The Difference between Affluent, Rich, and Super-Rich

One of the best things I’ve read this week is Ben Casnocha’s blog post titled “The Goldilocks Theory of Being Rich” on what it means to be rich. In the post, Ben correctly posits that today there’s a very small difference between the rich and the American middle class in terms of quality of life. In the post, Ben differentiates among affluent, rich, and the super-rich…

The actual best part about being super rich, as far as I can tell, is this: You’re more likely to feel like you led a life of meaning. You might not be happy all the time or most of the time, but you will feel like your time on this earth counted for something. One way to distinguish happiness from meaning is that happiness is the day to day bounce of emotions while meaning is what you feel when you step back, take a minute, and reflect on what will go in your obituary. (Here’s my post on meaning vs. happiness.)

How so? The feeling of meaning and making a difference manifests in real, concrete ways. Someone like Meg Whitman can walk the HP campus and see thousands of employees who support their families thanks to employment at HP; she can read stories about the millions of people who use HP products every day to be better at their job. That imbues her life with a sense that her life matters. If you don’t have a corporate campus to walk around—if, for example, you’re an options trader and not a builder of things—fear not. With a supple bank account, you can still take actions that generate meaning. Write big checks to charity and you’ll get thank you notes from the children at the public school you helped. You’ll get enough feel-good ooze from your charitable giving to last you a lifetime. Entrepreneur and billionaire Marc Benioff has said, “Nothing is going to make you feel better. Philanthropy is absolutely the best drug I’ve ever taken.”

I liked this analogy posited by Tim O’Reilly:

…money is like gasoline while driving. You never want to run out, but the point of life is not to go on a tour of gas stations.

The distinction between affluent, rich, and super-rich:

Maybe wealth needs its own Goldilocks porridge story: you want not too much, not too little. And I think that ideal middle ground is the “Rich” category in the hierarchy I opened with. More crudely, this ideal amount of money is termed “fuck-you money.” With fuck you money, you can’t fly around the world on a private jet (so you’re not as rich as the Super Rich) but do you have the power to say fuck you to essentially anyone or anything that doesn’t interest you (which means you’re richer than the merely affluent).

Put another way, if you work on stuff that doesn’t excite you for more than one day a week, in my estimation you do not have fuck-you money. You’re still working for the man. At the other end of the spectrum, if you find yourself being invited to more than a few charity galas a year, worrying about physical and cyber security at your home, and asking a PR person to review your public statements, you have a lot more than fuck-you money and all the corresponding drawbacks.

Definitely worth reading this thought-provoking post in its entirety.

Kevin Kelly on Time vs. Money

Insightful take from Kevin Kelly on the valuation of time vs. money:

When you are older, you tend to have more money than time. If you have only two week vacation, you need to rush things so you can keep your job. You’ll pay to fly in to the hotspot rather than spend your two weeks in the back of the bus getting there. You’ll pay extra for the express train because it will save you a day — and its clean bathrooms will delight your 12-year-old daughter. Maybe you hire a guide to take you directly to the festival instead of wasting an afternoon wandering around. With money you can eat whatever you desire.

Here is what I learned from 40 years of traveling: Of the two modes, it is far better to have more time than money.

Time is the one thing you can give yourself in abundance. It is often the one resource the young own…

Explaining How Money Works to a Five-Year-Old

One reddit user was confused about the current financial crisis and posed the following question:

Where is all the money? I hear nothing but bad news about financial crisis all over the world, and it seems that there is a shortage of cash – like it is some sort of natural resource.

People haven’t stopped buying stuff. They still need food, clothing, medicine, shelter. Taxes are still collected. Fines are still levied.

So where is all the money? I mean, labor has been produced to make things and wages paid to the laborers. The things are purchased by other laborers, who were paid for producing goods or services, etc. It’s a closed loop, right?

And he wanted it explained as though he were a five-year-old. So in steps user otherwiseyep who offers the following detailed explanation. It’s excellent and well-worth the read:

All actual “money” is debt. All of it, including monetary gold, etc. (Don’t argue with me yet, I’ll get to that.)

