Quotulatiousness

July 9, 2019

The main economic damage of Brexit is the extended period of uncertainty

Filed under: Britain, Economics, Europe, Government — Tags: , , , — Nicholas @ 03:00

At the Continental Telegraph, Tim Worstall interprets a recent Bank of England recommendation to really mean “do Brexit” and “get it over with”:

To pull that out of the jargon, when every bugger’s running around screaming because they don’t know what’s going to happen then things are dark for the long term future of the economy. Just because the screaming and the running around means no bugger is doing anything else.

And here’s the thing – that lookin’ dark bit gets worse the longer the uncertainty lasts. To the point that the effect just of the not knowing becomes greater than the possible effect of any particular event in that universe of possibilities. It really is true that continuing to delay Brexit will, at some point, become worse than any particular Brexit outcome.

Thus get on with it, get it done. And given that we’ll get something of a bloody revolution if the Remainers win – we Brits being really quite keen on this democracy idea, we get to choose not they – then the getting on with it will have to be to leave. Yesterday would have been good, tomorrow if that’s not possible.

July 8, 2019

Bitcoin and its successors lack one thing that Libra has

Filed under: Economics — Tags: , , , , — Nicholas @ 03:00

Andrew Coyne on cryptocurrencies:

Sign of the times: the convenience store in my block of mid-town Toronto has installed, in addition to the usual fare of milk, cigarettes and magazines, an ATM dispensing bitcoins. Customers insert their debit cards and buy bitcoin, which they can then use to … to …

To do what, exactly, that they could not do with regular money? Bitcoin, the original cryptocurrency — there are now dozens of competitors — has always struck me as a solution in search of a problem. Its chief selling point, the anonymity made possible by its system of ultra-encrypted peer-to-peer transactions, unmediated by the banking system and beyond reach of the regulators, would seem of most appeal to two groups: crooks and cranks.

Oh, and a third: speculators. The price of cryptocurrencies has tended to fluctuate wildly — having fallen to a third of its peak against the U.S. dollar last year, Bitcoin has tripled in value so far in 2019. Cryptocurrencies are unlikely to achieve widespread use as mediums of exchange so long as they fail to fulfil one of money’s other primary functions, as stores of value.

The Wild West reputation the privately issued currencies have acquired — one of the most popular, Dogecoin, was invented by a 26-year-old Australian in 2013 as a joke — will be one of the early hurdles confronting Facebook’s recent entry into the field. The company hopes its 2.4 billion users will soon be buying goods and services from each other with Libra, as the proposed digital currency is called, wherever on earth either party may happen to be.

And yet Libra differs from Bitcoin and its ilk in several important ways. One, while it makes use of the same blockchain encryption technology as Bitcoin to ensure the security of payments, it is not based on the same anarchic premise.

In contrast to Bitcoin’s unsupervised, massively distributed, “permissionless” network, Libra will operate, at least initially, via Facebook’s Messenger and WhatsApp platforms, which are very much subject to its control. The company, and the others it has recruited as partners — names like Visa, Mastercard, and PayPal — are likewise highly visible targets of regulatory oversight, and indeed have signalled they intend to work with national banking regulators.

May 26, 2019

Game of Theories: The Austrians

Filed under: Economics — Tags: , , — Nicholas @ 02:00

Marginal Revolution University
Published on 28 Nov 2017

Austrian business cycle theorists argue that the central bank could be distorting market signals for entrepreneurs. How does this contribute to booms and busts?

March 22, 2019

Understanding the Great Depression

Filed under: Business, Economics, Environment, Government, History, USA — Tags: , , , , , , — Nicholas @ 02:00

Marginal Revolution University
Published on 23 May 2017

In this video, we examine the causes behind the Great Depression with the help of the aggregate demand-aggregate supply model.

In 1929, the stock market crashed and an air of pessimism swept across America — making bank depositors nervous. What would you do if you thought your money might not be safe with the bank? You’d probably want it back in your own hands. What happened next? A run on the banks.

