What Does Money Measure Anyway?
Money numbers are ubiquitous
Almost all the numbers used in business and economics have money as the unit of measure. Money is the most common measure used throughout business to measure performance … the money expended, the money that is received, and then the profit. Most economic measures are expressed in money terms … and indexes are derivatives of money measures.
Money … a currency as a unit of measure
Cost, price and profit are very important numbers in money accounting related to all economic activity. Though modern society is founded on economic activity, there is a surprising lack of information about cost and value though there are massive datasets about prices. ... that is what a buyer pays for a product or services, and what prices stocks and other financial interests are trading at, what prices commodities are trading at, etc. There is by contrast almost no data about costs ... and even less organized data about value.
Corporate accountancy is only about money cost and money price. TVM uses cost, price and value. Cost, price and value are the three key numbers that describe economic activity. The relationship between these numbers determines the performance of almost any economic activity. All of these measures are important ... any one missing and the understanding of the dynamic of societal progress is compromised.
What is money?
Money as a metric used to be easy … its simple definition was that it was a medium of exchange and a store of value. The size of money was fixed relative to a given amount of gold. Gold was fixed in price relative to money and money was fixed relative to gold, or fixed relative to another system of money that was fixed relative to gold.
But all the simplicity disappears when the size of money is driven by market forces and economic decision makers rather than being related to a given amount of gold. With money no longer tied to gold but reflecting market forces and economic decisions the use of money as a metric becomes problematic.
What is wealth?
Wealth is a concept of the amount of economic good that there is. Wealth may be owned by an individual or family, or it may exist in the society at large. Typically wealth is measured in money terms.
Many global currencies
In the first half of the 20th century the UK Pound Sterling and the US Dollar were the dominant world currencies. In the post WWII era the UK Pound declined in importance and the US dollar became the dominant world currency. As the global economy has grown, many other currencies have grown in importance, and come to serve different needs.
For example, the Swiss Franc has become a safe haven currency, and the Japanese Yen came to represent the strength of the emerging Asian economies … and then years later the Chinese Yuan became another strong Asian currency reflecting the success of the huge emerging Chinese economy. Many of the European currencies were merged into a single European currency … giving the Euro currency grand scale, but limiting the room for monetary maneuver by the individual countries within the Euro Zone.
Money used for business metrics
Important that there is good understanding of what is cost, and what is price. From the view of the buyer, then the price paid is the cost. If it is the view of the seller, then the price paid is the price. Money cost is what gets paid for someone to have a good or service. Money cost is also the use of resources to create a good or service ... the aggregation of all the elements of cost that go into creating something. Elements of cost are things like: labor; materials; operating expenses, admin and overhead expenses, depreciation and financial costs.
There are very little easily accessible data about costs. In most good organizations, cost accounting is detailed ... and often very informative ... but also maybe overwhelming. Standard costs and variance analysis are methods that help clarify cost data, identify variations that need explanation and measure cost efficiency. Cost has multiple components, and one of the most useful data points for cost is the one that eliminates all the profit elements from the cost value chain. The socio-economic success of the last two centuries has been reduction in cost.
Price and revenue
Price is what a buyer pays for some good or service. It is what the customer pays at the supermarket or drug store. Price is what is being paid for the item ... price is the money received when an item is sold. For a buyer, the price is a cost ... something of a conundrum that confuses analysis!
Understanding price ought to be simple ... but is not. The price is usually framed in a way that makes comparison between different products as difficult as possible. This is no accident ... it is designed to confuse the customer and mis-inform as much as possible. Making comparison difficult is a standard practice in marketing.
There are also prices all the way along the value or distribution chain from factory gate to final retail sale. This chain sometimes involves changes in ownership, in which case there are prices that are reflected on invoices ... but the distribution chain may be under single ownership in which case there is no inter-organization price, merely a transfer price as the items moves along the distribution chain.
Price is also associated with the problem of affordability. People who need something may be poor and not have enough money to pay the price that the supplier can demand. This is a key issue in public policy for health, education and a number of other essential services needed by a progressing society such as water and sanitation.
