs now corresponded to the same amount of coffee/tea, each individual cigarette corresponded to less coffee/less tea.

The opposite also held true:

The fewer cigs the Red Cross placed, the greater the exchange value (purchasing power) of each cig.

3/ In short, the purchasing power of a unit of currency has nothing to do with how much it costs to produce but, rather, its relative abundance or scarcity.

Imagine that a prisoner has been hoarding his cigarettes in order to make a large purchase...

4/ Suddenly, the Red Cross sends tons of cigarettes to the captives.

Overnight, the exchange value of the prisoner's cigarettes drops, and his parsimony and abstinence have been to no avail.

5/ In this way we see how having access to a currency lubricates transactions to no end, helping the economy move more commodities more quickly.

On the other hand, for a currency to function it requires trust and faith...

6/ The trust that everyone will accept it in return for any commodity, which is in turn based on faith that the currency’s exchange value will be maintained.

What gives value to money is the legal obligation to accept it and the belief that it is and will remain valuable.

7/ One night Allied Bombers hammered the area where the camp was located.

The bombs landed closer and closer, some falling in the camp itself.

All night long the prisoners wondered whether they would live to see daybreak.

8/ The next day the exchange value of cigarettes had gone through the roof!

Why?

Because over the course of that endless night, surrounded by exploding bombs and consumed by anxiety, the prisoners had smoked cigarette after cigarette.

9/ In the morning the total number of cigarettes had shrunk dramatically in relation to the other goods.

Previously 5 cigarettes had been needed to buy one chocolate bar.

Now only 1 cigarette was needed to buy that same bar.

10/ The bombardment had caused price deflation: a decrease in all prices as a result of a reduction of the quantity of money in relation to all other goods.

The opposite, an increase in prices as a larger quantity of money in the overall system, is known as price inflation.

11/ This quote is from @yanisvaroufakis book:

Talking to My Daughter About the Economy: Or, How Capitalism Works — and How It Fails

amazon.com/Talking-Daught…