Frequently Asked Questions:
on the stock exchange?



The financial markets: how they work and for whom.

This FAQ is written for activists involved in preparations for the M1 blockades of stock exchanges, to provide some basic information on exactly what the stock market, and related financial markets, do.

Part I: The basics
1. What is the stock market?
2. Which are the largest stock markets in the world and how much do they trade?
3. What about the Australian Stock Exchange?
4. What are the financial markets?
5. How quick have the financial markets grown in the 1990s?
6. Why such growth?

Part II: What stock markets don't do
7. What do stock markets claim they do?
8. Hasn't share ownership broadened considerably?
9. Don't stock markets promote a "wealth effect", boosting growth?
10. Don't stock markets fund investment?
11. Don't stock markets allow for rational allocation of capital?

Part III: What stock exchanges do
12. What economic purpose does speculation play?
13. What could be done with financial markets' turnover?
14. Who are the major players in the financial markets?
15. What impact has rising stock markets had on the balance of power?
16. What risks are associated with stock markets?


Part I:The basics

1. What is the stock market?

The stock market is a place where "stocks" (also called "shares" or "equities") are bought and sold.

A stock is a tradeable certificate of part-ownership of a company listed on a stock exchange.

A stockholder owns a part of the company, is entitled to vote in its annual general meetings (in proportion to the number of their shares) and is entitled to a portion of the company's profits (a "dividend").

In the past, stock markets were physical places where buyers and sellers would meet; some places (like New York) still have physical trading.

Increasingly, however, stock markets are fully computerised and automated.

The Australian Stock Exchange, for example, is fully computerised, buyers and sellers communicating by computer.

The ASX's offices are administrative entities; buyers and sellers don't do business there.

For its stock to be bought and sold, a company has to be "listed" on that stock exchange; it has to be a "public" company.

Various exchanges have various rules and benchmarks for listing, but everywhere the largest companies are "listed" ones: on their home country's exchange and, increasingly commonly, on selected foreign exchanges as well.

Pick any giant corporation and you can be sure its stocks are being bought and sold on some exchange somewhere.

Various exchanges compile "indexes", aggregates of the share prices of the particular companies chosen to be part of that index.

For example, the Australian Stock Exchange's basic index is the "All Ordinaries", while New York's basic is the "Dow Jones", London's is the "FTSE 100" and so on.

There are hundreds of these, some broad and general, some very specific.

This is what is going up or down when news reports say "the stock market fell today".


2. Which are the largest stock markets in the world and how much do they trade?

The largest stock market in the world is the New York Stock Exchange, on Wall Street.

The value of its trading averaged US$35.5 billion each day in 1999 and totalled US$8.9 trillion for the year.

The "market capitalisation" (that is, the total dollar value of every single share listed on it) for domestic operating companies was US$11.4 trillion in 1999.

The NYSE is followed by the NASDAQ, a US market for mainly technology stocks which don't (or choose not to) meet the NYSE's listing requirements; its market capitalisation for domestic operating companies was US$5.2 trillion in 1999.

Then follows the markets in Tokyo (US$4.5 trillion) and London (US$3.0 trillion).


3. What about the Australian Stock Exchange?

The Australian Stock Exchange (ASX) is a minnow in comparison.

In 1999, its daily trading averaged $1.213 billion; its yearly trading totalled $306.9 billion.

Its domestic market capitalisation totalled $653.5 billion in December 1999.

While far less than the market cap of New York, that amount is still enormous in Australian economic terms: it's equal to 94.8% of that year's gross domestic product for the whole country.

In addition to selling stocks, the ASX also sells certain classes of derivatives, specifically 63 different classes of standardised options.

In 1999, the 9,991,424 derivative contracts bought and sold on the ASX were worth $8.13 billion; these figures are 23.7% and 36.2% up on the previous year's trading, respectively. (See question 4 for a definition of "derivative" and "option".)


4. What are the financial markets?

Stock markets may be the most famous and the most watched, but they are only one part of what is collectively known as the "financial markets".

