• Where Did The Money Go?

    This post originally appeared on The Finance Buff.

    In 2008 U.S. households lost just over $11 trillion in wealth, or 20 percent off the 2007 peak. Most of that loss was in the value of housing and equity holdings. Some have asked, “Where did the money go?” (Google this phrase and you’ll see it is a hot topic.) This question is actually pretty easy to answer, and I will do so. But I also find it interesting to explore why it is asked.

    First of all, when asset values are growing very few ask, “Where did the money come from?” Perhaps we take for granted that asset prices rise over time and rarely stop to think about the source of the value. Nevertheless, when things go bad many people want to know where their money went.

    But assets like houses and stock shares are not money in the same sense that cash, checking account balances, or money market funds are money. Such financial assets are valued in money (dollars in the U.S.) and are bought and sold for money, but they’re not money: houses are shelter (clearly not money), an equity share is a unit of corporate ownership (not money either). In fact, for the purposes of considering abstractly their market value you can think of stocks and houses as consumer goods, like toasters or iPods.

    The value of an asset is determined by the market: supply and demand. The price today is different than the price yesterday or tomorrow. Maybe yesterday everyone wanted an iPod so it had a high price. Tomorrow everyone decides to buy the new brain implant and the iPod’s price plummets. The value of all those iPods on shelves or in circulation drops.

    The same thing happens to houses and stocks. When the market for them weakens, wealth is destroyed, but only insofar as wealth is measured by the value of those assets. No actual money is destroyed, and nobody gets an offsetting gain. No money went anywhere.

    Fundamentally, numbers are abstract. When you subtract two from four nothing tangible is destroyed. Nevertheless, the answer is two. Where did the other two go? I guess the same place it came from. There is not a fixed supply of twos. The price of a house is just a number. It goes up and down. When it goes up we say that there is more house-wealth. When it goes down, some wealth has been lost. Still, no money has been destroyed since houses are not money. Nobody gets an offsetting loss when your house appreciates, and nobody gets an offsetting gain when it depreciates. The money value of houses (or assets in general) doesn’t go anywhere.

    Why do we ask, “Where did the money go?” during an economic downturn? Why is there a notion of conservation of the money value of assets, that everything is zero-sum? I think the confusion stems from two other ideas in finance and economics. One is the zero-sum nature of a transaction. When I buy a toaster from you for $20, my $20 becomes yours and your toaster becomes mine. There is no overall change in money or toasters between us. Both obey the law of zero-sum (my gain is your loss, and vice versa).

    Another concept related to the conservation of money is the size of the money supply. The total amount of cash in circulation is fixed, until the Treasury Department prints more. We do not normally think of cash being destroyed, of piles of currency going up in smoke. (Currency can devalue so there is a sense in which it isn’t that different from an asset. Let’s not go there.)

    So, if we have the notions of zero-sum transactions and a fixed money supply we are easily tricked into thinking wealth cannot be destroyed in aggregate. My loss must be somebody’s gain. The money must have gone somewhere. But, as I said, assets are not cash. And, while a transaction may be zero-sum, what happens later to the value of the assets that were transferred is not zero-sum. When the toaster I bought from you depreciates to $10 you still have the $20 I gave you. That I may now only be able to trade my toaster for $10 on the secondary toaster market has nothing to do with the $20 I paid you for it. You do not achieve any further gain for my loss of toaster-wealth. My declining wealth in toasters is my own, offset by nothing.

    So, where does the money go when wealth is destroyed? Answer: the same place the two goes when you subtract it from four. It was a number. It wasn’t money. Wealth, yes, with value denominated in money, yes. But money itself, no.

    • Nice post. I’m really enjoying your stuff so far TIE.

    • Thanks for the post, TIE. People love to ask “Where Did The Money Go?” when they lose, but rarely ever ask “From Whence Did The Money Come?” when they win.


      I love the 4-2 analogy…

      This goes along w/ an idea I was toying w/ the only way efficiency isn’t punished is if the standard of living goes up… o/w bad things happen hehe

    • geoff-

      >> Nice post. I’m really enjoying your stuff so far TIE.

