Doug Orr, Guest Blogger
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)
Every night on the evening news we hear something like this: “In economic news, the Dow is up by 1.5%, the S&P is up by 1.2% and the NASDAQ is down by 0.3%, based on ….” Reporting these numbers so prominently and giving a supposed link to the events of the day gives the impression that the stock market plays a central role in moving the economy forward and that everyone has a stake in these daily changes. In fact, the movement of these stock indices on a day-to-day basis has almost nothing to do with the actual economy and, except in times of economic crisis, the stock market has almost no impact on the lives of most Americans. Fewer than half of American families own a single share of stock, and only about a third own shares totaling more than $5000. The stock market is the realm of the elite, and for the past several decades has had a negative impact on the real economy.
Who 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 you, as a student, learn new skills that make you 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. Further, savers can get their money back if they need it in the future, because loans get repaid.
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, however, 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. But no one would buy a share of stock if they could not get their money back when they needed it. The useful role of the stock exchanges, what we call the “stock market,” is to provide “liquidity.” One individual who has money to save today can buy a share of stock from someone who needs to get their past savings back.
The words we use to describe things matter. Investors are usually seen as contributing to the economy because they hire workers to build new factories, new machines and other productive assets, and these assets can make the real economy more productive. Workers create the assets, and the investors are given the credit. On the other hand, gamblers and speculators are usually seen as frivolous and destructive.
The biggest propaganda coup of the 20th century was convincing the media and the general public to call the speculators on the New York Stock Exchange (NYSE) “investors.” They did it by blurring the positive role of the stock market with the speculative role. If you buy a share of Pacific Gas and Electric (PG&E) stock on the stock exchange, you will get a quarterly dividend payment, just like the interest you get from the money you put in a bank. But, PG&E does not get any new money to use for actual investment. The price you pay for the stock goes to the previous owner of the stock, not PG&E.
On November 8, 2013, the Dow-Jones index hit a record high of 15,761.78, on news that the unemployment rate was up, median family incomes were falling and, six years after the start of the last recession, the economy has not yet recovered. That day, NYSE market volume was 823 million shares, and another 1.96 billion shares were traded on the NASDAQ. More than $50 billion changed hands, yet not a penny of all this money went to a corporation for use as productive investment.
The biggest casino in the world is located at the corner of Wall Street and Broad Street in New York City. Calling the players on the NYSE “investors” completely changes our understanding of the role they play. Consider rewording some recent stories: “Gamblers bet big on new Genentech drug,” or “Speculators made 73% in one day buying Twitter’s IPO in the morning and reselling later in the day to suckers caught up in the excitement.” The Wall Street Journal does occasionally tell us the truth when they report on the “bets” made by “players” on the NYSE. Speculators betting that the price of a share will rise want to buy it and those betting that the price will fall want to sell it. If there are more buyers than sellers, the price will rise, regardless of anything that is happening in the real economy. Reporting a record high for the NYSE has about as much importance as reporting a record amount of gambling in Las Vegas. Except the gambling on the NYSE can have a much larger negative impact on the real economy.
Big Gambling Does Big Damage
The reason why the volume on the NYSE is so high is because speculators engage in high-frequency trading. An analyst predicts that, based on breaking news, the price of a particular stock may go up. If you can be the first to buy the stock before the price goes up, you can sell it a few minutes later (or even seconds, or fractions of a second, later) and make a profit. This is why brokerage houses now rely on “program trading.” Computers can see price differentials and make trades much faster than humans can. Brokerage firms need to have the fastest possible computers and the fastest network connections because milliseconds matter. By 2010, this type of high-frequency, or “quant” trading made up 70% of the bloated stock trading volume.
If you buy a share of stock for $100 and sell it 30 minutes later for $100.50, you make a profit of 50 cents, or 0.5%. If you buy a million shares, you make half a million dollars for a half an hour of “work.” But the “work” was done by a computer program and you have done nothing to make the economy more productive, to create jobs, or to increase GDP. All you have done is to bring a large pile of money to the table at the casino. You have redistributed money from one person at the table to another, and for this, the Wall Street Journal calls you an “investor.” You can use your winnings to hire the best and brightest minds to give you an edge at the table, and you will pay them well.
We are being told how important it is to get students into STEM (science, technology, engineering and math). Yet government funding for these fields is being cut and jobs prospects are uncertain. Stock market speculation diverts the best and brightest minds away from solving the real problems facing the world. Instead they are writing software to “read” news feeds looking for key phrases that might indicate a change in speculators’ sentiment toward a particular stock, so that instantaneous trades can be made. They are writing algorithms to find the most minute correlations between economic indicators and changes in share prices. Landing a job at a big Wall Street firm can lead to annual bonuses in the millions of dollars. Jobs in basic scientific research and engineering cannot hope to compete.
