[ThrustVectoring]

>What am I getting wrong?

You are correct when taking the view of the financial sector as a whole - every asset purchase merely swaps who has the cash and who has the asset. You're not getting much of anything wrong, merely missing a behavioral trait of many market participants: they desire a fixed ratio between their various financial assets. An extreme example of this is an index fund, which has a formulaic relationship between their book value and how much of what assets they own.

In essence, what happens is that cash gets dumped into the laps of various market participants, who then notice that they have "too much" cash. They then bid on various assets until there no longer is "too much" cash in the system for the total value of assets around.

[pontifier]

I totally had this happen. When I was growing up we didn't have much money, and I've always tried to be really frugal. I tend to agonize over minor necessary expenses like gloves or shoes. When I went from a couple hundred bucks in the bank to almost a million I felt strange. I tried to ignore those feelings, so I could live like a normal person. It only took me about a year to...

I mean... Well... It goes pretty fast and things are pretty much back to the way things were.

I did not understand at all how people who win the lottery could blow through it all so quickly. Growing up, the limit on my spending was availability. When that availability went up, I didn't really have the right tools to change my internal spending algorithm quickly enough to maintain a comfortable level for a longer time.

It truly didn't fix as many problems as I had hoped, and it turns out a million dollars isn't nearly as much as I thought it was.

[nostrademons]

It's possible to avoid this by having separate buckets for consumption and savings. Hold your consumption bucket constant (some people call this "budgeting", but it could be done more informally), and all the excess cash you're making, by definition, will go into investments. Then you just have to learn how to invest prudently. :-)

GP is talking about the investment side of this, where "investing prudently" usually means looking at the relative prices of different investments and putting your money only into the ones that are undervalued. If enough people do this, a.) relative prices approach a pretty good approximation of their true value, and b.) those prices are going to be much higher when a lot of cash went into savings than if there's not much cash going into savings.

[pontifier]

Oh I invested most of it, and now I don't have all that cash anymore. I have assets instead. I'm back where I can worry about spending a few bucks on something minor.

[AnimalMuppet]

So let's say that the entire world is index funds (plus the stocks they own). An index fund has "too much cash", so they buy stocks. Some other index fund sees that the price is attractive, and sells, but then that fund has too much cash.

But the funds each keep some amount (1%?) of their assets in cash. So isn't the net result that stock prices go up until the value of the stock is 99 times the amount of cash in the system?

More generally, then, doesn't the price of assets go up until the participants are comfortable with that much cash as part of their asset mix?

[ClumsyPilot]

Yes, Exactly.

So if you double amlunt of money is the system, house prices will double.

It is not 'inflation' because food prices do not react in the same way. You 'normal' inflation could stay at zero.

You can create housing shortage through financial system alone, without changing population/ housebuilding rates

[medvezhenok]

If you want a little more reading on the subject, there's a neat writeup here:

https://www.philosophicaleconomics.com/2013/08/the-great-rot...

"(1) For every share of every asset in existence, someone must willingly hold that share at all times. If no one can be found who wants to hold a share, its market price will fall until someone is found.

(2) The total “amount” or “supply” of a financial asset is the total market value of it in existence: the number of shares outstanding times the market price. Asset “amount” or “supply” is therefore flexible for all assets except cash, whose market price is always unity. If there is more financial wealth that wants to be allocated into an asset than exists of that asset, the market price of each share of the asset will rise, which will expand the supply of the asset so that the demand can be satisfied."

"Money is not something that can go into or come out of assets; rather, it itself is an asset that is traded for other assets. The offered rate of exchange is the price. Changes in the price can create the perception that money is moving, but, in reality, nothing needs to be moving at all. Any movement that does occur is incidental to the underlying process.

Likewise, investors cannot leave or enter any asset class. All they can do is fight with each other over who will hold each asset class, offering to exchange money at various rates in exchange for the privilege of holding something else. The consequence of shifting preferences and exchange rates may be a destruction or creation of wealth in various places, but it is never a “movement” of wealth."

[steve_gh]

>> The total “amount” or “supply” of a financial asset is the total market value of it in existence: the number of shares outstanding times the market price.

Isn't this assuming 'mark to market' - the assumption that the entire supply of an asset class could be sold at the selling price of some (usually very small) fraction of the supply that has most recently been traded.

If my understanding is correct, this is the fallacy that has underpinned the inflated valuations of many crypto assets (SBF etc)

[ThrustVectoring]

>Some other index fund sees that the price is attractive

Index funds do not have opinions on the attractiveness of prices. What happens in this hypothetical when one index fund has a cash inflow is that it bids on all the assets it is "short" of, which increases the price until the other index funds have "too much" of the now-higher-priced asset and decide to sell.

But generally speaking yes, there's cash or cash-equivalent in the overall market's mix, and it stays relatively constant. When these cash assets get dumped onto balance sheets, other assets get bid up until their sizes are appropriate for the amount of cash around.

[di4na]

Yes. Except there is also a group of people that sit on the side scamming everyone by building assets that promise to fit in the index but are just trash and return nothing.

:Cough: VC and Growth-based startup :cough:

[skybrian]

Kind of. Desired asset mix is an important motivator. (Seems like it's a respectable version of "fear of missing out?")

But it's not the only one. Fear of a price drop can be motivating too.