Questions concerning economics

[TNAR]

As long as prices stay the same the power of your money should be about the same I think. Maybe some people got rich some people got poor and the economy just in general slowed down?

It was a good catch and you are right that the money just shuffles around in my example. The problem is that it becomes exceedingly confusing when we begin to bring in the fraction reserve status of banks and the multitude of hands the assets and money passes through. The thing to remember is that the debt instruments (e.g. mortgages) are treated as assets for the bank. So when the asset is suddenly not valued as highly as it was previously the bank must reduce its assets which is essentially like erasing money from its account.

 

[Rhapsody1447]

All this means is that the rich guy had a net loss between the two transactions. This doesn't mean that wealth was destroyed.

The analogy was for the depreciation of the asset (in this case the painting). In my first post, I used a mortgage or a house.

 

[Khayembii Communique]

The analogy was for the depreciation of the asset (in this case the painting). In my first post, I used a mortgage or a house.

Sure, but there isn't any wealth destroyed in a zero-net-production economy unless the commodities themselves are withdrawn from the market. Again, depreciation of an asset =/= destruction of wealth. Nor can it be used in place of a debt instrument, as credit is entirely different in the sense that it is a claim, or an advance on future wealth creation that, depending on the accounting, creates a fictitious wealth until it is realized. Therefore, ceteris paribus, the "wealth destruction" even in this case is just the destruction of fictitious wealth, wealth that never existed as such.

 

[imagep]

That is where the wealth was created. Where are you suggesting the wealth was created?

So if wealth is only created when transactions happen, producers don't neccesarally create wealth.

I don't know that I buy that.

Wealth isn't money, wealth is the stuff and services that we have. If I create something of value, then I have created wealth. If I sell that item, all I have done is transfered that wealth to another person, in exchange for some money (which in itself has no value).

I don't understand how the creation of an item of value isn't creation of wealth, or why the exchange of something is the creation of wealth.

 

[imagep]

I would agree with that as well. If I owned the painting I could place a monetary value of whatever I believed was accurate based on my own perception. I may value it at $1 million and it would be accurate from my own perspective. The fact that nobody else would pay that amount means little unless I desired to sell it.

Thats a lot like the morgage mess that contributed to our recession.

Banking accounting proceedures were changed, and banks were required to value their inventory (morgages) at whatever they think they were currently worth. So when the morgage market was in a bubble, they placed values on those morgages that were higher than what any reasonable person would have valued them. this created artificial profits. The bankers then patted themselves on the back and gave themselves huge bonuses and pay increases. Then, when the bubble started to burst, they had to value the morgages at a much lower amount, which essentially took away not only all of the artifical profits, but even more as the morgage market was panicking.

Thats exactly why we shouldn't look at wealth creation based upon transactions.

True wealth is only created when goods and services are created. True wealth is never created by transactions.

Does a bank robber create wealth when he robs a bank (which is a transaction)? Nope. What about Maddoff, did he create wealth? Nope.

Does a taylor create wealth when he makes a new suite? Absolutely.

Money is not wealth, and transactions do not create wealth.

 

[imagep]

Not exactly.

Yes, the value of currency is based off its acceptance in trade for other commodities. However, this is not a discussion of the value of currency, it is a discussion concerning the elimination of large amounts of wealth on paper due to a revaluation of assets against which debt instruments are written.

Monetary revaluation of assets does not create or distroy wealth. It just changes how we measure wealth.

Simply stating that a house is now worth $100,000 less does not distroy the value of the house. Burning down that house would most certainly distroy the value of the house.

 

[TNAR]

So if wealth is only created when transactions happen, producers don't neccesarally create wealth.

Freudian slip on my part. As Rhapsody1447 most astutely pointed out, the transaction simply quantifies the wealth which has been created. Wealth is communicated in monetary terms and since prices are subjective there is no way to quantify wealth or value unless someone is willing to purchase it. Take the "toxic" MBSs the banks held after 2008 for instance; they could not be assigned a value because nobody was willing to purchase them. This was why the Federal Reserve swooped in to the rescue and created a market for them in order to save the banks. If they had been allowed to be sold on the open market they would likely have gotten virtually nothing and the banks involved would have collapsed (which would have been a good thing IMO).