      Thanks! That’s so nice to hear (read).


    • Well said. The key phrase that I kept thinking while reading your post was “unrealized gains in wealth.”

      Something that would beneficial to your readers (or at least me) would be to link the rise and subsequent fall of home values more clearly with the “wealth” produced through derivatives and credit default swaps.


    • Isn’t this oversimplifying things a bit?

      If I bought one share xyz.com stock at $100 last March and today the value is $50 for that share, the money did really go somewhere. It did not never exist because it went from my bank account to someone else’s. I am left with the same shares, but the money did really go somewhere.

      The same goes for a house. If I bought a house for $200,0000 last year and borrow $150,0000 the bank I borrow from must satisfy the $150,000 balance to owner of the property at closing. If today the value of the house, which I still have, changes to $100,000 you cannot say that $50,000 of my real money paid at closing and another $50,000 of the bank’s money never existed.

      The better question to ask is not where did the money go, but why did the price change so rapidly? What caused “the market” to suddenly decide xyz.com shares are only worth 1/2 the price everyone believed it was worth the previous day? How many sellers did it take to make this change happen so fast?

      Anecdotally (is that a word?) speaking everyone lost huge on the stock market collapse. How? Shouldn’t only the people that have not sold anything lost huge? Yet that is not what we hear. Wouldn’t a market movement of this magnitude require a very large portion of investors to have sold their positions? Did this happen? If not why did the price change if there weren’t that many sellers? Has anyone done a study on the allocations by % of shares of investors (not counting market movement) from last year to now?

    • @Ted – I was thinking along the same line. For people who had the assets that rose in value and now dropped in value, they still have the same assets. No money changed hands. But assets don’t just magically drop onto your lap. For people who paid money for those assets when prices were high, they lost money. The lost money went to the sellers and all people involved in the transactions. There’s nothing theoretical about it. Suppose I bought my house at $600k while it really should’ve been $300k without the real estate bubble. The seller got cash. The real estate agents got their commissions based on the inflated price. The mortgage brokers or bank loan officers got their pay based on the loan amount which was driven from the inflated price. Counties got more taxes than they should’ve received. All those were paid with money. At least some money went to those parties.

    • ted, TFB–

      You both are arguing that you lose wealth when your asset values decline. That is absolutely correct. You do lose wealth. The question people ask is where did that money go? I have interpreted that to mean that there is an expectation on the part of the questioner that someone gained by virtue of your loss. That is the fallacy. Lost wealth, lost opportunities based upon that wealth, yes indeed. A corresponding gain by someone else, not at all. That’s what I’m talking about. It is different to lose wealth than to lose cash in a transaction. The former is your loss and that is all, the latter is a zero-sum situation where someone else gains what you lose.

      TFB, I do not believe it is helpful to think that once your asset loses value the person from whom you bought it gains. The amount received by the seller when you bought it is fixed at the time of transaction and for all time thereafter. Any subsequent loss of value does not cause a gain to that seller. This is exactly my toaster example.

      If we still disagree I think it must only be a matter of interpretation and semantics. It is absolutely clear who has what money and who suffers from the loss of asset value and your examples do not contradict anything I am saying.


    • TIE – I agree it’s probably a matter of interpretation and semantics. Let me try again. If you bought a Rolex for $7,000 and it turned out to be a fake afterwards, $7,000 were transferred from your bank account to the seller’s bank account. Unless you trick someone else into buying that fake Rolex from you for thousands of dollars, the loss is permanent. You lost wealth. You lost cash too: you used to have $7,000 cash in the bank; now you don’t. The seller does not have to be a fraud. He may not have known it was a fake. Fraud or not, you lost cash anyway. Cash in the bank is gone. When did the loss of cash occur? At the time when you bought? Or at the time when the watch was discovered to be a fake? I take you are saying the former while I say the latter. Either way, if someone asks me “Where did the money go?” I will answer “To the seller.”

      It’s a different story if you inherited a Rolex that’s always been in your family. You always thought it was genuine, and then one day you discover it’s a fake. If someone asks “Where did the money go?” I will say “Nowhere.”

