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Archive for the ‘currency’ Category

This past week’s This American Life podcast is called “The Invention of Money,” tackling what host Ira Glass calls the “stoner-ish question” of what money is.

 

 

In the prologue, the discussion revolves around the confusion a reporter feels when during the peak of the financial crisis in 2008 he heard news reports of billions and trillions of dollars disappearing from the stock market. How could money just disappear, he wonders; where did it all go? His answer, which he receives from some businesswoman aunt, is that the money never existed because money is “fiction.” Cue soundtrack from The Social Network.

The podcast proceeds from this conclusion, and while the episode is entertaining the content fell short for me as a result. The main mistake is to think of money in terms of a) only coins and bills, and b) only as a medium of exchange. The reason billions of dollars can disappear from the stock market is not because the physical currency was “fictional” but because money in this case is serving as a measurement of value (the economics term is the not-so-descriptive unit of account). And value, like beauty, is measured subjectively. If I intended to buy 5 pounds of potatoes but only went home with 3 pounds because the grocer’s scale was off, it’s fair to say 2 pounds of my potatoes have become fiction. If I go home with £5 of potatoes today and discover that I can only sell them for £3 tomorrow, however,  the two pound difference is reality.

In Act One, the fiction line is cast to Brazil, where its currency switch in 1994 to the real is framed as grand scheme that successfully duped the people into thinking the new money had value. This misses the real magic, which is something more akin to the food fight scene in Hook:


The real had value not because folks believed in a lie, but because they trusted the government and each other that the new currency could be used to exchange for things they wanted. When the people acted as though the bills and coins were money, they became so; the real became real.

Act Two, which is my favorite segment of the bunch (and not just because of the title), does a good job of explaining the Federal Reserve vis-à-vis the financial crisis. I especially liked how they avoided the typical journalist mistake by explaining that the Fed works with the money supply, and not interest rates directly. My quibble here is that they give listeners the impression that only a central bank can create money,  when in fact any bank in the world that loans out some of its deposits (i.e. fractional reserve banking) is doing the same thing, just on a smaller scale.

For the non-pedantic non-economists among you who nonetheless find interest in the inscrutable nature of money, do give it a listen. You may also enjoy revisiting this short but content-packed interview with Niall Ferguson on the Colbert Report from a couple of years ago.

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Paperweight

Imagine you handle the money for a small business in a cash-based economy whose largest denomination bill is worth about nine bucks; what might your desk look like come deposit day?

For a sense of proportion, that pen has a thickness of 16 inches.

As an aside, the odor of Rwandan francs–which often spend part of their lives crumpled in the sweaty pockets of moto drivers–will scent my memories long after I leave.

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The greatest emasculation of the US dollar came several weeks ago when the value of the Canadian dollar–or colloquially, the “loonie”–reached and exceeded parity with its American counterpart (currently it’s about 1 to 1). But, as I noted earlier, a strong currency does not necessarily a happy citizenry make. Indeed, those Canadians inclined to a good read every so often are actually quite livid at the loonie’s recent flight.

The usually mild-mannered Canadians are so distraught because most American books have twin prices (American and Canadian) printed on the cover–Alan Greenspan’s recent book displays the twin prices of $35 and C$43.95 on its jacket, for example. Previously the higher Canadian price reflected the lower value of its currency, but now that the loonie is worth slightly more than the dollar, Canadians are paying a 22 percent tax (in the case of the above example) simply for having bought the book in Canada and not the United States. As a result, Canadians are either demanding that booksellers lower prices, driving to the US to satisfy their literary fixes, or simply buying online from American retailers (savvy American entrepreneurs could, of course, load up a few trucks full of popular books and head north as well).

“But Jeff,” says the fictitious reader in my mind who reads my blog daily with ferocious devotion. “How can this happen? Markets–including those in currency–are supposed to be efficient. How can this price disparity occur?”

Well, there are few reasons why this can occur, dear fictitious reader:

  1. Markets are not perfectly efficient in the short-run. Just as it takes a few moments for someone to notice a $100 bill on the sidewalk and pick it up, so too does it take time for arbitrage opportunities in a market to be taken advantage of and prices brought back in line.
  2. Most currency exchange is based on the idea of purchasing power parity (PPP), which postulates that all goods and services should cost the same in all countries when measured in a common currency. Daily exchange rates usually deviate significantly from what PPP implies because it is a long-run concept. Thus, in the short-run it’s perfectly normal to have one currency with significantly more purchasing power than another.
  3. Publishers have to print new books when it changes the price, which is costly to the firm. When confronted with these “menu costs,” it often more profitable for a firm–even in highly competitive market–to leave prices at the previous level instead of incurring the costs of changing prices to the market-clearing level.

On a personal note, I’ve realized that I can buy books online from US retailers and have them shipped over more cheaply than I can by buying from German bookstores or online retailers. I take special pride in the knowledge that by doing this, I’m not only saving money but also helping to make global markets more efficient.

You might say that by buying books, some of which are leather-bound, I’ve become kind of a big deal.

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