Price Divorced From Value in Modern Economy

Written By: The WealthCycles Staff

Prices display the intersection between the two sides to every trade.

Often we value whether we should make a purchase, trade or sell something based on prices, but, as our readers know, there is a vast difference between price and value.

For more on the difference between price and value, see: The Hidden Secrets of Money – Episode 1 – The Difference Between Currency and Money

There is a problem, however, with how price is determined in our modern economy: prices are being manipulated and fixed, and that interference with price is distorting profit and loss calculations of businesses and entrepreneurs, globally.

It is for this reason Mike Maloney has taught us to remove currency from the analysis—when assets are compared against other assets, we can see that asset values rise and fall in a cycle. This is how Mike knew to say “we’ve got a hyper-bubble” in September of 2005, a year-and-a-half before any official stated the same—plenty of time to take action. In this article, we will look at how prices form, rather than the wealth cycles specifically.

If price is NOT the same as value, yet we all use prices to determine the wisdom of a transaction, then we’re knowingly measuring incorrectly.

Without the ability to measure value, you could be overpaying, or missing out on, a great deal.

Irving Fisher, the economist who invented the famed “quantity theory of money,” wanted “to discover the primary determinants of the purchasing power of money.” He failed. His “system” stated stock prices were at a “permanently high plateau” as the Federal Reserve began boosting reserves. We all know of the Great Depression that followed, stock prices were as it happens, not on a permanent plateau. We know the depression very well, in fact, as we are entering one today.

Unemployment in Europe is already higher than it was during the Great Depression, and a normal labor force puts U.S. unemployment over 11%, with over 5 million jobs lost since January 2007 for workers ages 25 to 54.

Employment Chart January 2007 2013 US jobs depression


And no, contrary to media reports, there is not a manufacturing renaissance:


Chart Manufacturing Employment Jobs US 2013 depression

The ongoing hollowing of the American and European economies is the critical symptom of a monetary system built upon debt. For each dollar the privately owned monetary system prints, a dollar plus interest is required to repay them.

This has the effect of transferring value the users of the system to the owners of the system.

The system also distorts the economic calculation necessary for a functioning free market by distorting prices themselves.

How is this accomplished?

We learned in the WealthCycles article What is Monetary Velocity? quite a bit about how prices ARE formed. And we learned that the frequency with which people changes their minds (velocity) is NOT a determinant. Here’s "the economic conscience of our country," Henry Hazlitt, to explain:

[C]hanged valuation by individuals of either goods or money or both causes the increased velocity of circulation as well as the price rise.
To go further… Increased velocity of circulation is not, in itself, even a contributing cause of higher commodity prices.
It is not even a link in the chain of causation.
Increased velocity of circulation and higher commodity prices are joint results of a change in the value of money in relation to the value of goods.

Europeans and Americans are looking at value on both sides of the trade, more and more. Rising prices are now polling as the most important economic issue facing constituents on both sides of the Atlantic.

When people value money less in relation to goods, they offer more money for goods; when they value it more in relation to goods, they offer less money for goods.
Any change in velocity of circulation is likely to be a result of these changed value decisions.

So when we see each dollar change hands more often (an increase in velocity), it will mean people are changing their minds more often about the mix of cash and goods they prefer to hold. We expect people to respond to the current downturn with a cash-hoarding savings-fest, however, this will end.

It will end in what Austrian economist Ludwig von Mises called “the crack-up boom.” Economist and investment expert Dr. Marc Faber also speaks of the crack-up boom in his Swiss-tinted English.

The crack-up boom is the moment when global investors and families alike realize the only path that has ever existed within our debt-based monetary system is that of ever-increasing inflation, despite over a century of promises to the contrary. In response to this sudden realization, all make changes in their mix of holdings seemingly simultaneously.

Consider the idea of an economic slowdown every four to six years. Consider that debt is higher and higher with each slowdown, and so the response is necessarily larger. During each print-a-thon, the central bankers talk about stopping, slowing and recovery. Before re-inflation begins, they talk of a need for jobs, stability and to jump-starting recovery.

They’ve stopped printing often throughout the new depression. Here is what happened when they did (grey areas):

QE POMO Printing Taper Withdrawls SPX S&P500 Chart 2009 2013

Prices begin to find fair value. This is why even talking about slowing printing (tapering) now creates these downdrafts.

It’s nice to look at what printing has done to prices since the 2008 crash, but does performance look this good over a decade?

If you invested in the S&P500 stocks in September of 1999 at 1,318.17, your up 23% in nominal (dollar) terms, but to find real return, you’d need to subtract the loss of purchasing power in the dollar—that’s looking at both sides of the trade.

