The logic implied by the existence of the stock market seems unassailable. Companies need financing to start or expand their operations. People want to invest their surplus funds in a way that promises a better return than a savings account or government bond even if there is an element of risk involved. A market for buying and selling shares in companies needs to exist, and the more people can have access to it the better. The problem is the way the stock market seems to evolve into the world’s largest casino.

No one will argue with the idea that investing is necessary for the development of the economy or even just for maintenance of infrastructure and the adaptation to changing circumstances. Technology will continually create opportunities for new (and perhaps better) products and services. The question is where the money should come from. Financial markets based on the pursuit of liquidity are not the best way to finance the maintenance and improvement of the economy.

Most transactions in the stock market do not directly benefit the company for which shares are being bought and sold. Except for an initial public offering and for times when company decides to finance expansion by selling more shares, a stock market transaction is just between two parties who may not have any other involvement in the company. One may benefit by selling the shares for more than they cost, but the only benefit to the company is the indirect one when the value of its shares increase. Financial markets evaluate a company by the market value of its shares and a company’s ability to secure debt financing may depend on this evaluation. [see Debt Financing] Executive compensation may also be tied to share value so that management may be more focused on short term share value than the long term stability and health of the company. There is no benefit to the “real” economy from this, only a increase in the disparity in income and wealth.

If neither the current version of the stock market nor debt financing are appropriate ways to finance investment in the real economy, what is? Financing should be done either through the extension of credit by banks, by some agency of the government or by individual investors who are committed for the long term. Investors in a company should be partners who are willing to share the risks involved rather than speculators who can just cash out when the going gets rough. Perhaps in certain circumstances such a partner could sell his shares back to the company based on a standardize accounting method for determining their value.

Some economists justify the speculative activity on the stock market and other financial markets as a way of generating information about the prospects of a company or the economy as a whole – as though traders exploiting share price volatility know more about the health of a company than its management or accountants. While management may often be loathe to reveal details of a company’s financial state, this hesitancy is exacerbated by the influence of financial markets.

The most extreme and absurd example of this faith in markets as a source of information about future events was proposal by the department of defense for a futures market in terrorism to be used in helping to formulate public policy. The Pentagon, in defending the program, said such futures trading had proven effective in predicting other events like oil prices, elections and movie ticket sales. ”Research indicates that markets are extremely efficient, effective and timely aggregators of dispersed and even hidden information,” the Defense Department said in a statement. ”Futures markets have proven themselves to be good at predicting such things as elections results; they are often better than expert opinions.’'[see NY Times July 29, 2003]

As Keynes famously pointed out the stock market is like a beauty contest where the judges are attempting to say not which contestant is the best looking but rather which contestant the other judges will think is best looking. What most investors care about is share price, and there are a host of things which can affect share price other than the fundamental soundness of the company.

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