Wealth - True or False?

Wealth defined:
2: abundance of valuable material possessions or resources

3: abundant supply : profusion

4 a: all property that has a money value or an exchangeable value b: all material objects that have economic utility ; especially : the stock of useful goods having economic value in existence at any one time.

Source: Merriam-Webster Dictionary

At some level we have lost the perspective on what wealth is.

The World Economic Forum reported at the end of January 2009 that 40% of the world's wealth was lost in the last 5 quarters. http://www.telegraph.co.uk/finance/financetopics/davos/4374492/WEF-2009-Global-crisis-has-destroyed-40pc-of-world-wealth.html

Commentary: By most definitions this was NOT wealth that was destroyed (definition #2), but value assigned to wealth. The wealth described (see #4) was paper gain on assets such as stocks and real estate. The assets themselves: buildings, factories, houses, gold, silver, oil still exist. The driving factor for much of the rapid increase in value in these assets was due to very low interest rates by historical standards.

An example of what I will call False Wealth follows:

Say a business has a net income of $10,000 per year and generates 10% return for investors. Its value is calculated as $10,000/0.10 = $100,000.

Now if the investment environment changed and investors demanded a lower return of 5%because of a low interest rate policy by central banks, the numbers are thus:

$10,000/0.05 = $200,000.

Here we have the same business with the same net income but the value has doubled because of a ridiculous low interest rate policy by a central bank. This has caused MASSIVE DISTORTIONS in our markets. In my example the business owner thinks his business is worth double what an undistorted market would pay. This is false wealth.

More on this topic tomorrow....