Liquidity and the Holidays

Dec 2, 2006 by

December has arrived, and many of us are shopping for gifts. Most of the gifts that I have received have come in one of three forms: tangible goods (books, sweaters, fruitcakes, etc.), money, and illiquid quasi-cash (gift certificates, savings bonds, etc.). My favorite two types of gifts are tangible goods and money, and my least favorite is illiquid quasi-cash.

I like tangible gifts because they show me that my friends and family have taken the time to think of what items would bring me the most utility. When I use the gifts, they make me happy. A well-chosen tangible gift is better than money, as I gain utility from receiving an item from someone else more than I do from purchasing that item myself. Furthermore, sometimes the gifts are items I did not realize that I needed (and thus would not have purchased), but in fact did need.

When people do not know what I would like, or would like to give a substantial gift, I like to receive money. Often times, I do not immediately link the money to a purchase, but instead put it in a slush-fund that I use for daily expenses. When the slush-fund grows too large, I skim some off the top and put it in my investing account. The joy of receiving money is that it can be spent on anything; either consumption or investment. Also, money can be spent on any form of consumption and any form of investment, anywhere, at any time. Money is completely liquid, and places no constraints on its use.

Gift certificates, on the other hand, are rather illiquid. By their very definition, they force the receiver to use the quasi-cash towards consumption. Many certificates force the receiver to consume in the near future via monthly account fees and expiration dates. There is also a non-zero probability that the receiver will not use them, essentially making the gift give them no utility. To make matters worse, store specific gift certificates force consumption at a specific store. Often the certificates I have received have been for brick-and-mortar stores that have substantially higher prices than online stores. Thus, receiving $M to spend at a physical retailer buys me less goods than receiving an unrestricted gift of $M. As a result of this illiquidity, an $M gift certificate is worth less than $M in cash. At http://gift-certificates.ebay.com/ it is possible to buy gift certificates at slightly below their face value. The reason that they resell for less than their face value is due to the disutility caused by the illiquidity. Another problem with gift certificates is that they force consumption. Given the choice between using a certain amount of money to acquire wealth or to acquire consumer goods, some people would rather use the money to acquire wealth. A gift certificate forces the receiver to consume at a point in time in which they may not be interested in doing so.

On a similar note, I dislike savings bonds due to their illiquidity. Just as a gift certificate forces someone to consume through a specific store, a savings bond forces a person to invest through a specific vehicle. This illiquidity and inflexibility may cause a person to receive an investment that they would not have made on their own, if given cash. (Furthermore, some of the savings bonds I have seen pay less interest than my savings account does today, reinforcing my belief that people are better off being left to choose their own investment vehicles.)

So, as the holidays approach, I urge readers to shop thoughtfully for those they care about, or to give liquid assets that can be used flexibly. All of that being said, I am appreciative of every gift that I receive, regardless of its liquidity. However, I am able to achieve the most utility from receiving tangible goods and money.

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