Non-physical assets valuation

Credit or Cash (Flow)? Which Game Is Being Played?  December 25, 2011 – 09:08 am

This week, I read this passage in the Economist:

This in turn sparked huge and occasionally destabilising flows of cross-border capital and a massive burst of credit creation. Total credit in the American economy passed $1 trillion in 1964; by 2007, it had exceeded $50 trillion.

This debt explosion showed up not in consumer prices but in asset prices, notably in property. The cycle was self-reinforcing: banks lent money to people to buy property, causing prices to rise, making banks more willing to lend, and so on.

It got me to thinking.  To understand the modern economy, you have to account for the general uptrend in availability and cost of credit as described above.  The fact that the supply of money has an effect on valuation of assets is simultaneously obvious and also deeply strange and unsettling in highlighting that the notion of valuation is inherently unstable.

To see why, let’s step back and think of valuation.  In simplest form, valuation is simply where supply meets demand, but the precursor question to that is how are the supply and demand functions set.  Among the approaches to valuation, let ‘s talk about two.

The first is a function of the discounted cash flows of the specific asset to be valued; the second is driven by the ease and availability of credit in the economic generally.  Where it gets interesting is when these two co-exist for the same asset and/or where there are both financial buyers (who are relatively indifferent to the asset other than as a store of value) and physical buyers (who will use the asset).

Source: takingpitches

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