Sunday, October 12, 2008

What is Wealth?

According to the conventional wisdom, people are seeing their wealth eroded all over the world by the current financial crisis. Except they aren't; not really, because that wealth never existed.

Real wealth consists of goods and services that people actually need or want, and use. The total quantity of these should not be in the least affected by the banking crisis. We have just as much land to grow food on; just as many mines to dig out raw materials from; just as many oil wells to extract fuel from; just as many factories to produce goods in; just as many workers to work in those factories or in shops or restaurants or wherever else they are needed; just as many ships and trucks to deliver goods; just as many cars to drive, just as many houses to live in; just as many CDs to listen to, pubs to drink in, restaurants to eat in, clothes to wear, books to read, TVs to watch, planes to fly, parks to relax in, schools to study in, sports grounds to play on, churches to worship in if so inclined, and so on ad infinitum. In short, just as much wealth.

Those things are real wealth. All the rest - bits of paper, entries in ledgers, magnetic impulses in computer storage - money, in other words - is fictional wealth; a set of symbols that we have agreed on to represent real wealth.

How did the human race get in a position where these symbols so dominate our way of life that their absence, or a disturbance in their supply, can threaten our access to real wealth? Where large numbers of people spend their working lives manipulating these symbols without adding one iota to the underlying store of real goods and (useful) services? Foreign exchnge dealers, for example, convert one set of symbols into another set, without adding to the value of the goods represented by those symbols (i.e. creating wealth) in the slightest.

In their greed, America's bankers forgot that money is only a symbol, and created more and more symbols in the form of subprime mortgages until their nominal value far exceded the real value of the houses they were supposed to represent. (Real value is essentially measured by what goods could be exchanged for in a perfect barter system.) They then packaged up these inflated symbols and passed them on to other greedy bankers around the world, who also wanted a slice of this largely fictitious wealth. Some of these in turn resold them to the public in the form of yet more dubious financial instruments such as Lehman's minibonds.

Finally reality intruded and it became clear the emperor had no clothes - these symbols did not represent anywhere near the value of the real wealth they claimed to represent. The result: banks left with insufficient meaningful symbols to meet their obligations; angry people demanding to know why they had been sold worthless symbols; and governments around the world pouring meaningful symbols (representing the labour of taxpayers) into financial institutions to rescue them from the consequences of their own stupidity.

So what next - back to barter?


Unknown said...

Excellent analysis - just as even 'normal' housing bubbles, without the enhancement of sub-prime, occur when the multiple of individual earnings to house price. That is to say the ability to pay for them out of earnings from the real economy is stretched to breaking point, usually by people's belief that house prices will increase indefinitely by 20% per year while earnings are increasing by 5%. Time and time again.

Gweipo said...

so right.
I keep on telling my kids how wealthy we are. Especially when they insist we need a car and driver.

Bin Lobo said...

fine analysis and very timely too be reminded what real wealth is all about ..and to know the difference between " to have or to be "