“The stock market creates wealth.” This is obviously false. Unlike Social Security, no dollar ever comes out of the market into an investor’s pocket that didn’t go into the market from another investor’s pocket…
This is true, but not in the sense that the author seems to intend it. The market doesn’t create value. It reflects it. But sure you can make money in the stock market.
It seems to me that it should be intuitively obvious that the stock market is a zero-sum game, but I guess some people don’t think so. Maybe they don’t understand what a zero-sum game is. Or maybe they have some other reason for wanting to believe that the market magically creates wealth.
This just happens to be completely wrong, for reasons I will describe.
If we take a market as a “blob” then, yes, the blob creates value. If you break down markets into their functional parts, then trades are zero sum: the cook got a dollar’s worth of carrots and the farmer got a dollar’s worth of money. That both valued the outcome as positive is a given as otherwise the trade would not have happened. Seen in that light the trade was a win-win transaction but we have no way of measuring either win without knowing the previous pre-trade state. To me one thing becomes clear, that value is created between trades and realized by the trade.
I’m trying to discover why and how markets work. Markets don’t grind out value like a factory grinds out sausages. Markets grind out trades. Where then does value come? It’s an emergent property of markets. By being able to trade something less useful for something more useful at par, both sides have gained in value. But it wasn’t the trade that created the value, the trade only realized the value.
Denny has the germ of it here, but the gain value reflected in the stock market can’t be described with money paid for carrots. Think of it this way. You are buying a piece of a company. Okay, say I bought the share in the company from Mr. Smith for $50. He bought it a year ago from someone else for $25 dollars. The company did well and grew and made money and built more factories, etc. That’s why the share, which had been worth $25, was now worth $50. However, all the market did was reflect that change in value when Mr. Smith sold the share to me for $50. There was no corresponding loser of the $25 he gained. It was NOT a zero-sum game in any sense. The market has simply reflected the progress of the company. It didn’t make the wealth. It’s simply the place where I could buy a share of the company. It’s just the mechanism that allowed me, who wanted a share in this company, to find Mr. Smith who wanted to sell a share of the company… because he wanted to buy a pair of Skechers.
Now I’ve held the stock for a year or so and the company has continued to grow so my one share has grown in value to $100. (The market has again reflected the progress of the company). I decide to sell my share to Mr. Jones for $100. I gained $50. No one lost $50. Mr. Smith didn’t lose anything; he’s long gone. Mr. Jones didn’t lose anything. He just wandered on the scene. In fact he just heard about the company yesterday. This is not a zero-sum game like a futures contract or option contract that will expire and whatever one party gains some other party will lose. This has simply nothing to do with the concept of a zero-sum game.
And if the company prospers and its share increases in value and Mr. Jones sells it for $175 in a year or so, and makes $75, he gains that $75. There is no loser. I didn’t lose anything, the person who bought it from him didn’t lose anything. He simply gained $75. But the market didn’t create the $75. It’s just the mechanism that allowed Mr. Jones to find a buyer for his share.
I hope this helps.
Saul
PS If you want to think of it in farmer terms, I bought a spindly-legged little colt for $50. It ate a lot of grass and grew into a big strong valuable horse worth $250. I took it to the Saturday market in town and sold my piece of property, which had appreciated in value, for $250. I made $200 profit. I didn’t even pay for the grass. There was no loser. It had nothing to do with a zero-sum game when you understand what a zero-sum game is. The Saturday market (stock market) didn’t create any wealth. It was simply where I sold my horse. Period.