Risk & Fragility: What's in your wallet?

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Money. The enabler of all economic activity. The root of all evil. Whatever soubriquet you attribute to it, its nature and substance are becoming the topic of a vigorous debate as of late. A topic that was thought to have been fully settled over half a century ago and relegated to the thought experiments of historians and academics has been gaining renewed interest. This debate was triggered by the 2008 financial crisis in the US and the subsequent astronomical bailouts. The troubles in the Euro zone  have added fuel to the fire since the future of the Euro itself is currently in doubt.

Economists define money in so many different ways. For our purposes, however, we can define it as a universally (within the target population) accepted divisible medium of exchange of a stable value. Divisibility allows money to be used to trade objects of optionally small value. Stability permits the use of money as a store of value. The current debate about money seems to be entirely focused on this latter feature, namely stability. Many argue that without a rigid link between the supply of money and a commodity of a limited supply, the value of money cannot be guaranteed. In the case of fiat currencies (defined as money whose value is regulated by government law), value stability is entirely in the hands of the issuing central authority. In such a case, perception of stability is a direct result of the amount of trust one places in such authority. Political pressure and corruption can (and ultimately always do) lead to undisciplined dilution and harmful devaluation of the money supply.

The scope of worries concerning devaluation, however, seems at least a quarter of a century too old. These concerns are mostly preoccupied with paper fiat currency and their potential devaluation. They are framed in the days when money was kept as wads of cash in a bank vault, when you could walk into the bank and talk to the manager, when the manager used to know the customer, and banks had humanly legible books to validate an account status.

A visit to the mall, your neighborhood Starbucks or to your bank's website should quickly reveal that those days are long gone. Paper money belongs to the quaint world of yesteryear. Today, your money is electronic. It resides on a hard-drive somewhere around the world. No one in your neighborhood branch has a clue about why the computer shows the figures it does. Most of your buying and selling is done using your credit/debit card, iPhone or other similar means. Most banks and other financial institutions are always nudging you towards a fully electronic means of receiving your statements and other bank communication.

The northeast power outage of August 2003, the recent power outage of the Washington DC area of July 2012, the loss of 40 percent of my account with MF Global, the repeated flash crashes in the stock market and the arbitrary resolution of subsequent trades, and a recent failure of my server's RAID drive adapter were all incidents that caused me to check my wallet (or, my account balances). To my dismay there was nothing there.

The fragility of the system is glaring. You have been working all your life to amass a heap of digits. A computer glitch, a power outage or a fraudulent banker can wipe all your digits away.

  • What if you try to log on to your bank's website but your password is not acceptable and no one can tell you why?
  • What if after you log in you see an account value of $0.00 and you can't prove otherwise?
  • What if you can't log in or transact at all because of a power outage?

In light of these incidents and questions, the concern of politically driven devaluation seems pretty academic indeed.  Check back in the coming weeks for more on system fragility, including some thoughts on possible solutions.

Image provided by 401k Calculator // attribution by creative commons

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Maged Tawfik

Financial Risk Specialist

Financial Risk Specialist SAS Institute, Cary, NC Cornell University, PhD

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