There is a scene in The Prestige – a shockingly underrated cinematic masterpiece – which I’m rather fond of. Michael Caine, who plays a stage engineer for two troubled magicians, is explaining the components of a magic trick. I will leave the full uninterrupted quote for you below so you can enjoy reading it in Caine’s dulcet London tones.
“Every magic trick consists of three parts, or acts. The first part is called “The Pledge”. The magician shows you something ordinary: a deck of cards, a bird or a man. He shows you this object. Perhaps he asks you to inspect it to see if it is indeed real, unaltered, normal. But of course… it probably isn’t. The second act is called “The Turn”. The magician takes the ordinary something and makes it do something extraordinary. Now you’re looking for the secret… but you won’t find it, because of course you’re not really looking. You don’t really want to know. You want to be fooled. But you wouldn’t clap yet. Because making something disappear isn’t enough; you have to bring it back. That’s why every magic trick has a third act, the hardest part, the part we call “The Prestige”.”
Today I want to write about one of the greatest magic tricks of all. Like all magic tricks, it features The Pledge, The Turn and The Prestige. As we look across the world and try to understand the unfolding madness, this illusion helps to explain why we are where we are. But pay careful attention, because you may not enjoy the ending.
The trick begins with a banknote. The magician shows the banknote to his audience and allows them to inspect it. He tells the audience that because it was created by the magic circle, they can use that magic banknote, which is the only one of its kind in existence, to buy potions. There is just one rule: they are strictly forbidden from using another provider’s banknotes.
Once the audience has been shown The Pledge, the magician moves to The Turn. With a click of his fingers, he produces five new shiny magic banknotes, as if summoned from thin air. “On the magic circle’s orders,” he says, “the local Bank of Magic has been authorised to take this banknote and lend five more powerful banknotes so more people can buy potions!”
The audience cheers. Some look confused and some simply look on in awe at the magician’s sleight of hand. But he is yet to get to the third act, The Prestige. “Because I am a member of the magic circle,” he says, pausing to remove a small wand from his pocket. “And because we are concerned that not enough people are buying potions, I am hereby authorised to take any action necessary to increase potion purchases!” With a gentle wave of the wand, the magician launches hundreds of banknotes into the air, again seemingly appearing from nothing.
The audience is stunned into applause, and with a short bow, a warm smile and a gesture of appreciation for his audience, the magician leaves the stage. “Fools,” he says to the stage engineer once behind the curtain.
The Real-Life Magic Trick
Let us break down the trick by revealing its true participants and consequences in the real world.
The magician in this trick represents the central bank. This is the institution that manages the currency and monetary policy of a nation or monetary union. Real-world examples include the Bank of England for the United Kingdom, the Federal Reserve for the United States, and the European Central Bank for euro-zone countries. The central bank has a monopoly on money supply and a range of regulatory powers over the financial system. In many countries, the central bank is considered independent from the government.
But while the magician (central bank) is said to be independent, the magic circle (government) sets the rules and picks the leadership. As the government spends beyond its means, indebting our children and grandchildren to serve short-term electoral cycles, the central bank has no choice but to fund the growing debt through the creation of new money. As we work backwards to understand this system, it will therefore become clear that the “independence” label is an outright lie.
The final participant in this magic trick is the audience. That, in case you hadn’t already guessed, is us. Unlike in our magician’s trick, the real-life magic trick doesn’t have a happy ending for the audience. Unless we are one of a lucky minority, we do not walk away delighted with the show. First dazzled by all the new shiny currency, eventually we figure out the scam. But often, it is too late.
In the real world, each stage of this trick is performed more gradually, often over decades. It begins with The Pledge, where the central bank issues a currency which it says will reliably hold its value against gold. Each unit of currency is exchangeable for a fixed unit of gold. Such systems were known as gold standards. The last major version of such a system, in the United States, ended in 1971 with the end of the Bretton Woods era. The idea of this system was to ensure that the currency acted as a store of value. Over time, $1 bought the same amount of gold, instilling confidence and credibility in the currency. Removing a gold standard opened the potential for currency devaluation and manipulation.
The art of the trick begins in The Turn. The banking system, you see, operates under a process known as fractional-reserve banking. That sounds like jargon but it essentially means that $1 deposited with a bank can be lent out more than one time. The banks themselves therefore increase the amount of currency in supply through the loans-deposit ratio. One of the reasons that attempts at sound money have failed throughout history is precisely because of this fractional system. It risks the possibility that if there a sudden run on a bank (a rush of people trying to withdraw their cash), the bank would not be able to fund the returns of deposits. While not shouted from the rooftops, part of the reason for the central banking system is to transfer losses from banks to the public in such circumstances, ensuring that this lucrative hustle can continue.
