ONE of the most persistent of the hallucinations which prevail among people otherwise apparently lucid and well informed is the conception that operations on stock and produce exchanges are pure gambling. A moment’s reflection, it would seem, might convince such persons that a function which occupies so important a place in the mechanism of modern exchange must be a useful and necessary part of that mechanism ; but reflection seems to have little part in the intellectual equipment of the assailants of organized markets. Only recently I picked up a book purporting to treat of the subject of ethics, and found this remarkable passage: —
“ If, instead of betting on something so small as falling dice, one bets on the rise and fall of stocks or on the price which wheat will reach some months hence, and if by such betting one corners the community in an article essential to its welfare, throwing a continent into confusion, the law will pay not the slightest attention. A gambling house for these larger purposes may be built conspicuously in any city, the sign ‘ Stock Exchange ' be set over its door, influential men appointed its officers, and the law will protect it and them as it does the churches. How infamous to forbid gambling on a small scale and almost to encourage it on a large.”
The writer who undertook to discuss the stock exchange in that manner in a book on ethics might very well have devoted himself less earnestly to the smaller refinements of ethical definition and reverted to the ancient maxim, “Thou shalt not bear false witness against thy neighbour.” What he says is a hodgepodge of misconceptions. If it be true that betting on the rise and fall of stocks be gambling, as it undoubtedly is, then what follows has no relation to this first suggestion. To one having any knowledge of the subject matter, the two parts of the first sentence are inconsistent with each other and mutually destructive. Pure betting is done in bucket shops, is of no use to the community, is destructive to the morals and pockets of young men, and cannot be too severely censured. But such betting is not carried on in buildings bearing the sign “ Stock Exchange. ” It has nothing to do with the legitimate processes of the exchanges. Moreover, one cannot corner the community on any “article essential to its welfare” by betting in bucket shops. He may perhaps do it within certain limits by actual transactions on the produce exchanges, because they involve the right to demand delivery. If it were true, however, that no such deliveries were contemplated or could be made, as is usually the case in bucket-shop gambling, it would no more be possible to corner the supply of wheat by betting on its future price than it is possible for a politician to carry the election his way by laying heavy odds on his candidate. His bets would not make votes, and merely betting on the prices of a commodity would not influence the supPly.
The fact that such confusion of ideas prevails, and that the stock and produce exchanges continue to be looked upon by many good people as a sort of adjunct of Monte Carlo, justifies an occasional restatement of the essential part which these exchanges play in the mechanism of business. To take the subject up from an elementary standpoint, it is well to say a word regarding the function of stock companies. The discovery was made long before our time that a piece of property or a new enterprise could be given mobility and divisibility by putting the title to its ownership into transferable shares. The creation of share companies enables the small capital of individuals to be gathered into the large funds necessary to build factories and railways. It divides the risk of an undertaking among many persons, and places the enterprise beyond the accidents of a single human existence by giving it a fictitious body dowered by law with perpetual life.
To give mobility to the shares thus created, it is necessary that they should have a market. It would be comparatively useless to divide an enterprise into shares if there were no means of transferring these shares readily from hand to hand. Therefore, a market for the shares and bonds issued by such enterprises is one of the vital necessities of their creation. Such a market is afforded by the stock exchange. The fact that the stock market is sometimes abused by people who go into it in a gambling spirit, who know nothing of its purposes, and who are incapable of understanding the mighty influences which dominate it, is no reason for treating it as a harmful excrescence on the body politic. Railways have not been abolished because a locomotive runs over men occasionally and kills them; banks have not been abolished because one occasionally suspends; and if enlightened judgment had been used, legislation would never have been enacted in Germany and seriously considered in other countries for stamping out or hampering the operations of the stock and produce markets.
It is not proposed in this article to deal with the abuses which have sometimes arisen through the manipulation of organized markets for improper purposes. It is proposed only to set forth the fundamental principles which prove the value of these markets to modern society and, therefore, afford their reason for being. The wrongs which have been perpetrated on the exchanges have come largely from perversion of their essential functions as the public mirror of values. It has been the dream of great manipulators to warp this mirror so that it would mislead the public to their own profit. The success which such manipulations have attained has, however, been greatly exaggerated in the public mind. It is truthfully declared by Courtois, in his Traité des Opérations de Bourse et de Change, that a fictitious movement, even on the part of the most powerful operators, cannot overcome the natural tendencies of values, and that the most that can be accomplished is to sometimes hasten or retard slightly the certain effect of a foreseen event.
