Can wealth be destroyed or merely transferred?

[darkhorse70]

For example if the stock market crashes, and billions or trillions vanish does wealth simply vanish or is just transferred from one hand to another. For example wealth is created in a bull market for person A and wealth is lost in a bear market for person B so its essentially equal? Is that correct or incorrect.

 

[minwa]

Transferred.

If a share goes to zero the stockholder loses and whoever sold it to him last gained the cash. The "wealth" that's transferred is in the form of that cash which that person may have invested into other things or taken out as cash to spend on other things. If a share to went to 0 you can bet that the people who short sold the share or held puts will want to get their cash.

Maybe in a total collapse of the stock exchange system or financial system and the exchange does not honor/sort out counter party risk then is wealth destroyed. Then again, in that case the exchange gains the wealth by paying less than they owed.

 

[cynic]

A further aspect needs to be considered, namely the illusion of wealth creation/destruction that is caused by the process of "marking to market".

e.g. if 10 traders start their portfolio by buying equal quantities of all floated shares of XYZ for $10ps and the only subsequent trade for that day was one of those traders selling his/her XYZ shares for $11ps, then how would one account for the entirety of the 10% paper profit that would be deemed to have appeared on the remaining 9 shareholders' portfolios when only 1/10 of 10% (i.e. 1%) of real wealth was added to the total shares on issue?

 

[Value Collector]

Companies can destroy wealth,

If a company builds a $1billion oil rig, and it blows up and sinks to the ocean floor, that $1billion asset is gone, the loss might be spread around by insurance, but still our economy has lost a $1billion asset

 

[Knobby22]

I agree. Wealth is not like entropy. it is continually created and destroyed.

In a stockmarket crash, not every share is shorted so wealth is destroyed.
If a person buys a share at $1 and sells at 10c, then he is undergoing wealth destruction. True the person who sold the share at $1 still retains the $1 and the person who buys the share at 10c still has the share but the person in he middle of the transaction has lost 90% of his wealth due to that company.

Growth has made us all wealthier, we are far wealthier due to advances in technology, efficiency of services, supply chains and manufacturing. If oil say went to $100 a litre we would all be poorer in today's world as food etc. would be more expensive.

 

[darkhorse70]

Thanks for the reply guys. Im goung to assume it can be created and destroyed then. The illusion is to mind boggling for me to grasp haha. I had to ask this qs or I couldnt go to sleep. The example im going to use is that if I bought a vehicle off a car maker then I recieve an asset and he recieves money. If I crash the vehicle then I have lost wealth (no insurance). Its vanished? Disregard depreciation etc. In reality the wealth of that asset was consumed into thin air. Haha I wonder if this subjectis debatable by economusts. Watching a doco yesterday about economists who argue that humans are rational investors vs they are not.

 

[So_Cynical]

I think there is a creation and destruction cycle going on with an element of transference.

 

[minwa]

Companies can destroy wealth,

If a company builds a $1billion oil rig, and it blows up and sinks to the ocean floor, that $1billion asset is gone, the loss might be spread around by insurance, but still our economy has lost a $1billion asset

We're talking about the stock market. Obviously in the real world wealth can be destroyed.

I agree. Wealth is not like entropy. it is continually created and destroyed.

In a stockmarket crash, not every share is shorted so wealth is destroyed.
If a person buys a share at $1 and sells at 10c, then he is undergoing wealth destruction. True the person who sold the share at $1 still retains the $1 and the person who buys the share at 10c still has the share but the person in he middle of the transaction has lost 90% of his wealth due to that company.

Every share IS SHORTED. For shares to start trading they must be SOLD to the market. The company retains the short position until they buyback the shares. For 100 shares to begin trading on the market, the company has to sell 100 shares to the market. There has to be a seller for there to be a buyer. The 100 issued shares to be traded on the exchange DOES NOT CHANGE unless split/buyback occurs. There has to be a -100 position/+100 position for the shares to continue trading. It is then traded around by the market participants.

In your example of a crash assuming the company initially started trading at $1, $1 of cash is gained by the company. Price goes to 10c, stockholder(the shares traded on the market) lost 90c. So what happens here ?

Company gains 90c of wealth. (+$1 cash minus 10c of liability (current share price) = +90c.
Stockholder loses 90c of wealth. (-$1 cash minus 10c of asset (the shares)) = -90c.

