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Sentences to ponder
No rational regulator concerned with substantive transparency would approve of common stock, if it were a novel investment vehicle. It guarantees no cash flows whatever, its "control rights" are so weak for most purchasers that representations thereof should be viewed as fraudulent. Empirically common stock behavior is very weakly coupled to the performance and health of the firms that stocks fund. The only instrument in wide use more substantatively opaque than common stock is fiat money.
Here is more, interesting throughout.
Posted by Tyler Cowen on November 28, 2008 at 08:42 AM in Economics | Permalink
Comments
Can anyone explain to me what motivates a company to care about the price of its stock? I would think that once a company has sold shares to raise capital that it no longer affects the company whether the price of those shares goes up or down. I'm sorry if this is a horribly ignorant question, but will appreciate being made less ignorant.
Posted by: John Mansfield at Nov 28, 2008 10:24:39 AM
The management should care because:
1) It represents the market view as to the expectations of their future performance.
2) If the price is too low, there is the danger of the company being taken over, and so they may lose their jobs.
Posted by: Anon at Nov 28, 2008 10:57:07 AM
Unless there is compulsory Public Offer requirement to gain control that makes a hostil adquisition almost impossible.
For sure , the CEO will care if his salary is linked to market performance
Posted by: k at Nov 28, 2008 11:17:45 AM
Also, it's often that executives are paid in stock. Meaning, that their pay is directly correlated to the performance of the stock price. This again brings up issues of principal-agent problem, as executives may smooth cash flows or force short-term performance.
Posted by: Alex at Nov 28, 2008 12:35:11 PM
Well the reason executives are paid in stock is due to the assumption that stock price and performance are strongly correlated which, according to Tyler's quote, is not true.
Posted by: MS at Nov 28, 2008 12:48:48 PM
There is nothing opaque about fiat money, because there is no such thing as fiat money. The US dollar, for example, is backed by the assets of the federal reserve (i.e., gold and bonds). Even though the fed will not buy back its dollars with gold, it does stand ready to buy back its dollars with its bonds. If any country were able to issue paper money that was worth more than the assets held against it, then that country would be getting a free lunch. This would attract rival currencies to circulate, which would reduce demand for the so-called 'fiat money' until the value was driven down to equality with its backing.
Posted by: Mike Sproul at Nov 28, 2008 12:51:14 PM
Ask a banker if he cares.
Posted by: Andrew at Nov 28, 2008 1:06:26 PM
Mike,
I disagree with your assessment of why fiat money has value. Fiat money has a huge inherent value that is in no way associated with the assets held against that money.
Fiat money is all that is accepted for federal taxes. One cannot pay taxes in anything else, so therefore there is demand for money. Taxes drive the demand for fiat money as a medium of exchange.
Posted by: mickslam at Nov 28, 2008 3:26:00 PM
Mike Sproul, you are fundamentally mistaken. Furthermore, if you think about the details you will see why you are mistaken.
Whoever lied to you about this got right past your critical thinking skills. Think about how that happened and what you can do to reduce the chance it happens again.
Posted by: J Thomas at Nov 28, 2008 3:50:01 PM
Mickslam:
When money is acceptable for taxes, then the tax collecting ability of the government constitutes the backing. If the government lost the ability to collect taxes, then the money would lose value. In the same way, a if a banker lost the ability to pay out one paper dollar for each of his checking account dollars, those checking account dollars would lose value. Note that I am saying that taxes create backing for money, while you are saying taxes create a demand for money. We both understand your view. I doubt that you have ever considered mine.
This is covered in more detail in the 'Tax Backing' section of my paper "There's No Such Thing as Fiat Money", which you can find by clicking my name above.
J. Thomas
The idea that paper money is backed is a result of simple arbitrage arguments. If the value of money exceeds its backing, then arbitragers and issuers of rival moneys can profit by either selling the over-valued currency or by issuing rival currencies of their own.
Posted by: Mike Sproul at Nov 28, 2008 4:24:41 PM
"If the government lost the ability to collect taxes, then the money would lose value."
Governments that cannot collect taxes should not be considered governments, in general. What is the definition of govt? Isn't it a monopoly on the use of force within the borders?
Plus, what I am saying is that money in and of itself has no real value except as a relative value counter. Money is given value from acceptance by someone for something else of value, not by issuance by someone who has something of value. Unless they accept it back in exchange for that something of value, the money they issue is worthless. This chain of acceptance starts for fiat money with the govt only accepting fiat money for taxes.
Posted by: mickslam at Nov 28, 2008 5:20:10 PM
Mike Sprout, I was mistaken about you. It isn't that you didn't think it out. It's that you have thought it out your own special way, which might be reasonable given its special assumptions and definitions.
Superficially, the federal government forbids everybody except foreign governments from creating their own money. No counterfeiting. No banknotes. Etc. If other entities have found ways to create their own money and arbitrage against dollars, then the government is falling down on its job of upholding its laws. But there could be deeper meanings that make you right.
The way you quickly explained it the first time was obviously wrong. You said the Fed backs the money, not with gold but with bonds. I could do that myself. I could print my own currency, call it the zloty. I try to pass it to other people and if they ask me what backs it, I can point to my bonds which pay off in more zlotys.
