first majestic silver

Value

June 25, 2005

On June 23rd 2005 - in the case of Kelo vs City of New London - the US Supreme Court ruled, in a split decision, that the "Property Development" under contemplation constituted land to be used for "Public Use" and was therefore "In the Public Interest". Flowing from this decision it became legally allowable for a Municipality to expropriate (and pay for) privately owned land for the purposes of property development. It is also of importance that the position of the dissenting judges was that there was not "clear and convincing evidence" that the economic benefits of the [property development] plan would come to pass. i.e. Their dissent flowed from a purely economic frame of reference.

What was the "key implication" of this case?

From this writer's perspective, the ruling will have far reaching effects which are so significant that they have the potential to destabilise the very foundation of the Developed World's economy. Clearly, because this statement has melodramatic overtones, it is important that it be justified.

The Institute of Liberty and Democracy was set up in response to the research efforts of one Hernando De Soto (thank you Steve Kurtz); and details of De Soto's work can be found on www.ild.org.pe/eng/contenido.htm

In essence, the difference between the economies of Third World countries and First World countries lies in "land tenure". This allows people to put down roots and plan for the long term. Usually, in planning for the long term, one thinks in terms of acquiring assets so that one can be self sufficient in one's old age.

In Third World countries where there is no significant land tenure, the response to the need to provide for one's old age is to have large numbers of children - such that these children can be (between them) relied upon to support one in one's old age.

By undermining the inaliable right to land tenure, the Supreme Court of the USA - in the case of Kelo vs City of New London - has struck a blow against the concept of long term planning on the part of the average individual, and in favour of the right of property developers to make profits - all in the name of "public interest".

What has this to do with "Value"?

The word value is defined in the World Dictionary as "Worth, excellence, usefulness, importance." In its financial sense it is defined as "real worth; proper price".

Clearly, the "real worth" and "proper price" of anything flows from its perceived excellence, usefulness and importance.

Last week I demonstrated that the market appears to be ascribing a price to MACMIN shares that is roughly consistent with their underlying real worth - taking into account most of the key variables. In other words, the market appears to be acting fairly rationally. (Note: The article made no reference to outstanding options, but at the current share price it seems unlikely that the options will be exercised)

But there are times when markets do not act rationally, and the question arises as to why the prices within a market place will drift away from underlying value.

In thinking about this for a few days I finally came to the conclusion that "honest people's" perceptions of value can be influenced by "dishonest people's" desires to make profits - to the point that the market takes leave of its senses.

Take the Nasdaq bubble of a few years ago, as an example.

In essence, what happened there was that a promoter would establish a business at a cost of (say) $1. Provided his/her business had the smell of being new age and/or high tech, it was perceived to have a high value that was yet to be realised. To assist him/her to realise the business' value, he/she would then bring in a Venture Capitalist at an interim valuation of (say) $4; and the VC would then take the company to market via an IPO amidst much fanfare, at a listed price of (say) $20, and the fanfare would continue until the share price peaked at (say) $100 and then the share price collapsed back to its "real worth" of (say) $3. The VC's were smart enough to lock in the promoters shares in escrow, and so relatively few promoters actually realised their paper profits.

Clearly, the patsies here were the gullible public, and the primary beneficiaries were the arbitrageurs who on-sold to the greater fools at prices that were kept artificially high because of the escrow conditions which limited the promoters stock sales until the financial investors had sold.

Now we have a real estate bubble. Or do we? The value of domestic property is not being perceived (at least in Australia) as a function of the rental you can charge a tenant, as can be seen from the following chart (source Commonwealth Bank)

This chart shows that the P/E ratio of domestic housing in Australia has risen in the past few years from its 40 year average of 35 to a current level of around 60. i.e. At current rentals it will take a domestic property investor over 60 years to get his/her capital back.

In this writer's view, the reason that real estate prices have risen so high is that, in the end analysis, a "man's home is his castle". The value inherent in owning your own home is that you can set down roots in the secure knowledge that - in a fast changing and unpredictable world - at least something in your life is permanent. What is being valued here is the state of "permanence" as opposed to real estate itself; and the perceived value of permanence has been escalating as the environment has become more threatening.

