Saturday, 31 August 2013

Economic Myths: Interest rates and asset prices

From AME Info:

The relationship between the cost of money and asset prices is pretty well established. Asset prices tend to rise if interest rates are falling, and fall if interest rates are rising. Last week interest rates went up, so are stocks and real estate coming down in price?

... What ultimately determines the value of an asset is its return relative to interest rates. Share dividend yields can be low if interest rates are low; house rental yields can be low if interest rates are low.

But if interest rates go up then dividends on shares are worth less by comparison and so share prices generally fall. Likewise if the cost of a mortgage goes up then the value of a house has to fall to compensate for the increased cost of money and the relative decline in rental value.


That is all broadly correct of course, all things being equal.

What is a myth, or obfuscation at best, is the notion that stocks, shares and land are "assets".

Surely things like cars, machines, buildings, software, experience and know-how are "real assets"? The price/cost/value of these is largely unaffected by interest rate changes.

The "assets" whose price changes as a result of interest rate changes are not "real assets", they are flows of monopoly-type income, i.e. where the amount of income the owner receives from the "asset" is fairly fixed and cannot (easily) be competed away; the only way to get your hands on those sources of income is to buy the "asset" itself.

And taking the economy as a whole, for every recipient of such income there is a payer, and such "assets" add nothing to overall national wealth or national income.

- Interest received by holders of government bonds are matched with taxes paid by taxpayers.
- If there were no barriers to entry in any industry, then shares in companies would only be worth what the underlying "real assets" are worth, so the surplus of the share price over net asset values is a measure of any company's monopoly income. Where there are monopolies, innovation and competition is stifled and prices are pushed higher (or output pushed lower). This is bad.
- For every landlord there is a tenant - if the net present value of the rental income goes down (or up), then so does the net present value of the future rental payments from the tenant's point of view. Collecting land rents (also a kind of monopoly income) adds nothing to the economy, they are a way of redistributing GDP to landowners.

It is quite different with "real assets".

If a building burns down, or a car rusts to bits, or a machine breaks down, then clearly, not only is the individual owner of that "real asset" worse off, but the whole of society is worse off.

18 comments:

Kj said...

I think there's still a need to differentiate the case the ownership of "real assets", the businesses that organise them, and land.
I still believe that there is such a thing as "monopoly"-income over above the return on tangible asset, that are not caused by some monopoly that is either static in supply (land), or state-enforced* (patents, copyrights). It's perfectly just and socially efficient, to gain higher profits from first-mover advantages, trademarks/brands, efficiently organised labour etc.. Even relatively low barriers of entry allows this from time to time, and so it should. Yes, the classic monopoly types incomes are ofcourse much larger in quantity, but the "good" forms of monopoly income is kind of what drives innovation, higher living standards and all that.

And whatever you think about shares, if someone wants to offload this vain promise of future yield, and someone wants to buy it, that's sort of a issue of freedom.

*yes I know trademark is state-enforced, but it's an anti-fraud measure, and unless given willy-nilly, perfectly just IMO.

Mark Wadsworth said...

Kj: "It's perfectly just and socially efficient, to gain higher profits from first-mover advantages, trademarks/brands, efficiently organised labour etc."

Agreed.

But I was trying to keep the post simple.

Bayard said...

The financial industry has its own meaning for words, so, for them "assets" also means stocks and land, just as "investor" also means gambler on "assets". So it's an obfuscation.

"If there were no barriers to entry in any industry, then shares in companies would only be worth what the underlying "real assets" are worth"

How do shares in a company end up being worth less than the underlying assets, then?

Kj said...

B: debt, plus the stock market as it works don't really put that much "stock" in the salvage value of assets, unless they are of a monopoly nature.

Mark Wadsworth said...

B: "How do shares in a company end up being worth less than the underlying assets, then?"

Good answer by Kj.

Private ownership of businesses = a good thing.

But "shares" and "speculating in shares" (i.e. making bets about future interest rates and profits) = Bad Thing.

But there is no need for private businesses to be divided into "shares" owned by "shareholders", there are lots of other forms of ownership (partnerships, building societies) which are privately owned without there being any shares.

DBC Reed said...

@B
Shares have ended up being worth less than the underlying assets throughout the post war era: it was (is) the basis of asset stripping.Firm was n't making much employing people to make things = low share price.Shareholders get attractive offer (financed with debt),the workers get the sack and the "assets are realised"i.e. all the land and property is sold for residential or the factory gets converted into flats.That's the way the money goes ,pop goes the weasel.
One argument for LVT is that it stops landed assets inflating out of phase with productive assets so cuts asset stripping and keeps peo-ple in work.

Bayard said...

DBCR I was aware of asset stripping, but couldn't see how, if the minimum of the total share price was the worth, of the "underlying assets", the situation could arise where such a thing would be profitable. Or is it the site value that makes the difference?

DBC Reed said...