The financial markets comprise many interlocking markets in different financial instruments.

These are the basic ones:

Bonds: A bond is a tradeable certificate of debt which guarantees the bondholder an interest payment (a "yield") when the time limit on the bond expires (when it "matures").

Bonds can be sovereign (government debt) or corporate, long or short term, investment-grade (low risk, low return) or junk (high risk, high return).

The king of all bonds is the Treasury bond, issued by the US Federal Reserve.

Foreign exchange: The oldest form of financial market transaction is the buying and selling of national currencies one for the other.

Originally, forex transactions were to fund purchases of goods and services.

Now forex markets are the major venue for speculation, dwarfing all others: more than US$1.5 trillion crosses the wires in currency trades each day.

Derivatives: The collective name for futures, options and swaps, as they are all "derived" from more basic instruments, such as stocks, bonds or commodities.

Derivatives can either be standardised and regulated and sold on exchanges, or over the counter ("OTC"), and completely unregulated.

Futures: A future is a tradeable agreement to buy or sell a particular amount of a particular commodity (whether US dollars or pork bellies) at a particular time.

Swaps: A swap is a tradeable package of parts of two different cash flows, which don't involve trading the underlying asset.

Swaps are of two basic types: "interest-rate swaps" (where counterparties swap floating for fixed interest rate payments) and "currency swaps" (where counterparties swap interest payments in two different currencies).

Options: An option is the right, but not the obligation, to buy or sell an underlying asset, whether a bond or a stock or whatever, within a certain period.

Options can either be "call" options (the right to buy) or "put" options (the right to sell).

There are constant new financial "innovations" being invented, bought and sold - in large part in an effort to avoid regulation.


5. How quick have the financial markets grown in the 1990s?

All of the financial markets have grown tremendously in the last decade.

Since 1980, the value of the global stock of financial assets has increased more than twice as fast as the gross domestic product of the rich countries, from $12 trillion then to $80 trillion now.

During the 1990s, the value of shares traded on the New York Stock Exchange, the largest in the world, increased more than fivefold, from US$1.74 trillion in 1992 to US$8.94 trillion in 1999.

According to ASX figures, the total value of equities traded on the Australian Stock Exchange over the year 1989 was $56.6 billion; ten years later, that figure had increased sixfold, to $306.8 billion.

The total domestic market capitalisation was $163.3 billion in 1989 and nearly four times larger, $593.6 billion (year average), in 1999.

The same has held true of all the other financial markets.

The most dramatic has been the growth in the foreign exchange, or forex, market.

According to the Bank of International Settlements, each day more than US$1.5 trillion crosses the wires in currency trades; in 1989, the figure was US$590 billion, in 1977, it was $18.3 billion.

Yearly trading on forex markets is today worth more than 10 times world gross domestic = product.


6. Why such growth?

There are many, varied reasons for this enormous increase in liquid capital in the financial markets.

Fundamentally, the two main factors are:

1. speculation is enormously profitable for those who engage in it, certainly far more profitable than productive investment, and 2. it has been made much, much easier to do so.

More on factor 1, the profitability of speculation, later. (See question 16).

As for factor 2, increased ease, there have been an enormous range of measures introduced during the 1990s which have promoted growth in the financial markets.

These include: the privatisation of state assets, the enormous growth in superannuation and pension funds (in part as a result of the privatisation of social security), the liberalisation of capital accounts which has allowed finance to flow almost freely across most national borders, the liberalisation of laws restricting mergers and acquisitions.

All these have been deliberate policies enacted by pro-business governments, which had, at least in part, the goal of precisely adding to the strength of the financial markets.

Over and on top of all that has been an enormous and until recently ever-growing speculative bubble, especially in the giant US market and even more especially in stocks for high technology companies.

This bubble has attracted even more capital towards it as it has grown.


Part II: What stock markets don't do

7. What do stock markets claim they do?

Backers of stock markets make four principal claims as to their purpose and effect:

* they even out inequality by broadening ownership;

* they encourage economic growth and prosperity;

* they fund investment; and

* they allocate funds efficiently to the most appropriate sectors.

