Handling Finances

When I traveled to London, England recently, I found that my money was only worth half what it was in America.  In other words, I got half as much as the same money would have purchased at home.  That got me wondering what my money is actually worth.  My bills claim to be “legal tender for all debts public and private” but what does that mean and why does the same dollar buy half as much (in terms of both goods and British Pounds) in England?

A Brief History of Money

Early currency was simply representative of various goods.  Precious metals were used to represent things like grain or livestock.  The first coins allowed for easier transactions and let merchants travel and do business without having to carry around all their goods.  Coins also allowed for the first accounting system and allowed people to store wealth more easily than maintaining and guarding large caches of food or large herds of animals.  In Europe, gold, silver and copper were used as currency because there was a fixed amount of each metal in the civilization.  A person could be reasonably sure your gold would be just as valuable next year since it wasn’t being mined and so inflation wasn’t much of an issue with the basic coins (though of course commodities would fluctuate in value according to supply and demand).

Coins were a huge innovation, but they were still rather difficult to haul around and trade in large quantities.  Banknotes were issued in China around 1000 AD and were redeemable for coins or goods on a regional basis.  A more universal Chinese currency was introduced around 1250 AD o make long-range trading easier.  At the same time, paper currency and many financial constructs like savings accounts and exchange rates were being developed independently in the Islamic culture.

In Europe, paper currency was somewhat less orderly as governments had a tendency to print more money than they had resources.  In other words, if everybody redeemed their currency, the government would run out of coins and goods promised on the notes.

So what are dollars worth now?

Ever since the United States ended its agreement to convert dollars to gold in 1971, American dollars have been worth only what two parties are willing to exchange for American dollars.  Of course, since the US government only accepts US dollars as payment of taxes, the US dollar will be good to get the IRS off your back as long as the IRS exists (and keeps the current policy).  This is known as a ‘fiat currency’ as the US dollar’s value is defined by fiat.  That’s no small thing, and the perceived stability of the US government is a large part of why many other world currencies are pegged to the dollar and many markets (even overseas) do business in US dollars.

If the US government wanted to spend more money, they could simply print more bills, but the more they printed, the easier it would be for people to get their hands on bills to pay taxes and as with any situation of supply vs. demand, the value of each dollar would decline resulting in inflation.  If the government were to print way too many bills (as in Germany after WWI when huge reparations exceeded the amount of money they could take in in taxes) the bills can become totally worthless as citizens find that their cash is worth more as toilet paper fuel for heating fires than as currency.

It seems weird in a way to be dealing with money that is only representative of future taxes.  While it legally must also be accepted for debts in America (like credit card debt or to settle a resturaunt bill when you pay after you eat) there is no legal reason a supermarket would have to accept cash as payment for food.  Yes, they’ll lose a lot of business if they only accept gold bullion or Euros, but it’s at least possible.

It’s a funny world where we go around exchanging little green pieces of paper, but it’s better than lugging around piles of gold coins.  It’s also much easier to control the supply of US dollars than it is to control the supply and demand of a precious metal like gold when gold can be found and dug up much more easily than in midieval times.  I suspect that in the far future, we’ll do away with paper and coin money altogether and move to an entirely electronic financial system.  We might even end up pegging our monitary system to something that’s useful to everybody — like energy (what good would cashing in your dollars for gold REALLY do you)?  Until then, we’ll just have to keep doing business in our governments’ future taxes and simply be thankful we don’t have to carry around wagons full of wheat, chests full of gold, or strings of rare seashells when we go shopping!

I was talking to a coworker of mine who has an MBA about one of the biggest lessons in business management classes that gets ignored not only in business management, but in national policy and yes, in our own personal finances.  Quite simply, it is never wise to base major decisions on ANY single event!  Terrorism is a big problem worldwide, but the additional safety to our airplanes of having our nail clippers confiscated and eye-drops visible in plastic baggies is insignificant compared to the added cost of even badly enforcing these new rules.  Some oversight of mortgage brokers would be a good thing, but it should be broad and loose rather than simply cracking down hard on a specific two or three practices that led to the recent increase in forclosures.  And yes, spending less than you earn is a great idea, but you shouldn’t decide to save just because you declared bankruptcy!

That’s right, even good decisions should never be based on rare events.  You shouldn’t decide to go with a used car because a friend had to fight with a dealer over whether their new car was a lemon.  You shouldn’t ride your bike to work because you normally drive over a bridge and you heard about the 35-W bridge collapse.  You certainly shouldn’t save for retirement because Enron went bankrupt and their pensions became worthless.

Emotions are healthy, but they can never be trusted to drive major decisions. If you’re looking to buy a car, certainly take the chances of buying a lemon into account, but only as part of your decision.  Look carefully at the price differences, warranties, reviews, safety information, fuel effiency etc…  You might end up buying a used car anyway, but you won’t be risking your hard-earned cash on a hasty decision.  Similarly, don’t save for retirement just because Enron’s collapse scared you — evaluate your expected income from social security, private pensions, annuities etc… and look carefully at how likely they’ll be there until you die.  Hopefully you do decide to save significantly for the time when you may be unable to work, but you’ll be better educated to be able to decide how much you’ll need each year and how much you need to save to meet your goals.

