<Anyway, we never did figure out how much market cap went to money heaven and how much went into the money market. I have never been able to figure out how to measure that. >
CB, Suppose there is a new country, Hobbitland, and these Hobbits print 10 billion brand new currency units, the hobbit, so they can start buying and sellng without having to dig up gold, collect sea shells or move a lot of sheep around. The currency isn't backed by anything, [than the promise of the central bank not to print a whole lot and devalue it], it just is.
Suppose they are a creative and energetic lot who have figured out that you can dig up the earth and shape it into superconductor cars, photon converters for communications [voice, images and data], solid state data storage, comet busters, aircraft, DNA gene identifiers, manipulators and all sorts of amazing things from hydroponic crop glasshouses to nanotechnology medical equipment.
They need to buy and sell those services so they form a stockmarket so they can trade their ownership of their creative efforts. When they want to take a big break, they sell their shares in their company, put it in the bank and buy stuff they want.
They have a stock market and the prices of the shares are available 724 on their little CDMA-linked 3D retina scan cyberspace observers anywhere, anytime. They can buy and sell any time because all their communications are done automatically and directly with other buyers and sellers in cyberspace via software programmes rather than stock brokers
Things are going well after centuries of slow progress. It does take quite a bit of figuring out how to invent a shovel and a wheelbarrow, then dig up some more dirt and make it into a 500 passenger aircraft, with CDMA cyberspace links via satellites in space, which can fly itself at 4000 kph. But now, they were cooking!
Say the number of Hobbits has stayed constant at 1,000,000 and they were each issued H10,000 when the hobbit currency was produced.
Because the new things being invented are so attractive to the Hobbits, the profit from the companies producing the clever new stuff is zooming up as all of them want to buy the latest gadgets and since it only costs H3.141 per unit to produce the new laser-link phone but the Hobbits are willing to pay H999.99 for one of them, the profits are great.
So, the Hobbits start thinking the stockmarket is great! The owners are making a LOT of money and getting rich. Most of the companies are inventing new stuff and new ways to do things and there seems no end of it. So those owning the companies are reluctant to sell them and hold the hobbit, which only earns 10% in the bank by being loaned to others who want to bring some purchase forwards with the promise to keep working and pay it back later from future earnings.
So, sellers double the price of their shares. Buyers pay that! So sellers double their price again. And again. And again. Hobbits have seen the prices rise for decades and profits have been going quite well too as it increasingly takes less effort to invent even better new things. But profits haven't been growing anywhere near as fast as the expectations of the now quite addled, irrationally-exuberant Hobbits who are paying 1000 times what the shares were 10 years before. The shares used to earn 5% return, pretty much like the money kept in the bank [there was a risk premium on the shares because sometimes companies were mismanaged or simply producing things which nobody wanted any more and went broke]. After the huge increases, they were only earning 0.1% on the current price of the shares, despite continued new inventions and increased profits.
But exactly the same number of hobbits are in circulation. They never did increase the number of hobbits. So, at the beginning of the sharemarket irrational exuberance, there were exactly 10 billion hobbits recorded in the cyberbank as being in various Hobbits' accounts. At the end of the sharemarket boom, there were still exactly 10 billion hobbits in various Hobbit's accounts.
Some Hobbits borrowed other Hobbits' hobbits to buy more shares, promising to pay 10% interest and repay the loan from future earnings. So the banks entered debits and credits in the respective accounts. But exactly the same number of hobbits remain in existence. The loans appear as red and the credits as green.
One day, a Kiwi Wizard comes to town and explains to the Hobbits that they aren't able to repay 10% interest from 0.1% profits and profits aren't improving very fast at all [it still takes a lot of creative effort to make new things and improve profits - it can't be done very quickly, so profits can't grow extremely fast]. The Hobbits ponder this for a while and nervously notice that there is a ring of truth in it. Hobbits, being sensitive about rings, start perspiring slightly.
The Hobbits were thinking they were wealthy. Many had given up their jobs [thinking that they didn't need to work any more] so the creative process at companies slowed although sales were still going very well as the newly-wealthy Hobbits borrowed hobbits and spent them on fun things, so company profits went up. But companies were having to pay more to get Hobbits to work [they just wanted to play golf and amuse themselves in other ways] because so many thought they were wealthy, so it became harder to make profits.
Unfortunately for them, the share-owning Hobbits had to keep paying the 10% interest to the bank and their profits from the shares and their earnings [being retired] weren't covering the interest bill. The banks told them they'd have to sell some shares to pay their interest bills.
