At the end of 2019, the total size of the US debt and equity markets stood at $99 trillion (composed of $55 trillion of equities and $44 trillion of treasuries, bonds, money market funds, and mortgages). Given the performance of markets and new IPOs and debt issuances in 2020 and 2021, the current figure is likely materially higher, perhaps closer to $130 trillion.
On a global basis, the total is, of course, higher.
More than 2x higher at $200 trillion+.
Given how much money and wealth exists in the world, it’s surprising how little people understand about where money comes from and how it is created, even by many financial professionals.
I’m going to let you in on a little secret that may change how you view money and assets.
The greatest trick the Devil ever played is to convince you that $200 trillion+ of money and wealth actually exists.
Because it doesn’t.
It only exists on paper, and it will only continue to exist as long as you and everyone around you believe that it exists and believe it will continue to exist.
So what does exist?
The only “money” that truly exists is the currency in circulation. These are the currency bills that have been printed and can be withdrawn and used.
It should be obvious that if you can’t withdraw it from…somewhere…and use the money, can you really say it exists? You may consider your stocks “money”, but your stock certificates is not “money” until you convert it into cash because you can’t use your stock certificates to buy candies at the store. Until you turn it into cash, whatever you think it is worth is only an opinion.
A lot of financial numbers fly straight over people’s heads because without context it’s hard to make any sense of it.
What does $2.1 trillion mean? Is it a lot or a little?
It means that if Capital Flywheels somehow accomplished the Herculean task of gathering and owning every single US currency bill in the entire world, I would “only” have $2.1 trillion at my disposal.
Yes, Capital Flywheels would become far wealthier than the current wealthiest person on Earth (Elon Musk) by a large, large margin (~10x more)…but simultaneously it should be shocking to you that “only” $2.1 trillion of “money” underpins the entire $99 trillion+ of US dollar wealth we believe we have.
And if you think the global situation is any better…of the next largest currencies, there is only an addition $1.7 trillion of Euros and $1.1 trillion of Yen in circulation. These three currencies (USD, EUR, JPY) collectively make up ~85% of global currency reserves. That means collectively “only” ~$5 trillion of “money” actually exists and underpins more than $200 trillion+ of wealth that we believe we have.
Since money is already complicated, I will keep it simply by only focusing on the USD and US wealth. But the dynamics discussed below are the same no matter which country you consider, either alone or collectively.
Why is $2.1 trillion of USD money shocking?
$2.1 trillion is shocking because it means that even if I had all the USD in existence, I would not actually be able to buy out a company like Apple with a $2.2 trillion market cap. It means I would barely be able to buy Microsoft with a $1.8 trillion market cap or Amazon with a $1.7 trillion market cap.
Think about that!
If I had all of the USD in existence, I actually wouldn’t be able to afford to buy Apple at existing prices.
And this is just one company…
All that $55 trillion of stocks listed in the US? It cannot fetch more than $2.1 trillion if you actually wanted to sell and turn it into cash.
All those treasuries, mortgages, and bonds totaling $44 trillion on paper? It cannot fetch more than $2.1 trillion if you actually wanted to sell and turn it into cash.
Because all the USD in the world only totals up to $2.1 trillion.
The truth is, there is not actually enough “money” in the world to pay for what we all think things are worth, at least on paper.
Despite all the “money printing” you hear about, there is only a very small sum of money printed relative to all the “money” we think we have.
So how does the world go from $2.1 trillion of actual printed money to $99 trillion+ of “money”?
It happens through mostly two magic tricks…
The first one:
The first trick is that we simply double or triple or quadruple or quintuple count (or more) the same money.
Yes, you read that right.
We simply count the money a few more times than it actually exists.
How does this happen?
This happens because of the magic of deposit and lending (happening mostly through banks).
Let’s say I have $1000.
I go, and I deposit it at the bank.
I still have $1000. Not with me, but it’s still mine. It’s just at the bank.
But, the bank will usually turn around and lend some of it out to someone else (either a person or a business). If the bank, for example, goes and lends $900 back out, suddenly the economy feels like it has $1900 instead of the $1000 I started with.
I still have $1000 (in the bank), and I will live my life as if I have $1000 in the bank. When I was 20 and had $1000, I felt pretty rich! The person or business that received the $900 loan now also has $900 to spend (or invest). Suddenly there is $1900 of assets on paper, but still only $1000 in reality.
This process can continue a few times.
When a business (or person) borrows money, they don’t necessarily need to use it right away. It’s always good to have some cash flexibility, especially if you are running a business. So the business that received that $900 loan may actually just decide to keep it as a deposit at the bank. And when this happens, if the bank decides to lend some of this (borrowed) money out, it can “create” even more money in the world.
For example, if the borrower deposits $900 at the bank, and the bank lends out $800 to another client…
…then, suddenly the world has $1000 + $900 + $800 = $2700 of assets on paper all despite only having $1000 in physical reality.
Most people believe money is primarily created by the Federal Reserve or the Treasury. Yes, they are responsible for creating the actual physical money, but the vast majority of money expansion (through duplicate counting) is actually done through banks and the financial system.