The fundamental function of the exchanges, as already suggested, is to give mobility to capital. Without them the stock and bonds of the share company could not be placed to advantage. Nobody would know what their value was on any given day, because the transactions in them, if they occurred, would be private and unrecorded. The opportunities for fraud would be multiplied a hundredfold as compared with the publicity which is given under present conditions to the least movements on the stock exchange. The mobility for capital afforded by the limited liability company would be meagre and inadequate if the holder of its bonds and shares did not know that at any moment he could take them to the exchanges and sell them for a price. He cannot be misled as to this price, because every newspaper in the land, if the security is one of importance, gives him each morning the value which it possessed the day before in the markets of the world. The holder of it thus knows what the average judgment of hundreds of men is upon the value of that security. If it were not thus quoted, he would have to rely upon the judgment of a few people, expressing their opinion privately and perhaps interested in misleading him.
The publicity which prevails in stock exchange quotations gives the holder of a security not only the direct benefit afforded by such publicity for the moment, but gives him, free of charge, the opinion of the most competent financiers in the capitals of Europe and America. If they were dealing with him privately, instead of through organized markets, they might withhold the information which years of study and observation of railway properties and industrial enterprises have put in their possession ; but when they go into the market and bid a price for securities, by that very act they give their advice free of charge. That quoted price stands as a guide to the most ignorant holder of these securities as to their value in the present and their probable value in the future.
The second benefit of organized markets is in affording a test of the utility to the community of the enterprises which solicit the support of investors. The judgment of experts is there expressed, through the medium of price, on the utility of the object dealt in. If a railway is built in the wilderness of Manitoba and proves unprofitable, the investor does not need to hunt up people in Manitoba to ask how much freight and how many passengers it is carrying; he has only to look at the quotations for its bonds or stock on the New York Stock Exchange to know at once what is the judgment of experts on its value as a commercial enterprise. The prudent investor does not buy stocks which are declining, unless he has confidence in their future value. He withholds his capital from that type of investment. If he finds that the bonds or shares of cotton mills are generally declining on the market, he makes up his mind that there is no further demand for cotton mills, and does not snap at the prospectuses which ask him to invest in them. If he finds that certain railway securities are persistently declining, he concludes that they have acquired too high a value in relation to the return which they pay, and that there is no need to increase railway equipment in their localities by offering capital for new railway shares. All this information is put before the investor in a simple table of figures, which any man may read, as a result of the modern organization of the stock market and the publicity of what is done there. It would be practically unattainable by any other system. Thus through the publicity of knowledge and prices, the bringing of a multitude of fallible judgments upon this common ground to an average, there is afforded to capital throughout the world an almost unfailing index of the course in which new production should be directed.
Suppose for a moment that the stock markets of the world were closed, that it was no longer possible to learn what railways were paying dividends, what their stocks were worth, how industrial enterprises were faring, — whether they were loaded up with surplus goods or had orders ahead. Suppose that the information afforded by public quotations on the stock and produce exchanges were wiped from the slate of human knowledge. How would the average man, how even would a man with the intelligence and foresight of a Pierpont Morgan, determine how new capital should be invested? He would have no guide except the most isolated facts gathered here and there at great trouble and expense. A greater misdirection of capital and energy would result than has been possible since the organization of modern economic machinery. Mr. Morgan or any other capitalist might be expending millions of dollars in building new railways or cotton mills when there was no necessity for them, while a hundred other industries beneficial to the public were stagnant for lack of capital. There would be no safe guide as to whether the world needed more railroads and fewer cotton mills, or more cotton mills and fewer railroads. Great sums would be wasted in bootless enterprises, which would prove unprofitable and carry down their owners to ruin. All the capital represented, all the labor, thought, foresight, and inventive genius involved in them, would be sacrificed to the lack of an effective public organ for pointing out the direction in which capital was needed.
