Stock Market vs. The Economy - Conclusion

The AWFUL music is from Sonic The Hedgehog’s ‘Casino Level’ video game; please accept my apologies!

Profit

Last Thursday, we left off with the motive for the stock market’s existence. Profit.

Where does this profit come from? Somebody ELSE who thinks that the amount he/she is paying is STILL a lot less than what it can be sold for at a later date.

Casino

The Stock Market is little more than a sophisticated (or should I say COMPLICATED) Casino. It’s where people either gamble with large amounts of money, or they make their trades with factual information that they have at their disposal (otherwise known as insider trading, which, though illegal, is practiced all the time).

A Very Complex Set Of Rules

I say the stock market is complicated, but obfuscated is probably a better word to describe it. It’s obfuscated by the ongoing invention of derivatives. Derivatives are little more than a series of new ways to make trading products and shares more difficult, making the stock market less available to those who aren’t “in the know”. Financial instruments such as options, futures, swaps and forwards are all forms of derivative, and they make understanding the processes too complex for the average person, who is working a job, to deal with.

Zero Sum

The stock market is a “zero sum game”. Any trader or investor will tell you that; it’s almost a cliché. What this means is simply this: NOTHING is ever created in the stock market. Products aren’t created, nor is wealth created. If somebody wins, somebody else must lose.

Or IS Something Created?

It COULD be said that money is created, but that’s NOT A good thing for a country’s economy. Just creating money (with no new invention, product, service or discovery to support it) and pumping it into the economy can only ever HURT a country’s economy. It does this by devaluing whatever currency is already in circulation, leading, inevitably, to inflation (or even hyper-inflation).

How To Increase Share Price

If you take a group of companies whose stock price has plummeted, pressure is put on the CEO’s to make the share prices rise again. They often achieve this by cutting costs. One of the highest costs in any company is staff; so this is an area where cuts are made very quickly. This is good for shareholders the short term (the largest shareholders often being the Chairmen, Board, CFO’s and CEO’s of those companies), but not in the long term, because the share price is not being represented accurately.

Don’t Confuse the Two

So if the stock market is not the way to know whether a country is in good financial shape, what is? Whether it’s a family, a company, a state or a Nation, the only way to determine the financial condition it’s in, is to answer the question “is it producing more than it’s consuming”. If the answer is “no”, then it is easy to draw an accurate conclusion.

The stock market is NOT the economy. They should be thought of as two entirely separate entities rather than viewing them as different expressions of the same thing, which is what most people do.

As I write this (the end of July 2009) the stock market is seeing a slight rebound. Why do you think this is? Because the economy is improving and we’ll be out of this “great recession” (read DEPRESSION) in a few months? Or is it because the publicly traded companies are slashing their costs by cutting jobs and are therefore SEEN to be doing better financially?

I know what I think. How about you?

Luke.