Wealth isn't money, wealth is the stuff and services that we have. If I create something of value, then I have created wealth. If I sell that item, all I have done is transfered that wealth to another person, in exchange for some money (which in itself has no value).

Correct. However, money does have value. The value of money is determined by the goods which it can be exchanged for. But this is the same for any commodity and is no special rule for money.

 

[imagep]

So in the housing market (or any other economic good) when a house is built it only has value when it can be sold (or if the person who owns it places a value on it).

Rediculous. If having a house is desirable, then houses have value all of the time, and not only at the time of sale. Selling a house is mearly transfering ownership and does not directly create or distroy aggregate wealth. If they seller made a profit the seller may FEEL like he created wealth, and if the buyer got a good deal he may FEEL like he created wealth, but the actual wealth creation occured when the house was manufactured, not when it was sold.

Unsold inventory most definately has value, and is thus wealth. Don't believe me? then go to any retailer and asked them to give you all of their inventory...for free...because it has no value. See if they will agree with that.

 

[Khayembii Communique]

Freudian slip on my part. As Rhapsody1447 most astutely pointed out, the transaction simply quantifies the wealth which has been created. Wealth is communicated in monetary terms and since prices are subjective there is no way to quantify wealth or value unless someone is willing to purchase it. Take the "toxic" MBSs the banks held after 2008 for instance; they could not be assigned a value because nobody was willing to purchase them. This was why the Federal Reserve swooped in to the rescue and created a market for them in order to save the banks. If they had been allowed to be sold on the open market they would likely have gotten virtually nothing and the banks involved would have collapsed (which would have been a good thing IMO).

"Something is worthless if nobody wants it."

You have quite the knack for stating the obvious...

Rediculous. If having a house is desirable, then houses have value all of the time, and not only at the time of sale. Selling a house is mearly transfering ownership and does not directly create or distroy aggregate wealth. If they seller made a profit the seller may FEEL like he created wealth, and if the buyer got a good deal he may FEEL like he created wealth, but the actual wealth creation occured when the house was manufactured, not when it was sold.

Unsold inventory most definately has value, and is thus wealth. Don't believe me? then go to any retailer and asked them to give you all of their inventory...for free...because it has no value. See if they will agree with that.

TNAR is merely stating obvious common sense facts. This is generally how the field of Economics works nowadays. Most economists don't have much understanding of the world beyond such simple observations.

 

[imagep]

Correct. However, money does have value.

I believe it would be more correct to say that money represents value.

I can't eat money, I can burn it for fuel but it doesn't have a lot of fuel value, I can wear it but it's not as good for clothing as standard clothing. These days most money is just binary code - and has zero physical value, but of course the purpose of binary code is to represent something. Money is mighty good for representing wealth though.

I can have a piece of paper on my desk that says "two apples" on it. Well I know how many the number "two" represents, and I know what apples are, so I understand that piece of paper represents two apples. Now that doesn't mean that the piece of paper is two apples.

And I may also have a ten dollar bill laying on my desk. I have a rough understanding of how much wealth a dollar represents, and I have an understanding of the number "ten". Yes, I have a piece of paper on my desk that represents ten dollars worth of wealth. That doesn't mean that it IS ten dollars of wealth, it just represents that much. The ten dollars of wealth is whatever I exchange the ten dollar bill for, not the ten dollar bill itself.

now lets say that I exchange the ten dollar bill for a bag of apples, and i lay that bag of apples on my desk. I could correctly point to the apples and state that it had a value of $10 and that the bag was wealth itself.

 

[Khayembii Communique]

I believe it would be more correct to say that money represents value.