But to-day the organization of the stock market affords a register of values so sensitive that its very sensitiveness and accuracy are causes of thoughtless complaint. Men who plunge into the stock market without knowing its laws, and imagine that because stocks are rising they will always rise, complain because this sensitive reflector of values responds suddenly to some distant and unexpected event by a decline in prices. Perhaps in the Orient there are threatenings of war between two great powers, which would unsettle the relation between production and consumption ; or in India there is a crop failure, which will influence the price of silver, and react upon the finances of America. It is true, no doubt, that the stock market sometimes seems unduly sensitive to these widely separated and isolated events, but if one looks to the fundamental conditions which govern economic society, it must be clear that it is better that it should be too sensitive than not sufficiently so. It is better that any rumor of war, with a threatened cessation of production and consumption, should be reflected on organized markets than that people should go on recklessly investing capital in enterprises which may afterwards prove unproductive. The stock market is the great governor of values, and the determinant of the relationship between production and consumption, — the guide which points the finger as to where capital is needed and where it has ceased to be needed.
The very sensitiveness of the stock market is one of its safeguards. Again and again it is declared in the market reports that certain events have been “discounted; ” that the effect of the death of President McKinley, or promised peace between Great Britain and the Boers, has already produced in advance its natural influence in the stock exchange; and when the event actually happens, it results in no such great disturbance to values as was expected. Is it not better that this discounting of future possibilities should occur, — that the effect of a given cause acting upon the market should be felt by graded steps instead of coming like a cataclysm ? Is it desirable that capital and production should march blindly to the edge of a precipice and then leap off, instead of descending a gradual decline, — that a certain security, instead of falling by degrees, should fall thirty or forty per cent on the occurrence of some foretold event?
This foreseeing and discriminating calculation of the effects of coming events, known as “discounting” of the market, is one of the most useful functions of the exchanges. It enables the man who holds a given security, and sees that it is falling in value, to convert it into money without losing enough to be ruined. It enables the prudent man, who believes that an event will not cause the disaster which some anticipate, to hold on to his securities, and even to buy those of the frightened and more excited. Consider for a moment the effect of abolishing the produce exchanges and leaving events in the wheat and cotton market to have their full influence when they occur. What would be the effect upon the farmer ? Instead of being able day by day to trace the course of wheat and cotton, to learn what supplies were coming upon the market and what the effect upon prices would probably be of the crops of the world, he would be at the mercy of every traveling factor, of every unscrupulous representative of some big commission house who could get his ear. He would be told by them that crops in Europe were enormous, that wheat and cotton were going down, and he had better take the price which they offered to-day. Thus he might be misled into selling at much less than the fair price of his crop. With no public knowledge of present or probable future events, he would be helplessly at the mercy of every idle rumor. But to-day, if a cotton factor or unscrupulous agent of a commission house tries to mislead the farmer, the farmer has only to turn to his daily paper and say, “There is the judgment of all the world upon the present value of my crop and upon its future value.” If he has reason for not accepting that judgment, he is free to disregard it, but in any event he is not the plaything of misconception and false representation regarding the average opinion of other experts interested in the same commodity.
There is nothing, perhaps, more valuable to society than this power of the produce exchanges to discount changes in production and consumption of the great staples of food and clothing. The fact that future wheat is selling high, that there is a general belief that it is scarce, that the world’s crop is deficient, acts not only upon the farmer and dealer in this commodity, but also in a certain degree upon the whole community. Prices are likely to rise, the community becomes more economical in the use of the product affected, and the scanty supply in existence is husbanded during the period intervening before another crop. If it were not so, people would buy at low prices while the crop was diminishing, and the community might suddenly face a famine for which it had made no preparation. The operation of the produce exchanges in thus discounting the future, by gradually raising prices to meet a scarce supply, or gradually letting them fall to meet an excessive supply, is beneficial not merely to producers and consumers, but to the community as a whole.
