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Listener and reader Jens Eldrup-Jorgensen from Bath, Maine, asks:
If the stock market declines by 20%, is money (or assets) really “lost”? It is reported that the total valuation of the stock market has decreased by 20% which sounds as if the money has been lost. However as the stocks were sold (and the value declined), the sale resulted in cash to the sellers that was put in savings accounts or bonds so the total valuation of another asset class increased by a similar amount. So although those who bought stocks when they were high lost value, those who sold stocks when they were high gained value and the total valuation of all asset classes remained comparable.
Amid supply chain issues, the war in Ukraine and rising inflation, stock and crypto markets have plummeted this year.
Financial experts say: Yes, this indeed can be considered “lost” wealth. It’s gone.
Financial markets are not a zero-sum game compared to, say, a betting market, explained Robert R. Johnson, a finance professor at Creighton University’s Heider College of Business.
“A zero-sum game (like a betting market) is where money is simply transferred from winners to losers,” he wrote over email. “In a zero-sum game, no wealth is created or lost in aggregate.”
But with financial markets, wealth can indeed be created and destroyed.
“The financial markets, over the long run, have been positive-sum games. That is, wealth is truly created,” he said. “But, wealth can also be destroyed and that is what has happened recently in both the stock market and in the cryptocurrency markets.”
When headlines proclaim that these markets have declined by a certain amount, what they’re basically saying is that if you sold shares today, you would receive less in payment than if you had sold it at some point in the past when the price was higher, explained Albert “Pete” Kyle, a finance professor at the University of Maryland.
“It’s what historically people have called ‘paper losses,’” Kyle said. “But it’s real money for someone who actually is going to sell now as opposed to having sold out several months ago.”
If the price of a stock or bitcoin goes down, it doesn’t mean that investors were able to sell it and pocket that money, explained Asaf Manela, an associate finance professor at Washington University in St. Louis.
Manela said that’s because if we decide to sell an asset, somebody has to be on the other side of the transaction, agreeing to buy it.
If we decided to sell a company’s shares or bitcoin all at once, nobody would buy all of it, and the price would keep falling until it reaches a price where the average investor is willing to hold it, he said. In other words, the price can fall without meaning that most shares or bitcoin were sold, and thus investors wouldn’t have been able to pocket any money.
“There’s not that much of a relocation happening there,” Manela said.
He noted that some people will be able to buy and sell an asset quicker than others, avoiding losses in value.
“But for the average investor, they clearly lose value when the price goes down,” Manela said.