Stock markets like the New York Stock Exchange (NYSE) and London Stock Exchange (LSE) provide a trading platform where shares of publicly-held companies are sold and bought by different types of traders. Along with the debt markets dominated by commercial lenders, stock exchanges are an invaluable source of capital for businesses. As such, the behavior of a country’s stock markets can serve as a reliable indicator of national economic performance. So, how exactly does a stock market benefit an economy?
Source of business capital
Without stock markets, businesses would largely resort to borrowing huge loans - which must be repaid with interest- from banks or individuals with well-oiled pockets. Fortunately, businesses in both the developed and developing world can issue share to the public, raising vast amounts of cash that doesn’t come along with a repayment burden (public companies are under no obligation to pay dividends, especially when they incur losses). When businesses have access to such capital, they can easily expand their operations and create more job opportunities. From a national perspective, this will lower unemployment levels, and enable a government to earn move revenue from business taxes.
Investments, whether in the financial markets or product markets (agriculture, real estate, manufacturing etc.), are a key driver for economic trade, growth and prosperity. As governments focus on creating policies –like lowering interest rates – that promote a culture of investment, stock markets are gaining prominence as a top destination for investors. Increasingly more people are looking to invest in companies with growth potential. You don’t have to look further than Warren Buffet, one of the richest men of our times, to know that stocks create billionaires.
In addition, stock exchanges with high market values can attract foreign companies. For example, Manchester United left the LSE in 2005 and listed its shares in the NYSE in 2012, largely because of the latter’s ability to attract investors. When this happens, investors in the US have an even wider variety of businesses to invest in.
Source of government funds
Stock markets provide a trading platform for governments too. Sometimes a local, state or national government may need more money to develop a community housing estate, build a water treatment plant or initiate any other public projects. Instead of increasing taxes to raise the required revenue, it can issue bonds through the stock market. When investors buy these bonds, the government is able to raise the money it needs to launch various projects that can ease the cost of living or even create jobs for locals. In the long run, this improves the economy.
Influences economic perception
Even when the economies of nations like the US and the UK are hurting or doing badly, they are still considered economic powerhouses. How so? Welcome to the school of economic perceptions.
Countries whose stock markets are on the rise are considered to be emerging economies, while those with established stock markets are rightfully considered strong economies. These perceptions drive a number of economic activities, including foreign investments. Emerging economies, for instance, are promising grounds for both local and foreign investors to put their money.
But again, consequences can be devastating and far-reaching when the stock markets of established economies lose value. Back in October 29, 1929 – a day that would later come to be known as Black Tuesday – US stock market prices collapsed. The Great Depression would then follow, throwing much of the world into a downward economic spiral that lasted a decade or so. Many economists agree that Black Tuesday contributed greatly to the Great Depression.
Bottom line? When stocks markets are healthy, the world economy is considered healthy too.
Next time you find yourself watching world stock market coverage on your favorite cable news channel, don’t hastily tune away. You may want to stick around and gain more insights on how the economy is performing. You may also develop the urge to invest in stocks and grow your wealth.
What are your views about the stock market? Do you think it significantly influences the economy? Share your thoughts with us in the comments section below.