August 6, 2023

by Stephen Stofka

This week’s letter contains some idle thoughts on the exchange of money. Imagine a visitor from outer space who observes the exchange of cash for a $5 ice cream cone at a store. The buyer starts eating the ice cream. The store clerk puts the piece of paper in a black box, the cash drawer. It is clear to the visitor that the buyer has received something useful. What is not clear is what the store clerk received in exchange. The visitor has learned that creatures throughout the universe give up something in response to a reward or a threat. If the piece of paper was a threat, the clerk did not seem alarmed when the buyer offered the piece of paper across the counter. The visitor reasons that the paper is an energy packet which the clerk will consume later. Perhaps the clerk can put the paper into water and it will become food.

The visitor from outer space has realized an essential aspect of money. It contains potential energy that can be released immediately and exchanged for a good or service. It’s like an electrical capacitor ready to deliver an energy packet. We call that exchange energy purchasing power. Immediate release means that money has no maturity period, or a maturity of 0. A one-year CD cannot be spent because it has a maturity of one-year. To spend it, I need to wait until the one year is over or convert the CD to cash and receive a reduced amount, a penalty for early withdrawal.

The charge on that money capacitor can increase or decrease. We use the terms deflation and inflation for the increase and decay of money’s purchasing power. Inflation measures the percent of purchasing power lost over a period of time and that percentage lost cannot be more than 100%. In other words, a $1 bill cannot lose more than $1 of purchasing power. There is no theoretical limit to deflation, the increase in money’s purchasing power.

We use the terms yield and discount rate for the increase and decrease of money’s nominal value at some future time. These rates of change in purchasing power reveal another aspect of money – an exchange of time. What is time? A container of probabilities and that involves risk. Instead of consuming the ice cream cone, let’s say the buyer left the ice cream cone in a freezer for a period of time. What is the chance that some random power outage occurs and the ice cream melted while the freezer was off? When the freezer is opened, will the cone of ice cream be intact and ready to enjoy or will it be a discardable mess of ice cream protoplasm? Readers will note the analogy with Schrodinger’s thought experiment about a cat in an unopened box containing a life-threatening amount of radioactive material.

A lottery winner must decide between a series of payments and a lump sum payment that is far less than the nominal amount of winnings. The difference between now consumption and future consumption is called the discount rate, which includes a rate of risk that the winner does not live to receive all the payments. Social Security allows people to claim benefits at age 62 but the monthly payments are substantially lower than someone who waits until full retirement age. The discount rate is about 8% per year, almost the average annual return on the stock market. The risk is that a retiree dies prematurely and leaves money on  the table, so to speak.

There is no objective or time-invariant value in an exchange of energy. The exchange value of time varies by person and circumstance. In case of death or injury, the insurance industry calculates an average annual loss of income, or purchasing power, multiplied by an average estimate of years remaining in a person’s life. Ken Feinberg worked pro bono as the master of the 9-11 Victim’s Compensation Fund set up by Congress to resolve and expedite the many lawsuits that victims and their families would bring against the airlines. Feinberg agreed that an objective measure like years lost cannot compensate for the subjective loss of a life to a victim’s family. Money cannot measure life.

The exchange of money for goods and services connects buyers and sellers to a tree of information. Transactions take two forms: those that are recorded or “witnessed” by a third party and those that are not. If a buyer uses a check or credit card to buy an ice cream cone, a bank records the exchange of money for ice cream. If the buyer uses cash, only the merchant and the buyer have a record. The merchant records a sale and the buyers gets a receipt if they ask. The merchant reports the sum of sales to a government agency for sales tax and income purposes. In the case of a food-borne disease the USDA will investigate the many branches of that tree, searching the vendors, distributors, packagers and growers to isolate the source of contamination.

The exchange of ice cream for money is a connection to a tree of production. The manufacture and storage of the ice cream involved a network of power plants to generate electricity, machinery and labor for production, as well as natural and artificial ingredients. The buyer has the purchasing power in her pocket because of some past exchange of energy as part of a production process.

The sidewalk and street outside a store connects a buyer to a tree of organizational authority. Some public entity had the ability to gather the resources to build that infrastructure. The use of those public facilities might have cost the ice cream buyer 30 to 40 cents in sales tax. Over decades metropolitan areas have attracted people because cities offer an economic bargain of public benefit for relatively small cost.

The exchange of ice cream for money connects the buyer and seller to a network of rules and expectations of behavior. The clerk won’t sing the Star Spangled Banner when she receives the money. She won’t do a magic trick with the ice cream. The buyer will not give a dramatic reading of the serial number on the $5 bill before handing it to the clerk. Exchange requires a tacit cooperation, an agreement to follow the rules.

As a child I learned that there was electricity inside the walls. The air I walked through and breathed was full of radio waves in addition to light and sound waves. There was literally music in the air, captured and translated by a portable radio. Today our cell phones interpret the microwave radiation emitted by hundreds of nearby cell towers. Our thoughts and senses are connected to each other as we walk through the information stream. The ultimate source of every bit of that information is the effort of another human being. For the monthly cost of a cell phone bill, we have access to that effort, that infrastructure, the taxing and regulatory authority that supports that exchange. The exchange of money connects our efforts, yet talking about money usually introduces dissension. We disagree about the distribution of money, the priorities of public spending and the principles of taxation. Then we blame money instead of ourselves.     

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Photo by Artem Sapegin on Unsplash