Imagine a pretend world with no money, some kind of primitive villiage or something. Now let’s invent paper money. You can’t just print a bunch of paper that says people have to give you stuff, because nobody would honor it. But you could print IOUs. Let’s walk through this…

  • Let’s say you’re an apple-farmer and I’m a hunter. You want some meat but haven’t harvested your crops yet. You say to me, “hey, go hunt me some meat and I’ll give you 1/10th of my apple harvest in the fall”. Fair enough, I give you meat, you owe me apples. There’s probably a lot of this kind of stuff going on, in addition to normal barter. In time, standard “prices” start to emerge: a deer haunch is worth a bushel of apples, or whatever.
  • Now, let’s say a week later, I realize that my kid needs a new pair of shoes more than I need a bushel of apples. I come back to you and say, “Hey remember that bushel of apples you owe me? Could you write a marker, redeemable for one bushel of apples, that I can give to the shoemaker in trade for a pair of shoes?” You say okay, and we have invented a transferable note, something a lot like money.
  • In time, our little villiage starts to figure out that a note redeemable for a bushel of apples can be swapped for all kinds of things. The fisherman who doesn’t even like apples will accept apple-certificates in trade for fish, because he knows he can trade them to boat-builder who loves apples. In time, you can even start to hire farm-workers without giving them anything except a note promising a cut of the future harvest.

Now, you are issuing debt: a promise to provide apples. The “money” is a transferable IOU– your workers get a promise to provide value equal to a day of farm-work, or whatever, and it’s transferrable, so they can use it to buy whatever they want. The worker gets fish from the fisherman, not in exchange for doing any work or giving him anything he can use, but in exchange for an IOU that the fisherman can redeem anywhere.

So far so good. But there are a couple of forks in the road here, on the way to a realistic monetary system, that we’ll address separately:

  • What happens if your apple orchard is destroyed in a wildfire? Suddenly all the notes that everyone has been trading are basically wiped out. It didn’t “go” anywhere, it’s just gone, it doesn’t exist. Real value was genuinely destroyed. There is no thermodynamic law of the conservation of monetary value– just as you and I created it by creating transferable debt, it can also be genuinely destroyed. (We’ll get back to this in a minute, it gets interesting).
  • The second issue is that, in all probability, the whole town is not just trading apple-certificates. I could also issue promises to catch deer, the fisherman could issue promises of fish, and so on. This could get pretty messy, especially if you got the notion to issue more apple-certificates than you can grow: you could buy all kinds of stuff with self-issued debt that you could never repay, and the town wouldn’t find out until harvest-time comes. Once again, value has been “destroyed” people worked and made stuff and gave you stuff in exchange for something that doesn’t exist, and will never exist. All that stuff they made is gone, you consumed it, and there is nothing to show for it.

The above two concerns are likely to become manifest in our village sooner or later, and probably sooner. This leads to the question of credit, which is, at its most basic, a measure of credibility. Every time you issue an apple-certificate, you are borrowing, with a promise to repay from future apple-harvests.

After the first couple of town scandals, people will start taking a closer look at the credibility of the issuer. Let’s say the town potato-farmer comes up with a scheme where his potato-certificates are actually issued by some credible third-party, say the town priest or whatever, who starts every growing season with a book of numbered certificates equal to the typical crop-yield and no more, and keeps half of the certificate on file, issuing the other half. Now there is an audit trail and a very credible system that is likely to earn the potato-grower a lot of credit, compared to other farmers in town. That means that the potato-grower can probably issue more notes at a better exchange rate than some murkier system. Similarly, the town drunk probably won’t get much value for his certificates promising a ship of gold.

