Prices rose and fell depending on the influx of Red Cross supplies. When cigarette rations were reduced, prices rose. Markets were created by lists on the wall of each building, showing offers to buy or sell various goods, with prices listed in cigarettes.
The most fascinating part of the story is how closely it mirrors modern life; professional traders emerged, attempts to fix prices led to black market trading, and a fiat paper currency was created. A shop and restaurant were organized, and in order to purchase raw supplies for the store, issued paper notes that were each worth one cigarette, and were accepted in payment for anything in the store. The store became a bank, issuing paper money out of "thin air," and prisoners willingly accepted the paper because the shop agreed to trade it for goods at any time in the future. The paper money traded at par with cigarettes for a time, until the camp store began price-fixing schemes, and the camp became destabilized by bombing raids.
This method for issuing new paper money is the same system used today by modern banks. They issue new notes when they create new loans (mortgages, car loans, etc) with a few keystrokes, and insure that they are valuable by agreeing to exchange their collateral for notes in the future. The bank agrees to exchange a car title for dollars in the same way that the POW store agreed to exchange soap for new paper money.
The most interesting part of this narrative is that inflation eventually destroyed the paper money, but it was not because of excessive printing of notes. Printing too many notes would have been impossible; every purchase the central-store made with its new paper notes was kept in the store, available to be traded back to the men at the same fixed-price. If butter had been purchased for ten new paper notes, it would sit in the store, available for purchase for ten paper notes until it was sold. Even if the store went crazy, buying up all of the assets in camp with new paper money, inflation would not occur, because everything purchased would still be available for sale, priced in paper money.
Paper notes lost value for two reasons. First, they lost value when the future of the camp was in jeopardy; when prisoners feared that the store might not exist in the future. Second, they lost value because of the store's efforts to fix prices, and its policy of removing an item from the shelves if the "official price" was too low compared to the black market. If soap's official price was ten cigarettes/paper notes, and was selling for 20 outside the store, it would be removed from shelves. Eventually the store only contained items that were not very desirable, and thus paper notes could only buy a few limited items in the store. When the camp was disbanded, all paper notes were eventually exchanged as agreed in the store, but the variety of items available was limited.
It follows that inflation of a paper currency in modern economies is created by destabilization of government (war), and by the implied price-fixing that occurs when a bank agrees to exchange loan-collateral at a fixed price. If a loan is issued for a car, the bank agrees to exchange dollars for collateral-free ownership if the loan is paid off. The bank is effectively offering the home for sale in paper money at an "official,"fixed price.
If the market exchange-rate for soap goes too high, the store stops selling soap. The same thing effectively occurs in a market where home prices are rising; banks "take the soap off the shelf" by adding pre-payment penalties to mortgage contracts, which make it more expensive the pay off the mortgage; makes it more expensive to "buy the home" by paying off the loan. Banks don't remove the possibility of trading paper for the house completely, as was done with POW soap, but the inflationary effect should still be there.
A third way that inflation may occur is if the POW store began buying supplies with new paper and did not offer them for sale at all. This is what the Fed does when it engages in quantitative easing.
A fourth possible cause for inflation would involve the store accidentally buying supplies above the market price, and upon placing the asset on its shelf, finding that no one will pay 40 for soap because it trades at 20 outside the store. This effectively removes the bar of soap from the market, but leaves the new money in circulation to purchase anything else in the store, putting pressure on all other prices to rise and lowering the value of paper. This is what has effectively happened when housing prices collapsed and left many in upside-down mortgages -- the money remains in circulation but the home is priced incorrectly in the mortgage contract. The home is now effectively "off the market" just like the soap, no one will pay off a $500,000 mortgage on a house now worth $300,000. This effect is countered by mortgage defaults, which is equivalent to the POW camp store changing the price of soap to match market value. A bank prices the home correctly when it repossesses it and sells it at auction.
A final possible method for creating inflation would manifest itself if the camp's store were to begin issuing unsecured loans with new paper money. Nothing would be available in the store to match the new paper, and prices would be pressured to rise as the supply of new dollars outpaced the goods available in the store. This occurs today any time a bank issues an unsecured loan, and occurred heavily during the 1970s when banks issued massive amounts of unsecured loans to South American nations, causing massive inflation during that era and culminating in the August 1982 default of Mexico and eventually to a reduction of unsecured lending to the third world and a reduction in inflation during the 1980s.
