Economic myths and fallacies

Great Debates
1

Muth: When you buy stocks, you put money in the stock market. This one is one that’s easily proven wrong, but that lots of people seem to believe implicity anyway. For example:

When Stock Market Prices Drop , Where’s the Money?

[When stocks take a beating, where does the lost money go?"][Q:]When stocks take a beating, where does the lost money go?]([Q:)

The money doesn’t “go” anywhere, of course, because there’s no money in it.

It’s like a Ponzi scheme (I use “like”, rather than “is”', on purpose.)You buy for a price, hoping someone else will buy for a higher price later on.

Myth: Stocks are called “The Greatest Wealth Creating Machine of all Time.”

But, if you’re talking about capital gains, there’s not “wealth” being created.

Imagine a group of men sitting around a table. One of them owns a pebble, and sells it for a dollar. He proceeds to sell it for $2. The new owner sells it for $4, and they keep at it, eventually bidding up the price of the pebble to $1,000,000,000. The men sitting at the table have - collectively - increased their net wealth by $1,000,000,000.

They’re all a lot richer, but nothing’s been made. Nobody’s served coffee, or planted corn, or patented anything, or written a novel.

Stock trading doesn’t itself create wealth. It makes some people richer, the exact amount amount it make other poor. (Plus, a lot of Wall Street peole make money along the way.)

2

Were you looking for a debate, here?

3

ISTM he is proposing two things: That the stock market is like a Ponzi scheme, and that the stock market doesn’t produce anything. So the debate would be whether those proposals are true.

4

TVTropes, believe it or not, has a good list of economic fallacies. Note this one in particular:

5

Really? Wow, I didn’t know getting rich was so easy! I’m going to get some friends together and organize a pebble-selling party right away!

6

Or you buy if the net present value of expected dividends is higher than the current stock price.

7

The stock market certainly makes it possible for many businesses to grow and expand and become more profitable.
So in that sense it makes money, even if stock trading itself is a zero-sum game.

8

So the points of debate would be, (1) is there any money in the stock market? (And if it’s obvious that there’s not why do so many people think there is?)

And, (2) if the market doesn’t so much “build” wealth, as shift money from one place to another, why do the call it a “wealth building machine”?

9

Alternatively, you could organize a gold selling party (it could be a gold pebble, if you like, or a gold colored one), or a baseball card party, or beanie-babies, or tulip bulb, or what’re. The principles the same, regardless.

10

But that only happens when the company sells the stock. Subsequent trades of a given share provide no revenue to the company.

11

But a stock isn’t like any of those things. A stock represents ownership of a company, which is (hopefully) growing, buying more physical capital, patenting more goods, etc. If you bought stock in Microsoft in 1986 and still have it, you own something that is in fact a much larger company then it was, and is correspondingly worth more money.

Or put another way: how much does a pebble pay in dividends?

12

OTOH, the stock market is hypersensitive. An item in the news can send prices soaring or plummeting, and not because of any change in business success of the publicly-traded corporations represented.

13

Laws and policies are structured so that getting rich is very hard if you’re starting from the bottom, but (those same the laws and policies) are carved in such a way that* staying* rich is much easier. Play with me here. Let’s say you win the lottery for $2 million dollars. Say, you’re responsible, so you spend the first $1 million and park the additional $1 million in a savings account with an annual percentage yield of 4%. You get ~$40,000 a year salary just for sitting on your ass, doing nothing, and that money is taxed at a lower rate than the rest of us.

If I were God-King of America (please elect me), this would be reversed: capital gains would be taxed at highest marginal income-tax rate (which is currently 39.6%), while primary income up to the first $100,000 (or median income for zipcode, *if *greater), would be taxed at 0 - 15%, sliding up toward the highest marginal income-tax rate on the first $400,000 made.

  • Honesty
14

Yes, using the common conception of what a stock market is. Buying stocks on the open market is “putting money in the stock market”, in that it is an investment in a specific investment vehicle. Selling a stock would be “taking money out of the stock market”. Similarly, buying gold as an investment is “putting money in the gold market”.

It does both; the stock market funds companies that then create wealth. As a result, investment in stocks over the long run has produced outstanding returns, as your article illustrates. For an individual who invests in stocks and sees a great lifetime return, the market has functioned as a “wealth building machine”, but this is because of the performance of the companies that issue stock. The wealth doesn’t come from thin air.

15

Becuase share prices represent expectations about future earnings as well. So a news item that makes it sound like profits will shrink will affect the share (which is why small companies with no profits can still be a worth a lot, people expect them to be worth more in the future).

But that doesn’t change the fact that shares represent something physical, and something whose value changes over time for (usually) rational reasons.*

16

Trades don’t, but the stocks themselves do. A stock represents a claim on the profits of a company. In some cases this is actually paid out in the form of dividends, but in others its reinvested in the company. This reinvestment funds the companies further growth.

17

But, that reinvestment comes from the profits, not from the stocks. A privately-held company could reinvest its profits in exactly the same way.

18

A privately held company has stock, its just not traded on the market. More generally, I don’t think there’s really any difference between “stock” and “a claim on the companies profits and capital”*, so saying a company could reinvest its profits without stock is kind of meaningless.

*(Indeed, that’s basically the etymology of the term: stock: “supply for future use” (early 15c.), “sum of money” (mid-15c.))

19

Indeed. The purpose of offering stock is to open up ownership to more people, bringing in more money.
A privately owned company has a more limited pool of funds but greater autonomy. A publicly traded company can have greater resources, but is accountable to stockholders.

20

There are the CEO’s who are paid bonuses that often exceed their actual salary by factors of ten thousand according to how much they add to the stock value. They are voted these blandishments by the Board, elected by or consisting of people who own lots of stock. Value of the stock goes up, CEO gets richer, Board that hires him gets richer.

Or its doesn’t, and you do the Ballmer Bounce, you get fired and turned out wearing the Golden Cone of Shame and cry all the way to the bank. Actually, the bank sends a limo, but you get the idea.

Hysterically, Wall Street luvs luvs luvs the guy who comes on board talking about getting “lean and mean”, cutting labor costs, increasing productivity without raising wages for the peed upon.

Feh.