Three economics challenges
Jul. 28th, 2004 01:19 pm![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
nibot(1) Popular wisdom has it that corporations are quite concerned about their stock price, that when the company is doing well, the stock price goes "up", and when the company is doing poorly, the stock price goes "down". In other words, changes in stock price are directly tied to the performance of a company. (One share in a corporation means that you own 1/N of that company, where N is the total number of shares. Dividends are periodic cash payouts to shareholders, maybe $0.50 per share per quarter.)
My question is how? Tell me one way in which the performance of a company is actually tied to the price of its stock.
The price of a share in company FOO should be exactly the expectation value of all future dividends paid by that company, and at one time this was true. At one time, people invested in corporations in order to provide the capital to perform some undertaking (say, "Buy ships and hire a crew to sail to the New World and dig up riches!") with the expectation of future rewards ("Profit from riches dug up in the new world."). But these days this is no longer true. Companies rarely issue substantial dividends any more. Microsoft recently did, but that was sufficiently suprising to be sort of the "exception that proved the rule."
Shares in a company (stock) are bought and sold willy-nilly. After the initial sale of shares to investors (for publicly traded corporations, this is the venerated IPO, or "Initial Public Offering"), the price of stock is utterly irrelevent to the company itself, since the only time the company gains capital is when the company sells shares to an initial investor. An investor selling his share to another investor does nothing for the company.
People buy stock (shares) not because they expect future dividends, but because they expect the price of the stock to go up. But I see no actual mechanism to tie the performance of a company to its stock price. In this case, "investing" in the stock market is no more than speculation, and the whole system is nothing more than a pyramid scheme. Indeed, the only reason that investing in the stock market usually pays off is because the amount invested is growing. Every year more people invest in the stock market, fuelling the pyramid scheme.
Prove me wrong.
(2) I hate chains. I mean stores like McDonalds or Blockbuster or Walmart or Borders Books And Music or Best Buy. I detest them, but I can't put my finger on exactly what about them I find so reprehensible. I dislike the homogeneity, the impersonalness, the fact that the employees are robots. Somehow Independent Businesses just seem "better". Their products are more interesting and you can see that their revenue is reinvested directly in the local community, instead of being siphoned off to an absentee owner. I want to figure out whether this is a reasonable position. Should I just embrace "chain stores"?
One of my big suspicions is that we need chain stores, because the base of potential business owners simply lacks the creativity and manpower to produce a zillion independent businesses, whereas it's relatively easy to clone an already-successful business to operate in a zillion locations. Also, I understand the economy of scale. It's certainly vastly more efficient to have the supply chain available to supply your chain business with what it needs. It also mitigates risk. When there are a zillion copies of a business, the other copies can keep a less successful copy afloat until it takes root.
Then there is another distinction (as![[livejournal.com profile]](https://www.dreamwidth.org/img/external/lj-userinfo.gif)
squibb points out). Franchises, like, say, Subway, are independent business. The franchisee buys a "kit" from the motherbusiness (Subway, Inc) and starts a business using their paraphernalia. It's a recognizable copy of another business with a recognizable brand, but it's locally owned. Then there are centrally-owned businesses, like our old friend Starbucks, where every single store is owned and operated from central headquarters. Franchises seem a lot less evil than these centrally-owned businesses, but I really don't like either.
Are chains really bad? Am I irrational for hating them? I have never, and, as far as I'm concerned, I will never, patronize Starbucks. So far I'm Wal-Mart free as well. Is this reasonable?
(3) Define "wealth". How is it created? What is "inflation"?
--
By the way, a good site for background info is invest-faq.com. I think the only two books I've read in this milieu are A Random Walk Down Wall Street and Steven Landsburg's The Armchair Economist. Other references appreciated.
My question is how? Tell me one way in which the performance of a company is actually tied to the price of its stock.
The price of a share in company FOO should be exactly the expectation value of all future dividends paid by that company, and at one time this was true. At one time, people invested in corporations in order to provide the capital to perform some undertaking (say, "Buy ships and hire a crew to sail to the New World and dig up riches!") with the expectation of future rewards ("Profit from riches dug up in the new world."). But these days this is no longer true. Companies rarely issue substantial dividends any more. Microsoft recently did, but that was sufficiently suprising to be sort of the "exception that proved the rule."
Shares in a company (stock) are bought and sold willy-nilly. After the initial sale of shares to investors (for publicly traded corporations, this is the venerated IPO, or "Initial Public Offering"), the price of stock is utterly irrelevent to the company itself, since the only time the company gains capital is when the company sells shares to an initial investor. An investor selling his share to another investor does nothing for the company.
People buy stock (shares) not because they expect future dividends, but because they expect the price of the stock to go up. But I see no actual mechanism to tie the performance of a company to its stock price. In this case, "investing" in the stock market is no more than speculation, and the whole system is nothing more than a pyramid scheme. Indeed, the only reason that investing in the stock market usually pays off is because the amount invested is growing. Every year more people invest in the stock market, fuelling the pyramid scheme.
