Investing for Value

In my reporting at Salem News I will do my best to apply historically informed critical analysis to the most important issues in the areas of investment, economics, business and government that face the citizens of our State.

Courtesy: gelman.gwu.edu

(EUGENE, Ore.) - I will be joining the Salem News team as a Business reporter. It is our hope that my contributions in this area will expand the scope of coverage at Salem News and increase the value of that coverage for its readers. In order to introduce myself, I would like to share a little bit about my background, and how I will be approaching this job.

I am an Oregon native. I grew up on the coast, lived in Portland for ten years, and now reside in Eugene. I have a B.S. in Economics from Portland State University. I have written about media, economics, and politics on blogs for several years. Working with Salem News, I will be focusing much more narrowly on the subject of business and investment in the State, and focusing more on reporting than on opinion oriented writing.

While my writing for Salem News will not be primarily opinion oriented, my background, analytical approach, and philosophy will continue to play a major role in what I cover, how I cover it, and how it is presented to the reader. Over time, I will be sharing more about my perspective through my writing, but I would like to begin here by addressing the subject of value.

The subject of value, in economics, is more appropriately referred to as “the question of value.” What is value? Value sounds good. People like value. Business and investment are focused on creating value.

Even though the concept of value is easily understood, a precise definition of value is difficult to establish. Answering the question of value is essential to business and investment, because if your purpose is to create value, then you must understand what it is that you are setting out to create.

The History of Value in Economics

Adam Smith is a well recognized figure in the economics world. Most people in our society, and especially in the business community, have probably heard his name in connection with the “free-market” or the “invisible hand.” What may be less known is that Adam Smith learned many of his economic ideas from François Quesnay.

Both Quesnay and Smith paid great attention to the question of value, because they understood that it is impossible to have a coherent economic theory that does not start by answering the question of its own purpose.

Quesnay postulated that land is the source of all value. Quesnay approached the question of value from a physical sciences perspective, and concluded that because food is the source of all energy expended in human activity, the land that produces the food is the source of all value. He theorized that because all human activity falls within the bounds of energy produced from food, the value of everything in an economy is limited by food production. In a mixed economy, where only some people produce food, food is traded by the food producers for the things they need. This economy is perfectly balanced because the value of everything is set by food production. All goods are valued relative to their cost of production, which is the food that the producers of goods must trade their goods for.

Quesnay was the European originator of the concept of a perfectly balance free market. Adam Smith expounded on this idea, and added to it the concept of labor as value. In Smith's theory, the labor expended on producing a good was equal to its value. This model of value is consistent with Quesnay, because labor expended is equal to food consumed, and so value in the labor model can ultimately be traced back to value in the land model. The major contribution of the labor theory of value is that it takes into account variations in the efficiency of production between various producers of goods and shows how markets can adjust the value assigned to different goods when the efficiency of their production changes.

This is but a brief overview of the theory of value in economics. The salient point is that “economic laws,” such as market efficiency, are rooted in a physical science approach to value. It is only by tracing value to an objective physical basis, such as the energy produced and expended in working the land, that it is possible to assert that there are physical laws that control economic activity.

Money and Value

Money is not equal to value. The classical economists did not deal with subject of money to a great extent because it is impossible to derive scientific laws about something that does not have an objective physical basis. Money is an abstraction of value. When money is used in exchange, a relationship can be established between money and value, but that relationship does not necessarily have any objective or rational basis. The economic laws based on a theory of value rooted in physical science cannot be applied to the value of money, which is a question of social science.

The history of people confusing money with value is long and sordid. One of the best examples is the case of the Spanish Empire. At the time, gold and silver where the primary types of money in circulation. In the pursuit of getting rich, the Spanish built a global empire with the primary purpose of acquiring large amounts of gold and silver. All that resulted from this was inflation, because gold and silver have no real value. The more money they dumped into their economy, the less valuable it became. As the Spaniards wasted real resources on acquiring something with no real value, the real economy declined and collapsed.

The economic situation of the United States and Europe at this time is very similar. A great deal of resources are expended on the acquisition of money. In this case money is either paper, or merely entries on digital balance sheets. Money has no value in itself, but only in what it can be traded for. As more money is produced, its value declines. As more people devote their time to the acquisition of money, as opposed to production of things with real value, the more the real economy declines.

