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Whenever someone sells stocks to raise cash, there must be someone on the other side of that transaction who is losing cash in order to acquire more stocks. FULL ARTICLE by Robert P. Murphy
Perhaps a simple example is the trading of baseball cards (or old comic books). What was once a purchase of 10 cents can become a collector’s item of $10,000, while if attitudes change can be reduced to say $100. The cards do not change, but their market value does. Isn’t this simply an example of the subjective theory of value?
Here is where I become a little confused; let’s say that after I invest $10,000 in a stock, the total value, at a later time, drops to $5,000 for my investment. Well, the original $10,000 went somewhere, no? The value of the shares I bought dropped, so when I want to redeem them, they will be of lesser value then my original purchase price. But again, the company I invested in still took that and spent my investment. So I’m failing to see how the money stock decreased there.
“..But again, the company I invested in still took that and spent my investment.”
Only if you bought in the IPO. If you bought in the secondary mkt, the co. wouldn’t see a dime.
Using Allen’s example, I buy a rare comic book in mint condition for $10000. The person I bought it from uses the money. But then I accidentally spill something on the comic book and its value drops to $5000. Where did the money go, you ask. The only money here was the $10000; the comic book isn’t money, simply something of value, and whose value dropped.
It’s surprisingly difficult to explain this concept in a normal conversation. What I see so clearly can sometimes be hard to explain in a way others can understand. I’ll definitely make sure to save this for future reference.
I agree with this.
This is where I become lost when it comes to investing in the stock market. You have any links you could forward my way to help me understand this a little better? Thank you!
Investopedia is good.
But it’s fairly simple…
primary mkt: co. issues stock and investors buy it.
secondary mkt: Stockholders buy & sell amongst themselves/ to third parties.
The Stock Market, Credit, and Capital Formation by Machlup.
So with dividends at pennies per share and the IPO money keeping the lights on for, oh, about a week, the market is really more about stockholders seeking greater fools to unload their stocks on while the exchange takes its cut.
First, cash is no longer a store of value, it is an IOU that can be traded for goods and services. In this electronic transfer economy time is almost exactly the same as money.
Second, hard assets like land and oil wells are different than liquid assets like stocks and cash. One can live on the land but ignoring dividends, a share stock isn’t worth anything until it is sold.
“First, cash is no longer a store of value, it is an IOU that can be traded for goods and services. ”
It’s a medium of exchange. An IOU is credit… Of course I’m talking about a sane economy, not the FRB la-la-land.
In the example, the value of the stock decreased, but the value of the cash increased. In the beginning $10 would buy a share of stock; at the end that $10 would buy 3 1/3 shares.
The total money supply didn’t change, and the total of “stuff” to buy didn’t change, what changed was only the relative value of the cash vs. the stock.
If we instead use the above mentioned cards or comics, it’s clear that they didn’t disappear, they simply changed in value relative to the cash. So, the total of physical wealth didn’t change, it’s just that our subjective valuation of that wealth compared to cash changed.
I wonder about the reverse.
When the stock market is rising and we believe it to be a bubble, does the reverse logic apply? My initial thought is that somewhere someone created a bunch of new money to pump up the bubble. However, this example, if reversed, would mean only that the valuations of stocks increased relative to cash. But this wouldn’t seem to jive with what we know about the central bank and previous stock market bubbles.
This brief example is adequate for its intended purpose, but it also brings to my mind the deeper question of the true nature of wealth. From a strict individualistic point of view one’s wealth is based on the value one subjectively assigns to the goods and services that one owns. In this case one’s wealth is independent of anyone else’s valuations—i.e. it is independent of the market’s valuation of these goods and services. Indeed the very fact that I retain some good means that my reservation demand is high enough to keep this particular good off of the market. So if I purchased a sander last year for use in various home improvement projects that I value, the fact that the same sander can be purchased at 50% off this year does not affect the value that I subjectively derive from the service of my sander, especially if I intend to exhaust all of the service “stored” within it.
The individualistic conception of wealth becomes murkier with regard to financial assets (stocks, bonds, money) because their prices are determined almost continuously by an extremely wide market place. The value that I hold in money (i.e. claims on current production) is entirely market dependent if I assume that money’s commodity value is negligible compared to its exchange value.
The wealth that I perceive in bonds can be less market dependent. If I buy a non-callable bond with of known maturity that pays a fixed real return over this time then it will have served my purpose—I will not care how its market price fluctuates over the interim. I become concerned when the interest payment is interrupted or the real value of the payments decline. In these cases the market’s valuation of my bond becomes more aligned with my own valuation as the probability that I will sell it grows.
Publicly traded stocks form an intermediate set: stocks become more bond-like when they pay a consistent real dividend and more money-like when they pay no dividend. In theory one buys a stock because of a belief that the present value of all future dividends or earnings is greater than the market expects. It is conceivable a high-conviction stockholder will not sense a loss in personal wealth with a given decline in the market share price as this event may induce him to purchase more shares and obtain an even greater expected capital gain in the future.
“the value of the cash increased”
I don’t know about that. It’s true that each unit of cash can now purchase a higher percentage of ownership in the company — but the company is now worth less. The currency’s purchasing power has not increased.
What’s with the inane tags on the article proper? I keep seeing tags like these on articles.
Obviously someone doesn’t like the site and doesn’t want to post so instead trolls the tags.
I’m sure at some point they could consider implementing a ban system for bad tag entries if one doesn’t already exist.
