leftovers #3 - coining professor average (insurance)

A logical explanation for why we lack excess capacity throughout our society is the insurance industry. In one sense, insurance fills a massive need by charging policy holders a premium in exchange for storing value throughout the lifetime of the agreement. It's a way to hold excess capacity without taking on the full immediate cost. But there are at least two problems with this solution.

First, it means insurance seems to cost more than it's worth; not many see the wisdom in paying $11 for $10, even if the $1 is basically a service fee that ensures the $10 retains its value. Businesses and individuals with less money therefore opt for their own methods of keeping excess capacity. But for small-scale operations that are already cost-constrained, what does this actually mean? The coin laundry can keep some extra quarters on hand but it cannot afford to keep a massive stockpile; the local hospital might be able to keep a spare room or two for extra PPE but it needs to devote as much space as possible to earn revenue from other services. Insurance might seem like it's too expensive or just a bad deal, but this reasoning forgets an important fact; if you can't afford the insurance, you probably can't afford to buy your own spare capacity.

The second issue is that insurance fails when too many policies are cashed at once. The reason there is no such thing as 'quarter insurance' is because when one policyholder encountered circumstances that required quarters, it's likely these same circumstances apply to the other policyholders. It's not possible to run an insurance business when most premiums could be cashed out due to one event. This is why most hospitals couldn't sell their excess capacity to neighbors back in the spring - the catalyst for one hospital reaching capacity would quickly mean the same result for all others. If one passenger is boarding a lifeboat, you can be sure everyone is queuing up to do the same.

leftovers #2 - coining professor average (trickle up economics)

Last week, I added an extra thought that innovation is unlikely when markets discourage profits. But that's a long-term thought - what about now? I think a lot of small businesses are on their last legs at the moment and laundromats are no exception. The landscape for local laundry will change in the future, likely toward a model that accepts new forms of payment; it's hard to imagine the next generation collecting quarters for the laundry, so we know we'll get there somehow.

My guess is that the coin shortage will be contribute, perhaps mightily, to the eventual extinction of the coin laundromat. As each coin laundry closes, customers will shift their business to surviving competitors, which will most likely accept card payment. The coin laundromats that survive will likely be among the stronger operations and might draw on their strength to invest in a new payment system. The government could step in and propose policy solutions to save some laundromats. A program that offers to help laundromats convert to card payment systems is sensible because it eliminates an existential threat, but this is expensive; I have no expectations for such a program to be implemented on a widespread scale. The better bet is some kind of cash injection into the economy, which might help some customers acquire quarters but eventually creates inflationary pressure. Inflation means an opportunity to pay off prior investments but this only benefits firms that made investments, which we determined last time does not include struggling firms due to the dynamics previously described; inflation reinforces the initial advantage for the wealthier firms.

In other words, my guess is that the coin shortage will put the weakest firms out of business, redistribute customers toward stronger firms, and in the long-term exacerbate existing inequality between Main Street and Wall Street. Ronald Reagan's smile surely trickles down from the heavens, or maybe these missing quarters are glinting in the sun as they accumulate to the top; in any case, an unrestrained free market fetish reinforces inequality by forcing market share to accumulate at the top.

leftovers - coining professor average (imperfect perfect)

One (sub) rant that didn't make the first team was about what I'll call 'the imperfection of perfect competition' - the inability to increase costs unless it also increases return. In my mind it's a huge problem, and kind of explains why excess capacity is a pipe dream for most businesses - not enough lifeboats on the Titanic, not enough N95 masks in the storage closet, not enough quarters at the laundromat.

It's also hard to convince a business to make certain obvious upgrades - like a laundromat installing an electronic payment system - if it creates a risk of going out of business before the investment translates to increased return. Think about it - are you going to pay $1.50 with a card to help the laundromat pay off the new payment system, or will you stick with the coin laundromat and its $1 price? But if the laundromat charges $1 via card, where will it get the money to pay off the upgrade? It doesn't matter because customers do the best thing for themselves; the end result is 2020.

I think underlying all of this is the lack of growth, specifically the kind that starts with innovation, and it makes sense when you think about how much America glorifies the free market. A laundromat cannot innovate in any meaningful way because each quarter on its expense sheet goes toward staying in business; every story about healthcare workers improvising PPE suggests an inability of hospitals to dedicate meaningful resources toward investment in spare capacity. It's the imperfection of perfect competition - if investment in innovation relies on profits yet perfect competition by design rules out profits, then there is no growth - markets where firms are unable to generate consistent profits experience zero growth.

coining professor average

I've been casually following the story about our national coin shortage, one of those very real problems of the past few months that - like The Great 2020 Toilet Paper Rush - many are trying to navigate while dealing with far more significant concerns. It seems like the news coverage of the situation more or less follows the same tired template - summarize the situation (people don't have the coins required to complete cash transactions), list a series of facts that may or may not be relevant (people don't want to linger in front of coin exchange kiosks, bakeries are closed, etc), acknowledge that "coin shortage" is a technically imprecise label (semantics, but it is true that circulation hasn't been reduced), and maybe include one or two anecdotes that demonstrate the human side of the situation (a child writes a letter to the tooth fairy offering to accept bills instead of quarters).

