February 5, 2023
by Stephen Stofka
This week’s letter is about money, a peculiar thing invented by people that has no intrinsic value unless exchanged between people. Unlike other goods, the consumption of money satisfies no human wants. Price is the thing on the left side of an equation. On the right side can be a physical quantity like a haircut or a quart of milk, or a less physical good like the satisfaction of a debt owed, or the title of ownership to a car. Money is the equal sign of that equation, the channel that connects the price information to real goods and services.
Many goods have two types of value – subjective and objective. A tomato’s subjective value depends on the needs, preferences, and resources – the circumstances – of the consumer. These circumstances vary with time. A consumer who is hungry and who likes the taste of tomatoes values a tomato more than a consumer who is not hungry or who doesn’t like tomatoes. The subjective value depends on a consumer’s resources. A consumer with a fridge can preserve a tomato longer and might value a tomato more than someone who has no cool place to store a tomato. A further element of subjective value is the intended use for the good. A consumer who wants to eat a fresh tomato might have different quality standards than someone who wants to puree the tomato for a soup or sauce.
The second type of value is objective, an intrinsic value of the good itself – the nutrients and calories a tomato provides, the chemical changes that it undergoes, the pests that the tomato harbors within its skin. Just as the circumstances of the consumer vary with time, the benefits or dangers of a good’s consumption can vary with time.
Like the values of goods, the value of money has a subjective and objective component. The objective component is a decay in the exchange value of money on the left side of millions of exchange transactions. Economists measure thousands of prices each month and determine an average weighted price for a set of goods – a consumer price index. The annual, or year-over-year, percent change in that index is called inflation. It compares this month’s price index with the price index one year ago. Economists also measure the change in that percent change and the two sometimes get lumped together by the financial press. Inflation is like the odometer in a car. If I travel 50 miles in an hour, I have averaged 50 MPH but it is the speedometer that tells me my current speed, not the average over an hour. Too often the arguments on social media mix the two together. Imagine getting pulled over by a patrol car for speeding and explaining to the officer that your average speed for the past 15 minutes has been less than the speed limit. The officer cares only about your acceleration – the near instantaneous speed.
The value of money has a subjective component that depends on the user’s circumstances. Today-Money is that which is needed to satisfy current needs. Future-Money is savings. As prices go up, people tend to hold more money as a percent of their income to pay for living expenses. If a household spends 90% of their income on current needs, then much higher inflation rate might cause them to spend 100% of their income on expenses. A higher income household might spend only 60% of its income on expenses. The effect of inflation is lower for higher income households.
Savings is an exchange between two people in time, between a person today and that same person in the future. “You got to pay you,” we may be told when encouraged to save some of our paychecks. The first you is Today-You. The second you is Future-You, who will be grateful that Today-You was prudent. Future-You does no work yet enjoys all the sacrifices that Today-You makes, the extra work, the enjoyment of things not consumed in order to save. Future-You is truly the child of Today-You.
The financial system facilitates the exchange of money-value through time. In countries with a poor financial system, people place their savings in things, animals and children whose work or usefulness will provide for a person when they become less vigorous in their old age. A child may grow up with the moral and financial burden of having to care for their parents. In these pastoral societies, a child is considered a form of wealth.
Children in an area far from home or in a foreign country are expected to send a substantial part of their paychecks home to their parents or extended family. This moral burden drives young people to immigrate to another country where they can earn more money. Part of their earnings form the international flow of remittances which increased by almost 5%, according to the Migration Data Portal (2023). India, Mexico, and China were the top recipient countries in 2022, accounting for $310 billion of the $690 billion in remittances. This sum does not include informal or illegal transfers of goods and services between countries.
Money acts like a radio wave, conveying price information about the relative values of goods and services. It requires institutions to broadcast and relay that wave as it travels around the globe and through our lives.
Photo by Pawel Czerwinski on Unsplash
Migration Data Portal. (2023, January 6). Remittances. Migration data portal. Retrieved February 3, 2023, from https://www.migrationdataportal.org/themes/remittances. The portal was established in 2016 as a data repository founded under the auspices of the United Nations. It collects central bank data through the World Bank and IMF.