Well back in the day, when we were on the gold standard, money (i.e. gold) did have value. Currency was the representation of money as value. Nowadays there is no longer a single money commodity, as with a fiat the value of currency is simply the direct reflection of the sum total of commodities and their values. This allows for much easier creation of fictitious wealth and also in an increasingly centralized global economy further lubricates transactions. I wrote a piece on this and posted it in the economic forum a while ago that nobody really cared for (probably because it was rather esoteric, being written in Marxian jargon and whatnot).

I can't eat money, I can burn it for fuel but it doesn't have a lot of fuel value, I can wear it but it's not as good for clothing as standard clothing. These days most money is just binary code - and has zero physical value, but of course the purpose of binary code is to represent something. Money is mighty good for representing wealth though.

Interesting that you mention this. When I was going for my Econ undergrad I was smarter than most of my professors regarding economics (most hadn't read any of the primary materials, it seems) and I got in a long argument with my micro professor about how money is not a consumptive commodity and therefore the entire idea that money can have utility is a tautology. The argument resulted for the most part in a headache on my part, because he really had trouble understanding what I was arguing as it was above his sophomoric level of understanding.

 

[TNAR]

Thats a lot like the morgage mess that contributed to our recession.

That was the point of my example. I’m glad it was noticeable.

Thats exactly why we shouldn't look at wealth creation based upon transactions. True wealth is only created when goods and services are created. True wealth is never created by transactions.

I agree that wealth is not created during a transaction but it is quantified at that point. You mentioned that banks had to revalue their assets based on what price they thought someone would purchase them. How would this be accomplished differently if the value was quantified at creation? The manufacturer would still have to place a quantifiable value on the item based on his guess at market prices.

In spite of our best efforts to trivialize them, transactions (i.e. prices) are the only method available to accurately account for wealth.

Simply stating that a house is now worth $100,000 less does not distroy the value of the house. Burning down that house would most certainly distroy the value of the house.

Wealth is subjective. You can claim all day long that your favorite pair of jeans is worth $1 million to you but I can guarantee that nobody else would agree with you. If you list your jeans as a $1 million asset in your ledger and somebody steals your jeans you would have to reduce your net wealth but no wealth was destroyed. On the other hand, if you sold your jeans for $10 to your neighbor there would be a reduction of $999,990 in total wealth. Or, wealth would be destroyed. Perhaps not the subjective concept of the wealth but in a quantifiable manner (which is the important aspect in accounting).

Rediculous. If having a house is desirable, then houses have value all of the time, and not only at the time of sale.

Okay then, what is the value of a house before someone buys it?

Unsold inventory most definately has value, and is thus wealth.

That is not at issue here. Go to the same retailer and ask him how much a piece of his unsold inventory is worth today and then ask him how much a piece of his unsold inventory is six months from now. Depending on the industry and how quickly the item depreciates, he will tell you that the item will become worth less and less as time progresses.

Does this mean that the wealth is evaporating as the item sits on the shelf? Of course not. It means that it is impossible to determine wealth without a transaction.

TNAR is merely stating obvious common sense facts. This is generally how the field of Economics works nowadays. Most economists don't have much understanding of the world beyond such simple observations.

If this were the case I wouldn’t be forced to continually educate people on the fallacies of socialism, Keynesianism, Monetarism, protectionism, mercantilism, and any other –ism you can think of.

 

[Khayembii Communique]

Okay then, what is the value of a house before someone buys it?

Better question: If wealth is merely quantified at the point of transaction, then it must have been created at some other point. Do you agree or disagree that it was created through the production process and the creation of the commodity?

Follow up question: If you agree, then why ask this question?

 

[Rhapsody1447]

Sure, but there isn't any wealth destroyed in a zero-net-production economy unless the commodities themselves are withdrawn from the market. Again, depreciation of an asset =/= destruction of wealth. Nor can it be used in place of a debt instrument, as credit is entirely different in the sense that it is a claim, or an advance on future wealth creation that, depending on the accounting, creates a fictitious wealth until it is realized. Therefore, ceteris paribus, the "wealth destruction" even in this case is just the destruction of fictitious wealth, wealth that never existed as such.

