Survival__ Structuring Prosperity for Yourself and the Nation - Charles George Smith [196]
The relative value of gold and silver rises and falls according to supply and demand. In the Yukon Gold Rush, eggs were relatively scarce and gold relatively plentiful. So the owner of a dozen eggs was able to trade them for (let's say) one ounce of gold.
With gold at $1,000 an ounce as I write this in September 2009, then the relative value of eggs and gold is quite different due to supply and demand: one ounce of gold buys around 500 dozen eggs.
Thus scarcity and high demand and plentiful supply and low demand set the relative value of all stores of value and assets. The value of any money or asset can only be measured in terms of some other store of value or asset.
This concept can be confusing, for as consumers we naturally measure everything in our "home" currency. For example, as I write the S&P 500 (SPX) stock market index is around 1,000, and gold is around $1,000 per ounce. Thus we can say one ounce of gold can "buy" one "share" of the S&P 500. This is pricing the relative value of both the SPX and gold in dollars.
But if we price the S&P 500 in gold, then we reach a completely different valuation. At the top of 1999-2000 stock market, gold was about $300 an ounce and the SPX was above 1,000. Thus it took three ounces of gold to "buy" one share of the SPX.
Now that gold and the SPX are both 1,000, then it only takes one ounce of gold to buy a share of the SPX. Measured in gold, the SPX has fallen in value by two-thirds.
This fact draws instant violent protest from those holding a belief in the nominal value of the SPX: the only thing that matters is the nominal value (that is, whether it's 1,000, 900 or 1,100 today, yesterday, or ten years ago).
But this is obviously not an accurate measure of value or wealth. If the SPX priced in dollars is 1,000, and the dollar loses 90% of its value against all other measures of value (commodities, other currencies, gold, etc.), then the SPX at 1,000 represents a 90% loss of value.
One way to express value is purchasing power--what you can buy with a specific store of value. This is just another way of establishing relative value.
Put another way: how many loaves of bread does it take to buy a house? The answer gives us insight into the relative value of wheat and housing.
To sum up: we can measure value by intrinsic value and relative value.
Let's take another example: stocks and bonds. Can the value of stocks and bonds fall to near-zero? Yes--they have done so repeatedly in history. Ultimately, stocks and bonds are both valued on their income streams. If the income stream stops, and the promise of renewing the income is no longer credible, the value drops to near-zero.
While we can hope that these "claims on future income" still reflect the intrinsic value of the underlying assets--mortgages, factories, etc.--the intrinsic value of these underlying assets depends on the income being generated by those assets. If no income can be derived, then the value of those assets drops to scrap value (near-zero).
Thus we can conclude that investing in "claims on future income" is inherently risky and speculative in nature.
Does shelter/housing have intrinsic value? Yes, but in low-demand, abundant-supply situations, the value can still drop to zero. Abandoned farmhouses in the middle of nowhere illustrate this characteristic, as do empty condominium towers and decaying exurb developments.
Thus we have to careful to recognize that possessing some intrinsic value (shelter, lumber, arable soil, and so on) does not guarantee that the asset will have any market value in all places and times.
In credit booms, sellers of marginal raw land like to say, "they're not making any more of it." Later, when the credit bubble bursts, the value of that "scarce" land drops to near-zero as the demand