You might say in a stock market crash the company loses wealth too as well as investors. Has it really ?
Before a crash the company:
-holds $2 of cash
-holds $4 in real assets
-owes $1 to shareholders
total $5

After the crash the company:
-holds $2 of cash
-holds $4 in real assets
-owes $0.10 to shareholders
total $5.90

Where did the extra 90c come from ? Sentiment only affects stock market prices NOT real assets. Your tractor can can carry 100kgs of coal today. It will also carry 100kgs of coal tomorrow after a stock market crash.

Wealth is simply transferred WITHIN the stock market. Zero sum. 1 + 1 has to = 2.

Whatever happens in the middle does not matter. It might've been traded 100 or 1000 times, spread made by market makers, commissions made by brokers - wealth is simply transferred within there.

Growth has made us all wealthier, we are far wealthier due to advances in technology, efficiency of services, supply chains and manufacturing. If oil say went to $100 a litre we would all be poorer in today's world as food etc. would be more expensive.

True, outside the stock market. Although if oil went to $100 a litre we wouldn't ALL be poorer. The Arabs and oil investors will be laughing again. But you are right, real growth in the real world made us all wealthier.

 

[Value Collector]

We're talking about the stock market. Obviously in the real world wealth can be destroyed.

The stock market is just a list of real world companies. Any wealth destroyed In the "real world" is going to affect the stock market.

Eg. If that Oil rig I described is owned by BHP or Insured By QBE it will affect those shares.

 

[Knobby22]

In your example of a crash assuming the company initially started trading at $1, $1 of cash is gained by the company. Price goes to 10c, stockholder(the shares traded on the market) lost 90c. So what happens here ?

Company gains 90c of wealth. (+$1 cash minus 10c of liability (current share price) = +90c.
Stockholder loses 90c of wealth. (-$1 cash minus 10c of asset (the shares)) = -90c.

You might say in a stock market crash the company loses wealth too as well as investors. Has it really ?
Before a crash the company:
-holds $2 of cash
-holds $4 in real assets
-owes $1 to shareholders
total $5

After the crash the company:
-holds $2 of cash
-holds $4 in real assets
-owes $0.10 to shareholders
total $5.90

Where did the extra 90c come from ? Sentiment only affects stock market prices NOT real assets. Your tractor can can carry 100kgs of coal today. It will also carry 100kgs of coal tomorrow after a stock market crash.

Wealth is simply transferred WITHIN the stock market. Zero sum. 1 + 1 has to = 2.
.

I disagree. The purpose of a company is to make profits, not collect assets. There are plenty of companies with little in the ways of assets that are worth heaps.

Let's take a real world example, Fortescue.

If the iron ore price drops to $50, suddenly Fortescue is not profitable. It's assets are worth less. The share price drops. The company may even go broke.

Then you have high asset companies like Qantas. Sure they own planes and airport terminal rights but if they go broke, selling the planes is not going to cover the losses.

Flight Centre, a highly successful company that's only decent asset is its recognised name. If there is a change in consumer behaviour and their profit drops by half, then the share price will similarly fall.

Summarising

Before a crash the company:
-holds $2 of debt (most companies are leveraged)
-holds $5 in real assets
-owes $0 to shareholders (not true, the company doesn't owe anything to the shareholders, you are buying a share of a company.)
total $3

After the crash the company:
-holds $2 of debt
-holds $3 in real assets (assets devalue due to lower profits/crashing values)

total $1 the company is in danger of going broke if they start making losses.

 

[Knobby22]

In your example of a crash assuming the company initially started trading at $1, $1 of cash is gained by the company. Price goes to 10c, stockholder(the shares traded on the market) lost 90c. So what happens here ?

Company gains 90c of wealth. (+$1 cash minus 10c of liability (current share price) = +90c.
Stockholder loses 90c of wealth. (-$1 cash minus 10c of asset (the shares)) = -90c.

You might say in a stock market crash the company loses wealth too as well as investors. Has it really ?
Before a crash the company:
-holds $2 of cash
-holds $4 in real assets
-owes $1 to shareholders
total $5

After the crash the company:
-holds $2 of cash
-holds $4 in real assets
-owes $0.10 to shareholders
total $5.90

Where did the extra 90c come from ? Sentiment only affects stock market prices NOT real assets. Your tractor can can carry 100kgs of coal today. It will also carry 100kgs of coal tomorrow after a stock market crash.