In our modern era, most people have forgotten that this duplicate counting actually happens. This is because we no longer have to worry about the consequences of duplicate counting.
However, until just about 100 years ago, this was a serious concern that all depositors had with banks in general. Until the creation of the FDIC (deposit insurance), everyone knew that if enough people want to withdraw their money at the same time, most people would not get any of their money back.
In our example above, if the two borrowers and I decide we want to withdraw $2700 from the bank (our combined total deposits), well, tough luck…there’s only $1000 in reality to go around.
This is an important nuance – This fundamentally has nothing to do with how much risk a bank takes. The bank could be taking very, very reasonable risks. But if everyone wants their money at the same time, it cannot happen because the money doesn’t physically exist.
On top of this, banks do take some risk. This makes the situation even more dangerous. If your bank takes some risk and it turns out to be a bigger risk than it expected and incinerates some of that money in the process, this already dicey situation becomes even more unstable.
However, in the modern era, we have happily forgotten this problem exists because our deposits are guaranteed up to $250k per person per bank (which covers almost everyone’s needs except for those with above average wealth), and there are limits to how much money you can withdraw at any given time. In essence, it has essentially become operationally impossible for everyone to withdraw so much money such that the banking system cannot honor it (because such an outcome is just not allowed). But the fact is that there is a lot of money that simply does not really exist.
The system we have put up to protect banks and our money is fine if most of our money is still channeled through the banking system, but this has changed, especially within the last few decades.
As interest rates have plummeted to zero, most people don’t keep a lot of money at the bank. Money kept at the bank is no longer earning much if anything at all.
A lot of money has gone into other parts of the financial system and financial assets
This brings me to magic trick #2:
When it comes to financial assets like stocks and bonds and derivatives, there is no such corresponding trick like deposit and lending as there is for banks (though the process of “shorting” a stock comes closest…), but there is an even more nefarious way of “creating” money…
The way you can easily create money in financial assets is by simply accepting less in return for the same amount of money.
That statement probably didn’t blow you away, but it should because it’s the most important process in which current financial markets operate today.
Let’s go back to our Apple example.
Apple currently sports a market cap of $2.2 trillion. This is the value of the company if we pay ~$130 (the current market price) for every share of the company.
But as mentioned above, this is actually impossible. All the USD in the entire world put together only totals $2.1 trillion. It is impossible to come up with enough USD to actually realize that value for the whole company.
Yes, you can throw in other currencies or other assets, but fundamentally that would be no different from bartering. You can throw in a bunch of different things to add up to $2.2 trillion of value…perhaps $2.1 trillion of USD and $0.1 trillion of EUR or $0.1 trillion of Amazon stock, but there is no way to reach $2.2 trillion in the pricing currency (USD).
And this is truly bartering because there is no way to sell the EUR or Amazon stock for USD to raise the extra $0.1 trillion to provide a cash offer because even though you may have $0.1 trillion worth of EUR or $0.1 trillion of Amazon stock on paper, there would be no more USD in the world for you to obtain and add up to $2.2 trillion. $2.1 trillion is the max USD cash in the world at the moment.
But the world doesn’t operate in a bartering system.
How does Apple actually achieve a $2.2 trillion valuation? How does the stock market actually get valued at $55 trillion when the total money we can spend is far less?
By accepting less.
If I had all the USD in the world ($2.1 trillion), I could still value Apple at $2.2 trillion by trading my $2.1 trillion of cash for ~95% of the company instead of 100%.
In fact, this is effectively what happens with all financial assets.
Despite all of the financial assets outstanding, usually only a very small fraction of the assets trade.
For example, Apple is the largest company in the world and one of the most highly traded stocks in the world, yet only ~$15 billion of Apple stock trades per day, which is approximately 0.7% of the market cap. This means that Apple’s valuation of $2.2 trillion is determined only by ~$15 billion moving back and forth.
So on any given day, whatever people are willing to pay on a very, very tiny portion of shares (~0.7% of the total market cap) determines what the whole company is worth. And how that total value changes, depends on how many shares people accept in return for the $15 billion they pay.
This magic trick can be carried out to extremes.
For example, maybe in a week, people will decide that for $15 billion they are happy to get only 0.6% of Apple shares in return instead of the 0.7% that it fetches today. This would raise the valuation of the total company to $2.5 trillion. This process did not require more money, it simply required market participants to accept less in return for whatever money they already have.
Over the past year, capital markets and US wealth has expanded by trillions. Many people will simply point out that our government has printed a lot of money.
This is true.
But it’s not a complete answer.
The Federal Reserve has expanded its balance sheet by $3 trillion (however, physical bill printing is actually materially less at ~$400 billion). Even then, the Fed’s operations should be viewed more like transformation of money rather than creation of money. Still, that’s a lot of money! But it certainly did not create anywhere close to the amount of “money” that we have all added on paper. That extra “money” came from people accepting less, materially less for what that money would have bought previously.
Why is this possible?
