Far too often these days, we hear the claim that “the stock markets are parasitic and serve no purpose except for parasites to live off of the working class”. This claim is utter nonsense, and even an utterly immoral claim, founded in laziness, hatred and jealousy, as will be made evident in and by this article.
Let’s examine what stock markets actually are, what their purpose is, and whether or not the claim can be substantiated.
Corporations – a brief overview.
For starters, we need to take a look at how a corporation is formed. A corporation is a juridical entity, with a certain number of issued shares, as the fundamental part of the capital structure of the corporation – the equity. Each share carries with it ownership of a certain part of the company, which translates to the shareholder being allowed to cast votes with a count equal to how much is afforded to each share multiplied by the amount of shares a shareholder has.
Example: Corporation ABC’s capital structure consists of 1000 shares. Shareholder XYZ owns 100 shares, and thus has a voting power of 10%.
Additionally, shares give the shareholder a right to receive dividend pay-outs.
It should be noted that some corporations do have differing series of shares emitted in the equity part of their capital structure. This is fairly common in Sweden for instance, where I live. Several of our largest and not-so-large corporations that are publicly traded, have A- and B-series of shares, with the A-series having a greater voting power per share than the B-series, and with the A- and B-series carrying equal rights to dividends. Additionally, so-called preferential stocks have increased in use in the last 10-year period, and which if used in a corporation’s capital structure, usually receive most if not all of the corporations payouts, but might not have any voting power, and which have a greater seniority in the capital structure. So everything is not so simple as I make it seem in some of the examples in this article.
To summarize before we continue, the equity side of a corporation’s capital structure formally entails:
- Voting Rights.
- Right to dividends from the corporation’s cashflow (usually only if profits are made).
- Assumption of primary risk in case of a partial default or even total bankruptcy. Equities are hit first in a default situation.
Now, why would a company need to be registered as a juridical entity, and not as a sole proprietorship? The reason for this is that as a company grows, it might become very big and operate with potential liabilities that are far too big for any one individual to shoulder financially, morally and mentally.
Additionally, there are some economic endeavours which are very risky, but which yield large rewards if they are successful. The risks can be and often are far too great for a single person to shoulder with their personal private lives as a full backstop, as is the case with a sole proprietorship. A corporation structured as a separate juridical entity will in such a case provide a way to limit the risk for the people involved with running the operations of the corporation, as well as provide a way to create financing opportunities for the corporation.
Stock Markets – what primary purpose do they serve?
In most if not all jurisdictions, corporations can be private held and traded, or publicly traded. A corporation certainly doesn’t have to go to the public capital markets through an IPO (Initial Public Offering) and put all or parts of its equity up for trading there, if it doesn’t need any external capital to operate, or if it can find external capital outside of the public markets.
For instance, IKEA, the huge Swedish furniture manufacturer and vendor, whose founder Ingvar Kamprad is a billionaire, hasn’t traded on the public stock markets.
Other large companies have come and gone to the public capital markets. Sometimes they are acquired by competitors who are or aren’t themselves publicly traded companies. Sometimes they are bought by other interests who choose to hold them privately off the exchanges (or sometimes they only take a very large percentage of the shares off of the markets, leaving a smaller float that they do not own, still publicly traded).
So, the primary purpose of the stock markets to begin with, is to match up capital providers (willing buyers of the shares in the corporations) with corporations in need of financing and/or sellers of shares who choose to transact through the public exchanges.
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Who owns the shares of companies, and why? What does it entail?
Buying shares in a company means that you as a buyer have provided a part of the capital structure which the company needs to operate. Your risk-taking provides jobs to people. You as a buyer are actively taking on risk and stand to lose money in a partial or whole default of the corporation. In return – and depending on the exact specifications of the capital structure of said corporation – you receive voting rights, and rights to dividend pay-outs from the profits of the business.
Additionally, share prices might fluctuate, and most certainly will if the stock is publicly traded, which might mean that you stand to gain from an increase in the market price of the stocks you own, but conversely, your shares could also lose if the market collectively decides to push down the price of the stocks you own.
Owning stocks is – unless the company is engaging in egregiously criminal acts – a moral and upstanding thing to do. You are taking on risk, so that others can be gainfully employed. In return, you receive a certain amount of the profits generated by the employees. This is the definition of capitalism, that your capital provides opportunities for others to work and survive, while rewarding you with a portion of their efforts in return, but while also placing the monetary risk if the company fails, squarely on your shoulders.
All in all and generally speaking, owning stocks of reputable companies, providing reputable services and goods to people, is a very noble thing to do. There is no question about it, unless one has been brainwashed by the hopeless shambles that nowadays pass for Western “education”, and believes that the usage of capital for the purpose of enabling production of goods and services is somehow “exploitation”. Funnily enough, jurisdictions which have disallowed or discouraged capitalism, are hopelessly underdeveloped.