Along with the Stock Market Crash of 1929, it’s one of the iconic moments of the early days of Great Depression. However, the Great Depression was an incredibly complex downturn in which the economy experienced a series of aggregate demand shocks. By the end of this video, you’ll walk away with a better understanding of the many factors behind the Great Depression and how to apply the AD-AS model to a real-world scenario.

January 30, 2019

The high cost Canadians pay to support our oligopolies

Filed under: Cancon, Economics, Politics — Tags: , , , , , , — Nicholas @ 03:00

In the National Post, Andrew Coyne compares the Liberal and Conservative parties’ respective claims to lower the cost of living for Canadians, and points out some examples that neither party is willing to address:

For example, there is the notorious system of agricultural quotas known as supply management — a price-fixing ring the government not only approves but organizes and enforces, whose effect is to double or even triple the prices of such basic food items as milk, cheese, eggs and chicken. For all their pretended concern for affordability, all parties and every MP, with the sole exception of Maxime Bernier, are publicly, nay fervently in favour of it.

But while the farm cartel gets a lot of ink, there are plenty of other examples. Canadians pay among the highest wireless telephone fees in the world, for starters — maybe even the highest — as study after study has found. The latest report from Tefficient, a European consultancy, found Canada’s carriers take in more revenue per gigabyte of data than their counterparts anywhere else in the world — 23 times more than in Finland.

Similarly, Canadians pay among the highest air fares in the world. The travel website Kiwi. com recently found flights from Canada on a full-service airline cost roughly five times as much per 100 kilometres as flights from the United States. The situation was a little better for domestic flights, where costs were only twice as high as in the U.S. The makers of Hopper, the travel app, note it is typically cheaper to fly from Vancouver to Hawaii than from Vancouver to Regina, though Regina is 3,000 km closer.

Finally, there are Canadian bank fees, also — you guessed it — among the highest in the world, particularly for mutual funds. What is the common thread among these three industries? All are highly concentrated oligopolies: three big wireless carriers, two big airlines and five big banks dominate their respective markets.

Rather than compete as vigorously as they might for Canadian consumers, these quasi-cartels are permitted, in effect, to harvest them. They do so, again, not only with the tolerance but the active participation of the government. Foreigners are effectively precluded from competing in any of them, whether by foreign-ownership restrictions or outright prohibitions on competition — foreign airlines may not fly from one Canadian city to another, for example.

None of the parties currently boasting of their desire to make life more affordable for Canadians proposes to change a line of this, either. Whatever else may be in (artificially) scarce supply, in Canadian politics there’s never any shortage of rank hypocrisy.

November 26, 2018

England: South Sea Bubble – Too Big to Fail – Extra History – #2

Filed under: Americas, Britain, Business, Economics, Government, History — Tags: , , , — Nicholas @ 02:00

Extra Credits
Published on 14 Mar 2015

Support us on Patreon! http://bit.ly/EHPatreon
____________

Frustrated at every turn by the Whig-controlled Bank of England, Harley and Blunt decide to start their own institution: a trading company that will exchange government debt for stock shares. This new South Sea Company will have a monopoly on trade in the rich new lands of South America, but all the ports there are controlled by Spain, with whom Britain is at war. So Blunt pushes the country into a premature and unfavorable peace with Spain, enlisting famous authors to write his propaganda and convincing Queen Anne herself to tip the balance of Parliament in his favor. After the queen dies and the government changes hands, Blunt kicks Harley and his Tory leaders out of the company. He manages to bring King George I himself on board as a ceremonial leader, linking the success of the South Sea Company with the reputation of the monarchy. But while his maneuvering inflates the value of his company’s stock, it’s never produced anything close to the amount of money he’s convinced people to invest in it.

