• Travels of a Dollar

    May 22 • Money and Monetary Policy • 213 Views

    Having just followed the probable travels of a dollar bill at “wheresgeorge,” I’ve been thinking about money. Money is more than coin or paper currency. Because we can easily spend our demand deposits (checking accounts) and savings accounts, they too are money. Anything that people accept as payment, know the value of, and stores value can function as money. 

    At wheresgeorge.com, you can register a dollar bill and then trace its life if its holders record their transactions. Between Marc 5, 2002 and March 5, 2005, a certain dollar bill traveled from Dayton, Ohio to Rudyard, Michigan with stops in Kentucky, Tennessee, Florida, Texas, Louisiana, and Utah. Along the way, the dollar saw a food mart, a race track, and a McDonald’s. Its last recorded user said the bill “was getting pretty old looking.” At that point, we can guess that the bill was retired at a Federal Reserve Bank by someone’s local banker.

    According to the Federal Reserve, in 2007, located primarily abroad, there was approximately $829 billion of coin and paper currency in circulation. In the United States, if banks need more cash (maybe Mondays when ATMs are most popular), they withdraw it from the Federal Reserve bank in their area. On the other hand, when they have too much cash, banks take it to the Fed. At that time, the Fed destroys close to one third of the bills they receive.

    With the life span of a typical dollar 1.8 years, the bill traced by “wheresgeorge” lived to a ripe old age but not as long as most hundred dollar bills which live 7.4 years.  It cost the Bureau of Engraving and Printing four cents to make each bill. 

    The Economic Lesson

    All of this matters because the money supply has an impact on business activity. If there is too much money circulating, then its value can plummet. It fell so much in Zimbabwe recently that people needed wheelbarrows or U.S. money to buy milk. On the other hand, when there is too little money, producers have less incentive to create goods and services because people do not have enough money to spend. During the recent recession when credit froze, less money passed from hand to hand and businesses produced less.

    The Equation of Exchange, MV=PQ, illustrates the connection between the money supply and production (the G.D.P.). Here “M” equals the money supply; “V” is velocity, the number of times the same dollar is used; “P” is the average price of goods and services and “Q” is their quantity. 

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    More Taxing Decisions

    May 21 • Demand, Supply, and Markets, Economic Thinkers, Government • 233 Views

    Would you support a penny an ounce tax on sugar sweetened beverages? According to the NY Times and The New England Journal of Medicine, the idea is becoming increasingly attractive to many municipalities. By putting on our economic glasses, we can better decide whether to support it.

    First, we can ask whether society should be compensated for the cost it experiences from unhealthy behavior. Any cost absorbed by an “innocent” third party because of someone else’s behavior is called an externality. The tax would then be a payback. 

    To make up our minds, we can also assess the cost and benefit of the decision to tax sugary beverages. Diminishing obesity, increased intake of healthier foods, and decreased risk for diabetes, are several of the benefits associated with the impact of a soda tax. As suggested by one study, a 10% tax would decrease consumption by 7.8%. Meanwhile, on the cost side, we have the impact on manufacturers, on jobs, and the expense of implementing the tax. Some people believe the biggest cost, though, is the freedom we lose.

    Finally, we can focus on the tax itself. Opponents point out that the tax is regressive because when everyone pays the same amount, the less affluent feel a larger burden. By contrast, supporters ask us to focus on the revenue’s destination. If the soda tax becomes a “benefits received” levy, then the money would be destined for treatment of sugary drink related maladies.

    The Economic Lesson

    Named after economist Arthur Pigou (1877-1959), Pigovian taxes are levied on undesirable activities called negative externalities. At best, they eliminate the activity. But even when less successful, the revenue that is generated can be used productively.

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    Lessons for a Rainy Day

    May 20 • Businesses, Demand, Supply, and Markets, International Trade and Finance • 176 Views

    Last Tuesday was a bad day for most umbrellas. In New York City, it poured, it was windy, and most umbrellas were flipping out, blowing sidewards, and doing everything except what they were supposed to do.  It makes sense that someone should have invented a better umbrella. As economists, we have some answers about why no one has.

