Typography

Source: Gravity Glue (2014) Cryptocurrencies were supposed to destroy the traditional monetary system. Ten years on, where are we? Bitcoin has been wildly successful, but as a financial game --not as a medium of exchange. It's a fun (and potentially profitable) way to gamble on what Keynes once described as what "average opinion expects the average opinion to be." But no one really uses it to pay for stuff. It's nature as a gambling token makes it too awkward to serve as a true substitute for banknotes and credit cards. A number of stablecoins have emerged over the last five or six years. (I first wrote about stablecoins four years ago). Like bitcoin, stablecoins exist on a blockchain. But unlike bitcoin, these tokens have a mechanism for ensuring their stability. Stablecoin owners can convert tokens at par into underlying dollar balances maintained in the issuer's account at a regular bank. So stablecoin entrepreneur have basically built a new blockchain layer...

Nations never experience year-over-year declines in cash in circulation. Sweden (which I wrote about here , here , and here ) is one of the rare exceptions. India is another, but this was due to its notorious botched demonetization attempt (which I wrote about here , here , here , and here ). But now the UK seems to be joining this small group of outliers. Why does a nation's cash in circulation generally grow consistently from one year to the next? While economies do experience the odd recession, in general they are always improving. Improving economies coincide with more demand to make transactions, and for this the public needs to have greater amounts of cash on hand. There is a counter-cyclical element to cash holdings. When recessions occur, people often turn to unofficial sectors of the economy to make a living, and this often requires cash. The last explanation for the steady growth in cash outstanding is inflation. Let's assume an inflation rate of 10%. Someone who gene...

On Twitter , Noah Smith asks: @ClicheGuevara But why don't we use stock shares as our medium of exchange? — Noah Smith (@Noahpinion) June 13, 2015 He answers his own question on his blog . I pretty much agree. It's interesting to imagine science fiction worlds where people do use volatile instruments like stock as their medium of exchange. Why would people in these worlds be willing to adopt volatile media while people in our world don't? Liquidity, the world's best insurance policy against uncertainty First, we need to understand why our world has a preference for stable media of exchange. As Noah points out, people don't know exactly when they are going to need to spend money, or how much. Any individual faces the dizzying fact that any of an infinite number of events could hit them at any point in time. People have many ways to cope with this chaos, one of which is to build up an inventory of assets that can be deployed to help deal with surprises as they occur...

We all carry a variety of media of exchange in our portfolios, some more liquid than others. Deposits are pretty high on the liquidity scale, stocks and bonds a little less so, and our household's furniture is even less movable. The most sizable medium of exchange in our portfolios also happens to be our least liquid one: labor. Our capacity to use our brains and bodies to work is the primary currency that each of us own, although it isn't a particularly mobile one. Might things be different? Could labor be converted into a more effective medium of exchange that is capable of competing with highly fluid financial assets for preferred liquidity status? Much of our lives are spent trying to make marginal improvements to the liquidity of our labour. We may choose to learn more skills so that we can participate in multiple markets, the more markets being open to us on any given day the more saleable our labour. Alternatively we may choose to learn one thing very well. While this le...

I'm going to use a stock market analogy to work out the costs of manufacturing liquidity premia. In addition to paying dividends and providing price appreciation, stocks provide an amenity flow in the form of expected exchangeability , or liquidity. Like any other consumption good & service, the provision of such an amenity requires an outlay by the supplier. In the same way that a widget producer won't sell widgets below marginal cost, the marginal seller of stock, the issuing firm, won't manufacture new liquidity if the cost of production exceeds the benefits. Say that a firm can hire an entire investor relations department for next to no cost. The IR team, full of eager promoters, will double the price that the marginal investor is willing to pay for the liquidity services thrown off by the firm's stock. They go about improving the stock's liquidity services by evangelizing the firm's "story", thereby widening the base of investors who deal in t...

Real t-bill and bond yields have been falling for decades and are incredibly low right now, even negative (see chart below). With an eye to historical real returns of 2%, folks like Martin Feldstein think that bonds are currently mis-priced and warn that a bond bubble is ready to burst. Investors need to be careful about comparing real interest rates over different time periods. Today's bond is a sleek electronic entry that trades at lightning speed. Your grandfather's bond was a clunky piece of paper transferred by foot. It's very possible that a modern bond doesn't need to provide investors with the same 2% real coupon that it provided in times past because it provides a compensating return in the form of a higher liquidity yield. [By now, faithful readers of this blog will know that I'm just repeating the same argument I made about equity yields .] Here's a way to think about a bond's liquidity yield. Bonds are not merely impassive stores-of-value, they ...

