Wise Bread (Philip Brewer)

How to Not Be a Debt Slave

Philip Brewer — Wed, 01 Feb 2012 11:24:26 +0000

It's best not to get in debt at all, of course, but it's easy to accumulate debt without even really thinking about it. Your parents and guidance counselors tell you that a first-rate college education is worth it "no matter the cost," so you sign the loan papers to borrow whatever the financial aid office says you need to borrow. (See also: Student Loans: How to Make Post-College Decisions)

Even if you have second thoughts before the end of the first semester, you're already on a path that's pretty hard to get off of. Because, after all, what are your choices? Aside from the option of being a deadbeat, which is pretty unappealing, you really only have one — proceed to get an education, get a job, and put in as many years as it takes to pay off that debt.

The deadbeat path is a poor choice, especially for student loans (which generally can't be discharged in bankruptcy, although there is a new program for eventually escaping student loan debt).

This is because your creditors have serious powers to extract money from you:

They can seize any collateral that you pledged for your loan (although usually they'll only go to the trouble for the big stuff — your house, your car, your business).
They can seize any amount that you have in bank accounts (although your retirement accounts and anything you have coming to you from Social Security are supposed to be protected).
They can force your employer to give a big chunk of every paycheck to them — even if it's less than your minimum payment, meaning that your debt is still growing every month.

They can't technically have the police throw you into jail for not paying your debts — but they can have the police throw you into jail for failing to respond correctly to each and every item of paperwork when they sue you. And, since you can't afford a lawyer, that amounts to pretty much the same thing.

Does this amount to slavery? I think so. On the scale of historical forms of slavery, the level of violence is pretty low, but your freedom is severely constrained — you either do whatever it takes to make each and every debt payment, or your creditors will ruin your life.

There's only one good way to escape debt slavery, which is to buy your way out. If you earn a lot of money (or life cheaply enough), you can pay your debt down at an accelerated rate. This particular path makes a great story, because it's just an extreme version of the sort of "right living" that our culture supports.

The path is easy to describe, even if it's not so easy to do:

Boost your income and cut your expenses, to generate a surplus.
Make the minimum payments on all your debts (to do otherwise would be to rack up serious fees and penalties).
Pick one debt to pay off first, and apply all your remaining surplus to that one debt.
As each debt is paid off, roll the minimum payment for that debt into the surplus and repeat the process with the next debt. (This is called the "snowball method," for the way the surplus builds as each debt is paid off and its minimum payment can be rolled in.)

Better to avoid debt altogether, if you can.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Voluntary Slavery

Philip Brewer — Fri, 13 Jan 2012 11:00:18 +0000

When you think of slavery, you probably think of the brutal and violent sort of slavery, such as existed in the United States until the Civil War. But voluntary (or semi-voluntary) slavery has existed since ancient times. (See also: Wage Slave, Debt Slave)

In the minds of most people, slavery is defined by violence. Slaves were taken by force, held by force and compelled to work by force. But long before the present day there has been slavery with less violence. For example, the Bible provides a thoroughly worked-out set of rules for semi-voluntary slavery, under which the head of the family could sell family members into slavery to cover the family's debts. (The rules provided that you couldn't sell family members into perpetual slavery. They had to be given their freedom within no more than seven years.)

Even indentured servitude — a particular kind of voluntary slavery — used the threat of violence to compel labor, with police power used to keep people from reneging on their agreement to serve.

What I find so striking about society today is that we've just about gotten rid of the violence without getting rid of the slavery.

When I've talked about wage slavery and debt slavery before, I've gotten some criticism — "It isn't slavery if it's voluntary!" But I don't think that's true. As I said, voluntary slavery has existed since Old Testament times at least. But I don't want to argue about whether what we have now should be called slavery. I want to argue that, whatever we call it, it's an evil system. It's bad for the people who are trapped in it, and it is bad for the rest of us.

It's not the violence that makes slavery evil, so the evil does not disappear just because the violence has been (mostly) withdrawn. In the run-up to the civil war, there was a lot of propaganda to support slavery. One large category used images of "kindly masters" and "happy slaves" to disguise the brutality of the system. But that kind of propaganda never worked, because slavery is evil even without brutality. The true evil of slavery is that it denies people their freedom.

And yet, my critics have a point. Why should I complain about other people's voluntary choices?

I guess I complain for two reasons.

First, it makes me sad to watch. Sure, there are many who do fine in the system. The people I used to work with — software engineers, mainly — did pretty well. They led very comfortable lives, and their job skills meant that they were less trapped than many others — if something about their current job didn't suit, they could always find another that paid about as well. Others — most others — did not do so well.

But the pain of having to stand by and watch as people lock themselves into the gentle chains of wages and debt is only the smaller part of the reason I complain.

The bigger reason is that we all suffer when people aren't free. When people are dependent, they are constrained from doing what's right.

This was Thomas Jefferson's point when he wanted a nation of yeoman farmers. If you're beholden to the bosses, managers, owners, and financiers, you're constrained from following your own best judgment. At some level, you're always considering the interests and desires of your employer, your banker — and the government, which is all the more necessary, because its rules are all that protect you from the bosses and the financiers.

Voluntary slavery is nothing new. But even voluntary slavery is evil.

Editor's Note: The views shared by one writer does not reflect the views of all writers on Wise Bread.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Foraging: Not Insane, Useless, or Impossible

Philip Brewer — Tue, 10 Jan 2012 10:36:22 +0000

From time to time, I've suggested foraging — gathering food from the wild — as a technique for getting by in hard times. Whenever I do, people mock the idea. "It's the twenty-first century! There's no way to get enough food like that." They're missing the point. (See also: Getting by Without a Job part 4 — Get Free Stuff)

Calories Are Cheap

First of all, the point of foraging is not to provide all the calories you need to survive — that would be tough. But, calories are cheap at the grocery store. The problem is turning those cheap calories into a healthy diet.

If you make a diet out of the cheapest calories you can find in the supermarket, you're going to be missing out on nutrition, taste, and variety. And as a way to provide those things, foraging is perfect.

Nature's Food Is Bountiful — and Delicious

Second, they're just flat out wrong. There's a lot of food to be found in the wild, even in relatively urbanized areas. Edible weeds like lambsquarter, dandelion, and purslane grow right in your (or your park's) lawn along with a lot of edible flowers — dandelions again, violets, bee balm, chicory, chives... Larger edible plants like cattails and Jerusalem artichoke grow only a few steps further into the wild.

Of course, if you actually get out into the woods and fields, there's even more.

And it's not just "weird" foods that can be gathered from the wild. It's easy to find perfectly ordinary fruits and nuts — grapes, strawberries, raspberries, mulberries, persimmons, hickory nuts, walnuts — growing wild.

My mom was always interested in foraging. I remember any number of meals that she prepared that featured food gathered from the wild, usually inspired by the books of Euell Gibbons.

No article about foraging would be complete without a few warnings. Don't eat mushrooms that you find in the wild unless you've learned about the local mushrooms from someone who's gathered and eaten them for a long time. Avoid gathering food that might have been sprayed with herbicides or pesticides. Don't eat plants gathered from right along roadsides. There are a lot of good books on gathering wild foods, and a good book will guide you well enough on any topic except mushrooms.

Unless you're hunting or fishing, you'll only occasionally find your main dish in the wild — but, as I said above, that's not the point. If you've bought the cheapest lettuce you can get from the grocery store, you can make your salad a lot more interesting and nutritious by adding a handful of purslane. Extend your spinach, mustard greens, collard greens, or kale by cooking it up with some garlic mustard. If you can't afford desert, a handful of wild strawberries will serve the purpose.

You can eat really cheaply, if you need to — or if you simply want to, because there are other things you want to spend your money on besides food. And then — when you're eating the cheapest healthy diet you can put together at the grocery store — is when a bit of foraging can make a huge difference in the quality of your diet.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

The Freedom of the Independent Yeoman

Philip Brewer — Wed, 21 Dec 2011 11:24:54 +0000

The financial crisis is resurrecting the oldest economic tension in the country. Will it finally be the day of the independent yeoman? (See also: Self-Sufficiency, Self-Reliance, and Freedom)

Never mind that they were always more mythic creature than reality. Thomas Jefferson's model for the U.S. economy was built around the yeoman farmer.

