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Updated over 15 years ago, 03/26/2009
Destruction of Wealth?
People are saying that declining home, stock, 401(k), etc values is a destruction of wealth. But I don't believe it and have been arguing that wealth is not destroyed until there is material destruction (i.e. a house burns or a car is totaled). I have searched Google for an economic theory that covers this, but haven't found anything specifically. But I have found economists talking about how a rise in asset prices (without a material change in assets) is essentially redistribution of wealth from those without assets to those with assets.
Example:
Person 1: Has $100k in cash.
Person 2: Has 1 house.
House drops 50% in "value".
Person 1: Has $100k in cash.
Person 2: Has 1 house.
Where is the "destruction of wealth"? The same amount of wealth exists before and after ... 1 house and $100k in cash. If the house is valued at $75k, that doesn't mean $175k exists in the economy ... because there is only $100k of actual cash in the economy. What really exists is $100k of cash and 1 house. What has really happened is a redistribution of wealth. Watch this time:
Person 1: Has $100k in cash.
Person 2: Has 1 house.
Person 1 buys house from Person 2. Houses are currently selling for $100k each.
Person 1: Has 1 house.
Person 2: Has $100k in cash.
House drops 50% in "value".
Person 1: Has 1 house.
Person 2: Has $100k in cash.
Person 2 buys house from Person 1. Houses are currently selling for $50k each.
Person 1: Has $50k in cash.
Person 2: Has $50k in cash and 1 house.
The same amount of cash and houses exist at all steps in the process ... $100k in cash and 1 house. With the drop in housing prices, wealth has essentially been redistributed from those with houses to those without houses. The only way we can prove this is to have those with houses exchange them for cash after the drop in values and see where the cash sits.
We have 100 million owner occupied households in the USA, and the average house is valued around $250k, for a total value of $25 Trillion. Yet, $25 Trillion in cash (physical or electronic) doesn't exist. So if house values drop 50%, does that mean $12.5 Trillion has been lost? How can it be lost if it never existed in the first place?
What has really happened is a change in demand. Less houses are being demanded, so demand has shifted to other assets (hint hint, treasury bonds). So while the 30 year T bond is currently fetching 4% interest ... someone with a 30 year T bond from 1985 that is fetching 12% could easily sell their bond for 105% of its face value. Instead of a 2009 bond fetching 4% interest that could only be sold for 100% of its face value.
Wealth has been redistributed from house owners to 30 year T bond owners. Wealth is not destroyed until resources are used or there is a material loss.
Does anyone else understand this? Or am I alone here?
Interesting topic. I love threads like this.
Originally posted by jbrooks:
It has been said by many that we're about to have the greatest transfer of wealth in history. We're probably reading some of the same authors.
Originally posted by jbrooks:
Example:
Person 1: Has $100k in cash.
Person 2: Has 1 house.
House drops 50% in "value".
Person 1: Has $100k in cash.
Person 2: Has 1 house.
Where is the "destruction of wealth"? The same amount of wealth exists before and after ... 1 house and $100k in cash. If the house is valued at $75k, that doesn't mean $175k exists in the economy ...
I am not sure I agree here. If person 2 took a mortgage loan on the house, 90% of the mortgage amount is the equivalent of printing the money out of thin air (Fractional Reserve Banking). So there would be 100k cash from person , plus the 90% of the mortgage amount created out of thin air by person 2's mortgage loan. That's not real wealth to either of those people, but that's our Fed/Fractional Reserve banking system at work destroying real wealth. Stealing real wealth by charging interest on money that is created out of thin air, and taxing everyone else through inflation. Actually though that still falls in line with what you're saying. That just destroys the dollar and makes it literally impossible to remove all debt.
Originally posted by jbrooks:
Does anyone else understand this? Or am I alone here?
You're not alone. But I don't think most people understand it. I agree that those who do will be positioned to participate in the transfer of wealth. If most people really understood what was going on we'd have real change and a different financial system. But I have a feeling they'll be studying up a lot on it soon. Until now they wanted to pay someone else to figure out the next undervalued asset class so they could watch American Idol.
Originally posted by Matty M:
I am not sure I agree here. If person 2 took a mortgage loan on the house, 90% of the mortgage amount is the equivalent of printing the money out of thin air (Fractional Reserve Banking). So there would be 100k cash from person , plus the 90% of the mortgage amount created out of thin air by person 2's mortgage loan. That's not real wealth to either of those people, but that's our Fed/Fractional Reserve banking system at work destroying real wealth. Stealing real wealth by charging interest on money that is created out of thin air, and taxing everyone else through inflation. Actually though that still falls in line with what you're saying. That just destroys the dollar.
