Sunday, 20 January 2008

The End of the World News

'Where does it go?', I asked at lunch, 'All the wealth that is wiped off the value of stocks and shares every day?'

Here is the response, punctuated by drainings of glasses, more roast potatoes etc., and irrelevant bits of bickering and disagreement which have been edited silently:

'Out of the heads of world investors (actual and potential) into thin air. In physical terms world wealth remains the same every day - give or take the small net effects of accretions obsolescence and collapse. In value terms world wealth is nothing but the capitalised flow of net cash revenues expected of the physical assets capitalised, that is, at the current and expected interest rates.'

"Expected" is the operational word. Future net revenue and future interest rates change, not only from day to day but from second to second, according to what Keynes labelled "the state of the news". It was indeed Keynes who stressed the importance of expectations - expected quantities and prices - instead of actual current quantities and prices.'

Today's world is not just the ultimate keynesian world, it's a hyper-keynesian world with a vengeance.

(one of these days I shall deserve a BSc Econ.)


Sackerson said...

Presumably what it all means is that one party's share of the world has increased, and another's has decreased. The rest is a kind of legerdemain, smoke and mirrors, which is why finance will and must remain complex - otherwise we'd see the deception.

hatfield girl said...

This could be the case S, with asset holders losing wealth to employees/workers/the government.

But it could be a case also of pessimistic expectations being self-fulfilling and making everyone worse off.

Sometimes 'Thinking makes it so'.

(Keynes wrote in the preface to a late version of the General Theory that were he to rewrite then he would distinguish between correct and false expectations but, either way, they would still be crucial).

Anonymous said...

"'Where does it go?'"

The value goes to the remaining money; as supply decreases (ie billions disappearing) the remaining becomes more value (ie cash becomes King). The cash in your pocket is worth more - that's where it goes.

hatfield girl said...

That's confusing real and nominal values.

A given amount of money buys more physical assets but the earning power of those physical assets is irridemably reduced by pessimistic expectations.

Nick Drew said...

This is where mark-to-market accounting comes in (if not specifically, then conceptually)

it forces (well, encourages) any notional change in value due to changes in markets to be recognised actively in the P&L, and squares the conceptual circle

part of the beauty of it, is its symmetry: it includes gains and losses equally, on a systematic and constantly-updated basis

accrual accounting is horribly clunky, and (because asymmetrical) flouted at valuation-time, as companies (and Prime Ministers) turn their blind eye to the effective losses they are carrying, right up until the very last moment, and then some

the Enron thing has caused some foolish reactions to MtM from financial and accountancy regulators, as well as from commentators

(BTW, it was also Keynes who said - from memory, at this time of the morning -

"about future prices we know nothing"

to be distinguished carefully from futures prices)

coffee, I need coffee

hatfield girl said...

Yes ND, mark to market accounting used and accompanied by prudence, competence and honesty ... oh.

Anonymous said...

Yes, Mark-to-Market accounting can realistically register new value when it occurs rather than when it materialises as a cash flow. But MtM also enables companies to pretend that they have created new value which they know is never, never going to materialise. When this occurs, it is a fraud, which is harder to construe with accrual accounting.

This is what Enron did - apart from lots of other fraudolent sleights of hand – using MtM with SEC blessing, for instance writing into their balance sheet the present value of alleged future profits from their large-scale electricity generation plant in India, which was then and remains now unfinished for ever.

Yes, HG, Competence, Prudence and Honesty - unfortunately these are in short supply in corporate governance.

The redeeming thought is that, if financial markets are efficient, and corporate disclosures full transparent and trustworthy, the market will correctly reflect the true value of a company's assets - regardless of the accounting method actually employed.