Can wealth be destroyed or merely transferred?

[darkhorse70]

Wysiwyg part of my risk management concept is to have an understanding of the bigger picture of the economy as a whole just to aid my technical decisions. The problem is figuring out what is important and what is junk haha.
Minwa well when I look at a chart it is my hope that im seeing some thing others arent. Im also hoping the guy on the other side of the trade is the chump and not me haha. Klogg ive sort of read the fraction reserve banking system in my finance subject I think. Ill look it up again however. I feel like ill never be a successful trader if I dont understand the sinplest of subjects and the over all financial system.

 

[Value Collector]

I disagree. The purpose of a company is to make profits, not collect assets. There are plenty of companies with little in the ways of assets that are worth heaps.

The purpose of a company is to make profits, and if it can, use those profits to collect more high returning assets.

Look at Berkshire Hathaway, collecting assets is what it does, and its share price has gone from $9 to over $192,000 per share.

 

[qldfrog]

My own view:
It could be argued that buffettt has not "created" any wealth, merely extracted $ from others pockets;
In my opinion, it is always back to the basic:
a company/business/person only create wealth if it add "value":
ie gather berries, create jam-> result product jam as more value than the raw berries;
so only the wealth creation come from

• manufacturing and a small amount in service(the physical work attached: coffee maker, cook),
• agriculture (ie sun working for you),
• mining
  
  (well maybe just as long as you consider as in australia that a mining company can steal resource from a country citizen at barely any cost: no iron/coal get created on our timeline, and the processing adding value pick it up and put it in a truck is actually quite low)

financial wealth creation (interest, market(shares), etc) is justtransfer and vapourware on the grand scheme of things.
but I am happy with the system and do not reject my TD interest or the RE capital gain...

 

[DeepState]

It could be argued that buffettt has not "created" any wealth, merely extracted $ from others pockets...

...financial wealth creation (interest, market(shares), etc) is justtransfer and vapourware on the grand scheme of things. but I am happy with the system and do not reject my TD interest or the RE capital gain...

In relation to the above, please consider the net wealth of society that we have vs the one which would exist without the presence of banking and capital markets. The difference is vast and that difference is the value add from financial markets given a set of primary production activity. The alternative is a strict barter economy.

The question of wealth creation and destruction is actually one of relativity. Either case, destruction/transference, can be reasonably argued. We are used to seeing this from the perspective of immediate monetary mark to market value. We generally frame our thinking in this way. But this is just one perspective and one definition of wealth. It is not the only valid one. Change your definition of wealth to another very reasonable one and your answer changes. Secondly, within the most common framework we use, there is the definition of mark to market wealth and underlying, intrinsic wealth. It is possible to destroy both or each individually. Indeed, they can move in opposing directions.

 

[Value Collector]

My own view:
It could be argued that buffettt has not "created" any wealth, merely extracted $ from others pockets;

My comment was relating to one someone made saying the point of a company was to make profit not collect assets, My point was that the two go hand in hand.

In my opinion, it is always back to the basic:
a company/business/person only create wealth if it add "value":
ie gather berries, create jam-> result product jam as more value than the raw berries;
so only the wealth creation come from

Don't you think many companies inside warrens Berkshire Hathaway do just that, eg, coca cola company turns raw aluminium and corn syrup into cans of coke, he has many manufacturing businesses inside his company

(well maybe just as long as you consider as in australia that a mining company can steal resource from a country citizen at barely any cost: no iron/coal get created on our timeline, and the processing adding value pick it up and put it in a truck is actually quite low)

I think a tonne of coal sitting at the gate of a power station is more valueable that one buried 100M below the surface, and one we have found sitting 100M below the service is more value than one we haven't found yet.

So I think mining companies generate value all the way through exploration and production process, Not to mention the manufacturing industries can not exist without raw material. So the primary ( mining farming etc)industries are the ultimate

financial wealth creation (interest, market(shares), etc) is justtransfer and vapourware on the grand scheme of things.
but I am happy with the system and do not reject my TD interest or the RE capital gain...

I don't agree, The financial and investment industry does help generate real value, If you took out all the loans and investor capital out of the mining, farming, Transport, Infrastructure and manufacturing industries there would be almost none of the projects in existence that you say generate value.

 

[qldfrog]

Sure money is an enabler: a loan enables the farmer to buy atractor and then create wealth, without that money I do not deny the wealth would decrease as the field would not be harvested, but is the financial system (aka loan generating wealth ? not in my view)
idem Buffet, yes he "owns" factories etc and yes these generate real wealth but the Berkshier share increasing in value does not add wealth, it is just a reflection of the underlying assets productivity(when it is linked ->usually a very elastic link! as per PE variation along cycles)

 

[Smurf1976]

I don't agree, The financial and investment industry does help generate real value, If you took out all the loans and investor capital out of the mining, farming, Transport, Infrastructure and manufacturing industries there would be almost none of the projects in existence that you say generate value.

