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I look beyond the “there’s a crash coming” sentiment. In that opinion, he is like all other pundits yammering on CNBC: entertaining rather than enlightening. W

I look beyond the “there’s a crash coming” sentiment. In that opinion, he is like all other pundits yammering on CNBC: entertaining rather than enlightening. What I like about his article is the insight — new to me — about the nature of paper wealth vs real wealth. He described it in a way that is useful and enlightening to me. The assertion that a security (stock, bond) is not an addition to net wealth — just a zero sum transfer between individuals over time — is a provocative statement that I will ponder for some time.

lmm 9y ago
Trade is a wealth creation mechanism, because different people assign different values to things. When a baker exchanges some loaves of bread with a carpenter for a table, wealth is created: they're both rational actors who know that the thing they're getting is worth more (to them) than the thing they're giving away. The same is true when the baker sells bread for money. The same is true when they issue a bond for their baking business. Of course the bond just moves money around, but a lot of wealth creation consists of moving things around rather than directly building a physical thing.
- dpiers 9y ago
  Correct, but the article specifically referred to securities as zero-sum transfers. A security is linked to something that has value, and exchanging the security doesn’t alter the value of what the security is linked to.
  - lmm 9y ago
    A particular stream of payments with a particular risk profile is an asset that has different (present) value to different entities like any other.
    - shostack 9y ago
      I may not be using the proper terminology here, but would I be correct in restating this as: The underlying value of the asset is just one component, but the vehicle the asset is traded through can change that value equation by adding or removing its own value.
      - lmm 9y ago
        No, I don't think that's correct. A security doesn't have its own value independently of the payment stream it represents, any more than the deed to a house has its own value independently of the house. But the same payment stream (or house) might be of different value to different people, so buying or selling it can create wealth.
        shostack 9y ago
        So the risk and form that the payment stream takes (ie. bond coupons are different from rental property income) might both be $100 for example, but if someone is overindexed in real estate in their portfolio, there may be more value to them in the bond?
        lmm 9y ago
        Yeah. A risk profile isn't just a percentage, it's also a question of what it's correlated with.
herodotus 9y ago
And I think it is wrong. On initial offering, it moves money to a potential value adding activity. Even after that, stock can be used as an incentive to increase productivity (and hence add value to an economy). Certainly a single trade is in some sense "zero-sum", but the entire point is to provide efficient access to capital that can be (and is) used productively.
gregorias 9y ago
Thank you for this comment. There's so much negativity in the most-voted comments that it's refreshing to see an approach that tries to learn instead of discredit.
psyc 9y ago
It’s zero sum for the individual buyer and seller, but in aggregate it’s how the economy decides what work to do.
- BenoitEssiambre 9y ago
  I think I understand what you are saying but in macroeconomics it's usually stated the other way. On the aggregate debt and financial instruments net to zero. One person's debt is another person's saving and if you add all financials up, you get zero (or depending on what you are counting, you get the value of the physical assets behind the financial assets such as stuff, factories etc. On the other hand, for sub parts of the economy or for individuals there can be positive or negative financial equity or debt meaning some individuals or parts of the economy owe are are owed more than others.
  - FabHK 9y ago
    Correct me if I'm wrong though: equity is issued in net positive supply. And while the company has equity on the book as a liability, that liability does not go up when the stock price goes up, right. Thus, when stock price doubles, it is wealth creation for the shareholders (and if they'd sell to someone else, it would be realised). Edit to add: unlike derivatives (like call options), which are in net zero supply, thus their payouts are always zero-sum.
BenoitEssiambre 9y ago
Yes that is a key insight to understand about macroeconomics and the reason why growth in financial equity and other instruments is not counted in GDP, only production of real things, creation of factories and accumulation of inventories. One party's debt is another party's saving (the party that the debt is owed to) so debt nets to zero in the aggregate economy. It is also why cryptocurrencies are potentially dangerous to the economy if they become too popular. The situation could become similar to how gold hoarding caused the great depression (though I don't think it will be that catastrophic unless governments start tying their currencies to crypto tokens like they had done with gold.
bufordsharkley 9y ago
It's the kind of thing that isn't obvious at present, at least given most discussions of money, equities, and wealth. But with a different economic paradigm, some of things concepts become more obvious. Henry George was commenting on precisely this some 140 years ago: http://fortfairfieldjournal.com/mpl_hgeorge_money.htm http://fortfairfieldjournal.com/mpl_hgeorge_money.htm
fallingfrog 9y ago
I think the critical distinction to make is that if I trade you fish for wood, we are both getting something we need more than what we have. But if I trade two securities with you, we are essentially making a bet- and with a bet, one party wins and the other loses. It's a truly zero sum game.

