In the last few months, we have watched a considerable meltdown of wealth occur in financial markets; on Main Street; and in the personal investment accounts of individuals throughout the world. There are so many KNOWN reasons that this has been occurring, yet we seem to be led to believe by our president; treasury secretary; fed chairman and congress that they did not see a meltdown of this magnitude coming. I am not privy to the information disseminated among the powerful elite; yet anyone with any fiscal knowledge and savvy could see this train wreck coming down the track months and even years ago. Companies large and small; governments; and households have been fueling the economy for too long with borrowed money. Period! In this week's lesson we attempt to put some perspective on wealth and value and how it relates to our current mess.
The word "wealth" can take on many meanings. The dictionary definitions are an "abundance of valuable material, possessions or resources;" or "all goods or resources having economic value." The key word in defining wealth is VALUE.
In reviewing a classic book published in 1776 and written by Adam Smith titled "The Wealth of Nations," one can learn a great deal about WEALTH and VALUE. Adam Smith was a Scottish Professor who studied many centuries of economics. Ben Franklin used his works to lay the groundwork for the Economic Structure of the American Colonies. Even though Smith was writing for his own generation, the depth of his knowledge and the boldness of his vision have made him popular for over 230 years and Smith's book still stands today as a cornerstone of capitalism.
A keynote in Smith's book was how an individual places value on Goods and Services. He states "the value of anything is determined by the demand for it, as well its scarcity or difficulty in obtaining it." Value is a subjective phenomenon. It is not objective. In other words, value is based on opinion. You cannot say, "This glass bowl is worth $500 dollars because that's what I paid for it." The fact that you paid $500 for the bowl is merely a HISTORICAL fact. It just means that AT THAT TIME, you valued the bowl MORE than you valued the $500 in your pocket.
Let's say that your friend really likes your bowl, and offers you $200 for it. Being that you're living comfortably, and don't need the money, you refuse her offer. Besides, you're under the impression that IT'S WORTH $500. But let's say that your car breaks down, and needing some money, you call your friend and sell her the bowl for $200. What's the bowl really worth? $500? $200? The answer is neither. The bowl is only worth what a person values it at a particular moment in time. After all, when you bought the bowl you valued it at $500, but later you valued it at $200. Thus even your own valuation of the bowl changed from one day to another.
This same process goes on everyday on Wall Street and Main St. How can companies like GE or Wachovia Bank lose billions of dollars in market value in one day? Well it's been happening right before our eyes and for the same simple reasons as stated above. The price of oil goes up or down by as much as 8 % in a day and home values can drop by 15% in a month compared to the same month last year. Ford sold 34% less cars September and GM lost $15 billion in profit during the same quarter Exxon made $11 billion. Remember Smith's words that "the value of anything is determined by the demand for it, as well its scarcity or difficulty in obtaining it. Thus there are too many cars being built for the number of qualified buyers. Just like there are too many homes on the market for those who can afford them. Thus prices must come down on these items or disposable income and demand for these products must go up. If credit continues to tighten, it will make these homes and cars even more difficult to sell in the near future.
This process applies to every single thing in life that people put values on. It even applies to the value that people put on life itself. Some people value their lives and take good care of their health and personal affairs while others put a low value on their lives and squander their time, money and health away. It's all a matter of opinion and choice.
According to Smith, it doesn't make much difference that your service requires more labor or your components are the highest quality. What does matter is that your services exceed your customer's demands and you are unique by providing scarce services. In other words, it doesn't matter if you worked for 100 hours and spent $1,000 building something that you can only sell for $400. Obviously, there is no demand for it and you could have used your time, labor, and materials building something that is in high demand.
If you want to build wealth during your lifetime, devote your precious time toward creating valuable goods and services that are unique, scarce and in demand. This has been a sound recipe for success dating back to Adam Smith's days.