The Freedom of Self-Sufficiency

The yeoman farmer was free, because he was self-sufficient. He owned some land and the tools he needed to produce the necessities of life. When possible, of course, he'd produce more than that — a surplus to sell, so the family could afford more than the bare necessities. But even in bad times they could produce enough food, clothing, and shelter that they wouldn't starve or freeze.

Jefferson thought this was critical. Men who worked for wages were dependent on their bosses for their livelihood, and that sort of dependency was dangerous for a democracy. There was always pressure on employees to vote their employer's interests, rather than the country's interests.

Industry and Finance

On this issue — and even more so, on the issue of finance — Jefferson was the loser. The prevailing view was that of Alexander Hamilton, who wanted an industrial, financial basis to our economy.

This was anathema to Jefferson, who thought bankers were even worse than bosses. (Jefferson famously called banking institutions "more dangerous to our liberties than standing armies.") The whole enterprise of finance led to a concentration of money and power, while Jefferson thought the nation's interests were best served when money and power were dispersed to the individual citizens.

Jefferson lost — and we're all vastly richer because of it. I've got a post up about how to have a rich country on my personal blog, but the basics — privately property, free markets, and the rule of law — are well known. It was Hamilton's pushing that insured that we had those things, and more: industrial production and a financial industry.

It's tough to get rich as a subsistence farmer. (The only scenario that comes to my mind involves giving up subsistence farming after oil is discovered on your land.) You're going to have a higher standard of living if you work for money, and then use the money to buy the stuff you want.

But you give up a lot when you do that. I've talked before about the many reasons besides frugality to do for yourself. But even more important than those is the freedom that comes from actual self-sufficiency. That freedom has benefits for others besides just yourself. It benefits your neighbors. Indeed, as Jefferson understood, it benefits the whole country.

So, there's an upside to the knocks that the financial system is taking. They're pushing people to learn how to be a little more self-sufficient (sometimes, it's that or starve). They're pushing people to live off the grid. They're making the standard-of-living comparison a little less stark.

Attainable Self-Sufficiency

Real self-sufficiency is tough. But limited, partial self-sufficiency is easily within the grasp of most people.

A little frugality is an important first step. If there's only one job in town that pays enough to cover your expenses, what will you do if you lose that job? If you can get your expenses down to where there are a dozen jobs that would pay the bills, you're vastly more secure — and vastly more free. (Plus, if you happen to have the high-paying job, you're in a position to do some serious saving and investing.)

There are a lot of possible second steps. Find ways to acquire some of what you need outside the money economy — produce it yourself, barter or trade, share with friends and neighbors.

Although the yeoman farmer was Jefferson's model, the point is not to work the land. The point is to be free enough — to be self-sufficient enough — to follow your own conscience.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Put Off Saving for Retirement

Philip Brewer — Tue, 13 Dec 2011 11:00:17 +0000

Here's an unpopular idea. Everybody knows that you should start saving for retirement as early as possible, because everybody's seen the calculation where you put aside a few dollars every month starting at age 20 and with compound interest have a huge amount by the time you're 65. (See also: Don't Despair Over Small Retirement Savings)

There are three big problems with this scenario.

The first is that, right now anyway, it's impossible to earn any interest. That's not generally true, but it is true that you can't assume that any particular rate of return is going to be possible. (If only I were as rich as I'd imagined I might be when I did these sorts of calculations in the early 1980s, when long-term government bonds were paying 14%!)

The second is that there are certain phases of your life when you really need the money, and one of them is when you're first starting out. When you're trying to set up housekeeping for the first time — buying pots and dishes and furniture (not to mention paying off your student loans) — a few hundred dollars is going to make a much bigger difference to your standard of living than it will make when you're retired (even with compound interest).

The third is that people's incomes are low when they're young. Even with compounding, the ultimate contribution of those small, early deposits is insignificant, compared to the amount of money you can sock away in the last few years of your career.

The real reason to start saving for retirement early is to establish the habit of saving. So, let me be clear — I'm not recommended that you put off saving. I'm just recommending that you put off saving for retirement. By all means, start saving early. Save for an emergency fund. Save for down payments on a house and a car. Save for a vacation. Save for a luxury item you really, really want. Develop that habit of saving. Then, in a few years, when your income is a little higher and your household a bit better established, go ahead and start saving for retirement.

Your retirement will be just as secure, and your first few years will be a lot more comfortable.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Abandon Losing Strategies

Philip Brewer — Fri, 09 Dec 2011 11:24:46 +0000

Popular culture praises persistence. We go so far as to invent words like "sticktoitiveness" and repeat aphorisms like "try, try again" and "who dares, wins" and "never give up, never give in." (See also: Not the Sort of Person Who…)

The fact is, giving up is often the right strategy. If you're spending more than you earn, the sooner you give up, the less of a hole you'll be in. If you're living in a house you can't afford, the sooner you give up, the sooner you'll be able to put your finances right. If you're working at a dead-end job in a declining field, the sooner you give up, the sooner you'll be able to make the changes to put yourself on a path to success.

I wrote a four-part series on getting by without a job (it starts here: Part 1 — Losing a Job) that walks you through the specific moves you need to make when your income collapses. It's all about preserving what cash you have, cutting expenses, finding ways to bring in some money, and getting what you need to survive without money.

That doesn't mean it's going to be easy, and not only because popular culture is so opposed to "giving up."

Obstacles to Giving Up

The two biggest obstacles I see are self-image and the design snowball effect.

Self-Image

I've read many accounts of people whose income collapsed, but who took no action to cut expenses. They simply rode their life into the ground, even when they could see disaster looming ahead. When you ask them why they didn't take the sort of drastic action that could have averted total collapse, the answer almost always has to do with their self-image: they're not the sort of people who take in borders, have a roommate, move in with their brother-in-law, send their kids to public school, do manual labor, etc.

If you're not the sort of person who does those things, then you can't do them — even when they're the solution to your problem.

Design Snowball Effect

Everybody's lifestyle has critical dependencies on a few early decisions. I call this a "design snowball," because of the way a few small decisions produce a vast avalanche of consequences. An example I've talked about in the past is the decision to own a car, which locks in thousands of dollars a year of expenses, but enables a much wider range of employment and housing options. Abandoning that decision requires that you change everything else. The decision to own a house is another one, if for no other reason than that abandoning that one will require you to abandon most the stuff that used to fit into that house, but that won't fit into wherever you end up living. (I have some personal experience with that one.)

How to Abandon Losing Strategies

Whichever obstacle is keeping you from abandoning your losing strategies, I have two ideas that might help.

The first is to suggest that you look at your life as an adventure. Whatever the losses in abandoning a losing strategy (and they may be huge), big changes also mean big opportunities. When you're confronting the avalanche of changes the design snowball can produce, be sure to include on the list all the things about your life that you want to change — because this is probably the best chance you'll ever have to escape a boring career or a bad boss or an oppressive neighborhood or acquaintances who drag you down.

The other is a purely tactical idea, drawn from a post I wrote long ago — set aside part of your emergency fund as untouchable . . . until you make drastic changes. (The post was A Second Emergency Fund You Never Spend.) The idea is that a few thousand dollars isn't going to make much difference now, if you've got a losing strategy. But a few thousand dollars will make a huge difference later. When you're looking for a tiny apartment to replace your big house, you're going to need a damage deposit. Money that wouldn't even pay the registration on your car will buy you a perfectly adequate bicycle. (Heck, money that would pay the insurance on your car will buy you a perfectly adequate motorcycle.)

Make a plan up front that you'll never spend down the last of your emergency fund (or use up your retirement savings, or go into debt), just to stave off collapse for a few more weeks. Abandon losing strategies. Abandon them ruthlessly.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

The Psychology of Cash Flow

Philip Brewer — Mon, 14 Nov 2011 09:48:32 +0000

Money flows into your life, and money flows out. To deal, you need to get your finances right — but also your mind. (See also: Managing Your Short-Term Money)

Are your finances under control? One good test is how your spending is constrained by your income.

