Where does all money and wealth go in the recession?
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“The economy” is money moving around. A recession is when there is less money moving around. So it doesn’t really *go* anywhere – which is the problem.
The cheeky answer would be that rich people and banks are hoarding it. But that’s (kindof) a misleading understanding.
A recession is when spending and investment slow down. Consumers are afraid to make purchases, banks are afraid to make loans, businesses and investors are afraid to make investments in expansion. So instead of money *circulating* and moving quickly between buyers and sellers and lenders and debtors, people are kindof holding back, keeping what they can in savings, not taking any risks.
Also, and perhaps even more importantly, some of the “money” wasn’t exactly there in the first place. Loans/debts were getting passed around and treated as if they were money, but then some shock or failure happens and it turns out some of those debts aren’t going to be paid eventually, they’re just going to default. So that debt someone owns that was supposedly “worth” $10,000 or something is actually only worth $2,000, or maybe even just 0. Money gets wiped off of balance sheets.
Imagine a two person economy. Joe makes hamburgers, and Jane makes clothing. And for the sake of argument, Joe starts with $5 and both hamburgers and shirts cost $5.
So Joe buys a shirt. Jane now has $5, so she buys a hamburger. So Joe has $5 and he buys a shirt. Etc.
The economy isn’t $5, it’s the amount of hamburgers and shirts being sold. If times are good, they’re trading that same $5 back and forth lots of times. If times are bad, Joe sticks that $5 into his sock drawer and then neither of them get any food. The same $5 is there, but it isn’t moving back and forth.
Normally the recession happens in part due to the overinflated value of something. So the money that didn’t exist just simply disappears.
Imagine you announced you’re gonna bring a big pie to a birthday party, enough for 100 people. You make them happy as 100 people showed up, more or less. The next birthday party you announce you’re gonna bring a pie enough for 110 people, but it’s actually enough for 115. You make people extra happy, exceeding forecasts. Some get to eat extra slices.
Next birthday party you announce a pie enough for 120 people, and 120 show up, But it’s actually enough only for 118. People are slightly bummed, but it’s still more than last year.
This goes on for many birthday parties in a row, sometimes more than you announce, sometimes less. You’re now up to a mighty 150-people pie. But next party, due to unforeseen events such as sugar costing twice as much, you announce you’re going to make a pie enough for only 145 people. This isn’t even the same as last party, this is *less* when people expected more. There’s 160 people at the party. There’s going to be some major rationing in order to make it work. People won’t be happy.
So you see, in a recession, it’s not that wealth and money ‘go somewhere’, but rather that you just haven’t created as much as people expected.
Wealth is very fluid. The values of everything constantly fluctuates, including how much a dollar is worth. During a recession when markets crash, wealth on “paper” can simply vanish. If I own $1000 in stocks, and the value drops by 50%, and then sell, my wealth has dropped by 50%. But somebody else bought those shares, and if they hold and it rebounds they gain a lot. If I just held those shares until they rebounded, then I didn’t lose anything(no including inflation to sinplify this).
Takpeople often think of their wealth as how many dollars can I sell this or that for, but it really isn’t that simple. That metric only really matters when it comes time to sell an asset, so you can use those dollars for some other product or service.
That is why we have paper gains and realized gains. Paper gains are what you could sell for, while Realized is what you have sold for to get currency.
Things change in value without any moving hands or going anywhere. For example, house may be worth 1.1 million during a boom, then drop to 600k during a recession even though it was never sold. The market changed and it dropped in value. Same with stock. I have owned stock that dropped 50% and then came back up to its original value. I never sold it, it just changed value. Most wealth is this type of wealth – on paper only with the value of it based on what someone will buy it for.
So a bunch of these answers are wrong. It’s not people hoarding anything, not spending enough, or any of that nonsense.
What is actually happening during a recession is a correction of past mistakes. So for example, imagine you own a restaurant in a city and where the world cup is playing. You aren’t a soccer fan, so you don’t know why you have a LOT more customers than usual. This is the boom. But you mistakenly think that your good fortune is permanent. You hire new servers, cooks, and even take out a loan to add a new room and buy another grill. Then the world cup ends and the new customers stop coming. You only see your old customers. Well now you have a loan to pay off and additional staff to pay. If you continue paying them you will go under. So you lay off those extra servers, sell your grill, try to cancel your construction, and whatnot. And you take a loss doing all of that. Now you need to work overtime to make up for it. This is your personal recession.
You are having to endure the recession because of your past mistakes. Not because customers are hoarding their money. You mistakenly splurged on equipment and employees while thinking the world cup crowd was permanent. While the recession is painful, it is necessary for you to stay in business. It is the “correction”. In short, it is the cure not the disease.
Likewise, recessions in our history have been corrections for previous mistakes. The housing crisis was a result of too loose lending prior. The 2000 recession was a correction after the dot-com bubble.
So to answer your question.. the money doesn’t really “go” anywhere. It still exists. Whoever had those dollars before still have them. People still exchange stuff with dollars. But people also owned stuff that they thought was more valuable than it really was (like your restaurant.. or stocks, etc.). The value of their other assets lost value. People are not willing to buy them for as much as they would have prior. So they lost wealth, the money that people use across the country didn’t evaporate with it.
Where does the speed go when you take your foot off the gas of your car, or when you stop pedaling a bicycle? If you learn literally nothing else about economics, understand this fundamental truth: **ECONOMIES ARE RECIPROCAL**. My expenses are someone else’s income, and someone else’s income comes out of my expenses. So, fundamentally, a recession is just the natural outcome of a lot of people losing income, and therefore cutting back on spending, at the same time.
The profits a huge corporation makes from launching a successful product don’t just get thrown into a hole in the ground, they’re re-invested into other money-making ventures, and those ventures go on to employ other people, consume resources, put products on shelves, and try, in turn, to earn profits, so the cycle can renew itself.
So, when there’s a large economic disruption, like, say, a housing bubble that suddenly bursts, or a worldwide pandemic which disrupts manufacturing and supply chains, or sharp rises in tariffs throttling international trade, that cycle is disrupted. Businesses earn less profit, that comes out of new money invested into new ventures, research, development, advertising, construction of facilities, you name it. And those decisions, in turn, have knock on effects.
If I have an asset, that someone else is willing to pay a million dollars for. Congratulations. I’m a millionaire, on paper. Even if I don’t sell it.
A recession come, suddenly, people are only willing to pay 100 grand for it. I’ve now lost 90% of my wealth. Even though I own the same asset.
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