Stock Market Crash - Did $3 Trillion Really Just Disappear?

by: Erik Conley

It didn't disappear. It was never there to begin with.

Brexit is the biggest economic news story since the global financial crisis in 2008, and news outlets are competing for clicks and eyeballs. One way to stand out is to make scary but dubious claims that investors have "lost" $3 trillion in the last two days. But is that really true? NO!

What's true is that some investors who panicked and sold stocks in reaction to the Brexit fear-mongering may have lost money. But most investors didn't do that. And for them, no money was actually lost. It's a tricky concept, but I'll try to make my argument without playing Pollyanna to their Cassandra.

The Arguments

If the stock market crashes, do people lose their investments? Will ordinary people lose their pensions? Where does all of the money go? These trillions of dollars that are lost must go somewhere. So who gets it?

The argument that the pundits are making goes like this. Two days ago, the global stock markets were worth $70 trillion. Today they're worth $67 trillion. Therefore, $3 trillion were lost, or disappeared, or were somehow "wiped out." My argument is that this mythical $3 trillion was never there to begin with. To use Jim Grant's phrase, that $3 trillion was just "money of the mind."

Money of The Mind

Stocks represent shares of ownership in an underlying business. They are worth whatever investors believe they're worth. Two days ago, investors believed that all stocks that were available in the market were worth $70 trillion, and today they are worth $67 trillion. The value of the businesses themselves did not change, but the perception of what they are worth did. Money of the mind.

The only way to actually lose money in the stock market is by selling a stock for less than you paid when you bought it. A change in market price in the absence of a sale is called a "mark-to-market." That $3 trillion mark-to-market is real, and scary, and significant as a news item, but it's not an actual loss of capital.

Other Voices

Here's what Investopedia has to say on the subject:

Fortunately, money that is gained or lost on a stock doesn't just disappear. Read to find out what happens to it and what causes it.

Before we get to how money disappears, it is important to understand that regardless of whether the market is in bull (appreciating) or bear (depreciating) mode, supply and demand drive the price of stocks, and fluctuations in stock prices determine whether you make money or lose it.

So, if you purchase a stock for $10 and then sell it for only $5, you will (obviously) lose $5. It may feel like that money must go to someone else, but that isn't exactly true. It doesn't go to the person who buys the stock from you. The company that issued the stock doesn't get it either. The brokerage is also left empty-handed, as you only paid it to make the transaction on your behalf. So the question remains: where did the money go?

The most straightforward answer to this question is that it actually disappeared into thin air, along with the decrease in demand for the stock, or, more specifically, the decrease in investors' favorable perception of it."

Here's how another investing website explained it:

Did anyone really lose money when the stock market crashed?

Yes, some folks did lose money. Those are investors who purchased shares of XYZ at $100 and sold at $80 when the prices fell. (Hope you are not one of them!) But those who held onto their shares did not lose real money, they just lost money on paper.

Say, for example, the stock market recovers after six months and the price of XYZ rises to $110. Those folks who held onto their shares when the price fell to $80 can now sell at $110 for a real profit of $10 per share.

In summary, you lose real money in a stock market crash only if you sell any of your shares at a price lower than what you purchased them for. If you don't need the money right away and if you are patient enough to hold onto your shares, you can potentially sell the shares later at a higher price than you purchased them for."

Here's how a professor at Regis University explained it:

The money does not "go" anywhere. It is literally lost. Stock market money is mostly a measure of value, not a medium of exchange. When the value of a stock goes down, the money by which it is measured simply disappears.

The value of money in the stock market is based on faith in the value of the stocks that the money represents. So when the value of the stocks declines, the money that measures the value of the stocks declines by the same amount. No one gets the money that is lost. It simply evaporates.

It's a mistake to think of money as something real, rather than what it is - a symbol. Money seems "real" because we use it as a taken-for-granted medium of exchange in daily transactions. We use money because we know it "works" to make these transactions. But money is simply a system of accounting for trades in real goods and services. To the extent that it measures anything, it does so because we believe that it does.

"Money" is not the material representation of "dollars" or "change" you carry around with you. It is an "idea," a concept that is based on nothing other than our faith in (a) its usefulness in procuring what we want, and (b) its capacity to measure the "value" of the things we think we "own." When we lose faith in those functions, money ceases to exist. Hence, the money we invest in stocks disappears when the stock loses value."

Conclusion

$3 trillion did not disappear from the face of the earth over the last two days. But investors still feel the pain as if it did. If you are convinced that the fallout from the Brexit vote will be so bad that the stock market will continue going down and not recover before you need to cash out your retirement account, then you should probably get out now. But for most investors, just cutting back a little on equity exposure should be enough to calm the mind and protect the portfolio.