Unfortunately, we are wired to make snap decisions based on emotions. It’s a great survival trick from back when we had to choose to fight or run when staring into the eyes of a tiger.  It’s a great way to be manipulated though as politicians routinely use natural disasters or (in these days) terrorist attacks to get votes.  Yes, it’s best to have FEMA be prepared to respond to the next emergency, and we certainly want to avoid as many terrorist attacks as possible!  Still, it’s important to evaluate the facts — would adding a billion dollars to the INS budget really prevent determined terrorists from bombing shopping malls?  What about ten billion, a hundred billion?  How much liquid does a potential terrorist need to down a plane?  (answer: less than you could fit in a shampoo bottle).  Will suspending the national gas tax bring down the price of gas?  I haven’t yet heard a professional energy analyst say yes — we’d perceive gas prices as a “deal” and increased use would push the price far higher than the 18 cent “sale.”

Of course, emotions are a vital part of being human and they can’t be ignored either.  Any decision should certainly take into account our stress levels and how a decision will affect us emotionally! In some cases, as with tragedies that affect us and our families, emotional factors may even be the primary reason for making a particular decision.  Even when that happens, though, it’s important to step back, look at the facts, and then choose one way or another.  Because while you might feel better for a little while in a large new house to soothe your feelings about living in a tiny shack as a child, reality will eventually catch up and you might wish you’d looked at facts as you’re being evicted.

Everybody has their favorite pet theory about why gas prices are so high. It could be the evil excessive profits taken by oil companies, risky speculation by profit-seeking investors, a simple case of supply vs. demand or all/none of the above. It’s very hard to know since most of these effects are unquantifiable and it seems like politics has more to do with a person’s answers than actual facts.
Whatever the cause, high gas prices aren’t as bad as most people seem to think. Here in America, gas has been almost ridiculously cheap compared to the rest of the world. By itself that’s not a problem or anything, but it does mean that we’ve become used to thinking of gas as an abundant and cheap source of energy. We’ve built an entire country with sprawling suburbs and extremely limited train and subway access that heavily depends on cheap and abundant gasoline. We’ve scorned fuel efficiency and invested heavily in the largest, most powerful vehicles.

Since oil takes millions of years to form in any useful quantities, it is clearly a limited resource at the rate we’re using it! I should qualify that — we will never run out of oil altogether, it will just become more and more expensive to extract from the ground until some other form of energy is cheaper. We know we’re going to run out of oil at some point, so clearly we need to prepare well in advance. Except, we’re not remotely prepared. We’re decades away from any other fuel source for our vehicles and that’s assuming significant investment for those decades.

One option that gets thrown around a lot is to allow drilling in X or Y location that is currently being protected for Z reason. This will make the situation worse — prices will drop, investment will drop with it and we’ll be right where we started except X and Y reserves will now be depleted.

An unpopular solution.

Quite simply, we need to feel some pain in order to prepare for the future. When prices are low, some people simply deny that there will ever be a problem, the majority simply doesn’t care as long as their tanks are full and a second minority complains ineffectively that our increasing suburban sprawl and refusal to develop alternative technologies or even simply more fuel-efficient vehicles is just digging us further into a hole. When prices hit $3.00 per gallon in America, the former and latter groups grew for a while and then everybody went back to not caring. Now that gas costs $4.00 per gallon, people are really starting to hurt and put a significant bit of money toward changing our habits now so we can avoid wasting a huge amount of money changing once we’ve exhausted our last reserves and gas jumps to $5.00 or $6.00.

High gas prices aren’t all good — the poorest among us who have no cushion will suffer the most as they have to choose between gas to get to work and food. I certainly don’t enjoy paying twice as much for gas as a couple years ago. At the same time, this is the first I’ve seen long-term efforts to increase the reach of mass transit, to develop electric and hydrogen-fueled vehicles and to actually make token efforts to use currently available technologies to increase fuel efficiency in the average American car.

I won’t claim that the days of the 4-car family or the 1-kid family with and SUV and pickup that gets used once a year are over. Many of us have grown quite accustomed to the convenience of these light trucks even if we could easily do without. I’ve even heard some people who genuinely feel entitled to the affordable use of a Ford F-350 used primarily in a daily hour-long freeway commute. In the end though, we’re just going through the pain at the start of any new exercise routine. It won’t be easy, and it might not feel good at first, but in the end, we’ll stop wasting a limited resource, limit pollution, and save billions of dollars that are currently going toward oil companies and oil producing countries. And hey, if we can avoid pumping up the last of the American reserves in the process, then we might truly become less dependent on foreign oil rather than putting ourselves in a desperate position by using all our oil first.