This is certainly not to say that all big corporations are engaged in benevolent behaviour, especially not in this stage of Western civilization, as regulatory capture in most (if not all…) industries have allowed and encouraged increasing forms of corruption, as well as increasingly idiotic and short-sighted leadership of even some of the biggest and most important corporations out there. And some moneyed people are certainly corrupt criminals, if not in the eyes of the laws on the books, then certainly by any ethical standards worthy of mention.
But this is more of a late-credit-expansion-cycle type of phenomena, rather than an indictment of the act of capitalism itself, which is to provide others with the means of production of goods and services, which they could NOT provide for themselves, at least not in any quick and expedient and worthwhile fashion.
What function does trading of equities on the stock markets fulfil?
So, we’ve gone through these points thus far:
- What the equity side of a corporation’s capital structure is.
- What the equity side of a corporation’s capital structure does.
- The reasons for why a corporation might need to be structured as a juridical entity rather than being connected to a physical person as in a sole proprietorship.
Let’s now move on to what role and function the public stock markets and the trading flows satisfy. While most people in the Western populace usually have insufficient knowledge about equities in the sense I’ve already covered in this article, even less understood is the trading part of public stock markets, and why trading is necessary and an act that benefits society.
All human productive activity is future oriented. We take a certain action in the now, in order to gain an effect at some point in the future. Sometimes this effect is almost immediate, and sometimes it will only occur maybe decades into the future. For instance, creating some simple widget out of a piece of wood which we intend to sell later the same day, has a pretty much immediate effect. Starting a family and raising children (which used to be considered part of an economic survival strategy), or running our own business and/or partaking in some sort of lengthy R&D project, is something which will usually come to full fruition only much later.
Economic activity is all about guessing what other people will want to procure at some future point, measured in both goods and services. Through the institution of centralized and well-regulated means of exchange (money), humanity in most place around the world now operates with an advanced form of bartering system which enables us to effectively own and control and exchange a wide range of productive means, goods and services, all available to us through our own economic power.
That is, beyond the immediate work we can undertake because of our natural abilities, talents and/or education and experience, we can also use our condensed labour in the form of money, to purchase or set up productive assets which other people can operate.
This is what the stock market helps us accomplish; the acquiring and divestment of productive assets. A centralized marketplace for productive assets of various sorts, where we can increase our productive capability, or divest some of it, all through the medium of money.
This much is probably obvious to most readers. Where it gets interesting, is when we start to ask some critical questions with respect to how the trading of financial assets on the stock markets takes place. Here are some common questions/objections/claims:
- “The stock markets are parasitical and not part of the real economy.”
- “What economic value is there in short-term trading?”
- “We should restrict short-term trading and force people to hold their stock investments for longer periods of time.”
The first claim – “The stock markets are parasitical and not part of the real economy”, or even the claim that “the stock markets drain the real economy”, is flat out wrong. As clearly outlined and explained earlier in this article, the stock markets are all about allocating capital to corporations, so that gainful economic activity can be undertaken (or developed), and people have jobs to go to, and all on an order of magnitude that is far greater than could be shouldered by corporations in the form of sole proprietorships.
All well-developed well-functioning economies rely on corporations and capitalism, with no exceptions to date, at least none that I know of. And the stock markets fulfil the role of being capital allocators and providers to some of the bigger corporations. And it is corporations of all manners and sizes that are a significant part of the real economy in the world of today.
Companies tied to physical persons (sole proprietorships) are simply too small to handle the multitude of complex systems required by the many of processes needed to produce most of the advanced goods we enjoy consuming today. On the other hand, there are also certainly cases where a large company is simply too big and too complicated to get certain things done. I’m not arguing for “big business only”, that would be a violation of the free market capitalism I advocate for (although I’m not a libertarian in the strict sense of the word).
The second question is “What economic value is there in short-term trading?”.
In general, short-term traders tend to provide the market with a more-or-less continuous flow of price quotes, as well as narrowing the bid and ask spread. That is, short-term traders make the market more transparent, and more actionable for all other participants on the sidelines. Their actions serve to provide other market participants, who might not be short-term traders, with a very clear picture of at which price they can trade in or out of a particular financial instrument.
Short-term traders are also rewarded (if they are any good, and most of them aren’t…) with money if they guess the future outcome correctly in the financial markets, and punished if they make mistakes and lose money.
Since effective human economic activity rests on being able to accurately predict both cycles in nature, but also what our fellow humans might want and need to buy from us or other people, the markets serve to reward those who are skilled predictors of the actions of others, with more money and resources, that they themselves can then allocate.
Hence, short-term trading is both ethical and moral, because it finds or makes winners who can provide greater economic outcomes that benefit other people, and rewards them with more resources to spend as they see fit.