    On the demand side of umbrella markets, consumers are behaving rationally. Most of us easily lose umbrellas, they are not very durable, and they rarely provide a fashion statement. In fact, according to a recent WSJ article, 794 umbrellas were reported lost in New York’s Grand Central terminal and its Metro North line. The result? We want cheap umbrellas. With an average umbrella selling for $6, most consumers care more about price than progress.

    Knowing that umbrellas have to be inexpensive, sellers keep production costs low. Consequently, most umbrellas are made in countries such as China with lower labor costs. Innovate? There is little financial incentive to innovate if price and profit margins are low.

    Still though, several manufacturers are considering the high end. For the aspirational shopper and tech savvy individuals, umbrellas have countless possibilities. With additional wind tunnel research and experimentation with steel, fiber glass, aluminum, and other metals, a “souped-up” umbrella could develop a following. The 11% jump in umbrella sales during 2009 was on the high end of the market. Sellers of pricey umbrellas are even thinking of loss insurance to generate more interest.

    The Economic Lesson

    In order to understand the umbrella market, we need to look beyond demand and supply basics. Also, resource costs, the aspirational shopper, international trade and tariffs, research and development, and risk relate to buy and sell decisions. The umbrella is even reminiscent of the Model-T and its low price, high volume profile. Indeed, an umbrella is not just an umbrella.

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    Airplane Crashes and Financial Crashes

    May 19 • Economic Thinkers, Regulation • 183 Views

    When an airplane crashes, investigators rush to the scene, gather evidence, and ultimately hope to emerge with updated safety suggestions. It would be wonderful if we, when assessing the “flash crash” or slower stock market dives, could also diagnose the problems, identify the faulty mechanisms, and repair or redesign them. 

    George Mason economist Russell Roberts tells us, though, that financial crashes are very different from the world of aviation. He suggests that the financial world reflects the interaction of “investors, regulators, and politicians” in which the behavior of one group sets the other two in motion. Consequently, the permutations are infinite.

    His advice? He provides a short list from which I especially liked his reminder that “Capitalism is a profit and loss system.” He also says that “Policymakers who make creditors and lenders whole should be excoriated, condemned and called to account rather than praised and honored.”

    Your opinion?

    The Economic Lesson

    Perhaps economist Friedrich Hayek (1899-1992, the Austrian school) summed up our problem when he said “The curious task of economics is to demonstrate to men how iittle they really know about what they imagine they can design.” 

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    Public and Private Incentive

    May 18 • Businesses, Demand, Supply, and Markets, Government, Innovation • 187 Views

    For centuries, the US Postal Service delivered most of the mail. The job it did was satisfactory but not optimal. Yes, through sleet and snow, etc., we received our letters and packages but employees rarely focused on cutting costs and innovating. Two results? The USPS loses money each year and entrepreneurs create FedEx and UPS.

    Concerned about government’s inefficiencies, economic historian, John Steel Gordon, provided some history. The problem, we soon see, is the wrong incentives. Save money? Your budget decreases. Innovate? People might lose jobs. However, the 19th century British Navy had a solution. Seamen who captured enemy vessels shared the loot. A 21st century version could let bureaucrats share contemporary plunder. According to Gordon, any public employee who devised a cost saving initiative would receive some of the money saved or a financial regulator who uncovered massive fraud could receive a reward.

    My concern takes me back to incentives. In the former Soviet Union, no one ever figured out how to stimulate efficiency and productivity through government selected incentives. When people knew they would be rewarded for increasing production in a lamp factory, they produced lighter lamps. When the quota was weight, each lamp became heavier. All too frequently, bureaucratic incentives become perverse incentives that have unexpected consequences.

    The Economic lesson

    Adam Smith, in 1776, suggested that we are such a diverse population that no government individual could possibly know what is best for each of us. For that reason, he preferred the market and individual initiative as the source of a just and fair society. With 21st century government burgeoning, is it possible to create the incentives that would optimize its performance?

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