lmm 9y ago

Trade is a wealth creation mechanism, because different people assign different values to things. When a baker exchanges some loaves of bread with a carpenter for a table, wealth is created: they're both rational actors who know that the thing they're getting is worth more (to them) than the thing they're giving away. The same is true when the baker sells bread for money. The same is true when they issue a bond for their baking business. Of course the bond just moves money around, but a lot of wealth creation consists of moving things around rather than directly building a physical thing.

dpiers 9y ago
Correct, but the article specifically referred to securities as zero-sum transfers. A security is linked to something that has value, and exchanging the security doesn’t alter the value of what the security is linked to.
- lmm 9y ago
  A particular stream of payments with a particular risk profile is an asset that has different (present) value to different entities like any other.
  - shostack 9y ago
    I may not be using the proper terminology here, but would I be correct in restating this as: The underlying value of the asset is just one component, but the vehicle the asset is traded through can change that value equation by adding or removing its own value.
    - lmm 9y ago
      No, I don't think that's correct. A security doesn't have its own value independently of the payment stream it represents, any more than the deed to a house has its own value independently of the house. But the same payment stream (or house) might be of different value to different people, so buying or selling it can create wealth.
      - shostack 9y ago
        So the risk and form that the payment stream takes (ie. bond coupons are different from rental property income) might both be $100 for example, but if someone is overindexed in real estate in their portfolio, there may be more value to them in the bond?
        lmm 9y ago
        Yeah. A risk profile isn't just a percentage, it's also a question of what it's correlated with.

herodotus 9y ago

And I think it is wrong. On initial offering, it moves money to a potential value adding activity. Even after that, stock can be used as an incentive to increase productivity (and hence add value to an economy). Certainly a single trade is in some sense "zero-sum", but the entire point is to provide efficient access to capital that can be (and is) used productively.

gregorias 9y ago

Thank you for this comment. There's so much negativity in the most-voted comments that it's refreshing to see an approach that tries to learn instead of discredit.

psyc 9y ago

It’s zero sum for the individual buyer and seller, but in aggregate it’s how the economy decides what work to do.

BenoitEssiambre 9y ago
I think I understand what you are saying but in macroeconomics it's usually stated the other way. On the aggregate debt and financial instruments net to zero. One person's debt is another person's saving and if you add all financials up, you get zero (or depending on what you are counting, you get the value of the physical assets behind the financial assets such as stuff, factories etc. On the other hand, for sub parts of the economy or for individuals there can be positive or negative financial equity or debt meaning some individuals or parts of the economy owe are are owed more than others.
- FabHK 9y ago
  Correct me if I'm wrong though: equity is issued in net positive supply. And while the company has equity on the book as a liability, that liability does not go up when the stock price goes up, right. Thus, when stock price doubles, it is wealth creation for the shareholders (and if they'd sell to someone else, it would be realised). Edit to add: unlike derivatives (like call options), which are in net zero supply, thus their payouts are always zero-sum.

BenoitEssiambre 9y ago

Yes that is a key insight to understand about macroeconomics and the reason why growth in financial equity and other instruments is not counted in GDP, only production of real things, creation of factories and accumulation of inventories. One party's debt is another party's saving (the party that the debt is owed to) so debt nets to zero in the aggregate economy. It is also why cryptocurrencies are potentially dangerous to the economy if they become too popular. The situation could become similar to how gold hoarding caused the great depression (though I don't think it will be that catastrophic unless governments start tying their currencies to crypto tokens like they had done with gold.

bufordsharkley 9y ago

It's the kind of thing that isn't obvious at present, at least given most discussions of money, equities, and wealth. But with a different economic paradigm, some of things concepts become more obvious. Henry George was commenting on precisely this some 140 years ago: http://fortfairfieldjournal.com/mpl_hgeorge_money.htm http://fortfairfieldjournal.com/mpl_hgeorge_money.htm

fallingfrog 9y ago

I think the critical distinction to make is that if I trade you fish for wood, we are both getting something we need more than what we have. But if I trade two securities with you, we are essentially making a bet- and with a bet, one party wins and the other loses. It's a truly zero sum game.