Here's a video tutorial:
(Music is "Prince Charming" by Jim's Big Ego.)
And if you prefer to see still shots, here's a Flickr photoset showing you how-to!
Start with a flattened plastic grocery bag. It's better if it's kind of flimsy.
Fold one side to the middle.
Then fold the other side to the middle.
Fold it again.
One more time.
Cut off the handles and recycle them.
Cut off the bottom of the bag and recycle it.
Cut the rest into strips. How big the strips are depends on how thick or thin you want your plarn to be. It doesn't have to be exact.
Unfold one of the strips into a loop.
Lay two loops down, one over the other.
Fold one of the loops up over the other one.
Then bring that loop through itself.
Pull it tight! If it breaks, just recycle it and use a new loop.
You can make a whole bunch of it at once, or just add on loops as you go to form a pattern.
I made this purse out of it!
...And this hideous hat.