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The Monetary Duration Dilemma

Summary:
I’ve been careful in my research on money not to call money a “store of value”. There’s a good reason for this which I will try to explain in this piece. In traditional definitions of money three criteria are generally applied: Unit of account Medium of exchange Store of value The first two are uncontroversial. Money needs to be denominated in a unit of account (the USD, Yen, Euro, etc) and it needs to be a medium of exchange. As a store of value, however, the best money cannot serve this purpose. Stick with me.  I’ve always described money as existing on a spectrum as a medium of exchange. For instance, bank deposits are excellent money because they are a stable medium of exchange and virtually everyone will accept them in exchange for goods and services. Stocks, however, are not a

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I’ve been careful in my research on money not to call money a “store of value”. There’s a good reason for this which I will try to explain in this piece.

In traditional definitions of money three criteria are generally applied:

  1. Unit of account
  2. Medium of exchange
  3. Store of value

The first two are uncontroversial. Money needs to be denominated in a unit of account (the USD, Yen, Euro, etc) and it needs to be a medium of exchange. As a store of value, however, the best money cannot serve this purpose. Stick with me. 

I’ve always described money as existing on a spectrum as a medium of exchange. For instance, bank deposits are excellent money because they are a stable medium of exchange and virtually everyone will accept them in exchange for goods and services. Stocks, however, are not a very good form of money since the price is unstable and while corporations can buy certain things with them (labor, other companies, etc), they cannot buy very many things.¹

The store of value argument is trickier. You see, an ideal form of money should have a constant nominal value and at least a somewhat stable real value. After all, the whole point of money is to be able to purchase stuff. So, for instance, a dollar bill is always worth $1 in nominal terms and will be worth roughly $0.98 next year (even though you won’t notice the price change on the bill). That makes a dollar a very good form of money, but it also makes it a pretty terrible store of value. In fact, as I often say, the very worst investment you can make is holding cash for the long-term because, despite giving you near perfect short-term purchasing optionality, it will erode your purchasing power with every year you hold it.

What gives? Well, you have a duration dilemma. Financial assets that are very good forms of money in the short-term will have a stable value in the short-term and financial assets that are good stores of value (like stocks) will have an unstable value in the short-term. This is nothing more than a risk/reward trade off. Cash will not earn a high real return in the short-term because it takes a long time for cash flow to accrue to the issuers of these assets. Likewise, financial assets like stocks are inherently long-term instruments that earn their cash flows over very long periods of time. The more patient you are the more cash flow is likely to accrue to you. This makes stocks a good store of value and a bad mediums of exchange.

The bottom line is, you can’t have it both ways. You either have to accept money at a stable short-term value and eroding long-term value OR you need to accept that financial assets that are a good long-term value will tend to earn that risk premium by being unstable short-term stores of value. But the key point is, money, being an inherently short-term instrument, designed to service our short-term spending needs, is inherently a bad store of short-term value if it’s to serve its primary role as a stable medium of exchange.

¹ – Gold, interestingly, is a terrible form of money because it has an unstable short-term value and is rarely accepted in exchange for goods and services. 

NB – This is the inherent flaw in Bitcoin as a form of money. In order to be a good form of money it needs to have a stable value, however, it can’t have a stable value because it has no cash flows or intrinsic value which can be applied to it. 

Cullen Roche
Former mail delivery boy turned multi-asset investment manager, author, Ironman & chicken farmer. Probably should have stayed with mail delivery....

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