Finally, we get the pièce de resistance: The Prestige. Here the central bank itself sees it within its rights to print more of the currency in order to stimulate the economy and maintain a steady rate of inflation. The last part of that sentence bears repeating: to maintain a steady rate of inflation. That’s right, it is the expressed goal of the central bank that the currency is debased each year. Your currency comes with a debasement guarantee.
Before we go on, perhaps it is worth pausing here to reemphasise why this all matters. The key word is devaluation. As the central bank prints more, the currency becomes less scarce and its value diminishes. The same amount of currency buys less than it did before. Inflation eats away the real value.
We can visualise the financial damage by considering how the currency value diminished after the gold standard was abolished in the UK. The gold standard ended in the UK in 1931. Before then, the currency was exchangeable for gold at a price of £4.25 per ounce. It is interesting to consider how inflation has eroded purchasing power since then, using official inflation data. As in Figure 1, we can illustrate the devastating devaluation of purchasing power with the sight of a ten-pound note being eaten away of the years. The upshot of this image is that if you had kept £10 under your mattress since 1930, that £10 would have lost 99% of its purchasing power over those years.
As we will explore later, official inflation statistics are not always accurate. It is therefore useful to consider the impact of dropping gold standards on our purchasing power for gold itself. Consider the case of the United States, which as previously mentioned, dropped its gold standard in 1971. As you can see in Figure 2, gold purchasing power plunged during the stagflation of the 1970s, when the gold standard was ended, and has continued its demise since. In just 50 years, the US went from exchanging dollars for an ounce of gold at a $35 peg to a price of more than $1,800.
This theme is true across all fiat currencies. Through the cartel of central banking, fiat currencies around the world have seen staggering debasement as currencies have been counterfeited through fractional reserve banking, debt monetisation and monetary stimulus. The implications of this debasement go beyond your home, utilities and groceries costing more. It has profound psychological and societal implications.
As fiat currencies come with a debasement guarantee, people’s time preference changes in favour of immediate consumption. A something-for-nothing culture starts to emerge. Conspicuous consumption blossoms. Speculative investment becomes rife, with productive investment disincentivised. There is little incentive left to defer gratification, and as we have discussed previously on this blog, shortfalls in this important human capacity can gradually have far-reaching consequences on education, health and happiness.
But that’s not the half of it. On a political level, the system that underpins the magic trick enables stupidity and terror. Government expenditure that can be immediately funded by printed money is plainly unaccountable government expenditure. And in a line of work that attracts a large proportion of sociopaths with a predilection for central planning and a lust for power, this doesn’t seem like a formula for long-term success. On the contrary, it is a formula for disaster. Such monetary systems appear uncoincidentally to have been breeding grounds for tyrants throughout history. They fund unaccountable wars and death. In short, contrary to the ideas conveyed in economic schools of thought that have infiltrated a century of academia, inflation is not good for society; it is extremely dangerous to society.
How to Manage
Alas, we cannot expect to change the monetary system on our own. True to the common thread in this blog, instead we must focus on what we can control and make concerted efforts to address the consequences on a personal level. There are three important steps we can take.
#1. Understand real vs. nominal value
One of the reasons that central banks and governments get away with this devaluation of currency over time centres on a cognitive bias known as the money illusion. This refers to the idea that we have a natural tendency to consider currency on face value, even as its real value diminishes. It means that even if our $100 buys less groceries from one year to the next, we continue to believe that it will still buy the same groceries as it did before.
To contextualise this idea further, think of it another way. Experiments show that if we receive a two percent pay cut, generally we’re a bit pissed off. No surprise here. But if we receive a two percent pay rise with four percent inflation, we view this as a fairer outcome. In real terms, we are two percent worse off in both cases, but because we make the mistake of measuring our purchasing power in nominal terms rather than real terms, we miss the trick.
This trap is an insidious process, not least when the central bank is sneakily targeting a modest two percent debasement of the currency each year, which it often exceeds. It’s easy enough to not feel this level of inflation. It has been normalised and accepted as part and parcel of economic life. But as the impact compounds from year to year, our focus on nominal value can carry a heavy price.
There is, of course, a tipping point in our point of reference. When price rises become more salient – for example, during hyperinflationary periods – we will start to consider the real value of our money. Better late than never, but at this point, we risk having already lost out.
The money illusion rests on the simple distinction between nominal and real value. Because nominal value is what we continually see, switching to a real value mindset requires concerted effort. As Daniel Kahneman might describe it, it requires us to engage our Systems 2 deliberate mode of thinking instead of our System 1 automatic mode of thinking.
