I think maybe stock markets (and possibly commodities and currency markets as they currently exist) are bad and we shouldn’t have them. Willing to hear reasons why that’s wrong. Let me set out my stall.
My dumb-dumb notion of a stock market is: A market for the buying and selling of notional fractions of notional entities themselves engaged in commerce. A trader on this market will buy stocks in a company on the basis that she believes the company’s profits either are or will become high enough to generate an acceptable dividend. A speculative trader may buy a stock on the understanding that real-world market conditions indicate that the company’s chances of generating profits at that level are due to increase, hoping to sell the stocks for a profit later.
That last bit creates an interesting phenomenon: the Keynesian Beauty Contest. From Wikipedia:
Keynes described the action of rational agents in a market using an analogy based on a fictional newspaper contest, in which entrants are asked to choose the six most attractive faces from a hundred photographs. Those who picked the most popular faces are then eligible for a prize.
A naive strategy would be to choose the face that, in the opinion of the entrant, is the most handsome. A more sophisticated contest entrant, wishing to maximize the chances of winning a prize, would think about what the majority perception of attractiveness is, and then make a selection based on some inference from their knowledge of public perceptions. This can be carried one step further to take into account the fact that other entrants would each have their own opinion of what public perceptions are. Thus the strategy can be extended to the next order and the next and so on, at each level attempting to predict the eventual outcome of the process based on the reasoning of other rational agents.
So in reality, the stock market never functions per my dumb-dumb notion above. Instead, trading comes to revolve far more around the perceived actions, appraisals and intentions of other actors on the stock market than on the real-world market conditions as appraised by the trader herself. Let’s call this the “Spock market”. My first contention is: Any sufficiently mature stock market will become a Spock market.
I’ve read that after the stock market crash of 1929, it was initially assumed that there would be no major impact on the ‘real economy’. Commodities were still being sold at retail, primary resources were still being extracted etc. All that had happened was that the notional value of notional fractions of notional entities had rapidly decreased. We would never think that now. The Depression, Black Wednesday, 2008 and other, smaller, but fairly frequent market meltdowns have left us entirely used to the Spock market periodically threatening us all with disaster and occasionally delivering.
Major real-world events are reflected in the markets, and people look in no small part to the markets to assess the actual impact of the real-world events. Governments that struggle to fund essential services will glibly throw a trillion(!) dollars onto the markets like sugar onto a dying fire, in the hopes of staving off disaster. Come fire, famine or plague, the market must not flag. The worst possible thing that could happen, the apocalypse in whose face all else must be sacrificed, is a drop in market prices. Let’s call this the “shock market”. My second contention is that any sufficiently mature Spock market will become a shock market.
A funny thing happened over the course of the pandemic, sort of an inversion of early assumptions about the 1929 crash: everyone assumed the impact on the ‘real economy’ — shutdowns, lockdowns, cessation of productive activity etc — would be disastrous for the stock market. What happened, as far as I can make out, was that the Spock market shat the bed for about six weeks starting in February, as traders accounted for the fact that everyone assumed this. But the S&P closed out 2020 up 16% on the year, a record high.
So my question for all the smart guy centrists is: What good is the shock market? What are the benefits that redound to society as a result of its existence? It’s an honest question and I’d quite like to know. I can see that a stock market allows people to start up and expand businesses without onerous seed-capital requirements and I suppose that’s good. I have more trouble with the Spock market — I really don’t see what societal benefit it’s supposed to have. And all I see in the shock market is a monster that eats money and periodically destroys a bunch of stuff. So what am I missing?
Relatedly — am I wrong that stock markets always become Spock markets? Can a stock market be regulated in a way that will prevent that? Can a Spock market be regulated in a way that prevents the emergence of the shock market?
