Tuesday, October 26, 2010

Some notes on Scalability, Stocks, ΔS, and Individual Corporate Ownership.

As anyone who has heard me BS on Thursday evenings knows, I like my arguments scalable. I like things that are true in micro to be true in macro. I’m not a big fan of emergent complexity. And I don’t like things being more than the sum of their parts unless the relationship between the thing and the sum of its parts can be described by simple math. Ask me about my scalability constants for complex phenomena. I’m not a big fan of calculus and neither are Newton and Leibniz. (That’s why they hated each so much: they each blamed the other for inventing calculus.)
Last week, Ed was trying on an argument for size. Buying and selling stocks is a zero sum game. It makes sense to me. I mean think about it. How do we know what things are worth? I can think of two ways. One, we try and sell it. The thing is only worth what we can get for it. You only know something’s monetary value the minute we no longer own it. The other way would be its opportunity cost. What you had to give up in order to get it. That is kind of a backward way of saying things are only worth what you can sell them for. I guess things are only worth what you can buy them for too… This argument is kind of stupid, because it’s simple and ignores emerging complexity of a larger market. Please bear with me for a minute as I try and expand it.
Let’s assume stocks don’t have any other value besides being available to buy and sell. Ok, they have value as a free society detector, thank you Mises. Alright, individual shares of Playboy have other value as well, they act as d-bag detectors and can alert young women that the dorm they are about to enter is potentially dangerous. (You reading this Paul?) Fine, they also have value because some of them pay dividends. I get it, they also have value by allowing people to take ownership of, and in sufficient quantity, take control of corporations. Other than that, they are only worth what you can sell them for. They are only valuable as instruments of trade.
How is wealth created in a stock market? It is created by making more stocks. That’s it. Read the zero sum post Sherri emailed us: http://tradingandriskmanagement.blogspot.com/2009/05/stock-market-is-not-zero-sum-game.html. The guy argues that it would only be a zero-sum game if there were an equal number of short and long positions. To quote: “The question is not "Is there a buyer for every seller?" but "Is there a short position for every long position?" to determine if it is a zero-sum game. As long as there is a short position for every long position, every time one person makes a dollar someone else loses a dollar. That makes the total average return (before expenses) zero. With a stock, there can never be as many short positions as long positions. When a company first issues shares there are no short positions. After that, every time someone shorts a share one new long share is essentially created, so there will always be more long shares than short shares.”
I think this argument is stupid. If you sell a stock, someone has to buy it, and the stock is only worth the price it sold for. If the guy who bought it sells it for more later, no wealth was created, because someone had to give up the amount of money the stock was ‘worth’ to buy it! The second guy has more money then he used to, but there hasn’t been any wealth generated. If you buy into the ‘imaginary poverty’ thing like most economists do, then the original owner ‘lost money’ because he sold it for less than he could have. In other words the stock is now worth more than the original owner sold it for. Stop creating new stocks. Trade the current ones for one hundred years. Look at the total value of every share. Compare that value to the total from one hundred years ago. It might be 10 times higher it might be 30 times less, but no wealth was created or destroyed. You’ve just spent a century detecting free economies and detecting d-bags.


  1. It is so hard to pick up whether something is sarcastic in text. And if you respond to this I still won't be able to tell if your answer was sarcastic.

    Either way, I would like to posit that even the initial IPO is a transfer, not a generator of wealth. The buyer is extending credit in exchange for future income that would otherwise belong to the original owner. Now, the actions that the company take create wealth by creating goods or services. Those are positive sum. The stockholder creates no wealth by trading stocks. It is the means, not the ends. The price then reflects the success (or more formally, the expected success) of the company that is creating wealth. Just because a stock goes up in value does not means that the stock market creates real wealth.

  2. Obviously wealth gets created somewhere. (Not in stocks, but in the world.) I guess the only way to create wealth would be to create more people or more productivity. I'm going to have to side with stock creation = wealth creation. No one would argue that the farmer who grows oranges creates new wealth with every new crop. He's turning photons and time in to money. I guess it would be possible to say that selling oranges is a transfer not a generator of wealth. The buyer is extending credit in exchange for future citrusy flavor? Is wealth still generated if the buyer throws the orange in the river?

    I guess your argument is that stocks aren't like a haircut, or an orange. You can't get any utility out of the stock other then selling it. I think I disagree.

  3. The exchange of commodities, whether durable goods, capital, or consumption goods have different values to different people. The redistribution of goods from the hands of the people that have lower value into the hands of those with higher value increases the efficiency of the market/world. That is how wealth is increased by trade. There is both a transfer of wealth and a creation of wealth in this case. A financial instrument only has value in that it is a store of wealth. No wealth is created by its trade.

  4. Ed, your description of stocks appears to define them as a system of currency. I am reminded of the international currency system. Certainly there are groups who trade dollars for pounds or yuan (as in the stock market), but it would seem difficult to argue that the dollar has no value other than the potential to trade it for yuans.