All of these claims are wrong.


8. Don't stock markets broaden share ownership?

Greater numbers of people than ever now own shares, that's true - but this has not reduced inequality even in share ownership itself.

The ASX's 2000 Australian Shareowners Study claims that the total proportion of Australian adults who directly owned shares increased from 10.2% in 1991 to 40.6% in 2000, while the proportion who owned shares both directly and indirectly (for example, through their super fund) rose from 14.7% to 53.7%.

Most of these however are small shareholders.

According to the same ASX data, the average share portfolio was worth $28,000, while 41% of shareholders has under $10,000 invested - small beer in comparison to the major market players.

Moreover, 31% of all shareholders only held shares in one company, while a further 19% held shares in only two.

In many cases, these companies would be those like Telstra, the Commonwealth Bank, the NRMA, which only a few years ago were either state-owned (and therefore everyone's property, at least technically) or mutualised (like NRMA).

Rather than being democratised by this influx of new investors, however, share ownership is still highly concentrated in the hands of the super-rich.

A study published in the Economic Monitor in November 1998 by Hans Baekgaard estimated that in Australia 90% of all shares are owned by 10% of shareholders, while 60% of shares are owned by 1% of shareholders.

Estimates made from tax office data by Laurie Aarons, in his 1999 book Casino Oz, go further.

Aarons studied "dividend imputation credits", the return which the government gives back to shareholders if they've paid tax on shares in a corporate which has already paid company tax (in such a case, a company's dividends are said to be "franked").

They're not a perfect measure, as only about a third of shares pay "franked" dividends; they are an indicator, however.

On the basis of his study, Aarons concluded that 274,458 people, or just 2.8% of the almost 10 million people who filed tax returns in 1995-96, owned 72% of all shares paying "franked" dividends.

Close to 8 million working people, 88% of people who put in tax returns, received no dividend imputation credits.

Small shareholders have increased in number, but they play much the same = role as that of small depositors: they give the big boys their dollars, = let them play with it as they will and get a few cents in return.


9. Don't stock markets promote economic growth?

There is no causal or necessary connection between booming stock markets and economic growth.

The principal proof that there is such a connection is derived from a misreading of the 1990s US boom, which did see the two, rising stock markets and growth, coincide.

According to the backers of this argument, stock market rises created a "wealth effect": as people's share portfolios increased in value, they felt richer, were more confident in economic prospects and spent more.

This, the theory, goes even applied to those who didn't own shares: they too felt richer and acted like it.

As private consumption accounts for two-thirds of all demand in the US economy, this increased consumption powered the boom.

The US Federal Reserve has even put the figures to the "wealth effect": it estimates for every US$1 dollar in stock market profits Americans pocketed, they spent an extra three to four cents on purchasing extra consumer items.

However, the "wealth effect" would better be called the "debt effect", because that's what has powered the 1990s US boom in consumer spending.

Households in the US now have negative savings.

The ratio of US household debt to equity rose from 84% to 105% during the 1990s; they = owe more than they own.

This burgeoning debt is just as much a sign of growing poverty as it is of growing wealth.

Expanding share portfolios certainly have prompted a spending binge by the wealthy classes.

But poor and middle-income households have been borrowing, not on the prospects of more consumption but rather just to keep their heads above water.

The US Federal Reserve estimated in 1998 that 70% of debt was held by the bottom 90% of households.

There are plenty of country histories which show the opposite correlation to that supposedly shown by the US economy in the 1990s.

For example, Mexico before its crisis in 1994 witnessed a major boom in its stock markets, driven by an inflow of foreign capital, even as its "real" economy stagnated and even declined - needless to say, this stock market boom was also a major cause of the eventual 1994 crisis, as well.

In a longer view, the relationship between stock market performance and economic growth is pretty much random.

Some studies find positive correlation, others find negative correlation, others none at all.

One analysis, by Federal Reserve Bank of New York economist John Mullin, which studied the relationship between the two in 13 countries between 1976 and 1991, found no pattern whatsoever.