I've managed to confuse myself in this thread. My first attempt at explaining where the "money" went was separate from the wealth destruction/creation argument. After TNAR's analogy I didn't think it was an example of wealth destruction and then changed my mind and thought it was. Personally, I believe asset depreciation is considered wealth destruction but I'm not qualified enough to make the assertion. I would consider my original example of equity devaluations and debt writedowns wealth destruction (note: I did say the "money", which is separate from wealth, never existed) when using the economics definition of wealth in the dictionary:

Wealth | Define Wealth at Dictionary.com
noun
1. a great quantity or store of money, valuable possessions, property, or other riches: the wealth of a city.
2. an abundance or profusion of anything; plentiful amount: a wealth of imagery.
3. Economics .
a. all things that have a monetary or exchange value.
b.anything that has utility and is capable of being appropriated or exchanged.
4.rich or valuable contents or produce: the wealth of the soil.
5.the state of being rich; prosperity; affluence: persons of wealth and standing.

When my house loses value or money that is owed to me is defaulted on, I would consider part of my wealth destroyed. I agree with your term of "fictitious wealth" in that debt is borrowed future demand and equity prices are subject to market fluctuations. My guess is that we are arguing between the two definitions of wealth used in the dictionary. Your example of commodities in a fixed economy have inherent utility and you are correct wealth would be destroyed if they were removed. However, I believe price deflation in your example would also constitute as wealth destruction as it would impact net worth, quality of life, and the monetary or exchange value of the fixed number of goods. Of course it's hard for me to picture such an economy since it is so hypothetical. I believe the more relevant example of our current economy would dictate that wealth destruction occurs when value is destroyed. Wealth creation happens when something is created that provides utility. I may find utility in a painting that brings me joy, so the painter created "wealth" in that it provides me utility and I am willing to place a monetary value on it. Other productive tools such as the internal combustion engine is another example of wealth creation in that it provides utility to a large number of people who are willing to exchange other goods and services for it. The whole is greater than the sum of the parts.

I believe TNAR has said he has advanced degrees in economics. Although I disagree with him on other points (e.g. fiat/commodity-back currencies), I will concede the argument to him.

 

[Khayembii Communique]

However, I believe price deflation in your example would also constitute as wealth destruction as it would impact net worth, quality of life, and the monetary or exchange value of the fixed number of goods.

In an autarkic economy with zero net production price inflation/deflation can only happen on a nominal basis.

I believe the more relevant example of our current economy would dictate that wealth destruction occurs when value is destroyed. Wealth creation happens when something is created that provides utility. I may find utility in a painting that brings me joy, so the painter created "wealth" in that it provides me utility and I am willing to place a monetary value on it. Other productive tools such as the internal combustion engine is another example of wealth creation in that it provides utility to a large number of people who are willing to exchange other goods and services for it. The whole is greater than the sum of the parts.

Correct. Wealth is created in the production process.

I believe TNAR has said he has advanced degrees in economics.

Economics degrees are worthless. Trust me, I have one, econ majors are a step down from business majors.

 

[TNAR]

… when we were on the gold standard, money (i.e. gold) did have value.

There is no difference beyond the limited ability of the mint to print more money at will. The value of gold is determined by the amount of goods it may be exchanged for. The value of a fiat dollar is determined by the amount of goods it may be exchanged for. This line of thinking may be continued for every good on the market.

… the value of currency is simply the direct reflection of the sum total of commodities and their values.

Not only is it impossible for anyone to determine the total sum of all commodities in the economy or place a quantifiable value on those commodities, it is impossible for any one person to keep this figure in mind as he makes purchases. The value of currency is based squarely and solely on its ability to be traded for other goods.

This allows for much easier creation of fictitious wealth and also in an increasingly centralized global economy further lubricates transactions.

Agreed. I’ll check out your linked article when I get the chance.

Better question: If wealth is merely quantified at the point of transaction, then it must have been created at some other point. Do you agree or disagree that it was created through the production process and the creation of the commodity?