Now we have something like a credit market emerging, and the potato-farmer is issuing something closer to what we might call a modern “bond”…

  • So some time goes by and people start catching onto this system of credit-worthiness, and farmers and fishermen and so on start to realize that they can get better value for their IOUs by demonstrating credibility. People with shakier reputations or dubious prospects may not be able to “issue money”, or might only be able to do so at very high “interest”. E.g., a new farmer with no track-record might have to promise me twice as many potatoes in exchange for a deer haunch, due to the risk that I might never see any potatoes at all.
  • This obviously gets very messy fast, as different apple- and potato-certificates have different values depending on whether they were issued by Bob or Jane, and everyone has to keep track of and evaluate whose future apples are worth what.
  • Some enterprising person, maybe the merchant who runs the trading-post, comes up with the idea to just issue one note for all the farms in town. He calls a meeting with all the farmers, and proposes to have the town priest keep a book of certificates and so on, and the farmers will get notes just like everyone else in exchange for the crops they contribute to the pool, and the merchant will keep a cut of the crops with which to hire some accountants and farm-surveyors to estimate the total crop yields across town and so on.
  • Everyone agrees (or at least, enough farmers agree to kind of force the other ones to get on-board if they want to participate meaningfully in the town economy), and we now have something like a central bank issuing something like fiat currency: that is, currency whose value is “decided” by some central authority, as opposed to the kind of straight-up exchange certificates that can be traded for an actual apple from the issuer, for example.
  • Now we have something that looks a lot like a modern monetary system. The town can set up audit committees or whatever, but the idea is that there is some central authority basically tasked with issuing money, and regulating the supply of that money according to the estimated size of ongoing and future economic activity (future crop yields).
  • If they issue too much money, we get inflation, where more apple-certificates are issued than apples grown, and each apple-note ends up being worth only three-quarters of an apple come harvest-time. If they issue too little currency, economic activity is needlessly restricted: the farmers are not able to hire enough workers to maximize crop yields and so on, the hunter starts hunting less because his deer meat is going bad since nobody has money to buy it, and so on.

At this point, you may be asking, “Why the hell go through all this complexity just to trade apples for deer and shoes? Isn’t this more trouble than it’s worth?”

The answer is because this is a vastly more efficient system than pure barter. I, as a hunter, no longer need to trade a physical deer haunch for a bushel of apples to carry over to the shoemaker in order to get shoes. You, as an apple-farmer, can hire workers before the crop is harvested, and therefore can grow more, and your workers can eat year-round instead of just getting a huge pile of apples at harvest-time to try and trade for for whatever they will need for the rest of the year.

So back to money…

The thing to remember is that all throughout, from the initial trade to this central-banking system, all of this money is debt. It is IOUs, except instead of being an IOU that says “Kancho_Ninja will give one bushel of apples to the bearer of this bond in October”, it says “Anyone in town will give you anything worth one bushel of apples in trade.”

The money is not an actual thing that you can eat or wear or build a house with, it’s an IOU that is redeemable anywhere, for anything, from anyone. It is a promise to pay equivalent value at some time in the future, except the holder of the money can call on anybody at all to fulfill that promise– they don’t have to go back to the original promiser.

This is where it starts getting interesting, and where we can start to answer your question…

(for the sake of simplicity, let’s stop calling these notes “apple certificates”, and pretend that the village has decided to call them “Loddars”).

  • So now you’re still growing apples, but instead of trading them for deer-haunches and shoes, you trade them for Loddars. So far, so good.
  • Once again, you want some meat, except harvest time hasn’t come yet so you don’t have any Loddars to buy meat with. You call me up (cellphones have been invented in this newly-efficient economy), “Hey otherwiseyep, any chance you could kill me a deer and I’ll give you ten Loddars for it at harvest-time?”
  • I say, “Jeez, I’d love to, but I really need all the cash I can get for every deer right now: my kid is out-growing shoes like crazy. Tell you what: if you can write me a promise to pay twelve Loddars in October, I can give that to the shoe-maker.” You groan about the “interest rate” but agree.

Did a lightbulb just go off? You and I have once again created Money. Twelve loddars now exist in the town economy that have not been printed by the central bank. Counting all the money trading hands in the village, there are now (a) all the loddars that have ever been printed, plus (b) twelve more that you have promised to produce.

This is important to understand: I just spent money on shoes, which you spent on deer meat, that has never been printed. It’s obviously not any of the banknotes that have already been issued, but it’s definitely real money, because I traded it for new shoes, and you traded it for a dead deer.

