[p2p-research] Fwd: Where does the "lost" money go ? can we find it and get it back ?

[Stan Rhodes]

Michel,

Thanks, I'll try to answer your questions, but I think in some cases
they carry incorrect assumptions that must be teased out.

1. The value of assets is not in the market as actual money.  The
assumption that "at one point, somebody did buy it at such value" is
incorrect if you mean the current valuation.  As with the diamond
example, if I pay $75, and then it increases to perceived value on up
to $200, but then I have it appraised and it's not worth anything, how
much did I lose?  I lost $75 (plus interest, or some sort of
opportunity cost).  Not $200.  Being valued at $200 doesn't mean I
bought it for $200, nor that anyone else did.   People may have been
willing to buy it for $200 before it was appraised, but once they find
out it's glass, they'll offer me only a penny.  The price of the asset
is always an estimation of its value by others in the market.

The speed/ease with which assets can be converted to cash is known as
their liquidity or marketability.  Since assets are not money, but
stores of perceived value, some are far easier to sell for cash than
others.

A quick and simplified example of an asset relevant to the crisis: a
mortgage, which is a promise to pay some amount every month.  If I'm
an investor and I have a slice of that mortgage, I get paid every
month, and I get more back from my investment in that mortgage than I
might have if I had deposited the money in a savings account.
However, the mortgage has more risk: the borrower might default.  To
communicate this risk to investors and the market in general,
borrowers and mortgages themselves are rated.  The rating system
failed.  Between conflicts of interest and improper checks and
balances, it failed to properly assess risk.  Of course, there was
more than a single mortgage: there were pools of mortgages that were
sliced and diced, repackaged, and swapped about.


2. I can't tell if you see a problem with assets, or a problem with
the fractional-reserve system, or are somehow sort of combining the
two.  I will separate the two.

First, I'll use mortgages to clarify.  Sure, in some cases people took
out a loan and used it for a vacation, but many also used one for home
improvement, thus--in theory--increasing the value of their home.

Assets and credit/loans are two different things.  The diamond analogy
only goes so far; instead, maybe I should have used a laying hen that
produces eggs regularly... does a foreclosed chicken = dinner? The
trick is that in a mortgage, a person's promise to pay is used as an
asset by the bank, as mentioned above.  On the borrower's side is a
line of credit or loan in exchange for his promise to pay, with his
house as collateral.

If the borrower does not pay back as promised, the bank forecloses on
the property.  The bank then attempts to sell the collateral (the
property), and apply that money toward the debt.  Remember, the
mortgage--as an asset--has value because of the income stream created
by the borrower paying back his loan.  If the borrower defaults, that
income stream doesn't exist, and the value of the mortgage drops.

Second, concerning loans: the bank can always lend money.  The riddle
is this: If the bank "lends again," is it lending the same money it
"destroyed," or different money?  The answer: It's irrelevant.  The
bank's books just have to balance.  This is hard to grasp because most
of us earn money and treat it as a tangible, real unit that is
exchanged for goods and services.  You have to forget what you think
you know about money, and look at the actual flow.

In theory, what Thomas said about the loan is correct, but in
practice, it's not visible or particularly relevant.  That may seem
extreme, but what actually matters to a bank is how much it can lend.
How much the bank can lend is determined by the regulations of our
fractional-reserve system:
http://en.wikipedia.org/wiki/Fractional-reserve_banking

The original questions concerned the drop in value in financial
markets, and where that perceived value--which was confused with
money--went.  The super-brief response to the original questions is
this:

The (US) stock market is valued using a dollar amount, but that amount
is actually _perceived value_.  The dollar value is only a measure of
estimated worth of assets; it does not exist as money.

-- Stan

On Fri, Jan 9, 2009 at 5:04 AM, Michel Bauwens <michelsub2004 at gmail.com> wrote:
> Dear Stan,
>
> Thanks for taking all that time to explain things,
>
> however, I still don't see the logic of the 2 things that thomas claimed, so
> perhaps you, or someone, could answer those very specifically
>
> PROBLEM 1:
>
> - the stock market is worth say $3Tr, and because of a crash, it's suddenly
> only worth $1Tr. I'm assuming that money has disappeared from circulation,
> because at one point, somebody did buy it at such value, yet is not getting
> it back ... (or is it not really destroyed, because somebody actually got
> paid that overvalued amount at some point?). In the first case, if the $2Tr
> is destroyed, and the govt only creates $1Tr, then there is still less in
> circulation than before, and therefore, there is no inflation. Would a case
> in point not be japan, that flooded the market after the 90's crisis, yet
> remained in deflation because it could not compensate the value loss. In any
> case, I have seen this argument being used by serious economists
>
>
> PROBLEM 2
>
> - Thomas says that when A creates a loan for B, and B repays that loan, that
> money is destroyed, yet, this is money that the bank can lend again. On the
> other hand, if person B invests that money  in a diamond, which turns out to
> be glass, and looses that value, then the money is not destroyed, even
> though he cannot actually use that money again .. The issue is the same here
> I think: do we consider that this lost value was at least paid to someone,
> who presumably could use it. If that is the case, then the money was not
> lost. However, that doesn't change the argument concerning the bank, and the
> illogicallity of pretending that a repaid loan that can be used for new
> loans actually means that the money was destroyed ...
>
> Michel