Stock money origin and existence

Question

If a company has in total 20 shares, selling at the original price with $100 each.

A user (A) buys 10 shares and a user (B) buys 10 shares (which makes half). Then each individual pays with real life money $1000 for their shares (so $2000 in total). The real money should go to some bank account.

If user (A) makes an order, bid for $80 a share. User (B) agreed that price and sells at low price and the stocks go down. (A) pays from his pocket and this money goes directly to (B). (B) earns back 10*80 = $800.

So we have a pool money of $2000 (in some back account) + $800 (in B's pocket) = $2800 worth in real life money exchanged!

(A) now holds 20 shares * $80 = $1600 worth (B) now holds $800 as real life money

The total makes 2800-1600-800=400

So where does the lost money of $400 goes?

On the contrary, if the (A) is willing to buy at the price $120 per share, the stocks goes up. We now have 2000+1200=$3200 of real life money exchanged.

(A) now holds 20 shares * $120 = $2400 worth
(B) now holds $1200 as real life money

The total makes 3200-2400-1200=-400

So where does the virtual extra money of $400 comes from? (because material can't pop out of existence, the real life money is still put somewhere)

Answer 1

The price of a stock is not 'real' in the sense that it represents a guaranteed value. The price of a stock is simply the last agreed price where someone wanted to buy, and someone wanted to sell. If the buyer overpaid, then they wasted that money by paying too much. If the buyer underpaid, then they 'cheated' the seller out of value.

Forget about 'where the money went' with stock. What if I bought a pizza for $20, and sold it to you for $15. What happened to that '$5'? Well, I thought I had an 'asset' worth $20, but since I gave it up for only $15, somewhere between buying the pizza and selling it to you, the value of the pizza dropped by $5.

What if I bought a pizza for $20, and sold it to you for $10,000. How did that value get created? Either I underpaid at the store, or I conned you into paying more than it was worth, or the value of the pizza increased between those times. Now what if I bought 3 pizzas for $20 each, and sold one to you for $10,000. Do I now have 2 pizzas worth $20,000, + $10k in cash from you? You could say that I 'created $20k in value' out of thin air, but what really happened is there was a reassessment of what my pizza was worth. And that extra pizza value I have is only worth $20k, if I can get someone to buy it for that much.

Similarly, the last price of a share sale is only reflective of the actual value of those shares, if the price paid was fair. For most high volume stocks, prices don't move much between trades. But for low-liquidity stocks [that trade infrequently], the last trade might not reflect current value, and you can't "manipulate" the true value into something different buy trading for the 'wrong' price, because that value is only true if someone else would also pay that price. You might be able to move the needle on last traded price, but actual underlying value doesn't change based on the price paid [although the perception may change].

Answer 2

Simply put, there is no such thing as "conservation of value" in an economy. There is no reason why a stock that was originally valued at $2000 should continue to have that value forever - over time, people may value any item, including stock, more or less than before. Suppose you buy a cassette tape player in 1985 - there's no particular reason why you should be able to sell it for the same price you bought it in 2022. That is also true if you buy stock in a company that makes cassette tapes. Cassette tapes are simply less valuable than they used to be. In retrospect, both A and B "overpaid" for their shares if the stock price goes down, as they each spent $1000 on shares that are currently worth $800. The $400 difference is, in a way, in the pocket of whoever sold them the shares in the first place, since they were able to sell something ultimately worth $1600 for $2000.

Answer 3

No money is lost or created when stocks are bought and sold.

Stocks aren't money. You are incorrectly counting the value of stocks as part of the money, but it isn't part of the money supply.

If we have N stocks exchanged at a price of P/stock, the amount of money exchanged is P*N. Someone loses that amount of money, and someone else gains that amount of money. The amount of money stays constant.

So, in other words: if you have $1000, and buy stocks for which you pay $1000, you no longer have $1000. You just lost $1000 of your money. You gained something that was at the time of the purchase worth $1000, but that could be worth anything later. The securities that were worth $1000 at the moment of purchase aren't money.

A sale of stocks, therefore, results in no money lost. It results in no money created.

How money is created is by fractional-reserve banking and by central banks.

