A better question might be: How does anything lose value?

No one has ever posed this question to me, but I do find myself explaining it every time I talk about the stock market.  If the Dow is down 300 points, then the market has lost value?  But what difference does it make really?  There is (more or less) a set amount of money flowing around the world so how do I lose money when the Dow is down?

We must first distinguish a few things.  Most importantly, when you own stock, you do not own money.  Sure its value is always presented in term of dollars, but one share of Coke is really only worth one vote in the company.  This makes it an asset, not a type of currency.  Sure you can exchange the share for money at almost any time, but you can’t go down to the 7/11 and trade your Coke stock for a Cherry Pepsi (blasphemy!).  That’s because to share is an asset.

There are two types of assets in the world.  We have tangible and intangible assets.  A wedding ring is a tangible asset.  Actually the gold is a tangible asset.  Gold will probably always be the most pure of tangible assets.  Its tangible because you can tangi it.  No tangible means you can touch it, feel it, caress it, kiss it, OK this is getting weird.

Then you have intangible assets, that’s something you can’t touch.  Your share of Coke stock can be on a certificate, but since it represents your vote, you can’t touch your vote.  This is an intangible asset (so no kissing).

Tangible assets tend to have more long term stability in their values.  Gold has always been valuable to us, oil has been for centuries and will remain so for the foreseeable future.  Intangible assets fluctuate much more often, and are capable of completely losing their value more so than the tangibles.

I’m going to talk how the market loses value by explaining how an intangible asset becomes worthless.  Let’s pretend for a moment that I’m the only person in the world that holds the secret recipe for Coke.  Its my formula, and (as in reality) it is one of the most valuable intangible assets in the world.  I could sell it for billions of dollars.  This makes my net worth in the billions of dollars as well.

It makes it easy for me to get money.  I can go down to the bank and say I own the recipe and would like to borrow some money.  The bank would be happy to loan me the money, because if I come on hard times I can sell the ownership of the recipe and pay off the loan.  So my intangible asset got me tangible money.  For all intents and purposes, I’m a wealthy person.

But what would happen if the asset was no longer valuable, or worse, worthless?  My net worth would be nil!  No one would loan me money now.  So what horrific event would make my secret recipe worthless?  Well one night I got really drunk.  I mean the kind of drunk where you wake up the next day in the dumpster and you’re missing a shoe only to think “I can’t remember last night but I’m sure it was fun”, not that that’s ever happened to me.  Well that night I had apparently decided to mix rum and tequila and chase it all down with a box of wine.  So on a dare from my idiot friends I posted the recipe for Coke on the internet.

By morning every newspaper in the country was printing the secret.  Now what was once an intangible asset that existed only in my head is simply a few words of text on a newspaper.  Worthless.  I have no money, no asset.  The asset has lost its value.

This was my first, and probably not my last, attempt at explaining the relationship between an asset and our money.  Our economy is held up by intangible assets, think stock markets.  This is why every time these assets lose value, you get the impression of having lost money.  No you didn’t lose money when the S&P drops 100 points, you never had money, you lost value.  Your net worth decreased but the amount of money you have in your bank account did not change.  The people that freak out when the market dips are the ones that don’t understand this, its the most important distinction any investor can make.

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  By 		The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics. Also keep in mind that nothing I say can be construed as financial advice.

categories: economics, investing, personal finance