Another study, by InvesTech's James Stack in 1994, studied annual stock returns in the US since the 1950s.

It found that annual returns averaged +20.1% when capacity utilisation was below 82% (ie. when production was contracting) and +6.0% when it was above 82%; +16.9% when the Volumbia University Centre for International Business Cycle Research's leading index of inflation was below 0% (ie. when the economy was deflating) and +8.2% when it was above 0%; and +17.7% when the annual change in spot raw materials prices was below 0% (ie. when commodity prices were = dropping) and -0.7% when it was above 0%.

Evidence suggests that booming stock markets have far more to do with profit rates in speculation: such as rises in the total amount of dividends paid out by companies.

Booming stock markets are also frequently self-perpetuating: as asset prices rise, everyone wants in - at least until the bubble bursts.


10. Don't stock markets fund investment?

Stock markets play virtually no role in raising funds for investment.

The overwhelming bulk of trading on any stock exchange is trading in existing shares, which are feverishly handed from one owner to another.

Proceeds from the sale of shares go to the last shareholder, not to the company, just like Ford gets nothing when you sell one of its cars second-hand.

The only sale of shares which could in any way be linked with investment are "equity capital raisings" - which occur either when a new company lists on the stock exchange and sells a pile of shares in itself (called an "initial public offering", or IPO) or when an existing listed company decides to issue a certain number of new shares in itself on top of those already issued.

According to ASX figures, in 1999 capital raisings accounted for $33 billion out of a domestic market capitalisation of $578.8 billion.

This means that stock markets only contributed 5.7% of their value to what could potentially be new investment, about average for the decade.

The long-term average rate in the US is lower, 4%.

Even this is a very generous figure, as it presumes that new stock is issued to fund investment.

During the 1990s, that wasn't the case most of the time.

IPOs, especially of internet start-ups, were driven by company founders' knowledge that, in the market's frenzy for IT stock, their share prices would rise very rapidly and that they could sell up their own holdings (sometimes within days of the float) and make a quick killing.

Among the companies listed on the US Dow Jones Industrial index, only a handful have issued any new stock in last 30 years.

Most companies fund new investment out of their retained earnings or through debt (either bonds or bank loans).

Ninety-two percent of US companies' investment was funded this way between the 1950s and the 1990s; the Australian proportion is similar.

20 At best, it could be argued that a share price deemed healthy by the markets would allow a company to borrow money on better terms.

But to say that this means the stock market raises funds for investment would be an abuse of the English language.


11. Don't stock markets allow efficient allocation of resources to the most appropriate sectors?

"Manic" would be a better description than "rational" or "efficient".

Stock markets are not just prone to violent swings between euphoria and despair; such swings are intrinsic to their operations.

Stock markets, throughout their entire history, are given to massive bubbles: periods of extreme euphoria where everyone wants to buy a piece of a rising stock, sending the price up and up and up until its price has no relationship with reality, at which point it invariably bursts.

Such bubbles have included the classical South Sea Bubble of 1711, the bubble that burst in 1929 prompting the Great Depression, the Japanese bubble which burst in 1989 and which that country has still not recovered from, the finance and real estate bubble in Thailand which prompted the 1997 Asian economic crisis and dozens, if not hundreds, of others.

The massive speculative bubble in US technology stocks, which is now bursting, is another case in point, probably the most extreme case in market history.

The classical benchmark for judging whether a stock is overvalued is the ratio between a company's share price and the profit paid on each share (the price-earnings or P/E ratio).

For the S&P 500, the broader US market index, the P/E ratio is 25:1, meaning it would take 25 years of dividends for a share to pay for itself.

This is a little high but still reasonable, the historically average figure is around 15:1.

In 1985, the P/E ratio on the US NASDAQ index, where most technology stocks are listed, was 51:1.

In 1999, it was 118:1; it hit its peak in 2000 at 400:1, which means a single share would take 400 years to pay for itself.

