3 questions about Americans and money

It’s a slow, rainy Sunday around here, which is as good an occasion as any to contemplate the mysteries of life. In that spirit, here are three questions I genuinely don’t know the answers to about Americans and their financial habits.

Why don’t Americans save in other currencies?

I’m fascinated by currency risk and have written before about exposure to currency risk in the context of long-term investing. But even outside the context of long-term investing, as far as I can tell Americans have no easy access non-dollar-denominated accounts, and even less interest in them.

Why would you want to save in euros, pounds, or yen? Well, because you plan to spend euros, pounds, or yen! If you’re planning a trip to the United Kingdom in June, 2019, you know for a fact that you’ll have to spend pounds for your accommodations, meals, transportation, and souvenirs. What you don’t know is what the exchange rate will be in June, 2019, so you have no idea how many dollars you’ll need to cover those expenses.

The sensible solution is to save not in dollars, but in pounds. This is perfectly legal, and it’s even possible, but only at great cost and inconvenience. For example, a nearby mall has a Travelex currency exchange booth where they’ll happily sell you pounds in exchange for dollars. But what then? You’ve got a stack of pounds you’ve got to do something with, and your bank doesn’t accept pound-denominated deposits.

The main thing I want to stress is how unusual this is. Every bank I know of in Russia allows customers to open accounts denominated in US dollars, euros, or Russian rubles. In Poland people took out home mortgages denominated in Swiss francs. There’s no technical or administrative barrier to denominating assets and liabilities in any currency you please; it’s a purely cultural barrier.

In principle I understand that it “feels” riskier to save in a different currency. You might lose money if the exchange rate moves against the currency you’re saving! But you might also end up having to take a shorter vacation, eat worse meals, and buy fewer souvenirs if the dollar drops against the currency in your destination. Ordinarily, that’s the kind of risk it makes sense to hedge against, and Americans don’t have a convenient way to do so.

As a travel hacker in my day job, I feel compelled to point out that it’s travel hackers and miles-and-points enthusiasts who really do “save” in a currency besides their home currency. The relative “stickiness” of hotel pricing in each hotel chain’s loyalty currency means you can relatively predictably know how many points a stay will cost: if the destination currency moves higher against your home currency, it’s unlikely the price in points will immediately react, while if the destination currency falls in value, you can pay with dollars instead (of course, “relatively” is doing a lot of work here; hotels move around in redemption cost all the time).

Why do Americans debt-finance everything?

This morning I came across a very strange story in the Washington Post, titled “The latest blow to struggling family farms: Rising interest rates.”

Broadly speaking, there are three ways to finance a business:

• raise money with debt;
• raise money with equity;
• and reinvest retained earnings.

There are of course variations on these themes, like mutual aid societies, Islamic finance, or rotating savings clubs, but the general idea is that you can either pay a fixed rate of interest for access to money, you can sell a share of your future profits, or you can reinvest the business’s profits instead of withdrawing them to spend.

While there is a theorem in economics that capital structure is “irrelevant” we know this is not true in the real world, and for obvious reasons: a firm that is certain of its success is likely to use debt financing in order to preserve as much profit as possible for its owners, while a speculative enterprise is more likely to use equity in order to put as little of the founders’ capital at risk as possible.

What is baffling to me, and what the Washington Post article above illustrates clearly, is that Americans are way, way too reliant on debt financing.

This is not entirely irrational. For example, under conditions of accelerating tuition and decreasing state support for higher education, debt financing (“student loans”) is a sensible response, since college students don’t typically have any prior earnings they could use to pay tuition, and the extremely wide distribution of incomes in American society means they would have to sign over an unacceptably high percentage of their lifetime income to raise equity financing.

Likewise equity financing of car purchases makes little sense, since virtually all cars are used for the same morning and evening hours so few people would want to share ownership of a depreciating asset (although there’s no reason coworkers couldn’t share ownership of a vehicle they are all able to carpool to work in).

All of this brings me back to the plight of the family farmers in today’s Washington Post. It seems obvious to me that they’ve made a simple mistake: they used debt financing instead of equity financing for an incredibly speculative enterprise. They thought they would be able to buy seed and equipment, and pay their farmhands, using borrowed money, then repay the borrowed amount with interest while turning enough of a profit on the sale of their crops to make withdrawals that meet their own personal spending needs.

Why did they think this? I have no idea.

Farming is a complex enterprise, forcing farmers to deal with a multitude of factors, but the one thing that isn’t complex about it is that commodity prices fluctuate, meaning each growing season’s profits is entirely out of the farmer’s hands. In other words, it’s a perfect candidate for equity financing, or financing out of retained earnings.

Someone who raises equity financing and promises to pay out profits in proportion to the ownership stake of their investors never needs to worry about rising interest rates. Someone who saves their profits in profitable years never needs to worry about lower commodity prices or rising interest rates, as long as their savings hold out.

Maybe the savings won’t hold out! But that’s a consequence of your inability to run a profitable business, which is obviously not something that rises to the level of national emergency.

Why do Americans take financial advice from commissioned salespeople?

In a whole range of commercial activities, Americans are some of the most skeptical people on the planet. We know used car salesmen are con artists, we know “extended warranties” are scams, we know “travel insurance” is a racket, we know rental car insurance is a joke.

But when it comes to financial advice, Americans are still rubes. Of course it’s not as bad today as when you would call up “your” stockbroker and ask what he (and it was almost always a he) thought was going up and what he thought was going down, send him your money, and cross your fingers.

But it hasn’t gotten a whole lot better.

Part of the problem is surely the famous “fear of missing out,” which means people are reluctant to “merely” earn the market rate of return on their savings as long they’re reading every day about bitcoin millionaires, venture capitalists, and private equity.

But it’s nonetheless true that smart, educated, professional people (the only people these days who have any excess income to invest) fall for the most preposterous scams imaginable, whether it’s variable annuities, actively-managed mutual funds, or whole life insurance policies. And I don’t have a good answer why our natural skepticism breaks down when confronted with a sufficiently analgesic Powerpoint presentation.

When it comes to insurance Americans at least have the excuse that it’s literally illegal to sell policies on anything but a commission basis. But that does nothing to explain the love affair of American investors with stock brokers who are paid to rip them off.