Subscribe in a readerWhere’s All That Money You’ve Lost?Posted by ahc99 on October 12th, 2008
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Everybody has been losing their shirt and putting off their retirements in light of the current financial crisis that has plunged the Dow from a high of 14,279 to the current 8,451. In just last week, investors lost $2.4 trillion and over the past year, losses total to $8.4 trillion. But where has all that money gone? Associated Press has a good article that helps explain it:
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 is 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.
“It’s in people’s minds,” Shiller explains. “We’re just recording a measure of what people think the stock market is worth. What the people who are willing to trade today — who are very, very few people — are actually trading at. So we’re just extrapolating that and thinking, well, maybe that’s what everyone thinks it’s worth.”
Shiller uses the example of an appraiser who values a house at $350,000, a week after saying it was worth $400,000.
“In a sense, $50,000 just disappeared when he said that,” he said. “But it’s all in the mind.”
Though something, of course, is disappearing as markets and real estate values tumble. Even if a share of stock you own isn’t a wad of bills in your wallet, even if the value of your home isn’t something you can redeem at will, surely you can lose potential money — that is, the money that would be yours to spend if you sold your house or emptied out your mutual funds right now.
And if you’re a few months away from retirement, or hoping to sell your house and buy a smaller one to help pay for your kid’s college tuition, this “potential money” is something you’re counting on to get by. For people who need cash and need it now, this is as real as money gets, whether or not it meets the technical definition of the word.
Still, you run into trouble when you think of that potential money as being the same thing as the cash in your purse or your checking account.
“That’s a big mistake,” says Dale Jorgenson, an economics professor at Harvard.
There’s a key distinction here: While the money in your pocket is unlikely to just vanish into thin air, the money you could have had, if only you’d sold your house or drained your stock-heavy mutual funds a year ago, most certainly can.
So that money was never yours to being with. It was all psychological. People mistakenly believed what was shown in their retirement account balance and house appraisal as actual money that they own. However, that money was never locked in to being with, it was just the best guess estimate of how much the collective society believes it to be worth. And like all other estimates, it can vary depending on the consumer confidence. I found this part of the article to be the most interesting:
“You can’t enjoy the benefits of your 401(k) if it’s disappeared,” Jorgenson explains. “If you had it all in financial stocks and they’ve all gone down by 80 percent — sorry! That is a permanent loss because those folks aren’t coming back. We’re gonna have a huge shrinkage in the financial sector.”
If you choose, you can pour most of your money into stocks and track their value in real time on a computer screen, confident that you’ll get good money for them when you decide to sell. And you won’t be alone — staring at millions of computer screens are other investors who share your confidence that the value of their portfolios will hold up.
But that collective confidence, Jorgenson says, is gone. And when confidence is drained out of a financial system, a lot of investors will decide to sell at any price, and a big chunk of that money you thought your investments were worth simply goes away.
If you once thought your investment portfolio was as good as a suitcase full of twenties, you might suddenly suspect that it’s not.
In the process, of course, you’re losing wealth. But does that mean someone else must be gaining it? Does the world have some fixed amount of wealth that shifts between people, nations and institutions with the ebb and flow of the economy?
Jorgenson says no — the amount of wealth in the world “simply decreases in a situation like this.” And he cautions against assuming that your investment losses mean a gain for someone else — like wealthy stock speculators who try to make money by betting that the market will drop.
“Those folks in general have been losing their shirts at a prodigious rate,” he said. “They took a big risk and now they’re suffering from the consequences.”
If anybody believes that the US stock market and global economy is just going to bounce back like before and be stronger than before then they are delusional. Huge international companies such as AIG and Lehman Brothers have basically bit the dust and aren’t going to make a comeback anytime soon. This will have severe repercussions for the US economy and like the article states, we are going to have a huge shrinkage in the financial sector.
And since they have really been wiped out, how can we reach the Dow high of 14,279 that we saw just a year ago? The simple answer is that we can’t. The economy is going to need to slowly rebuild itself, it is definitely not going to just bounce back as quickly as before. Most likely we are either going to see a U or L shaped recession and not the V shaped one we saw in the dot-com crash. This is of course based on the assumption that not more banks and institutions will be failing in the near future (which truthfully, I think some more major ones will be gone before this financial meltdown is through). Overall, the global net wealth has just decreased and it has not transferred from one person to another. It is just gone into the ether. It was never really there to being with since it was just our best guess estimate.