Since the bubble burst in April, the NASDAQ has lost 57% of its value, or US$3.4 trillion.

And no wonder.

Many of these NASDAQ-listed companies had never made a profit, had little revenue, owned next to no assets and were purely a product of rampant speculation, which forced their share price up and up and up and until it popped.

Does that sound rational?

These bubbles are not just a quirk of individual traders.

Herd behaviour is an intrinsic, unalterable part of stock markets; those who don't engage in it, lose out.

Listen to Jeffrey Winters, in a paper delivered to a 1998 conference at Murdoch University on the Asian crisis, explain how emerging markets fund managers (EMFMs) spread the Thai crisis to other countries:

"Suddenly you receive disturbing news that Thailand is in serious trouble, and you must decide immediately what to do with your Malaysian investments.

It is in this moment that the escape psychology and syndrome begins.

"First, you immediately wonder if the disturbing new information leaking out about Thailand applies to Malaysia as well.

You think it does not, but you are not sure.

Second, you must instantly behin to think strategically about how other EMFMs and independent investors are going to react, and of course they are thinking simultaneously about how you are going to react.

And third, you are fully aware, as are all the other managers, that the first ones to sell as a market turns negative will be hurt the least, and the ones in the middle and at the end will lose the most value for their portfolio - and likely to be fired from their position as an EMFM as well.

In a situation of low systemic transparency, the sensible reaction will be to sell and escape.

"Notice that even if you use your good connections in the Malaysian government and business community to receive highly reliable information that the country is healthy and not suffering from the same problems as Thailand, you will still sell and escape.

Why? Because you cannot ignore the likely behaviour of all the other investors.

And since they do not have access to the reliable information you have, there is a high probability that their uncertainty will lead them to choose escape.

If you hesitate while they rush to sell their shares, the market will drop rapidly and the value of your portfolio will start to evaporate before your eyes."

Perfectly efficient - for the fund manager, but not for Malaysia or Thailand.


Part III: What stock exchanges do

12. What economic purpose does speculation play?

The basic function of the stock market, and of all financial markets, is parasitic: they divert funds from productive investment to speculative activities, which are generally far more profitable.

They are proof of how capitalism holds back not only social equity but also economic development, the thing it is supposed to be best at. Capital's joyous, head-long flight into speculation is a retreat from investment in production, caused by a long-term decline of profitability in "real economy" industries and a vast over-capacity problem.

World manufacturing capacity was operating at 65-70% in 1998, while the car industry, one of the global economy's largest and most important, can build 20 million more vehicles than it can sell each year.

Obviously, in a capitalist economy, companies aren't going to give their product away, so they simply stop producing and search for other ways to make a buck.

As a result, investment is heading downwards.

In the United States during the 1950s and 1960s, capital expenditure by non-financial = corporations averaged 8.5% of GDP; in 1995-97, it averaged 6.2%. The answer to dropping profitability has been speculation.

The most glaring example is the forex market.

In the 1970s, 90% of foreign exchange transactions were related to trade and investment - companies bought and sold national currencies in order to buy and sell real goods or services.

Today, the global annual value of exports of goods and services amounts to only four days trading on forex markets; the rest is about speculators betting against national currencies.

The rewards of speculation are grand, for those who can get in on the game.

In the United States, the profit rate of non-financial corporations peaked at 7.5% in 1997, after slumping to 3% in the early 1980s; in contrast, the profit rate of mutual funds averaged 13% and that of hedge funds averaged 20% during the 1990s.

In Australia, the finance and investment sector's rate of return in 1999-2000 was 11.1%, more than twice the economy-wide rate of return of 5.4%.

Even industrial corporations are now devoting greater funds to = speculating in the financial markets.

The world's 11th largest multinational, General Electric, a giant in manufacturing, made 40% of its 1997 income from its speculative arm, GE Capital, for example.


13. What could be done with financial markets' turnover?

A further proof of parasitism, and of how destructive in human terms capital's increasing reliance on speculation is, is a simple tallying of what that turnover could have done:

One day's trading on the Australian Stock Exchange averaged $1.49 billion in January (according to the Reserve Bank of Australia).