Far too many people are forced to arrange their bill paying around their income schedule. They put bills aside until their paychecks arrive, then they write the checks (or authorize payments online), hoping they don't run out of money before they run out of bills.

If your finances are under control, there's no need to do that. You always have enough money to pay your bills, whether "payday" is today or tomorrow or next week.

Control Your Finances

You only need two things to get your finances under control:

You need to have an income that's larger than your expenses.
You need to have "enough" money sitting in your checking account.

In this case, "enough" is a reasonably specific amount — enough to pay the largest sum of bills that can be expected to arrive between two paychecks. For most people, one month's expenses is a handy target. There are, of course, special circumstances, such as annual or semi-annual bills for car insurance or property taxes. You could just leave enough money in your checking account for those, but they're probably better handled by accumulating money in some sort of savings or investment account.

If those two measures aren't in place, you need to take action right away. Perhaps emergency belt tightening is in order to get your expenses below your income, and then to accumulate the appropriate cash balance in your checking account. But even once you've got those measures in place, getting this right is tough, because this isn't just a matter of getting your finances under control. You also need to get your mind under control.

Case in point — me.

Not having a regular job, I get my income from various sources — interest, dividends, payments for my stories or articles, and so on.

One of my regular payments used to arrive late in the month, but a while back things got rearranged, and it started arriving early in the month.

This turned out to have an unexpected psychological impact.

Here's the thing — the payment used to arrive shortly before we'd make the monthly transfer into our checking account to cover that month's expenses. Now, the payment arrives half a month away.

Before, it felt like my writing income was paying a big chunk of the bills, and then we'd transfer money to cover the various small expenses that show up over the course of the rest of the month. Now, it feels like we're drawing down capital to pay our bills, while my writing income ends up dribbling away to pay those ancillary expenses.

The reality of the situation hasn't changed at all. The right way — the smart way, the useful way — to think of the situation is to view all the money that flows into my life as my money. I've written about this before — it's all your money.

Control Your Mind

It's hard to defeat the notion that the dates that the money flows in and out make a difference. But even though it's hard, it's worth doing.

Getting this right is key to financial success.

Get your finances under control. Your spending should be controlled by your budget, not by when your paycheck arrives. See past the illusion that money that arrives one day has anything to do with the money that gets spent the next.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Escape Student Loan Debt — Slowly

Philip Brewer — Wed, 26 Oct 2011 22:49:43 +0000

If you've got student loan debts that you'll never be able to pay off, you've now got a better chance to escape. It's still going to take a while. (See also: Wage Slave, Debt Slave)

Under new rules that Obama announced today, students who can't afford to pay off their student loans will be able to cap their payments at 10% of their discretionary income. If they make those payments for 20 years, any remaining debt owed will be written off.

This is a modest improvement to an already existing program that our own Xin Liu wrote about back in 2009. The older version only wrote the remaining debt off after 25 years, and it required payments of 15% of discretionary income.

For people with low incomes — or people with moderate incomes, but a lot of student loan debt — this will be a huge change. One of the examples in the White House fact sheet is of a nurse earning $45,000 with $60,000 in federal student loans:

Under the standard repayment plan, this borrower’s monthly repayment amount is $690. The currently available IBR plan would reduce this borrower’s payment by $332 to $358. President Obama’s improved ‘Pay As You Earn’ plan will reduce her payment by an additional $119 to a more manageable $239 — a total reduction of $451 a month.

This isn't a new idea. At least as far back as 1980, there was serious talk of letting students pay for their whole education on these terms: They'd sign a note promising the college or university 10% of their income for 20 years, and in exchange the school would provide their education. (I remember reading later that there had been some experiments along those lines, but that they'd been pretty unsuccessful because people who expected to earn a high income — doctors, lawyers, business majors — never signed up. It was only people getting degrees in social work, elementary education, theology, and such who went with the plan — and 10% of their income for 20 years didn't come close to covering the cost of their education.)

I've complained before about how debt traps people in the money economy. On a temporary basis, most people can cut their expenses almost to zero — except that they can't, if they have debts. Paying your debts requires fixed-dollar payments.

That's the big win of this program — the amount people need to pay isn't fixed in dollars; it's fixed in terms of income. If your income is very low, the amount you need to pay back will be very low as well.

There are a few other changes. In particular, it'll become easier to consolidate student loans (and the consolidated loans will get a small interest rate reduction.

Perhaps more important in the long run, the new Consumer Financial Protection Bureau is teaming up with the Department of Education to offer a "Know Before You Owe" financial aid shopping sheet.

I've always been unhappy about the way parents, teachers, guidance counselors, and college admissions officers lead kids (juniors in high school, often only 17 or even 16 years old) to commit themselves to pay back tens of thousands dollars in debt. It makes me unhappy even though the adults have the best intentions, and even though a good education is very important. Yes, other decisions made at that age (such as the decision to have a child) inevitably have life-long consequences — but you don't see students' adult advisors encouraging them to follow that path. I think the decision to take on tens of thousands of dollars in debt is a decision of the same magnitude, and yet many students blithely sign up for it, with little consideration of the consequences or the alternatives.

You're better off avoiding excessive debt in the first place — and maybe the new sheet from the CFPB and the DoE will help. But if that choice has already been made, and student loan debt is a burden, here's a way to reduce that burden significantly.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Why Inflation?

Philip Brewer — Wed, 12 Oct 2011 10:24:12 +0000

We know how inflation happens—excess growth in the money supply. But why does inflation happen? (See also: Can a Little Inflation be Good?)

Most people have a misunderstanding of inflation, because certain recent inflations—those of the 1970s in Europe and the United States—were unusual.

The 1970s inflations were largely side-effects: Working to keep their economies running at full speed, central banks boosted the money supply on the theory that accepting a certain amount of inflation would allow the economy to run with a lower level of unemployment. That theory turned out to be false, but that's not the important point. What's important is that "side-effect" inflation is the exception.

Most inflation—going back over hundreds of years and dozens of countries—is deliberate inflation, inflation produced with a goal: to reduce debt burdens.

Most often, the goal is to reduce the burdens of government debt. (Makes sense—governments control the money supply, and they tend to run up a lot of debt.)

Sometimes the goal is to reduce the debt burdens of ordinary folks. This isn't as common, in particular because inflation tends to hurt those with money, and people with money tend to have influence over the government. But, especially in democracies, and especially when society ends up divided between the few (who are very rich) and the many (who are poor and often in debt), the many turn out to have enough influence to call for some inflation to lower debt burdens.

Inflation does work for this purpose, but it doesn't work very well.

First of all, inflation only reduces the burdens of debts that already exist (and then only debts at a fixed interest rate). That's great for a government with a big public debt, and it's okay for homeowners (if they have fixed-rate mortgages) and recent graduates (if they have student loans at fixed rates), but it actually sucks for anyone who needs to borrow money—because they're going to face very high interest rates.

Inflation also produces all sorts of distortions. It creates phantom profits (where much, all, or even more than all of the gain is just inflation)—not so bad, except that phantom profits are often taxed just like real ones. It causes suffering because many prices can go up daily, while incomes often go up only annually. It makes it hard to plan for the long term (because you don't know what prices will be tomorrow, let alone 10 years from now).

The fundamental problem with inflation is that it fools people—it obscures true values and that leads people to make bad decisions. They get a good raise, and think they're better off. They see growing sales, and think their business is growing. Only later—when they see that prices have gone up and that even with the extra money that's come in they're no better off than they were—do they realize that they'd been misled. And if they made commitments based on that misunderstanding of their real situation, they may be in real trouble.

Right at this moment, things rather hang in the balance. As I said, the pressure for inflation is always strongest when the money is in the hands of the few and the many are in debt. Especially in a democracy, that's a dangerous situation.

Inflation is terribly pernicious. It's a blunt instrument that does reduce the burdens of debt, but does so in a crude fashion, with winners and losers selected for no more reason that that they had already borrowed (rather than being about to borrow) and that they had borrowed at fixed rates. There are things you can do to reduce the harm that inflation will do on your household economy (check out my post How to Live with Inflation), but even better is to avoid inflation.

