Where did all the Money Go?

http://www.gold-eagle.com/gold_digest_01/corrigan040601.html

As the Great Bear Market grinds down investors, traders and borrowers, this question is increasingly heard rippling around the bars and bulletin boards. Often it is accompanied by the Little Man's usual paranoia that Big Money is somehow ripping him off, that the heirs of Morgan and Livermore and Sell'Em Ben Smith got out at the top and have since parked their money in a tax-free money market mutual fund to await the opportune moment to snap up cheap stocks when the ordinary people are driven to capitulate.

In essence this is also part of the wrong-headedness behind Wall Street's great myth that a final bout of panic selling is what is needed to establish the elusive 'bottom' in the market. While this latter may be true of speculative markets where overstretch in either direction, away from some demonstrable idea of value, is often resolved spectacularly, in an equity market still adjusting to deteriorating fundamentals and back from one of the greatest excesses in modern history, it is unlikely to be borne out in reality. 1930-33 certainly did not work this way, when arguably the bulk of the damage inflicted was done to those players who took the Nov/Dec 1929 recovery from October's cataclysm to be the signal for renewed optimism.

Before we counter some of the fallacies - inherent in all episodes where paper valuations are misconstrued for real wealth - in detail, we should perhaps pose one obvious question of our own, in true Socratic fashion. Namely, where did all the money come from in the first place?

Isn't it strange how no-one thinks to ask that question on the way up?

Consider the following scenario. A stock, which has a float of, say, five billion shares, is priced at $50 per share, for a total market cap of $250 billion. Such a stock - the ACME Network Corporation, let's call it - is a darling of the new speculative fever, a true Builder of Tomorrow actively traded by everyone from Janus to Janice Doe. In the course of the daily frenzy, it churns over some one per cent of its float - a not unrealistic sum since the NASDAQ as a whole has seen an average 1.6% of total market cap change hands daily in the last 18 months year or so, with the comparable figure for the NYSE at 0.4%.

One fine morning, the Street Snake Oil sellers get up bright and early and start promoting ACME on CNBC, which Maria further pumps up in her usual measured manner, sparking a flurry of activity.

Bid-offer, bought-sold, ACME runs around the ticker-tape like some demented clockwork locomotive in Santa's Grotto. It rises in 10 cent increments to finish the day at $52, with 50 million shares traded - for a four percent gain on the day, adding $10 billion to its capitalization and so supposedly increasing the 'wealth' of its owners by the same amount.

On the simplifying, but not unrealistic assumption that the buyers and sellers were equally involved throughout the day, with former just bidding up the last price to end in possession of the stock, the eventual group of holders will have bought 11 lots of shares at an average price of $51 and sold 10 lots in the intervals, at the same average price.

When the dust has settled, and all the trades are netted out, if the total turnover was 1% - or 50 million shares - a cash sum of 50 x 51/21 million, or $121 million will need to change hands. At just under 5% of the total volume traded, this is typical of the proportion regularly recorded at the Depository Trust Clearing Corporation in the US.

Now comes the neat bit: effectively $121 million in 'new' money has helped move the price of the stock up 4%, adding $10 billion to the market cap - a leverage of over 82 to 1.

If we consider that between October 1998 and the market peak in March 2000, the Wilshire 5000 rallied 74%, or 6,371 points, adding a notional $7.5 trillion to its capitalization, while margin debt increased from $130 billion to $279 billion, we could derive an effective 50:1 ratio all through the SuperBubble and HyperBubble phases.

In practice, of course, this is likely to be an overestimate for several reasons; only 50% of the value of a stock may be borrowed through official channels, the statistics do not allow for ad hoc lending away from the exchange, no account is taken of indirect financing of stock purchases by drawing down on home equity loans or other sources of personal finance.

The point remains unblunted, however: by valuing companies and markets as a whole at the price of the last marginal trade, we greatly distort even the paper worth of our assets. The only time such valuations are achieved in practice, after all, is when a takeover occurs and that, by definition can hardly hold true for the whole market.

What does go up in reality, however is both people's subjective appraisal of their net worth and their lenders' objective assessment of their collateral when extending yet more credit. The fact that only a fraction of the reported rise in an index actually represents a direct cash infusion neither enters a borrower's calculations, nor, crucially, a lender's.

Naturally, this process also works in reverse - far less money is extracted from the market than appears on the surface. Moreover, we have assumed two, relatively homogeneous groups of buyers and sellers, continually involved in the game. In practice, of course, there will be many more participants who deal and walk away, implying that even the reduced net at which we have arrived will be dissipated across many small accounts.

Expenses will also be a friction, whether brokerage and clearing charges or taxes on whatever gains there are to be made. Whether this friction represents government confiscation or Wall Street consumption, it still disappears from the table and the higher the churn, the greater the toll exacted.

Perhaps most importantly - those winnings which are made, or that salvage value realised, does not represent a pool of available money in any case. If the proceeds are used to extinguish some of the horrendous debts incurred, liquidity is contracting: if the proceeds are consumed, they are also lost - once you eat your table stake, you are out of the game for good.

Finally, to the extent that winners and losers do match up in mere monetary terms, they will be very different actors psychologically. There is an inherent asymmetry in behaviour between the two which means that winners may do less good in future than losers do harm - belt-tightening, distress selling and even default are possible choices for the latter group.

It is emphatically not a zero-sum game, then, and the process of creating money via credit extended against the security of the asset on which the money may be subsequently spent again is the key to the question. This is the mechanism responsible for the acceleration upwards and no less so for the death spiral on the way down and the more credit created to fuel the boom, as opposed to claims to genuine savings simply being exchanged via the market, the more devastating the bust is likely to be.

Where has all the money gone? Back to where it came from largely - thin air - and that isn't likely to function anytime soon in stabilising the decline, no matter how hot it blows from Wall Street.

Sean Corrigan

Capital Insight http://www.capitalinsight.co.uk

6 April 2001

Fair use for educational/research purposes only!

-- Anonymous, April 05, 2001

Answers

Response to Where did all the Money Go?

Thank goodness you're back, Maher, we've missed articles like this.

-- Anonymous, April 05, 2001