The stock market had a bad day once and someone said “a billion dollars was lost”. I dont understand where this billion dollars went. Did the net worth of the country decrease by that billion dollars? If the people that lost the billion dollars had sold the stock the day before and bought a billion dollars worth of gold, then the billion would have been lost by the suckers who bought the stock the day before but the net worth of the country would be a billion greater. This doesnt make sense to me. What am I missing?
From my limited understanding of the market, the problem seems to be unrealistic profit expectations.
To put this in simple terms:
ABC Company has 100 outstanding shares of stock each selling for $1.00 on the market.
ABC Company reports expected profits of $1,000. So people buy stock trusting the analysis and would be willing to pay up to $10 a share, hoping that $1,000 split 100 ways would net them $10 a share. So like sheep they buy shares of ABC at various prices until it soars to $10 a share.
Then ABC reports they were wrong, the expected profits are only $600. So anyone who was unfortunate to pay more than $6 a share gets shafted.
The combination of all these shortcomings amounts to the total the market lost in a given day.
It means that the new worth of the stock market went down by a billion dollars. For example, say that there are 100 million shares which are being traded at $20 a share on the stock market. Some bad news is released, and all of a sudden nobody in their right minds would pay $20 for one of those shares, but maybe they’d pay $10. In effect, the market has decreased in value by a billion dollars.
justinh, I asked this the other day but it was about what happened to that $3.7T (yes, T, not B) & the answer is the same, it just disappears, its just value on paper that’s all.
Yeah, I know you are thinking, it must be in a bank somewhere but no,its just paper.
The billion dollars lost is just money on paper, not to be confused with paper money (aka Federal Reserve Notes).
There are four totals of “real” money:
[ul]
[li]The Federal Reserve (FR) total for all the coins and bills in circulation, estimated at about $500,000,000.[/li][li]The FR count called M1, which is all of the above, plus all the money in checking accounts and travels’ checks, about $1.1 trillion.[/li][li]FR count M2, which is M1 plus all of the money held in money market funds, savings accounts and small CDs. This is about $4.6 trillion.[/li][li]M3, which is M2 plus all of the large CDs. This is about $6.25 trillion.[/li][/ul]
Funds in any of these accounts, from penny jars on your night stand to corporate 401(k) savings accounts, need either a physical transfer of cash, or a certified funds transfer via the Federal Reserve computers. When my company pays me via direct deposit, it’s as real as if they’d counted out a stack of $20 bills and handed it to me. What they’re really doing is telling the FR to increase my checking account by $XXX and at the same time decrease their payroll checking account by $XXX. At the end of the day, all the increases in accounts should match all the decreases exactly. Any discrepancies are investigated. So if by some mistake, $10,000 is accidentally put in your checking, don’t go spending it, because they’ll find someone who’s missing $10,000 and trace it back to your account.
The stock market, on the other hand, can be valued by its capitalization, which is the outstanding shares of stock multiplied by its particular price. IIRC, this is about $15-20 trillion.
Now, there’s no way that this capitalization can be turned into real cash. Only a small portion of it can be liquidated at any time. Every sell will drive down the price of a stock, however minisculey (sp?). If someone who owned, say, 30% of IBM tried to sell all their shares, it might set off a panic from other shareholders who don’t want to lose too much of their money, paper-based as it is. There are now safeguards in place that recognize any frenzied trading (more so than what usually happens on the NYSE floor) by mathematical means, then closes the exchange for business unitl it can be determined what is causing the panic.
To follow Moonshine’s example and address where the billion dollars went, it’s in the pockets of the people who sold the shares for $20.
In Rainbow Dragon’s example, $400 in value was lost within the market, but the people who sold their shares at $10 have $400 more in their personal fortunes than if they had hung onto the shares.
My understanding of the market is also limited but I think that, even if the markets plunge and trillions disappear within the market, no money was vaporized. Sellers sold the shares at the high prices the stocks plunged from. If 100% of the shares went down in value because nobody wanted to buy them from the frantic sellers, the markets would lose trillions in value, but it would mean that the usual hundreds of millions of buyers would be sitting on equivalent trillions in cash.
The mind boggles.
I don’t think that’s the way it works. Look at it at a micro level: Let’s take stock TSD. Yesterday it was trading at $20 a share with 100M shares outstanding, total market cap is $2B. Last night, the company announced a $100 million loss for the last quarter. This morning at market open it’s trading at $10 a share, now the total market cap is $1B. What happened to the other billion? It’s gone. Nobody profited on it, the value of the stock dropped. It doesn’t require $1B worth of transactions for that value to go down; it goes down because the buyers of this stock are only willing to pay $10 a share.
As another example, suppose you buy a work of art valued at $5,000. Next year you sell it, but can only get $2,500 for it. What happened to the other $2,500? You lost it, it’s gone because the artwork dropped in value. Why is it only worth $2,500 now? Because that’s what a buyer is willing to give you. Nobody else profited on it (it could be argued that the person who bought the artwork profited, but only if she is able to sell it for more than she paid for it).
