The Secret of Aladdin's Cave

Think of this as Volume 17, Number 31 of the newsletter I have written weekly since March, 1997. Enjoy.

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Money that isn't working doesn't exist.

The world of fiction is filled with stories like that of Aladdin's Cave, where an innocent comes upon a huge stash of loot and becomes wealthy.

But here's the big secret of money, teased out over a long career covering business, finance and history.

The value of that money while it was in the stash? Nothing. The value of money sitting in a cave? Also nothing.

Money that isn't working has no value. When Aladdin tried to “spend” all those gems and gold he found in his cave, what mainly happened was that the value of gems and gold outside the cave went down. Some people probably found other things to trade with, things that had real value, value created by their scarcity in trade.

If an ancestor was trying to get a loan on their diamond ring after Aladdin came back from the cave, they probably left the pawn broker muttering curses on Aladdin's hide and soul.

Money is just a medium of exchange, a commodity. Any commodity worth anything becomes money when it's exchanged. But when you eat the bread made from the wheat that was traded on the Chicago Merc just last week, that bread becomes shit.

This is something conservatives can't get their heads around. It's why we managed to recover from the Great Recession.

What happened after the recession was that money went on strike. Money cowered in fear, inside vaults, and their equivalents. A lot of it went into gold, whose price boomed. While it helped that the President put some money to work, almost $1 trillion worth in the 2009 stimulus, the impact of that rolled off within about a year, and no more stimulus was forthcoming because conservatives don't know money.

Thus, we've been left with just monetary policy fueling our growth. The result is an economy annoyingly similar, in some ways, to the one we left behind during the Bush years.

In order to get the money that was being hoarded back to work, Fed chairman Ben Bernanke created more money. A lot more money. He pushed the value of loans toward zero and beyond. Eventually, bankers took this free money and found ways to make money with it. In the process of making loans on hard assets they bid up the price of those assets, assets like houses.

Despite what anyone tells you, there's a second housing bubble in America, created by all this free money. Houses shouldn't be worth what they're now worth, given the size of the underlying economy. A house, after all, is just a place to keep your stuff. It's only worth what people can pay for it, and they get that money from the real ecnomy. When we find better things to do with money – when the value of money inevitably goes down because it comes out of all the vaults and goes to work – we'll see that in relative terms we have a housing bust.

Money, you see, isn't really a noun at all. It's a verb. And it exists only in the marketplace. When it can be exchanged for other things, and used to create things.

What does this mean for policy? Once all the money comes back to work, money will be worth less. Physical goods – the things money can buy – will be worth more.

Oil is a bit like money, in that it's a valuable commodity. But it's also like the wheat in bread, because once it's burned there's nothing left but pollution it costs more money to clear out.

The real story of America today lies in the oil industry's renewed ability to bring oil and gas to the surface through fracking, and entrepreneurs' ability to coax more energy out of the Earth using technology. The Sun shines, the wind blows, etc.

Because we use so much energy, energy currently has a high price. Good for frackers, good for America. Drive through San Antonio sometime, in the center of the Eagle Ford shale boom, and watch out for those new SUVs and pick-ups bought with shale royalty money. A single barrel can be worth $22 to a landowner right now, and 25 mcf of gas the same. Money is coming out of the ground again.

With money coming out of the ground in America, and with fracking remaining controversial elsewhere (or even unnecessary), the price of oil stays up and we reap the benefits.

But what happens when there is more energy than we temporarily need? What happens as efficiency increases, as solar and wind costs continue to decline? The value of all energy goes down. Oil, as a commodity, falls in price, and marginal production is forced out of the market.

Thus the next recession comes more clearly into view. Lots of money, too much really, turning into inflation, with the relative value of money going down, along with the value of assets like oil. People claim today's era is bad for savers, but inflation is also bad, because you can't safely keep up with it from the interest a bank pays. They're in the business of buying money at one price and selling it at a higher one, after all.

At the same time money is losing value, so oil and gas will be losing their value. Once people start seeing a future where we need less oil and gas, the value of reserves in the ground will start to decline, and the incentive to exploit what's there, while its value is at its peak, goes up. That's the real match lighting the fire. Aladdin comes back from his cave with diamonds, people who need to eat go to the pawn broker with their diamonds, and the value of diamonds goes down. Better to be in food. Better, then, to be in stocks that create real value, companies that make stuff.

Whoever succeeds Bernanke then will have the same job Paul Volcker had a generation ago, reining in the money supply, causing new unemployment, until a new balance is restored. 

The best thing you can do with money is use it to create new value. The best thing you can do with money is put it to work, either lending it, or investing it in a money making enterprise, despite the risks, or in just spending it. Money makes the world go round, and when it's not doing that, the economic world just doesn't go around.

That's what I've learned about money.