It matters little whether physical delivery of the products dealt in is made in all these cases or not. The action taken by speculators, so called, in buying and selling wheat and cotton for future delivery is simply the expression of their judgment as to certain future contingencies. They are willing to pay for errors in that judgment out of their own pockets. If, when the time comes at which they have agreed to deliver a certain quantity of wheat or cotton, the price has gone higher than the price at which they sold, they are bound to make the delivery or pay the difference. But what does it matter which course they pursue ? The broker is only the intermediary in any event. If he has agreed to deliver 1000 bushels of wheat for $1000 on a given date, and the price rises to $1.20 a bushel, he and every producer know that he can obtain the wheat only at $1.20 a bushel, or 1000 bushels for $1200. If it is mutually convenient for the broker to pay the buyer the difference in cash which will enable the latter to buy the wheat at the net cost which he contracted for, it comes to exactly the same thing in the end as if the man who had given the order insisted upon a physical delivery of the wheat by the person who promised him future delivery. The buyer has simply been insured. Having contracted to receive a certain quantity of wheat for $1000, he gets it at that net cost to himself. The broker acts as insurer by paying the difference between the actual present price and the contract price made with the buyer. The latter is protected by his purchase for future delivery against the risk of a rise which he foresaw. If, on the other hand, the price has fallen to ninety cents per bushel, it is all the same to him if the seller accepts ten cents per bushel as the price of the insurance he granted and sends the buyer into the open market for his wheat. In either case the buyer obtains the wheat at the price he was willing to pay when he originally bought, and he has been insured against fluctuations of price in either direction.
The produce exchanges thus afford a form of insurance. They enable a man with contracts to execute in the future to ascertain to-day what will be the cost of his raw material in the future, and to know that he will get the raw material at that cost, even though it may rise in the open market above the price which he could afford to pay for it in view of the price at which he has contracted to deliver his finished products. Prudent dealers in great staples go into the market and buy and sell futures in such a way as to protect themselves, just as the prudent man of family goes to the insurance company and pays a premium in order to get a guarantee that his family will be protected against what may occur through the failure of his capacities, his disability, or his death. There is speculation in this and in all the various forms of insurance. In the language of the critics of the exchanges, it might be said that the man taking insurance bets with the insurance company that he will die sooner than their mortality tables indicate and thereby make a profit for his family. The operation is more like betting than transactions on the exchanges, because insurance cannot alter the length of human life. It is simply a speculation on what life will be. But society sanctions insurance, because it distributes risks among those who are willing to assume them and who have made calculations which lead them to believe that they will not on the average be losers by their transactions. That is to some extent the character of legitimate dealings on the produce exchange. The fact that physical delivery by the particular individual making the sale is not insisted upon has no bearing upon the case.
Physical delivery is not insisted upon in a hundred transactions which do not fall under the criticism of persons like the writer on ethics quoted above. If a retail coal dealer in July agrees to deliver to a patron in December ten tons of coal at a certain price, he probably does it on a purely speculative basis. He has not on hand the coal with which to fulfill his contract when the time comes. Does he commit any crime against the social order if he transfers the order to the shipping company and directs them to make the delivery direct from the cars to the purchaser ? Can fault be found with the fact that the retailer does not insist upon the coal passing through his hands, involving extra handling and expense, in order to avoid the charge of indulging in a speculative transaction ? That is what is happening constantly on the stock and produce exchanges. Physical delivery is made to the people who want the products. Between intermediaries the transactions are cleared against one another. The manufacturer of flour who has gone into the exchange and bought and sold futures in wheat, in order to protect himself against an undue rise in that product after he has made his contracts to deliver flour, knows that all the wheat he desires will be delivered to him. He simply clears his contracts at one price against those at another, in order to get the exact amount he wants without being obliged to receive the excess physically on the one hand, and deliver it over to somebody else on the other. It is the same principle of clearing which runs through banking transactions and through every account at a store where transactions on two sides are concerned, and it cannot properly be contended that there is necessarily anything speculative or of the spirit of gambling inherent in the nature of such transactions.
Another important influence of the stock exchanges in particular, and to some extent perhaps of the produce exchanges, is that which they exert upon the money market. The possession by any country of a large mass of salable securities affords a powerful guarantee against the effects of a severe money panic. If in New York there arises a sudden pressure for money, so that confidence becomes impaired, and people having contracts entitling them to future or immediate delivery of money insist that these contracts shall be executed in money instead of other forms of promises, what happens ? The banks call in loans and begin to husband their cash. If they hold large quantities of securities salable on the London or Paris or Berlin market, a cable order will effect the sale of these in an hour, and the gold proceeds will be on their way across the Atlantic within a day.
