Where does destroyed wealth go?

[dont]

Agree with everything you said,

but its difficult for them to take the inflation route, because we all know that they could try it, so when they issue debt, you as the buyer demand a floating rate, now when inflation bites they (the government) have to pay a huge coupon.

An inflation shock has to be unexpected like the oil shock in the 1970's.


Deflation is on the cards, they will pour money into it but ultimately they will fail.

But maybe just maybe they will prevent a contraction in GDP of 10%

 

[BlueHorseshoe]

Seems most here are talking about 'money' when the title asks a different question, i.e. where does the 'wealth' go?

Oftentimes percieved 'wealth' doesn't exist in the first place: it is only, in the words of PIMCO, a 'state of mind.'

I give you two simple examples:

1. Suppose there is a stock WLTH that trades on Nasdaq. Well, it is a very thin issue - for simplicity sake lets say it doesn't trade at all, but the market makers always quote on both sides of the market. Now imagine there is talk of a one or more tender offers at much higher prices, so market makers quote the shares very high, and the condition persists, again with little or no trading activity, i.e. no money is changing hands.

Shareholders may perceive that they are 'wealthier' because they can ostensibly calculate the value of their shares. Thus, they may become more profligate spenders, borrow against their shares, or otherwise take more risks.

Finally, assume the company adopts a poison pill and suitors all walk away. Thus market makers bring the quotes down dramatically, but again without any meaningful trading activity.

What happened to the wealth??? It only existed the minds of shareholders. It altered their behavior. And it vanished in the blink of an eye. Most importantly, that 'wealth' had only a tenuous relationship with money.

Example #2. Bob and Slob live next door too each other in $100k houses. Now suppose some numbhead overpays for the house across the street - say he pays $200k. Realtors knock on Bob and Slob's doors and tell them their homes are worth $200k and show them questionable appraisals to that effect. Suddenly Bob and Slob both feel wealthier. Bob convinces a mortgage lender to lend him a total $150k on his house based on the appraisal. Slob puts $50k on his credit card to buy that boat he wanted, comfortable in the thought that he can take a second mortgage if needed.

A year or two passes before all realize the house across way is only worth $100k like all the others, buyer only paid more because, as it turns out, he thought there was a seam of gold running underneath that specific property and he needed to get an old lady to move out of the home she was born in. When he didn't find the gold, he dumped the house for $100k.

Eventually Bob gets transferred out of state and puts his house on the market. Uh oh, he has $150k mortgage on a $100k house. Slob has a new boat and credit cards he cannot pay off. Both of them held imaginary wealth. Where did it go? It never existed in the first place - it was only a state of mind.

 

[joeski]

Thanks for the answers. Lots to think about.

 

[Rickb]

scriabinop23 has it exactly right.

Simply, money= credit. (not actually that simple but...) Credit was created out of nothing by banks to lend out (fractional reserve lending).

When debt is defaulted upon, debt gets repaid, or even lending slows from past lending rates, fractional lending runs in reverse and money literally disappears (goes back to zero) from the overall system.

On an individual level, as there is less money in the system, prices fall for all assets clases (some more than others due to supply and demand). Us individuals just trade around stuff using less overall money in the monopoly game.

Although money appears lost on an individual level, the disappearance occurs at the bank level, which is why no one can understand where it goes.

 

[bbqbbq]

the money didn't disappear. there are hidden winners in the US, who sold houses and stocks at the top. but who's gonna say they won, when everybody else is losing their jobs?

 

[telozo]

Money and wealth are two different things, as others here pointed out.

Let's say there are 10 houses on a block, and one of them just sold for 1,000,000. The only money that changed hands is the million for the house that sold, but everyone on the block thinks he owns a million dollar house, that is, 10 million of wealth lives on that block, but that is not money, is just the perceived wealth. Now let's say that the area falls out of favor because a nuclear plant is beeing built near by. One of the guys on the block sells his house for 500,000. Again, the only money that changed hands is half mil, but the wealth on the block has been reduced to 5 mil from 10.
This is my understanding of the matter.

 

[jprad]

Quote from joeski:

However, the money from the loan went to purchase something, no matter how dubious its valuation at the time of the transaction.

It also depends on what that something was. Was it a hard asset? Does the asset have the potential to appreciate or will it only depreciate to zero? Was it a consumable or a service?

why do people constantly mention the $11 trillion (or 16 or whatever) of wealth that has evaporated?

I presume you're referring to the talking heads on the idiot box. It's infuriating to hear them talk that way due to the simple movement of an index.

The gain (or loss) isn't realized until you sell what you bought. There's also the sticky issue of short positions in those markets that provide the ability to profit on devaluation.

 

[jprad]

Quote from W4rl0ck:

Money "conjured out of thin air" is leverage.

No, it's debt-based money.

You "create" the money via a journal entry. There's a very real debit that's created when the loan is made and the principle and interest has to be repaid to remove that entry.

That's also why the money "disappears" after the debt has been paid.

The rub is the interest, which requires additional money to have been created elsewhere.

Someone daytrades a security at 4/1 margin. The margin money comes out of thin air.

No, your broker is on the hook (liability) if you can't pay off the debit created as a result of the margin loan.

That's why they'll close out your position once you get close to wiping out the real value of your account.

In the good old days (pre 2002), banks required lots of collateral and ability to cover of the interest payments. Then they didn't and when the underlying asset price went down the banks had to eat the loss.

Not all banks bought into the scheme. There are plenty of small banks that continued to use the same means tests for making loans.

 

[jprad]

Quote from kxvid:

On housing wealth evaporation: Lets say you became a homeowner and bought a house. Your house appreciated due to the massive housing bubble. Lets say you then sold you house for a nice profit to someone who bought it using a subprime loan. You have then profited from this mortgage party.

Realizing a profit has nothing to do with wealth evaporation. Once you realize a profit you're out of the picture, your wealth is unaffected by current market conditions, assuming you've not used that profit as collateral for another home.

Say then the new owner is 200k underwater and cant afford payments so the exercise their contractual right: they default on the loan.

Being underwater, which is an unrealized loss, has nothing to do with not being able to service a loan. That's a cash flow problem.

However, say you profited 150k by selling that appreciated house to someone who took out a subprime loan they couldn't repay. They money was simply transferred to you at the expense of bank of america, goldman sachs, freddie mae or ivy league endowment loaded up with toxic products.

Again, your profit is irrelevant.

As for it being toxic, that's an aspect of structured financing. It'd help if you read up on it rather than conjuring it up out of thin air:

http://www.moneymorning.com/2008/09/24/financial-meltdown/

 

[BVM88]

Quote from joeski:

If there are so many losers, why aren't there an equal number of winners so that spending remains the same.

To summarise what others have said here, there can't be "an equal number of winners" because prices are set at the margin. It only takes one seller at a lower price to reduce everyone's wealth.