If person 2 takes a mortgage, that's not anything created out of thin air. Yes, he has 90K more cash than he used to, but he also has 90K more debt.
Suppose I buy a rental property, finance it by taking out a mortgage and get the down payment from the HELOC on my residence. If I then rent this property out for 30 years and pay off both of those debts without ever putting up any of my own cash, according to you guys I've not only made money out of thin air, but I've also stolen wealth from my tenants. I suppose you could look at it that way, but since I'd have taken on this debt and all the financial risk while providing my tenants a place to live at a fair market rent, I prefer to look at it as having earned that money in return for taking on that risk, maintaining that property, and providing that place to live. That's just being a capitalist.
Originally posted by Dave V.:
If person 2 takes a mortgage, that's not anything created out of thin air. Yes, he has 90K more cash than he used to, but he also has 90K more debt.
person 2 has 90k debt, and he also added 90k to someone else's bank. That next bank can now loan out 90% of that 90k out of thin air. Look up fractional reserve banking. It is basically the same as printing money.
No one is saying that you don't deserve your wealth for taking risks. I am here learning about real estate, wealth creation, and I am taking big risks myself. I am just stating my understanding of the facts about of fractional reserve banking, and how it destroys the dollar asset class. Please correct me if I am wrong on those facts. The dollar does not have to represent wealth. In fact it probably will not soon. I actually agree with the original poster more than I originally thought.
I think a lot of people put too much "stock" in the stock market.
They think the value of stocks is an indicator of the economy.
Stocks are shares in businesses.
I put all my stock in me and my businesses. I'm not registered on the stock market as a business. I don't own shares in others' businesses anymore, why should I? I can make so much more money by investing in myself.
This is a very interesting thought jbrooks, I never really stopped to think about it this way. I think when people are talking about destruction of wealth they are not looking at it at the high level that your example provides.
In terms of individual people and business there is true destruction in wealth on their financials. Fair value determination, mark to market accounting and timid auditors and executives in applying these rules are the cause for this.
I love topics like this, they really get you thinking about things. There are three ways the government actually creates currency, only one of them actually creates a physical bill. The other two are government securities and fractional reserve banking. With the fractional reserve banking the amount of new money created is determined by the money multiplier. Basically the amount of money created from a new deposit can be determined from the reserve requirement the government places on the bank.
Money created = 1/Reserve Requirement (RR). So when the (RR) is 10%, every new dollar deposited creates 10 dollars.
As far as the destruction of wealth, I don't know if there is an economic paper on the subject [maybe I should write one:) ] but it is my personal belief that real wealth is like energy, neither created nor destroyed. It doesn't matter how much currency is printed or destroyed, real wealth is just transferred. If currency is printed, we have inflation, people holding cash or who have lent money out lose wealth, people with debt and who hold RE, gold, commodities and things like that have more real wealth. Thats why the government likes inflation, they have a lot of debt.
On the creation and destruction of physical things like houses, wealth doesn't reall change. If a house burns down, the owner of that house loses wealth, but the supply of housing is now lower so the value of the surrounding houses actually increases.
Just my opinion, take it for what its worth.
Lance
they really are not losing money, just someone else has it.
Nobody has lost an M1. The bankers are losing M2 and M3 by the bucket. It went from "Vapor to Paper", now it goes back to Vapor.
Enjoy the show......
Certainly real wealth on an individual level can be lost. In the example above, if you bought a house for $100K and now the most you can sell it for is $50K, you've lost $50K real dollars if you sell.
On a macro scale, the lifestyles we've experienced over the past few decades were paid for with borrowed money, money that was created out of thin air thanks to fractional reserve banking. Much of the "wealth" people thought they had never existed - it was just a fantasy that has now disappeared as reality has come back into focus.
Mike
#2 Off Topic Contributor
- Real Estate Investor
- the villages, FL
I have to disagree with a couple statements by Lance. Real walth IS created and IS destroyed. With all the values of real estate and stocks, peoples' wealth has been reduced and in many cases destroyed. When I was young and buying houses for $25K in CA, and the values increased to 300K, I was creating wealth. Even though inflation caused milk and cars to go up the same %, I was creating enormous wealth because my inflationary asset was much larger than the mailk or car. Therefore, my wealth was being created from nothing, not being transferred from any where or any one else.
Mike,
A poor choice can destroy wealth. It is what it is.