Actually, long-term trading/investing does the same thing, if we boil things down.
However, not all short-term trading is equal. Over the last years, an epidemic of dubious if not outright fraudulent HFT practices have arisen, and not been stopped by the relevant authorities. Perhaps most egregious is the type of HFT front-running of other participants market orders, which sometimes seems to occur with the blessings of the exchange operators, and which inflicts small but over time (and in volume…) considerable losses for other market participants.
This type of short-term HFT is morally and ethically bankrupt, since it rests not on accurately predicting what others might do, but on actually taking their order data – which should be confidential until the moment it hits the books – and trading in front of it where possible. This type of short-term trading is fraudulent, unethical and one shouldn’t have any respect at all for any institution involved in this sort of shady, back-alley thuggery-and-muggery type of micro-becomes-macro-thievery at all. This is not to imply that all HFT programs operate in this way.
I’ve been an active trader and market analyst for more than a decade (actually closing in on two decades… time flies…), and if we disregard price movements in singular stock names on occasion, I’ve not seen any evidence that the market patterns have been effective altered by all the computerized trading – my opinion is that all of the HFT actors cancel each other out when it comes to the patterns formed in the markets. My conclusion is that HFT hasn’t altered the fundamental ways markets behave at all. If we want to find something that has, we should look to central banks and their insane and irresponsible balance sheet expansion.
The third claim, “We should restrict short-term trading and force people to hold their stock investments for longer periods of time.”, is a very ill-thought out suggestion.
If traders are forced to hold positions for longer periods of time, that will simply bring about the following considerations/consequences:
- Since a position can no longer be quickly liquidated if the trader has made a mistake in his analysis process, he or she will want to pay less for the financial asset in question, or not participate at all in trading it.
- Forced longer holding periods will also force traders to take the dividends pay-outs into much greater considerations, driving demands for the direct yield (the effective interest rate in %) to generally be higher, and/or lowering the price of the stock until the direct yield is more palatable. This has to do with the fact that being forced to hold risk for a certain amount of time, means you will want to be more compensated for the act of doing so.
- Greater and perhaps unnecessarily large capital flows will go to businesses which are already well-established and reliable, and which are less likely to cause any unwanted surprises for the traders during the holding period. In turn, this will deprive riskier but potentially very good business opportunities that might produce a greater amount of wealth and prosperity for the whole economy, of the funding these businesses might need, effectively reducing innovation and causing further economic stagnation.
In general, Monetary Velocity in the entire economy will drop considerably if long-term holding periods are enforced on the stock markets, thus reducing the wealth, prosperity and living standards considerably, and arresting innovation. Just the very act of restricting the stock market trading will bring this about, according to the laws of economics and human psychology, because the free exchange of capital and ideas about the future will be constrained, and the knock-on effects are too large for most haters of free-market capitalism to even begin to comprehend.
A small caveat here is in order: The suggestion made by many HFT critics, for example Karl Denninger, that holding periods and order placement restrictions measured in at least a few seconds are to be instituted to prevent some fraudulent HFT practices that involve illegal displays of order depth, is very unlikely to constrain economic activity and innovation.
Forcing market orders to be valid for at least 1 second or so, is in line with human reaction speeds. Spoofing of order depth which the HFT actor has no intention of actually executing at, but only uses to force human traders to take actions, should be limited or outright forbidden, as it is already outlawed by the Terms of Service agreements for most if not all public exchanges.
Where the critics and haters of capitalism get it wrong.
The claim that capitalism doesn’t work and that the free markets and capitalism itself needed to be rescued in the aftermath of the 2007-2009 financial crises, rests upon the fact that numerous types of bailouts were launched to prop up various financial institutions in the West, using taxpayer money. Critics of the market economy take this to mean that capitalism cannot survive without state power, a conclusion which is totally wrong.
Sadly, the numerous taxpayer financed bailout process disrupted the function of the free markets, which can simply be described as rewarding success and punishing failure and carelessness. For several years leading up to the crisis, state power had been improperly intervening in the financial markets, restricting parts of their natural function, propping up bad companies, cutting central bank interest rates to low, and most of all, allowing banks to get away with thoroughly criminal lending practices that were in obvious breach of the law.
Prior to the crisis, the Western financial system wasn’t totally free. Indeed, banks had access to state powers to backstop them to some degree, in form of the taxpayer backed Federal Reserve System in the US, and in the form of the ECB in Europe.
However, if you do give banks such a backstop, you MUST at the same time also institute regulations regarding the practices of bank lending. Otherwise, you are simply encouraging fraud.
And here’s where things went wrong. State power was erroneously instituted to backstop the banks, while a balancing amount of regulatory state power was NOT PROPERLY APPLIED in the form of proper supervision of the banks’ lending practices.
