Saturday, June 18, 2011

The Alchemists of Money

Before we begin our journey, I need to establish some definitions. Without a clear understanding of what things are, it becomes impossible to examine them.

I want to clear some misconceptions and misinterpretations of the actual nature of money. There are several terms that are generally used interchangeably and incorrectly so. This, my dear reader, is by design and demonstrably so.

The first concept I want to define is currency. Currency is not money or wealth. Currency can be used to purchase money or wealth but it is not either by itself. 

What is currency? Currency is any agreed upon medium of exchange.

Casino chips, Chuckee Cheese bucks and airline reward points are all currencies. The value of a currency is your ability to trade the currency for actual money or wealth. You can voluntarily accept this medium of exchange either by the apparent benefits of accepting the currency or by your desire to participate in an activity that requires the use of such currency to participate. Monopoly “money” is a good example of a currency. Although it has no value outside of the game of monopoly, while playing, you behave as if it had value because it has value for the limited duration of that activity.

The first disadvantage of currency is that it is generally based on faith; on your faith that you can exchange the currency, at a later point, for money or wealth. The problem is that the value of the currency is subject to the desires of the issuing authority and the agreement by the trading party of the value of it. You could choose a particular airline because you believe that you will accumulate enough miles to trade the bonus points (currency) for free flights (a tangible benefit). Of course, the airline has the ability to change the terms of the program, therefore the value of the reward points (currency) as it wishes and reducing the expected benefit that you based your original decision on.

I have no philosophical disagreement with currencies. As long as they are used by two parties in a free agreement to the value and usage, they can provide benefit to all parties involved. Casino chips provide the casino with a captive audience that fails to psychologically connect monetary losses in chips with losses in wealth. Casino patrons gain the advantage of the entertainment gained by participating in the casino.

My opposition to currencies begins when the currency becomes a fiat standard. Fiat, a Latin word meaning “let it be so”, is a government imposed medium of exchange. Governments decree that a particular medium of exchange will be used for all transactions as “legal tender” and removes the voluntary element from the transaction. Let’s forget for a moment that government’s involvement in voluntary commercial transactions between free people is an abomination. The fact that a government can decree the method of exchange and the value of such method is ripe with the opportunity for theft. More on that later.

Money, the second concept we need to discuss, can be used as currency and it is by itself a tangible good. As an example, in early colonial days, tobacco was used as money. Tobacco, a valuable export crop could be used as a method of exchange and then traded for gold or other goods. Since tobacco has an inherent value in and of itself, it is money fulfilling the role of currency.

In general money must have inherent, widely accepted value, it must be easy to recognize and divisible into smaller units and it must retain its value for a reasonable period of time. Beads, gold, silver, spices, tobacco and other consumer goods have been historically used as money. Please understand that for a commodity to be money, even if used as currency, it must meet its general value, divisibility and longevity requirements. It must also, ideally, be rare and require work in order to exist.

Sea shells picked up on the beach could be used as currency but are not money. The ease of collecting them and its wide availability make them inherently worthless. Diamonds, although somewhat rare and requiring work, are not easily divisible or recognizable (cubic zirconia anyone?)

Certain commodities fill the role of money better than others. Thru history, men have chosen gold and silver as ideal forms of money. Gold and silver are relatively rare, limited in availability (cannot be manufactured), divisible, durable and inherently valuable. For centuries, men have known the medicinal properties of silver. Gold, although we have only recently discovered many of its advantages in electrical and thermal conductivity, it’s extremely durable and malleable.

The next term that demands clarification is wealth. What is wealth? Wealth is not money or currency. Money and currencies are vouchers for future wealth.  Wealth is, in essence, the tools and supplies needed to support your quality of life. A plot of farm land is wealth, when owned by a farmer. A steel lathe is wealth, when owned by a machinist in the production of goods. A loaf of bread or a bushel of wheat is wealth. Any item that can keep man alive, healthy or assist in that man’s production is wealth. The can of beans in your pantry is wealth. The Federal Reserve Note in your pocket stamped “one dollar” is not. You use currency or money to purchase wealth. The car you fully own in your driveway is wealth. The $20k balance in your 401K is not.