Corporate managers are rewarded with bonuses for increases in stock prices, regardless of the long-term impacts on the firm. Cutting jobs and driving down wages can increase stock prices, but this has devastating impacts on the lives of ordinary people. If the price of a company’s stock starts to fall, management may use the cash held by the company to buy back shares in order to prop up the price. This diverts resources that could have been used for productive investment into the hands of stock market speculators.
If enough of these speculators believe prices will continue to rise, they will pour more money into stocks, and share prices will rise. Speculation can be self-fulfilling and create price bubbles. But if speculators turn pessimistic, they can also create stock market crashes. If this only affected the gamblers it would not be a problem. But as a company’s stock price falls, it may be harder for the firm to borrow from banks or the bond market to pay for day-to-day operations. This can crash the real economy and drive up unemployment. As stock prices fall, the retirement savings of millions of workers (who have seen their defined-benefit pensions stolen and converted into 401(k) savings accounts) will also decline. Ordinary people reap little benefit from the daily speculation on the stock market, but millions experience real losses when the bets go bad. The Big Casino does very real damage to the real economy.
One way to reduce the damage would be to put a tax on the socially destructive behavior. We tax cigarettes and alcohol because of the damage they do. We tax gambling in Atlantic City at 8% and in Las Vegas at 6.25%. The sales taxes on socially useful items like shoes and computers are often more than 7%. There should also be a sales tax on stock market transactions, i.e., speculation.
To be sure, Wall Street lobbyists will try to scare the pubic in thinking that taxing speculation will somehow kill “investment” and jobs. Because unemployment is still high, anything that reduces employment growth will be seen as negative. But this tax will not reduce job creation. Stock market speculation already does that. Between 2008 and 2013, the dollar value of shares repurchased by corporations was higher than the amount raised by IPOs. So the stock market has actually drained resources away from real investment and job creation.
In 2007, the year before the most recent collapse of a speculative bubble, $43.8 trillion in stocks changed hands on just the NYSE and the NASDAQ. That same year, only $65.1 billion was raised in IPOs. That is $673 dollars of speculation for every $1 allocated from savers to real investors. Putting a tax on stock speculation will have almost no impact on productive investment by businesses, but it will raise much needed revenue for public investments in education and infrastructure.
What we need is a “speculation-reduction tax.” Gamblers and speculators are seen as frivolous and destructive, and a tax that would restrict their behavior would be positively received. To be fully effective, the tax should be “progressive” with respect to time. If a stock is held for less than a day, the tax on the trade should be 5% of the value of the trade. The tax on a stock held for a week would be 2%; for a month, 1%; and, for a year, 0.5%. But opponents will make the case that this is too complex and too costly, so a flat-rate tax is more feasible.
The European Union is likely to implement a FTT rate of 0.1% in 2014. This rate is too small to have much of an impact on speculation. The UK has had a tax rate of 0.5% since 1986. It has not restricted the basic functioning of their stock market, but a tax of this amount makes the short-term trade described above unprofitable. Since 2009, ten different FTT bills have been introduced in the U.S. House and four in the Senate, most at a rate less than 0.5%. If a 0.5% tax were implemented in the United States, the Congressional Research Service estimates revenue generation of $164 to $264 billion per year, depending on the decline in speculative trading. The liberal Center for Economic and Policy Research (CEPR) estimates revenues will be between $110 to $220 billion for a 0.5% tax.
If we implement this type of speculation-reduction tax, it will reallocate much needed resources to productive public investment and away from job-killing stock speculation. This idea, first proposed by John Maynard Keynes in 1936, is long over-due. As Dean Baker, co-director of CEPR, put it in 1994: “Government is perfectly willingly to tax Las Vegas, Atlantic City and the lotteries, where working people place their bets with virtually no consequence to the country’s economic future. Why then should it not also tax the preferred gambling venue of the wealthy, especially given the serious costs their activities impose on the economic prospects of the majority?”
Sources: Dean Baker, et.al., “The Potential Revenue from Financial Transactions Taxes,” Center for Economic and Policy Research, Dec. 2009; “A securities Transactions Tax: Brief Analytic Overview with Revenue Estimates,” Congressional Research Service, June 2012; Stephany Griffith-Jones, “Germany wants the Robin Hood tax,” The Guardian, Oct. 2013; Robert Pollin and James Heintz, “Transaction Costs, Trading Elasticities and the Revenue Potential of Financial Transaction Taxes for the United States,” Political Economy Research Institute, Dec. 2011; Dean Baker, Robert Pollin and Marc Schaberg, “Taxing the Big Casino,” The Nation, May 1994; NYSE Technologies Market Data (nyxdata.com); NASDAQ Trader (NASDAQtrader.com); PriceWaterhouse IPO Watch (pwc.com).
Doug Orr teaches economics at City College of San Francisco.
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