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Monday, March 23, 2009

Put Down Your Lighters

"I never heard of an old man forgetting where he had buried his money! Old people remember what interests them: the dates fixed for their lawsuits, and the names of their debtors and creditors." - Cicero

Now hold one just a minute.

It is just me, or do other people get the sense that they've had to spend a larger share of their time talking others down from various extremist positions lately?

The concept of money is one of those deliciously complex ideas, which seems so simple at first; the fact that we use it everyday, the fact that it is so familiar, makes us forget what, exactly, we're talking about most of the time. The 'undergraduate explanation,' to borrow a phrase from one of my colleagues, is that money serves three purposes: 1) as a medium of exchange, 2) as a store of value, and 3) as a unit of account.

In other words, farmers use money because it's easier to trade dollars for haircuts than radishes, and because dollars don't go bad, unlike radishes, and because it's easier to tell others how productive your farm is in dollars, rather than in radishes.

There are, of course, other philosophical motivations for money. One of my personal favorites has always been Ayn Rand's, in Atlas Shrugged:

"When you accept money in payment for your effort, you do so only on the conviction that you will exchange it for the product of the effort of others. ... Those pieces of paper, which should have been gold, are a token of honor -- your claim upon the energy of men who produce. Your wallet is your statement of hope that somewhere in the world around you there are men who will not default on that moral principle which is the root of money."

Of course, I do take issue with some of Rand's claims (that of a gold standard, mainly), but general point is still valid: we hold money because we believe other people will hold it as well; money has value for me, today, because it has value for others today, and tomorrow as well.

But back to the point at hand -- burning our wallets.

Maxwell brings up an important problem, one that was especially common back in the days of gold-(and other 'scarce resources)-backed currencies. The easiest way to think of it is this:

A country has a fixed amount of resources at any given time(i.e. 'stuff'), and some production technology (i.e. means to make more 'stuff') which allows for unbounded growth (i.e. over time, the amount of 'stuff' keeps going up). If the country has a fixed amount of money, each unit will become worth more over time. On the other hand, if the amount of 'stuff' goes down drastically - or if the quantity of money available drastically increases - then each unit becomes worth less.

This, in and of itself, isn't necessarily a problem. One example of this is Milton Friedman's concept of a 'helicopter drop' -- if the government were to simply give everyone more money, nothing would change, in relative terms. The price of a loaf of bread might double, but, if your salary (and the price of milk, eggs, haircuts, etc.) doubles as well, it doesn't matter.

The problem Maxwell mentions, with the candy, is an artifact of the discrete world we live in - things like indivisible units, transaction costs, and so on. Of course, there are cases in which this doesn't matter: the other major form of currency we use is electronic currency, which, theoretically, can be divided as much as we want. And, in other cases, there may be other issues: recently, there's been much discussion about retiring the penny from use in the US, with supporters claiming that the cost of producing and using the coins far outweighs the cost of potential issues (like those described above!).

Which brings us, again, back to the original point -- burning out wallets.

If there was ever a time to burn our wallets, this is most definitely NOT the time to do it. If anything, the value of the cash in your wallet may actually be going up, given current circumstances.

The concept of inflation is relatively well-known to most of us - the idea that money, over time, becomes less valuable. Intuitively, the 'inflation rate' is the rate of interest you'd have to be getting on your money for it to maintain its value over time. Usually, this is calculated using what is known as the Consumer Price Index, or CPI. The CPI is a measure of how much a 'standard bundle of goods' costs, in dollars, at some time. So, since the CPI in January of 1991 was 134.6, and in February was 134.8, we know that things 'cost more,' in a very specific, quantitative way.

So, why is this interesting right now? According to most measures, we're in a period of deflation at the moment.

In 2008, the CPI slowly crept up, from 211.080 in January, to a high of 219.964 in July. But then it began to fall, dropping to 215.303 in December. The CPI went up from January to February, but February's numbers were still a good deal lower than the peak last July, coming in at 212.193.

Now, I'm not predicting that this trend will continue, and that in a few months, $5 will buy you a new car, but I think it's safe to say that it's not quite time to reach for the lighter yet...

- Marcus Tulius Tiro

A side note: I meant to talk about more current events, and some of the other reasons (and there are many) that we shouldn't be burning our wallets (but why it might still be a good idea for Maxwell to be telling you all to do so), but I managed to get a bit off track. Hopefully, this means I'll be posting again soon!

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