That same sum could:

* write off nearly all of Papua New Guinea's debt;

* quadruple Australia's overseas development aid;

* build 12,000 public houses;

* increase tenfold the number of pre-school child care places;

* restore higher education funding levels to what they were before 1990.

One day's trading on the New York Stock Exchange averaged US$35.5 = billion in 1999.

US$30 billion would be enough to double rich countries' overseas development aid to the Third World. (UN estimate.)

Six months' trading on the Australian Stock Exchange in 1999 was worth $153 billion.

$160 billion is the amount needed to fund universal provision of basic = services (health, water, education) to everyone on the planet. (UN = estimate.)

One day's trading on international foreign exchange markets in 2000 was worth US$1.5 trillion.

US$1.58 trillion is the amount needed to wipe out the debt of the 92 Third World countries which most need it. (Jubilee 2000 estimate.)

The year's trading on the New York Stock Exchange in 1999 was worth US$8.9 trillion.

US$8 trillion is the amount needed to fund the basic industrialisation of Asia, Africa and Latin America. (UN estimate.)


14. Who are the major players in the financial markets?

While most media attention is on the small investor (who the big broking houses sneeringly call "retail investors"), the financial markets are made by the big institutional investors.

These can be broadly categorised as follows: Commercial banks: The traditional big boys of the financial world, commercial banks' basic business is retail: to pay depositors less interest than they take from debtors.

In addition, they've been major investors in bond, currency and equity markets for over a century, although their market share has declined with time. (Example: Citibank, National Australia Bank.)

Investment banks: Otherwise known as merchant banks, investment banks don't handle ordinary accounts but rather act as intermediaries for companies wishing to float on the stock exchange, issue bonds, arrange syndicated bank loans or buy other companies.

They also speculate heavily in financial markets on their own account. (Example: Merrill Lynch, Goldman Sachs.)

Managed funds: The new big boys on the block, managed funds include both private and public pension funds, which invest heavily in securities, and mutual funds (unit trusts), in which investors pool funds in order to acquire greater market leverage and thus returns.

Together, managed funds account for two-thirds of all equity owned by institutional investors in the US. (Example: Bankers Trust, AMP.)

Hedge funds: The sharks with the sharpest teeth, hedge funds are private investment partnerships, generally between groups of super-wealthy individuals and other institutional investors, which engage in especially high-risk speculation.

Blamed for igniting the world financial crisis of 1997-97, hedge funds went into temporary decline but are now on the rise again. (Example: George Soros' Quantum Fund, Long Term Capital Management.)

Corporate finance departments: So lucrative is speculation that the treasuries and finance departments of many non-financial institutions are putting serious money in, either in order to protect against risk or for purely profit-making purposes. (Example: GE Capital.)


15. What impact has rising stock markets had on the balance of power?

Stock markets don't just encourage speculative parasitism; they greatly empower the parasites.

A company listed on a stock exchange is based on a division between management and ownership.

The senior managers run the company day to day, but ownership is in the hands of the shareholders, what Lenin called "coupon clippers".

It's these dividend-seeking rentiers, particularly the large institutional investors like investment bankers and fund managers, who get to pick the board of directors and, indirectly at least, the senior managers.

Their shares are perpetual ownership rights in a pipeline direct into a company's profit stream, and their will is that that pipeline continues to pump out dividend cheques with ever-increasing numbers of zeroes on the end of them.

The most important thing therefore for any chief executive officer is their company's share price, a 24-hour, real-time indicator of whether or not their largest shareholders are happy with them.

This process is euphemistically known as "market discipline" but - markets being collections of people, rather than disembodied, ethereal things - "rentier discipline" is probably a more accurate term.

A falling share price reduces the value of a firm's assets, thereby making it costlier for companies to borrow and, if sustained, even leaving a company open to a hostile takeover.

It also hits CEOs where they hurt - most executive salary packages include large quantities of stock and options, a fall in share price reduces executives' salaries.