Agree.

Follow up question: If you agree, then why ask this question?

Because imagep suggested that “we shouldn't look at wealth creation based upon transactions.” This was in reference to revaluing assets on a bank ledger resulting in the loss of wealth. I contend that it is impossible to quantify value (e.g. wealth) without a transaction. He replied with the assertion that “houses have value all of the time, and not only at the time of sale”. I agree with this but am pointing out that, once again, it is impossible to quantify this value without the offer of purchase.

I've managed to confuse myself in this thread. ... I would consider my original example of equity devaluations and debt writedowns wealth destruction

I don’t recall your example but devaluing equity and debt instruments is certainly wealth destruction. Seems you’re not that confused.

When my house loses value or money that is owed to me is defaulted on, I would consider part of my wealth destroyed.

Almost. If you list your house as an asset but the market suddenly takes a dive you do not actually lose any wealth. It is only when you attempt to sell that asset that you must properly align your perception of value and that of the market.

For instance, if you purchase a stock at $5 and it takes a nose dive to $1 over the following week did you lose any wealth? No (though some people will contend that you lost wealth on paper). As the saying goes, you never lose money until you sell. You may keep the stock listed as an asset of $5 per share until you decide to sell. At the point of sale you will determine your profit or loss. Should the stock go back up to $10 you got yourself a healthy profit. Only if you decide to sell at less than $5 is any of your wealth getting destroyed.

Obviously this is not exactly how the housing industry works but I think you’ll get the point.

 

[Khayembii Communique]

There is no difference beyond the limited ability of the mint to print more money at will. The value of gold is determined by the amount of goods it may be exchanged for. The value of a fiat dollar is determined by the amount of goods it may be exchanged for. This line of thinking may be continued for every good on the market.

I was using a Marxian category of value, sorry you didn't understand that.

Not only is it impossible for anyone to determine the total sum of all commodities in the economy or place a quantifiable value on those commodities

So now you don't know what price level is, either. :ssst:

EDIT: You also apparently don't know what fiat currency is, specifically the fundamental notion that aggregate monetary value of a fiat is tied to GDP. This is something you learn in high school economics.

EDIT 2: Just to drive the knife in a little further, do you recognize this equation?

it is impossible for any one person to keep this figure in mind as he makes purchases.

They don't need to. That's what price is for.

The value of currency is based squarely and solely on its ability to be traded for other goods.

Currency by definition is exchangeable for other goods. You're back to tautologies, here.

 

[TNAR]

I was using a Marxian category of value, sorry you didn't understand that.

I don't use fallacious theories.

So now you don't know what price level is, either.

Apparently you missed the fifth word in the supplied link. Would you like me to define hypothetical for you?

This is something you learn in high school economics.

Again, I don't utilize fallacious theory.

They don't need to. That's what price is for.

I agree. So tell me, is the price being paid based on the entire valuation of every single commodity available for purchase or is it based on the subjective valuation of the consumer with regards to his wants and means?

 

[Khayembii Communique]

Apparently you missed the fifth word in the supplied link. Would you like me to define hypothetical for you?

So you reject anything that has to do with price level.

Again, I don't utilize fallacious theory.

So you reject the Quantity Theory of Money, then.

I agree. So tell me, is the price being paid based on the entire valuation of every single commodity available for purchase or is it based on the subjective valuation of the consumer with regards to his wants and means?

Market prices are not determined by the subjective valuation of the consumer with regards to his wants and means. Try going into a Best Buy and offering $5 for a tv. Let me know how it goes.

 

[TNAR]

So you reject anything that has to do with price level.

No, I am saying the price level is impossible to quantify outside of a thought experiment.

So you reject the Quantity Theory of Money, then.

Only if you take a holistic view that changes in the money supply affect all prices at the same time and at the same level.

Market prices are not determined by the subjective valuation of the consumer with regards to his wants and means. Try going into a Best Buy and offering $5 for a tv.

