Sunday, November 01, 2009

The "Secret" of "Winning" Investment Advice?

Ersun Warnke writes on “Investing for Value” in HERE:

The History of Value in Economics”

"Adam Smith is a well recognized figure in the economics world. Most people in our society, and especially in the business community, have probably heard his name in connection with the “free-market” or the “invisible hand.” What may be less known is that Adam Smith learned many of his economic ideas from François Quesnay.

Both Quesnay and Smith paid great attention to the question of value, because they understood that it is impossible to have a coherent economic theory that does not start by answering the question of its own purpose.

Quesnay postulated that land is the source of all value. Quesnay approached the question of value from a physical sciences perspective, and concluded that because food is the source of all energy expended in human activity, the land that produces the food is the source of all value. He theorized that because all human activity falls within the bounds of energy produced from food, the value of everything in an economy is limited by food production. In a mixed economy, where only some people produce food, food is traded by the food producers for the things they need. This economy is perfectly balanced because the value of everything is set by food production. All goods are valued relative to their cost of production, which is the food that the producers of goods must trade their goods for.

Quesnay was the European originator of the concept of a perfectly balance free market. Adam Smith expounded on this idea, and added to it the concept of labor as value. In Smith's theory, the labor expended on producing a good was equal to its value. This model of value is consistent with Quesnay, because labor expended is equal to food consumed, and so value in the labor model can ultimately be traced back to value in the land model. The major contribution of the labor theory of value is that it takes into account variations in the efficiency of production between various producers of goods and shows how markets can adjust the value assigned to different goods when the efficiency of their production changes.

This is but a brief overview of the theory of value in economics. The salient point is that “economic laws,” such as market efficiency, are rooted in a physical science approach to value. It is only by tracing value to an objective physical basis, such as the energy produced and expended in working the land, that it is possible to assert that there are physical laws that control economic activity

Ersun Warnke has a “theory”, of which he is so proud that he believes that it explains everything.

The problem is that he indulges in hubris without thinking for a moment that the plausibility of his “theory” may be compromised by the fact that others, iin over two-hundred years, have not noticed that the outcome of investment decisions, dependent as they are on the unpredictability of future events, would be predictable if only they followed Ersun Warnke’s “theory”, based as it is on a notion from Quesnay, and picked up allegedly by Adam Smith in the 18th century.

Smith admired Quesnay, whom he met and discussed with on his visit to France, 1764-6. Smith was critical too, especially of Quesnay’s focus on land as the sole source of productive labour; manufacturing, in Quesnay’s doctrine, was designated as “sterile” (WN IV.ix.38: 678), which Smith considered, rightly, as a major source of wealth creation (wealth, that is, defined as the annual output of “the necessaries, conveniences, and amusements of human life” (WN I.v. 1: 47).

Smith was more than skeptical (his personal respect for “Dr Quesnai”, the celebrity physician in the French Court, restrained his tone of rejection of the basic concept guiding the Tableau Economique) of Quesnay’s ideas.

He specifically rejected the pre-requisite necessity of an economy in “perfect liberty” for progress to opulence:

Some speculative physicians seem to have imagined that the health of the human body could be preserved only by a certain precise regimen of diet and exercise, of which every, the smallest, violation necessarily occasioned some degree of disease or disorder proportioned to the degree of the violation. Experience, however, would seem to show that the human body frequently preserves, to all appearances at least, the most perfect state of health under a vast variety of different regimens; even under some which are generally believed to be very far from being perfectly wholesome. But the healthful state of the human body, it would seem, contains in itself some unknown principle of preservation, capable either of preventing or of correcting, in many respects, the bad effects even of a very faulty regimen. Mr. Quesnai, who was himself a physician, and a very speculative physician, seems to have entertained a notion of the same kind concerning the political body, and to have imagined that it would thrive and prosper only under a certain precise regimen, the exact regimen of perfect liberty and perfect justice. He seems not to have considered that, in the political body, the natural effort which every man is continually making to better his own condition is a principle of preservation capable of preventing and correcting, in many respects, the bad effects of a political œconomy, in some degree, both partial and oppressive. Such a political œconomy, though it no doubt retards more or less, is not always capable of stopping altogether the natural progress of a nation towards wealth and prosperity, and still less of making it go backwards. If a nation could not prosper without the enjoyment of perfect liberty and perfect justice, there is not in the world a nation which could ever have prospered. In the political body, however, the wisdom of nature has fortunately made ample provision for remedying many of the bad effects of the folly and injustice of man, in the same manner as it has done in the natural body for remedying those of his sloth and intemperance” (WN IV.ix.28: 673-4).

Smith did not envisage the “concept of a perfectly balance[d] free market”. That is a post-Smithian, 19th-20th century retrospective invention (used by some theorists to trace ‘general equilibrium’ theories back to Adam Smith). If anything, Smith was about ‘disequilibrium’ economics.

Smith did not just “add” to Quesnay’s land-is-value belief, “the concept of labor as value”. Moreover, the labour theory of value was a distraction, and in its muddled presentation in Wealth Of Nations it is not clear if Smith really had a ‘LTV’ at all. It certainly is not a basis for modern valuations to determine investment decisions.

There is no inherent ‘value’ in a commodity. Exchange value is a ratio; as Smith showed, it is what we give up to get what we want. “Give me that which I want, and you shall have this which you want” (WN I.ii.2: 26) is the meaning of offers in bargaining.

And exchange value can change rapidly and extraordinarily. Consider Richard III’s offer of a fine bargain: “A horse, a horse, my kingdom for a horse” (The Tragedy of Richard III, Shakespeare).

Ersun Warnke may prosper as an advisor of the readers of Salem (I wish him well), but, probably, he, or more importantly, his readers, may not.

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