Consumption and Production of Value

The relationship between land and value is as strong today as ever. All human activity requires energy, and the energy available is still the constraining limit on economic activity. Agriculture is no longer the only source of energy available. We now have a variety of fossil fuels, along with nuclear, wind, solar, and other energy sources available to us. All of these energy sources are still rooted in the land, and the sum of all economic activity can still be thought of theoretically as the net produce of energy derived from natural resources.

With an expanded definition of value based on the energy expended to produce useful things, it is important to delineate between production processes that consume value and production processes that create value. Agriculture produces value because it yields a net return on energy expended for the farmer. Extraction of oil and coal produce value because they yield a net return on energy expended for extractors.

Agriculture has always been plagued by the problem of exhaustion of the land. The fertility of land and the availability of soil suitable for growing is limited. Agriculture that consumes large amounts of productive land appears in the short term to be highly productive. In the long term, the capacity of the land for production is destroyed, leading to catastrophic failures in agricultural production. Managing land to provide sustainable crop yields is an essential component of any agrarian experiment that hopes to survive for even a few years, let alone generations.

Production of energy from fossil fuel resources is similar to agriculture. While increases in the efficiency of extraction appear to yield great returns in value, those yields are inherently short term. Increasing the efficiency of extraction for a fixed resource is not actually an increase in the production of value but an increase in the consumption of value. Industrial “production” has been incredibly successful, not because it creates value, but because it is actually industrial consumption: a highly efficient means of consuming accumulated value.

Investing for Value

It is impossible, or at least very difficult, to engage in investment that does not take money into account. From an investment perspective, it is crucial to consider both the financial aspect of the investment and the value of the investment. An investment that makes money may not create any value, and an investment that creates value may result in monetary losses. As an investor, you must first delineate between money and value, and then make investment decisions that balance your need to make money with your desire to create value.

In order for an investment to create value, it must yield more energy than it consumes. A great deal of investment is in producing goods or offering services that only consume energy. It this case, for an investment to create value it must improve the efficiency of existing energy consumption. An example of improving efficiency could be some new method or device that improves the efficiency of production for other essential goods; something that improves the efficiency of agricultural production or resource extraction; or something that improves the efficiency of daily life for the average person.

In many cases, increasing returns on investment in terms of money will be inversely related to increasing returns on investment in terms of value. If a new good or service provides real value, then it will also have money value. However, the more you increase the cost in money of that good or service, the less people will use it, and the lower the net increase in value provided by it will be. If you invest to maximize your returns in money, you will be sacrificing returns in value.

Maximizing returns in money can in extreme cases lead to value destruction. The most obvious examples are those given above, where energy is expended purely to create money. Creating money consumes value while creating nothing. The result is total net value destruction. Energy extraction, in some cases, results in net value destruction, but at a lower level.

Extraction of energy from tar sands, from corn based ethanol, and from some other “alternative energy” sources, consumes more energy than is produced. These activities are engaged in because they are profitable in terms of money, even though they result in destruction of value. The disconnect between money and value in these cases is a result of temporary market imbalances, but the destruction of value is permanent. Investing for value is the process of taking into account both money and value in your investment decisions, and making investments that properly balance returns for both.

Conclusion

The theories of value and money that I have laid out here play a major role in my analysis of investment, business, and government. Some of the concepts introduced here will probably be novel to some readers. They are certainly a novelty in the business pages of any newspaper. This is not novelty for its own sake, nor is it invention, which is why I go to some lengths to provide the historical basis for my perspective.

In my reporting at Salem News I will be doing my best to apply this style of historically informed critical analysis to the most important issues in the areas of investment, economics, business and government that face the citizens of our State. Whether you are an investor, business person, worker, or farmer, it is my hope that my reporting will be informative, enlightening, and profitable for you.

Salem-News.com Business/Economy Reporter Ersun Warncke is a native Oregonian. He has a degree in Economics from Portland State University and studied Law at University of Oregon. At a young age, his career spans a wide variety of fields, from fast food, to union labor, to computer programming. He has published works concerning economics, business, government, and media on blogs for several years. He currently works as an independent software designer specializing in web based applications, open source software, and peer-to-peer (P2P) applications.

Ersun describes his writing as being "in the language of the boardroom from the perspective of the shop floor." He adds that "he has no education in journalism other than reading Hunter S. Thompson." But along with life comes the real experience that indeed creates quality writers. Right now, every detail that can help the general public get ahead in life financially, is of paramount importance.

You can write to Ersun at: warncke@comcast.net