Is it correct to say that wealth is "destroyed" when an asset bubble bursts?

Question

I was reading this article from the World Economic Forum, when I came across this passage:

When the global equity and real estate markets hit their lowest points in March 2009, \$34.4 trillion of global wealth was destroyed. US households lost almost \$8 trillion in the stock market, on top of the \$6 trillion loss in the market value of their homes.

Is it fair to truth to say that the wealth was "destroyed"? I ask this because that type of phrasing gives the impression that the wealth was really there at one point, and that it wasn't merely an illusion.

I can think of a few reasons why this may be true:

• The wealth really did exist elsewhere at first, but when resources were diverted from other assets/resources and invested into real estate – which turned out to be a bubble – those resources had been spent on assets that weren't productive (i.e. didn't give a positive return). The wealth was moved over from valuable assets to less valuable/worthless assets. Capital and labor was spent for nothing.

• Wealth is never really expressed in intrinsic "real" terms, but is always a subject of valuation. Wealth is only worth what people value it to be, i.e. what resources they would give up for a transaction of that wealth.

So, is it correct to say that wealth can be destroyed if there was nothing substantial to back it up?

Answer 1

We need to distinguish two things here: the intrinsic value of the assets, and their fair value, or market value.

No matter how much the price of an asset changes on financial markets (say, stock exchanges), its intrincic value stays the same, all other things equals. Typically, you could use the cost of the asset to assess its intrinsic value: for a house, the price of its construction. For a share, the book value per share of the underlying firm. For bonds, the nominal (or face value) amount.

But assessing cost is sometimes tricky. The book value might incorporate things that are valued at fair value. For real estate, the price of the land is a large part of the total cost, and it changes all the time. For bonds, you could incorporate interests and discount them, but you need to choose a discount rate.

Thus we typically assess wealth using fair value. It's a concept precisely defined by IFRS (IFRS 13 - Fair value measurement). Basically, the fair value of an asset is the price at which you could sell it under normal market conditions ('at arm's length'). It is true 'value', as you could trade the asset against that amount of cash.

To come back to your question: wealth is measured at fair value, or market value. Therefore, the $34.4bn were indeed destroyed, or disappeared, even though the intrinsic value may have been constant. Your second suggestion is correct.