ELI5. If inflation is driven partly by surplus money in the system, will big losses in stocks and crypto reduce inflation by reducing the amount of money?


I keep hearing about multi-trillion dollar losses in retirement funds, investment funds, and crypto markets. If all that value is evaporating, doesn’t it increase the value of currency and reduce inflation?

In: 45

It may not be affected. If you look at 2007 (2.8% inflation) and 2008 (3.8% inflation), trillions of dollars in value disappeared in the housing market + investment banks, and inflation wasn’t really affected. The largest insurance company lost over a trillion.

It’s not that it can’t happen, but the economy will probably need to slow down even more.

No, because the value of an asset isn’t “money” the way that economists think about it. When economists talk about money, they are talking about the [money supply](https://en.wikipedia.org/wiki/Money_supply) – the liquid currency available for spending.

_Edit: I should also mention that [velocity of money](https://en.wikipedia.org/wiki/Velocity_of_money) – how fast money is spent – matters too. The faster money changes hands, the faster we see inflation. Thanks, u/TbarretH for pointing that out._

An asset losing value doesn’t affect this very much. Lets say that you did buy some Bitcoin at $60k and not it is at $20k – you lost 2/3 of your wealth, but the amount of USD you have in the bank didn’t change by even $0.01. There is no more and no less currency floating around, so there is no direct impact to inflation.

Now, there may be second or third-order effects that affect inflation. A person who just lost 2/3 of their wealth is _probably_ not looking to spend extravigantly right now, and that will reduce the currency flowing through the economy.

No. There isn’t money attached to value. If you own a $500,000 home, there isn’t $500,000 attached to that home. It is just a valuation. For example, an artist cannot paint a picture and claim it is worth $10million dollars and expect $10million dollars to be created simply because of that picture.

What will likely happen is that because asset values are dropping, some/many people might feel less wealthy (their assets have depreciated in value) and therefore opt to spend less and save more. This reduced spending should contribute to lower inflation. So there is definitely an impact on inflation when assets devalue but it is somewhat indirect.

tfw you have to read an eli5 questions multiple times to understand it and you feel like a 3yo

It should help reduce inflation, but not as directly as you outline. Most people aren’t funding discretionary spending directly from their retirement accounts. So income or cash flow isn’t really affected. But, people are less likely to spend discretionary money when they feel less wealthy or less secure about their retirement accounts. Inflation is about demand exceeding supply. Reduced retirement account values should absolutely reduce demand.