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Sunday, May 16, 2010

Pyramid Valuation Scheme

I have been thinking greatly on the concept of wealth or savings for months now. All objects are worth something relative to each other. Any one object is not "magically" somehow tied to absolute wealth. Everything is in effect a barter value system, including currencies, precious metals, energy, food, real estate, and labor.

The other valuation of wealth is the social power a person or group possesses. In the business world this usually translates into earning power through a complicated relationship with power/influence. In government it is military and command-and-control over people. I will concentrate purely on financial and not power based wealth.

Once the concept of all items have financial worth to humans, based on a relative trade value is accepted, then the next question rises, well, how does "stuff" become more valuable than other stuff?

If I own 100 US dollars today, then how much Gold, real estate, food, labor, chewing gum, can I buy with it? Also if I have 1 ounce of gold, 100 lbs of bananas, 100 people in slave labor, how does the value of these items change relative to 100 dollars?

The answer is clear to me, everything is based on the concept of demand. But what exactly is demand? Well, lets say we have 1 million people that doubles in population every x years, what is created is in effect a valuation system that is ever increasing as "limited resources" become more valuable over time.

A "limited resource" is boils down to one simple concept: More demand than supply.

In effect, increasing value is demand is greater than the supply, OR the value of the item which has plentiful demand is PERCEIVED to have greater value than the supply would indicate. This second item can be seen in parabolic valuations, such as beanie babies. Clearly there was no true shortage of beanie babies, or real estate condominiums in Florida.

That means all items, change in valuation relative to each other, based upon supply and demand (real or perceived). Yea, that was quite a bit of blog typing to come to a 101 economics mantra over valuation.

But what most people don't truly comprehend is EVERYTHING based upon this valuation system is in effect a pyramid scheme. From Wikipedia:

A pyramid scheme is a non-sustainable business model that involves the exchange of money primarily for enrolling other people into the scheme, without any product or service being delivered. Pyramid schemes are a form of fraud[1]
Notice what is crucial a non-sustainable business model, without any product or service being delivered.

For this blog entry, I will create my own version of Pyramid scheme, what I will refer to a pyramid valuation scheme and define it as:
A pyramid valuation scheme involves the exchange of money primarily for enrolling other people into a system of increasing demand, with or without any product or service being delivered. Pyramid valuation schemes will fall when demand inverts.

Using this definition, everything in human society is based upon a "pyramid valuation scheme", meaning the greater the demand relative to supply, the greater the valuation. If/when the demand declines, the valuation will devalue until it matches the demand value.

Assuming you accept this definition as appropriate, and the argument applies to all items being valued in society, it is critical then to jump the conclusion that everything you own has a valuation that is not absolute, and ever changing, including pure USD cash.

Therefore, all your assets are at risk, but the risk of different asset classes varies based upon historical precedence. Historic valuation stability is not a guarantee against future risk, but is the best society can do for conveying "wealth safety".

All Wealth is a pyramid valuation scheme
Since all wealth is a pyramid valuation scheme, what we have seen in the last 10 years is multiple large schemes orchestrated. There was first loose credit around the .com bubble, creating unsustainable valuation. Then there was the US real estate bubble, based yet again around loose credit causing yet another Pyramid Valuation Scheme. We just saw the government pump huge sums of money and credit to prop up the US financial industry, creating NOT a sound economic recovery, but yet another Pyramid Valuation Scheme. When this scheme blows, and it looks like it started, there will be the final bubble to end all bubbles. People since 2008 have been and will once again run sovereign debt (Government bonds) and/or gold as a safety play, creating what is amounting to the Final of all currency Pyramid Valuation Schemes.

This bubble is likely to blow sky high as currency become the only place to be....then once the pyramid over extends it self....it will be the LAST place you want to be. This final play includes US Dollars/bonds as well as gold. I am not stating run away from US dollar/bonds and somewhat more risky, precious metals. Quite the contrary, run toward them. But be ready to be early to leave. Both safety plays should be the place to be as the market falls, gold may be quite a bit more volatile.

Safest storage of wealth to me is: undeveloped/farming land, food, international corporations based on food, basic energy, and innovators of new technology.

The message is there is NO place that is safe to store wealth over long durations of time, keep in mind always, everything is a Pyramid Valuation Scheme.

One final thought, since the creation of man kind, humans have been on a trajectory of increasing population. I am ignoring calamities that last years such as an ice age, black plague, WW I, etc. Human kind has decided as a race to procreate less. 1962 +2.2%, 2010 +1.1%, 2044 +0.55% or may go NEGATIVE. If humans start to invert, will everything continue to increase in value? Houses? Gold? Why? I can only see "new tech", new capability continue to rise in value, but I can't see objects to hold wealth through this inversion. Call me a pessimist, but the "high" UN Valuation was probably extra high, to ensure the median didn't show to peak soon. I therefore lean to reality between the low and median.

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