The Big Casino

[marmar]

from Dollars & Sense:


The Big Casino
How to Rein in Stock-Market Speculation

BY DOUG ORR | MAY/JUNE 2014

Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.
—John Maynard Keynes (1936)

On April 13, Flash Boys, by business writer Michael Lewis, opened at number one on the New York TImes best-seller list. Reviews of the book had appeared on the front page of every major business publication in the United States and most major mainstream news outlets, both in print and on the web. The book explains how new technological advances in stock-market trading have given an unfair advantage to some wealthy traders and have allowed them to make billions of dollars at the expense of everyone else in the market.

Lewis’ books are always highly readable. He conveys technical detail by couching it in a story with heroes and villains. In this case the villains are high-frequency traders. The hero is Brad Katsuyama, an employee of the Royal Bank of Canada, who unraveled a mystery that even some of the biggest brokerage houses did not understand. Over the course of two years, Katsuyama was able to discover how high-frequency traders “front-run” others—exploiting differences of just milliseconds in computer-network communication times. Katsuyama is the hero because he created a new stock exchange to thwart the villains.

.....(snip).....

Who Really Are the “Investors”?

Economic textbooks tell us that financial markets play an important role in the economy, linking saving to investment. Some individuals have more income than they currently want to spend, so they engage in saving. Other individuals need money to engage in investment. “Investment” in this context means the creation of new, physically productive resources. If a firm builds a new factory, installs new machines, or buys new software to do its accounting, that is investment. When students spend time and money to acquire new skills that make them more productive, that is investment. So when a bank takes people’s savings and lends it to the owner of a restaurant to buy a new stove, the bank plays an important economic role. Savers can get their money back if they need it in the future, because loans get repaid and other savers are putting new money into the bank. When you put money in the bank you receive interest. This is your reward for saving and giving the bank the use of your money. But you are not engaging in investment. The person who borrows the money and puts it to productive use is the investor. When you put money in the bank, you are a saver, not an investor.

Corporations can bypass banks and gain access to financial capital by issuing stock. When a company issues new shares of stock, the money raised from the sale can be used to engage in productive investment. The issuing of new shares is called an “initial public offering,” or IPO. IPOs are not done on stock exchanges. They are handled by investment banks. These IPOs transfer savings to firms and the firms can use the money for real investment. If these investments are successful, GDP will rise as consumers gain access to new products, the firm will grow and become more profitable, and the price of their shares will rise, which provides savers a long-term capital gain as a return on their saving. This usually occurs over an extended period of time. ...............(more)

The complete piece is at: http://www.dollarsandsense.org/archives/2014/0514orr.html