The formula to determine the fair value of a share is pretty simple – take the expected future dividends,adjust them using the discount rate, and add them up, there’s your fair share price. Of course, expectations on future dividends and people’s discount rates vary but it should all be pretty simple. It isn’t though because the kind of people who trade shares and other financial instruments are risk-takers who typically measure their self-worth by how much money they make. They are always out to find an extra way to make a buck for their bosses. Rather than trading on the fair value of shares and other instruments, they speculate on others’ demand, buying for more than fair value in the expectation that others will pay even more later. Of course, this a game of hot potato; no-one wants to be the one to take the loss when the music stops, speculation dries up and the instrument is only worth its underlying value.
Now, the music is teetering on stopping. The speculators have stuffed up so badly by fooling themselves into thinking they had created huge wealth trading in near-worthless mortgages that they could now drag the rest of us down unless taxpayers in the US and other countries bail them out (they won’t personally suffer, of course, this is capitalism and they are the agents of capital).
The people who like to consider themselves the smartest guys in the room are now in such a panic that sharemarkets are gaining and losing as much as 7% a day as they jump from euphora to dispair over the US bailout plan. Nothing has fundamentally changed for the companies whose shares are being traded, some will be affected by difficulties they might find in raising credit but that, once again, is the fault of the speculators not the underlying economy.
Why do we organise our economy in such a way that we’re dependent on a bunch of greedy gamblers not stuffing up?
[on a separate note. Why is John Key setting up a blind trust for his shares (which is taking an awfully long time) if, as he said on Sunrise yesterday, he hasn’t traded any shares in public companies since 2003?]