This is possible because when we buy financial assets, we are not committed to buying all of the same financial assets at the transaction price. Financial assets have the magic of being fractional. You do not have to buy 100% of Apple at whatever price you pay. You can buy a very, very small piece of Apple. And if you want to pay a lot for a very, very small piece of Apple, you can certainly do that! If you want to pay $130 for a share of Apple, you can do that. And when you do that, you suddenly, magically create a lot of money on paper. If you suddenly feel like paying $200 for a share of Apple next month, you can do that, too, and create a lot more money on paper. But whether that total value can ever be realized is a very different story.
But we’ve gone even a step further.
While financial assets like stocks allow you to buy a piece of something, what if you can buy a piece of THAT piece of something?
Well, this has actually happened!
This is effectively what happens in fractional share buying.
There’s a lot of attention on how Robinhood and WallStreetBets and retail has “broken” the markets, but Capital Flywheels believes the most under appreciated “innovation” is the introduction of fractional share buying by Robinhood and Cash App in late 2019.
Fractional shares were already offered by some of the smaller players prior to that, but the launch of fractional shares in Cash App in October 2019 and by Robinhood in December 2019 fundamentally changed how investing works.
Previously, fractionalized companies (e.g. stocks) already made it easy to “create” money. You can create money by just paying up more for a small portion of the company (or accept less stock for the same amount of money).
But fractionalized shares of companies have fundamentally hyper-charged the process because now people no longer even have to think about the price they are paying.
A share of Apple at $130 feels more expensive than a share of Apple at $100 or $50 (obviously).
But what if you simply can buy $100 of Apple today no matter what price it is? What if you could buy $100 of Apple today regardless of whether Apple is $130 or $150 or $200 or $2000? To you, you are simply putting up $100.
THIS is what it means to accept less for the same price.
Given the attention on Robinhood these past few weeks, you’ve probably seen this chart on how Robinhood’s trading volumes have exploded since the pandemic started and reached the stratosphere in late January, coinciding with the GameStop mania:
I know what the prevailing narrative is – Everyone is at home because of COVID-19 and is bored and wants to trade…
That is probably true, but if you look deeper, you will see a slightly different story.
This is what that chart looks like leading up to March 2020 (i.e. approximately the START of the pandemic lockdowns in the US):
The explosion in trading actually predates the start of the lockdowns in the US! The explosion in the trading started in…December 2019.
Capital Flywheels is a firm believer that small changes in perceptions can lead to drastic changes in behavior.
I believe there is a strong case to be made that when you can buy $100 of any stock regardless of the price of the stock, a good number of people may start to not care what price they pay. They can finally buy Amazon (or Tesla or…) even if they only have $100 instead of $3300 (which is approximately what a whole share of Amazon costs right now). And for $100, you don’t even have to care if Amazon is trading at $3000 or $4000 or $5000. To you, it’s all the same. It’s $100.
So what does this mean?
We have already been living in a world where money is magically “created”.
Some money is created by the Federal Reserve and Treasury, but most money is actually created by banks and the financial system.
We (as in, WE THE PEOPLE) are currently the largest driving force in “money” creation in Capital Flywheels opinion.
It’s not the Fed…
WE are creating “money” by accepting less for the money we have. The Fed gave us a few trillions more to play around with, but WE THE PEOPLE have magically conjured up tens of trillions of more paper money.
I’ll close off with this…
All of this wealth creation, is it real?
In a way it is.
But in other ways, it isn’t.
It’s real in the sense that you DO have that money. You CAN go to a bank and borrow even more money against it.
For example, perhaps you have $1 million of stocks, and instead of paying cash for a house, you go get a mortgage for $1 million. Suddenly you have even more money via the magic of the banking duplicate counting power.
But what you don’t have is cash.
And this leaves the ultimate tail scenario – In some dark and unpredictable future day, a LOT of people may suddenly one day decide that they want cash. Maybe they think the market will crash and don’t want to hold financial assets. Maybe there is a natural disaster that may require you to spend a lot of money quickly and you want to have the safety of cash. Or maybe there is a looming recession and you’re uncertain about your own income situation and want to have a cash cushion.
Whatever the reason…
No matter how much “money” we all have on paper, whether it is $99 trillion or $130 trillion or $150 trillion or maybe eventually $200 trillion…
No matter what it is, if enough people suddenly want cash, ALL of those assets cannot be worth more than $2.1 trillion because that’s all the USD that actually exists.
For a base of $130 trillion of assets, if only 1.6% of that wants to convert to cash, THAT alone is already all the USD in existence.
In a highly financialized world and an ever more financializing world, this growing gap between what we believe we are worth on paper and what can actually be turned into cash is a key driver of market crashes during times of stress precisely when a lot of people suddenly want cash.
Although I am not a bitcoin-truther and do not know whether bitcoin is our future or not, one thing that is true of both bitcoin and all financial assets today is that its existing value can only hold if you increasingly convince holders to HODL.
Because if any meaningful portion of hodlers want to go back to cash, it will be a rude awakening for all of us. All the more so because financial asset valuations have dramatically expanded far more than even our actual money printing.