  • Once you and I and others start to catch on that this is possible, that we can spend money that we don’t have and that hasn’t even been printed yet, it is entirely possible for a situation to arise where the total amount of money changing hand in the village vastly exceeds the number of loddars that have actually been printed. And this can happen without fraud or inflation or anything like that, and can be perfectly legitimate.
  • Now, what happens if another wildfire hits your orchard? Those twelve loddars are destroyed, they are gone, the shoe-maker is twelve loddars poorer, without spending it and without anyone else getting twelve loddars richer.

The money that bought your deer and my shoes has simply vanished from the economy, as though it never existed, despite the fact that it bought stuff with genuine economic utility and value.

The above pretend history of the pretend village is not how modern money actually came to be. In reality, things are much less sequential and happen much more contemporaneously without the “eureka!” moments. The above was a parable to illustrate how money works to a 5-year-old, not an actual history of how money emerged.

Until fairly recent times, paper money was not really very useful or practical for most purposes, especially if you wanted to spend money in a different village than where it was printed.

If we go back in time a period before ATMs, wire-transfers, widespread literacy, etc, then a piece of paper written in Timbuktu is not likely to get you very far in Kathmandu. You could take your apples and deer-haunches and shoes around with you to trade, but the earliest naturally-emerging currencies tend to be hard things that were rare and easily-identifiable (jewels, colored shells, etc), and they frequently coincided with the personal decorations of the rich, in a self-reinforcing feedback loop (people with a surplus of time and food could decorate themselves with pretty things, which became valuable as status symbols, which made them more valuable as decorations, which made them more valuable as barter objects, which made them more prestigious shows of wealth, etc).

Gold emerged as a sort of inevitable global currency, before people even thought of it as currency. It is rare, portable, easy to identify, can easily be made into jewelry, and can be easily quantified (unlike, say, jewels or seashells, which are harder to treat as a “substance”). Once word got around that rich people like it, it became easy to barter with anyone, anywhere, for anything.

In the early stages, it was not really the same thing as “money”, it was just an easy thing to barter. But it had money-like characteristics:

  • If someone walked into your apple-orchard offering to trade a yellow rock for apples, you might look at them a little funny. What use does an apple-grower have for a yellow rock?
  • But if you know that rich people in town covet this soft yellow metal as something they can make jewelry out of, then you might be happy to trade apples for it.
  • Once everyone knows that rich people will trade for this stuff, it becomes something like actual currency: neither the hunter, the shoemaker, nor the fisherman in town has much use for it, but because they know they can redeem it for the stuff they do want and need, it becomes a sort of transferable IOU that can be redeemed anywhere, i.e., money.

The early history of paper money did not evolve the way I described in the earlier posts (although it could have, and would have got to the same place). Instead, the early history of paper money was certificates issued by storage-vaults of precious metals (i.e., early “banks”). Instead of carrying around yellow and silver rocks, you could deposit them somewhere and get a piece of paper entitling the holder to withdraw a certain quantity of gold or silver or whatever.

(via reddit)

On Investments and Time

Paul Graham, in this essay from 2010, makes a great point on investments (both in terms of money and our use of time):

In most people’s minds, spending money on luxuries sets off alarms that making investments doesn’t. Luxuries seem self-indulgent. And unless you got the money by inheriting it or winning a lottery, you’ve already been thoroughly trained that self-indulgence leads to trouble. Investing bypasses those alarms. You’re not spending the money; you’re just moving it from one asset to another. Which is why people trying to sell you expensive things say “it’s an investment.”

The solution is to develop new alarms. This can be a tricky business, because while the alarms that prevent you from overspending are so basic that they may even be in our DNA, the ones that prevent you from making bad investments have to be learned, and are sometimes fairly counterintuitive.

A few days ago I realized something surprising: the situation with time is much the same as with money. The most dangerous way to lose time is not to spend it having fun, but to spend it doing fake work. When you spend time having fun, you know you’re being self-indulgent. Alarms start to go off fairly quickly. If I woke up one morning and sat down on the sofa and watched TV all day, I’d feel like something was terribly wrong. Just thinking about it makes me wince. I’d start to feel uncomfortable after sitting on a sofa watching TV for 2 hours, let alone a whole day.