Agreed that finance is an enabler certainly.

But if the share market drops 50% then that is a loss of "paper" wealth only. The mines, farms, trucks and so on are still exactly the same as they were when the share price was higher. Nothing has happened to that "real" wealth, it's only the "paper" aspect that has changed.

A dam, canal, penstocks and power station is a real, physical asset. It takes something of little or no value "as is" (water) and turns it into something of real use (ie electricity). You can see and touch those physical assets, they are absolutely real and relatively permanent. On the other hand, simply speculating on the price of electricity is transferring wealth - a megawatt hour is still a megawatt hour whether it sells for $10 or $10,000 (and both those extremes are reached from time to time in the electricity market).

Lending money to build the dam or coal mine and the power station etc is certainly enabling the physical production of electricity. Speculating on the price of the product isn't - it's just transferring wealth from one party to another. Same with anything from steel to soft drinks.

 

[luutzu]

Sure money is an enabler: a loan enables the farmer to buy atractor and then create wealth, without that money I do not deny the wealth would decrease as the field would not be harvested, but is the financial system (aka loan generating wealth ? not in my view)
idem Buffet, yes he "owns" factories etc and yes these generate real wealth but the Berkshier share increasing in value does not add wealth, it is just a reflection of the underlying assets productivity(when it is linked ->usually a very elastic link! as per PE variation along cycles)

Wouldn't that make the loan a two bird with one stone value creator? That it enable value to the farmer AND it brings value (in terms of interests) for the lender.

Without money, nothing will get done - no one would work for free, and the entrepreneur that does do so in hope of getting a big return in the future.

Without money and a good mind behind it, things can get done, but done badly and often wastefully - destroying both the capital, the opportunity that that capital would otherwise have been employed and waste the potential value on projects that a good capitalist would have demanded more research or planning before investing in.

I mean, what sane investor would fund a recent Chinese water cannon that shoots water vapour 300m into the air to soak up air pollution. But it was done at a cost of some $US160K each - and then realised the water droplets are too large to soak up air particles, and we all know a super vacuum cleaner would do a better job.

 

[DeepState]

Sure money is an enabler: a loan enables the farmer to buy atractor and then create wealth, without that money I do not deny the wealth would decrease as the field would not be harvested, but is the financial system (aka loan generating wealth ? not in my view)

When the farm produce is created but stays at the farm to rot, was value actually created?

If not, then if there was transport to get to a market where produce could be bartered, is the transportation merely enabling, or is it value creating?

What if, the watermelons go to market by magic, but just rot? Was value ever created?

When the watermelon actually is exchanged for something the producer values, value is created. Somewhere between the thing just rotting in the market and being sold, value was created. That transaction required effort. The person doing it produced a transaction. The same way that his Dad produced a watermelon. Without both, there is no value creation.

If not, then is the person who made hats to protect the farmer whilst tilling the fields really adding value, or just enabling?

Where does the border of production end and enabling begin?

If buying and selling goods is production, is buying and selling a service just enabling or is it value accretive? Services represent far more of the economy now than primary production.

If a service like examining the fields and offering advice on which way to hoe it is a value accretive service, and/or transport is a value accretive service then money exchange, securitisation, deposit taking and lending are also services as they are essentially the transport of money. The loan involved securing deposits, checking ability to pay...this could also take place in a barter economy and would require the 'services' of some guy running around trying to barter goods for everything else and excess watermelons for the promise of a woollen coat in 3 months (which is the barter equivalent of bond issuance). He is engaging in banking.

 

[DeepState]

Speculating on the price of the product isn't - it's just transferring wealth from one party to another. Same with anything from steel to soft drinks.

Without the process of subsequent price discovery, how will the primary markets function? Their presence creates economic value by fostering more efficient uses of capital and providing liquidity as well as offering a price discovery mechanism. Without these, there would be a primary market consisting of buy and hold to maturity assets. Producers of steel would not be able to hedge their production or cost inputs, making them far more risk averse and dropping the ROA. The absence of a secondary market would also greatly increase cost of capital and, in combination, reduce economic production.

 

[qldfrog]

I never argued against $/finance system, just different view as to whether finance actually create wealth which I bring down to value as for me, it is only by creating value that wealth can increase and not be just transfered.
knowledge can be a created value (was discussed in both exploration in mining/actual loan check etc in finance industry) but still find it hard to see a major value creation in the finance industry /system;
there are some good point:
easier to transport/transfer via netbank $1000 than giving a few tonnes of carrots to pay your electricity bill;
money is lighter will save time/fuel/wear and tears on your vehicle..yes there is so value on top of the enabling facility, but is any financial tool or exchange (it is called exchange BTW) creating any real world value.
I am still unconvinced
and my apologies for the typos, always typing in a rush last few days
have all a great day, an interesting thread indeed

 

[DeepState]

I never argued against $/finance system, just different view as to whether finance actually create wealth which I bring down to value as for me, it is only by creating value that wealth can increase and not be just transfered.

