Pounds, Shillings, and Pence

Several weeks ago, my wife asked what I was reading before we settled in for the night.

I told her, “The history and monetary implications of the British pounds, shillings, and pence system... and Britain’s move to decimal currency in 1971.”

Riveting, I know. As you can probably imagine, she was about as interested as you may be at this point, but hang with me. This started because I wanted to understand a monetary system that sounds more like Harry Potter than modern finance, and finally figure out what Mary Poppins meant by “Tuppence a Bag.” That opened a rabbit hole.

The star of the story was the farthing. It was worth just one quarter of a penny, or 1/960 of a pound. We already debate whether it is worth minting pennies, yet Britain used a coin worth four times less that remained part of everyday commerce for generations.

Under monetary systems tied to scarce precious metals, purchasing power could remain relatively stable over long periods. Tiny denominations stayed useful because prices generally moved much more slowly than they do today. After the inflation of the past few years, there is an obvious allure to that kind of stability. But it is easy to romanticize it.

Stable money came with a much more rigid economy. Stable money came with a much more rigid economy. Lending was more constrained, and financial crises were much harder to manage. When banks came under stress, credit could dry up quickly, bank runs were harder to contain, businesses stopped investing, and families delayed spending.

Modern fiat money made the system much for flexible. Banks lend. Businesses invest. Families finance homes. Capital is deployed toward equipment, infrastructure, innovation, and new ideas. You aren't rewarded for hording cash, inflation is a feature, not a bug. Just as importantly, ordinary households now have practical access to productive capital.

With a low cost index fund, a teacher, engineer, physician, or small business owner can own pieces of thousands of companies around the world. Those businesses can innovate, improve productivity, raise prices, and grow as the value of money changes. Of course, the modern system has its own problems. We contend with inflation, rising government debt, policy mistakes, and the possibility of financial repression, where inflation quietly outpaces the returns available on safer assets. Those concerns are legitimate and help explain the appeal of gold, cryptocurrency, and skepticism of bonds. 

Fiat money is not perfect, and it will almost certainly continue to evolve. But compared with the rigid systems that preceded it, it dramatically broadened access to credit, productive investment, and economic opportunity.

That is why stocks remain the portfolio’s primary long-term defense against inflation. Ownership of productive assets provides the growth needed to preserve purchasing power over time.

Much of today’s skepticism toward bonds stems from 2022, when stocks and bonds both declined as interest rates rose rapidly. Longer-duration bonds were hit especially hard because their prices are more sensitive to changing rates. Which is why considering your overall bond maturities matter. That was painful, but it was not evidence that bonds no longer serve a purpose. And even today, when everywhere you look are headlines about bond pressure from the higher yields, we have to remember bonds have a different job.

Bonds are the boring ballast. They provide liquidity, fund spending when needed, and give us something more stable to rebalance from when stocks decline. Their purpose is not to outgrow inflation over decades. Their purpose is to give the growth assets in the portfolio time to do exactly that. They can hit rough patches when rates increase, but you can mitigate that with your overall maturity exposure, and eventually those higher payments are recouped.

Every monetary system has flaws. Every portfolio has trade-offs. The goal is not to find the perfect monetary system or the perfect asset. It is to understand what each is designed to do, then build a portfolio where every piece has a purpose.