Perhaps knowing why inflation happens will help with that.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Occupy Wall Street, the 99%, and All That

Philip Brewer — Fri, 07 Oct 2011 15:56:45 +0000

The Occupy Wall Street movement does not lack a unified message. What they're saying is perfectly clear to me. (See also: Peak Debt and Income)

To understand Occupy Wall Street, start with the people who say "We are the 99 percent." (That link goes to a site with statements from people who aren't in the top 1% of wealth and income. Pretty much by definition, that's just about everybody.)

To understand the 99%, begin with recognizing that their incomes have been stagnant for 40 years — a period during which the income of the top 1% has soared. Also, recognize the reason this happened — the reason things changed from prior decades during which the middle class got their full share of economic growth — is a long list of changes to laws, regulations, common practices, policies, and procedures.

What the 99% want is economic justice. But they don't have a single "demand," because there's no single thing that produced this result. (See above: long list of changes.) Instead, they see a long list of things that are wrong:

An unfair foreclosure process
Government bailouts of big business (with the money ending up in the hands of the same executives that put the company at risk in the first place)
Unrelenting efforts to strip workers of the rights to organize and to have a safe workplace
A system of higher education that saddles students with a decade of debt
A healthcare system that bankrupts people without insurance — and denies insurance to anyone who's sick

That's what the Occupy Wall Street movement is trying to fix — a political and economic system where the extremely wealthy (and the corporations they own) buy laws and regulations to ensure that future economic growth (like the economic growth of the past 40 years) continues to flow into the hands of the 1%.

All of my posts are aimed at helping people live large on a small budget. Some are about tactics (how to spend less, how to get more for what you spend), some are about strategy (how to design your life for living large), and some are about understanding the economy (to help you do your own strategic and tactical thinking). I'd like to think this post fits into that third category.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Avoiding the Poverty Tax

Philip Brewer — Fri, 07 Oct 2011 10:24:24 +0000

There's a lot of money in poverty. Not for the poor folks, of course. (See also: Too Broke to be Frugal)

The money in poverty is for the rich folks who sell things to the poor. You'd think that that there'd be more money in selling to the wealthy, but the wealthy tend to be difficult customers. The poor, on the other hand, are sharply constrained in ways that make them a very profitable market segment.

Rich folks — even middle-class folks — get a whole bunch of stuff for free, starting with free checking. They also get stuff cheap — in particular, they get low rates when they borrow. Most important, they can take advantage of deals that are unavailable to poor folks. (For example, they can get huge tax-free investment returns by stocking up and they can afford to drop collision coverage on their car insurance.)

Poor folks end up dealing with check-cashing stores, payday lenders, rent-to-own stores, pawn shops, and all the other businesses that cater to poor customers — and end up paying a lot more.

You'd think that the shops that cater to rich folks would charge more, but that's often not true. The stores that charge the most are the small shops in poor neighborhoods with a captive market of people whose work schedules and transportation options make it impossible for them to shop elsewhere.

Gary Rivlin, in a new book on the topic called Broke, USA, suggests that poverty ends up adding something like 10% to the cost of living for a poor person — it's like an extra 10% tax just for being poor.

But (and this is the whole reason it's worth writing a post about) it's only like a tax. It's more accurate to analyze it as a fee — a fee charged, not on poverty itself, but on people who lack a set of skills related to running their household economy.

Most of us here at Wise Bread have these skills. We learned them from our parents, from our parents' friends, from our peers, from books, from websites like Wise Bread, and maybe even in school. We know how to balance a check register, which means we don't pay overdraft fees and we don't end up bouncing so many checks that banks won't take our business. We know how to create a budget, so deciding to go into debt is a decision, rather than something that just happens while you're not looking. We know how to read the literature the bank sends with the rules for the various kinds of accounts.

The fundamental skill for avoiding the poverty tax is the ability to calculate the all-in cost of a particular set of choices.

For example, we can take the bank's list of account types and figure out which kind of account will give us the services we need for the lowest cost.

Avoiding the poverty tax is simply a matter of applying that skill to the larger questions of your household economy.

When your grocery budget is tiny, it's tough to stock up on stuff that's on sale — but it's not impossible. Start with one can of tomato paste on sale. The following week you can use that one, freeing up enough cash to buy two of something else that's on sale.

Long before your emergency fund grows to the recommended six months' spending, it's large enough to save you a fortune in late fees and finance charges. (And once it's a little bigger than that, it can provide the security you need to save even more money with higher insurance deductibles.)

The trade-offs involved in deciding to buy a car are hugely complex — balancing all the costs (financing, registration, insurance, maintenance, fuel, parking) against the savings and income made possible by the increased mobility. But identifying the key variables and their approximate magnitudes is enough to make useful comparisons. You can, for example, figure out that you come out ahead by living within walking distance of work, even if your rent is much higher.

Of course, just having the skill is not enough. You also have to use those insights to guide your actions. This is also made tougher by poverty. If your finances are already in desperate straits, it's easy to imagine that any particular error or indulgence won't make any difference.

That's just another example of how the poverty tax ends up hitting poor folks while the wealthy don't even notice. But really, avoiding the poverty tax isn't a matter of wealth. It's a matter of skill.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

4 Ways to Beat Debit Card Fees

Philip Brewer — Thu, 06 Oct 2011 10:36:22 +0000

Several banks just announced new monthly fees for debit card users. Fortunately, there are plenty ways to avoid them. (See also: That Sneaky Bank Almost Got Me)

Until this month, the large swipe fees they charged merchants made debit cards a huge profit center for banks. They were so profitable, banks were offering all manner of perks if you'd promise to use your debit card at least 5, 7, or 12 times a month.

Those days are gone. As of October 1st, the swipe fee is limited to just 24 cents. That's still plenty of money to make the debit card business profitable for the bank, but it's not going to fund the huge bonuses that bankers have gotten used to. So, they're looking for other sources of money.

Once source they looking at is a monthly fee. Bank of America is going to hit your account with a $5 fee every month that there's even one debit card transaction. Wells Fargo and Chase are testing monthly fees as well.

You don't need to pay those fees. Here are four ways to avoid them.

1. Change Banks

The big money-center banks don't want your piddly little consumer banking business anyway. They make their money from packaging corporate finance deals, selling credit default swaps, and creating collateralized debt obligations. They figure the plain-jane transaction business of debit cards is beneath them (unless there's some serious fee income involved).

Instead of a big money-center bank, consider:

Smaller Banks

The medium-sized regional banks probably aren't much better than the money-center banks — they'd also rather be pocketing a million-dollar fee for arranging a standby letter of credit than handling your checking account. But, as the banks get smaller, they start taking real interest in serving their smaller customers. There are plenty of small, local banks that don't charge a fee for checking accounts, with or without debit cards.

Credit Unions

Credit unions are owned by their members. Serving your financial needs is what they're all about. They're a lot less likely to charge a fee than a bank is.

Brokerage Firms and Other Non-Banks

If you're wealthy or broke, this may be the option for you.

If you're wealthy, get a cash management account at a brokerage fund. They'll issue you a debit card that will give you access to your wealth, and they won't charge a fee for the card. (Big-name brokerage firms charge a hefty fee for the account; discount brokers tend not to.)

If you're broke, get a reloadable debit card. They have fees as well, but the fees are for specific services (like cashing a check, checking your balance, or using an ATM). Many now allow one free ATM withdrawal per month, and most charge no fee to accept direct deposit. If you track your balance yourself (so you don't need to check your balance), you can use them in a way that's practically fee-free.

2. Use a Credit Card

Just about any place that will take a debit card will take a credit card as well. There are a few exceptions, but not many.

Of course, it's easy to get over your head in debt. But that's not the credit card's fault. If you can use a debit card and not spend more than you have in your checking account, you can do exactly the same thing with a credit card. The only difference is you have to do it yourself. This may be the right choice — if you're ready to control your spending without training wheels.

3. Pay Cash

Go totally old school and pay for things with money! Yeah, plenty of people say they spend more if they have cash in their pocket. I say, get over it. You have exactly the same amount of will power and self-control with cash in your wallet as you do with a debit card.

