In this issue we shall look at a SABSA Business Attribute that is especially slippery in its character: the attribute ‘valuable’. Value is measureable, but how reliable are those measurements? That’s the slippery bit. The concept of ‘value’ is closely coupled with risk. The concept of ‘risk appetite’ is also involved. This is best explored through a series of case studies.
Recently we witnessed a global collapse of the banking system and the world economy. We were wealthy and growing wealthier. Now we’re all poor. Questions that have been asked are: where did all the money go? Who finished up with the money? Who’s got it now? People think real life can be captured in the form of a game of Monopoly, in which there is a fixed amount of money and it’s just a question of who can get hold of it. The game does capture risk-taking, but the model is far too simple as a metaphor for what really happens. The game has a set of rules that constrain the risk levels. In real life these rules don’t apply.
The answers to these perplexing questions are simple: there never was any money. There was ‘value’, in shares, in houses and commercial properties and in material things in general. This gives the impression that value has a materiality – something solid and tangible, but this is an illusion. In reality, value is all in the mind, a psychological phenomenon, and a very slippery fish indeed. Spanish banks invested in property and had healthy balance sheets. The country had a strong economy. Then property prices plunged because there was too much supply and little demand (market forces), and so all the value drained from those balance sheets in a couple of years. Where did the money go? It never existed other than as bookkeeping entries.
Value is driven by human desire to own something. It is an emotional quality. What’s valuable to one person may not be valuable to another. Since the earliest days of human society, men have fought wars to acquire desirable things – territory and natural resources such as gold (shiny and rare) and oil (energy needed to keep life going). Value is entirely created by desirability and need. At some point ‘the market’ invented money, to be a liquid form of value that could easily be transferred from one owner to another in exchange for the things of real (perceived) value. However, money itself is only a series of tokens and only its linkage to the desirable objects that are priced in terms of money underpins its value. The value of money is therefore just as variable as the material objects to which it is linked, as we can see in the money markets. Things became much more risky as we moved on in economic growth, because we moved away from the ‘gold standard’ (actual gold stored in vaults as the basis for printing bank notes). We printed more money than we had gold, this time underpinned by other material ‘valuables’ such as property.
Value is created because ‘the market’ has confidence that these material objects are worth something. The measured value is determined by operation of free market forces. Pricing is based on a ‘mark to market’ philosophy, which means that something is worth whatever someone else will pay to acquire it. So when someone says that they’ve had their business or house independently valued, what they have is an expert opinion, which may or may not be validated by putting the asset on the market and finding a buyer.
The inherent systemic risk in this free market is in the form of ‘bubbles’. Assets become over-valued because of market enthusiasm that will ultimately collapse. The next one that will hit the global economy is the so-called ‘carbon bubble’. Because energy is so desirable, the reserves of oil, gas and coal still in the earth are highly valued. Companies owning these assets have highly valued shares, because the market perceives an opportunity to get rich as these energy reserves are extracted and used.
So where’s the threat? Governments around the world (including China) have agreed to limit climate change to a maximum temperature rise of two degrees Celsius. If this plan is implemented then more than half of these reserves are unburnable and therefore worthless, and the global economy will once again collapse. The markets have a risk appetite that is betting on this plan not being implemented. Investors think that there will be warning signals and they will have time to get out as the market peaks, but not everyone can get through the exit at the same time because sellers need buyers, and most will fail because the collapse will be very quick. Maybe the world needs a bit more SABSA thinking injected into it.