[This is a continuation of my post on liquidity adjusted equity valuation .] If your favorite holding period is forever, then today's stock markets just aren't meant for you. As I pointed out in my previous post on stocks and liquidity, stocks can do more money-ish and cashlike things than in times past. For most people, the ability of stock (or any other good or asset) to be easily-exchanged is desirable since it ensures that come some unforeseen event, that stock can quickly be swapped for more suitable items. We can think of easily-exchangeable stock as insurance against uncertainty. Investors estimate the stream of 'expected comfort' or 'uncertainty alleviation' that a stock's degree of exchangeability will provide, discount these streams into the present, and arrive at some value for the liquidity return provided by a stock. The more moneylike or liquid a stock, the higher its liquidity return . A stock's liquidity return makes up but one bit of a ...

There is a recurring story in the media that 150oz Tide detergent bottles are being used as money by criminals. It's a fun story and I can't resist using it to illustrate the idea of liquidity premia. Assume that two types of detergent bottles are held in individual's inventories. Say that they are entirely similar except one bottle is harder to sell than the other. If some unexpected event were to happen, the liquid (excuse the pun) bottle of detergent can be easily sold so as to mobilize resources to deal with the event. The illiquid one can't. This ability to serve as a superior hedge against the unexpected is a valuable service. Even if the unexpected doesn't occur, anyone holding the liquid bottle will face less stress and unease over time knowing that they are positioned to deal with any eventuality. A forward-looking individual will anticipate this stream of uncertainty-shielding services provided by the more saleable bottle, discount these streams into the...

Christmas is upon us, and so is the seasonal spike in the demand for cash. This Christmas bump relates to the previous post on liquidity and uncertainty. Christmas isn't just about buying presents – it's also about traveling to distant places to meet up with family and friends. We realize that we can't anticipate all eventualities along the way. To insure ourselves against these uncertainties we carry a bigger wad of cash. This liquid wad provides a very real service by comforting us, even if we never end up having to use it. It's illuminating to plot the Christmas spike in cash in order to compare it over decades. See below. The data I'm using is the weekly currency component of M1 from the Federal Reserve. We can eyeball a few trends from the chart. First, we see a consistent seasonal spike in currency in circulation in December and climaxing around New Year's Day. Cash falls heavily in January as people and businesses redeposit it at the bank. While the Chr...

In between my more practical posts, once every week or so I'll do something on the idea of moneyness . Economists have known for a long time that the concepts of uncertainty and money are intimately intertwined. George Costanza knows this too. He holds a bunch of cash to deal with all eventualities... until his wallet blows up. I'll show how we can just as easily replace money with moneyness in this two-step with uncertainty. Uncertainty is an uncomfortable feeling one endures when thinking about an unforeseeable future. One of the ways to shield oneself from uncertainty is to devote a certain portion of one's portfolio to "money" – dollar bills, bank deposits, and such. Because these money items are liquid, it will be relatively easy for their holder to offload them in the future should some unanticipated eventuality arise. Holding money therefore alleviates discomfort about the future. This is the same sort of service that a fire extinguisher provides. Though ...

On November 15 @ 5:37 PM, Wordpress.com tweeted that it would be accepting bitcoin as payment. Over the next twenty-four hours, the price of bitcoin steadily rose on Mt. Gox , the major bitcoin exchange. See chart below. This is a great illustration of the idea of a liquidity premium . All assets carry a liquidity premium. This premium will be smaller or larger depending on an asset's ability to be easily bought and sold, or its liquidity. The idea of liquidity is straight from Carl Menger, who figured things out back in 1872 ( pdf ). Keynes also knew this, read Chapter 17 of the General Theory. (This is one of those great examples of Austrians and Keynesians agreeing). Other words for liquidity include saleability and marketability. In short, the more marketable an asset, the larger its liquidity premium, which in turn means a higher price. Illiquid assets have small premiums and lower prices. In announcing the acceptance of bitcoin, Wordpress has added yet another avenue for th...