The key to the game is to turn Faux money into cash every chance you get
I think we're dealing a lot with perceived values, and those can fluctuate.
Even money is just a number on a piece of paper, a bill, a balance sheet, or in a computer. It represents what you can trade it for, and market prices of assets fluctuate according to supply and demand.
Wealth can certainly be created. Wealth is pretty similar to productivity. If there are X amount of cars, Y amount of houses, Z amount of diamond rings in the economy ... and I go out and find a gold nugget in the ground and introduce it into the economy ... I've created my own wealth. As well, if I take a bunch of raw steel, plastic, and copper that fetches $5k as raw material ... and turn into a car that has utility in the economy and fetches $20k ... I've created wealth through productivity.
But how is buying a $50k house, sitting on it for 20 years without materially improving it, and selling it for $300k creating wealth for the economy on a whole? Yes, you are creating wealth for yourself. And when house prices go up/down, you personally gain/lose money. But the headlines are saying that the entire economy has lost wealth. That can't be true if prices are going down on houses but prices are going up on other assets (not many of them, but for example the 20 year old 30 year T Bond getting 12% interest).
My point in trying to understand this is to figure out what is going to happen in the near future. If people believe Trillions in wealth are actually being destroyed, then pumping Trillions of cash into the economy isn't as big of a deal. But if it's not being destroyed (just redistributed), and the people who are receiving it are just sitting on it waiting, then the Trillions being pumped into the economy is going to be worse than expected.
maybe, because logically, a house is still a house is still a house.
it's when you assign fluctuating numbers of value like currency to it, when it gets confusing.
I figure, if inflation or crash or whatever, I want all my wealth to be in physical assets, and assets that I actually want to own, that can be productive, and can be traded. even in a great economy, that makes sense.
I want to hedge my bets to work, 100% certain if possible, not to risk. and diversified.
used to be wealth was productivity and multiplication, still is for businesses. look at nature, seeds, animals, look how everything multiplies.
now we work to pay recurring bills, it really is quite opposite. but people are getting paid those bills so it depends on which side you're on.
yes wealth can be created. please write obama and explain that.
Originally posted by jbrooks:
My point in trying to understand this is to figure out what is going to happen in the near future. If people believe Trillions in wealth are actually being destroyed, then pumping Trillions of cash into the economy isn't as big of a deal. But if it's not being destroyed (just redistributed), and the people who are receiving it are just sitting on it waiting, then the Trillions being pumped into the economy is going to be worse than expected.
It sounds like you are talking about two different things, the money supply and value. Going back to Matty M's comments with the fractional reserve bankins system, you can create value and destroy value by creating false money by making loans.
In terms of physical dollars the only way that this is created or destroyed is by the government printing money or taking money out of circulation via monetary policy. In my opinion the physical dollars are being hoarded by the banks by stricter loan requirements and out right suspension of lending. If business/individuals don't have access to loans then they cannot purchase goods/captial assets at current prices. Prices will decline as retailers do not want to sit on slow moving inventory and value declines.
I think the pumping of trillions into the economy will cause inflation as the banks start pouring out their reserves.
Destruction of wealth, or natural economic cycle?
Capitalism's success and failure is a product of greed!
It is amusing to me that greed is looked at as a wonderful thing when times are tough, and a bastard child when it fails.......
#2 Off Topic Contributor
- Real Estate Investor
- the villages, FL
Is the desire of a business to make more money a matter of capitalism at its' best, greed or both? My vote is on capitalism, and barack hussein obama is doing his best to destroy it imo.
I don't think 'greed' is really the only reason why people are motivated to succeed financially, most of us I would imagine succeed in other areas in our lives than just financial, and because of that I think it is more of a desire to accomplish or to live our dream or to create the world outside that we see of ourselves on the inside.
Some of us were born to create and achieve and to grow wealth. I think the laws of nature show that things continually multiply and this world was created with abundant resources.
People who create businesses and gain wealth usually do so by providing for others something they want or need.
The issue I have with Obama's approach is that he seems to know how to work the system (ie live off the system) rather than actually how the system works. I don't see him creating productivity figures just spending and moving money around. That is not going to fix the economy and if he doesn't listen to business people and focus on future growth then we will have to do what we do and try to better the financial situation for ourselves and our communities/states/countries with or without his help.
Greed is here no matter what economic/political system we have. So far capitalism seems like the best way to handle it instead of a centralized power.
Milton Friedman, said it a lot better on Donahue a long time ago: