Thinking About Thinking

This is the purest business idea of all time – give me a dollar and I’ll give you 90 cents (or something less) back.  Ridiculous, right?  Yet, it happens in so many different forms that it’s somewhat surprising.  Why would anyone in their right mind give someone a dollar just to get less money back?  And, I’m not talking about you giving someone a dollar so that they give someone else 90 cents back.  That’s money movement.  I’m talking about a direct trade – you give someone money just for the privilege of getting less money back.  It happens a lot and we’ve all participated in it.   

Here are some ways this model exists in business – and I’ll rank order them by the models that give you the most money back to the ones that give you the least.  I’m going to spend a little extra time on the last business which I think is the most onerous of them all.  Here we go:

1.  ATMs.  The most obvious model – you give the bank a dollar, and they give you 98%-100% of it back every time you withdraw it from the ATM.  Their service: accessibility and interest. 

2.  Travelers Checks.  We all know that companies like American Express have made a great business in taking your money, and giving you 96%-99% of the value back in the form of a less liquid travelers check.  What’s the embedded service?  Insurance. 

3.  Check Cashing.  Companies like Western Union will take your check and give you cash worth about 95%-99% of the value.  Their value: liquidity, especially to the unbanked.

4.  Currency Exchange.  Companies like Travelex have made a great living taking your money, and giving you 90%-98% of the value back in the form of another currency.  The implied service:  local purchasing power.

5.  Coinstar.  These guys own the kiosks you see at the grocery store where you put in a bag of coins and they give you 90% of the value back in the form of cash.  It’s an amazing business to say the least.  What’s their underlying service?  Money portability.

And last but certainly not least:

6.  Gold Buyers.  These companies allow you to trade in your gold jewelry, and they give you cash for the gold.  Not a fair example you say?  I think it’s very fair – gold is a currency and so are the dollars you’re getting in return.  Their true service: liquidity.

Here’s why I think the gold buying services are truly the worst economic deal of them all.  There are two compounding issues.  First, these companies are not giving you anywhere close to value of your gold, dollar for dollar.  While the above businesses give you 90%+ of the value of your dollar, some people who have used these gold buying services have calculated that they have received 17%-18% of the value of their gold.  That’s an 80%+ tax right there.  (UPDATE: This CNN report that came out today says gold buyers pay between 18%-60% of face.)  But, let’s not stop with that.  There’s a second compounding issue that can be material.  Gold is an appreciating asset.  The US Dollar is a declining asset. 

Here’s the historical price of gold:

Here’s the strength of the US Dollar over the same time period:

[UPDATE: Just a note – past performance is not indicative of future returns.  Either currency could go up or down from here.  It’s unlikely that any currency fluctuation up or down would make up for the initial 80% tax though.]

Here are the real economics:  let’s just say you sold your gold jewelry in 2003 where the actual gold value is $100.  Let’s say you got $18 for that $100 of gold.  And then let’s just say you held that cash until now.  The purchasing power of that $18 has declined to ~$14 since 2003.  Meanwhile, if you just held the $100 of gold in the form of the jewelry, it would now be worth over $350.  I’m not exactly sure how to properly index two bifurcating currencies, but in a nominal sense, you traded something worth $350 for $14.  You got paid 4 cents for your dollar.  Instead of saying “We Pay Top Dollar” – these companies should say we pay you cents on the dollar. 

[UPDATE: This is what happens when you whip together a blog post late at night.  Since the gold is priced in dollars, the depreciation of the dollar is embedded in the gold price.  So, I didn’t need the second chart so I double counted the impact of the dollar depreciation.]

Now to be fair – most gold sellers probably don’t hold their cash so the separation from gold’s appreciation and the dollar’s depreciation may not actually have time to play out.  The seller gets the value of instant liquidity and they probably use it.  In addition, the gold buyers do need to have infrastructure to appraise, melt, and monetize gold if they do it themselves.  Nonetheless, the tax these companies charge to give you your money back is pretty onerous no matter how you cut it.  But, it just goes to show, there’s always ways to get people to give you money in exchange for less money back.