David R. Henderson  

Murphy on the Stock Market

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In this month's Econlib Feature Article, which posted a few minutes ago, Robert Murphy lays out the basics of the stock market. A key paragraph:

Despite its importance, the stock market remains a bit of a mystery, even to many otherwise staunch champions of the free market. People who have no problem defending the actions of advertising executives or payday lenders, often fall short of defending the stock speculator or "corporate raider." Yet these popular villains actually perform vital services, and government policies against "hostile takeovers" actually make us poorer.

Also, Murphy writes:
One popular complaint about the stock market is that it fails to channel savings into productive investment. According to this thinking, someone who takes $1,000 out of his paycheck to buy shares of Acme stock doesn't really "invest in" Acme, but rather transfers cash to a prior holder of Acme stock. The corporation doesn't get its hands on this $1,000; it's not available for Acme to expand its factories or hire new talent.

Then he responds to this complaint. Read the whole thing.

Also, for more on how the government prevents companies from being sold to those who would likely run them better, often by kicking out incumbent management, read Jonathan Macey's "The Market for Corporate Control" in The Concise Encyclopedia of Economics. One of the biggest obstacles is the Williams Act, named for U.S. Senator Harrison Williams, D-NJ, who later went to prison for taking bribes.


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COMMENTS (2 to date)
stuhlmann writes:

Mr Murphy's article was very informative, but there are still a couple things that are not so clear. It was said that speculators provide a useful service by providing information about a stock's price, whether it is under- or over-valued. I can see how this is so when a speculator buys or sells a stock, because I believe the price paid is a matter of public record, via the stock exchanges. What about when a speculator shorts a stock? Other than the two parties involved in the deal, who else knows? If no one but the two parties knows that the stock is being shorted, how does this help with price discovery?

rpl writes:

Even if short sale arrangements were known only to the parties involved, short-selling a stock involves selling it at the market price. As such, it will affect the order book the same as if it were a normal sale. To wit, someone's buy order will be filled and removed from the book, generally pushing the bid price downward.

In practice, short sales aren't even secret, since broker-dealers report stock lending to the exchanges (see, for instance, http://en.wikipedia.org/wiki/Short_selling#Sources_of_short_interest_data ), and this is compiled into various statistics, which provide further information about the value of the stock.

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