@B The situation did n't arise when firms went bankrupt but when they were ticking over, e.g Sears/True-form in 1953 "Sears operated the country's largest chain of footwearshops and Clore had spotted that these properties were not reflected in the share price" Geoffrey Owen, Corporate Governance in Britain: is incremental reform enough" on Net. Owen suggests that "Another stimulus to take-over activity was the 1948 Companies Act which obliged companies to make a fuller disclosure of their assets and properties." So Clore, who was not an asset stripper in the mould of the later Slater/ Walker (Walker became a Tory cabinet Minister!),was probably enabled by the Companies Act to work out where property values were not reflected in the share price.
Sears plc on Answers com is more punchy "The reason Clore wanted Sears had more to do with shops than shoes" .."From his property dealing experience ,he could see that the company shop sites were worth more than its directors realised."
The economic and social history of the UK over the last 60 years has been shaped by the lure for investment of landed property over the production of goods and services.The Conservative Party has been the real enemy of productive enterprise: it has never relinquished its identification with the landed interest.

DBC Reed said...

@MW Your comments on "Nationalisation and "subsidies for unviable industries" surely fall foul of the Thatcherite fallacy that every industry must balance its books or show a profit. She, in her mad way, banged on about the national economy being like the household accounts (which she, as a woman, was uniquely qualified to appreciate).In a large firm some departments are being subsidised by the people who provide the service or make the stuff.In a national economy subsidised energy and transport would serve the same function of increasing overall wealth.The national economy is an elaborate system of cross subsidies.Do you expect the courts, the fire brigade,and the army to show a trading surplus every year?

DBC Reed said...

My apologies.My comment above should have appeared under "Monopolies, rents ,taxes"

Bayard said...

"Do you expect the courts, the fire brigade,and the army to show a trading surplus every year?"

Well, no, but they are not nationalised industries. They never were private companies (apart from, possibly , the fire brigades) and always were amongst a list of things that the state does better than private enterprise. This is not true of most nationalised industries (e.g. BA, British Steel, the docks). Having worked in a business (not a nationalised industry) where it was known that there was always going to be someone to pick up the tab at the end of the day, I am convinced that it is a surefire recipe for unprofitability.

Bayard said...

DBCR, thanks, so it was land after all.

Mark Wadsworth said...

DBC: "Do you expect the courts, the fire brigade,and the army to show a trading surplus every year?"

No of course not and I have written many a post trying to point this out.

I refer you to Bayard's reply re "public goods". You can't generalise about these things, some things are truly "public goods" like courts, fire brigade, army.

Other stuff is "of general benefit to the public" like transport, electricity, but where do you draw the line between "public goods" and "subsidised industry"?

I personally count public transport (and roads generally) as public goods and worthy of state subsidy, but not electricity.

All "the state" had to do was set up the National Grid* and decide on a standard voltage and frequency, the rest sorted itself out.

* Without compulsory purchase orders, the grid would never have happened.

Kj said...

DBC: you could(and you have), say that about any business at all, retailing, airlines, electricity, steel manufacturing, pubs, coal mining, am I forgetting something? That they should be subsidised if they are "important" and ownership concentration makes it look like it could become a monopoly. But the thing is we have very little knowledge about what we truly need and want, except price signals. And we need private ownership and markets to respond to those price-signals. And if you think that market-signals might as well work without private ownership, I´d go back to Bayard´s point, that it simply doesn´t happen that a public company adapts to price signals the way companies that can go bankrupt do.
And there is also something called rationing scarce resources. When we subsidise the use of scarce resources, we don´t conserve them. So we are in big trouble at a point in the future if we start to subsidise everything to increase wealth.

DBC Reed said...

@KJ
Price signals are useless, absent stringent intervention on rent seeking. All that is happening now in the UK ,is that developers and investors work out what price can be extorted for housing ,then control the build rate so the average price never drops.As so much of people's budgets and bank lending is committed to an inflated housing market ,we are well and truly screwed. Still its nice for the Austrian-minded that the price signal system is working perfectly.

Mark Wadsworth said...

DBC, firstly that's being a bit rude to Kj, who said no such thing, and secondly of course "price signals" are important.

How do we know that large landowners and landlords are taking the piss? Because of the outrageous prices they charge. Those are our signals.

The fact that supply or houses does not respond to demand (i.e. high prices) is down to the actions of the government (i.e. because it is too scared to implement LVT or at least build loads of social housing).

As long as supply responds to demand, then prices stay the same but supply increases. As long as that happens, I see little need for state intervention.

Kj said...

Ooh, "austrians". Powerful stuff DBC. You fix housing with LVT, which is a price-signal measure. And what that has to do with nationalising industries I have no idea, but whatever.

DBC Reed said...

So the great advantage of the private sector is that it generates price signals and then you can stage massive State interventions when the private sector deliberately ignores them and screws up the economy.
BTW LVT is a type of nationalisation: nationalising the land rent rather than the land.Its supposed to be easier with none of that administrative hard work of actually owning it and assigning it.Of course there is the corker problem of why anybody would want to continue to own land with all the rent gone.Perhaps as Gesell said they'd want to dump it into nationalisers hands?But that option's off.Hey ho!