Sitting at my dining table, I have been looking over the Santa Monica Bay where fog has overtaken our skies for the past three days. That is not typical here. We don’t share that feature with our Northern California cousins. Staring into the grayness of the fog, I’ve found myself thinking more and more about money.
It probably has something to do with the fact that my wife is pregnant. I think all men probably have an extra gear they kick into when they know their new child is coming into the world. A lot of my thoughts are about increasing my own personal production by closing some new clients. I’ve been actively moving some pieces around the board to increase revenues. Some of my thinking is about developing a comprehensive financial plan for my family.
I always think that every single dollar you have should be tied to a goal. I have been updating plans around retirement, investments to produce more passive income and buying a new home, which got me thinking about money. I recently read a book that made a distinction between money and currency, and I’ve found it particularly interesting.
There are big differences between money and currency, though we collapse these two all the time. What are the differences and how might collapsing those two ideas be affecting us? Let’s first define both currency and money.
CURRENCY
Currency is a medium of exchange. There are a few considerations that make something a good currency. It needs to be portable. It needs to be not easily counterfeited. It needs to be widely accepted. It needs to be trustworthy. All of these factors determine whether something is a good candidate for being a currency.
MONEY
Money is a store of value. There are a few characteristics that make good money. Over the millennia, gold has been a good store of value over a long period of time. What makes gold be good as money is that its rare (based on physical rarity or tight supply/demand), portable, divisible, durable, fungible, and non-consumable. What makes something a good candidate for money is how well it maintains its purchasing power over time — a store of value.
WHY DOES THIS DISTINCTION MATTER
These two concepts often get confused. Paper currency backed by a government seems to work pretty well for being currency. However, paper currency doesn’t seem to be good at being money over longer periods.
THE HISTORY THE U.S. DOLLAR
In its history, the U.S. Dollar has been both currency and money. It started out being both. It was a store of value and a medium of exchange. While there have been various versions of a “gold standard” in the U.S., the dollar has spent most of its time being backed by gold.
In its latest iteration, the dollar was backed by gold as outlined in the Bretton Woods system right after WWII. The agreement tied all major world currencies to the U.S. dollar and the U.S. dollar to gold. The pivotal moment came in 1971 when Nixon pulled the U.S. off the gold standard. At that moment, our money really became currency. The U.S. dollar is used as a medium of exchange, but it is no longer a good store of value, especially over the long term.
PURCHASING POWER
So that we can compare apples to apples over time, we need to focus more on the purchasing power of our currency. Purchasing power is really the most important factor when determining how well currency is the store of value. The U.S. dollar has lost 95% of its purchasing power over the last 100 years, and it’s lost 40% of its purchasing power since 2000. To me, that shows that the dollar is a leaky boat when it comes to the test of how well it stores value over time.
BRINGING THIS HOME
Our parents used to highlight the value of saving money. I think it’s important to note that they learned personal finance back when the dollar was money; it was tethered to gold and it was a good store of value. The dollar is now really just currency, not money. It’s a good medium of exchange but not a good store of value.
What we used to think of as safe is now risky. Saving money in a savings account used to produce a nice return in the form of interest payments and the underlying value of the money saved was stable. That is no longer the case. We don’t earn much interest from a savings account (<1%), and the purchasing power of our saved dollar deteriorates over time.
My grandparents used to think of investing as risky, but now investing is really the new safe. Having an investment plan as a part of my family’s overall financial plan has become even more important. It allows us to increase our purchasing power over time. Saving money in a savings account is no longer safe; it’s risky.
The goal of long-term money is to store purchasing power for use in the future. Noting the difference between currency and money is going to help store purchasing power for the future. If each dollar you own is tied to a goal, you want to use currency for short-term goals for liquidity and ease of access. For long-term goals, you want to make sure you storing long-term value, through holding money or investing.
When you start to create or update your financial plan, consider the distinction between currency and money. See where that may affect your strategy and approach. Having a savings account is important for the goal of saving for emergencies because a savings account is liquid — having quick access to the funds. However, a savings account may not be as safe as you think for the long-term. Instead, think about an investing plan to maintain your long-term purchasing power. You can get more information about savings in my article “Level III — Create a Cash Cushion” and investing rituals in “Level IV — Start an Investment Account”.
For more, join us on Facebook, Twitter and if you want to receive latest weekly updates on Investing, Entrepreneurship & Personal Finance, feel free to subscribe to our NEWSLETTER.