The Difference Between Money and Wealth
Wealth is measured by money, but money isn't wealth.
Imagine a household on the brink of bankruptcy. Perhaps their expenses have been running dangerously ahead of their income causing them to pile up debt on credit cards. The mortgage and car loans add to the leverage. And then the sole income producer unexpectedly is loses his job. With two young kids to care for, the mother isn’t in a great position to work. Meanwhile the husband who was employed in a very specialized role with fairly high pay cannot find a comparable job. You get the picture.
They had been spending a lot of money, but they were not monetarily wealthy in a sustainable way. They were just living as if they were. With high leverage, insolvency—the inability to cover your debt payments—can come fast. For this unfortunate family it has.
Now suppose while trying to distract himself from his distress, the husband is working in the basement sorting and cleaning—an overdue chore that he unfortunately now has time for. But suddenly, a miracle. He notices a cinderblock is ajar on the back wall. When he goes to align it, it falls outward revealing a small safe. He quickly pries it open with a crowbar to reveal three gold bars totaling 500 troy ounces in weight. He is now $1.25 million richer!1
He can pay off all of his debts and still have $500,000 cash left to show for it. His family is saved from bankruptcy . . . for now.
If he doesn’t find another job and/or adjust their spending levels, he easily could find himself back in this same position soon enough. Money has not made him rich. It has made him solvent and liquid.
We could explore a similar story with a company. Consider two different versions:
A bank that is now insolvent—it has more debts/liabilities (customer deposits, etc.) than assets (loans, etc.) to cover them.
A manufacturing firm that makes widgets that cannot cover its expenses including debt payments—it’s inventory is basically all sold, but the revenues did not raise enough to turn a profit. And now no one will extend it more credit.
Both of these firms are facing big problems. The FDIC is going to shut down the bank and sell it off to another bank to manage the deposits and loans.2 The widget maker is headed to bankruptcy court to consider liquidation or reorganization. For the owners of each company it is haircuts all around.
But suppose the bank discovers a forgotten room in its vault that contains precious metals and cash it had somehow misplaced—all of it assets of the bank, not held for others. Suppose the widget maker realizes it has a huge inventory stockpile of ready-to-sell widgets sitting in a warehouse offsite. Both companies have discovered a get-out-of-insolvency card good for a one-time use.
But if the bank keeps making bad loans or paying interest to depositors above the interest it generates, it will be back in the same boat soon enough. So too the widget maker if it cannot figure out a way to be profitable.
The money (actual cash or near cash like gold or saleable inventory like the widgets) is not wealth. It saves the day, but it does nothing to win the war.
Now think about this from a broad social perspective. For society as a whole nothing has changed in any of these situations before or after the bankruptcy-saving windfall. The world is not richer or poorer in any case.
It would seem that there is a paradox: It appears that the family, bank, and widget maker are all suddenly richer at the expense of no one else but at the same time the larger society to which they belong (the full economy) is unchanged—no richer, no poorer. Understanding that money is not wealth resolves the paradox.
In fact if anything, the paradox is how the family, bank, and firm were all “saved” but the larger society is actually poorer as a result. This is because three entities that have been destroying wealth (running up expenses they couldn’t cover, not turning a profit, etc.) have gotten their hands on more resources3 to potentially squander.
Money is a claim on wealth. That is how it is a measure of wealth. If we print or discover more money, we just transfer wealth among ourselves. The family or firm that suddenly has more money is “wealthier” for the time being at least while all other holders of money are a little bit less wealthy such that net wealth is unchanged—it is a zero-sum game.
Alternatively the creation of wealth is a positive-sum game. If the mother in our example family figures out a way to turn her craft into a profitable business turning around the family’s fortunes, the family and the society to which they belong are now truly wealthier. If the bank hires new management who can clean up the balance sheet or if the widget firm finds a way to squeeze costs down for profitability, both those companies and society benefit.
Money is not wealth; therefore, more money is not more wealth. More money may signify more wealth, but this wealth might be simply a transfer from others rather than a true wealth creation.
Wealth comes from putting resources to use to create additional, new resources. More wealth comes from more resources not more claims on resources. While the difference may seem at once to be obvious, it is nuanced and lost on many.
PS, The recent riches discovered in Guyana are yet another twist on this. Exxon has found a very large deposit of oil off the country’s north coast. It is so large relative to the very poor nation that their per capita GDP has more than quadrupled with more growth to come. Oil is different than gold and money. It is a resource with value beyond simply speculation and exchange. Does this make Guyana wealthy? It will for at least some time, and it may endure. But it takes more than resource wealth to stay wealthy. Neighboring Venezuela is great evidence of that. Without good institutions and a proper culture, a resource rich nation can find itself poorer than the example family that started the post.
If you don’t like this hypothetical, simply substitute that he pays a dollar to play the lottery and wins $1.25 million.
Notice this is different from a situation where the bank lacks liquidity—it cannot access enough cash to cover withdrawal demands despite its asset value exceeding its debt. In that case the Federal Reserve would be the lender of last resort ready to extend credit on good collateral at a penalty interest rate (Bagehot’s rule).
Technically access to resources via money, which is only a claim on resources.