by: Jeff Nielson
July 30, 2012
In our daily lives, we learn that there are many immutable principles of cause-and-effect. Drop an object from your hand and it will fall down, not up. Throw a rock at a pane of glass and it will break. Put an ice cube in the sun and it will melt.
So too it is with the cause-and-effect known as dilution. Whether we are an adult buying watered-down booze from a bar, or a child buying a watered-down beverage from a lemonade stand; we immediately comprehend that diluting the product has reduced its value – and thus we refuse to pay the same price for it.
Similarly, should a jeweler attempt to tell us that (less pure) 10-karat gold is worth as much as (more pure) 24-karat gold, we would simply scoff at such nonsense and walk away. And as I have noted several times in prior commentaries, even the dim-bulbs in the mainstream media can grasp the concept that if a company prints up a lot of shares (and thus dilutes shareholder equity) that the value of its shares must decline.
Indeed, in the entire known universe we have only one example of an item which (supposedly) does not automatically decline in value as it is diluted: the bankers’ fiat paper currencies. In fact, we have no shortage of clueless scribes claiming that it is possible for these currencies to actually increase in value as they are being diluted. Search the phrase “U.S. dollar rises in value”, and you would acquire repetitive strain disorder before you finished reading all the idiocy on that subject.
Regular readers know that I have found this logical absurdity to be positively maddening. Suggesting that (any of) our incessantly-diluted paper currencies could rise in value is just as insane as suggesting that I could drop something and it would “fall” upward…at least at first glance.
Then it suddenly occurred to me that there was one (and only one) theoretically possible scenario where a good which is being diluted could rise in value: if it was already worthlessbefore the dilution even began. Obviously something which is “worthless” cannot possibly decline in value, as a matter of definition. So even though there is no reason to expect a worthless item to increase in value (as it’s being diluted), since it’s impossible to decline in value then it becomes at least quasi-rational to suggest that it might appreciate in value (somehow).
There is no other possible exception to the principle of dilution: the only good which would not automatically decline in value as it is being diluted is a good which was already worthless before the dilution commenced.