Incidentally, I meant to pick a hypothetical stock, but TSD is an actual stock (TELE SUDESTE), whose current market cap is coincidentally quite close to $1B. They haven’t had a much better year than my hypothetical situation, BTW.
They are talking about money, they are talking about wealth. When the market loses $1 billion then people are $1 billion less wealthy which means they are less likley to be able to buy houses, cars, computers, steak, go to the movies, etc. It may just be on paper but it is clearly a loss nonetheless.
The finances that AWB so aptly described are part of a “zero sum” system. In order for one entity to gain money one or more others must lose an equal amount. The stock market, while surrounded by zero sum systems, is not one in and of itself. To exand on frogstein’s example:
Day 1) I write a check for $5000 to buy the work of art (a numbered copy, 254 of 1000, of a statue). My account is debited $5000 dollars. When the dealer deposits the check his account is credited $5000. Debit $5000 + Credit $5000 = zero sum.
Day 2) I have the statue appraised. The appraiser says “You got a deal! All over the world people are buying numbered copies of this statue for $10,000!”. I now have a work of art “worth” $10,000. Do I have an additional $5000 in my account? No. I have doubled my investment on paper but not in reality.
Day 3) Another collector offers me $15,000 for my work of art. I decline, believing that the work will appreciate even more over time. I have now, on paper, tripled my $5000 investment. I still have nothing real to show for my increased wealth, except that I may be able to use the new value of my statue as collateral for a loan.
Day 4) The artist who made my statue announces he will authorize another run of 1000. The appraiser says my statue is now worth only $3000. How much have I lost? Nothing, unless I sell. If I do sell now my actual loss is $2000, even though yesterday the statue was “worth” $15,000. Here is where the media would say “Art investor loses $12,000 in one day!”
Day 5) The artist dies before signing the authorization for the additional run. The art world goes crazy and my statue is bid up to $50,000. My net worth increased $47,000 over night, but how much have I truely gained? Nothing, unless I sell.
In the above example I, on paper, I gained $5000 twice, lost $12,000 once, and gained $47,000 once. Nobody lost money when my worth went up and I had to pay no one when my worth went down. On paper I had a hell of a ride. In reality, until another zero sum transaction takes place there is no gain or loss.
And that is how the stock market works.
Doctor Jackson wrote
I suppose it’s definition, but I disagree. Your net worth has in fact gone up and down with the value of your statue. The exact value of your statue at any given point in time can only be estimated until a transaction is completed, but the value does go up and down.
Simple evidence of this is your point that you may be able to get a loan against the value of your statue.
It’s not necessarily a ‘paper’ loss. It’s real money. What do you think all those Dot Coms ran on? They took the money they raised in the market from IPOs and bought buildings, furniture, and paid the salaries of a whole lot of people. In the end, they create nothing of value, and close down shop.
The money they raised came out of the pockets of the investors who bought their shares. They spent that real money, then went bankrupt and the shares became worthless.
So consider it about as real as loaning $500 to your uncle Fred who promises to invest it in his store and give you back your $500 plus interest. Instead, he goes on a drinking binge and blows the money, then declares bankruptcy and leaves you on the hook for it.
A ‘paper’ losss merely represents lost opportunity. i.e. if you buy a stock for $5 and it goes up to $10, you’ve made a ‘paper’ profit until you sell the stock. If it then drops back to $5, you had a paper loss of $5 per share.
However, if you fork over your money for a $5 share and it then drops to nothing, that is not a paper loss. That’s cash gone.
The real damage to the economy comes from the diversion of capital and resources into areas that don’t warrant it. If you add up all the money spent by the dot coms that are now bankrupt, it comes to hundreds of billions of dollars that could have been spent more efficiently. Thus it acts as a drag on economic growth.
The OP is not talking about IPOs. He is asking about the market as a whole.
Same thing applies. If you buy a stock at $1.00, and it climbs to $70, there’s only one reason - because someone out there was willing to pay $70 for it. If that stock subsequently crashes back to $1.00, the guy who bought it at $70 loses everything, and the guy who sold it at $70 gets the cash.
The point is that this is not all just paper. Real wealth was being spread around and spent. And there are a lot of economic liabilities that result. For one thing, capital is diverted from real companies into the speculative bubble. For another, a lot of instant millionaires got themselves into debt leveraging their stocks and not only lost all the stocks, but are now carrying the debt.
The stock market is all about efficient movement of capital. The existance of the stock market allows funds to flow to those who can use it best. When a speculative bubble happens, it diverts capital, skews the market, and adds inefficiency to the system. Then when the bubble pops, it causes further structural problems in the economy and scares people out of the market entirely, causing a lot of real companies with real value to run into trouble. Badness all around.
