What good is paper wealth when it all collapses?
The value of paper assets depends on the stability of a financial system. When a system collapses, it can become worthless. For this reason, those concerned about financial instability often diversify into real assets as a hedge against catastrophic loss.
What is paper wealth?
Paper wealth refers to financial assets that are not tangible goods but represent a claim of ownership or value. Its value is based on the trust and stability of the underlying economic system.
- Financial assets:Â Examples include stocks, bonds, mutual funds, ETFs, and bank accounts. The number on a brokerage statement represents a share of a company or a debt obligation, not a physical object.
- Fiat currency:Â Modern money is “fiat currency,” meaning it is not backed by a physical commodity like gold. Instead, its value is derived from government decree and public trust. If that trust is lost, the currency can become worthless.
- Asset bubbles:Â In a booming market, “paper millionaires” can emerge when asset prices skyrocket. However, this wealth is not realized until the assets are sold. If a bubble bursts, as happened with the dot-com bubble, that paper wealth can evaporate almost instantly.
Why paper wealth can collapse
The collapse of paper wealth is not a new or theoretical concept; historical precedent demonstrates how it can occur.
- Economic collapse:Â During a major financial crisis or depression, falling asset prices can cause the value of stocks, bonds, and other financial products to plummet. Banks may also fail, causing bank deposits to disappear, as happened during the Great Depression.
- Hyperinflation:Â When a government prints excessive amounts of money to fund its spending, the currency loses value. This can spiral into hyperinflation, rendering cash and other fiat-based assets worthless. This occurred in countries like Zimbabwe and Venezuela.
- Systemic failure:Â In a worst-case scenario, the entire economic and legal system that gives paper assets their value could disintegrate due to war, revolution, or civil unrest. Without a government to enforce laws and contracts, paper claims of ownership lose all meaning.
Hedging against a collapse of paper wealth
In response to the potential instability of paper wealth, investors turn to strategies that diversify into real assets. This helps maintain value outside the conventional financial system and provides utility even in a crisis.