This malfeasance on parts of the Western governments, created an unbalanced and not really free market, where because of state power, the banks could freely engage in utterly disgusting behaviour with respect to lending. It could not have happened without state power meddling in the free markets and disrupting them to some degree.
Then, once the crisis struck, the governments of the West made a most serious mistake again, when they disallowed the natural cleansing fires of bankruptcies, to clear out the bad debt from the economy, and destroy bad actors and bad companies.
In other words, state power created the imbalances which led to the financial crisis, which was then blamed on free market capitalism, and used by dishonest and in most cases ignorant politicians and socialist social commentators, to call for more state power. The political Left claims that the markets failed and then needed state power, but the reality is that it was malfeasant state power (something the Left wants more of) and state interference in the previously relatively free and fair markets, that caused the festering credit disease that ultimately triggered the crisis of 2007-2009. This is what the political Left always engage in. They create problems, blame them on everyone else, and then try to usurp more power.
The financial market should have been left to their own devices before, during, and after the financial crisis.
The banking sector and the financial markets did NOT need any help at all during the financial crisis. None whatsoever. What was needed then, and is still needed, is that governments stop interfering in the financial markets and stop trying to hold up a system stacked with insolvent enterprises with horrid amounts of bad debts on their books.
If nothing had been done in terms of interventions, the free market would have bankrupted as much bad debt and as many corrupt and in some cases criminal institutions as would be necessary to restore monetary velocity and general trust in the economy.
And instead of the zombie economy of the last 8 years, which has served to further hollow-out the middle class in the US and Europe, we’d be in a much healthier economic paradigm, with bad decisions being punished by the markets, most of the bad debt defaulted. We would probably not have today’s environment of continuing credit expansion which even now is starting to fail, and which no longer drives GDP growth sufficiently to be considered sustainable.
Unfortunately, state power in the West has NOT been applied properly since the financial crisis, and today’s situation is in many respects even worse than it was before the last crisis struck.
Concluding thoughts on the nature of the stock markets and trading.
The equity markets are an indispensable part of decreasing capital allocation hurdles in the modern economy. Through the equity markets, anyone with condensed work (money) can acquire or divest themselves of productive assets, be they already producing or be they speculative, as the investors and traders wish.
Our modern capital markets offer the to-date most flexible and unobtrusive and non-coercive way to allocate capital as one sees fit.
They also reward those among us who are the best predictors of future economic and human outcomes (well, at least they used to do, before the central banks (state power, which is very dangerous and often leads to very bad outcomes…) decided to most foolishly start to make winners and losers at their leisure utilizing tax payer funds, a devastating crime against the whole economy and an absolutely disgusting show of disrespect for all the good that (relatively) free markets and free enterprises have brought humanity over the last 500-800 years or so).
As such, trading at both shorter and longer time horizons is by itself a productive process, and it has the positive outcome of – over time – redistributing wealth to people who are better at deciding what to do with it. With some HFT practices being an exception, as noted.
The Leftist propaganda against the free markets and the stock markets is utter nonsense, spouted by radicals who have laid waste to academia in the West and reduced it to a laughable state of idiocy (just go watch some videos of politically correct “professors” and “students” at your random US college or university, and you’ll get the picture…), and whom themselves are largely parasitic entities, living off taxpayer funds. Additionally, many if not most of the Leftists are utterly ignorant about how the free market system functions.
And yet these Leftists, who in most cases live on taxpayer funds and are actual parasites themselves, dare hold the opinion that the stock markets and trading is parasitic? This is not only ridiculous, it is outrageous and a totally unacceptable display of arrogance and stupidity.
Their anti-free market propaganda is a dangerous testament to what negative and incompetent and hateful people do with their time, if given the means to survive by benevolent and naïve productive tax payers. The left criticizes an economic system which has led to the greatest boom in productivity and prosperity of all recorded human history. So great has the positive transformation of free market capitalism been, that even corrupt dictatorships have benefitted from existing in a world dominated by powerful free-market nations.
There is absolutely nothing immoral about trading the financial markets. Indeed, the risk-taking it involves is most noble, in the sense that it provides other people with means they do not have themselves, of producing goods and services and sustain themselves while doing so. (Yes, there are some exceptions, for instance, dubious financial instruments issued by dubious institutions and individuals – but fraud is unfortunately present in every sphere of human life to some degree.)
What we all should do, is make sure that we continuously highlight malfeasance and immoral and unethical behaviour amongst all sectors of life, be it the public sector or the private sector businesses. What we absolutely shouldn’t do, is to engage in utterly dishonest attacks upon the free market which has lifted the entire world up enormously over the last few centuries, in terms of living standards, and demand its abolishment. We need more free market capitalism, not less.
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