If Best Buy is selling TVs for $100,000 is that what they are worth? No, the TV is worthless if it cannot be sold.

 

[Khayembii Communique]

Only if you take a holistic view that changes in the money supply affect all prices at the same time and at the same level.

They would in an autarkic economy with zero net production...

If Best Buy is selling TVs for $100,000 is that what they are worth? No, the TV is worthless if it cannot be sold.

Only in the field of economics can you proclaim "People do whatever they want because they want to" and have it be a groundbreaking assertion. I wonder what would happen if you wrote a psychology paper that was just like "He did it because he wanted to"....

 

[InTraining]

There are two spheres: monetary and wealth. Monetary is the dollar amount of everything. Wealth includes everything like the actual house, a painting, an apple, love, happiness, the bond between mother and child. The "financial crisis" occurred because there is an imperfect mapping between these two spheres. These imperfections mainly come in three forms. 1) a house that is rarely bought/sold may have an out of date monetary value. 2) some of the wealth like mother-child bond is highly personal (which is why ransoms work so well). 3) a lot of wealth is based on emotions which are capricious and can change (whether the house’s blue tiles are in fashion)
We intuitively understand the wealth aspect, as it translates directly to our evolved emotions. The monetary is a social construct that is not at all intuitive. The only intuitive aspect of the monetary sphere is the $888B of hard cold cash, which is the only thing that directly and perfectly maps from the wealth sphere to the monetary sphere. Everything else is imperfect, and this is the source of a lot of confusion in economics, because so many people try to translate our intuition in the wealth sphere over to the monetary sphere through using cash.
This is why, in the previous example, even though there is always the same $500,150 of cash in the system in every stage, there were changes of value in the wealth sphere, (as well as an increase in value in the monetary sphere of $50). Value in the wealth sphere was increased when two people fall in love, just like when a painter creates a painting. Value in the monetary sphere is highly subjected to how the buyer/seller maps between the monetary and wealth spheres, and to how the painting’s value changes in the buyer/sellers’ wealth spheres.
When we eat an apple, we destroy wealth. Foods eaten are the tax of biology, and dropped vases are the tax of misfortune. When John eats an apple, John gains the opportunity to create more wealth, to hopefully create wealth worth more than the one apple he ate. Paintings in the museum offer so much wealth as it allows appreciation and happiness to everyone who passes by.
The reason why many of these financial instruments are despised, is because these are indeed wealth, but these are wealth that refers only to the monetary sphere, so people misinterpret it to be a loop that refers back to itself, and thus is like a Ponzi scheme. What these people miss out on, is that these financial instruments do count as wealth, not through what they refer to in the monetary sphere, but instead through their reductions of risk.

 

[TNAR]

They would in an autarkic economy with zero net production...

Why in the world would anyone subject themselves to this horror?

Again you are displaying your knack for answering questions without offering any evidence or truly addressing the issue.

 

[Khayembii Communique]

Why in the world would anyone subject themselves to this horror?

Again you are displaying your knack for answering questions without offering any evidence or truly addressing the issue.

Dude, you're disagreeing with one of the most basic economics concepts that you learn in Intro to Macro. Hell, here it is in my old textbook:

Why don't you go take it up with Mankiw if you're so insistent that such a basic self-evident common sense statement is wrong.

 

[InTraining]

Wealth creation/destruction is dangerous because it is based heavily on capricious human perception. The financial crisis occurred when the financial instruments created were perceived to map to a higher value in the monetary sphere than it really should. People thought they had more wealth than they really had. Then, 2008 came, and all this wealth was “destroyed”. In reality, the financial crisis was not a destruction of wealth, but instead, the creation and destruction of wealth. It is like painters who realized people would buy their red squares as long as it had their names on it, and these red squares would be painted, and there would be much more wealth in the world. However, wealth would be destroyed when these red squares are no longer seen as beautiful. This wealth destruction and creation is alright. It happens all the time, as when couples divorce or vases are dropped. It is alright, as long as humanity creates more apples than it consumes, so that humans do not go extinct.