When Is “Money” Not Really Money?

By David L. Brown

Back in the antediluvian world of ancient times, about three weeks ago, I wrote about the fact that the word “money” no longer means what it used to. Money once had innate value. For example, gold or silver coins were made of precious metals, and paper currencies could once be redeemed for those same metals. Dollar bills were called “silver certificates,” for they served only as a proxy for the metal itself. Money was actually “worth” something, because it was tied to things of actual value such as the gold in Fort Knox.

No more. Much of today’s “money” is a phantom, something that exists in computer networks and can flit around the globe at the press of a key. It is a fiction, a mere cloud of bits and bytes, and there is where the trouble starts.

This is particularly true when we speak of “money” as used to value paper assets such as stocks, bonds, futures options, derivatives and the like. These things may have some value, but that value is based more on faith than on fact. And the kind of “money” they represent just doesn’t exist in any real sense. After all, have you ever seen anyone buy groceries with stock shares, gas up their car and pay for it with futures derivatives, or buy a new suit of clothes with corporate bonds? No, of course not. These investment vehicles can be bought and sold for dollars, but they are not in themselves money in any sense, the kind you can spend or use to pay your bills.

Since I wrote on that subject a few weeks ago a trillion “dollars,” or two, or maybe three, has “disappeared” from the world economy. Where has it gone? Well, contrary to what one might think, it has not gone anywhere at all, because it never existed in the first place. There were no trillions of actual dollars that disappeared.

Hmm, you’re probably thinking, that cannot be. Why just the other day I had X dollars in my investment portfolios, and now I have a lot less. The difference just had to go somewhere. Who took it? Was it Wall Street thieves? OPEC? Bent politicians? That suspicious looking guy down the street? Who took my money?

An Associated Press story today addresses the situation:

Robert Shiller, an economist at Yale, puts it bluntly: The notion that you lose a pile of money whenever the stock market tanks is a “fallacy.” He says the price of a stock has never been the same thing as money — it’s simply the “best guess” of what the stock is worth.

“It’s in people’s minds,” Shiller explains. “We’re just recording a measure of what people think the stock market is worth. What the people who are willing to trade today — who are very, very few people — are actually trading at. So we’re just extrapolating that and thinking, well, maybe that’s what everyone thinks it’s worth.”

See, the “money” represented by an investment portfolio has no real value, because it is based on supposition, hope, and, yes, faith. And, it depends in large part on what was originally spent to obtain the shares, bonds, or whatever.

But what about “real” money in the form of actual dollars? Surely a dollar is worth, well, a dollar. And that is true, as far as it goes. But if you are familiar with the concepts of inflation and deflation you know that the “value” of the dollar can rise or fall. That means that at any given time a dollar will buy more or less of any given commodity based on the fluctuation in its value. Stash dollar bills in your mattress and the future worth will depend upon the trends of inflation or deflation, not on any value innate in the cash itself.

Well, then one should instead hoard hard assets instead of cash, for example gold ingots. Right? Sorry, but the value of gold and any other commodity also fluctuates, rising and falling with the demand and supply. Again, there is nothing “real” about the value of gold, because its present value can vary. (Gold can be a hedge against the value of cash, since a falling dollar has historically caused the value of gold to rise, although even that rule has begun to break down.)

What about your house? Well, anyone who has been awake during the past couple of years knows that real estate is also a commodity, subject to the vagaries of supply and demand. Right now demand is low and supply is high, so your house is “worth” fewer dollars than it was before the housing bubble burst. But what does the value of your house matter if you intend to simply continue to live in it? You bought it for a certain amount, thus assuring yourself of a roof over your head.

Now let’s consider another fact, that the amount of “money” you lose when your investments drop depends on when you bought them and how much they have gained. Let’s say you bought 1000 shares of stock in Widgets-R-Us when it was selling for $5 a share. That’s an investment of $5000. Let’s assume that during the heyday of the stock market when the Dow was up around 14,000 the price of Widgets-R-Us shares soared to $70. Your holding was then worth $70,000 and you were “richer” by $65,000. Whoopee!