4. Write a Check

Actually, even I don't do this any more. I still pay bills by writing a check (really!), but I can't remember the last time I wrote a check at a store. And yet, it can be done. It used to be done routinely.

This is hardly the end to the possibilities. The transaction business is about to go non-linear. Paying online, or with your cell phone or your mobile device, is already here, and it's just going to get more common.

With all those ways to avoid debit card fees, there's no reason to pay one.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Social Security Is Not a Ponzi Scheme

Philip Brewer — Thu, 15 Sep 2011 10:24:17 +0000

Once again, people are comparing Social Security to a Ponzi scheme. That's a bogus comparison. (See also: Don't Despair Over Small Retirement Savings)

A Ponzi scheme is a lie. Named after Charles Ponzi, it's a fraudulent investment where the operators report fake profits — and then support those illusory profits by paying out cash from new investors. Ponzi schemes always collapse eventually, because they depend on an ever-increasing number of new investors to provide enough cash to make payments to the old investors.

The reason that Social Security isn't a Ponzi scheme is that it isn't a lie. It keeps accurate books, attested to by a board of trustees and an actuary.

What Social Security is, is an inter-generational transfer. To solve a problem (old-age poverty), we as a society decided to transfer some income from workers to the elderly.

That worked pretty well for several decades. Then, in the early 1980s, the trustees realized that the baby boomers presented a problem. They were going to expect to receive a lot of money in two or three decades, but the workforce was going to be shrinking and there wouldn't be enough.

That problem was fixed in 1983. Benefits for younger folks were cut slightly, Social Security taxes were increased slightly, and for the next three decades money was set aside, with a plan to pay it out when the baby boomers retired. That money will have all have been paid out in just a few decades — but that's fine, because the next generation doesn't have the same kind of bulge of retirees.

See the difference? The Social Security Administration never pretended that investment returns were going to fund everyone's pension. They never lied and said that your contributions were waiting to pay your pension when you retired.

The issue keeps getting raised — usually by people who object to the whole idea and say "Ponzi scheme" to inflame emotions. But anyone willing to do a little research comes up with the same answer every time — as, for example, our own Xin Lu did in her 2008 post Is Social Security is Just a Grand Ponzi Scheme?

Social Security: Not a Ponzi scheme; an inter-generational transfer.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Less or Cheaper?

Philip Brewer — Thu, 08 Sep 2011 10:36:25 +0000

It's always worth investigating cheaper alternatives, but sometimes it's even better to just use a little less of your first choice. (See also: Frugalize Any Recipe)

Back when I used to work as a software engineer, my wife and I invented a drink. It's just like a Cuba Libre, except instead of rum it has bourbon and instead of Coke it has Mountain Dew. We named it a Cubicle Libre, as I drank one most weekdays to celebrate each day's escape from my cubicle. Oh, and it has ice cubes. A Cubicle Libre has to have ice cubes.

In those days, I had plenty of money. I saved a lot, which is how I can now work as a writer and still make ends meet, but I also indulged myself in certain luxuries. In particular, I bought a moderately expensive bourbon for my Cubicle Libres.

The past few years money is a bit tighter, and I've experimented with cheap bourbon. The thing is, cheap bourbon isn't as good. So another experiment I did was using less.

We have some small highball glasses (perhaps more the size of an old fashioned glass). I also have a small shot glass that I bought during a trip to Germany many years ago. It has a line indicating 2 centiliters (which turns out to be 0.68 ounces — a bit less than half a jigger).

If I make a drink in one of those glasses with two ice cubes, that much bourbon, and enough Mountain Dew to comfortably fill the glass, I get a drink that's perfectly proportioned.

Now, perhaps this seems like a rather long way around to suggesting that a half-sized drink can be made for half the cost. But I offer it as an example of some more general principles. These smaller drinks are not just cheaper, they're better. That's because:

They're made with superior ingredients
They follow a thoughtful design
The tools I use to make them are meaningful — they have their own history
The construction of each drink is a small ritual

The first two points are where I thought I was headed when I started this post: Superior ingredients make for superior results, and taking a bit of care with the design of the drink let me make the most of the smaller quantities.

But upon reflection, I think it's really the latter two points that have real applicability to living large on a small budget.

Anyone can save money by using less, and saving money on quantity can enable spending on quality. But living large has little to do with the size of your portions. Living large has to do with meaning, and meaning comes from these other things — from care, from mindfulness, from ritual, from history, from companionship in both the work of making and the pleasure of consuming.

When you want to live large, put meaning ahead of either quantity or quality.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Stay in School until the Job Market Improves?

Philip Brewer — Mon, 15 Aug 2011 10:24:22 +0000

For decades it's been a common strategy that's worked out pretty well: If the job market is crappy when you graduate, find a way to stay in school for a year or two—add a second major, go to grad school, find a post-doc. This time, that's not looking like such a good idea. (See also: A Society of Fear)

It used to be, even though an extra year or two of school meant a year or two when you were hardly earning any money, you'd still come out ahead—because the higher starting salary you got entering the job market at a more favorable time would be the base for all your future raises.

That worked great in the days when being a student merely meant that you were broke. Now, being a student means you're going into debt to the tune of tens of thousand dollars a year. If that's what you're doing, you're probably digging yourself a hole that you'll never be able to earn your way out of.

Only time will tell what the new winning strategy will be, but my best guess is that you'll still want to avoid beginning your career during a severe downturn. You'll just want to do it without adding to your debt load.

If you can mark time without growing your debt—for example, as a grad student with an adequate fellowship or assistantship—then go ahead.

If you can't stay in school without taking on even more debt, consider making a temporary entry into the job market. Don't begin your career, but find some paid work that lets you support yourself. Then, when the market looks like it's finally turning around, do something to mark a break with your temporary work and then begin your career.

The obvious thing to mark that break would be to go back to school for the second major or the advanced degree, but that's hardly the only choice. Others would be to take on an internship, do an open-source project, volunteer at a non-profit, start a small company, or write a book.

The point of the break is simply to make it clear that what you were doing before wasn't a failed career, but was rather (like a string of post-docs) just something that you were doing before beginning your career. (My article Fund Your Own Sabbatical is on-topic here. The issues, in terms of taking a break and then reentering the job market, are largely the same.)

The way we fund undergraduate eduction in this country is already leading to a whole cohort of new workers who will be permanently indebted. With a bad job market tempting them to stay in school, the unavoidable additional debt load is just going to make things worse. It's reasonable to be leery about entering the job market during a downturn, but taking on even more debt is not a better choice.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Debt Ceiling Contingency Plans

Philip Brewer — Fri, 29 Jul 2011 22:59:53 +0000

What will the Treasury do if there's no increase in the debt ceiling? What should you do?

Back in April I wrote a post about what would happen if the debt ceiling were not raised. I suggested that the Treasury could deal with a cash shortage the same way Illinois had — by delaying some payments and prioritizing others. I also suggested that Congress, seeing the Executive branch grab all that power, would move quickly to end that experiment.

Looking back, even though I intended that post to be a bit tongue-in-cheek, I'm thinking I was a bit blasé about the whole thing. (See also: The Debt Ceiling Crisis in Everyday English)

Can the Treasury Prioritize?

Everyone has been assuming that the Treasury will respond by prioritizing certain payments — interest on the debt will be paid, social security will be paid, soldiers will be paid — and that other bills will be deferred.

The Treasury has been at pains to refute this assumption:

Treasury officials have maintained that the department lacks formal legal authority to establish priorities to pay obligations, asserting, in effect, that each law obligating funds and authorizing expenditures stands on an equal footing. In other words, Treasury would have to make payments on obligations as they come due. — Reaching the Debt Limit: Background and Potential Effects on Government Operations (PDF)

Beyond statements like that, the Treasury (and the Federal Reserve) have been quite steadfast about refusing to discuss contingency plans.

This is primarily a tactical move. Their position is that not raising the debt limit is unthinkable. Any indication that they're thinking about it would tend to undermine that position.

Still, their position is not unreasonable. Several presidents have tried the tactic of not spending all the money that Congress had appropriated — sometimes because they didn't like the program the money was being spent on, other times because they wanted to reduce government spending. Whenever this has been done, the courts have ruled against the practice. Congress has the power to spend money; the president has no power to "just not spend" money that Congress has appropriated.

