Closet Currency: Let's Keep It Real

Today, I learned a new term from an Instagram post by @ebaywatches. That term is "closet currency." No, this doesn't refer to someone stacking bills in some dark corner of their wardrobe.

Instead, closet currency is the value that is stored in items that you put in your closet. At least, that's what I think it means. I arrived at this conclusion since eBay's post featured YouTuber Jose Zeniga describing the monetary value of different luxury watches. Zeniga also described a "luxury exchange" that eBay set up in NYC. In essence, you could take something out of your closet, go to the exchange, get an appraisal value, and then use your item and its appraisal to purchase another item that was available on the exchange. The formal definition of money is anything that is generally accepted as payment. In essense, eBay set up a NYC micro-economy in which almost any closet item could be used as money.

Money is actually a pretty complex topic. It took a lot of smart people in Europe a decade to introduce a new form of money: the Euro. Sam Blankman-Fried earned a degree in physics from MIT. Yet he seems to have fumbled when it comes to another new form of money (cryptocurrency, which is actually low in moniness but I digress). According to Forbes, his errors cost him $14.6 billion overnight.

One of the errors we know people are prone to make when it comes to money is something we economists call money illusion.

A shop window in New York City, 1956. Source: Library of Congress

This is the tendency to think of value in terms of today's prices and / or earnings. For example, it seems like sausages for 70 cents, as shown in this photo from New York City in 1956, are really cheap. We definitely can't find sausages for that price today. However, there were fewer zeros in the typical person's income in 1956. In fact, median income in the United States was estimated at $4,800 in that year. It's a lot harder to scrape together 70 cents when you are earning less than $5,000 per year and it's also hard for us to presently imagine what that was like. In 2021, median househond income was closer to $80,000, more than fifteen times greater than earnings in 1956. If we adjust the 1956 price of sausages for all the inflation that has taken place over the past six decades, we end up with a price of $7.67, which is probably about what you would expect for sausages in New York City today.

If luxury buyers are now thinking in terms of "closet currency" then there is also a risk they will fall prey to "closet currency illusion." This would be a tendency to not adjust the value of items in your closet for what is happening to inflation as time progresses. I've previously discussed the emergence of data analytics providers in the luxury watch space. Given how they operate, I believe closet currency illusion is not just an abstract risk, it is actually happening.

Trend for the nominal and real "watch price" index.

Let me show an example. I used a piece of software to create a spreadsheet from the values of a "watch price index" published as a graph by a watch data analytics provider (I did this in a prior post; I've also shared concerns about watch price indices in that same post but I'm going to gloss over those concerns for the purposes of today's post). I've presented the unadjusted value of their index for the past three years in the graph I've shared here. That information is given by the blue line. I then converted the index to its real value, a process which involved using the consumer price index for durable goods to adjust the raw data for inflation. The result is the orange line.

Comparing these two lines makes a few things clear. First, in real terms, the increase in watch prices wasn't as significant as the nominal (non-adjusted) index suggests. At the peak, unadjusted watch prices increased by 216%. If we look at the real value of watches though (adjust for inflation in durable goods) we conclude that the increase to peak value is smaller: 177%. This is still an astronomical rate of increase over a short period of time, but it is also importantly smaller than closet currency illusion would suggest.

There are a few other things we learn from the real watch price index. Closet currency illusion would suggest that from its peak, the watch price index declined by 17.2% (the blue line). In reality, though, the decrease was larger because the price of other durable goods continued to climb while watch prices were falling. When we consider the real watch price index (the orange line), the decrease from peak is 23.1%, a fair bit larger. From this perspective, the decline in watch price values from their peak is more significant. The overall trend is also interesting. Closet currency illusion would suggest that the watch price index increased in value by 67.5% over the past three years. However, in real terms, watch prices have only increased by 36%. Illusion would cause you to overstate the appreciation in the value of watches by a factor of about 1.88.

Wrapping Up

At the close of the recent Geneva watch auctions, I exchanged direct messages with a very well-known and important private watch dealer. One of their comments, in particular, drew my attention: "we're in trouble." If we look at watch prices without illusion, I can understand this sentiment. The decrease in watch prices from peak is more significant than nominal values would suggest. However, I think the collecting community has still, net, benefitted significantly from rising interest in fine watches. A 36% real increase in value over slightly less than three years is nothing to sneeze at. It amounts to approximately 12% per year, a rate of growth which exceeds the appreciation of US stocks over the same period. Again, major caveat, this assumes the watch price index is a valid measure of aggregate prices in the watch industry and I am really not certain that is the case. The major point here is that the decline in watch values could have been worse. At the end of the day, if you enjoy your watches and they increase in value a little bit, you've had a pretty good go of things during some otherwise fairly turbulent times.

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