Where does money go in a financial meltdown?

When investments tank and lots of people are losing money, does this mean that a small number of fat cats are making money?

This question came in for quite a bit of discussion at our house last night. We hosted the monthly meeting of our Salon discussion group, where we talk about whatever is on people's minds.

And right now losing money in the financial meltdown is front and center in most American psyches.

A few in our group were convinced that somebody has the money they've lost in the stock market. "How could it just disappear?" they said. "It has to be somewhere, which means someone is profiting from our losses."

Fortunately, we had a retired economics professor, Russ, in the room, or we could have kept on arguing about this all night.

Because common sense argues for the "one person wins, another loses" financial view. After all, if you drop a twenty dollar bill on the sidewalk, and a guy behind you picks it up, you've lost $20 and he's gained the same amount.

But Russ pointed out that this is erroneous when it comes to investments -- which behave differently from cash in your pocket or a checking account.

The value of stock, or a home, can simply disappear. No one has to buy and sell it, even though buying and selling is one way the value of an investment is determined. Note: one way.

There are other ways, Russ said. We've seen these happening a lot the past few months, such as when bad economic news triggers a sharp decline in the stock market.

Share prices may open lower in the absence of buying and selling. If I understand correctly what Russ was saying, it is new information about likely future profits that reduces investment values.

Yes, sometimes it is possible to trace where the money goes in a series of stock trades. In this case the amount of money made by some is balanced by the amount lost by others.

However, this Associated Press story presents a broader and more accurate picture of what's happening in a financial meltdown.

Whether you're a stock broker or Joe Six-pack, if you have a 401(k), a mutual fund or a college savings plan, tumbling stock markets and sagging home prices mean you've lost a whole lot of the money that was right there on your account statements just a few months ago.

But if you no longer have that money, who does? The fat cats on Wall Street? Some oil baron in Saudi Arabia? The government of China?

Or is it just — gone?

If you're looking to track down your missing money — figure out who has it now, maybe ask to have it back — you might be disappointed to learn that it was never really money in the first place.

Robert Shiller, an economist at Yale, puts it bluntly: The notion that you lose a pile of money whenever the stock market tanks is a "fallacy." He says the price of a stock has never been the same thing as money — it's simply the "best guess" of what the stock is worth.

This also is the answer given in today's Parade magazine "Ask Marilyn" feature by Marilyn vos Savant. She says that lost investment value in the stock market never existed in the first place, because it is based on what shares would theoretically sell for.

Makes sense.

For one thing, if the last transaction of a company's shares occurs at a $100 trade value, this doesn't mean that everyone who owns those shares could completely sell out at that price.

Obviously all that selling would drive down the price, just as every house in a neighborhood may be worth $500-600,000 -- but if each owner puts a "For Sale" sign up at once, almost certainly they won't get what they think their investment is worth.

Here's another answer to the question "When the stock market crashes, where does the money go?" Same conclusion: nowhere, because it never really existed.

The money does not "go" anywhere. It is literally lost. Stock market money is mostly a store (measure) of value, not a medium of exchange. When the value of a stock goes down, the money by which it is measured simply disappears.

Remember that money, especially as a store of value, is a matter of faith: it cannot be exchanged for anything tangible (e.g., gold or silver) except in a market in which the value of products is largely a matter of faith. The value of money in the stock market is based on faith in the value of the stocks that the money represents. So when the value of the stocks declines, the money that measures the value of the stocks declines by the same amount. No one gets the money that is lost. It simply evaporates.

Well, it's reassuring to know that someone else doesn't have the money that my wife and I have lost in the meltdown.

But it sure would be a lot more reassuring to get the money back.

Comments

[Rain]

but as you said, that money was possible money. Not too many people lost their actual input to the accounts. They lost what they thought they made. And a few people could have gotten that 'thought they made' money if they cashed out before this happened and are holding the cash. That's money you put in and they might have that. It's what happened apparently in the Ponzi scheme where some of his family and a few others cashed out which is why there might not be enough in the account (where he wasn't actually investing it maybe at all) to cover all that people originally put into it.

We have been living in an illusion and reality is coming home.

[Robert Paul Howard]

Dear Brian,

I noticed the assertion that "...money...is a matter of faith...."

It appears that you have lost your faith once more.

Robert Paul Howard

[Brian]

Well, I've never had faith that money can't be lost...or gained. Obviously money comes and money goes.

What the quote refers to, I think, is that there's nothing substantial behind money. It involves societal agreements founded on a fabric of civilization.

You can't eat money. Or plant it. Or live in it. When I used to read science fiction stories about the end of the world as we know it, money quickly becomes useless as lawless hordes roam the earth.

Hopefully we'll never get to that point. But the current financial meltdown does show how fragile our concepts surrounding "money" are.

[Robert Paul Howard]

Thank you, Acomplia, for slipping your advertisement into Brian's blog. He's let several others in (on penis enlargement) recently, too. This is, apparently, the way of the world.

Robert Paul Howard

[Brian]

Robert, I can assure you that I don't "let in" comment spam. When it slips through the TypePad spam filter, I delete the crap as soon as I notice it.

I'm supposed to get emails of every comment, but some spam comments don't get to my inbox. I'm going to complain to TypePad about this. (I just deleted the comment, so it won't show up now.)

[Robert Paul Howard]

Dear Brian,

Thank you.

Robert Paul Howard