Every time stock markets drop, headlines say that billions have been lost. But where does that money actually go? If you want to understand crashes, confidence, and the baked bean market (trust me), this one's for you.
This is the audio version:
This is the transcript:
I am expecting a stock market crash. I don't know when it's going to happen. I do think it will happen.
Why do I think it will happen? Because the peace that has been brokered in the Middle East is not going to last, and the euphoria that is still sweeping markets is going to end, and as a consequence, I think markets will fall.
Every time that happens, a newsreader in a studio in the UK reads out a headline that says something like "A hundred billion pounds was wiped off the value of the stock market today", and the question that I'm always asked as a result is, where did that money go? And the answer is nowhere. Let me explain.
Imagine that there aren't shares for sale, but instead, there are tins of baked beans for sale in the stock market, and the stock market looks remarkably like Sainsbury's, or Tesco, or Lidl, or Asda, or wherever else you go. Let's give the Co-op an honourable mention.
Those tins of baked beans are sitting there at a price of £1 each. And suppose that there are one million tins of baked beans available for sale today in the UK, which is a number which I suspect is not far from the truth.
Now, what is the total value of the baked bean market today? If the beans are sold for one pound each, it's £1 million. That's the value of the baked bean market.
Now, let's suppose that one of those supermarkets decides that it's going to drop its price of baked beans from £1 to 80p, and all the others will copy because this is one of those benchmark items on which they price match. So the consequence is, everybody will cut the price of baked beans to 80p, and there are still 1 million tins available, so what is the value of the baked bean market today? It's £800,000.
£200,000 has disappeared, apparently, except it never existed.
The £1 price tag that was attached to the baked beans was simply a hope value. It was a measure of what the supermarket hoped that you would buy baked beans for, but until you paid it, there was actually no proof that the price was right.
And now the hoped-for price of baked beans has fallen from £1 to 80p. The market has revalued baked beans. Hopes have changed, but no real money changed hands as a consequence.
The same thing happens in stock markets. If £100 billion is lost because the price of shares has fallen, people are no longer willing to pay the higher price. A share that was valued at £1 is now valued at 80p, in exactly the same way that a tin of baked beans that was valued at £1 can now be valued at 80p.
No money's disappeared. All it means is that the expectation of the sale price that the share in question might realise if somebody came along to buy it has changed.
There's been a repricing of hope in the stock market, and stock market values in this sense have nothing to do with money in the bank. They're a measure of the hope of the amount of money that might end up in the bank if every single share that was available for sale in the market was sold at the price somebody might pay today.
In other words, that value is just a guess. It's nothing more than that. There has been no sale to prove it's right in most cases. There has been no money made across the market as a whole at the price in question.
So, when, and if, markets are revalued, the people who hold the shares that have now fallen in value will have made a loss, but only on the shares they're holding for sale. If they didn't expect to sell them, they've lost nothing at all. They've still got the share, and that's exactly the same with the supermarket. They will, as a consequence of repricing baked beans from £1 to 80p have lost 20p on each tin of beans that they sell, but suppose that in the couple of days time everybody is flooding into the shops and buying lots of bake beans, they can put the price back up to £1 again, and their hope value will have been restored. The loss would've been small. So might it be when there's a hundred billion pounds written off the value of stock markets.
The point is this. Markets are not built on certain prices. They're built on confidence, and confidence comes and goes. When confidence is high, prices go up. When confidence is low, prices fall. But that doesn't mean that money has gone anywhere, because all that the price of a share represents is that ticket, which is on the stock market shelf, which says you can buy this if you are willing to part with this much now, and the price of a share can move quicker than the price of any tin of baked beans because that's just the way that stock markets are designed. But to suggest that the value was certain in the first place is wrong. It was wrong, in fact, to price the product - the share - at £1 - because, in fact, it turns out it was only worth 80p.
So the point is, has there been a profit? Has there been a loss? Well, in principle, those who own the shares that they could put up for sale have made a loss, but if they sit things out, as I just explained with regard to baked beans, the price might go up again very soon, and they've lost nothing at all.
