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It’s easy to forget, but money is never destroyed – it just moves around

by Aaron McCormack on November 4, 2013

greater foolA few pieces recently about the (re) emergence of boom conditions in some places.  Whether it is house prices in Dublin/London, or the surge in tech-startup funding that is being reported.

In most of these cases, people talk about a huge destruction of value that occurs when bubbles burst or when a tech investment fails.  It is as if the money suddenly disappears into a great fire, never to be seen again.

If you end up selling a house or a share for less than you buy it for, then you have certainly lost money.  In your world, the money may as well have disappeared.  But it hasn’t.

If you put $1 million into a tech startup and it fails, then you have lost your money.  But it didn’t disappear.  It paid salaries and rent and consultants fees and for computers and servers and hosting and internet connections.

It’s called the principle of the Conservation of Capital.  It is like the principle of the Conservation of Energy in physics.

In a boom it is known as the Greater Fool Theory.  If you are foolish enough to buy an overvalued stock or house in the heat of the bubble, you are a fool.  But if you wait a while, an even Greater Fool may well pay more for it.

greater-fool-venn

Thinking about where money goes when people “lose” is a fascinating exercise.  You can be sure in most cases that a number of people along the way have racked up fees – and those people make more money when prices are higher.  Real-estate agents, stockbrokers, investment banks, advisers – and, yes, governments (through transactional, property, income or capital gains taxes).  That may give some insight as to why institutions who are in the best position to spot and stop bubbles will rarely be motivated to do so.

One last question people often ask me when I go on this riff…..what about governments printing money?  How does that affect the picture?

At this point it means that banks in particular (although companies too – an estimated $3trillion in the US alone) are sitting on piles and piles of money with no obvious place to invest it.  That may explain low borrowing costs for some people, companies and governments as well as the somewhat surprising levels of the stock market indices. (Risk-aversion, however, means that these piles of cash, until now, have only been flowing in the main to “safe” places and people – that’s why a lot of people and small businesses cannot get a loan).

However, the fundamental, long-run action of printing is to make all the other money out there that little bit less valuable than it was before.  It takes a while to make this happen.  It acts through mechanisms such as inflation but also in collapsing bubbles and their fallout.  The money, however freshly minted, is never destroyed.  It does, however, tend to end up in the hands of those who already have a lot of it.

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