Of course, this is a special case. The power to tax and to borrow also belongs to Congress. When Congress chooses not to get the arithmetic right — when the spending is greater than the sum of the taxing and the borrowing — the Treasury is placed in an untenable position. When it's impossible to follow the law, the Treasury has to make a choice. Currently the Treasury is playing its cards very close to the vest. There were rumors that it would provide some hints as to its contingency plans last night or today, but so far it has not.

Prioritizing payments has been the preferred strategy of the House Republicans who have been most adamant about refusing to raise the debt ceiling. They claim that the government should just live within its means, and that refusing to raise the debt limit, combined with prioritization, would be a way to force that.

Other people point out that the arithmetic goes against this strategy very quickly. Once you pay for Social Security, Medicare, Medicaid, the Defense Department, and unemployment, you've already spent all the money.

As I explained in my post Stalemate on the Debt Ceiling, that's not how I figure things will go — because government contractors will go on providing services for some time, even if they aren't getting paid, so those are the bills to not pay. Seniors would still get health care (for a little while), even if the Medicare service providers didn't get paid. Fuel for fighter jets would still get delivered (for a little while), even if the oil companies didn't get paid.

I still think the most likely option would be for the Treasury to prioritize spending. It would pay the interest on the debt, it would pay Social Security, it would pay federal employees (perhaps after laying off non-essential ones), it would pay soldiers. What it wouldn't pay would be the ordinary business debts of the government — defense contractors, drug companies, landlords, utility bills — including the big ones, like payments for Medicare and Medicaid, etc. (No smart drug company executive would quit delivering drugs to a VA hospital just because its bill was a bit late getting paid.)

And, as I said, I think Congress would cave pretty quickly, once business interests found that they were still providing services for the government, but were no longer getting paid.

Other Options

With the Treasury being so coy, I thought I'd at least touch on the other possibilities.

Pay Late

The Treasury has hinted that it would just pay the government's obligations in the order that they were due, making payments as and when the money arrives. For the first few days, we'd just be paying a few days late. Very shortly after, we'd be paying several days late. They'd treat every debt the same, including interest payments on the national debt. The result would be technical default almost immediately.

I think that's pretty unlikely. The Treasury is keeping the option on the table to pressure Congress, but managing the debt is the department's whole reason for existence; they'd never willingly make an interest payment late.

Issue Debt Anyway

Some people have pointed to a provision in the 14th Amendment to the Constitution, which says, "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned," and suggested that the Treasury could call that authority for selling enough debt to make the payments that Congress has already authorized.

I think that's even less likely.

Run an Overdraft at the Fed

The Federal Reserve acts as the Treasury's bank. When someone deposits a government check, the bank presents it to the Fed. The Fed then gives the bank money, and debits the Treasury's account at the Fed. The Treasury's accounts are kept topped off through tax receipts and issuing government debt.

Suppose the Treasury just went right on writing checks, even though there wasn't enough money in the account? The Fed could either bounce the check, or pay it — letting the Treasury run an overdraft.

Paying the check would create money out of thin air, threatening inflation. However, the Fed could "sterilize" that money by selling enough assets to soak up the excess cash.

I see that as almost as unlikely as the 14th Amendment scenario. The folks at the Fed are bankers; they're not going to let the Treasury run an unlimited overdraft.

What You Can Do

I've been wracking my brain to come up with anything clever that individuals can do to make the whole situation less fraught, and I haven't come up with anything.

You could sell your Treasury securities, but what would you do with the money? If U.S. government bonds are no good, in what way would U.S. government currency be better? You could invest in foreign bonds, but which ones? The euro has its own problems — arguably worse than ours, because they're real (while ours are entirely self-inflicted). You could put some money in Swiss francs or Japanese yen or Canadian dollars, but that's a lot of trouble for no particular gain that I can see. You could buy gold, but it's already gone up a lot on the panic trade, and will almost certainly come down if debt problems are resolved.

The only bit of advice I've got is to trust banks over money funds. Money funds invest all their money in just the sort of securities that suddenly become worthless if the markets seize up (as they did after the Lehman bankruptcy in 2008). Banks, on the other hand, have actual assets (loans to local businesses) and they have access to the Federal Reserve to get cash if necessary.

The Treasury has started hinting that it will provide some guidance about its contingency plans before August 2nd. I'll keep an eye out and will post further, if there's any new news.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Understanding the Gold Standard

Philip Brewer — Tue, 26 Jul 2011 10:00:05 +0000

I first starting thinking seriously about the gold standard back in 1980, when inflation spiked up over 10% (completely destroying my very first budget) and the value of the dollar seemed to be collapsing. (See also: Surviving a Financial Panic — Lessons from the Past)

During the early 1980s, I read quite a few "hard money" books. Each of them included refutations of the arguments against a gold standard — refutations of arguments I hadn't yet been exposed to, so my experience was a little backwards — but I learned why a gold standard was good and got the gold bug chapter and verse on why the arguments against the gold standard were all bogus.

(The term "gold bug" was originally a pejorative term for those who thought that only gold was "real money," and was quickly expanded to include anyone who thought gold was a great investment. Over time, though, the hard money advocates embraced the term and started calling themselves gold bugs.)

You will not be surprised to learn that it turns out to be more complicated than either the gold bugs or their detractors would have you believe.

Historical Gold Standards

Since ancient times, gold coins have circulated as money. That was always problematic, and gold was only rarely the main sort of money. Actual gold coins would be used by rich people and for certain kinds of transactions — in particular, to pay taxes and to trade internationally.

For ordinary transactions, though, gold tended to be too valuable. The monthly pay for a Roman legionnaire was one gold aureus (a coin about the size of a nickel, weighing a bit less than a quarter of a troy ounce). It was a lot of money — a similar size coin right now would cost you about $400. (Back in those days it was similarly valuable, although relative prices have changed so much it's pretty hard to compare. The historical record shows 8 aurei buying 23 acres of woodland in Kent.) That's a lot of wealth to carry around in a short stack of small coins.

Paper money was invented (gradually, with various intermediate forms) to solve some of the problems with gold coins.

In the heyday of the gold standard, banknotes were issued by banks against gold held in their vaults and circulated in parallel with gold coins. If you had a banknote, you could go to the bank that issued it, present the note, and receive gold coin in exchange. Contrariwise, you could deposit your coins at the bank and receive banknotes in exchange.

There were lots of reasons to go with banknotes. For one thing, you could have a $1 (or smaller) note — smaller than any practical gold coin. You could also pack very large sums into a reasonably small case — a bundle worth $50,000 could fit in your coat pocket. That amount in gold coin would weigh a couple hundred pounds.

That sort of gold standard worked pretty well over a fairly long period. It doesn't prevent inflation (you'd have inflation any time the gold supply was growing faster than the economy), but it limited inflation. Importantly, it kept inflation from being a political tool.

An Inconsistent Standard

The downside of banknotes was that you were relying on the bank to be sound. Sometimes banks are, but the temptation to issue more banknotes than they have gold on hand is irresistible.

Still, the real problem with a gold standard isn't unsound banks. That would be easy enough fix — a regulator could track the issue of banknotes and audit the gold supplies in the vault. The real problem is that there isn't one, true gold price.

The price of gold is set by the market — and the market is strongly influenced by psychology. During good times, the price of gold is modest. (For example, during the 1990s — after the previous decade's inflation had been squelched and before the dotcom boom popped — the gold price hovered around $300 a troy ounce.) During bad times, the price of gold spikes up toward infinity.

Since we're not on the gold standard, those price changes show up as changes in the price of gold. If you're on a gold standard, they don't show up that way. But that doesn't mean that they don't happen. It just means that the price change shows up as change in the value of the currency.

Over the last decade, the price of gold has spiked up more than 460% (an annual rate well above 19%). That's a lot higher than the inflation rate over the same period. (The CPI is only up 27% over the same period, an annual rate of less than 2.5%.)