So, the Hobbits started selling a few shares. But prices had got so high that a lot of Hobbits were getting nervous that maybe things weren't all that good. With the Kiwi Wizard in town, the word suddenly got out that they were living in fool's paradise. Quite a few Hobbits had been having trouble with their interest charges and they'd been spending a lot of money lately, [being newly-wealthy, they wanted to buy a LOT more gadgets], so they decided to sell quite a few shares to cover their margin calls.
But bloody hell, prices were dropping because not many Hobbits were prepared to pay the prices asked when the share price profit was only 0.1% compared with 10% in the bank. Prices went into free fall.
Suddenly, the newly-wealthy Hobbits, who had been spending up large, buying new stuff, were not buying much of anything and could only sell their shares [which they were forced to sell to cover margin calls] for derisory amounts. Other Hobbits, who had the hobbits safely stashed in their cyberbank accounts, were only prepared to pay much lower prices for the shares.
Pretty soon, the shares were right back to where they were before the bidding war started when the irrational exuberance began. The margin loans had been repaid. But there was general panic, anxiety and fear, even in the Hobbits who held the cash, because companies which had geared up to supply the newly-wealthy hobbits were going broke and firing Hobbits [they'd borrowed hobbits to expand production and now they couldn't repay their loans because they didn't have profits and they couldn't sell their new production facilities].
There were still exactly 10 billion hobbits in circulation. But the newly-wealthy Hobbits were now newly-poor and they were not buying anything except cheap food [which they got at the newly-built soup kitchen for no charge from sympathetic Hobbits who had donated some money to provide for the hungry who now had no job and no wealth].
So now, many companies have gone bust [due to mismanagement during the sharemarket boom and wealth effect], unemployment is up, wealth effect has gone and huge market cap has gone to money heaven. It has not gone to the money markets, where there is still, just as at the beginning, exactly 10 billion hobbits sitting in bank accounts [but with a LOT less loans as people have been sold up for vast market cap losses].
So, a happy Hobbitland went from creative production and a great lifestyle derived from their ability to dig up dirt and make it into golf clubs, boats, planes, cybergadgets and all sorts of things, to a sad, depressed place with unemployment, poor effect instead of wealth effect, bankruptcy and closed businesses. The retired wealth-effect Hobbits are retraining to do something useful for those with the 10 billion hobbits.
So, market caps go to money heaven. Irrational exuberance causes stock market rises and macroeconomic destruction. Debts allow increased irrational exuberance and accelerate and exacerbate the collapse.
But, still there are 10 billion hobbits. They have not gone to money market heaven. They have all been right there in the cyberbank accounts all along. They just changed hands as buyers and sellers of shares and goods and services did deals with each other. It's just the market cap which has gone "poof" at the wave of the Kiwi Wizard's Wand.
Mqurice
PS: Then, along comes Uncle Green$pan, who teaches the Hobbits that they can reduce the rate of economic crunch, and the final level of it, by printing a LOT more hobbits and cutting interest rates, which makes share profits look more attractive compared with interest rates. That also slows the selling of shares, which slows the bankruptcies and rate increase of unemployment. It gives hobbits a chance to reorder their lives, before things get too bad in a big hurry.
But Uncle Al is diluting the hobbit holders who are disappointed with their new, lower interest rates and devalued currency. Pretty soon, the hobbit-holders decide they'd better spend those hobbits because they can see inflation is going to steal it from them by quantum tunneling effects. So they go shopping, which makes a lot of companies breathe a sigh of relief.
Pretty soon, the unemployed Hobbits have got new jobs, the margin loans have been repaid, new owners of bankrupt businesses have taken over the assets and the Hobbits get up in the morning and check the sunrise and the birds singing instead of the share price, then head off to work to invent some great new gadgets from a shovelful of dirt.
It all seems like a distant dream.
20 years later.....
A young Hobbit, who has heard of the great crash but wasn't born then and figures they were not very bright Hobbits then, figures he can borrow a bunch of money, and buy some shares, which have been rising very nicely. He sells them for a BIG profit a year later and boasts to his buddies. Who decide to do the same. They want to be rich too. It's boring fiddling with shovelfuls of dirt all day. They are envious of his new superconductor GSRS [TM] personal transporter. So, they go and arrange a margin loan agreement .....
GSRS = Graviton Spin Reversal System [puts the Segway out of business]. |
