The FT’s Philip Stephens expresses what is fast becoming conventional wisdom:
1. Markets incentivize entrepreneurs. Although stock markets don’t invest in companies when they are cheap, they do when they are expensive. Investors consistently pay too much when firms float on the market; remember all those tech stocks that floated in the late 90s, or the mining stocks that joined Aim a couple of years ago?
This in turn gives managers a big incentive to put together a reasonable-looking company - because they know they could well be over-rewarded for doing so. This is why private equity paid so well for so long.
This matters, because in normal market conditions the returns to innovation are paltry. In paying too much for new companies, however, the stock market helps raise these returns. And this should raise the supply of innovation.
2. It’s a place to put our savings. Although the stock market does little to improve the performance of quoted companies, it’s a great help to many savers as it’s often a source of good long-run returns.
Granted, this hasn’t been the case recently; had you bought at the wrong time in 1987 or 1990 (let alone more recently) you’d have been better off in gilts than in the All-share. But this year’s falls actually remind us why shares should do well in the long-run - it’s because investors get compensation either for the risk of the market collapsing, or for overcoming myopic loss aversion (pdf).
3. It’s a laboratory for studying human behaviour. Do people judge risks accurately or are they prone to cognitive biases? What do we mean by risk? Stock markets shed light on these questions. In this sense, they are like the Large Hadron Collider. They might be expensive, but they are interesting.
4. They have comic value. If stock markets didn’t exist, Mike Ashley would never have been able to sell Sports Direct at a silly price and wouldn’t have been able to buy Newcastle United. This would have deprived the nation of months of high comedy.
In cost-benefit terms, this matters. Let's assume two hours of laughs are valued at £20 - the price of a ticket to see Jimmy Carr at the Wolverhampton Civic Hall. This means that if five million people have spent two hours a week laughing at Newcastle over a six month period, the benefits are worth over £5 billion. So perhaps stock markets can justify their existence.
Even when the toxic loans are finally driven from the system, the banks will badly need capital. Government may be the only source.
This poses the question. If stock markets provide neither capital nor control - they certainly don’t provide any discipline upon managers - what do they do? I’d suggest four things:1. Markets incentivize entrepreneurs. Although stock markets don’t invest in companies when they are cheap, they do when they are expensive. Investors consistently pay too much when firms float on the market; remember all those tech stocks that floated in the late 90s, or the mining stocks that joined Aim a couple of years ago?
This in turn gives managers a big incentive to put together a reasonable-looking company - because they know they could well be over-rewarded for doing so. This is why private equity paid so well for so long.
This matters, because in normal market conditions the returns to innovation are paltry. In paying too much for new companies, however, the stock market helps raise these returns. And this should raise the supply of innovation.
2. It’s a place to put our savings. Although the stock market does little to improve the performance of quoted companies, it’s a great help to many savers as it’s often a source of good long-run returns.
Granted, this hasn’t been the case recently; had you bought at the wrong time in 1987 or 1990 (let alone more recently) you’d have been better off in gilts than in the All-share. But this year’s falls actually remind us why shares should do well in the long-run - it’s because investors get compensation either for the risk of the market collapsing, or for overcoming myopic loss aversion (pdf).
3. It’s a laboratory for studying human behaviour. Do people judge risks accurately or are they prone to cognitive biases? What do we mean by risk? Stock markets shed light on these questions. In this sense, they are like the Large Hadron Collider. They might be expensive, but they are interesting.
4. They have comic value. If stock markets didn’t exist, Mike Ashley would never have been able to sell Sports Direct at a silly price and wouldn’t have been able to buy Newcastle United. This would have deprived the nation of months of high comedy.
In cost-benefit terms, this matters. Let's assume two hours of laughs are valued at £20 - the price of a ticket to see Jimmy Carr at the Wolverhampton Civic Hall. This means that if five million people have spent two hours a week laughing at Newcastle over a six month period, the benefits are worth over £5 billion. So perhaps stock markets can justify their existence.
"Stock markets...are like the Large Hadron Collider. They might be expensive, but they are interesting. "
And they can risk destroying the world.
Posted by: Tom Freeman | October 07, 2008 at 03:24 PM
Actually, Chris, what is being played out is a gigantic game of Chicken. The cost of capital at the moment is sky high - so everyone hopes to get it cheaper from the Government. The Fed's commercial paper facility effectively is the Fed blinking - everyone else says its too risky, so the Fed has to do it to keep the wheels working. But if they hadn't stepped in, yes there would have been a few weeks of hiatus, and afterwards it would all have been wrokign perfectly.
Of course, in Icelands case noone realised that was what they were doing....
Posted by: kinglear | October 07, 2008 at 03:43 PM
erm - large hadron colliders may be well cheaper!
Personally I've dug a hole in my garden and buried some gold there. Its probably the safest investment at the moment.
Posted by: Glenn | October 07, 2008 at 10:24 PM
You've only been laughing at Newcastle for six months?
Posted by: ejh | October 08, 2008 at 08:59 AM