Whenever there is a sharp drop on the price of securities like the one we just experienced last week, people talk about the value destroyed in the economy that such a drop represents. Now I am an Engineer, with a handful of years of admittedly limited training in economic theory, and I therefore find the idea of valuations as value creation somewhere in the boundary between questionable and absurd.
My father once taught me that all value is subjective, and while I struggled with this idea for some time, I have come to believe it to be largely but not completely true. Largely because lately I have come to believe that the value of anything is derived from two very different sources which I like to call Intrinsic and Extrinsic value. Intrinsic value is that which does not depend on the scarcity or abundance of something but rather on the usefulness or purposefulness of the thing. I design machine components and I think of this kind of value as the reason why a finished steel part is worth more than the raw bar that it was cut from. The part is better fit to perform the specific functions it is designed to do. There is intrinsic value added onto the raw material that is now embedded in the finished product. On the other hand we have extrinsic value that is primarily derived from how scarce something is, as in the ball of a famous hitter's 1000's home-run. In its ability to perform any an all functions of a baseball, its simply one more but to the millions who witnessed the "event" of it being hit, and who would want to own it, it is unique and hence very, very valuable. Society as a whole suffers from aberrations and distortions by placing too much weight on extrinsic value and too little weight on its intrinsic counterpart. Take air for example: it is a very abundant resource, so abundant that at some point in history we essentially considered it inexhaustible. For that reason we treated the air we breathe, that very most essential resource without which none of us could live for more than a few minutes, as worthless. In the other extreme we take a single company like Facebook, and because we are all hoping for a piece of "the next big thing" we collectively decided that a black hole of time that is probably robbing our planet of billions of hours of productivity each day is somehow worth 100 billion dollars.
Back to the event of stock market crashes, I find it hard to accept that when a crash takes place any intrinsic value has been lost at all: corporate physical and intellectual assets have not changed or deteriorated, revenue opportunities remain unchanged and the human capital able to transform supplies into products are all there immediately after the turmoil. All that has changed is the perception of the future potential of the firm. The loss is a reflection of our collective gambling and evidence that the "value" that existed prior the crash was simply a large stack of empty promises packaged as solid gold.
I have said it before and I'll say it again: the stock market is fundamentally broken and if we are looking for a resource allocation mechanism we need to think long and hard of a better way to achieve this goal. We need to stop accepting that the people brokering the transfer of resources from those who have it to those who can use it productively somehow deserve to keep half of the pie. I feel for the millions of people who lost their life savings, again, during this crash. We are being sold worthless paper every day by a reckless system closer to a pyramid scheme than it is to real investment. But we need to come to terms that when the house of cards comes tumbling down all we lost was the illusion that it could stand forever.
