Valuing the Essential Nature of Stuff
Updated: Aug 3, 2022
There is a remarkably simple test for whether something has intrinsic value
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Over the years I have had numerous discussions about the meaning of intrinsic value and the difference between value and price.
Intrinsic means 'belonging to the essential nature or constitution of a thing'. Price is the amount of money that can be received for something. Value is the measure of the utility, the usefulness, of something but sometimes also gets defined as the price. Because of this latter ambiguity, it is necessary to append the word intrinsic to make it clear that the relevant definition of value in the context of this discussion is the one pertaining to utility. While the price of something often reflects its value, they can sometimes be very different – for example, at the height of a speculative bubble or after one has burst and deflated.
Usefulness is subjective. A fridge would be of less use than a thick blanket to an Arctic fur trapper, particularly if there was no electricity supply. However, most people are not Arctic fur trappers and can agree that fridges are generally useful. Furthermore, we are not in unison going to wake up tomorrow and feel that a fridge is less – or indeed more - useful than it was yesterday. There is a stability to intrinsic value.
The intrinsic value of a government bond is that it provides safety: governments generally do not go bust and are thus able to pay coupons and principal from taxes they impose and collect. A government bond also provides a degree of inflation protection. This is not to say that the prices of government bonds always correctly reflect this utility, as many have found out the hard way over the last two years.
As for equities, people working together, aided by real and intangible assets such as machinery and brand names - aka a company - tend to produce more than they would working as asset-less individuals.
A dollar bill can be carried easily and used to buy things.
A barrel of oil contains approx. 1.5 million kcals of energy, equivalent to 12.5 years of hard human work. Of course, to tap into this energy the oil must be burned, which we now understand does untold damage to the environment - to the essential nature of…nature.
Most people like to wear things made of gold. It is weighty, shiny, and thus physically attractive. And because of its scarcity people fought over it, so it became a status symbol. Gold is used to store wealth, but this is only because of its physical attractiveness and symbolism. People would soon lose interest in gold bars if gold jewellery went out of fashion.
For many, casino games like Roulette provide a simple adrenaline rush that they cannot get elsewhere. Players accept that the casino must make money but know that to be competitive it sets the utility i.e., the expected pay out, just below the price i.e., the stake. There wouldn't be much interest in a wheel with just one red slot offering 50/50 odds on red.
Unlike Roulette, the expected pay out of a lottery ticket can be considerably lower than the price. However, a lottery ticket provides a unique chance to get rich beyond one's wildest dreams. Also, some lotteries, The National Lottery for example, fund worthwhile projects, helping ticket buyers feel altruistic.
A banana? It tastes good. And is good for you.
I'm not a fan of Group 2 cryptos like Bitcoin as I think they have negligible intrinsic value. Fans of Bitcoin however think the opposite. Below are the various arguments for it having intrinsic value that have been put to me, together with my rebuttals.
1. You can transfer wealth more safely, efficiently and cheaply than a bank. In that case why not use a stable, reserve-backed Group 1 crypto whose price does not have the potential to fall quickly?
2. Blockchain technology is useful. True, but this is about the intrinsic value of blockchain not of Bitcoin.
3. Store of value. Store of value requires some intrinsic value - gold is a store of value because it is physically attractive and thus worn by many as jewellery. Being a store of value in itself is not intrinsic value. Wearing a thumb drive around your neck is not fashionable nor will it ever be. Unless it’s made of gold. Oh, the irony of $B gold necklaces!
4. Scarcity. Again, scarcity is only meaningful if there is some utility. The smallpox virus is scarce. To most it would not be useful.
5. Get rich! Price volatility can indeed provide the potential to make you rich but this is not intrinsic value. And price volatility can also make you poor.
It could be argued, tenuously in my view, that in its early days, Bitcoin's intrinsic value was that it was new, unique and would capture the imagination of millions. However, while these features may have triggered the exponential rise in the price, the intrinsic value they imparted would never – could never - rise alongside it. New things become older. People jump on bandwagons; there are now thousands of cryptos. And eventually you run out of imaginations to capture, as indeed happened to Charles Ponzi in the 1920s and to many since.
Price is dependent on intrinsic value, not vice versa. Intrinsic value is the independent variable and price the dependent one. If the utility of something pertains only to the possibility of its price going up, that is not intrinsic value.
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.
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