It can be seen from the above chart (source: Commonwealth Bank) that at 160%, the ratio of Australian Household Liabilities to Disposable Income is the highest in the World. In short, the Australian public's response to the "dishonesty" of the Reserve Bank's behaviour - which has created instability in the financial arena - has been to go deeply into debt in an effort to seek stability in the housing arena. (Of course, at the margin, there have been the arbitrageurs who have been flipping their domestic property investments, but at the core of society, most people buy a house to live in it)

Which brings us back to Kelo vs City of New London.

If the stability of home ownership is no longer sacrosanct; and the stability of the financial infrastructure is now also in doubt, how will the public react; and how will this reaction be "managed" by the authorities?

In my view (expressed in previous articles published on Gold-Eagle), we are witnessing the beginning of the end of the age of materialism.

This could have one of two outcomes.

Pessimistically: If people can no longer find stability flowing from the acquisition of material assets, there is likely to be a breakdown in law and order as "social values" shift further away from permanency and further towards short term consumerism. People will focus increasingly on day-to-day living and will worry decreasingly about consequences. Commercial contracts will increasingly be dishonoured, and the "rule of law" will, at the extreme, disintegrate.

Based on historical trends, the authorities' response to this anarchy will be to increase the number of laws and, concomitantly, the propensity for authoritarianism and dictatorship will also escalate - as it already appears to have been doing.

Optimistically: Flowing from the fact that the human race appears to be evolving and growing up, it seems possible that materialism will be eschewed in favour of an old-fashioned concept called "menschkeit".

What is menschkeit?

In essence, menschkeit is the first rung in the ladder of spirituality. It represents the acknowledgement of our fellow human beings. In turn, this is a condition precedent to moral integrity which, once attained, can lead to behaviour that is consistent with social conscience.

In a "love thy neighbour' world, if I can trust you not to murder me while I am sleeping in my bed, and you and I can agree to pool our collective resources and talents for our mutual benefit, then - if this thought process is extended to the community as a whole - it will become unnecessary for me to acquire assets to provide for my old age. I simply will not need to own any "superfluous" assets.

This is not a simple concept to be labelled as "socialism" or "communism" or any other "ism". Under such (perhaps utopian) circumstances, I can be motivated by the enlightened force of "self actualization" rather than by the more Neanderthal force of "ego". I can be enabled to do what I am best suited to do in terms of my genetic design, and to thereby realise my full potential as a human being.

In the Australian environment, there are tentative signs that menschkeit is going to win over materialism. The following chart (Commonwealth Bank) shows that Australians are increasingly moving to pay down their mortgage debt which, in turn, is going to put downward pressure on the multiplier effect (velocity of money), and on GDP growth.

In an environment where 60% of the Australian economy is driven by consumer purchases, this does not auger well for growth in Australian GDP.

Conclusion

Value is a subjective concept, because it is dependent on one's personal perceptions of what is important and what is not important.

We have been brought up in a world which values material possessions, and in such a world there are mechanical methods for quantifying value, based on "generally accepted" valuation principles. There are also cynical (and perhaps dishonest) people who attempt to exaggerate the importance of what they are selling so that the buyers will pay more than the mechanical methods would anticipate.

With the emergence of the various financial bubbles, there is evidence that these "generally accepted" principles are changing, and that the very foundations of our value set may be shifting.

It appears that there are two possible outcomes of this shift. Either:

  • We will continue to place a disproportionate value on material possessions, and this will force a downward spiral in the quality of life as the economy continues to unravel. In this case, the age of materialism will culminate because we can no longer afford to buy superfluous assets.
  • We will start to understand that ownership of two houses and three motor cars and a wardrobe full of disposable clothing does not really contribute to "inner peace", and that contentment does not flow from what you own or who you know, but from who you are. In this case, the age of materialism will culminate because we no longer aspire to own superfluous assets.

 

Finally, in an environment where, regardless of whatever price you may pay for a home you cannot rely on security of tenure, neither of these outcomes is relevant. Why would anyone aspire to own even one house?


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