Photo: TelstarWhen the stock market plummets, where does the value of your holdings actually go? This article from Investopedia explains it well.
Stocks, like money itself, have an explicit value and an implicit value. Back in the day, when currencies like shells and salt fell out of fashion, it was their implicit value that plummeted; their usefulness didn’t change. Similarly, in a market panic, a stock’s value may simply vanish — like your socks in the dryer. (Keep this in mind when the stock market starts to rise, for that value too is as implicit as a barnful of salt.)
Stocks and currency are, of course, not the only things heavily dependent on implicit value. Think about diamonds, for one: why, exactly, are they so expensive?
A far humbler example but one that is closer to home (for me at least) is a book. When a book that you’re dying to read is published, you might be happy to shell out $25 on the spot. But for everyone who doesn’t buy the book, it has a far smaller implicit value. If demand is low enough, that same book might end up for sale for $1 on the street in a matter of months. At that price, it is probably worth it for just about anyone, for although this asset is usually overlooked, a hardcover book — held firmly, spine out — makes a fine weapon.
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A better example would be trendy items like night clubs or high fashion clothing. A garment that costs $1000 early in its season can be seen for a few bucks at the outlet store just weeks later. And the lines outside a trendy nightclub disappear when the “in” crowd moves to the next one.
I prefer to view the market as a Ponzi scheme. My money is in fact sitting in the bank account of the party from whom I bought the stock. The money represented by the value of my holdings is sitting in the bank account of the unknown future purchaser of my stock. If they never buy into the scheme, or insist on paying a lower fee to enter, I end up losing.
This is exactly what happened to the Madoff investors. Their money didn’t go up in smoke; it ended up in the bank accounts of people who left the scheme earlier.
@ #10
The stock market is not a Ponzi scheme, because you do not need a future investor in order to make money, assuming you bought at a sensible price.
Many companies pay dividends to their shareholders, and if the market were to ever shut down because there were literally zero interested buyers, all profitable companies would pay dividends. If you paid less than the value of the companies future earnings for your shares, you will profit from receiving your share of said future earnings.
Isn’t this why in macroeconomics price is denominated as simply the cost of a basket of goods in relation to some other basket of goods, not dollar (or real, or peso) cost? The fact that people don’t realize that the currency basket (or stock basket, or real estate basket) has a variable worth is why we’re in our current mess.
I notice that most necessary things tend to be inexpensive, whereas unnecessary things tend to be expensive.
Take gasoline and soda pop, for example. Gasoline clearly is a necessary good, whereas soda pop clearly is unnecessary. And gasoline costs much less per gallon than soda pop.
One could make any number of similar comparisons. All lead to the same conclusion that food, clothing, and shelter (the “necessaries,” as they were once called) always tend to be affordable for the majority of people.
For this reason, the idea of “implicit” versus “explicit” value can be misleading. More fundamental is the concept of “inherent” value.
Stocks and currency may have no _inherent_ value at all, but the necessary goods for which they trade certainly _do_.
So, when value evaporates from stocks and currency, the first question to ask is, To what extent are unnecessary goods reflected in the loss? Then, of course, the next question is, To what extent are _necessary_ goods reflected?
Those sliced & diced mortgages that Wall Street resold as some kind of investment instrument remind me of the old days when banks printed their own currency. Didn’t that scheme provoke a bank panic? Like socks, they stink.
If banks holding recent mortagges wanted to invest in Wall St. why didn’t they just send them US dollars, an instrument backed by the government and basically accepted anywhere.
This post is pretty far off in clarifying economic reasoning. No need to think of explicit/implicit values for any market based goods like stocks and books. “Intrinsic” value is something that can differ from the token value of money, but that is only the case for moneys and even then only works for official government money that gains its value from faith that the government won’t overproduce it.
1. Stock market price reflects investors best sense of future profitability vs. the opportunity cost of buying the stock. Holding constant the opportunity cost of money (interrest rates), the price either rightly or wrongly reflects furure corporate profitability. The ex post rate of return will rise and fall with current decreases and increases in the stock price.
2. A book’s price reflects the value to the marginal (last) buyers of the book. If it sells less well than expected, the large supply of the books has to go deeply into the pool of potential buyers to find people who would not value it at $25 but would find it worth at least a dollar. Those $25 potential buyers get a bump in consumer surplus from their purchase by getting to buy it at $1, but the least excited buyers get no consumer surplus, since they value the book at exactly $1.
I think it really makes sense to analyse how material things may have an ‘implicit value’, or, well simply said, information.
I believe an easier example of the ‘sock/stock’ analogy, or implicit value, would be the sentimental value we apply on objects, by many reasons (because it has been on the family for generations, because it belonged to a lost friend, because you gained it on your first date), altough it only matters to whoever knows or understands the feeling attached.
Just like Toffler wrote on his “The Third Wave”, information is a key element on money (well, since we assume that paper with treasure printing IS worth more or less depending on the number, which is cheer information), and it will sure change the way we look at economy in the following years. As it has been changing, and will continue…