November 25, 2018

England: South Sea Bubble – The Sharp Mind of John Blunt – Extra History – #1

Filed under: Britain, Business, Economics, History — Tags: , , — Nicholas @ 02:00

Extra Credits
Published on 28 Feb 2015

Support us on Patreon! http://bit.ly/EHPatreon
____________

When Robert Harley steps in as England’s new Chancellor of the Exchequer, he discovers that not only is the government deeply in debt, but no one knows quite how much debt it owes. Because vicious political infighting between the Tory and Whig politic parties made it difficult to pass new tax laws, Harley turned to a private financier named John Blunt to help find enough money for England to keep up with its expenses for the year. Using Harley’s government resources, Blunt instigated a series of get-rich schemes that drove artificial demand for unsustainable land and lottery investments with tremendous short term gains. Before the year was done, Blunt had successfully covered the shortfall for the government that year – albeit at the cost of driving England’s already outrageous debt even higher.

November 15, 2018

“… like watching a spontaneous Humanitarian Olympics rise up out of the town itself”

Filed under: Business, Liberty, USA — Tags: , , — Nicholas @ 06:00

Gerard Vanderleun is one of the refugees from the Camp fire that burned out all of the town of Paradise, California. He’s staying in Chico, fortunately with a roof over his head, unlike many of his fellow Paradisians who lost literally everything but what they were wearing:

In the 24-Hour Walgreens Pharmacy on East Avenue, the pharmacists have been working overlapping shifts since the fire swept over Paradise last Thursday. These people and their back up staff work seemingly rock solid for hours on end. They fill and file and dispense medications which people from Paradise do not have with them. This is a demanding and thankless and exhausting task. And yet — I am the witness — they have been doing this without letup. Many have come in from surrounding towns, from Redding, to help and to keep the medications needed by a town of 30,000 displaced into a city of 80,000. Yes, the Walgreens pharmacists are leaving it all on the field.

Today, after the banking holiday of Monday, there was what can only be described as a run on the banks. Not a hostile or panicked run on the banks but just an overwhelming number of people needing to get their money straight in one way or another… such as “My ATM Card and My ID were melted in my wallet when my pants burst into flame.” Please understand that today in Chico that is a reasonable statement. And the bankers all showed up looking cool and formal and professional and competent and moved the vast lines of people through with all hands on deck and cleared up a myriad of money crises. One banker I spoke with came up from Santa Rosa on his day off to help the team. He was a sharp dressed man. He and the other bankers were leaving it all on the field.

They all were leaving it all on the field everywhere in Chico. From Penny’s in the Mall to the Birkenstocks Store downtown on Broadway. In big jobs, and in small jobs, there was a long train of people working at the top of their game no matter what their game was. It has been days of this now in Chico; days of there being no big jobs or small jobs but only the unremitting effort the people to help their fellow citizens no matter what.

And since none of the Acronym Agencies have really shown up yet, this has all been done without any real government organization. Instead, it has been like watching a spontaneous Humanitarian Olympics rise up out of the town itself; and once started it has become as self-organizing and self-sustaining as the fire itself. Today as I moved around Chico I saw a town, untouched itself by the flames, rise up to restore and rebuild the lives of their fellow citizens of Paradise; lives that the fire had stolen. And by the end of the day, you could feel, palpably feel, that Chico knew it would win. Chico was leaving it all on the field.

Tomorrow? Chico will do the same.

