Thursday, November 20, 2008

The Greatest Invention - MONEY

Money is not a force of nature, but an invention of mankind.

As a Patent Attorney, oftentimes I get asked, "What do you think was the greatest invention of all time?"

Without missing a beat, I reply, "Money."

This usually generates two negative reactions. First, there are some that think that money is not an invention at all. But if you think about it, it is not a part of nature, it is an invention of man. Actually, if you think about it, money exists totally in the mind. Today, we recognize "methods of doing business" as Patentable, and if such Patents had existed in 10,000 B.C. (or whenever), money could have been Patented - if the actual inventors could be tracked down.

However, like most great ideas, money evolved in a number of different places in the world at aroud the same time, with no one birth mother claiming credit for the idea. Nevertheless, it is an invention. It did not occur in nature.

The second objection I get is from folks who say things like "Money is the root of all evil! It says so in the Bible! Money is bad! Money is the cause of all the problems in our society!"

These sort of rants can be difficult to parse. To begin with, the Bible does not say that "money is the root of all evil" unless you take the quote out of context. That would be like saying Bill Clinton once said "I. . ... had sex with that woman!". When you delete the words "did not" from the quote it changes the whole meaning. By the way, people who do things like that (Second Amendment types, for example) really annoy me. The actual quote is:

“For the love of money is the root of all evil.” Timothy, 6:10.

Note that this quote from Timothy is neutral on money itself, it is the LOVE of money that is bad. So forget alleged Biblical admonitions. And besides, the whole point of this blog is just what this quote from Timothy is getting at - that chasing after and spending money is evil - and destructive. You can live a "rich" life without loving money. That does not mean you shouldn't respect it as the powerful and potentially dangerous invention that it is.

All inventions are dangerous and destructive in some applications. From the first inventions ever made by man (the blunt club, fire, the sharpened stone tool) to the latest (nuclear power, the internet, the automobile). All can be used for good or evil purposes. Cars kill 45,000 people a year in America alone and also pollute the air and dimish resources. A sharpened stone can be used to scrape an animal hide or kill the caveman in the next cave. It's all in how you use it.

And yes, money can be used in very evil ways. But oftentimes, it is the "love of money" that is the downfall of the victims of money. People who end up being scammed by evil people are scammed because they are greedy. In your typical MLM scam or Nigerian scam, or Invention Broker scam, or Real Estate scam, who is the "evil" person? The one raking in all the money, or the greedy victim who thought he could make "something for nothing" and "get rich quick"?

The folks who decry money as inheriently "evil" are usually the ones who do not understand it or treat it carefully and with respect. They get burned by money a lot, so they blame money for their woes, when in fact it is often their own actions that are the real source of their misery - money is only the scorecard of their difficulties.

And that is the point of this blog. If you treat money carelessly, like a loaded handgun, it will probably hurt you or someone you love. If you treat it carefully - like a loaded handgun - it will be safe and might be useful to you.

So why do I think money is the greatest invention of all time? Well, without it, most subsequent inventions would not be possible. You cannot build a moon rocket without money. Bartering chickens or eggs for a Saturn-V booster just is not practical. So any major undertaking of mankind usually requires some sort of money or money-like medium of exchange. Money allowed the creation of modern societies. Money allowed us as Humans to do things other than scratch in the soil all day long. Money allows me to sit here and type this blog, rather than be out hunting for food all day long.

Money also allows us as humans to time-shift wealth. In many more primitive societies, people try to have as many children as possible in order to insure that in their old age, they will be cared for. Overpopulation has often been the result of this practice. Without money, and a means of storing it over time, the only option for insuring wealth over time is to have a large family and hope they will take care of you later on.

Now, one might argue that such an arrangement tends to strengthen the family unit more. Since parents rely on their children in their old age, they might tend to treat their children better, and children tend to honor their parents (as it says in the Bible) as part of a cultural tradition. And these cultural traditions are precisely the outgrowth of such human necessities.

However, such arrangements can be grossly unfair. A couple without children might find itself destitute in such a society, whether they cannot conceive or whether their children die off. People without families are left with few options other than begging. In an industrializing society, where mobility of the workforce is essential, such arrangements may not be practical. And finally, such traditional arrangements prevent one from breaking free of traditional roles and boundaries.

Money allows a person to create wealth and also store it for future needs. You can invest money in stocks or bonds or whatever, and later on in life have a resource to rely upon to support yourself. Money allows a person to live independently and provides freedom. I'll take money over bartering, any day.