Wonderful has been the effect within the last twenty-five years of this steadying influence of the stock market upon the demand for money and upon the smoothness of the operations of the mechanism of the exchanges. What has just been put in a crude form by referring to a crisis occurs daily and hourly on the stock exchanges, and prevents sudden contraction and expansion in the rate for loans. The manufacturer goes placidly on paying his four or five per cent for commercial loans, when if there were no stock exchanges where securities could be sold in one market at a slight profit over another he would find that his bank was first charging seven or eight per cent, then dropping to three or four, and then going back to eight. By means of the facility which the stock market affords for placing credit instantly at the command of one market or another the pressure for money is mitigated, and has but little effect upon the commercial borrower. Such pressure as now occurs is transferred to the borrower on call, — the broker in stocks, who thus acts as insurer for the commercial borrower. This influence of the stock market has much the effect of a buffer upon the impact of two solid bodies. Crises are prevented when they can be prevented, and when they cannot they are anticipated, and their force is broken into a mild succession of ripples instead of a tidal wave.
Securities form one of the greatest and most important parts of the modern mechanism of exchange. They are, in many cases, as good as money, and in some cases are better than money. If a large shipment of money has to be made from New York to London, it is much more economical to ship securities of the same amount than to ship kegs of gold. Credit is forwarded by cable and the securities follow by mail. All markets are thus brought into touch with one another, and respond to a fluctuation of a fraction of one per cent, but without the confusion and crash which would ensue if every sudden pressure for money was felt upon a market naked of such securities.
Japan passed through a severe crisis in 1901, and part of the year before, because of the barrenness of her stock market. She had been engaged in great enterprises, but the stimulus given her industrial interests did not prove immediately profitable. Her people had begun importing great quantities of foreign goods, including too many luxuries, and the result was that she had large debts to pay abroad. If she had had a good security market these debts would have been settled by the transfer of securities ; but having only a few securities, and those of doubtful value, to throw upon the London market, she was compelled to settle at a sacrifice the demands upon her for money. She was compelled to sell goods for any price that could be obtained. A check was put upon foreign importations, industry was brought suddenly to a halt, and famine stared her in the face. This influence of the market for securities upon prices is one of its most important benefits. If Japan in this case, instead of unloading her goods so suddenly and at such sacrifices, could have made the descent gradually, she would have been able to sell by degrees and at higher prices than those actually realized, and so would have been saved the economic loss which follows from the sacrifice of commodities under the pressure of necessity.
France was saved from one of the greatest crises of history by the large holdings of securities among her people during the Franco-Prussian war. When Germany demanded an indemnity of five thousand millions of francs ($1,000, - 000,000), it was in the belief that its payment would throw a paralysis upon French industry and enterprise which would prostrate them for a generation. But what happened ? When the French government appealed to the people, saying, “We need five thousand millions of francs to pay off this indebtedness, ” the whole matter was adjusted through the securities market, and in a few years the Bank of France resumed the payment of gold for its notes. Frenchmen subscribed liberally for the securities of the new loans to pay off Germany, and in order to obtain the necessary funds they directed their brokers to sell in London, Berlin, Vienna, Brussels, and New York the old securities which they held. Five thousand million francs were taken from the capital of France, but she was so rich that she was able to submit to it without disaster. She was rich because she had piled up these securities, with which she was able to part without suffering. The crushing debt imposed by the conqueror was practically canceled by transferring to other markets the titles of the debts which Frenchmen held against foreign peoples. No such operation would have been possible before the organization of the modern securities market, responsive as it is to the slightest change in supply or demand, the slightest rumor of war or peace.
France, by the possession of a flexible stock exchange and a great mass of the securities negotiable upon such exchanges, was saved from the convulsion which must have prostrated her entire industrial system if it had been necessary for her to find money to discharge the demands of the conqueror. Similar great transactions are constantly carried on by our kings of finance without any such disturbance to the money market as would occur if this resource were not available. If a hundred millions of dollars are needed to consummate a great transfer, or for a public loan, the money comes promptly to hand by the sale of those securities, or else by simply borrowing on them in foreign markets where the securities are put up as guarantee for ultimate payment. Through all the processes of modern industrial life the existence of the securities market acts as a buffer, as a guarantee to the business community that in times of emergency and crisis the shock shall not be too sudden, that nothing determining the value of great industries shall be done in a corner, and that the market shall be kept as nearly level as actual conditions will permit it to be kept.