November 4, 2018

Statistics Canada wants to become “Stasi”-tistics Canada by grabbing personal financial data

Filed under: Bureaucracy, Cancon, Government, Liberty — Tags: , , , — Nicholas @ 05:00

“Stasi” was the abbreviation for the German Democratic Republic’s State Security Service, East Germany’s successor to the Gestapo. Not only did they perform similar functions to the Gestapo, they were even more involved in spying on Germans than their Nazi predecessors had been. Wikipedia says that “the Stasi employed one secret policeman for every 166 East Germans; by comparison, the Gestapo deployed one secret policeman per 2,000 people. As ubiquitous as this was, the ratios swelled when informers were factored in: counting part-time informers, the Stasi had one agent per 6.5 people. This comparison led Nazi hunter Simon Wiesenthal to call the Stasi even more oppressive than the Gestapo.” Statistics Canada doesn’t want to get the full story on us by physically spying — that’s the RCMP’s job — but they do want to grab huge amounts of our personal financial data to “ensur[e that] government programs remain relevant and effective for Canadians”. Terence Corcoran explains why this might not be such a good idea:

When news broke earlier this year that the accounts of maybe 600,000 Canadian Facebook users had been compromised, Ottawa swung into action to shut down this alarming example of creeping surveillance capitalism. Scott Brison, then acting minister of democratic institutions, said his government had dispatched Canada’s national spy agency to make sure the privacy of Canadians had not been compromised. “Social media platforms have a responsibility to protect the privacy and personal data of citizens,” said Brison.

But when news broke last week that Statistics Canada wants to expand its inventory of data on Canadians by collecting real hard-core personal information on the banking activities of 500,000 Canadians annually, the Trudeau government was suddenly not at all concerned about privacy breaches or even the principle of privacy protection. Instead of waving a red flag over the prospect that StatCan would end up with computers full of private financial details on millions of citizens, Prime Minister Justin Trudeau brushed off privacy concerns, which he implied take a back seat to the government’s need for “high quality and timely data.” Such data, he said, are “critical to ensuring government programs remain relevant and effective for Canadians.”

Spoken like a true central planner and enthusiastic purveyor of policy-based evidence making. Nobody seems to know why StatCan wants to begin collecting personal banking information on individual Canadians, information that Canada’s bankers are rightly reluctant to provide. In the all-new era of fintech and blockchain, the great concern among regulators is how data privacy will be protected. At StatCan, the concern is: “How do we get our hands on the data?”

[…]

StatCan’s assurances on privacy protection are not all that reassuring. In a document dated October 2018 — obtained by David Akin at Global News— the chief statistician describes his agency’s “Generic Privacy Impact Assessment related to the acquisition of financial transactions information.” It is clear that the names of millions of Canadians, their bank account numbers and transactions, their bill payments and personal activities, will be collected and stored in government computers. StatCan is not merely getting useful generic data on the spending and banking habits of Canadians, it is collecting the actual spending and banking habits and names of individual Canadians.

It is one thing to collect and analyze statistics based on anonymous data. It is quite another to “require” — Arora’s word — that the banks provide “individual payments and income history.” Even though billions of bits of private, individual and personal information will be collected, StatCan says that, “Under no circumstances will the personal information obtained from financial institutions be used to perform credit, expenditure or income checks on individual Canadians.” He said none of the resulting statistical reports will include any personal data.

That’s not good enough.

November 2, 2018

Operation Choke Point

Filed under: Bureaucracy, Business, Government, USA — Tags: , , — Nicholas @ 03:00

In Forbes, John Berlau details how expansive regulatory powers and vindictive bureaucrats make doing business in the United States less “free enterprise” and more “shame if something were to happen to it”:

Every Halloween, there exists the temptation for bloggers, pundits, and commentators to describe routine events in the news with adjectives like “scary” and “frightening.” Sensitive to sounding clichéd or inflammatory, I try usually to avoid using such terminology in my descriptions of the policy process.

Yet after reading through new documents introduced into a lawsuit stemming from the Obama administration’s “Operation Choke Point,” I find that “scary” and “frightening” actually fit. These documents show that powerful bank regulatory agencies engaged in an effort of intimidation and threats to put legal industries they dislike out of business by denying them access to the banking system.

While I am often outraged about things the government does, now I am truly scared and frightened about the ability of government bureaucrats to shut down arbitrarily whole classes of businesses they deem to be “politically incorrect.” As one who champions the FinTech sector and the benefits it can bring, I also worry that such powers may be uses to shut down innovative new industries, such as cryptocurrency, that carry some perceived or real risks.

Choke Point was a multi-agency operation in which several entities engaged in a campaign of threats and intimidation to get the banks that they regulate cut off financial services – from providing credit to maintaining deposit accounts — to certain industries regulators deemed harmful a bank’s “reputation management.” The newly released documents – introduced in two court filings in a lawsuit against Choke Point — show that the genesis of Choke Point actually predated Barack Obama’s presidency, and began when President George W. Bush was in power.

[…]

When the Obama administration came into power, the FDIC would expand the definition of “reputation risk” even further, and other federal agencies, bureaus, and departments would soon jump on the proverbial bandwagon. Much of Operation Choke point would again be accomplished by “guidance documents,” which my Competitive Enterprise Institute colleague Wayne Crews refers to as “regulatory dark matter,” since they have legal force but allow regulators to bypass the sunlight of the notice-and-comment process of a formal rule.

In 2011, an FDIC guidance document featured a chart of business categories engaged in what it called “high-risk activity.” These included “dating services,” “escort services,” “drug paraphernalia,” “Ponzi schemes,” “racist materials,” “coin dealers,” “firearm sales,” and “payday loans.” The FDIC would post this and similar lists in other guidance documents and on its web site.

A staff report of the House Government Reform and Oversight Committee puzzled over many of these categories. “FDIC provided no explanation or warrant for the designation of particular merchants as ‘high-risk,’” the report observed. “Furthermore, there is no explanation for the implicit equation of legitimate activities such as coin dealers and firearm sales with such patently illegal or offensive activities as Ponzi schemes, racist materials, and drug paraphernalia.”

October 2, 2018

Costs of Inflation: Financial Intermediation Failure

Filed under: Economics — Tags: , , , — Nicholas @ 02:00

Marginal Revolution University
Published on 7 Feb 2017

In the previous video, we learned that inflation can add noise to price signals resulting in some costly mistakes from price confusion and money illusion. Now, we’ll look at how it can interfere with long-term contracting with financial intermediaries.

Let’s say you want to take out a big loan, such as a mortgage on a house. The financial intermediary (in this case, a commercial bank) is going to charge you an interest rate as their profit for loaning you the money. In this situation, inflation has the potential to work against you or it can work against the bank.

If the bank charges you a nominal interest rate (i.e., the interest rate on paper before taking inflation into account) of 5% and inflation climbs unexpectedly to 10% for the year, the real interest rate (nominal minus inflation) falls to -5%. The bank actually loses money. However, if inflation has been higher and banks are charging 15% for mortgages and inflation rates fall unexpectedly to 3%, you’re stuck paying a real interest rate of 12%!

The above scenarios are similar to what actually happened in the United States in the 1960s and 1970s. Inflation was low in the 60s. But then in 70s, inflation rates climbed up unexpectedly. People that purchased a home in the 60s lucked out with low interest rates on their mortgages coupled with higher inflation, and many were able to pay off the loans more quickly than expected. But anyone that purchased a higher interest rate mortgage in the 70s only saw inflation fall back down. It was good for the banks and a costly choice for the homeowners. They were saddled with a high-interest mortgage while lower inflation meant a lower increase in wages.

It’s not that the people buying homes in the 1960s were smarter than those in the 70s. As we’ve noted in previous videos, inflation can be very difficult to predict. When banks expect that inflation might be 10% in the coming years, they will generally adjust their nominal interest rates in order to achieve the desired real interest rate. This relationship between real and nominal interest rates and inflation is known as the Fisher effect, after economist Irving Fisher.

We can see the Fisher effect in the data for nominal interest rates on U.S. mortgages from the 1960s through today. As inflation rates rise, nominal interest rates try to keep up. And as the inflation rates fall, nominal interest rates trail behind.