Now, with the recent downturn in the stock market, some folks might argue "Well, that defeats your argument - how can you save for retirement if the market crashes or is manipulated?"

Well, that's why I mentioned that you have to respect money. It takes a long and painful time to save up even a few dollars. With all the expenses of living and the scarcity of wages, saving even a buck or two is a heroic process. One would think that after all that sweat and toil most folks would be vigilent of what they do with their savings.

One would think, anyway.

In reality, most folks have little or no idea where their money is. They might put it all in a mutual fund and occasionally glace at the Statement every month. "I don't know what to invest in" is a common thing I hear from regular folks. Or, "I just don't understand these things, so I let my broker handle it."

Even more disturbing is when people actually try to invest their money and things go horribly wrong. Most phoney investment schemes target the poor or lower classes, as they tend to be less educated and respect money less. How can I say this? Well, think about it, why are they poor in the first place (lack of education and respect for money). So things like MLM (Multi-Level Marketing) schemes are targeted at the poorest segment of our population, with the promise of easy riches - for a small initial investment.

Let me just note the obvious here. If there were such a thing as easy riches, everyone would be doing it, and you wouldn't be hearing about it through an e-mail or on a carboard sign tacked to a utility pole. If you could make a fortune in MLM, Warren Buffet would be hawking health products door-to-door. The reality is, MLM is nothing more than a pyramid scheme, and only those running such schemes make any real money. Period. And no, this is not open for discussion.

In my line of work, we have what are called "Invention Brokers" who promise starry-eyed inventors riches beyond their dreams - if only they can pony up $5,000 to $20,000 in fees. Oftentimes the victims of these cons are from the poorest segments of our society. How they come up with the money is beyond me. But they do. And the largest invention brokers rake in tens of millions of dollars a year in these fees. They don't really care about the inventions (which never go anywhere) they want the fees.

But even middle class America ends up getting screwed through their own ignorance. Several older friends of mine have complained that, during the recent downturn their retirement incomes have been cut way back. I was flabberghasted to hear this from a number of people, as all the literature I've read has said that, by the time you reach age 70, you shouldn't be playing the market.

A person in their 30's or 40's should have 3/4 of their retirement savings in equities (stocks) and maybe 1/4 in "safe" investments like bonds or government funds. By the time you are nearing retirement, the ratio should be reversed - mostly bonds and "safe" investments and maybe a small portion in stocks and other riskier investments.

But for some reason, my friends, based on advice from brokers, ended up in stocks, and now, at age 70, are looking at a bleaker retirement as a result.

Respect for money means that you have to take advice from investment managers, brokers, retirement planners and the like with a grain of salt. Bear in mind that all of these folks get commissions from your investments. They are not your friends giving you advice from the goodness of their hearts. They are out to make a profit.

So the onus is on YOU to educate yourself the best you can as to how to invest. Many people think that this is impossible to do, as the subject is too complicated or difficult to understand. Nonsense. Libraries are full of books with investment advice. And most of it is just plain common sense.

Anyone can figure out basic investments without too much difficulty. The first thing to rely on is your gut instincts. If something doesn't sound right to you, or you are being asked to invest in something you don't understand fully, or if someone promises crazy returns for your investment, then just GO with that gut feeling and walk away.

The second thing is to DIVERSIFY. Handing over all your money to one investment advisor or broker or mutual fund, or stock, or whatever is never a very good idea. If that advisor or broker turns out to be a crook, or the mutual fund is run into the ground, or the stock crashes, you are dead broke.

In my short time on this planet, I've seen all of these things happen. People who invested all their money in Enron stock, only to lose everything they have worked for. People who put all their money in one mutual fund, only to see it mismanaged into the ground. People who handed over all their money to a crooked broker who "churned" their account for trading fees until nothing was left. Warren Buffet has said "put all your eggs in one basket - and then watch that basket" but I disagree. Even the best-watched basket can fall and break all your eggs. Better off to have multiple baskets so that at least SOMETHING is saved if the worst happens.

The third thing is to avoid fancy investments. The invention of money has also allowed the creation of many dervative invesments. When I say "dervative" I mean this in the Calculus sense. In mathematics, speed (change in distance over time) is the dervative of distance. Acceleration (change in speed of over time) is the derivitive of speed, or the second dervative of distance. With money, things like "futures" are called "dervatives" for the same reason. You are not betting on the price of a commodity or stock, but the direction of travel (and how far) the price will change over time - which could be considered the second derivative of price.

Such inverstments are complex and require skill and management. For the average investor, playing with derivatives is like playing Russian Roulette. You have to respect a loaded handgun. You have to respect money. I know folks who tried to "bet" on the price of a stock, only to end up losing tens of thousands of dollars, maybe more. Such "investing" is little more than gambling. And gambling is no way to respect money.

Similarly, other "schemes" like day trading of stocks are a really, really bad idea. Betting on the direction of a price of stock during one day is little more than gambling, unless you have insider information, which is illegal. Yet may do it, claiming to have a "system" for always coming out ahead. But here's the deal: Money doesn't conform to some "system" where prices and values go up and down according to anything other than the perceived values of the underlying stock. Betting on stocks based on phases of the moon makes as much sense as betting on horses based on numerology. You are better off betting on the fastest horse.

Which brings us to the ultimate in disrespect for money: Gambling. Gambling is just plain bad, and if you one of those people who likes to throw biblical verse at me about "Root of all evil" check your Bible to see what God has to say about gambling.

Gamblers always lose. Period. Movies, television, and literature are full of romatic stories about how "professional gamblers" make big money at gambling. James Bond saunters into the casino in his white dinner jacket, and bankrupts the evil opponnet at Baccarat. It is a glamorous fantasy. The casinos and other gambling businesses (who euphamistically refer to gambling as "gaming") love to perpetuate these myths. The cold hard reality is that if you gamble at a probability game long enough (slots, roulette, etc.) you will eventually lose all the money you came in with. The house always takes a percentage, and for every dollar that enters a casino, less than 90 cents goes back out (if that). And no one in a modern casino is wearing a dinner jacket. There is no glamor in gambling, just ugliness.

Gambling games which are not enitrely dependant on probability, such as card games (poker) or sports events (races, football, etc.) are also losers. Yes, someone who is a good bluffer in poker might be able to win - against players with less skill, but on the average, most people walk away from the card table with less money than they came in with. The popularty of poker tournaments in the US recently has illustrated that even "professional" players can lose on more than one occasion. In many instances, some unknown player of mediocre caliber wins the tournament, not because of skill, but the sheer law of probability.

Playing with your money is not respecting it. And yet many folks do just that, and lose enormous sums in the process - money they can ill-afford to lose. Gambling ties into the compulsive-addiction parts of our brains, and those who have addictive personalities are particularly susceptible to gambling's allure. Like drugs, you can't do "just a little bit" and kid yourself that you have the problem "under control". The best thing to do, is just say "No" completely.

The only people to make money gambling are the casinos, the people running numbers, or the folks taking bets on college football. Goverments make billions on lotteries and payout maybe a few million to some "lucky" chump once in a while. If you want to make money gambling, open a casino. Otherwise, forget it.

So, money can be powerful. Money can be dangerous. Money should be respected. But what exactly IS money? It is an IDEA, plain and simple - and nothing more.

In popular action movies, there is usually a scene where the bad guys open an aluminum briefcase filled with neatly stacked $100 bills. Everyone in the audience drools at this point. Lookit all dat money! But often in the same movies, the villan (or hero) replaces the briefcase with one filled with worthless pieces of cut up newspaper. Boo! Hiss!

But what, exactly, is the difference between the two? Both are suitcases filled with paper. Why is one valuable and one worthless? The difference between the two is all in your head - literally. (And if you think about it, it is just a movie, and even the "real" suitcase is just filled with fake prop money and has no real value other than the suitcase itself.)

Money is nothing more than an IDEA. It doesn't physcially exist anywhere. Those hundred-dollar bills are merely an expression of the IDEA of money, not actual money itself. Most money exchanged today doesn't even have a physical embodiment, but exists merely as numbers in banking computers, representing balances, charges, debits, and credits.

For example, I go to a restaurant and have a meal. I give the owner a card encoded with a number on it. He processes the card through a computer, which then debits a balance sheet with my name on it by a number deemed equal to the value of the meal. Later on, a client sends me a slip of paper with another number on it. I give this to my bank, and they credit the same balance sheet with another number deemed equal to the value of my services. The entire transaction really doesn't "exist" anywhere except in the bank's servers and other records. We might exchange slips of papers with numbers on them to "prove" the transaction took place, but more and more, we are dispensing even with that. Receipts are often just a waste of paper. And mailing checks is giving way to electronic transfers (and with Check-21, a check is little more than a request for an electronic transfer).

