On Monetary Premia

In chapter six of Paul Seabright’s great Company of Strangers: A Natural History of Economic Life, we’re treated to an account of the monetary troubles of post-communist Russia. In a setting where inflation ran in the thousands of percent and nobody could trust another’s (paper) promises, large industrial firms turned to bartering food, animal skins, and anything else they could get their hands on. The lack of a viable money simply left no other choice. To carry out their main businesses, these companies had to make auxiliary investments in warehouses and have people acquire durable products to trade for tools needed from suppliers. They resorted to paying their workers “salaries” in whatever suitable goods they could get their hands on. A large batch of potatoes was heartily welcomed, reports Seabright; “if it could have held its value, money would have been much cheaper to store.”

Instead, individuals and businesses wasted resources performing a sort of dog-and-pony dance to get around their monetary problem. Reading it from the comfort of a monetary economy thirty years later, the period seems comical. Didn’t they realize that they could have just had a well-functioning monetary system instead…?

The wonder of money is precisely that it allows for this great human cooperation that is the world economy. Writes Seabright:

Money is one of the great human inventions precisely because it helps to narrow the gulf between the ingenuity of each individual and the interest of others; it helps our inventiveness to serve purposes other than mutual theft […]. It frees shoe manufacturers to do what they are good at (making shoes), instead of obliging them to become porcelain merchants, sausage-skin manufactures, or stockists of potatoes simply in order to keep their shoemaking business afloat.

Money is the technology by which we arrange the division of labor; it is the way we move economic value across time and space, between the times of production and consumption. The object we choose for these purposes thus acquires an outsized economic role. It will be held and demanded by more people and thus trade at a higher relative price than its nonmonetary use warrants. The difference we call “monetary premium.”

For any object with nonmonetary use, even if it functions acceptably as money, it’s obvious how it becomes wasteful for society: Merchants and consumers and manufacturers must diverge sausage skin and potatoes and shiny yellow rocks from their real economic uses. Some nonmonetary uses become too costly to pursue with the object’s use as money “crowding out” its real-world use. 

While fiat currencies don’t have nonmonetary use, they still crowd out real-world use in a roundabout way. Their unstable, unpredictable price level and constant erosion mean that a saver is forced into other assets to protect his purchasing power. Beyond that he needs to research, manage, and check in on those assets, creating auxiliary services much like the warehouses for sausage skins. When the (fiat) money doesn’t function well, concludes Lyn Alden in her excellent book Broken Money (which, full disclosure, I helped edit and research), “people would rather hold almost anything else than cash, whether it be equities, real estate, or collectives even at inflated valuations. […] These things acquire a monetary premium.”

We may laugh at that needlessly complicated dance in stories from post-communist Russia, while we diligently max out our 401(k) contributions, buy second homes and fill them with expensive art, research which mutual fund or stocks to entrust our surplus cash, and hire managers to look after everything — in a word, storing economic value in everything but money. My friend has recently pitched me whisky as a fun thing for us to “invest” in rather than drink (talk about wasted opportunity!).

House prices, adjusted for consumer prices, were roughly flat for hundreds of years. They were long-lived consumables, not investment assets; in no sane and dynamically consistent sense are homes and home ownership designed to “build capital,” as my octogenarian grandpa often quips — his large house with a sea view literally clouding his vision on this topic. But of course, how could he think differently? For his entire life, house prices have done nothing but increase in (real) value, giving him an unfair wealth bonus from simply having been first to the Ponzi-type endeavors that characterize 21st-century housing markets.

Sometimes we must step outside of a system to clearly see the absurdities in it. Writes Parker Lewis for Unchained Capital, a bitcoin financial services company: “Believing that financial engineering is a necessary path to a happy retirement might lack common sense, but it is the conventional wisdom.” Alden reports that under the fiat dollar, long-run price changes squeeze value from holders of money to holders of assets — the scarcer, the better: “The scarcest things […] tend to go up in price as fast as the money supply does. That’s because these things are truly finite, and we don’t get more efficient at making them.” 

Miami beachfront property increased by 6.4 percent compounded over 92 years, echoing money supply growth for the same period. “In the absence of good money,” Alden writes, “everything else that has some degree of scarcity gets monetized instead”:

Semi-scarce things such as gold, oil, beef, and median homes tend to go up in price at a 4-5 percent annual rate if money supply growth is 6-7%, because we get moderately better at producing them over time, due to better technology. A barrel of oil, for example, went from an average of $0.95 in 1913 to an average of $94 in 2022, which was only a 100-fold increase, or 4.3 percent compounded annually. The price of beef similarly increased at a 4.1 percent compounded annual rate from the 1930s through 2022.

The consumer price index since 1913 compounded at 3.2 percent — across some turbulent wars, depressions, and monetary regime switches. Wages grew by 4.6 percent-4.9 percent, which does make us somewhat better off in terms of (low-quality?) consumables, but when things like house prices run further and further ahead, that creates a gap we can only cover by debt. 

Over time, the structure becomes clear. By holding cash, to echo MicroStrategy Executive Chairman and Bitcoin bull Michael Saylor, you’re “on the wrong side of an economic war.” You can’t outwork being on the wrong side of that monetary extraction. The perverse conclusion is to never, ever hold money, the very object whose social-economic function is to move economic value. Instead hold highly leveraged assets for peak fiat tax efficiency.

In a well-functioning free market, all these prices of commodities and equities and houses with monetary premium should result in more raw materials mined, more companies created, and more houses built — just like high prices for other goods in the economy (oranges, toilet paper) give strong reasons for producers to make more of those things. For various reasons, that doesn’t happen. We can’t make more Miami beachfront, and houses are heavily restricted by where and how entrepreneurs can overcome zoning restrictions. Higher equity valuation just means that investors (sorry, “savers”) just pay more for future income streams, with the free-money era of the 2010s where P/E ratios touched the sky culminated in some spectacularly stupid malinvestments — think WeWork, BeyondMeat, or, you know, government bonds, the collapse of which led to the bank failures in March of this year. 

We are closer to the sausage-skin peddling businesses in 1990s Russia than we care to admit. One day we might look back at our cottage industry of diversified funds, tax-favored retirement accounts, capital gains taxes, clever accountants, hedge fund managers, Fed watchers, and army of central bank economists as positively medieval — unnecessary fluff, existing only because the money is broken. One day, they might seem as quaint and literally unbelievable as the barter systems in post-communist Russia seem to us today. As Lewis rhetorically asks: “maybe you just need a better form of money?”

Our grandchildren might reasonably ask us how we could fail to see that there was a better way to organize the economic cooperation that is money.

It’s a good question. I wonder if we’ll have a respectable answer for them. 

Related Articles – Books, Currency, Inflation, Monetary Policy