How is wealth destroyed and where does wealth come from? October 11, 2008
Posted by Andy Roberts in : economics, theory , trackbackWhere did the wealth destroyed on Stock Markets come from?
If 20 percent of the value of world stock markets can be wiped out in one week, as has just happened, then where does that wealth actually disappear to? Is it buried in a big hole somewhere, scuttled at sea or sent on a rocket into outer space? Apparently not, but if money can simply disappear from world markets how can we make any sense of the concept of value in finance. How is it measured and where did it come from in the first place?
Theories of value
In the first post of this series I asked “where does money come from” and gave a brief history of the origins of money in the form of precious metal coins used to facilitate the process of trade from simple barter to the exchange of goods of different values. Without exactly defining where money comes from I hinted at the idea that monetary value is realted to the total amount of work or labour which is tied up in bringing the goods to market. That’s a theory which is known as the labour theory of value and is not always widely accepted, probably due to association with a certain Karl Marx who took that theory, which was already known by cpaitalist economists, and developed it a bit further with his concept of “socially necessary labour time”.
Money grows on trees
People who don’t subscribe to the labour theory of value believe that money comes from being rewarded for taking risks, that value is determined entirely by the balance between supply and demand, and that substantial sums of money can somehow just “grow”. They say that money doesn’t grow on trees, but that’s not too dissimilar to the idea that interest just accumulates on investments because money begets more money. In reality, investments such as stocks and bank deposits typically pass through a number of hands but end up being used to buy goods not for consumption but for increased or more efficient production. Investment of capital buys machine tools, land, property and other wherewithal to employing labour in order to create goods or services for the market which can be sold at a profit. The important point here is that the capital doesn’t generate a single penny of orginal value until the employment of labour has happened. To be profitable, the output from this process of applying labour to previously accumulated capital must be of actual use to a buying market, and must be produced with a total number of labour hours which is competitive with alternative setups, such as differently tooled machine shops employing labour under different terms and conditions. That’s pretty much all that’s meant by the “socially necessary labour time” formulation really, to counter the idea that simply getting enough people to work hard for the the most minimal wages will necessarily creaste wealth.
Wealth Ceated by Labour
All wealth is created in the first place by labour, and that is the real answer to the question answer “where does money come from”. It comes from work that has been done by somebody, that has been abstracted and turned into a type of commodity itself, which can then change hands and accumulate, which can be exchanged for special kinds of products, Which can then be deployed in the employment of further labour. Capital is an accumulation of the results of previous rounds of expended labour, or “dead labour” as is sometimes expressed. The capital exchanged on world money markets then represents a further abstraction as speculators buy and sell options to receive the fruits of other people’s labour in the future, that hasn’t even been expended yet, and place bets on the likelihood of prices rising and falling.
Destruction of Wealth in a Slump
In a serious recession, when stock markets crash, and seemingly abstract wealth is destroyed, this is not just a accountancy game played out with pieces of paper or rather electronic transfers. It does actually play out into the very real destruction of productive capacity as enterprises go under or cut back and the very concrete machinery, buildings, expertise and systems are abandoned due to lack of a buying market that can afford their products at a profitable price. All of that overcapicity which has been built up out of the relentless requirement to reinvest and expand will be scrapped, levelled, and laid waste at the greatest of human cost until enough real capital has been wiped out for the accumulation cycle to begin all over again. In the current circumstances the effects are particularly catastrophic because the downturn had been temporarily postponed for a couple of decades or so through the use of massively expanded credit, which could distort the outward shape of the cycle for a short while, but never the underlying forces at work in any free market system based on the private ownership of capital.
is an online professional who initiated DARnet 
Wait for the pension funds to finally declare that half the value of their stock holdings has gone south. Then it will start to ripple through to real people.
That’s correct, the management of pension funds has generally been abstracted by the employers agents against the interests of the pensioners and workers who paid into them. When the value of stocks goes up, the employers take “contribution holidays” but when they go down, the ensuing deficit is borne by retirees.
One of the curiosities of all this wealth creation and loss is that it tends to be all on paper or—referring to it in an even more abstract fasion—in the ether. Until you go to use it and see where the buck actually stops. And a further look reveals that in the upper strata—the people who don’t rely on their paychecks to survive—aren’t really phased at that point, either. Except perhaps for the annoyance. No, again, it’s the wage earners who feel the effect and the hurt, prob’ly because it’s not our wealth that suffers but our lives.
>All wealth is created in the first place by labour
Argh, not sure if I completely agree with that premise.
If I find an apple, hasn’t my wealth increased. When I use tools, my wealth increases, but not entirely do to labor.