Now, if inflation rates are both high and volatile, lending and borrowing gets scary for both sides. Long-term contracts like mortgages become more costly for everyone with much higher risk, so it happens less. This is damaging for an economy. Coordinating saving and investment is an important function of the market. If high and volatile inflation is making that inefficient and less common, total wealth declines.

Up next, we’ll explore why governments create inflation in the first place.

August 20, 2018

Causes of Inflation

Filed under: Economics — Tags: , , , , , — Nicholas @ 02:00

Marginal Revolution University
Published on 24 Jan 2017

In the last video, we learned the quantity theory of money and its corresponding identity equation: M x V = P x Y

For a quick refresher:

‌•M is the money supply.

‌•V is the velocity of money.

‌•P is the price level.

‌•And Y is the real GDP.

In this video, we’re rewriting the equation slightly to divide both sides by Y and explore the causes behind inflation. What we discover is that a change in P has three possible causes – changes in M, V, or Y.

You probably know that prices can change a lot, even over a short period of time.

Y, or real GDP, tends to change rather slowly. Even a seemingly small jump or fall in Y, such as 10% in a year, would signal astonishing economic growth or a great depression. Y probably isn’t our usual culprit for inflation.

V, or the velocity of money, also tends to be rather stable for an economy. The average dollar in the United States has a velocity of about 7. That may fall or rise slightly, but not enough to influence prices.

That leaves us with M. Changes in the money supply are the driving factor behind inflation. Put simply, when more money chases the same amount of goods and services, prices must rise.

Can we put this theory to the test? Let’s look at some real-world examples and see if the quantity theory of money holds up.

In Peru in 1990, hyperinflation came into full swing. If we track the growth rate of the money supply to the growth rate of prices, we can see that they align almost perfectly on a graph with both clocking in around 6,000% that year.

If we plot the growth rates of the money supply along with the growth rates of prices for a many countries over a long stretch of time, we can see the same relationship.

We’ll wrap-up the causes of inflation with three principles to keep in mind as we continue exploring this topic: ‌

•Money is neutral in the long run: a doubling of the money supply will eventually mean a doubling of the price level.
‌•“Inflation is always and everywhere a monetary phenomena.” – Milton Friedman ‌
•Central banks have significant control over a nation’s money supply and inflation rate.

August 14, 2018

QotD: The money pump

Filed under: Economics, Quotations — Tags: , — Nicholas @ 01:00

I would like to introduce you to the idea of a money pump. A money pump is a person whose irrationalities can be systematically exploited for financial gain. The simplest money pump is a person who prefers an apple to a doughnut, prefers a doughnut to a chocolate bar, and prefers a chocolate bar to an apple. Just offer them an apple in exchange for their doughnut plus a penny. They will accept. Then offer them a chocolate bar for their apple plus a penny. Then offer them a doughnut for their chocolate bar plus a penny. They end up with their original doughnut and are three pence poorer. Repeat for ever.

Money-pump arguments are sometimes deployed to object that people cannot be irrational, otherwise they would be bankrupted by money pumping. But economists are increasingly coming to realise that, instead, we should be looking for money pumping in action.

Given our anxiety about small risks, what would the money pumping look like? It would be an insurance policy focused on the narrowest possible slice of risk. It would be sold alongside another product or service, often at the last moment. It would be marketed by creating anxiety and then offering the product to make the anxiety go away. In short, it would look like the collision damage waiver, the extended warranty, and PPI [payment protection insurance]. These bespoke slices of insurance are among the largest money-pumping projects in the modern economy. No wonder the banks abandoned their principles to join in.

Tim Harford, “How insurers keep the money-pump flowing”, TimHarford.com, 2016-09-21.

July 20, 2018

Fiat currency and the impact of cryptocurrencies

Filed under: Economics, Government, Technology — Tags: , , , , — Nicholas @ 03:00

At Catallaxy Files, Sinclair Davidson explains some of the advantages and disadvantages of both fiat (government-issued) and private currency:

As George Selgin, Larry White and others have shown, many historical societies had systems of private money — free banking — where the institution of money was provided by the market.