If somebody's got to sell today because the share is sitting on the shelf and has to go by tonight, like some perishable food item rather than a tin of baked beans, then yes, sure, they've made a short-term loss.
But there's only really a big loss if everybody starts to sell in a panic, and all of those people who then force their shares into the market create massive cash losses, and that's what, for example, happened in 1929, and to some extent it happened in 1987, and it happened again in 2008. It's only panic that really creates big, real losses in financial markets, when there are usually just small movements day by day, and the market goes up by a few billion or down by a few billion. Then there's not really any cash loss at all. This is just a simple repricing exercise. So crashes shift hopes, but unless everybody sells at the new lower price and nobody is normally forced to do so, they don't shift bank balances.
So, did money go anywhere as a result of that £100 billion being wiped off the markets?
No, the money didn't disappear because it was never there in the first place. The only thing that was there were shares that were made available for sale at the wrong price, and as a result of things changing, expectations changing, there's been a revaluation of the market, but there's been no destruction of cash.
The simple point is, value is a guess; we get our guesses wrong, stock markets reprice our expectations, and then share trading carries on. Market crashes are about emotion, not the physical exchange of goods or services, or even money. They are just about people having hopes for the future, which they sometimes get wrong, and when they do, the value of stock markets falls, but don't let that sort of panic define your truth. A stock market crash does not need to mean an economic downturn.
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Even though you need a certain amount of selling to force share prices down, I always laugh at the news items you mention.
It’s really basic – you only lose value if you sell for less than you bought the share for.
I lost money when I sold my last house.
Long story
BUT I did so on he basis that hanging on to it carried significant risks that I was unwilling and unable to run.
So in the same way with any asset, if I thing Company X is looking iffy then taking a loss on its shares today may be better than losing the lot next month.
Plus of course in the time I owned it I had the benefit first of living in it and then the rent it produced.
Ditto with shares and dividends
Yes, it is hope value, and there is no actual loss unless you sell.
Suppose the supermarket bought the beans at 50p per can, hoping to sell at £1, and the retail price collapses to 25p. Then it has to dump its stock at a loss, and the money goes to money heaven. That is what happens to people who buy high, hoping to chase prices even higher, when they are forced to liquidate at a real loss to raise cash.
The press hype everything. In the Independent this morning I read hype about market reactions to the Reeves tearful show at PMQs.
There are some serious valuation issues to explore. Surveyors, for example, value multi-tenanted office and shop developments based on the last rent achieved, which leads to rent-free periods so that developers can keep their banks happy. Defined benefit pension funds value future pension liabilities using a discount rate that may or may not ever be realistic. When asset values go into decline in a recession, such assumptions can be faulty.
“If somebody’s got to sell today because the share is sitting on the shelf and has to go by tonight, like some perishable food item rather than a tin of baked beans, then yes, sure, they’ve made a short-term loss.”
And you have only actually made a loss of money if you paid more for the item than you are forced to sell it for; in the same way that any gambler loses when their horse does not win. Otherwise, what you have lost is hope and expectation,
You get the point.
As you so often explain, there is a serious misunderstanding amongst the public and far too many professionals about the workings of the money economy. This is based on the ‘household budget’ comparison with gov finances. Even this morning, we have Farage( who should know better) saying he would run gov finances as a business. I don’t think this would have any chance of achieving gov objectives as businesses are trying to achieve a profit or surplus. It might sound good to the uninformed public, but anyone who really knows economics can see it would be disastrous for everyone except Farage and his pals. Trump is on the same path, drastically reducing basic services for citizens and shrinking the economy as a result.
Agreed
And Farage does not know better
He knows very little
You state the bleeding obvious..
And your problem with that is?
That was really helpful. Although I still struggle to fully understand the political role played in our state economies by the gilt bond markets. I just posted this Guardian UK Politics Live comment over on Robert Reich’s substack. It neatly sums up the feeling of so many of us. Haveaperspective wrote:
What is the point of having government if the financial sector rules ? It’s like living on top of a volcano.
Ha! This reminds me of the Great Sheffield Bean Wars of some decades ago when competition forced the price of a tin of beans down to 2-3p!
