“Supply” and “Demand” for Financial Assets
Okay, once again I’m going to sacrifice my body here, risk looking stupid by asking what seems to me to be a vexatious question. Here’s the setup:
When you exchange some of your money (bank deposits) for some shares of Apple stock, those shares aren’t removed from the supply of Apple shares. (Likewise your “money”; it still exists.) The stock-supply, at least, is unchanged.
When you buy some apples for consumption, they are removed from the supply — both stock and flow.
Can we model or think about these two markets in the same way? One is a circular flow in which supply is never consumed (that is the sine qua non of financial assets: they embody exchange value that can’t be consumed to derive human utility). The other is a conveyor belt, where the supply falls off the end and disappears (or magically transforms into “utility” via consumption), with real production/resource constraints at the beginning.
Related: Clower/Burshaw on the difference between “stock supply” and “flow supply.” Or peruse the literature here.
I’ve wrestled with this before, as have my thoughtful commenters therein.
But nobody has ever come back to me with thoughtful discussion of stock supply and flow supply, or satisfactorily answered the question at the end of that post (accompanied by a Holy Grail clip that is a propos). The question posed above leaves me even more perplexed.
Am I foolish to suggest that the central concepts of economics, supply and demand, are embarassingly un(der)theorized?
Theres’ a great example in this Felix Salmon post, discussing difference between the global “supply” and “demand” for bonds — which here seems to mean “bonds issued” and “bonds purchased” (designated in dollars). Mustn’t these values as implicitly defined here be identical — at least when viewed ex-post — making a discussion of their difference conceptually problematic?
Cross-posted at Asymptosis.
Why do you assume that the stock supply is unchanged, but the physical apple supply is reduced? If you buy apple stock and “lock it away” you’ve effectively reduced supply. Similarly, if you buy physical apples and preserve them on your bookshelf you haven’t reduced the total number of physical apples in the world.
The clip is not from Holy Grail, but from the Princess Bride.
Your buying stock on the secondary market doesn’t change demand and supply of stock or money if it doesn’t change the price, but that doesn’t mean Apple buying back its own stock or issuing new stock doesn’t affect the supply. If you bought up enough to increase the price or sold enough to decrease it you would be increasing or decreasing the demand for stock and decreasing or increasing the demand for money but only by the amount of the change. Notably buying enough to raise the price of the last lot increases the value of all stock just as selling enough to lower the price of the last lot decreases the value of all stock since it is all priced at the margin.
Let me add another spin.
The Fed bought a huge amount of Treasuries in at least the first two rounds of QE and most news and blog stories seem to assume that this position has to be wound down, so that in the terms of Steve’s question haven’t changed the supply. But the Fed is not sensitive to price in the same way that other bond investors are, I mean it is not like you can make a margin call on the people who control the money supply, and so is free to hold those securities to maturity. Which it seems to me does two things. One it would directly change supply. And two since the Fed returns all profits to the Treasury have the effect from Treasury’s point of view actually represents a retirement of that ‘Debt Held by the Public’.
Yet no one that I can see even entertains this as a possibility. And yet having essentially covered the market on high yielding issued long bonds why on earth would the Fed be impelled to sell? Why have a renewed supply of higher yield instruments to compete against Treasury’s new issues and as I understand the mechanism serve to drive the face yield and so debt service of those new issues UP?
I have got some answers to this but am not at all sure they make any sense at all. So am just throwing this out into this supply and demand post. Because money can be consumed, that is the Fed can move the various M’s up or down by action and policy, and it would seem that they have the same power over Debt Held by the Public should they choose to exercise it simply by adopting a Buy and Hold strategy in regards to that asset class. What am I missing here?