It really really isnt about a hat. I think you need to have been in the situation to understand it. I mean a situation where a parent blatantly favours one child over the other and then it get projected on to the next generation.
I was raised in a low income family. Which meant I had no contribution to education at all. At university I got not a single penny. Not a single book bought for me, no money for clothes or food and not anything for my graduation paid for. I just took the hit and used my overdraft, credit card for graduation.
Now though after having years and years of paying back heavy uni debts. I am doing ok. My sister didnt go to university and doesn't earn much, though her husband does so he pays for what they need. The problem with that is, although her DH pays for the essentials, she doesn't have a huge amount of her own spending money. My mum thinks I have more than my sister because of this reason.
For example when I bought some skin care items that were a good brand my sister said god I cant afford that and she looked pissed. I have a few items of better quality high street clothes such as Karen Millen but I bought these clothes in the back end of the sale when they were 60% off. I never buy full price clothes. Also it is my money and I work for it. It was remarked to me that sister cant afford these clothes and they dont like it.
My mum said the "poor" children are wearing boots and next brand clothing. For a start what is wrong with that? Then I reminded her they are 2 & 5 and outgrow their clothes so quickly so there is no point spending money on expensive childrens clothes at this age. My mum actually compared me (her grown working daughter) to two kids who will outgrow their clothes in a year because I had better clothes quality than them.
My mum is very protective of my sister in a way she never has been with me. She will consume herself trying to sort out my sisters problems and make it her life mission but with me, she shrugs and sometimes even blames me for what befalls me. I can sort myself out and deal with it but with my sister she is a poor girl and she doesn't have much.
This thread makes me very very uncomfortable for these reasons as I have always been in the situation where my sister was seen as the more disavantaged one and needing more. Even though she quite clearly isnt. I can quite imagine my mum behaving this way if I had any children.
In the context of the OP, for whatever reason MIL sees her other son as the poor one and wants to give him a helping hand and that has been projected on to her youngest granddaughter. MIL will go to any lengths to "help" them even if that means taking something as simple as a article of clothing off one granddaughter and giving it to the other one. It is a symptom of a much bigger problem. I would stop using her for childcare but the OP said she was already looking into that. If she feels that her youngest granddaughter is more deserving of nice clothes than her eldest granddaughter, then she probably wont miss having time alone with the eldest granddaughter either. She can provide an extra day of care to the young one to give them a bigger helping hand.