Archive: Business & Technology

Click to purchaseThe use of money can be traced back to ancient times.  Most people can tell you what it is for… it makes trade easier.  Let’s say you make tires for a living.  If you’re paid in tires, and take a couple of tires to trade for your weekly groceries, it might work out.  But if you only need a gallon of milk, how do you get your remaining value back?  Change makes it so much easier to do. 

Even a three year old knows to ask for money to use in the candy machine. Gum or chocolate are useful; but what do you do with money?  What value does it have?  You can’t eat it.  It’s not REAL estate, nor REAL assets.  Its worth is only that it can be traded. While few are anarchists, there are even fewer on the other end of the spectrum completely trusting their government.   Even the US Government prints ‘In God We Trust’ on its money to help with credibility.  At one point it was backed by gold.  (Explaining why George Washington who couldn’t tell a lie; or Honest Abe had to back our money with precious metal… while Tricky Dick got the rest of the world to take our government’s word for it…  fodder for a sequel.)

Let’s face it, real value comes from doing work, changing or creating real things…   food, shelter, clothing, jewelry, entertainment, toys, memories… are all things that someone may perceive of value and trade. Some things of real value are perishable; some things of real personal value are priceless.  But money is only money until you spend it.   In fact, money is provided as a service of the US Treasury in order to facilitate trade and commerce of items of real value. 

‘With power comes responsibility…’ isn’t just a concept from Spiderman. In a recent PBS series, Downton Abbey, the family patriarch, Lord Branscom, points this out to his potential heir.  He explains that the centuries old estate is not his; but rather his responsibility.  Proper care ensures that the land and real assets continue to provide for all of the stakeholders…   from the lord of the manor’s family to the working villagers.  After all, isn’t the point of capitalism that allowing ownership of private property for the purpose of creating value becomes a benefit to all society?  Entrepreneurs are encouraged to invest capital funds into this private property.  When the owner(s) of capital put it to productive use, the market will trade for its product, service, or use.   Capital invested in wisely allows the owners (i.e. capitalists, entrepreneurs) to reap a profitable share of the reward for which they were responsible.  If a motivated capitalist is really good, they can become wealthy… by increasing their investments and spending their extra currency.  When the extra currency, aka money, is ported back into the system, it enables further value creation, trade, and commerce which allow another capitalist to enable a transaction.

How frequently this money is circulated to allow trade is referred to as the ‘velocity of money’ by economists.  Imagine if you completed a building project and were paid six months later for your work… then you finally buy groceries and put the money back in the system.  Pretty slow process compared to getting paid immediately, going right to the store and spending it, the grocer replenishes inventory, pays their staff, who immediately after work go to the bar or barber shop, make their car payment, etc…  The faster the money moves, the more transactions can occur only limited by the value of the transaction. 

It can get too fast… let’s say we give everyone their own money printer.  If there is too much money compared to the real wealth out there, then each unit of wealth will demand a proportionately higher amount of money in trade. 

There was a time when it was easier to identify the quantity of money in the economy and to estimate its velocity.   Today it is more difficult because of modern electronic transactions, credit cards, lines of credit, etc.  The central banks job is to ensure that there is enough money out there so that we can have a reasonable frequency between transactions; but not so much money out there that if you don’t spend every cent instantly it will be worth less in trade.  How they manage this is called monetary policy.  By holding more or less money in reserve, against what is assumed to be a constant demand for the trade of goods and services, the central bank drives more or less ‘want’ for money.  The velocity of money is an indicator of economic activity.  When there is more money available to everyone, we all feel wealthier. It’s human nature to become less frugal and to feel the cash ‘burn a hole in your pocket’.  If too much money becomes available, and it outstrips the pace of underlying economic activity, inflation occurs. In the corporate world, too much money is referred to as a ‘free cash flow’ problem because it can lead to unnecessary spending.

If the economy becomes overheated, either inflation and / or a decrease in productivity occur.  If less real value is created, than the economy slows, fewer jobs are available, unemployment is difficult to manage.  If the economy slows to the point where it shrinks, we call it a recession.  Eventually, the central bank has reached its limit.  If releasing more money (easing credit) is likely to drive inflation, then the government can help…   How??  By making up for the spending that private sector isn’t doing.  The guy on the paver could care less if his paycheck comes from paving a street or paving a mall parking lot.  (Assuming it’s the same pay rate… again, another future book).

So now, hopefully you see this economic dynamic, but are asking yourself…  “Can’t I put my money to work instead of me??”  The answer is ‘Yes, to some extent…’  If you’re reading this in a carpool now, discuss…

Remember Popeye...  the character Wimpy?  I’ll give you a dollar tomorrow for a hamburger today??  When you buy on credit, you’re deciding that the value received today is worth paying tomorrow’s price.  The difference in today’s price and tomorrow’s payment is real interest.  The difference in today’s price and tomorrow’s price is inflation.  The real interest is the money the lender can make by putting his money to work.  When you put your money in a bank, buy a bond, or loan it directly for interest you are participating in this positive aspect of capitalism.  Let’s explore ‘Yes, to some extent…’ together.

If everyone loaned all their money and lived only off of the money’s earning’s, who would be creating or using the real wealth??  If you said no one, you’re correct.  There would be no goods or services and therefore the money to buy them with isn’t worth the paper it’s printed on. 

If no one loaned any of their money and therefore the ability for others to invest on credit in items like housing, transportation, factories, farms, etc…  lived only off of the money’s earning’s, who would be creating or using the real wealth??  Only those with large inheritances…  Fewer people… so the economy could slow.

Try this puzzle …   If I buy a share of existing stock in company X from my aunt, expecting to sell it later for more money, did I just create wealth?? 

• Did your transaction with your Aunt cause something of real value (her smile doesn’t count) to be created? …  No.
• Are you receiving dividends until you sell the stock?
• Yes …  then you have exchanged, but not created wealth
• No … then No wealth is created.
• But if I sell the stock for more than I paid did I create wealth?  You may have accumulated more wealth, for the risk of assuming you would come out ahead.  By the way, this also means you took wealth from your Aunt…

Value and wealth are not like matter which cannot be created nor destroyed.  Like matter, however, value and wealth can be traded or changed in form. When that happens, the parties come out ahead, behind, or neutral… but the total net exchange is always neutral.  

But does that mean I shouldn’t save for a rainy day?  No, go back and read the Pharaoh’s dream in Genesis about the seven year bubble and recession.

There is certainly a need to earn, accumulate, save and spend in life.  And the levels vary across life and circumstance.  But when we exchange money for other forms of currency, we are not creating wealth.  We are using arbitrage (trading indirectly for advantage), or accumulating money, or gambling.  Investing to make an economic reward vs. the risk taken without directly contributing to the creation of wealth is a form of gambling….  And for every win, there is an offset loss.  If your financial advisor disagrees, ask them to provide you a written explanation of Put-Call parity.  If he or she still disagrees; we advise finding another advisor.

Back to John McCain’s statement… ‘… We still have the same people, resources, and capacities …   that make up the economy…’  True, but it ignores the importance of the ‘how much money is in my pocket’ mentality.

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