At its essence, wealth is the product of your efforts.

Wealth is produced by you or traded for freely with those that produce other goods in exchange for yours. If you are a machinist, you trade the products of your labor (a new engine part) for the products of someone else’s labor (the wheat produced by the farmer who needed the new engine part). Since you still need to eat and the farmer does not always needs a new engine part, currency serves a valuable means to measure the value of your production to others and as a means to trade for the production of others.

Money, in the other hand, serves as a storage mechanism for future wealth. You store your surplus production as money in order to exchange it for someone else’s future production. That is why it is critical that the value of money be stable thru generations and free from outside interference. Let’s say that you spend 20 hours of labor in order to earn, by your production, 20 units of wampum.  You save these 20 units of wampum with the expectation that in a future date, the 20 units of wampum will purchase the same amount of wealth that it could have purchased when you earned them. If your wampum would buy you a bushel of wheat today, you know that 20 hours of your labor are worth one bushel of wheat. You should reasonably expect that one year from now, if you have an accident or disease, that you can still trade the stored surplus production, the 20 wampum, for a bushel of wheat. You should also reasonably expect that, at the end of your life, you are free to pass along you wealth (land, factories, cars) or your money, the accumulated wampum, to your progeny in order to build multi generational wealth. Your surplus production today can be added to the surplus production of your children to benefit your grand children. Their surplus production, when added to yours, can amount to a fortune of wealth in the benefit of their grandchildren.

When you take into account improvement in efficiencies of production created by the minds of men, the storage of your surplus production should actually be exponential. The farmer that could only plow 10 acres of farmland with a plow and an ox is exponentially more efficient than the savage that plowed 1 acre with a stick or a hand plow. The farmer that can plow 100 acres, in the same amount of time, with a tractor, is 10 times more efficient than the farmer with the ox and 100 times more efficient than the savage with the stick. It stands to reason, that as the technological efficiencies created by the minds of men increase production, generational wealth would also grow exponentially. Yet it doesn’t.

Credit or debt is a lien on your future production. A farmer that borrows in order to purchase seed or buy a tool to increase his production; does so on the expectation that he can pay back the debt with a portion of his surplus production. If the farmer is wise, his debt can be easily eliminated with the increased efficiencies gained by the wealth purchased on credit and his new efficiency will, within reason, improve all future production well beyond the extinguishing of the debt.

Debt is not wealth.

 Debt borrows future wealth in order to provide it today. If the debt results in increased production above and beyond the cost of the debt, it is a useful tool. A man borrowing money from investors to purchase a factory that can reasonably be expected to produce many times more money than it cost, is engaging in productive borrowing and using an available tool efficiently. A bum borrowing money to buy a bottle of whiskey is not. Using your credit card to buy a new computer that can improve your efficiency as a writer or accountant is using debt wisely. Purchasing a new laptop on credit to surf for porn is not. A student loan taken in order to learn a critical skill that you can reasonably use to earn, by means of your production, many times more wealth than the cost of the education and the difference between having the skill or not having the skill can be a wise investment in your future. An $80,000 dollar student loan to get a degree in women studies in order to gain the “college experience” and ending up working in Wal-Mart is not. President Jefferson borrowing money to purchase the Louisiana territory from the French in order to gain a large amount of arable land for the nation is smart borrowing. The Federal Government borrowing 100 million dollars from the Chinese government in order to give it as a gift to the” Palestinian” authority is not.

The last concept I want to discus today is investment. This widely misused word has a specific meaning.

An investment is wealth acquired today for the purpose of increasing future production or wealth.

The home you purchased on credit to live in is not an investment. The home itself is wealth and the mortgage is a liability (debt). A commercial property purchased as a rental unit that can reasonably produce long term residual income is an investment. Purchasing new clothing in for a job interview is an investment. Spinner rims and a killer radio system for your Gremlin is not.

It is critical that you understand these concepts before we venture down the rabbit hole. The Alchemists of Money have worked very hard in confusing the real meaning of these terms to their advantage and are using your confusion to rob you blind.

... to be continued

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