It could be argued that the reason people accept money is that everybody else does. Kind of like the reason businessmen wear neckties. If you were to try to sell stuff and you insisted that you wouldn't accept dollars as payment but you would be paid only in rutabagas, you would have trouble staying in business. Similarly if you tried to pay your rent in rutabagas. You use money because it's the way things are done. People do lots of things for that reason.
And yet, the argument that things really don't make sense is not a compelling one. That fundamental things about the economy which feeds us are completely arbitrary and irrational -- that would be scary. Far easier to believe there's a market necessity for it.
Posted by: J Thomas at Nov 28, 2008 9:39:50 PM
Mickslam:
So far, we agree that a government that can't collect taxes is not a government, and that the money issued by that government will have no value. We also agree money will have value if that money is issued by someone who will accept it back in exchange for something of value. The US government currently accepts dollars in exchange for not throwing us in jail. Sounds like a valuable asset to me.
J. Thomas:
I could pay my mechanic with 100 Mike dollars. He could pay his driver those same mike dollars. The driver rents a house from me, so he could pay the rent (which I, the landlord, refer to as taxes) with my Mike dollars. Eventually, someone who sees my Mike dollars circulating, and never being redeemed for gold, will call them fiat money, meaning that they have no backing. They'd be just as wrong as the people who believe the US dollar is fiat money.
Posted by: Mike Sproul at Nov 28, 2008 10:29:30 PM
Mike, you could be right but your example does not give any evidence.
In your story, to your renter your money is backed up by his apartment. And to your mechanic the money is backed up by his driver.
In an ideal world your money could be like a directed acyclic graph. You dole out money at each leaf -- in return for goods and services offered to you -- and you get money back at the root, in return for goods and services that you offer.
But in reality it isn't acyclic at all. There are lots and lots of cycles where money can spin around for long periods. And the money isn't just backed by your goods and services, it's backed by every vendor who accepts your money. In theory you are the only one who can cause inflation, because you are the only one who can put new dollars into circulation. But in practice, no. Every individual in the graph has to decide how much he's willing to do for your dollars, and it's the sum total of those decisions that makes inflation.
I want to note that it isn't absolutely necessary to collect taxes. The Confederacy of the southeast part of north america did not do so. They printed money and didnt collect taxes. Everybody knew that would be inflationary but everybody accepted it. For awhile the inflation was reasonable, it only turned into hyperinflation after the yankee blockade got so bad that there was little to buy.
What's the difference between financing government with taxes versus inflation? Taxation allows a government to be more fair. A government can choose who to collect taxes from and make sure they collect them in the fairest way. But inflation is a tax on everybody who has money, with no obvious way to avoid the tax except to avoid money.
Posted by: J Thomas at Nov 29, 2008 8:36:03 AM
ah, I see what you are saying Mike S. Fiat as a term doesn't work for you because the precise meaning of the term is that it must be accepted as payment. What you and I are saying is different than that because we are talking about the value of money and what gives it value.
You are saying that the level of govt assets relative to the amount of currency defines the value of money. I disagree with that as I say it is the value of staying out of jail that gives money its value. You call staying out of jail an asset, which it can be, but I still think there is some significant differences between our views. I will have to read more of the info before I can really comment
J Thomas,
I don't think money without taxation is possible, even though inflation can be thought of as a tax. Your example of the confederacy makes this clear - one of the major problems with the confederacy was that they could not or would not collect taxes.
Posted by: mickslam at Nov 29, 2008 9:46:28 AM
J Thomas:
If you want evidence that the value of money is determined by the assets of the issuer, start with papers by Sargent, Smith, Calomiris, Bomberger, etc., all of whom are cited in my "There's No Such Thing as Fiat Money" paper.
Actually, Mike dollars are backed by my assets. If I lost my assets, neither my mechanic nor his driver would accept them. If I have assets, both the mechanic and the driver would accept them whether or not other people would, since they both know that I have enough assets to redeem them.
Taxes are not necessary to back money, since there are other things that can back it. In the case of the Confederacy, people thought (wrongly) that their dollars were backed by future (post-war) taxes.
Mickslam:
Money can be backed with many things, one of which is the threat of jail. In 1685, the payroll ship was late in arriving at a French fort in Quebec. The intendant paid the soldiers with paper IOU's written on playing cards, each of which was to be redeemed for silver livres once the ship arrived. That paper money was backed by coins that they hoped were on a ship in the Atlantic, sent by a King who had raised them by taxation, borrowing, plunder, or, perhaps, productive activity.
Posted by: Mike Sproul at Nov 29, 2008 10:09:32 AM
Hey I just started reading the general theory for the first time. Wow - lots of ideas in that book, and it really hits the ground running from the very first pages.
Posted by: mickslam at Nov 29, 2008 10:17:58 AM
Back to the article. I think his arguments are that investments need to be turned into things you buy like soap. I think it unlikely that his method to allow non-standard contracts could work in such a world.
Posted by: Huggy at Nov 29, 2008 4:14:10 PM
Back to the article. I think his arguments are that investments need to be turned into things you buy like soap. I think it unlikely that his method to allow non-standard contracts could work in such a world.
Posted by: Huggy at Nov 29, 2008 4:15:14 PM
