Many people
don’t fully grasp how the stock market works and what its economic function
actually is. Behind all the complicated
maths and (deliberate and unhelpful) mystique is a very simple economic
function. Entrepreneurs need capital to
operate their businesses and individuals need outlets for savings. Individuals can give entrepreneurs money in
return for a SHARE of the company’s future profits or a STOCK of the company’s
capital. An individual can, at any time,
sell this right to a share in the company’s future profits to another
individual – this market, which can be organised or informal, is known as the
share market or stock market. Below is a
great cartoon from the 1950s, unearthed by Graeme Acheson, which provides a
helpful (if dated) explanation of how the stock market works.
My colleague and former PhD student Gareth Campbell has created a website about the British Railway Mania - click here . This episode has been described by the Economist as probably the greatest bubble in human history. Gareth's website provides background on the Mania and posits some explanations for the 'bubble'. In his explanation of why the bubble happened, Gareth places a lot of emphasis on investor myopia regarding future dividends and uncalled capital. His study of investors during the episode does not support the view that this episode was fuelled by naive and irrational investors.