In other words, I've read a few thousand words about the coin shortage without learning anything; there is no shortage of inane coverage. Could we at least get some insight into why it's happening in America, but not in Europe? Anyway, I'm here with my offer to help: a classic TOA examination of this situation, where I don my well-worn Professor Average hat to help analyze the situation, and maybe come up with an observation or two. At the start, I will helpfully highlight any particularly important principles, but once I've laid out the main argument I will leave you to reach your own conclusions. Most importantly, I will make a significant effort to avoid the pitfall of the coverage I've seen thus far - allowing trivia to deputize for explanation.

Let's start at a hypothetical coin laundromat, which to keep it simple for this example we'll say has advanced machines that wash AND dry your clothes (but no folding). In other words, customers use a machine once per load, and the cost is $1 in quarters. So how many quarters does the laundromat need to run itself? The answer is FOUR. If it sounds crazy, that's because it is, but it would still work; one customer would exchange a dollar for the four quarters and start Machine #1, then an employee would remove the four quarters and exchange those with the next customer for another dollar bill. There are 500 million quarters in circulation but you only need four to run this laundromat - you don't need much cash to facilitate transactions.

Of course, you don't need me to tell you that although four quarters is a theoretical minimum, this is a very precarious environment for our laundromat; imagine going out of business because you can't reach a quarter that rolled behind a machine. Plus, it requires some additional cost burdens, such as needing to have an employee on the premises at all times to unload The Four Quarters anytime someone started a machine. Technically, the minimum number of quarters you need to run any coin laundromat is the cost of the most expensive machine, but that's like saying the minimum number of socks you need to get through the week is two. In practice, the laundromat will keep some quarters in reserve, with the exact number reflecting their tolerance for the risk of running out.

The problem with having an onsite quarter reserve is that idle cash has no intrinsic value; in fact, idle cash is costly. The laundromat pays an endless list of hidden costs to hold the extra quarters - it forgoes potential income from savings or investments, buys depreciating equipment for storing the quarters, devotes space in the laundromat solely for storage, and so on. To avoid paying these storage-related costs, a clever owner might pass the burden on to the customer and refuse quarter exchanges, essentially implementing a 'bring your own quarters' policy. Initially, this might be a good idea as each customer ensures a healthy quarter reserve, but since the laundromat's entire revenue now comes exclusively in quarters, it means a lot more work to handle the money compared to collecting revenue in dollar bills. It's going to take more time for the boss to use those quarters to make purchases, pay employees, or even just bring the money to the bank. And if the bank doesn't want to accept a burlap sack full of coins, the owner must budget additional time for rolling quarters (or pay the commission rate imposed by coin sorting machines). 'Bring your own quarters' solves the issue of having reserve quarters in the back room but the eventual cost increase is enormous, measured mostly in longer processing time.

Given the inefficiency of the two extremes, I think it's pretty clear that we'll end up with something in the middle, which was life in February - laundromats have extra coins for exchanges but customers still bring in a few of their own; both parties save time. The system leans on the excesses of our mints and printing presses - there is around $1.5 trillion in circulation, or just over $4,000 per American, which seems like a lot given that I almost never have more than $100 in cash at any one moment. This informal measurement suggests that there might be as much as 40x more cash in circulation than necessary (40x is highly unlikely to be the true factor, but illustrates the larger idea that we have more supply than necessary to complete daily cash transactions). And yet, as we are learning this summer, when it comes to cash we always have plenty of excess capacity... until we don't. But is there a better solution for this current situation than releasing additional cash into circulation?

This cycle is fueled by an underlying problem with our economic system while also serving as a microcosm of it - there is no incentive to produce (or purchase) anything 'just in case'; output (and spending) must have measurable present value. In theory, we buy umbrellas for a rainy day; in practice, we get soaked, then buy two umbrellas for next time. It doesn't seem like a huge deal when we are talking about the way people pay for laundry. But each shortage for something like toilet paper or laundry quarters is further evidence that any sector in our economy which operates with similar free market principles will someday face this issue.

A more serious consideration is ICU capacity. It's too early to say how many people will suffer in this pandemic because their local hospital ran out of treatment capacity; it's certainly unlikely that we won't learn from our errors. But what can we expect based on the history of similar errors? Let's just say I assume whatever happens in the hospitals will stay in the hospitals. Titanic didn't gross $2 billion for its commentary on why no one felt 'just in case' was good enough reason to stock sufficient lifeboats; I suppose we felt the lesson was applied once all ocean liners met modern safety standards. Our laser focus within domains ensures we don't hit the same rock bottom twice; the strict application of lessons within narrow confines suggests every domain will hit rock bottom once. I'm confident there will soon be a push to expand hospital capacity to prepare for future pandemics, but will the lessons extend beyond the healthcare realm? I'm not even sure these lessons will ensure sufficient stockpiles of PPE.