But wait, now comes the stock market decline and Widgets-R-Us stock drops by half and is now worth only $35 a share. You sell and complain that you just lost $35,000. But did you really? Well, no. In actual fact you still have $35,000 left, and your original investment was only $5,000 so you have made a 600 percent profit on your investment. That other $35,000 that you think you lost never existed except as an unrealized potential.

See how slippery those missing “dollars” are? Sometimes they can be seen as real, sometimes they appear to disappear like the morning mist. But the secret is that it’s a casino game from the start. The only thing “real” in this example is the $5,000 you put into the game in the first place. Whatever you gained or lost was paper profits or losses that did not exist until you cashed out and walked away from the table. Meanwhile, you were just letting your winnings ride, as true gamblers might say.

Now if the value of “money” and things that are priced in monetary terms (which is to say, just about everything) cannot be relied upon, if it is indeed a fiction and a phantom, then what can we conclude from that? Well, for one thing we should recognize that there are certain values that are innate in the economy. For example, while currencies might crash in value as has recently occurred in Zimbabwe, where a 250 million Zimbabwean dollar bill might buy you a loaf of bread today, hard assets such as real estate retain core value as long as you step back and stop viewing them as chips to be used in a casino.

For example your house should be viewed as the place where you live, not a speculative investment. A big part of the problem with the real estate market today is that too many people kept giving in to the temptation to “refinance” as their house values rose, taking out the appreciation and spending it instead of letting it build up over their lifetimes. Seen as a long-term investment for the purpose of providing shelter, a house is a fairly rational form of real value. It’s only when the real estate market is turned into a casino that trouble arises, and if you are in it for the long haul it shouldn’t matter to you whether you could sell high, low or in between.

The same logic once applied to the markets for stocks, futures options, bonds and other vehicles valued in monetary terms. Stocks and bonds were once purchased by prudent investors for the long term, and provided capital for companies to grow and prosper down through the years. Futures options were created to allow hedging, for example, so that a food company such as Sara Lee could lock in the future cost of wheat.

These markets were created to serve serious purposes, and yet they have been turned into a kind of global casino that puts Las Vegas to shame. Day traders, hedge fund managers, monetary fund speculators, and a host of other gamblers have turned the financial world into what amounts to a circus sideshow of whirling roulette wheels, craps tables with dice flying in every direction, and slot machines grinding away 24/7/365. The world of finance has been populated by gambling addicts. On-line trading replaced the bookies and numbers runners of a former era and spread the gambling bug far and wide. And — it was legal!

All that “money to be made — valued in Dollars, Euros, Pounds, Yen, Rubles, Yuan, Pesos and every currency on the planet — piling up in accounts from Wall Street to Lichenstein to the Bahamas, and flowing in the form of electrons and microwaves hither and yon all around the globe. Trillions of dollars worth of “money,” and yet … What was it really, and where has it gone?

It has gone to the place where fairies lurk, where leprechauns hide their pots of gold, the place where dreams go when the dreamer awakens. Those things never existed, any more so than unrealized paper profits.

Yes, Virginia, those trillions of dollars that “disappeared” in the world economy were what we call “paper profits,” real only in a virtual sense. The advice famously given by Bernard Baruch to “Buy low, sell high,” is still sound and I suspect that many prudent investors have come out ahead even if they sold into the present panic. All they lost was the unrealized fantasy “money” that never really existed.

It would be interesting to know the facts behind the staggering “losses” that have been incurred in the past week. How many investors actually cashed out with a profit? How many others took actual net losses? (I am talking about real, prudent investors here, not the greed-afflicted day traders, speculators, and scoundrels.) I suspect that a very large proportion of the “losses” were of the paper variety, and that quite a lot of net profits have been registered as investment positions were sold. Those who bought low and sold higher, if not at the highest, are still ahead. And never forget that bear markets always present new buying opportunities for investors to begin to create new stashes of imaginary “money”.

And finally, to answer the question in the headline: Money isn’t really money when it’s funny money. Personally, I prefer to play Monopoly. At least in that game, you KNOW the money isn’t real.

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