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Choosing a numeraire is the most important decision an investor can make. But few investors even know what a numeraire is let alone have put deliberate thought into choosing their numeraire. With advances in technology using a reliable numeraire is easier than ever.
Investing is the process of allocating capital. Capital is the result of consuming less than what is produced.
For example, if 10 pounds of corn are produced and 7 pounds of corn are eaten then there are 3 pounds of surplus corn. This 3 pounds of corn is capital that can then be allocated and produce a return. That return can be measured using financial statements, like an income statement and balance sheet, and an accurate numeraire.
As individuals or society wisely allocate capital that generates a return then the standard of living will increase. For example, enough capital may be stored and then allocated resulting in a the farmer being able to purchase and use a shovel instead of his hands to produce more corn. Now the farmer can spend the same amount of time but produce 2-3x as much corn because of the capital that has been stored and allocated into shovels, plows, tractors, semi-trucks, etc. This is called increased productivity.
On the other hand, if an individual or society consumes more than they produce then they begin to erode their capital. Generally, this is unwise and will lead to a lower standard of living. Remember the old advice: do not eat the seed corn.
Like gravity does not care whether the sentient human or inanimate rock knows their condition as they hurl towards the earth from thousands of feet in the air so likewise economic law does not care whether individuals and society can accurately measure whether their capital is being accumulated or eroded.
In this process of investing an individual makes a value calculation about whether to consume or save resources. The key role interest rates play is in regulating production and consumption over time. Generally, low interest rates encourage consumption while high interest rates encourage saving.
Individuals produce commodities because they add value. Corn is for food, oil is for fuel, steel is for buildings and water is for drinking. Commodities are vital to sustain life. Consequently, accurately measuring the demand for commodities over time is equally important so that the market can provide supply and avoid consequences such as starvation, dehydration, malnutrition, etc. The Founding Fathers understood these economic principles and with the 1792 Coinage Act answered the question: What Is A Dollar? They were strict in the 1792 Coinage Act for good reasons.
In economics, the numeraire is an item or commodity acting as a measure of value or as a standard for currency exchange. In accordance with Article 1 Section 8 Clause 5 and Article 10 Section 10 Clause 1 of the United States Constitution the Coinage Act of 1792 provided in Section 9:
DOLLARS or UNITS – each to be of the value of a Spanish milled dollar as the same is now current, and to contain three hundred and seventy one grains and four sixteenth parts of a grain of pure, or four hundred and sixteen grains of standard silver.
However, government has strayed with unconstitutional legal tender laws and along with central bank intervention in the gold market the environment is extremely difficult, if not impossible, to accurately perform mental calculations of value. The result is a broken pricing mechanism.
Additionally, most people are completely oblivious to the importance of choosing an accurate numeraire. More daunting is that for the small percentage of people who measure their financial vital signs few use a precise numeraire to do so.
To assist you in performing these two tasks for an example I have created The Numeraire Spreadsheet. It functions as an example of how to implement provident living principles using an alternative numeraire.
Keeping financial statements such as an income statement and balance sheet takes diligence. It also takes persistence and diligence to use an accurate numeraire. But doing so will allow you to view your financial condition with improved clarity and which will likely increase your ability to perform better allocations of capital which will help you multiply your net worth. For the New Year make it a goal to spend about 15-30 minutes per month to accurately measure and track your financial condition.
If you have an suggestions for The Numeraire Spreadsheet or any stories from using it then please leave a comment.
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