If you go back in the archives, you’ll find that I was predicting exactly what happened right from the day that the dot coms started to take off several years ago. I was in the industry, and knew that there was very little real value in some of these multi-billion dollar valuations of companies. I mean, it didn’t take a rocket scientist to figure out that something was wrong when pets.com, which owned a big warehouse and a bunch of web computers, was worth more on paper than Toys R’ Us, which has something like 7000 stores, huge brand recognition, hundreds of millions in hard assets, AND the same type of web site.
I wish I had put my money where my mouth was and sold a bunch of those stocks short.
I agree with the posts above me for a personal account…however as a global society is wealth ever destroyed? Aside from physically destroying currency, the money doesn’t disappear.
In the stock world, somebody bought/sold $800 for Qualcomm last year. That $800 share, while now it might be worth only $50 (or so), still created $750 of wealth in the economy that wasn’t there before. That $750 didn’t disappear; it just got (presumably) reinvested. And thus a circular pattern begins.
The way I see it, there is as much money in the economy today as there was at its’ highest point (sometime last year), and the total wealth cannot shrink; it will remain at the same level until some new records are broken.
Even when the M1/2/3 money supplies decrease (which is rare), that money is going out of circulation and into the Federal Reserve. It is not destroyed, just taken off the table…
Where am I wrong?
sethdallob, the money is gone. If you pay somebody $100k for a house, and the house goes up in value to $150k, there is now a very real $50k of extra value in the world, specifically in your pocket. On the other hand, if that house goes down in value to $75k, there is a very real loss of $25k from the worlds economy, specifically from your pocket. Who you bought the house from, and what you paid them is irrelevant; if the house goes up or down in value, your net worth goes up or down. Now add the value of everyone’s possessions together and get the value of the world’s economy. It goes up and down; it does not remain static. Stocks are just another possession that rises and falls with their relative desirability.
“Same thing applies. If you buy a stock at $1.00, and it climbs to $70, there’s only one reason -
because someone out there was willing to pay $70 for it. If that stock subsequently crashes back
to $1.00, the guy who bought it at $70 loses everything, and the guy who sold it at $70 gets the
cash.”
You are assuming that all the stock in a comp was sold. But that is not the case at all.
The best example of this money theory is Gates. He has about a billion shares of Microsoft. If one share of his stock is sold for $100.00 then you could say Gates is worth $100B. Then if that one share is sold for $50.00 again you could assume he was worth then $50B. What happened to that $50B (100-50)??? Nothing.
Isn’t this the difference between the stock market and the futures market–the zero sum game? It seems to me that the example of “losing” a billion dollars overnight in stock prices is accurate. However, what about trading futures contracts on real goods (e.g., wheat, cattle, gold, or frozen concentrated orange juice) or stocks for that matter too?
I think these examples do represent an application of the zero sum idea. If I’m a cattle farmer and I hope to secure a price of 75 cents/lb. in three months when the cattle goes to market, I sell a futures contract now (in March) at 75 cents/lb. Then, if the price of beef drops between now and June (three months hence) my actual cows, Elsie and all her friends, are worth only 50 cents/lb at the market. No problem for me though, because I’ve already sold the June contract at 75 cents/lb. So all I need to do is buy it back in June at 50 cents/lb. and I make a profit of 25 cents/lb. on the futures contract which when I add to my actual sale of Elsie et al. at 50 cents/lb. nets me my intended 75 cents/lb.–just what I wanted. Zero sum, right?
what bothers me about he equation is:
I have a billion dollars worth of stock on day 1 (paper value).
on day 3 the price drops to zero. i have lost a billion dollars in net worth (paper value).
on the other hand.
what happens if i had sold the stock on day 2 and bought gold from south africa with it. i still have then same
value (gold this time instead of paper) and the stock buyer has 1 billion dollars in net worth. (paper value). so there is a net zero gain.
BUT on day 3 when the price drops and he loses his billion dollars. I still have mine in gold. the country is one billion dollars richer. so it is not net zero.
I was the poor boob who lost 1 billion in the first example. but in the second I am the happiest person in the world but the buyer is the poor boob. but there is a billion dollars more net worth to the country.
Your presumed net worth rises and falls with the value of your investments. No money is gained or lost until a zero sum transaction occurs. There is a difference between money and net worth (wealth). If you don’t believe me, try deducting from your taxes your “loss” in stock value without first selling the stock. The IRS will not be amused.
The key word there is “may”. Actually few, if any, lenders will make a loan with art work as the collateral - precisely because the value is subject to fluctuations. The same is true of stocks. If you did get a stock based loan you can be sure it would be for a fraction of the “value” of the stock. Lenders generally do not gamble any more than they absolutely have to. Even real estate loans are usually limited to 80% of the appraised value as a hedge against a falling real estate market.
Only if he sells. It is a paper loss until a zero sum transaction occurs. The stock could go back up to $70 or more if he holds.