...I am still unconvinced

...an interesting thread indeed

Fascinating how an ostensibly simple question can lead to this. There is actually no correct answer, in my view. Per previous post, it depends on your definition of wealth. Yours is perfectly reasonable. Primary production. All other activity is housed within it. It just differs from the way the National Accounts are structured and how some others think about it. Who says they are right? It's just an opinion. There are much wilder but possibly more accurate definitions out there.

If I inferred you said that finance does not add value in some way as an enabler, then I withdraw whatever statement led to that belief. I do not believe that you ever said that.

 

[qldfrog]

If I inferred you said that finance does not add value in some way as an enabler, then I withdraw whatever statement led to that belief. I do not believe that you ever said that.

no worries there, we are all probably all on the same page.
The further I dig in the less black and white the answer becomes, at least as I see thing;
I is also interesting to see how Smurf and I share so many views, I would say probably as we both have an engineering background [only guessing by the history in various thread].
It is good to have these exchanges.

 

[Smurf1976]

Without the process of subsequent price discovery, how will the primary markets function?

No argument that there's a need for markets etc.

I could perhaps refine my point to distinguish markets in terms of speculation and non-speculative activity. Lending money, hedging and so on all enables production. But if the price of BHP shares drops 10% tomorrow, nothing physically has been lost. Some numbers changed on a computer, that's it really. The iron ore etc is still in the ground and still being mined just as it was today.

As a practical example, they've been mining brown coal and using it to generate power at Yallourn (Vic) since 1924. It was 1995, 71 years later, when the concept of a financial market for the product (ie electricity) emerged and even today there is still no financial market at all for the coal itself.

That lack of ability to speculate didn't in any way stop the physical assets being built and operated, indeed the maximum rate of production (early 1980's) was long before the concept of a trading market had been thought of.

So using the Yallourn example, yes you need a financial market to provide capital for construction etc but you sure don't need the ability to speculate upon the price of the product in order to produce it.

 

[John H2O]

Stock market crashes are a great income earner for the US. Mum and Dad from Australia, UK, or wherever invest $100K in the latest dot.com that money is paid mainly to US citizens who build houses etc. The dot.com goes bust and the money is lost to Mum and Dad in Australia etc and stays in the US. Same deal with sub-prime.

Maybe this is the reason why the US and UK don't regulate their financial markets like many would like to see.

For example if the stock market crashes, and billions or trillions vanish does wealth simply vanish or is just transferred from one hand to another. For example wealth is created in a bull market for person A and wealth is lost in a bear market for person B so its essentially equal? Is that correct or incorrect.

 

[DeepState]

1. Lending money, hedging and so on all enables production. But if the price of BHP shares drops 10% tomorrow, nothing physically has been lost. Some numbers changed on a computer, that's it really. The iron ore etc is still in the ground and still being mined just as it was today.

2. As a practical example, they've been mining brown coal and using it to generate power at Yallourn (Vic) since 1924. It was 1995, 71 years later, when the concept of a financial market for the product (ie electricity) emerged and even today there is still no financial market at all for the coal itself.

That lack of ability to speculate didn't in any way stop the physical assets being built and operated, indeed the maximum rate of production (early 1980's) was long before the concept of a trading market had been thought of.

So using the Yallourn example, yes you need a financial market to provide capital for construction etc but you sure don't need the ability to speculate upon the price of the product in order to produce it.

Since we're chatting....

1. The price we pay for BHP shares is a best guess at the value of residual income to shareholders. A guess can fail to truly reflect the unobservable value. It may be that the 10% fall does not reflect the reality of a, say, stable underlying intrinsic value as you have illustrated. In this example, the underlying intrinsic value of BHP is largely unchanged. We will still see wealth effects flow through to consumption and investment and the economy will shrink at the margin. Perception is, actually, reality.

2. You do not need a futures market to produce. But it sure helps. So you can have a coal producer doing its thing without a futures market for coal (one may exist in swaps: http://www.westpac.com.au/docs/pdf/pb/Energy_Swap_PDS.pdf) and coal futures trade on CME.

A gazillion years ago, they took corn off the cob in the wild. Then agriculture came along and farmed it...without a derivatives market over the top. But one was formed about 1,000 yrs ago. The natural position for producers is to hedge. Selling their expected corn production at a forward rate. This provides certainty and ability to plan. Having this reduces risk and encourages behavior to extract more value from available investment. The only people in the other side of the natural position are speculators. Without them, the futures market cannot exist. The process by which price discovery is achieved is value additive. All subsequent trade is as per our previous exchange on the value of a secondary market.