I sent a note to the webmaster regarding the unbecoming tags; then I noticed that there are many articles with tags like this. Too bad it is so hard for some people to extend their thinking in a rational and civil manner.
NIce and clear, Bob.
Except I’m puzzling why you didn’t extend this just wee bit to suss out the Broken Windows fallacy and why “”GDP”can mask losses in wealth, including destruction of commons assets. Such as this bone-headed piece by WSJ about the GGF Oil Spill boosting GDP:
Will you be addressing these later?
“Now suppose that Bill realizes the current administration is staffed by Marxists”
I thought there were only three people; I guess that means Alice and Charlie are Marxists, lol. Just yanking your chain Murphy, thanks for the good article.
You catch on fast.
Pretty much that. I’ve always called the stock market a giant casino and have refused to play that game. I do well enough on bonds, which are really what you could call an investment.
As I see it, that means the site is becoming influential and some people really don’t like that. Out of the way or sites that otherwise have no impact won’t get trolls. It’s a mark of honor, a mark that the opposition is afraid. I like to see that sort of thing.
A website’s success is directly proportionate to the number of detractors it generates.
While the typical investor’s secondary market stock purchase doesn’t directly fund the company whose stock he purchases, it does help the company by tending to increase the stock’s price. This is helpful because a high stock price implies a lower cost of raising equity capital when the company returns to the primary market with a new stock offering.
So, the better a company’s stock performs, the lower its cost for raising capital, because it is cheaper for a company’s owners/stockholders for the company to raise $10 million by issuing 10,000 shares at $1,000 per share than it is to raise $10 million by issuing 100,000 shares at $100. Fewer shares issued means less dilution of ownership and a lower cost of equity capital.
Thanks Mr. Murphy. This clarifies what should be an obvious point, but for the failure to see “that which is not seen”. Most people (and I guess that’s where the NPR guys where going) focus on the increase in Bill’s bank account by $1,500, and treat that as net new money leaving the stock market. But they don’t see Alice’s account decreasing by the same $1,500.
Actually Ryssdal never said that money was flowing OUT of the stock market. At least not in the snippet we were given. All he did was examine the money that was leaving, noting that a lot of it was going into bank accounts. He said nothing about the kind of money that was bottom feeding– going into the market when stocks were being offered at bargain levels.
That would have been an interesting topic to explore.
I remotely remember seeing some bozo financial expert on CNN two years ago talking about how saving is bad for our economy. He went on to say that when people aren’t spending money our economy will tank further and go into a greater depression with little to no hope of recovery. This was when the House actually voted against the bailout if I remember correctly. Anyway, this bozo said if we spend our own money more we’d become wealthy somehow… I failed to see how he connected these dots. So this bozo is advocating I, as a person watching him on t.v., go out and empty my wallet. This sort of seems off-topic but after reading this article I was reminded that some people really think we can spend our way out of a recession. It’s truly mind-boggling. Wealthy people create healthy economies.
I like your blog,and also like the article,and thank you for provide me so much information )
Time and money that important? Many of the answer is important, but time isn’t the social reality, the reality is cruel, many people for money won’t consider personal health, feel some theory in reality is not practical, most people would consider yourself for money is healthy, perhaps this is the social cruelty
I like your blog,and also like the article ,thankn you can poovide shese information,Hope can share your blog
As described in bible you dont need to worry about feeding or living or having the basic to live, just trust in god or universe or whatever spirtual power you believe in, this is so true, actually meditating is a way of faith reinforcement, a reminder that the spirit is still alive in you and can manifest into anything you really want, still cant manifest something that you are not clear about, and of course you cannot make things happen if you try to detail plan the roadmap or have a conflict between your goals. Generally speaking you should walk your thought.
Also what the mind does when we not thinkin? is putting things together, using high consiousness, just by turning off the logic and the self talk we let the universe/god come into our existence and enrich us, this inside light gives power to our thoughts and goals to manifest and strengthens the communicative bound with the higher consousness…
The only exception might be the fed, where they are not exactly losing cash, but just passing zeros.
This goes along with what Michael Covel talks about in his book Trend Following. The stock market is a zero-sum game. If someone is taking money out of stocks to raise cash, then someone must be exchanging cash with that person in order to buy stock. In the same way, if someone is selling a stock, there is someone else on the other end who is buying those exact same shares. If someone is losing a lot of money while they are long a stock, there’s someone on the other end profiting handsomely from a short sale. The only thing that goes against this is that not all stocks can be sold short, and the number of shares sold short of a stock typically doesn’t get higher than even 25% of the float of a stock. A little chink in the armor, but the financial markets are largely a zero-sum exchange.
Nice Blog. Keep posting more
That’s really awesome.. I hope I can see more of this.. I am looking forward for your next post..
If you buy a house for $200,000 and two years later you try to sell it and the house is in just as good of shape as it was in, but house prices have all dropped and you can only get $120,000 the money doesn’t go anywhere. It already is gone. You paid $200K to whoever bout it from you. He may have used it for another house and lost half of his totol money. But he may have bought gold and it doubled in value. It is not a zero sum game like a bet. Your house is just worth what someone will pay. Stock is similar. If the value fo the company goes up because people will pay more you can sell it for more. If it goes down it is becaue people will pay less. Many factors can affect this. There are some examples of corporate coruption and other things that the government has done that has devalued some companies. But theoretically buying stock is buying a part of a company which has assets and you own shares of the assets and speculation as to how the business will do in the future.
What a helpful post really will be coming back to this time and time again. Thanks
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