The speculative boom of the 1990s has considerably strengthened the rentiers, and made them hungrier.

The most visible proof of that is the share of after-tax profits paid out to shareholders in dividends: in the US, it averaged 44% from the 1940s to the 1960s, declined to 39% in the 1970s and has since risen to just under 70% in the 1990s.

The added power of rentiers has acted to multiply parasitic capital-destroying activities.

Between 1984 and 1997, non-financial institutions in the US spent $864 billion buying back their own stock, a popular move with shareholders as it raises the value of the individual share.

They also spent $3 trillion between 1980 and 1997 buying each other. Needless to say, the increased power of the rentier has greatly increased pressure on corporations to pursue no goal of any sort - environmental, social, economic, ethical - other than a maximised share price and maximised dividends.

The "market discipline" of the stock markets thereby ensures that = corporations stay powerful, greedy and ruthless.


16. What risks are associated with stock markets?

Stock markets, and financial markets more generally, make catastrophic financial and economic crises more likely and, when they inevitably occur, more devastating.

During the 1990s, major financial crises averaged one a year, the social and economic costs of which were universally paid by working people.

Some of these crises are deliberately brought on by the actions of speculators.

The 36% plunge in the value of the Turkish lira on February 22 was brought about by Western portfolio investors withdrawing their money from the country's stock exchange in protest about the government's lack of progress in imposing a harsh austerity package on the population.

Currency traders targeted the lira, and bought on the cheap US$7.5 billion of the country's reserves when the central bank desperately attempted to protect its value.

Inflation is expected to sky-rocket as a result, hurting living standards, and the International Monetary Fund is in the process of drawing up an even harsher austerity package as a condition for bailout loans.

The deliberate actions of speculators played a major role in similar crises in countries like Mexico (in 1994-95), East Asia (1997), Russia (1998) and Brazil (1998-99).

In each case, Western speculators made a killing, while millions in the targeted countries suffered. Other crises are accidental, but no less inevitable.

The price of the premium rate of return on speculative capital is a far greater degree of risk.

Speculators fund their activities primarily with other people's money, through credit - and the 1990s bubble in portfolio assets has greatly increased speculators' capacity to borrow.

When a gamble goes wrong, however, this high degree of borrowing (called "leverage") boosts the chance of not only the borrower but also its creditors going bust - and of then sparking a domino-like "contagion" of unpayable or bad debts throughout the financial sector.

The world came within a hair's breath of such a catastrophic financial collapse in August 1998, when Russia announced that it would default on its debt, throwing forex and bond markets into a spin.

One large hedge fund, Long Term Capital Management, had made huge profits on gambling on the spreads between different governments' bonds but suddenly found the entire market shifting under its bets.

Making matters worse, it was highly leveraged - from a capital base of US$4.8 = billion, it had an exposure of US$1.25 trillion.

In early September 1998, LTCM was forced to tell the US Federal Reserve that, as a result of Russia's default, it had lost 90% of its equity in one month.

The panic was intense and immediate - many commercial and investment banks and rich individuals had sunk billions into LTCM, either in equity or loans, which they would lose if LTCM collapsed.

Maybe they'd even collapse themselves, bringing global financial markets with them.

The hedge fund's creditors and shareholders all pleaded with the Fed for an enormous bailout package - which they duly got.

Even on a smaller scale, such collapses can be devastating to communities.

In 1994, Orange County, south of Los Angeles, lost US$2 billion in a failed gamble on the derivatives market: they thought interest rates would fall or remain stable, instead they fell.

As a result Orange County went bankrupt, US$40 million was cut from the county budget, social welfare programs for low-income families were slashed and council workers lost their jobs.

If the world slips into recession this year, as is looking increasingly likely, a large part of the blame can be placed on the financial markets, in particular for causing the US stock market bubble, whose bursting threatens to turn a periodic slowdown into a major social and economic crisis.







The Australian Stock Exchange is fully computerised.





Written by Sean Healy, Green Left Weekly. Permission to reprint is given, provided author and source are credited.

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