• / Free eNewsletters & Magazine
  • / My Account
Home>Research & Insights>Morningstar Conversation>Unraveling the Mysteries of Money

Related Content

  1. Videos
  2. Articles
  1. How Can I Protect My Portfolio From the Inflation Boogeyman?

    Northern Trust's Mark Carlson, State Street's Chris Goolgasian, and Merk Investments' Axel Merk discuss ways investors can hedge against rising inflation concerns, including the potential usage of commodities, gold, and TIPS, the effects of Fed action, and more.

  2. Round and Round Go Europe's Debt Problems

    Germany is hitting negative sovereign yields, while Spanish regions and banks seek financial assistance from their parent country, which needs a bailout of its own.

  3. Sharpen Your Portfolio Plan for 2014 and Beyond

    Roundtable Report: At the outset of 2014, Morningstar strategists dig into the market's current valuation and expected return, seek out high-quality U.S. and foreign stock opportunities, size up the role of cash today, assess the Fed's impact on the market, and reveal the best ways to fight inflation .

  4. Deciphering the Big Picture

    In Session 1 of the 2013 Morningstar Individual Investor Conference, Northern Trust's Katie Nixon, Charlie Bobrinskoy of Ariel, and Morningstar's Bob Johnson tackle today's macro questions on government policy, economic growth, inflation , and more.

Unraveling the Mysteries of Money

University of Chicago professors John Cochrane and Harald Uhlig debate money and economic policy during times of crisis.

Gideon Magnus, 08/14/2012

This article originally appeared in the August/September 2012 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000. 

View the related MorningstarAdvisor Magazine video

To many people, the way money works and its link to inflation is rather mysterious, despite its obvious importance in the economy. We take it for granted that the dollar bills in our wallets can be exchanged for goods and services, but what determines their value? Why does a Big Mac cost $3.45, and not $345?

Most people think of inflation as the price of goods and services rising, but really inflation is about the value of money going down. So, if we want to think about inflation or deflation, we have to think about what gives money its value. Are dollar bills intrinsically worthless pieces of paper that are nevertheless valued simply because everyone believes them to be valuable? Or is money perhaps a government liability, backed by an implicit guarantee that the government will be there, if necessary, to accept it in exchange for something of real value?

To get the answers to these questions, we invited two distinguished experts to Morningstar’s Chicago offices on June 8: John H. Cochrane and Harald Uhlig. Cochrane is the AQR Capital Management Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. Uhlig is a professor in economics and the chairman of the Department of Economics at the University of Chicago.

Before we get into our discussion about money, we need to define what money is. Money is basically an asset, just like a stock or bond. It is an asset, however, with some particular characteristics. It is both a unit of account and a medium of exchange. There are different types of money. The monetary base is money issued by the Federal Reserve, a bank owned and run by the federal government. Part of the monetary base exists in physical form (dollar bills and coins), or currency. The rest is electronic, or reserves, which are accounts that banks have at the Federal Reserve.

People tend to hold a fraction of their wealth in the form of money, because we need money to purchase goods and services and we obtain money when we sell them. How much money we hold depends on money’s returns. If the returns to holding money are very low (compared with other investments), we try to hold less money. This low return occurs during inflation, when money is losing value quickly. Conversely, people are willing to hold a lot of money during a deflation.

How much money we hold also depends on the overall level of economic activity—how much we’re buying and selling—and the costs of exchanging money for other assets. To hold very little money, you have to make a lot of trips to the ATM. Finally, people choose to hold a lot of money when the risks of holding other assets seem very high. We saw a massive increase in money demand during the financial crisis.

Gideon Magnus, director of quantitative research at Morningstar.

blog comments powered by Disqus
Upcoming Events
Conferences
Webinars

©2014 Morningstar Advisor. All right reserved.