Posted On 20 Dec 2011
Failure to think clearly about monetary value is a chief cause of bad financial decisions.
It’s not so much that we reason invalidly when it comes to making financial decisions; rather, it’s that we typically reason from false premises.
I confess that I have that tendency. If you do, too, the purpose of this post is to encourage you to stop doing that and, so, to make better financial decisions.
Where does that tendency come from?
It comes from ignorance, laziness, or a combination of the two. Since the ignorance is easy to cure, my guess is that the primary cause is laziness.
So, let’s eliminate the ignorance and then explain how to eliminate the laziness. If you do that, the quality of your financial decisions will improve dramatically.
The ignorance comes from a failure to distinguish currency from money.
Currency is a physical object that we have agreed to use to transfer value from one asset to another. United States dollars are the world’s chief currency; other currencies are pegged to them.
Historically, there’s nothing special about such paper currency. There’s no reason why we could not use beads or shells or wampum or cattle as currency.
The good news about popular paper currency like dollars is that it’s easy to measure. If you want to know the price of a shirt or a bicycle or house, it’s easy to find out.
The bad news about paper currency is that it really has no intrinsic value. You can’t wear or ride or live in paper!
Historically, money has intrinsic value. Historically, the only money has been gold and silver.
All the currencies in the world today are fiat currencies and, sooner or later, all fiat currencies collapse. Since the trust that backs dollars could evaporate quickly at any time, it’s important not to think in terms of dollars when making important financial decisions.
The good news about gold and silver is that everyone understands that they are precious metals. This has been true for thousands of years.
The bad news about gold and silver is that real or monetary value is not easy to measure. What is the real value of a shirt or bicycle or house?
There are different kinds of value. Something’s monetary value, for example, is not the same as its utilitarian value or its sentimental value (assuming it has utilitarian or sentimental value). An old coat could be very warm and, so, useful in the winter while having almost no monetary value. An old photograph could have a lot of sentimental value for someone without having any monetary value.
Our topic here is only monetary value.
The distinction between currency and money is easy to understand. Once it’s pointed out, it’s easy to understand that, when making financial decisions, it’s always better to think in terms of monetary value than dollar value. (Also see the post “Currency Collapse.”)
The laziness comes from a failure always to think in terms of monetary value.
When making an important financial decision to buy or sell something, always think in terms of its monetary value as opposed to its dollar value.
That makes sense, doesn’t it? However, there’s a problem doing it.
The reason there’s a problem is that it’s much easier to think in terms of currency, in terms of dollars, than it is to think in terms of real value.
It’s not just that it is so familiar that nearly everyone does it. It’s also, again, that it is not easy to measure real value.
So the critical practical question is: How is it possible to measure monetary value?
Until we answer it, even if we want to we cannot overcome the chief cause of making poor financial decisions.
Here’s the answer: to measure real value, stop thinking in terms of dollars and begin thinking in terms of other real assets.
In fact, it’s best to use several different asset classes such as gold, silver, crude oil, commodities, industrial metals, or agricultural products.
The basic problem with thinking in terms of dollars is that dollars have no intrinsic value. In fact, due to inflation, the value of a dollar has been decreasing for a long time. You know that because, when real goods are always costing more in terms of dollars, the value of the dollar is always decreasing.
So there’s no such thing as the value of a dollar. A moment’s thought reveals that the value of a dollar is constantly changing.
If you insist on thinking in terms of dollars, at least translate the prices of real goods into some standard dollar valuation (such as its value in 1971 when it was completely freed from being pegged to gold) in order to adjust for inflation. The problem is that, because of rampant credit creation, this isn’t so easy to do.
Here’s a better idea. I agree completely with Michael Maloney: “stop measuring value with the dollar” and “start using things with inherent value to measure other things with inherent value” [Guide to Investing in Gold and Silver, pp. 71 & 72.]
For example, do you want to know whether the monetary value of your house has increased in value, decreased in value, or stayed the same over the length of time you have owned it?
Pick another asset class to use to measure it. For example, how many ounces of silver was it worth when you purchased it? How many ounces of silver is it worth today? It’s easy to calculate because it’s easy to find out the price of an ounce of silver in dollars at those two different times. Then compare the result.
If you did the same calculation also with, say, barrels of crude oil and ounces of gold and the value of the Dow, that would give you four measures of the monetary value of your house. You’d have a good idea what it’s really worth.
Does it take a little work to do that? Yes. However, it really pays not to be lazy in such cases.
If you use dollars, you are simply lying to yourself. Believing your own lies may make you feel good, but it won’t help your financial bottom line!
Furthermore, it’s not difficult to do with the worldwide web as an information source. You can easily find the relevant numbers simply by searching for them. There are even websites that do all the work for you by putting the information into easy-to-read charts!
Similarly, if you insist on thinking in terms of dollars, there are websites designed just to calculate for you the real cost to you of inflation. (The government does not make that easy to do. Why? It doesn’t want to undermine confidence in dollars.)
If you’ll educate yourself about how to calculate real monetary value and begin thinking in those terms, I predict that, if you are like most people, you’ll have an epiphany, a serious change of context, when it comes to thinking about the financial climate.
As always, I encourage your feedback, especially if you’d like me to write more on measuring monetary value. It’s not a really fun topic, but, if you ignore it, you’ll find out the hard way sooner or later that it’s an important one.