There are very few true surprises; most risks are simply ignored. And yet, we are constantly surprised when things go wrong. So what is going on here? We've seen so far that in a truly efficient setup, the minimum resource requirement can be very low (four coins for the laundromat) yet intuitively we know it's foolish to do anything at the bare minimum (two socks example). We've noted that the balance between survival and excess is controlled mostly by cost considerations (idle cash produces nothing) yet we leave ourselves exposed to risk by prioritizing present cost reductions until the risk harms us; we eventually eliminate the risk with an excessive overreaction (umbrella example). Finally, although we understand all of this in a broad sense, it seems like we don't apply lessons across all domains (the Titanic ensured sufficient excess capacity for lifeboats, but not all other concerns). To put it all into one sentence, we can get by on very little, but we build in some slack just in case, which lulls us into a false sense of security despite history being filled with endless examples demonstrating why this is the first step toward disaster.

This essentially helps us put the coin shortage into proper perspective as part of an ongoing cycle of creating slack, eating it up, and creating more slack, but there is a missing piece in the puzzle - why do we bother using up the slack at all? I think the coin laundromat offers a hint. The system strains from the moment people fear there will not be enough coins to conduct laundry transactions, which means laundry customers might start hoarding quarters in anticipation of a future shortage. But why would people believe in the possibility of a coin shortage? I worked this out by inverting the question - how would someone refute reports of an upcoming coin shortage? The solution is labor-intensive, but I think it's the only way - you would need to talk to enough people until you were convinced that in an absolute pinch you could rely on someone else for quarters (and everyone else could rely on you). This might be feasible in a small neighborhood but in larger communities or disconnected environments it quickly becomes more difficult, then impossible.

I suspect that what happened recently is that a few people saw some patterns, made some associations, and came to fear an upcoming coin shortage. They didn't get the assurances they needed from others - perhaps due to the generally increasing isolation many of us are experiencing thanks to everything associated with COVID - so they decided to look out for themselves and collect some extra coins 'just in case'. And now we have a situation vaguely similar to what we had earlier in the year with toilet paper - plenty in circulation for everyone yet a complicated situation if you ran out.

I think the real story of the coin shortage isn't the same old list of explanations I see in the news coverage. It isn't about offering to accept Venmo from the tooth fairies. It's about trust, or the lack of it; it's about a trust shortage. And in many ways, the trust shortage is causing or exacerbating many of 2020's problems, including the shortages in both coins and toilet paper. As I noted above, there are factors of the economic system at play here - the idea most relevant to this examination is individuality, and it exists in the roots of the system. Individuality means that despite the constant threat of scarcity, people looking out for themselves, driven entirely by self-interest, can weave an intricate tapestry of economic activity through their transactions that ultimately leads to efficient markets and a rising tide for all of us. But in this system - or at least in the models of it that I studied as an undergraduate - there is very little room for trust. If I remember correctly, the only time trust came up was when we studied lemon problems, which implied that trusting others in the market ensured a lifetime of being sold defective goods by shady salesmen.

I hinted at a solution to the coin shortage in small pieces throughout this post. The Four Quarters of the hypothetical laundromat is one way while the exercise of confirming you could rely on all your neighbors is another. Both methods are agreements to share a scarce resource and in this they resemble the theory suggested in the prior paragraph; the difference is that these methods rely on coordination, not market interactions, which means these methods are almost entirely reliant on trust. Another way to think of this is that if my responsibility was to ensure everyone had enough quarters for the laundry just as my neighbors were responsible for ensuring there were enough quarters for me, I'm almost certain there would be no concerns about the coin shortage.

I think when people talk about alternatives to a capitalist system, this is basically what they are talking about - a world where individuals think collectively because they trust the collective will reciprocate and take care of them. A thoughtful analysis of the coin shortage - or the toilet paper rush, or even the challenge of getting everyone to wear a mask - would think more about the role of trust in the problem. Unfortunately, I worry we are too far away from a world of trust to connect these dots, and the trends of 2020 don't offer much hope for an immediate change. But I think developing this mentality of taking care of others because they will take care of you is a crucial long-term goal for humanity. In a community built on trust - which can be as large as a country, or even the world - people will naturally make sacrifices for the greater good because they believe others will do the same. We're not quite there yet; we're not really close. When I think of how much time, money, and energy is wasted each day because of our trust shortage - the result of increasing isolation, polarization, and resentment - I realize we have a lot of work to do before we can repair an economic value system that has no place for trust.