Here's that chart of over a decade of bear market bubbles (and Jack Bogle, founder of Vanguard, said in 2012 he expects two more 50% drops within the next decade):

SPX S&P500 Stock Market Chart 1999 2013 Bear Market Bubbles

When the next big downturn hits, likely after the Federal Reserve tapers printing speed even more, there will undoubtedly be another return to printing to “assist the economy” and, of course, to provide the flow (or “price instances”) necessary to bid markets back to wealth-effect, break-even levels last seen in 2000 (yes, it really has been over a decade of stocks going nowhere in real terms).

Therefore, we predict by this winter the masses will realize there will not be any green shoots, there is no recovery, and the fact that grandpa is now working as a Wal-Mart greeter does not signal a new era of gainful employment. The masses will then be treated to a fourth (or fifth) promise that printing will not raise prices, but rather will boost jobs and economic “growth.” This falsehood will NOT be believed in perpetuity.

In reality, economic “growth” is federal government spending, counted as GDP, and printing pays for it.

The economic takeover by governments is not unnoticed by the populace, either in the U.S. or in Europe. There is a growing realization of the extent of the depression. Children, rather than learning, are rummaging (Greece) in dumpsters (Spain). Popular uncertainty over the near-term economic future is demonstrated by the dormant velocity of money: hold all the cash you can until you know what to do. This is mirrored in corporation actions (hey, corporations are people, too). As the chart below shows, this is true more now, than even in the nadir of 2009:

Velocity of Money Chart MZMV 1999 2013


“The service that money renders does not consist in its turnover,” Mises writes to Hazlitt, “it consists in its being ready in cash holdings for any future use.”


Price Formation

A price takes into account the subjective value-scales of the individual—one person feels something is worth less or more to them, than another person does.

Consider stocks. What if I think the Dow is worth over 15,000 right now, and so I buy one share of the index for that price? It is recorded that the last trade was at $15,000, despite the fact that other, prior trades were made for lower prices. My trade influences other market participants’ newest market price evaluation.

Now, what if we do this often? Small trades, small volume, but quite often. It is akin to saying:


Hey! The price is 15,000

Hey! The price is 15,000

Hey! The price is 15,000

Hey! The price is 15,000

Hey! The price is 15,000

Hey! The price is 15,000

Hey! The price is 15,000

Hey! The price is 15,000

Hey! The price is 15,000

Hey! The price is 15,000

Hey! The price is 15,000


Eventually these small-volume trades are translated internally to mean,  “Hey! Fair market value is 15,000.”

Contrast this with large trades which are not repeated, such as on May 21 of last year, when Facebook was “valued” at 3 times larger than the entire world output or $178 trillion, when four shares traded for €50,000 each.

Facebook IPO €50000 share chart 78 trillion market cap

This explains why stock prices creep higher on “no volume,” but plummet lower when left alone for a second.

This also explains why printing “flow,” “pace” or “speed” is presently the most important determinant of prices, as each NEW dollar provides an opportunity, or instance, to set a price. Without a flow of trades, and cash flow to place trades with, influencing market participants becomes less frequent—where real prices overpower the few trades executed at planner-preferred levels.

This phenomenon is often discussed with respect to gold. One can imagine prices being set within a range, where market trades temporarily spike prices, only to have a reminder it “must have been an outlier.”

Remember, it is the incremental dollar, the next opportunity to express your price, that is registered. The outstanding stock of dollars does not determine their value. As we will see below, it plays a small part in the determination of a dollar’s purchasing power as we move forward.

We feel it is wise to save, to eliminate debt, and to be set up to “buy while blood is in the streets.” But we would caution that gold typically forecasts, moving ahead of events, so being positioned a few months ahead of time will be far, far better than a day late. If Dr. Marc Faber and Mike Maloney are right, again, that “gold may be forecasting deflation,” gold may also then forecast the crack-up boom, as citizens begin to chart out the ultimate destination for the dollar.

Again Robert Blumen helps us consider what DOES determine purchasing power, reminding us that “these factors do not act directly on prices. Instead, they are focused through the prism of investor preferences, which are not measurable.” [our brackets]

1.   The current purchasing power of money [prices today]

2.   Expectations about the future purchasing power of money [future prices]

3.   The growth rates of various national money supplies [printing flow, NOT stock/quantity]

4.   The volume of bad debts in the system [contraction in money supply]

5.   Expected growth rates of bad debts [future contraction in money supply]

6.   The attractiveness of other available investments

7.   The investor’s preference for consumption rather than investment

testiomials The crack-up boom is the moment when global investors and families alike realize the only path that has ever existed is that of ever-increasing inflation, despite a century of promises to the contrary.”

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