Money represents a quantity of something physical (real) say gold. By printing more currency against the same physical quantity, the relationship is redefined and there is loss of value (in relation to this physical reality).
When something like a mortgage instrument is created, what we do is create money in another form i.e. money that is backed by future earnings. Physical reality remaining the same, by creating this money, the value of money degrades.
When such mortgage is available against even dubious future earnings, the value degrades further. Everything becomes more expensive. Simply because the supply of money has increased.
Interestingly the additional money made by the business in the process is not passed on to the workers down the line quickly enough (it really is a trickle) for reasons of greed or prudent management (to account for the replacement cost given that everything is becoming more expensive). The result is that the borrower now buys stuff using depreciated money and pays a charge (interest) on this money.
Given that there is more money to be made per transaction the entrepreneur has no time for such distracting tasks like productivity improvement or innovation. He'd rather focus on the maximizing the number of transactions and bargaining an even better price per transaction. So the costs keep rising. The situation is further precipitated by the fact that inefficient and wasteful methods continue to perpetuate on an even larger scale putting a higher demand on the resources (both natural and man made) driving the prices even higher.
All this time ever larger quantities of money is moving into fewer hands while only a small trickle flows downstream.
Eventually this creates many a distortions in the economy. The most critical being the one between the real income of the people and the rising cost of living leading to distress abandonment of assets and possessions that no longer can be supported on a narrowing purchasing power.
Financial innovations such as these fail to provide the 'intended' benefits to the consumers. On the other hand innovations and productivity improvements (especially those that provide breakthrough gains) are a more definite way to spread the benefits to consumers (evenly across the society).
Innovation and productivity improvement increase the supply of goods and services and therefore increase the value of the money making it a faster way to spread prosperity than the 'trickle down effect' of capitalism.
The point is fewer and fewer people want to undertake the 'stupid' work of building an enterprise, improving productivity or indulge in innovating things. Even entrepreneurs these day think more in terms of trading their ideas and businesses for cash that they can then use to make more cash. Hopefully the current crisis will set the balance right between real world innovations and financial innovations.
The future of capitalism lies in the real market place and not in the money markets.
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