Speculators are actually necessary for a functional market and their presence is value creating for an economy as a whole. That's until they blow a hole though the balance sheet of every investment bank on the planet at one time. But that's just a blip and we can ignore it as an outlier.....

 

[DeepState]

no worries there, we are all probably all on the same page.
The further I dig in the less black and white the answer becomes, at least as I see thing;
I is also interesting to see how Smurf and I share so many views, I would say probably as we both have an engineering background [only guessing by the history in various thread].
It is good to have these exchanges.

I can understand the perception and perspective you have.

"What the heck do those finance guys do anyway?" is a very common perspective for people who make stuff.

 

[Smurf1976]

"What the heck do those finance guys do anyway?" is a very common perspective for people who make stuff.

Another one is "it's always the financial people who mess up" and a general thought that "banks ought to be properly regulated".

In terms of regulation etc, the general thought goes along the lines that "finance people" at the global level don't manage risks well enough. Engineering 101 - to the greatest extent possible, no single failure should in any way threaten the whole system.

That's not always practical, eg if a wing falls off a plane then a crash is inevitable, but there's a good reason why commercial airliners have two or more engines and a lot of redundant systems. Most individual parts can suffer a failure without causing the plane to crash. And wings don't generally fall off planes, they're built such that it's a very unlikely scenario.

In contrast, the banks etc seem to have all sorts of incredibly complex derivative contracts etc that nobody seems able to fully explain. Nobody seems able to state with confidence that if, to pick a random example, HSBC or JP Morgan goes broke then it won't cause any other bank to also go broke. The thinking is that one bank going bust may well bring the others down too - and that's a completely unacceptable risk in terms of how engineers think. If one bank goes bust, then that should be it. One bank is gone, but the others should be able to carry on without disruption, no one part of the system should threaten the whole in the event that it fails.

So the perception is that at the global level, "financial people" are doing something with very high consequences in the event of failure, but don't seem to have properly assessed what could go wrong and put in place measures to contain any problem that occurs.

 

[DeepState]

Another one is "it's always the financial people who mess up" and a general thought that "banks ought to be properly regulated".

In terms of regulation etc, the general thought goes along the lines that "finance people" at the global level don't manage risks well enough. Engineering 101 - to the greatest extent possible, no single failure should in any way threaten the whole system.

That's not always practical, eg if a wing falls off a plane then a crash is inevitable, but there's a good reason why commercial airliners have two or more engines and a lot of redundant systems. Most individual parts can suffer a failure without causing the plane to crash. And wings don't generally fall off planes, they're built such that it's a very unlikely scenario.

In contrast, the banks etc seem to have all sorts of incredibly complex derivative contracts etc that nobody seems able to fully explain. Nobody seems able to state with confidence that if, to pick a random example, HSBC or JP Morgan goes broke then it won't cause any other bank to also go broke. The thinking is that one bank going bust may well bring the others down too - and that's a completely unacceptable risk in terms of how engineers think. If one bank goes bust, then that should be it. One bank is gone, but the others should be able to carry on without disruption, no one part of the system should threaten the whole in the event that it fails.

So the perception is that at the global level, "financial people" are doing something with very high consequences in the event of failure, but don't seem to have properly assessed what could go wrong and put in place measures to contain any problem that occurs.

There's a pretty big difference between laws of engineering and the laws of capital markets. A plane engine doesn't change its basic characteristics and is unaware of what is happening in seat 17A. In financial markets, the 'effective agents', which may be organisations or certain groups/people change their connections and alter their perceptions all the time. This keeps morphing the system behavior. Large connective hubs get formed and this makes them seriously important organs through which finance is channeled. The bigger you are, the bigger you become because you are big (at least in some key parts). Incentives are such that any law that gets made will be largely circumvented in some form of regulatory arbitrage (hedge funds are replacing trading desks and essentially taking up that behavior and they are exempt from capital requirements). Individuals are simply doing what they are incented to do. That often leads to situations where it is in no-one's particular interests (at least no-one who actually calls the shots) to contain systemic risk.

Financial crisis is not a new feature on our society. Things like the introduction of central banks, separation of trading from deposit taking institutions, capital requirements, deposit insurance, licensing....have all been added as stabilisers. Yet it keeps happening and more stuff gets added. You can see the cycles, there is rhythm. It's in the nature of the beast. Do you kill it? Harness it? Cage it? ... do whatever, just don't neuter it.

 

[Value Collector]

The central banking system is meant to beable to step in and stop the whole system from collapsing, and that is what they did, and they would have done it quicker if it wasn't for congress playing chicken to win political points.