But for the most part, private monies have been displaced by fiat currencies, and live on as a historical curiosity.

We can explain this with an ‘institutional possibility frontier’; a framework developed first by Harvard economist Andrei Shleifer and his various co-authors. Shleifer and colleagues array social institutions according to how they trade-off the risks of disorder (that is, private fraud and theft) against the risk of dictatorship (that is, government expropriation, oppression, etc.) along the frontier.

As the graph shows, for money these risks are counterfeiting (disorder) and unexpected inflation (dictatorship). The free banking era taught us that private currencies are vulnerable to counterfeiting, but due to competitive market pressure, minimise the risk of inflation.

By contrast, fiat currencies are less susceptible to counterfeiting. Governments are a trusted third party that aggressively prosecutes currency fraud. The tradeoff though is that governments get the power of inflating the currency.

The fact that fiat currencies seem to be widely preferred in the world isn’t only because of fiat currency laws. It’s that citizens seem to be relatively happy with this tradeoff. They would prefer to take the risk of inflation over the risk of counterfeiting.

One reason why this might be the case is because they can both diversify and hedge against the likelihood of inflation by holding assets such as gold, or foreign currency.

The dictatorship costs of fiat currency are apparently not as high as ‘hard money’ theorists imagine.

Introducing cryptocurrencies

Cryptocurrencies significantly change this dynamic.

Cryptocurrencies are a form of private money that substantially, if not entirely, eliminate the risk of counterfeiting. Blockchains underpin cryptocurrency tokens as a secure, decentralised digital asset.

They’re not just an asset to diversify away from inflationary fiat currency, or a hedge to protect against unwanted dictatorship. Cryptocurrencies are a (near — and increasing) substitute for fiat currency.

This means that the disorder costs of private money drop dramatically.

In fact, the counterfeiting risk for mature cryptocurrencies like Bitcoin is currently less than fiat currency. Fiat currency can still be counterfeited. A stable and secure blockchain eliminates the risk of counterfeiting entirely.

June 29, 2018

QotD: What is a discount rate?

Filed under: Economics, Quotations — Tags: , , , , — Nicholas @ 01:00

It is not the 20 percent savings you got by buying a new washing machine on Black Friday last year. A discount rate is a way of accounting for the fact that dollars in the future are not quite the same as dollars you have right now.

You know this, don’t you? Imagine I offered to give you a dollar right now, or a dollar a year from now. You don’t have to think hard about that decision, because you know instinctively that the dollar that’s right there, able to be instantly transferred into your sweaty little hand, is much more valuable. It can, in fact, be easily transformed into a dollar a year from now, by the simple expedient of sticking it in a drawer and waiting. It can also, however, be spent before then. It has all the good stuff offered by a dollar later, plus some option value.

Even if you’re sure you don’t want to spend it in the next year, however, a dollar later is not as good as a dollar now, because it’s riskier. That dollar I’m holding now can be taken now, and then you will definitely have it. If you’re counting on getting a dollar from me a year from now, well, maybe I’ll die, or forget, or go bankrupt.

The point is that if you’re valuing assets, and some of your assets are dollars you actually have, and others are dollars that someone has promised to give to you at some point in the future, you should value the dollars you have in your possession more highly than dollars you’re supposed to get later.

The rule for establishing an exchange rate between future dollars and current ones is known as the “discount rate.” Basically, it’s a steady annual percentage by which you lower the value of dollars you get in future years.

All you need to remember is two things: the longer you have to wait to get paid, the less that promise is worth to you today. And the higher the discount rate you apply, the lower you’re valuing that future dollar.

Megan McArdle, “Public Pensions Are Being Overly Optimistic”, Bloomberg View, 2016-09-21.

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