Despite my early adherence to Capitalism - I called myself a Capitalist without any Capital in those years - I have always felt a little uneasy about trading on the Stock market. … Is there not an element of ‘second-handing’ in profitting by others ideas and work, their success or failure? Doesn’t this also contradict the virtue of individual productiveness?
Information and risk-taking have already been covered so I wont go into those again. What’s been left out is the issue of capital formation itself.
In the primary market, ie the purchase of new stocks and bonds, the investor is creating value by turning resources into capital. Prior to then, the owner of those resources is entitled to consume them, which is the end of their story. By investing them, however, they are forwarded to the company and are then used to generate goods and services that in turn aid production of more goods and services. By delaying consumption now the investor is creating value by making possible extra production in the future and so earns a chunk of that extra production fair and square, even when that investor is only occasionally checking out what the CEO et al are doing or plays no part in business operations.
I think anyone who isn’t anti-business will have few problems with the primary market, so I’ll leave it at that. What’s more problematic for the unitiated is the secondary market, which I will give more attention to.
In the secondary market, ie trading of existing stocks and bonds, the investor isn’t giving new money to the company but just buying the stocks from previous investors. What value, then, is the second investor generating (besides information and risk-bearing already covered)? Again it comes back to provision of capital, in two ways.
The first benefit is that it preserves the company’s business capital (ie its buildings, machines, IP, etc) against having to sell some of it to allow an investor to exit. This separation of investor trading of financial capital from company usage of business capital then allows the CEO et al to spend a far greater proportion of their time dealing with operating the company, and also to do so on a longer term basis with less fear of having to sell assets to cover disinvestments. That makes the use of capital more efficient, and keeps the total amount of capital in existence higher than it would be without the secondary market. Together this means more production than would otherwise take place, and so the secondary market investors earn a share of that production because they helped make it possible.
As a counterpart of the CEO acting with greater certainty of future conditions, the secondary market also also allows investors themselves to act with greater certainty in getting their money back. This is especially important when the company rules out investors withdrawing capital before a set time so they don’t have to deal with partial liquidations. The benefit here is that the increased ease of investor exit reduces the barriers against primary-market investors investing in the first place. That makes then it worthwhile for more people to be primary investors than would be the case, which in turn leads to there being more primary investment total than would be the case. Once again the secondary investors - ie the day traders and Wall Street firms et al - make that possible, and so are in turn entitled to a share of what the companies themselves produce.
JJM