Prove me wrong.
(2) I hate chains. I mean stores like McDonalds or Blockbuster or Walmart or Borders Books And Music or Best Buy. I detest them, but I can't put my finger on exactly what about them I find so reprehensible. I dislike the homogeneity, the impersonalness, the fact that the employees are robots. Somehow Independent Businesses just seem "better". Their products are more interesting and you can see that their revenue is reinvested directly in the local community, instead of being siphoned off to an absentee owner. I want to figure out whether this is a reasonable position. Should I just embrace "chain stores"?
One of my big suspicions is that we need chain stores, because the base of potential business owners simply lacks the creativity and manpower to produce a zillion independent businesses, whereas it's relatively easy to clone an already-successful business to operate in a zillion locations. Also, I understand the economy of scale. It's certainly vastly more efficient to have the supply chain available to supply your chain business with what it needs. It also mitigates risk. When there are a zillion copies of a business, the other copies can keep a less successful copy afloat until it takes root.
Then there is another distinction (as
squibb points out). Franchises, like, say, Subway, are independent business. The franchisee buys a "kit" from the motherbusiness (Subway, Inc) and starts a business using their paraphernalia. It's a recognizable copy of another business with a recognizable brand, but it's locally owned. Then there are centrally-owned businesses, like our old friend Starbucks, where every single store is owned and operated from central headquarters. Franchises seem a lot less evil than these centrally-owned businesses, but I really don't like either.Are chains really bad? Am I irrational for hating them? I have never, and, as far as I'm concerned, I will never, patronize Starbucks. So far I'm Wal-Mart free as well. Is this reasonable?
(3) Define "wealth". How is it created? What is "inflation"?
--
By the way, a good site for background info is invest-faq.com. I think the only two books I've read in this milieu are A Random Walk Down Wall Street and Steven Landsburg's The Armchair Economist. Other references appreciated.
![[identity profile]](https://www.dreamwidth.org/img/silk/identity/openid.png){kind=small}
Finally something I can talk about
Date: 2004-07-28 03:58 pm (UTC)(side note, statistically speaking, emerging growth companies indexes perform the worst of all pure stock indexes.)
2) Chain stores are actually a reaction to the "personality" of small businesses. People wanted a uniform and consistent product and service wherever they go. If you were to go into an In-N-Out, you know exactly what you're going to be getting in service and food quality.
3) "Capitalism lifts all boats" (I forgot who said it). And wealth is "created" by TVM (time value of money) and preception of value. What's more valuable a gallon of water or 1 kilo of cocaine? (sorry, been playing DopeWars) If I'm in the desert the water is much more value, probably be able to trade a of diamonds or something for it from my thirsty comrades. But what's worth more in say downtown LA? I can get trucks of water for the kilo of cocaine. Money is just an easy exchange medium.
If you own a million home, are you wealthy? Yes and no and yes. Yes, because if you paid $200K for it, in theory you can access $800K from the home. The money is "created" based not on the money you put into it or the money you'll repaid the loan, but on the market value (supply and demand) of that home if you were to sell it. So you just created $800K out of nothing more than expectation. Just like most currencies are floated (based on the strength of the countries' economy). No, because you have to repay about 2X-3X your borrowed amount in interest.....BUT yes, although you're going to be paying 3-4X ($800K + 2-3X of interest) your amount over 30 years, $800K will double 3 times if you invested it in a very conservative pure bond (7%) investment. Cost = $3.2 million, Earnings = $6.4 million. So you created wealth. BTW, there are investments that have no downside risks are return 6%-10%.
Which is worst: inflation or deflation? Depends.... Inflation is the "increasing costs of doing business." Largest cost of doing business is interest rate on loans. And that is partly Feds Fund Rate, Fed Discount Rate, Require Reserves, and of course supply and demand of loans. Out of control inflation hurts growth because your money gets devalue quicker than you can spend it, so it causes people to buy more leading to more inflation (ie. money chasing after limit goods and services).
Deflation: US's Great Depression and Japan's somewhat current situation. When I was a freshmen there as a theory that most economists didn't think could happen, the "liquidity trap." Basically, interest rate would be so low that the was no room to lower them yet there was no growth. Well, that's exactly what happened in Japan. After decades of easy money, the banks in Japan had a lot of bad loans on the books (ie. businesses that shouldn't have gotten money in the first place). What's the solution? Growth. Meaning you have to create more businesses, so the banks competed to loan out more bad money....interest rate (supply and demand component) dropped to almost zero. The banks couldn't call their loans or else the write off would be so great that it would bring down the system, so they lend more money out....lowering interest rate again. As it stands right now, Japan's debt is 125% of GDP.
So what's the theme of this post....suppply and demand rules the day.