Friday, March 12, 2010

Market capitalization ... and perpetual motion

Dear Colleagues

The importance of the market economy has been promoted without much of a challenge for 30 years ... President Reagan in the USA and Prime Minister Thatcher in the UK must take some of the blame! But so also must the academic community that taught only half of what should have been taught.

The Wall Street quants love the market model for creating profit and money denominated wealth because they are able to report profit without ever actually having to "do" anything. This is about as sound as the science of alchemy in the Middle Ages ... or the viability of perpetual motion.

At the end of the 1980s Bill Gates was reported as being a very rich man because his stock holding in Microsoft was valued at a very large number ... but the value of the stock based on market capitalization was a multiple of the cumulated earnings of the company. In this the wealth of Bill Gates was a multiple of what had ever been earned. This is an interesting reality ... or is this a ridiculous misrepresentation.

This morning the Apple company is starting to take orders for a new product, the iPad ... and the market capitalization of the Apple company is huge ... bigger than the market capitalization of the BNSF railroad, and other well known companies. This is symptomatic of the profit focus stock market pricing model that ignores the value adding dimension of a company's performance.

With this sort of market economy, the allocation of resources is optimized for profit, but not optimized for value ... and in the end, the economy crashes. This happened with the bubble, then with the sub-prime housing market bubble, and then again ... almost ... with the complex instruments of the financial system.

So far this last bubble has been sustained by an economic and financial establishment ... together with some in the business and political community ... that has every reason to keep the bubble from bursting. But it will deflate ... maybe by good people managing a paradigm shift ... or simply by a catastrophic crash.

What needs to happen for a managed paradigm shift is for the metrics of society to reflect not only the money profit elements of the economy, but also the value elements which are presently not included in any of the news babble that determines stock market sentiment.

The value idea has been in play in academic circles for decades ... but careful isolated from the real world of money and the various markets that are built on multiples of profit. This needs to change ... and the time for this change is now!

Peter Burgess

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