Wealth is simply transferred WITHIN the stock market. Zero sum. 1 + 1 has to = 2.
.

I disagree. The purpose of a company is to make profits, not collect assets. There are plenty of companies with little in the ways of assets that are worth heaps.

Let's take a real world example, Fortescue.

If the iron ore price drops to $50, suddenly Fortescue is not profitable. It's assets are worth less. The share price drops. The company may even go broke.

Then you have high asset companies like Qantas. Sure they own planes and airport terminal rights but if they go broke, selling the planes is not going to cover the losses.

Flight Centre, a highly successful company that's only decent asset is its recognised name. If there is a change in consumer behaviour and their profit drops by half, then the share price will similarly fall.

Summarising

Before a crash the company:
-holds $2 of debt (most companies are leveraged)
-holds $5 in real assets
-owes $0 to shareholders (the company doesn't owe anything to the shareholders, you are buying a share of a company.)
makes healthy profits
total $3 but this is not true, invstors buy on profits so say P/E ratio is 14 and the company is providing eps of 50c then price is $7

After the crash the company (and recession):
-holds $2 of debt
-holds $3 in real assets (assets devalue due to lower profits/crashing values)
Profit drops to 10c eps, Assuming P/E vale remains at 14 Sp is $1.40 however if the company starts losing money, then the banks may foreclose.

 

[Value Collector]

For example if the stock market crashes, and billions or trillions vanish does wealth simply vanish or is just transferred from one hand to another. For example wealth is created in a bull market for person A and wealth is lost in a bear market for person B so its essentially equal? Is that correct or incorrect.

I suppose you could ask the question "Did the wealth exist"

for example if a companies shares are trading at $10, and there are 1million shares, the company is worth $10Million dollars.

But if I buy the last share traded that day, and I by it for $100, Suddenly the company will be quoted as being worth $100Million, Did me buying one share for $100 really create $90,000,000 in value? and if tomorrow some one sells a share for $5 was $95,000,000 really lost

 

[minwa]

The stock market is just a list of real world companies. Any wealth destroyed In the "real world" is going to affect the stock market.

Eg. If that Oil rig I described is owned by BHP or Insured By QBE it will affect those shares.

Not true. If oil rig blows up and no one except BHP knows about it and they decide to go fraud route and clean it up quietly and not disclose it, stock market is NOT affected. Real wealth destroyed yes, stock not affected. Fradulent accountants prove this by cooking the books - company is doing bad in the real world, real wealth decrease, but on paper it's going great, stock market not affected as market participants have no knowledge of the fraud. Stock price is affected by SENTIMENT not real wealth. ONLY if the real wealth causes the sentiment to shift does it cause the movement, but not always the case.

I disagree. The purpose of a company is to make profits, not collect assets. There are plenty of companies with little in the ways of assets that are worth heaps.

Let's take a real world example, Fortescue.

If the iron ore price drops to $50, suddenly Fortescue is not profitable. It's assets are worth less. The share price drops. The company may even go broke.

Then you have high asset companies like Qantas. Sure they own planes and airport terminal rights but if they go broke, selling the planes is not going to cover the losses.

Flight Centre, a highly successful company that's only decent asset is its recognised name. If there is a change in consumer behaviour and their profit drops by half, then the share price will similarly fall.

Summarising

Before a crash the company:
-holds $2 of debt (most companies are leveraged)
-holds $5 in real assets
-owes $0 to shareholders (not true, the company doesn't owe anything to the shareholders, you are buying a share of a company.)
total $3

After the crash the company:
-holds $2 of debt
-holds $3 in real assets (assets devalue due to lower profits/crashing values)

total $1 the company is in danger of going broke if they start making losses.

I did not state the purpose of the company is to collect assets. Accounting equation: Assets = Liabilities + Owner's Equity. The company owes the shares to the shareholders in basic accounting terms - you can call it debt, owing, equity, whatever - it falls under the same side on the accounting equation. For assets to increase when they raise cash from issue stocks - the owner's equity/liability side has to increase.

You automatically link stock market crash = real assets devalued/profits drop. Not true. As above, you are missing that investor sentiment decides share prices. A company can be making big profits in the real world and have its share price drop.

 

[darkhorse70]

Haha value collector. Im just going to assume that wealth is transferred in the stock markets but can be destroyed in real life scenarios? The real question is does understanding this concept make me a better trader haha

 

[Wysiwyg]

The real question is does understanding this concept make me a better trader haha

That depends on how you apply this understanding. Manage the risk.

