The Real to Potential Wealth Ratio
A common phrase heard in market discussion is the notion that wealth is “created or destroyed”. This concept does a disservice for what wealth is and helps reinforce the aspect of a mysterious market where wealth vanishes and reappears mysteriously. For any given individual, wealth is the sum of a resource or derivative thereof and stored labor. The notion that wealth is created and destroyed is only in relationship to the individual and doesn’t tell the full picture. The wealth that is “gained or lost” is actually transferred. This dynamic occurs continuously and having a good understanding of the “Real to Potential Wealth ratio” can help every individual better understand and manage their wealth.
The oxford dictionary defines capital as “wealth in the form of money and other assets” but as discussed in a previous post, "Saving for the Future", capital actual takes 8 different forms; financial being the form that I will use for this post. Financial capital is wealth in the form of money and assets. Carl Menger outlines that Money originates from surplus of resources and as I discussed in a previous post, this makes money a “Scarcity Signal” that tells us how hard an individual or group labors to produce a given resource or asset. Therefore, we can surmise that money is stored labor. Assets are resources in a raw state or resources transformed into a new form or product. Therefore wealth is a combination of resource ownership, stored labor or resource that have had labor or resources applied to create an asset.
Humans require resources to live and resources are finite since the planet is finite. The first law of thermodynamics states that “energy can be transformed from one form to another, but can be neither created nor destroyed”. If energy cannot be created or destroyed and resources are a form of energy, financial wealth can’t be created or destroyed. Just like energy is persistent and varies from potential to active forms, Financial wealth is persistent but varies between potential and stable forms. To an individual, financial wealth is the ratio of stable wealth to potential wealth that shifts based on an individual’s actions.
An example of weather with a high real to potential wealth ratio may be the direct use of resources or some derivative of those resources that eliminates the need of an individual to use their labor. If an individual has a month supply of food that will not perish, this food has a high real to potential wealth ratio. However if we took that same food and gave it to another individual who may not value the food as highly as the first individual, maybe only 20% of the food is real wealth and the other is 80% potential wealth, that food has a low real to potential wealth ratio. This wealth has a low ratio because that individual may want to sell the food to another individual or end up throwing it away.
The key difference between Potential wealth and Real wealth is that potential wealth does not cleanly transfer from individual to individual. Individuals have less control to preserve potential wealth as it is not valued the same from individual to individual, or when the potential wealth is transferred it may be transferred to the ecosystem, be released as energy or given to another individual. This is another indication as to why money arose as a valuable communication tool, it helps us maximize the efficiency in the transfer of potential wealth into real wealth for the most individuals.
Low real to potential wealth ratio examples include in ground oil reserves stored in the ground, financial derivatives, grocery store food, wildlife, timber, etc. High real to potential wealth ratio examples include money, food that will be consumed, occupied housing, a bed to sleep in, etc.
What is the Real to Potential Wealth ratio for your wealth? Are you posturing yourself correctly for the future? What about the other forms of capital? This post focused on financial capital but what are your examples of real and potential experiential, intellectual, material, social, living, cultural, and living capital?
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