Market Crazy Part 2

by Phil Anderson

“Wall Street is a world of pure finance in the business of using money to make money—by whatever means—for people who have money. Any contribution to the production of real goods and services is purely an incidental by-product.” David Korten in YES! Magazine, May 5, 2010.

Last week I talked about how the speculative trading in stocks can be harmful to the real goods and services producing economy. This is not just my opinion. There are economists and business people saying the same thing. Forbes magazine (a conservative business and investment publication) says,

“Wall Street has thus become, not just a moral problem with rampant illegality and outlandish compensation of executives and traders: Wall Street is a macro-economic problem of the first order.” 

Forbes cites a World Monetary Fund study that says the U.S. economy loses $320 billion, or 2% of GDP growth, per year due to excessive financial speculation. Too much emphasis on making money “out of money” with high risk, complex financial manipulations hurts the real economy and causes market crashes (Wall Street Costs The Economy 2% Of GDP Each Year, Forbes, Steve Denning, May 31, 2015). 

This week I offer more questions about the “markets” and invite readers to correct the errors of my reasoning. 

What are stocks?

Selling stocks is one way to raise money to start, or expand, a business. It is not the only way. You can sell bonds or use loans of various kinds. But loans and bonds  have to be paid back with interest. Money raised by selling stock is not paid back. Stocks represent part ownership in a company and stockholders share the risks of the business venture. 

A share of stock is property similar to owning any other asset, like a car or a house. Property can be bought or sold. The purpose of the stock markets is to allow a convenient way to make these trades. So stock markets like the NASDAQ or New York Stock Exchange have a purpose.  
There are two ways stock owners are rewarded for risking their money. Companies may, or may not, share the profits with stockholders (called dividends). The other way is by increases of the stock price (buy low, sell high). Historically the stock price (or “value”) of profitable companies increased over time. But there is a risk that the company would not be profitable or go out of business. Also stock prices can go up, or down, for no rational reason. I suspect few “investors” buy stocks in anticipation of dividends. Most are hoping for stock price increases. Speculators are hoping for short term dramatic increases in price and could care less about the company.  

Is the stock price important to a company?

A  company only receives income from a share of stock when it is first sold to the public. The company receives no income from subsequent sales of the share of stock. But we are told creating “shareholder value” is the goal, and legal obligation, of a corporation. Maintaining or increasing the stock price is corporate management’s number one job. Why? If you buy a car, or a house does the manufacturer or builder care what you later sell it for? 

Why are stocks different?  

Perhaps it is because corporate management gets paid in stock options and are stock owners. Supposedly this gives them “skin in the game” and promotes better management. But it also means they have a conflict of interest. They will personally gain from decisions that increase short term stock prices rather than the long term good of the company. They are gambling with their company’s stock price. This “next quarter” focus by corporate management is well known and often criticized. An example is how many companies are spending the recent corporate tax cuts. Companies have been using the money to buy their own stock (thus manipulating stock prices) rather hiring employees or investing in plant or equipment.

Why are rising market indexes so important?

Stock indexes, like the DOW or NASDAQ, are the average stock prices for one day. It only includes the stocks tracked by the index. The stock price of individual companies may be different than the average. What is important to any individual “investor” is what happens to the stock they own not what happens to an index average. Also increasing stock prices mean nothing to any individual UNLESS they sell the stock. All the “wealth” gained is only an on-paper ”value” and may disappear the next day. At the end of 2018 all the market “gains” from the year were gone. 

Why don’t we distinguish between investing and speculating?

Humans will bet on anything. Wall Street gambles on financial instruments called “derivatives.” These include stock futures, collateralized debt obligations, and credit default swaps that are based on other financial assets. Essentially speculators are betting on the future outcomes of other bets. Speculation in derivatives was partly responsible for the 2007-8 market melt down. Speculators only care about making money from price changes. Obviously it is impossible for ”day traders” and high frequency trading computers to think about the long term financial health of a company. Investors support the real economy. Speculators bet on economic disruption. 

  Is all the gambling necessary?

Gambling on stock prices is not necessary to a capitalist economy. In fact it is harmful. Commerce, the making and trading in stuff, is as old as humans. Capitalism, the corporate business model, and public trading in stocks is not that old. Nor are economic practices immutable laws of nature. We can have private ownership, free enterprise, and functioning financial institutions and markets without the destructive greed and speculation that characterizes the current crazy system. The system should support the whole economy and not just make a few big players wealthy. We can structure the stock, bond, money, commodities, and real estate markets to support the real economy, not trash it. 

We can build an economy that works for every one. To do this we control the casino gambling on Wall Street. In part three of this series I will discuss necessary reforms to make this possible.