Posts Tagged ‘commerce’

The Economy Built on Confidence

You may have heard the term consumer confidence bantered around by economists and journalists.  The consumer confidence index is an attempt to determine the opinion of the public at-large regarding the economy.  It’s supposed to be an indicator of spending and savings habits.  In a consumer-driven economy, consumer spending has a tremendous impact on the overall state of the economy.

Confidence has a much larger impact on the US economy than the number of new cars, flat-screen televisions and iPhones that will be purchased.   To a certain extent, the entire economy is built upon confidence.

It starts with confidence in the US government, or at least in the money they print.  If you read my prior article on the Value of Money – Part III, you’ll recall that US currency is fiat money.  Since value is not determined by gold or any other asset, its value is solely derived from the full faith and credit of the US government.  Consequently, the confidence that people and investors have in the US government affects the value of the dollar. Should people lose confidence in the US government, the value of the US dollar will drop.  Considering the size of the current foreign trade deficit, it would instantly result in higher prices of things like oil and gasoline.  It would also raise the cost of borrowing, further exacerbating the current annual budget deficit and total debt obligation.

Confidence also plays a huge role in the banking and financial sector.  How would you react if you seriously questioned the long-term viability of the bank that holds all of your money?  You may be a loyal customer, but no one would be surprised if you transferred your funds to another institution.  Even if all of your money was FDIC insured, would you want to take the risk that some of it could be unavailable while the regulators sort through the mess?

The entire financial system was facing a crisis of confidence in September 2008.  Lehman Brothers declared bankruptcy on September 15, 2008; on the next day, the Federal Reserve Bank put up $85 billion to save AIG from a similar fate; and the Reserve Primary Fund money market broke the buck later in the day.  These historic events happening in a matter of days caused many people to speculate that it was the beginning of another Great Depression. The lack of confidence in the financial market was causing paralysis.  Everyone wanted their money to be safe but didn’t know where to put it, for fear that any institution could be the next to fail.

To instill confidence back into the markets, Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke rolled out the Troubled Asset Relief Program (TARP) on September 19, 2008.  We can debate the merits of TARP, but at the time, it did appear to bring enough confidence back into the markets to stave off a complete meltdown.

A lack of confidence can also wreak havoc on a company.  General Motors and Chrysler are two good examples.  As they were teetering on the brink of bankruptcy, potential buyers questioned the survival of the automakers and were very reluctant to buy their vehicles.  People were concerned about the companies’ ability to honor their warranties and the future availability of repair parts.   Once again the US government intervened in an unprecedented manner and guaranteed the warranties of all new cars being purchased.  The government guarantee provided consumers with the confidence they needed to make the purchase.  Again, we can debate the propriety of this move, but would you want to buy a product from a company you didn’t think would exist in a few months or years?

Confidence has become the underpinning of the entire economy.  Confidence determines the value of your money.  It determines the security of your savings and provides you with the ability to save, spend and transact business with others.  It also can determine the success or failure of the company you own or work for.  

Now you can understand why the President, government officials and business leaders do their best to instill a sense of confidence in the economy.  It’s more than politics and positive thinking.  Once you witness the downward spiral that a lack of confidence brings, you get a better appreciation why consumer and economic confidence, whether real or perceived, is necessary.

Like trust, confidence is hard to gain and easy to lose.  In an economy built on confidence, maintaining a sense of confidence becomes the most significant economic indicator of success or failure.

Currency & Commerce (The Value of Money – Part II)

One of the primary values of money is the facilitation of commerce.  A common currency is the medium of exchange which facilitates your ability to buy or sell something.   The buyer and seller know what they are giving up in value and what they are receiving in return.

What would you do if you didn’t have money or your money had no value?  You might try bartering for what you need.  Try that the next time you go to the store to buy groceries or stop at the gas station to fill up.  Imagine the look on the cashier’s face when you ask if you could pay with your watch or a sack of potatoes, rather than cash or your debit/credit card.

The current economic climate and concerns for the future have caused some people to suggest that you should stock up on gold and silver to preserve your ability to continue buying things in the event of a complete economic collapse.  Dave Ramsey is one prominent opponent to this idea.  His contention is that gold would be as useless as paper money because people would resort to bartering instead.

Without addressing the point of whether or not gold is a good investment.  I see his point. Even when gold was the principle form of money, it was still transformed into a common currency.  No one carried around bags of gold rocks or bullion. They used gold coins… minted into identical sizes and shapes representing specified values (just like our silver coins today).

At the same time, I don’t think that even in a complete economic collapse bartering would last long. It may occur for a short time following a major catastrophe or natural disaster, but our society is far too complex and advanced to function solely through bartering.  Most of us would be in deep trouble if we had to barter for our existence.  Urban society doesn’t lend itself to providing food yourself and most of our skills have a limited marketplace.  My family would be in trouble if I had to barter tax and accounting services with everyone necessary for us to live.

Gold, silver and other precious metals are commodities and may have a place in your portfolio as a hedge against inflation.   However, I don’t think it should be seen as a replacement currency to purchase goods and services.  Gold and silver coins might be easier to barter, but I doubt that they would become a replacement currency.  How would a merchant know what your gold coin is worth?  How would they know if it’s pure gold or just gold-plated?

In the event of a major economic catastrophe or collapse of the financial system, I would prefer to have a stash of cash in a safe deposit box than try to barter with gold and silver.  Hyperinflation may cause the cash to be worth less, but at least it’s a standard that everyone know how to value.

As long as we’re talking gold, the Value of Money – Part III will address the paper money and the gold standard.