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Tuesday, September 30, 2008

$1 Trillion Doesn't Vanish Into Thin Air

Yesterday, the US stock market declined by approximately $1 trillion total market capitalization. The mainstream media falsely says "$1 trillion in wealth was destroyed yesterday."

Let's consider an analogous headline "100 million people took a sledgehammer and intentionally wrecked their car." Assuming a value of $10,000 per car, then that headline means that $1 trillion in real wealth was destroyed.

No actual real wealth is destroyed when the stock market declines. No actual real wealth is created when the stock market rises.

A declining stock market means that it's harder for corporations to raise money. When CEOs pay themselves with options and equity, that perk is worth less in a declining market. If a corporation does not need to raise money, then a shareholder owns the same percentage of the company after a market decline.

A rising stock market makes it easier for corporations to raise money.

In the long run, stock market returns are a couple percent less than true inflation. An individual investor can't prevent corporate management from paying themselves huge salaries and squandering resources. Overall stock market returns are strongly correlated with true inflation minus a few percent.

Of course, if you buy a stock just before a 10% decline, then you just squandered 10% of your savings. Similarly, if you buy a stock just before a 10% rise, then you just extended your savings by 10%. However, wealth was not created or destroyed by either scenario. Wealth was merely moved from one person's pocket to another person's pocket. An individual investor usually times his transactions poorly. An individual investor usually performs worse than random investing or investing equal amounts at equal intervals.

In most people's minds, pieces of paper and actual real wealth are confused.


eagledove9 said...

Deliberate Deflation

Let's ask this question another way.

Suppose you wanted to make trillions of dollars vanish into thin air ON PURPOSE. What would you have to do?

Time frame to achieve the goal could range from 'overnight' to 'several months,' but less than a year.

I'm not thinking of making paper money disappear. That would be like if a bank vault caught fire or something, and that's not what I'm thinking of. Instead, I'm thinking of ELECTRONIC money, the stuff that only exists on computers, and the stuff that exists on paper except its value is determined by the market.

What are your thoughts on that?

Anonymous said...

Here, we actually can touch on what a fiat government can do.

Everyone talk about inflation/deflation as if paper money system must obey some sort of rules...

What prevents government from creating, say 10 trillions overnight and secretly distributing this to the banks? What, an accountant? Shortage of paper?

Intentional deflation is harder simply because you need a willing party to lose money, where for an inflation, anyone would go along.

Would you mind receiving 10 mln on your bank account? I wouldn't. Because I am human. But, I won't like to play the game if my money were to "secretly vaporise".

This is why, there can only be an inflation, as money can not destroy themselves and will only change accounts, until government interferes in an only accepted way - bringing in extra money.

This is why inflation is guaranteed, but not because of some rules or laws, but strictly because a recipient won't mind.

The only way an deflation might occur, is if participants allow their impoverishment, such as, for example, when government defaults on it's promises.

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