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Suggested Related Essays:
"A Public Stock Exchange"   and:    "A New Economics."

The irrational evil of the Stock Exchange

Reining in the stock speculators

August 2011

The world's stock exchanges work as positive feedback loops to magnify the momentary and often uninformed fears of traders into needless national and world-wide economic crises. To combat the destructive and illogical nexus between the whims of speculators and our economic well-being we need to establish a public exchange for investors, where the rules of the game exclude speculators. Establishment of a new "U.S. Investors Exchange" is proposed (again).
In our private enterprise economy, sufficient available capital is a key to healthy economic activity. Corporations regularly need access to capital in order to carry out projects that generate goods, services, and jobs. And the key to obtaining working capital is a company's credit, which is a function of the company's worth. So how do we assess the worth of companies? The tried and trusted method is that the stock market values the company, by trading activity in the company's stock. The theory goes that stock traders examine the company's physical resources, its obligations, its history, the viability of its products or services, the effectiveness, inventiveness and adaptability of its management, its public relations, and other factors, and having arrived at their best estimate of the value of the firm, engage in informed buyer-seller negotiations to value its stock. This process certainly sounds reasonable and intelligent.

If it actually worked that way. But it doesn't. The problem is that thorough assessment of companies for the purpose of supportive investment in a company is no longer what goes on in the stock market. That kind of investment, the kind that keeps a company stable and productive, accounts for only a small portion of stock transactions. The vast majority of buys and sells are made by traders who guess at the near future trend of the stock price and who buy and sell strictly for the purpose of making a profit on the transaction. These traders rarely care about the companies whose stock they are trading; they may never own that stock again. Their only concern is the stock price at a given hour of a given day. And what sophisticated mechanism is used by these traders to determine a company's worth? Mostly rumors, fears, and the news of the day.

We shouldn't care about these traders' activities were it not for the fact that their trading influences the paper value of the companies being traded, and therefore their access to capital. This in turn is directly tied to the companies' ability to launch projects, which determines their ability to create jobs. In short, stock traders' short-term decisions based on momentary rumors, hopes, and fears determine in large part the long-term viability of our companies and our economic well-being. Since this is clearly irrational, it is time to change the game.

Three years ago, during the 2008 financial crisis, this column proposed that Congress establish a "Public Stock Exchange" with anti-speculating trading rules, for companies that prefer their stock to be traded among investors rather than gamblers. This month the US as well as the rest of the world has again experienced the disastrous connection between the nation's economic health and the momentary psychology of stock traders in the exchanges. A pronouncement by a key public figure, or any wild rumor propagates like wild-fire among speculators, and within a few minutes or hours fully viable companies find themselves at the edge of an abyss due to illogical fluctuations in their stock value.

This is a perfect example of the "self-fulfilling prophecy." When speculators see a small chance of a development that may adversely impact the prospects of a company whose stock they hold, they'll dump the stock, and as more speculators follow suit the stock price will drop. The lowered stock price will increase the chances that the company will face difficulties. The speculators' panic sales made the forecast of hard times come true. What had been a small chance of a rough road ahead became a likelihood as a result of the action of the traders.

There is no desirable connection between the momentary psychology of a few overheated stock traders and the value or strength of our corporate economy. Yet in actuality there is a very real, direct, and destructive connection, which the US government can ameliorate by launching an alternative publicly owned stock exchange for investors, an exchange where short sales, risky derivatives, and similar self-serving speculator-driven mechanisms would have no place. An exchange for corporations who prefer investments from actual stock holders, not speculators. The 2008 essay noted above, "A Public Stock Exchange," laid out some sample rules to be considered as starters, including transaction delays and a minimum stock holding period.

This idea deserves support, and deserves our time to contact our Washington representatives and senators. Do it now.

© 2011 H. Paul Lillebo

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