When I’m on Robinson Crusoe’s island, and I forego eating a fish for “savings” that let’s me create something (i.e., a weir) that pays off in lots of fish. Wealth (i.e., all those EXTRA fish my weir collects) is a product of more than just labor.
I think there are more traditional formulations about wealth. Consumption that is the product of labor, capital, savings, and raw materials.
But, I’m an injineer. I’ll defer to the eckkynononymists.
Traditional capitalist economics treats raw materials, labour and capital as three distinct components but the value of raw materials is actually derived indirectly from the amount of effort required to find, extract and transport them to where they can be worked, so this is related to labour value again. Similarly the building of tools to increase the efficiency of fishing or improve the process of manufacturing goods represents a consumption of previously expended labour power as a form of investment that yields an increased profitability again and again for the owner of that previously expended labour power. Fish in the ocean are a natural resource which really need to be managed for sustainability but the price of fish at the market only represents the total labour involved in maintaining a boat, finding, catching, chilling and transporting the fish to the market. As the fish stocks are depleted, the boats need to go further and stay out for longer to catch the same volume of fish so the price goes up.
Andy, good series - check out: Money As Debt - http://video.google.com/videoplay?docid=-9050474362583451279
Hi Andy,
I’m curious about your take on this, Money as Debt: http://video.google.com/videoplay?docid=-9050474362583451279 where money DOES grow on trees, but only the banks own the trees. Thoughts? Ted
The argument between two strands of capitalist ideology has just shifted enormously in the past weeks from monetarist to Keynsian economic theory, but this doesn’t alter the underlying trends towards artificial booms and devastating slumps. Printing new money has long been used by governments and national banks to ‘pump prime’ economies but the result is always the same - higher inflation and a devaluation of ordinary people’s savings and earnings. In fact, prudent monetarist policies have already been largely abandoned so the scope for generating even more new debt to spend on infrastructure is limited. So the real alternative as I see it, is not between monetarism and keynsianism (the so called ‘mixed’ economy) but between a system based on the private ownership of capital, even with some institutions temporarily ‘nationalised’ in the capitalists interests or one which deploys social ownership with genuine democratic control and deliberate planning.
The core problem is that the belief that the total value of the market is the sum of the value of all stocks based on the instantaneous price of each stocks most recent sale.
Clearly all the people who did not sell or buy at that time believe that the company was not valued correctly - and they are in the vast majority.
Without linking price to volume and possibly some for of multi week average the real value of an company - and by extension the market - cannot be known.
While the instantaneous method akes good press it’s highly misleading.
I don’t really understand this proposal. Surely the price of stocks as listed at any particular moment is constantly adjusted according to whatever somebody is willing to pay at the time. When the prices go into freefall such that it is believed the true value is not being reflected then the market is temporarily suspended. The introduction of new communications technology into market trading in recent decades has speeded up a process which would otherwise play out with a little less panic perhaps, but this only exacerbates an existing mechanism inherent in all market systems.
The issue I was trying to make is to extrapolate the value of a company from a few trades makes little sense any more than to assume that the value of the market is represented in the sum of all the trades on a particular day.
It’s only when all the shares of a company are tendered/bought at one time that we have a true reflection of company value. Sometimes that is at a premium to the stock price, sometimes it is less that the stock price (Bear Sterns).
The point is that daily trades of small blocks of stock are based on momentary estimates what the buyer believes the future value of the company will be when (s)he wants to sell.
Neither that buyer, nor the potential future buyer have sufficient information to accurately access true vlaue for the compamy or stock.
It’s been easier to read the mass psychology - which influences how many buyers vs seller there are at any one time - but the real value of a company remains elusive - and therefor the real value of the market is also elusive - not the extrapolated sum of the days trades.
http://www.lewrockwell.com/rozeff/rozeff232.html
Has a much better explanation that I was able to create off the cuff. It guesstimates that 50-75% is labor.
Submitted for your consideration,
fjohn
Thanks for the interesting link which quaintly appears to argue for a totally unregulated and unsubsidised free market economy, as has been the popular dogma particularly in the US but also worldwide in the recent period.
I have depicted Capital as being comprised of “an accumulation of the results of previous rounds of expended labour, or dead labour” whereas this Professor of Finance refers to Capital costs as “time”. It’s difficult to see how we could have a conversation about that but it’s interesting that his equation which makes the price paid to produce pearls tend to equate to the price that consumers pay for pearls, completely omits any mention of any profit. Maybe the reader is supposed to conclude that profit is concocted out of time as well?
Where does the wealth actually go? As wealth is pouring out of people’s 401(k)’s, money market accounts, etc., where is it ‘transferred to’? As the overwhelming majority of people are losing their wealth, who/what entity is gaining it?