Thursday, October 27, 2011

Money as a Commodity

Money is a commodity, just like oil and pork bellies.  But consumers fail to realize this.

Money is a commodity.  To a currency trader or any banker, this seems like an obvious statement.  But to you and me, Joe Consumer, it is somewhat non-intuitive.

We tend to view money as something else - a means of keeping score, a marker of value itself, or even something more than that - a mystical dream to be chased after.  But as I have noted before, money is just an idea, really - an idea of wealth.  And ideas have value and these values change over time.

Like any commodity, money is subject to the laws of supply and demand.  And in the last few years, we have seen how this has worked with money.   During the last two decades, a lot of "funny money" has been floating around, in the form of freely given mortgages and homeowner lines of credit.  On paper, everyone was "making money" on their home and on their 401(k), so it seemed only natural to spend some of it.

And since the cost of many consumer goods has dropped in the last few decades, people were able to buy more - and still have money left over.  When economists talk about inflation rates, they talk about overall inflation.  And oftentimes this overlooks single segments.  For example, consumer electronics have dropped in price by a factor of 10 (at least) over the last few decades.  My first computer cost nearly $3000.   Today, you can buy a computer that is 100 times as powerful for 1/10th as much.  Televisions, stereos, and other equipment falls along the same line.

As a result, I think, in the last two decades, people had more money to spend, and spent it they did - on Real Estate.  Once the money supply (or apparent supply of money) increased, the amount people were willing to pay for houses shot up.

And in a similar way, the cost of an education has shot up as the supply of money to pay for it has increased.  With more and more "funny money" student loans available, schools can raise prices and no one squawks.

Of course, today, the supply of money is lower - as people flee to safe harbors and banks are reluctant to lend money out.  So money is more dear, and prices are remaining flat - and housing prices are flat.

The big problem, of course, is down the road.  What happens when the supply of money increases again?  And in particular, what happens when baby boomers start withdrawing money from their retirement accounts en masse?

As we have discussed previously, the last price paid for a share of stock in a company is not necessarily the liquidation value of the company.  Know-nothing financial analysts will say stupid things like "Apple Corp. is worth umpteen billion dollars" by taking the last share price and multiplying it by the number of outstanding shares.  But of course, if all those shares went on sale at the same time, the price would drop dramatically.  The only reason the "last share sold" was so high in price was that few people wanted to sell - and a lot wanted to buy. 

Supply and demand, again, putting a market value on something.  And market values are not necessarily real values, in terms of actual worth.

So, the baby boomers all sell their stock at once.  What happens?  Stock prices dive, as the supply increases dramatically and demand (people wanting to buy stocks from the smaller next generation) declines.  Yet another "ouch" or "market correction" coming along.

And as the supply of money increases, prices will go up as well - inflation will rear its ugly head, as everyone has more money - and thus money is worth less.

This is not to say that the world is going to hell in a hand basket - only to observe how things can change and how we fail to take into account that things as simple as money have a value that varies depending on a lot of things - including how much is being thrown around.

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