The Greater Fool Theory is an investing strategy that some traders use to try to make money. But before we get into it, we should talk about an object’s intrinsic value.
The intrinsic value of something (a stock, commodity, etc) is the value that is inherent in the object for it’s own sake. You can determine the intrinsic value of a share of company stock by calculating the tangible and intangible factors of the company and then dividing that total value by the number of shares. The intrinsic value of a barrel of oil can be determined by how much work it can produce. There is intrinsic value in a pallet of lumber, a spool of wire and your house.
That doesn’t mean that all items can be bought or sold for their intrinsic value. The market drives the prices for items like oil, lumber and real estate. Those prices can be above or below the intrinsic value of the item. When an item’s price is much higher than it’s intrinsic value, that is when the Greater Fool Theory comes into play.
The Greater Fool Theory states that the price of an object is not determined by it’s intrinsic value, but instead by irrational beliefs and expectations of market participants. In other words, items can be bought and sold at much higher levels than their intrinsic value. The idea is that there is always a “greater fool” that you can sell the item to at a higher price…until there isn’t.
There are two commodities that I want to mention in regards to the Greater Fool Theory. The first is bitcoin. Bitcoin does not have an intrinsic value. It’s market price is solely determined by the market’s beliefs and expectations of the future ability to trade the commodity. The majority of cryptocurrencies are valued in this manner. As the flavor of the month moves from one cryptocurrency to the other, the market prices of these commodities will change.
Does art have intrinsic value? The value of the parts of a painting (frame, canvas, paint) can be much, much lower than the market value of the finished item, but beauty is in the eyes of the beholder. While you can reliably expect a Monet to retain it’s value, art either trades at values much higher than it’s intrinsic value or it doesn’t trade at all. If you appreciate a piece of art, buy it, but don’t think of it as an investment. People who invest in art are constantly looking for the greater fool.