Some of those who admit the value of the stock market have subjected to severe criticism those who speculate for the fall of stocks. One reads constantly of the “bears ” trying to accomplish such and such results by depressing securities. Napoleon had a long talk with Mollien, his Minister of Finance, in seeking to demonstrate that those who sold “short,” in the belief that national securities would fall, were traitors to their country. He argued that if these men were selling national securities for future delivery at less than their present value, they were guilty of treason to the state. But Mollien replied in substance, “These men are not the ones who determine the price ; they are only expressing their judgment upon what it will be. If they are wrong, if the credit of our state is to be maintained in the future at its former high standard, in spite of your military preparations, these men will suffer the penalty by having to make delivery at the price for which they sold, for they must go into the market and buy at the then prevailing price. It is their judgment, not their wish, that they express. ” The short seller — the “bear ” of the money market — is often one of its greatest benefactors. He calls a halt on reckless speculation, and his acts, tending to depress prices, produce their natural result of repressing extravagant inflation of values, if his judgment is sustained by facts and by the judgment of other men. If it is simply a mistaken individual judgment, he pays for his error in cash to some one with a more hopeful and saner judgment.
The organized stock and produce markets constitute, therefore, not only a vital factor in modern exchange, but so far from being a necessary evil, as some ethical writers claim, they constitute one of the most beneficial instruments of modern civilization. Without them modern business could not be conducted, or could be conducted only with a series of shocks, upheavals, and convulsions which would result in robbing the manufacturer and consumer for the benefit of the shrewdest speculators in actual commodities.
There is another important consideration in this influence of the stock market upon modern society, which will perhaps gather up and bring into a clearer light some of the other points which have been made. The stock market, by bringing all values to a level in a common and public market, determines the direction of production in the only way in which it can be safely determined under the modern industrial system of the division of labor and production in anticipation of demand. It does so by offering the highest price for money and for the earnings of money at the point where they are most needed. A market denuded of capital will pay a high price for capital. It is only through the mechanism of the money market and the stock exchange together that any real clue is afforded of the need for capital, either territorially or in different industries. Through the influences which the rates for money and capital exert upon investment in new industries, through the fact that capital is attracted to securities which are selling high because the industries they represent are earning well, there results a closer adjustment of production to consumption, of the world’s work to the world’s need, than would be possible under any other system.
From this point of view, the mechanism of modern industry affords an almost insuperable objection to state socialism. If it were attempted to establish any system of state socialism, it would have to be determined in just what proportion every article should be produced, — just how many shoes and hats, how much clothing and sugar and vinegar the world needed, and it would be necessary to adjust the supply to that need. To-day through the mechanism of the stock market it is determined, as precisely as human ingenuity has yet found it possible, just how much is needed of every commodity, because the products of those industries which are needed are rising in value, tempting to increased production, and those which are not needed are falling, giving warning that production should be curtailed. If the stock market were abolished and state socialism set up, who would be the judges of the direction of production ? Who would determine whether there should be a million more pairs of shoes produced or only ten thousand? Who would determine whether human energy should be wasted in producing shoes nobody could use, or utilized in building railways where they were badly needed ?
The guiding factor of rising and falling prices having been eliminated, there would be no means of determining promptly when the supply of any article had reached the limit of the world’s need. An executive board of one hundred of the ablest men in the world could not possibly determine the direction which production should take without the index afforded by prices in the merchandise and stock markets. But through the stock market it is determined almost automatically, with as much nicety as anything can be determined which depends upon human judgment, where further production is needed and where capital is needed. Upon that market is concentrated, in a sense, the judgment of every human being in the world having any interest in production either as consumer or producer, — not only of those who deal in stocks and securities, but those also who are directly concerned in the industries and interests which those securities represent. That delicate register of values, that sensitive governor of production, that accurate barometer of the people’s needs, could not be replaced by any process that any state socialist has devised or suggested.
Charles A. Conant.