And price may be value ... but usually is not. The price is merely what an item is traded at ... and may or may not have anything to do with value. Many factors influence price ... and where price is determined by market forces, there are many factor that influence the behavior of prices in a market.
Profit is the top metric of corporate performance … almost nothing else matters. In a simpler time, this was a reasonable situation, but in an era where corporate organizations are multinational and in many cases way larger than some national economies, the simple pursuit of profit creates many undesirable unintended consequences.
At its simplest, profit is the derivative of costs and revenues … reduce costs or increase revenues and profit increases. But what about tomorrow's profit … and what about social impact? These matters are not part of the profit metric, and not given much weight in the performance analysis of the company.
Over the past two decades there has been a powerful outsourcing movement … where costly activities in one country and moved to be done in another country where the costs are lower. The corporate impact is increased profit, and a related increase in stock price. The community impact, however, is an undesirable reduction in employment in the job losing community in one country that is matched by a desirable increase in employment in the job gaining country. Profit is the only metric and is the primary incentive that drives decision making … with community impacts being completely ignored.
Money used for economic metrics
Stock market price levels
The world of business news thrives on movements of the various stock market price indexes. Theses indexes are based on the stock price movements of relatively few stocks, yet have a great amount of weight in determining sentiment about the performance of society that is really unjustified. In the first place business profit performance is only about money performance ignoring social value and the relationship between profit and stock price may vary considerable because of perception about the state of the economy and the potential performance of the business over time.
Nothing in the stock market indexes relates closely to the quality of life of society. These indexes ignore the matter of social value almost totally.
Gross Domestic Product (GDP)
Gross Domestic Product (GDP) is another deeply flawed economic measure. It does not really reflect economic “product” but uses various proxies for economic activity and product that, over time, have distorted GDP in dangerous ways. In a closed “prosumer” economy … that is where production and consumption are essentially one and the same … it is reasonable to think of consumption as being a “product”. This is not a valid assumption where there are substantial trade flows and consumption and production have different behaviors over time. There are also problems with GDP in connection with many service sector activities including health and education. In the case of healthcare, the “product” is good health … which has little correlation with the amount of money that gets spent on healthcare.
Modern money … changing in size all the time
No longer a good standard for measurement
Money is a poor way to measure anything because it is changing all the time. This is bad for measurement, though it does have advantages for policy makers and those that ought to be held accountable for the socio-economic performance of society.
In simple terms the buying power of a US dollar of 2010 is something like 7 to 10 cents of a 1960 US dollar … and this may be a rather nice treatment of the 2010 US dollar. In terms of gold … gold, which used to be 36 US dollars an ounce in the gold standard era, now has a market price of around US$ 1,200.
The “size” or “value” of money is changing all the time. A measure should not change over time … but money does … it changes a lot.
I bought a house in New Jersey USA for $60,000 in 1976 … the same house sold for some $880,000 in 2006, 30 years later. This was not because the house had changed very much, but money and its buying power had changed a lot!
Inflation is often measured using various proxy measures like the Consumer Price Index (CPI) … and it is interesting that the CPI has not reflected much US inflation over the 20 year period 1990 to 2010. Why not? … and the simple answer is that many products were outsourced to low cost manufacturing locations so that money prices could stay the same and money profits go up. Meanwhile everything that was a US based production or service activity reflected quite substantial cost push inflation together with an associated pressure on profits.
Modern economic commentary does not differentiate rigorously between the various component of “inflation” … the price changes that are a result of “cost push” and the changes that are the result of “demand pull”.
Inflation is also affected by productivity … with improved productivity making it possible for prices to drop, and high pricing of inputs to goods and services making it necessary to have high prices.
Inflation is a complex outcome … but in itself not important. It is an almost meaningless money measure … not enough related to anything that is to do with value and the quality of life.
Money exchange rates
Money exchange rates are one of the major sources of global economic distortion. Basic economics of supply and demand make it possible to change exchange rates simply by the “printing money” and thereby debasing the currency.