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Last week the British voted to leave the European Union. The next day stock markets all over the world declined precipitously. The DOW in this country dropped 610 points in one day. According to Reuters news agency, global stock markets “lost” $2 trillion in value the day after the vote. Why did this happen? What does it mean?
Wild fluctuations like this often occur with stock markets. The news media, pundits, and investment hucksters, of course, always have explanations. The usual spin is that “investors” have lost confidence, or they are “taking profits,” or the “market” is responding to some world event. In this case “investors” were surprised by the unexpected results of the vote and were “uncertain” about the future for trade and the impact on business. It seems reasonable that companies involved in trade between Britain and other EU countries could be impacted by the vote. This might, over time, have an affect on investments and stock prices. But why would stocks of unaffected companies in other countries take a dive?
In my observation these explanations of market volatility seldom make any sense or explain what actually happens in the economy. The spin just doesn’t fit the facts. For example, for every worried seller of stock there must be a buyer, who apparently is not worried about the future or he wouldn’t be buying. So the trite explanations make no sense.
The EU vote aftermath is another example. The volatility could not be driven by real concerns over what may happen from the EU exit. This is proven by the events. The “uncertainty” lasted only two days. Nothing happened to mitigate the uncertainty, but one week later the markets are back at their original level. If “investors” are this irrational, or easily panicked, perhaps they should not be allowed to play games with the economic well being of the rest of us.
The EU vote meltdown does raise questions about the “markets.” Why do we ascribe meaning to the speculative feeding frenzy of stock markets? Why do we allow this gambling casino to have so much impact on our economy? Why do we allow greed driven speculation to impact our pension and retirement savings programs? Or to cause recessions? Maybe readers more knowledgeable than I can provide answers.
The stock markets do have useful business functions. Selling stock in a company is one way to raise capital for business ventures. Buying stock makes you a part owner of a company. By investing in a company you share in the profits (if any) through dividends. You can also make (or lose) money from changes in the stock prices. This investing is a way to build wealth. This allows pensions and retirement savings programs to create income for retirees. Stock markets provide a useful exchange for these important activities.
But speculation on stock prices does not support these useful market functions. There is a difference between investors and speculators. Investors look at the actual prospects for the company, its products, and its future profits. They buy shares with the intention of receiving dividends. They “hold” stocks long term, sometimes for decades. Speculators don’t care about success of the company. They are only interested in short term stock price fluctuations. Buying low and selling high is the goal.
Price speculation can hurt real business activity. Companies are “valued” by what the market is willing to pay as measured by the stock price. Wild, short term swings in stock price do not serve this purpose well. It should be obvious that a company with real property assets (its buildings, equipment, inventory, etc.) does not, nor should not, change value because of arbitrary, daily changes in stock price created by market volatility.
A company only receives money from the initial sale of stock. This is when capital is created, not when stock is later bought or sold. Future stock trades provide no income (or loss) to the company. So changes in ownership or price fluctuations of the stock should not affect the ability of the company to provide products, employ people, or conduct business operations. The stock price and “value” of the company can impact the company’s ability to borrow or sell additional stock. But a stable, well capitalized company should not be affected by short term stock price fluctuations. Despite this, wild price volatility does negatively impact real business growth and stability.
It is also curious that so much attention is given to stock markets when large numbers of businesses have nothing to do with stocks. About 80% of businesses are small and do not raise capital by selling stock. Many corporations are closely held and their stock is not publicly traded. Many other businesses, even large ones, are partnerships, sole proprietors, or cooperatives. Much of the actual producing of goods and services has nothing to do with the stock markets. So why do we fixate on the “performance” of the markets?
The Dow Jones Industrial average (DOW) is made up of only 30 companies out of more than 5.7 million businesses in the U.S. The DOW includes “industrial” giants like WalMart, Home Depot, and McDonald’s. How can this index measure the strength of the whole economy? Coming back to the EU example, are Americans going to buy less stuff, eat fewer burgers, or not remodel their homes because of what happened in Europe? Of course not. Reputable investment advisers counsel ignoring day to day market volatility. One wonders why the media even reports the daily ups and downs.
What does make sense is that the “market” swings are driven by speculation to make the quick buck. It is not “investing.” It is gambling on meaningless price changes. This is clearly shown by the use of high frequency trading (HFT). Computers allow trading stocks multiple times a second. They allow speculators to make money on high volume trades involving fractions of a cent profits. Over 50% of market activity is the result of automatic high frequency trading. Obviously, this is not actual investing in companies. It is not a rational way to value a company. HFT allows speculation to become increasingly dangerous to real investors and the economy. It only creates the volatility necessary to make fortunes by flipping stocks.
So why do we allow real business activity to be destabilized by excessive speculation? Why do we allow the greed of the few to endanger the financial well being of the rest of us? As clearly demonstrated by recent events, stock markets need regulation to reign in speculative trading. This should include a transaction tax, ending high frequency trading, outlawing selling short, and increasing taxes on capital gains. We need markets that serve the real needs of business, investors, pension funds, and the public.