My Two Cents - "What have you bought me lately?"

6/22/2007

In the 1930's during the Great Depression, there are literally thousands of cases where people stuffed money under their mattresses because they were scared of putting it in banks. They had confidence that when they needed the money six months or a year later that it would buy them what they needed to survive. The fact that we were in a deflationary depression validated their strategy. In a deflationary environment, cash is King. Hold onto it and it will buy at least as much as it did when you stuffed it under the bed, maybe even more. I think that a few too many Americans paid a little too much attention to these stories and automatically assume that the same strategy will work today.

I continue to be amazed at the disconnect in understanding between money and purchasing power. This disconnect is perpetuated by the financial press, Wall Street, and academia. This is one of the many casualties of a fiat money system. When the price of everything is denominated in a currency that is constantly changing value, getting a handle on real wealth becomes rather problematic.

Let me use the following example. Say a man in 1933 stuffed twenty dollars under his bed. Since gasoline is a hot-button item, I'll use that. In 1933, the price of a gallon of gas was around 10 cents. So the twenty dollars was worth 200 gallons of gas. In 1970, gas sold on average for 34 cents/gallon. The twenty dollars is now only worth 59 gallons of gas.

To buy the same 200 gallons in 1970, instead of twenty dollars you'd need sixty-eight dollars. The 1970 dollars bought less than the 1933 dollars.

Today, I paid $2.89/ gallon. The twenty dollars would buy only 6.92 gallons of gas. To recap, the twenty dollar bill that in 1933 bought 200 gallons of gas today only buys 6.92 gallons.

This should illustrate the point that you can't simply look at an account, a sum of money, your 401K or your paycheck and marvel at the number of dollars. No one collects dollars for the sake of collecting dollars. The only reason to have dollars is to offer them in exchange for other items which we desire. So we need to rewire ourselves to always think about our dollar holdings in terms of what they'll buy. I certainly don't mean that we should go around and say "I got my paycheck today and I got 132 gallons of gas or 291 loaves of bread." However, at the end of the day, that is what it boils down to.

This exercise is essential in the investment planning strategy and is part of setting logical investment goals. Surely if you asked someone if they'd rather get 12% on their stock portfolio or be able to buy the same amount of goods with those stocks next year, I'll bet you'd invariably get 12% for an answer. For me personally, in both 2005 and 2006, getting 12% would have resulted in me being poorer. Thinking dollars has become a mental trap and it is one that many of us simply cannot seem to free ourselves from.

While a great many lessons may be learned from the Great Depression, the one lesson that we should forget is that cash is King. In a brave new world of reverse mortgages, collateralized debt obligations and fractional reserve banking, cash is no longer King; cash is trash.

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Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. This article and other information is located at http://www.my2centsonline.com Please feel free to distribute, copy or otherwise disseminate this information.