Money Heaven
At some point in every trader’s career, usually after he or she has witnessed their first major market decline, they arrive at the same question:
When the market drops, where does all that money go?
First of all, let me just say that it’s not the evil short sellers. If a company has 1 billion shares of stock outstanding, and there are 50 million shares sold short, when the stock declines the value lost on the other 950 million shares doesn’t go directly into anyone’s pocket. Please note that I said directly.(see below)
My first response to the Big Question is to answer it with another question - - the old Zen Koan from elementary school:
Where do the words go when you erase them from the chalkboard?
… “No, not the chalk, the words.”
If they press, I go into a long, boring dissertation about the liquidity drained from the equity market being the result of an inflationary oversupply of devalued dollars by a zealous Fed intent on fueling the acid train to hell that has become of our consumption-based immediate-gratification economy. That always clears things up.
Eventually I give them what many find a more satisfactory answer:
“It goes to Money Heaven.”
What’s the real answer? It’s that all that value doesn’t really vanish into thin air. It’s just transferred in a somewhat counterintuitive manner. Here’s a great article explaining the quite plausible alternative to Money Heaven.
…
Richard said,
August 10, 2006 @ 4:30 pm
Say I spot a chair for sale at $20, and I think it’s worth more than that. So, I buy it and try to sell it for a profit. But, it turns out I was wrong, and no one wants the chair. So, I end up selling it for only $15.
Do I then ask, “where did the other $5 go?” Of course I don’t. Obviously, all $20 original dollars went to whoever sold me the chair. Obviously, all $15 dollars I have now came from whoever bought the chair from me.
Maybe I oversimplify things, but to me, stocks are no different. People that wonder where the money goes are confusing stocks with money, aren’t they? In fact, stocks are not money. They are just pieces of paper.
Will said,
August 13, 2006 @ 4:49 pm
Richard- thanks for the comment. I was mainly poking fun at the (mis)perception that folks often have (and I myself had at one point) that if they lost money in the stock market, someone else must have made money (the old “for every winner there’s a loser” saw), or else it must have vanished into thin air.
As the referenced article demonstrates (as does your example), it’s not money that disappears, it’s value. Simple enough in everyday examples, but sometimes more obscure for thick skulls like mine when dealing with as many variables as the equity market introduces.
As for “just pieces of paper,” that’s a bit of a slippery slope. Our currency notes are similarly just pieces of paper, and are only guaranteed as legal to offer for payment. No law requires that they be accepted. Since our currency’s value is purely based on faith, its value is subject to a catastrophic decline should that faith be at all tested. Enter hyperinflation. Thus there exists a scenario where you may want to trade your dollars for a chair, but it turns out no one wants the dollars!
Cheers!