There are numerous ways we might go about activating System 2 to better understand this distinction. For example, we might track our costs. By frequently reminding ourselves of rising costs for the same basket of goods, this raises our awareness of real value. And as we raise our awareness of real value, we become better equipped to understand the worth of our income. If we want to keep pace in real terms – or better, get ahead in real terms – we must be attentive to real value in salary negotiations. At the very least, we should be pushing for increases that match the official inflation rates. But as we’ll show next, even the official inflation rate will not give us the complete story.
#2. Beware the con within the con
Over many years, the magician in our story has mastered his sleight of hand. Through careful disguise, the implications of his theft have been masked from “official” view. No clearer is this act of disguise than in official inflation rates of countries. Over the last few decades, we have seen a clear and deliberate attempt to manipulate inflation rates lower through careful customisation of calculations by the official statistics bodies.
There are several techniques that these statistics bodies use to disguise the true extent of purchasing power erosion. Each is worth brief reflection.
- They measure the price of a basket of particular goods by product not by weight or size. This means that the calculation ignores “shrinkflation”. When a company decides to reduce a product’s weight but sell at the same price, this is not considered inflationary. In other words, despite the consumer having to buy more of the product to fulfil the same need, our government statistics ignore this.
- They substitute products in the calculation. This often involves changing one product for another where inflation may be lower.
- They change the weighting of products in the calculation. Again, by manipulating weighting from high-inflation product to low-inflation product, they can massage the inflation figure lower.
- They make “hedonic adjustments”. True to the madness that has consumed mainstream economics, rather than leave the calculation alone, they also make adjustments to the calculation in an attempt to the reflect the perceived utility of each product. This technique again provides an open goal to manipulate the inflation statistics lower.
The upshot here is that these techniques result in grossly underestimated inflation. To prove this isn’t a speculative idea, consider analysis that has been done to assess inflation using older, less manipulated methodologies. Shadow Stats, a website dedicated to analysing beyond US government economic reporting, tracks CPI (Consumer Price Inflation) using the inflation methodology prior to 1980 versus the latest official CPI figures from the US government. During 2022, with Western economies rocked by high official inflation, Shadow Stats estimated that the real situation was nearly twice as bad. In other words, an 8 percent inflation rate was really closer to 16 percent based on the old methodology.
The lesson is that inflation statistics may look bad enough, but the real situation is likely worse. So, what can we do about it? Apart from monitoring the dent in our wallets, there is another somewhat wacky way we might get around this manipulation. By measuring our wealth in money used for millennia, we can form a truer view of our purchasing power erosion.
That form of money is gold, and while the idea might sound insane, considering your wealth in gold ounces is a useful tool to bypass statistical manipulation. But changing the way we measure our wealth is not enough on its own. We need to protect ourselves from the magic trick.
#3: Own physical assets
History tells us that the magician will occasionally realise he has made too much money appear. The reaction will be hard and fast. It is this cyclical process of boom and bust that central banks seem to have mastered. But over the long run, one fact has always held true since the creation of central banks and fiat money: the erosion of purchasing power. Indeed, history tells us that extreme debt bubbles (hint: we’re in one) almost always end with more money printing. We must therefore get our houses in order and protect ourselves from the consequences of central bank lunacy.
In an increasingly virtual world, the greatest financial protection is paradoxically found in the physical world. Areas where we see the greatest imbalance in supply and demand, like energy, utilities and agriculture, tend to perform well in inflationary cycles. Gold may first act confused in the face of tepid interest rate hikes as central banks pretend to care years too late, but it has consistently proven its robustness as a monetary asset during full inflation cycles. It may be careless to ignore it.
Magic is perhaps too flattering a term to describe the scale of theft that the central banking cartel has overseen. It is the greatest hustle in human history, a silent assassin of decency, corrosive to human wellbeing. It has created an illusion of wealth, binding citizens to debt servitude. This may sound hyperbolic, but the coming years will spell this out for even the most sceptical. The curtain will be pulled back to reveal the laughing magician and stage engineer.
This process is not going to be pleasant, even for the most prepared. And rest assured, the greatest hustle in human history is not going to come to an end without a fight. The central banking cartel will produce new, cutting-edge magic in the form of Central Bank Digital Currencies (CBDCs). CBDCs will be the next frontier in the central bank madness, offering customisability and programmability. This, in essence, will offer the opportunity for a magic trick that is bespoke for each member of the audience. The question is, how many members of the audience will fall for the latest version of the same magic trick?
We might be in the final moments of a longstanding hustle as we know it today. Our fiat currency systems will look very different in a matter of years rather than decades. Now might be a good time to explore what happens in societies where the hustle is finally outed – and to explore what might be coming in its place.