Imagine that the value of your money had spiked up by that much! Of course, it'd be great if you had a lot of money. (I expect this is why gold bugs don't tend to worry about this scenario — in fact, with a bunch of gold in their portfolios, they're positively yearning for it.) But what if you didn't? What if you were a businessman who had to sign long-term contracts with customers and vendors? When the value of the money jumps around like that, you're totally screwed. Worse yet, what if you're in debt? If the value of the money spikes up, the cost of making your loan payments spikes up as well. Could you pay your mortgage if it took you a week to earn what you'd earned in a hour a few years ago?

The gold bugs counter that we wouldn't see scenarios like that. The spike in the price of gold is due to a collapse in confidence in paper money. If the money were as good as gold, confidence wouldn't collapse and values would be relatively stable.

There's some truth to that, but we know it's not completely true. During the gold standard in the 1800s and early 1900s, prices were pretty stable — but only on average, only over the long term. But short-term price swings produced just the sort of effect I'm describing.

It could happen due to ordinary market forces. The supply of gold would fluctuate as new mines opened and old mines closed. The demand for gold would fluctuate as well — in particular, as exciting new overseas markets heated up, gold would flow to those countries to invest in the hot new thing. The result was a flow of gold out of established markets, producing just the sort of jump in the value of gold that I'm describing. Of course, it didn't show up as a price spike, but rather as deflation.

So, it wasn't just a theoretical problem. It actually happened, over and over again.

All these things — wars, financial disruptions of all kinds, inflation or deflation due to changes in the gold supply or changes in the demand for gold various places around the world — made the gold standard problematic. The worst was a particular kind of financial crisis called a panic.

The Problem of Panics

Panics happened when people began to doubt the soundness of their banks or their money and decided that they'd better turn in their paper and get actual gold coins instead. Because there was rarely as much gold in the vaults as there was paper in circulation, the result was a crisis.

During the days of the gold standard, panics were perfectly ordinary — there'd be one every ten years or so. (We had something pretty close to a panic in 2007–2008, our first in something like 70 years. I wrote about it at the time in a post called Credit Squeeze (Formerly Known as a Panic).)

Having sound banks that don't issue paper beyond the gold in their vault would reduce the severity of a panic, but that turns out to be a poor solution. There are reasons why banks issue more paper than they have gold, and it's not just because it's like printing money. Rather, it's because during good times, the amount of money that the economy can put to good use is larger than the value of the gold stock. The only way to have that much money in the economy would be to set the value of gold to be much higher — rather like setting the price of gold to levels that are only typical during a panic. That sounds great to a gold bug (who probably has a bunch of gold), but it doesn't work, because that's not the price of gold. The price of gold — the real, market price — is almost always much less than that.

You can set a different price. You could, for example, set the price of a new gold dollar by dividing the US government's gold reserves (about 261 million troy ounces) into the total supply of currency in circulation (about 10,000 billion dollars) and suggest that a new gold dollar should be valued at $4,000 a troy ounce. Except that's not what gold is worth.

You could set the current market price (about $1,600 a troy ounce), but even that is the price level based on the current near-panic conditions about the value of the dollar.

If people weren't worried about the future of the dollar, the global economy, the deficit, the debt ceiling, the European debt crisis, etc., I suspect the price of gold would be pretty close to the $300 a troy ounce that we saw through most of the 1990s.

(You'd think that gold bugs of the libertarian sort would understand that prices are set by the market, rather than by government fiat. But for all they rag on fiat currency — that is, money that only has value because the government says it does — they seem utterly oblivious to the notion that denominating gold in dollars is another fiat decision.)

And that's the problem with a gold standard. There isn't one true price for gold. The right price — the market price — surges and collapses with the psychology of the market. You can let your whole economy get dragged around by that — most of the world did for centuries — but don't imagine that they did so without difficulty. They had panics, they had inflation, they had deflation, and they had all manner of crises when gold flows caused by booms in far off parts of the world threatened to crush local economies.

The End of the Gold Standard

When things got particularly bad — usually either a war or some sort of financial crisis — banks or governments would suspend convertibility into gold. If both the country and the currency survived, convertibility would eventually be restored. If just the country survived, a new convertible currency would be introduced (the old currency by then being nothing but waste paper).

In the depths of the Great Depression, the U.S. took a slightly different path. In 1933, instead of suspending convertibility, the government banned the private ownership of gold, requiring citizens to turn in their gold in exchange for banknotes at the then current gold price of $20.67 per troy ounce. Shortly thereafter the value of the dollar was changed to a new parity of $35 per troy ounce. Convertibility was preserved (although only for foreigners), but at the new parity gold flowed into (rather than out of) the United States.

Gold ownership by U.S. citizens wasn't legalized until 1974.

In the run-up to World War II, the last few countries that had tried to stay on the gold standard had to suspend convertibility. Since then, essentially no currency has been convertible into gold — they're all fiat currencies. (For a few decades after the war, the U.S. dollar was technically convertible — but only for foreign central banks).

It turns out a good fiat currency can avoid most of the problems of a gold standard. Our fiat currency hasn't always been good, but it's been doing sorta okay for a long while now.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Live Where It's Cheap

Philip Brewer — Tue, 21 Jun 2011 10:24:25 +0000

More effective than giving up luxuries, using coupons, choosing store brands, or buying in bulk, the most powerful enabler of frugal living is to live where it's cheap. (See also: Voluntary Simplicity as Hedonism)

For basic stuff like rent and food, it can easily cost two or three times as much to live where it's expensive. For example, compared to where I live now (Champaign, Illinois), my rent in Manhattan would be 326% more while groceries would cost 57% more. (That according to this cost of living calculator at CNN Money.)

Of course, there are downsides to living where it's cheap. There's probably less to do and less to buy, although the internet eases those burdens immensely. (There's a lot less need to go to the big city to shop, and between on-line entertainment and DVDs, you don't miss out the way you would have just one or two decades ago.)

Many will argue that they have to live somewhere expensive. Maybe their family is there. Maybe their job is there. (If you're a ballet dancer, you have to live where there's a ballet company. If you're a TV scriptwriter, you have to live within commuting distance of Hollywood.) Maybe they just really, really want to live there.

That may be. I'm not here to second-guess the necessities of your life. Rather, I want to suggest that you think deeply about what you want and about the best way to achieve those wants.

Learn From My Experience

Even if you really want the amenities of an expensive location, think about whether living there is the best way to take advantage of them.

I lived in Los Angeles for a while, back in the mid-1980s. That gave me the opportunity to do all sorts of things that aren't possible anywhere else. (For example, I was able to shop at a store dedicated to selling survivalist supplies — they sold foods preserved for long-term storage, books on building and stocking your survival retreat, water purifying equipment, etc. There aren't many of those around.)

But living there was so expensive! Working at a regular job, I only had so much time to take advantage of the unique opportunities of my location.

For example, I only managed one visit to the La Brea tar pits and only went to one comedy club. (My life wasn't quite that boring, but my other adventures — such as camping at Joshua Tree and Sequoia National Forest — didn't depend on living in Los Angeles. In fact, they'd have been easier if I'd lived in some small town in Nevada — less traffic to fight through when heading out for some weekend camping.)

The money I saved the first year after I moved to Champaign just on rent would have covered the cost of flying to LA, staying in a hotel, hiring a limo, and admission to the La Brea tar pits, with enough left over for cover and drinks at the comedy club.

Throw in the savings from everything else being cheaper as well — food, gasoline, electricity, clothing — and it probably would have paid for two such trips.

What you're actually going to do (as opposed to what you'd theoretically be able to do) makes a big difference. If you're not going to buy something, it doesn't much matter how easy it is to buy.

If you're a serious skier, living close enough to the slopes that you can ski any time you get a couple of hours off is a huge boost to your standard of living. If, like me with the comedy club, you only get on the mountain once or twice a year anyway, you might just as well live somewhere cheaper and then take a ski holiday.

Income Also Varies

For some work, the amount of money you can earn may vary depending on where you live. For other work, it doesn't.

The amount that writers, artists, or web designers can charge has little to do with where they live. For other jobs, especially for jobs providing personal services to locals (hairdresser, receptionist, clerk, massage therapist), it's possible to earn a lot more per hour if you live somewhere expensive than it is if you live somewhere cheap. That's partly because the people who are hiring you have more money, and partly because your competition can't afford to undercut your price (because they need more money to live there just like you do).

