Tuesday, August 01, 2006

What's in Your Wallet?

Suppose you have two things in your wallet: a $20 bill and a frequent flier card. Which of these is considered money?

The formal definition of money is that it is (1) a medium of exchange, (2) a store of value, and (3) a unit of measure. The $20 bill clearly meets all three. The frequent flier miles are a tougher question.

These days, you can use frequent flier miles for a lot more than just booking plane tickets. Airlines have cross-promotions with magazines and home entertainment stores that enable you to cash in your miles for all kinds of goodies. At the same time, it's getting tougher to actually fly with frequent flier miles, as airlines reduce the number of seats eligible for frequent flier redemptions. Even if airlines stopped issuing miles, it would take people years to draw down their current stash of frequent flier miles. Hence, the pressure to create uses for miles that don't involve air travel, making miles a true medium of exchange.

In many ways, then, frequent flier miles act as a sort of mirror currency. Are they a good store of value, though? With airline bankruptcies mounting, David A. Kelly of the New York Times offers some free "Advice to Mileage Misers: Use the Hoard Now." He argues that evaporating opportunities to use miles amount to inflation of the frequent flier currency. That is, as the airlines reduce the number of redeemable seats, the purchasing power of frequent flier miles falls. Kelly quotes Tim Jarrell, publisher of Fodor's Travel Publications: "They're not bank accounts that earn interest." Another interesting quote from the article:

"Frequent-flier programs have turned into trading stamp programs without the stamps," said Terry Trippler, spokesman for CheapSeats.com. "Instead of opening up more seats for travelers, most programs are now offering magazine subscriptions, gift certificates or merchandise such as TVs instead. I sometimes wonder if the TV sets they're offering will last longer than the airlines themselves."

1. There are lots of other things that act like currency in our society, from Starbucks stored value cards to credits on iTunes. Some are even purely virtual, like currency in online fantasy games like Ultima. (See this BBC News article. Interestingly, the Gaming Open Market that it refers to is now closed, with a rather humorous sign-off.) Can you name a few more? What do they have in common with cash? What differentiates them from traditional currency? Do any of the stored value cards or credit systems gain value over time; are any of them worth hoarding?

2. A $20 Starbucks stored value card is clearly worth less than a $20 bill. Why do people buy stored value cards at face value?

3. Kelly has many useful nuggets of advice for using up your frequent flier miles. In many cases, he says, a trip from point A to point B may be possible, but it's made difficult because there are many possible routes that need to be checked. For example, he cites a case in which agents tell customers it's impossible to fly to Asia on frequent flier miles, while it is in fact possible, but only if you go through Amsterdam, which takes a bit longer. Why is it profitable for airlines to make it difficult to redeem miles? Is there an optimal level of difficulty? If you were in charge of an airline frequent-flier program, how would you find that optimal level?



  • At 10:50 AM, August 03, 2006, Blogger Jeff Shepley said…

    2. A $20 Starbucks stored value card is clearly worth less than a $20 bill.

    This is not clear. The value card can do loads of things a twenty dollar bill cannot (and this is why people buy them).

    1. It can be used over and over (well maybe twice at Starbucks) and you never get hard to handle change in return.

    2. You can give it as a gift and therefrom exert some control over the recepients purchasing patterns. The would work for a parent who derives value from seeing her child spend the money well (like on caffiene as opposed to illegal drugs). That is, unless the recipient could sell it for less than $20. However the drugs that could be bought for less than $20 are obviously less than those which can be bought for $20. However, if addicted, the child may resort to other, undesirable means of obtain said drugs.

    3. You can break into doors with the card, not the cash.

    My money is on number 1.

  • At 11:44 AM, August 03, 2006, Blogger Chris Makler said…

    Hi Jeff,

    I like your logic, though my addiction to Starbucks means that those who love me should probably not feed my habit. :)

    There is a serious answer to your question, though, and I think you hint at it in #1. In theory, purchasing a stored-value card can only make you worse off, since it reduces your budget set. For example, suppose you had $100 to spend on Starbucks drinks and other goods. Picture a budget line diagram with "Starbucks drinks" on the horizontal axis and "All other goods" on the vertical axis. With $100 in cash, your budget line is a straight line from (0, 100) to (100, 0). If you use $20 of that to buy a Starbucks stored value card, your budget line is now kinked: it goes from (0, 80) to (20, 80) to (100, 0). In short, you can now no longer buy combinations of goods like ($90 no other goods, $10 on Starbucks).

    For this reason, a $20 Starbucks stored-value card makes a worse gift than a $20 bill, since if the recipient doesn't like Starbucks, it doesn't make them as well off as the more flexible cash would.

    However, if you buy it for yourself (or someone like me who goes to Starbucks on a disturbingly regular basis), and if your initial optimal point on your budget line involves buying more than $20 of goods from Starbucks, then there may indeed be some value from buying the card, in terms of the added convenience if you're short on cash or just don't like being saddled with change.

    In fact, the real value of stored-value cards may be for those who don't have bank accounts. See this article in Forbes.

  • At 5:13 PM, August 03, 2006, Blogger Albert said…

    Please. Just like dollar no longer tags with gold, no one uses frequent flier Credit Card anymore. Everyone uses cash-back or reward-point credit cards. Please wake up. This is the year of 2006


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