Handling Finances

When I traveled to London, England recently, I found that my money was only worth half what it was in America.  In other words, I got half as much as the same money would have purchased at home.  That got me wondering what my money is actually worth.  My bills claim to be “legal tender for all debts public and private” but what does that mean and why does the same dollar buy half as much (in terms of both goods and British Pounds) in England?

A Brief History of Money

Early currency was simply representative of various goods.  Precious metals were used to represent things like grain or livestock.  The first coins allowed for easier transactions and let merchants travel and do business without having to carry around all their goods.  Coins also allowed for the first accounting system and allowed people to store wealth more easily than maintaining and guarding large caches of food or large herds of animals.  In Europe, gold, silver and copper were used as currency because there was a fixed amount of each metal in the civilization.  A person could be reasonably sure your gold would be just as valuable next year since it wasn’t being mined and so inflation wasn’t much of an issue with the basic coins (though of course commodities would fluctuate in value according to supply and demand).

Coins were a huge innovation, but they were still rather difficult to haul around and trade in large quantities.  Banknotes were issued in China around 1000 AD and were redeemable for coins or goods on a regional basis.  A more universal Chinese currency was introduced around 1250 AD o make long-range trading easier.  At the same time, paper currency and many financial constructs like savings accounts and exchange rates were being developed independently in the Islamic culture.

In Europe, paper currency was somewhat less orderly as governments had a tendency to print more money than they had resources.  In other words, if everybody redeemed their currency, the government would run out of coins and goods promised on the notes.

So what are dollars worth now?

Ever since the United States ended its agreement to convert dollars to gold in 1971, American dollars have been worth only what two parties are willing to exchange for American dollars.  Of course, since the US government only accepts US dollars as payment of taxes, the US dollar will be good to get the IRS off your back as long as the IRS exists (and keeps the current policy).  This is known as a ‘fiat currency’ as the US dollar’s value is defined by fiat.  That’s no small thing, and the perceived stability of the US government is a large part of why many other world currencies are pegged to the dollar and many markets (even overseas) do business in US dollars.

If the US government wanted to spend more money, they could simply print more bills, but the more they printed, the easier it would be for people to get their hands on bills to pay taxes and as with any situation of supply vs. demand, the value of each dollar would decline resulting in inflation.  If the government were to print way too many bills (as in Germany after WWI when huge reparations exceeded the amount of money they could take in in taxes) the bills can become totally worthless as citizens find that their cash is worth more as toilet paper fuel for heating fires than as currency.

It seems weird in a way to be dealing with money that is only representative of future taxes.  While it legally must also be accepted for debts in America (like credit card debt or to settle a resturaunt bill when you pay after you eat) there is no legal reason a supermarket would have to accept cash as payment for food.  Yes, they’ll lose a lot of business if they only accept gold bullion or Euros, but it’s at least possible.

It’s a funny world where we go around exchanging little green pieces of paper, but it’s better than lugging around piles of gold coins.  It’s also much easier to control the supply of US dollars than it is to control the supply and demand of a precious metal like gold when gold can be found and dug up much more easily than in midieval times.  I suspect that in the far future, we’ll do away with paper and coin money altogether and move to an entirely electronic financial system.  We might even end up pegging our monitary system to something that’s useful to everybody — like energy (what good would cashing in your dollars for gold REALLY do you)?  Until then, we’ll just have to keep doing business in our governments’ future taxes and simply be thankful we don’t have to carry around wagons full of wheat, chests full of gold, or strings of rare seashells when we go shopping!

When I started this blog, my net worth was right around zero, I’d paid off my student loans and had just landed a great new job.  Even with a trip to London, a new digital camera, and the occasional car repairs, our net worth is climbing between $2,000 and $5,000 a month.  While I’m confident this is sustainable, it’s not really how we plan to live long-term.  My wife would very much like to quit her nanny job and volunteer more.  We’re also looking at buying a house and then making, buying and renting children (through pregnancy, adoption and foster care) so we’ll be paying interest instead of earning interest and our costs will increase.  At the same time, if we can continue to save just over $2,000 per month (including part of our house payments that goes toward principal) and don’t turn rabidly materialistic in the next couple of years, I think we’re in good shape to hit this goal.

My net worth is computed very simply.  I add together my retirement accounts and my savings accounts and subtract my credit card debt (which is paid off each month).  In Quicken this is automatic so the only thing I have to do is review the transactions to make sure everything is copacetic.  I purposefully don’t add in the value of our two cars as they’re both worth no more than a couple thousand dollars and we intend to drive them until they’re more trouble than they’re worth.  If I purchase a new car someday I might include it in my net worth, but even then I suspect I’d prefer to treat it as spent money rather than an asset I can buy or sell.  When I purchase a house, that will certainly be included in my net worth.

Quicken doesn’t track all my money as the $500 I’ve put into Prosper isn’t included and my wife has an account she uses for selling Avon that I choose not to track, but overall it gives a good picture of my financial situation.

It’s hard for me to think about reasonable and useful goals more than a few years in advance so I just figured I’d set my first longer-term goal at the arbitrarily significant figure of $100,000.  A little math showed me that I’d hit it by or at least in 2010 if our cash flow stays reasonably static so that’s what I’ll shoot for.  If history is any guide, that’ll be somewhere around half in retirement savings so I’ll have a good start on avoiding dog food when I’m too feeble to play with lasers.

Having spent the last week in London, I’m still a bit jet-lagged, but quite happy. It was my wife’s first time to another country (barring Canada) and happily she loved it! London’s pretty benign with their amazing and convenient subway system and although it’s an expensive place to visit, we kept our spending rather low and didn’t skimp on sightseeing one bit!

My first bit of advice regarding overseas travel, however, is much more basic and applies virtually worldwide.  Get a credit or debit card that charges low fees! Visa and Mastercard both charge 1% for foreign (non-US) purchases, and while most card issuers charge another 2% for a total of 3%, many smaller banks don’t add on any fees and Capital One actually eats the 1% Visa/MC fee and charges 0%.  I didn’t do my research ahead of time, so I got stuck with 1-3% on most of my purchases (1% on my debit card and 3% for a couple credit card purchases) and while that was only about $40, I hate to throw away money that’s not necessary!  To be fair, I understand the fees — processing transactions in England does cost the banks more, but when competition drives down the amount I have to pay, I’m happy to shop around!

I paid for most of my trip with cash taken out of ATMs every other day or so — a very convenient and reasonably secure way to deal with foreign money.  When dealing with ATMs though, it’s important to go only to ATMs that are physically connected to major banks.  You can shop around for the ones with no fees, but if you take out your money at ATMs of the money-changers that set up at every airport and tourist attraction, you can pay as much as 2-5% more than you would at a major bank’s ATM.