Students and pub landlords were happy but I don’t know whether the sales volumes of other supermarket items increased…
As well as the fallacy of ‘government should be prudent and run the economy like a household’, so widespread among the public, so persistent in the background of media commentary – and so well debunked here! – there’s also the public misconception of what the stock market actually does: they (Joe Public) seem to think that people buying shares on LSE or wherever are actually ‘investing in ABC plc’; whereas really they’re only buying into the expectation (or hope) of future cashflows from dividends or share buybacks, or capital gains (if and only if they sell). Hence Finance 101, ‘fundamental’ valuation of the share price; all based on assumptions about the future; onto which we have to add all the charting and other analyses and the emotions, ‘behavioural finance’ or ‘animal spirits’, of the stock-market trading community themselves, to get the market price. Price, not ‘value’…
As I repeatedly say to people: “The trouble with the future is that we don’t know what occurred because it hasn’t happened yet.” And of course, “Past performance is no guarantee of the future” as the financial advisers are always obliged to say; whilst offering loads of advice based on the ‘track record’ and strategy of the fund manager or company directors…
So the buying and selling in the stock market is effectively a zero-sum game, simply transferring assets (of unknown real value and fluctuating price) in exchange for ‘real’ money. That money was actually never ‘in’ the market: it was in the bank account of the buyer; and then transferred to the account of the seller.
Perhaps to extend the analogy of the supermarket baked beans re-pricing: if someone bought a tin of beans at today’s price; and whatever its price tomorrow; if they want to eat beans, they have the ‘use value’ of one tin. By analogy, they will get the income from buying a financial instrument, whatever price they paid for it. (The analogy weakens, in the case of shares, since that income is uncertain; only in the case of a bond with a fixed coupon is it a fixed amount – though not in terms of yield on the price paid. And bonds still have some uncertainty, except for the near-zero risk of gilts.) It’s only if the bean-buyer decides to become a bean-trader that they’ll realise any capital gain or loss.
Why therefore do the media obsess over ‘losses’ in the market?
Perhaps because of leverage and the possible contagion across wider financial sectors, banking and liability-driven asset sales? Probably because we’re into the ‘Ponzi’ stage of financialized capitalism (using Minsky’s terminology) – in which capital gains are essential to maintain the ability to repay the credit used to leverage investment (ie. speculation)? Then, falls in market prices can bring on the recessionary part of a business cycle, as investors are forced to realise losses.
Thanks
And much to agree with
[…] Cross-posted from Richard Murphy’s blog […]
Where does money come from when share prices rise?
In monetary terms, something is only “worth” what someone else will actually pay you for it in an actual sale (or more generally the cash flows you can derive from owning it). Unrealised gains, unrealised losses, are just written on paper; easy come, easy go. Cash is king.
Thank you Richard. As Jake says, it is bleeding obvious. Unfortunately, most people don’t get it. Since political success depends on getting the votes of “most people”, Governments don’t get it either. To be precise, some MPs get it, but find it expedient to keep quiet. Or like the chancellor, they really don’t get it.
A small-scale corollary: A bank makes a loan to the supermarket to buy the baked beans, the price of baked beans goes down, the supermarket can’t repay the loan. The bank makes good the deficit from interest on its other loans. So whose money did the bank lose? Presumably Government-printed money, so that the Government will have had to create or borrow money to make good the bank’s loss?
So that when the chancellor tries to “balance the books”, she has to help the banks before she can help the disabled
Nice video! But as a professor of economics, I think this is wrong, or at least leaves out some crucial points. What you’re saying is correct if there are no fundamental movements (and so might describe purely speculative assets such as crypto), but is at odds with the dividend discount model and similar concepts of fundamental value. If, say, Trump imposes new tariffs, this will have two effects. First, some mutually beneficial trades can no longer occur, so the total size of the pie is now smaller (we know there will now be fewer cans of beans in the shelves). Second, in anticipation of this smaller size of the total pie, stock markets will drop, because discounted firm profits will now be smaller. So the price in the stock market indicates the expected shrinking of the total size of the pie. Value has actually been destroyed. Yes, it’s future value, but its a real not merely a nominal or speculative effect.
See a reply on my blog.