And yet I’ve definitely had days when I might as well have sat in front of a TV all day—days at the end of which, if I asked myself what I got done that day, the answer would have been: basically, nothing. I feel bad after these days too, but nothing like as bad as I’d feel if I spent the whole day on the sofa watching TV. If I spent a whole day watching TV I’d feel like I was descending into perdition. But the same alarms don’t go off on the days when I get nothing done, because I’m doing stuff that seems, superficially, like real work. Dealing with email, for example. You do it sitting at a desk. It’s not fun. So it must be work.

With time, as with money, avoiding pleasure is no longer enough to protect you. It probably was enough to protect hunter-gatherers, and perhaps all pre-industrial societies. So nature and nurture combine to make us avoid self-indulgence. But the world has gotten more complicated: the most dangerous traps now are new behaviors that bypass our alarms about self-indulgence by mimicking more virtuous types. And the worst thing is, they’re not even fun.

Do you have days like the ones Paul describes? The day breezes by, and you seem like you’ve accomplished nothing?

On Moral vs. Contractual Obligations

From a very good personal story in The New York Times, about a financial planner who ended up losing his house:

Borrowing that much had seemed to make sense when the value of the home was still rising substantially every year, taking our net worth higher with it. But at that point, there was no way we could sell the home for anywhere near what we owed. Some of my friends were already doing short sales, where the bank agrees to let you sell the house for less than your loan balance. I was also aware you had to be three months behind in your payments before the bank would talk to you about the possibility.

At first, I dismissed the idea of a short sale. Late that summer, I sat down with a really close friend in Las Vegas, someone I looked up to. He cut to the heart of the matter right away: Why, he wanted to know, were we still making the payments?

Because I have a moral obligation, I said. You pay your debts.

He proceeded to explain that I didn’t have a moral obligation to the bank. I had a moral obligation to my family. I had a contractual obligation to the bank, along with a clear moral obligation to be honest in my dealings. What he was asking was this: Which is more important? Your contractual obligation to the bank or your obligation to your family to preserve your ability to make a living?

I had never thought of it that way. But it made sense. I summed it up to myself like this: I have a contractual obligation to the bank (as well as a moral obligation not to skirt the consequences of breaking it: losing my house and wrecking my credit score). But my moral obligation to my family trumps the contractual obligation to the bank.

I found this paragraph particularly enlightening. Do not be quick to judge others’ financial habits:

For one thing, I am less quick to judge other people’s financial behavior. I’m also more inclined to take into account personal factors that determine how people behave around money.

I have a friend who is going through a tough time financially. He has a high income, but is burdened by debt from a few real estate deals that went south. He continues to take fairly expensive ski trips. That would seem irresponsible in his situation, and maybe they are.

But I now realize that it is not that simple. Maybe those trips are keeping the guy alive, or saving his marriage or keeping him sane enough to work.

The author of the piece, Carl Richards, is coming out with a book The Behavior Gap: Simple Ways to Stop Doing Dumb Things With Money early next year.

Paul Graham on Wealth

I can’t remember how I stumbled upon Paul Graham’s classic 2004 essay on wealth, but I am glad I re-read it last night. Excerpt below:

Wealth is the fundamental thing. Wealth is stuff we want: food, clothes, houses, cars, gadgets, travel to interesting places, and so on. You can have wealth without having money. If you had a magic machine that could on command make you a car or cook you dinner or do your laundry, or do anything else you wanted, you wouldn’t need money. Whereas if you were in the middle of Antarctica, where there is nothing to buy, it wouldn’t matter how much money you had.

Wealth is what you want, not money. But if wealth is the important thing, why does everyone talk about making money? It is a kind of shorthand: money is a way of moving wealth, and in practice they are usually interchangeable. But they are not the same thing, and unless you plan to get rich by counterfeiting, talking about making money can make it harder to understand how to make money.

Highly recommend reading the whole thing. It’s long, but it’s worth it.

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Question of the day: What is wealth for you?