The “Nothing” Theory of Value

Phillip Coggan at the Economist in Great Britain is warning of stock overvaluation because stocks keep going up, while companies no longer produce actual goods or services anymore, and have decreasing revenues. Indeed, this has perplexed most economists (including myself) since the bull market rally of 2009. I wrote about this in September 2013, warning that it was a bubble rising, reminiscent of the dot com days when company stock rose without having any products to sell.

But it’s more than just another bubble now.

It’s been a very busy month for me personally, but I am working on a book review and a journal article. One of the things I’ve been reading is the history of Leveraged Buy Outs, which is basically when a group of rich people take out loans (through a junk bond market) to buy low valued (presumably unproductive) companies, and then dismantle the company, selling it for parts for profit.

There’s a very interesting aspect to the LBO heydays of the 1980s: it’s not that companies were not producing anything. In fact, some companies were producing quite well, and had great cashflows. The problem was that a vast majority of companies in the 1980s were UNDER valuated, making them vulnerable to hostile takeovers. IBM, a staple in the American Institutions staved off three hostile takeovers, and they had great products and cashflow at the time.

Fast forward through the dot com, and to 2015, where companies are OVER valuated for producing nothing. What are the consequences of that? While Coggan didn’t quite know, we can see some of the consequences in the data, through low consumption demand.

fredgraph

Inventories are rising against durable goods orders, which is really bad in the macro sense. However, the cause is micro: people don’t have enough money to buy stuff. They don’t have enough money to buy stuff because they don’t have enough wages, and there aren’t enough jobs with full time hours for them to afford to buy stuff. This is why we see a flat inflation level on discretionary consumption (non-food/housing/energy buying).

Ricardo said that the value of something is the labor that’s put into its production. The neoclassical theory is that a company is worth what the stock price is. But how is stock price determined? It’s supposed to be a “discovery” process through the market. In other words, the stock price is what ever people are willing to pay for it. And by “people,” I mean investment banks, and private equity.

As long as investment banks and private equity (vis-a-vis hedge funds) are willing to buy over valued stocks instead of spending actual capital on actual production of actual goods and services, that create actual, real jobs (and Ricardian value) for people, then the P/E ratios will continue to climb in a “nothing” theory of value. People will not be able to buy (consume) what stuff is actually being produced, and there is no monetary policy to fix that. Only fiscal policy can.

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