 

[Knobby22]

You automatically link stock market crash = real assets devalued/profits drop. Not true. As above, you are missing that investor sentiment decides share prices. A company can be making big profits in the real world and have its share price drop.

True, sentiment is one of the factors that decides share prices. What I don't like about this argument is that if the price falls then it must be a bargain. It equally could be that the fundamentals have changed within the business and only the insiders know or the macroeconomics have changed and everyone hasn't realised it yet.

Fundamentals decide share prices and though the price is connected by the elastic band that is sentiment, fundamentals ultimately set the anchor.

 

[minwa]

True, sentiment is one of the factors that decides share prices. What I don't like about this argument is that if the price falls then it must be a bargain. It equally could be that the fundamentals have changed within the business and only the insiders know or the macroeconomics have changed and everyone hasn't realised it yet.

Fundamentals decide share prices and though the price is connected by the elastic band that is sentiment, fundamentals ultimately set the anchor.

Fundamentals decide prices in the future or not is a neverending discussion..but for TODAY's price, fundamental does not decide the price otherwise there would no bid & ask, no trading, just one price, THE price.

Haha value collector. Im just going to assume that wealth is transferred in the stock markets but can be destroyed in real life scenarios? The real question is does understanding this concept make me a better trader haha

If you understand the zero sum concept of trading it may cause you to think more before you enter a position. Why does the person taking your other side of the trade have enough conviction to take that position against you ? We all have the same fundamental reports/price data charts..it's how differently we interpret those information and willing to risk money to speculate those views that makes the market.

We all know to buy low sell high or sell high buy low. To enter a order with a good chance of getting filled you have to buy closer to the ask and sell closer to the bid. That goes against buy low/sell high principle. So you must have a pretty strong view to execute the trade against the principle of making money. Think about that view and know that there is someone else with the opposite of that view.

 

[Klogg]

For example if the stock market crashes, and billions or trillions vanish does wealth simply vanish or is just transferred from one hand to another. For example wealth is created in a bull market for person A and wealth is lost in a bear market for person B so its essentially equal? Is that correct or incorrect.

In the context of only a market in its purest sense, then yes, its transfered. But it's never that simple. Consider the effects of margin lending (and interest paid), trading costs, dividends, etc. If you consider these to be separate from 'the market', then yes, it's a transfer of wealth.

For example:
Person A buys Company A for $100. Holds for 1 year, receives $20 in dividends, sells for $80 to Person B.
Each paid $1 in trading costs

Net change in wealth for Person A = $20 (dividend received) - $1 cost = $19
Net change in wealth for Person B = $0 ($80 in cash to $80 in shares) - $1 cost = -$1
Change in total wealth = $18

To really understand it, I'd suggest reading up on the fractional reserve banking system, as this ultimately dictates the total money supply (i.e. total amount of 'wealth')

 

[minwa]

For example:
Person A buys Company A for $100. Holds for 1 year, receives $20 in dividends, sells for $80 to Person B.
Each paid $1 in trading costs

Net change in wealth for Person A = $20 (dividend received) - $1 cost = $19
Net change in wealth for Person B = $0 ($80 in cash to $80 in shares) - $1 cost = -$1
Change in total wealth = $18

You have to subtract the loss for buying for $100 and selling for $80 for Person A ? Person A = -$1 from trading costs, same as Person B. Change in total wealth for the traders = -$2, just trading costs "wealth" which is transferred to the broker who +$2.

 

[Smurf1976]

Stock market crash = "paper" wealth is destroyed and to some extent transferred. A portfolio worth $100K is now worth $50K - the paper wealth has disappeared.

Real, tangible wealth hasn't changed however - if the company owns a coal mine with 100 million tonnes of coal in the ground and associated mining equipment etc then they've still got the mine, coal and machinery whether the share price is $1 or $100. Who owns the shares and their market value has changed, but the physical assets are still there.

Oil rig sinks etc - real wealth has been lost regardless of what happens to the share price. We had a working oil rig, now we don't. It's gone.

If real estate crashes then the "paper" value of my house will be reduced. But it has no impact at all on the utility function of the house - I can still live in it just the same whether it's worth $350K or just $350. But if it burns down then wealth has been destroyed no matter who incurs the cost - me or the insurer.