On the other hand, where you live will usually have no influence on non-work sources of income — your stocks and bonds will pay the same dividends and interest no matter where you live.

This insight sometimes leads people to figure that they should live where they can earn the maximum amount during their working years, planning to save up money (investing in those stocks and bonds), and then move somewhere cheap where their dividends and interest will go further. That can work, but it often doesn't. The high costs of living somewhere expensive — especially when you figure in the higher taxes on that higher income — often leave you with little in the way of actual surplus savings.

The details matter. There's no alternative to actually doing the calculations yourself if you want to get the right answer.

Live Where It's Really, Really Cheap

One option worth considering is living where it's really, really cheap. Especially in rural areas, it's often possible to find housing that's virtually free (or even actually free, such as in exchange for a few hours of work as a caretaker).

Another option for living where it's really, really cheap is to live overseas in a country with a lower cost of living. You have to live where people are poor if you want to save money (otherwise you can do just as well living someplace cheap in the U.S.), but there are plenty of places where it's cheaper to live than it would be anywhere in the U.S.

My Strategy

To my mind, the winning strategy in this, as it is in most financial decisions, is to think carefully about what you really want, check prices, and make a budget that lets you afford the things that are most important to you.

My own calculations have led me to live someplace fairly cheap, yet fairly close to some big cities. (St. Louis, Indianapolis, and Chicago are all close enough to make day trips; Chicago by train.)

The decision was pretty easy for me. I want to be a writer. What I get paid is the same no matter where I live. By living somewhere cheap, I'm able to be a full-time writer. If I lived somewhere expensive, I'd have to get a day job. And then I wouldn't have as much time for writing. I'd be less productive and less happy. I'd also make less money from my writing, putting me even further behind.

Many people choose to live where it's expensive, but to do so on the cheap — a house in the far-out exurbs and a fuel-efficient car for commuting. That may be the best choice for them — as I say, I don't want to be second-guessing somebody else's life — but a lot of people make that choice by default, rather than because they ran the numbers and figured out that it put them ahead of where they'd be if they lived someplace cheap.

If you've been living in a big city, you'll probably be pretty surprised how much cheaper you can live in a small town or a rural area — and even more surprised how accessible the big-city amenities turn out to be for someone who's not spending every waking hour earning enough money to pay their big-city rent.

Written by Philip Brewer and published on Wise Bread. Read more Lifestyle articles from Wise Bread.

New Tools for the Unbanked

Philip Brewer — Wed, 15 Jun 2011 10:24:21 +0000

Until just the past few years, lack of access to the banking system has been an expensive burden on the poor. Just recently, a surge in new financial products make it a lot less expensive to be unbanked. (See also Making Direct Deposit Safe for the Garnished)

It used to be that you either used the banking system, or you paid through the nose to buy individual banking services (3% or more at a check cashing store, $1 or more for a money order, outlandish rates for a payday loan).

The Unbanked

Although the barrier to using the banking system is usually described in terms of poverty, merely having little or no money doesn't need to block access. It's really a cluster of related problems that add up to make using conventional banking services so difficult and expensive that people end up choosing to do without:

No cash to keep a minimum balance
No regular paycheck to have direct deposited to qualify for a no-fee account
Not living in a neighborhood with a local bank
Not speaking (or reading) English well enough to use banking services
Not having the skills to maintain a check register
Having a history of bounced checks or unpaid debts
Working during banking hours

Any two or three of those issues can put the regular banking system out of reach (although someone with a little financial savvy can almost always find a cheap way into the banking system).

But if the way you live your financial life makes the banking system a poor fit, there are now some alternative financial service providers that can be cheaper than regular banks.

The New Prepaid Cards

These alternatives are organized around a prepaid debit card. Instead of cashing a check, they put the money onto your card. This is just as good for you (you can get cash at an ATM) and cheaper for them.

These cards do charge fees — a lot of them. There's often a fee to get a card, a fee to add money, a fee to use an ATM, a fee to check your balance, a monthly fee, etc. But the fees are clear (rather than mysterious the way bank fees can seem to someone whose parents didn't teach them how to use a bank). And they're low — a careful user can keep the monthly charges at just a few dollars (less than they'd pay for a bank account).

Further, we're about to see another step down in these fees. That's because the new cap on debit card swipe fees has an exception for reloadable debit cards — provided the cards have no overdraft charges and allow at least one no-fee ATM withdrawal per month.

That exemption has already drawn American Express into the market for reloadable debit cards. I expect that the other similar prepaid card providers will quickly start offering one free ATM withdrawal per month in order to qualify under the same exemption. (The new American Express card also offers some on-line services — such as checking the balance on the card — for free. I expect competition will force others to follow.)

I still think the banking system is the better choice for most people. But for everyone else, the next generation of prepaid cards will provide most of the banking services they need, and do it with lower fees than ever before.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Building a Credit History

Philip Brewer — Tue, 24 May 2011 10:00:16 +0000

Books on personal finance used to have a chapter on building a credit history, because it used to be harder to do. Young people used to find themselves in a classic chicken-and-egg situation, unable to borrow money without a credit history, but unable to build a credit history without borrowing.

Things changed about twenty years ago, when the credit card industry started giving anyone who could scrawl their name a credit card. That's become a little less true since the financial crisis, but only a little.

So, it's pretty easy nowadays to build a credit history. Even so, it's worth giving the topic some careful attention, because building a good credit history can save you a lot of money over the course of your life. (See also: How Debt Fools People)

How to Build Your Credit History

The procedure is easy. There are three steps:

Borrow money
Make payments on time
Make the last payment a little early

As I say, that first step used to be tricky, back when lenders insisted that their borrowers be credit worthy. Nowadays, it's not so tough.

Don't just skip to the last step, though. You might imagine that you could just borrow some money, then pay it back, and you'd be done. But that's not the sort of credit history that borrowers want. What they really care about (and they care about it more deeply than you might imagine) is that you can make payments on time.

They care for two reasons.

First, because a proven ability to make the payments turns out to be a very good indicator of your ability to eventually pay the money back, even if you run into problems. (That is, they're not interested in your ability to borrow money, stash it in a bank account for a month, and then pay it back.) They care about your demonstrated ability to be organized enough to get the payments made. They care about your demonstrated willingness to make the little sacrifices needed to make the payments even when there's some glitch in your income or an unexpected expense.

Second, that's how they make money. A borrower who pays the money right back is of no particular interest to a lender, because he or she pays much less interest.

Making the last payment a little early is no longer as important as it used to be, but it can't hurt. (It was important back in the days when the records were kept on paper — when an actual person had to look down a row of entries in a ledger to see if your payments had been made on time. Lazy people would just check that you made all the payments, and then check that the loan was paid in full by the due date.)

Building Your Credit Score

Be aware that your credit history is only one piece of minimizing your borrowing costs; you also want a great credit score.

Happily, if your credit history shows you can make monthly payments on time, you're most of the way there.

The other important factors for your credit score are:

A Longstanding Credit History

If all your debts are new, it hurts your credit score. Solution: Keep your oldest credit card active.

Plenty of Available Credit

If your cards are maxed out, it hurts your credit score. Solution: Don't approach the limits on your cards.

Few Credit Checks

If your credit history is checked by multiple potential lenders, there's no way for the lenders to tell if you're just shopping around, trying to get the best deal on a loan (fine), or desperately trying to arrange more credit because you're overextended (not fine). Solution: When shopping for additional credit, apply to a small number of lenders, and apply to them all at once.

A good credit history and a good credit score can save you a huge amount of money on a mortgage and a modest amount of money on a car loan. But remember — you're just "saving" money compared to what it would cost to borrow if you had a crappy credit history. In actual fact, borrowing costs you money, no matter how good your credit history is. The real way to save money is not to borrow in the first place. That's not to say that credit can't be a reasonable choice at certain times — it's just never the cheapest choice.

Written by Philip Brewer and published on Wise Bread. Read more Debt Management articles from Wise Bread.