    • TFB,

      Take away the fakeness and trickery of your Rolex example and it still illustrates the issues. At the time of transaction neither the purchaser nor the seller has lost or gained any value. It was a zero-sum exchange. $7k in cash for $7k in Rolex. Later, when the Rolex loses (or gains) value (for whatever reason), is it zero sum or not? Is there an offsetting loss (or gain)? No! You cannot find any. Only the owner of the Rolex suffers the loss (or enjoys the gain). How can the original seller benefit (or suffer)? He has $7k in cash. That is all.

      The issue I’m addressing is what is meant when economists use the term “wealth destruction.” They say the US lost $11B in wealth last year. Where did it go? Can you find that $11B? Does someone have it? No. Wealth was destroyed.

      Run it in reverse. When we gained $11B, when all our home values went up did someone lose $11B? No. We got wealthier. It was new wealth, obtained at no one’s expense.

      Imagine you and I have an economy. Nobody else is in it. I have $20 cash and you have a toaster. I agree with you that the toaster is worth $20. That’s what I’ll pay for it. This is a $40 economy, $20 in cash and $20 in toaster. I buy the toaster from you. Now you have the $20 cash and I have the $20 toaster. Economy is still at $40.

      Later, I want to sell the toaster back to you but you say it is only worth $10 (depreciation). You still have $20 but now I have $10 in toaster value. This is a $30 economy. Where did the $10 go? Destroyed. Gone. Nobody got it. Burned up with the toast.

      We can agree to disagree on the words. But this is wealth destruction and nobody benefits from it.


    • TIE – Ah, I see you are looking at the aggregate level while I’m looking at the individual level. I agree with you at the aggregate level. Say I had a toaster and you had $20 cash. You wanted a toaster badly and offered to pay me $20 for my toaster. I didn’t understand why you wanted to pay that much for my toaster. It was really only worth $10 in my mind but how could I turn down the offer? You reported to the higher-ups we had a $40 economy between the two of us. A year later, you realize that little toaster is worth only $10 anyway. Now our economy is $30. Our economy remains the same though: one toaster and $20 cash. Money didn’t leave the system although wealth is destructed. I agree with that. At the individual level though, I now have $20, and you have my shabby toaster. Who’s happier about the toaster bubble?

    • TFB,

      Yes, you see it now. It isn’t about individual happiness. It’s about wealth and “where it goes” when you lose some. All we have are prices. You can call them “inflated” or “undervalued” or whatever. But that’s how we measure wealth economically. There is no other way. Even an inflated price has opportunity, if one can time it.


    • Interesting discussion guys. Reminds me of this riddle:

      Buffy, Cherri, and Candi are staying at a motel while in town for the big cheerleading convention. The motel manager said a room cost $30, so each woman put up $10 and went to their room.

      A little while later the manager realized the room was only $25, so he sent the bellhop back to the three gals’ room with $5. When he got to the room, the women couldn’t figure out how to split the $5, so they kept $1 each and gave the other $2 to the bellhop as a tip.

      This meant that the 3 women paid $9 each for the room for a total of $27. Add the $2 that the bellhop got = $29.

      Where did the other dollar go?

    • ted-

      It’s a good riddle. TFB included it in one of his posts: http://thefinancebuff.com/2008/07/401k-loan-double-taxation-myth.html

      He has a link to an explanation and also includes a brief one in his post. I’ll try for the shortest possible explanation:

      30 – 3 – 2 != 30 – 3 + 2


    • Ted:

      I’ve heard that riddle so many times and still get tripped by it lol. You add the 25 + 3*1 + 2 right?

      Sorry if i ruined it =(!

      So… demand right?

    • I basically have the same as the solution you gave in that link right? The main difference is which point i am accounting for haha…

      Read thru the double taxation and seems like a good solution to me 😀

      Btw, you are required to pay state taxes on that loan? or no… that always confused me heh.

    • @SJ – You subtract 2 from 27. 27 – 2 = 25, which is the cost of the room. Not 27 + 2 = meaningless. Now can you solve the 401k loan double taxation problem?