Grades are a score that parents can use to compare their children to other children.

It doesn't take too many parent-teacher conferences to figure out that the parents that ask for parent-teacher conferences want to see "the line go up" and aren't necessarily concerned with their children being challenged or learning much of anything.

The squeekiest of those wheels move from parent-teacher conferences to parent-administrator conferences (and sometimes parent-lawyer-administrator conferences) and you end up with school-wide policies like failure quotas where you are not allowed to have more than 5% of your students fail your class (ie the responsibility of the students grade falls on the teacher, not the student). And that is how grades stop being a measure of a student's understanding of the material.