March 04, 2009

How do you “lose” billions of dollars?

I still can’t quite figure this out. How are these companies losing billions of dollars? I suppose it all comes down to greed and mismanagement, but the money has to be somewhere, right? Let me give you an example.

Say I make blankets in my shop. Each blanket consists of yarn and labor. Furthermore, let’s say the yarn costs $10 per blanket and the labor costs $25 per blanket. My breakeven point would be $35 (ignore other indirect costs for the purpose of this example).

If I sell the blanket for anything more than $35, I make a profit. If I sell it for less than $35, I “lose” money.

Let’s say I sell the blanket for $10. Technically, I “lose” $25 on the deal. But that $25 really isn’t lost is it? Of course not, I gave that $25 to the person who made the blanket.

So the money is still out there somewhere, it is just in someone else’s pocket. That person then takes the $25 and buys things with it. So they don’t have the money anymore either. They have passed it on to someone else. This is the way our economic system works.

When AIG says they lost $60 billion, is that money gone or is it just in someone else’s pocket? I content that if the $60 billion loss is real and not just some type of accounting technicality, then someone HAS AIG’s $60 billion. It just didn’t disappear. Someone has AIG’s $60 billion! If it was just an accounting technicality, then it never existed in the first place, so there isn’t a loss!

A similar situation occurs with the stock market. For every trade there is a buyer and a seller. When the market drops that means people are selling, but it also means someone is buying.

The question is, who is this someone? Who has AIG’s $60 billion? Who is buying in this market?

Those questions I cannot answer, can you?


No comments: