Eli5; Why is the US economy so dictated by the ups & downs of Wall Street?
In: 15
It’s important to recognize that the most economies can be divided into general groups: the economy of work and the economy of speculation. The economy that most people deal with is the economy of work, which a much smaller number of people get to play in the economy of speculation.
In the economy of work, people get paid for providing goods or services: doing work. To paraphrase Adam Smith’s “The Wealth of Labour”: the difference between the value of the raw materials and the value of a finished good is the value of the labour used to produce said good. In the economy of work, when someone is paid, they use the majority of their economy to purchase more goods and services, resulting in more workers getting paid and purchasing more goods and services, etc, until someone decides to save it. This means that a single dollar in the economy of work can produce several times it’s own value in economic activity. Gross Domestic Product (GDP) is the economic measurement used to measure this velocity of money and it generally considered one of the major economic indicators.
In the economy of speculation, there isn’t any work. No new value is actually being created. Instead, ownership of contract is exchanged. The most well know of these are stocks, but there are other kind of contracts that are traded on these markets. These contracts have two kinds of worth: Held worth and Resell worth. Held worth is the value you get for just own a contract. In a stock, this is the dividends. Some of the value produced by the workers isn’t used to pay them for their labour, but is instead funneled to shareholders who own the stock because doing so is written into the contracts. If the company is doing well, it will be able to pay large dividends and it’s Held worth is high, making the stock valuable. Resell worth is the value that a contract could be exchanged for if it was sold again. When one of these contract is created it doesn’t have any innate value and the people issuing the contracts have to convince people to buy it, either by suggesting that it will produce a lot of value if held, or it will be able to be sold later for a higher value. This is what companies are doing during a public option: they are raising money to support the business by giving people a chance to buy their stocks. Dividends are written into stock contracts to make them appealing to buy. Again, no new value is created, only existing value is exchanged by the parties evolved. Whenever a person buys stock or other contracts from anyone by their original issuers, no new value has been invested in the issuing body. Trading of a stock doesn’t result in the generation of new economy activity, just the exchange of existing value between people. This is why the economy of speculation should be view as different from the economy of work, as the underlying function of the economies is fundamentally different.
You should have noticed that the paying of dividends results in the movement of value from the economy of work into the economy of speculation. This is why some people believe that the value in the economy of speculation can be used as an economy measure of the economy as a whole. If the economy is doing well, companies will be able to pay large dividends, making their stocks more valuable, resulting the value of the stock market increasing as people pay more to get those stocks. Unfortunately, this doesn’t really hold up. There is a perverse incentive that wrecks the entire system and it’s why the stock market keeps bubbling and crashing to destructive effect. When a person buys a contract, the price they pay is based on what they think the value of that asset will be and they can’t predict what the value of that asset will be. Beyond all the frauds that this enables, the resell worth of an asset is generally thought to be dependent on the direction the market is moving. If the market is going up, people tend to assume that they will be able to sell the asset on the market at a higher price, but the value of the market is dependent on both the held worth and the resell worth of the assets in it. This means that buying and selling assets at high prices will drive the value of the overall market up, *increasing the prices that people are will to pay*. This feedback loop isn’t stable and it creates a bunch of problems. At some point, it creates a deflationary crisis in the economy of work: the perceived value of the stocks gets so high that spending money on goods or services doesn’t make sense now. Buying a hamburger on Monday doesn’t make sense if you can buy a stock instead and get 10 hamburgers on Friday with the money you get selling the stock. Of course, if every one realized just how crazy that is before Friday and starts selling their stocks like mad, you won’t have your hamburger money, because no body will buy your stock at that price. If the value of the market is down, people will be willing to pay less for assets in it. You also need a continual supply of new “investors” in order to keep pumping money from the economy of work into the economy of speculation, resulting in more people getting hurt when the perceived of their assets plummet. This is why the US economy is highly dependent on it’s financial markets: Tremendous amount of value has been shifts into it over the years, to the point that most working people have some kind of asset that is part of it, usually their retirement savings.
Latest Answers