In the early days of money, precious metals or other materials were used to represent the idea of money. Why was this? Metals like gold and silver were valued for their relative rarity, to be sure. But the real reason earlier cultures used metal-based currencies was simply to help prevent counterfeiting. Think about it. In Roman times, couterfeiting their primitive coins was not a difficult matter, given the primitive dies of the time. But if the coins were made of precious metals, it made it harder to make fake ones, unless you scrounged up more metal that the counterfeit would be worth. It was a pretty good self-policing system. Detecting fake coins (made of lesser metals) could easily be determined by the weight and density of the coin.

By the way, the penalty for counterfeiting, in most primitive societies, was usually death. This alone tells you how important it is to police the idea of money. If people get it in their heads that money is nothing more than slips of papers, well, then, the game is up. Chaos would result.

Many (idiots) are calling for a return to the "Gold Standard" or some other metal-based money. However, even if you based currency on the price of a commodity such a Gold or Silver, it still does not make your money anything more than a concept or idea. Gold and Silver have some industrial values. However, their perceived value is based entirely on the IDEA that they are valuable. We tell ourselves they are "precious metals" and as a result, they are. Gold has no intrinsic value in and of itself, other than as an industrial material.

Diamonds fall into the same category. Despite the fact they are made of one of the most common substances on the planet (carbon) the folks who mine and market diamonds are careful to insure that the perception of diamonds as "precious stones" is not tampered with. Industrial processes can now make flawless diamonds artifically. Such stones have no value, as you can make an infinite amount of them. The diamond people are not happy about that!

You can't eat gold. You can't eat diamonds. You can't burn them in the engine of your car, or use them to build tall buildings or rocket ships. They have some industrial uses, but that's about it. When we exchange gold coins for merchandise or services, we are trading the IDEA of wealth for those goods or services. The recipient of that gold coin, in turn, hopes to exchange the coin for goods or services that he might need. He cannot use the gold coin in and of itself, unless he melts it down to make jewelry or electrical connectors.

And that is the point of money - and its genius. Money provides a means whereby one can exchange any good or any service, anywhere in the world, with any other person, for any other good or any other service. Corn grown in Illinois can be traded for a car made in Michigan, which can be traded for a computer made in Taiwan, which can be traded for a barrel of oil from Saudi Arabia, which can be traded for a load of timber from Canada, which can be traded for a week's labor in Utah, which can be traded for something else, and down the line. No complex system of bartering is necessary. And the system is self-regulating in terms of exchange. Each user finds the correct "price" for the goods he wants (or the best price he can get, anyway).

Now to be sure, there is a dark side to this intellectual fantasy. Money also allows an hour of prostitution fom New York to be exchanged for a bag of cocoa leaves in the mountains of Colombia. Money has the power to do good or evil, depending on how it is used by the user. Money itself, however, is value-neutral.

Money can also be used to buy money. You can spend money to borrow money, and you can also make money by lending it. These are the first dervitives of money. And yes, some say the Bible warns against money lending. Ben Franklin is alleged to have said "neither borrower or lender be". Given the potential for mishaps in borrowing or lending money, it is not hard to understand why some folks would prescribe a blanket proscription of such practices. If you loan out money to someone who defaults, you could be broke. And if you borrow too much and cannot pay it back, the same thing could happen.

However, loaning money is probably the cornerstone of our economy. In fact, the real value of money today is not determined by the value of Gold or Silver, or even a barrel of oil, but by the interest rates set by the Federal Reserve. Big M, they call it, the Money Supply, controls the value of money, and Big M is tied to the prime rate. The more money in the economy, the cheaper it is to borrow it. But the more money, the higher the inflation rate can be. So the Fed controls Big M to try to control the value of money. It is not an exact science, to be sure.

The value of money is what it will be worth tomorrow. This means, however, that since not all of us have access to loans at the "prime rate" or can earn interest at the highest rates, money has a higher value to some folks than it does to others. And as you might expect, since the rich have access to the best rates, money is much cheaper to them than it is to the poor.

And that, perhaps, is the most interesting thing about Money. Even though it is an age-old invention, and we've had tens of thousands of years to play with it, experiment, examine it, and understand it, mankind still does not have a real handle on this deceptively simple invention. Econmics is still considerd a dark art - more magic than science. And even today, new "theories" of economics are still being developed.

The more complicated aspects of money are still not fully understood. Every time some young hotshot claims to have a new computer model for trading dervatives, you can be sure that a major market crash is right around the corner. Most of the new models (like "mark to market" accounting) end up being less science and more people telling themselves what they want to hear. When fantasy clashes with reality, the inevitable happens.

Dealing with money requires little more than common sense, respect, and perhaps a little luck. But bear in mind, it is an invention, not a force of nature.

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