If you assumed that equity capitalization equity cash was static, then you could not create more cash supply from any sale because as you pointed out it would be a “zero sum” game.. However it is not static. There is new cash entering and leaving the playing field from various sources such govt money printing, the creation of new companies and asset materials such as precious metals, existing companies issuing new stock or repurchasing existing stock, sell and purchase of other assets such as real estate and commodities, not to mention the interaction with foreign assets. In a recession/depression, cash leaves the playing field to pay other living expenses that it would not normally be needed for.

Your second hypothetical, where everyone purchases at the same time is simply the converse of your first riddle. If all the cash decided to buy, The equity players who sold would then become the cash pool. If they in turn decided to turn around and rebuy equities, then the process would continue to cycle. But every time there is a sale, the seller, is momentarily left with cash.

Another separate comment is that the money market supplies don’t change as much as does the relationship to the sum totals of cash and equity.

For example purposes, assume that 3 players comprised all the equity assets and cash assets in the playing field and assume that

Player A owns 1 trillion in equities
Player B owns 1 trillion in equities
Player C owns 1 trillion held in temporary cash (mm) account.

Assume no new players or cash enter the game.

The % of cash to equity Cash is 33%

Now assume that equity prices have decreased by 50%, similar to 2008-09. Now all of sudden

Player A owns 1/2 trillion in equities
Player B owns 1/2 trillion in equities
Player C still owns 1 trillion in cash

Now the % of Cash to Equity Cash is 50%, but the actual cash amount has not changed.

Now assume Player C decides to buy equities with all of his cash. Then the relationship would become

Player A owns 1/2 trillion in equities
Player B owns 1/2 trillion in equities
Player C owns 1 trillion in equities.

The % of cash to equity Cash is still 33%, it has simply been redistributed. But the point is that the % of cash moved from 50% to 33% based solely on price of equities and not who decided to buy or sale.

Again this is all theoretical based on a static capitalization playing field and I point out again that the cash in the playing field is not static, but usually growing due to inflationary pressures and a litany of other reasons, some of which I pointed out in the first paragraph.

“Money” can be invested to all kinds of other assets like bonds or withdrawed to put into bank CD for example…

Twisting the question around a bit: if cash levels don’t change or, as you put it, there is always a ton of money on the sidelines, implying that those levels stay the same…then how do you explain fluctuations in Money Market Funds? Answer that, and you probably have the answer to your original question.

Yours is a great question though!

There is a reason they call it “trading”.

Interestingly, I have noticed this argument trotted out when there are no more fundamental arguments to justify market valuation. I heard it a lot in the Spring ‘07, Fall ‘07, and Spring ‘08. Now I hear it again. Next, I expect to hear about how the stock market is cheap according to the IBES/Fed model.

Trader A (on the sidelines) buys stock from Trader B (in the game). Now Trader A is in the game and Trader B is on the sidelines with the cash received from Trader A.

Has any money been removed from the sidelines?