I see the benefits of the stock market as two-fold:
- It allows companies to raise money and create value.
- It allows the general public to participate (using their own capital) in the growth of the economy
But it seems to have some societal costs:
- It propagates inequality.
- It dangerously ties the economy to a speculative and volatile market. A stock market crash can crash the economy. It should only be the reverse. This is currently tying the Fed’s hands. The long-term effects of our inability to raise interest rates during a period of growth may make the next recession much more disastrous…
The first is a more general problem of capital appreciation. Maybe that is out-of-scope for this discussion, but it does bring up issues with the second benefit… The second cost, as noted, is because the stock market is so speculative. Must it be? And if so, is it worth it?
Well, speculation drives market efficiency. In the stock market, efficiency means that companies are priced “fairly” (I think there are definitional issues here). This directs capital investment to companies with the most potential to generate value. At least theoretically, the more efficient the market, the more efficiently capital is used. And the abundance of speculation encourages investment by providing liquidity to investors who participate in company public offerings.
So speculation does good stuff. But it is everywhere! Almost all of the volume of trades on the stock market is on the secondary market, not the primary market (I can’t find data but I think it must be >99.99%). That means “investors” are trading with other “investors”, not actually investing in companies. I call this speculation, although theoretically it could be simply exchanges of people who want to liquidate or invest their capital, for example in index funds.
Is there any way to keep the stock market working without so much speculation? Reducing liquidity by shrinking the secondary market would decrease investment. Startups have essentially no liquidity and that doesn’t stop venture capitalists (although it should the general public). Here is a call for a larger secondary market for small businesses.
If not, is the stock market worth keeping? Maybe you think this is self-evident. But are there other ways to efficiently direct capital to companies? Central planning??
I think economists would not be big fans of my ideas. Anything recommended reading to correct my view?