If for example government borrows $1000 from a bank (and thus the bank loses $1000 of money and the government gains $1000 of money), and the lending bank gets a government bond worth $1000, the lending bank can later sell that bond to central bank, getting $1000 of money in exchange. Then the amount of money supply increased from $1000 to $2000. It's also possible for the lending bank to borrow money from the central bank, using that government bond as a collateral. It, too, results in the creation of money, although only temporarily (the loan has to be paid back). But central banks buying government bonds are temporary too: eventually the central bank sells that bond, and gets money back in return.

Also, the bank that got $1000 of new money can lend most of that to individual A. It won't lend all due to having to have certain reserves, but it may very well lend $900. Then $900 of new money was created. Individual A has that money in bank account, and the bank (maybe the same bank, maybe some other bank) can lend most of that, let's say $810, to individual B. Then $810 of new money was created. The process continues, and at each iteration, the amount of money created will be smaller due to the bank having to have enough reserves for unforeseen withdrawals. The end result is that the central bank that injected $1000 of new money into the system caused the creation of far more than $1000 of money, via fractional-reserve banking.

Answer 4

(A) now holds 20 shares * $80 = $1600 worth (B) now holds $800 as real life money

Compared to where they started, A has -$1800 and 20 shares, B has -$200 and no shares, and the original seller has $2000 and -20 shares. Nothing has been gained or lost from the economy as a whole, only redistributed.

(A) might account their holding as "20 shares of Blah Co., current valuation $1600", but there is no $1600.

Answer 5

A stock's price is based on what people think the company (or the stock, at least) will be worth in the future. So the change in value, in some sense, is borrowed from the future.

Note that this produces some unintuitive behavior. People may buy stock with the expectation that the company will make a certain amount of profit, and what they pay for the stock is affected by that. If the company then announces profits which, while good, aren't as good as expected, the perceived value of a share of the company drops from that earlier estimate and the stock price drops with it. Stock movement isn't tied to good news, but to how that compares with expected news. Which illustrates the borrowed-from-the-future effect, and shows that it works both for gain and loss.

Answer 6

The shares are not money. The company could go out of business and the price could drop to $0 tomorrow. You need to track the actual money.

1. A starts with $1800 and winds up with $0 and 20 shares
2. B starts with $1000 and winds up with $800 and 0 shares
3. The company starts with 20 shares and winds up with $2000 and 0 shares

Start imagining A and B have more actual money than they spend on stock, since A obviously has at least $1800 since he pays the company $1000 and pays B $800:

• Company: $0 + 20 'shares'
• A: $10000, 0 shares
• B: $10000, 0 shares

Initial public offering: The company wants to raise money. They offer ownership of the company in the form of stock. This is offered to investors at a set price. Each of A and B buy 10 shares for $100 each. Why? Because they think the stock price will increase due to other people wanting to buy the shares, or the company could make a profit and offer dividends, or just because they want to own some shares.

• Company: $2000, 0 shares
• A: $9000, 10 shares
• B: $9000, 10 shares

At this point the stock does not have a 'price'. We know what each person just spent on the IPO, but the Stock Market is a place where people bid money for shares and ask for money for their shares. In this simple example you are just talking about two people. But we can imagine there are 'bid' orders out there for $75 meaning people will buy a certain amount of stock for $75, but neither A nor B want to sell for that price. We can also imagine A and B have ask orders out there offering to sell their shares for say $110, but there are no takers. The price you usually see is the last traded price I believe so the price on websites would read $100. At any time people could pay $110 to buy shares from A or B and A or B could decide to sell their shares for $75.

To break this stalemate, you need to find someone willing to trade at some price in-between. This is when B sees that nobody is interested in buying at $110 and wants to get some of his money back. Maybe he needs liquid cash, so he decides to offer to sell his shares for $80 because he isn't quite willing to lose 25%, but 20% is ok. A was not willing to buy when B was selling at $110, but he believes in the company and thinks the ask price will eventually go above 80 at least, so he buys all 10 shares at $80:

• Company: $2000, 0 shares
• A: $8200, 20 shares (down $1800, but with 20 shares)
• B: $9800, 0 shares (down $200)

The last trade was then at $80, so you could say that A's 20 shares are worth $1600, but he could really only sell them at $75 with the current offers so they are really worth $1500 if he wanted to convert them to cash right now. Maybe he wants to hold on and other people place bid orders at $90. Now his stock is worth the $1800 he spent if he wants to sell it at that price, but that stock is not really money.